Greater Role for Judicial Intervention in Foreign Arbitration

The decision of the Supreme Court in Bhatia International and its implications are well known, and have been discussed on this blog on several occasions. In a recent judgment, the Supreme Court has further entrenched the decision. The decision, Citation Infowares Ltd. v. Equinox Corporation, (2009) 5 UJ 2066 (SC), raised the question as to whether a court can appoint an arbitrator under an agreement to arbitrate that has its seat of arbitration outside India.

In Bhatia International, the Court had held that there is a presumption that Part I of the Act applies to international commercial arbitrations outside India as well, which may be rebutted through an express or implied agreement to the contrary. One of the factors that weighed heavily with the Court in Bhatia was that a party would be left without a remedy if Part I did not apply, and the property of the other party was situate in India, for he then would be unable to obtain an interim injunction and enforce it. However, since Bhatia did not confine its decision to s. 9 of the Act (interim measures), subsequent decisions have extended its application to other provisions in Part I, where it may not be appropriate to interfere with foreign arbitral proceedings. Citation v. Equinox is an example of this phenomenon.

Equinox Corporation was incorporated in the USA and entered into an outsourcing agreement with Citation Softwares, a company incorporated in India, and the contract provided that any disputes would be referred to a mutually acceptable arbitrator, and that the contract was governed by Californian law. The parties did not specify a seat of arbitration. Equinox Corporation terminated the contract prematurely, and resisted Citation’s application to invoke the arbitration clause in India. Citation then filed an application under s. 11, seeking the appointment of an arbitrator, and the question that arose was whether this application was barred by virtue of the fact that the parties had subjected the contract to Californian law.

In Indtel Technical Services, the Court had found that a similar provision in a contract was sufficient to indicate that the parties intended to hold the arbitration outside India, but followed Bhatia International and found that Part I applied nonetheless. That decision has been analysed here. In this case, it was argued that there is a presumption that the proper law of contract is also the proper law of arbitration, and that consequently the Indian Act was inapplicable. The Court held that this presumption is limited, and applies only when parties have failed to designate any substantive law, but have indicated a seat of arbitration, so that then the court may infer that the designation of the seat of arbitration is an indicator that its laws are to govern both substantive and procedural questions. From this point, it was not difficult for the Court to conclude that the Indian Act applied, and that an arbitrator could consequently be appointed by the court under s. 11.

This strengthens the rule in arbitration law that the only way for parties to oust Indian courts of jurisdiction is to designate a seat of arbitration outside India and specify that their relations are governed by that seat’s Arbitration Act. It will not be sufficient to merely designate a foreign law as the substantive law of the contract. Nor will it be sufficient to indicate a seat of arbitration outside India. It will be interesting to observe whether the Supreme Court in the future attempts to distinguish between the driving force behind Bhatia International – interim injunctions – and other provisions of Part I of the Act.

"Clarifications" by SEBI to the additional 5% creeping acquisition requirements

Readers may recollect that SEBI had amended the Takeover Regulations vide a notification dated October 30, 2008 and a 5% creeping acquisition was introduced for holding between 55-75% under certain conditions. This notification was discussed by me in this blog here. Certain concerns were raised as to the interpretation of the notifications. SEBI has apparently given certain clarifications as reported by www.moneycontrol.com and the clarifications were made apparently at the Board Meeting of SEBI of July 10, 2009. As I write this post, no formal clarification – neither a press release nor a notification - apart from this media report, is available from SEBI but I am sure a formal circular/notification will soon follow.

The report states that “there were several misconceptions and several clarifications which the corporate world and legal fraternity had been seeking from the regulator” and thus SEBI has given certain clarifications.

The clarifications do not give a picture that is significantly different in what we felt here at this blog. Let me highlight the major of the clarifications as per this report.

“is this 5% an annual exercise; is it something that I can do once every year. SEBI has clarified that that’s not the case. It is a onetime 5%. It’s a cap of 5%, however, it has clarified it can be done in one or several tranches.”.

This is exactly what was felt to be the right view by this blog – I had stated that “This new creeping acquisition is not available annually and repetitively, unlike the creeping acquisitions upto 55%. Thus, the acquirer will be able to increase his holding by another 5% only. To give an example, the holding of 58% can be increase upto 63% only. It is not as if such a person can go on increasing 5% every year.”

The next clarification is on whether the creeping acquisition is financial year related. The clarification given by SEBI is, :-

“The other big issue was is the financial year linked––does that mean that March 31, 2009 onwards that limit of 5% goes away. SEBI has clarified that’s not the case. There is no specified time period within which one needs to do this 5%. It can be done as and when wanted and no time period has been fixed.”.

Again, nothing new – this was also what was felt earlier to be the right view – as per my earlier blog, :-

“Having said that, there is no time limit for acquiring this additional 5% and it can be done even in stages. One could say that this facility has been introduced to deal with the low market prices today. However, there is no restriction of time or stock market indices and one can acquire this additional 5% even if the markets have boomed again!”

Finally, the question was whether the creeping acquisition limit stops at 75% or whether the 5% limit applies. In other words, if, e.g., a Promoter holds 73%, will the 5% limit apply, overriding the other 75% limit? SEBI as clarified as follows:-

“The other clarification that has come out from SEBI is that post 75% one cannot do this even if it were at 73% and one could go technically up to 78%––it will be capped-off at 75%.”

Again, this was precisely stated in this blog as follows:-

“4) Also, the maximum holding after this additional acquisition can be only upto 75%. Thus, for example, a person holding 73% can acquire only an additional 2% and not 5%.”

These clarifications seem to be the major ones and the formal notification that may follow may give more.

Finally, I had expressed a thought in my earlier post that,:-

“However, there is no restriction of time or stock market indices and one can acquire this additional 5% even if the markets have boomed again! Of course, SEBI could drop this facility at that time!!”

The report states that SEBI is contemplating whether or not to drop this facility. The report observes:-

“(SEBI) is reviewing the shareholding pattern on the basis of March 2009 filings of all corporate and it may add or delete from this special exemption.”.

To conclude, some issues seem to have got resolved even if we were to complain that the clarifications are too late since the amendments were to beat depressed markets and that the amendments come through the media rather than at least a press release by SEBI.

Anyway, let us wait for the formal notification and see what SEBI actually says.

- Jayant Thakur

A Dubious Interpretation of Dharmendra Textile

Three earlier posts have discussed the decision of the Supreme Court in Dharmendra Textile v. Union of India, and how two benches of the ITAT, in Pune and Bombay, have attempted to narrow down the scope of the decision. This reading down has been done in cases where the fact scenarios did not come strictly within the scope of Dharmendra, and involved a stretching of the principles laid down in the case, which these Tribunals declined to do. However, a recent decision of the Punjab and Haryana High Court, in CIT v. Sidhartha Enterprises has gone a step ahead, and if followed would mean that Dharmendra would be restricted to its own particular facts.

