Monday, November 29, 2010

Further Observations on SEBI’s Order in the Sahara Case

(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)
Further to the earlier post on this Blog, a few aspects that emerge from the order are as follows:
(a) SEBI has come to the conclusion that OFCDs issued by SIRECL and SHICL are securities issued to the public and therefore such issue has to be in accordance with SEBI (ICDR) Regulations. SEBI has come to this conclusion on the presumption that the offer has been made to more than 50 members at a time and hence this constitutes a public offer.

However, a careful reading of the proviso to Section 67(3) gives rise to another point of view. For the sake of ready reference I am reproducing the proviso to Section 67(3):
“Provided that nothing contained in this sub-section shall apply in a case where the offer or invitation to subscribe for shares or debentures is made to fifty persons or more.”
Use of the expression “the” becomes very important from the perspective of interpretation. It suggests that ‘each offer shall not be made to 50 persons or more’ such that the offer is a private offer and not public offer. Therefore, the number of persons which is 50 or more must be read in the context of each and every offer made by the Company. If a Company makes an offer on a daily (regular) basis, each offer could arguably be a separate offer and such offer if made to less than 50 persons would not make such issue to be a public issue. Where shares are offered based on a single information memorandum of an even date, then an offer made to 50 or more persons would constitute it as an offer to the public.

(b) From the order passed by SEBI, it is understood that SIRECL and SHICL have wrongly submitted that private placement of debentures made under Section 81(1A) of the Companies Act, 1956 means that such issue of debentures is not a public issue. Section 81(1A) as rightly held by SEBI prescribes the procedure for issue of shares to persons other than existing shareholders of the company. It has nothing to do with determining whether the issue is public issue or private placement. In fact, sub section (3) of Section 81 states that provisions of Section 81(1A) are not applicable to increase of subscribed capital of a public company caused by an exercise of an option attached to the debentures issued by the Company to convert such debentures into shares in the Company.

The proviso to Section 81(3) states that the terms of issue of such debentures include a term providing for such option and such term has been approved by the Central Government before issue of debentures or the issue of such debentures is in conformity with the rules laid down by the Government, which rules are Public Companies (Terms of issue of debentures and Raising of Loans With Option to Convert Such Debentures or Loans to Shares) Rules, 1977. After the advent of SEBI under Section 55A, now SEBI (ICDR) regulations also need to be complied with.

(c) Further, Section 60B does not provide an alternate route for issue of securities. In fact the information memorandum as prescribed in Section 2(19B) is a method adopted for determining the demand available in the market for the securities proposed to be issued to enable the Company fix price a band for the securities proposed to be issued. The moment offer is made to 50 or more persons, the provisions of public issue in the Companies Act and SEBI (ICDR) Regulations are attracted.

(d) Section 55A also makes it amply clear that SEBI has jurisdiction in respect of matters pertaining to Sections 55 to 58, 59 to 81 etc. which includes Section 60B, Section 67 and Section 73. As per sub section (3) of Section 60B, all obligations as applicable to prospectus are applicable to information memorandum and to red herring prospectus. As per Section 73, every company intending to offer shares or debentures to the public for subscription by issue of prospectus shall, before making such issue, make an application to one or more recognized stock exchanges for permission for the shares or debentures intending to be so offered to be dealt with in the stock exchange or each such stock exchange.

(e) Section 73 states that if the issue (shares or debentures) is made to the public, the application to the Stock exchanges for listing is mandatory and there is no option left open to the Company to escape from the provisions of listing of these shares/debentures. Therefore, by virtue of Section 73(1), the moment shares/debentures are issued to the public it is presumed that they are intended to be listed on the stock exchanges. In such a scenario, Section 55A is automatically invoked granting jurisdiction to SEBI to monitor such issues and to ensure that such issues of shares/debentures are in accordance with SEBI (ICDR) Regulations.
From the information based on which SEBI has passed the order it seems that the issue of OFCDs by SIRECL and SHICL is a public issue which is within the jurisdiction of SEBI entitling it to monitor and exercise control over such issues.

- Vijay Kumar

Saturday, November 27, 2010

A Season For Insider Trading Probes

in the U.S. (involving the hedge fund industry),

… as well as in India (involving certain large financial institutions and companies) arising out of the so-called loan scam.

The larger question is whether (and how) the investigations would be pursued to their logical conclusion resulting in effective enforcement of the regulations, which is never an easy task in the case of insider trading.

The Court of Appeals on Dishonest Assistance

The United Kingdom Court of Appeals recently considered an interesting case concerning the standard of dishonesty required to hold a person guilty of assisting in the breach of trust. The factual background in Starglade Properties v. Roland Nash is complex, but for the purposes of this discussion, it is sufficient to note that as a result of certain contractual obligations, Larkstore Ltd., the company of which the defendant Mr. Nash was the sole director, held certain amounts in trust for the claimants Starglade Properties Ltd. However, in breach of this trust, Mr. Nash distributed large parts of the amount held to several persons. On facts, it was not argued that these payments in themselves were fraudulent, and they were considered to be discharges of debt. However, it was established on facts that all the debts discharged were owed to people who were connected with Mr. Nash. Also, it was established that although Mr. Nash had legal advice, that legal advice was vague, and only dealt with the question of whether he could pay off the largest creditor (which was not ultimately paid off) in preference to Starglade.

The crux of the appeal hinged around what the legal test for determining dishonesty is. The High Court Judge, Nicholas Strauss QC, came to the following conclusion,

The question whether a company director may prefer some creditors over others is not one to which most people would know the answer as a matter of law, nor in my judgment would there be a general view as to what was honest or dishonest in this connection. It might well be dishonest to prefer creditors having received advice that it was unlawful, or having actual knowledge of the decided cases referred to above establishing that it was unlawful, but not in my view otherwise. In the absence of such specific advice of knowledge, Mr. Nash's conduct was not conduct which would have transgressed generally accepted standards of commercial behaviour on the part of a person in his position, even if he had had greater commercial experience. His lack of experience and lack of understanding as to the legal position are additional relevant factors. [emphases supplied]

The meaning of dishonest assistance has had a chequered history in English law, with two Privy Council decisions, and one House of Lords decision, arriving at seemingly different conclusions. Lord Nicholls, in Royal Brunei Airlines v Tan, [1995] 2 AC 378, observed that honesty is to be determined by an objective standard, but “does have a strong subjective element in that it is a description of a type of conduct assessed in the light of what a person actually knew at the time, as distinct from what a reasonable person would have known or appreciated.” At the same time, he also clarified that “these subjective characteristics of honesty do not mean that individuals are free to set their own standard of honesty in particular circumstances”. The House of Lords however, in Twinsectra Ltd v Yardley, [2002] 2 AC 164, complicated matters. Lord Hutton, approved of the test laid down by Lord Nicholls, observing, “I consider that the courts should continue to apply that test and that your Lordships should state that dishonesty requires knowledge by the defendant that what he was doing would be regarded as dishonest by honest people, although he should not escape a finding of dishonesty because he sets his own standards of honesty and does not regard as dishonest what he knows would offend the normally accepted standards of honest conduct”.

