Saturday, November 29, 2008

Supreme Court on 'Allotment of Shares' and 'Issue of Bonus Shares'

In a recent judgment (Khoday Distilleries v. CIT, Civil Appeal 6654/2008, judgment of 14 November 2008), the Supreme Court explained some important corporate law concepts. The issues before the Supreme Court arose out of a matter under the Gift Tax Act, 1958; and the Supreme Court had to elaborate upon the nature of an allotment of rights issue.

In the facts of the case, twenty out of the twenty-seven shareholders of the appellant company did not take part in a rights issue, upon which the shares were allotted to the other seven shareholders. The contention raised by the Revenue was that this amounted to a ‘transfer’ in favour of the seven shareholders.

The Court explained that the term “allotment of shares” is used to indicate “… the creation of shares by appropriation out of the unappropriated share capital to a particular person. A share is a chose in action. A chose in action implies existence of some person entitled to rights in action in contradistinction from rights in possession. There is a difference between issue of a share to a subscriber and the purchase of a share from an existing shareholder. The first case is that of creation whereas the second case is that of transfer of chose in action. In this case, when twenty shareholders did not subscribe to the rights issue, the appellant allotted them to the seven investment companies, such allotment was not transfer.

The Court held that for a ‘transfer’ of shares to take place, it was essential that some right was transferred from one person to another. In an allotment of shares such as the one seen in the case, the shares were created for the first time – there was no transfer of any right but the creation of a right.

It is perhaps still open to the Department to contend that in certain situations, such a transaction may be treated as a device for evasion; and that the substance of the transaction is one of transfer. In that case, however, the transfer would not be from the company, but from the shareholders who did not take part in the rights issue. Thus, under no circumstances can the company be said to have transferred shares through an allotment.

The case also discussed the nature of an issue of bonus shares. The question in this connection was “Whether there is an element of ‘gift’ in the appellant issuing bonus shares in the ratio of 1:23?”

The Court explained, “The idea behind the issue of bonus shares is to bring the nominal share capital into line with the excess of assets over liabilities. A company would like to have more working capital but it need not go into the market for obtaining fresh capital by issuing fresh shares. The necessary money is available with it and this money is converted into shares, which really means that the undistributed profits have been ploughed back into the business and converted into share capital. Therefore, fully paid bonus shares are merely a distribution of capitalized undivided profit. It would be a misnomer to call the recipients of bonus shares as donees of shares from the company.


We would like to express our sincere condolences to all those who have been affected by the recent events in Mumbai, which have left the world in shock and disbelief.

We, at this Blog, indeed have a very close connection with this city. Not only is Mumbai the financial capital of India and the nerve centre for Indian corporate law, but it is home to a significant number of our readers as well as contributors.

Our thoughts and prayers are with the victims and their families during this difficult time.

Paper on Capital Flows into India

The RBI has published a paper by its Deputy Governor, Rakesh Mohan, titled “Capital Flows to India”. Although it approaches the topic predominantly from an economy and policy standpoint, it is also helpful in identifying the different types of flows (debt and equity) and carries a historical account of capital flows since liberalisation in 1991.

Friday, November 28, 2008

Minimum Pricing Norms Eased for GDRs/FCCBs

In yet another move to boost the capital markets, the Government has relaxed the minimum pricing norms for the issue of securities (being GDRs/ADRs/FCCBs) to foreign investors. This comes on the heels of similar relaxations provided to qualified institutional placements (QIPs) some weeks ago.

There are two changes proposed:

(i) the minimum price will be the average weekly high and low prices for the 2 weeks prior to the relevant date, instead of the previous price determined as the higher of the average for 6 months and 2 weeks;

(ii) the relevant date for price determination will the date on which the board decides to issue to securities, and not 30 days prior to the shareholders’ resolution as it earlier stood.

The measures will ensure that the price is commensurate with the current market rather than an average over a longer period. This will help companies raise finances at lower prices during falling market conditions.


Further, as the Economic Times reports, some procedural issues regarding issue of warrants (which can be converted into shares over a period of time) are also being resolved so as to make it convenient for foreign investors to take warrants in Indian companies.

Monday, November 24, 2008

A New Theory of Commercial Disparagement

An earlier post had noted recent decisions of the Delhi High Court on the issue of comparative advertising and commercial disparagement. It is becoming increasingly commonplace today to see advertising battles fought out in Courts. A recent decision of the Madras High Court, however, has substantially changed the law on the point – Colgate Palmolive v. Anchor Health and Beauty Care Pvt. Ltd., MANU/TN/0980/2008, decided on September 4, 2008.

Anchor telecast an advertisement claiming that its toothpaste was the “only” toothpaste to contain certain important ingredients, and also the “first” toothpaste providing all round protection. Colgate took exception to these claims and filed an application seeking an injunction against the telecast of this advertisement. This judgment is significant not because of these facts, but because it applies entirely new principles to ascertain disparagement.

The settled law until this decision was based on English precedent, and in brief, was that a tradesman could puff his own goods even by making false claims, so long as these claims did not contain misrepresentations about a competitor’s goods. This principle had been applied by several High Courts in India, and is noticed in the judgment of the Madras High Court. The Court, however, ruled that it is unwise to rely on English precedent in light of subsequent statutory and regulatory developments in England and in the USA. The Court noted that the Federal Trade Commission in the USA is empowered to take into account the consumer’s interest by injuncting false and misleading advertisements, regardless of whether these advertisements are mere ‘puff’ or disparage a competitor’s goods. Similarly, the Court notes a host of regulations in the United Kingdom, such as the Control of Misleading Advertisements Regulations 1988, Consumer Protection from Unfair Trading Regulations 2008, Business Protection from Misleading Marketing Regulations 2008, the Communications Act, 2003 etc. The Court concluded that these developments, subsequent to the leading decision on the point (De Beers Abrasive Products v. International General Electric, [1975] 2 All ER 599), have made the principles enunciated by those decisions unreliable.

As to what principles apply in Indian law, the Court turned to analogous statutory instruments, since there is no law directly regulating comparative advertising, and since the Advertisement Code does not explicitly deal with it. The Court considered the definition of ‘unfair trade practice’ in Section 36A of the MRTP Act, and concluded that although this Act has been repealed by the Competition Act, the definition in Section 36A has been incorporated into the Consumer Protection Act, 1986. Thus, the Court held that once the section repealing the MRTP Act is notified, a manufacturer can still have recourse to civil courts to in effect apply the definition contained in the Act.

