Thursday, June 30, 2016

Guest Post: Independence and Impartiality of Arbitrators: The Applicability and Scope of amended Section 12

(The following post is contributed by Shubham Jain, who is a student at the National Law School of India University, Bangalore)


The enactment of the Arbitration and Conciliation (Amendment) Act, 2015 (“the amendment”) has brought a slew of changes in the two decade old Arbitration and Conciliation Act, 1996 (“the Act”). Based on the recommendations of the 246th Report of the Law Commission, the Amendment sought to address the difficulties faced in the working of the Act.

One of the major changes brought about by the amendment was the inclusion of provisions to ensure independence and impartiality of arbitrators. Based on the Red and orange lists of IBA Guidelines on Conflicts of Interest in International Arbitration, the amended Section 12(1) read along with the newly inserted Schedule V provides an illustrative list of situations which can raise doubt over the independence of an arbitrator. More importantly, Section 12(5) creates a non obstante whereby any person whose relationship, with the parties, counsel or the subject-matter, falls under any of the categories specified in Schedule VII, is deemed ineligible to be appointed as an arbitrator and is treated as de jure unable to perform his function under Section 14. The questions over the scope of amended Section 12 and its applicability to pre-amendment arbitration agreements have been addressed by the recent judgment of the Delhi High Court in             Assignia-VIL JV v. Rail Vikas Nigam Limited, Arbitration Petition No. 677/ 2015 (Decided on April 29, 2016).

Background Facts and Issue:
The dispute relates to the alleged illegal termination of the works and construction contract by Railways. Assignia sought to resolve the dispute amicably in terms of Clause 20.2 of the contract. On receiving no response, it invoked the arbitration clause contained in Clause 20.3. However, the respondent failed to nominate the names of arbitrators as per the procedure and the petitioner filed a Section 11 petition for appointment of arbitrator. There were several issues before the court including whether the dispute could be referred to a new tribunal in light of a pre-existing tribunal to adjudicate disputes arising from the same contract. However, two issues that merit consideration are first, the applicability of amended Section 12 and second, the scope of amended Section 12.

1.                  Applicability of amended Section 12: Commencement of Proceedings
Section 26 of the amended Act states that the provisions of the amendment apply to all arbitral proceedings commencing after the commencement of the amendment Act unless the parties otherwise agree. As per Section 21 of the Act, “Commencement of arbitral proceedings” is deemed to take place on the date on which a request for that dispute to be referred to arbitration is received by the respondent. In the instant case, the petitioner asked for reference of the dispute to arbitration on October 26, 2015 while as per Section 1(2) of the amendment act, it came into force on October 23, 2015. Hence, there was no difficulty in applying the amendment provisions to this case.

However, a more expansive position was taken by the Guwahati High Court in Panihati Rubber Limited v. The Principal Chief Engineer, Northeast Frontier Railway, Arbitration Petition No. 12/ 2011 (Decided on March 15, 2016). The contract contained an arbitration clause similar to Assignia

The petitioner had requested the respondents to refer the matter to an arbitral tribunal way back in 2011 and had subsequently filed a Section 11 petition due to the inaction on part of the respondents. The question before the court was whether the appointment of the arbitrator during the pendency of the petition was a valid one. While the court was correct on its reliance on Datar Switchgears Ltd. v. Tata Finance Ltd. to conclude that the respondents had forfeited their right to appoint the arbitrator, its additional reliance on the amendment to conclude that in any case, an interested party is barred from being an arbitrator as per Section 12(5) suggests that the court has failed to take notice of Section 26 unlike the Delhi High Court in Assignia (¶¶ 36, 40).

In light of the clear definition of commencement of arbitral proceedings, the proceedings would be deemed to have commenced in 2011 and therefore, the amendment was inapplicable in the instant case. Merely because an arbitration petition is decided after the amendment should not mean that the provisions of the amendment can be applied to the case. Therefore, it is respectfully submitted that the court was incorrect while placing reliance on amended Section 12.

