Tuesday, December 25, 2012

A Round Up of a Rollercoaster Year

As 2012 began, several BRICS economies that showed immense promise began to face slower growth. This was also influenced by developments elsewhere (including the crisis in Europe). India was affected by the same phenomenon.

The Indian situation was also marred by several policy-related issues that continued to remain for nearly two-thirds of the year. This includes the “policy paralysis” that afflicted Government decision-making for most of the year. More so, the Government’s harsh reaction to Supreme Court’s Vodafone judgment and the introduction of the general anti-avoidance rules (GAAR) as also the fallout of the 2G scam lowered the buoyancy of the economy and the capital markets.

However, towards the last quarter of 2012, the Government stepped in to take some corrective measures. Its bold moves to reintroduce foreign direct investment (FDI) in the multi brand retail sector, to postpone the introduction of GAAR, and to introduce reforms in company law and banking legislation have spurred some interest in the economy. While these measures have introduced some element of optimism as we usher in 2013, it would be too much to expect big bang reforms in that year. Given that the next general elections are due in 2014, one can expect next generation reforms to occur only after that. The hope is that a steady course is maintained until then with no adverse policy decisions.

In this post, we recapitulate some of the key developments of the year in the business law sphere, and ponder over what lies in store for the year ahead.

Corporate Law and Governance

Clearly, one of the significant events of the year is the approval of the Companies Bill, 2011 by the Lok Sabha. This brings company law reforms, which have been pending for over a decade now, closer to reality. The Bill requires the approval of the Rajya Sabha and the assent of the President before it can become law, and these are expected to occur early next year. Surprisingly, the sticking point on the Bill for most of this year was the provision on corporate social responsibility (CSR). While the Parliamentary Standing Committee on Finance kept insisting on mandatory CSR spending, the final compromise reflects a “comply or explain” approach. When the company law reforms are implemented (next year), it will represent a sea change in the way companies operate, and both companies and their advisors will have to come to terms with a new regime and adapt themselves towards that.

From a corporate governance perspective, the year has not seen wide ranging reforms. However, one aspect that stands out is the move towards greater participation on the part of the shareholders. SEBI has made e-voting mandatory for top listed companies. Apart from governmental effort, the market has adapted itself towards greater shareholder activism through involvement of proxy advisory firms and even activist hedge funds adopting a combative approach towards some Indian companies, all of which are sought to be documented in this working paper.

Foreign Direct Investment

Given that the Government had proposed FDI in the multi brand retail sector in 2011 and had to immediately withdraw it, the sentiment for foreign investment was not so positive going into 2012. The initial months also witnessed policy paralysis that resulted in substantial outflow of foreign investment in the country. However, the big bang reforms witnessed towards the end of the year brings some economic cheer. The Government reintroduced changes that allow FDI in the multi brand sector, and also eased the conditions for FDI in the single brand retail sector. The FDI reforms were made immediately effective through executive action and also put to vote in Parliament where assent was received.

Among other changes, the introduction of a new route for foreign investment in the form of the qualified foreign investor (QFI) scheme is noteworthy. This permits foreign individuals and corporations to invest in a portfolio of Indian stocks without specific registration. Despite the fanfare with which this scheme was introduced, it is yet to make any significant impact and fund flows are still very thin.

Securities Regulation

This area has witnessed enormous activity in 2012, most of which has come in the form of enforcement initiatives by the Securities and Exchange Board of India (SEBI) and somewhat less so in the form of legislative/regulatory initiatives.

Capital markets in India have had a lackluster year, with very few primary offerings to speak of. Globally, however, the Facebook IPO stirred the markets but with some different outcomes in the end. Not only has it been difficult since for the company’s stock price to be sustained at IPO levels, but it also resulted in regulatory actions against some of Facebook’s investment bankers for selective release of information during the IPO process.

Back in India, SEBI’s legislative initiatives that are noteworthy include its norms on alternative investment funds and those on consent order norms (which have substantially tightened the scope and process). SEBI has also been insistent on ensuring that listed companies comply with the minimum public float norms by 2013, and has prescribed additional methods for achieving the same, including offer for sale through the stock exchange, and the institutional placement programme.

