Author name: CBCL

High Frequency Trading: A Switchback for Indian Capital Market

Capital Markets and Securities Law /

[By Ananya Sahu and Ketan Priyadarshee] The authors are students at Maharashtra National Law University, Aurangabad. High-Frequency Trading (HFT) is a wide term with no precise definition in any statute. It is usually explained as a subset of algorithmic trading that uses “latency-sensitive strategies”, “co-location”, “high-speed networks”, and deploys technology to place orders and execute it as trades in a fraction of a second. This technology in the realm of securities has drawn notable consideration of investors and regulating bodies with respect to its responsiveness to the directives and accurate decision making which manually could have never been thought of and concerns regarding defeating fairness in the market respectively. Ever since COVID-19 has hit the Indian capital market, banking on technology to help sustain and fuel the growth would be a good call. However, it has its downsides and risks associated. Securities and Exchange Board of India (SEBI) as a regulating body has proposed measures, some of which might turn out to be far-reaching, while others might undermine the potential of HFT. This article attempts to highlight the opportunities and obstacles algorithmic trading is chained with. While discussing it the article tries to emphasize how the most controversial form of algorithmic trading can be appreciated and adopted by the market players to triumph over the menace of COVID. Benefits and Obstacles of HFT The advent of technology in the stock market has had many benefits over the years. HFT has played a huge role in improving the traditional market quality measures like depth and liquidity; it has the potential to reduce market volatility and trading costs. HFT has had an important role in reducing the bid-ask spread and tends to skim less off each trade when compared to old school market makers. It is a competitor to itself and therefore the claims that it will make markets one-sided is false. Markets are always fixed in favor of those with the best information and it is with the enhanced use of computers that the informational advantage has somewhat been neutralized. Academics are divided about whether HFT is beneficial or harmful. There is a potential to lose control of computers. There have been instances of software malfunctions that have wiped off millions from the market within hours. The high speed of HFT also raises the potential for more vigorous market manipulation and acts like spoofing. Many contend that HFT provides pseudo-liquidity to the market. Others believe that HFT only operates for short term profit and has no meaningful contribution to the markets. There are various ways to keep HFT in check and reduce the risks associated with it and a lot of these have already been put in place or are being used in markets and exchanges globally. Technological innovation is crucial for market development but there must be a simultaneous adoption of safeguards at the same pace as technology develops. SEBI’s Functions as a Check Post  SEBI was established essentially to regulate the capital market of India. One of its primary functions under section 11 (e) of SEBI Act, 1992 is, prohibiting fraudulent and unfair trade practices associated with the market. In pursuant to that SEBI has released numerous guidelines addressing the potential threats and widespread concerns of HFT since 2012, the latest of which came in June 2020; to regulate the functioning of HFT in the Indian capital market. It strives to set up a level playing field for the market players. At the very outset, the discussion paper has identified the following proposals: To hold back the algo traders from placing huge orders and canceling them within a very short span of time, it has introduced a “minimum resting time” with respect to orders taking place through HFT. Resting time appertains to the period between the actual execution of the orders and the receipt of the orders by the respective exchanges. This step shall lower down the instances of frequent cancellation of orders by the traders that intends to create phantom liquidity in the. Co-location is one of the major advantages of HFT where traders are present in close proximity and the information and signals travel fast to the other trader. This has caused more harm than good since only a handful of the traders can afford this facility. To stricture such activity, SEBI has proposed to match orders in a system where the exchanges would first accumulate all the orders for a specific duration of time later matching orders of that batch. The substantial difference which this technology has given rise to is with respect to time. Transactions are completed within a blink of an eye, which seems to be unattainable if the trading is restricted to human intelligence. To make sure that speed, as a discrete strategy does not help, SEBI has suggested incorporating a delay of few milliseconds while the processing of orders is in transit. This would hardly affect the non-algo traders. However, authors believe that time plays a significant role in algorithmic trading, and measures that defeat the purpose of bringing technology into use might discourage the traders involved in HFT. A large number of orders take place and are canceled the next moment. SEBI proposes to limit the Order to Trade Ratio (OTR). It refers to the ratio between orders taking place, modifications, and cancellations to the actual execution of orders that generates confirmed trades at any exchange. For securing a minimum of one trade for a set of orders, capping on OTR is suggested. Traders exceeding the ratio shall be penalized while placing the next set of orders. SEBI has taken drastic steps to curtail the shortcoming of HFT. However certain proposals in the discussion paper have overshadowed the incentive of time enjoyed by the users of HFT and should also take the prospect of issues like insider trading associated with algo trading into consideration. Any set of regulations shall strive to provide a comprehensive solution, which while addressing the potential threats simultaneously, preserve the quintessence of HFT. The Road Ahead

