Author name: CBCL

Dealing with Cross-Border Insolvencies: An Analysis of the Jet Airways saga

Contemporary Issues, Insolvency Law /

[By Shivam Bhattacharya & Naman Jain]  The authors are students at the Gujarat National Law University.  The recent order of the Mumbai Bench of the NCLT approving the resolution plan for the revival of Jet Airways has marked the end of one of the earliest cases of cross-border insolvency determined under the Insolvency and Bankruptcy Code, 2016 (hereinafter “Code”). The final determination by the Court has in addition to providing insights into the working of the Code, also laid bare some of its limitations for resolving cross-border insolvency disputes. In pursuance of this, the authors intend to examine the entire case in light of the recent judgment by presenting the facts, orders and judgments passed. This article will also analyze the limitations of the Code in this regard and elaborate on how adopting some of the provisions of the UNCITRAL Model Law could help in dealing with similar insolvency disputes. Background The present case begins with the initiation of ‘corporate insolvency proceedings’ against Jet Airways and concludes with the final approval of the resolution plan for its revival by the NCLT. It spans three different Court orders over a period of two years. Company Petition No. 2205 (IB)/MB/2019 in NCLT, Mumbai Bench Three petitions were filed against Jet Airways, the Corporate Debtor in this case, for the initiation of Corporate Insolvency Resolution Process (CIRP) against it for the huge outstanding debt is owed. During the first hearing, the NCLT Bench was apprised of the fact that insolvency proceedings against Jet Airways had already begun a month prior in theDistrict Court of Netherlands. The Bench in this regard opined that conducting concurrent proceedings in the same matter would cause delay and vitiate the proceedings in the case. The reasoning put forth was that the two sections, Section 234 and 235 in the CODE for recognizing the orders of a foreign jurisdiction, mandate the requirement of the Indian Government to have reciprocal arrangements with the foreign country. However, the Court noted that in the instant case there were no reciprocal arrangements were made with the Dutch authorities. Furthermore, the Bench also took into consideration that the registered office of ‘Jet Airways’ and their primary assets were located in India, and therefore the NCLT had the requisite jurisdiction in the instant matter. The Bench via its order dated 20th June 2019set aside the proceedings of the Dutch Court and declared it as a nullity. The initiation of the corporate insolvency resolution process in India against Jet Airways was accepted by the NCLT. Company Appeal (AT) (Insolvency) No. 707 of 2019 in NCLAT, Delhi The order passed by the NCLT bench on the aspect of non-recognition of the Dutch proceedings was challenged before the NCLAT by the Dutch Trustee. The NCLAT considered the appeal and directed the ‘Resolution Professional’(hereinafter “RP”), appointed on behalf of Jet Airways, to consider the feasibility of having a joint ‘corporate insolvency resolution process in coordination with the Dutch Trustee.  The RP along with the Dutch trustee reached an agreement for facilitating the resolution process through a ‘Proposed Cooperation’model. Both the parties reached a final agreement on the proposed model and submitted it to the NCLAT for approval. The NCLAT accepted the model via its order dated 26th September. The Bench also allowed the Dutch Court Administration to attend the meetings of Jet Airways. Interlocutory Application No. 2081 of 2020 in NCLT, Mumbai Bench An application for the final approval of the ‘Resolution Plan’ was filed before the Mumbai Bench of the NCLT. The Bench via its order dated 22nd June 2021accepted the ‘Resolution plan’ on a majority of the points, and gave a time period of 90 days to the consortium for taking the necessary regulatory approvals and permissions from the DGCA. The Bench ordered the formation of a Monitoring Committee for overseeing the entire process. Though the final determination by the Benchmarked the end of India’s first cross-border insolvency case settled under the Code, however, it raised some key concerns regarding the inadequacy of insolvency provisions in the Code. Analysis and Suggestions With transnational business increasing at a rapid pace and big corporations setting up offices in multiple jurisdictions, this decision by the NCLT assumes much significance. The final order passed has revealed several lacunae present in the Code for dealing with insolvency cases involving foreign creditors or debtors. A major point of contention was the ‘non-recognition of the proceedings which took place in the Dutch Court by the NCLT in its earlier order. The subsequent confusion and delay caused, led to the increasing chorus for including uniform provisions within the ambit of the Code, for dealing with cross-jurisdictional insolvency cases. In pursuance of this, it can be inferred that a major drawback of the provisions within the Code for resolving cross-border disputes is that it mandates the formation of separate and individual bilateral agreements with other countries for enforcing the provisions of the Code. Such a type of arrangement would in addition to requiring a lot of time and negotiations also increase the probability of conflicting claims being made from both sides in connection with the judicial proceedings undertaken by their respective Courts. In light of the aforementioned discussion, the authors are of the opinion that adopting the provisions of the UNCITRAL Model Law would be integral for reducing instances of conflict between the insolvency laws of two or more different jurisdictions. The Model Law provides for three essential and inherent provisions which aim at placing both the national and the foreign creditors or debtors on an equal pedestal. Firstly, the principle of recognition in the Model Law provides for the recognition of the Court proceedings in a foreign jurisdiction, which ensures that no unnecessary time is lost and the dispute is resolved in an effective manner. It also allows proceedings to be conducted in a parallel and concurrent manner.  Secondly, the ‘principle of access’ allows the foreign creditors and debtors to attend the Court proceedings taking place in a different jurisdiction. In essence this principle aids in bringing

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Mens rea and Insider trading: A comparative study of the Indian and US regulatory frameworks

