Wednesday, March 28, 2012

Further Order by SEBI on Shareholding Disclosures

(The following post is contributed by Yogesh Chande, an advocate
 practising in Mumbai)
SEBI’s whole time member in an order dated 26 March 2012 (Order), has revoked the directions which were issued by an interim order dated 8 March 2010 (which has been discussed earlier) against the entities mentioned in paragraph 4 of the Order. One of the issues which required to be examined by the whole time member was a reference received by SEBI from RBI as regards incorrect disclosure made by the erstwhile listed bank (Bank) regarding the shareholding pattern of the promoter group of the Bank.
Interestingly, in paragraph 9 of the Order the SEBI whole time member has observed as follows in relation to the incorrect shareholding of the said entities:
The second issue to be examined is whether any such attempt at camouflaging the real level of share holding by promoters should be considered as a serious, very serious or fatal threat to the securities market. Again, as a baseline, the securities regulations are disclosure based and the securities market regulator does expect that all disclosures should be true and fair. I am of the opinion that such an offence would have been considered as very serious or fatal if the wrongful disclosures would have led genuine investors into trades that would eventually expose them to much greater risk. I have noted that there is no allegation as to any price or volume manipulation by the promoters. Therefore, I am of the opinion that purely from a securities market point of view, the severity of the offence could be considered not very grave.
While there may not be any allegation as to any price or volume manipulation by the promoters, it is possible to argue that an incorrect disclosure of shareholding amounts to indulging in fraudulent and unfair trade practice,[1] thereby misleading the investors and depriving of correct information at the relevant point of time to the shareholders and investors.
The words underlined above could be a possible defence available going forward to companies/promoters in cases where shareholding is incorrect and there is no allegation of any price manipulation, notwithstanding that the incorrect reporting of shareholding was deliberate.
-  Yogesh Chande

[1] Section 15HA of the Securities and Exchange Board of India Act, 1992 read with applicable provisions of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations, 2003.

Sunday, March 25, 2012

The Debate over Staggered Boards

Staggered boards are found to be a form of anti-takeover defence. This concept, which is prevalent in several U.S. companies, ensures that only a third of the board can change each year. Hence, it would not be possible for shareholders to replace the board, except through a gradual process of changing a third of the board each year.
There is an interesting battle brewing in the U.S. with increasing calls from investors and a section of the legal academia for dismantling staggered boards so that takeovers (including hostile ones) are facilitated with greater ease. On the other hand, corporate managers and their advisors warn that such a move will adversely affect the ability of managers to effectively carry on business (without the threat of coercive takeovers) and that this will also play into the hands of the more short-term investors such as hedge funds. This battle is not only being played out through legal discourse, but also in decision-making at shareholders’ meetings as the Harvard Law School Shareholder Rights program is spearheading shareholder initiatives as a clinical program.
In the Indian context, however, this discuss has more of an academic relevance. Sections 255 and 256 of the Companies Act, 1956 provide for an element of staggering of the board, in as much as they provide that at least two-thirds of the board should consist of directors who retire by rotation. The remaining one-third is appointed in the manner permitted by the articles of association. Despite some shades of similarity between the Indian and U.S. position, there is one stark difference. And that is that Indian directors (whether appointed by general meeting through rotation or in the manner permitted by the articles) are all liable to be removed by the shareholders through an ordinary resolution (simple majority) at a shareholders meeting (Section 284, Companies Act, 1956). This is a significant power in the hands of Indian shareholders that makes staggered boards an entirely ineffective defence, if at all, in the context of takeovers.

Tuesday, March 20, 2012

Secondary Market Purchases by Foreign Venture Capital Investors

The Reserve Bank of India (RBI) has issued a circular that expands the scope of investments that foreign venture capital investors (FVCIs) can make in Indian companies. Hitherto, FVCI investments were permitted either through initial public offerings or through private placements. Under the new regime, FVCIs may acquire shares in the secondary markets from existing shareholders. The operative portion of the RBI circular reads as follows:
It has now been decided, to allow FVCIs to invest in the eligible securities (equity, equity linked instruments, debt, debt instruments, debentures of an [Indian Venture Capital Undertaking] or [Venture Capital Fund (VCF)], units of schemes / funds set up by  a VCF) by way of private arrangement / purchase from a third party also, subject to terms and conditions as stipulated in Schedule 6 of Notification No. FEMA 20 / 2000 -RB dated May 3, 2000 as amended from time to time. It is also being clarified that SEBI registered FVCIs would also be allowed to invest in securities on a recognized stock exchange subject to the provisions of the SEBI (FVCI) Regulations, 2000, as amended from time to time, as well as the terms and conditions stipulated therein.
This appears to be aimed at deepening the markets by providing greater avenues for investments in the growth sectors, a theme that is also highlighted in some of the proposals in the Budget announced last week (such as expansion of external commercial borrowings in the infrastructure sector, allowing qualified foreign institutional investors to invest in the bond markets, etc.).

Monday, March 19, 2012

Of NGOs, FDI and Corporate Governance

My fortnightly column published in today's edition of Business Standard draws a line across (i) the government's attitude towards companies it owns and lists on stock exchanges to raise public money; (ii) how the government can choke non-governmental organisations that protest well; and (iii) parallels between activism against bad corporate governance by the government and activism against governance of the polity.

