Monday, March 31, 2014

Rajat Gupta Insider Trading Case: Appellate Decision

Last week, the United States Court of Appeals for the Second Circuit issued its opinion in United States of America v. Rajat K. Gupta, in which it upheld all the findings of the district court convicting Rajat Gupta on various counts of securities fraud.

Although several questions were raised in the appeal relating to the robustness of the evidence in support of the conviction, the appellate court’s decision is fairly unequivocal in upholding the district court’s findings. The appellate decision is largely based on the facts and the admissibility of various types of evidence against Gupta, including through wiretaps and call records. This ruling effectively stamps a seal of approval on the use of circumstantial evidence (perhaps even as the sole evidence) in insider trading and other securities fraud related cases.

Of course, this entire episode that unfolded in the US has found some impact in India as well. SEBI has sought greater investigative and information-seeking powers, which have found its way into the SEBI Act through the recent re-promulgated Securities Law (Amendment) Ordinance, 2014 that was notified on March 28, 2014. A more substantive framework on insider trading is expected to be introduced following the report of the Justice Sodhi Committee Report on Insider Trading. Nevertheless, some doubts remain regarding the strength of insider trading regulation in comparison with the regulatory success enjoyed in enforcing such regulations in the US, as this recent column by Swaminathan SA Aiyar suggests.

Scope of a “Debenture”

The England and Wales Court of Appeal recently had occasion to consider the meaning and scope of the expression “debenture” in the context of a charge document. Consistent with some previous rulings of English Courts, the Court of Appeal provided a somewhat expansive definition of the expression “debenture” so as include within its fold a shareholder loan agreement.

In Fons Hf v. Corporate Ltd & Anor, the claimant Fons Hf had granted a charge in favour of Kaupthing Bank Luxembourg S.A. over, among other things, Shares. The expression “Shares” was defined in the charge document to mean:

“all shares (if any) specified in Schedule 1 (Shares), and also all other stocks, shares, debentures, bonds, warrants, coupons or other securities now or in the future owned by the Chargor in Corporal from time to time or any in which it has an interest.”

Under two separate shareholder loan agreements (SLAs), Fons Hf had made unsecured loans to a company, Corporal Limited, in which it held both ordinary and preference shares. Kaupthing contended that the rights of Fons Hf under the SLAs were covered within the charge in its favour either as “debentures” or “other securities” within the meaning of the definition set out above. The court of first instance rejected this contention, against which Kaupthing appealed.

Speaking through the lead judgment of Patten LJ, the Court of Appeal considered the principles applicable to interpretation of such a charge document, including that the “task of the court is to determine what the parties meant by the language which they used. Consistently with that objective, the court will seek to give the words their natural and ordinary meaning derived from the context of the agreement and all other relevant facts indicating the nature and purpose of the transaction.” (at para. 14).

More specifically, the Court of Appeal examined the scope of “debentures” and “other securities” as used in the charge document. A review of previous case law (in paras. 26 to 35) suggested that courts were willing to provide a wide definition of the term “debentures”, based on which Patten LJ expressed the following opinion:

36. One can see from those authorities … that “debenture” had a wider and less specific meaning that “bonds, warrants and coupons” and, context apart, was not limited to an instrument which was transmissible or of a bearer nature. As a matter of language, the term can apply to any document which creates or acknowledges a debt; does not have to include some form of charge; and can be a single instrument rather than one in a series. …

37. On this basis, the SLAs are debentures. They comprise in each case a written instrument (albeit not under seal) which creates and thereby acknowledges the relevant debts owed by Corporal. …

The general approach of the Court of Appeal has been to continue the position that the meaning of the expression “debentures” is wide in nature, and thereby must be strong reasons on the facts and circumstances of a given case to warrant a narrower interpretation.

Applying this to the Indian context, section 2(30) of the Companies Act, 2013 defines debentures to “[include] debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not”. Even this statutory definition is expressed in wide terms. Not only is the definition inclusive in nature, but it also encompasses “any other instrument of a company evidencing a debt”, which is expansive in its terms. The previous provisions of section 2(12) of the Companies Act, 1956 have also received wide interpretation by the courts, somewhat consistent with the English approach.