The Court then found that the question of disparagement involves ‘balancing’ two rights – the fundamental right under Art. 19(1)(g) of the Constitution protecting commercial speech, and the right of consumers to reliable information. The Court held that the existing law in India, based on English precedent, “recognises the right of producers to puff their own products even with untrue claims, but without denigrating or slandering each other's product. But the recognition of this right of the producers would be to de-recognise the rights of the consumers guaranteed under the Consumer Protection Act, 1986.” Thus, the Court concluded that an action for disparagement lies if the definition of ‘false or misleading facts disparaging the goods, services or trade of another person’ as per section 2(1)(r)(1)(x) of the Consumer Protection Act. The advertisement would be injuncted even if it did not satisfy this definition, so long as it constituted an unfair trade practice as defined in s. 2(1)(r)(1) of the Act. As to when an injunction is the appropriate remedy, the Court held that there is no question of damages being an adequate alternative where public interest is involved, and issued directions in this case to Anchor to omit the words “first” and “only” from the offending advertisement.

Thus, there is now a conflict between different High Courts in the country on the law applicable to cases of commercial disparagement, which is likely to continue until it is resolved by the Supreme Court.

Friday, November 21, 2008

Rating the Raters

Even since the subprime crisis erupted last year, there has been an extensive debate about the role of credit rating agencies in exacerbating the crisis. Questions have been raised whether the rating agencies ought to have raised the red flag much earlier than they actually did, thereby protecting the interests of investors who placed reliance on their reports.

The debate over rating agencies largely focuses on two key issues. First, there is an utter lack of competition among rating agencies. Worldwide, there are three main rating agencies, Standards & Poor, Moody’s and Fitch, and as far as India is concerned, the two main agencies are CRISIL and ICRA (both of which are affiliated to two of the worldwide agencies). It is alleged that this lack of competition does not incentivise the rating agencies to improve the quality of their ratings practices. Second, there is the issue allegiance. Currently, it is the issuers of securities who remunerate the rating agencies, owing to which, the argument goes, the rating agencies tend to provide more optimistic ratings to issuers so as to help better market and sell their securities. On the other hand, there are proposals for rating agencies to be remunerated by the investors instead, as it is the investors who rely on the rating reports. The debate on these issues continues, although there are increased efforts by governments in various countries to rein in the activities of credit rating agencies through stringent regulation.

In this context, there are two interesting columns. The first by Jaimini Bhagwati in the Business Standard tackles the first issue of competition and suggests the establishment of a public sector rating agencies. He states:

"One of the reasons why CRAs have been found wanting is that S&P and Moody’s are in duopoly in most financial markets and a corrective measure would be to increase the level of competition. Higher competition and a better balance between income maximisation and investors’ interests could be achieved in India by the setting up of a majority government owned CRA. It is high time that benchmarks are set for the credit rating function since it provides critically important inputs for debt and equity issuance and investment activities. A public sector CRA should be conservative in its creditworthiness assessments and provide guidelines for investors on how best to interpret its credit ratings.

To summarise, for CRAs there is a near duopoly situation internationally and in India. The ratings provided by private sector CRAs have been inconsistent with market signals and rating agencies have pushed for higher earnings at the cost of investor interests. Further, it is likely that if this quasi-regulatory function is left exclusively to private sector CRAs, ratings would continue to be governed by profit maximisation considerations. It follows that it is necessary to set up an Indian public sector CRA to increase competition and provide benchmark standards."
In a separate column in the Hindu Business Line, Roopa Kudva of CRISIL deals with the second issue of who should remunerate the credit rating agencies, in which she defends the present position of the issuers paying for the rating rather than the investors, and also highlights some of the other issues involving the rating industry. She justifies the status quo as follows:

“The complaint against the issuer-pays model — where the entity issuing debt pays for the rating — is that it compromises the quality of analysis and ratings. Some suggest an investor-pays model instead, while others recommend third-party involvement such as a regulator.

Will the investor-pays model work? When a rating is assigned, the investor is generally not known. If investors were to pay for ratings, then only those paying will have access to the ratings. Lenders and the market cannot benefit from the ratings. Today, all the ratings are available to all — including retail investors — free of charge, and are widely disseminated by agency Web sites and the media because the issuers pay for them.

The issuer-pays model also gives rating agencies easy access to company managements, which provide insights into strategy that might otherwise not be widely known, and help the rating agencies evaluate them better. It is hard to imagine this level of information-sharing under an investor-pays model.

The issuer-pays model enables rating agencies to provide a quality and depth of analysis to the market that public-information-based opinions and model-driven approaches cannot.”

Difficulties in Insider Trading Actions

One usually tends to lament that the Indian securities regulator, SEBI, has been unsuccessful yet in its prosecution of insider trading cases. Several high profile cases were initiated by SEBI only to be overturned by the appellate authorities. This tends to be on account of the fact that insider trading cases are difficult to prove.

A new case initiated by the Securities and Exchange Commission (SEC) in the US highlights some of these difficulties even in that regime (which has a treasure trove of judicial precedents in insider trading cases). The Deal Professor has an interesting take on the action:

“The S.E.C. complaint alleges that Mr. Cuban learned about a planned PIPE (private investment in public equity) offering by, in which he was the largest individual shareholder with 600,000 shares. PIPE deals are a sure-fire sign that a company’s finances are in bad shape, and the market’s response to such transactions is almost always negative.

According to the commission, although Mr. Cuban was told that the information was confidential, he sold all his shares to avoid the hit they were sure to take after the announcement of the PIPE deal. The “loss avoided” is estimated at $750,000 — a pittance to someone like Mr. Cuban, who made his money by selling to Yahoo for $1 billion.

Mr. Cuban’s sale occurred in June 2004, more than four years ago. What took so long to bring the case? News reports indicate that the S.E.C. did not learn of the transaction until early 2007, so the case was already old before it got started. No criminal charges have been filed. Indeed, criminal charges can often slow down a securities case because the prosecutors need to conduct their own investigation.”
Aside from the insider trading issue, the report also questions whether securities regulators ought to be focusing on more pressing matters rather than pursuing dated insider trading actions:

“The S.E.C. needs to establish its presence as the market policeman, there to protect investors. Yet in recent years the commission, whether by choice or legal restriction, allowed wide swaths of the market to go largely unregulated. The courts rejected the S.E.C.’s assertion of authority to regulate hedge funds. The commission let Wall Street firms increase their leverage and employ their own internal risk assessment models, allowing them to invest heavily in mortgage-backed securities and other real estate investment vehicles. That decision allowed companies like Lehman to put themselves at risk when the housing market cratered. There was no cop within a hundred miles of that decision.

So the commission decides to pick a fight with Mark Cuban in a case that may not be all that easy to win. The typical insider trading case involves someone with a fiduciary responsibility to a company, such as an officer, employee or outside adviser, who trades in the shares. Mr. Cuban was an investor in, and its management sought to interest him in the PIPE deal, which did not make him very happy. But owning shares in a company does not make one a fiduciary, and there are no restrictions on the right to sell one’s shares.”