It is on the enforcement side, however, that SEBI has had an extremely busy year. It returned from the Supreme Court with resounding success in the Sahara case. Disappointingly, however, the saga continues with disputes between SEBI and the Sahara group regarding the submission of documents and return of monies to investors going back and forth between various fora including the Supreme Court and the Securities Appellate Tribunal (SAT). Any meaningful conclusion can be expected only next year.

SEBI’s push on securities frauds has been met with mixed success. Several appeals on matters such as insider trading and front running have been decided by SAT during the year, with a few of them in favour of SEBI and many against it. Noteworthy among them include the insider trading cases involving the Jaypee Group, a director of Ranbaxy Laboratories and Rasi Electrodes Limited. SAT’s decisions on cases involving front running and the SEBI adjudicating officer’s response leave the matter wide open, with some action possible in the next year to resolve issues. Contrast this with the successful prosecution, conviction and sentencing of Rajat Gupta (and earlier of Raj Rajaratnam) in the US, which has triggered a debate on whether that is likely to mount severe pressure on SEBI’s enforcement mechanism and resources on cases involving securities frauds.

While there is every reason to expect SEBI’s enforcement push to continue into next year, there is at least one pending issue where SEBI’s legislative or regulatory intervention is overdue and is remaining on the industry’s wish list. That pertains to the open question regarding the enforceability of put and call options. While there was some clarity from the Bombay High Court in the MCX case, that matter was settled before the Supreme Court leaving the question of law open. It is hoped that SEBI will clarify the position in the new year.

Mergers & Acquisitions (M&A)

2012 turned out to be a bit of a lackluster year for M&A. While there were indeed a handful of mega deals, the overall level of activity was nowhere near the pre-crisis levels. Inbound deals appear to be more prominent than outbound deals. Part of the drop in activity may also be attributable to the fear psychosis created by the post-Vodafone events in the form of budget announcements and GAAR. The M&A sphere has been dogged by tax uncertainties, which are enumerated in the next section below.

There have been no significant legislative developments in this area to speak of. The SEBI Takeover Regulations were overhauled in the previous year, and are only yet being fully tested. Given the enhanced threshold of 25% for mandatory public offers, there is more room for investors to acquire stakes in listed companies without triggering such offers.

The year is significant for the complete acceptance of competition law implications as an integral part of M&A deal making. The Competition Commission of India (CCI) has made its presence strongly felt in a positive way. The initial resistance from industry towards merger control regulations due to possible impediments and delays from CCI has given way to a more optimistic outlook given the recent track record of the CCI clearing proposals at such regulatory speeds hitherto unknown. Since its existence, the CCI has already handled over 100 proposals in the M&A sphere. There is a sense that all the cases before the CCI thus far have been fairly straightforward, and the CCI would be fully tested when more complex situations begins to emerge. Nevertheless, it has been a good start.


Taxation issues pertaining to M&A transactions caused a major upheaval this year that affected not only M&A specifically but also the investor sentiment in the Indian economy more generally. The corporate community welcomed the Supreme Court’s decision in the Vodafone case with much relief. But, that was only to be short-lived. The subsequent response of the Government by introducing retrospective amendments to the Income Tax Act during the budget of 2012 caused substantial uncertainty on taxation of M&A transactions that also resulted in a negative outlook for India among foreign investors. The threat of imposing GAAR further exacerbated the issue. However, more recent efforts have been taken by the Government to assuage corporate concerns. The Shome committee was appointed to examine these in detail, which provided its report that recommended among other things that the scope of GAAR be restricted when introduced. This, along with the deferral of GAAR, has brought some cheer to investors.