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Anup Dubey v. NAFED: NCLAT includes Lease and Rentals as Operational Debt

Insolvency Law /

[By Aashna Shah] The author is a student at the Institute of Law, Nirma University. Indian courts have pronounced inconsistent judgements regarding the classification of dues arising out of Lease and rentals as Operational Debts. With contradictory reasoning, courts had earlier put the creditors at a great disadvantage, thus neglecting the objective of the Insolvency and Bankruptcy Code, 2016 (“IB Code” or “the Code”) to balance the interests of all stakeholders. Finally, this ambiguity was settled in the case of Anup Dubey v. National Agricultural Co-operative Marketing Federation of India Ltd. & Ors., wherein the court stated that Lease and License agreements shall come within the ambit of section 5(21) of the IB Code i.e., they shall be construed as operational debts. Hence the adjudicating authority deviated from its judgement in Ravindranath Reddy v. G. Kishan, wherein it had excluded Lease and Rentals as Operational Debts. In this article, the author shall provide an analytical account of the present case. Additionally, the author will explain arguments that could have been used by the NCLAT to strengthen its decision. Factual Background M/s. National Agriculture Co-operative Marketing Federation of India Ltd. (“Operational Creditor”) entered into a leave and license agreement (“Agreement”) with Umarai Worldwide Private Limited (“Corporate Debtor”) to use cold storage facilities for three years. The corporate debtor started defaulting in the payments as stipulated in the agreement from September 2017. The operational creditor contended that despite repeated reminders to pay the ‘outstanding debt’, and serving an eviction notice, the Corporate debtor did not pay the outstanding debt. Subsequently, the Operational creditor sent a demand notice under section 8 of the IB Code. The Corporate debtor, in its reply, denied all the claims and requested for renewal of the agreement. Thereafter, the Operational creditor initiated insolvency proceedings against the Corporate debtor under section 9 of the IB Code, which was accordingly admitted by the National Company Law Tribunal, Mumbai (“MNLCT”). While admitting the application, the MNCLT stated that the Corporate debtor vide two letters had confirmed to pay the outstanding dues for rent as established by the agreement. Hence, the Corporate debtor has committed a default by not paying the debt due to the Operational creditor. The Corporate debtor’s suspended board member challenged this order of MNCLT before the National Company Law Appellate Tribunal (“NCLAT”).  The NCLAT upheld the order of MNCLT and stated that lease rentals which arise due to the use and occupation of a cold storage unit for commercial purposes shall come under the ambit of section 5(21) of the IB Code i.e., it shall be considered as an ‘Operational Debt’. Analysis The adjudicating authority examined section 5(21) of the code which states that for a debt to be construed as an ‘Operational debt’ it should arise out of any of the following: (a) Claim in respect of provisions for goods and services (b) Employment or debt in respect of dues and (c) Such repayment of dues which should arise under any law in force at that time What Operational debt can be construed as has been interpreted by the courts time and again because the legislature has not defined the term ‘goods and services.’ This lacuna in law has given rise to the varying application of this provision. In Ravindranath Reddy v. G. Kishan, NCLAT wrongly observed that there is no difference between ‘essential goods and services’ under section 14(2) of the IB Code and ‘goods and services’ under section 5(21) of the Code. Hence, the goods and services stated under section 14(2) shall only be construed as Operational debts. This incorrect position of law was rectified in the present case, where the same tribunal refused to consider the contention of the Corporate debtor that section 14(2) read with Regulation 32 (Insolvency Resolution Process for Corporate persons, Regulation 2016) do not include rental dues from cold storage facilities, which is why it should not be considered Operational debt. The adjudicating authority rightly differentiated between ‘goods and services’ and ‘essential goods and services’ because the latter only comprises of those goods and services whose supply is not to be terminated during Corporate Insolvency Resolution Proceedings. Also, it is nowhere mentioned in the Code, that essential goods and services under Section 14(2) are the same goods and services under section 5(21). .The adjudicating authority rejected the reasoning provided by the Tribunal in Ravindranath’s case for excluding dues out of lease agreements as Operational Debt. In the aforementioned case, the tribunal had stated that for the determination of dues arising out of a lease agreement, the court will have to rely on evidence. But the tribunal will not be able to investigate as it exercises a summary jurisdiction, hence dues arising out of lease agreements are not considered to be Operational debts. Instead in support of its decision, the court relied on the judgement of the Supreme court in the case of Mobilox Innovations Private Ltd vs Kirusa Software Private Ltd, wherein debts arising out of lease rentals were included under Operational debt. The judgement of the apex court was pronounced by relying on recommendations of the Bankruptcy Law reforms committee report (BLRC) which stated that the liability of Operational creditors arises due to transactions on operations. Hence, in Lease and Rentals which are included in the operations, any debt arising thereof should be considered as an operational debt. The only issue on placing reliance on the report is that despite the suggestions of the committee, the Legislature never expressly included Lease and Rentals as an Operational debt. Additionally, the adjudicating authority in the present matter did not state that in cases of Operational debts, the very reason that the Corporate Debtor can claim the defence of the existence of a dispute is because of the lack of evidence relating to the ‘Existence of Debt’. This completely negates the reasoning of the tribunal in the Ravindranth case related to the investigation of the evidence for the existence of debt and would have strengthened the decision of the tribunal to