The Direct Tax Proposals in Budget 2012

Unsurprisingly, the retrospective amendment proposed to be made to sections 2 and 9 of the Income Tax Act has dominated analysis of the direct tax proposals in the budget. There is no doubt that these amendments, and particularly the validation clause in cl 113 of the Finance Bill, may be vulnerable to a constitutional challenge, and this is a subject we will discuss in more detail. Budget 2012, however, has proposed a number of other fundamental changes to the fabric of the Income Tax Act, and a recurring theme is the desire of the legislature to “clarify” what we are told was “always” its intention.
The following is a summary of the more important of these changes.
Definition of Royalty
There has been considerable controversy over the meaning of royalty under section 9(1)(vi), particularly in the context of computer software. Some decisions had taken the view that even payment for off-the-shelf software constitutes royalty, while others rejected this view on the ground that it failed to distinguish between a transaction involving a copyright from one involving the licence or sale of a copyrighted article. We have discussed this controversy here. The Finance Bill, 2012 proposes to insert Explanations 4 and 5 to s 9(1)(vi) to “clarify” that the term royalty includes, in relation to computer software, a “transfer of all or any right for use or right to use (including granting of a licence)” and more generally, that the term covers “consideration in respect of any right, property or information” regardless of the payer retaining possession or control and the location of the right.
The language of Explanations 4 and 5 is unfortunate. For one, the easy assumption of the legislature that the present formulation is what it “always intended” may be challenged because it appears to be the principal ground on which retrospectivity is justified even in the Explanatory Memorandum, and the Supreme Court has held more than once in testing the vires of retrospective legislation that it is not bound by a declaration that a provision is clarificatory (see for example NACMF v Union of India 260 ITR 548 and the oft-quoted principle of “small repairs”). Leaving aside the question of validity, the thrust of this Explanation substantially broadens the scope of the definition (compare “consideration for the transfer of any rights in respect of” with “consideration in respect of”), particularly since the relevance of possession and control is proposed to be discarded. So wide a definition of royalty may conceivably capture payments that do not in any way resemble what would ordinarily be regarded as royalty, including the sale simpliciter of off-the-shelf software.  
General Anti-Avoidance Rule
A General Anti Avoidance Rule is proposed to be inserted as Chapter X-A of the ITA 1961. The language of the GAAR is similar to the GAAR in the proposed DTC and allows a transaction to be declared as an “impermissible avoidance arrangement”, if the main purpose or one of the purposes of an arrangement is a tax benefit and the arrangement creates non-arm’s length rights or obligations or it results in an “abuse or misuse” of the provisions of the Act or it “lacks commercial substanceor is entered into in a manner not ordinarily employed for “bona fide” purposes. Some of these terms are defined with more precision and if this provision is enacted into law India will have to confront some of the familiar problems a GAAR brings – the relationship between a GAAR and beneficial provisions of the ITA etc. The answers the courts have given in Australia and New Zealand show that this is no easy task. As Lord Hoffmann said in 2005, a GAAR may be a cure that is worse than the disease.
Treaty Override and Certificate of Residency
The GAAR also contains a non-obtstante clause providing that it overrides “anything contained in the Act” (thereby including section 90). Cl 31 of the Finance Bill proposes to make this explicit by adding section 90(2A) to provide that Chapter X-A applies to an assessee even if it is not more beneficial to him. Another limitation to the existing DTAA regime is the introduction of s 90(4) which provides that an assessee shall not be entitled to claim treaty benefits unless he obtains a certificate of his residency in the other contracting State from that Government or other competent authority. That means that he cannot prove residency by simply satisfying the requirements of article 6 in an Indian court, even if in reality he is a resident in those terms.
Transfer Pricing for Domestic Transactions and Advance Pricing Agreement
Section 92BA is proposed to be inserted extending the transfer pricing provisions to “specified domestic transactions”. The transactions in respect of which the domestic TP provisions would apply are enumerated in section 92B (principally deduction provisions where profit shifting is possible to claim a higher deduction for the eligible unit) and must exceed Rs. 5 crore in aggregate in the previous year.
The Advance Pricing Agreement in section 92CC is an agreement that determines the arm’s length price in advance in relation to an international transaction, and the agreement is valid for five years. There is an analogy with the AAR mechanism, for this agreement is binding on the taxpayer and the Commissioner but not if there is a change in law or facts or if it is found that the agreement was obtained by fraud or misrepresentation.
Returns, Reassessment and TDS in respect of foreign transactions
Important amendments are proposed to be made to sections 139, 147 and 195. As to section 139, the Finance Bill provides that every resident who is otherwise not required to file a return shall file a return if he has any asset outside India or signing authority in any account located outside India. As to section 149, the Finance Bill proposes to permit reopening for upto sixteen years if income in relation to “any asset located outside India” has escaped assessment. As to section 195, readers may recall that the Chief Justice held that presence is required in relation to the particular transaction out of which the tax liability is alleged to arise, and that Justice Radhakrishnan went further to hold that it can only be fastened on a resident. Cl 75 of the Finance Bill proposes to insert Explanation 2 (it goes without saying that this purports to be “clarificatory”!) to provide that s 195 applies to any person, whether resident or not, and regardless of residence, place of business, business connection or “any other presence in any manner whatsoever” in India.
In the coming days, we will have an opportunity to discuss the vires and implications of some of these amendments at length. It is certain, however, that the proposed retrospective amendments are not only liable to be tested on the element of retrospectivity, but also for territorial nexus, for the Supreme Court has confirmed last year, albeit in language that gives considerable latitude in legislation, that territorial nexus is a limitation on Parliament’s power to legislate under art 245 of the Constitution.
Copies of the Finance Bill, 2012 and the Explanatory Memorandum are available.

Friday, March 16, 2012

Budget 2012: Retrospective Amendments to Sections 2(14), 2(47) and 9

Copies of the Finance Bill, 2012 and the Explanatory Memorandum are now available. During the course of the day, we will highlight the important changes made and examine their implications. The purpose of this post, however, is to highlight that the Bill proposes a retrospective amendment to sections 2(14), 2(47) and 9 of the Income Tax Act, 1961, and this amendment purports to be clarificatory.
The amendments are set out below with brief comments.
Section 2(14): This provision defines a “capital asset”. Readers may recall that both the Bombay High Court and the Supreme Court held in Vodafone that “controlling interest” is not a capital asset. The Finance Bill proposes to add the following Explanation:
Cl. 3(i):
In clause (14), at the end, the following Explanation shall be inserted and shall be deemed to have been inserted with effect from the 1st day of April 1962, namely:
Explanation- For the removal of doubts, it is hereby clarified that ‘property’ includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever
Section 2(47): This provision defines a “transfer”. Readers may recall that the Revenue’s primary case in Vodafone in the Supreme Court was that there was an “extinguishment” under this provision.
Cl. 3(iv):
In clause 47, the Explanation shall be numbered as Explanation 1 thereof and after Explanation 1 as so numbered, the following Explanation shall be inserted and shall be deemed to have been inserted with effect from the 1st day of April, 1962, namely:
Explanation 2: For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed always to have included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company incorporated outside India.”
Section 9: This provision defines when income is deemed to accrue or arise in India, and the Supreme Court held in Vodafone that the words “directly or indirectly” do not qualify the transfer of the asset.
Cl. 4: In section 9 of the Income Tax Act, in sub-section (1)-
(a) in clause (i), after Explanation 3, the following Explanations shall be inserted and shall be deemed to have been inserted with effect from the 1st day of April 1962, namely:-
Explanation 4: For the removal of doubts, it is hereby clarified that the expression “through” shall mean and include and shall be deemed to have always meant and included “by means of”, “in consequence of” or “by reason of”.
Explanation 5: For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share of the interest derives, directly or indirectly, its value substantially from the assets located in India.

The Budget Memorandum (at page 16) describes this as a clarificatory amendment. Readers will recall that the fulcrum of the judgment of the Supreme Court in Vodafone was that a controlling interest is not a capital asset and that section 9 of the Act is not a “look-through” provision. Indeed, in ¶69 of the judgment, the Chief Justice records that the Revenue’s argument in Vodafone was that the word “through” means “in consequence of”, which was rejected. The proposed amendments to sections 9, 2(14) and 2(47) are an attempt to make such transactions taxable. All three amendments are proposed to be made applicable with retrospective effect from 1 April, 1962.
We will discuss these and other proposals in more detail in subsequent posts.