The House of Lords thus added two components to Lord Nicholls’ test- (1) that while the conduct need not be dishonest according to the defendant’s subjective standards of honesty, it needs to be dishonest according to the beliefs of reasonable and honest people; and (2) that the defendant should know that his conduct is dishonest according to the beliefs of reasonable and honest people. The second of these additions was successfully challenged before the Privy Council in Barlow Clowes Ltd v Eurotrust Ltd, [2006] 1 WLR 1476. Lord Hoffman observes that Lord Hutton’s speech was “intended to require consciousness of those elements of the transaction which make participation transgress ordinary standards of honest behaviour. It did not also to require him to have thought about what those standards were”.

So, the position that seems to emerge from the three decisions discussed above is that the conduct of a person is to be determined in light of his knowledge at the time of his act (subjective), and whether such conduct was dishonest given his knowledge is to be determined by the beliefs of reasonable and honest people (objective). On facts here, Mr. Nash was aware that he was preferring other creditors over Starglade. He was also aware that the company was bound to make the payment to Starglade since the money was held in a trust for Starglade. Thus, the question to be asked according to the Court of Appeals was whether such a frustration of Starglade’s rights could be considered as being honest.

It was argued by the counsel for Mr. Nash that his conduct was not something that would be considered dishonest in the commercial world. This clearly derived some force from the first addition which Twinsectra had made to Royal Brunei Airlines. However, the Court of Appeals rejected this argument, observing that,

The relevant standard, described variously in the statements I have quoted, is the ordinary standard of honest behaviour. Just as the subjective understanding of the person concerned as to whether his conduct is dishonest is irrelevant so also is it irrelevant that there may be a body of opinion which regards the ordinary standard of honest behaviour as being set too high. Ultimately, in civil proceedings, it is for the court to determine what that standard is and to apply it to the facts of the case.

...

the question was whether the relevant conduct of Mr Nash in seeking to frustrate Starglade, given that he knew that Larkstore was insolvent but otherwise had sufficient assets to pay a dividend to its creditors, was dishonest. The deputy judge never looked at that issue. He concentrated on whether payments to or security given to Glancestyle might be set aside in due course by a liquidator of Larkstore. No advice was sought or given on what Mr Nash proposed to do or did or his reasons for doing so. The deliberate removal of the assets of an insolvent company so as entirely to defeat the just claim of a creditor is, in my view, not in accordance with the ordinary standards of honest commercial behaviour, however much it may occur. Nor could a person in the position of Mr Nash have thought otherwise notwithstanding a lack of understanding as to the legal position.

Thus, the test for determining whether a particular act amounts to dishonest assistance of a breach of trust is whether given the knowledge of the defendant, the acts alleged to be assisting the breach would be considered dishonest by objective standards. In that sense, the test does not depart from that which emerged after Barlow Clowes. However, what the Court of Appeals does clarify is the nature of objective inquiry. When talking of ‘the beliefs of reasonable and honest people’, it is not the actual subjective beliefs of people that is conclusive, but the hypothetical reasonable man test adopted in many different areas of the law.

Friday, November 26, 2010

Offering of Debentures: SEBI’s Order in the Sahara Case

Earlier this week, SEBI issued an order restraining two entities of the Sahara group as well as certain promoters and directors from accessing the capital markets. While Sahara Prime City Limited had filed its draft red herring prospectus (DRHP) with SEBI in connection with its proposed IPO, SEBI received complaints that its group companies Sahara India Real Estate Corporation Limited (SIRECL) and Sahara Housing Investment Corportion Limtied (SHICL) were issuing optionally fully convertible debentures (OFCDs) to the public and that was not disclosed in the DRHP. The company argued that the OFCDs were being offered only to friends/associates/employees and that they were being issued pursuant to an information memorandum filed with the Registrar of Companies (ROC).

The key questions were whether such offering of the OFCDs was within the purview of SEBI, and if so whether they should have been offered pursuant to an offering document registered with SEBI. On the merits, SEBI concluded as follows:
1. Any offering of securities to 50 persons or more is a public offering by virtue of Section 67(3) of the Companies Act, 1956. It does not matter whether the offerees are all identified or whether they belong to a close group of associates.

2. The mere fact that the offering is supported by a special resolution of the issuing company’s shareholders under Section 81(1A) of the Act does not override the requirement to comply with the provisions regarding public offering and registration of prospectus.

3. The fact that the issuer has filed a red herring prospectus with the ROC indicates that the OFCDs were intended to be offered to the public.

4. Every company offering securities to the public is required to seek approval for listing of the securities on one or more recognised stock exchanges. SEBI observed: “The requirement of listing in respect of a public issue is to ensure that the subscribers to the shares or debentures have a facility to approach a stock exchange for having their holdings converted into cash, whenever they desire and to provide liquidity and exit opportunity to the investors, especially in case when the offer is made to large number of investors (50 or more).”

5. Section 60B of the Companies Act (dealing with information memorandum) does not prescribe an alternate procedure that enables issuers to overcome the obligation to comply with provisions of the Act relating to public offering.
In arriving at its conclusion, SEBI refused to accept the contrary position adopted by the company, which was supported by legal opinions. SEBI’s order observes:
Given this background, I note that the issuances of securities by the said companies, ostebsibly by an interpretation of the phrase in Section 60B of the Act, as discussed previously, challenges the basic fabric of how a company can access funds from the public. If left unchecked, it leads to further unbridled solicitation of money from the public at large, without complying with the statutory requirements, without adequately disclosing the risks involved, and without adhering to other checks and balances built-in to protect the interest of the investors.

The contentions given by the companies are prima facie devoid of any merit. I have little hesitation in observing that these merely are put forward to defeat the whole purpose of the statutes that govern public issues and other incidental requirements. … If companies are allowed to go ahead in such a manner and raise vast sums of capital in the guise of private placement, it would be a mockery of the entire capital market framework and all established mechanisms to protect investor’s interest.
It is hard to disagree with SEBI’s conclusion and reasoning. Although there was previously some ambiguity on what constitutes a public offering of shares, that was put to rest with the Companies (Amendment) Act, 2000 which introduced the numerical test of offering to 50 persons or more in order to constitute a public offering. This test may be criticized as being too rigid and inflexible, but it is clearly an objective test leaving little room for ambiguity.

(Update - December 2, 2010: It has been reported that the Sahara Group has filed a petition before the Allahabad High Court challenging SEBI's order)

Thursday, November 25, 2010

Proxies for Shareholders; Alternates for Directors

A column in today’s Business Line by S. Murlidharan analyzes the appointment of proxies by shareholders to attend general meetings as compared to the appointment of alternate directors on the board. Although the author alludes to the “shareholder’s proxy” and “director’s proxy” (the latter being the alternate director), he highlights the all-important difference between the two: while the proxy for general meeting is appointed by the relevant shareholder, an alternate director is appointed by the board. This gives rise to certain fundamental legal distinctions between the two concepts.