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Analysis of D&O Liability Insurance vis-a-vis Companies (Amendment) Act, 2020

Company Law /

[By Varun Akar and Ashuthosh V] The authors are students at the Institute of Law, Nirma University. Introduction Directors[i] and Officers[ii] (D&Os’) are considered to be the heart and soul of the company as they make crucial decisions for running the company smoothly. Such people are highly qualified, experienced, and well-versed with the affairs of the company. In the aftermath of the Kingfisher, PNB, L&T scams, etc., the role of D&Os’ has been given importance to improve corporate governance and reduce the possibility of financial fraud. They undertake the responsibilities which are in the interest of the company for maximizing its profits. However, while carrying out such functions, they are susceptible to certain risks which may make them jointly or severally and personally liable for the losses or harm suffered by the company. Moreover, they also have the duties towards various stakeholders such as shareholders, creditors, customers, etc. as mentioned under Section 166[iii], breach of which would result in claims against them. Hence, there arises a need to protect them from unnecessary claims. Companies Act, 2013 provides for D&O Liability Insurance under Sections 197(13) and 149(8) r/w Schedule IV. The provisions do not mandate a company to take the insurance, however, it is recommended to have a D&O Insurance to indemnify the injuries suffered except for fraud, wilful misconduct, bribery, insider trading, etc. Section 197(13) enables a company to take insurance on behalf of D&Os’ to indemnify them against any liability arising out of default, misfeasance, negligence, breach of duty & trust. Also, premiums paid by the company to the insurer shall not be considered as a part of the remuneration paid/payable to the D&Os’, however, if they are proven guilty for acting contrary to any provision given under the Companies Act, 2013, the same shall be considered as a part of their remuneration.[iv] Section 149(8) provides for the manner of appointment of Independent Directors which may or may not consist of D&O Insurance. Key Features of D&O Insurance Policy: A D&O Insurance covers the repercussions arising out of decisions or actions taken by D&Os’ in the natural course of business, i.e, managing trade in the normal routine[v] as per the object clause in the memorandum. However, in some cases, the benefits of these policies are extended to the employees by including them in the definition of ‘Insured Person’. Such policies are available to current, incoming and retired D&Os’ of a company or its subsidiaries. The company receives the money from the insurer only if the claim is made during the policy period within which the policy is in effect and therefore, enforceable. Such a policy period is usually for 12 months but it may extend on the mutual agreement between the parties. A D&O Insurance policy shall have the following indemnification clauses; For the protection of the personal assets of D&Os’ from being used to satisfy the claims against the company. This clause shall be enforceable when the company does not indemnify its D&Os’ against any claim. Therefore, such cover directly protects personnel from personal liability. For indemnifying a company to the extent that it covers the litigation expenses and cost incurred by the company on behalf of its D&Os’. For providing indemnification to a company for its securities claims. This is the only clause that protects a company for its liability, distinct from the liability of its D&Os’. It provides coverage only against claims made by shareholders against the company because of an action of offer, sale, or purchase of securities. Therefore, such cover is often taken by listed public companies. Benefits of D&O Insurance Policy: It enables the company to hire and retain qualified and experienced D&Os’. Protects the directors and the company from the unprecedented and high litigation cost and expenses against claims made by the stakeholders and also prevent invocation of personal liability in case of defaults. It facilitates the personnel to take risky decisions with confidence in the interest and growth of the business. Improving better corporate governance practices by providing coverage only in cases of genuine defaults or negligence, and not wilful defaults or fraud. It provides compensation for the harm caused to the reputation of the personnel during the litigation. Lastly, the amount of coverage shall vary in each D&O Insurance policy based on relevant factors such as the nature and size of the business, the line of business, industry or market conditions, associated risks, and “penalties provided in the Companies Act, 2013“. Possible Impacts on D&O Insurance after enforcement of Companies (Amendment) Act, 2020 The Ministry of Law and Justice on September 28, 2020, brought in significant changes through the Companies (Amendment) Act, 2020 in the penalties of the personnel under a variety of sections of Companies Act, 2013. Few of which are mentioned below[vi]: The penalties provided under Section 135 of the officers has been amended from the imprisonment up to 3 years and fine which may range between Rs 50,000 – Rs 5,00,000 to a new reduced penalty of 1/10th of the amount required for the CSR or Rs 2,00,000 whichever is less and with no imprisonment. The penalties in case of delay in filing of financial statements with the registrar under Section 137 has been reduced from a minimum of Rs 1,00,000 and a maximum of Rs 5,00,000 to Rs 10,000 and Rs 50,000 respectively. Penalties under Section 167 for vacation of Office of Director has been reduced from imprisonment of one year or fine of Rs 5,00,000 or both to only fine of Rs 5,00,000. For the contravention of the provisions of Chapter XI, the penalties under Section 172 have been reduced from a maximum of Rs 5,00,000 to Rs 1,00,000. Similar reductions in penalties have been made under various sections. The above reductions constitute a material change in the policy. Materiality is the basis on which the insurance company decides whether or not to go ahead with the policy. Every fact which has an impact on the risk-bearing shall constitute a material fact. Further, any

