Monday, October 31, 2011
Saturday, October 22, 2011
The English High Court, in August this year, has decided an important point on the scope of an arbitration agreement, which, given the similarities in language between section 9 of the English Arbitration Act and section 8 of the Indian Act, is of significance in the Indian context too.
The claimant in Deutsche Bank v Tongkah Harbour had provide a financing arrangement to the Tungkum Limited, which was a gold exploration and mining company based in Thailand. It was a subsidiary of another Thai company, Tongkah, which was the second respondent. Under the financing arrangement, the Bangkok branch of Deutsche Bank entered into a Facility Agreement, by which it lent funds to Tungkum. At the same time, Tungkum entered into an Exports Contract with Deutsche Bank’s London branch, under which it was to sell gold at a price calculated in accordance with a given formula. The net result of this arrangement was that Tungkum would repay the loan given by the Bangkok branch to the London branch. Tungkum’s performance under this arrangement was secured by way of a guarantee provided by Tongkah to Deutsche Bank’s Amsterdam branch. Due to a state of emergency declared subsequently in Thailand, and other difficulties, Tungkum was unable to perform its obligations under the Exports Contract, leading to the London branch granting it a ‘Holiday Period’ in consideration for a revision of the financing agreements. However, taking the stance that these pricing arrangements were unfair, Tongkah and Tungkum refused to revise the agreements, leading to ‘Events of Default’ occurring under the agreements.
The Facility and the Export Contracts entered into between Deutsche Bank and Tungkum granted jurisdiction to English Courts, but in addition, also granted Deutsche Bank the option to pursue their claims in arbitral proceedings. This option was available only to Deutsche Bank and not to Tungkum in either case. The Guarantee Contract did not have any such option for either party. Deuteche Bank began proceedings against Tungkum in relation to the Facility Agreement, and against Tongkah in relation to the Guarantee, in the English Courts. However, it sought arbitral proceedings against Tungkum for the breaches under the Exports Contract. Tungkum and Tongkah challenged the jurisdiction of the English courts on the basis that once Deutsche Bank had begun arbitral proceedings under the Exports Contract, given the strong nexus between the different contracts, and the fact that they performance thresholds in each were calibrated with respect to the others, the ‘matter’ in respect of which the English court proceedings had been brought had been referred to arbitration, leading to a mandatory stay under section 9 of the Arbitration Act.
Section 9(1) of the Act reads-
Stay of legal proceedings.
(1) A party to an arbitration agreement against whom legal proceedings are brought (whether by way of claim or counterclaim) in respect of a matter which under the agreement is to be referred to arbitration may (upon notice to the other parties to the proceedings) apply to the court in which the proceedings have been brought to stay the proceedings so far as they concern that matter.
Before moving on to the respective contentions and decisions in this case, it is instructive to compare the language with section 8(1) of the Indian Act, which provides-
Power to refer parties to arbitration where there is an arbitration agreement.
A judicial authority before which an action is brought in a matter which is the subject of an arbitration agreement shall, if a party so applies not later than when submitting his first statement on the substance of the dispute, refer the parties to arbitration.
While the language of the clauses is not identical, the concept of a matter ‘which is the subject of an arbitration agreement’, and ‘which under the agreement, is to be referred to arbitration’ is sufficiently similar.
Deutsche Bank argued that although the substance of the claim in the two cases may be similar, the primary issue in the arbitral proceedings was the breach of the Export Contract, which was different from the breach of the Facility Agreement being litigated in the court proceedings. Rejecting the contention, and granting a stay of the judicial proceedings, Blair J held that this reading of section 9 was flawed. Relying on Fiona Trust v Privalov for the presumption in favour of parties wanting only on tribunal to decide all disputes arising out of their relationship, and basing his decision of the substance of the claim rather than its formulation, he held that the parallel proceedings could not be allowed to continue.
What is interesting in this decision is the extent to it was influenced by the fact that the different branches of Deutsche Bank were not separate entities. While section 9 does mention the party against whom the legal proceedings are brought, it does not contain any requirement that the claim be brought by the party who has referred the same matter to arbitration. In most cases, however, the requirement that the ‘matter’ be the same will also mean that the party bringing the claims is the same in both proceedings. However, in the case of inter-connected contacts like the ones here, would the decision have been different if the different branches had in fact been subsidiaries, and hence independent legal entities?
In ¶ 27, dealing with Deutsche Bank’s contention that since different branches of Deutsche Bank brought the different proceedings, Blair J observes that,
It seems to me however that the fact that different divisions of the bank are concerned adds nothing to the legal analysis. Deutsche Bank is a single contracting party. Nor does it matter that different branches of the bank are concerned, this not being a situation analogous (for example) to a bank's liability to repay deposits, where for some purposes its branches are treated as separate entities. In any case, on the facts the point has limited force, because the Export Contract (the province of global commodities) provided the mechanism by which the loans extended under the Facility Agreement (the province of structured commodity trade finance) were to be repaid. It is the connection between the contracts which is at issue.