Uncategorized /

[By Rishika Sharma & Rishi Raj]  The authors are students at the Maharastra National Law University, Aurangabad.     Introduction To achieve the goal of safeguarding the interests of the investors, the Securities Regulators around the globe have consistently imposed stricter insider trading regulations to ensure and sustain capital market transparency and fairness. It was given broad powers, including the ability to enact regulations prohibiting insider trading as it deemed fit but not enough which can include mens rea as an essential of insider trading. Before we proceed to examine the role of mens rea in insider trading it is essential to elucidate this topic. The watchdog of the Indian securities regulator i.e., Securities and Exchange Board of India (SEBI) prohibits the practice of insider trading under SEBI (Prohibition of Insider Trading) Regulations, 2015 (SEBI Regulations). The SEBI Regulations define insider trading as an offence against dealing with a company’s securities on the basis of unpublished price sensitive information (UPSI) to gain an undue advantage over the other people who do not have such information. Regulation 2(1)(n) of the SEBI Regulations provides that information that is related to a company or its securities, that is not generally available to the public, which upon disclosure is likely to affect the price of securities can be termed as UPSI. A comparative study of the need for inclusion of mens rea This article seeks to examine the necessity of mens rea in the provisions of insider trading in the USA and India. These regimes were chosen because the United States, as one of the world’s largest financial markets, may serve as a model for India’s securities market. Further, the authors are of the opinion that India needs adequate penal laws to protect investors’ interest in the securities market which prohibits the practise of insider trading and those laws must meet the regulations of developed nations. 2.1 The Indian position  It would be very prudent to start analysing the Indian regulatory framework where mens rea has not been recognised as an essential of insider trading. Regulation 3(1) of SEBI Regulations states that any person who is in the possession of UPSI shall be considered to be an “insider” irrespective of how the person gained such information. In addition to this, Section 15G of the Securities and Exchange Board of India Act, 1992 (SEBI Act) lays down the penalty for violation of the provisions of Insider trading. In Hindustan Lever Limited v. SEBI wherein it was contended that for imposing any penalty under insider trading it is essential to prove that the purchase was made for making profit or to avoid loss. While rejecting the contentions Securities Appellate Tribunal observed that information or knowledge is irrespective of Insider trading. It is noteworthy here to observe that the SEBI Act does not recognise the need for the inclusion of mens rea in insider trading. It is not considered an essential element in insider trading and a person can be convicted regardless of his intentions. The Securities Appeal Tribunal, however, did not always have the same view. A contrary view was taken by it in Rakesh Aggarwal v. SEBI wherein it held that intention or knowledge has to be taken into cognizance in case of insider trading even though the statute doesn’t particularly bring mens rea as an essential criterion but it was subsequently overruled. However, in SEBI v. Cabot International Capital Corporation, the Bombay High Court held that the punishment prescribed in the SEBI Act and SEBI Regulations are for the non-compliances of the provisions. The proceedings relating to Section 15G are neither criminal nor quasi-criminal, as the Act and The Regulations provides that there is no question of proof of mens rea is required as a fundamental component for the imposition of penalty. The SEBI Act and SEBI Regulations were enacted to punish those individuals who are in default of statutory provisions and hence the intention of the parties committing such violation becomes wholly irrelevant. Therefore, it is noteworthy to observe that the statutory provisions contradict the principle of “no mens rea, no punishment” which is a settled principle in common law countries. Further, the authors are of the opinion that the present provisions make somehow mens rea is not an essentials of insider trading. This negates the purpose of criminalising insider trading as a means of gaining an unfair advantage based on price-sensitive information. The mere possession of unpublished price-sensitive information should not be considered as sufficient grounds for insider trading. Further, it is noteworthy to observe that the views adopted by the Indian judiciary and regulatory authorities is wrong and hence, mens rea must be included as a fundamental of insider trading. 2.2 The US position  The US frequently acts as the “gold standard” for many emerging economies, it is necessary to understand what constitutes mens rea in order to attract criminal responsibility for insider trading offences committed within the jurisdiction of the US. The U.S. Securities and Exchange Commission (SEC) defines Insider trading in a much broader sense when compared to the Indian provisions. Instead of only buying or selling securities on the basis of UPSI, SEC also includes “breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, non-public information about the security” under the ambit of insider trading. In 1984, for the first time, the US Supreme Court in Dirks v. SEC observed that the mens rea must be considered while determining the Insider trading proceedings. Further, in deciding whether or not the insider has violated a fiduciary obligation, the Court reached its conclusion by using a test to determine if the tippee committed the insider trading offence. The Court laid down a test to determine the Insider’s knowledge by [i] insider’s personal benefit from his disclosures [ii] absence of personal gains and [iii] absence of breach by the insider. Hence, after the Dirks judgement, in US v. Newman, the Court ruled out the term “mens rea” and made it far more difficult

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The Tale of Venture Capital Funds: A New Breeding Ground of Tax Evasion?