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Garden Leave Clause: A Win-Win Scenario

Company Law /

[By Aparajita Marwah and Saavni Kamath] The authors are students at the National Law Institute University, Bhopal. Introduction Gardening Leave is a measure taken by the employer when an employee is terminated or tenders resignation and denotes the period of time between service of notice of termination and actual termination. A garden leave clause may be effected at any stage of an employee’s course of employment, but is largely restricted to being imposed during the notice period. In such a scenario, companies generally take steps to ensure that during this period, the employee undergoing the process of termination is no longer an active part of their workforce and has no access to clients, co-workers, or sensitive information pertaining to the organization, while still being paid a regular salary with benefits. During such leave, the employee would bound by the employment contract nonetheless and would have to refrain from any act that could hamper the interests of the employer. The reasons for imposing a gardening leave clause upon an employee are manifold. Firstly, these clauses prevent an outgoing employee from being employed by a rival organization during that period, thereby effectively restricting the sharing of any confidential information. Secondly, limiting the employee’s access to company data, clients, or other employees during this transition period, reduces the threat of any possible informational leak once the employee is free from their contract. Further, in terms of the etymological roots of the expression, it essentially means that the employee in question would bide this period by engaging in hobbies such as gardening or could also be negatively perceived in the sense that the employee in question could not even be considered fit to garden. It is imperative to point out that employers may not place an employee on garden leave without such a clause as a part of their employment contract. In the event there is an existing clause, wrongfully place such employee under leave without any wrongdoing on the latter’s part. Alternative to Non-Compete Clauses While both Garden Leave and Non-Compete Clauses are invoked during the termination of employment in order to prevent the employee from engaging with another employer for a period of time and essentially seek to serve the same end, the means used are vastly different. The latter is utilized when employment is terminated and prohibits the employee, for a stipulated period, from being employed with a rival company or engaging in a rival practice. Non-Compete Clauses are also harsher in terms of the conditions set forth and employees are not provided with salary or bonus benefits throughout this duration, resulting in stricter judicial scrutiny regarding the fairness of these terms. In comparison, Garden Leave clauses provide greater leeway and are not particularly disadvantageous to the employee being terminated. Although the employees’ access to the market is restricted during this period, they still owe a fiduciary duty to the employer and enjoy salary benefits. This subsists until the employee in question has not been terminated. Additionally, it is pertinent to distinguish between paid non-compete periods from garden leave clauses as there is a tendency to consider the two as the same. Paid non-compete periods begin only after the termination of employment and share the same advantages that a garden leave clause might grant. Judicial Perspective within the Indian Spectrum Garden Leave Clauses along with Non- Compete Clauses are generally considered within the ambit of restrictive covenants. As a result, they are often subject to rigorous judicial scrutiny, to determine whether these clauses prohibit the freedom of trade and business granted to the employee, by way of Article 19 of the Indian Constitution. Moreover, contracts that impose restrictions upon the person’s freedom to trade or business are rendered void. While there has been no statutory recognition accorded to Garden Leave Clauses in any Indian legislation, there have been several judicial decisions discussing its validity and applicability. One of the first judgments regarding the application of Garden Leave Clauses was tendered by the Bombay High Court in VFS Global Services Private Limited v. Suprit Roy. The case was filed in lieu of execution of an agreement which contained a Garden Leave Clause. However, the errant drafting of the clause wrongfully imposed garden leave upon the employee, after the termination of employment was considered void within the ambit of Section 27 of the Indian Contracts Act, 1872. The Court added that Garden Leave Clauses themselves are not restrictive of trade and if applied in the manner prescribed, could prove to be beneficial for both the employee and the employer. In subsequent judgments such as that of Niranjan Shankar Golikari v. Century Spg. & Mfg. Co. Ltd. and Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr., the Court distinguished between garden leave and non-compete clauses, and established that the employee may be restricted during the term of employment but not after termination. Further, the Court by its decision in Kouni Travel Pvt. Ltd. v. Ashish Kishore and Tapas Kanti Mandal v. Cosmo Films Ltd., upheld the validity of Garden Leave Clauses and affirmed that they can be invoked to ensure the protection of trade secrets, as long as the employee in question is remunerated during the specified period. Effect of the COVID-19 Pandemic The ongoing health crisis has exacerbated the process of decline of both the economy and the job market. It has triggered a string of consequences including reductions in employee remunerations and large-scale layoffs. With employment rates at an all-time low, the question of applicability of restrictive covenants such as garden leave clauses is a poignant one. There are two diverging opinions with regard to whether or not a Garden Leave Clause, as a part of an employment contract, should be invoked during the current scenario. The first opinion and more widely asserted contention against invoking Garden Leave Clause is the fact that tough exit clauses make it all the more difficult for employees to seek employment elsewhere, in lieu of the current environment. Considering such clauses are widely

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Analysis of Excessive Stress on Connection Between Parties to a Manipulative Trade