Thursday, March 15, 2012

Bombay HC in the MCX Case: Partial Reprieve to “Options” in Securities

Apart from dealing with specific issues relating to the facts of MCX’s application to commence the business of a stock exchange, the Bombay High Court’s judgment introduces greater clarity regarding the enforceability of options in securities of Indian public unlisted companies.
The court was concerned with two issues pertaining to buyback and option arrangements that were entered into between certain shareholders of MCX. The first pertains to the lack of disclosure of these arrangements to SEBI. The Court found that these arrangements should not have been withheld by the company (and its shareholders) from SEBI, particularly in the context of a stock exchange that also performs a certain regulatory role. The second pertains to the legal validity and enforceability of buyback and option arrangements under law, more specifically the Securities Contracts (Regulation) Act, 1956 (SCRA). This post focuses on the second aspect that relates to substantive aspects of the enforceability of options in securities.
The Court’s ruling on this count may be divided into three parts:
(i) whether options in securities constitute a forward contract that is illegal;
(ii) whether the SCRA applies to unlisted public companies; and
(iii) whether the options violate s. 18A of the SCRA as they are not traded and settled through a stock exchange.
As to the first issue, there appears to be a difference in the characterization of the transaction by SEBI in its order of 23 September 2010 and subsequent submissions to the High Court. Although SEBI’s order proceeds on the basis that the arrangements involved a firm buyback of shares, subsequent determination indicates that these were only “options” and not firm arrangements in the nature of forward contracts. The High Court came to the conclusion that what is proscribed under the SCRA are firm buyback contracts (or forward contracts), and not options. The distinction between the two types of arrangements has been carefully considered by the court as follows:
75. In a buy back agreement of the nature involved in the present case, the promissor who makes an offer to buy back shares cannot compel the exercise of the option by the promisee to sell the shares at a future point in time. If the promisee declines to exercise the option, the promissor cannot compel performance. A concluded contract for the sale and purchase of shares comes into existence only when the promisee upon whom an option is conferred, exercises the option to sell the shares. Hence, an option to purchase or repurchase is regarded as being in the nature of a privilege.
77. The distinction between an option to purchase or repurchase and an agreement for sale and purchase simpliciter lies in the fact that the former is by its nature dependent on the discretion of the person who is granted the option whereas the latter is a reciprocal arrangement imposing obligations and benefits on the promissor and the promisee. The performance of an option cannot be compelled by the person who has granted the option. Contrariwise in the case of an agreement, performance can be elicited at the behest of either of the parties. In the case of an option, a concluded contract for purchase or repurchase arises only if the option is exercised and upon the exercise of the option. Under the notification that has been issued under the SCRA, a contract for the sale or purchase of securities has to be a spot delivery contract or a contract for cash or hand delivery or special delivery. In the present case, the contract for sale or purchase of the securities would fructify only upon the exercise of the option … in future. If the option were not to be exercised by them, no contract for sale or purchase of securities would come into existence. Moreover, if the option were to be exercised, there is nothing to indicate that the performance of the contract would be by anything other than by a spot delivery, cash or special delivery. 
In arriving at this conclusion, the court relied on an earlier decision of the Bombay High Court in Jethalal P. Thakkar v. R.N. Kapur, AIR 1956 Bom 74. Although there was a subsequent decision of the single judge to the contrary in Niskalp Investments and Trading Company Ltd. v. Hinduja TMT Ltd. (2008) 143 Comp. Cas. 204 (Bom), that was not considered as it did not “advance the discourse” for it was “rendered on a summons for judgment in a summary suit”.
Certain observations of the court also indicate that where shares are dealt with through the depository system, then that would automatically be treated as “spot delivery” as the definition of that expression permits such treatment. For example, the Court observes:
Where securities are dealt with by a depository, the transfer of securities by a depository from the account of a beneficial owner to another beneficial owner is within the ambit of spot delivery.
While this is helpful in advancing the cause of enforceability of options by ensuring that the shares are held in dematerialized form, it is possible to push the envelope a further to argue that the same principle should even apply to a firm buyback arrangement or forward contract, as it would be treated as a “spot delivery” contract merely by virtue of the securities being held in dematerialized form and transferred through the depository. This aspect has not been considered by the Court expressly, but it might be a plausible argument through logical extension of what has been expressed by the court.
As to the second issue, the Court considered the available case law on whether the SCRA encompasses public unlisted companies as well as listed ones. On this question, the Court has relied upon the Supreme Court’s rulings in Naresh K. Aggarwala v. Canbank Financial Services Ltd. (2010) 6 SCC 178 and Bank of India Finance Ltd. v. The Custodian AIR 1997 SC 1952 to suggest that the SCRA applies even to public unlisted companies. Hence, the scope and applicability of that continues to be quite wide in nature.
The third issue pertains to whether options can be traded only on the stock exchange, or whether they can be entered into privately on a negotiated basis. This is in view of s. 18A of the SCRA which provides that contracts in derivatives are legal only if they are traded on a recognized stock exchange. The Court did not pronounce its opinion on this issue because it was not advanced initially in the show cause notice of SEBI, and was raised only in subsequent submissions.
I have had occasion to consider the enforceability of options in securities in some detail in this paper, which has now been published in the NUJS Law Review, where I argued that (i) “options” are not forward contracts, they are different from buyback arrangements, and hence should be enforceable under the SCRA; (ii) the SCRA should apply only to listed companies and not to public unlisted companies; and (iii) s. 18A should not apply to physically-settled options that are entered into over-the-counter. The Bombay High Court in the MCX case has vindicated the stance on the first issue, rejected the approach on the second issue (primarily due to the existence of Supreme Court’s rulings on the point, which only it can overturn) and refused to decide on the third issue due to procedural considerations.
The Bombay High Court’s judgment represents a step forward in resolving the issue pertaining to the enforceability of options in securities that has continued to vex corporate practitioners for over two decades now. However, it is difficult to assume that the last word has been said on the matter. Certain issues, such as the impact of s. 18A, still remain. While the significance of the legal issues raised in this case may very well command an appeal to the Supreme Court, much of this ambivalence can be ended by appropriate notification or regulation by SEBI under SCRA to induce the necessary clarity rather than to place the onus on the judiciary to resolve them.

