Author name: CBCL

Ratification of Breach of Duty by Shareholders – Case Analysis

Uncategorized /

[By Harshit Joshi] The author is a student at the Vivekananda Institute of Professional Studies. Introduction According to common law principles, a breach of duty by a director can be ratified if the shareholders pass a resolution exonerating the director from the liability arising from such breach. It is an expansion of the common law concept that states people who owe duties may be relieved from the legal obligations resulting from those duties by those to whom the duties are owed. Therefore, shareholders have the authority and power to ratify any irregularities in the company’s operations, relieving directors of personal obligations to the company. This article examines the case of Terrascope Ventures Limited v. Securities and Exchange Board of India, in which the Securities Appellate Tribunal, Mumbai (“SAT”) recently upheld the validity of shareholders’ ratification of breach of fiduciary duties by directors on June 2, 2022. Through this study, the article aims to investigate the validity and relevance of the ratification principle in regard to Indian law by tracking its prevalence in common law jurisdictions. Brief Facts According to section 166 of the Companies Act 2013, directors of companies owe a fiduciary and statutory duty to the company, its personnel, and its shareholders. The validity of any ratification by shareholders subsequent to the adoption of a special resolution is conditional on the nature of the director’s breach of duty. In order for the shareholders to make an informed choice, this ratification procedure is subject to full and open disclosure of all relevant information. Directors who are also shareholders cannot ratify their own breach of duty. Shareholders cannot approve a breach of duty resulting from an act ultra vires of the company. A special resolution enacted on October 1, 2012, in accordance with section 81(1A) of the Companies Act, 1956, authorized Terrascope Ventures Limited, formerly known as Moryo Industries Limited, to issue 63,50,000 shares as a preference. The shareholders and general public were informed at an extraordinary general meeting held the same day that the funds raised through the preferential issue would be used for the following: (1) capital expenditures, including the purchase of businesses or companies; (2) opening of offices abroad; (3) funding long-term working capital requirements; (4) marketing; and, (5) for other authorized corporate purposes. The company’s trading operations were the subject of a Securities Exchange Board of India (“SEBI”) inquiry from 15 January 2013 to 31 August 2014. According to the adjudicating authority’s order, the proceeds from the preferential issue were used to buy shares in other companies and to extend loans and advances to other businesses and entities, which was against regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003. This was done in contrast to the objectives stated in the notice given at the Extraordinary General Meeting. The adjudicating officer further observed that the company had broken the terms of Section 21 of the Securities Contracts (Regulation) Act, 1956, read with Clause 43 of the Listing Agreement by failing to disclose the variation in how the proceeds were utilized to the Stock Exchange (which requires listed companies to furnish a statement to stock exchanges indicating the variations between projected and actual utilization of funds). Furthermore, the directors’ report in Moryo’s annual report for the fiscal years 2012–13 and 2013–14 did not offer an explanation for the discrepancy between intended and actual utilization. The firm’s shareholders approved a special resolution on September 29, 2017, approving all the acts, deeds, and things the company had done regarding the use of the money from the preferential issue. The adjudicating officer stated that such post-facto approval of the company’s misconduct was unlawful. The Hon’ble Tribunal has observed that penal liability is neither dependent upon the intention of parties nor gains accrued from such delay in its judgment of Akriti Global Traders Ltd. v. Securities and Exchange Board of India. The adjudicating officer noted that even though the utilization of revenues did not produce any excessive advantages, a penal liability nevertheless exists because regulations’ provisions were breached. In accordance with section 15 HA of the SEBI Act of 1992 and section 23E of the Securities Contracts (Regulation) Act of 1956, the order imposed a fine of Rs. 1 crore on the company and Rs. 25 lakhs on each of the directors. Order of the Securities Appellate Tribunal, Mumbai The SAT effectively overturned the SEBI ruling by holding that although the use of the proceeds from the preferential offer was carried out in deviation from the objects issued, the shareholders later approved the deviation. This post-facto ratification of a duty breach was recognized as legal by the tribunal. The tribunal, in its order, relied on the ruling of the Supreme Court in the case of National Institute of Technology vs Pannalal Choudhury. The Supreme Court has observed that the expression “ratification” means “the making valid of an act already done”. This principle is derived from the Latin maxim “ratihabitio mandato aequiparatur” meaning thereby “a subsequent ratification of an act is equivalent to a prior authority to perform such act.” The tribunal further ruled that because the variation in the use of the funds was ratified by the shareholders, it was no longer a “variance” that needed to be notified to the stock exchange and so did not breach clause 43 of the Listing Agreement. Provision of Ratification in Common Law Most common law countries statutorily recognize the competence of shareholders to ratify directors’ breaches of duty, absolving them of corresponding liabilities. However, Indian laws do not provide any such power to shareholders and only acknowledge the competence of the courts to acquit directors of their violation of duty after full consideration of the circumstances of the case. There is no enabling mechanism that creates the conditions under which ratification would be declared legally effective because there is no statutory mention of shareholders’ power to ratify directors’ breach of duty. Section 239 of the UK Companies Act 2006 applies where a company ratifies the action of

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FDI vis-à-vis National Security: a half-baked exercise?

