Sunday, July 29, 2012

Synchronised Trades Per Se Not Illegal

There is no prohibition on synchronised trading in securities, so long as the securities are delivered and that the transaction has not been effected with manipulative intent to artificially move the price of the stock. This position has been reiterated in a recent order of the Securities Appellate Tribunal (SAT) involving Subhkam Securities Private Limited. The relevant portions of the order are extracted below:
The transactions were executed at the prevailing market price and there is no allegation of price manipulation.  The trades were carried out on the floor of the exchange and there was transfer of beneficial ownership in all the transactions. Assuming that the trades were synchronized, the fact remains that the trades were executed over a period of three months and there is no allegation that it affected the price of the scrip.  It is an admitted position that synchronized trades per se are not illegal.  It is only when synchronized trades are executed with a view to manipulate the price of the scrip that the provisions of the FUTP Regulations will get attracted.  All these trades were executed on behalf of the clients and no action is said to have been taken by the Board against these clients. In view of the foregoing discussions, we are of the view that in the facts and circumstances of this case, the charge of violating the provisions of regulations 4(b) and (d) of the FUTP Regulations is not made out.  [emphasis added]
Although not germane to the substantive issue at hand, the SAT also made observations regarding the inordinate delays in SEBI’s investigation in the matter. SEBI’s order, which was passed in March 2012, related to trades that occurred way back in 2000. Relevant extracts follow:
Inordinate delay in conducting inquiries and in punishing the delinquent not only permits market manipulator to operate in the market, it also has demoralizing effect on the market players who are ultimately ‘not found guilty’ but damocles’ sword of inquiry keeps hanging on them for years together from the date of starting investigation by the Board to the date of completion of inquiry proceedings.  ...  A market player has a right that if proceedings are initiated against him by the Board for violation of any rules  and regulations, the proceedings against him, are also concluded expeditiously and he is not made to undergo mental agony when these are unnecessarily prolonged without any fault on his part in delaying  the proceedings. We hope that the Board will take necessary steps to ensure that inquiry proceedings against market manipulators are completed expeditiously and guilty persons are punished in a time bound manner so that the objective of having a clean and investor friendly market can be achieved. 


1.         Online Shareholder Participation
In a previous post, we discussed the recent introduction of mandatory e-voting for large listed companies with effect from October 1, 2012. The Harvard Law School Corporate Governance Forum has a post that sets out some principles and best practices that companies are encouraged to adopt while conducting electronic shareholders meetings and voting. Although that is set in the context of laws applicable in the U.S., some of the general principles would be useful for Indian companies as well.
2.         Offer for Sale by Promoters Through the Stock Exchange Mechanism
Earlier this year, SEBI had issued detailed guidelines on offer for sale by promoters through the stock exchange mechanism (analysed here). This is in pursuance of the requirement for listed companies to achieve their minimum public shareholding by next year. Due to concerns raised in connection with the offer process, it has now been relaxed, and a new set of guidelines have been issued via SEBI’s circular dated July 18, 2012. Some press reports that track SEBI’s decision on this issue are contained here, here and here.
3.         Special Rights to Specific Shareholders
It is quite customary for companies (including listed ones) to offer special rights to financial investors such as private equity funds and venture capital investors. These rights include board representation, special quorum requirements and affirmative voting rights on specific matters both at the board and shareholder meetings. While such rights have been historically the subject matter of discussion on their legalities such as their enforceability under certain provisions of the Companies Act, whether they amount to “control” under the SEBI Takeover Regulations, and whether the stock exchanges would permit inclusion of these special rights in the articles of association, these rights have now been the focus of corporate governance concerns. In a recent instance involving one company, the merits of providing these rights to a shareholder holding as low as one share have been questioned by other minority shareholders.

Monday, July 23, 2012

Guarantees and Performance Bonds

Payment obligations under commercial contracts are often secured by means of guarantees issued by banks, which guarantee the performance of the payment obligation by the buyer. For instance, if A and B enter into a contract whereby A agrees to sell B a ship for the price of $50 million, B's bank may issue to a payment guarantee to A to secure the payment of this amount from B. In the alternative, the contractual arrangements between A, B and the bank may be such that the bank issues a performance bond to A. However, there is a fundamental difference in the nature of the obligation assumed by the bank in the two cases.

If the bank issues a guarantee, the contractual arrangement between the parties is trilateral, whereby the bank undertakes a secondary obligation to guarantee that B will perform its contractual obligations to A. Therefore, any defences available to B are also available to the bank, and A must prove that B has invalidly failed to perform its contractual obligations. In such a case, depending on the nature of the guarantee, A can have recourse against the bank: (a) in damages, for a breach of the bank's obligation to ensure B's performance; or (b) requiring it to step into B's shoes and pay the amount owed by B on the satisfaction of any notice or demand requirements contained in the guarantee.

To the contrary, when the bank issues a performance bond, there are two independent bilateral arrangements in place: one between A and B, and the other between A and the bank. By virtue of the performance bond, the bank is obliged to pay A the secured amount if certain notice/demand conditions are satisfied, irrespective of whether any payment is due from B to A under the primary contractual arrangement.

Therefore, whether a given transaction involves a guarantee or a performance bond depends on the relative bargaining strengths of the parties, and the difference assumes great significance in cases where there is a dispute between A and B as to the existence of the primary payment obligation. It was one such case which was recently considered by the English High Court in Wuhan Guoyu v Emporiki Bank of Greece [2012] EWHC 1715 (Comm).

The facts of the case involved a shipbuilding contract, under which the buyer was to pay the consideration amount in instalments on the completion of certain activities in relation to the ship. The payment of these instalments was secured by means of a 'Payment Guarantee' which was Exhibit B to the primary contract, and was issued by the buyer's financing bank. The seller's bank had also issued a 'Refund Guarantee' to the buyer (Exhibit A), to secure repayment of the consideration amounts if the contract was rescinded or cancelled in accordance with its terms. Both these documents were referred to in the contract as 'irrevocable letters of guarantee'.

The buyer paid the first instalment, following which there was a dispute between the buyer and the seller as to whether the second instalment was due. The seller sought payment of the instalment from the bank notwithstanding this underlying dispute, thus calling upon the High Court to decide whether the 'Payment Guarantee' was a guarantee in the true sense, or in fact a performance a bond.