Contemporary Issues /

[By Aarushi Kapoor] The author is a fourth year student at the Hidayatullah National Law University. Introduction The Customs Excise and Service Tax Appellate Tribunal (hereinafter ‘Tribunal’), Bangalore bench, in ICICI Econet and Internet Technology Fund v. Commissioner of Central Tax, has recently confirmed the service tax liability on the expenses incurred by the venture capital fund (hereinafter ‘VCF’), as the consideration received towards the asset management services which are employed for the administration of funds. The VCFs are incorporated as trusts. Such incorporation in the form of the trusts is always a favourable mode of incorporation because of the application of the principle of mutuality. According to this principle, a trust is not separate from its beneficiaries and hence, the activities pursuant to such an institution cannot be taxed. However, this judgment has challenged this long age industrial practice. Pertinent Facts In the present case, ICICI Econet and Internet Technology Fund was a VCF created to make large investments in portfolio companies using the contributions received from a variety of investors. For the management of these contributions, an investment manager or the asset management companies was appointed to analyse the investments received in the form of contributions and decide the future course of actions in the form of investment and disinvestment. The contributories were referred to as unit holders. It is imperative to mention that in the present case, the asset management companies in addition to providing advisory services also contributed to the fund and hence, were entitled to the payments which included a payment equal to the capital invested plus a promised rate of return like the other unit holders. Issues which required consideration This return on investment paid to the asset management companies in this instance was much more than the quantum of the investment made by them. It is here, where the bone of contention appeared. The main question before the tribunal was whether the enhanced amount being paid to the asset management companies comprised of the operating expenses and carried interest in addition to the legitimate return of investment. It was to this question, that the tribunal actually answered in affirmative by concluding that payments included payments of carried interests being made to the asset management companies in the disguise of return on investment, and hence this amount attracted the service tax liability in the hands of asset management companies. Critical Analysis: An Insights into the Implications After having discussed the background of the issue at hand, it now becomes essential to discuss the implications that this decision is likely to have on the equity industry. VCF is no longer a trust The structure of the trust is based on the principle of mutuality. According to this doctrine, whenever there is an oneness of the contributors to the fund and the recipients from the fund and the fund has been constituted for the convenience and common benefits of the members backed by the impossibility that the contributors derive profit from such contributions, mutuality comes into play. As an implied conclusion, it follows that a person cannot make profit out of himself. Hence, this profit cannot be regarded as income and hence, it is not taxable. However, accordingly to the decision of the Tribunal, the VCFs which were traditionally incorporated as trusts, have been denied to continue applying doctrine of mutuality. Accordingly to the reasoning of the Tribunal, the VCFs breached the principles of mutuality by breaking the closed circuit within which only the trust and the beneficiaries used to interact. In contravention, the VCFs made an attempt to engage in pure commercial operations in order to provide a favourable return to the contributories. In other words, it could be said that the contributions received from the contributories were invested in the portfolio companies and arrangements were created in a manner to ensure that a profitable return at the end is distributed. This resulted in the collapse of the closed circuit within which the doctrine of mutuality operated. The tribunal instead warned that the structure of the VCF fund was a mere façade. The aim of such a foul play was to provide every opportunity and fortune to the investment management companies to avoid taxation. The intent was somehow to benefit themselves through earning performance fees in the form of carried interests. Fails to analyze the other factors One of the most critical analyses of the judgment rendered by the tribunal is the fact that the order is very case specific. It is important to keep in mind that while making a judgment that is likely to have an impact on the entire private equity industry, a holistic consideration of the facts and circumstances in required. However, the judgment fails to analyse the status quo on such considerations. For instance, the detailed list of payments which the VCFs are legally entitled to make to the asset management companies as a consideration for the services rendered. The Chapter 10 of the Master Circular on Mutual Funds explains list of fees, charges and expenses which can be ideally charged by the collective investment schemes pursuant to the regulations and approval of SEBI. However, under the same guidelines, there is a prohibition on the collective investment schemes like VCFs to charge the expenses related to the payment of performance or management fees to the investment management companies. So as a necessary corollary, it can be deduced that the logical reasoning of the tribunal is backed by the SEBI regulations and circulars.[1] However, what needs to be determined is the fact that whether the enhanced payment made to the asset management companies by the VCFs comprised of the lawful payments or the prohibited performance fees. The tribunal has failed to take into account the balance sheets of the VCFs and contractual arrangements between the VCFs and the asset management companies. Detrimental for Private Equity and Management Industry The above decision of the tribunal is likely to have a very detrimental impact on the private equity Industry especially in India.

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Predicament of NPAs in India – Can bad banks solve it?

