Extra-Territoriality of U.S. Securities Laws

Given the robust nature of the class action mechanism in the U.S., it is hardly surprising that plaintiffs rush to initiate legal actions before the U.S. courts even in relation to foreign companies that have issued securities listed on non-U.S. stock exchanges. U.S. courts have been left to combat with what are known as “foreign-cubed” or “f-cubed” class action law suits, defined broadly as law suits that “involve fraud claims brought by foreign investors against foreign issuers, based on harm arising out of investment transactions on foreign securities exchanges”. Historically, U.S. courts have been sympathetic to such claims. However, in a far-reaching judgment in Morrisson v. National Australia Bank Ltd., the U.S. Supreme Court yesterday put an end to this practice by defining the territorial application of U.S. securities laws narrowly.

The Court held that Section 10(b) of the U.S. Securities Exchange Act of 1934 “does not provide a cause of action to foreign plaintiffs suing foreign and American defendants for misconduct in connection with securities traded on foreign exchanges”. Following this, the Court held that if Section 10(b) is not extra-territorial, then the concomitant anti-fraud provision in Rule 10b-5 would also not be extra-territorial. Hence, the focus is “not on the place where the deception originated but on purchases and sales of securities in the United States”.

As far as Indian companies are concerned, it circumscribes the situations in which Indian listed companies may be sued in the U.S. for securities laws violations. However, it does not affect Indian companies who have ADRs listed on the U.S. stock exchanges, as they continue to be subject to U.S. securities laws and to actions by ADR holders who have acquired them on U.S. stock exchange. To that extent, the decision does not have any impact on the lawsuits relating to Satyam that are pending before the U.S. courts.

Enron/Skilling Case: In another decision rendered yesterday in Skilling v. United States, the U.S. Supreme Court decided against Jeff Skilling (the former CEO on Enron) on his objection to the venue of trial in Houston on grounds of pretrial publicity, but ruled in his favour on the argument that he did not violate a statute on “theft of honest services”, which it interpreted narrowly to mainly include bribery and kickback schemes. The court found that the “Government charged Skilling with conspiring to defraud Enron’s shareholders by misrepresenting the company’s fiscal health to his own profit, but the Government never alleged that he solicited or accepted side payments from a third party in exchange for making these representations.”

The Social Cost of Corporations

Recent events, both in India and elsewhere, have thrown the spotlight on the roles and responsibilities of companies in society. In an interesting article “The Conscience of Capitalism” in Forbes India, Arun Maira discusses (in a non-technical fashion) the difficulties in pinning responsibility for wrongdoing by a company.

Pertinently, he notes that while the “limited liability corporation is an invention of man” and a “device created to attract capital”, we also have “institutions and laws whereby corporations can internalise and privatise profits while costs of damages to communities and the environment are externalised and socialised”.

He notes:

When a citizen does wrong, you know whose ass to kick. When a corporation causes harm, who exactly should take the rap? Moreover, unlike a person, as Nace points out, a corporation can do the Houdini — disappear and reappear in another body with a new name — and avoid being punished. Such are the questions that President Obama and the American people, and also the Indian government and Indian people, are grappling with.

This is similar to the difficulties judges earlier encountered in finding corporations guilty of crime. The statement by Edwin Thurlow, 1st Baron Thurlow (1731-1806) comes to mind: “Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?”

To a large extent, this only carries historical value because the ability of companies to be punished for crime has developed over the years, and has been recognised in India even for offences involving mandatory imprisonment and fine. Supreme Court’s decision in Standard Chartered Bank v. Directorate of Enforcement is noteworthy on this count.

Returning to Arun Maira’s observations, here are some further excerpts:

Mankind has developed many powerful ‘dual use’ technologies that can do great good but, in the wrong hands, can do great harm too. … The large, limited liability corporation is also a powerful ‘dual use’ concept invented by man. …

Business needs freedom to take risks, innovate and increase wealth. Governments must protect their citizens and promote the common cause. Therefore, even as governments promote business, they must also regulate it. Business leaders resent regulation. They would rather be trusted to regulate their own behaviour. They must always remember that corporations are given a licence to operate by society, and that society can curb or even withdraw that license. …

Self regulation requires a conscience. Corporations are the engines of capitalism. Wherein lies the conscience of the corporation — an inanimate, legal construct devised by man? That is the question at the heart of corporate governance. Does it lie in the board, which society should trust to ensure that the corporation causes no harm? If so, is the board equipped with the moral precepts, intellectual ideas and norms of conduct that will enable it to discharge its responsibility to society? The responsibility of the chairman of the board is to ensure that the board is so equipped. A capable board with a conscience can ensure that the corporation’s executive management is well equipped to act responsibly too.