The Court began by clarifying that the question is one of construing the contract, and while previous cases could provide guidance as to the relevance of several factors, the identity of each document depended on its particular language and context. Based on a very useful survey of authorities (contained in paragraphs 32-54 of the report), the Court culled out the following principles which are relevant to determining the identity of a particular document:
  • The labelling of the document as a 'guarantee' is not determinative, and neither is an elaboration of the commercial purpose of the document (e.g. 'to indemnify …')
  • An undertaking to pay the on 'first written demand' and a provision that such demand is the only condition for payment indicates that the document is a performance bond
  • The reasoning must start with the wording of the contract and the Court must not bring any pre-conceived notions to interpreting the document
  • A key question is whether the condition for payment is the presentation of documents which assert certain facts, or the actual existence of the facts asserted
  • A clause stating that the presentation of certain documents shall be 'conclusive evidence' indicates that the document may be a performance bond
  • The issuance of the document in a banking context is material. In non-banking contexts, there is a strong presumption against it being a performance bond
  • If the transaction is cross-jurisdictional, it may suggest that the parties would prefer to avoid a detailed proving of the merits of the underlying claim (and hence provide a performance bond)

On a detailed consideration of these factors, the Court concluded that the document in question was a guarantee and not a performance bond. While a detailed discussion of the conclusions would be out of place here, some interesting points emerging from the reasoning are:
  • The fact that both the Payment Guarantee and the Refund Guarantee were referred to as 'irrevocable letters of guarantee' suggested that they had the same legal effect. The Refund Guarantee was undoubtedly a guarantee in legal terms (the contrary view would be commercially unreasonable), and therefore the Payment Guarantee was also likely a guarantee.
  • The reference to the bank as the 'primary obligor' was not conclusive, since it begged the question of what the bank's primary obligation was. If the effect of the document was to create an obligation to guarantee and not to pay, then the reference to 'primary obligor' was not material.
  • The bank's obligation arose if the buyer breached its obligations and then the seller issued a demand, which suggested that the breach a necessary precondition to payment. Although there is authority indicating that the use of such language ('if … when'; 'then') was not conclusive, when read in the context, the language here suggested that payment was condition on more than just the presentation of a demand notice.
  • The fact that the bank was financing the buyer provided some commercial context to the bank's likely obligations. It was not a pure banking relationship, and the bank, in its capacity as the buyer's financer, was also likely to have an interest in the performance of the primary contract. While this was not a "particularly sure guide to the correct interpretation", it nevertheless refuted the seller's argument that the bank had no interest in the merits of the underlying transaction.

In sum, the decision provides a useful summary of the applicable principles in distinguishing between guarantees and performance bonds, and also is an example of their application to an interesting but not unusual set of facts.

Wednesday, July 18, 2012

Enforceability of side letters - a postscript

In an earlier post, we had discussed the decision of the English High Court in Barbudev v Eurocom on the issue of the enforceability of side letters. In April this year, the Court of Appeal upheld the ultimate decision of the High Court, departing however, from the reasoning adopted.

As discussed in the earlier post, the key issue in the case was whether a side letter signed by the parties could be enforced by the claimant. The judge at first instance concluded that the side letter was a mere 'agreement to agree', and was hence unenforceable in English law. Since the side letter was unenforceable, the judge also concluded that the letter was not intended to create any legal relation between the parties. This connection between the two issues formed an important part of the judge's reasoning, and was based on dicta of an earlier decision of the High Court in Dhanani v Crasnianski [2011] EWHC 926 (Comm), where the Court had observed, "the circumstance that an agreement is no more than [an] agreement to negotiate and agree may show objectively that the parties to it cannot objectively have intended it to be legally binding, notwithstanding that it had certain characteristics which otherwise might have evinced an intention to agree". On that basis, Blair J in the High Court in Barbudev found it difficult to see how "an agreement can be intended to create legal relations if it is unenforceable in its entirety" (paragraph 96). In addition, slightly confusing observations by the High Court relating to whether this inquiry was subjective or objective (paragraphs 91 and 93) created some further cause for discomfort.

The claimant appealed to the Court of Appeal on the primary bases (amongst others) that (1) the parties did intend to create legal relations; and that (2) the side letter was more than an agreement to agree, and hence, enforceable.

On the first of these questions, the Court concluded that when considering a wholly written contract, "the court must consider the language used and ascertain what a reasonable person … would have understood the parties to have meant. The court must have regard to all the relevant circumstances and, in a business context, it should prefer the construction that is more consistent with business common sense" (paragraph 31). It further reiterated that this test was an objective one. However, in the Court's view, even without resorting to the surrounding circumstances, the side letter was clearly intended to create legal relations. This was because (a) it was drafted by external legal advisers (Freshfields); (b) it contained language which was "that of legal relations" ('in consideration of …'); (c) the reference to an English statute and a provision that the contract was governed by English law; and (d) a clear intention that the confidentiality clause in the side letter was intended to be legally binding. On that basis, the Court of Appeal concluded that the High Court had erred in holding that the side letter was not intended to create legal relations.

However, having decided that the side letter was intended to create legal relations, the Court of Appeal then moved on to the independent question of whether these intended legal relations were enforceable. On a review of the side letter, the Court concluded that it amounted to no more than an 'agreement to agree', by which the respondents had agreed to negotiate with the claimant in good faith. Based on the concession of the claimant's counsel, and the decision of the House of Lords in Walford v Miles [1992] 2 AC 128, this necessarily meant that the side letter, though intended to create legal relations, was unenforceable.

Therefore, the Court of Appeal ultimately agreed with the High Court that the side letter in question here was unenforceable, since it was no more than an 'agreement to agree'. However, what is significant is that the Court of Appeal divorced this question of enforceability from the independent question of whether the side letter was intended to create legal relations. Although the outcome remained the same on facts, the decision is a useful clarification of the two step process involved in determining the binding nature of an agreement between parties: focussing, first on the intention of the parties (as objectively evidenced by the terms of the agreement and the communication between them), and only later on the second question of whether this intention to create legal relations had been successfully implemented through an enforceable contract.

Tuesday, July 17, 2012

Ostensible Authority and Estoppel

The Privy Council in Kelly v. Fraser, [2012] UKPC 25, recently revisited the issue of whether an agent can be said to have ostensible authority on the basis of his own representations.

Mr. Fraser, the Respondent, became the CEO of Island Life Insurance Company on 1st February, 2000, and shortly after that became a member of the Salaried Staff Pension Plan (“SSP”) of the company. The SSP was operated under a trust deed, which vested the management of the plan to trustees. The trustees delegated day-to-day administration to the employee benefits division of the company. Mr. Fraser was initially employed by another company, and had contributed to that company’s pension scheme. He discussed with Mr. Masters, the Vice-President of Island Life’s employee benefits division, the possibility of a transfer of the accrued value of his entitlement from the other company’s scheme to SSP. Under SSP’s trust deed, such transfer was to be carried out “in a manner and on the terms and conditions determined by the trustees in their sole discretion… but if in the judgment of the trustees this is impractical, inadvisable or inexpedient, the benefits and amounts accrued to the contributor shall remain in the said other company pension plan…” A letter requesting approval for the transfer was sent to the trustees, but evidently, no further action was taken on the letter. It was admitted that the trustees were not aware of the application/letter. Subsequently, in December 2000, Mr. Masters wrote the Mr. Fraser, confirming that “the Trustees… have transferred…” the accrued benefits to the SSP. In reality the trustees had not. Subsequently, the SSP was to be wound up, and the issue arose as to whether Mr. Fraser’s entitlement to the corpus should be calculated on the basis of his ordinary contributions alone, or on the basis of the ordinary contributions plus the accrued benefits.