2.                  Scope of Amended Section 12: The Death knell of In-House Arbitrators

Clause 20.3 of the contract signed by the petitioners in Assignia provided that the tribunal shall consist of 3 arbitrators with one arbitrator being a working or retired officer of the Indian Railways Accounts Service, one arbitrator being a working or retired officer of any Engineering service of Indian Railways and the presiding member being a serving railway/ RVNL officer. A prima facie look at the clause is sufficient to make one wonder if a tribunal of such composition can decide the dispute in a fair and unbiased manner. However, the erstwhile Section 12 created no bar on such clauses. A catena of apex court decisions (See 246th Report of Law Commission of India, ¶¶ 53-56) had held such clauses to be enforceable. The locus classicus in this regard is Indian Oil Corporation Ltd. v. M/S Raja Transport (P) Ltd.

In Indian Oil, it was held the “senior officer/s (usually heads of department or equivalent) of a government/statutory corporation/ public sector undertaking, not associated with the contract, are considered to be independent and impartial and are not barred from functioning as Arbitrators merely because their employer is a party to the contract.” While it might be argued that party autonomy is the cornerstone of arbitration and clauses providing for in-house arbitrators could be negotiated upon, such negotiations seldom take place in practice. Lucrative government contracts often see fierce bidding from parties with relatively weak bargaining power. Therefore, such clauses are commonplace in all contracts with public sector undertakings.  

The Law Commission opposed such clauses on the ground of violation of principles of natural justice. It was of the view that the distinction between private and public sector entities was superfluous and the concept of party autonomy needs to be balanced with neutrality of arbitrators. Therefore, it proposed the aforesaid amendments. The court in Assignia denied the appointment as per the terms of the arbitration clause as the same could have been said to be in violation of Entry 1 of Schedule VII.


In effect, the amendment has brought as end to the practice of having “in-house arbitrators” by state or its instrumentalities. It has brought the Indian law at par with international standards. This has been reinforced by the judgment in Assignia. However, courts need to exercise caution while applying the amended provisions. As shown by the judgment given by the Guwahati High Court, a partial reading of the provisions could lead to unintended consequences. The amendment makes it clear that it is applicable only to proceedings commencing after the commencement of the amendment and it would be wrong for courts to make it applicable to proceedings that have commenced earlier. Such decisions could lead to increased uncertainty in the arbitration regime, something that the amendment sought to reduce.

Wednesday, June 22, 2016

Disgorgement of profits – profits made in violation of SEBI directions vs. profits made in violation of law

In perhaps a first, SEBI has ordered impounding of profits that were made through legitimate and non-manipulative trades though in violation of SEBI directions not to trade.

An earlier order against certain persons had “prohibited them from buying, selling or dealing in the securities market, directly or indirectly, till further orders.”. While such directions were in force, such parties allegedly dealt in securities indirectly and earned huge profits.

SEBI ordered impounding of such profits of Rs. 27.44 crores (including interest of Rs.8.45 crores @12% pa till date of order). This is pending completion of investigation after which SEBI may pass final orders for disgorgement of such profits.

The order is interesting. The earlier order prohibiting them from such dealings was because of alleged market manipulations by such persons. However, while the parties violated this order of prohibition, they did not carry out any manipulations in such dealings. The profits have been made from dealings in securities that were otherwise in ordinary course of business. The interesting question is whether such profits can and should be subject of disgorgement.

The explanation to Section 11B of the SEBI Act clarifies that SEBI has power to order  disgorgement of “wrongful gains” made “by indulging in any transaction or activity in contravention of the provisions of this Act or regulations made thereunder”. The question is whether this would include profits made in contravention of directions of SEBI. The requirement also is that such “wrongful gains” should have been made “by such contravention”. Whether such gains can be said to be “wrongful” and also whether they are made “by such contravention”.

SEBI does have power to levy penalty where any person does not comply with directions of SEBI. Section 15HB provides for a penalty of upto Rs. 1 crore on a person who “fails to comply with any provision of this Act, the rules or the regulations made or directions issued by the Board”.