Capital Markets and Securities Law /

[By Anurag Shah] The author is a student at the School of Law, Christ (Deemed to be University), Bangalore. Introduction The online trading system of the Indian Stock Exchange works on the ‘blind trading system’. Such a system does not permit a buyer and a seller to have any form of interaction on the platform while undertaking a trade. The system works in such a way that after the buy order is placed on the trading platform, the system matches the same with a sell order and then a trade is executed on a price-time priority basis by the system. However, even in such a spill-proof system, time and again buyers and sellers have indulged in manipulative trades which lead to market rigging. The players have identified multiple ways to execute this rigging, which include illegal synchronized trades or trades that manipulate the Last Traded Price. However, the securities regulator in India has tried to prosecute players undertaking such trades through the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (PFUTP Regulations). This regulation prohibits manipulative, fraudulent, and unfair trade practices. Whether a manipulation has been done or not is largely gathered from the intentions of the parties, however, most of the time there is no direct or conclusive evidence to such intentions. Therefore, in the absence of the same, the Courts have time and again looked into different aspects to ascertain manipulation. One such aspect is the connection between the parties to a trade. Whether it is an inter se connection between the brokers and the parties or a connection between seller and buyer, the Courts have used the same to conclusively conclude manipulation. However, recently the Securities Appellate Tribunal (SAT) has been stressing excessively on the presence of this connection. This can be analyzed through two recent orders by the SAT passed in August 2020. SAT order in the matter of Bharti Goyal v. SEBI The SAT in the matter of Bharti Goyal v. SEBI, modified a penalty of Rs. 5 lakhs issued by SEBI into a warning for the alleged violation of the PFUTP Regulations. SEBI had passed an order against sixteen entities for manipulating the price of the scrip of Mapro Industries Limited. The order held that even though no connection could be established between the suspected entities, by the very nature of their trades they manipulated the prices and disturbed the market equilibrium. The aggrieved appellants approached the SAT. The first appellant defended his trades by submitting that he was a salaried employee who occasionally engaged in the stock market trading and therefore undertook the trade only based on the rumors and had no intention to manipulate the prices. The second appellant as well maintained that the trades were done in the normal course of business without any intent to manipulate. Moreover, both the appellants stressed the fact they had no connection or relationship with any connected or suspected entity. SEBI maintained its position that making such trades was completely irrational and no rational person would do such trades until they wanted to manipulate scrip. SEBI contended that the appellants had manipulated both the price and volume of the scrip and therefore violated Regulations 3 and 4 of the PFUTP Regulations. SEBI reiterated that even though no connection/relationship of the two appellants with other authorities in question could be established, the nature and pattern of their trade itself could be found to be foul of the provisions. For this they relied upon the decision of the Supreme Court of India in the case of Securities and Exchange Board of India vs. Kishore R. Ajmera wherein the Hon’ble Court was of the view that in absence of hard evidence, the conclusion has to be gathered from various circumstances like that volume of the trade and such other relevant factors. The tribunal was not satisfied with the contention of the appellants that they made the trades because they were keen to invest in Mapro Industries owing to its extremely promising nature. This was because the scrip was not liquid or lucrative for investment. On the other hand, the tribunal also took note of the fact that the SEBI order could not join the dots concerning the connection or relationship between the suspected entities and the appellants. Therefore due to the nature and pattern of the trades, the appellants violated the regulations, but since no conclusive relationship/connection or interaction between the appellants and the other suspected entities is established, the SAT modified the penalty into a warning. SAT order in the matter of Rajesh Jivan Patel v. SEBI The SAT in the matter of Rajesh Jivan Patel v. SEBI quashed an order by a Whole Time Member (WTM) of SEBI through which SEBI had restrained the appellants and other noticees from accessing the securities market for six months and further froze the mutual funds and other securities of the appellants. The order was passed by SEBI after an investigation was conducted on the alleged violations of Regulations 3 and 4 of the PFUTP Regulations. SEBI had alleged that the appellants along with a few parties, without any intention to sell, had sold meager amounts of the shares of a company over a period of time to establish a price above the Last Trading Price (LTP). The same, if done in collusion would amount to price manipulation under the PFUTP Regulations. The WTM while adjudicating on the order held that even though there was no connection between the buyer and the seller, they had unilaterally manipulated the price. SEBI also stated that a connection between a buyer and a seller was immaterial in the question of price manipulation under the PFUTP Regulations 2013 unless it a synchronized trade. The aggrieved appellants had appealed to the said order in the SAT. While quashing the order SAT held that the WTM had traveled beyond the specific charges listed by the SEBI in the Show Cause Notice (SCN), which included inter alia a collision to manipulate

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Evaluating India’s Overseas Direct Investment Policy: A Call For Reform