The short point was whether Mr. Master’s representation could act as an estoppel against the Trustees from subsequently denying that the transfer had occurred. It was admitted that only the Trustees had the authority to approve the transfer: Mr. Masters had no such authority. Equally, it was admitted that Mr. Masters had no actual authority to inform Mr. Fraser that everything was in order if it was not. The question therefore was whether Mr. Masters had the ostensible authority to tell Mr. Fraser that whatever steps needed to be taken to carry out the transaction had been duly performed, although he had no authority (actual or ostensible) to take those steps himself.

The trustees relied on certain observations of Goff LJ (confirmed by Lord Keith in the House of Lords) in Armagas v. Mundogas, [1986] AC 717 to the effect that English law does not accept the general proposition that ostensible authority of an agent to communicate agreement by his principal to a particular transaction is different from ostensible authority to enter into that particular transaction. In other words, Armagas suggests that ostensible authority to communicate agreement is conceptually similar to ostensible authority to enter into the agreement: so if there is no authority to agree, there is no ostensible authority to communicate agreement either. There were some views to the contrary: First Energy v. Hungarian International Benk, [1993] 2 Lloyd’s Rep 194, Egyptian International v. Soplex, [1985] 2 Lloyd’s Rep 36.  In First Energy, Evans LJ said that there is “no requirement that the authority to communicate decisions should be commensurate with the authority to enter into a transaction…”

After considering these cases in Kelly v. Fraser, Lord Sumption explained the position thus: “An agent cannot be said to have authority solely on the basis that he has held himself out as having it. It is, however, perfectly possible for the proper authorities of a company (or, for that matter, any other principal) to organise its affairs in such a way that subordinates who would not have authority to approve a transaction are nevertheless held out by those authorities as the persons who are to communicate to outsiders the fact that it has been approved by those who are authorised to approve it or that some particular agent has been duly authorised to approve it…Armagas was explained as turning on its “complex and extraordinary facts”: in particular, the third party knew that the agent had no authority to do the specific act, which the agent held himself out as having the authority to do. Armagas was therefore treated as a case where the third party has been put on notice, and that case “is not authority for the broader proposition that a person without authority of any kind to enter into a transaction cannot as a matter of law occupy a position in which he has ostensible authority to tell a third party that the proper person has authorised it…

By way of analogy, Lord Sumption pointed out that a company secretary does not have the actual authority which the Board of Directors has, but the secretary does have ostensible authority “by virtue of his functions” to communicate what the board has decided. The analogy is interesting: and gives rise to an additional debate. Is ‘authority by virtue of his functions’ another manner of saying ‘usual authority’ – and if that is so, is that better regarded as implied actual authority rather than ostensible authority? In Kelly’s case, it was admitted that there was no actual authority (whether express or implied) to communicate as they did – the point was solely pertaining to ostensible authority. Be that as it may, the Privy Council seems to have confirmed that there may be situations where an agent has the authority to communicate the acceptance of an agreement although he has no authority to agree. That communication may in turn give rise to an estoppel as against the principal.

This conclusion, reconciling Armagas and First Energy, has also found acceptance in other common law jurisdictions. Interested readers may refer to the judgment of Chan Sek Keong CJ in Skandinaviska Enskilda v. Asia Pacific Breweries, [2011] 3 SLR 540. Kelly v.Fraser also has interesting observations on the issue of what constitutes “detrimental reliance” for the purpose of creating an estoppel: the Privy Council clarified that “the detriment need not be financially quantifiable, let alone quantified, provided that it is substantial and such as to make it unjust for the representor to resile. A common form of detriment, possibly the commonest of all, is that as a result of his reliance on the representation, the representee has lost an opportunity to protect his interests by taking some alternative course of action. It is well established that the loss of such an opportunity may be a sufficient detriment if there were alternative courses available which offered a real prospect of benefit, notwithstanding that the prospect was contingent and uncertain…” The advice of the Privy Council in Kelly is available on BAILII, and can be accessed here.

Announcement: NLSIR Call for Submissions

(I have received the following announcement from the NLSIR, which may be of interest to our readers)

The National Law School of India Review is now accepting submissions for its upcoming issue - Volume 25(1). The National Law School of India Review (NLSIR) is the flagship law journal of the National Law School of India University, Bangalore, India. The NLSIR is a bi-annual, student edited, peer-reviewed law journal providing incisive legal scholarship on issues that are at the forefront of contemporary legal discourse. Over the last 20 years, the NLSIR has regularly featured articles authored by judges of the Indian Supreme Court, Senior Counsel practicing at the Indian bar, and several renowned academics. 

The most recent issue of the NLSIR, Vol. 23(2), featured contributions by Mr Aseem Chawla (Partner, Amarchand & Mangaldas & Suresh A. Shroff & Co.),  Mr Sunil Jain  (Partner, Direct Tax, J Sagar Associates, Advocates & Solicitors) and Mr. Ravishankar Raghavan (Principal, Tax Group, Majumdar & Co., India) among several others. Moreover, in August 2009, NLSIR attained the unique distinction of being the only Indian student-run law journal to be cited by the Supreme Court of India, in Action Committee, Un-Aided Private Schools v. Director of Education. NLSIR has also recently been cited in Justice R. S. Bachawat's Law of Arbitration and Conciliation, a leading treatise on arbitration law in India.

