Saturday, May 31, 2014

Codification of Directors’ Duties: Is Common Law Excluded?

Background

Hitherto, directors had negligible guidance under company law as regards their duties and liabilities. The preexisting Companies Act, 1956 (the 1956 Act) did not explicitly stipulate directors’ duties, which made it necessary to fall back on common law principles (to be articulated by courts while delivering specific decisions). The statutory uncertainty was compounded by the absence of significant cases of director duties and liabilities before Indian courts.

This somewhat unsatisfactory situation has been mended in the Companies Act, 2013 (the 2013 Act), which is rather explicit about directors’ duties (somewhat similar to the codification of directors’ duties under the UK Companies Act of 2006, section 172). The new provisions not only provide greater certainty to directors regarding their conduct, but also enable the beneficiaries as well as courts and regulators to judge the discharge of directors’ duties more objectively.

The duties of directors are set forth in section 166 of the 2013 Act, and are principally as follows:

-           To act in accordance with the articles of association of the company;

-           To act in good faith to promote the objects of the company;

-           To act in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment;

-           To exercise duties with due and reasonable care, skill and diligence and to exercise independent judgment;

-           To not be involved in a situation of direct or indirect conflict with the interests of the company; and

-           To not achieve any undue gain or advantage.

These duties can broadly be classified into two:

(i)          duty of care, skill and diligence; and

(ii)         fiduciary duties.

The duty of care, skill and diligence requires directors to devote the requisite time and attention to affairs of the company, pursue issues that may arise through “red flags” and take decisions that do not expose the company to unnecessary risks. Fiduciary duties, on the other hand, require the directors to put the interests of the company ahead of their own personal interests. Rules that prevent conflict of interest and self-dealing on the part of directors are integral to this set of duties.

Section 166 also provides for the consequences of breach of these duties. Sub-section (5) provides for civil liability that requires a breaching director to return any undue gain or advantage received as a result of such breach. Sub-section (7) is a penal provision that imposes a fine of Rs. 1 lac to Rs. 5 lac (i.e. rupees 0.1 million to 0.5 million) on directors who have contravened the section.

Comparative Position

The effort to codify directors’ duties is not altogether novel, as it has been undertaken in other common law jurisdictions such as the UK and Singapore. However, in one significant respect, the Indian codification exercise is different from the UK and Singapore. Under the 2013 Act in India, there is no provision that reserves the application of common law following codification. Contrastingly, both in the UK and in Singapore, the applicability of common law has been preserved to the extent that it can be utilized to interpret the statutory provisions relating to directors’ duties.

The following provisions in the UK Companies Act of 2006 are relevant:

Section 170 Scope and nature of general duties

[….]

(3) The general duties are based on certain common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director.

(4) The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.

(emphasis added)

The relevant provision in the Singapore Companies Act (Cap. 50, Rev. Ed. 2006) is as follows:

S. 157 As to the duty and liability of officers

[….]

(4)  This section is in addition to and not in derogation of any other written law or rule of law relating to the duty or liability of directors or officers of a company.

In stark contrast, the 2013 Act in India does not carry a similar provision explaining whether the principles of common law are applicable (or excluded) in the interpretation of the directors’ duties as codified in common law. This would give rise to an interpretational issue as discussed below. While this issue is somewhat technical in nature from a jurisprudential standpoint, it could turn out to be a reality once cases relating to directors’ duties under section 166 of the 2013 Act come up for litigation before the courts.

The legislative history appears to be silent regarding the rationale for the manner in which section 166 has been drafted. Furthermore, this specific issue has also not received the attention of the Parliamentary Standing Committee on Finance that extensively reviewed the Companies Bill prior to its enactment.

Issue

Whether section 166 of the Companies Act, 2013 is exhaustive regarding duties or company directors, or whether directors are also bound by common law duties (that are either in addition to the statutory duties or that can be used to interpret or explicate the statutory duties)?

Options

Similar to a format previously followed on this Blog, I propose to refrain from expressing any preferences or stating arguments on this issue. Instead, I set out two possible views along with some rationale for each, and invite readers to post their comments on these or other possible views or arguments on the issue.

Option 1: Section 166 is exhaustive of directors’ duties and is a complete code.