Bombay HC in the MCX Case: Summary of the Judgment

The following is a summary of the various issues decided by the court, as extracted from the conclusions in the judgment itself:
(i) Though the MIMPS Regulations in terms apply to a stock exchange in respect of which a Scheme for demutualisation and corporatisation has been approved under Section 4B, the application of those regulations was extended to the Petitioner by SEBI as a condition for the grant of recognition. Though initially SEBI demanded full compliance with the MIMPS Regulations, the requirement which was imposed while extending recognition thereafter, was full compliance with the relevant Regulations. In either view of the matter, there must be a genuine, bona fide and honest attempt to comply with the MIMPS Regulations;
(iii) Regulation 8 prescribes the limit for holding of shares in a stock exchange by a person resident in India, individually or with persons acting in concert. The manner in which a dilution of the equity stake of the promoters had to take place in order to ensure compliance with the provisions of the MIMPS Regulations was not confined to the modes specified in Regulation 4. Many of the modalities prescribed in Regulation 4 do not apply to a stock exchange like the Petitioner which has no trading members. So long as there is a genuine divestment of the equity stake of the promoters in excess of the limit prescribed by Regulation 8, that would fulfill the requirement of Regulation 8;
(iv) Stock exchanges are an integral part of the statutory framework which SEBI regulates in relation to the securities market. The relationship between a stock exchange and SEBI is one based on trust and utmost good faith. A stock exchange is duty bound to make a full and honest disclosure of all material and relevant facts which have a bearing on the issue as to whether the requirements of the MIMPS Regulations have been fulfilled. The existence of the buy back agreements was a material circumstance which ought to have been disclosed to SEBI;
(v) The sanctioning of the Scheme of capital reduction by the Company Judge under Sections 391 to 393 read with Sections 100 to 103 of the Companies' Act, 1956, does not preclude SEBI as a statutory regulator from determining as to whether the provisions of the MIMPS Regulations have been complied with. SEBI is independently entitled to ensure compliance with the MIMPS Regulations which have been made a condition for the grant of recognition. The statutory functions conferred upon SEBI under the SCRA and cognate legislation are not diluted;
(vii) The buy back agreements cannot be held to be illegal as found in the impugned order of the Whole Time Member of SEBI on the ground that they constitute forward contracts. A buy back confers an option on the promisee and no contract for the purchase and sale of shares is made until the option is exercised. The promissor cannot compel the exercise of the option and if the promisee were not to exercise the option in future, there would be no contract for the sale and purchase of shares. Once a contract is arrived at upon the option being exercised, the contract would be fulfilled by spot delivery and would, therefore, not be unlawful.
(viii) The alternate submission which has been urged on behalf of SEBI at the hearing that the buy back agreements constitute an option in securities and being derivatives violate the provisions of Section 18A of the SCRA is not the basis either of the notice to show cause that was issued to the Petitioner or of the order passed by the Whole Time Member of SEBI. SEBI has in fact, issued a notice to show cause to the Petitioner subsequent to the order asserting that as a ground. In that view of the matter, it will not be appropriate or proper for this Court to render any finding on that aspect, particularly when it did not find a place either in the notice to show cause or in the order passed thereon;
(ix) The definition of the expression "persons acting in concert" is for the purpose of the MIMPS Regulations derived from the Takeover Regulations, by Explanation (IV) to Regulation 8 of the MIMPS Regulations. Regulation 8 after its amendment in 2008, refers only to the holding of shares and not to the acquisition and holding of the shares as earlier. In applying the provisions of Regulation 2(1)(e) of the Takeover Regulations (which defines "persons acting in concert") to the MIMPS Regulations, it would be permissible following well settled principles in that regard to make some alteration in detail to render the regulations meaningful and effective. However, the essential ingredients of the expression "persons acting in concert" in the Takeover Regulations cannot be abrogated. …;
(x) The impugned order passed by the Whole Time Member has failed to apply the principal test enunciated by the judgment of the Supreme Court in Daichi Sankyo (supra) in determining as to whether certain persons may be held to be acting in concert. The mere fact that two persons have come together in promoting a Company does not lead to the inference that they are acting in concert for the purposes of the Takeover Regulations. …;
(xii) On the aspect as to whether the Petitioner is a fit and proper person for the grant of recognition, the finding which has been arrived at in the impugned order is inter alia based on a conclusion as to the illegality of the buy back agreements on the ground that they are forward contracts, which is found to be erroneous in the present judgment. The effect of the non- disclosure of the buy back agreements to SEBI should be considered having regard to the fact that a genuine attempt has been made by the promoters by tendering an undertaking to the Court that their shareholding together shall not exceed five per cent of the equity capital, notwithstanding the exercise of the options.

Bhopal Gas Tragedy: Revisiting Issues of Liability under Corporate Law

Over at Critical Twenties, Arghya Sengupta has initiated a debate “on the twin issues of the legal responsibility of a successor multi-national company for the liabilities of its predecessor as well as … thoughts on the appropriateness of the Olympics partnering with such a corporation would be most appreciated.”
I have sought to step into the debate by addressing questions of legal liability where corporate law plays a crucial role in determining where the liability stands fixed. Two principles come into play. The first is whether a parent company is liable for acts or omissions of a subsidiary company, and the second is what happens to the liability of company when it (or its business) is sold. In order to read the full post, please click here.

Wednesday, March 14, 2012

Bombay HC Ruling on the MCX-SEBI Case

The Bombay High Court has pronounced its judgment today in the matter relating to the denial of a stock exchange licence to the MCX Exchange. The Court has set aside SEBI's order of 23 September 2010 (which was discussed here) and directed SEBI to reconsider MCX's application afresh in the light of the Court's observations.

The judgment has significant implications on various aspects, including "persons acting in concert" and the enforceability of buyback arrangements and options in securities. We will have the opportunity to discuss some of these in greater detail.