A proxy is created through the concept of agency whereby the proxy is conferred authority by the principal (being the shareholder). Consistent with the principles of agency, the acts of the agent (proxy) will bind the principal (shareholder) as the votes of the proxy on a poll are recognized as votes of the shareholder. A proxy merely gives effect to the intention of the shareholder, except in the case of a discretionary proxy where the proxy can decide which way to vote.

The position of an alternate director is altogether different from a legal perspective. As the column notes, an alternate director is not appointed by the original director but rather by the board. More importantly, the alternate director is not an agent of the original director; the concept of agency does not come into the picture at all. Consequently, the alternate director’s actions are not attributable to the original director. The alternate director will be subject to all the duties, responsibilities and liabilities like any other director. The column, however, raises the interesting question regarding alternates for executive directors, as company law does not prohibit such a possibility. The appointment of such alternates ought to take into account the nature and position of executive directors. Individuals occupying such a position are directors under company law and they, in addition, possess executive powers and functions. While appointing an alternate for an executive director, the board should not only appoint such a person as a director on the board, but should also vest all the executive powers as appropriate. That leaves the question of whether the alternate director does possess all the skill and competence in order to be able to exercise such executive functions.

In all, the column raises some interesting questions about the continued relevance (or obsolescence) of the concepts such as proxy and alternate directors given advances in technology.

Ownership and Governance of Market Infrastructure Institutions

The report of the Bimal Jalan committee on “Review of Ownership and Governance of Market Infrastructure Institutions” is now available on SEBI’s website for public comments (due on December 31, 2010). The report makes a number of key recommendations regarding the ownership structure and corporate governance norms pertaining to three key institutions providing securities market infrastructure, being the stock exchanges, clearing corporations and depositories. Of the three institutions, matters relating to stock exchanges have evoked the greatest amount of debate recently.

On the one hand, stock exchanges are crucial to a country economic infrastructure and they perform a public function by engaging in regulatory supervision over companies that are listed on it. On the other hand, stock exchanges need to evolve their businesses and practices through innovation and competition fuelled by private entrepreneurship and capital investments. The committee report essentially attempts to reconcile these somewhat conflicting objectives. This it does so by: (i) imposing restrictions on maximum ownership of market infrastructure institutions (MIIs), (ii) providing greater means of attracting long-term committed “anchor” financial investors rather than short-term investors or speculators, (iii) prohibiting listing of MIIs, (iv) prescribing stringent corporate governance norms for such institutions, including the appointment of public interest directors.

As we have previously discussed on this Blog, the crucial element of regulation of MIIs, and particularly stock exchanges, is the conflicts of interest they create: “stock exchanges are not only profit-making institutions that are companies in form and substance, but they also carry out a regulatory role in respect of companies that are listed on them.” The committee report is helpful as it discusses (on pages 22 and 23) the various methods by which such conflicts have been addressed:
Strong Exchange SRO Model: A public authority is the primary regulator, it relies on Exchange(s) to perform extensive regulatory functions that extend beyond its market operations, including regulating member’s business conduct. Examples: US (CME), Australia (ASX), Japan (TSE, OSE), Malaysia (Bursa Malaysia).


India has adopted the strong exchange SRO model. It is premature to think of the ‘independent SRO model’ [where the exchange performs extensive regulatory functions] in the Indian context given its evolution over a period to is present state; the government model may not be entirely possible in the Indian context considering the size of the market. However, due to the potential conflict of interest in the strong exchange SRO model, the Committee is of the view that SEBI must take a more active role in setting a level playing field with regard to fees, entry, etc. of members of MIIs.
In order to address these conflicts in terms of process, the Committee has recommended that regulatory functions of the exchange (such as risk management, surveillance, listing, enforcement, etc.) should report directly to an independent committee of the board consisting of a majority of public interest directors and also to the CEO (through dual reporting).

The detailed recommendations of the committee have been summarized and analysed here, here and here.

While imposing high barriers to entry into the market infrastructure sector will ensure quality and integrity of players, there exist arguments to the contrary that such a regime will encourage monopolistic behavior and discourage the useful effects of competition.

Friday, November 19, 2010

Some further thoughts on Iridium/Motorola: Deviating from Meridian?

As Mr. Umakanth discussed in this post, the Supreme Court of India in Iridium India Telecom v. Motorola Inc. (Criminal Appeal No. 688 of 2005, judgment dated October 20, 2010) has confirmed that companies can be prosecuted for offences involving mens rea. The Court in Iridium appears to have approved of the theory through which the intention of the directing mind and will of a company is attributed to the company. The Supreme Court has expressly approved of Lord Denning’s comparison of the company with a human body; and has also approved of the decision in Tesco v. Natrass.

Lord Denning and Tesco:

Lord Denning had stated in H.L. Bolton (Engg.) Co. Ltd. v. T.J.Graham, [1957] 1 QB 169, “A company may in many ways be likened to a human body. They have a brain and a nerve centre which controls what they do. They also have hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will. Others are directors and managers who represent the directing mind and will of the company, and control what they do. The state of mind of these managers is the state of mind of the company and is treated by the law as such. So you will find that in cases where the law requires personal fault as a condition of liability in tort, the fault of the manager will be the personal fault of the company. That is made clear in Lord Haldane's speech in Lennard's Carrying Co. Ltd. v. Asiatic Petroleum Co. Ltd. (AC at pp. 713, 714). So also in the criminal law, in cases where the law requires a guilty mind as a condition of a criminal offence, the guilty mind of the directors or the managers will render the company themselves guilty…” 

In Tesco Supermarkets v. Nattrass, Lord Reid clarified the distinction between primary liability through attribution and vicarious liability, and observed, “I must start by considering the nature of the personality which by a fiction the law attributes to a corporation. A living person has a mind which can have knowledge or intention or be negligent and he has hands to carry out his intentions. A corporation has none of these; it must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company. There is no question of the company being vicariously liable. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is guilty mind then that guilt is the guilt of the company. It must be a question of law whether, once the facts have been ascertained, a person in doing particular things is to be regarded as the company or merely as the company's servant or agent. In that case any liability of the company can only be a statutory or vicarious liability.

The decision in Meridian:

It is noteworthy that in Meridian Global Funds Management Asia Ltd. v. The Securities Commission, [1995] UKPC 5, Lord Hoffman specifically rejected what he called the “anthropomorphism” of Lord Denning. Lord Hoffman noted, “But this anthropomorphism, by the very power of the image, distracts attention from the purpose for which Viscount Haldane said he was using the notion of directing mind and will, namely to apply the attribution rule derived from section 502 (of the relevant Act in Lennard’s case) to the particular defendant…” In Lord Hoffman’s inimitable style, the question “is one of construction not of metaphysics”. The principles in relation to attribution were then summarised (after taking into account Tesco, as well as In Re Ready Mixed Concrete [a decision which is not noticed by the Supreme Court in Iridium]) in a passage which is now widely regarded as laying down the correct position of English law on the point of when attribution may occur:  

The company's primary rules of attribution (by this, Lord Hoffman means the rules in the companies constitutional documents) together with the general principles of agency, vicarious liability and so forth are usually sufficient to enable one to determine its rights and obligations. In exceptional cases, however, they will not provide an answer. This will be the case when a rule of law, either expressly or by implication, excludes attribution on the basis of the general principles of agency or vicarious liability. For example, a rule may be stated in language primarily applicable to a natural person and require some act or state of mind on the part of that person "himself", as opposed to his servants or agents. This is generally true of rules of the criminal law, which ordinarily impose liability only for the actus reus and mens rea of the defendant himself. How is such a rule to be applied to a company? One possibility is that the court may come to the conclusion that the rule was not intended to apply to companies at all; for example, a law which created an offence for which the only penalty was community service. Another possibility is that the court might interpret the law as meaning that it could apply to a company only on the basis of its primary rules of attribution, i.e. if the act giving rise to liability was specifically authorised by a resolution of the board or a unanimous agreement of the shareholders. But there will be many cases in which neither of these solutions is satisfactory; in which the court considers that the law was intended to apply to companies and that, although it excludes ordinary vicarious liability, insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy.