According to this view, the codification exercise is exhaustive, and directors’ duties must be determined solely by the language of the statutory provision. It leaves no room for the application of common law.

This option emerges from a plain and simple textual interpretation. It is also consistent with the objective of codification, which is to introduce certainty and clarity. If directors are nevertheless subjected to common law principles, the codification exercise might be rendered redundant (at least partially). Moreover, unlike the company law statutes in countries such as the UK and Singapore, there is no express provision that preserves the use of common law either in addition to the statutory duties or by way of an aid to interpret the statutory provisions.

Option 2: Section 166 is only a partial codification of directors’ duties, and the principles of common law are preserved through implication and operate in addition to the statutory provisions or to at least aid in their interpretation.

In this dispensation, the codification in the 2013 Act is incomplete as the statutory provisions lay down only the broad and basic principles, and do not provide the details as to how the duties must be discharged by the directors. Moreover, it is not possible for the statute to envisage all possible situations in which directors must discharge their duties and also the manner in which they are to do so. Those details are to be determined by the courts based on the facts and circumstances of each case, which is where common law comes into the picture.

Furthermore, if common law were not resorted to, the remedies would be inadequate as well apart from the substantive duties themselves. For example, Mihir has elaborately discussed in an earlier post, the statutory remedy for breach of directors’ duties is only a return of profits or undue gains. This is only a personal remedy, and there is no provision for proprietary remedies such as constructive trust. Moreover, staying with personal remedies, there could be scenarios where a director has not received a gain but the company has suffered a loss. In that case, without resorting to common law, it is not possible for the company to recover such losses from the director by way of damages or compensation. Therefore, any inability to import principles of common law will substantially diminish the scope of remedies for breaches of directors’ duties.

Finally, and more specifically, the 2013 Act does not have a section corresponding to section 170 (3) of the UK Companies Act of 2006 (extracted above) which specifically states that that the duties in section166 (are based on common law rules and equitable principles and) shall have effect in place of such rules and principles. In other words, there is no express provision to state that the statutory duties replace the common law duties.

Readers’ comments are welcome.

(The motivation for this post arose from immensely helpful discussions with (i) Shinoj Koshy, Ashwin Bishnoi and Arjya Majumdar on the sidelines of the International Conference on Trade, Investment and Corporate Governance: Law and Policy in India and China, and (ii) the students in the intensive course on “Corporate Governance” held in April 2014 at the National Law School of India University, Bangalore. As might be evident, those discussions remain inconclusive, and a search for the yet elusive answer continues!)

Friday, May 30, 2014

Proposal to Overhaul Delisting Regime

Delisting of companies from the stock exchange (also known as privatization) has become a common phenomenon around the world, as it has in India. The rationale for delisting a company is detailed below:

A number of reasons are proffered as motivations for delisting. Where there is a perception that the market price of the company is not reflective of the true value of its businesses, share price may cease to be an accurate indicator of the company’s worth. By privatising the company, the target and its management obtain greater flexibility in managing the business of the company without being dictated by market expectations, which can often be short-term in nature. In other words, the management is free from market pressures. This flexibility would help in responding to a more challenging business environment. Moreover, the skyrocketing costs as well as management attention required to ensure compliance with increasingly onerous securities laws and regulations as well as listing standards compel managements and controlling shareholders to delist the company so as to enable greater focus on the company’s business.[1]

For these and other reasons, the Indian markets have witnessed delistings by controlling shareholders who are either domestic promoters or multinational companies (MNCs). The spate of MNC delistings have been occasioned also by the relaxation of sectoral caps under the foreign direct investment norms whereby the MNC promoters are able to shore up their holdings beyond restrictions that were previously placed that enable a delisting of the Indian listed subsidiary.

At the same time, delisting can also result in significant risk to minority shareholders. As observed in the work referred to above: “A combination of factors conspires to provide undue advantage to the target and its controlling shareholders. These include the fact that the target and controlling shareholders can determine the time of delisting, that they benefit from information asymmetry that operates in their favour and that they are entirely in control of the process.” For example, the controlling shareholder may be in a position to initiate a delisting when the share price of the company is low. The company may also significant important projects or developments until the delisting is completed so that the prospects from those are not factored into the share price taken into account for the delisting.