Papers may be submitted as Long Articles (approximately 8000 words), Essays (approximately 5000 words) or Notes (approximately 2500 words). Submissions may be made to under the subject heading  25(1) NLSIR - Submissions. Queries regarding submission may be sent to the same email address. The last date for submissions is November 15, 2012. For more information, please visit -

E-voting in Top Listed Companies

As we have previously discussed, the participation of retail (or even institutional) shareholders in Indian companies’ decision-making is still far from desirable. The Government has, however, been taking steps to enhance participation. About a decade ago, the concept of postal ballot was introduced. However, that has not made significant inroads, due to which the next round of reforms have been initiated. This is through the method of e-voting, which was introduced initially as an option for companies to offer their shareholders. SEBI has now made e-voting mandatory for top listed companies.
Last week, SEBI issued an amendment to the listing agreement making it mandatory for the top 500 companies listed at BSE and NSE to provide e-voting facility. This is in addition to the postal ballot option that continues to be available. This mandatory e-voting for top listed companies comes into effect on October 1, 2012, and applies to meetings for which notices are sent out after such a date. Companies are allowed to use recognised e-voting platforms, and the two depositories in India have already established their platforms – e.g. NSDL e-voting system and CDSL e-voting system.
This is likely to bring about significant change in the manner in which major corporate decisions are taken. Shareholders may no longer be taken for granted, as their likelihood of participation is greater. However, this will function effectively only if the information requirements are enhanced as well. For example, greater details will have to be provided in the notice of the meeting/e-voting in a manner that can be appreciated by shareholders who are then able to decide in an informed manner. This deficiency is being addressed by another phenomenon that was hitherto non-existent in India, and that is proxy advisory firms. The rapid emergence of 3 proxy advisory firms that are currently operational in India perform the role of educating shareholders regarding specific resolutions that are put to vote, so that the shareholders may vote in an informed manner. In addition, shareholders (particularly of the institutional variety) are themselves becoming more active in the oversight of their portfolio of investments and are no longer passive spectators who only vote with their feet when confronted with strenuous relationships with managements or promoters. The TCI-Coal India episode is emblematic of this trend, which will likely compel managements to be more vigilant and receptive to shareholder interests and sentiments.

Saturday, July 14, 2012

The Constitution Bench elides repugnance and occupied field

That the title of this post is a part of Indian constitutional law is explained by the fact that the validity of tax and commercial legislation is often challenged on the ground that it conflicts with a similar legislation enacted by another legislature. Often the challenge is on the basis of legislative competence, and this requires a careful analysis of not only the words of Schedule VII, but of the principles upon which legislative power is distributed in India.

Until 7 May, 2012, it was taken for granted that the doctrines of occupied field and repugnance are as different as chalk and cheese. The easiest way of explaining the difference is to say that occupied field is concerned with the existence of legislative power, while repugnance is concerned with the exercise of legislative power that is shown or assumed to exist. In more precise terms, the doctrine of repugnance, found in article 254 of the Constitution, is that a State legislation which is repugnant to a law enacted by Parliament is void to the extent of repugnance. Some doubts about the scope of art 254 arose on account of the words “with respect to one of the matters enumerated in the Concurrent List”. A close analysis of these words demonstrates that the “comma” is placed after the words “competent to enact” rather than “an existing law”, suggesting that article 254 is confined to Central legislation in the Concurrent List only in respect of pre-1950 legislation. But the Supreme Court rejected this interpretation in many cases, notably VK Sharma v State of Karnataka AIR 1990 SC 2072, and held that article 254 is applicable only to a conflict between a State and a Central legislation enacted under the same entry in the Concurrent List.

While there are, of course, two views about whether this is correct or not, two basic propositions about repugnance were never questioned even in this line of case law: (i) repugnance arises only if there is an actual conflict between two legislations, one enacted by the State Legislature and the other by Parliament, both of which were competent to do so; and (ii) the State law is void only to the extent of repugnance, subject to art 254(2).

Occupied field, on the other hand, has nothing at all to do with a conflict between two laws. It is perhaps an unfortunate expression because it is used in precisely this sense in the jurisprudence of other countries. But in India it simply a compendious way of referring to a few legislative entries in List II of Schedule VII, which are expressly made “subject” to a corresponding Entry in List I or List III. The two most important instances of such entries are Entry 24, List II (“Industries”, made subject to Entry 52, List I, which provides that Parliament may declare, by law, that the control of a certain industry by the Union is in the public interest) and Entry 23, List II (Mines and mineral development, made subject to Entry 54 List I, which provides that Parliament may by law declare that the control of mines and mineral development by the Union is in the public interest). By making such a declaration in a legislation (for example the Essential Commodities Act or the MMRDA), Parliament acquires legislative competence over what would otherwise be a field of State legislation, and the State is entirely denuded of legislative competence. It is apparent that no question of repugnance arises: if a field is validly occupied, that field ceases to form part of the State List. As one judge put it, that field is “subtracted” from the State List and “added” to the Union List.

One controversy that arose in occupied field litigation was whether Parliament could occupy a field by simply making a declaration. For example, suppose Parliament declares in the MMRDA that mines and mineral development under the control of the Union is expedient in the public interest, but merely provides in the operative part that “the mining sector shall comply with such rules as may be notified by the Competent Authority”, and the competent authority notifies no such rules. A concern was expressed that if occupied field is invoked in this way, neither the State (because it cannot), nor the Union (because it does not) legislates for that sector, leading to a “legislative vacuum”. In the leading Entry 54 cases (Hingir Rampur Coal Co, MA Tulloch and Baijnath Kedia), the Supreme Court held that this is irrelevant, because Entry 54 denudes the States of competence the moment the declaration is made by Parliament. But some leading Entry 52 cases, particularly Belsund Sugar and Ishwari Khetan, suggested otherwise. This apparent conflict was not really a conflict – without going into more detail than is necessary, the difference is explained by the fact that the Supreme Court had previously construed the substance of Entry 52 more narrowly (and correctly) than it did Entry 54 (see Tika Ramji affirmed in a judgment rich in scholarship by Ruma Pal, J., in ITC v AMPC, over Pattnaik, J’s dissent).

It is crucial to note that none of this had anything to do with repugnance. The controversy over “mere declaration” versus “actual legislation” was at all times confined to the few entries in the Constitution that expressly permit Parliament to occupy a State field. Indeed, when the point was argued in relation to repugnance, the Supreme Court authoritatively held in Tika Ramji (para 18) that “repugnancy must exist in fact, and not depend merely on a possibility”. Conceptually, it is submitted that this is correct – the Constitution has two mechanisms to deal with legislative conflicts: one deals with who has the power to enact a law in a certain field of legislation in List II (ordinarily the State, unless the Centre occupies the field in the manner specified in the corresponding entry in List I) and the other with what happens when two legislatures, both of which have the power to enact laws, enact conflicting laws (repugnance). Indeed, repugnance presupposes that both laws have been enacted by competent legislatures – thus, if the State of Tamil Nadu imposes income tax, and this is in conflict with the Income Tax Act, 1961, it is unnecessary to resort to art 254, because the Tamil Nadu Act is void ab initio for the legislature lacks competence. On the other hand, if the State of Tamil Nadu enacts the Sales Tax Act, and Parliament enacts the Central Excise Act, and it is argued that the two legislations somehow conflict, the solution is article 254 (conceptually – in practice, article 254 would be unavailable because of VK Sharma and one would have to resort to the non-obstante clause in article 246). But if the Centre has not enacted the Central Excise Act, and it is sought to be shown that the Tamil Nadu legislature still lacks the power to enact it, there can be no question of repugnance. That contention can succeed only if it is shown that: (i) “tax on sale of goods” is not in the State List or (ii) the Centre has validly occupied the field of “tax on sale of goods” (which it can never do, it is not expressly subject to a List I entry) or (iii) the Tamil Nadu Act is, in pith and substance, not within “tax on sale of goods”. Repugnance, it is submitted, can never arise when there is only one law in operation.