The case involved an appeal by the Revenue against a decision of the Tribunal deleting a penalty which had been imposed by the ITO. In filing returns, the assessee had claimed a set-off on account of capital loss against business income. Disallowing this set-off, a penalty was also imposed on the assessee in the assessment proceedings, and it was this penalty that had been deleted by the Tribunal. The basis on which the deletion was made was that there had been no concealment, and that the set-off had been incorrectly claimed on account of a mistake by the assessee’s counsel. This rationale is identical to that adopted by the Bombay ITAT in ACIT v. VIP Industries, discussed earlier, and seems to be in consonance with the decision in Dharmendra Textile.

However, on appeal, the High Court chose to decide the case on a broader interpretation of Dharmendra Textile, rather than the narrower approach adopted by the Tribunal. The Court held, “The judgment of the Hon’ble Supreme Court in Dharmendra Textile cannot be read as laying down that in every case where particulars of income are inaccurate, penalty must follow. What has been laid down is that qualitative difference between criminal liability under section 276C and penalty under section 271(1) ( c) had to be kept in mind and approach adopted to the trial of a criminal case need not be adopted while considering the levy of penalty. Even so, concept of penalty has not undergone change by virtue of the said judgment. Penalty is imposed only when there is some element of deliberate default and not a mere mistake”.

This seems to be in conflict with the decision in Dharmendra Textile. In overruling Dilip Shroff, Dharmendra Textile had stated that s. 271(1)(c) is only a civil liability. In Kanbay Software, the Pune ITAT held that the same liability can be both civil and penal in nature, and that 271(1)(c) did not cease to be a penal liability just because of the decision in Dharmendra. However, both Kanbay Software and VIP Industries do not directly conflict with Dharmendra on the requirement of mens rea, and suggest that the burden of proof is on the assessee. By stating that mere mistake is insufficient for s. 271(1)(c), the Court in Sidhartha Enterprises seems to have departed from even these decisions narrowing Dharmendra. While on the facts of Sidhartha Enterprises, the decision is justified since the incorrect set-off meant that there had been no disclosure (in keeping with the decision in VIP Industries), this requirement of mens rea seems to be a departure from Dharmendra Textile.

While the decision as it stands today must be considered to conflict with Dharmendra, the outcome of a possible appeal to the Supreme Court would of great interest to tax practitioners, since it would provide the Apex Court an opportunity to explain precisely the scope of Dharmendra Textile, in light of the numerous lower Court decisions that have diluted it.

Competition Law in Transition: Multiplicity of Regulators

In competition law, there seems to be a duopoly situation as far as the regulatory sphere is concerned. The Competition Commission of India (CCI) is already in place with several provisions of the Competition Act, 2002 having been notified to take effect from May 20, 2009. Moreover, the CCI has also begun acting on cases involving cartelisation. Curiously enough, the Business Standard reports that the erstwhile regulator in this arena, the Monopolies and Restrictive Trade Practices Commission (MRTPC) continues to be in existence and continues to receive cases as it is yet to be dissolved:

“The government is yet to notify Section 66 of the Competition Act and unless it is notified MRTPC would continue to function like before,” said an official of MRTPC. In fact, added the official, MRTPC has been getting new cases even after the CCI has became operational.

India’s antitrust body CCI, which would ultimately replace MRTPC, is an independent body responsible for investigating mergers, market shares and conditions and the regulation of firms. Section 66 of the Competition Act deals with repealing and dissolution of the MRTPC Act, 1969.

With the operationalisation of CCI, MRTPC was supposed to stop entertaining new cases and was to deal with pending cases for two years before being completely dissolved. However, MRTPC is not only fully functional but is also taking fresh cases though it’s been facing acute staff shortage at all levels. “We have been getting at least 30 cases in a month,” said the official.

While the merger control provisions under the Competition Act have been delayed pending notification of the detailed regulations, it appears that there is some overlap regarding the role of the CCI in other areas as well.

An Analysis of the LLP Act

A paper titled The Indian LLP Law: Some Concerns for Lawyers and CAs by Amit M. Sachdeva and Sachin Sachdeva has been posted on SSRN. Here is the extract:

With a view to giving the entrepreneurs the necessary regulatory support, India enacted its first law on limited liability partnerships in December 2008, after almost two years of debate. An LLP, as a hybrid business form, coalesces the separate legal existence and limited liability attributes of a company and the organizational suppleness of a general partnership. The Indian LLP Act is based on the LLP legislations in the UK and Singapore.

While this is a promising entity, there are some defects that seem to have crept in. This paper, besides tracing the conceptual and legislative history of this concept, does a general survey of the provisions of the Act. The paper also uses some of the decisions rendered by the English courts to further explain the concept of an LLP.

In the second part, the authors argue that the LLP Act, 2008 seems to have left some concerns unaddressed. Most significant amongst them appears to be the continued application of Section 11 of the Indian Companies Act, 1956, which requires that any entity which associates more than 20 persons must, of necessity, be registered as a company under the Companies Act, 1956. The assumed non-prescription of the limit on the number of partners was seen by lawyers, among others, a robust incentive to incorporate themselves into LLPs. The paper argues against the obviousness of this assumption. Similarly, it is doubted by the authors if the LLP Act would be able to bypass the requirements of the Advocates Act and the Bar Council Rules and permit an association between "advocates" and "non-advocates".

The article is helpful in that it analyses recent English court decisions on the concept of an LLP, particularly its feature of separate legal existence. The article also seeks to debunk the notion that the LLP Act does away with the limit of 20 partners in case of firms. As the authors rightly state, the 20-partner limit is imposed by Section 11 of the Companies Act and until that section is amended the limit would possibly apply to LLPs as well. As regards criticisms regarding the ambiguity in tax position relating to LLPs, the authors’ fears appear to have been allayed by the Budget 2009 that clarifies that LLPs would be taxed in a similar manner as general partnerships. Finally, the article (somewhat inconclusively, as the authors themselves state) deals with the issue of professional rules governing lawyers and the effect of the LLP law on them.

Is a tax avoidance motive necessary for application of Transfer Pricing provisions?

In a recent decision, ACIT v. MSS India, ITA No. 393/PN/07, the Pune Bench of the Income Tax Appellate Tribunal had to consider an interesting issue pertaining to the application of transfer pricing provisions. On an appeal after a transfer pricing assessment, the CIT (Appeals) had held in favour of the assessee; deciding that as the assessee was a 100% export oriented undertaking exempt from income tax, it could not be said to have a tax avoidance motive. In the absence of such a motive, transfer pricing provisions could not be resorted to. The CIT (Appeals) also went ahead to comment on the merits of the arms length price adjustments made by the Transfer Pricing Officer as well; again deciding in favour of the assessee.

The Revenue preferred an appeal before the Tribunal. The two issues which came up for the consideration of the Tribunal related to whether transfer pricing provisions for calculation of arms length price could be resorted to in the case of an assessee exempt from income tax (therefore, presumably, there being no tax avoidance motive); and if they could be so resorted to, what would be the appropriate method to be used for calculating arms length price.