The effort of regulations pertaining to delisting must strike a delicate balance. On the one hand, it must permit value-enhancing delistings that are beneficial to both the promoters as well as the company, but on the other hand it must not result in deprivation of value that the minority shareholders are otherwise entitled to when they decide to exit from the company. The complexities involved in formulating a regulatory regime for delisting is clearly evident from the evolution of such a regime in India. Although specific regulation of delistings in India is only over a decade old, it has been unsuccessful in achieving it objective, due to which it is under a constant state of revision (with the accompanying flux and lack of clarity or certainty). The first set of SEBI (Delisting of Securities) Guidelines, 2003 was substituted by the SEBI (Delisting of Equity Shares) Regulations, 2009. Even the relatively new guidelines have not achieved the desired success, and hence the need has been felt for a further review of the regime.

It is in this context that SEBI earlier this month issued a Discussion Paper on Review of Delisting Regulations. The Discussion Paper seeks to review the current state of affairs, identify the deficiencies in the delisting regime and propose some suggestions for overhaul. It observes:

The overall delisting activity has gone down considerably after the introduction of the [2009] Regulations. A total of 38 offers have been made during the period between the introduction of the said Regulations and March' 2014. …

Out of the above 38 offers, 29 offers were successful. Amongst 9 unsuccessful offers, in case of 7 offers, the number of shares tendered were less than the number required under the said Regulations. In the remaining 2 offers, acquirer rejected the discovered price.

Out of 38 companies, discovered / exit price in case of 7 companies was equal to the floor price. However, in case of 11 companies, premium in the discovered price was more than 100%. Premium is the price differential of discovered/exit price over and above the floor price.

Several difficulties have been identified with the current regime, but here I discuss only two of the crucial ones. The first is the use of the reverse bookbuilding mechanism (RBB) for price discovery for the delisting, and the second is the considerably elongated timeline that includes the need for shareholder approval through special resolution.

Reverse Bookbuilding

Under the RBB process, the company must fix a floor price, which is based on several financial and trading parameters. Public shareholders are able to place their bids for sale of shares in the delisting through an electronically linked transparent facility on the stock exchange at or above the floor. The final bid price is determined as one at which the maximum number of equity shares are tendered by the public shareholders. However, the promoter/acquirer has the ability to either accept the offer at that price or reject the same.

In the Discussion Paper, SEBI identified several problems with the RBB process. Public shareholders holding a significant stake can dictate terms as to the determination of the delisting price and thereby hold the other shareholders to ransom. Since bids are placed at a significant premium to the floor price giving rise to the likelihood of their rejection by the promoters, the minority shareholders are denied a fair exit. Moreover, the RBB process was found to be complex thereby resulting in incomprehensibility on the part of the minority shareholders, especially of the retail variety.

Due to this, SEBI has come out with various suggestions, some of which relate to amending the RBB process to make it more workable, with others that relate to doing away with that process altogether by migrating to an alternative price discovery mechanism.

Suggestions: In my view, there is merit in migrating from the RBB process (or a variant thereof) to another more flexible price discovery mechanism. While the RBB provides considerable power to the public shareholders, that power is capable of being usurped by the more significant among such shareholders who hold a large number of shares. Although it would be possible to make some adjustments to this mechanism to avoid these distortions, they cannot be eliminated altogether. The RBB process is rigid and inflexible, and any benefit of certainty and clarity it provides is overshadowed by the restrictions it imposes in a successful completion of the delisting offer.

Hence, the recommended option would be for the promoters/acquirers to propose a bid price, which the public shareholders may either accept or reject (by either tendering their shares in the delisting offer or refraining from doing so). At first blush, this might seem to provide too much leeway to the acquirers. But, that can be counteracted through other protective measures, which are discussed below.

(i)        First, if the price is too low, the public shareholders will not tender their shares so as to not provide the minimum required acceptances to make the delisting offer successful.

(ii)       Second, the board of the target company must be foisted with the duty to advise the shareholders as to whether the terms of the delisting offer are fair and reasonable. In doing so, there must be a committee of independent directors that provides the advice/recommendations. This is consistent with developments such as the Companies Act, 2013 and the revised Clause 49, which impose greater roles and responsibilities on independent directors, especially when the board or promoters are afflicted with conflicts of interests such as in the case of delisting.