Tuesday, November 18, 2008

Daga Capital - A decision with implications for trade in shares and securities

In a case decided less than a month back, a special (3 member) bench of the Bombay ITAT considered and decided a number of tax issues arising with respect to entities dealing in shares and securities. Given the considerable attention devoted on late to financial institutions and mutual funds, this decision is one of enormous significance.

The Bench considered three appeals together, one by the Revenue in a case involving M/s Daga Capital Management Pvt. Ltd., and two by assessees (M/s Cheminvest Ltd., New Delhi and M/s Maxopp Investments Ltd., New Delhi). Daga Capital dealt in shares and securities, and had incurred expenditure in the form of losses incurred in dealing in shares and securities and also interest on the moneys borrowed for the purposes of purchasing shares. There was some income earned in the form of dividend, which was exempt under s. 10(33), Income tax Act. The Assessing Officer allowed the losses to be deducted, but didn’t allow the interest on moneys borrowed, on the basis of s. 14A, Income Tax Act. S. 14A(1) states: “For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.” The AO held that the interest was expenditure incurred ‘in relation to’ to the dividend income, which ‘did not form part of total income’ due to the exemption under s. 10(33). On this basis, he disallowed the expenditure. On appeal, the CIT(A) reversed the decision, which was appealed against by the Revenue. The cases of Cheminvest and Maxopp also involved allowability of interest on moneys borrowed for purchasing shares. However, the facts differed slightly, in that, the two were investment companies with largely stable shareholding and not too many transactions in shares.

In this factual matrix, the three major issues arose before the Court: (1) relationship between s. 14A and the rest of the Act; (2) the retrospectivity of ss. 14A(2) & (3), which are procedural provisions dealing with computation under s. 14A(1); and (3) the meaning on ‘in relation to’ as used in s. 14A(1). Of these, the first and the third and relevant for the purposes of this discussion, while the second was decided largely on the basis of the presumption of retrospectivity of procedural and clarificatory provisions, relying on the recent decision of the Supreme Court in Gold Coin health Foods Ltd. [(2008) 304 ITR 308 (SC)].

With regard to the first issue, all the members of the tribunal were unanimous in holding that the provision overrode the rest of the provisions of the Act. The assessee had contended that if an amount is deductible as business expenditure under s. 36, it cannot be disallowed under s. 14A. The Tribunal rightly held that such an interpretation would render s. 14A nugatory and should be rejected. Thus, irrespective of the allowability of expenditure under any other provision, if covered by s. 14A, the expenditure would be disallowed.

I now come to the crux of the case, the meaning of ‘in relation to’, on which the Vice-President of the Tribunal dissented from the other two members. The tribunal had before it two decisions of the Supreme Court – a 11 judge bench decision in H.H. Maharajadhiraja Madhav Rao Jivaji Rao Scindia Bahadur of Gwalior v. Union of India [(1971) 1 SCC 85] and a 2 judge decision in Doypack Systems Pvt. Ltd. V. Union of India [(1988) 2 SCC 299]. In Scindia, the Court had held that ‘in relation to’ meant ‘dominant and immediate connection’. On the other hand, Doypack held that the phrase includes ‘direct and indirect connection’. The Vice-President relied on a couple of Supreme Court dicta to hold that the meaning of a phrase as decided by prior decisions can be considered relevant when determining the meaning of the phrase when subsequently used by the legislature, which is deemed to be aware of these decisions. Given that Doypack was a smaller bench and had failed to cite Scindia, he opined that Doypack need not be followed. Thus, ‘in relation to’ required a dominant and immediate connection, which would have to be determined based on the intent of the parties. Having made this finding on law, he applied it to the facts at hand. He held that in the case of Daga Capital, the intent at the time of borrowing the money was to use it for purchasing and selling shares and securities and not making an investment. Hence, the expenditure was not in relation to the exempt income, and was allowable. However, for the other two assessees, he held that given the scarcity of share transactions entered into by them, their intent was to hold investments and not to trade in shares. Hence, the expenditure was not allowable due to s. 14A.

The majority of two members, in a decision marked by acute and literal statutory interpretation, held that even the expenditure incurred by Daga Capital should not be allowed. Starting first with the conflict between Scindia and Doypack, they disagreed with the view that the meaning of phrases in one statute could be blindly imported into another. On the other hand, they opined that the context in which the phrase was used in the statute is significant. Applying this, they held that while Scindia dealt with constitutional interpretation, Doypack dealt with a tax-related matter, and was of greater relevance. They also held, interestingly, that the phrase in question in Scindia was ‘relating to’ and not ‘in relation to’ further detracting from its application to the issue at hand. In addition, they opined that even applying the ‘dominant and immediate’ test, the expenditure would be disallowed. For arriving at this decision, they applied the but-for test, stating that it was only due to the moneys borrowed that the dividend income was earned, thus satisfying the ‘dominant and immediate’ test. On the interpretation of the statute, they pointed out that the provision does not talk of looking at the expenditure and then looking for income resulting from it. Instead, it mandates an examination of the exempt income followed by an examination of the expenditure which has been incurred ‘in relation to’ such exempt income. Thus, the dissenting decision, in their opinion, put the proverbial ‘cart before the horse’. They supported this interpretation by pointing out that the Rules meant for computation under s. 14A provided for interest and similar other indirect expenditures, which would not have been the case had the provision to be read narrowly. Next, the assessee contended that Rule 8D used the term ‘value of investment’, suggesting that only expenditure meant for an investment was envisaged by the provision and not money spent in something like trading in shares and securities. The members again drew a distinction between ‘value of investment’ and ‘value of assets held as investment’, holding that the former refers to any money spent, while the latter would refer to money spent in the form of a long-term investment. Finally, dealing with the argument of intent, they held that intent was irrelevant now that the ‘dominant and immediate’ test was rejected. Also, since there was no distinction drawn in the Act between directly and incidentally earned income, the mere fact that the dividend income was incidentally earned had no tax implications. Finally, the Tribunal looked at a few decisions prior to the introduction of s. 14A, which had held that if the business in indivisible, expenditure in relation to all the income should be allowed, notwithstanding the fact that some of the income was tax-exempt. The Tribunal observed that s. 14A was introduced precisely in order to remedy this situation. Hence, even if the business was indivisible, the tax-exempt income was to be computed and the expenditure proportionately spent in relation to it to be determined.

