Friday, October 29, 2010

More Hurdles for LLPs

As we have previously noted on this Blog, the popularity of limited liability partnerships (LLPs) has not met with expectations since introduction of that business vehicle in April 2009. While the Government has taken certain steps to boost the utility of LLPs, such as by considering the possibility of foreign investment into LLPs discussed in this paper issued by the Department of Industrial Policy & Promotion, more recent steps taken and views adopted by the regulatory may amount to a retrograde step.

First, as the Economic Times reports, it is currently not possible for various corporate groups to restructure their holding companies so as to convert them into LLPs. The reasoning is as follows:
But, corporates planning to convert their holding companies into LLPs have been told by the registrar of companies (ROC) to get a no-objection certificate (NOC) from RBI; and the central bank is unwilling to give one. "There is a concern that the moment a company becomes LLP, it will be out of the RBI radar. These companies are core investment companies and under new rules they will be monitored, like non-banking finance companies (NBFCs), by the regulator," said an RBI official.

Currently, the definition of NBFC under the RBI Act does not specifically cover LLPs. Only companies registered under the Companies Act can form NBFCs. "We have told RBI that the law has to be changed to enable recognition of LLPs as core investment companies under the NBFC format," said an official in the registrar of LLPs in Delhi. An RBI spokesperson confirmed that the central bank is in discussion with the ministry of corporate affairs on the subject.

The LLP structure was introduced primarily keeping in mind operating companies, and not holding and investment companies.

Although there is no restriction under the LLP Act as to the activities that an LLP can carry out, the lack of acceptance of the new business vehicle under other legislation such as the RBI Act has given rise to such ambiguities, thereby curtailing the utility of the LLP and its benefits.
Second, although FDI into LLPs is being actively considered, it has been reported that there is no momentum to permit LLPs to raise overseas debt in the form of external commercial borrowings:
The finance ministry and the Reserve Bank of India have opposed changes in the external commercial borrowings (ECB) policy to allow overseas borrowings by LLPs, while responding to a discussion paper on this form of business put out by the department of industrial policy and planning (DIPP), the policymaking body on foreign investment.

The ECB regime should be identical to the one applicable for partnerships, the finance ministry said in response to the paper. The finance ministry is of the view that while FDI can be allowed in this form of business entities, but not overseas debt, said a government official privy to the discussions.

The current policy allows companies to raise ECBs, but sole proprietorship firms and partnerships are prohibited from accessing such debt. Though, LLPs combine features of the corporate form of business and partnerships, they are closer to partnerships. …

Thursday, October 28, 2010

Software and Royalty: Further Controversies

In an earlier post, I had stated:

“The judgment in TCS as also the subsequent decision of the ITAT in Sonata, (2007) 106 T.T.J. (ITAT) 797, make it abundantly clear that payments for shrink-wrapped software would not be chargeable to tax in India. V. Niranjan, in a recent article published in the Journal of Business Law describes the decision in Sonata thus:

"The leading case is Sonata Information Technology v Additional Commissioner of Income Tax, International Taxation. The Income Tax Assessing Officer considered that the payment for software import constituted "royalty" under s.9(1)(vi) of the Income Tax Act 1961, on the reasoning that there was no sale of software as there was no transfer of ownership rights and sale, if any, was only restricted to the CDs in which the software is transacted… Royalty is payable only if the copyright itself is transferred, and Sonata correctly observed only a copy of the copyrighted software is licensed to the user. However, Sonata then followed Tata Consultancy Services to hold that it is a sale of goods, which by definition does not attract royalty."[Footnotes omitted]

(See: V. Niranjan, “A Software Transfer Agreement And Its Implications For Contract, Sale Of Goods And Taxation”, [2009] 8 J.B.L. 799)”

This general statement of the law on the point may have to be modified in view of the recent decision of the Delhi Bench of the Income Tax Appellate Tribunal, in Gracemac v. ADIT and Microsoft v. ADIT, where payment for supply of off-the-shelf, shrink-wrapped software was considered to be royalty. The decisions in TCS and Sonata were distinguished. We will subsequently discuss whether this treatment of the previous cases was based on genuinely relevant factual differences, or whether the decision of the Delhi Bench amounts to a categorical change in the legal position. Meanwhile, the decision itself (along with a summary) is available on the ITAT Bar Association website, here.

Wednesday, October 27, 2010

Changes to Capital Markets Regulations

On October 25, 2010, SEBI announced a number of changes to regulations governing capital markets.

1. Public offerings.

A new regime is being established for IPOs by insurance companies. Rather than issue a new set of guidelines for that industry, SEBI has decided to apply the ICDR Regulations, 2009 along with additional industry-specific disclosures such as specific risk factors, overview of the insurance industry and a glossary of terms. Other changes in public offering norms include enhancement of a maximum application size for retail individual investors to Rs. 2 lakhs across all issues, the introduction of mandatory pro forma financial statements for issuer companies that have undergone a merger or restructuring after the last disclosed financial statements and the removal of a requirement for minimum promoters’ contribution in a further public offering (FPO).

In progressively addressing issues of gun-jumping, SEBI now requires investment banks to submit a compliance certificate “as to whether the contents of the news reports that appear after the filing of the [draft offer document] are supported by disclosures in offer document or not”. An item which is noteworthy is the reference to news reports appearing in media where the issuer has a private treaty with such media group. This will ensure that the securities are sold pursuant to the offer document, which constitutes the single source of information for marketing purpose as also for legal consequences (such as liability of misrepresentation).

2. Preferential Issues

In a measure that tightens restrictions on issue of securities to promoters, SEBI has provided that promoters (or promoter group) are ineligible to receive equity shares, convertible securities or warrants for a period of one year if they have failed to exercise previously issued warrants. This will operate as a disincentive against issue of warrants to promoters and promoter group, and further curb the misuse of warrants. For a previous discussion on regulation of such warrants, see here and here).

3. Rights Issue for IDRs

SEBI has proposed a new framework for rights issues for foreign companies that have outstanding Indian depository receipts (IDRs). Issuers are required to circulate a wrap document that contains information specific to IDR holders. The level disclosures will be similar to that expected in a rights issue by an Indian company. On a related note, the IDR holders of Standard Chartered were faced with certain legal and regulatory issues regarding their ability to participate in the bank’s recent rights offering, and it is hoped that the new regulatory framework will iron out those issues.

Sunday, October 24, 2010

Advisory Boards for Indian Companies

About a week ago the Economic Times’ Corporate Dossier carried two columns (here and here) highlighting the growing popularity of advisory boards in Indian companies. The individuals on such boards perform advisory functions and almost no monitoring functions. In that sense, an advisory board is distinct from the statutorily required board of directors of a company. As one column notes:

Fiduciary boards are mandated as per statute. They are created at the company level and at times their formal nature & structure can prohibit an effective leverage of their capability. Advisory boards, on the other hand, are their non-fiduciary, informal and non binding. They can be set up for a CEO or promoter rather than for the company. They are inherently flexible and can have a narrowly focussed objective to a wider governance role.