(iii)      Third, the committee of independent directors must obtain advice from an independent financial adviser or valuer who provides an opinion as to the fairness and reasonableness of the terms of the delisting offer. This would ensure the review of the terms by an outside gatekeeper.

This approach of price discovery is desirable as it is both flexible and protective. It is also consistent with the approach followed for delistings in several developed jurisdictions. From a comparative standpoint, the RBB process in India appears to be a rarity, and SEBI must not continue to embrace it unless there are compelling reasons to do so. If past experience is anything to go by, such a rationale for continuance does not appear compelling.

Shareholder Approval

Under the current regime, delisting can be allowed only if approved by way of a special resolution by the shareholders through postal ballot. Further, the special resolution stands supported only if the votes cast by public shareholders in favour of the proposal is at least twice the number of votes cast against it. In other words, apart from a standard special resolution, the proposal must enjoy the support of the public shareholders. However, the Discussion Paper highlights a practical concern whereby this requirement adds considerably to the timeline for delisting that takes away from its effectiveness. Delistings are said to take anywhere between 4 and 6 months. One proposal is to do away with the shareholder approval requirement with others suggestions making variations as to timing.

Suggestion: Despite the concern on timing, the shareholder approval requirement is an important protection to public/minority shareholders and ought not to be done away with. As indicated earlier in this post, the public shareholders are vulnerable in a delisting, as the process is orchestrated by the promoters/acquirers who are conferred a natural advantage. Unlike a standard takeover offer (which does not require shareholder approval), the delisting will result in illiquidity of the shares of the target company. Before public shareholders have been deprived of such liquidity on their shares (which does not occur in a standard takeover offer), their consent must be obtained. The additional approval through a requisite majority of public shareholders is also an important one that must be retained because the promoters/acquirers are interested in a delisting due to which their vote must be discounted. What is required is an approval through a “majority of the minority” vote, which is now a recognised concept under the Companies Act, 2013 (e.g. for material related party transactions).

Conclusion

The Discussion Paper also makes a number of other suggestions that relate to the process of delisting, disclosure requirements, eligibility, etc., which are not capable of being discussed within the confines of a blog post. However, one issue that is conspicuous by its absence in the Discussion Paper relates to the interplay between the SEBI Delisting Regulations and the SEBI Takeover Regulations. Currently, there appear to be difficulties in undertaking a takeover offer that would be followed by a delisting in case of requisite acceptances that reduce the public shareholding below the minimum. Although SEBI had been providing indications that the asymmetry between the two sets of regulations will be ironed out in due course, no concrete proposal has been forthcoming in that regard.

In all, the effort to overhaul the delisting regulations is an important and timely one. Given the spate of delistings that have been attempted in India (and more that may perhaps ensue in the near future), it is necessary to provide for a regime that efficient, timely and carries the necessary clarity and certainty for the promoters/acquirers, but also one that sufficiently protects the interests of the public shareholders.


[1] Wan Wai Yee & Umakanth Varottil, Mergers and Acquisitions in Singapore: Law and Practice (Singapore: LexisNexis, 2013).

Thursday, May 29, 2014

Report on Governance of Banks

Historically, the governance of banks has received greater (and somewhat different) attention when compared to governance of companies carrying on other forms of business. This is because banks deal with depositors’ funds and their actions or misdeeds can cause a more severe strain on the economy as a whole. Hence, while banks that are established as companies (and listed on the stock exchanges) are covered by the regular corporate governance norms prescribed for listed companies, they are also subject to additional governance requirements imposed by the banking regulator. Hence, the governance norms focus beyond merely the enhancement of shareholder interests, but extend to incorporating other interests such as depositors, the financial markets, the economy and the general public.

It is in this background that one needs to view the recommendations of a committee under the chairmanship of Mr. P.J. Nayak that was tasked by the Reserve Bank of India (RBI) to review the governance of bank boards in India. The committee issued its report earlier this month. The report identifies the ills that afflict the current system of governance in India’s banking sector and seeks to make suggestions for overhaul of the system, many of which are quite radical in nature. Overall, the report is quite detailed and well-researched, and is the result of a meticulous study that is supported by extensive data collection.