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[By Aditya Maheshwari and Dhruv Gupta] The authors are students at the Gujarat National Law University. Introduction Both global and domestic markets witnessed continuous growth post-1991’s globalization policy. One of the outcomes of this policy was Foreign Direct Investment (“FDI”). It can be understood as financial transactions between a foreign and a domestic entity where the former has a significant say in the management of the latter. Over the years, the Ministry of Corporate Affairs (“MCA”), along with the Reserve Bank of India (“RBI”), has liberalized the FDI Policy to provide an opportunity to foreign investors and Indian companies to boost access to investment opportunities. In the Consolidated Foreign Direct Investment Policy, 2017 (“Policy”), only investors from Bangladesh and Pakistan are required to take permission from the govt, while others were allowed to invest through an automatic route. However, due to the threat posed by opportunistic takeovers by investors from bordering countries, certain amendments were introduced by the MCA to strengthen national security against such investments. This article intends to take the lid off the amendments that are being brought since the inception of Covid-19, the cause and effects of such amendments, and the loopholes in the present legal regime of the FDI Policy. Press note No. 3 (2020) – a first step towards preventing opportunistic takeovers The Department of Promotion of Industry and Internal Trade (“DPIIT”) vide Press Note No. 3 (2020 Series) (“PN3”) amended para 3.1.1 of the Policy. Consequently, the restriction to take the govt route for FDI by a citizen or an entity of Bangladesh and Pakistan had been replaced with “an entity of a country which shares a land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country.” As PN3’s subject indicates, DPIIT’s sought to check opportunistic takeovers/acquisitions of Indian companies in light of the pandemic. The approach to making amendments is evident from the fact that China’s central bank has acquired a 1% stake in India’s largest mortgage lender i.e., Housing Development Finance Corporation Ltd (“HDFC”). This was the first-time efforts were made to strengthen national security by not allowing Chinese investors to go through the automatic route. Consolidating the FDI Policy against Border Sharing Countries After over two years of PN3, the MCA understood the FDI Policy 2020 to be insufficient in insulating Indian companies against opportunistic takeovers: it lacked protection regarding managerial aspects of the company. Thus, certain amendments have been made in 2022 to remedy the loophole and to insulate against managerial takeovers. Amendment related to Investment 1. Transfer of shares As of May 4, 2022, the Companies (Share Capital and Debentures) Rules, 2014 were amended. There is now a provision requiring transferees to furnish a statement regarding the application of the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 (“NDI Rules”) to transferred assets. Thus, if shares are being transferred to a citizen or legal entity of a country sharing a land border with India, said citizen or entity must first secure government approval in accordance with the NDI Rules. This approval must be submitted alongside Form SH-4, the appropriate form for transferring shares. 2. Private Placement As of May 05, 2022, the Companies (Prospectus and Allotment of Securities) Rules, 2014 were amended. Now, in cases of private placement, if the proposed allottee is from a country sharing a land border with India, it has to attach government approval along with the private placement offer-cum-application letter- “PAS-4.” A declaration regarding the applicability of NDI rules is to be given by the proposed allottee in PAS-4. Amendment related to Management 1. Appointment of Director in a company The MCA has made it mandatory to obtain security clearance from the Ministry of Home Affairs (“MHA”) for nationals of a country sharing a land border with India before becoming a director of an Indian company. The director has to attach the approval along with the consent letter i.e., DIR-2. This amendment is brought vide Companies (Appointment and Qualification of Directors) Amendment Rules, 2022 effective from 01 June 2022. 2. Application for Director Identification Number (“DIN”) Where a national of a country sharing a land border with India applies for DIN, he has to attach the security clearance along with the DIN application i.e.,  DIR-3. A declaration in this regard has been inserted in the e-Form DIR-3 vide Companies (Appointment and Qualification of Directors) Amendment Rules, 2022 effective from 01 June 2022. Analysis – Impact and the shortcomings in the present FDI regime The impact and reasons behind the Amendments made by the MCA While the amendment made by the MCA was done considering national security and the prevention of opportunistic takeovers by the investors or entities of bordering countries, FDI inflow is bound to be impacted negatively. Data indicates that FDI for 2021 fell 30% in comparison to 2020. One of the reasons for this fall is the restriction being imposed by the government on the use of the automatic route by bordering countries. It must be noted that this reduction in value must not be misunderstood as arising from Covid-19. During the same period, China, the country most affected by Covid-19, had a growth rate of 21%. In the coming months, with the present restrictions becoming more rigorous, FDI in India is only going to decrease. Moreover, imposing stringent restrictions on China and Hong Kong, the largest investors in the region, won’t benefit the Indian economy in the long run. It must be highlighted that the amendment through PN3 was insufficient to prevent opportunistic takeovers. To circumvent the PN3-imposed restrictions, the affected investors created a US or Cayman-based entity, using it to route the investment without any restriction. The same is suggested by the data released by the MCA where 490 foreign nationals are registered as active directors as of Feb 2022. Thus, to prevent managerial control over Indian companies, the amendment vide Notification dated June 01, 2022, in regard to security clearance was added. Loopholes in the present FDI

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Is the Remedy of Substituted Performance truly a Novel Remedy?