Having access to a high quality advisory can enhance an company’s odds of success. An advisory board can serve as a feeder group for board directors. Development of a board of directors is a long term project and by observing the commitment and contribution of some of the advisory board members they can be appointed to the board of directors.

Advisory board formation and its objectives vary across diverse contexts. Multinational corporations (MNCs), for example, are reluctant to give meaningful authority to a fiduciary board of their local subsidiary.
The other column goes on to discuss the viability of the concept:

But why form an additional board when all registered companies already have a statutory board of directors mandated by law? The raison d'ĂȘtre for advisory boards is different for different sets of companies. For conglomerates, there's a need for a set of senior leaders with relevant expertise who can look at opportunities and issues at the group level. The various company level boards within a conglomerate provide strategic input and compliance for a particular company, but at the group level a different kind of strategic insight is needed.

But like any management practice, advisory boards have its fair share of critics too. The toothless nature of the board is what critics point out as its biggest drawback. And the ills of the statutory boardrooms, like 'Groupthink' and the 'golf buddies syndrome' affect advisory boards too. Companies are known to constitute advisory boards to get access and credibility.

For the companies wanting to constitute advisory boards, getting candidates can be tricky. Some experienced members are not comfortable with providing just advice - they'd rather have some level of control that being a statutory board member provides. For some, an advisory role suits just fine because it doesn't come with liabilities listed companies throw up.
Advisory boards are non-statutory and hence the acts of their members are unlikely to carry legal consequences. However, in certain limited circumstances, the Companies Act imposes duties and liabilities on a person “in accordance with whose directions or instructions” the board of directors of a company is accustomed to act. Such person is otherwise referred to as a “shadow director”, and is generally subject to all the duties and liabilities of any other director.

So long as the advice from the advisory board is not binding on the statutory board of directors and that the statutory board is not accustomed to following their advice, the advisors will not be treated as shadow directors. This position is somewhat reinforced by section 7 of the Companies Act, which provides: “Except where this Act expressly provides otherwise, a person shall not be deemed to be, within the meaning of any provision in this Act, a person in accordance with whose directions or instructions the Board of directors of a company is accustomed to act, by reason only that the Board acts on advice given by him in a professional capacity.” Complete reliance on this section may, however, require demonstration that the advice was provided in a professional capacity.

Saturday, October 23, 2010

Dosco India v Doosan: The Sequel to Citation Infowares

One of the more important recent controversies over the Indian Arbitration Act has been the interpretation of the “express or implied exclusion” to the rule in Bhatia International. As is well known, the Supreme Court held in Bhatia International that Part I of the Indian Arbitration Act applies to international commercial arbitrations held outside India, unless it is “expressly or impliedly” excluded by the parties. Although the decision is seen in some quarters as unhelpful to international arbitration, and is proposed to be nullified by the Government, it remains binding law today, and it has become necessary to determine exactly what constitutes an “implied exclusion”.

We have discussed three cases that considered this matter – Indtel Technical Services, Citation Infowares and Venture Global. In Indtel and Citation, the governing law of the contract was English and American law respectively, and the parties had not explicitly specified a seat of arbitration. It was argued that the mere designation of foreign law as the proper law of contract constitutes an implied exclusion for the purposes of Bhatia International, and reliance was placed on the decision in NTPC v Singer, where the Supreme Court was said to have held that the proper law of arbitration is presumed to follow the proper law of contract. These contentions were rejected by Kabir J. in Indtel and Sirpurkar J. in Citation, and it was explained that the “presumption” referred to in NTPC operates only when the parties designate a seat of arbitration, giving room for the inference that they intended all aspects of their relationship to be governed by the law of that country.

If this is true, however, the question arises what suffices to “impliedly” exclude the application of Part I of the Act. While an obvious answer is that specifying the seat of arbitration and a foreign proper law would suffice, it was not clear that courts would acceded to that proposition in the wake of Indtel, Citation and Venture. With one qualification that we will discuss below, the Supreme Court now appears to have clarified that this is the case, in Dozco India v Doosan, decided on 5 October, 2010.

Dozco India, an Indian company, had entered into a Distributorship Agreement [“DA”] in 2004 with a company incorporated in Seoul, South Korea. Art. 22.1 of the DA provided that the “agreement shall be governed and construed in accordance with the laws of the Republic of Korea” – a clause that is materially identical to the clause in Citation and Indtel. However, Art. 22.2, unlike the clauses in Citation and Indtel, went further and provided that all disputes would be finally settled by “arbitration in Seoul, Korea (or such other place as the parties may agree in writing), pursuant to the rules of agreement then in force of the International Chamber of Commerce”.

Disputes arose, and Dozco filed a petition under s. 11(6) of the Indian Arbitration Act, seeking the appointment of an arbitrator. Doosan conceded the existence of an arbitration clause but argued that the petition is not maintainable since the Indian Act has been excluded. Interestingly, this case too came up before Sirpurkar J.* as the designate. The Court held, for two reasons, that the application is not maintainable. First, the Court found that the parties had concluded an agreement that committed disputes to be resolved by arbitration in Seoul, Korea. The expression “or such other place as the parties may agree in writing” was held not to alter this conclusion, because a “bracket cannot be allowed to control the main clause”. Secondly, the Court held that the designation of a seat of arbitration in Art. 22 took this case out of the purview of the rule established in Citation and Indtel, since the parties could now be taken to have intended to use the law of Korea to govern their relationship.

Two points are noteworthy. First, the Court held that the designation of the seat of arbitration and the foreign law constitutes an “express exclusion of Part I of the Act”. It is submitted, with respect, that this is not so. The distinction between an “express” and an “implied” finding arising out of any document or circumstance is that the finding is stated in terms in the former, and is inferred, albeit by necessary implication, in the latter. Thus, even the strongest implied finding, on which no reasonable person would take a different view, is not an “express” finding. The reference of the Supreme Court in Bhatia International to” an express or an implied exclusion seems, therefore, to contemplate either an explicit statement in the contract that the Indian Act, or Part I thereof, does not apply, or a court finding that that was the intention of the parties, through usual principles of document construction. This distinction is of more than semantic importance, since Citation, Indtel and Venture were decided on the basis that there was no implied exclusion. Thus, it is possible, although not likely, that this judgment is read not to constitute authority for the proposition that designating a foreign seat of arbitration and a foreign applicable law constitutes an implied exclusion – and that could become significant if courts differ on whether this constitutes an express exclusion in the first place. Secondly, the Court distinguished Citation and Venture on the basis that the parties had not designated a seat of arbitration in those cases. It is submitted that this is correct.

It is clear that the last word has not been said on this subject.