1.         Reactions to Vodafone
The discussions on the Vodafone judgment of the Supreme Court continue to raise questions regarding tax avoidance, and also aspects of corporate law (distinguishing the sale of shares and sale of assets). While Prashant Bhushan has raised questions regarding the judgment on several counts (here and here), Arvind Datar rationalizes the Supreme Court’s conclusion.
2.         Airline Companies and Corporate Governance
In the context of the grave financial issues airline companies are facing, a piece in the Business Line looks at the impact of corporate governance. The author argues that while it is possible to change bad management, it is more difficult (if not impossible) to replace ownership, and that affects all stakeholders in the business.
3.         Shareholder Activism
Although one of the key criticisms of corporate governance in India has been the lack of shareholder activism, there are signs that this might change. For example, India has witnessed the emergence of proxy-advisory firms that take an active role in advising investors on how to vote at shareholders’ meetings. This is meant to energize otherwise passive shareholders, particularly the retail ones.
Shareholder activism sometimes also takes on a more direct and adversarial form, as witnessed in the Western markets, where investors or groups of them directly engage with the company to protect shareholder interest and value. That type of activism too appears to be surfacing as this report in the Business Standard suggests. However, as Mobis Phillipose analyzes in the Mint, while this denotes a healthy move toward protection of minority shareholders, the ability of investors to successfully obtain legal remedies against errant companies or their directors is altogether a different matter.
4.         Advisors' Conflicts in M&A Transactions
A recent decision of the Delaware Chancery Court deals with a conflict of interest of Goldman Sachs, who, as an advisor to the target company El Paso, had a significant interest in the bidder, being Kinder Morgan. Although the court came down on the role of the investment bank, it did not prevent the offer from proceeding. A summary of the decision set out at the beginning of the Court’s opinion is extracted below:
The chief executive officer of El Paso, a public company, undertook sole responsibility for negotiating the sale of El Paso to Kinder Morgan in the Merger. Kinder Morgan intended to keep El Paso’s pipeline business and sell off El Paso’s exploration and production, or “E&P,” business to finance the purchase. The CEO did not disclose to the El Paso board of directors (the “Board”) his interest in working with other El Paso managers in making a bid to buy the E&P business from Kinder Morgan. He kept that motive secret, negotiated the Merger, and then approached Kinder Morgan’s CEO on two occasions to try to interest him in the idea. In other words, when El Paso’s CEO was supposed to be getting the maximum price from Kinder Morgan, he actually had an interest in not doing that.
This undisclosed conflict of interest compounded the reality that the Board and management of El Paso relied in part on advice given by a financial advisor, Goldman, Sachs & Co., which owned 19% of Kinder Morgan (a $4 billion investment) and controlled two Kinder Morgan board seats. Although Goldman’s conflict was known, inadequate efforts to cabin its role were made. When a second investment bank was brought in to address Goldman’s economic incentive for a deal with, and on terms that favored, Kinder Morgan, Goldman continued to intervene and advise El Paso on strategic alternatives, and with its friends in El Paso management, was able to achieve a remarkable feat: giving the new investment bank an incentive to favor the Merger by making sure that this bank only got paid if El Paso adopted the strategic option of selling to Kinder Morgan. In other words, the conflict-cleansing bank only got paid if the option Goldman’s financial incentives gave it a reason to prefer was the one chosen. On top of this, the lead Goldman banker advising El Paso did not disclose that he personally owned approximately $340,000 of stock in Kinder Morgan.
The record is filled with debatable negotiating and tactical choices made by El Paso fiduciaries and advisors. … In the case of Goldman, it claimed to step out of the process while failing to do so completely and while playing a key role in distorting the economic incentives of the bank that came in to ensure that Goldman’s conflict did not taint the Board’s deliberations. This behavior makes it difficult to conclude that the Board’s less than aggressive negotiating strategy and its failure to test Kinder Morgan’s bid actively in the market through even a quiet, soft market check were not compromised by the conflicting financial incentives of these key players.
The record thus persuades me that the plaintiffs have a reasonable likelihood of success in proving that the Merger was tainted by disloyalty. Because, however, there is no other bid on the table and the stockholders of El Paso, as the seller, have a choice whether to turn down the Merger themselves, the balance of harms counsels against a preliminary injunction. Although the pursuit of a monetary damages award may not be likely to promise full relief, the record does not instill in me the confidence to deny, by grant of an injunction, El Paso’s stockholders from accepting a transaction that they may find desirable in current market conditions, despite the disturbing behavior that led to its final terms.
The Deal Professor has an analysis of the decision.

Tuesday, March 13, 2012

The Bombay High Court on applying Vodafone to Sham Transactions

In Killick Nixon v DCIT, decided on 6 March 2012, a Division Bench of the Bombay High Court (Dr DY Chandrachud and MS Sanklecha JJ.) has considered the application of the guidance given by the Supreme Court in Vodafone to a transaction that was found at first instance to constitute a sham.
The attempt by the taxpayer in this case is reminiscent of the tax avoidance transactions that shaped English law in the 80s, and in particular, of the judgment of the House of Lords in IRC v Burmah Oil. The taxpayer had executed a guarantee in favour of Vysya Bank for a loan the bank had advanced to Geekay Exim India Ltd [“GEIL”], a company belonging to the G.K. Rathi Group. When GEIL defaulted, Vysya Bank invoked the guarantee, and the taxpayer sold land that it owned in satisfaction of the claim, and capital gains of Rs. 49.72 crores arose from this transaction. In a period of three days between 28 and 30 March 2000 (perhaps the month is no coincidence), the taxpayer purchased shares in four of its wholly owned subsidiaries for a total of Rs. 48 crores. These shares, with a face value of Rs. 10, were purchased at a premium of Rs. 140, although they were valued at Rs. 23 on price earning capacity and valued at a negative on the net value basis. Two other facts are even more significant: first, the source of the Rs. 48 crores required to purchase these shares was the GK Rathi Group – four group companies made a contribution to the taxpayer of Rs. 48 crores, and secondly, the four subsidiary companies whose shares were purchased transferred the Rs. 48 crores they received to a GK Rathi Group company. The effect of this transaction was that Rs. 48 crores left the GK Rathi group on 28 March (through contributions to the taxpayer) and came back to the GK Rathi group on 31 March (through transfers by the four companies whose shares were purchased at a premium of Rs. 140). The Assessing Officer made the following finding of fact:
The money never existed. Only debit and credit entries were created in Bank by issuing cheques to one party and receiving the same amount through that party by circular transaction.  Thus   the   Bank   accounts   got   squared   up showing no negative balance or positive balance at the end of a particular date on account of the activity
These shares, purchased in AY 2000-2001 at Rs. 150 each, were then sold by the taxpayer in AY 2001-’02 for Rs. 5 each to two companies and the taxpayer claimed the resultant capital loss. The Assessing Officer found that the two companies which purchased the shares for Rs. 5 each had received the funds necessary for this purpose from the Chairman of the taxpayer company and from a GK Rathi group company. There were two other claims by the taxpayer in this case that need not be described in detail at this stage (interested readers may refer to para 4(c) and 4(d) of the judgment).
The case for the taxpayer in the Bombay High Court appears to have been argued principally on the basis that the Tribunal erred in relying on a judgment that neither counsel had referred to, in concluding that the test of examining the surrounding circumstances and human probabilities pointed to the conclusion that the taxpayer’s transactions were not genuine. The Court had little difficulty in rejecting this contention, but as a result was not required to examine at length the law on tax avoidance. In principle, there are two bases on which the taxpayer’s claim could have been rejected – the first is the conclusion that these transactions are shams in the sense in which that word is used in English and Indian tax avoidance jurisprudence, and the second is that the claim fails even if the transactions are not shams. A sham, as Lord Wilberforce explained in Ramsay, “means that while professing to be one thing, it is in fact something different”. The important point is that the sham doctrine does not invite any substance over form analysis – as Diplock LJ’s judgment in Snook points out, a document is a sham if the parties give it an appearance is at variance with their own intention. The findings of the Assessing Officer in this case perhaps justify the inference that there was a sham and if so that is the end of the matter.
However, the taxpayer’s case is difficult to sustain even on the alternative hypothesis that this was not a sham. As our readers will recall, the attempt in Burmah Oil was similar: Burmah had sustained a capital loss of around £160 million (in the form of a bad debt owed by its subsidiary, Holdings, to it) that was not allowable under the capital gains legislation in England and wished to “covert” it into a form that was. So it lent a sum of £160 million to MORH, another subsidiary, which in turn lent it to Holdings which paid off the debt of £160 million. Holdings then issued shares worth £160 million to which Burmah subscribed, and Holdings used that money to pay off its debt to MORH, which repaid Burmah. Holdings then went into voluntary liquidation and Burmah claimed the cost of acquisition of its new shares in computing the capital gains on the disposal of its shares in Holdings. Lord Diplock and Lord Fraser of Tullybelton accepted that this was not a sham since the transaction was what it professed to be, but nevertheless held that Burmah suffered “no real loss” since the £160 million which left it in order to provide the funds to repay the debt came back to it when MORH repaid the loan it had been given. Although this is not a subject we can explore in detail here, the conclusion in Burmah Oil, unlike Furniss v Dawson, is unaffected by the subsequent decisions of the English courts.
The Bombay High Court has relied on the observation in the judgment of the Chief Justice in ¶64 of Vodafone that there is no conflict between McDowell and Azadi Bachao Andolan in those cases in which the taxpayer uses “colourable devices”. Sanklecha J. makes the following observations in paragraph 15:
The aforesaid observations of the Supreme Court makes it very clear that a colourable device cannot be a part of tax planning. Therefore where a transaction is  sham and not genuine as in the present case then it cannot be considered to be a part of tax planning or legitimate avoidance of tax liability. The Supreme Court in fact concluded that there is no conflict between its decisions in the matter of  McDowell (supra),  Azadi Bachao (supra)  and Mathuram Agarwal (supra). In the present case the purchase and sale of shares, so as to take long term and short term capital loss was found as a matter of fact by all the three authorities to be a sham. Therefore authorities came to a finding that the same was not genuine.
On the facts of this case, the Bombay High Court was therefore not required to consider what the law in India is once the assessing officer finds that a transaction, albeit effected perhaps solely to avoid tax, is not a sham in the Snook sense. As we have pointed out, the Chief Justice’s judgment in Vodafone appears to indicate that Indian law on that question may be narrower than English law.