Contract Law, Guest Posts /

[By Aman Sadiwala] The author is an associate at Rashmikant and Partners. The contract enforcement mechanism of India has been subject to criticism for being inefficient. This was reflected in the World Bank’s Ease of Doing Business Report 2016 where India ranked 130th overall and 178th on contract enforcement (out of 189 countries).[1] This spurred the Government of India to constitute an Expert Committee to propose reforms to the Specific Relief Act, 1963 (“SRA”). The report of the Expert Committee (“Report”) resulted in the Specific Relief (Amendment) Act, 2018 (“2018 Amendment”). Prior to 2018, the default remedy for the breach of contract was that of damages, which was governed by Sections 73 to 75 of the Indian Contract Act 1872 (“ICA”), with specific performance being the discretionary remedy.[2] The 2018 Amendment changed the position of law by giving primacy to specific performance over damages. It also introduced substituted performance as a remedy.[3] Post the 2018 Amendment, Section 20 of the SRA provides for substituted performance whereby the promisee, on the breach, has the option to obtain performance by a third party or its own agency and recover the costs and expenses of the same from the breaching promisor,[4] subject to certain conditions.[5] The promisee cannot claim the relief of specific performance after getting the contract performed through substituted performance.[6] In this piece, the author argues that while the remedy of substituted performance is not truly a novel remedy, it does go beyond what was permissible under Sections 73 to 75 of the ICA in terms of making it easier for the promisee to recover the expenses and costs associated with the substituted performance. While there are some advantages that a remedy like substituted performance has – like securing the expectation interests of parties (which damages might also secure), faster implementation of contractual terms and solidifying the claim that the promisee has, is this remedy one that did not exist before the 2018 Amendment? The possibility of obtaining substituted performance and recovering the cost for it was possible even in the pre-2018 Amendment paradigm through Section 73 of the ICA. It states that a party suffering from a breach of contract can claim “compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach”.[7] This involves compensation for the “cost of cure” which is provided for in illustrations (f), (k), and (l) to Section 73.[8] Illustrations are parts of the section and help in elucidating its underlying principle.[9] Therefore, one can conclude with relative certainty that Section 73 of the ICA does, in a way, provide for compensation for substituted performance. Even Section 41 of the ICA talks about the “effect of accepting performance from third person” whereby the promisee cannot then enforce the performance as against the promisor.[10] There are other instances where compensation for substituted performance was awarded. One situation relates to when the contractual framework allows the promisee to get the performance from a third party and recover the costs from the promisor.[11] This includes contracts with a “risk and cost” clause which allows the promisee to engage a third party to obtain performance and get compensated to that extent by the promisor.[12] One must look at the Report to see why a specific amendment was added when substituted performance as a remedy existed in the pre-2018 Amendment regime as well. The Report assumes that in cases of breach of contract, a promisee will aim to complete its business and resort to substitutes if available.[13] It goes on to state that this must be encouraged as it allows the promisee to complete its task (and fulfill the expectation interest) while leaving open the option to claim compensation in case of a substantial loss.[14] The Report opines how the option of substituted performance can nearly achieve the same result as actual specific performance.[15] It recognizes how other jurisdictions[16] have allowed for substituted performance while Indian law does not provide for compensation for substituted performance as a substantive right.[17] The explicit provision of substituted performance as a substantive right has important implications. Section 73 of the ICA provides that “[s]uch compensation is not to be given for any remote and indirect loss or damage”.[18] The award of compensation under Section 73 is governed by the principles of causation, foreseeability, and mitigation;[19] while Section 20 of the SRA does away with these factors by using the phrase “recover the expenses and other costs actually incurred, spent or suffered by him”.[20] This change was brought with the view that while a claim under Section 73 of the ICA might not give the promisee the entire extent of the amount it has spent on substituted performance, Section 20 of the SRA would do so.[21] It was also believed that this standard would give the promisee the benefit of having its contract fulfilled at the earliest, while also pushing the promisor itself to perform the contract.[22] At the same time, the Expert Committee recognized that this situation might place a heavy burden on the promisor, especially when a promisee abuses its rights.[23] It provided for safeguards in the form of prior notice to the other party,[24] and providing proof of breach of contract,[25] the costs and expenses incurred in the suit,[26] and reasonability of the amount claimed.[27] In the opinion of the author, the threshold of the safeguards was significantly weakened when the Expert Committee also proposed that the amount claimed in the notice to the other party ought to be deemed reasonable if it had been actually spent or suffered.[28] While the provision for notice has been retained by the legislature,[29] the other safeguards especially the one pertaining to the reasonableness of the amount claimed do not find mention in the 2018 Amendment. This issue has also been flagged by Professor Nilima Bhadbhade, who was a member of the Expert Committee.[30] This had led to a scenario where it is significantly easier for the promisee to recover the expenses and costs associated

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Competition Foreclosure in the App Economy by Apple and Google