In this passage, while he does seem to base his decision on the branches not being separate entities, he ends by saying that it is the connection between the contracts (and not the connection between the claimants) that is the issue. However, two observations later in the judgment suggest that had the branches been subsidiaries, the decision may have been different. In ¶ 29, he observes,
What it comes to is that whereas in the Commercial Court action, the bank claims the outstanding loan amount, in the arbitration it claims the early termination amount. It is correct that these are different claims, but they arise out of the same breach of the same contractual arrangements. They are (in my judgment) aspects of the same matter. I fully agree that Deutsche Bank bargained for the right of access to this court, and should not be deprived of it. But it is not being deprived of it. It could have referred the matter to the court, or it could have referred it to arbitration.
This finding that no deprivation of a contractual right had occurred would possibly (though by no means necessarily) have been different, had the branches been independent legal entities. More crucially, in deciding whether the claims against Tongkah under the Guarantee Contract should also be stayed, he observes (¶ 30),
The more substantial point argued by Tongkah is that since its liability under the Guarantee is of a secondary nature, the court should stay the proceedings under its inherent jurisdiction, and/or under its case management powers, pending the arbitration. I reject that submission also. A claim under a guarantee may raise similar or even the same issues as the claim against the principal debtor, but the covenant to pay is given by a different party, here the parent company. Deutsche Bank is entitled to enforce the Guarantee if it can make good its claim, regardless of the claim against the principal debtor. The fact that there may be (as the defendants say) substantial overlap between the claims does not affect this conclusion.
Given the rationale adopted in this passage, it appears that mere overlapping between the contentions is not sufficient to meet the requirements of section 9, unless the party bringing the claim in arbitration is the same as that which also sues in court. However, since Blair J was not explicitly referring to the Arbitration Act, and was rejecting the exercise of the Court’s inherent jurisdiction and its case management powers, this passage is not conclusive of the section 9 question.
Returning again to section 8 of the Indian Act, the difference between ‘which under the agreement is to referred to arbitration’ and ‘which is the subject of an arbitration agreement’ means that this issue arises in the Indian context as well. As discussed here, when dealing with section 9 of the Act, Indian Courts have been undecided on the extent to which third parties to the arbitration can be affected by interim measures granted under section 9. Whether a similar stance is adopted with reference to section 8 is an open question.
[Note: While I am not aware of an Indian case conclusively deciding this issue on the interpretation of section 8, inputs from readers on possible authorities on the point are most welcome].
Wednesday, October 19, 2011
(This post has been contributed by Amit Agrawal, a legal practitioner practicing before Rajasthan High Court, Jaipur and an alumnus of the National Law School of India University, Bangalore)The Securities Appellate Tribunal (SAT) delivered its judgment yesterday in the case involving issue of securities by certain companies within the Sahara group.
The judgment has come after many rounds of legal proceedings before different fora. It may be recalled that Sahara had first challenged the interim order of SEBI passed in November 2010 before the Allahabad High Court. The Allahabad High Court stayed the operation of SEBI’s order in December 2010, which thereby permitted the Sahara entities to continue raising monies from investors. This stay order was challenged before the Supreme Court which however refused to interfere with the interim order of High Court on 4 January 2011 but requested the High Court to expedite the hearing. The matter however could not be disposed in the expected time frame. Subsequently, the Allahabad High Court vacated its previous stay order in April 2011 due to the evasive conduct of Sahara in the matter. Such order vacating the stay was again challenged before the Supreme Court which on 12 May 2011 directed SEBI to complete the inquiry and pass the final order to enable the Supreme Court to pass further orders. SEBI then passed its order in June 2011 confirming its interim order. The Supreme Court thereafter did not examine the merits of the contentions. Through its order dated 15 July 2011 (in Special Leave to Appeal (Civil) No. 11023/2011 with 13204/2011) it directed the parties to appear before SAT. Though the reasons were not expressly recorded for relegating the parties to SAT (where they should in fact have been in the first place) perhaps such an order was passed for the following reasons:
- Any expression of the opinion on the merits of the matter, while hearing an appeal emanating from an interim order (though confirmed in due course), would have prejudicially affected the interests of the parties.The matter was thereafter argued for several days before SAT. In comparison to the lengthy submissions made before SAT, its order is rather concise. The order focuses on the arguments raised rather than attempting to be an encyclopedia of judicial or academic authorities.
- Adjudication by the Supreme Court on merits would have deprived the parties to appeal to any other forum.