Banking Law /

[By Karma Shah and Diya Vaya] The authors are third year students at the Gujarat National Law University. Introduction Our nation is facing a massive issue of Non-Performing Assets (hereinafter “NPAs”). Put simply, an NPA is any bank asset or receivable that has stopped making payments to the bank and has remained unpaid for a specified amount of time. The Reserve Bank of India (hereinafter “RBI”), in its Master Circular, dated 30th August, 2001, has given an extensive definition of NPAs, which aids Indian banks in identifying and treating NPAs. In this definition, the RBI has specified the period after which assets stop giving returns as a meagre 90 days. NPAs are a threat to the Indian economy, as due to the strict prudential norms set by the RBI with respect to NPAs, banks have virtually stopped lending. This has led to the downfall of economic growth. An increase in NPAs leads to several unfavourable outcomes for the economy as a whole. These include, but are not limited to first, lower profit margins for banks and an increase in rates by banks for achieving a higher profit margin, second, reduction of liquidity in the organised financial sector, third, increased work-load on the judiciary, leading to an increased social cost to the society and lastly, stressed balance sheets of banks, less return to investors, and other such tangential issues. To combat this threat to the nation’s economy, Ms. Nirmala Sitharaman (hereinafter “the finance minister”) proposed the introduction and setting up of ‘bad banks’ in the 2020-2021 Union Budget. Moreover, most recently, i.e., on 16th September 2021, the finance minister laid down the framework for the National Asset Reconstruction Company Ltd. (hereinafter “NARC”), India’s first ‘bad bank’. This blog aims to, first, explain the meaning of bad banks and their crucial need in the contemporary Indian economy. Second, examine the recent framework establishing bad banks laid down by the finance minister, and third, analyze the impact on the banks and the national economy. Bad Banks – Meaning and Function Bad banks are those institutions that, simply put, buy the NPAs and bad loans of banks and other financial institutions in exchange for cash and/or securities. The first-ever bad bank set up in the world was by Mellon Bank in the USA. In practice, a bad bank plays the role of asset reconstruction. It buys the NPAs, bad loans, and other risky assets from various financial institutions, specifically banks. The bad bank then manages and recovers these over time. Hence, contrary to a conventional bank, their core and primary function is the recovery of NPAs and bad loans. Banks essentially isolate and divide their assets into two separate categories. One category contains the illiquid assets, including the NPAs, risky securities, non-strategic assets from businesses that are no longer beneficial to the bank, non-performing loans, and other high-risk or troubled assets. The second category contains the good and beneficial assets that perform well and represent the bank’s core business. A bad bank, a corporate structure, takes the NPAs and bad loans of such banks and provides cash and/or government securities in return. This allows the bank to clear their balance sheets, infuse themselves with liquidity, and helps them focus on their core business instead of trying and recovering the NPAs. The Critical Need for Bad Banks in the Indian Economy  The Covid-19 pandemic has led to an unprecedented negative impact on our economy. Cash flow has reduced, leading to issues of loan repayments, tax payments, and interest payments. Furthermore, NPAs have been blocking the progress of our economy since the last decade. In such a desperate financial scenario, the need of introducing bad banks in the Indian Economy was critically felt due to the following reasons: First, primarily to resolve the NPA crisis. NPAs have been a constant obstacle preventing the Indian economy from unleashing its true potential. NPAs have started to drastically increase in Indian Banks since 2013, forming almost 10% of the loans provided by the banks. As per RBI, NPAs of all the scheduled commercial banks have increased from 2.35% in 2011 to 8.21% in 2021, amounting to an increase of almost 250% in a decade. Moreover, due to the onset of Covid-19, RBI has presented a warning in its July 2021 Financial Stability Report that the gross NPA ratio may increase to 9.80 percent by March 2022 under the baseline scenario; and to 11.22 percent under a severe stress scenario. India has the third-highest gross NPA ratio. When a bank has a high NPA ratio, it spends a high percentage of its profits covering consequential losses incurred due to the high NPAs. This creates a situation of decelerating the cash flow in the economy, reducing the lending frequency of the banks and ultimately affecting the economy as a whole. . In this scenario, NARC is a much-needed expert entity required to fuel the economy’s growth, provide capital to banks and resolve the financial crisis. Second, to provide support to the Insolvency and Bankruptcy regime (hereinafter “IBC”). The IBC was enacted with the objective of debt recovery and reducing the NPAs in the economy, among others. However, it did not perform as per expectations. Furthermore, it is argued that the IBC and associated debt recovery mechanisms are still at a nascent stage in India. For IBC to resolve all issues of NPAs plaguing our economy it requires greater judicial capacity, manpower and time. This can be provided by the bad bank, which creates a separate entity for quicker and more efficient one-time resolution and debt recovery. Now, banks need not worry about debts and can focus on strengthening the economy. Furthermore, the appreciable role played by bad-banks in other countries is the greatest testimony of its potential to resolve the issue of NPA’s in India and accelerate economic growth. Hence, a bad bank is necessary to tackle the issue of the large stock of NPAs in the economy as a one-time solution. Impact of the recent framework on Banks and Indian Economy On September 16, 2021, the finance minister set

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Redefining the Scope of Section 3(1): Towards a Purposive Interpretation

Uncategorized /

[By Shubham Gandhi & Aditya Puri] The authors are students at the Dharmashastra National Law University, Jabalpur.  The Competition Act, 2002 (“the Act”), as legislated by the Parliament, is a special statute that governs the practices conducted in a market and ensures that healthy competition is maintained. The legislature in the Competition (Amendment) Bill, 2020 has stressed the need to identify a legislative way to cover agreements that otherwise do not fall in the ambit section 3(3) and 3(4). Considering the scheme of the Act, the question which arises is whether the Act contains enough space to accommodate the independent application of section 3(1) read with (“r/w”) 19(3) or the two agreements, i.e., horizontal and vertical agreements, are exhaustive of the scope of anti-competitive agreements as restricted by the Act under section 3(3) and 3(4) of the Act, respectively. This issue is yet to be settled with finality by the Apex court of the land. The author(s) in this article will throw open the discourse with regards to scope and extent of umbrella provisions viz. section 3(1), undertake a purposive interpretation of the Act to disseminate the scheme of section 3(1), highlight the precedents recognizing the extent of section 3(1) and will exemplify the growing need to curb advance anti-competitive agreements which do not fall under section 3(3) or 3(4) of the Act. Underlying Purposive Interpretation The words used in the literal sense are the most reliable source of interpretation. It is to be emphasized that statutes invariably have some purpose of accomplishing. The sympathetic discovery of the purpose is the best guide to the intended meaning of the statute. In clear terms, the apex court in Excel Corp v. CCI laid down that, “In ordinary circumstances, once the ‘plain meaning’ of the words in a statute has been identified there is no need for further interpretation. Different considerations can apply, however, in cases where a statute would be unconstitutional if interpreted literally.“ The preamble of the Act provides for sustenance and protection of competition, ensuring the freedom of trade for the other participants of the market in light of economic development of the country, and preventing practices that have the potential of causing an adverse effect on competition, as laid down in the judgment of CCI v. SAIL. The factor of “economic development” is a dynamic phenomenon requiring flexibility on the part of the commission to accommodate the changing nature of anti-competitive agreements. To achieve the said purpose, the Act bestowed upon the commission the power to take action under section 18 of the Act. The literal semantics of section 3(1) nowhere suggests that the scope of agreements mentioned therein are limited to the ones categorically mentioned under sections 3(3) and 3(4), i.e., horizontal and vertical agreements, respectively. The section explicitly uses the phrase “any agreements” while prescribing the anti-competitive agreements. To disseminate our argument, reproduction of section 3(1) is necessary: “No enterprise or association of enterprises or person or association of persons shall enter into any agreement in respect of production, supply, distribution, storage, acquisition or control of goods or provision of services, which causes or is likely to cause an appreciable adverse effect on competition within India.” It is just a matter that the horizontal and vertical agreements are certain in structure and scope that they deserve a categorical mention. Further, the other agreements not mentioned under section 3 are, in author(s) view, not certain in scope and structure to be bestowed with a categorical mention. Also, the definition of ‘agreements’ under section 2(2) has been left wide and open to facilitate the inclusion of even a blink of an eye. In such a scenario, defining the contours of all the agreements covered under section 3 is nearly impossible. It is the contention of the author(s) that agreements stipulated under sections 3(3) and 3(4) are only illustrative of “any agreements” under section 3(1). They do not exhaust the scope of section 3(1). Hence, the legislators used the phrase “any agreement” to leave the scope of the section open-ended to accommodate the ever-changing dynamics of anti-competitive agreements entered by market players to “eliminate practices having an adverse effect on the competition, to protect the interest of the consumers.” Therefore, any interpretation inclining towards restricting the reading of section 3(1) to horizontal and vertical agreements would be a creative exercise unnecessarily narrowing the scope of section 3(1). The approach adopted by CCI The CCI first decided the issue regarding the standalone application of section 3(1) in the case of Ramakant Kini v. Dr. Lh Hiranandani Hospital, wherein the commission categorically stated that if the agreement does not fall within the ambit of section 3(3) or 3(4) due to its nature, then resort shall be made to section 3(1) r/w 19(3) to serve the purpose of the Act. Although the Ramakant case was overruled by order of COMPAT, as the agreement in the specific case does not vitiate the principles of AAEC, it does not discuss the interpretation done by CCI regarding 3(1). After that, the CCI in P.K Krishnan v. Paul Madavana, while referring to the Ramakant Kini Judgment, held that “in Dr. L. H. Hiranandani Case (Ramakant Kini case) the position is quite clear that an agreement, even if it is not falling under section 3(3) or 3(4) of the Act, is amenable to the jurisdiction of the Commission under section 3(1) if the same has an appreciable adverse effect on competition.” CCI again accepted this line of reasoning in the case of Rohit Medical Store v. Macleods Pharmaceutical Ltd. The author(s) find the interpretation adopted by CCI in the aforementioned cases in line with the preamble. Also, section 18 puts the commission under a duty to prevent practices from having adverse effects on competition. Moreover, it is observed in various cases, like      Builders Association of India v. Cement Manufacturers’ Association and CCI v. Co-ordination Committee of Artists, that the associations always contend that they were merely an association of people and did not undertake any economic