Competition Law /

[By Sharia Shoaib] The author is a student at the National Law University, Jodhpur. The Competition Commission of India (CCI) has recently probed into alleged abuse of the dominant position by Google for discriminately enforcing their payment systems on app developers. Google’s Play Store billing policy makes it mandatory for app developers to pay a hefty commission fee of up to 30 percent from the in-app earnings on the sale of digital goods and services. Additionally, the inability of app developers to use any third-party payment systems for marketing their digital content seems like a restrictive and unfair condition violating Section 4(2)(a)(i) of the Competition Act 2022. Around the same time, the European Commission (EC) had also begun its initial investigation into competition concerns related to iOS App Store’s conduct in the market for music streaming services, upon a complaint filed by Spotify. Similarly, the Spotify v. Apple music debacle also involves Spotify paying a 30% Commission to Apple on digital purchases made through Apple’s in-app purchase system (IAP) which raises Spotify’s costs and that of Spotify users indirectly. It is often argued that this exclusionary behavior by the twin mobile giants is capable of foreclosing effective competition, and profitable access to a market, resulting in high barriers to entry and other anticompetitive effects[i]. Are Google and Apple dominant entities? The two-sided transaction intermediary role an app store plays is essential to understand the competitive constraints for third-party app developers and app users in the relevant markets. Google Play and Apple App Store serve as sole gatekeepers for access to app-based services on mobile phones running their smartphone operating systems, Android OS and iOS respectively, by prohibiting sideloading of third-party applications. As a result, it forms a “closed ecosystem” that locks in developers as well as app users once they buy an Android or Apple device. Apple app store enjoys a prominent presence in the European Union (EU) market by virtue of ‘network effects’ and a high consumer base in the smartphone market. Moreover, the Court of Justice of the European Union (CJEU) has, in various instances, like in  NV Nederlandsche Banden Industrie Michelin v Commission and Eurofix-Bauco v Hilti used conduct that acts as a barrier of entry for new entrants or constraints to competitors’ expansion as a factor indicating dominance. This is further affirmed by EC in its preliminary view in Apple v. Spotify, wherein it concluded that Apple has distorted competition by “abusing its dominant position in the market for music streaming apps through its App Store platform.” Likewise, the judgment in Umar Javeed v. Google LLC assumes significance while determining Google’s dominant position in the relevant market using factors mentioned under Section19(4) of the Act. By exercising the powers vested in it under Section 26 of the Act, the CCI found it to be dominant in the “smartphone OS market”. What is the abusive conduct? As the primary channel for app discovery and distribution, dominant app stores have a special responsibility to maintain a healthy app ecosystem and not impair undistorted competition by engaging in conduct falling outside the competition on merits. In Fast Track Call Cab Pvt Ltd v. ANI Technologies Pvt Ltd, the CCI extended the ambit of special responsibility to include online platforms and digital markets. As a result, an important platform functionality of such app stores is to ensure equality of opportunity and a level playing field to compete for various economic operators i.e. app developers. Google and Apple’s conduct to make their own IAP a mandatory payment gateway can qualify as a “tie-in arrangement,” according to competition laws around the globe. In India, Google’s conduct would prima facie be considered violative of Sections 4(2)(d) and 4(2)(e) of the Act whereas in the European jurisdiction, abusive tying would amount to a violation of Article 102(d) of Treaty of Functioning of European Union (TFEU). Legal position of abuse of tying in India and EU In the Indian case of Sonam Sharma v. Apple, the CCI laid down the conditions that amounted to anti-competitive tying: The presence of two separate products or services capable of being tied; The seller must have sufficient economic power with respect to the tying product to appreciably restrain free competition in the market for the tied product; and The tying arrangement must affect a “not insubstantial” amount of commerce. While the Microsoft case (2004), establishes that for tying to infringe Article 102 TFEU, there must be two separate products; dominance in the tying market; coercion of customers who have no option to obtain the tying product alone; and foreclosure of competition as a result. Upon a bare perusal of the aforementioned conditions, it can be ascertained that the elements of tying are similar in both jurisdictions. Now, the distinctness of products is established if there exists independent consumer demand for tying and tied products[ii]. By charging up to 30% commission through their own payment service, Apple and Google in an attempt to leverage their market power have unlawfully tied their payment processing service to the app distribution market, both offering different functionalities, hence, separate products. For instance, Google Pay has an independent demand in the payment services market and the existence of independent companies specializing in payment services, such as Paytm, is ‘serious evidence’ of the distinction of products. Apple and Google, disregarding the special responsibility owed to them due to their dominance in app store market, prohibit app developers from offering information about alternative payment mechanisms, which are usually cheaper, amounting to coercion and deprivation of choice. To affirm the view, an anti-circumvention rule this rigid making it difficult to profitably market services was found to be anticompetitive by the European Commission in Apple v. Epic games. The conduct of such app stores not mandating the use of their IAP for some of their own apps is discriminatory and gives a competitive edge to their own activities. In other words, app store’s fees hurt competition by raising costs for app developers and indirectly for app users, affecting a

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Licensing Fee for Immovable Property: The Expanding Scope of Operational Debt

Contemporary Issues, Insolvency Law, Taxation Law /

[By KV Kailash Ramanathan] The author is a student at the National University of Advanced Legal Studies (NUALS), Kochi. Recently, the NCLAT in Jaipur Trade Expocentre Pvt Ltd vs M/s Metro Jet Airways examined the issue of whether claims of license fee for the use of immovable property to conduct business, falls within the ambit of ‘operational debt’ under S5(21) of the Insolvency and Bankruptcy Code (hereinafter referred to as the ‘code’). In doing so, the Appellate Tribunal also had to rule on the legal correctness of earlier decisions in M Ravindranath Reddy, and Promila Taneja which answered the question in the negative. The five-judge bench of the NCLAT, upon reference to it from a smaller bench, decided that the claim of such licence fee arising from a licence agreement for immovable properties would come within the definition of operational debt, thereby overruling earlier judgments to the contrary. The verdict paves the way for initiation of the Corporate Insolvency Resolution Process (hereinafter referred to as ‘CIRP’) under section 9 by operational creditors for default of licence fee or rent on immovable properties used for a business purpose. In this piece, the author seeks to analyse the judgment by discussing the key issues dealt with and possible legislative action that can follow as a result. Factual Matrix The Appellant Jaipur Trade Expocentre Private Ltd, had entered into a licensing agreement with the respondent M/s Metro Jet Airways Private Ltd. Under the agreement, the Appellant licensor had granted the licence of a building with requisite fittings and fixtures to the respondent licensee for the purpose of running an educational establishment. The original agreement was to run for five years and the amount fixed as consideration was Rs. 4,00,000 per month lump sum plus government consideration. Initially, a part payment was made by Metro Jet Airways towards the licence fee. The contract however started running into rough weather when the corporate debtor subsequently issued two cheques on different dates in discharge of the outstanding dues, and both were dishonoured. In response to such default, the creditor Jaipur Trade Expocentre sent a demand notice under Section 8 of the Code seeking payment from Metro Jet Airways for the total sum due plus taxes and the interest thereon. No reply was received. Later civil proceedings were instituted by the corporate debtor. As a result of these developments, the creditor filed an application for initiation of CIRP under Section 9 of the Code. The corporate debtor disputed the debt. After perusing submissions from both parties, the adjudicating authority dismissed the application, holding that the claim arising out of the grant of license for the use of immovable property does not fall under the category of goods or services. Thus, the amount claimed in the Section 9 Application was held to not be an unpaid operational debt and therefore, the former was not allowed. Aggrieved by the above order, the creditor preferred an appeal and the matter was referred to a larger bench whose judgment is dealt with in this piece. Issues The crux of the issue is whether a claim of licence fee or rent over an immovable property would qualify as an ‘operational debt’ under S 5 (21) of the code. More specifically whether such an agreement can be considered under the provision of a ‘service’ as specified in the section. Ruling and Analysis Under Section 5(21) of the Code ‘operational debt’ has been defined as “a claim in respect of the provision of goods or services including employment or a debt in respect of the [payment] of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.” From the aforementioned definition, it is clear that only claims in respect of goods and services can be considered as operational debt. The Code is silent on the definition of services. Therefore, the onus was on the judiciary to interpret the term with due consideration to precedents, reports, and principles of statutory interpretation. The following are the noteworthy considerations from the judgments including but not limited to arguments advanced by the NCLAT for arriving at such a decision. Agreement Providing for Corporate Debtor to bear GST The agreement between the parties explicitly stated that the payments of GST would have to be borne by the corporate debtor. GST is a tax contemplated only on goods and services. Thus, it was evident from the agreement that the corporate debtor bearing the GST was being taxed for services. This was clear by looking at the definition of goods under Section 2(52) of the Goods and Services Tax Act which reads “goods” means “every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply”. As per such definition, the agreement cannot be considered as being for goods under the GST Act making it conclusive that the levy was for a service. Therefore, the contention of the Corporate Debtor that the agreement by nature does not provide for service was dismissed. Definitions of Service presented under Other Statutes In Anup Sushil Dubey v. National Agriculture Co-operative Marketing Federation of India ltd. and Anr. , one of the questions the Tribunal dealt with was whether dues, if any, arising from the Leave and License agreement can be construed as an ‘Operational Debt’? Reliance was placed on Schedule II of the CGST Act 2017 which classifies lease of building as a service, and Section 2 (42) of the Consumer Protection Act, under which an inclusive definition of ‘service’ has been made out to include the provision of facilities connected to a host of commercial activities. The Tribunal held that subject lease rentals arising out of use and occupation of a cold storage unit for Commercial Purpose is an ‘Operational Debt’ as envisaged under Section 5(21) of the Code. The stated principle has