- The Supreme Court, consistent with its view noted in Clariant International AIR 2004 SC 4236 (“….without meaning any disrespect to the judges of the High Court, we think neither the High Court nor the Supreme Court would in reality be appropriate appellate forums in dealing with this type of factual and technical matters”), felt hesitant to decide the matter without having the benefit of opinion of the expert tribunal. For the same reason, it thought that the pending writ petition before the Allahabad High Court should be withdrawn.
Permitting a loss making company with a capital base of Rs. 10 lakhs only to gather approximately Rs. 20,000 crores through use of about 2900 branch offices and ten lakh agents would have been a mockery of the securities law framework – is the thought, not an incorrect one, which underpins the SAT’s order. Important findings of SAT in the matter are:
- A private placement is made to a handful of known persons whose number is less than 50 and therefore an issue to more than such a number is a public issue.Whilst the conclusions drawn by SAT on each of the points contended are correct yet the reasoning at times is unclear. The analysis of definition of ‘security’ in particular is arguably open to questioning, in my view. The approach to determining the meaning of an expression for the purposes of SEBI Act, 1992 (which is not defined therein) by looking at the SCRA or Depositories Act only and by refusing to consider the Companies Act, 1956 is highly debatable for corporate laws which are otherwise quite inter-woven. The approach of SEBI as compared to SAT on this point is rather more instructive.
- Optionally fully convertible debentures (OFCDs) are “securities” within the meaning of the Securities Contracts (Regulation) Act, 1956 (SCRA) and consequently SEBI Act, 1992.
- Disclosures made in red herring prospectus (RHP) were not true and fair. Contents of the RHP camouflaged the key issue and concealed more than they disclosed. The fact that millions of investors will be approached was not disclosed.
- Proclamations on paper that the companies did not intend to get listed were not material for ascertaining whether company in fact did not intend to get listed. Their conduct and scheme of operation showed otherwise.
- The companies in fact made a public issue by approaching thirty million investors but by avoiding the rigours of law.
- Untrue statements and misstatements in the RHP can be questioned by SEBI also. This view has also been taken previously by SAT that investor protection is an overlapping concern between the Companies Act and SEBI and is not in the zone of one to the exclusion of another.
- SEBI has jurisdiction over unlisted companies too as long as the same can be said to be ‘persons associated with securities market’. This position has been taken by SAT in its various judgments and also by the Bombay High Court in Price Waterhouse & Co.
- SEBI can change its stand on the questions of law in particular with regard to jurisdiction over unlisted companies.
As regards jurisdiction, an issue which the Supreme Court also considered quite central to the controversy, SAT records: “Whether Sebi has the power to deal with such companies or whether they are to be regulated by the Central Government are complicated and important questions of law pertaining to jurisdiction which are to be decided on the interpretation of the provisions of the SEBI Act and the Companies Act”. But its treatment to this particular aspect is quite cursory in nature.
Also, the issue pertaining to the lack of estoppel against the law has not been fleshed out in as much detail. It observed: “There is no principle of administrative law that statutory bodies like SEBI cannot be permitted to alter their interpretation of a provision of a statute particularly when the matter pertains to jurisdiction.” Could a mistake committed once bind one for eternity, was the question it should have answered with greater clarity in the context.
The order of SAT will perhaps be agitated soon before the Supreme Court. Given that all the contentions pertain to questions of law (with no disputed facts) the entire matter is likely to be re-argued before the Supreme Court.
However, two points which follow from the order of SAT are:
- Is any further action likely to ensue in the wake of finding that disclosures made in the RHP were not true and fair?- Amit Agrawal
- Will an attempt, citing SAT’s observations on jurisdiction (and taking cue from Swedish Match AIR 2004 SC 4219), be made to dodge the penalty proceedings (if any) by requesting the Supreme Court to exercise its extra-ordinary powers under Article 142?
Tuesday, October 11, 2011
As far as the Takeover Code of 1997 is concerned, we have previously seen (here and here) that the Code itself does not prohibit hostile takeovers. Moreover, the operation of several corporate and securities laws in India come in the way of establishment of customary takeover defences by Indian companies or their promoters. It is only the high incidence of promoter shareholding in most Indian companies that generally operates to stave off hostile raiders on such companies.
The issue of hostile takeovers acquires importance in the new Code as it specifically prescribes conditions upon which an acquirer can make a “voluntary offer” to acquire shares of an Indian listed company. Regulation 6 sets out the conditions, which can be summarized as follows:
1. A voluntary offer can be made only by a person who holds at least 25% shares in a company, but not more than 75% (taking account of the maximum permissible public shareholding). Hence, a person who does not hold any shares, or holds less than 25% shares, in a company cannot make a voluntary offer without first triggering the mandatory public offer requirement by crossing the 25% threshold.All these conditions that operate before, during and after the voluntary offer effectively make a classic hostile takeover almost impossible in the Indian context. It appears that this is a wholly unintended consequence.
