Enforceability of Put and Call Options: Reality Soon?

Although put and call options are quite common in investment agreements, its enforceability under Indian law has been in serious doubt due to age-old provisions in securities laws which have not been updated to meet with the requirement of the times. I have discussed the issue in detail in this paper and also called “for a reconsideration of the legal regime so that physically settled options that are customary in investment agreements may be treated as valid and legally enforceable”.

Although this issue has been on the anvil for a long time, now there seems to be some tangible movement towards resolution. News reports indicate that the Law Ministry has, based on a proposal from the Finance Ministry, decided to permit options in investment agreements.

It is not clear how the revisions will be effected. It could be done simply by way of a notification by SEBI amending/repealing its earlier notification of March 1, 2000, which put paid to these options. The other alternative would be to amend the Securities Contracts (Regulation) Act, 1956 (SCRA), which is perhaps both unnecessary and more cumbersome given that the intervention of Parliament will be required.

It is too early to be euphoric because the devil is always in the detail!

Papers published on BALCO

Ironically, the judgment of the Constitution Bench in BALCO may turn out to be as significant for domestic arbitration as it is for finally shattering the misconception that the omission of the word “only” in section 2(2) of the Arbitration and Conciliation Act 1996 was designed to expand the jurisdiction of the Indian courts in relation to foreign arbitration. Some of these questions have been explored in three articles recently published in the Supreme Court Cases journal, of which the following is a brief summary.

Shantanu and I wrote a paper titled “Three Errors in BALCO” ((2012) 9 SCC J-26) in which we argued that while the Court was entirely right in overruling Bhatia International on the applicability of Part I of the Act to foreign arbitrations, it nevertheless made-as the title of the article suggests-three significant errors on other points. To briefly summarise:

       (1)   The conclusion in paragraph 96 that section 2(1)(e) of the Act refers to two courts, the court of the seat and the court of the cause of action is, with respect, clearly incorrect. Section 2(1)(e) confers jurisdiction on the court which would have had jurisdiction to entertain a suit forming the subject matter of the arbitration. As the Delhi High Court rightly pointed out in GE Countrywide, this means that a court in which an application under the 1996 Act is instituted must imagine that the arbitration clause does not exist and ascertain whether it would have had jurisdiction to entertain a suit relating to that dispute. So, if two parties from Mumbai and Delhi respectively choose Calcutta as the seat of arbitration, the Calcutta High Court would not have jurisdiction to entertain an application under the 1996 Act unless it was shown that some part of the cause of action arose in Calcutta. Unfortunately, the Supreme Court assumed in paragraph 96 of its judgment that section 2(1)(e) is a reference to two courts (the court of the seat and the court of the cause of action) and has therefore overruled by implication, a consistent view that has prevailed for over seventy years.

   (2) The Court, with respect, misunderstood the decision of the House of Lords in the Siskina and consequently proceeded on the erroneous premise that an action instituted solely to obtain interim relief in aid of foreign arbitration is alien to the common law. Had the Court appreciated that the common law does recognise such an action, it would then have had the opportunity to consider whether such an action is recognised by Indian law. We suggested that such an inquiry would likely have led the Court to conclude that such an action may be brought under section 151 CPC, addressing one of the major concerns raised by practitioners about the consequences of BALCO.

   (3)   There was no case whatsoever for overruling Bhatia International prospectively, considering that the dispute related to a point of statutory construction, and in particular a jurisdictional statute. As the House of Lords emphasised in Re Spectrum, the power should be exercised only in wholly exceptional cases, and with particular caution if the point the court is asked to overrule prospectively is one of statutory construction rather than the common law (Lord Scott of Foscote in his dissenting speech thought the power should never be exercised in relation to statutory construction).

A response to this article titled "Not Three but Half an Error in  BALCO" ((2013) 1 SCC J-81) was published by Mr SK Dholakia, Senior Advocate and Ms Aarthi Rajan, Advocate  in which they sought to support the judgment of the Court. In summary, their contention on section 2(1)(e) was that the “overarching seat theory” was the basis of which BALCO was decided, and led to the conclusion that the territorial court for domestic arbitration is solely the court of the seat, regardless of where the cause of action arises. According to them, in the Mumbai/Calcutta example above, the Calcutta High Court would have exclusive jurisdiction by virtue of being the supervisory court, that is, the court exercising territorial jurisdiction over the chosen seat of arbitration. They make the powerful argument that if two foreign parties choose Chennai as the seat of arbitration, and the cause of action arises entirely outside India, neither the Madras High Court nor any other Indian court would have jurisdiction under section 2(1)(e) even though Part I of the Act applies (by virtue of section 2(2)), which they contend is an anomaly that impedes the growth of arbitration where India is a neutral forum. In relation to our argument on the maintainability of an action for interim relief in aid of foreign arbitrations, they relied on the well-known judgments of the English courts in Castanho and Siskina, and the recent judgment of the High Court in Royal Westminster, to suggest that there can be no “suit” purely for interim relief. They also suggest that section 151 CPC cannot be invoked for this purpose because Order 39 Rule 1 is exhaustive. In relation to prospective overruling, they agree that using arbitration agreements (as opposed to pending petitions or applications, for instance) entered into after 06.09.2012 as the yardstick was erroneous, but support the use of prospective overruling in principle, relying on Patel Engineering.