Thus, as things stand today, the interpretation of s. 14A, with regard to allowability of expenditures on exempt income is as follows:
• The first inquiry is to determine the income which is exempt under any provision of the Act
• Next, determine the expenditure which is, in any way, related to this income
• Such expenditure as is related is not allowed, the rest is
• The intent of the parties at the time of making the investment is not relevant
• Allowability of the expenditure under any provision of the Act is overridden by s. 14A
• Indivisibility of the business is not relevant, and the tax-exempt income is to be computed and the expenditure proportionate to it to be determined and disallowed

Wednesday, November 12, 2008

Listed Government Companies and Corporate Governance: A Supplement

A previous post on this Blog by Mr. Jayant Thakur raises valid issues regarding corporate governance and government-owned companies. Although I am in agreement with the position stated, it may be useful to highlight certain other complexities this matter gives rise to. I initially began by writing a comment to his post, but owing to its length, decided to post it separately as a supplement. Here are the additional issues:

1. As pointed out in Mr. Thakur’s post, Government companies that raise finance from the capital markets ought to be subject to the same requirements that other companies are subject to. Listed government companies too have minority shareholders (banks, financial institutions, both domestic and foreign, and the general public) like any other listed company in the private sector. It is curious as to why the minority shareholders in Government companies should be given separate treatment (indeed inferior protection from a corporate governance standpoint) compared to shareholders in other listed companies. SEBI’s current order impliedly seeks to make such a distinction.

2. Is there a reversal in SEBI’s position? For the last few years, since introduction of the new corporate governance norms (i.e. the amended clause 49 of the listing agreement), SEBI has been publicly adopting a stern stance that government companies will not be given any waiver from compliance with the listing agreement. In fact, one of the reasons for the delay in implementation of the 2004 amendments to clause 49 until January 1, 2006 was for companies (especially government companies) to put in place mechanisms such as independent directors and audit committees. That position also seems to be the genesis for the notices issued last year under which the present adjudication took place. However, the recent adjudication orders will certainly soften the regulatory stance towards government companies.

3. The SEBI orders also expose serious lacunae in the regulatory oversight with reference to corporate governance, and may necessitate a review of the entire mechanism for implementation of corporate governance. On its merit, it may not be possible to go to the extent of criticising the SEBI order as being bad in law. What may perhaps deserve some criticism is the law itself. The current scheme on corporate governance is administered through the listing agreement. Therefore, SEBI and the stock exchanges have privity with, and cause of action against, the companies that are parties to the listing agreement and not any against dominant or controlling shareholders (e.g., the Government in case of a government-company). Whenever there is a violation of the listing agreement, various actions may be initiated against the listed company, one of which would be to seek to delist the company from the stock exchanges. But, the irony of it all is that when actions such as delisting are initiated against the company, it is the minority shareholders that suffer although the corporate governance mechanisms through the listing agreement were set up to protect their interests in the first place.

Of course, this is not an issue peculiar to India, as most other countries (including U.S., Singapore, China, etc.) administer their corporate governance mechanisms through the listing agreement. However, it is necessary to ponder whether there could be other mechanisms available to ensure compliance with corporate governance norms, which measures target not only the listed company but also its dominant shareholders. One solution may be to incorporate some of the corporate governance norms under company law that may have wider application and recourse to a larger number of players in the corporate governance arena. Such a move appears to have been taken, at least partially, with the Companies Bill, 2008 introducing requirements as to independent directors, which is otherwise within the realm of SEBI.

4. Moving from a technical level towards a softer element of corporate governance, one always finds that good governance is a matter that ought to be inculcated in the corporate actors (whether they be companies, directors, officers, auditors, dominant shareholders, etc.) and there would be limitations in mandating corporate governance through law. In other words, corporate governance involves more substance than form, more spirit than the letter of the law. From that perspective, compliance or otherwise of corporate governance norms by government companies has an important signalling effect. Strict adherence to these norms by government companies may persuade others to follow as well. But, when government companies violate the norms with impunity, it is bound to trigger negative consequences in the market place thereby making implementation of corporate governance norms a more arduous task.

Tuesday, November 11, 2008

Listed Government Companies - Violations of Corporate Governance requirements - early orders of SEBI

Gail, ONGC, Indian Oil Corporation, etc. have, as per Orders of Adjudicating Officer (see, e.g., Indian Oil order here and others available on SEBI site) allegedly violated Clause 49 of the Listing Agreement since they allegedly delayed the appointment of Independent Directors. These orders are perhaps of the earliest of orders of adjudication of violation of requirements in relation to Corporate Governance under the Listing Agreement.

Apart from revealing SEBI's approach in dealing with violations of Clause 49, these Orders bring out strange reasoning underlying the dropping of the proceedings without levy of penalty in any of these cases. Essentially, the reasoning is as follows. These companies are Government Companies. Appointment of Directors on these Companies, under Articles, is to be made by the President - effectively by the concerned Ministry. The Companies have been diligent in follow up with the Ministry for appointment of Independent Directors in accordance with Clause 49. The Company cannot be held liable for delay by the Ministry/majority shareholders. Taking these and other factors into account - using the euphemistic term "peculiar facts and circumstances" - the proceedings against these companies have been dropped without levy of any penalty.

To some extent one has undoubtedly to consider the underlying realities of a Government Company in which majority shares are held by the Government of India. However, one cannot leave it at that in view of the reasoning given. The point is, can a Company validly give a reason that it did the follow up required with its dominant shareholders who, incidentally, had powers codified under the Articles too. Would the same relief be given to, for example, an MNC whose majority shares are held by a foreign parent where the Company had made similar petitions to its parent company? Would the same reasoning apply also to a situation where a promoter family holds majority shares and also similarly neglects?

Further, for how long and to what extent can a Government Company continue escaping norms applicable to listed companies to which it bound itself by becoming a listed company in which the public have a stake and which stake is the resulting of raising of huge funds?

Generally, questions would also arise whether the Company as a corporate entity and/or its minority shareholders should suffer on account of defaults of majority shareholders more so when there are clauses in the Articles that make the Company helpless in taking any action?

I reiterate that Government Companies do have "peculiar facts and circumstances" and, on the positive side, perhaps it is commendable enough that SEBI initiated proceedings (interestingly, these proceedings were consciously started after receiving preliminary replies). But, then, such orders raise more questions than give answers.

- Jayant Thakur, CA

Monday, November 10, 2008

Legality of 'Exotic' Derivatives - Part II

In a previous post, I had discussed the preliminary and procedural aspects of the decision of the Madras High Court on legality of derivative transactions. This post considers the substantive aspects of the decision.