Contemporary Issues /

[By Divyani Auti ] The author is a student at the Maharashtra National Law University, Nagpur. Introduction As the world enters into an era of financial austerity amidst an economic slowdown brought about by the Covid-19 pandemic, the restrictive regulatory stance of the Reserve Bank of India (RBI) in relation to cross-border flow of capital has been attracting considerable attention lately. In recent years, there has been an increase in Overseas Direct Investment (ODI) from India and consensus seems to be evolving in favour of liberalizing the current framework to facilitate such investments. At a broader level, such outflow of capital has been happening in two ways: first, expansion of business operations through cross border mergers and acquisitions to facilitate wider access to overseas markets (internationalisation); second and more commonly, incorporation of foreign holding companies by Indian entities to take advantage of favourable regulatory framework (externalisation). Against this backdrop, this post advocates the rationalisation of the regulatory framework governing such cross-border investment whilst highlighting the practical challenges associated with the current framework. In particular, this post shall examine the setting up of step-down subsidiaries overseas and critique the differential treatment meted out to resident individuals. It will then conclude by tracing the round-tripping concerns underlying the prevailing stance and suggest potential changes to help strengthen the framework. Overseas Direct Investment in India It is a known fact that investors look for ways to maximise their returns, while businesses look to raise capital from newer markets. This brings into sharp focus the need to find ways to overcome barriers to the cross-border flow of capital. There are many strategic incentives for internationalisation/externalisation, foremost of these being access to capital from global investors resulting in the diversification of investor base. This way, companies don’t have to solely rely on domestic investors who have typically shown less appetite for nascent companies. Also, establishing holding companies offshore provides for greater commercial certainty due to consistency in adjudication, mitigates tax risks, and protects against currency fluctuation. Here, it is pertinent to mention that Foreign Exchange Management Act, 1999 (FEMA) along with FEMA 120 Regulations govern the ODI framework in India. India’s Regulatory Approach And Impact On International Investors Recently, the RBI issued clarifications stating that under the FEMA 120 Regulations an Indian party is not permitted to acquire a stake in a foreign company that already has Foreign Direct Investment (FDI) in India. This observation is significant as it characterises even instances wherein an Indian Party doesn’t hold a controlling stake in the overseas company, which in turn has a downstream investment in India as a contravention of applicable law. To better understand the implications of this, let us consider the case of an individual (Indian Party) holding a single share, with no power to influence investment decisions in the overseas company (ODI approval route). Under the current framework, it is entirely plausible that even this would be considered as a joint venture (JV) and consequently, the liability imposed would be disproportionate and can have the effect of curbing entrepreneurial