We have now published a response to this article titled “Three Errors Revisited” ((2013) 4 SCC J-1), explaining our original argument and responding to some of the points raised by Mr Dholakia and Ms Rajan. We point out that the jurisdiction of the Indian courts to supervise arbitration is statutory, not inherent, supporting the view taken by the Delhi High Court in GE Countrywide, and therefore that it is not permissible for an Court to assume jurisdiction not provided by section 2(1)(e) on the basis of the "overarching seat theory". This cause-of-action based system of organising jurisdiction has, for better or worse, been part of Indian law for over seventy years. Whether that should be discarded in favour of a consent-based system of jurisdiction is, we suggest, a decision for Parliament, not the Supreme Court. On the maintainability of an action for interim relief in aid of foreign arbitrations, we demonstrate that the transition from the 1882 CPC to the 1908 CPC contains indications that what is now Order 39 Rule 1 is not exhaustive (indeed, the Calcutta High Court so held in the early 1900s), and that section 151 CPC is a possible basis on which such interim relief may be granted. We also revisit the discussion of the common law and establish that it contains no bar to such an action. Finally, we reiterate that it was not appropriate to overrule Bhatia International prospectively, because the appellants had not established that this was, to quote Lord Nicholls in Re Spectrum, “the wholly exceptional case” in which parties had relied on Bhatia International in organising their affairs. More generally, we suggest that prospective overruling should not be used on a case-by-case analysis of the “justice” of the competing claims but should proceed on the basis of clearly established legal principle, which should distinguish between overruling a point of common law and overruling a point of statutory construction.

Call for Papers – Journal on Governance

[The following announcement is posted on behalf of the Center for Governance, National Law University, Jodhpur]

Center for Governance, National Law University, Jodhpur, proposes the VII issue of “Journal on Governance,” its annual publication.  Journal on Governance offers a forum for critical research on interplay of contemporary corporate governance issues with other disciplines, including, inter alia, law, management and societal studies.  Aside to highlighting the problems and the challenges, the Journal attempts to explore and offer workable solutions, which may be helpful in regulatory and policy decisions.

A few of the Center’s such endeavours include comments on the consultative paper on the SEBI’s suggested Clause 49 reforms, followed by a panel discussion involving eminent stalwarts like Padmabhushan Shri D.R. Mehta (Founder Chairman, SEBI), and Ms. Usha Narayanan (Former Executive Director, SEBI, and currently partner, Amarchand & Mangaldas & Suresh A Shroff & Co.).

Previous issues of the Journal boast of scholarly discourses from eminent legal practitioners, academicians, research scholars and students.  The articles for publication are selected through a meticulous and intense process of review, edit and refinement. The Journal has received acclaim and appreciation from all contours of the industry and academia.  For the forthcoming issue, the Center invites Articles on the following sub-themes under the broad theme of "Governance- the contemporary challenges":

1.         Governance in Microfinance Industry

2.         SEBI’s Jurisdiction on Corporate Governance- a critical assessment

3.         Governance in PPP Model of Infrastructure Projects

4.         Corruption and Corporate Citizenship

5.         Conflict of Governance and Related Party Transaction

Please note that the submissions must conform to the following requirements:

- The acceptable length of Articles is 5000 words, and of notes and comments is 3000 words, including footnotes.

- All submissions must include an abstract of not more than 300 words, explaining the main idea, objective of the article and the conclusions drawn from it.

- The Article should be on A4 sized paper, in Times New Roman Font Type, font size 12, 1.5 line Spacing and 1 inch margins on each side. Authors should follow Harvard Blue Book Footnoting style. Footnotes should be in font size 10 and with single line spacing.

- Authors should provide their contact details, designation and institutional affiliation in the covering letter for the submission.

- The submission must be the original work of the authors. Any form of plagiarism will lead to direct rejection. The relevant sources should be duly acknowledged as footnotes. The decision of the reviewers in this regard shall be final.

- Authors are requested to send an electronic version of their manuscripts (.doc or .docx format) to journal.governance@gmail.com with the subject as “Submission”. All queries may be addressed to the Editors on the aforementioned email address.

- Submission deadline for the Article, Notes and Comments is on the 31 July 2013. 

Extension of Date for Implementation of Modified ESOP Rules

Earlier this year, SEBI had announced the implementation of amended rules for the issue of employee stock options (ESOPs), which restricted the types of schemes to only those that comply with SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. Particularly, curbs were imposed on the acquisition of shares in the secondary markets by ESOP trusts. The rationale for these measures was previously discussed on this Blog. These measures were to take effect on June 30, 2013 by which time companies were required to ensure compliance of their ESOP programmes with these requirements.