* It is often thought that a judge is entitled to “clarify” passages in prior judgments delivered by him. However, as Lord Hoffman points out in a famous passage in Deutsche Morgan Grenfell, [2007] 1 AC 558, 568, “[o]nce a judgment has been published, its interpretation belongs to posterity and its author and those who agreed with him at the time have no better claim to be able to declare its meaning than anyone else.” Fortunately, the Court was not called upon in Dozco to interpret ambiguous passages in Citation since it was clear that the seat of arbitration had not been designated in Citation.

Wednesday, October 20, 2010

The Sale of Liverpool Football Club

Last week, the English High Court of Justice considered a very interesting legal issue, also having great relevance for the football world. This concerned the sale of Liverpool Football Club [“Club”] to NESV, an American company which also owns the baseball team Red Sox.

The owners of the Club, Mr. Hicks and Mr. Gillett purchased the club in 2007, funded to the extent of 75% by the Royal Bank of Scotland [“RBS”]. The structure of the transaction was that the Club was owned by Kop Football Limited, which was owned by Kop Football (Holding) Ltd., which in turn was owned by Kop Football (Cayman) Ltd., in which Mr. Hicks and Mr. Gillett [“Owners”] had an indirect ownership of 50% each. As security for the financing, RBS had fixed and floating charges over the assets of the Club and the intermediate companies. The club got into financial trouble (alongwith footballing trouble), causing RBS to push for its sale. In April this year, RBS agreed to extend credit facilities till 15th October, on the condition that an agreement for sale would be entered into under Mr. Martin Broughton, who would be appointed Chairman of KFL and KF(H)L. Apart from the Owners, the other two members of the Boards would also be nominees of Mr. Broughton. An agreement titled Corporate Governance Side Letter [“CGSL”] forming part of the finance arrangements provided that there would be no representatives of the Owners on the boards, other than themselves, and that the Owners would not exercise their rights ‘as direct or indirect shareholders in the Company and its subsidiaries in a manner that would be contrary to the corporate governance arrangements contemplated by this letter’.

Inspite of the efforts of the newly constituted board, no sale could be finalised till 5th October. On this day, Mr. Broughton received a letter from the Owners along with Special Resolutions dismissing Mr. Broughton’s nominees from the Board and appointing two of their own. The Owners refused to attend subsequent meetings of the old Board, at which meetings, the sale of the Club to NESV was finalised. The SPA was scheduled to complete on 15th October, and RBS had also given its nod to the sale. One of the terms of the SPA was an undertaking by the seller (KF(H)L) to ‘commence appropriate legal proceedings and use all other reasonable endeavours to obtain a declaratory judgment confirming its ability to enter into this Agreement and consummate the transactions described herein’. Further, it provided that ‘This Agreement may be terminated and the Transaction abandoned at any time prior to Completion by either the Seller or the Purchaser if a declaratory judgment confirming the ability of the Seller to enter into this Agreement’ before 1st November, or such later date as the parties may agree. On an aside, had the club gone into administration on 15th October, it would have been docked 9 points in the English Premier League table, drastically affecting its prospects over the course of the season, and hence possibly prompting a rethink on the part of the prospective buyers.

It is against this factual backdrop that RBS approached the Court for an injunction restoring the composition of the old Boards on the ground that the new Board were constituted in breach of the CGSL. The Owners also approached the Court for an injunction restraining the sale to NESV. The Court granted the injunction sought by RBS, and denied the Owners’ claim. While this outcome seems quite unremarkable on the facts, the reasoning adopted by the Court in a couple of places merits mention.

The main defence of the Owners to the alleged breach of the CGSL was that they had been excluded from the sale negotiations, and by supporting the sale, RBS had acted in breach of the CGSL. Thus, they were entitled to repudiate the contract. However, the Court, on perusing their contentions, observed that the supposed exclusion from negotiations happened only after 5th October, which was the date on which the Owners were alleged to have breached the CGSL (¶¶ 32, 33). Thus, RBS was not responsible for any conduct which would entitle the Owners to repudiate the CGSL. What is more interesting however, is the question of whether RBS were entitled to an injunction. Now, what RBS was seeking was a mandatory injunction.* In the locus classicus on the issue of granting interim injunctions, the House of Lords in American Cyanamid v. Ethicon had held that an injunction can only be granted when a part makes out a serious arguable issue, the other party suffers no irreparable injury, and when the balance of convenience favours the applicant. However, very interestingly, the Court applies this test to the defence raised by the Owners, instead of the claim by RBS. In the words of Justice Floyd (¶ 26),

It is common ground that considerations of the balance of convenience do not arise where a party has a case to which no arguable defence can be mounted. This is entirely in conformity with the principles set out by the House of Lords in American Cyanamid v. Ethicon [1975] AC 396. There is simply no serious issue to be tried. The court is not concerned in such a case about whether its decision to grant or refuse an injunction might turn out later to be wrong. In that context, there is no need for the balancing exercise which is otherwise necessary to determine which course carries the least risk of injustice. In such a case there should not, therefore, be a two stage approach withholding relief from a party until a second hearing at which there is no prospect of a different result being achieved. Mr. Snowden put his case for the mandatory relief on this principle, without abandoning the alternative case based on the balance of convenience.

By the looks of it, the Court seems to have interpreted American Cyanamid as saying that unless the claim is debatable, due to persuasive arguments being made by the defence, one need not consider balance of convenience. This seems to be the complete opposite of what the case actually held- that the plaintiff must make out an arguable case, and then show the other two requirements. On facts however, Justice Floyd seems to have followed the dictum since he establishes that there is no irreparable injury caused to the Owners who anyway wished to sell the Club (¶ 47). Their only contention was that all bids had not been duly considered, but this contention was not sufficiently established on facts. On the other hand, the possibility of the club going into administration, the docking of points by the English Premier League, and the possibility of the sale agreement falling through established that consequences that the Club would suffer if an injunction were not granted.

In sum, the sale of Liverpool Football Club raised some interesting issues of conflicts between the shareholders and directors of a company. However, due to the existence of the CGSL, the resolution of this conflict did not require the application of company law principles. The other interesting issue was of the grounds for granting an injunction. While the judgment seems to be correct on facts, its understanding and application of American Cyanamid raises a few eyebrows.

* It is not clear whether this was an application for interim or final injunction. If it was for an interim injunction, which is not clear from the judgment, Cyanamid can be applied. However, if it was an application for a final injunction, then the serious issue test in Cyanamid is, with respect, not applicable.

Monday, October 18, 2010

The Currency Conundrum

The financial press has been abuzz with discussions and commentaries on the recently initiated “currency war”. While much of the discussion is deeply embedded in macro-economics, the Critical Twenties blog has a useful overview of the tricky issues involved and their possible impact on the Indian economy, written in a manner that is palatable to the non-economist.