The recent Court of Appeal decision in Fons Hf is a reminder that parties drafting and structuring debt instruments must be conscious of the fact that such interpretation could lead to such instruments being treated as debentures either for statutory purposes under companies’ legislation or for interpretation of contracts which may have an impact on such instruments.

Sunday, March 30, 2014

Guest Post: Regulations by SEBI under the Companies Act, 2013 for Promoter Acquisitions

[The following post is contributed by Yogesh Chande, who is a Consultant with Economic Laws Practice, Advocates & Solicitors. Views of the author are personal]

In terms of section 13(8) of the Companies Act, 2013 (Act), a company, which has raised money from public through prospectus and has any unutilised amount out of the money so raised, is not permitted to change its objects for which it raised the money through prospectus unless a special resolution is passed by the company and the dissenting shareholders are given an opportunity to exit by the promoters and shareholders having control in accordance with regulation to be specified by Securities and Exchange Board of India (SEBI).

Similarly, in terms of section 27 of the Act, a company is not permitted, at any time, to vary the terms of a contract referred to in the prospectus or objects for which the prospectus was issued, except subject to the approval of, or except subject to an authority given by the company in general meeting by way of special resolution and the dissenting shareholders have been given an opportunity to exit by the promoters or the controlling shareholders at such exit price, and in such manner and conditions as may be prescribed by SEBI by making regulations in this behalf.

Acquisition by the promoters of the nature mentioned above is likely to have an impact on the existing shareholding of such promoters and therefore subject to the quantum of shares being purchased by them, will have repercussions under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (SEBI Takeover Regulations).

So far, SEBI has not issued any regulations for such acquisitions and such purchases by the promoters are currently not exempted under Regulation 10 of the SEBI Takeover Regulations. Assuming SEBI does not amend the SEBI Takeover Regulations governing such acquisitions, any such purchases exceeding 5% in a financial year[1] will trigger an obligation on the promoters to make an open offer. An open offer in such a situation may sound paradoxical, since the promoter will have to make an open offer to the public shareholders of the target company as a consequence of promoter purchasing another set of public shareholders of the target company who are desirous of exiting the target company.

It will be possible for the promoters to seek specific exemption of SEBI under Regulation 11 of the SEBI Takeover Regulations for such acquisitions, prior to them making an offer to the dissenting shareholders for acquiring their shares in terms of the Act.

In view of the above, it is fair to expect that SEBI will issue regulations in this regard as envisaged under the Act, including making necessary amendments to the SEBI Takeover Regulations.

Before concluding, it is pertinent to mention that acquisitions by the promoters of the nature mentioned above may also lead to an increase in the maximum permissible non-public shareholding [i.e. promoter shareholding crossing 75%], thus the amendments to the SEBI Takeover Regulations will have to, amongst other things, also take into consideration such a scenario and clarify whether the same shall be permissible, and its likely impact on the continuous listing requirement of maintaining the minimum public shareholding of at least 25% in a listed company.

Yogesh Chande

[1] Regulation 3(2) of the SEBI Takeover Regulations

Wednesday, March 26, 2014

Further Provisions of Companies Act, 2013 Notified

The Ministry of Corporate Affairs today issued a notification that brings into effect several provisions of the Companies Act, 2013 with effect from April 1, 2014. These include several substantive provisions that would affect the manner in which companies are managed.

A quick review of the notification suggests that the key provisions yet to be brought into force involve the National Company Law Tribunal (NCLT) that is yet to be established. This is because the provisions of the Act relating to NCLT have been challenged before the Supreme Court.