Monday, March 12, 2012

Paper on Enforceability of Share Transfer Restrictions

Niranjan and I have posted a paper titled “The Enforceability of Contractual Restrictions on the Transfer of Shares” on SSRN. The abstract is as follows:
This paper analyzes the judicial trends regarding the enforceability of clauses in shareholders’ agreements that restrict the transfer of shares in Indian companies. The authors argue that neither VB Rangaraj’s case nor section 111A(2) of the Companies Act, correctly interpreted, supports the view that contractual restrictions on the transfer of shares are unenforceable qua the shareholders. As to the former, they argue that VB Rangaraj was wrongly decided because it misinterpreted section 82 of the Companies Act, and relied on two English judgments that in fact dealt with the power of the board of directors to refuse registration, and not with the ability of private parties to create contractual restrictions. As to the latter, they argue that a close analysis of the legislative history and contemporaneous interpretation of section 22A of the Securities Contract (Regulation) Act, 1956 (the precursor to section 111A(2)) demonstrates conclusively that Parliament simply regulated the power of the board of directors to refuse registration and never intended to invalidate contractual restrictions. 

The doubtful provenance of these two propositions has led to a sharp divergence of opinion across the High Courts, which the authors suggest is best resolved by the Supreme Court clearly emphasising that section 111A(2) is in reality irrelevant to the validity of contractual restrictions. The Court has an opportunity to do so in deciding the appeal challenging Messer Holdings, and the authors argue that the best course is for the Court to overrule VB Rangaraj and Messer Holdings insofar as it relies on VB Rangaraj, and affirm Messer Holdings insofar as section 111A(2) is concerned.

PIL in Kerala to axe the vexed Intermediary Rules

(The following post is contributed by Rohan Bagai)

In the midst of the tempestuous brouhaha over internet censorship and filtering of online content while US corporations like Microsoft and Yahoo are being let off on account of scanty evidence of objectionable content in their court battles at Delhi, a public interest litigation (PIL) has been filed in the Kerala High Court contesting the constitutional validity of the allegedly vexed provisions of the much hyped ‘Information Technology (Intermediaries guidelines) Rules, 2011 (“Intermediaries Guidelines”), and the Information Technology (Procedure and Safeguard for Blocking for access of information by public) Rules, 2009 (“IT Rules 2009”).

The Hon’ble High Court has reportedly admitted the PIL [WP (C) 5236 of 2012] and sought the Ministry of Communications & Information Technology, Government of India to file its response within 8 weeks. The petition specifically challenges Rule 4 of the Intermediaries Guidelines and Rules 8 and 16 of the IT Rules 2009 and labels these Rules as arbitrary, unreasonable and violative of the fundamental right of the internet users to “freedom of speech and expression” guaranteed under Article 19 (1) (a) of the Constitution of India.

Rule 4 of the Intermediaries Guidelines empowers the intermediary, on whose computer system the information is stored or hosted or published (upon obtaining knowledge by itself or been brought to actual knowledge by an affected person), to act within thirty six (36) hours and where applicable, work with user or owner of such information to disable such information/content that is unlawful or objectionable in accordance with these Guidelines. Essentially, this gives the  intermediary the power to censor, block or ban the websites and/or content that appears on the internet.  

The petitioner casts aspersions on the intermediaries submitting that “these are private companies who have their own business interest to protect. The intermediaries cannot be expected to be guardians of free speech. They engage in blocking, censoring internet content arbitrarily and on the basis of any frivolous complaint. They do not have the responsibility to verify the genuineness of the complaint received. The blockings are arbitrary and not in conformity with the principles of natural justice like notice and fair hearing. The Rule requires the intermediary to work with the user concerned before censoring any content. But the user concerned is not given any notice or a chance for a hearing in the matter by the intermediaries. This is a gross violation of the fundamental right of free speech and expression guaranteed under Article 19 (1) (a) of the Constitution of India.”