Disclosures on Management Changes

The saga involving the removal of SKS Microfinance’s chief executive raises a number of issues relating to corporate governance as well as securities regulation. One such issue pertains to the nature of public disclosures made regarding the removal of the chief executive, which acquires prominence considering SKS is a public listed company. Circumstances that have panned out over the last few days indicate that the company at first merely notified the stock exchange of the event. Detailed reasons were forthcoming only subsequently after requests were made by SEBI and questions were raised in the media. Apart from the specificities of the goings on in SKS, this episode provides an opportunity to review the disclosure norms applicable in this regard.

Clause 41(IV) of the listing agreement provides for continuous disclosures by listed companies as follows:
k) The company shall disclose any event or transaction which occurred during or before the quarter that is material to an understanding of the results for the quarter including but not limited to completion of expansion and diversification programmes, strikes and lock-outs, change in management and change in capital structure. The company shall also disclose similar material events or transactions that take place subsequent to the end of the quarter.
At the outset, it may seem that SKS has been in technical compliance with the requirements of the clause as they notified the stock exchanges of the change. However, the more crucial information regarding the background and reasons for the change were missing. If the stock markets are to be truly efficient the reasons are as important for securities investors as the management change itself. The current requirements focus on the events to be reported without emphasis on the underlying reasons.

This raises a larger issue of disparity between primary market disclosures and secondary market disclosures. While there have been significant regulatory developments in strengthening primary market disclosures over the years (recently culminating in the promulgation of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009), the disclosure requirements in the secondary markets (primarily contained in the listing agreement) have not quite kept up pace. Although there have been constant calls for streamlining primary and secondary market disclosures, no concrete steps appear to have been taken in that direction, although it is a matter that requires attention.

For a previous discussion pointing to the disparity between primary and secondary market disclosures, see this post discussing SEBI’s proposal over 2 years ago to introduce integrated disclosures, and also a paper by Sandeep Parekh.

Friday, October 15, 2010

UK Court of Appeal holds that legal professional privilege reserved for lawyers

In the matter of Prudential PLC and Prudential (Gibraltar) Limited v Special Commissioner of Income Tax and Philip Pandolfo (HM Inspector of Taxes), the UK Court of Appeal has unanimously confirmed that legal professional privilege (LPP) does not apply to any other professional except qualified lawyers - solicitors, barristers and "appropriately qualified" foreign lawyers.

Prudential had sought to extend the existing rule of LPP - which gives certain communications between a lawyer and their client absolute confidentiality so that it cannot be disclosed to the court or third parties without the client’s consent - to advice on tax law given by accountants. The Court of Appeal emphasised that extending LPP communications to other professionals, such as accountants, was a matter for Parliament not for the courts. The Court noted that Parliament had considered the matter several times over the past 40 years and “that failure to change the law in this respect is not an accident.”

Prudential had argued that taxpayers often approach accountants rather than lawyers for advice on tax liabilities, which involves a consideration of, and advice about, the relevant law. They had argued that a client’s communications should be protected from disclosure if the advice is given by an accountant in the same way as it would be if given by a solicitor. The Court rejected that proposition.

The Court did note in its judgement that tax legislation makes express provision in relation to tax accountants and to tax advisers with a carefully formulated equivalent of privilege which is limited in its scope. A copy of the judgement is available here.

Saturday, October 9, 2010

Legality of Sale of NPAs Between Banks

Last week, the Supreme Court issued its ruling on whether non-performing assets/loans (NPAs) can be transferred between banks without the concurrence of the borrowers.

The case involved a transfer of NPAs (relating to the borrower, APS Star Industries Ltd.) from ICICI Bank to Kotak Mahindra Bank. The borrower was in liquidation. When the assignee Kotak Mahindra Bank sought before the Company Court to substitute its name as lender, the borrower objected on several grounds (including improper payment of stamp duty). The Company Court refused to recognize the assignee on account of improper presentation of the document of transfer. On appeal, a Division Bench of the Gujarat High Court upheld the Company Court’s decision, but on a different ground, i.e. that the assignment of debts by banks is not an activity permissible under the Banking Regulation Act, 1949 (BR Act).

On further appeal, the Supreme Court considered two issues:
1. Whether inter se transfer of debts between banks is an activity permissible under the BR Act?

2. Whether the assignee bank (Kotak Mahindra) is entitled to substitution in place of the original lender / assignor (ICICI Bank) in proceedings relating to liquidation of the borrower company?
On the first issue, the Court examined in detail the scheme and provisions of the BR Act and concluded that assignment of NPAs is within the purview of a bank’s permitted business activity:
- The Reserve Bank of India (RBI) can lay down parameters enabling banking companies to expand its business;

- Apart from accepting deposits and lending, the BR Act leaves ample scope for banks to venture into new businesses being subject to the control of RBI;

- Section 6(1)(n) of the BR Act “enables a banking company to do all things that are incidental or conducive to promotion or advancement of the business of the company”;

- The Guidelines on Purchase / Sale of Non Performing Financial Assets dated 13 July 2005 issued by the RBI allow banks to deal inter se in NPAs, which makes the activity a bona fide business. After going into the rationale for declaring a loan as an NPA, the court goes on to hold that the Guidelines “have been issued as a “restructuring measure” in order to avoid setbacks in the banking system”.
On the second issue, the Court distinguished between the transfer of (i) mere rights, which can be effected without concurrence of the borrower, and (ii) obligations, which requires a novation of the contract (thereby necessitating concurrence of the borrower):
- In the present case, it was found that the assignor is only transferring the rights under contract (which represent its assets);

- There is no transfer of obligations of the assignor towards the assignee, as they continue to be borne by the assignor;

- Hence the deed of assignment transferring the NPAs from ICICI Bank to Kotak Mahindra Bank is not unsustainable in law.
In addition, the court also ruled that the provisions of the SARFAESI Act, 2002 are not applicable to the case because that relates to a transfer of financial assets from banks to specific types of financial vehicles (such as securitization companies and asset reconstruction companies).

With its ruling on the limited questions before it, the Supreme Court remitted the matter to the Gujarat High Court for consideration of the other issues.

Ajay Shah’s Blog has a nice summary and analysis of the judgment, while this discussion on CNBC-TV18 also examines the impact of the decision on the securitization markets. As these demonstrate, in view of the Supreme Court’s limited mandate, it can be said to have merely covered the tip of the iceberg when it comes to the plethora of issues that arise from securitization of financial assets. More issues can be expected to be addressed through the future course the matter is likely to take.

Although securitization has acquired popularity in the Indian markets for over a decade now, the legal regime has been founded on age-old principles of law laid down in legislation such as the Transfer of Property Act, 1882, and the law relating to stamp duty and registration. While these laws do provide solid fundamentals in terms of legal concepts within which modern financial practices such as securitization can be worked, the judiciary has been presented with limited circumstances to interpret these legislation in the modern context. The opportunity that the current batch of cases presents the judiciary may well help clear the air on some of the issues.