Tuesday, March 25, 2014

Guest Post: Directorship in a Company: Cap of Thorns

[The following post is contributed by Nidhi Bothra and Abhirup Ghosh at Vinod Kothari & Co. They can be contacted at and respectively]

The Companies Act, 2013 (CA, 2013) brings about a sea change in the way the charter guiding corporate India will look like. The existing Act of 1956 has been the guiding force for nearly 60 years now but the overhaul was felt necessary with the changing times. In the urge to update the laws with the changing times the new Act brings a lot of responsibility on the directors to act with greater wisdom and prudence and to ensure that they act in the best interest of the companies than merely being status heads sitting on the board. For instance, independent directors now need to be aware of the decisions taken by the company in the meetings in which they attend and those which they do not attend as well.

With this greater responsibility instilled on the directors comes greater accountability and liability as well. CA, 2013 is filled with such stringent penal provisions which did not feature in the earlier Act. While from the view of protecting the interest of the stakeholders tighter vigilance is welcomed but from the provisions of CA, 2013 it seems it shall be more of a burden for directors to hold office. The article weighs the onus of holding office and the far reaching implications on the directors.

Defaulter by keeping silent

Directors are the ones who are responsible for carrying out the business and management of the company. So this is an implied rule that the directors should act to the best interest of the company and its stakeholders and carry out their duties diligently. It is a very common thing under various Indian laws to hold the directors liable for the defaults on the part of the company as they are ones who are responsible for such default. It was a commonality to see the definition of “officers in default” under section 5 of the 1956 Act to include directors of the company chargeable for offences for non-compliance with the provisions of the Act. Similarly, CA, 2013 also has the definition of “officers in default” under section 2(60) which now includes such directors who become aware of the contraventions by default by receiving the proceedings of the meetings or where attending the meeting have not objected to the connivance or contravention was taking place. The relevant extract of the section is as below –

“officer who is in default”, for the purpose of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely:—
(vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance


This means that the director is not only in default if s/he was party to the contravention by attending the meeting but also in default where s/he receives the proceedings to the minutes of the meetings and does not object to such a contravention. Also the director now needs to ensure that is objection to any decision is recorded in the minutes appropriately.

Duties of Directors

The duties of the directors of a company have been implicitly known to be working in the best interest of the Company and ultimately for the stakeholders of the company. For the first time CA, 2013 spells out the duties of the directors in section 166 of the CA, 2013 and the duties include a) acting in good faith to promote the objects of the company, b)  exercise duties with diligence and independence, c) not involve in a situation where there would be conflict of interest with the company, d) not attempt to attain undue gain or advantage either personally or to affiliates, e) not assign office and such other duties that the articles may prescribe.

Contravention to compliance of the section attracts fine of minimum Rs. 1 lac and may extend upto Rs. 5 lacs. The duties of the director were never before laid down in the statute and the need for defining the role by the statute is least understood. So the onus is on the director to prove by conduct and intent that the duties are being fulfilled at all the times.

Compliance burden

The filing requirements under u/s 117 of the CA, 2013 provide for filing of certain resolutions passed by way of board resolutions (reference to section 179 (3) of the CA, 2013). Section 179(3) along with the draft rules lists down some 22 new items for filing and includes approval of quarterly statements, appointment of key managerial personnel (KMP) and senior management, one level below the KMP. The compliance burden is increased manifold and it seems that the proceedings of the board do not remain private anymore and will be available for public viewing. The compliance burden is much felt when such administrative filing requirements attract fines on the company and each office in default of the company. There is a fine between Rs. 1 lac to Rs 5 lac on every officer in default of the company for non-compliance of the filing requirements.

Further, section 134 (5) of CA, 2013 with regard to Board’s Report and furnishing of Directors’ Responsibility Statement (DRS) requires the directors to state that the directors have devised proper systems to ensure compliance with the provisions of all applicable laws and that such systems were adequate and operating effectively. Non-compliance with the provisions of the section attracts imprisonment for a term of three years or fine of not less than Rs. 50,000 and may extend upto Rs. 25 lacs or both. This would mean that the directors while making such a statement in the DRS will have to ensure that there are adequate systems in the company for ensuring compliance with the provisions of all applicable laws. So the new Act in essence puts tremendous compliance burden on the directors of the company.