The whole issue of taxation of M&A transactions, believed to have been resolved by the Vodafone case, has resurfaced in yet another form (coincidentally in a case involving another transaction of Vodafone). This case involves a demerger scheme proposed by Vodafone Essar Gujarat and several other companies. While the scheme was approved by several High Courts, it was rejected by a single judge of the Gujarat High Court due to objections from the tax authorities. This decision was reversed on appeal by a division bench of the Gujarat High Court, which ruled in favour of Vodafone Essar. The tax authorities have now appealed to the Supreme Court. Interestingly, the Supreme Court is not expected only to decide on this specific issue, but the Government has sought for the entire issue of “tax avoidance” to be dealt with afresh by a larger bench of the Supreme Court. This is an area that requires a close watch in the new year given the likelihood that an issue of immense importance is likely to be dealt with de novo, and could be a game changer as such.

Commercial Dispute Resolution

The problems of delay that plague the Indian court system have not dissipated. A recent study finds that while the new caseload at the lower courts is decreasing, at the higher courts it is increasing at a rapid pace, thereby creating a bottleneck at the topic of the justice system. Interestingly, a number of cases relating to matters such as company law, arbitration and taxation are being admitted at the highest courts, including the Supreme Court. This research also supports anecdotal evidence of several cases in these fields that have gone all the way up the Supreme Court in a very short period of time, many of which have been discussed in this very post.

The conventional approach to bypass the difficulties of the court system is to opt for arbitration instead. However, in the past, that approach has encountered difficulties due to the inability of parties to enforce arbitration awards (particularly in international commercial arbitration) due to a string of decisions of the Supreme Court, notably in the case of Bhatia International. However, those difficulties have been put to rest (at least going forward) in the landmark decision of Balco that was pronounced by the Supreme Court this year. This will give the much needed fillip to arbitration of commercial disputes, although the judgment also leaves some difficult questions, such as its prospective overruling of Bhatia International and on the ability to approach Indian courts for interim reliefs in international commercial arbitration with a foreign venue.

Finally, the SAT, an active adjudicator of securities law disputes arising from orders of SEBI, finds itself in an odd situation at the end of the year without the necessary quorum. A lot has been written about this issue and a petition has also been filed before the court, and it is hoped that immediate steps will be taken to remedy the situation.

Overall, 2012 has been an eventful year in the business law area in India. While some of the developments may rather be forgotten, they provide valuable lessons for the future.


Anonymous said...

The IT Dept as well as critics of the SC judgment in Vodafone case cast it as a `tax avoidance device'. This sounds strange as in the typical tax planning / avoidance (depending on how one looks at it), the parties would go to great lengths to hide the economic substance of the transaction and make it appear something else. Here the SPA etc. clearly mentioned the purpose to be transfer of Hutch’s Indian telecom business to Vodafone! I think the Department’s argument here (capitalizing on the word `indirect’ in Section 9), was more akin to the `conduct and effects’ test adopted by some US Circuit courts in the context of securities fraud till it was junked by the US SC in the Morrison case (2010). In effect, the Dept. seems to have argued that the `conduct’ (buying a single share in…) was abroad, but its `effect’ (transfer of the telecom business to Vodafone) was in India, which no party ever denied. In my opinion, the SC correctly refused to buy this by pointing out that `indirect’ qualifies transfer, not situate in India.

Does all this make a difference? I think it does. Strip the issue of its `device’ colour, and the moral outrage disappears. Then this case becomes a purely technical one implicating the interpretation of Section 9, and there is no issue reg. the alleged intention to `deceive’.

-Mangesh Patwardhan

vswami said...

Many developments in the fields relating to, either impacting or impairing, the national economy, falling within the ambit of financial and fiscal policies aiming at reforms have been sought to be rolled into and fairly summed up.

Two of the areas so focussed on pertain to Taxation and Commercial Dispute Resolution. The significance of and important role the machinery of arbitration could play in resolving commercial disputes has been touched upon.

It may be added that, similar recourse to international arbitration is no less significant or important hence might go a long way in resolving taxation disputes, particularly in respect of cross-border transactions, as well.
In the mentioned vodafone case, as lastly reported in the media, a move had been made to take the matter forward in that direction, for a speedier and effective resolution; in one's opinion rightly so.

Refer Vodafone seeks international arbitration in India tax case - CIO

Anonymous said...

With regard to SEBI there were several primary market reforms and these reforms are very significant from the perspective of shareholders. These reforms needs special mention.