Finally, when the SARFAESI Act was enacted in 2002, there was great expectation that such a law would create a modern framework to carry out securitization transactions. However, with its limited application (recognized by the Supreme Court in this latest decision), one cannot afford to turn a blind eye towards pre-existing law on transfer of financial assets.

The Supreme Court on the scope of winding-up jurisdiction

It is well-known that one of the grounds for winding up a company under Indian company law is its inability to pay “debts”. S. 433(e) explicitly provides that a company may be wound up by the company court if it is “unable to pay its debts” and s. 434(1)(a) lists three circumstances where a company is deemed to be unable to pay its debts. “Debt” has been construed widely in Indian law, and controversy has arisen recently over the precise scope of the winding-up provision. While the Supreme Court addressed part of this in 2008 in Vijay Industries v. NATL Technologies, it had occasion to consider the law in more detail late last month, in IBA Health v. Info-Drive Systems (CA No. 8230/2010).

IBA Health Systems Ltd. [“IBA”], an Indian company, had developed, inter alia, Hospital Information Software [“HIS-I”]. In 2002, it entered into a Cooperation Agreement with Info-Drive Systems [“IDS”], a Malaysian company, pursuant to which IDS introduced IBA to a third company and facilitated the sale of the HIS-I software to that company. For this service, IBA agreed to pay IDS a commission. Subsequently, disputes arose between the parties on the payment of commission, and they entered into a “Deed of Settlement” in 2003. To further complicate the matter, IBA (it was known as Medicom previously) was to be taken over, which IDS sought to prevent by filing a civil suit in the jurisdictional court in Bangalore. In 2006, the parties filed a compromise petition, reiterating that their relationship would be governed by the terms of the Deed of Settlement. In essence, the Deed of Settlement provided that IBA would pay IDS a specified percentage of certain types of payments it received from its customer, and IDS in turn acknowledged that IBA had paid all its dues to date, and undertook not to make any other claim in respect of the HIS-I transaction.

However, a year later, IDS demanded from IBA its share of a payment it alleged IBA had received from its customer. IBA disputed both the existence of any such receipt and its liability to IDS. At this point, IDS issued notice under s. 434 of the Companies Act, and filed a company petition seeking a winding-up order. The Company Court, over IBA’s objections, admitted the petition, found that IDS had established a prima facie case and indicated that it would pass orders in relation to the customary advertisement to be published. Naturally, this would have caused IBA substantial detriment, both commercially and more generally, and it challenged the order of the Company Judge.

Kapadia C.J. begins his analysis by noting that the Company Court is not required in a winding-up proceeding to examine complex issues of law and fact, or resolve serious disputes between parties, and relied in support on prior decisions of the Court in Amalgamated Commercial Traders, Mediquip Systems etc. As a result, the Supreme Court held that a Company Court cannot proceed with a winding-up petition if the respondent raises a “substantial” or “bona fide” dispute as to the existence of the debt. The following observations are pertinent:

A dispute would be substantial and genuine if it is bona fide and not spurious, speculative, illusory or misconceived. The Company Court, at that stage, is not expected to hold a full trial of the matter. It must decide whether the grounds appear to be substantial. The grounds of dispute, of course, must not consist of some ingenious mask invented to deprive a creditor of a just and honest entitlement and must not be a mere wrangle. It is settled law that if the creditor's debt is bona fide disputed on substantial grounds, the court should dismiss the petition and leave the creditor first to establish his claim in an action, lest there is danger of abuse of winding up procedure. The Company Court always retains the discretion, but a party to a dispute should not be allowed to use the threat of winding up petition as a means of forcing the company to pay a bona fide disputed debt.

Although the Court subsequently uses other expressions to indicate the threshold a company court must use to dismiss a winding-up petition (“hotly contested debt”, “also doubtful” etc.), it seems clear from the above observations and from the context of the judgment that the standard is one of “reasonable” or “bona fide” defence – a standard that appears to be higher than a prima facie case but lower than the standard required to succeed (or resist) in civil court.

The case is also authority for one other interesting proposition. It was argued by IBA that the winding-up petition should be dismissed notwithstanding the court’s finding on the extent of the dispute, because IBA was “commercially solvent” and “able to pay its debts”. The Court rejected this contention, holding that the solvency of a company cannot stand in the way of a winding-up petition if the company does indeed owe an unpaid debt to the creditor. At first sight, this does seem surprising, for s. 433(e) refers to a company that is unable to pay its debts. However, it is submitted that the Court is correct, since s. 434(1)(a) provides that a company shall be deemed to be unable to pay its debts if it has “neglected to pay” a certain sum for three weeks after notice is duly served on it. S. 434(1)(a) refers, therefore, merely to the factum of non-payment. It may be suggested that s. 433(e) is not exhausted by the circumstances enumerated in s. 434(1)(a), and that a company can demonstrate its ability to satisfy debts. The Court, however, addresses this point by noting that “the company of course will have an opportunity on the liquidation application to rebut that presumption.” In addition, commercial solvency is also relevant to determine whether there is a serious dispute between the parties over the existence of liability.

The Court concludes by pointing out that the Company Court cannot be “maliciously” used as a “debt collecting agency”, and that “an action may lie in appropriate Court in respect of the injury to reputation caused by maliciously and unreasonably commencing liquidation proceedings against a company and later dismissed when a proper defence is made out on substantial grounds.” This judgment may ensure that a winding-up petition is scrutinised more carefully before it is admitted.