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SEBI’s New Guidelines for IPOs: A Welcome Move?

Capital Markets and Securities Law /

[By Ayush Hoonka and Akarsh Singh] The authors are students at the School of Law, Christ (Deemed to be University). Introduction Over the years, the Indian capital market has undergone significant changes and has evolved over a period of time. This is especially true in regards to the equity segment of the capital market, where just the total market capitalization of the Indian equity market stood at 3.21 trillion dollars which makes it the fifth-largest equity market in the world. This has been correlated with the rise of the Indian manufacturing sector, which contributed up to 17.4% to the Indian gross domestic product in the year 2020. This has also been correlated with the massive rise of the Indian technology sector, which has been the engine driver of growth of the Indian economy, contributing 8% to the total gross domestic product in 2021 while reaching a peak of 9.5% in 2015. As a result, there has been a rise of early-stage start-up companies being incorporated in the country and ultimately going public through the traditional initial public offering or the IPO route. As a result,  81 IPOs were offered in the time frame between 2020 and 2022, raising almost 1.52 lakh crore, according to a KMPG study. The performance of most of the new-age start-ups has been less than ideal as shares of stocks such as Paytm, Zomato, Policy Bazar, and Nykaa have plunged 61%,49%,49%, and 46%, respectively, compared to their all-time highs at the time of listing according to data compiled by Bloomberg. Further, this has also correlated with the fact that these companies were primarily “growth stocks” which are yet to achieve maturity in the market regarding their cash flows and business models. This has also led to the Indian capital market regulator, i.e., the Securities and Exchange Board of India (SEBI), floating a consultation paper that proposed that the companies justify their valuation at the time of going public through an IPO, and subsequently, the auditor advising the company to verify the valuation being proposed by the company’s management through key performance indicators. Analysing the Consultation Paper The new proposed rules by the SEBI’s Primary Market Advisory Committee (PMAC) not only want start-ups to reveal their price to earnings multiples (PE ratio) and earning per share (EPS ratio). They also want disclosures and revelations in regards to key performance indicators (KPIs) which venture capital firms use, angel investors as well as private equity firms as a means and a measure to decide whether the newly found start-up is worth investing in. The KPIs are not just supposed to be traditional financial yardsticks to judge a company according to its competitors but also include metrics such as subscriber growth, market penetration since inception, and future expected growth rate. These metrics are further proposed to justify their valuation, which would further be audited by an accountant or an auditor with which the firm registers. Furthermore, SEBI also wants the companies to declare the correspondence between the venture capital firms, angel investors, and private equity firms during their fundraising in regards to these key performance indicators prior to them being listed through an IPO route. The proposal aims to disclose the key performance indicators (KPI) of the preceding three years prior to the company being listed and also wants the listed entity to compare the KPI with other new-age start-up firms across the globe in an effort to get a sense of whether the company’s valuation is justified or not. The objective of the proposed disclosure is that newly formed technological start-ups or growth stocks normally are not profiting in terms of their cash flows, especially when going public. As seen recently in the case of Delhivery being listed, these growth stocks usually prioritize gaining economies of scale, economies of scope, and competitive dominance in the marketplace as a means to achieve growth. This has been true historically for the past 20 years. One prominent example is Amazon, whose founder Jeff Bezos has always prioritized future long-term growth over short-term financial returns. This also requires good capital budgeting and investment decisions, which vary among companies in terms of their business model. Response from the Industry After the SEBI, in its recent consultation paper, has proposed that all the upcoming new-age technology companies have to justify the pricing of their shares at the IPO, the industry has not welcomed this move. The proposal aims to bring transparency so that the investors do not suffer. This idea was proposed due to the meltdown in the four recently listed stocks. However, these proposed rules will make it challenging for the new-age firms to list themselves. Another important thing that the new-age technology companies have to take care of is that the company’s auditors should have audited all the information they are providing to SEBI. The SEBI has also asked the companies to inform about the price-to-earnings ratio, how the valuation of shares is done, and how the price per share is decided. The reason behind this is that SEBI wants to understand how the price of a share is fixed. SEBI, at the moment, asks the companies to disclose their earnings per share, price-to-earnings ratio, return on capital, and return on net worth. However, the new-age technology loss-making companies do not earn any profits; therefore, it would not be possible for them to disclose these as these cannot be applied to the loss-making companies. Therefore, these companies would have to disclose KPIs additionally. These KPIs are valuation based and dependent on the past transactions done by the companies. They are not validated by the companies and are mostly tracked internally. However, if these indicators have to be submitted to SEBI, the act would not be welcomed by the industry as the valuation of these indicators is a lengthy process. If these stringent norms are applied, it will hamper the growth of the companies. Analysis and suggestions: Although the disclosures that the SEBI is discussing are being done in good faith and taking into