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Front Running: A Non-Intermediary’s Accountability for the Ill-Gotten Gains

Capital Markets and Securities Law /

[By Renuka Nevgi]  The author is a student at Maharashtra National Law University, Mumbai.  Introduction: Meaning and Nature Front running is an illegal act of buying or selling securities based on non-public information regarding a substantial future transaction likely to influence the price. It includes entering into options or futures contracts before an imminent transaction while anticipating the fluctuation in the price after the information will become public. This term has been defined in the SEBI Circular dated 25th May 2012. Regulation 4(2)(q) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 classifies front running as a manipulative, fraudulent and unfair trade practice. Furthermore, Sec. 12A(e) of the SEBI Act also lays down that a person shall not deal in securities directly or indirectly while possessing non-public information. Front running may take place in several ways through intermediaries as well as non-intermediaries. Orders can be placed in tranches and all such tranches placed before the last tranche of the Big Client will classify as front running transactions. This practice involves illegal usage of confidential information given to an intermediary resultantly amounting to unfair leverage. This article critically analyses the extant legal provisions as well as judicial decisions dealing with front running by non-intermediaries and juxtaposes it with those in the other jurisdictions. The author also attempts to provide constructive suggestions in order to impose effective strictures on this manipulative practice. Kinds of Front running According to the decision in case of SEBI v. Shri Kanaiyalal Baldevbhai Patel and Ors, front running consists of three forms of conduct: (1) ‘tippee trading’ which means trading by third parties who are given information or tipped on an impending block trade, (2) ‘self- front running’ implying the transactions wherein the purchasers or owners of block themselves involve in offsetting options or futures transaction by indulging in ‘hedging’, and (3) ‘trading ahead’ refers to a transaction in which an intermediary trades for own profit ahead of an impending customer block order. When confidential information is passed on to a third party, it results in the breach of duty prescribed by law. Specifically, if the tippee is cognizant of the breach and thereby induces the person to share such information, it is considered to be a ‘fraud’ by the recipient tippee. Front running behaviour can be classified into two categories as confirmed by a SEBI Order in the matter of Reliance Securities Ltd.: (i) ‘BBS’ or Buy-Buy-Sell: This is when the front-runner places own buy order preceding the last tranche of Big Client’s buy order. Subsequently, the front runner keeps selling the securities bought earlier at an escalated price. And (ii) ‘SSB’ or Sell-Sell-Buy: This happens when the front-runner places own sell orders preceding the last tranche of Big Client’s sell order. Consequently, the front-runner buys securities at a reduced price as and when the Big Client’s sell order gets executed. Indian judicial pronouncements w.r.t. non-intermediaries If only intermediaries are held responsible for front running, then the manipulators will get the leeway to engage in iniquitous activities through name lending or by masking their identity. However, as decided in the matter of Manish Chaturvedi & Ors., name lending is a serious offence and one cannot be absolved of the liability simply by claiming obliviousness. If these activities remain uncontrolled, then those who aid and abet such unfair practices will also detrimentally affect the interest of investors. When the accounts are rented out to third parties, they become the custodians of those securities or funds. Although the account holder still remains as the technical owner, the non-intermediary or third party employs its own resources which may be utilised for illegal purposes. The account holder may also receive direct or indirect gratification in return for the same. This deceitful practise helps the third parties to carry out fraudulent activities while concealing their identity. Under Indian law, the standard of proof required to establish front-running by third parties is a preponderance of probability, whereas any clinching evidence is not needed. The modus operandi is determined by collective analysis which leads to inference in relation to the conduct of the manipulators in the securities market. Circumstantial evidence including the pattern of trading could suffice to prove a fact. Different participants in the front running are broadly categorised as (1) ‘information carriers’ which have access to the content of non-public information (2) ‘front runner holder accounts’ that are registered owners of the trading accounts. (3) ‘mule account holders’ are the entities employed by the information carrier which operates the account set comprising of the trading account, Demat account and bank account. In case of defiance of PFUTP regulations, SEBI had also imposed penalties that that act as a deterrent to all those who indulged in serious violations. A maximum penalty of INR 25 crores or three times of profits generated from such practice can be imposed under the SEBI Act. Along with this, SEBI is also vested with the power to institute other civil suits under the SEBI (Intermediaries) Regulations, 2008 and criminal proceedings under Sec. 24 of the SEBI Act. Regulations in foreign countries In the jurisdiction of U.S., front running has been classified as a separate offence by the Financial Industry Regulatory Authority. The brokers or firms are not allowed to place their interests after gaining knowledge of an imminent trade. However, if such a trade is necessary to facilitate the execution of the client’s order, they can do it with the client’s free consent. Rule 5270 includes mule account holders because it has a wide scope since it includes members as well as the persons associated with members. Thus, the third-party traders are also impliedly included within the purview of frontrunning under the FINRA Rules. Likewise, under the EU Market Abuse Regulations, Rules 23 and 24 categorically include third parties whose account is used by the trader to obtain unfair gains indirectly. It also contains a presumption of the traders themselves placing the orders if such confidential information is used to