Having said that, there is no doubt that this apparent conflict in the occupied field cases on the need for actual legislation as opposed to a mere declaration is an important one, and ought to have been decided by the Supreme Court. Unfortunately, the Supreme Court, with respect, picked the wrong case, when it decided State of Kerala v Mar Appraem Kuri on 7 May, 2012. Simplifying the facts, the Centre enacted the Chit Funds Act, 1982 [“the Central Act”] which would become operative in the State of Kerala upon the issue of a notification under s 1(3) of the Central Act, and the State of Kerala enacted the Kerala Chitties Act, 1975. The Centre did not notify the Central Act in the State of Kerala. The result was that there was only one law in force in the State of Kerala – the Kerala Act. Chit funds filed a writ petition in the Kerala High Court and managed to persuade a Division Bench that the Kerala Act was repugnant to the un-notified Central Act. The State of Kerala appealed. The Supreme Court referred the matter to a Constitution Bench.

Surprisingly, the Constitution Bench accepted the contention of the chit funds that even an un-notified Central law attracts art 254. The Chief Justice gives two reasons for this conclusion: (i) article 254 uses the verb “made” and the form “making” - the “making” of a law is complete on enactment, even before the law is notified and (ii) Parliament, by enacting the Central Act, intended “to occupy the entire field falling in Entry 7 of List III” and therefore the State Legislature is denuded of legislative competence unless article 254(2) is applicable.

With great respect, it is submitted that this decision is incorrect and unfortunately conflates occupied field and repugnance. First, the verb “made” is used, as senior counsel rightly submitted in oral argument, not to indicate when a law becomes repugnant, but to identify the law which must independently be shown to be repugnant. Secondly, the conceptual distinction between repugnance and occupied field – or between the existence of legislative power and its exercise – is at the heart of the Constitution’s distribution of legislative powers. To hold that a mechanism intended to solve conflicts arising out of the latter is in fact applicable because the field is occupied is, it is respectfully submitted, unfortunate.

The second reason the Court gives is an illustration of why it may be dangerous to use the expression “occupied field” – in the law of other countries, notably America, it is possible for the Federal legislature to oust the Provincial Legislature’s legislative competence by “evincing an intention” to enact a complete code. This is sometimes called “occupied field”. That conception of occupied field has no place at all in Indian constitutional law. This is clear not only as a matter of concept, but also from a number of Supreme Court authorities, particularly Tika Ramji.

The final point is that the Chief Justice rejected the State of Kerala’s reliance on paragraph 18 of Tika Ramji by relying on MA Tulloch, which had held that a mere declaration can denude the State Legislature of legislative competence. Once again, it is submitted with respect that the error is to confuse occupied field with repugnance – MA Tulloch held that occupied field under Entry 54 only requires a declaration. It did not hold, and could not have held, that a mere declaration suffices for repugnance under art 254.

Since it is unlikely that the Supreme Court will revisit this issue, this judgment will fundamentally alter Indian constitutional law on the distribution of legislative power, with significant consequences for virtually every area of law in which Parliament or the States have legislated.

Friday, July 13, 2012

SEBI’s complex formula for settlement by consent – some concerns

The recent amendments to the guidelines/circular relating to Consent Orders were discussed here earlier. The latter more detailed guidelines provide for determination of the “Indicative Amount” (leading to final Settlement Amount) and some thoughts on them are shared here. These Guidelines provide very elaborate mathematical formula to cover a variety of violations, facts and the alleged culprits.

By trying to quantify as much as possible this Indicative Amount, SEBI has tried to meet the criticism that the settlement process was arbitrary and – as some people alleged, though without substantiating it - even at times corrupt. Settlement was indeed done earlier at differing amounts for similar violations. The published Consent Orders did not reveal the detailed facts, the wrong doing allegations or the reasoning involved in arriving at the settlement amount and this made the process uncertain for an applicant.

But SEBI has not merely tried to make the process transparent and quantifiable but made the quantification rational too. It has used factors that are relevant to the violation in determining the settlement amount. For example, in case of allegations of price manipulation, the turnover carried out by parties as percentage of market turnover, the price movements, etc. are made part of the formula. Again, where the allegation is of not making an open offer, the amount of open offer is taken as basis. Even the time value of the profits made is taken into account by adding interest.

The background of the person who has allegedly committed the wrong is also now factored in and a minimum Indicative Amount appropriately given. Promoters, for example, face a higher penalty if they are allegedly involved in price manipulation.

The earlier a person comes forward for settlement, the lower the Indicative Amount and this is done by assigning weights for each step in the litigation process. In fact, if one comes after making an appeal against an Order of SEBI, then there is an extra premium/cost to be paid.

This commendable quantification comes at the cost of making the whole process very complicated. Earlier, the process was exceedingly simple and it was common for parties to do-it-yourself the consent application for violations that were not serious. In fact, many professional advisors even refused to handle such cases. Now, taking help of professional advisors seems unavoidable.

Note, however, that the Indicative Amount arrived at by the formula is not final and the settlement will not necessarily take place at the amount arrived at as per this formula. The Guidelines give considerable discretion for SEBI to settle at a higher or lower amount or not settle at all. In fact, there are so many such “back doors” open that one may wonder whether there can still be arbitrariness in the process. This is particularly because even the amended Guidelines still do not require much details of the settlement process to be given. We will have to see how the new Orders come, though I personally do not think SEBI will go far beyond the Indicative Amount as per formula in most cases and there will be definitely specific reasons – even if not expressed in the Consent Order – for such departure.

But while discussing the very detailed formula and its countless parameters would be a subject by itself, some areas of concern are worth highlighting.

There is effectively a minimum Indicative Amount of Rs. 2 lakhs for first timers – meaning someone coming for settlement for the first time. For second time and onwards, it is at least Rs. 5 lakhs. We have seen earlier that the settlement amount in numerous cases has been in 5 figures, i.e., less than Rs. 1 lakh. Even SEBI’s orders in several cases levy such penalty. Of course, SEBI has powers to levy almost sky high amount of penalties but obviously that is to cover the most extreme of cases. On appeal, the SAT also has reduced penalties to such lower amounts. Question is whether such minimum amounts are justified? SEBI’s contention often has been that Consent Order help in the alleged violator going taint free and thus he should pay a cost.