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A Critique On CCI’s Discretion to Vitiate an Inquiry

Competition Law, Contemporary Issues /

[By Ashutosh Rajput] The author is a student at the Hidayatullah National Law University, Raipur. The Draft Competition Amendment Bill, 2020 (Draft Amendment) proposes the insertion of clause (2A) to Section 26 of the Competition Act, 2002 (Act). The proposed amendment reads “The Commission may not inquire into agreements referred to in section 3 or into conduct of an enterprise or group under section 4, if the same or substantially the same facts and issues raised in the information or reference from Central Government or a State Government or a statutory authority has already been decided by the Commission in previous orders”. In a nutshell, this proposed amendment allows the Competition Commission of India (CCI/Commission) to do away with the inquiry into agreements pursuant to Section 19(3) of the Act and into the conduct of an enterprise or group pursuant to Section 19(4) of the Act, which talks about inquiry into certain agreement and dominant position of enterprise, respectively. The author argues that with the changing period, the market conditions also change. Therefore, it would not be prudent if, on the same or substantially same facts and issues, the Commission chooses not to inquire into the contravention. Commission’s power to inquire under the Act: A primer Pursuant to Section 19(1) of the Act, the Commission can inquire into any contravention relating to Section 3(1) or Section 4(1) of the Act either on its own motion or on receipt of any information or on a reference made to it by the Central or State Government. Further, Section 26 of the Act lays down the procedure for carrying out such an inquiry. While carrying out an inquiry into contravention of Section 3(1) of the Act, the Commission has to give due regard to the factors such as the creation of barriers to new entrants, foreclosure of competition, and so forth. Similarly, while carrying out such an inquiry for the contravention of Section 4(1), the market share, economic power, entry barriers, market structure, and size of the enterprise has to be taken into consideration. In addition, factors such as regulatory trade barriers, national procurement policies, and consumer preferences, end-use of the product will also have to be considered while delineating the relevant market. These all factors are bound to change with the changing circumstances. It is interesting to note that the proposed amendment does not in toto vitiate the Commission’s power to vacate the inquiry, rather discretion has been imposed on the Commission in accordance with the term ‘may’ appearing in Section 26(2A) of the Draft Amendment. However, Commission cannot vitiate inquiry even at its discretion if the case is being inquired suo moto which is nonetheless, a step in the right direction. Changing market dynamics in competition law analysis The Organization for Economic Co-operation and Development (OECD), in its research paper titled “Using Market Studies to Tackle Emerging Competition Issues” has rightly observed that the market structure changes due to public policy interventions, technological innovations and so forth. Moreover, the change in market circumstances can very well be ascertained from the case of Indian National Shipowners’ Association (INSA) v. Oil and Natural Gas Corporation Limited (ONGC). In this case, INSA levied allegations of abuse of dominant position against ONGC for unilaterally terminating the contract. The Director General (DG) noted that since there was a fall in crude price, the Opposite Party (OP) was justified in terminating the contract. The commission, by supporting DG’s report, noted that “It is unambiguously established by the evidence on record that the conduct of ONGC was driven solely in response to an exceptional change in market conditions.” The change in market dynamics can also be ascertained in circumstances where the same party is again being tried before the Commission. It would allow comparative analysis for the assessment of market dynamics. One such instance is the case of Amit Mittal v. DLF Limited and Another (DLF Case), wherein the Commission found DLF Limited, the opposite party, not to be dominant in the relevant market. The Commission took note of the fact that in Belaire Owner’s Association v. DLF Limited, the Commission had found DLF Limited to be dominant in the relevant market, however, due to the changing market dynamics the market structure has been changed. It further noted that the primary distinguishing factor is the period of assessment. In the present case, the allegation of abuse was booked in the year 2011-12 whereas in the previous case, such allegation was booked in the year 2006-2009. By considering the time period of contravention to be the essence of assessing market dynamics, the Commission concluded that DLF Limited is not dominant in the relevant market. Another such instance is the case of Mr. Ajit Mishra v. Supertech Limited, wherein there was a substantial increase in the construction price, which resulted in depriving the original allottees of the flats for claiming the allotments in the agreed price, rather they were made to pay more price than the agreed price. The Commission made out a case of abuse of dominant position against Supertech Limited by noting that the facts and circumstances of the case are more or less similar to the case of Shivangi Agrawal & Anr. v. Supertech Ltd. Noida. Interestingly, unlike the DLF Case, the contravention in the present case occurred in the same year. Hence, undisputedly this case supports the ratio decidendi laid down in the DLF Case that the time period of contravention is the essence of assessing market dynamics.  Furthermore, in Rajiv Kumar Chauhan v. M/s BPTP Ltd., the Commission by relying on the case of M/s BPTP Ltd & Ors., noted that since there is no change in circumstances, BPTP Ltd., the opposite party, cannot be said to be in a dominant position. This was again reiterated by the Commission in the case of Mr. Ravinder Pal Singh v. BPTP Ltd & Ors. A comparative reading of BPTP cases as mentioned above, illustrates that the contravention took place in the year 2009-10, which led the