A description of the nature of the transaction is available in the previous post. The challenge to its validity rested on two grounds – wagering and public policy. The effect in both cases is to make the transaction void and ineffective in law, under Sections 23 and 30 of the Contract Act, respectively. It was argued that the transaction is one of wager because unlike with normal derivative deals, there was no ‘underlying transaction’. In other words, the suggestion was that the transaction is of the kind classically banned in law as a wager – one where the parties do not control and are not interested in the contingency on which the transaction is based. The Contract Act does not define ‘wager’, and the Court followed common law principles. The Court found that the three classic ingredients of a wagering agreement are : (a) 2 persons holding opposite views touching a future uncertain event; (b) Each party must stand do either win or lose on the happening of this event and (c) The interest of the parties is not in the occurrence of the event, but in its stake. The restrictive nature of this test invalidated commodity market transactions in the 1850’s, and Courts created a fourth ingredient – common intention to wager. In other words, the commercial transaction must be shown to be a ‘cloak’ which neither party intended would have any legal operation. Further, the Court observed that Courts in England and India had taken a liberal view with respect to wagering agreements – collateral contracts were enforced in England until statutory intervention, and are still enforced in India. Analysing the agreement itself, the Court came to the conclusion that there are ‘some contingencies’ where the Bank pays RSC, and others where RSC pays the Bank. “Thus the plaintiff stands to gain at times, while the Bank stands to gain at other times. The gain for the plaintiff is intended to off-set the loss that they may incur in their foreign currency receivables or payables.” The Court found that the transaction in question passed all these tests, especially since documents revealed that RSC had intended the arrangement to be a sort of overall exposure hedge – in the words of the Court, an agreement akin to an insurance arrangement. The contention that the CFO acted beyond the scope of his authority was rejected on the basis of the doctrine of indoor management. An earlier post has discussed the issues arising out of the claim of misrepresentation.

The other ground of challenge was public policy. In a clear analysis of the law, the Court held that what is expressly permitted by law cannot be said to be opposed to public policy. To show that derivatives are indeed expressly permitted, the Court cites pre-independence legislation from pre-independence Bombay to the Forward Contracts (Regulation) Act, 1952, Securities Contract (Regulation) Act, 1956 and several other legislations. The Court noted that the RBI has even notified Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000. A challenge to the validity of the transaction on the basis of RBI Master Circulars was also rejected.

In other words, both contentions failed because the Court found on fact that the object of the arrangement was consistent with the nature of a derivatives contract, based as it was on an underlying transaction. Thus, while this judgment will be of substantial importance to the law on this area, future decisions will need to first establish that there is an underlying transaction before applying this reasoning.

Saturday, November 8, 2008


In the case of Sumitomo Corporation v. CDC Financial Services (Mauritius) Ltd. and Ors., delivered by a two judge bench of the Supreme Court, the basic issue was whether, in case of a conflict, Section 10(1)(a) of the Companies Act, 1956 would take precedence over Section 50 of the Arbitration and Conciliation Act.

The facts of the case were as follows: In 1984, Sumitomo Corporation (appellant) entered into a Joint Venture Agreement with two of the respondents, which clearly specified the rights and obligations of the parties, and also included an arbitration agreement. Subsequently, in 2005, the parties entered into another agreement for transfer of shares, which also included an arbitration agreement. In May-June 2006, a dispute arose between the parties in relation to the interpretation of the Joint Venture Agreement with respect to the powers of nomination to the board of directors. The Respondents filed a petition before the Company Law Board, Principal Branch, New Delhi, seeking redressal under Sections 397, 398 and 402 of the Companies Act, 1956. The appellant filed an application seeking reference to arbitration under Section 45, or Section 8 of the Arbitration and Conciliation Act. On the Company Law Board’s refusal to do so, the appellant filed an appeal under Section 50 of the Arbitration and Conciliation Act in the High Court of Delhi. The High Court found that it lacked territorial jurisdiction over the matter, as Section 10(1)(a) of the Companies Act would take precedence over Section 50 of the Arbitration and Conciliation Act. Aggrieved by this, the appellant came before the Supreme Court.

Section 50(1)(a) of the Arbitration and Conciliation Act provides that an appeal shall lie from an order refusing to refer the parties to arbitration… to the Court authorized by law to hear appeals from such order (Emphasis Supplied). On the other hand, Section 10(1)(a) of the Companies Act provides that the Court having jurisdiction will be the High Court having jurisdiction in relation to the place at which the registered office of the company concerned is situated. Moreover, Section 10F specifically provides that an appeal from a decision made by the Company Law Board would lie to the High Court. Therefore, in order to determine territorial jurisdiction, the first thing the Court had to determine was which of the provisions – Section 50(1)(a), or Section 10(1)(a) - would be applicable. The controversy is whether the High Court to which the appeal lies under Section 10F from an order of the CLB is the High Court within whose territorial jurisdiction the registered office of the Company is situated or is it the High Court having jurisdiction in relation to the place at which the Company Law Board makes the order under appeal.

The appellants contended that the correct forum for hearing the appeal was provided under Section 50 of the Arbitration Act and not any provision under the Companies Act. Section 50 of the Arbitration Act specifically provides for appeal against orders refusing to refer the parties to Arbitration under Section 45 of the Arbitration Act. It was further contended that Arbitration Act is a ‘complete code’ in itself as far as arbitration law is concerned. Moreover, being a special statute dealing specifically with the law of arbitration, it should have precedence over any similar provisions under Companies Act. Therefore, it contended that the appropriate Court authorized by law under Section 50 is the Court having jurisdiction at the place where the Company Law Board heard the matter, which in this case, was the Delhi High Court.

On the contrary, it was argued that as per Section 50, the appropriate forum for hearing the appeal from the orders of Company Law Board is the High Court within the jurisdiction of which the Registered Office of the company in issue is situated (the Madras High Court, in the present case). This is in accordance with Section 10F read with Section 10(1)(a) of the Companies Act.

The apex Court giving precedence to Section 10(1)(a) r/w Section 10F observed that only the forum which is authorized to hear appeals from the Company Law Board would possess the jurisdiction to hear such appeals. It is a specific appellate forum and not every Court exercising civil jurisdiction can entertain such appeals. And as per Section 10F & 10(1)(a), it is the High Court within whose territorial jurisdiction the Registry office of the Company in issue is situated.

The Supreme Court observed that the appeal always lies to the Court which is authorized to hear the appeal. It is not the Court which would have possessed original jurisdiction had the matter been brought to it at first instance as a suit. Therefore, the appeal would not lie to the High Court having jurisdiction in relation to the place at which the Company Law Board makes the order under appeal. Thus, reading Section 10(1)(a) with Section 10F, the Court concluded that Madras High Court had the territorial jurisdiction to hear the matter, as the Registered Office was situated within its jurisdiction.

Therefore, the important of this judgment lies in settling the law on the point of precedence in the event of a conflict between provisions of two of the most important and topical acts in modern commercial law, the Companies Act and the Arbitration and Conciliation Act.

- Gautam Bhatia & Venugopal Mahapatra

Thursday, November 6, 2008

Companies Bill: New Entities

The Companies Bill, 2008, which has been introduced in the Lok Sabha, contains two entities that are fairly novel in the Indian corporate scenario, and it might be useful to briefly discuss these two types of entities. They are: (i) one person company (OPC); and (ii) “small” company.