Thus Lord Hoffman qualified what appear to be absolute statements in Bolton and Tesco; to suggest that while a company will be imputed with mens rea of its directing mind, who that directing mind is will depend on the specific interpretation of the relevant statutory provisions.

The Meridian test under Indian Law:

The judgment of the Supreme Court however does not mention the decision in Meridian, and whether this Meridian principle applies in India or not is thus an open question. (This is somewhat surprising – Meridian is widely regarded as the locus classicus on the subject in general and the facts in Meridian also were concerned with securities transactions. The difference is of course that – as Mr. Umakanth has pointed out – the complaint in Iridium was under the IPC and not under securities legislation. I am not sure however that this is enough to completely distinguish Meridian) The Court has stated, “The criminal liability of a corporation would arise when an offence is committed in relation to the business of the corporation by a person or body of persons in control of its affairs. In such circumstances, it would be necessary to ascertain that the degree and control of the person or body of persons is so intense that a corporation may be said to think and act through the person or the body of persons.” This perhaps indicates that the Supreme Court has adopted a “one size fits all” approach; treating the issue of ‘who is the directing mind and will’ as a question independent of the underlying statutory provision, contrary to the approach in Meridian. It appears that the test is the same regardless of the statutory language of the provisions concerned. For example, there may be several situations where a statutory construction approach would indicate that the acts of (say) a local manager could be attributed to the company. The Supreme Court’s test of the entire corporation “thinking and acting” through such person need not be satisfied. The difference between the Supreme Court’s approach and the Meridian approach can be illustrated through an example. Let us suppose that a statute punishing environmental pollution requires mens rea. A local branch manager of a company branch which has caused the relevant actus has the required mens rea. Is his mens rea to be imputed to the company? Under the Meridian statutory construction approach, this would be an arguable case dependant on the wordings of the statute – it could be argued that the relevant mens rea under the statute specifically was the mens rea of the person in charge of the polluting unit. On the other hand, a strict application of the Supreme Court’s decision in Iridium would not leave such a possibility open at all (unless of course the Chairman/Board of Directors/senior executives also had the relevant mens rea). (The facts in Meridian itself also show how the tests are different.)

Other related issues:

Another aspect which the Supreme Court has not dealt with is whether there can be any exceptions to the attribution – once it is admitted that a person is the directing mind and will, can there still be cases where attribution should not take place? One instance comes to mind – when the directing mind is himself playing a fraud on the company; or when the company is a victim of the directing mind’s criminal/fraudulent acts. The decision of the Canadian Supreme Court in Canadian Dredge & Dock suggests that such an exception does exist. The Supreme Court in India has in one sentence approved of the general Canadian position on the point; but without any specific reference to this issue. We have discussed some similar issues in relation to the decision of the House of Lords in Stone & Rolls v. Moore Stephens elsewhere. Admittedly, the case before the Supreme Court was an appeal against a quashing petition under Section 482 of the Code of Criminal procedure, so possible exceptions would not be in issue before the Court. However, the issue is likely to be important in an analysis of the Indian law on attribution as a whole; and is still an unsettled one.

Corporate Criminal Liability: The Iridium/Motorola Case

The judgment of the Supreme Court in Iridium India Telecom Ltd. v. Motorola Inc. is now available on JUDIS (date: 20 October 2010).

M.J. Antony has a summary and analysis of the case in the Business Standard:
The question of punishing a corporation came up recently in the Supreme Court in a criminal case filed by Iridium India Telecom Ltd against Motorola Incorporated. The allegations were cheating and criminal conspiracy. The magistrate in Pune started proceedings against Motorola. It moved the Bombay High Court against the prosecution. The high court quashed the proceedings giving several reasons, one of them being that a corporation was incapable of committing the offence of cheating as it has no mind. According to the high court, although a company can be a victim of deception, it cannot be the perpetrator of deception. Only a natural person is capable of having a guilty mind to commit an offence.

However, the Supreme Court set aside the high court’s finding and asserted that a corporate body can be prosecuted for cheating and conspiracy under the Indian Penal Code. The offences for which companies can be criminally prosecuted are not limited only to the specific provisions made in the Income Tax Act, the Essential Commodities Act, and the Prevention of Food Adulteration Act. Several other statutes also make a company liable for prosecution, conviction and sentence.

The court allowed the prosecution to go on, stating that companies and corporate houses can no longer claim immunity from criminal prosecution on the ground that they are incapable of possessing the necessary mens rea for the commission of criminal offences. The legal position in England and the United States has now crystallised to leave no manner of doubt that a corporation would be liable for crimes of intent. This is the position all over the world where rule of law supreme.
In its ruling, the Supreme Court reiterated the legal position on two counts: (i) the scope of jurisdiction of the High Court in quashing criminal proceedings under Section 482 of the Criminal Procedure Code; and (ii) the fact that companies can be prosecuted for offences involving mens rea. On the second count, the Supreme Court merely reiterated the principles laid down in the previous case of Standard Chartered Bank v. Directorate of Enforcement [(2005) 4 SCC 405].

The Supreme Court, however, did not have the opportunity to rule on certain other important aspects of the case, which relate to the liability of a company for misstatements or non-disclosures in an information memorandum issued in connection with an offering of securities. That would be the subject-matter of the prosecution that would continue now that the Supreme Court has flashed the green signal.

The criminal complaint pertains to a charge of cheating under section 420 read with section 120B (conspiracy) under the Indian Penal Code (I.P.C.). The allegation is that Motorala Inc., the respondent in the case and the primary contractor for the Iridium system/project, floated a private placement memorandum (PPM) to obtain funds/investments to finance the Iridium project. The project was “represented as being the world’s first commercial system designed to provide global digital hand held telephone data … and it was intended to be a wireless communication system through a constellation of 66 satellites in low orbit to provide digital service to mobile phones and other subscriber equipment locally.” Several financial institutions invested in the project based on the information contained in the PPM. However, it is alleged that the representations were false and that the project turned out to the commercially unviable resulting in significant loss to the investors.

The facts of the case provide the basis for potentially interesting legal issues.