Friday, October 8, 2010

Corporate Governance: India and China Compared

While a fairly extensive body of literature that compares India and China has developed in the economics and business spheres, comparative analyses of the legal regime in these two countries is somewhat nascent. In that regard, a new book China, India and the International Economic Order, edited by Professors M. Sornarajah and Wang Jiangyu at the Faculty of Law, National University of Singapore (NUS) represents an important contribution to the legal comparison of economic, business and trade matters relating to the two emerging giants. The abstract of the book is as follows:
With contributions by a variety of internationally distinguished scholars on international law, world trade, business law and development, this unique examination of the roles of China and India in the new world economy adopts the perspectives of international economic law and comparative law. The two countries are compared with respect to issues concerning trade and development, the World Trade Organization, international dispute settlement, regional/free trade agreements, outsourcing, international investment, foreign investment, corporate governance, competition law and policy, and law and development in general. The findings demonstrate that, though their domestic approaches to economic issues diverge, China and India adopt similar stances at the international level on many major issues, recapturing images which existed during the immediate post-colonial era. Cooperation between China and India could provide leadership in the struggle for economic development in developing countries.
Of immediate relevance to the theme of this Blog is a chapter The Development of Modern Corporate Governance in China and India authored by Professors Nicholas C. Howson and Vikramaditya Khanna at the University of Michigan Law School, the abstract of which is as follows:
This chapter examines the development of corporate governance in the world’s two biggest and fastest growing emerging markets - China and India. Although both countries are different in important ways, they also share significant similarities such as rapid economic development, significant foreign investment, economic, structural and legal reform, and a shared interest in (if not implementation of) essentially Anglo-American corporate law norms. These differences and similarities provide an interesting and rich platform for consideration of popular or contested corporate governance precepts. In particular, after an extensive discussion of corporate governance reforms in both countries and corporatization in China, we examine the impact of “legal origins” (common law or civil law) as compared to “politics” on the development of corporate governance and stock markets in both countries. In addition, we focus on the question of whether India and China provide supporting or contradicting evidence for some kind of global convergence in corporate law. We find that the support for the “legal origins” view is not strong, but rather the “politics” accounts seem more convincing as explanations for corporate governance and stock market development in India and China. Further, while there is a good deal of evidence of partial formal convergence in corporate law, we cannot identify the same or expected convergence in ownership or corporate structure. This creates an odd fit between corporate and securities law and the corporations they shape and regulate, suggesting some significant path dependence for these two important economies.

Monday, October 4, 2010

Arbitration: MSM Satellite v. World Sport Group – Part 2

(The following is the continuation of this previous post, and has been contributed by Vijay Kumar, a lawyer and a company secretary by qualification, who is practising as an Advocate in the Chennai High Court with the law firm of Iyer and Thomas)

a. The Dispute in reality is between MSM and WSGML and the question is whether MSM is liable to WSGML under the facilitation deed. This question has nothing to do with the plea for public policy raised or BCCI being affected by reason of the Dispute. The Media Release Rights continue to remain with BCCI which is their owner. BCCI is not affected by the present dispute. In fact, BCCI has agreed to continue with the Media release rights arrangement with MSM by way of an undertaking in the previous suit filed by MSM. In such a situation the Court could have left it to MSM and WSGA to decide the validity of the agreement and their liability under the agreement and work out their remedies in Arbitration. Neither BCCI nor the Media Release License rights would be affected by the reason of the present dispute. Therefore, the parties must have been allowed to work out their remedies in Arbitration in accordance with the provisions of Section 8 of the Act.

b. It was for the Arbitrators to decide if the consent of MSM to the Facilitation Deed is obtained by fraud and if that be the case the same can be decided in favour of MSM. BCCI need not be party to such proceedings as evidence of the fraud let by MSM would have been sufficient to prove the same. It is open to MSM to plead fraud against WSGML and therefore take a view that MSM shall not be liable for any payment to WSGML.

c. The Court unnecessarily mixed up the issues of the earlier suit filed by MSM where BCCI and WSGA and others are made as parties. The earlier suit was filed for protection of interests of MSM and its Media Rights license and that suit does not affect the arbitration to be presently commenced between the parties. The causes of action of both the suits are different. In the first suit filed by MSM (where BCCI is a party), the cause of action is the fear of BCCI terminating broadcasting rights. In the second suit, the cause of action is whether MSM is liable to make payment to WSGML under the Facilitation deed and the binding nature of Facilitation Deed on its parties.

d. For the parties to be restrained from submitting to arbitration under Section 45 of the Arbitration and Conciliation Act, the very necessity is that the agreement is rendered void or inoperative or incapable of being performed. The Hon’ble Court never came to the conclusion that the facilitation deed is void. It referred to the Dispute resolution mechanism agreed between the parties and held that one of the clauses that restricts the parties from approaching the Civil Court for a remedy is void under Section 28. Further, adjudication of Media Release Rights which has its situs in India as per English Law would be against public policy in India. With due respect, the clause which prevents parties from approaching Ordinary Courts is capable of being severed from the clause of Arbitration and the parties could have been relegated to arbitration. The requirement is that the agreement relied on by the parties has become void; the arbitration agreement has become void and only in that event reference to arbitration is void. Here, only an inference as to the arbitration (dispute resolution mechanism) clause being void has been arrived at. No conclusive decision has been made as to the arbitration agreement or the main agreement being void. Such conclusion is one of the prime necessities to restrain conduct of arbitration which has not been arrived in the present decision.

e. The Court failed to justify how public policy would be affected if WSGML and MSM are referred to arbitration. How BCCI which is the owner of Media Release Rights is affected by referring parties to arbitration. If MSM commits a breach of the present agreement, BCCI shall be entitled to terminate the agreement and license the rights in favour of another broadcaster and provide the same service. The disputes between MSM and WSGML are private disputes and need to be determined by the parties. The mode of resolution is arbitration which is not in contrary to public policy. Determination of private disputes does not affect public policy. As a result the arbitration is not void; hence Section 45 cannot be invoked. The argument of public policy is fallacious because the Media Rights released by BCCI is not in question. The question is whether MSM continues to be liable for payment to WSGML under the Deed of Facilitation. This could have been decided independently based on evidence let in by the parties. It is for MSM to show that fraud is played and therefore WSGML is not entitled to any amounts under the Deed. The Arbitrators are entitled to let in evidence and come to such conclusion. Such conclusion would not change whether it is under Indian Law or English Law. An agreement which is vitiated by fraud is fraudulent agreement under all laws. Therefore the plea raised that such determination cannot be arrived without BCCI being a party is fallacious. It is evidence that determines fraud and BCCI as witness can let in evidence to show WSGML fraud.

f. For restraining the parties from being referred to arbitration it was held in Shin- EtSu versus Aksh OptiFibre Ltd as follows-
Clearly Section 45 casts an obligation upon the judicial authority when seized of the matter to record a finding as to the validity of the arbitration agreement as stipulated in the Section and there is nothing to suggest either from the language of the section or otherwise that the finding to be recorded is to be only ex facie or prima facie. It is true that Section 5 limits judicial intervention in the manner provided therein. Both provisions are differently structured albeit the purpose of both is to refer parties to arbitration but in one case domestic arbitration and in other case international arbitration. Unlike Section 8 which provides that the application shall be moved not later than when submitting the first statement of the substance of the dispute, under Section 45 there is no such limitation. The apparent reason is that insofar as domestic arbitration is concerned, the legislature intended to achieve speedy reference of disputes to arbitration tribunal and left most of the matters to be raised before the arbitrators or post award. In case of foreign arbitration, however, in its wisdom the legislature left the question relating to validity of arbitration agreement being examined by the court. One of the main reasons for the departure being the heavy expense involved in such arbitrations which may be unnecessary if the arbitration agreement is to be invalidated in the manner prescribed in Section 45. In view of the aforesaid, adopting liberal approach and restricting the determination by judicial authority about validity of agreement only from prima facie angle, would amount to adding words to Section 45 without there being any ambiguity or vagueness therein.