Court of Appeal on the 'True and Fair view'

In an earlier post, Shantanu had discussed the judgment of the England & Wales High Court in Macquarie  Internationale Investments Ltd. v. Glencore UK Ltd. The decision of the High Court has been upheld on appeal by the Court of Appeal in a judgment available here. The Court of Appeal observes (paragraphs 51, 52 and 54) in relation to the ‘true and fair view’:

On this issue a joint opinion written by Mr Leonard Hoffmann QC and Ms Mary Arden in September 1983 has been highly influential… The essential thesis of Mr Hoffmann and Ms Arden was that the concept of “true and fair view” as used in the Companies Acts is an abstraction. It is for the courts to decide in any given case whether the accounts do give a true and fair view. However, in deciding this question the courts look for guidance to the ordinary practices of accountants and in particular to the standards published by the relevant professional body. These published standards not only guide accountants in the preparation of accounts but also mould the expectations of those who read or use the accounts. Therefore compliance with professional standards is prima facie evidence that the accounts present a true and fair view of the assets and liabilities of the company or the group. Deviation from accepted accounting principles is prima facie evidence that the accounts do not present a true and fair view of the assets and liabilities of the company or the group… Mr Glick drew our attention to the decision of the House of Lords in Smith New Court Securities Ltd v Citibank N.A., [1997] AC 254, in particular the speech of Lord Steyn at page 271, in support of the proposition that accounts properly prepared may subsequently turn out not to have presented a true and fair view. However, I do not think that this authority supports that proposition…

The Corporate Law and Governance blog notes that the 1983 joint opinion referred to in the above passage is available at this link (along with an opinion in 2008 prepared by Martin Moore QC).

ULIPs regularised, Insurance companies given absolution

As reported in the press, the President has finally issued an Ordinance dated 18th June 2010, coming into effect immediately from that date, for, what I would call, “regularising” ULIPs. I use that word because not only it is declared that ULIPs (as very widely defined) issued by an insurer are life insurance business but also that they were always so for all practical purposes in this context. 

To emphasise, the Ordinance covers ULIPs as we ordinarily understand them and more - the relevant extract of the definition reads - “any unit linked insurance policy or scrips or any such instrument or unit, by whatever name called, which provides a component of investment and a component of insurance issued by an insurer”. 

No minimum insurance component is required in this widely defined ULIPs. Thus, ULIPs would cover even the type of ULIPs referred to in SEBI’s order of 9th April 2010, which started all this, where the insurance component was just 2%. (see my earlier post on this decision and also several other posts around that date on this order)

There is thus an irony to this. ULIPs containing just 2% (or theoretically even less) insurance component can be issued only by insurers registered with IRDA. However, mutual fund or other entities that are not insurers cannot issue a ULIP having 98% or more investment component.

The Ordinance amends several laws – the Insurance Act, the Securities (Contracts) Regulation Act, 1956, the Securities and Exchange Board of India Act, 1992 and the Reserve Bank of India Act, 1934.

The aims are several.

Firstly, as referred earlier, it is to include ULIPs in life insurance business and thus not only validate issue of ULIPs by insurers but confirm (if there was any doubt), for all practical purposes, that ULIPs are an exclusive business of insurers and governed exclusively by IRDA.

Secondly, all earlier issues of ULIPs are effectively validated. It is specifically stated that this is so despite anything contained in any judgment or order of any court, tribunal or other authority (effectively covering SEBI’s order). It is also stated that the validity of issue of such ULIPs cannot be called in question before any court or authority on grounds such as non-registration under any law (effectively neutralising even existing references before Courts). 

For future jurisdictional disputes amongst specified regulators on whether specified instruments such as ULIPs, money market instruments, etc. are composite/hybrid instruments, a dispute resolution mechanism is laid down. The regulators to whom this would apply are the Reserve Bank of India, Securities and Exchange Board of India, Insurance Regulatory and Development Authority or the Pension Fund Regulatory and Development Authority. Such disputes shall be referred to a Joint Committee consisting of 7 persons of which 3 represent the Central Government and 1 representing each of the 4 regulators.

Any member may make a reference of such a difference of opinion to the Joint Committee and the decision of the Joint Committee would be binding on the four regulators.

The saddest part of this is that there is no reference to the biggest complaint against ULIPs and insurers/agents and that is of mis-selling, encouraged by comparatively high initial commissions and also higher other upfront costs. 

There is also no attempt to empower IRDA with powers similar to SEBI to punish errant insurers and their agents. Even a cursory comparison of the SEBI Act and the Insurance/IRDA Acts shows that IRDA is wholly ill-equipped to protect investors of ULIPs, at least nowhere in comparison of the powers that SEBI has. The Insurance Act seems more focussed on protecting the interests of term and endowment policy holders and thus there is almost obsessive focus on matters such as where the funds paid by such policy holders are invested. 

For ULIPs holders, however, it appears that since they “knowingly” investing in “risk” assets, they do not need similar protection (i.e., the Buyer Beware principle applies). Thus, the Ordinance is a disappointment. Not only past sins are given absolution but the existing setup of poor effective protection and minimal powers to prevent future ones also continues.