First, it must be noted that the complaint has been brought under the I.P.C. (being the general criminal law) and not under any specific corporate or securities legislation. That is understandable because the PPM did not pertain to a “public” offering of shares, and hence the relevant prospectus provisions (and concomitant liability issues therein) are not attracted. The transaction appears to be in the nature of a private placement and hence governed contractually rather than as a matter of public securities laws. Whether or not the use of general offences of cheating and conspiracy to offerings of corporate securities would enure to the benefit of the complainant or the respondent remains to be seen.

Second, the issuer has placed reliance on the extensive nature of risk factors and disclaimers in the PPM as a defence against criminal liability. Although the High Court was persuaded by the existence of such cautionary language in the PPM, the Supreme Court did not place much importance to risk factors, at least at the present stage of deciding whether to allow the prosecution to continue. The validity of, and weightage given to, disclaimers and risk factors in a PPM is sure to be tested.

Third, it would be necessary to consider the question whether sophisticated investors such as financial institutions would be held to a higher standard while considering whether there had been “deception” practised by the issuer company.

Finally, the court would have to draw a clear line on the facts as to whether there was deception and inducement “fraudulently and dishonestly” on the part of the issuer company, or whether it was merely a case of bad business judgment. Although the distinction may be fairly stark as a matter of law, it may not always be quite as clear on a given set of facts and circumstances.

Thursday, November 18, 2010

Disclosure as an Instrument of Securities Regulation

The almost universally accepted strategy for securities regulation is to require issuers to make adequate disclosures in offering documents. The role of the regulators is to determine the extent of disclosures required. It is then left to investors to rely upon the disclosures and to make a decision as to whether to invest or not. Sophisticated investors such as financial institutions rely on their internal personnel such as analysts to decipher the information in the disclosures, while retail investors tend to pay heed to analyst reports of brokerage houses or analysis by the media or even simply rely on their own intuition.

Although offering documents were originally intended to be selling documents, they have metamorphosed into legal documents that are now drafted by lawyers as a matter of practice. A report in the Mint last week has an interesting take:
If the IPO documents of all 109 [filed this year] are piled up, at an average of 5,000 copies per company and an average 1.8cm thickness, it would create a stack some 9.8km high, about a kilometre taller than Mount Everest.

But that’s only one part of the story. How many people actually read these documents and what part do they play in helping them reach an investment decision?

Only about 1%, or say 50 people, on an average actually read them… .
The reasoning for this trend is as follows:
Bankers say they’re just following the legal requirements as set out by market regulator Securities and Exchange Board of India (Sebi) while drafting the prospectus.

The regulator has laid out the norms for offer documents in the Disclosure and Investor Protection Guidelines, an exhaustive document that even specifies the thickness of the prospectus cover and the colours that may be used. But there is no guidance on style or clarity.

SEC has tried to solve this problem by issuing a plain English handbook for underwriters that offers guidelines on clear writing with examples.

However, the fear of liability is the key concern for bankers and companies. In other words, the guidelines notwithstanding, US documents too are known to contain 89-word sentences with a dozen numbers.
The question that is being raised is whether disclosure continues to serve the ends of securities regulation. Is too much information and legalese confusing rather than aiding the investor? In a recent paper, Simon C.Y. Wong cautions overreliance on disclosure as a mode of securities regulation. Using the U.S. model as an example, he argues:
The US approach to regulating the securities markets is underpinned by disclosure, and US policymakers have tended to respond to corporate and systemic crises by strengthening disclosure requirements. For example, in response to the global financial crisis, the US Securities and Exchange Commission recently adopted new rules enhancing disclosure of risk oversight by the board of directors, executive remuneration, and conflicts of interest of compensation consultants.

US disclosure-based regulation, however, suffers from two critical failings. First, it lacks coherence in that shareholder rights are presently too weak to compensate for the hands-off regulatory approach. Second, disclosure has been deployed excessively as a regulatory tool, resulting in inundation and poor quality of information as well as other unintended outcomes. Moreover, disclosure has been ineffectively used to address issues that are better tackled through substantive regulation.
Over the last two decades, SEBI as the capital markets regulator has moved away from merit-regulation of public offering and towards disclosure-based regulation. This may be an opportune moment to revisit the approach, at least to streamline and simplify the disclosure requirements and to make it more user-friendly.

Tuesday, November 16, 2010

Res Judicata and Special Statutes

The rapid proliferation of Tribunals in India has perhaps masked an allied, and yet facially less controversial feature of adjudication – the growth of special statutes and the creation of jurisdictional courts to resolve disputes arising out of those statutes. Facially, no constitutional vice attaches to such statutes – indeed, it is often the ordinary civil court that is designated as the jurisdictional court under the special statute. This, however, has at times obscured the important point that although the same court hears the dispute, it exercises a different type of jurisdiction. This has interesting consequences on a wide gamut of procedural and substantive stages of litigation – one of which the Supreme Court considered recently, in Md. Nooman v Md. Jabed Alam.

The issue before the Court in Nooman was whether a finding as to title in a suit for eviction operates as res judicata in a subsequent suit for declaration of title. To illustrate the implications of this judgment on the impact of findings under special statutes, it is necessary to give a somewhat elaborate account of the facts. In Nooman, a suit for eviction was instituted in 1973 in the Munsif Court in Arrah by the plaintiff. Her case was that she had acquired the suit property from her mother-in-law through a Registered Sale Deed in 1957, and relied on mutation in the revenue and municipal records to support title. The defendant tenant, her brother-in-law, ran the opposite case, claiming that the property in fact belonged to him, as it had been gifted to him by his mother. The Trial Court framed seven issues, of which Issues 3 and 4 were, respectively: “Has the plaintiff got title to the suit land” and “Is the sale deed valid… Both parties adduced detailed evidence in support of these claims and examined witnesses.

The Trial Court found for the plaintiff on Issues 3 and 4 above, but dismissed the suit because she had not proved the existence of a landlord-tenant relationship between the parties, and since it is a rule of procedure that an eviction suit cannot be converted into a declaratory suit. Appeals were dismissed. In 1979, the plaintiff filed a Title Suit against the defendant tenant, seeking declaration and recovery of possession. The parties ran exactly the same case, and the issues the Trial Court framed were, inter alia, Has the Plaintiff got title over suit property” and “Is there any relationship of landlord-tenant”. The Trial Court once again found for the plaintiff on the title issue, and decreed the suit, finding that she had proved the landlord-tenant relationship. An appeal was filed against that judgment, and the appellate court, after reappraising the evidence, held that the plaintiff had not proved title, and dismissed the suit. The High Court reversed, finding that the judgment of the Rent Court operated as res judicata on the question of title. By the time the Supreme Court considered this question, both parties had died, and been substituted by legal representatives.

The short issue before the Supreme Court was res judicata. As is well known, res judicata is governed by s. 11 of the Code of Civil Procedure, 1908 [“CPC”], which reads as follows:

11. Res judicata.—No Court shall try any suit or issue in which the matter directly and substantially in issue has been directly and substantially in issue in a former suit between the same parties, or between parties under whom they or any of them claim, litigating under the same title, in a Court competent to try such subsequent suit or the suit in which such issue has been heard and finally decided by such Court [emphasis added].