Whether SEBI should disgorge such amounts is also an interesting question. For answering this question, an incidental question could be whether such directions were punitive or preventive (decision of Supreme Court in SEBI vs. Ajay Agarwal ((2010) 3 SCC 765) is relevant here). A person who indulges in manipulative transactions may be prevented from repeating them by prohibiting him from dealings in securities. However, if he yet carries out such dealings, albeit in a legitimate manner without any manipulations, he can be penalised for violating the directions. Should he be asked to surrender the profits made too? The penalty of Rs. 1 crore under Section 15HB would not be a sufficient deterrent to a person who has opportunity for making, as in the present case, far higher profits.

One looks forward to the final order in this case. Hopefully, if it does order disgorgement, it also gives detailed reasoning and legal basis for disgorgement in such situations.

Friday, June 17, 2016

Wilful Defaulter Provisions: A Spanner in the Works for M&A Transactions?

[The following post is contributed by Malek Shipchandler, a lawyer at Shardul Amarchand Mangaldas & Co. Views expressed herein are solely that of the author and do not in any way represent the views of his organization]

The Indian securities regulator, the Securities and Exchange Board of India (SEBI) recently notified an amendment to the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Regulations) which prohibits a person or entity that is declared a “wilful defaulter” from making a public announcement to acquire shares of an Indian listed company (Listco) or enter into any transaction that would attract the obligation to make a public announcement to acquire the shares of a Listco under the Takeover Regulations (Prohibition). The text of this amendment viz. Regulation 6A reads:

“Notwithstanding anything contained in these regulations, no person who is a wilful defaulter shall make a public announcement of an open offer for acquiring shares or enter into any transaction that would attract the obligation to make a public announcement of an open offer for acquiring shares under these regulations.

Provided that this regulation shall not prohibit the wilful defaulter from making a competing offer in accordance with regulation 20 of these regulations upon any other person making an open offer for acquiring shares of the target company.”

The text of Regulation 2(1)(ze) which defines a “wilful defaulter” reads:

““wilful defaulter” means any person who is categorized as a wilful defaulter by any bank or financial institution or consortium thereof, in accordance with the guidelines on wilful defaulters issued by the Reserve Bank of India and includes any person whose director, promoter or partner is categorized as such;”

Under clause 2.1.3 of the master circular on wilful defaulters dated July 1, 2015 (Circular) issued by the Reserve Bank of India (RBI), a “wilful default” is deemed to have occurred where a person or entity (whether incorporated or not) has intentionally, deliberately and calculatingly defaulted in meeting payment obligations to a lender (a) when it has capacity to make the payment; (b) and has not utilized the finance availed of for purposes designated but instead diverted the funds for other purposes; (c) and has siphoned off funds nor are the funds available in the form of assets and (d) and has disposed off or removed the assets given (for securing the loan) without the knowledge of the lender.

Under clause 2.6 of the Circular, a guarantor (be it a group company of the defaulting entity or otherwise) that refuses to comply with a payment demand made by a lender, is also treated as a wilful defaulter.

A few observations and thoughts in connection with the above are set out below:

1.         Indirect open offers: The Prohibition, by using the language “any transaction that would attract the obligation to make a public announcement” (Language), covers indirect open offers as well. Therefore, hypothetically, where by virtue of an underlying transaction which results in a change in control of a Listco, an open offer obligation is triggered; if the acquirer (or even a person acting in concert with the acquirer) has been declared a wilful defaulter (in capacity of a borrower or guarantor) under the Circular, such acquirer and/or person(s) acting in concert cannot make an open offer – which essentially means, the acquirer and/or person(s) acting in concert cannot enter (or agree to enter) into any underlying transactions. Therefore, the Prohibition does not just extend to transactions directly involving a Listco. An intriguing conundrum would be a case of an overseas transaction triggering an indirect open offer in India where the acquirer or person(s) acting in concert have been declared wilful defaulters – this Prohibition would need to be given thought to while, inter alia, structuring global transactions affecting a Listco and which persons/entities to designate as “person(s) acting in concert” for purposes of the open offer.