- Jayant Thakur

Webinar on ‘Revision of the ICC Arbitration Rules’

(The following post comes to us from Rohan Bagai, who has previously contributed posts on this Blog here and here)

The International Chamber of Commerce (ICC) Court of Arbitration Secretary General, Mr. Jason Fry and Ms. Francesca Mazza, Counsel and Secretary to the ICC Commission on Arbitration are set to impart their knowledge and share their experience in a one-hour, interactive webinar (web-based seminar) on June 23, 2010 at 4 pm (GMT+2), which focuses on revision of the ICC Rules of Arbitration (the “Rules”).

In October 2008, a ‘Task Force on Revision of the ICC Rules of Arbitration’ (the “Task Force”) was constituted in order to ensure that the Rules continue to meet the needs of their users, reflecting best practice in the field of international arbitration.

As members of the Drafting Sub-Committee of the Task Force and the Court Secretariat, Mr. Fry and Ms. Mazza will explain the reasons for starting the Rules revision process, its procedure and the current status, and give examples of the changes being presently debated.

The webinar guarantees a live and interactive learning experience for all participants, which would include practicing lawyers, corporate counsels, arbitrators or any other professionals in the field of dispute resolution, who will be able to ask questions and get answers in real time.

- Rohan Bagai

The "right" of retention

It is generally accepted that a defendant in an action for damages cannot exercise the right of “set-off” on the basis of a mere “claim”, which has not crystallised. For example, while the law permits a defendant to set off debts owed to him by the plaintiff against a successful claim in court, he cannot normally resist the plaintiff’s case on the basis that litigation is pending in other courts, resulting potentially in a decree worth more than the sum due to the plaintiff. The rationale for this rule is that a plaintiff who has successfully pursued an action against a defendant cannot have his claim frustrated on the mere possibility of a decree against him in the future.

There are, however, exceptions to this rule, and the right of “retention” is perhaps the most well-known exception. There is terminological confusion over exactly what the term “retention” means, and it has been used to denote two allied but very different legal concepts. Recently, the United Kingdom Supreme Court considered this issue elaborately, in Inveresk plc v. Tullis Russell, [2010] UKSC 19. Although the issue arose as a part of Scots law, Lord Collins observed that English law is no different.

Inveresk had agreed to sell certain intellectual property to Tullis, and the commercial arrangement between the parties was captured in two contracts, which, as Lord Hope notes in his judgment, is common in these transactions. Under the first contract, Tullis agreed to pay an initial sum of £5 million, and subsequently “Additional Consideration”, depending on the volume of sales in a defined time period. Under the second contract, Inveresk agreed to continue manufacture, sale for the same period, and ensure that the value of the assets did not diminish in the course of completing the formalities of transfer. Subsequently, disputes arose between the parties as to the sum of Additional Consideration payable by Tullis, and Inveresk brought an action to recover approximately £900,000. Tullis, meanwhile, brought an action against Inveresk alleging a breach of the second contract, since Inveresk had allegedly not dealt with customers in accordance with the terms of the contract, resulting in a drop in the value of the assets Tullis was to buy. This claim was for about £5 million – substantially greater than the sum Inveresk claimed.

The matter was heard by the Supreme Court on two narrow points, of which one turned on the language of the particular contract. The second point, however, was Tullis’ plea that should Inveresk succeed in its claim of £900,000, it was entitled to “retain” that sum pending resolution of its claim for £5 million against Inveresk. This, naturally, is contrary to the general rule of law that a mere uncrystallised claim cannot be the subject of a set-off, and the Court therefore had occasion to consider the scope of the exception to this general rule, and the circumstances in which it becomes applicable.

Lord Rodger’s judgment is particularly significant. He begins by noting that the term “retention” is “most unhelpfully” applied to two different legal doctrines. The first is the well-accepted principle that a party is not required to perform his obligations under a contract unless the other party does so as well. For example, a tenant can lawfully withhold rent if he alleges that he has not received possession, as can a buyer who claims that he has received “materially defective goods”. At times, this right is also known as “retention”, and is normally allowed when a party is able to establish that the two obligations in question are “counterparts” of each other.

What is more controversial is the claim that a party is entitled to withhold or “retain” the debt, regardless of the performance of the other party of the contractual obligations giving rise to the debt, on the ground that other claims are pending against that party, and that it is therefore “just and equitable” to “postpone” or “retain” this debt. The concept is clear from the following words of Lord Rodger, extracted from paragraphs 57 and 77 of his judgment:

Firstly, a defender has a right to withhold or “retain” payment of, say, the price of goods which he says are materially defective, until the pursuer proves that he has supplied goods which are conform to the contract. But the term “retention” is also applied to the (different) situation where a defender admits that, say, the price of goods is due. In that situation he cannot have any right to withhold payment of the price. But he can submit to the court that he should not be obliged to pay the price until some unliquidated claim which he has against the pursuer (here, a claim for damages) is resolved. In effect, the defender asks the court to allow him to “retain” the price meantime so that, if his claim for damages succeeds, he can offset the liquid damages against the liquid price.