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Reviewing Merger Control Regime and Analysing Competition in the Aviation Industry: Tata-Air India Case Study

Competition Law, Contemporary Issues, Mergers & Acquisitions /

[By Divya Khanwani and Suneel Kumar] The authors are students at the National Law School of India University, Bengaluru. Introduction On January 27, 2022, Talace acquired 100% equity share capital and sole control over the management and operations of Air India and AIXL, and 50% equity share capital and joint control over the management and operations of AISATS. The transaction meets the threshold for activating a requirement of notifying the CCI under s6(2) of the Competition Act, 2002 (‘The Act’) because two prerequisites are fulfilled. First, the notification (S.O. 988E), extended for 5 years on 16.03.2022, exempts any enterprise being acquired (target) having (i) assets less than INR 350 crore, or (ii) turnover less than INR 1000 crore, from notifying the CCI. The combined turnover of the target (Air India, AISATS and AIXL) far exceeds the required limits. Name of the Parties Assets (as of 31st March 2021) (INR crore) Turnover (for FY 2020-21) India (INR crore) Air India 63,317.23 8,224.19 AIXL 4,529.50 920.66 AISATS 213 730 Combined 68,059.73 9847.85   Therefore, the transaction cannot avail the benefit of the exemption. Second, if the transaction classifies as a combination under s5 of the Act, it needs to be notified to CCI under s6(2) of the Act. Name of the Parties Assets (as on 31st March 2021) (INR crore) Turnover (for FY 2020-21) India (INR crore) Talace 0.08 unavailable Tata Sons  102,969.01 9,460 Combined (Target) 68,059.73 9847.85 Combined 1,71,028.82 19,334.85 s5(a)(i)(A) In India, parties to jointly have  assets > 2000 INR crore Total assets =1,71,028.82 INR crore Condition fulfilled Effect: The transaction is a combination under s5(a)(i), and therefore, needs to be notified under s6(2) of the Act. s5(a)(i)(B) In India, parties to jointly have a turnover> 6000 INR crore Total turnover (India) = 19,334.85 INR crore Condition fulfilled   Consequently, the merger notification was filed by Talace on November 30, 2021,[i] which was approved by the CCI under s31(1) of the Act on December 20, 2021. This post argues that the acquisition of Air India by Tata Sons causes an appreciable adverse effect on competition (AAEC) in the relevant market, and therefore, should not have been approved by CCI. Substantial Overlaps The transaction will result in significant overlaps in horizontal,[ii] and non-horizontal relevant markets. Vistara and AirAsia, subsidiaries of Tata Sons, operate in international and domestic passenger air transport on nine and ninety-one overlapping origin-destination routes respectively with the Target. After the fruition of the transaction, Vistara and AirAsia will also share business with the Target in international and domestic cargo services, charter flight services and ground and cargo handling services. With respect to vertical/complementary relationships, AISATS provides ground handling services to airlines at the Bengaluru, Hyderabad, Delhi, Thiruvananthapuram and Mangalore airports, while AirAsia India provides passenger air transport services in all these airports and Vistara provides passenger air transport services at all these airports except Mangalore airport. AISATS provides cargo handling services to airlines at the Bengaluru airport, while Vistara and AirAsia India provide passenger air transport services at the Bengaluru airport. Taj SATS and its wholly-owned subsidiary Taj Madras provide in-flight catering services to airlines in India, while Air India and AIXL provide passenger air transport services in India. Plummeting Competition in the Aviation Industry S20(4) lays down the factors, which the CCI shall have due regard while determining whether a combination would have an AAEC in the relevant market. This section seeks to analyse the Tata- Air India combination through the lens of the factors mentioned in s20(4) of the Act. Changing Market Composition in the domestic market In 2021, the domestic passenger air traffic market share for Air Asia and Vistara was 13.2% and for the Target was 12%. The total market share of Tata-Air India enterprise will be 25.2% [in reference to s20(4)(h)]. The combination along with the three major competitors [Indigo (54.8%), Spice Jet (10.5%) and Go Air (8.8%)] occupies more than 99% of the market share. The current composition indicates a highly concentrated market, which becomes more obvious in a comprehensive HHI analysis. HHI CALCULATION- DOMESTIC PASSENGER TRAFFIC- 2021 Market shares Square before merger Square after merger Acquirer (and its affiliates) (combined) 13.2 174.24 Target (combined) 12 144 Total Combined 25.2 635.04 Indigo 54.8 3003.04 3003.04 Spice Jet 10.5 110.25 110.25 Go Air 8.8 77.4 77.4 HHI (Total) 3,509.26 3,826.09   An HHI of 2500 or greater is indicative of highly concentrated market. In this market, even before acquisition, the HHI was of 3509, which implies very low competition. As a general rule, mergers or acquisitions that increase the HHI between 100- 200 points in highly concentrated markets raise antitrust concerns, as they are assumed to create barriers to entry for potential competitors [s20(4)(b)] and to increase the likelihood drive out the existing competitors [s20(4)(c)]. Hence, it goes without saying that this acquisition will exacerbate anti-competitiveness in the market and will drive the market towards a more oligopolistic structure. Explicating Ripple Effect The incident of Tata-Air India enterprise occupying a share of more than 25% in the domestic passenger traffic market, has consequences and ramifications beyond this market. A larger share enables the combination to exercise significant influence in other relevant markets. For instance, it enables Tata Sons to secure favourable ground handling and in-flight catering service contracts. Another relevant example is that the transaction will provide Tata Sons control over 22% share in the domestic cargo air transport market instead of the previous acquisition share of 13%. This will provide Tata Sons an upper-hand in the cargo handling services, thereby creating unfair hardships for existing enterprises providing similar services. Aggravating factors The dominance in market share will enable Tata Sons to acquire the benefits of economies of scale. However, the anti-competitive impact of the transaction does not stop at the effects of the increased market share. The peculiar features of the aviation industry enable the acquisition to be an extremely powerful tool for driving out potential competitors. Consequent to the transaction, Tata Sons will enjoy the benefits of ‘grandfathering rights’ in slot