2.         Creeping acquisition: The Prohibition does not appear to prohibit wilful defaulters from making creeping acquisitions. Essentially, a wilful defaulter already holding a 25% stake in a Listco, can undertake stake building by acquiring up to 5% in any financial year, since open offer obligations are triggered only when an acquisition is made of a more than 5% stake in a financial year. Whether this leeway (intentional or unintentional) afforded by SEBI actually resonates with its intent reflected at clause 17 of a discussion paper floated by it in January 2016, is questionable.

3.         Exemptions: The Takeover Regulations exempt an acquirer from complying with open offer related obligations if certain transactions and/or thresholds are met with. Examples are inter-se promoter transfers, inter-group transfers and schemes of arrangement (directly or indirectly involving the Listco, whether implemented in India or overseas). The exemption provisions can be availed of when an open offer obligation is triggered. Therefore, it can be mooted that the Prohibition extends to exempted transactions under the Takeover Regulations as well, because, if not for the exemptions, the transaction (i.e. an acquisition) would otherwise trigger open offer obligations. To articulate this interpretation differently: the exemptions can be ‘activated’ only if and when an open offer obligation is triggered; thus. Perhaps, by way of insertion of another proviso (instead of a FAQ or an informal guidance), SEBI could consider clarifying its position.

4.         Competing offers: The proviso to the Prohibition allowing wilful defaulters to make a competing open offer looks out of place and begs the question: why? SEBI’s intent behind this proviso can be gauged from clause 19.4 of the discussion paper floated by it in January 2016 which states: “If a hostile bid is made on a listed company which is controlled by a person categorized as a wilful defaulter, restricting such wilful defaulter from making a counter offer may not be legally tenable.” The question of legal tenability in allowing a wilful defaulter to make a competing offer is another discussion altogether. Be that as it may, SEBI, to align the literal construction of the proviso with its intent, could consider crisping the proviso to state: “… this regulation shall not prohibit a person in control of the target company who is a wilful defaulter from making a competing offer…”, since the extant proviso appears to allow any wilful defaulter to make a competing offer.

5.         Consequences: While SEBI’s insertion of this Prohibition is well intended, there is no express provision spelling out the consequence(s) if a wilful defaulter violates the Prohibition. The author has discussed a similar lapse in relation to another amendment by SEBI here. As such, the consequence(s) under the general provisions of the Takeover Regulations and/or SEBI Act, 1992 will not only fall on the wilful defaulter (and person(s) acting in concert), but also on the merchant banker appointed to manage the open offer.

- Malek Shipchandler

Wednesday, June 15, 2016

Analysis of RBI’s Draft Guidelines for On-tap Licensing of Universal Banks in the Private Sector

[The following guest post is contributed by Aditya Sood, who is a 4th year BA, LLB (Hons) student at the West Bengal National University of Juridical Sciences, Kolkata]

The Reserve Bank of India (RBI) on May 5, 2016 released Draft Guidelines for on-tap licensing of universal banks in private sector in India (“Draft Guidelines”).[1] The Draft Guidelines, if accepted, would mark a significant shift from the current “stop and go” policy of licensing of banks undertaken by RBI.[2] The guidelines envisage a “continuous authorization” policy with a view to “increase the level of competition” and “bring new ideas in the system”. This post looks at some of the key provisions of the Draft Guidelines and the issues that need to be addressed before these guidelines are accepted.

1.         Eligible Promoters

Under the Draft Guidelines, the following entities have been prescribed as eligible promoters: (i) existing non-banking finance companies (NBFCs) controlled by residents,[3] (ii) individuals or professionals who are residents and (iii) entities or groups in private sector owned and controlled by residents.