It is important to carefully distinguish between the two types of retention that Lord Rodger refers to above. Lord Rodger traced the “second” right of retention (of illiquid claims) to the Compensation Act, 1592 and cases on the scope of that statute and allied rights. As is obvious, retention, in the proper sense of the term, is not a right as much as it is a remedy in equity, to be granted by a court at its discretion. Lord Rodger was able to demonstrate, therefore, from the authorities on the subject, that a court has the power to allow a defendant to retain a “debt” pending resolution of a claim “arising out of wholly different circumstances”.

Two points are noteworthy. First, Lord Rodger was careful to note that this power of the court to allow the equitable remedy is an “exception” to the general rule that the law will not permit a defendant to postpone the payment of a liquid debt against him in order to have the opportunity to crystallize his own illiquid claim against the plaintiff and then set it off against the plaintiff’s claim. The general rule remains, and courts may resort to the exception only when, for some reason, that would be the just and equitable way to proceed in the particular circumstances”. Secondly, while there is naturally no exhaustive answer to what those particular circumstances are, the fact that the two claims arise out of the same contract or transaction is “a relevant factor”. Another possible factor is the relationship between the magnitude of the claims – if the defendant seeks to retain a debt against a substantially larger claim, he has a better prospect of succeeding.

This issue has never arisen directly in India. Two Supreme Court decisions on the possibility of setting off a mere “claim” – Union of India v. Raman Foundry, AIR 1974 SC 1265, overruled in Kamaluddin Ansari v. Union of India, AIR 1984 SC 29 – turned on a specific clause in a contract. It will be interesting to observe whether Indian courts follow the UK approach, for retention, although sparingly granted, is a powerful remedy for a defendant.

Further analysis of this judgment is available on Legal Developments.

Bhopal Gas Disaster Case

The Law and Other Things Blog links to Frontline’s extensive coverage of the judgment rendered last week by the Chief Judicial Magistrate in Bhopal. It also provides a detailed account of the twists and turns encountered by various parties to the litigation for the last 25 years.

Bits of Interest

1. Mutual Funds and Unit Premium

The Law-In-Perspective Blog uses the analogy of Ponzi schemes to explain a March 2010 circular of SEBI that prohibits mutual funds from using the unit premium reserve to pay dividends. If one would prefer to avoid the negative connotation associated with a Ponzi scheme, the post also looks at another parallel, being the restrictions under the Companies Act, 1956 on return of premium on shares of a company through payment of dividend.

2. Indianizing Corporate Governance

In a Business Standard column, Pratip Kar calls for the localization of corporate governance norms. He argues:

The conceptual underpinnings of corporate governance, in their present form, are rooted in the western culture and thought or in the western “dharma” (in the wider sense of the word); and in the rational jurisprudence of the Roman law and the western law. Hence they lend themselves to an easy adaptation by the English-speaking peoples. They are a product of European liberalism. They have evolved through the debates on the beneficiaries of a governance process between the Magna Carta and the American War of Independence. Board activism and empowerment, at the heart of which is the demand to strengthen the board, also have their origins in the English-speaking countries such as Australia, Canada, the United Kingdom and the United States. However, those countries whose economic and political traditions, and institutions and ownership structures, are different from the English-speaking countries, find these concepts distant as well as foreign; or in a sense “not invented here”; and not easy to accept.

In India, the way corporate governance came to be formally adopted by firms especially after 2000 reflects the natural dominance of the contemporary western culture and thought over Indian perceptions and readings. It has not often been realised that the principles of corporate governance have always been an integral part of Indian culture and society. This has its advantages as well as weaknesses.

Advantages arise from the fact that in an era of globalisation, when the Indian economy is seeking to integrate itself with the global economy, and when there is a concerted move towards harmonisation of global regulatory standards and accounting principles, it is only pragmatic that the corporate governance architecture should be built on globally-recognisable design, and the standards scripted in globally-understood alphabets. For this reason, long before the two words became a business reality in India, the principles of corporate governance came to be easily adopted by those companies and people behind them, who had by education or by business came in closer touch with the western world.

The weakness is that, unless the founding principles of business are rooted in the dharma and culture of a country, their easy and wider acceptability and adaptability become elusive, if not difficult. It is important for us to find our own idiom for true governance, one that is rooted in the Indian ethos, but speaks the global language.

This is a path on which some of us on this Blog have tread in examining corporate governance in India. A more general analysis on transplant of corporate governance norms in India is available here, while a specific analysis on independent directors is available here.

3. A Holding Company for PSEs

A Financial Express column proposes the idea of setting up a holding company for public sector enterprises (PSEs) in India. While this idea is worth exploring further, its results will be effective only if the holding company itself is immune from the several issues such as excessive governmental interference currently plaguing PSEs.

The holding company model is not without other examples. China has gone down the path of consolidating the holdings of its state owned enterprises under the State-owned Assets Supervision and Administration Commission (or SASAC) and it would be useful to draw from results of the Chinese experience as well.