While on this, it may be remembered that there is restriction now on repetitive consent settlement. An alleged default (unless minor) committed within two years of a consent order cannot be settled. If the applicant has obtained more than two consent orders, then he cannot apply for consent for three years from the last consent order. In contrast, the Reserve Bank of India compounding regulations restrict repetitive compounding only if the default is of a similar nature. However, SEBI has put an absolute bar.

As can be also seen from the formula, for several types of violations, there are even higher minimum Indicative Amounts provided. A person charged for financing a transaction of price manipulation has to face a minimum settlement amount of Rs. 15 lakhs, irrespective of the amount financed. Promoters even having a slight connection with price manipulation will have to pay at least Rs. 1 crore. A Promoter of a typical listed company with 50% holding who files his annual disclosure of holdings even one day late under the Takeover Regulations faces a minimum penalty of Rs. 15 lakhs. And so on.

In practice, not just the Consent Orders but even adjudication orders after following due process do not see such high amounts. Thus, parties may feel dissuaded from coming forward and settle in many cases.

Then there is another concern. Assuming that parties do not opt for settlement through consent orders and allow the adjudication or other process to full take place. In such a case, will the penalties be at least such minimum amount? One argument could be that, yes, the adjudication process which proves the violation should be higher than such minimum amount. At the stage of settlement, the violation is not proved and hence, settlement could be at lower price but not if the violation is proved. Moreover, the party has made SEBI go through the effort of proving the violation and hence even to cover the costs and efforts of SEBI, the penalty should be higher.

My view is that the settlement process and adjudication process should be kept as independent as possible and the settlement amount and the penalty under the respective process should be arrived at independently. The object of settlement is to cut short the proceedings and no full opportunity in law is provided to the applicant. The objective is to only have a prima facie look at the facts gathered in the investigation and make a judgment. Considering that now a formula is provided now, even the amount is to be determined objectively.

The factors for adjudication and levy of penalty are different. The violation would first need to be proved. There may be mitigating factors that maybe relevant for determining the quantum of penalty. Factors like repetitive nature of default, gains made or losses caused, etc. are considered. Each adjudication order would be thus different because facts would be different. Thus, on a certain set of facts, even a Promoter alleged to be connected with a price manipulation  will not face a minimum penalty of Rs. 1 crore but could pay much less. Also, obviously, if the allegation is not proved, there will not be any penalty at all. 

One would have to see how the amended Scheme is applied in practice. While the earlier Scheme was simple - it was actually too simplistic and there were concerns that it was arbitrary and misapplied in many cases. The new Scheme seems to go in the other extreme and now there are concerns whether it will defeat the whole purpose in many cases and make parties prefer litigation as a rule.

Thursday, July 12, 2012

Interpreting the Takeover Regulations

With the current Takeover Regulations (that came into effect in October 2011) being fairly recent, they are being subjected to interpretation during the course of their functioning. SEBI this week issued two sets of informal guidance in the context of one takeover.
The first pertains to whether an acquirer holding less than 25% can make a voluntary offer and then acquire shares in the market during the course of the offer so as to cross that limit. SEBI’s response is in the affirmative, as Reg. 22(1) (which prevents completion of acquisitions before completion of the public offer) applies only to acquisitions under an “agreement” and not through open-market purchases. While this approach is consistent with the scheme of the regulations, it could be subjected to abuse by acquirers in the manner detailed in the company’s letter to SEBI.
The second relates to the size of a competing offer, and whether that ought to have a minimum of 26% similar to an original offer. SEBI confirmed that this was not necessary in view of the specific provisions of Reg. 20(2).
Although the two sets of informal guidance deal with technical (and somewhat minor) details, they can make a significant difference in a takeover scenario, particularly one where there is an element of hostility between and acquirer and promoters, or between competing acquirers. The previous versions of the Takeover Regulations had built up a significant body of interpretation through orders of the court, the Securities Appellate Tribunal and SEBI. That looks set to continue under the new dispensation as well. Since litigation during the course of a takeover can result in considerable delays that may be disastrous to investors due to adverse price movements in the interim, speedy decision-making is of the essence.

Wednesday, July 11, 2012

The LIBOR Crisis and Corporate Governance

Whenever a corporate crisis erupts (a phenomenon all so common these days), questions quickly emerge regarding the role of governance (or failure thereof) at the companies involved. On a similar note, questions are being raised regarding the failure of board oversight, risk management systems and internal controls at banks such as Barclays that failed to curb manipulation in “fixing” the LIBOR rates. As this report by Reuters notes:
The lack of specific internal controls, particularly in reviewing email communications, was one of the failures cited by a Commodity Futures Trading Commission regulatory order implementing its share of the Barclays settlement. The CFTC said Barclays lacked daily supervision and periodic reviews that could have detected the interest rate manipulation. The order also accused the bank’s senior management of encouraging executives to submit lower rates than the bank was actually paying.
From a corporate governance perspective, this is a manifestation of the classic agency problem between managers and shareholders. While managers are incentivized through executive compensation (a large part of which is variable in nature), it is the shareholders who suffer in such episodes. Even in the Barclays settlement where the company agreed to pay hundreds of millions of dollars in fine, not only does that cause a dent in books of the company, but the resultant fall in stock price also further erodes shareholder value.
While some of the key managers were forced to vacate their positions with the company, negotiations were underway on the severance packages to be paid to them even though there were strong objections to payment of such significant sums of money. However, it has been reported that the former CEO of Barclays has forfeited his bonus but retained a year’s salary.
The repercussions of the LIBOR saga could be several, for both Barclays as well as the other banks involved. The immediate fallout could be lawsuits against the banks and their directors. The long-term implications could be reforms in governance norms that could become tighter, particularly with reference to executive pay. The UK has already initiated steps to insist on a binding shareholder vote for executive pay, as we have previously discussed, and such moves could receive further impetus in the light of the new developments. These are again classic instances of lawmaking in the wake of a crisis, which some commentators warn may be counterproductive and therefore ought to be avoided.