On the question of whether a tax avoidance motive is necessary before invoking transfer pricing provisions, the Philips Software v. ACIT (2008 TIOL 471 ITAT Bangalore) decision had suggested that motive was a requirement. In that case, the Bangalore Bench had distinguished an earlier five-member Bench in Aztec Software and Technology Services v. ACIT (294 ITR AT 32).

ITAT Online had summarized an important portion of the Philips judgment as holding, “While the motive of tax avoidance need not be shown at the time of initiating transfer pricing provisions, the same is required to be shown at the stage of making the assessment. The AO has to show that the assessee manipulated prices to shift profits outside India. In view of the fact that the assessee enjoyed exemption u/s 10A, the transfer pricing provisions ought not to have been applied…” (The decision has been discussed on this blog here)

The Pune Bench in MSS India however took a different view and held that the decision in Philips Software was in reality conflicting with the decision of the 5-member Special Bench in Aztec Software. Further, it was held that there is no meeting ground between the two conflicting decisions. As such, the decision in Philips Software (being of a smaller Bench) could not be followed; and Aztec cannot be said to have been watered down by Philips. Therefore, the conclusion of the CIT (Appeals) that transfer pricing provisions could not be invoked at all could not be sustained.

On the merits of the adjustment, the Bench provided relief to the assessee. It was held (taking into consideration Rule 10C of the Income Tax Rules, 1962) that in a case where the Revenue sought determine the arms length price by a method different from that which had been adopted by the assessee, it was for the Revenue to demonstrate that its proposed method would be more appropriate than the assessee’s method. Also, it was held that the transaction profit methods of determination of arms length price should be used only when other standard or traditional methods are incapable of being properly applied to the facts of the case. On the facts of the case, the Revenue’s burden was held to be not discharged.

Thus, while the final result was that the Revenue’s appeal was dismissed, the case will be of use to the Revenue authorities in invoking transfer pricing provisions.

SEBI Notification Regarding Anchor Investors, etc.

A couple of weeks ago, we had discussed some primary market reforms that were announced by SEBI. Most of those reforms have now been notified by SEBI by way of amendments to the SEBI (Disclosure and Investor Protection) Guidelines, 2000. The notification contains a fair amount of detail regarding anchor investors. Although such investors are conferred discretionary allocation rights, they are subject to a fairly onerous requirement as regards price:

If the price fixed for the public issue through book building process is higher than the price at which the allocation is made to Anchor Investors, the additional amount shall be paid by the Anchor Investors. However, if the price fixed for public issue is lower than the price at which the allocation is made to Anchor Investors, difference shall not be payable to the Anchor Investors.

One of the issues that was the subject-matter of debate in the comments to the previous post was the prohibition on issue of shares with “superior” voting rights. However, that issue is conspicuous by its absence in the recent round of changes that have been notified by SEBI. Similarly, the rights issue reforms are also yet to take effect.

Depository Receipts and the Takeover Regulations

SEBI yesterday published its informal guidance in the matter pertaining to Bharti Airtel Limited. The question was whether the acquisition of 36% global depository receipts (GDRs) in Bharti Airtel Limited by MTN and its shareholders as part of the combination transaction would trigger various obligations under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.

There are principally two obligations on the part of an acquirer under the Takeover Regulations, (i) to make an open offer to the other shareholders where the acquisition exceeds 15% shares; and (ii) to make requisite disclosures where the acquisition crosses certain thresholds, e.g. 5%, 10%, 14%, etc. Apart from the Takeover Regulations there are disclosure obligations under the SEBI (Prohibition of Insider Trading) Regulations, 1992.

The Bharti-MTN combination presents a specific issue since MTN and its shareholders will not be acquiring shares in Bharti, but would be acquiring GDRs instead. In its informal guidance, SEBI ruled that the GDR holders would be required to make an open offer to the other shareholders of Bharti only when they convert their GDRs into shares whereby their shareholding exceeds 15%. It, however, ruled that the disclosure requirements under the Takeover Regulations as well as the Insider Trading Regulations would apply at the time of acquisition of GDRs itself.

This position is fairly clear from the text of the Regulations themselves. Reg. 3(2) of the Takeover Regulations provides: “Nothing contained in Chapter III of the regulations shall apply to the acquisition of Global Depository Receipts or American Depository Receipts so long as they are not converted into shares carrying voting rights”. It is Chapter III that prescribes open offer requirements on acquirers exceeding 15% shares in the company. GDRs do not fall within the ambit of these requirements.

On the other hand, as far as disclosures are concerned, they are prescribed in Chapter II of the Regulations to which the above exemption does not apply. Moreover, the definition of “shares” under Reg. 2(k) of the Takeover Regulations includes “any security which would entitle the holder to receive shares with voting rights”. Since GDRs can potentially be converted into equity shares, they would fall within the scope of this definition. Hence, all disclosure requirements applicable to shares would apply to GDRs as well, at the time of their acquisition and even before they are converted. As regards the Insider Trading Regulations, they do not carry a definition of “shares” so as to include convertible instruments such as GDRs. Although it is arguable that in those circumstances “shares” do not include “GDRs” thereby staying outside the purview of the disclosure requirement, SEBI has nevertheless adopted a more conservative stance of requiring disclosure (although the informal guidance opinion is devoid of any reasoning on this count). From a practical standpoint, this debate is of minimal relevance because if disclosure of acquisition of GDRs is required anyway, it matters less as to which precise regulation the disclosure needs to be made under.

It is not clear as to what the rationale behind this somewhat complex scheme of things in the Takeover Regulations was, but it does certainly encourage Indian companies to use depository receipts (ADRs and GDRs) as currency for effecting overseas acquisitions of companies. This is also well-supported by the various guidelines under the Foreign Exchange Management Act pertaining to the issue of depository receipts in lieu of overseas acquisitions (see relevant Master Circular issued by the Reserve Bank of India).

The Duties of Non-Executive Directors

Earlier discussions on corporate governance norms have raised questions about the role of independent non-executive directors in maintaining appropriate standards of governance. In this context, a recent Australian judgment indicates the nature of duties which a non-executive director may be required to discharge.