I am of the view that Indian Legislature has consciously adopted a conventional approach so as to save the huge expense involved in international commercial arbitration as compared to domestic arbitration. In view of the aforesaid discussion, I am of the view that under Section 45 of the Act, the determination has to be on merits, final and binding and not prima facie.
The findings in the above case decided by Supreme Court have not been considered. Instead summary conclusion has been arrived without examining and considering evidence in detail.

g. The dispute resolution mechanism is not restrictive and is in accordance with the provisions of Section 28 of the Indian Contact Act. It empowers parties to approach the Courts in Singapore or such other court having jurisdiction. Such clause cannot be considered as restrictive in jurisdiction when parties are given the option to invoke the jurisdiction of any Court which has jurisdiction.

To sum up, the decision raises certain serious questions as to the circumstances in which Section 45 of the Arbitration and Conciliation Act, 1996 can be invoked and the extent of caution that needs to be exercised to ensure that exercise of jurisdiction is not unnecessary judicial interference. This decision once again stresses the need for extensive guidelines that the Apex Court needs to lay down on the circumstances in which exercising of jurisdiction under Section 45 of the Arbitration and Conciliation Act, 1996 is warranted.

Arbitration: MSM Satellite v. World Sport Group – Part 1

(The following post has been contributed by Vijay Kumar, a lawyer and a company secretary by qualification, who is practising as an Advocate in the Chennai High Court with the law firm of Iyer and Thomas)
Appeal in the Bombay High Court

MSM Satellite (Singapore) Ltd (MSM) had filed a suit against World Sport Group (Mauritius) Limited (WSGML) and had moved a notice of motion before the Learned single judge for restraining WSGML from referring the disputes between the parties to this suit to arbitration and preventing invocation of arbitration clause in the Deed of Facilitation dated 25th March 2009. The said notice of motion was not allowed and hence has been challenged in Appeal

The order in detail is given here. The subject matter of contention is that there were agreements for media rights license of cricket matches (in the Indian subcontinent and rest of the world) entered into between MSM and WSGML and between MSM and the Board of Control for Cricket in India (BCCI), and between WSGML and BCCI. The first agreement was entered between MSM and BCCI in 2008. There were certain allegations of breach of this agreement by BCCI against MSM. The matter was pending before the Bombay High Court and a limited injunction was granted by the Court in favor of MSM for protection of its rights. During the pendency of the matter before the Court, BCCI through Lalit Modi cancelled the said Media Rights License Agreement and created fresh rights in favour of WSGML. WSGML is a Company whose details of incorporation and legal status are not known. However, it was admittedly not a broadcaster and was in search of broadcaster for sub-licensing of its media licensing rights. BCCI had granted only 72 hours (commencing 15.03.2009) to WSGML for finding a new broadcaster for the media rights of Indian subcontinent more particularly for IPL II cricket failing which these rights would revert back to BCCI. To overcome the situation and to participate in broadcasting of the IPL II, MSM entered into a facilitation deed with WSGML for consideration of Rs. 425 crores of which admittedly Rs. 125 crores has been paid by MSM to WSGML.

After the controversy around Lalit Modi and his acts became public, BCCI wrote to MSM specifying that WSGML has no role to play in the Licensing of Media Rights to MSM. WSGML is a ruse created by Lalit Modi and that BCCI which is owner of Media Rights has not authorized WSGML either to enter into facilitation deed or to sub license these rights. BCCI also states that WSGML never had media rights to sub- license the same in favour of MSM. It was also stated that the media rights had reverted back to BCCI by the time Facilitation Deed was entered between MSM and WSGML as WSGM failed to find broadcaster within 72 hours. WSGML in the meanwhile, when a prior suit filed by MSM for protecting its license for media rights was pending, issued the notice for commencement of Arbitration between WSGML and MSM. WSGML made a claim for damages and for the balance sum of Rs. 300 crores as agreed in the Facilitation Deed and sought to relegate the parties to arbitration. As a result the present suit is filed by MSM to prevent WSGML from invoking arbitration and to prevent the parties from being referred to arbitration. The agreement provides for arbitration only in accordance with English Law in Singapore and that parties agree that all their rights under that agreement in event of dispute shall be determined only by way of arbitration.

The relief is sought on the following grounds –
a. Fraud has been played on MSM by WSGML by making false and fraudulent representations. Matters involving complex facts and those pertaining to fraud can be decided only after detailed evidence is let in and not by way of arbitration.

b. BCCI is a necessary party for adjudication of the dispute as it is the owner of the media release rights. BCCI however is not a party to facilitation deed and to the arbitration.

c. The facilitation deed between MSM and WSGML cannot be read independently. All the documents between BCCI, MSM and WSGML must be read and understood together so that effect can be given to the intention of the parties.

d. Public policy is involved. Cricket is a sport of the nation and BCCI regulates this sport. Any agreement which is in the nature of fraud would affect the right of MSM and consequently the broadcasting and viewing rights of the public. The interests of people in the Indian sub continent are involved and therefore parties cannot be allowed to decide the dispute based on English laws (the agreed law for settlement of dispute). Such decision would affect public policy and is in contravention of Section 23 of the Indian Contract Act.

e. Last but not the least, the Arbitrators have to consider and decide on their jurisdiction to determine the dispute, which question of the jurisdiction is also before the Court and that the Court thinks fit that it needs to decide this issue. The same issue is subject matter of Lodging No. 1901 of 2010 in the earlier suit filed by MSM against WSGML and BCCI. This is a principle propounded in Russell’s Arbitration.
Conclusions arrived by the Court

1. The Court held that such agreements which take away the rights of the parties to approach civil Court would be hit by the provisions of Section 23 and 28 of Indian Contract Act. It is necessary here to mention that Section 28 which relates agreement in restraint of legal proceedings was amended in 1997. The amendment empowers parties to the agreement to provide that parties to the agreement can refer any dispute that may arise between them to arbitration. The present clause relating to adjudication of disputes also provides for reference of dispute to arbitration. The Learned bench failed to consider the same. It goes on to say that arbitration proceedings can be stayed on the ground that it violates Section 23 and Section 28 of the Indian Contract Act, 1872. Consequently, the agreement is void and hence the arbitration between foreign parties is liable to be stayed under Section 45 of the Arbitration and Conciliation Act.