Tuesday, July 10, 2012

Registrar of Companies and the Right to Information Act

In the past, there has been some discussion on whether the concept of right to information should be extended to the corporate sector or not, but presently it applies only to a “public authority”. At most, it might include government companies as the definition of a “public authority” includes “any ... body owned, controlled or substantially financed ... directly or indirectly by funds provided by the appropriate Government”.
The next question is whether the Right to Information Act, 2005 (RTI) can be utilised to obtain information regarding specific companies that may be available with the Registrar of Companies (RoC). Under the Companies Act, 1956, companies are required to make several filings with the RoC. Moreover, under section 610 of the Companies Act, any person may seek to inspect records at the RoC, and also obtain copies or extracts of documents for payment of a fee.
The question as to whether a person may access the RTI Act to obtain records from the RoC rather than through the inspection provision under the Companies Act, 1956, was the subject matter of a dispute that was decided by the Delhi High Court in Registrar of Companies v. Dharmendra Kumar. In that case, the Delhi High Court ruled in favour of the RoC that denied access under the RTI Act on the ground that the Act was unavailable to applicants when the same right could be exercised through inspection under section 610 of the Companies Act. The court observed:
23. There can be no doubt that the documents kept by the Registrar, which are filed or registered by him, as well as the record of any fact required or authorized to be recorded by the Registrar or registered in pursuance of the Companies Act qualifies as ―information‖ within the meaning of that expression as used in Section 2(f) of the RTI Act. However, the question is  — whether the mere fact that the said documents/record constitutes ―information‖, is sufficient to entitle a citizen to invoke the provisions of the RTI Act to access the same?
35. The mere prescription of a higher charge in the other statutory mechanism (in this case Section 610 of the Companies Act), than that prescribed under the RTI Act does not make any difference whatsoever.  The right available to any person to seek inspection/copies of documents under Section 610 of the Companies Act is governed by the Companies (Central Government’s) General Rules & Forms, 1956, which are statutory rules and prescribe the fees for inspection of documents, etc. in Rule 21A.  The said rules being statutory in nature and specific in their application, do not get overridden by the rules framed under the RTI Act with regard to prescription of fee for supply of information, which is general in nature, and apply to all kinds of applications made under the RTI Act to seek information.  It would also be complete waste of public funds to require the creation and maintenance of two parallel machineries by the ROC – one under Section 610 of the Companies Act, and the other under the RTI Act to provide the same information to an applicant.  It would lead to unnecessary and avoidable duplication of work and consequent expenditure.
The Court was also confronted with the question as to whether there is any inconsistency between the RTI Act and the Companies Act, which it answered to the negative. It reasoned as follows:
42. Firstly, I may notice that I do not find anything inconsistent between the scheme provided under Section 610 of the Companies Act and the provisions of the RTI Act.  Merely because a different charge is collected for providing information under Section 610 of the Companies Act than that prescribed as the fee for providing information under the RTI Act does not lead to an inconsistency in the provisions of these two enactments.  Even otherwise, the provisions of the RTI Act would not override the provision contained in Section 610 of the Companies Act. Section 610 of the Companies Act is an earlier piece of legislation.  The said provision was introduced in the Companies Act, 1956 at the time of its enactment in the year 1956 itself.  On the other hand, the RTI Act is a much later enactment, enacted in the year 2005.  The RTI Act is a general law/enactment which deals with the right of a citizen to access information available with a public authority, subject to the conditions and limitations prescribed in the said Act.  On the other hand, Section 610 of the Companies Act is a piece of special legislation, which deals specifically with the right of any person to inspect and obtain records i.e. information from the ROC.   Therefore, the later general law cannot be read or understood to have abrogated the earlier special law.
While I am somewhat sanguine about the conclusion arrived at by the court in the context of the Companies Act, Prashant Reddy provides a critique of the judgment on the Law and Other Things Blog and points to the dangers of overextending this principle.
Hat-tip: Law and Other Things

Thursday, July 5, 2012

The GAAR Guidelines

One of the major changes implemented by the Finance Act has been the introduction of the General Anti-Avoidance Rules (GAAR). The Government has recently issued draft GAAR Guidelines in this connection, which can be downloaded from here.

It is proposed to introduce a monetary threshold for invocation of the GAAR provisions, and time limits (such as time limits for making references to the Approving Panel) have been introduced. Substantively, the Guidelines clarify that GAAR will apply to income accruing or arising on or after 1.4.2013.

Further, it is stated that (in para 1.1, Annexure D) the GAAR “is a codification of the proposition that while interpreting the tax legislation, substance should be preferred over the legal form… These propositions have otherwise been part of jurisprudence in direct tax laws as reflected in various judicial decisions. The GAAR provisions codify this substance over form ‘rule’…”  Thus, the Guidelines clarify that the purpose behind GAAR is not to change the landscape, but to only codify the existing law. Thus, it is arguable that in a situation where a Court (under current law) has upheld a type of transaction as having commercial substance, the GAAR should (so far as possible) be interpreted in line with that view. For example, in the Vodafone case, the Supreme Court did examine the factual matrix of the transactions, and concluded that there was commercial substance: it is at the very least arguable that the GAAR would not hit a similar transaction. However, the Guideline then goes on to indicate that there is no mere codification prescribed: the intent is to tackle avoidance, as distinct from both evasion and mitigation.

It is further clarified that the burden of proving the existence of an arrangement, the fact of tax benefit, and the purpose behind the arrangement being to obtain that benefit is on the Revenue.  The draft guideline then gives a number of illustrations where the provisions of GAAR could be invoked, and where the provisions would not be invoked. If one examines these illustrations, it appears that in most cases where there is no DTAA involved, GAAR would not really result in an outcome different from one which could be expected under current law. The provisions would make a major difference in cases where there is a DTAA. A few examples are seen below:

Example Number as per Guideline
Whether under current law this arrangement would be disregarded?
Whether GAAR would be invoked under the Guideline?
A business sets up an undertaking in an under developed area by putting in substantial investment of capital, carries out manufacturing activities therein and claims a tax deduction on sale of such production/manufacturing
No – this is to be treated as a case of tax mitigation. Taking advantage of a fiscal incentive granted by statute would not amount to an impermissible tax avoidance arrangement.
A business sets up a factory for manufacturing in an under developed tax exempt area. It then diverts its production from other connected manufacturing units and shows the same as manufactured in the tax exempt unit (while doing only process of packaging there)
[It is not clear from the illustration what ‘diverts its production means’]
Yes: if the statutory condition is that the tax exempt unit must manufacture, and if there is a diversion of production in the sense that production is carried on in one unit but disclosed in the books of another, then it is open to examine the true facts.

Yes [but see the comments as to what is intended by ‘diverts its production’]

If ‘diversion’ means that production in one unit is stopped and production in the tax-exempt unit is started, then there would not be any interference under current law. Even under the GAAR, under example 1, this is arguably a case of tax mitigation
A foreign investor has invested in India through a holding company situated in a low tax jurisdiction X. The holding company is doing business in the country of incorporation, i.e. X, has a Board of Directors that meets in that country and carries out business with adequate manpower, capital and infrastructure of its own and therefore, has substantial commercial substance in the said country X.
No: there is commercial substance
The merger of a loss making company into a profit making one results in losses off setting profits, a lower net profit and lower tax liability for the merged company.
No – set off would be allowed as per normal provisions, which have in-built measures to check abuse
A choice made by a company between leasing an asset and purchasing the same asset. The company would claim deduction for leasing rentals rather than depreciation if it had their own asset.
In the case of leasing transactions, the Courts have been open to look into the “true nature” of the transaction, to determine who gets the benefit of depreciation, as recently discussed in this post.
If there is a circular lease, the Revenue would invoke GAAR
A company has raised funds from an unconnected party through borrowings, when it could have issued equity. Would interest payments be denied as expenditure?
If the borrowed funds are used for the purposes of business then deduction would be allowed. Payments to connected parties may be disallowed to the extent possible u/s 40A(2)(a)
Whether a business should have raised funds through equity instead of as a loan should generally be left to commercial judgment. GAAR would not typically be attracted.