Australian Securities and Investment Commission v. MacDonald involved a situation where the Australian market regulator, ASIC, alleged certain malpractices in the form of misinformation being given to the market regulator by the board of the defendant company. ASIC alleged “that a Draft ASX Announcement was approved at the 15 February 2001 Meeting of the JHIL board of directors and that it contained a number of statements to the effect that the Foundation would have sufficient funds to meet all legitimate Asbestos Claims, that it was fully funded and provided certainty for people with legitimate Asbestos Claims. ASIC alleged that those statements were false or misleading and that the directors were in breach of (their duties)…”

Among the many issues raised were those concerning the duty of care imposed on executive and non-executive directors; as well as those pertaining to the extent to which non-executive directors could rely while exercising their duties on the information given to them from others. The Court noted at the outset that the position in relation to non-executive directors was unclear. Non-executive directors were undoubtedly subject to similar fiduciary duties as executive directors such as the duty to act in good faith and for proper purposes, duties of no conflict etc. Nonetheless, there was considerable uncertainty in determining how these duties applied to non-executive directors. Quoting from a leading Australian textbook, it was noted:

“For a non-executive director case law has supplied no objective standard of the reasonably competent company director analogous to the reasonably competent member of a particular profession or trade, such as architect, solicitor, physician or builder, against whom the conduct of a director can be measured when determining whether there has been a breach of the duty of care, diligence and skill. Part of the reason is the absence of any shared body of detailed expert knowledge of what is involved in the directing of companies. The diversity of companies and varieties of business endeavour are such as to allow uniformity of standards only on very general matters.”

The Court however went on to hold that all directors, including non-executive ones, should have known that there was a possibility that the statements in the Announcement were false and/or misleading. Significantly, the Court decided that non-executive directors could not simply rely on the information provided by the management or by the executive directors. “This was a key statement in relation to a highly significant restructure of the James Hardie group. Management having brought the matter to the board, none of them was entitled to abdicate responsibility by delegating his or her duty to a fellow director.” Thus, the Court seems to have imposed a duty of care on non-executive directors which cannot be satisfied simply by relying on information provided to them by others. What exactly is the content of this duty is a question not conclusively answered.

Nonetheless, the ASIC has described the decision as “a landmark decision in Australian corporate governance”; and it appears that non-executive directors will not be held to have satisfied their duties by arguing that they relied in good faith on certain information provided to them. Particularly when the information concerns an important management decision, there appears to be a duty on non-executive directors to confirm the veracity of the information independently.

Foreign Venture Capital: Firm Commitment

In order to obliterate the disparity in firm commitment requirements for domestic venture capital funds (VCFs) and foreign venture capital investors (FVCI), SEBI has introduced a new requirement whereby FVCIs are to obtain firm commitment from their investors for contribution of at least US$ 1 million at the time of submission of application seeking registration as FVCIs. Domestic VCFs are required to provide a commitment of Rs. 5 crores (Rs. 50 million) “before the start of operations” by the VCF, while there was hitherto no explicit requirement of commitment for FVCIs that had resulted in a significant amount of ambiguity.

Budget 2009: Key Features and Some Thoughts

India’s Finance Minister, Mr. Pranab Mukherjee, presented the Government’s annual Budget in Parliament yesterday. While commentators brand it a mixed bag, the stock markets do not seem to have received the Budget favourably as the stock indices experienced their largest Budget-day fall in history.

The purpose of this post is to highlight some of the key items in the Budget that impact the corporate sector and matters that are of general interest considering the areas covered on this Blog (in no discernible sequence):

Disinvestment

While there was much anticipation about concrete announcements on this count, particularly in the absence of Left parties in the current Government, the Budget only suggests a general indication to undertake disinvestments. The Government, however, intends to retain control (51%) of public sector enterprises. As far as the banking and insurance industries are concerned, the Government proposes to continue to support public sector investment.

Also absent is any indication of liberalisation of foreign direct investment (FDI) rules, relaxation of sectoral caps (e.g. insurance, retail) or even any overhaul of the indirect investment guidelines represented by Press Notes 2, 3 and 4 of 2009.

Financial Sector

At a general level, the Finance Minister’s speech waxes eloquent about India’s existing policies of robust oversight and regulation of the financial industry that may have resulted in the Indian markets escaping some of the turbulence faced in other economies due to the global financial crisis.

On a more concrete note, the Budget proposes to increase the public float available in stock markets in a phased manner. This issue has perplexed regulators for a while now. There has been no uniformity on this count because securities regulations were modified over a period of time thereby permitting companies to list on the stock exchanges by offering varying amounts of shares to the public (from as high as 40% to as low as 10%). This has resulted in a disparity in public shareholding in Indian listed companies. The current proposal will introduce some parity in public float among companies, but there are bound to be several practical difficulties before that can be achieved. This has also been the subject matter of previous efforts by the Ministry of Finance as discussed here on the Blog.

Direct Taxes

1. There are no changes to the corporate tax rates.

2. The sun-set clauses for tax holidays available to the IT sector under sections 10A and 10B of the Income Tax Act have been extended for the financial year 2010-2011.

3. The fringe benefit tax (FBT) introduced in 2005 has been abolished due to the high administrative costs involved. While this is a matter to rejoice, it has been countered by the imposition of a tax on employees upon exercise of stock option and upon receipt of certain other perquisites through amendments to Section 17 of the Income Tax Act.

4. The minimum alternate tax (MAT) has been raised from 10% to 15%.

5. The commodities transaction tax (CTT), introduced last year but yet to be implemented, has now been abolished. This would enable commodities transactions to be conducted on recognised exchanges. At the same time, the securities transaction tax (STT) that was introduced earlier on transactions in stock markets would continue. Note that STT was introduced simultaneously with considerable relaxations on capital gains tax for shares.

6. A new dispute resolution mechanism will be created within the income tax department for resolution of transfer pricing disputes. Furthermore, the authorities for advance rulings on direct and indirect taxes will be merged into one in order to enhance efficiency in tax administration.

7. The Finance Minister has also proposed structural changes in direct taxes by “releasing the new Direct Taxes Code within 45 days and in indirect taxes by accelerating the process for the smooth introduction of the Goods and Services Tax (GST) with effect from 1^st April, 2010”.

Legal Profession

The Budget presents a mixed bag to the legal profession too. One the one hand, it has clarified the tax position regarding limited liability partnerships (LLPs). Although the LLP Act came into effect from April 1 this year, not many LLPs were in fact registered due to uncertainties in the tax regime. The Finance Bill, through some minor tweaks to the definitions of the terms “firm”, “partner” and “partnership” (by including an LLP within them), makes the tax position of an LLP similar to that of a general partnership. In that sense, there is no tax adversity if a person were to structure the firm as an LLP instead of a general partnership. This would possibly accelerate the process of conversion of various general partnerships, such as legal practices, to LLPs that enjoy the benefit of limited liability of the partners.

While clarification on LLP taxation would encourage lawyers to come together to combine their practices to take advantage of limited liability, another change in the tax law creates disincentives to such combinations of individual legal practices. The legal profession has hitherto successfully stayed outside the ambit of service tax. This is purportedly on the basis that lawyers do not perform a “service”. But, that has now changed with the Budget, as Mr. Mukherjee states by making reference to the previous Finance Minister Mr. P. Chidambaram: “Although there is a school of thought that legal consultants do not provide any service to their client, I hold my distinguished predecessor in high esteem and disagree! As such, I propose to extend service tax on advice, consultancy or technical assistance provided in the field of law.”