vision. Similarly, RBI also clarified that FDI in India through a foreign JV/wholly-owned subsidiary (WOS) in which an Indian Party has invested shall require specific approval of RBI. Again, this is crucial as even if it is a limited embargo it affects foreign investors looking to invest in India by increasing compliance costs. In fact, having such an onerous regulatory framework at a time when global supply chains are getting disrupted will not only be ill-suited but will also disincentivise businesses through FDI in India. Crucially, this being an insertion under Frequently Asked Questions (FAQ) and not a change in law, it can further have the effect of calling into question existing investment arrangements, which can lead to uncertainty. In view of these concerns, a High-Level Advisory Committee was constituted which recommended easing these restrictions to attract foreign investment. It emphasised the need to do away with RBI approval as long as the investments are routed through proper banking channels and are for legitimate business purposes. However, despite such strident calls for liberalisation, these measures have continued to elude the Indian framework. Overseas Direct Investments in Joint Venture/Wholly Owned Subsidiary The RBI’s restrictive stance towards ODI can be seen from its earlier embargo on ‘resident individuals’ from investing in overseas companies. Prior to the 2013 Amendment, the FEMA 120 Regulations only permitted an ‘Indian Party’ to invest overseas. While at first glance, this may be seemingly innocuous, however, it is crucial to note that the definition of ‘Indian Party’ did not extend its coverage to ‘resident individual’. Instead, only a company, statutory body and partnership firm were covered under this definition.[1] This predictably came with its own practical challenges as in contrast to FEMA 120 Regulations, the Liberalised Remittance Scheme (LRS) notwithstanding such embargo allowed individuals to get remittance for the purchase of securities. As a result of these divergent stances, it is not inconceivable that individuals already made remittances which resulted in the acquisition or setting up of businesses abroad. Therefore, the Kishori J. Udeshi Committee apprehending such a scenario characterised such restrictions as a ‘handicap’. It further observed that the provisions of then FEMA precluded resident individuals from acquiring the majority stake or establishing business outside India and consequently recommended liberalising the framework to achieve greater capital account convertibility. Thereafter, in a move affirming the Committee’s observations, the 2013 Amendment permitted resident individuals to invest in equity shares and compulsorily convertible preference shares (CCPS) of JV/WOS outside India.[2] The Amendment, although was welcomed by India Inc., was a fragmented effort at best. This was because the proposed framework whilst permitting the resident individual to set up JV/WOS abroad prohibited setting up or acquisition of a step-down subsidiary. In other words, the JV/WOS was only permitted to the extent that it was an operating entity and not a holding entity.[3] Further still, notwithstanding the 2013 Amendment which expanded the ‘Indian Party’ definition to include ‘resident individuals’ thereby permitting individuals to invest overseas, the

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Interest on Delayed Payment of GST – Murky Legal Waters