GAAR may be attracted if this is a case of connected party transaction.
[Arguably, here, disallowance if any should be left to 40A, and there is no need for invoking GAAR principles.]
Y company, a non- resident, and Z company, a resident of India, form a joint venture company X in India. Y incorporates a 100%subsidiary A in country ABC of which Y is not a resident. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges a minimal capital gains tax in its domestic law. A is also designated as a “permitted transferee” of Y. “Permitted transferee” means that though shares are held by A, all rights of voting, management, right to sell etc., are vested in Y. As provided by the joint venture agreement, 49% of X`s equity is allotted to company A (being 100% subsidiary and “permitted transferee” of Y) and the remaining 51% is allotted to the Z company. Thereafter, the shares of X held by A are sold by A to C (connected to the Z group).
Arguably the transaction could be disregarded: see Aditya Birla Nuvo’s case in the Bombay High Court
Company A, is incorporated in country ABC as a wholly owned subsidiary of company B which is not a resident of ABC or of India. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges a minimal capital gains tax in its domestic law. Some shares of an Indian Company C were acquired by A. The entire funding for investment by A in C was done by B. A has not made any other transaction. These shares were subsequently disposed of by A, thus resulting in capital gains which A claims as not being taxable in India by virtue of the India- ABC tax treaty.

[Example 18 is similar]
Probably not, under the ratio of Azadi Bachao Andolan
Yes: it appears that limitation of benefits clauses would be read in to existing DTAAs if GAAR were to apply in this manner.
An Indian Company A is a closely held company and its major shareholders are connected companies B, C and D. A was regularly distributing dividends but stopped distributing dividends from 1.4.2003, the date when Dividend Distribution Tax (DDT) was introduced in India. A allowed its reserves to grow by not paying out dividends. As a result no DDT was paid by the company. Subsequently, all its shareholders buyback [sic] of shares was offered by the Indian Company A to its shareholder company B based in country ABC and the other shareholders C and D who are not resident of ABC. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges very low capital gains tax in its domestic law. The buyback offer was only accepted by the entity B. The accumulated reserves of A were used to buyback the shares from the B entity.
The department has already taken the ground in a few cases that this buyback amounts to a payment of dividend. The department has also taken the contention that the amounts can be considered as deemed dividend u/s 2(22)(d)
A foreign bank Fs branch in India arranges loan for Indian borrower from F bank’s branch located in a third country. The loan is later assigned to F bank’s branch in XYZ country to take benefit of withholding provisions of India-XYZ treaty (India-XYZ Treaty provides no source based withholding tax on interest to a bank carrying out bona-fide business.)
Probably not, unless the assignment is shown to be a sham
An Indian company is in the business of import and export of certain goods. It purchases goods from Country A and sells the same in country B. It sets up a subsidiary in Country X - a zero/ low tax jurisdiction. The director of the Indian company finalizes the contracts in India but shows the documentation of the purchase and sale in Country X. The day to day management operations are carried out in India. The goods move from A directly to B. The transactions are recorded in the books of subsidiary in country X, where the profits are tax exempt.
It is arguable that this is a case of sham transactions/entries under current law
A company had a disputed claim with Z company. A transferred its actionable claims against Z for an amount which was low, say, for example 10 % of the value of the actionable claim against Z to a connected concern B by way of a transfer instrument. B transferred such claim to C company and C further gifted it to D company, another connected concern of A. Upon redemption of such actionable claims, D showed it as a capital receipt and claimed exemption
Under current law, even in a far less convoluted assignment of actionable claims, the Department has taken the stance that the arrangement must be disregarded. It appears that if there is some commercial substance behind the assignment then the assignment will be upheld. As assignment inter-se group companies where there is no possible commercial substance could arguable be disregarded even under current law.
The manner of the transactions indicates a lack of commercial substance: GAAR would be invoked

These illustrations indicate that the GAAR provisions would in several cases not have a drastic effect on the result of a tax-effective arrangement. Even under current law, Courts in several cases have been willing to disregard transactions which absolutely lack commercial substance. To an extent, due to the decision in Azadi Bachao, a greater amount of deference has been provided to the use of tax treaties; and the GAAR intends to tackle what it sees as abuse of the treaties. The wisdom of this policy is debatable; and once the policy has been decided on it is debatable whether a GAAR is appropriate to achieve this end instead of incorporating appropriate clauses in DTAAs. Furthermore, the guidelines (if finally incorporated) into a relevant Rule or Circular would unquestionably be binding on the Department. Thus, assuming that the examples above are incorporated in a Circular, the Revenue would not be able to invoke GAAR where the example says that there would be no recourse to GAAR. However, where the Circular provides for the application of GAAR, it would still be open to assessees to challenge this, if factually, commercial substance is shown. 

Unfortunately, several concerns raised relating to the GAAR (including problems pertaining to excessive discretion, procedure for approving panels etc) have not been clearly addressed in the Guidelines. The attitude of the Department appears to be of looking at the arrangement and determining the ‘substance’: an approach which is only likely to encourage roving enquiries. Another view to approach the GAAR is to begin not with the transaction/arrangement, but with the section conferring the relevant tax benefits. After a purposive analysis of the section, the GAAR could be invoked to defeat those transactions which obviously militate against the purpose of the tax benefit. This is the approach adopted by the Supreme Court of Canada in Canada Trustco Mortgage: “A transaction may be considered to be ‘artificial’ or to ‘lack substance’ with respect to specific provisions of the Income Tax Act, if allowing a tax benefit would not be consistent with the object, spirit or purpose of those provisions.  We should reject any analysis under s. 245(4) that depends entirely on ‘substance’ viewed in isolation from the proper interpretation of specific provisions of the Income Tax Act or the relevant factual context of a case.   However, abusive tax avoidance may be found where the relationships and transactions as expressed in the relevant documentation lack a proper basis relative to the object, spirit or purpose of the provisions that are purported to confer the tax benefit, or where they are wholly dissimilar to the relationships or transactions that are contemplated by the provisions… The GAAR may be applied to deny a tax benefit only after it is determined that it was not reasonable to consider the tax benefit to be within the object, spirit or purpose of the provisions relied upon by the taxpayer…” For other approaches to GAAR, interested readers may also wish to refer to this report from the United Kingdom, prepared by Graham Aaronson QC.