2. It has been repeatedly held that an order restraining arbitration must be exercised only in rarest of the rare cases. The present dispute falls under this category for following reasons-
a. Prima facie there is fraud played by the WSGML on MSM.

b. Rights of MSM for the sum of Rs. 125 crores already paid to WSGMA can be determined only if BCCI is party to the dispute. BCCI which is necessary party to determine the dispute is not a party to the Facilitation deed and hence to arbitration.

c. The clause pertaining to arbitration specifies the procedure for arbitration. Under the procedure, the laws of England would apply for determination of dispute between the parties. The Court held that the Media Release Rights pertain to Indian Sub Continent, which are held by BCCI. BCCI is a public body which regulates cricket in India. Public interest is involved in the game of cricket. The Court referred to the role of BCCI as was held in M/s Zee Telefilms Limited and others versus UOI (AIR 2005 SC 2677). Therefore, any adjudication of rights between MSM and WSGML would affect BCCI which holds Media release rights and consequently the public. Hence, the agreement for adjudication between MSM and WSGML is opposed to public policy.

d. Further, such an agreement which prevents parties from approaching ordinary civil courts would be against Section 28 of the Indian Contract Act and hence void.

e. The Agreement between the parties itself is challenged and therefore the validity of the arbitration itself is in question and hence the parties cannot be relegated to arbitration. It is not only the agreement that is vitiated by fraud but also the arbitration clause in the agreement, and as a result Arbitration needs to be stayed.

f. The Arbitrators have to consider and decide on their jurisdiction to determine the dispute. The same question of jurisdiction is also before the Court and that the Court thinks fit that it would decide on this issue of jurisdiction and not the arbitrators.

Friday, October 1, 2010

Bombay High Court on the Appointment of Arbitrators

Section 11 of the Indian Arbitration Act, 1996, has been subject of much controversy; primarily on the issue of whether the power of Chief Justice to appoint arbitrators provided therein, is judicial or administrative in nature. While that question gave rise to many issues of policy and the scheme of the Act as a whole, a narrower but equally interesting aspect of the provision seems to have gone unnoticed thus far. This issue was recently considered by the Bombay High Court in Thyssen Krupp v. SD Industries, coming to an interesting conclusion, on even more interesting reasoning.

Section 11(4) of the 1996 Arbitration Act reads-

(4) If the appointment procedure in sub-section (3) applies and

(a) a party fails to appoint an arbitrator within thirty days from the receipt of a request to do so from the other party; or

(b) the two appointed arbitrators fail to agree on the third arbitrator within thirty days from the date of their appointment,

the appointment shall be made, upon request of a party, by the Chief Justice or any person or institution designated by him. [emphases supplied]

In the case in question, the two parties had each appointed an arbitrator, who appointed the third arbitrator three years after their appointments. The appellant contended that this appointment of the third arbitrator was illegal, since after the 30-day period, only the Chief Justice may appoint an arbitrator, upon the request of a party. Hence, it was contended that the appointment of the third arbitrator was bad in law, and the award deserved to be set aside [there was also a challenge on merits, the grounds of which are not relevant for the discussion here].

The High Court, speaking through Justice Vazifdar, rejected this contention, primarily on the text of section 11(4). The Court noted the difference between the phrases ‘fails to appoint’ and ‘fails to agree’, and observed that the legislature having used different language, must be presumed to have meant different things by the phrases. In the opinion of the Court, the mere failure of the arbitrators to appoint a third arbitrator doesn’t give rise to the Chief Justice’s powers. For the last part of the provision to apply, there must be “a disagreement between the arbitrators on the name of the third arbitrator”. In the words of the Court,

There can be a failure to agree between the two arbitrators about the appointment of a third arbitrator only if and when the third arbitrator is named/identified by one of the arbitrators. In the absence thereof, there is nothing for them to agree to conversely nothing for them to fail to agree about. In the present case neither of the arbitrators proposed the name of a third arbitrator. The question of the said arbitrators having failed to agree on the appointment of the third arbitrator therefore does not arise.

The Court also drew support from the 1940 Arbitration Act as making a similar distinction. Finally, it rejected the contention that such an interpretation would result in neither party having any remedy if the arbitrators took no steps towards appointing the third arbitrator. The Court observed that if there is such inaction, it would amount to a failure of the arbitrators to act without undue delay, which would be a ground for terminating their appointment under section 14 and 15 of the Act.

Now, on a first reading, this decision seems to be based on a sound reading of the provision, and also pro-arbitration. However, a closer reading, some doubts arise about its propriety on text; and also just how much it will assist arbitral proceedings.

First, while the Court is right in noting the difference between failing to ‘appoint’ and failing to ‘agree’, the meaning which the Court imputes to this difference is dubious. Another simpler reason for the different language could be that there is no requirement of consent or agreement in the appointment of arbitrators by parties. Since the first act is a mere act of appointment, the provision speaks of the parties failing to ‘appoint’. However, the second part of the provision requires an agreement, leading the legislature to speak of the failure to ‘agree’. Thus, in both cases, the legislature meant ‘failing to do what is necessary to constitute the tribunal’. In fact, ‘failing to agree’ can have two possible meanings- the absence of an agreement, or the presence of a disagreement. The Court has imparted to the phrase the latter of these two meanings, without explaining why it cannot have the former meaning. Juxtaposing ‘agree’ with ‘appoint’ doesn’t answer the question of which of these two meanings of ‘fail to agree’ the legislature intended.

Secondly, there seems to be another reading of this delightfully ambiguous provision which would have led to the same conclusion on the facts of the case. In the case of a failure to agree on a third arbitrator, the provision states that ‘the appointment shall be made, upon request of a party, by the Chief Justice or any person or institution designated by him’ [emphases supplied]. Now, ‘shall’, as used here, may qualify (i) the entire process of appointment on the request of a party, or (ii) only the very act of appointment by the Chief Justice or designated authority, leaving it to the discretion of parties whether or not to make the request. If it qualifies the entire process, it means that the arbitrators do not retain the power to appoint a third arbitrator after the thirty day period, necessarily requiring the Chief Justice to step in. However, this would do violence to the provision; since it would render ‘request of the party’ irrelevant (there is no point in requiring a request if the process is mandatory). Hence, the appropriate interpretation seems to be that shall only qualifies the Chief Justice’s appointment, and that the party has the discretion to request the Chief Justice after the thirty day period. However, till such time as the request is made (after which the appointment is mandatory), the arbitrators retain the power to appoint a third arbitrator. If this were not the case, after the thirty day period, the arbitration would be in limbo, unless one of the parties requested the appointment of a third arbitrator by the Chief Justice. More importantly, there would be no option available to the parties to allow more time to the arbitrators due to some special circumstances or some other justified reason.

If this interpretation is accepted, it was open to the Court to hold that no request had been made by either party to the Chief Justice, and hence the arbitrators retained the power to appoint the third arbitrator even three years after their own appointment. It is submitted, with all due respect, that this would have achieved the same result, but on a sounder interpretation of the provision. While the Court’s interpretation is of interest from the purely textual viewpoint, as pointed out above, it seems suspect. Also, it creates a situation where, unless arbitrators disagree (as opposed to fail to appoint) a third arbitrator, a party has no option but to go to court to get the mandate of the arbitrators terminated. Thus, far from reducing the Court’s intervention (which the decision appears to do at first glance), it necessitates it.