Friday, May 7, 2010

The Supreme Court's Judgment in the Reliance Dispute - Part I

The Supreme Court’s judgment today in Reliance Natural Resources Ltd. [“RNRL”] v. Reliance Industries Ltd. [“RIL”] turns on several important propositions of corporate and contract law. It has been widely reported that RIL prevailed by a majority of 2:1. This is incorrect, for Justice Sudershan Reddy’s separate opinion concurred with the majority on all but one issue, on which he decided in favour of RIL. A copy of the judgment, which runs to more than 250 pages, is available here. This post outlines the complicated issues that the Court considered. The second post will discuss the more important of these issues in detail.

The dispute between RIL and RNRL has its origins in events following the decision of the Indian Government to allow limited private sector participation in gas exploration. The Government awarded particular “blocks” to private companies, and this relationship is governed by several documents that are well-known in the oil and gas industry, of which the most important for this case was the Production Sharing Contract [“PSC”]. Such a “block” in the Krishna-Godavari basin, known as KG-D6 was awarded to a RIL Consortium in 1999, and a PSC was duly entered into. In 2003, RIL tendered for the supply of gas to the National Thermal Power Corporation [“NTPC”], won the bid, and entered into an agreement to supply a specified quantity of gas at $2.34/mmBtu. In the meanwhile, differences had begun to emerge between the RIL principals – Mukesh and Anil Ambani – and a family arrangement or Memorandum of Understanding [“MoU”] was entered into between the two brothers and their mother, on 18 June, 2005, dividing RIL concerns between the brothers. The MoU gave RNRL a specified entitlement of oil and gas at the price at which RIL had agreed to supply gas to NTPC – in short, $2.34/mmBtu. The Bombay High Court approved the consequent Scheme, which required that “suitable arrangements” be made for the supply of gas by RIL to RNRL, and the Scheme became effective on 21 December, 2005.

Following this, the RIL and RNRL Boards (controlled at the time by the MDA Group) approved a draft Gas Sale Master Agreement [“GSMA”] and Gas Sale Purchase Agreement [“GSPA”]. Once control was transferred to the ADA Group, RNRL contended that the GSPA and GSMA were inconsistent with the scheme. Subsequently, the Ministry of Petroleum and Natural Gas declined to approve RIL’s request to supply gas to RNRL at the NTPC price of $2.34/mmBtu. Soon after, RNRL filed an application in the Bombay High Court requesting the Court to direct RIL to supply gas at the price agreed in the MoU. The single judge, having rejected jurisdictional objections, agreed with RNRL that the GSPA was in breach of the scheme, and directed the parties to comply with the “suitable arrangement” requirement in the Scheme, in light of the MoA. Both parties appealed to the Division Bench, which allowed the Union of India to intervene.

In August 2007, without prejudice to the decision of the Court, an Empowered Group of Ministers adopted a price formula that prescribed $4.20 as the ceiling, and applicable when the cost of oil is $60/barrel or more. Meanwhile, the Division Bench held that the “suitable arrangement” in the Scheme had to be formulated in light of the MoA, and further observed that nothing in the PSC prevented RIL from selling gas to a third party at a rate lower than that prescribed by the Union of India. All three parties – RIL, RNRL and the Union of India – appealed to the Supreme Court, which heard arguments for over 26 days.

From these complex factual circumstances, the following (main) issues arose before the Supreme Court:

  1. The maintainability of a petition under s. 392 of the Companies Act
  2. Whether the PSC overrides all other contracts, and affords the Government the power to control prices?
  3. The legal nature of a MoU and the applicability of the doctrine of “identification” or “attribution”
  4. The binding nature of a MoU on a company in the absence of an express provision in its Articles of Association

The majority opinion, authored by Justice Sathasivam, with which Chief Justice Balakrishnan concurred, found in RNRL’s favour on the jurisdictional issue, and in RIL’s on the remainder. Justice Sudershan Reddy found in RIL’s favour on all issues, and the Court set consequently aside the order of the Bombay High Court. The following is a brief account of the Court’s analysis.

RIL argued that a distinction exists between s. 392 and 394 of the Companies Act, and that s. 392 does not apply to a company which falls under ss. 391 and 394. In addition, it relied on landmark decisions such as Miheer Mafatlal and SK Gupta to argue that the power of supervision under s. 392 does not extend to altering the Scheme in the manner envisaged by RNRL. Justice Sathasivam rejected this contention, holding that the power of the Court to alter the Scheme is “unlimited” provided its “basic fabric” remains the same. Justice Sudershan Reddy, on the other hand, considered that granting RNRL’s requests would amount to interfering with the “basic fabric” of the Scheme, and held that the Bombay High Court should not have assumed jurisdiction.