On the face of it, this provision extends the operation of res judicata if the court that decided the issue was either competent to hear that suit, or would have been to hear the suit in which res judicata is raised. Explanation VIII goes further and provides that an issue heard and finally decided by a court of limited jurisdiction shall operate as res judicata in a subsequent suit.

The Supreme Court affirmed this conclusion, although, surprisingly, it did not refer to the provisions of s. 11 CPC. The contrary argument proceeded on the premise that the Rent Court satisfies itself only that there is prima facie title, for it is not competent to determine title except as incidental to a determination of the rights of the landlord and the tenant. This argument was rejected on the basis of Mr Justice Meredith’s observations in a 1949 decision of the Patna High Court, which are as follows:

The decision in a rent suit is not res judicata on the question of title unless the question of title had to be decided, was expressly raised, and was expressly decided between the parties and in each case it is necessary to examine carefully the decision in the rent suit before any opinion can be formed as to whether it operates as res judicata on the question of title or not. Ordinarily the decision would be res judicata only with regard to the existence of the relationship of landlord and tenant…

It is submitted that the Supreme Court was clearly correct in reaching this conclusion. It is, however, important to resist any temptation to conclude that the test advanced by Mr Justice Meredith is wider than s. 11 CPC r/w Explanation VIII, although that suggestion is not implausible on the plain language of the text. The more precise tests in the test above are best seen not as supplanting or amplifying the statutory formulation, but as offering courts useful indicators of when the statutory test is likely to be satisfied.

Wednesday, November 10, 2010

Companies Bill to be Deferred

A few weeks ago, newspaper reports had suggested that the Companies Bill, 2009 may be presented in amended form during the winter session of Parliament and that it may even be enacted by the end of the year. That was somewhat intriguing considering the magnitude of the discussions before the Parliamentary Standing Committee on Finance (SCF) and the drastic changes suggested by it to the Bill in relation to certain matters.

It has now been reported in the Mint that the Bill will after all not be presented in Parliament in the winter session. Instead, it is likely to be presented in the budget session early next year. That will provide more opportunity and lead time to iron out issues, many of which have substantial implications on the corporate sector. While the effort to overhaul the Companies Act began over a decade ago (with the Companies Bill, 1997) and the wait for a streamlined legislation continues, any enactment of the law in haste would certainly be counterproductive (and to that extent this development is understandable).

Tuesday, November 9, 2010

Incorporation of Contractual Terms by Reference

Last week, an interesting issue of contractual interpretation fell for the consideration of the United Kingdom Court of Appeals in Malone v. British Airways, [2010] EWCA Civ 1225. The Court was called on to decide circumstances in which terms may be incorporated into a contract from other related agreements or documents, leading it to some interesting conclusions.
In the wake of the economic recession in 2008-09, British Airways [“BA”] sought to reduce the size of its crew complements. There was no term preventing this in the individual employment contracts which BA had entered into with members of its crew. However, many aspects of the management of the business were governed by agreements entered into by BA with a trade union, of which 96% of its employees were members. Two of these agreements had provisions for the size of the crew complement, and this number could be reduced only by agreement. (It is worth noting in passing that the level provided by these agreements was well above the legally required minimum). However, none of these collective agreements were enforceable by themselves. The employees argued that this provision of the collective agreement was incorporated into their individual contracts, by virtue of a clause in their individual contracts, which provided,
Your employment …will be governed by…the Agreements between (BA) and the Employees' side of the NJCA (National Joint Council) so far as the same are applicable to your particular appointment. The NJC Agreements from time to time in force are deemed incorporated into this contract and you are referred to these Agreements for details of your hours of work, periods of notice, paid holiday entitlements, sickness benefits and general matters. [emphasis supplied]
Thus, the issue before the Court boiled down to whether the above provision resulted in the terms of the collective agreement relating to the size of the crew complement being incorporated into the individual contracts of the employees. The significance of the incorporation is that unless they were held to have been incorporated, the employees would not have an independent claim, and would have to approach the trade union for a remedy. Further, apart from being a tedious process, this was also not a feasible option due to factions having been formed within the union.
The employees proffered two arguments in favour of the incorporation- first, although there was no term in their individual contracts dealing with the size of the crew complement, a reduction of its size resulted in increased workload for the remaining members of the crew. Thus, albeit indirectly, the reduction had an effect on the terms of the individual contract. Secondly, and more significantly, there was a system by which BA paid members of a smaller crew compensation for the reduced size of the crew. This was relied on by the employees to argue that it was assumed and intended by the parties that the size of the crew complement was a term of the contract.
Lady Justice Smith, speaking for the Court of Appeals, rejected both these contentions. For starters, she held that the mere fact that the collective agreements were not enforceable does not mean that they could not have a binding effect if incorporated into the individual contracts. However, whether or not they were, and which parts of them were, incorporated would depend on a construction of the individual contracts, and an examination of the intention of the parties. She held that undoubtedly some provisions of the collective agreement were so incorporated, but the size of the crew complement was not one of them. She also accepted that a modification of the crew complement would affect the workload of the remaining crew members.
Her rejection of the argument was based solely on the implications of holding that the size of the crew complement was a term of the contract. If the size was a contractual term, then any member asked to board a flight with a reduced crew size would have the right to refuse, and this would lead to “disastrous consequences” (¶ 62). The clause as to the minimum size of the crew complement was held to be a specific undertaking and not only aspirational. However, this did not mean that it could be enforced by an individual employee. The rights it gave rise to were purely collective, since there was no way BA could have intended to grant an individual employee the right. In her words (¶¶ 61-62),
61. I am satisfied that crew complements do impact to some extent upon the working conditions of individual employees and that that is a pointer towards section 7.1 being intended as an individually enforceable term. I also accept that the fact that crew complements have, in the past, been negotiated as part of a productivity deal is another pointer towards enforceability. I accept also that an undertaking as to the size of the team of workers who will undertake a task may, in some circumstances, be enforceable by individuals.
62. Set against that are the disastrous consequences for BA which could ensue if this term were to be individually enforceable. It seems to me that they are so serious as to be unthinkable. By that I mean that if the parties had thought about the issue at the time of negotiation, they would have immediately have said it was not intended that section 7.1 could have the effect of enabling an individual or a small group of cabin crew members to bring a flight to a halt by refusing to work under complement ... I accept that there are pointers towards individual enforceability but these are not conclusive. In the end, I think that the true construction of this term is that it was intended as an undertaking by the employer towards its cabin crew employees collectively and was intended partly to protect jobs and partly to protect the crews, collectively, against excessive demands in terms of work and effort. I think that it was intended to be binding only in honour, although it created a danger that, if breached, industrial action would follow.
Thus, in sum, the Court of Appeal laid down three propositions for the incorporation of contractual terms-
First, the nature of the agreement from which terms are being incorporated is irrelevant to whether they are binding between the parties to the contract into which they are being incorporated. While this seems to be the tenor of the decision, it does not explain why the Court thought it necessary to clarify that the provisions in the collective agreement were undertakings and not merely aspirational
Secondly, the test for determining whether a term is incorporated is whether on a true construction of the contract into which they are being incorporated, the parties could have intended it to be incorporated.
Finally, and most importantly, the practical effects of such incorporation are crucial indicators to the parties’ intent. If the consequences of incorporation are such that the parties could not have possibly intended them, then the terms cannot be incorporated.
As a result, what can be taken away from the decision is that if a term is sought to incorporated, it should be referred to specifically, instead of the document in which it is contained being referred to generally.

