Monday, June 22, 2009

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.

Sunday, June 21, 2009

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.

Monday, June 15, 2009

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 (3rd), National Law Institute University, Bhopal (4th) and ILS Law College, Pune (5th).

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 2nd, followed by NALSAR, Hyderabad (3rd), ILS Law College, Pune (4th) and Symbiosis Law College, Pune (5th).)

Sunday, June 14, 2009

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.

Saturday, June 13, 2009

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.


Thursday, June 11, 2009

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

Tuesday, June 9, 2009

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.