SEBI has now extended the implementation of these new requirements until December 31, 2013, primarily due to representations received from industry participants. By then, the ESOP schemes of companies must be brought in line with these rules. Failing this, the securities acquired by the ESOP trusts must be divested by that date. It has also been clarified that this revised set of guidelines is applicable to all employee benefit schemes involving the securities of the company provided that the schemes are set up, managed or financed by the company directly or indirectly if any of the following conditions are satisfied:

a)  if the company has set up the scheme or the trust/agency managing the 
scheme; or

b)  if the company has direct or indirect control over the affairs of the scheme 
or the trust/agency managing the scheme; or

c)  if the company has extended any direct or indirect financial assistance to 
the employee benefit schemes or the trust/agency managing such schemes.

In other words, the stringency of these guidelines operates when there is a close nexus between the company and the trust, but not if the trust is set up and managed truly independently. The recent circular also sets out disclosure requirements regarding the operation of the ESOP schemes.

Miscellaneous

1.         Exemption from Takeover Regulations for Gift of Shares to Family Trust

SEBI has granted an exemption to an acquirer from making an open offer under the SEBI Takeover Regulations in the case involving Gujarat Organics Limited (the company). In that case, the promoter Mr. Ashwin S. Dani, owns 71.15% shares in the company, and proposes to transfer it by way of a gift to a private trust HD Trust, of which he is one of the trustees. The beneficiaries of the trust are his family members. The acquirer, HD Trust, does not hold any shares in the company, while Mr. Dani has been shown as a promoter for more than 3 years. SEBI granted the exemption for the transfer because this was an inter se reorganization of holdings that does not alter the control of the company in any way. Moreover, it was a gift and merely a private family arrangement to facilitate succession planning.

This is understandable because there is no change of effective control of the company, and an exemption order was sought from SEBI only because the transaction may not have satisfied the technical requirements for an automatic exemption.

2.         Another SEBI Adjudication Order in the IPCL Insider Trading Case

Last month, we had discussed an adjudicating order of SEBI finding that the charges of insider trading were not established against Mr. Manoj H. Modi and Mrs. Smita M. Modi in relation to the trading of shares in Indian Petrochemicals Corporation Limited (IPCL). Now, on a related set of facts and circumstances, another adjudicating order of SEBI has found that a charge of insider trading is sustainable against Reliance Petroinvestments Limited (RPIL), the controlling shareholder of IPCL, and also imposed a fine of Rs. 11 crores on RPIL. The facts relating to the information and announcements are essentially the same as that contained in the previous post, and are not repeated here.

From a legal perspective, SEBI’s assertions are based on two grounds. The first is that RPIL is a “deemed connected person” and second that it is “reasonably expected to have access to unpublished price sensitive information” with respect to IPCL. This is necessary to establish RPIL as an insider with respect to IPCL. On the first count, SEBI found that RPIL and IPCL are companies under the same management as they are under the common control of Reliance Industries Limited, which is a fact-based determination. On the second count, SEBI found that as a controlling shareholder of IPCL, RPIL is naturally said to have access to unpublished price sensitive information (UPSI) relating to IPCL:

25. The above facts establish that RPIL was having control over IPCL. It may therefore, be concluded that by virtue of RPIL having control over IPCL, it was reasonably expected to have access to UPSI of IPCL. Noticee being the promoter having control over the company holding approx. 46% shares of IPCL is inherently expected to have access to UPSI. Noticee being in such a position it is unacceptable that the Noticee was not aware of such major/ important decisions of the company IPCL.

This conclusion suggests that any promoter entity that falls within the definition of a “deemed connected person” would generally have access to UPSI in relation to the investee company and that nothing more needs to be shown.

3.         Interpretation of the MAC Clause in Financing Documentation

The England and Wales High Court passed a ruling, which interprets the material adverse change (MAC) clause in financing documentation. In that case, the lender withheld further funding based, among other things, upon the occurrence of a MAC event that adversely affected the borrowing company. Although the judgment is quite long and involves ascertainment of detailed facts, the interpretation of the MAC clause is summarised in the judgment as follows:

364.     In summary, authority supports the following conclusions. The interpretation of a "material adverse change" clause depends on the terms of the clause construed according to well established principles. In the present case, the clause is in simple form, the borrower representing that there has been no material adverse change in its financial condition since the date of the loan agreement. Under such terms, the assessment of the financial condition of the borrower should normally begin with its financial information at the relevant times, and a lender seeking to demonstrate a MAC should show an adverse change over the period in question by reference to that information. However the enquiry is not necessarily limited to the financial information if there is other compelling evidence. The adverse change will be material if it significantly affects the borrower's ability to repay the loan in question. However, a lender cannot trigger such a clause on the basis of circumstances of which it was aware at the time of the agreement. Finally, it is up to the lender to prove the breach.

The MAC clause has been extensively litigated in the last few years following the financial crisis, especially in M&A that is supported by acquisition financing.

Hat tip: Corporate Law and Governance