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Scarcely Regulated Family Investment Funds: Lessons from the Archegos Capital Wipe-Out

Capital Markets and Securities Law /

[By Sanchit Singh]  The author is a student at Vivekananda School of Law and Legal Studies, GGSIPU, Delhi.  The Dodd-Frank Wall Street Reforms and Consumer Protection Act, which came in response to the 2008 financial crisis, removed a historic exemption enabling the Securities and Exchange Commission (SEC) to regulate hedge funds and private fund, advisors. However, this included a new provision that required the SEC to define family offices in order to exclude them under Section 202(a)(11)(G) of the Investment Advisers Act, 1940. Among other aspects, family offices were not required to disclose their size or leverage as a result of this exemption. The family office, Archegos Capital Management’s extreme leverage led to a reported $10 Billion loss to some of the biggest banks globally in March 2021. This has attracted a great deal of discourse regarding the lack of transparency of family offices, especially the ability of these invisible whales to hurt the U.S. economy. The March 2021 Meltdown The losses resulted from the family office’s inability to meet margin calls relating to total return swap agreements and such positions that were financed by prime brokers. The U.S. Federal Reserve had raised attention to such practices in its May 2020 Financial Stability Report, noting that the concentration for hedge fund leverage had “increased markedly”where the top 25 hedge funds accounted for 50 per cent of industry borrowing. The reason for this concentration the report mentions “dealers have reportedly given preferential terms to their most-favoured hedge fund clients” and that “hedge funds with disproportionately high leverage can have outsized effects”. Despite this, the price decline in Archegos’ concentrated positions led to margin calls which prompted the sale of positions which further led to the decline of affected stocks, finally leading to the losses for the banks to bear. Japan’s largest investment bank, Nomura and Credit Suisse have been hit the hardest with them collectively facing losses close to $6 Billion alone. Other banks like JP Morgan, Goldman Sachs and Deutsche Bank were prompt to avert significant financial impact by de-risking their exposure to Archegos Capital. Were Disclosure Standards the Real Problem? As previously discussed, family offices are exempted from any registration with the SEC due to its exclusion under the Investment Advisors Act. Consequently, hedge funds like Archegos Capital do not need to file quarterly financial reports on their performance or the size of equity holdings including the types of assets. This hampers the ability for prime brokers of banks to evaluate risk and oversight by market regulators including the Federal Reserve and SEC. Despite this, many believe that adequate disclosure standards were not the main problem resulting to collapse. There has indeed been an evolution in the relationship between family offices and these banks. Deutsche Bank v. Sebastian Holdings Inc. (2013) was consequential for banks to realise that family offices were not significant institutional players, where the Deutsche was sued for $8 Billion in 2008 over margin calls arising from trades with the prime brokerage division. The court dismissed the entire claim and ordered the payment of $240 Million in dues. Thereafter, family offices were treated more like private clients which meant less leverage and higher trading costs. The preferential relationship with Archegos depicts a major change in attitude ever since. Clearly, banks with prime brokerages had loosened up restrictions in search of lucrative clients by providing high leverage, especially considering the staggering increase in the number of family offices where assets under management stood at $5.9 Trillion as of 2019, significantly larger than all U.S. private equity firms put together. In an independent review conducted by a law firm at the behest of Credit Suisse, there was enough evidence to suggest that the bank slept on multiple warning signals that could have prevented their burden of losses. Archegos Capital had begun frequently breaching its PE limit and by April 2020 it was ten times more than its $200 million limits. This evidently indicates highly volatile and under-margined swap positions of significant risk to the Bank. There does not seem to be any sign of fraudulent activities or corruption but rather rises questions on the Bank’s competence to identify and appreciate the scale and urgency of Archegos’ risk. While typically most family offices are risk-averse and their main objective is to preserve wealth but a different breed of such offices have come out that demonstrate speculative aggression much similar to some of the most competitive hedge funds. It becomes difficult to truly categorise Archegos Capital as a family office or a hedge fund outrightly, considering the scale of leveraging. The industry has come to refer to them as “invisible whales” equipped with great capabilities to move and influence the markets. With Credit Suisse’s specific example, one can imagine the systemic problem in the manner in which these large banks conduct business and manage risk. Potential Legislative Correction and the Exclusive Grandfather Clause HR 4620, the Family Office Regulation Act of 2021 was introduced in the House Financial Services Committee on 22 July 2021. The Bill has sought to reflect on the Archegos Capital meltdown and address the exemptive and exclusive clauses. As amended, HR 4620 would limit family office exclusion from “investment adviser” to a more comprehensively defined “covered family office” which includes family offices with less than $750 Million in assets under management. Offices with more than $750 Million under management would be exempted from registration with the SEC under the new legislation but will be required to submit reports in accordance with the Commission as exempted reporting advisors (ERA). Further, Section 409 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that allowed clients who were not members of the family to be eligible for the family office exclusion would be repealed. Lastly, the Bill would authorize the Commission to exclude a family office from the “covered family office” definition when the family office is highly leveraged and/or engages in high-risk activities in the interest to protect investors. While the legislative expectation for HR 4620