One Person Company

Under the existing Companies Act, 1956, a company can be incorporated with a minimum of two shareholders (in the case of a private limited company) and seven shareholders (in the case of a public limited company). Similarly, there is also a requirement to have minimum number of directors, which is two directors in the case of a private limited company, and three in the case of a public limited company. This often gives rise to several practical difficulties. For instance, certain affairs of the company cannot be carried out without the presence of at least two shareholders or directors at shareholders general meetings and board meetings respectively.

However, these requirements have, to some extent, lost their relevance in recent times, especially in the case of very closely held companies, because they can simply be overcome by introducing nominee shareholders and nominee directors. For instance, if one person (i.e. a legal person, being an individual or company) intends to form and operate a company, all that person needs to do is to find another person to act as a nominee to satisfy the two-shareholder requirement. Similarly, it is possible to find one or more friendly individuals to act as directors to satisfy the minimum director requirement. Since these requirements have become largely procedural in nature, the introduction of an OPC is welcome.

The OPC will act as a useful substitute to sole proprietorships, whereby single individuals carrying on business activity can take advantage of limited liability, which is not available in the case of a traditional sole proprietorship. In the case of an OPC, since the company would be a separate legal entity, the shareholder will not be liable for the debts of the OPC itself, subject of course to certain exceptions such as lifting of the corporate veil. This will perhaps help individuals structure their businesses in a more organised fashion, which would also help them raise finances from time to time in the form of equity or debt.

In the Bill, the OPC has certain special provisions applicable to it. The name of an OPC should carry the words “OPC Limited” so that the persons of dealing with it are aware of its character. The OPC is also exempted from some of the procedural requirements under the Bill, such as the need to hold a shareholders’ annual meeting. The OPC is required to have only one director on its board.

Relevant clauses in the Bill: 3(1), 5(1)(a), 13(1), 85(1), 120(1), 132(1)(a), 171, 421

Small Company

The Bill defines a small company as a company, other than a public company, whose (i) paid-up share capital does not exceed a prescribed amount that shall not be more than Rs. 5 crores (Rs. 50 million), or (ii) turnover does not exceed a prescribed amount that shall be no more than Rs. 20 crores (Rs. 200 million). The reference to a company “other than a public company” would mean that a “small company” would necessarily have to be a private company or an OPC.

Small companies are eligible to take advantage of certain simplified provisions of company law. The most significant of these benefits relates to a simplified procedure for amalgamation of small companies (in clause 204 of the Bill) that can be effected without prior approval of the National Company Law Tribunal.

Relevant clauses in the Bill: 2(1)(zzzg), 204, 421

How Far Does This Benefit OPCs and Small Companies?

Apart from the simplified provisions discussed above, both OPCs as well as small companies are required to comply with all the provisions of the Bill as in the case of other companies. However, clause 421 of the Bill provides that the Central Government may direct that certain provisions of the Bill shall not apply to a private company, OPC or small company. Hence, the simplification process is largely left to subordinate legislation and in the hands of the executive. The flexibility available to these entities can be determined only once such exemptions have been granted.

While the introduction of such new entitles are welcome in that they assist small businesses, there is a fundamental question regarding the approach adopted. One of the objectives of simplifying company law is to ensure that it caters all types of businesses at different points in the spectrum, i.e. with large listed companies at one end and small companies at the other. However, the starting point in the Bill seems to be the law as it applies to large listed companies, replete with all the detailed provisions. From that starting position, exceptions and carve outs are being made for small types of entities.

This does not account for the fact that a substantial number of companies that are registered in India are small private companies as opposed to the large public and listed companies. For example, the Annual Report (2007-08) issued by the Ministry of Company Affairs indicates that as of March 31, 2007, there were 7,43,678 companies, out of which 6,53,024 were private limited companies, while only 90,654 companies were public limited companies (out of which only a small percentage would be listed companies).

Therefore, unless OPCs and small companies are exempt by the Government from the operation of a large number of onerous provisions in the Bill (that are otherwise meant to apply to public companies and in certain cases to private companies), the objective of achieving simplification of company law for small and medium-size business would be difficult to achieve.

Misrepresentation by a Bank – Consequences – Rajshree Sugars v. Axis Bank

(In the following post, our guest contributor Karthik Seshadri examines the issue of misrepresentation arising out of the judgment of the Madras High Court in Rajshree Sugars v. Axis Bank. For a background of the case and issues involved, please see Niranjan’s earlier post)

In what can be termed as a locus classicus on the subject pertaining to Derivative transactions and their validity, Mr. Justice V.Ramasubramanian of the Madras High Court[1] has gone on to hold that “prima facie” the derivative transactions – option contracts – swap contracts etc., that were entered into by an exporter with a bank in order to hedge its risk against foreign exchange fluctuation were valid. The exporter in the instant case had taken a stand that the contracts were void ab initio as being hit by Section 23 (opposed to public policy), Section 30 (Wagering contract) of the Indian Contract Act, 1872 as also being opposed to provisions of the FEMA, 1999.

The Learned Judge in an exhaustive judgment and in a very characteristic manner dealt with all these objections and negatived the claim of the exporter. While dealing with the case on hand, the Learned Judge was confronted with a situation wherein the exporter was able to produce material to show that the Bank (counter party) had in fact represented to the exporter that US Dollar would never reach the stipulated level vis a vis the Swiss Franc to be faced with a situation where the exporter actually found itself in, prompting it to file the suit. The Learned Judge brushed aside the contention that there was no misrepresentation since both parties had no control over or knowledge as to how the currency would fluctuate. Is that the test? Was it correct on the part of the Bank to have made such a statement? What is level of diligence required of a Bank to make such a statement? This paper seeks to examine those aspects.[2]

Bank & Customer - Misrepresentation:

There was an economic slowdown happening in the United States of America with the “Sub Prime” crisis, ever since July-August 2007. This snowballed into a major crisis leading to credit squeeze, fall of major banks like Lehman Brothers, Bear Stearns collapsed and several others were either on the verge of a collapse or were putting up a “brave face”. Between January 2008 & March 2008 this started having an impact on Foreign Institutional Investors (FIIs’) and they started pulling out of the stock market in India as well. The Bombay Stock Exchange & National Stock Exchange started witnessing a slide as these institutions started pulling out of the market.