Conference on Goods and Services Tax

The School of Law, Christ University, in collaboration with Lakshmi Kumaran & Sridharan, Bangalore, are organizing a conference on the GST on 26 June 2010. Mr. Gautam Chawla of Christ University sends the following invitation, which might be of interest to readers:

The replacement of the state taxes by the Value Added Tax in 2005 marked a significant step forward in the reform of domestic trade taxes in India. Buoyed by the success of the State VAT, the Centre and the States have now embarked on the design and implementation of the perfect solution alluded to in the Bagchi Report. As announced by the Empowered Committee of State Finance Ministers in November 2007, the solution is to take the form of a ‘Dual’ Goods and Services Tax (GST), to be levied concurrently by both levels of Government. The Conference is an endeavor to discuss the political, social and economic character of GST and its impact on different sectors of the economy, and households in different social and economic strata of the nation.

The objective of this Conference is to bring about a multidisciplinary discussion on the subject so as to explore the implications of GST in India. Broadly the Conference has been divided into two themes – the Interplay between the State Tax Laws and GST and the Interplay between the Central Tax Laws and GST.

The themes will be discussed in two sessions. Each session will constitute of a Tax practitioner, a Senior Chartered Accountant, a Government Official (Commissioner / Additional commissioner of Sales Tax) and a representative from the Industry (Consulting firms / Manufacturers).

The confirmed speakers include:

v                             Mr. B.T. Manohar, FKCCI Chairman

v                             Mr.S. Venkataramani, Tax practitioner

v                             Mr. Pradeep Singh Kharola, I.A.S,  Commissioner of Commercial Taxes

v                             Mr. V. Raghuraman, Advocate, Partner, Raghuraman & Chythanya, Advocates

v                             Mr. G. Shivadass, Partner, Lakshmi Kumaran & Sridharan, Bangalore

v                             Mr. Nagendra Kumar, LTU Commissioner

The Conference will be held at Christ University Auditorium between 9:30am and 6pm on Saturday, 26 June 2010. Kindly confirm your participation by indicating the number of heads attending latest by Tuesday, 22 June 2010 by emailing at the below mentioned addresses. A nominal registration fee is being charged based on the following table. The registration fee is payable in cash on the Registration Desk between 8:30am and 9:30am on the Conference Day.

Category	Amount
Professionals /  CA’s	Rs. 1500 per delegate
Academicians and Research Scholars	Rs. 1000 per delegate
Students	Rs. 250 per delegate

For registration or any further queries, please feel free to write back or contact the Student Coordinators at:

Prarthna Kedia                                                            Shambhavi

+91 99868 92464                                                        +91 99457 85819

prarthana.kedia@law.christuniversity.in                    shambhavi@law.christuniversity.in

Trends in Private Equity Investment Structures

1. A report in the Mint demonstrates the popularity of convertible instruments over plain-vanilla equity when it comes to investments by private equity firms.

2. A post on New York Times’ Deal Professor Blog discusses trends in contractual structures for private equity investments from a broader perspective in the wake of the financial crisis. Most of those structures, however, are in the context of buyouts (by private equity firms) which continue to be few and far between in the Indian markets.

More on the Pricing Guidelines for Foreign Investment

(The following post is contributed by Raghav Sharma, who is an associate with a law firm in Delhi)

This post relates to Mr. Somasekhar Sundaresan’s article titled “RBI cuts sorry figure over norms for share transfers” wherein the author has highlighted certain ambiguities arising from the Reserve Bank of India’s (“RBI”) A.P. (DIR Series) Circular No. 49 dated May 4, 2010 (the “May Circular”). This article, which has been published in Business Standard’s edition on June 7, 2010, makes a very interesting reading for those who regularly come across difficult pricing issues in cross border transactions. Below are a few observations regarding the arguments canvassed by Mr. Sundaresan (I hope this would offer some food for thought for all of us):