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The Maruti Suzuki Judgment: A Slew of Missed Opportunities 

Competition Law /

[By Dharmvir Brahmbhatt & Aneeta Mathew]  Dharmvir Brahmbhatt is a student at the Gujarat National Law University and Aneeta Mathew is a student at the National University of Advanced Legal Studies. Introduction The CCI’s judgment in a Suo moto case against Maruti Suzuki India Ltd. (MSIL) grabbed eyeballs, both for the penalty of a whopping Rs. 200 Crore it imposed as well as for laying down the law that Discount Control Policies (DCP) imposed on dealers by manufacturers amounts to Retail Price Management (RPM) and hence is illegal. The CCI further flagged the appointment of Mystery Shopping Agencies (MSAs) to execute and monitor the policies and the use of such audits to penalize the dealers. This article attempts to delve deep into two aspects of the judgment where the CCI has faltered. Firstly, the authors critique the CCI’s hesitation to contribute to the larger debate on whether RPM is intrinsically anti-competitive or not. Secondly, the authors elaborate on why they view this decision as a missed opportunity to clarify the Indian legal position on MSA, which albeit having a few scattered mentions in Indian jurisprudence, is largely unexplored, compared to the international position on the same. Resale Price Maintenance – Per se illegal or rule of reason standard? Essentially RPM refers to a vertical agreement in which an upstream firm restricts the price at which a downstream firm can sell the product to the customer. DCP, which MSIL has been found guilty of employing by the CCI, is a subset of RPM. The kind of agreements that fall under the per se rule is so inherently anti-competitive that the courts condemn them without any inquiry into their effects. An example of the same would be bid-rigging among competitors. On the contrary rule of reason is the legal principle which when applied the court makes an attempt to look into and evaluate the pro-competitive effects of a prima facie restrictive trade practice.  Applying the “per se rule” courts have for a long time presumed RPM to be violative of competition disregarding any other factors in play. However, the trend has changed in the last decade. The US Supreme Court in the case of Leegin Creative Leather Products Inc. v. PSKS Inc. opined that not all RPM policies are per se illegal and must be evaluated by the standard of rule of reason. The Leegin case settled that RPM can have both pro-competitive and anti-competitive effects. In the opinion of the authors, the CCI in the MSIL judgement used the “per se rule” without considering the potential pro-competitive effects of the DCP imposed. The CCI failed to scrutinize the possible benefits of the DCP even though in the Jasper Infotech Private Limited (Snapdeal) v. KAFF Appliances (India) Pvt. Ltd. the CCI had recognized the pro-competitive effects of RPM. To analyze RPM and DCP it is necessary to compare the anti-competitive effects of RPM with the pro-competitive effects of RPM. Possible anti-competitive effects The possible anti-competitive effect that could have been caused by MSIL putting in place DCP as outlined by the CCI is that it may cause direct harm to consumers. The CCI in its order has opined that DCP has led to consumers being denied benefits as higher prices are being charged. This is an argument that is intrinsically flawed because the main purpose of imposing RPM policy is to ensure that customers are spending more despite the increased prices. In fact, the manufacturers would be wary of setting a retail price higher than the competitive prices due to inter-brand competition. The possibility of a net loss to consumer surplus is very distant. The same was pointed out by R D Blair in his paper titled The Demise of Dr. Miles: Some Troubling Consequences. Possible pro-competitive effects There are two possible pro-competitive effects of DCP which were enforced by MSIL. Firstly, it can be an effective measure against the free-rider problem plaguing the retail industry. A free rider is a person who benefits from something without paying for it. Generally, a few retailers will choose to offer pre and post-sale services including advice, demonstration, instruction, etc. Since buying an automobile needs technical knowledge these services would be essential for the customer. However, providing such services would be costly for the retailer and therefore the retailer will not be able to offer any discount. The retailers that do not provide services would want to be the free riders and offer heavy discounts to the consumer. The consumers therefore would seek services at no cost from one retailer and buy from the one offering a discount. This would cause market failure which can be understood with an example of the prisoner’s dilemma game. For example, ‘A’ and ‘B’ are two individuals who are considering a contribution of 10 units each for the larger good. The benefit would be 100 units for every 10 units contributed. P1 is the ideal scenario and P4 is the worst-case scenario as the net public benefit is 0 which would lead to market failure. In this game, both ‘A’ and ‘B’ would come to the conclusion that it is unwise to contribute anything to the public good unless both the players were assured of the fact that the other individual would also make a contribution. The DCP enforced by MSIL did exactly the same by ensuring that there was no price competition amongst retailers. When the retailers can’t compete on prices they would be forced to increase the level of services offered by them thereby increasing net public benefit. This would also promote intra-brand competition and increase consumer satisfaction. Secondly, because the DCP ensures that the services offered by the retailers are of the highest quality the consumers would be enticed to buy the products of the brand sold by those retailers and this, in turn, would promote inter-brand competition as retailers of other brands would be forced to either sell products at highly competitive rates or increase the level of services provided by them. And therefore, while the