The substantive part of the case turned, in the main, on two issues: whether the MoU entered into between the Ambani brothers was binding on the respective companies, and in any event, whether the PSC overrode all contracts to the contrary. Of these, the first issue is more important for our purposes. The majority held that the MoU could not bind the companies, because it was entered into by private persons. The majority rejected Mr. Jethmalani’s reliance on the doctrine of attribution/identification (para 35) with the proposition that “the doctrine of identification may be applicable only in respect of small undertakings but in the case of RIL and RNRL, the companies have more than three million shareholders, in such a situation, one cannot make the companies’ personality the same as that of persons involved.” The Court cited no authority for this proposition. Justice Sudershan Reddy reached a similar conclusion (para 140), on the basis that the “MoU was executed in the private domain, with the help and aid of a lawyer and then marked confidential”. Justice Reddy also held that the doctrine of identification applies mainly in cases of criminal or tortious liability. Both the majority and Justice Reddy (para 145) referred to s. 293 of the Companies Act to establish that the Board retained power to act, although it is not clear what the “undertaking” in question was. In one of the most important passages in the judgment, the majority held that the MoU is an “external aid” to ascertain the intention of the parties to the Scheme, but that considerations of national interest, natural resources etc. are relevant in formulating a “suitable arrangement” for gas supply (for eg, para 36).

Secondly, the majority appears to have held that, in any event, the MoU is not binding on the company, and cited its decision in VB Rangaraj v. VB Gopalakrishnan, which this blog has discussed here. This point, however, is not beyond doubt, because it is not clear from paragraph 29 of the judgment whether the majority merely recorded the submission of senior counsel for RIL, or expressed its view as to the scope of Rangaraj. Justice Sudershan Reddy does not refer to this judgment.

Finally, in perhaps the most significant issue in the context of the case, the majority and Justice Reddy agreed that the power of the Union to distribute natural resources for the good of the community overrides private agreements. In this respect, the Court relied on Art. 297 of the Constitution, which vests natural resources in the Union of India, Art. 39(b), which requires distribution of resources to subserve the common good, commercial practice in the oil and gas industry(para 84), the international principle of permanent sovereignty over natural resources adopted by the UN General Assembly in Resolution 1803 (para 88), the provisions of the PSC, the doctrine of public trust (para 97) etc.

Finally, Justice Sudershan Reddy (paras 21, 141) observed that directors owe a “fiduciary duty” to shareholders. Construed literally, this is a departure from the settled proposition that such duties are owed to the company. However, although this point is not free from doubt, it appears to be a passing observation, and the reference to shareholders seems to be intended to refer to the company as a “body” of shareholders.

In sum, the following propositions emerge from today’s judgment:

  1. A petition under s. 392 of the Companies Act is maintainable for modifications that do not alter the “basic fabric” of the Scheme.
  2. The Memorandum of Understanding is not binding since it was entered into in a private capacity (Justice Sudershan Reddy), and since the doctrine of identification does not apply to large companies with millions of shareholders (majority).
  3. Section 293 of the Companies Act indicates that the Board must have retained the power to act with respect to the price of supply of gas
  4. Such an MoU, in any case, may not be binding, following the Court’s decision in VB Rangaraj
  5. The PSC and constitutional provisions on natural resources override private agreements and the Government retains the power to control price.

These are clearly complex questions of law and fact, and a subsequent post will examine some of these in more detail.

3 comments:

Mandar said...

Just one small point: You seem to glean from Reddy J's statement (about director's fiduciaries towards shareholders) that "the reference to shareholders seems to be intended to refer to the company as a “body” of shareholders."

The Company is not a "body of shareholders". In any event, Indian corporate law borrows from the Berle-Means corporation and Jensen-Meckling inspired principal-agent model. So, maybe he is not wrong at all and knowingly made that statement.

V. Niranjan said...

I agree. The company is indeed not a sum of the shareholders. Two points, however, are noteworthy. First, this point was not at issue in the case, and secondly, Reddy J.'s alludes to it in the course of his analysis on the general duty of the "management" of a corporation. It is likely, therefore, that this observation will not bind courts, especially since it constitutes a departure from existing law.

Anonymous said...

JUSTICE ANOOP V. MOHTA -REASONS ON MOST POINTS:POLICY/S RATE, MOU HAVE BEEN UP HELD BY HON. SUPREME COURT SEE 2007 (SUPP.)BOM.C. R. 925 RELIANCE