Argument	Counter
In relation to NRIs and FIIs the new pricing norms stipulated under the May Circular are in conflict with already existing exchange control rules which allow NRIs and FIIs to trade on the stock exchange without adhering to any special pricing norms.	The May Circular amends the pricing guidelines stipulated under A.P. (DIR Series) Circular No. 16 dated October 4, 2004 (the “October Circular”). The May Circular includes NRIs and FIIs in the list of eligible non-resident transferees while prior to this, NRIs and FIIs were not eligible as transferees under the October Circular. However, as per paragraph 4 of the May Circular, it only amends paragraphs 2.2 and 2.3 of the Annex to the October Circular (dealing with pricing) and all other instructions of the October Circular remain unchanged. Paragraph 2.1 of the October Circular (which has not been amended by the May Circular) states that the pricing guidelines stipulated therein are applicable to transfers from residents to non-residents or vice versa, by way of sale under “private arrangement”. The crucial term is “private arrangement” which according to common understanding is a transaction where the buyer and seller know each other’s identities. Such a transaction may also occur on the stock exchange e.g. a block deal. The exchange control rules which allow NRIs and FIIs to sell on the stock exchange without any price restriction are those stipulated under Schedule 3 and Schedule 2 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (“FEMA 20”) respectively, i.e. the portfolio investment route. In such transactions, the buyer and seller do not know the identity of each other and the sale and purchase occurs on the normal segment of the stock exchange. Therefore, there does not appear to be any conflict as argued by Mr. Sundaresan. The only effect of the May Circular is that transfer by a resident to an NRI or an FII under Regulation 10A (b) of FEMA 20 can take place under the automatic route if the pricing guidelines are adhered to. Under the October Circular, NRIs and FIIs were not eligible transferees and thus, transfer by a resident to NRIs or FIIs by way of private arrangement would have required approval under Regulation 10A (b) of FEMA 20.
One of the consequences of applying the SEBI guidelines applicable in case of preferential allotment to transfer of shares of listed companies from residents to non-residents or vice versa would be that in case of companies whose equity shares have been listed for less than six months, the parties could potentially violate the foreign exchange law by either receiving less than the floor price or paying more than the ceiling price.	It seems that the reference in this argument is to Regulation 76(3) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR Regulations”) which requires recomputation of issue price of shares allotted on preferential basis in similar circumstances and payment of differential by the allottee to the issuer company. However, such a consequence does not flow from the text of the May Circular. The May Circular does not incorporate all the provisions of Regulation 76 by reference. It only adopts the SEBI pricing formula as a standard for determining the sale price while taking the relevant date to be the date of purchase or sale of shares. Mr. Sundaresan’s view appears to be a remote possibility as the text of the May Circular does not warrant the conclusion that the specific principle of recomputation specified in Regulation 76(3) was intended to be adopted in the May Circular.
SEBI has not envisaged a preferential allotment being made within two weeks of listing of a company. Thus, the price formula would not work in such cases and as a consequence of this no cross-border transfer of such shares may legitimately take place during such period.	Chapter VII of the ICDR Regulations (which deals with preferential allotment) does not prohibit a preferential allotment within two weeks of listing of a company. Assuming that the period of listing of the company is less than two weeks from the relevant date, Regulation 76(2) provides that where equity shares have been listed for a period less than six months as on the relevant date, then the floor price for allotment has to be higher of the following: (a)    price at which equity shares were issued by the issuer in its initial public offer or value per shares arrived in a scheme of arrangement pursuant to which shares were listed, as the case may be, or (b)   average of weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during the period the shares have been listed preceding the relevant date. There is no provision in the ICDR Regulations which prohibits a preferential allotment being made within two weeks of listing of a company and appropriate pricing formula has been prescribed.

- Raghav Sharma

UK: Consultation Paper on Takeover Bids

While the SEBI Takeover Regulations in India are a subject-matter of detailed review, elsewhere in the U.K. there are proposals for amending certain aspects of the City Code on Takeovers and Mergers. These changes have been necessitated on account of the widespread debate that followed the takeover of Cadbury plc by Kraft Foods Inc. early this year.

Towards that end, the Code Committee of the Takeover Panel has issued a Consultation Paper to review certain aspects of the regulation of takeover bids. The paper includes a detailed discussion of matters such as acceptance condition thresholds, the “disenfranchisement” of shares acquired during an offer period, disclosure of securities holdings, matters relating to advice on takeover offers, inducement fees, and similar matters. While the discussion in the paper may not directly resonate with many of the developments on the takeover front in India, it nevertheless provides conceptual clarity on a number of issues, although it does not attempt to provide any solutions. Overall, it is an interesting read.

25% Free Float Requirement Becomes Law

More than two years following the issue of a discussion paper on the topic, the Ministry of Finance (MOF) has on June 4, 2010 amended the Securities Contracts (Regulation) Rules, 1957 to set a limit of 25% minimum public shareholding for initial listing by companies on Indian stock exchanges as well as continued listing. MOF’s press release accompanying the notification summarizes the new requirements:

a)     The minimum threshold level of public holding will be 25% for all listed companies.

b)    Existing listed companies having less than 25% public holding have to reach the minimum 25% level by an annual addition of not less than 5% to public holding.

c)      For new listing, if the post issue capital of the company calculated at offer price is more than Rs. 4000 crore, the company may be allowed to go public with 10% public shareholding and comply with the 25% public shareholding requirement by increasing its public shareholding by at least 5% per annum.  

d)    For companies whose draft offer document is pending with Securities and Exchange Board of India on or before these amendments are required to comply with 25% public shareholding requirement by increasing its public shareholding by at least 5% per annum, irrespective of the amount of post issue capital of the company calculated at offer price.  

e)     A company may increase its public shareholding by less than 5% in a year if such increase brings its public shareholding to the level of 25% in that year.

f)      The requirement for continuous listing will be the same as the conditions for initial listing.

g)     Every listed company shall maintain public shareholding of at least 25%.  If the public shareholding in a listed company falls below 25% at any time, such company shall bring the public shareholding to 25% within a maximum period of 12 months from the date of such fall.