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Taxation Laws (Amendment) Act, 2021 In Reference to Cairn And Vodafone Dispute

Taxation Law /

[By Anshika Agarwal & Shubhi Singhal] Anshika Agarwal is a student at GGSIPU, Vivekananda Institute of professional studies, New Delhi and Shubhi Singhal is a student at the National Law Institute University, Bhopal.  Introduction Taxability of income arising from the indirect transfer of assets situated in India has been a subject matter of disputes for quite along. The issue has once again come into light with the introduction of the Taxation Laws (Amendment) Bill, 2021by the Finance Ministry on 5 August 2021. It was on 13 August 2021 that the said Bill received the President’s assent and the Taxation Laws (Amendment) Act, 2021 was notified. The said Act seeks to amend the Income Tax Act, 1961 (hereinafter “principal act”) and the Finance Act, 2012, thereby, cancelling the retrospective tax liability arising from the indirect transfer of the assets located in India. This means that all the tax demands raised for transactions relating to the transfer of Indian assets before 28 May 2012 will be nullified. The amendment can be perceived as a resolution mechanism in ending the far stretched Vodafone and CAIRN Energy tax disputes. The article aims to analyse the events leading to the introduction of the Taxation Laws (Amendment) Act and its overall impact. Laws Prior to the Finance Act 2012 and Their Repercussions  The principal Act of 1961 vide its Section 9 enlisted certain incomes, that were deemed to have arisen or accrued in India, to determine the scope of the taxability of the total income. As per Section 9(1)(i), incomes arising from or through an indirect or direct transfer of any capital asset or any property situated in India or any business having a connection in India will be deemed as income arising in India. The said transactions will be taxable for all the three categories of persons, i.e., Resident ordinarily resident (R-OR), Resident Non ordinarily resident (R-NOR) and Non-Resident (NR). The Vodafone Dispute The said provisions were, however, unclear to an extent that they failed to resolve the questions with respect to the taxability of income arising from the transfer of shares of a foreign company income. The said issue was first raised in 2006 when a foreign-based company Hutchison Telecommunications International Limited (hereinafter “HTIL”) transferred its foreign subsidiary’s share capital to Vodafone International Holdings. The said transaction entitled Vodafone to a controlling interest of 67% in Hutchison Essar Ltd., an Indian based joint venture. It was in 2007 that the cause of action arose when Vodafone failed to deduct tax from its gains arising from the indirect transfer of Indian assets to HTIL. On account of this non-compliance, a due notice was served by the Income Tax Department to Vodafone. The matter went up to the Supreme Court and was finally decided in the favour of Vodafone. Judicial Approach to the Vodafone Dispute In this case, i.e., Vodafone International Holdings B.V v. Union of India, the apex court ruled that since Section 9(1)(i) does not cover indirect transfers of capital assets/property situated in India and the said transfer being an indirect one could not be charged under the head capital gains. Therefore, in the present matter, Vodafone was not liable to deduct tax from its gains arising from the purchase of a 67 per cent stake in Hutchison Whampoa for $11 billion. The Court further observed that the expression “through” in Section 9 does not mean “in consequence of”. To circumvent the implication of the above decision, the Indian government came up with The Finance Act, 2012 which amended Section 9 of the principal Act. Laws as per Finance Act, 2012 The 2012 Act inserted Explanation 4 and Explanation 5 to Section 9(1)(i). The ambiguity that arose in the Vodafone case regarding the interpretation of the expression “through” was clarified by inserting Explanation 4 to Section 9(1)(i). It stated that, the expression “through” shall mean and include, and shall be deemed to have always meant and included, “by means of”, “in consequence of” or “by reason of”. By doing so, the Act imposed a retrospective tax on the indirect transfer of capital assets. This implies that an asset or a capital asset shall be deemed to be and shall always be deemed to have been situated in India if they derived their value “substantially” from the assets located in India, either directly or indirectly. Therefore, any capital gains arising from the transfer of such assets being any share or interest of an offshore company as well as the transactions that took place between 28 May 2012 and 1962 will be taxable. The CAIRN Dispute With the commencement of the said legislation, issues with respect to the tax liability of the transactions undertaken prior to 28th May 2012 began to surface. A similar transaction was entered into by CAIRN UK Holdings Limited (hereinafter “CUHL”), a UK-based company. CAIRN India Holdings Limited (hereinafter “CIHL”), a non-Indian wholly-owned subsidiary of CUHL was established in 2006 in New Jersey, USA. Further, CUHL transferred the shares of 9 of its subsidiaries to CIHL. In the same year, another wholly-owned subsidiary named CAIRN India Limited (hereinafter “CIL”) was established in India. Eventually, CUHL sold shares of CIHL to CIL and a subsequent IPO offer was issued by CIL proposing 30% of its stocks to the Indian share market. As a result, CUHL experienced a gain of approximately Rs. 6,101 crores. Though quite late, this whiff of money being pocketed by CUHL reached the eyes, nose and ears of the Income Tax Department in January 2014 and a preliminary assessment of ₹10,247 crore as tax liability was imposed. Arbitral Proceedings in the Matter of CAIRN and Vodafone After failure on the part of Indian courts to settle the disputes, Vodafone and CAIRN approached the Permanent Court of Arbitration in Hague, Netherlands. Herein, the court granted relief in favour of Vodafone and CAIRN ruling that the retrospective tax application of the Indian government is inconsistent with the “fair and equitable” provision envisaged under Article 3(2) of Bilateral Investment Treaty (BIT), entered

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