The fine-print in the Finance Bill reveals two exceptions to service tax on legal practices: (i) the tax is not applicable to “any service provided by way of appearance before any court, tribunal or authority”; and (ii) the tax is not applicable when the service-provider or recipient is an individual. In other words, service tax is not applicable litigation work. Even here, it seems that the exception does not cover all litigation work, but only that which relates to appearance before the court, tribunal or authority. On the face of it, while fees levied towards drafting, conferences, pleadings are likely to be within the service tax ambit, this is likely to be the subject-matter of greater interpretation and possible litigation. This would increase the burden on lawyers to maintain details of fees charged towards specific parts of work performed. Moreover, individual lawyers seem to be outside the purview of service tax. In that sense, this may incentivize lawyers to stay as solo practitioners rather than to form LLPs to avail of the benefits of limited liability. Having said that, service tax is usually passed on to the recipients of services, in this case the clients, which does not directly affect lawyers but only goes to increase the cost of obtaining legal services.

Overall, it seems that the Budget has not received overwhelming support by commentators, perhaps due to the high expectations that the Government would announce greater measures.

Doing Business in India 2009

The Doing Business in India 2009 report, a co-publication of the World Bank and the International Finance Corporation, has been released, along with a press release. The report contains a city-wise analysis that measures business regulations and their enforcement around India. Some of the results seem to defy conventional wisdom. Ludhiana has been found to be the city where it is easiest to do business, followed by Hyderabad and Bhubaneswar.

In order to start a business, the result finds that it is easiest in New Delhi, followed by Patna and Jaipur. In terms of the speed of starting a business though, the top honours are shared by Noida and Mumbai (at 30 days).

As regards enforcement of contracts and resolution of disputes, it is easiest in Hyderabad (at 2 years), while it is most cumbersome in Mumbai (at 4 years).

The report also ranks cities based on other criteria: dealing with construction permits, registering property, paying taxes, trading across borders and closing a business.

NCLT: Still Awaiting a Verdict

Although the establishment of the National Company Law Tribunal (NCLT) was envisaged through an amendment to the Companies Act nearly 7 years ago, it is yet to see the light of day. The NCLT is expected to take over the role of the High Court and the Company Law Board pertaining to various matters under the Companies Act, such as sanctioning of schemes of arrangement, ordering winding up of companies, dealing with petitions for oppression and mismanagement and the like. It is also expected to take over the functions of the Board of Industrial and Financial Reconstruction (BIFR) in relation to sick industrial companies.

The establishment of the NCLT has been the subject-matter of litigation and recent reports suggest that there has been an enormous delay in the resolution of disputes relating to its establishment. A column by M.J. Antony in today’s Business Standard details the issue:

Some important cases heard by the Constitution benches [of the Supreme Court of India] months ago are still awaiting judgement, stalling reforms in the law. The most prominent among them is the appeal of the Central government against the Madras High Court judgment, casting doubts on the legislative competence of establishing the proposed National Company Law Tribunal. The tribunal was proposed to take over the functions that are now being performed by the Company Law Board (CLB), Board for Industrial & Financial Reconstruction (BIFR), Appellate Authority for Industrial and Financial Reconstruction (AAIFR) as well as by the high courts in winding-up companies.

Recently there has been intense debate on the trend of ‘tribunalisation’. The question is whether the power of the judiciary can be transferred wholly to the tribunals, often packed with retired bureaucrats. The controversy delayed the establishment of the Competition Commission of India for years. The Company Law Tribunal is facing a similar impediment. The case against it started in the Madras High Court in 2003 and wound its way up to the Supreme Court where the hearing was concluded in January this year.

The Constitution bench felt that the issues involved are seminal as they are likely to have a serious impact on the very structure and independence of the judicial system. Having said so and heard all parties, the judgment is yet to be written. This delay in delivering judgments is something which the Supreme Court itself has criticised in the case of high courts.

As the column notes, this is the second instance in recent years (after the episode involving the Competition Commission) where establishment of an authority to deal with corporate and commercial matters has been significantly delayed due to litigation that has been appealed all the way to the Supreme Court.

The Convergence Debate and Indian Corporate Governance

An interesting article by Afra Afsharipour (UC Davis School of Law) titled Corporate Governance Convergence: Lessons from the Indian Experience is available on SSRN. Here is the abstract:

Over the past two decades, corporate governance reforms have emerged as a central focus of corporate law in countries across the development spectrum. Various legal scholars studying these reform efforts have engaged in a vigorous debate about whether globalization will lead to convergence of corporate governance laws toward one model of governance: namely the Anglo-American, dispersed shareholder model, or whether existing national characteristics will thwart convergence. Despite rapid economic growth and reforms in developing countries such as India, the legal literature discussing this debate primarily focuses on developed economies.

This Article examines recent corporate governance reforms in India as a case study for evaluating the competing claims on global convergence of corporate governance standards currently polarizing the field of corporate law. This Article seeks to make a fresh contribution to the convergence debate by examining the implications of India's corporate governance reform efforts. It contends that the Indian experience demonstrates that traditional theories predicting convergence, or a lack thereof, fail to fully capture the trajectory of actual corporate governance reforms. India's reform efforts demonstrate that while corporate governance rules may converge on a formal level with Anglo-American corporate governance norms, local characteristics tend to prevent reforms from being more than merely formal. India's inability to effectively implement and enforce its extensive new rules corroborates the argument that comprehensive convergence is limited, and that the transmission of ideas from one system to another is highly complex and difficult, requiring political, social and institutional changes that cannot be made easily.

SEBI’s Recent Primary Market Reforms

SEBI last week announced a slew of reforms to the primary capital markets. The key reforms are as follows:

Anchor Investors

The concept of “anchor investors” has been introduced in public issues whereby 30% of the institutional (QIB) portion will be allocated to anchor investors on a discretionary basis. This is to ensure minimum commitments from key investors that not only boosts the prospects of the offering, but also acts as an indicator to retail investors whose decisions to bid (or not) will follow. Anchor investors are required to bring in a 25% margin along with their application, while the balance 75% of the issue price is required to be paid within 2 days of closure of the public issue. There is also a 30-day lock-in on shares issued to anchor investors to ensure that the stock is not volatile immediately upon listing and trading.

Rights Issues

Historically, the offering process in a rights issue for a listed company was far simpler compared to a full-blown public issue such as an IPO. There is some logic to this position because shares of such a company are already traded on a stock exchange and information about the company is available in the public domain. However, over a period of time, the disclosure norms for rights issues were progressively strengthened, so much so that rights issue documents began resembling public issue documents both in content and size. More recently, there has been a call for simplifying the rights issue process in terms of disclosure requirements as well as the process (please see previous discussion on this Blog). Towards that end, SEBI has now decided to streamline the disclosures for rights issue, and does away with disclosures such as “summary of the industry and business of the issuer company, promise vs. performance with respect to earlier/ previous issues, ‘Management discussion and analysis’”. Other disclosures have been streamlined. This will help companies tap the rights issue avenue for raising funds in a more efficient manner.