Saturday, November 6, 2010

UK Supreme Court on Non-Signatory Parties in Arbitration: Part II


 

(Continued from Part I which is available here)

We can now briefly turn to the judgment of Lord Collins. Lord Collins elaborated the position on broadly similar reasoning. On the issue of the standard of review to be adopted, he observed, "The principle that a tribunal has jurisdiction to determine its own jurisdiction does not deal with, or still less answer, the question whether the tribunal's determination of its own jurisdiction is subject to review, or, if it is subject to review, what that level of review is or should be...
it does not follow that the tribunal has the exclusive power to determine its own jurisdiction, nor does it follow that the court of the seat may not determine whether the tribunal has jurisdiction before the tribunal has ruled on it. Nor does it follow that the question of jurisdiction may not be re-examined by the supervisory court of the seat in a challenge to the tribunal's ruling on jurisdiction. Still less does it mean that when the award comes to be enforced in another country, the foreign court may not re-examine the jurisdiction of the tribunal..." (This test may well be satisfactory when an arbitrator assumes jurisdiction without the interference of a Court – what about a situation where, in the Indian context, the arbitrator is appointed by the Chief Justice after a judicial determination?)

Lord Collins then discusses in detail the application of an arbitration agreement to non-signatory parties. Instead of the approach of Lord Mance (of applying supranational law as part of French law; or supranational law as applied by French courts), Lord Collins begins with a broad analysis of the issue on the general principles of international commercial arbitration. In the words of Lord Collins, "The issue has arisen frequently in two contexts: the first is the context of groups of companies where non-signatories in the group may seek to take advantage of the arbitration agreement, or where the other party may seek to bind them to it. The second context is where a State-owned entity with separate legal personality is the signatory and it is sought to bind the State to the arbitration agreement. Arbitration is a consensual process, and in each type of case the result will depend on a combination of (a) the applicable law; (b) the legal principle which that law uses to supply the answer (which may include agency, alter ego, estoppel, third-party beneficiary); and (c) the facts of the individual case..."

Lord Collins then discussed the point on the applicability of the doctrine of renvoi. "It is likely that renvoi is excluded from the New York Convention: see van den Berg, The New York Convention of 1958 (1981), p 291. But it does not follow that for an English court to test the jurisdiction of a Paris tribunal in an international commercial arbitration by reference to the transnational rule which a French court would apply is a case of renvoi. Renvoi is concerned with what happens when the English court refers an issue to a foreign system of law (here French law) and where under that country's conflict of laws rules the issue is referred to another country's law. That is not the case here. What French law does is to draw a distinction between domestic arbitrations in France, and international arbitrations in France. It applies certain rules to the former, and what it describes as transnational law or rules to the latter..."

Lord Collins then discussed the facts which in his view meant that the 'common intention' test was not satisfied:

First, throughout the transaction, Dallah was advised by a leading Pakistani law firm, which was responsible for the drafts of both the MoU and the Agreement. Secondly, there was a clear change in the proposed transaction from an agreement with the State to an agreement with the Trust. The MoU was expressed to be made between Dallah and the Government, whiile the agreement was not. Thirdly, at the time of its establishment, the Trust was established as a body corporate. Fourthly, the Agreement contained references to the Government only in its capacity as a guarantor and there was nothing to indicate that it was a party to the Agreement itself.

On these factual grounds, Lord Collins held that the Government could not be treated a s aparty, and there was no valid arbitration agreeemnt between the Government and Dallah.

Further, Lord Collins went on to criticise the Tribunal on the grounds that it "drew the conclusion that the organic control of the Government over the Trust, although insufficient to lead to the disregard of the separate legal entity of the Trust, constituted nevertheless an element of evidence as to the true intention of the Government to run and control directly and indirectly the activities of the Trust, and to view the Trust as one of its instruments." This observation perhaps goes to indicate that the test for determining whether a non-signatory is a party to an arbitration agreement or not is the same as that for determining whether the cirporate veil should be lifted. It is often thought that non-signatories can be made party to an arbitration agreement in two ways – one, by pleading that the corporate veil should be lifted; and secondly, by relying on arguments that as a matter of arbitration law (and not as a matter of company law), the non-signatory should be treated as a party. What Lord Collins's criticism (arguably obiter) indicates that there are no two tests – the test is a common one. This also appears to be the only exception left open in Indian law after Indowind.

The judgment of the UK Supreme Court is available here. The impugned decision of the Court of Appeal is available here.

A Kluwer Arbitration Blog note on the decision of the Court of Appeal is available here. The commentator raises the concern, "On a more fundamental level the Dallah decision raises the question whether the New York Convention is fulfilling its objectives if national courts ruling on enforcement of Convention awards interpret Article V as permitting them to reopen and completely rehear challenges to a tribunal's finding on the validity of the arbitration agreement, and hence its own jurisdiction..." This concern – somewhat reminiscent of the concerns expressed in relation to the intervention of the Indian judiciary in arbitration – is noteworthy and is as applicable to the Supreme Court's decision; yet as a matter of principle, the Supreme Court explains in great detail how the regular standard of review operates and is applicable in enforcement proceedings when the issue of validity of the agreement is in question. It is also important to note that nowhere can the decision be read as supporting such a threshold of judicial review on questions of the merits of the case, once jurisdiction has been established.


 

UK Supreme Court on Non-signatory Parties in Arbitration: Part I

We have previously discussed issues surrounding privity in arbitration agreements; and in a recent post, Shantanu looked at a recent decision of the Supreme Court of India on the point which lays down the proposition that an award cannot be enforced against a party merely by virtue of its association with the matter or the parties involved (in the facts of the case, the 'association' was in the nature of a guarantor relationship). We had also examined another decision of the Supreme Court in Indowind where the Court affirmed the sanctity of the corporate veil in determining who the parties to an arbitration agreement are. In these cases, the Court has taken a strict view of who a 'party' to an arbitration agreement is. In a recent decision of the UK Supreme Court, a similar view appears to have been taken in the context of enforcement of awards: Dallah Real Estate v. Ministry of Religious Affairs, Government of Pakistan. In particular, Lord Mance and Lord Collins examined the issue of when non-signatories may be treated as parties in great detail. The decision also decides important questions pertaining to the conflict of laws (such as whether the doctrine of renvoi would operate in the context of the New York Convention).

The Appellant ('Dallah') sought to enforce an award of an ICC Tribunal (with its seat in Paris) made against the Government of Pakistan ('Government'). The Government was not a signatory to the relevant arbitration agreement. The signatories were Dallah and Awami Hajj Trust ('Trust').