In the petition, the petitioner alleges that the owner/user of the content is not provided any opportunity to understand the reasons as to why his content has been censored or blocked and no order in this respect is ever communicated to the concerned content owner/user by the intermediaries. As a result, the aggrieved party has no redressal before any judicial forum, which is a clear infringement of the fundamental rights including the right to constitutional remedies.

One such instance cited in the petition is that of, in respect of which, on December 26th, 2011, the website was blocked on the basis of a complaint which was forwarded by the Mumbai crime branch police to the intermediary. The Indian intermediary ‘Big Rock’ which was the domain name registrar and also the web hosting company blocked the website without providing an opportunity to the content holder for a hearing before taking down the content.

Further, Rule 8 of the IT Rules 2009 authorizes the ‘Designated officer’ of the Computer Emergency Response Team (CERT-India) to identify the person or intermediary and issue a notice to appear and submit their replies at a specified date and time, upon receiving any complaint for blocking of access of any information by the public.

To this, the petitioner has asserted in the petition that “even though notice has to be given to the user concerned before blocking/banning/censoring any content, it is not complied with and the user concerned is not given a fair hearing. There is no mandate to issue notice to the ultimate affected user/owner of the content. The said Rule places a discretion to issue notice to the affected user or the intermediary. The intermediary is not an interested party and would not have an objection to block any content. The intermediaries, being private companies, are established for profit making objectives and are not concerned about blocking content”.     

Rule 16 of the IT Rules 2009 requires all requests and complaints received and actions taken thereof to be kept strictly confidential. Since the said Rule enables the Designated Officer to keep confidentiality the petitioner disputes that the said Rule can be misused by secretly engaging into censoring the internet. This is for the reason that “the provision enables the designated officer not to serve a copy of the complaint or order so as to curtail the rights of the user concerned to resort to judicial remedies”.

In effect, the PIL besides the highlighting the alleged constitutional invalidity of the above impugned provisions, urges the Hon’ble High Court to issue guidelines to the Respondent (the Government) in respect of the following:

(a)     Before banning the content it should be done with the prior notice to the owner of the content/user concerned in accordance with the principles of natural justice;

(b)    Immediately after the blocking, banning or censoring the content a copy of the order stating reasons should be communicated to the owner of the content/ user concerned so as to enable them to resort to judicial remedies;

(c)     To instruct the Internet Service Providers (ISP) to develop the technical competence to block only the specified web pages/websites which have been directed by the Courts/ orders of the government; and

(d)    To take away the deciding power and censoring power from the intermediaries and escalate such issues to a government appointed body like Computer Emergence Response Team (CERT-In) so as to ensure uniformity in the blockings.

There is no doubt that the process of filtering of content in the internet needs to be streamlined by ensuring transparency (by publishing all orders issued for blocking content on the website of CERT-India) and maintaining consistency (by giving a fair hearing to the users and not allowing the intermediaries to apply varying policies and yardsticks) in the standards in blocking content. However, it remains to be seen if the Government agencies in India can be steadfast in remaking public faith as “the people of this country have a right to know every public act, everything that is done is a public way, by their public functionaries. They are entitled to know the particulars of every public transaction in all its bearing. The right to know, which is derived from the freedom of speech, though not absolute, is a factor which should make one wary, when secrecy is claimed for transactions which can, at any rate, have no repercussion on public security”. (New York Times Co. V. United States ((1971) 29 Law Ed. 822= 403 U.S. 713)

Let’s see if this constitutional challenge goes any far. For now, we can only wait and watch.

 - Rohan Bagai

Sunday, March 11, 2012

The Socio-Legal Review: Essay Competition

The Socio-Legal Review, the student edited peer reviewed journal of the National Law School of India University, Bangalore is holding the 2nd Annual SLR Essay Competition.
Students from law schools and other undergraduate courses in India and around the world can participate and submit their essays on the topics mentioned below.
1. Emergent Civil Society: Redefining or negating participative democracy?
2. Rule of Law in Fledgling Societies: Is parliamentary democracy still the best solution? Discuss and highlight possible alternatives in light of the Arab Spring and Occupy Protests.
3. Freedom of Speech and Role of the Media: To what extent can and should the Press Council of India regulate content and reduce sensational Journalism
Word Limit: 2,500 to 3,000 words (exclusive of footnotes) and the essay is to be submitted via email and the deadline for submissions is 30th April, 2012
The essay competition is supported by a trust floated by Smt and Sri S.V.Joga Rao (visiting professor, NLSIU) In memory of their parents.

Monday, March 5, 2012

Outbound FDI and M&A

The Reserve Bank of India has published a paper/address titled “Outward Indian FDI – Recent Trends & Emerging Issues” that examines various regulatory aspects of outbound FDI by Indian companies. It considers various business aspects and comments upon regulatory issues and concerns.
The latest issue of The Economist also looks at outbound M&A from India, and analyzes the level of success that Indian outbound deals have achieved. While some deals have indeed been profitable, others may not have achieved the expected success for several reasons, including the global financial crisis that emerged at the peak of the Indian outbound M&A boom. Part of the issues identified relate to complexity in Indian corporate structures, and possible regulatory obstacles. For example, the article notes:
But to do more jumbo deals in a tougher world, Indian firms need to tackle a glaring area of weakness. This is their complex structures, which mean cash flows are spread thinly, and their dislike of issuing equity for fear of diluting their controlling shareholders. Both factors combined make it hard to marshal resources without resorting to risky levels of debt.
Nevertheless, it appears that the deal-flow on outbound Indian M&As have continued even into 2012 although the sizes of the deals have dropped in comparison with those witnessed during the boom.

Saturday, March 3, 2012

Offer for sale by promoters through stock exchange mechanism (OFS) – A welcome move