The report differentiates public sector banks from those in the private sector. In a scathing attack on public sector banks, it points to their significant weakening in recent years. Apart from excessive governmental control, the other factors are multiple layers of regulation and the lack of stringent governance norms and practices. In doing so, the committee seems to proceed on the basis of a correlation between governance and performance, and impliedly establishing better governance norms and practices as a measure to streamline performance. The committee’s principal solution to public sector bank governance is an overhaul of the holding structure of such banks. Currently, public sector banks are owned directly by the government. What the committee proposes is to establish a Bank Investment Company (BIC) as an intermediate holding company that holds shares in various public sector banks. While the committee makes this reform proposal, it has also suggested a phased introduction of the BIC, perhaps a sign of recognition that establishing such a model in the Indian context may be time consuming, and other measures may need to be put in place in the interim.

The idea of introducing an intermediate holding company structure is an interesting one. This idea draws inspiration from the models followed in Singapore, the UK and Belgium. For instance, shares in DBS (as well as several other government-linked companies) in Singapore are held by Temasek. Several banks and other state-owned enterprises (SOEs) in China are held by an intermediate entity called SASAC that is also billed as the world’s largest controlling shareholder. Such an intermediate holding structure would distance the public sector banks from direct government control and infuse a greater amount of independence and professionalization. While this idea is attractive in paper, several questions and complexities would arise in its implantation, as discussed here. Nevertheless, it is an idea worth considering. If the pilot efforts is successful for the banking sector, it could possibly be replicated for other public sector undertakings as well.

Private banks call for a different treatment. From a regulatory standpoint, they are subject to shareholding caps as well as voting caps that deny significant control to any individual shareholder or group. The committee recommends the creation of a new category of investors referred to as Authorised Bank Investors (ABIs), who can invest up to 20% shares in a bank without regulatory approval (or 15% in case the ABI seeks a board seat on the bank).

Finally, the committee makes several recommendations on board structure and performance, including board independence, tenure, separation of chief executive and chair, maximum age and the like. These requirements are in addition to those prescribed by clause 49 of the listing agreement that are applicable to all listed companies.

In all, the committee’s recommendations are quite focused and in some ways prescriptive, while some may be somewhat radical in nature requiring greater overhaul. Their acceptability would depend on whether there exists sufficient political will and momentum to push through such drastic reforms (which will not only require regulatory changes by the RBI but also statutory amendments through the legislative process), or whether the path of adopting incremental changes will be taken.

Wednesday, May 28, 2014

Guest Post: COMPAT upholds CCI order in DLF Belaire Owners Association Case

[The following post is contributed by Vaibhav Choukse, Senior Associate - Competition Law and Policy, Vaish Associates Advocates. Views are personal.]

Introduction

On May 19, 2014, in a landmark order, the Competition Appellate Tribunal (“COMPAT”) upheld the order of the Competition Commission of India (“CCI”) imposing a record penalty of INR 630 crores (USD 140 million) on DLF Limited (“DLF”) for abusing its dominant position (“COMPAT Order”). Based on a media report, the allottees are planning to move the COMPAT to file compensation claims under Section 53-N of the Competition Act, 2002 (the “Act”).

The COMPAT observed that the “Competition Law must be read in the light of the philosophy of the Constitution of India, which has concern for the consumers and the dominant player in the market has a special duty to be within the four corners of law.”

Background

On the basis of information filed by Belaire Owners’ Association, an association formed by the apartment allottees of a DLF building, the CCI found DLF guilty for abusing its dominant position in the market for services of developer/builder in respect of high-end residential accommodation in Gurgaon in contravention of Section 4 of the Act. The CCI imposed a penalty of INR 630 crores (USD 140 million), at the rate of 7% of the average turnover of DLF and issued a cease and desist order against DLF from imposing unfair conditions in the Apartment Buyer's Agreement (“ABA”) executed between DLF and allottees. CCI also directed DLF to suitably modify the terms of the ABA.

Following the order of CCI, DLF moved to COMPAT challenging the findings of the CCI. During the pendency of appeal, COMPAT directed the CCI to furnish a suitably modified ABA post consideration of the draft modified terms submitted by DLF and Association. Following the directions of COMPAT, the CCI suitably modified the abusive clauses of ABA.