At a conceptual level, is hard to quarrel with this new streamlined requirement. First, it prescribes a uniform limit of 25% public shareholding for all companies irrespective of what requirements applied to them at the time of their initial listing. Historically, companies were permitted to list at varying levels of public shareholding such as 40%, 25% and 10% thereby causing disparity regarding continuing requirement among listed companies (as previously discussed here). Second, by requiring several companies (including public sector undertakings) whose promoter shareholding is greater than 75% to sell down to the public, the change will induce greater liquidity in the Indian stock markets, which will benefit small investors. Third, by reducing concentration of ownership in Indian companies, it is also expected to result in ancillary benefits such as enhanced corporate governance through greater voice provided to minority shareholders, particularly institutional investors.

However, the new regime is likely to generate some difficulties, at least in the near term. For example, there are doubts about whether the depth of the Indian markets is adequate to absorb the stream of securities offerings that are likely to flood the capital markets. Listed companies too would be under pressure to offer securities to comply with the new requirements without having regard to market conditions, which may in turn impact valuations. Even from a legal and regulatory perspective, the devil, as usual, lies in the detail, and some elements of the new regime continue to elude clarity. For instance, while the expression “public” is defined to include persons other than the “promoter and promoter group”, the latter expressions are defined widely. Even the scope of the expression “control”, which is a crucial element of the definition of “promoter” is a subject-matter of litigation (as previously discussed here), and the issue is currently pending before the Supreme Court. Finally, the consequences of violating these new provisions assume importance. Although various options such as delisting, penalty and fine are available generally under the Securities Contracts (Regulation) Act, the appropriate and effective utilization of these remedies by the regulators would determine the success of the effort towards diffusing shareholding in the Indian capital markets.

Ostensible Authority and Indoor Management: Possible Implications of MRF v. Parrikar

In MRF Ltd. v. Manohar Parrikar (Civil Appeals No. 4219 and 4220 of 2010, decided on May 3, 2010), the Supreme Court of India highlighted some aspects of the operation of the indoor management rule (or the rule in Turquand’s case). While the issue before the Court was a matter of public law and reference was made to indoor management only as an analogy, the decision is noteworthy as it is perhaps the first time that the Supreme Court has analysed the rule in some detail.

The case before the Supreme Court arose from an appeal against a decision of Panaji Bench of the Bombay High Court, which involved a public interest petition questioning the legality of two notifications issued by Government of Goa in respect of grant of 25% rebate u/s 23 of the Electricity Act, 1910 to certain industrial consumers of electricity. The indoor management rule became relevant because of a contention taken that the conduct of some governmental authorities in the course of their activities is within the indoor management of the authorities; and the procedure must be taken to have been properly complied with. The analogy is somewhat far-fetched; and in fact, the Court cited its previous judgment in S. Dhawan v. Shaw Bros., (1992) 1 SCC 534, on the dangers of private law analogies before commencing its discussion on the point. The Court did go ahead and examine the nature of the indoor management rule to conclude that the analogy was in any case inapplicable. 

After discussing the leading judgment of Royal British Bank v. Turquand, the Court said, (The rule of constructive notice) prevents the outsider from alleging that he did not know that the constitution of the company rendered a particular act or a particular delegation of authority ultra vires. The doctrine of indoor management is an exception to the rule of constructive notice. It imposes an important limitation on the doctrine of constructive notice. According to this doctrine, persons dealing with the company are entitled to presume that internal requirements prescribed in memorandum and articles have been properly observed. Therefore doctrine of indoor management protects outsiders dealing or contracting with a company, whereas doctrine of constructive notice protects the insiders of a company or corporation against dealings with the outsiders. However suspicion of irregularity has been widely recognized as an exception to the doctrine of indoor management. The protection of the doctrine is not available where the circumstances surrounding the contract are suspicious and therefore invite inquiry…” On facts, the Court held that the ‘suspicion of irregularity’ threshold was satisfied in the case; and reliance on analogies of the indoor management rule was inapplicable. 

What is significant about the decision from a company law perspective is that it recognizes explicitly that indoor management operates as an exception to constructive notice. It must follow from this that indoor management does not have any authority-granting power on its own. Even before invoking the rule, it must be shown that the agent was acting within the scope of his ostensible authority. Unless this is shown, the question of constructive notice does not arise at all – and if the question of constructive notice does not arise, then there is no scope for invoking an exception to constructive notice.

Consequently, indoor management operates only when – once authority is established – the company pleads it is not bound under the constructive notice rule. In other words, the indoor management rule is a presumption that ostensible authority has not been curtailed by the principal’s instructions (this presumption can arise with constructive notice in some cases) – it is not a presumption that ostensible authority exists in the first place. As a leading authority on the law of agency, Prof. Peter Watts, notes, “there is a fallacy among lawyers that there is a presumption of regularity that automatically operates with company contracts… reference was usually made to ‘the rule in Turquand’s case’, or the ‘indoor management rule’. But this misunderstands that rule… The presumption of regularity kicks in only once the plaintiff has established that there was a holding out of the relevant agent as having authority to make a contract of the relevant sort …” See: Peter Watts, “Company Contracts and Reckless Trading: Re Global Print Strategies Ltd.”, 15 New Zealand Business Law Quarterly 3 (2009).