However, the Draft Guidelines specifically prohibit large industrial houses, which have diversified businesses, from being promoters of banks. These large industrial houses are defined in the Draft Guidelines as groups that have assets of Rs. 50 billion or more and the non-financial business of the group accounts for 40 per cent or more in terms of total assets or gross income. But these large industrial houses are permitted to hold up to 10 per cent equity in private banks through Individuals or companies connected with such large industrial houses. This limit of a maximum 10 per cent share will apply to individuals and all inter-connected companies belonging to the large industrial house on an aggregate basis. The objective of this provision is to prevent control of public money by large industrial or business groups that have diversified operations.

The promoters (whether individuals or entities) will have to fulfill the “fit and proper” criteria laid down by the RBI i.e. (i) minimum 10 years of experience in banking and finance (for individuals) or 10 years of experience in running their businesses (for entities and NBFCs), (ii) sound credentials and (iii) financial soundness and a successful track-record for at least 10 years. 

2.         Corporate Structure

The 2013 Guidelines for licensing of new banks (“2013 Guidelines”) mandated a Non Operative Financial Holding Company (“NOFHC”) model of corporate structure for a private sector bank. The basic objective of a NOFHC model is that the Holding Company should ring fence the financial activities (including the banking activities) of the promoter group from other activities not regulated by the financial regulators. The Draft Guidelines make a departure from the 2013 Guidelines by making the NOFHC model optional for individual promoters and standalone promoting or converting entities that do not have other group entities. Such promoters have been given the option of setting up or converting into a banking company under the Companies Act, 2013. However, for individuals or entities that have other group entities, the bank shall be set up only under the NOFHC model.

Corporate Structure of the NOFHC

The NOFHC has to be registered as a NBFC with the RBI. The minimum shareholding of promoters in the NOFHC has been fixed at 51 per cent of the total equity, which is lower than a wholly promoter-owned NOFHC under the 2013 Guidelines. This shows that RBI has permitted diversification of shareholding in the NOFHC. The Draft Guidelines prescribe the eligible shareholders of the NOFHC as, non-financial services companies, entities and NOFHCs, core investment companies, investment companies in the Group and individuals belonging to the Promoter Group. The shareholding of individuals belonging to the Promoter Group has been fixed at 15 per cent of the equity capital and shareholding by a single non-promoter individual shall not exceed 10 per cent of the equity capital.[4]

The Draft Guidelines state that only those regulated financial sector entities in which the individual promoter or Group has significant control will be held under the NOFHC. The determination of significant control will be done as per Accounting Standards AS 21 and AS 23.  

As per RBI’s mandate, there are certain activities such as, insurance, stock broking, mutual funds etc., which have to be conducted through a separate financial entity (other than the bank) under the NOFHC.[5] This separate entity could be a subsidiary, joint venture or an associate structure of the NOFHC. These entities are permitted to undertake only those activities that the bank is allowed to undertake under Section 6 (a) to (o) of the Banking Regulation Act, 1949.

3.         Minimum Capital requirement and Capital Adequacy Ratio (“CAR”)

The Draft Guidelines state that the initial minimum paid-up equity of the bank shall be Rs. 500 crore. The 2013 Guidelines also prescribed Rs. 500 crore as the minimum capital requirement for banks.

The initial minimum share of the promoters in the bank has been set at 40 per cent of the equity and if it is higher than 40 per cent then it has to be brought down to 40 per cent within 5 years of commencement of operations. The promoters’ share will remain locked-in for a period of 5 years from the commencement of operations. The Draft Guidelines provide for a gradual dilution of the promoter shareholding in the bank. The promoter share shall be brought down to 30 per cent of the equity within 10 years and to 15 per cent within a period of 12 years from date of commencement of business.

The Draft Guidelines also mandate the banks to maintain a minimum CAR of 13 per cent of the risk weighted assets (“RWA”) which is higher than the current CAR of 9 per cent of RWA for existing Scheduled Commercial Banks (“SCBs”).[6] The bank shall also list its securities on a stock exchange within 6 years of commencement of business.