Findings of the COMPAT

COMPAT has, inter alia, made the following observations:

Issue I: Jurisdiction of the CCI

The CCI was right in assuming the jurisdiction on the basis of the definition of the term ‘service’ in Section 2 (u). The term ‘service’ as contemplated in Section 4 has a direct relation to Section 2 (u), which provides for the ‘service’ of the nature which is being provided by DLF i.e. real estate & construction.

Issue II: Retrospective Operation of the Act & Applicability of Kingfisher Judgment

Retrospective Operation of the Act: Section 4 is not retrospective in operation. Section 4 (2) (a) will only attract if there is an imposition of unfair or discriminatory condition or price. In 2006-07, when the Section 4 was not in force, the allottees entered into ABA voluntary without any element of coercion and hence, there was no imposition of any condition in the ABA by DLF.

Applicability of the Kingfisher Judgment: COMPAT rejected CCI’s approach in examining the clauses of ABA and observed that all acts done in pursuance of the agreement before the Act came into force would be valid and cannot be questioned. But if the parties want to perform certain acts in pursuance of the agreement, which are now prohibited by the Act, then those acts would be illegal. No provision in the Act permits the re-writing of the agreements. If DLF acted in pursuance of ABA, which was contrary to the Act, then CCI could have taken an exception to those ‘acts’, but not to the ‘clauses’ of ABA, which were valid. Also, the continuation of the agreement after May 20, 2009 by itself would not attract the mischief of the Act, unless there was some act in pursuance of those clauses, which were not contemplated in the agreement and would, therefore, amount to an imposition of condition.

Moreover, the CCI cannot direct modification of the ABA. The power to modify agreements lies under Section 27(d). Only the agreement under Section 3 (anti-competitive agreements) can be ordered to be modified under Section 27(d), since, Section 27 speaks about ‘action’ when it speaks about contravention of Section 4.

Issue III: Relevant Market and Dominant Position of DLF

Relevant Market: The CCI market definition was correct i.e. services of developer / builder in respect of high-end residential accommodation in Gurgaon. On the issue of Geographic Market, it was observed that, the residential housing is not connected with investment. Ordinarily, for a common man, basic need is food, other amenities of life and a property to reside, as that creates a sense of security in his mind. If that is so, it will be futile to examine the question only from the angle of investors.

Dominance: The CCI’s reliance on the CMIE (Centre for Monitoring Indian Economy Private Limited) data over other data/ reports available while assessing market share (55%) of DLF was correct. DLF’s market share was more than double of its next biggest competitor, Unitech. DLF is a market leader and enjoy a unique position as it lay down the rules of the game, which power/strength it exercises in its favor to the potential detriment of its competitors and consumers' interests.

Issue IV: Abuse of Dominant Position by DLF

COMPAT did not consider any ABAs executed after May 20, 2009 and restricted the inquiry only to the ABAs executed in 2006-2007 against which the information was filed with the CCI. COMPAT only focused on the actions taken by DLF pursuant to ABA, post May 20, 2009.

ABA authorizes DLF to increase the number of floors by constructing additional floors, but this imposition of additional construction without intimation & consent from allottees and without prior approval from the Government Authority amounts to abuse of dominant position by DLF.

The DLF offer to the original allottees regarding moving to a higher floor is discriminatory vis-à-vis other allottees. It is against Article 14 of the Constitution of India and Section 4(2) (a) (i) of the Act.

Unilateral increase in the super area and holding charges by DLF was in breach of the ABA and amounted to abuse as DLF was well aware that allottees had no other choice, but to accept the same. The only option left with the allottees was to exit the scheme, which was unimaginably costly.

Issue V: Quantum of Penalty and Role of Government Departments

CCI has given sufficient reasons for imposing the penalty of INR 630 crores on DLF. Further, COMPAT severely criticized DTCP (Town & Country Planning Department, Haryana) for remaining blissfully ignorant about the illegal conduct and for not taking any action against DLF.

Analysis  

The COMPAT Order sends a strong signal to both the real estate industry and the state-level government authorities, and may even expedite the process of establishing a real-estate regulator by the new government. 