My wife & I, as any prudent middle class family would do, have invested our hard earned money into various security instruments, viz., shares, mutual funds, debt bonds, fixed deposits etc. Our investments are “advised” by a “new age bank”[3]. During one of our visit to the bank, the bank manager subtly told us that if we had some “spare cash” that we were looking to invest in, the ideal situation would be to invest into structured products that have been launched by certain mutual funds. That the returns on these structured products were linked to the NIFTY or the stock index; and that the structured products were capital guaranteed products. Since the NIFTY had come down to around 4000 levels, it would be very lucrative to invest in these structured products. The returns if calculated based on data on the movement of NIFTY over the years would show that the investor can get a return of about 15-18% annualised. Sounds very attractive and interesting for any investor in a sliding market!

Now, technically what was the manager doing? Was he providing an advise? Was it an advise that a normal, average man likely to rely upon and take a decision? Was the manager duty bound to explain any risk attached to the investment decision? What would happen to these structured instruments if the markets collapsed further and takes a very long time to recover?

In common law there are three kinds of misrepresentation and they are:

- Fraudulent misrepresentation occurs when one makes representation with intent to deceive and with the knowledge that it is false. An action for fraudulent misrepresentation allows for a remedy of damages and rescission. One can also sue for fraudulent misrepresentation in a tort action. Fraudulent misrepresentation is capable of being made recklessly.[4]

- Negligent misrepresentation occurs when the defendant carelessly makes a representation while having no reasonable basis to believe it to be true.[5] Lord Denning has stated this rule as:

“if a man, who has or professes to have special knowledge or skill, makes a representation by virtue thereof to another…with the intention of inducing him to enter into a contract with him, he is under a duty to use reasonable care to see that the representation is correct, and that the advice, information or opinion is reliable”[6]

- Innocent misrepresentation occurs when the representor had reasonable grounds for believing that his or her false statement was true. Prior to Hedley Byrne, all misrepresentations that were not fraudulent were considered to be innocent. This type of representation primarily allows for a remedy of rescission, the purpose of which is put the parties back into a position as if the contract had never taken place.[7]

In the Indian scenario, the law is governed by Section 18 of the Indian Contract Act, 1872.[8] The question therefore is, whether the bank manager or the agent dealing with the exporter in the ordinary course of business and selling the derivative product to the exporter is making any positive assertion to the exporter. Was not the bank under a duty to inform the exporter of the pit falls of the transaction? When the bank made a statement that the dollar would never reach the stipulated level vis a vis the Swiss Franc, was that statement that can be called a positive assertion, made out of experience, statistical data and a statement that the exporter relied upon, since it came from a person whom the exporter had no reason to doubt?

Role of Reserve Bank of India – Is there any duties cast on the Bank?

The Reserve Bank of India in exercise of its powers issued a Master Circular governing Foreign Exchange Derivative Contracts[9]. The RBI has mandated that in respect of foreign exchange derivative contracts both involving the rupee and not involving the rupee, banks should ensure that in the case of:

i. Swap structures where premium is inbuilt into the cost;
ii. Option contracts involving cost reduction structures;

• such structures do not result in increase in risk in any manner; and
• do not result in net receipt of premium by the customer

RBI has also prohibited the banks from offering leveraged swap structures or a swap route to become a surrogate for forward contracts for those who do not qualify for forward cover.

A reading of the Circular would suggest that the Reserve Bank of India as the primary regulator has imposed certain restrictions in the manner in which a Foreign Derivative Contract is entered into. A duty has been cast on the banks to ensure that certain foreign derivative contracts do not result in increase of risk in any manner nor result in net receipt of premium by the customer. The duty imposed on the banks automatically call for the banks to exercise due skill & care while providing advise to its customers and requires them to protect the client/customer from any “increase in risk”.

If that is the mandate, was such skill and care exercised by the banks? Did the banks protect its customers from any increase in risk? Even a prima facie look into the various derivative contracts would show that such application of skill and care was lacking. Further, when the bank asserts to its customer that the US Dollar would never reach the levels vis a vis the Swiss Franc, such a statement, it is submitted, apparently shows that the bank did not exercise due skill and care required of it. When the bank manager informed me that it would be attractive to invest in a structured product, certainly there was no disclosure of risks or application of skill and care expected of a bank.

Exporter getting a benefit on part of the contract – Does it make a difference?

A reading of the judgment of Mr. Justice V. Ramasubramanian would indicate that the Learned Judge was convinced that the exporter could not claim that the contract was illegal as they had derived a benefit from the same in part. It is respectfully submitted that such a view is contrary to law. Merely because a person derives a benefit from an illegality, it would not make an illegal transaction valid. The person who derived the benefit from such illegality ought to return the same. If after adopting an objective test, the court comes to a conclusion that a particular transaction is illegal, then all parts of the transaction are liable to be set aside.


Though the judgment of the Learned Single Judge is not the end of the road for the exporters and they have many more battles to fight. The current trends in foreign exchange situation could be a better solution for the exporters and the bank alike. Many transactions are getting knocked off and in some cases we have started witnessing negotiated settlements. After all, a commercial solution is better than a legal one. Or is it?

[1] Order dated 14.10.2008 by Hon’ble Mr. Justice V.Ramasubramanian, in CS No. 240 of 2008, High Court, Madras

[2] To understand a little more on Derivative transactions in India and more particularly how they were entered into in Tirupur, readers are urged to read S.Gurumurthy, …”Amstrong Palanisamy”, The Hindu, 04th & 05th July 2008.

[3] New age bank – is meant to denote a bank that markets various security products aggressively including helping customers decide in their investments in mutual funds, also through their business arms act as share brokers, provide what is termed as retail banking aggressively.

[4] Derry vs. Peek; (1889) 14 App. Cas. 337.

[5] It was first seen in the case of Hedley Byrne v. Heller; [1964] A.C. 465 where the court found that a statement made negligently that was relied upon can be actionable in tort.

[6] Esso Petroleum Co Ltd v. Mardon; [1976] 2 Lloyd's Rep 305.

[7] Section 2(2) Misrepresentation Act 1967 in England, however, allows for damages to be awarded in lieu of rescission if the court deems it equitable to do so. This is judged on both the nature of the innocent misrepresentation and the losses suffered by the claimant from it.

[8] 18. "Misrepresentation" means and includes­ -

(1) the positive assertion, in a manner not warranted by the information of the person making it, of that which is not true, though he believes it to be true ;
(2) any breach of duty which, without an intent to deceive, gains an advantage to the person committing it, or any one claiming under him, by misleading another to his prejudice or to the prejudice of anyone claiming under him ;
(3) causing, however innocently, a party to an agreement to make a mistake as to the substance of the thing which is the subject of the agreement.