4.         Foreign Shareholding of Banks

As per the Draft Guidelines, foreign shareholding in banks will be determined by the existing FDI policy. Presently, the Consolidated FDI Policy, 2015 prescribes for a maximum of 74 per cent of FDI in banking industry (up to 49 per cent through automatic route and after 49 per cent though approval of the Government).[7] Individual share of Foreign Institutional Investors (“FIIs”) or Foreign Portfolio Investors (“FPIs”) has been fixed at below 10 per cent of the paid up capital of the bank. Aggregate share of FIIs, FPIs and Qualified Institutional Investors (“QFIs”) cannot exceed 24 per cent of the total paid up capital of the bank and this limit can be raised up to 49 per cent through a resolution by the Bank’s Board of Directors followed by a special resolution to that effect by its General Body.[8]    

5.         Prudential and Exposure Norms

For a corporate structure without NOFHC, the prudential norms governing the new universal banks will be the existing norms on income recognition, asset classification and provisioning pertaining to advances, as specified by the RBI.  The banks are also prohibited from having any exposure to its promoters who have a shareholding greater than 10 per cent of the equity capital. The exposure norms will be the existing permissible exposures allowed by the RBI.

For a bank with a NOFHC structure, the prudential and exposure norms are same as prescribed in the 2013 guidelines in paragraphs 2 (G), (H) and (I). The earlier guidelines state that prudential norms will be applicable to the NOFHC both on a stand-alone and a consolidated basis and the norms will be on similar lines with the bank. The NOFHC and the bank are precluded from having any exposures to the Promoter Group and the banks are prohibited from investing in the equity or debt capital instruments of any financial entities held by the NOFHC.

6.         Other conditions

The applicants are required to submit a realistic and viable business plan along with their applications. It should state how the bank proposes to achieve the financial inclusion and should consist of a project report containing details about various aspects provided in Annexure II of the Draft Guidelines.

Further, the banks are required to comply with the priority sector lending targets as applicable to domestic banks. The present rate for priority sector lending is 40 per cent of the Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher for domestic scheduled banks.

The Draft Guidelines also mandate the banks to open at least 25 per cent of its branches in unbanked rural areas.

7.         Issues that need to be addressed

First, the Draft Guidelines nowhere provide for a time limit within which the application has to be accepted or rejected by the RBI. The RBI also does not need to provide any reasons for the rejection of application. There should be some provision in the Draft Guidelines to limit the time period for assessment of applications.

Second, the Draft Guidelines in paragraph 2(I)(xiii) state that

“Banking being a highly leveraged business, licences shall be issued on a very selective basis to those who conform to the above requirements, who have an impeccable track record and who are likely to conform to the best international and domestic standards of customer service and efficiency. Therefore, it may not be possible for RBI to issue licences to all the applicants just meeting the eligibility criteria prescribed above

This basically implies that even though theoretically RBI is shifting to on-tap licensing, however it will still have the final discretion to grant or reject a license even though an applicant fulfills all the criteria mentioned above. This provision defeats the purpose of on-tap licensing and makes it discretion based instead of being rule based.

The RBI has invited comments on the Draft Guidelines till June 30, 2016 and if the above issues are addressed, it would help in fulfilling the objective for which these guidelines were introduced.

- Aditya Sood

[2] According to the current policy, the RBI opens application for licenses of banks once in a decade and grants licenses to suitable applicants. The most recent round of granting licenses happened in 2013 where RBI granted licenses to IDFC Bank and Bandhan Financial Services.

[3] As defined in the relevant Foreign Exchange Management Regulations.

[4] Here individuals include their relatives as defined under Section 2(77) of the Companies Act, 2013 and other entities where individual and/or his relatives hold not less than 50 per cent of the voting equity shares.

[5] See RBI FAQs on Guidelines for Licensing of New Banks in the Private Sector, Question 86, available at

[6] Master Circular on Prudential Norms on Capital Adequacy (UCBs), published on July 1, 2015 available at

[7] Department of Industrial Policy and Promotion, Consolidated FDI Policy, 2015, at 68.

[8] Id.