The COMPAT Order assumes significance because, firstly, it is one of the initial cases of the CCI and COMPAT which dealt with ‘exploitative’ nature of abuse (exploiting customers) as the jurisprudence on abuse of dominant position mainly centered on the ‘exclusionary’ abuses like price predation or refusal to deal etc., resulting in the exclusion of a competitor from the market. Secondly, the COMPAT recognizes the principle of ‘special responsibility of a dominant enterprise’. This principle had been laid down by European Court of Justice in the Michelin Case in 1983. It means that a firm in a dominant position has a special responsibility not to allow its conduct to impair undistorted competition on the market. Thirdly, COMPAT confirmed the approach of the CCI on penalty, unlike the cases in the past where COMPAT has substantially reduced the penalty imposed by the CCI.

At present, the CCI is investigating more than 70 real-estate companies for alleged cartelization. In the wake of the COMPAT Order, the real estate industry must agree to voluntarily commit itself to ensuring the highest standards of competition law compliance within the sector by adhering to the principles of fair competition in all of its business practices. In this regard, Apex Builders Associations like CREDAI can play a vital role in sensitizing their member builders on the benefits of competition compliance.  In many other countries, responsible builders associations prescribe standard pro-forma contracts that are less skewed. For example, in Australia, there are three major associations of builders, each of which provides standard pro-forma contracts to the potential buyers for various kinds of contracts ranging from purchase of a new property to existing property to renovation of bathrooms and kitchen in order to reasonably protect the interests of homebuyers. Recently, National Federation of Builders (NFB), a prominent builders association in United Kingdom launched an industry-wide code of conduct. The code demands that UK construction companies meet the highest standards of competition law compliance and will form a mandatory part of the NFB’s code of conduct for members. It is time that real-estate developers fastened their best practices to responsible compliance with the Competition Act.

- Vaibhav Choukse

The Meaning of 'Plant and Machinery' for the Purposes of Capital Gains

The National Gallery describes Sir Joshua Reynolds as the “leading English portraitist of the 18th century” and expert “in the work of Rembrandt, Rubens and van Dyck”. Improbably, the sale of one of his great paintings, the Omai of the Friendly Isles, recently gave rise to an interesting question of income tax law that has also troubled the Indian courts: what precisely does ‘plant and machinery’ mean? The Court of Appeal’s excellent judgment contains a careful analysis of the law on this point and is also a good example of the correct approach to cases in which it appears that the legislature has unintentionally given the taxpayer a windfall: that, on its own, is no reason to strain the language the legislature has employed or artificially find that the tax is payable (and the converse, of course, is true as well: if the payment of a tax appears to cause hardship, that too is a matter for Parliament, not the courts).

Sir Joshua’s Omai painting was part of the art collection that belonged to Lord Howard of Henderskelfe, who died in November 1984. During his lifetime, and after his death, his residence in Yorkshire (‘Castle Howard’) was open to members of the public. The Omai painting was one of the many art works displayed there. The precise way in which this was done is of importance: a company called Castle Howard Estate Ltd (‘CHEL’) ran Castle Howard, was responsible for displaying the pictures and bore the expenses of insurance, security etc. But it had no formal lease or licence and did not pay any hire or rental fee to Lord Howard or, after his death, to the executors, who remained the owner of the Omai painting. As Lord Justice Rimer notes, the executors were the same individuals who were the directors of CHEL.

In 2001, the executors sold the Omai painting at a Sotheby’s auction for £9.4m, thereby making a large profit. As Lord Justice Rimer puts it, a layman may be forgiven for thinking that this obviously attracts capital gains tax: indeed, it seems to be the archetypal case of the sale of an asset for a substantially higher sum than the acquisition cost. The executors, however, argued (successfully) that it was entirely exempt from capital gains tax because it constituted ‘plant’. Sections 44 and 45 of the TCGA 1992 provide as follows:

‘44.           Meaning of “wasting asset”

(1) In this Chapter “wasting asset” means an asset with a predictable life not exceeding 50 years but so that –
             …
(c) plant and machinery shall in every case be regarded as having a predictable life of less than 50 years, and in estimating that life it shall be assumed that its life will end when it is finally put out of use as being unfit for further use, and that it is going to be used in the normal manner and to the normal extent and is going to be so used throughout its life as so estimated;

45.            Exemption for certain wasting assets

(1) Subject to the provisions of this section, no chargeable gain shall accrue on the disposal of, or of an interest in, an asset which is tangible movable property and which is a wasting asset.