Superior Voting Rights

SEBI has prohibited the issue of shares with “superior voting rights” by listed companies, in order to “avoid the possible misuse by the persons in control to the detriment of public shareholders”. The key question that arises is how different the shares with “superior voting rights” are from shares with “differential voting rights”, as it is the latter term that has attained some measure of popularity under Indian law and practice.

The term “differential voting rights” emanates from its usage in Section 86(a)(ii) of the Companies Act. The validity of such shares has also been subjected to judicial determination. In Anand Pershad Jaiswal v. Jagatjit Industries Limited, MANU/CL/0002/2009, the Company Law Board (CLB) upheld the validity of issue of shares with differential voting rights as being valid under Section 86 of the Companies Act as well as the Companies (Issue of Share Capital and Differential Voting Rights) Rules, 2001. Unfortunately, the CLB did not have the opportunity do delve into the details of the issues raised in that matter because it was settled through a consent order.

With the current suggestion by SEBI, it appears that while the expression “differential voting rights” is more generic in nature, “superior voting rights” means any rights that give the shareholder more than one vote per share on a poll, which is the usual norm. This is to prevent persons in control of a company from issuing shares to themselves which provide equal economic benefits with other shareholders (thereby requiring equal outflow of financial resources to obtain those shares), but one which gives greater voting rights and hence better control. Hence, while it is possible for listed companies to issue shares with differential voting rights which provide voting rights below the normal “one-share-one-vote” rule, conferring voting rights greater than that is proscribed.

In a sense, SEBI’s current pronouncement goes beyond the general rule of “differential voting rights”. Even in the Jagatjit case where differential voting rights were approved, the shareholders were conferred rights greater than the “one-share-one-vote” rule. Hence, while listed companies will now be allowed to issue differential voting entitlements only with rights inferior to one vote per share, unlisted companies will still be governed by Section 86 and the law laid down in Jagatjit whereby they have greater flexibility in issuing shares with differential voting rights, both superior and inferior.

Other Reforms

1. An unlisted company making an IPO should list on at least one stock exchange providing nation-wide trading terminals, in order to provide a liquid trading platform to investors.

2. The holding period of one year for an offer for sale of shares will include the period when fully-paid convertible instruments have been held prior to conversion into equity shares.

3. No entry load for mutual fund schemes.

Lead Managers, Bond Issues and Taxes

Previous posts have examined the scope of Indian taxation of fees for technical services that are paid to non-residents. This is an increasingly common commercial practice, especially in the context of issuing shares or bonds abroad. An interesting issue that has arisen recently before the Bombay ITAT is whether Indian companies that make use of this service are liable to make provision for TDS (Mahindra & Mahindra v. DCIT, MANU/IU/0033/2009). The question is really another way of asking whether such services are at all taxable in India, for liability to make provision for TDS arises under s. 195 of the Income Tax Act only if the item is chargeable to tax in the first place.

This issue came up in the context of Mahindra & Mahindra’s Ltd.’s [“MML”] Euro issue. In 1993 and 1996, MML had used this process to raise $74 and 100 million respectively. M/s Banque Paribas was appointed the lead manager, and paid marketing and underwriting commission of about Rs. 8 crore. The question that arose was whether MML was liable to make provision for TDS on these payments, or, in other words, whether these receipts in the hands of M/s Banque Paribas are taxable in India. The Assessing Officer took the view that these receipts were fees for technical services under s. 9(1)(vii) read with Explanation 2 to that provision. In response, the assessee raised two contentions: that the services in question were part of a “subscription agreement” and were not “technical services”, and that in any case, were exempt under Art. 13 of the Indo-UK DTAA. The case also deals with several other procedural questions, and one important issue on the scope of s. 205(1) of the Act.

The Tribunal, in a well-reasoned and comprehensive judgment, notes that it is a general principle that liability to tax arises only if it is chargeable both under the Income Tax Act and is not exempt under the relevant DTAA. This is the case because the provisions of a DTAA override domestic law, as per s. 90(2) of the Act. Therefore, it was necessary for the Department to establish that both these tests are satisfied with respect to FCCB commissions/payments. There was little difficulty for the Court in concluding that the first test was satisfied, as there is a consistent line of authority holding that such services are indeed technical services. The exception is underwriting services, since that is payable not on the provision of a service, but when there is an unsubscribed portion of the issued shares.

The controversial issue concerns the interpretation of the DTAA, and since similar provisions are adopted across many DTAAs, the issue is likely to be of some commercial importance. Two provisions are relevant – Art. 7 and 13. Art. 7 provides that that the profits of enterprises of Contracting State shall be taxable only in that State unless the enterprises carries on business in the other contracting State through a permanent establishment situated therein. However, the Court correctly held that this provisions, being general in nature, gives way to Art. 13, which specifically deals with royalties and fees for technical services. Art. 13(2) provides that royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to law of that State subject to certain conditions. However, Art. 13(4), which defines the term “technical services” states:

“(a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3(a) of this Article is received; or.

(b) are ancillary and subsidiary to the enjoyment of the property for which a payment described in paragraph 3(b) of this Article is received; or

(c) make available technical knowledge, experience, skill, know-how or processes, or consist of development and transfer of a technical plan or technical design.”

The question that arose was whether there is a distinction between “providing services” and “making available” services. The assessee argued that there is, and that the latter refers only to transactions where the so-called service can be independently utilised by the assessee in the future. The Court accepted this contention and observed as follows:

“Make available means to provide something to one, which is capable of use by the other. Such use may be for once only or on a continuous basis. In our context to make available the technical services means that such technical information or advice is the transmitted by the non-resident to the assessee, which remains at its disposal for taking the benefit there from by use. Even the use of such technical services by the recipient for once only will satisfy the test of making available the technical services to the assessee. If the non-resident uses all the technical services at its own the benefit of that directly and solely flows to the payer of the services, that cannot be characterized as the making available of the technical services to the recipient.”

An example the Court used to illustrate the distinction was a doctor who gives a patient a prescription, and a doctor who trains students on aspects of diagnosis. In both cases, the doctor “provides” a service, but in the second case, he also “makes it available”, since the student can in the future utilise the technical knowledge and experience. The result was that none of these items was taxable in India, and as a result, the Indian company is not liable to provide for TDS.

This decision is a welcome relief for Indian companies engaging foreign service providers. However, an appeal has been admitted by the Bombay High Court against another case which was based on the same distinction between “make available” and “provide”, and it remains to be seen whether the High Court affirms it.

Delisting Regulations could make fresh delistings an impossibility

Today's Business Standard published this column from me on the newly notified SEBI (Delisting of Equity Shares) Regulations, 2009. The new law makes delisting next to impossible.

The Practice of Corporate Governance in India

As far as corporate governance is concerned, although there are detailed norms on paper in the form of Clause 49 of the listing agreement, what matters is their implementation in practice. There are limits to legislating on corporate governance as a lot depends on the integrity and ethical values of various corporate players such as directors, managers, promoters and other stakeholders. There is a risk that corporate governance is treated as a “check-the-box” requirement rather than something that permeates the soul of the corporate sector.