This position – which on first principles appears to be the correct one – has been explicitly recognised in other jurisdictions. For instance, it has been held in Northside Developments Pty Ltd v Registrar-General, (1990) 170 CLR 146 that the rule “only has scope for operation if it can be established independently that the person purporting to represent the company had actual or ostensible authority to enter into the transaction. The rule is thus dependent upon the operation of normal agency principles; it operates only where on ordinary principles the person purporting to act on behalf of the company is acting within the scope of his actual or ostensible authority…”

There are however some observations of some High Courts in India holding that indoor management can be used for raising a presumption as to the existence of authority itself. The remarks of the Supreme Court could serve to clarify the position of law on this point; that being an exception to constructive notice, indoor management only gives back what constructive notice takes away. It cannot give back more than what constructive notice took away.

Encapsulating the Investor-State Dispute Settlement (ISDS) Regime of 2009

(The following post is contributed by Rohan Bagai, who is a corporate lawyer at one of the leading law firms in India. He holds a Master of Laws (LL.M.) degree from New York University School of Law (NYU), New York with a specialization in corporate laws)

The American Society of International Law (ASIL) recently posted “The United Nations Conference on Trade and Development (UNCTAD) report on the ‘Latest Developments in Investor-State Dispute Settlement’” [IIA Issues Note No.1 (2010)] (the “Report”) in its electronic publication, ‘International Law in Brief’ (ILIB).

The Report recapitulates the developments for the year 2009 as regards the ‘treaty based investor-State dispute settlement’ cases filed under International Investment Agreements (IIAs), recording the number of cases filed, the respondent countries i.e. the nations that have faced investment treaty arbitrations, the institutions/venues where the claims were initiated, the count of the decisions/awards rendered etc.

The Report sketches out noteworthy arbitral awards rendered in the year 2009 on substantive issues relating, inter alia, to the definition of ‘investment’, most favored nation (MFN) treatment, expropriation, compensation, fair and equitable treatment and full protection and security. In addition, it addresses procedural issues related to rules and standards in arbitration, which include burden of proof, annulment mechanism, challenge to arbitrators, damages, arbitration costs etc.

Given the deviating interpretations and distinct approaches followed by tribunals in a plethora of decisions adjudicated in the year 2009, diverging (and sometimes conflicting) awards have been on a rise. Besides, there is an emerging trend of dissenting opinions by one of the members of the tribunal ensuing uncertainty in the IIA regime.

The Report further observes that there have been earnest attempts made by IIA envoys and negotiators across the world in order to tackle concerns relating to high arbitration costs, lack of transparency, public inquiry etc. Some countries have even set in motion the process of revising the controversial treaty provisions with a view to clarify the scope of these provisions and ensure a more coherent and consistent interpretation.

All in all, the Report is an invaluable resource for investment law practitioners as it provides an all-inclusive appraisal of the significant decisions/awards of 2009.

- Rohan Bagai

Easy Exit for Defunct Companies

The inability to expeditiously close down businesses or companies in India often forms the subject matter of critical comment about doing business in India. In order to address this drawback, the Ministry of Corporate Affairs (MCA) has issued the Easy Exit Scheme, 2010 under which inoperative companies (“defunct companies” to use the technical expression) are given an opportunity to get their names struck off the register under Section 560 of the Companies Act, 1956.

This scheme is in effect from May 31, 2010 to August 31, 2010. Companies that wish to avail of this scheme should ensure that they take the necessary steps within this relatively short window.

While this scheme may enable smoother procedures under the Companies Act, its success may be circumscribed by a fairly long list of situations where the Easy Exit Scheme is not available. These include:

(a) listed companies;

(b) companies registered under section 25 of the Companies Act, 1956;

(c) vanishing companies;

(d) companies where inspection or investigation is ordered and being carried out or yet to be taken up or where completed prosecutions arising out of such inspection or investigation are pending in the court;

(e) companies where order under section 234 of the Companies Act, 1956 has been issued by the Registrar and reply thereto is pending or where prosecution if any, is pending in the court;

(f) companies against which prosecution for a noncompoundable offence is pending in court;

(g) companies accepted public deposits which are either outstanding or the company is in default in repayment of the same;

(h) company having secured loan ;

(i) company having management dispute;

(j) company in respect of which filing of documents have been stayed by court or Company Law Board(CLB) or Central Government or any other competent authority;

(k) company having dues towards income tax or sales tax or central excise or banks and financial institutions or any other Central Government or State Government Departments or authorities or any local authorities.

In other words, this scheme would help companies that have absolutely no pending obligations or dues owed to authorities. Hence, where the closure of companies requires the involvement of other contractual parties or the Government (such as the tax authorities), there could be obstacles in getting companies struck off the register in a timely manner. It is hard to argue with that logic (which has a larger social purpose) because defaulting companies cannot be permitted to avoid their existing obligations under law by closing down.

Separately, the MCA has issued the Company Law Settlement Scheme, 2010, which provides “an opportunity to the defaulting companies to enable them to make their default good by filing belated documents and to become a regular compliant in future”. This scheme too is in effect from May 31, 2010 to August 31, 2010.