(The following post is contributed by Yogesh Chande, an advocate practising in Mumbai)
The Securities and Exchange Board of India (SEBI) by a circular dated 1 February 2012[1] (Circular), has permitted the Bombay Stock Exchange Limited (BSE) and National Stock Exchange of India Limited (Stock Exchanges) to provide a separate window, i.e. apart from the existing trading system for the normal market segment, to facilitate promoters of listed companies to dilute/offload their holding in listed companies in a transparent manner with wider participation,. This was approved at the board meeting of SEBI held on 3 January 2012.
Following are the salient features of the Circular
1. Promoter / promoter group entities (Sellers) (that are eligible for trading) of listed companies which are required to comply with minimum public shareholding requirements[2] in terms of Securities Contracts (Regulation) Rules, 1957 can avail the OFS window.
2. the Sellers which belong to top 100 companies based on average market capitalization of the last completed quarter can also avail the OFS window to dilute their shareholding.
3. The Sellers should not have purchased and/or sold the shares of the target company in 12 weeks prior[3] to the OFS (Eligibility to sell). The Sellers will have to undertake not to purchase and/or sell shares of the target company for a period of 12 weeks after the OFS.
4. All investors registered with the brokers of the Stock Exchanges, other than the Sellers, will be eligible to buy the shares to be sold by the Sellers.
5. The minimum size of OFS should be as follows:
Minimum size of OFS / Dilution
Paid-up share capital
1% of paid-up share capital, subject to a minimum of Rs. 25 crore
More than Rs. 25 crore at closing price on the specified date*
10% of paid-up share capital or such lesser percentage so as to achieve minimum public shareholding in a single tranche.
Less than Rs. 25 crore at closing price on the specified date*
* Specified date means the last trading day of the last completed quarter.
6. Sellers are obliged to make an announcement of their intention to sell the shares, at least one clear trading day [and not one trading day][4] prior to the opening of the OFS. The announcement should contain information prescribed in the Circular[5]. Advertisement pertaining to the OFS can be made only after the announcement / notice of OFS has been made. Contents of the advertisement should be consistent with the announcement / notice issued to the Stock Exchanges.
7. All expenses relating to the OFS will have to be borne by the Sellers[6].
8. Sellers are required to appoint broker(s) for the purpose of OFS. Same broker is permitted to carry out the buy transaction on behalf of the buyer(s).
9. Sellers have an option to declare a floor price, either in the announcement or in a sealed envelope to Designation Stock Exchange (where the orders shall be placed) (DSE) before opening of the OFS in which case, the floor price shall not be disclosed to anybody including the selling broker(s). The sealed envelope shall be opened by DSE only after the closure of the OFS and the floor price shall be informed to the market. In case the floor price is disclosed, no bids shall be accepted below the floor price and no allocation will be made in case the bid is below the floor price.
10. Duration of the OFS cannot exceed one trading day and the orders will have to be placed by the trading members (selling brokers) during trading hours[7].
11. The order placement should be made through a separate window for the purpose of OFS. The modalities of the order placement have been prescribed in clause 5(e) of the Circular.
12. There is no price band for orders/bids placed in the OFS.
13. Buyer(s) will have to pay 100% of the order value in cash up-front. Correspondingly, the entire quantity of the shares proposed to be sold will have to be deposited by the Sellers prior to the OFS as margin.
14. A minimum of 25% of the shares offered is required to be reserved for mutual funds and insurance companies subject to allocation methodology[8]. There is an option as regards allocation methodology i.e. either on a price priority basis (at multiple clearing price) or on a proportionate basis at a single clearing price. No single bidder other than mutual funds and insurance companies can be allocated more than 25% of the shares being offered through OFS.
15. The settlement will take place similar to “trade-to-trade” basis[9] and will be completed on a T+2 basis.
16. The OFS, once announced, can be withdrawn prior to its proposed opening. There shall however be a gap of 10 trading days from the date of withdrawal before a subsequent OFS can be launched.
17. Cancellation of OFS during the bidding period is not permitted.
Some observations
A. The Circular is an additional window (other than the “block deal” window) available on the Stock Exchanges for specific purposes mentioned above.
B. The Stock Exchanges will have to issue a list of top 100 companies based on average market capitalization of the last completed quarter after the completion of every quarter.
C. There is no mandatory requirement under the Circular to appoint a SEBI registered merchant banker for conducting OFS.
D. As regards paragraph 3 mentioned above (i.e. Eligibility to sell), the Sellers will have to carry out a thorough due-diligence to ensure that, none of the entities forming part of the promoter/promoter group have purchased and/or sold the shares of the target company during the stipulated period prior to the OFS. From a diligence perspective, there could be issues typically in case of companies, where, for example either: (i) the promoter group is too large and there is no system in place to ensure this; or (ii) the compliance officer is not adequately kept informed about the trades; or (iii) there are factions within the promoter group leading to miscommunication etc.
E. The OFS window will be an “anonymous” trading window as far as the identity of the bidders is concerned, though the “category” of the bidders (e.g. mutual fund, insurance company) would be known. Identity of the Sellers will be known to the bidders and the buying brokers.
F. The responsibility of allocation of shares is vested with the DSE based on the methodology disclosed in the notice by the Sellers as explained in clause 14 above. Thus, there is no “consultation process” involved between the DSE, either with the Sellers or the selling broker, at the time of actual allocation of shares by the DSE. However, the DSE will have to ensure that, the spirit of the Circular i.e. the allocation is not only done in a transparent manner but also results in scattered allocation of the shares.
G. SEBI has correspondingly amended clause 40A of the equity listing agreement[10] and has included OFS as one of the mode for diluting promoter shareholding.
H. It appears that, the brokers will have to comply with the provisions of SEBI circular dealing with disclosure of trade details of bulk deals i.e. with respect to all transactions in a scrip where total quantity of shares bought/sold is more than 0.5% of the number of equity shares of the company listed on the Stock Exchanges.
I. As regards clause 5(b) of the Circular i.e. announcement / notice to Stock Exchanges of the OFS, though the responsibility is of the Sellers to make such an announcement, it is not clear whether such an announcement can be routed by the Sellers through the target company which in turn will inform the Stock Exchanges about the same or should the Sellers directly inform the Stock Exchanges about the same.
J. Again from a diligence perspective, the Sellers will have to be careful as regards provisions of SEBI (Prohibition of Insider Trading) Regulations, 1992 (Regulations) prior to affecting the sale through OFS because they have superior access to information pertaining to the target company. It will also be crucial at what point in time, the Sellers will inform the target company (as mentioned in I above) about their intent to dilute their shareholding in the target company, and whether such an event would require closure of the “trading window” by the target company in terms of the Regulations, till the information remains unpublished. Adequate “chinese walls” also need to be in place between the Sellers and the target company, till the time information pertaining to OFS is unpublished.
K. Needless to say that, the Sellers and the buyer(s) will have to comply with the applicable reporting requirements prescribed under the Regulations and under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
On 1 March 2012, the President of India acting through and represented by the Ministry of Petroleum and Natural Gas, Government of India, sold 427,774,504 equity shares held in ONGC by adopting the OFS window provided by the Stock Exchanges.

- Yogesh Chande

[1] And subsequent clarifications by circular dated 23 February 2012 and 27 February 2012.
[2] 25%.
[3] It will have to be examined whether, this will include for example “inter-se” transfer of shares if any, between the promoters.
[4] i.e. T minus 2, T being the trade date
[5] Clause 5(b) of the Circular
[6] Section 77(2) of the Companies Act, 1956
[7] Currently 9.15 am to 3.30 pm IST
[8] Unsubscribed portion thereof can be made available to other bidders
[9] Selling / buying of shares in that scrip results into giving / taking delivery of shares at gross level and no intra-day netting off / square off facility is permitted, unlike in case of a “compulsory rolling settlement”
[10] Circular dated 8 February 2012