Several empirical surveys in India have been conducted over the last couple of years that show that while the norms on the books are quite elaborate and stringent, they are not practised to the extent desirable. There is consensus on this broad trend, although there is some divergence as to the acceptance of specific governance practices. The purpose of this post is only to aggregate and list these surveys that can act as a reference point for the interested reader to delve into:

1. Firm-Level Corporate Governance in Emerging Markets: A Case Study of India (July 2008) by N. Balasubramanian, Bernard S. Black & Vikramaditya Khanna;

2. India Board Report – 2007: Findings, Action Plans and Innovative Strategies by AT Kearney, AZB & Partners and Hunt Partners;

3. CG Review 2009: India 101-500 (March 2009) by FICCI & Grant Thornton;

4. The State of Corporate Governance in India: A Poll (2009) by KPMG Audit Committee Institute; and

5. A recent survey by Bain & Company and KPMG reported in June 2009.

Ranking of India’s Top Law Schools - 2009

India Today has just published its survey of top educational institutions in India. As far as law schools are concerned, there has been a shuffle at the very top compared to 2008. National Law School of India University, Bangalore has regained the top spot, while NALSAR, Hyderabad ranks second. They are followed by Faculty of Law, Delhi University (3^rd), National Law Institute University, Bhopal (4^th) and ILS Law College, Pune (5^th).

Available online are a report on the leading law schools and a ranking of the top 25.

(Update – June 18, 2009: Outlook India magazine has also since released its ranking of law schools in India. While the National Law School, Bangalore remains on top, NUJS Kolkata is placed 2^nd, followed by NALSAR, Hyderabad (3^rd), ILS Law College, Pune (4^th) and Symbiosis Law College, Pune (5^th).)

Possible Delay in LLP Tax Clarification

Although the Limited Liability Partnership Act came into effect on April 1, 2009, it appears that only about 38 limited liability partnerships (LLPs) have registered themselves under this new legislation. One of the key shortcomings of the existing regime is the lack of clarity on taxation of LLPs as the Income Tax Act does not deal with such a business entity. Although it was earlier expected that the position regarding taxation of LLPs will be clarified in the forthcoming Budget session of Parliament, a recent media report suggests that the issue will be postponed to next year’s Budget. This does not augur well for LLPs as they are likely to utilised as a business vehicle only when the tax regime is clear, which may have to await another year.

Duties of the Official Liquidator: Madras HC decision

A recent judgment of the Madras High Court throws some light on the role of an Official Liquidator. In TCI Distribution Centers v. Official Liquidator (C.A. 1953/2008 in C.P. 526/2000), the Official Liquidator had sold certain properties through an auction-sale. The auction-purchaser later found out that the properties were not exactly the same as described in the sale advertisement. The purchaser therefore sought to set aside the sale. In rejecting the plea, the Court expanded on the duties and liabilities of the Official Liquidator.

The Court explained that under Section 456 of the Companies Act, the OL is required to take into his custody all the properties of the company in winding up. Nonetheless, following an earlier decision of the Bombay High Court, it was clarified that unlike the case of insolvency where property vests in the assignee, the property of the company does not vest in the OL. The property remains the property of the company [Maharashtra State Financial Corporation v. Official Liquidator, AIR 1993 Bom 392]. An ordinary owner usually “goes after” some property in order to purchase it and become its owner; on the other hand, property “falls into” the custody of the OL without the OL actually seeking for that property. From this, and again based on earlier precedent [United Bank of India v. Official Liquidator, (1994) 1 SCC 575], the Court held that when the OL sells any property of the company, he “cannot and does not hold out any guarantee or warranty” and in particular he offers no warranty of title.

Up to this point, the Madras High Court relied on existing precedent – but then, the Court went on to lay down what duty is actually owed by the OL. It was held that the OL should not commit deceit. Liability for deceit would require proof of a false statement of fact (with knowledge of falsity) or a deliberate concealment of fact (with knowledge of materiality of the fact). The Court also hinted that the OL should not commit the tort of negligent mis-statement; and if deceit or negligent mis-statement is made out, the sale of property would be voidable under contractual principles of misrepresentation/fraud. On facts, it was held that there was no ground for setting aside the sale.

As for the legal position, the case appears to be authority for the proposition that if not even one of the torts mentioned above (deceit/negligent mis-statement) were established, the sale cannot be set aside. In particular, the Court rejected the argument that such sales could be set aside on grounds analogous to those under Order 21, Rule 90 of the Code of Civil Procedure. Under Order 21, Rule 90, a sale in the course of execution proceedings can be set aside if substantial injury has been caused because of material irregularity in conducting or publishing the sale. It was argued that this provision should be applied by analogy, considering that the Company (Court) Rules, 1959 allowed for the application of CPC principles. The Court however held that the principles pertaining to execution proceedings could not apply by analogy considering the nature and purpose of winding up proceedings and the peculiar role which the OL finds himself in. Thus, effectively, the purchaser must be able to show the existence of either deceit or negligent mis-statement. If he does not do so, he cannot succeed in getting an auction sale by the OL set aside.

This is a high burden for a purchaser to discharge. Deceit under common law requires the presence of the specified mens rea – it is one of the few torts where mental state is relevant. Knowledge of falsity must be proved [Bradford Building Society v. Borders, (1941) 2 All ER 205]. The tort of negligent mis-statement requires the existence of a special relationship between the parties which would put the person making the statement under a special duty of care [Hedley Berne v. Heller & Partners, (1964) AC 465; Caparo v. Dickman, (1990) 2 AC 605]. An OL can hardly ever be said to be under a “special relationship” as contemplated under the law of negligent mis-statement. Perhaps, such a high burden is essential keeping in mind the role of the OL as well as the nature and purpose of winding up proceedings.

SEBI notifies Delisting Regulations 2009 - old but matured wine in a new bottle

SEBI has notified Regulations for delisting of equity shares (available here). While I will post a more detailed article over the weekend, some quick comments follow.

Delisting of equity shares is without any doubt a sensitive and controversial issue. A listed company may have several valid reasons for delisting its equity shares. However, even a whisper of delisting is often found sufficient to adversely affect the market price (though, at times, the price also moves upward if the offer price for delisting is expected to be higher than ruling market price). Delisting obviously affects seriously – even fatally – the liquidity of the shares. The issue also is not merely of liquidity but even fair price of the shares for the exit offer to public shareholders. By definition, and as per sound rules of valuation of shares, the value of the shares of a listed company are higher –the thumb rule is 33% - than that of the value of the shares of an unlisted company. To put in other words, the value of the  same shares change significantly once the listing tag is removed.

SEBI has been, I think, unable to address the issue of delisting in a satisfactory way despite repeated attempts and after adopting different techniques. The problem of delisting goes together with the related problem having minimum public shareholding which also remains largely unaddressed.