Dallah had proposed to the Government that it would provide certain facilities to pilgrims. In particular, Dallah proposed to the Government that it would "provide housing for pilgrims on a 55-year lease with associated financing". The Government approved of this the proposal in principle, and a Memorandum of Understanding was concluded between Dallah and the Government. Under this MoU, "land was to be purchased and housing facilities were to be constructed at a total cost not exceeding US$242 million and the Government was to take a 99-year lease subject to Dallah arranging the necessary financing to be secured by the Borrower designated by THE GOVERNMENT under the Sovereign Guarantee of THE GOVERNMENT." The President of Pakistan – acting in accordance with the terms discussed in the MoU and in subsequent communications between the parties – meanwhile promulgated an ordinance establishing and granting legal recognition the Trust. The Trust was to act as the Borrower as per the terms of the MoU. Further negotiations between Dallah and the Government led to the signing of the agreement ('Agreement') between Dallah and the Trust on 10 September 1996. The Agreement contained an arbitration clause.

Under the constitution of Pakistan as it stood at the relevant times, ordinances had to be either laid down before Parliament or would lapse unless re-promulgated after a specified duration. The re-promulgation of the ordinance continued for some duration, but after a change in the government of Pakistan, the ordinance was not re-promulgated after November 1996. Accordingly, in view of the applicable domestic laws of Pakistan, the Trust ceased to exist as a legal entity in December 1996. In 1998, in view of some disputes, Dallah sought to adjudicate the issues by means of arbitration under the Agreement.

On these facts, the Tribunal found that the Government was a 'true party' to the Agreement and an award was made against the Government.

In the English Courts, the Government relied on Section 103(2)(b) of the (UK) Arbitration Act, 1996 which states that enforcement of an award can be refused when "the arbitration agreement was not valid ….. under the law of the country where the award was made." The Government's argument was accepted by the Courts below, and the matter came up in appeal before the UK Supreme Court.

Lord Mance began his analysis by noting, "the 'validity' of the arbitration agreement depends in the present case upon whether there existed between Dallah and the Government any relevant arbitration agreement at all..."

First, the question arose whether the validity of the award was to be seen under French law. In this regard, it was accepted before the Court that the words "under the law of the country where the award was made" referred to French law. However, it was also common ground between the parties that "Under French law, the existence, validity and effectiveness of an arbitration agreement in an international arbitration …. need not be assessed on the basis of a national law, be it the law applicable to the main contract or any other law, and can be determined according to rules of transnational law..." In other words, this transnational law of arbitration or supra-national law of arbitration was to be treated as a part of French law. In order to determine what this supra-national test is, the UK Supreme Court referred to the decision of the Paris Court of Appeal – "According to the customary practices of international trade, the arbitration clause inserted into an international contract has its own validity and effectiveness which require that its application be extended to the parties directly involved in the performance of the contract and any disputes which may result therefrom, provided that it is established that their contractual situation, their activities and the normal commercial relations existing between the parties allow it to be presumed that they have accepted the arbitration clause of which they knew the existence and scope, even though they were not signatories of the contract containing it..." The UK Supreme Court agreed to apply this test, and noted "It is difficult to conceive that any more relaxed test would be consistent with justice and reasonable commercial expectations, however international the arbitration or transnational the principles applied." Nonetheless, giving weight to the fact that the applicable law was French law, and considering that French law co-opted supra-national law in this regard, the Supreme Court accepted this test as being the correct one to apply, and noted that effectively this was a test which required the 'common intention to arbitrate' of the parties to the proceedings to be ascertained.

The ICC Tribunal had adopted a similar test in holding that the Government was a true party to the award, and hence, next came the issue of whether the arbitrators' decision on the point was open to review. The Supreme Court held on this point that language of the English Act as well as the general principles of arbitration law point strongly "to ordinary judicial determination of that issue. Nor do Article VI and s.103(5) contain any suggestion that a person resisting recognition or enforcement in one country has any obligation to seek to set aside the award in the other country where it was made..." Thus, the standard at the stage of enforcement is that of a full judicial review, and is not limited to the grounds for setting aside and award. Lord Mance then proceeded to explain the relationship between enforcement proceedings and setting aside proceedings thus: "It is true that successful resistance by the Government to enforcement in England would not have the effect of setting aside the award in France. But that says nothing about whether there was actually any agreement by the Government to arbitrate in France or about whether the French award would actually prove binding in France if and when that question were to be examined there. Whether it is binding in France could only be decided in French court proceedings to recognise or enforce, such as those which Dallah has now begun. I note, however, that an English judgment holding that the award is not valid could prove significant in relation to such proceedings, if French courts recognise any principle similar to the English principle of issue estoppel (as to which see The Sennar (No. 2) [1985] 1 WLR 490). But that is a matter for the French courts to decide." Lord Mance also held that there is no difference in the standard of review in cases where the arbitrator assumes jurisdiction, and in cases where the arbitrator determines the existence of jurisdiction.

After a detailed examination of the correspondence between the parties, Lord Mance held that the Tribunal had erred in holding that the common intention test was satisfied.

(Continued in a subsequent post)

Two Global Indicators: Measuring India’s Performance

Doing Business

Doing Business 2011, a co-publication of the World Bank and the International Finance Corporation, was released earlier this week. As far as India’s position is concerned, nothing significant has altered compared to its ranking in last year’s report. Of a total of 183 countries covered in the report, India ranks 134 (one place above its ranking of 135 in the 2010 report). Even within individual sub-categories against which countries are measured, there has been no significant improvement in India’s performance.

The report indicates two specific areas where reforms in India have been implemented recently:
Starting a business India eased business start-up by establishing an online VAT registration system and replacing the physical stamp previously required with an online version.

Paying taxes India reduced the administrative burden of paying taxes by abolishing the fringe benefit tax and improving electronic payment.
On the other hand, India’s ranking continues to be low when it comes to enforcing contracts, where it is 182 (second from the bottom). This reflects upon the efficiency of the dispute resolution system, which is plagued by delays and costs.

While one may always quarrel with the veracity or even the necessity or relevance of such a report carrying a cross-country analysis, the fact of the matter is that the results do not bode well for India’s continued rise as a leading economic power, as this report suggests.

Human Development

Economic indicators tell us only part of the story. How does increase in business activity and economic progress impact livelihood of people inhabiting a country and affect human development? Coincidentally, this week also witnessed the release of the Human Development Report 2010 by UNDP. Indian ranks 117 out of a total of 169 countries based on human development indicators. On a positive note, India ranks high among countries who have witnessed improvements in HDI over the 1970-2010 period as measured by annual percentage growth rate in per capita GDP. However, this leaves unanswered questions when it comes to non-economic indicators. As the report notes:
India’s deregulation since the early 1990s. India has a long tradition of entrepreneurial activity, with well established business families and networks. Many business families supported the independence movement and were politically aligned with post-independence governments. The extensive regulations during the first few decades after independence restricted corporate activities but did not threaten domestic business interests. The 1990s liberalization removed restrictions on corporate activity and steadily opened the economy to foreign competition—in effect, reducing regulatory burdens in return for greater efficiency. The evidence on business development in new sectors and on entrepreneurs emerging from different socioeconomic groups suggests a new dynamism. But there is intense debate about rising inequality, the need for complementary social actions, and problems with specific aspects of corporate governance and state-business relations.