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PVR-INOX merger: Necessitating CCI To Be Empowered to Review Non-Notifiable Mergers

Competition Law, Contemporary Issues /

[By Swetha Somu and Sanigdh Budhia] The authors are students at the Gujarat National Law University. Mergers and acquisitions that fall below a certain threshold are not required to be disclosed to the Competition Commission of India (CCI) for prior clearance under the Competition Act, 2002 (the Act). This exemption, granted by the Indian Ministry of Corporate Affairs (MCA), is based on certain de-minimis thresholds enshrined under Section 5 and Section 6 of the Act. Transactions in which the target’s assets are valued at less than INR 350 crore; or the target’s turnover is less than INR 1,000 crore (Small Target Exemption) are exempted from the CCI’s approval requirement. First introduced on 27 March 2017, the MCA extended the applicability of the Small Target Exemption for another five years, till 27 March 2027, through a notice dated 16 March 2022. Recently, PVR Limited (PVR) and INOX Leisure Limited (INOX) announced their intention to merge. Post the merger (PVR-INOX Merger), INOX shareholders will get shares of PVR at the approved share swap agreement as a result of the transaction. While existing PVR and INOX screens will retain their current branding (i.e., ‘PVR’ or ‘INOX,’ respectively), new cinemas that open after the merger will be labelled as ‘PVR-INOX Ltd.’ With a combined network of over 1,500 screens, i.e., nearly 50% of the total screens in the country, the PVR-INOX Merger is intended to bring together two of India’s top multiplex companies. Normally, a deal of this nature would have necessitated prior permission from the CCI. However, this merger comes at a critical time as COVID-19 has adversely impacted multiplex businesses across the country due to fierce competition from over-the-top media service or OTT platforms. According to the financial documents of the fiscal year ending 2020-21, PVR’s revenue was INR 280 crore and INOX’s revenue was INR 106 crore. However, the PVR-INOX Merger is exempt from seeking CCI’s mandatory approval given that their post-merger turnover falls below the Small Target Exemption requirement (i.e., being below INR 1000 crores), In view of this, this article analyses the potential negative consequences of CCI’s inability to review non-notifiable mergers that prima facie seem to be anticompetitive in nature. The article further delves into existing international jurisprudence on merger reviews of non-notifiable mergers.  The authors then acknowledge the differences in the objectives and legislations between different jurisdictions, thus, finally concluding by recommending changes to the Indian framework on competition law. An Anti-Competitive Post-Merger Scenario and The Consequences Of the CCI Being Unable To Review Horizontal Mergers The CCI’s inability to review the PVR-INOX Merger may have severe implications on the promotion and sustenance of competition in India’s multiplex market as mentioned under the Act’s primary objectives. This is due to the fact that CCI is not empowered to review transactions that are exempted. Since the proposed merger is estimated to have a combined market share of 42%, there is a high possibility of the creation of a dominant position in the multiplex market. Whilst under the Act, being the dominant entity in a market is not per se unlawful; however, the abuse of that dominant position is strictly regulated under Section 4 of the Act. In addition to this, all anti-competitive agreements with or without abuse of such a dominant position will be subject to regulation under Section 3 of the Act. Section 3 and Section 4 of the Act will become applicable only at the post-merger stage. One of the key issues with post-merger regulation is the costs incurred by the parties to the transaction. A merger involves a change in the organisational structure. Given In the present scenario, both PVR and INOX may very well have invested large amounts into ensuring the legal and financial aspects of the PVR-INOX Merger are kosher. Moreover, horizontal mergers such as the PVR-INOX Merger eliminate one main competitor in the market thus reducing the competitive pressure (to reduce service prices) amongst them and the remaining non-merging firms as well. Consequently, this might result in a unilateral price increase or a coordinated price increase in the market. In both scenarios, the customers stand to lose due to increased prices and a smaller number of substitutes in the market. These anticompetitive post-merger scenarios could be avoided if CCI, like in the EU, the US or the UK, was empowered to review and regulate non-notifiable mergers that raise concerns. Although there are provisions under Indian law to regulate anti-competitive practices which arise post-merger, the late regulation of false-negative mergers incurs heavy costs. These costs have a negative take on the merged entities, their customers, the economic market structure and the consequences arising from it. The Reawakened Article 22 Of the European Union Merger Regulation (EUMR): An Inspiration  Article 22 of the EUMR has been reinvigorated through a new guidance issued by the European Commission (EC), (EUMR Guidance). The guidance allows the EC to review mergers falling under the national merger threshold through referrals raised by the member states. The condition for a referral by a European Union member state (Member State) is that “the concentration must: (i) affect trade between the Member States; and (ii) threaten to significantly affect competition within the territory of the Member State or States making the request.” The EUMR Guidance is designed to encourage Member States to approach the EC for the review of such mergers which are proved prima facie to be anticompetitive. This was brought in the light of a rise in ‘killer acquisitions’. A ‘killer acquisition’ is the acquisition of a small, nascent company by a large established entity. It has the potential to hamper effective competition by reducing the number of competitors while growing its own market share through such acquisitions. The guidance was brought to address this gap in enforcement, as the turnover of a small entity falls under the prescribed national threshold. Similarly in the United States, Section 7 of the Clayton Antitrust Act of 1914  provides for the Federal Trade Commission (FTC) or Department of Justice (DOJ) to prohibit

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