The new Regulations come into immediate effect. They replace the SEBI Delisting Guidelines of 2003 but continuity is ensured by a transitional provision.

The dominant role of Promoter in listed companies in India is recognized and thus for delisting, it is the Promoters who have to make an offer to the public shareholders to buy out their shares. This may sound appropriate considering the dominant role of Promoters in India but is also absurd if one sees from another angle. When a Company gets listed, usually (except, e.g., there is an offer for sale), it is the Company that receives the monies for the shares issued. But, for delisting, it is the Promoters who are required to arrange for money to buy out the shares of the public. Consider an example. A Company having a capital of Rs. 75 crores makes a public issue of Rs. 25 crores. Let us say 5 years later, the Company proposes to delist the shares and the public shareholding continues to be 25%. The most logical step is that 25% of the value in the Company should be returned to the public shareholders through the Company itself. But, no, this is not permitted. It is the Promoters who have to find, outside the Company, such amount and pay to the shareholders. To remove even the slightest of doubts, Regulation 4(4) provides that the Promoter shall not use the funds of the listed company directly or indirectly to give the required exit opportunity to public shareholders. Buyback of shares is also a prohibited route for delisting.

One concern relating to obtaining of approval for voluntary delisting (with an exit opportunity) has been addressed in an interesting way. The delisting proposal is now required to be be approved by a special resolution through the postal ballot route. However, in such postal ballot, the votes cast by public shareholders FOR the resolutions should be at least TWO TIMES  the votes AGAINST the resolution.

For the exit opportunity, the Promoter has to open an escrow account. However, importantly, the whole of the estimated amount of consideration payable for the full exit offer needs to be deposited in this account. Considering the long period of the exit offer, particularly where some shareholders typically do not participate in the first round, a fairly large sum of money would get blocked. However, bank guarantee is also permitted in addition to cash.

The new Regulations continue to fail to address the issue of giving a fair price to the shareholders for the exit though some small steps are taken in the direction. Essentially, delisting often is at a price which is already driven down by fears of delisting and impending illiquidity. While the Regulations do provide for taking past average price into account – similar to formula under the Takeover Regulations and preferential issue of shares, they still fail to address the basic issue. But more on this later.

A new complicated formula has been provided to calculate whether the offers received from the public for the exit are sufficient to permit delisting. However, those who have not offered their shares have the assurance of being given a second chance to exit.

Interestingly, a special chapter has been provided for “small companies” (defined as those whose paid up capital is upto Rs. 1 crore) whose shares are illiquid (also as defined) and their shares can be delisted through a special fast track route.

The issue of delisting is complex and has no easy comprehensive solution. The new Regulations make only incremental improvements without a quantum leap addressing some core issues.

-       Jayant Thakur

Government’s ‘Independent’ Directors

With the U.S. Government controlling various companies now, it is in the process of revamping the boards of directors of such companies. The obvious question relates to the role that the Government would take in the management of the companies, and particularly in the selection of their directors. In an op-ed column in the New York Times (NYT), Professors Gilson and Kraakman suggest the idea of a clearing-house for appointment of independent directors on such companies so that they are outside the purview of direct Government influence:

“What the Treasury needs is an independent, nonprofit clearinghouse to recruit and screen independent directors. Such an institution could easily be created by the government in cooperation with large institutional investors like public pension funds or large mutual fund groups like Vanguard or Fidelity. (Disclosure: one of us, Professor Gilson, is a director at American Century, a large mutual fund group.) At Harvard Business School, graduate students working under the supervision of Prof. Rakesh Khurana are exploring the forms that such a public-private clearinghouse could take.

Independent professional directors could help steer privately run corporations through this period of partial government ownership, helping to rebuild investor confidence in those companies. After all, private investors have no more experience investing in government-controlled businesses than the government has in running them.

Strong and independent boards of directors are needed to insulate corporations from political meddling. A chief executive cannot face down the government, but independent directors, who understand that their job is to protect the company from politics, can. In the end, Americans should be able to put their faith in these directors to assure that corporations that receive taxpayer assistance do not end up being run by the government.”

While this is certainly an interesting idea, a lot would depend on the integrity, conviction and independence of thought and action (as opposed to formal independence) of the individuals concerned. To take a recent Indian example, it was the Indian Government that nominated certain directors (with the approval of the Company Law Board) on the board of the embattled Satyam, but the outcome of such direct appointment was positive as the board was able to act in an effective manner so as to bring about a timely sale of the company and preserve the interests of all the stakeholders in the company. Although government nomination of directors is usually viewed with some amount of suspicion, this case was in fact an exception.

As for a directors’ guild or clearing house suggested in the column, there is already such an initiative existing in India in the form of the Directors Database, which is principally an online effort. The Database contains detailed statistics about independent directors on Indian companies, and this recent article by Prithvi Haldea (a founder of this database) provides an excellent account of the role of independent directors on Indian companies, particularly in the post-Satyam era.

Prospects for Recovery of Capital Markets

Now that green shoots are visible in the Indian markets with some encouragement from the formation of the new Government, there is an expectation that capital markets are poised for recovery. There seems to be a steady flow of foreign capital into the Indian markets, and Indian companies too seem to be raising capital, albeit from institutional sources. If the trend were to continue, there could be signs of greater primary market activity. But, the question, as we often ask on this Blog, is whether the regulatory regime is attuned to foster such market activity. Incidentally, there are several recent discussions through columns in the business press stating the need for reforms on various aspects of capital markets.

The first column calls for a uniform par value on shares. More specifically, the recommendation is for SEBI to issue a guideline mandating a one rupee (Re. 1) par value on all shares. While this approach is useful, having a small par value of Re. 1 could dilute the effectiveness of having a par value at all. Instead, the preferable approach may be to abolish par value for shares as we have previously argued (here and here).

The second calls for an overhaul of the primary markets regime so that price discovery in public offerings and rights offerings is possible in a timely manner. In the past, offers have failed due to the delayed period for effecting such offerings, as market prices of the stocks have moved adversely in the interim rendering the commercials of the offerings unviable.

The third, pertaining to the bond markets, laments the lack of a guarantee mechanism for corporate bonds issued to retail investors. In the absence of adequate credit protection, such bonds may not be entirely palatable to retail investors.

All of these are fairly significant issues that demand attention of the regulators in boosting capital markets through appropriate reforms.

Imminence of Merger Control Provisions

Although the draft of the merger control regulations under the Competition Act, 2002 were issued as early as January 2008 (more than a year ago), they are yet to be enacted. Specifically, there were concerns from industry that the scope and ambit of the regulations were too wide and onerous. Now that the new Government is in place with a new minister at the helm of affairs, it has been reported that the merger control regulations are likely to be enacted in the next three months. It is expected that these regulations would only apply prospectively, i.e., to transactions that have been formally initiated after the regulations come into force. Given the extensive debate surrounding the scope of merger control, it is possible that the draft regulations will be subject to a fair amount of changes and may not be enacted in their current form.