2. A voluntary offer can be made only by a person who has not acquired any shares in the target company in the preceding 52 weeks prior to the offer. In other words, there is a 52-week moratorium on acquisitions before the acquirer can make a voluntary offer.
3. During the offer period, the acquirer cannot acquire shares other than through the voluntary offer.
4. Once the voluntary offer is completed, the acquirer shall not acquire further shares in the target company for 6 months after completion of the offer. However, this excludes acquisitions by making a competing offer.
In order to ascertain the possible intention of the regulator, it is necessary to examine the source of this rule. This can be traced to the report of the Takeover Regulations Advisory Committee (TRAC), and Regulation 6 is effectively a reproduction of the draft suggested by TRAC. While the acceptance of the TRAC recommendations is understandable, the context in which the conditions were imposed is entirely different. This context appears to have been disregarded while accepting the draft of TRAC in the final Code.
Readers may recollect that TRAC had recommended that an offer under the Takeover Code must be for the entire remaining share capital of the company (i.e. up to 100%). One exception that was made related to voluntary offers, where a 10% limit was allowed. The reason for imposing several conditions for a voluntary offer appears to be to ensure that the acquirer becomes entitled to a lower offer size of 10% only when these conditions are satisfied. The relevant portions of the TRAC report are extracted below:
Current Provisions:The TRAC report (especially the underlined portions above) clearly indicate that the reason why all these conditions were introduced is because a voluntary offer (with a size of only 10%) was considered as an exception (with greater leniency to the acquirer) compared to the general offer size of all the remaining shares of the company (i.e. up to 100%). While the final form in which the new Takeover Code was accepted makes significant deviations from the overall offer size requirements by limiting it to 26%, there was no attempt to address the consequential conditions for voluntary offer that were based on the general offer size being 100%. Although the purpose for the introduction of these conditions loses relevance with the non-acceptance of the 100% offer size requirement imposed by TRAC, they have nevertheless found their way into the new Code leading to possible difficulties in effecting hostile takeovers.
2.18 Currently, the Takeover Regulations provide for consolidation of shareholding by an acquirer who is desirous of maximizing his shareholding without breaching the minimum public shareholding requirements. The offer size for an open offer under this provision is the lower of 20 % or the maximum permissible acquisition without breaching the minimum public shareholding requirement.
2.19 The Committee observed that with the proposed increase in the open offer size to 100% of the voting capital of the target company, there is a need to provide for flexibility to acquirers to voluntarily make open offers outside the mandatory public offer requirements. The Committee felt that voluntary offers are an important means for substantial shareholders to consolidate their stake and therefore recognized the need to introduce a specific framework for such open offers. However, to discourage nonserious voluntary offers, the Committee decided to set a minimum offer size of 10 %.
2.20 The Committee also observed that, inasmuch as the voluntary open offer is permitted as an exception to the general rule on the offer size, the ability to voluntarily make an open offer should not be available if in the proximate past, any of such persons have made acquisitions within the creeping acquisition limits permitted under the Regulations. Similarly, such an acquirer should be prohibited from making acquisitions outside the open offer during the offer period, and should also be prohibited from any further acquisitions for six months after the open offer. Also, such an offer should not lead to breach of the maximum permissible non-public shareholding.
2.21 The Committee therefore recommends that acquirers collectively holding shares entitling them to exercise 25 % or more voting rights in the target company may voluntarily make an open offer to consolidate their shareholding. The Committee has proposed a minimum open offer size of 10 % consistent with the rationale of consolidation option outside the creeping route. Voluntary offers should not, however, be of a size that could lead to breach of the maximum permissible non-public shareholding.
(See Regulation 6 of the Proposed Takeover Regulations)
Another possible interpretation is that given the genesis of these conditions as discussed in the TRAC report, they must become applicable only when a voluntary offer seeks to avail of the lower offer size of 10%, but not otherwise. In that sense, the voluntary offer mechanism in the Code is only an option that can be availed of by acquirers, but nothing prevents them from making a full offer for all of the remaining shares of the company (or even the general offer size of 26% that has been now prescribed) without complying with these conditions. However, these matters are open to interpretation, and clarity from regulators would help create the certainty required of the legal environment on this essential aspect of takeovers under Indian law.
Sunday, October 9, 2011
Owing to Article 141 of the Constitution of India, the decisions of the Supreme Court of India, continue to be the “law of the land” and are binding on all other Courts in the country. However, in light of Section 27 (5) of the Arbitration and Conciliation Act and the decisions of the Delhi High Court, the law on this subject needs to be revisited.