On these facts, principally two questions arose. First, was the Omai painting ‘plant’ for the purposes of section 44(1) and secondly, did either section 44 or section 45 contemplate that the disposal of the plant must be by the person in whose hands it was a plant? The classic exposition of the meaning of ‘plant’, of course, is that of Lord Justice Lindley in Yarmouth v France:

"There is no definition of plant in the Act: but, in its ordinary sense, it includes whatever apparatus is used by a business man for carrying on his business, — not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business."

Yarmouth v France has been followed on several occasions by the Indian courts. The argument of Lord Howard’s executors was that the Omai painting was used by CEHL as part of its business of displaying art works in Castle Howard to members of the public. At first sight, this appears to be plainly correct (although whether Parliament intended it to have this effect is another matter). But HMRC made two interesting arguments about why it was not plant. First, it was said that the company was not the owner of the painting; nor did it have the benefit of any licence or lease, since the arrangement was terminable at will, and therefore it did not meet the ‘permanent employment’ test outlined in Yarmouth v France. Lord Justice Rimer rejected this argument, pointing out ‘permanent’ relates to the nature of the asset, not the nature of the tenure:

29. In my view, there is nothing in this either. Lindley LJ, when referring to plant as apparatus kept for ‘permanent employment’ in the business, was simply contrasting it with the circulating nature of a trader’s stock in trade, which the trader buys and sells. He was not purporting to identify the type of tenure of the putative plant to which the trader must be entitled in order for it to qualify as plant.

Second, it was said that there was no ‘identity in interest’ between the 'plant' held by the CEHL (the right to display the painting) and the asset sold by the executors (the painting itself) and alternatively that it could not constitute plant because a painting is incapable of being a ‘wasting asset’. Lord Justice Rimer rejected these points as well:

32. There is in my view nothing in this either. The plant kept by the company for use in its trade was not such a limited interest, it was the picture itself. A limited interest in a chattel cannot constitute plant. There was, therefore, a complete identity between the asset used by the company and the asset sold by the executors. In any event, the submission that there needs to be such identity of interest is mistaken. Section 45(1) shows that the disposal of a limited interest in plant held by the trader will entitle the disponor to the exemption.

34. I would reject it. The problem with it is that what is ‘plant’ is not identified by the predictable life of a chattel. It is identified by whether or not the chattel passes the Yarmouth v. France test; and an item is capable of doing so whatever its predictable life. Once an item qualifies as ‘plant’, it is ‘in every case’ deemed by section 44(1)(c) to be a wasting asset; and for HMRC to argue that an item of plant enjoying unusual longevity is not plant at all is to advance an argument that the section expressly excludes and which amounts to no more than a pointless beating of the air.

This point—that the painting is not ‘plant’—was not HMRC’s primary case, as it argued that sections 44 and 45 require the disposal to be made by the person in whose hands the asset was a ‘plant’ and that in this case that condition was not satisfied because the painting was used for the company’s business but sold by the executors. The Court, after a careful analysis of the legislative history, rejected this submission but the point is of limited relevance to Indian law and it is unnecessary to explore it detail.

Finally, it is worth setting out Lord Justice Briggs’ more general observations about the construction of tax statutes in cases where the result contended for appears to have been an unintended consequence of the language used by the legislature:

It is, and despite these judgments will probably remain, surprising to those unfamiliar with the workings of Capital Gains Tax, that a famous Old Master like Omai should qualify for exemption from tax on the ground that it is either ‘plant’ or  a wasting asset, with a deemed predictable life of less than 50 years.  But this is the occasional consequence of the working of definitions and exclusions which, while aimed successfully at one potential inroad into the charge to tax, unavoidably allow others by what the legislators appear to permit as an acceptable if unwelcome side-wind…In such cases it is essential to address an issue of interpretation not by reference to the oddball example, like an Old Master used as plant, or by the vintage car rather than the deteriorating hatchback, but by focusing upon the purpose for which the provision being construed was introduced.