[9] RBI Master Circular No./6/2007-2008 dated July 02, 2007

Wednesday, November 5, 2008

Buyback and Takeover Regulations

The issue of whether a buyback of shares will trigger an open offer under the Takeover Regulations has been the subject-matter of extensive discussion on this Blog. In addition, one of our guest contributors, Somasekhar Sundaresan, has a guest column in the Business Standard, which details the issues involved and makes some proposals for change. He states:

“It is true that promoters in control of the company could use their control to expend company money to buy back shareholders and enjoy the consequential hike in stake. However, should Sebi desire to impose an open offer obligation pursuant to a buy-back, Sebi ought to correspondingly remove the ban on promoters participating in the buy-back.

There is another legislative option. Sebi could make it mandatory that the promoters refrain from voting on buy-back proposals, both at the level of the board decisions and at shareholder meetings, if their stake were to go up beyond 5 per cent. If the rest of the shareholders and the board were to implement the buy-back without the promoters voting, then an involuntary increase of any level of percentage holding of the promoter ought not to result in an open offer.”
The essence of this approach is to consider whether the promoters have been instrumental in the buy back (through exercise of control) or not.

It is necessary to note, however, that SEBI has announced amendments to the Takeover Regulations (discussed here and here) since publication of the above column.

New 5% creeping acquisition permission for 55-75% holders to go soon?!

Further to posts here regarding amendment to SEBI Takeover Regulations allowing persons holding 55-75% to acquire further 5%, see report in ET dated 5th November 2008 that says that this permission may soon be reversed.

Readers may recollect that this new amendment allowing such 5% increase was without any time limit and also not a recurring annual feature. Apparently it was to allow Promoters to acquire shares from the market since the prices were, as per perception, too low. This mopup may help restore prices to what they think are fair prices.

Now the ET report is like a "Last few days of SALE - buy quickly" signboard! Whether Promoters will respond is to be seen.

The ET report also shows how multiple authorities may come in each other's way and at times even carry on a perverse turf war. The Finance Ministry's logic for the demand for withdrawal of this amendment is that the public's holding would go down to below minimum public holding . Why, would you ask, should the public holding go down below public limits when the maximum limit for Promoters' holding is 75% even after the amendment? That is because the Finance Ministry wants to treat some categories of shareholders as non-public shareholders though as per SEBI's definition, these would fall under public shareholding.

The ET report is actually about the Finance Ministry's decision to defer the proposal to delist companies who do not have minimum public holding. ET says that this deferment is because the Ministry feels that the prices of shares today are too low and interestingly, a study by the Ministry has "revealed" that there is no relationship between Q1 and Q2 corporate profits and the "sharply lower valuation of blue-chip scrips". The Finance Ministry might "reveal" the "fair prices" of these shares so I can borrow and then rush and buy them!

- Jayant Thakur

Tuesday, November 4, 2008

Exercise of Share Warrants and triggering of open offer - whether? when? at what offer price? - SAT decides

SAT has recently decided here on the issue on whether, when and at what price would an open offer have to be made when Share Warrants are exercised. I am highlighting here just some interesting facts and decisions, simplifying them a little, to emphasize some interesting issues.

The Promoter of the target company, Genesis International Corporation Limited, was issued 3530000 Share Warrants therein at an Exercise Price of Rs. 19 per share in early 2007. The Promoter exercised Share Warrants in 2008 whereby his holding increased from 50.48% to 60.48%. He made a public announcement for open offer but there were disputes with SEBI regarding pricing. The Promoter submitted that the offer price should be Rs. 19 being the Exercise Price and also for this purpose calculating the price with reference of the date of allotment of Share Warrants. SEBI argued that the reference date should the date of allotment of the equity shares on exercise of the Share Warrants or the date of the public announcement for the open offer (it actually held to be the latter though the difference was of a few days only).

The difference between the open offer consideration as per these two prices, as per the Promoter, was Rs. 24 crores, apparently apart from interest that may arise. (the price determined by SEBI is not known but I did some back of the envelope reverse calculations and this price appears, assuming I am right, to be about Rs. 102 as compared to Rs. 19).

It appears that there was no dispute on whether an open offer arises in such facts or not (although this issue otherwise also appears to be well accepted, this decision is a good reference of record of this point).

The issue rather was whether the open offer arises when the Share Warrants were allotted or when the shares were allotted on their exercise. SAT held that it is when the shares, which carry the voting rights, are allotted that the open offer gets triggered. SAT observed, We agree with the learned senior counsel for respondent no.1 that it is the acquisition of voting rights that triggers the provisions regarding public announcements and public offers contained in the Regulations. Acquisition of securities without voting rights, including convertible warrants as in the present appeal, will not, by itself, necessitate any public announcement or public offer.

SAT further referred to various provisions and concluded Therefore, in the present case, the requirement of public announcement arises only with the allotment of shares and not with the allotment of warrants.

The answer to the issue of pricing then would logically follow and SAT held accordingly that Therefore, the reference date for computing the offer price should be 28.6.2008, the date of the BoD meeting when the shares were allotted and not 16.12.2006, as the appellant has taken nor 21.6.2008, the date of the public announcement, as decided by respondent no.1

Note the fine distinction, though of few days, drawn by SAT. It held that it is the date of the Board Meeting where the shares were allotted that would be the reference point and not the date of the public announcement for the open offer. With due respect, I am not sure how right this view is but see the decision where SAT has given detailed reasoning in paragraph 7 for this view.

SAT finally held that SEBI should issue a fresh communication within 2 weeks and allow a reasonable time for opening the offer and thereafter only provide for interest. With due respect, I submit as follows. The decision of SAT is dated 15th October 2008. Let us say that the offer starts on 1st January 2009. If one compares with the date held by SAT of June 2008, then shareholders would receive almost Rs. 30 crores (again as per rough back of the envelope calculations) after six months because the acquirer chose to litigate the issue and which was decided against him. Even at the 10% interest rate decided by SEBI (which the Honble SAT does not appear to have changed), the interest comes to Rs. 1.50 crores. With due respect, I submit that such interest, which is not costs that are awarded or not awarded as per facts, should have been required to be paid in the circumstances. I am not saying at all that the appellant was wrong in pursuing the matter in appeal I am asking why should the shareholders suffer on this account? Also, surely, the appellant had full use of the money and, perhaps, as a cautious person, put it in interest bearing fixed deposit.

Having said the above, it is possible that, in this particular case, though exact facts are not available, the shareholders may not have really suffered. This is because, as per statement of the appellant recorded in the decision, the higher price was on account of substantial increase in the price recently. However, open offer pricing usually applies the average price of an earlier period and therefore, possibly, the recent price could have been much more  than the higher open offer price held by SAT (yes, I admit my laziness in not looking up the price tables of this period - J). In that case, they had opportunity to exit at such higher market price and so in reality may not have reason to argue that they have suffered a lot, I respectfully submit again that the issue of interest remains a matter of concern.

All in all, I think the decision settles for the record some issues that are regularly faced by listed companies and Promoters.

© Jayant Thakur, CA