This is not all, there are several other issues in the CA, 2013 which attracts penalty of Rupees One Lakh or more like - if a company fails to deliver the memorandum of association or articles of association or any other such agreement as requested by the member within 7 days of such request, then the officer in default shall be punishable with a penalty of rupees one thousand per day of default or rupees one lakh, whichever is lower. Again if the company fails to intimate timely to the members or debenture-holders or holders of any other securities regarding the closure of the register then the officers in default are subject to a penalty of rupees five thousand per day of default whish shall be subject to rupees one lakh. Even the silliest of mistakes like failure to give notice of board meeting to the other directors or failure to appoint the key managerial personnel of the company in accordance with the provisions of Section 203 or failure to annex the secretarial audit report with the board’s report would also lead to similar punishment as above.

We find it very illogical to impose a penalty of rupees one lakh for a failure to deliver the copy of a document requested by the member timely. There are several other provisions which provide for similar kind of penalties and the list is seemingly long.

Routine issues causes civil and criminal liabilities

While most of the sections of CA, 2013 provide for monetary penalties, certain offences attract fines and imprisonment. On an average the minimum amount of fine that is imposed under certain sections is Rupees twenty five thousand while the maximum amount goes extends up to rupees twenty crores or may be more in certain cases. Most offences leading to imprisonment under CA, 2013 are non-cognizable in nature, i.e. it would need a warrant to arrest, but serious offences like those mentioned under section 212(6) of the Act are cognizable in nature and would not require a warrant to arrest, some of such offences have been mentioned below:

i.         Furnishing of any false or incorrect particulars of any information or suppresses any material information in any of the documents filed with the Registrar in relation to the registration of a company (Section 7(6));

ii.         Including in the prospectus any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead (Section 34);

iii.       Fraudulently inducing persons to invest any money (Section 36);

iv.        The company makes an offer or accepts money in contravention of the provisions regarding offer or invitation for subscription of securities on private placement basis (Section 42(10)).

v.        Where the business of the company has been conducted for a fraudulent or unlawful purpose (Second Proviso to Section 206(4); Proviso to Section 213);

Apart from such issues, the directors are also under the burden of ensuring that the debentures are redeemed timely under section 71 (11) of CA, 2013 else may have to suffer imprisonment for 3 years apart from fine. Of course needless to add that this imprisonment is apart from the disqualification they may suffer from being directors in a company u/s 164 of CA, 2013.

Further u/s 74 of CA, 2013 where a company does not repay deposits accepted before the commencement of CA, 2013 within the threshold limit as prescribed for under the section, then u/s 75 of CA, 2013 and it is proved that the deposits were accepted to defraud the depositors then every officer of the company who was responsible for acceptance of such deposits  shall be personally liable under section 447 of CA, 2013 for fraud, without any limitation of liability, for all the damages and losses that the depositors may have incurred.

As is already known section 447 of CA, 2013 is a cognizable and non-bailable section and the onus of proving that the intent of the company was not to defraud the depositors will be on the company and its officers. Interestingly the section calls for repayment of deposits accepted before the commencement of this Act and requires every office of the company who was responsible for accepting deposit to refund the same, one may believe that even such directors who are not on the board of the company after commencement of the Act yet were responsible for accepting deposits will be included in this section.

While the CA, 2013 mostly lays down criminal liabilities on the directors, only section 245(1)(g) of the Act provides for civil liabilities whereby the members or depositors filing class action suits may claim compensation from the directors for any fraudulent or unlawful act done on their part.


Considering the quantum of penalty imposed by the ministry even for the silliest of mistakes, the directors need to carry out their duties diligently and the make sure that their act’s are in the best interest of the stakeholders. They cannot afford to be careless any more, if they do they will simply have to shell money out of their pockets and if they act a bit too carelessly, they might even find themselves behind bars.

- Nidhi Bothra & Abhirup Ghosh