Taxation Law /

[By Aditya Bhayal] The author is a student at the NALSAR University of Law, Hyderabad          Introduction The Goods and Service Tax (GST) was introduced with ease of doing business as one of its main objectives. In its 3 year journey to date, the regime has faced quite a few roadblocks towards achieving that goal, one of them being the controversy surrounding the payment of interest on delayed payment of GST.  Section 50 of the CGST Act mandates such payment of interest. The moot point surrounding the quandary which marred the regime was whether the interest was to be paid on the gross-tax liability or the net-tax liability i.e. amount left after setting-off the Input Tax Credit (ITC), which was the case in the erstwhile regime. After shuttling back-and-forth for 3 years, the dust was finally settled when the amendment, which specified that interest is to be paid on net liability, was finally notified. This post seeks to reflect on the hue & cry surrounding this issue and discusses how the amendment, and its subsequent notification, leaves things to be desired for the taxpayers. Background Section 50 of the CGST Act, which imposes interest on delayed payment of GST, doesn’t specify the amount on which such interest is to be levied. GST Council, in its 31st meeting, took cognizance of the matter and suggested that the interest on such deferred payment is to be levied after setting-off ITC. Input Tax Credit allows the taxpayer to deduct the tax paid on its inputs for business from the tax collected on its output supply, thereby reducing the overall tax liability. Honoring the GST Council’s recommendations, the Government introduced the Finance Act (No.2) 2019, which amended  Section 50 to include a proviso clarifying that the interest is to be paid on the net-tax liability. As the amendment was never notified, the benefit never really reached the taxpayers. To the dismay of the taxpayers, the Telangana High Court in “Megha Industries and Infrastructure ltd. v. CCT”, held that the interest is to be levied on the gross-tax liability, which would exclude the deductions under ITC. The GST Council, in its 39th meeting, reiterated that the amendment would be notified with retrospective effect from 1st July, 2017. The Amendment was finally notified on 25th August, 2020 with a prospective effect given to the proviso. The Central Board of Indirect Taxes and Customs (‘CBIC’), on the very next day, came up with a clarification that although the amendment is being given a prospective effect due to technical reasons, but the authorities won’t be making any recoveries so as to give a retrospective effect to the amendment in essence. Prospective or Retrospective? Although CBIC had clarified that the authorities won’t be recovering any dues to give a retrospective effect to the amendment, but the Ministry did not give any indication as to what will happen to the taxpayers who, in light of the ambiguity which was prevalent until very recently, had deposited interest on the gross tax liability. As no guidance was given for such taxpayers, the law remains prospective in nature for these assesses. The Supreme Court, in the case of “Allied Motors v. CIT”, had held that “a proviso which is inserted to remedy unintended consequences and to make the provision workable, a proviso which supplies an obvious omission in the section and is required to be read into the section to give it a reasonable interpretation, requires to be treated as retrospective in operation so that a reasonable interpretation can be given to the section as a whole”. With regards to section 50, the proviso was included to provide a beneficial reading for the taxpayers and avoid the unintended interpretation which goes against their interests, and thus, there is a need for uniform retrospective application of the proviso. The Apex Court, in the case of “Vijay v. State of Maharashtra”, also held that “It is now well-settled that when a literal reading of the provision giving retrospective effect does not produce absurdity or anomaly, the same would not be construed to be only prospective. The negation is not a rigid rule and varies with the intention and purport of the legislature, but to apply it in such a case is a doctrine of fairness”. Imparting a retrospective reading to the beneficial provisions, like the one added by this amendment, would be exigent to avoid multiple litigations and provide hassle-free application of the section. Scope of Section 50 Section 50 is applicable to make good the deprival of the state and not when the state is retaining money to the credit of the assessee. ITC reflects the GST already deposited with the authorities. ITC is a book-entry and section 50 doesn’t envisage levying interest on something which is merely a book-entry. The section monitors cases of delayed payment of taxes for which the assessee is liable. It represents that part of tax which is unpaid. ITC is amassed to the taxpayer on the tax already paid. A right is accrued to the taxpayer when they pay tax on inputs. Moreover, the Supreme Court has previously ruled that interest is the payment to compensate the exchequer for delayed payment of tax. Taking a cue from the reasoning adopted by the Apex Court, it is only fair to hold that no such interest should be paid on loss that the government didn’t suffer in the first place. In such a scenario, it will be manifestly unjust on some taxpayers if the authorities fail to reimburse that amount of interest which was levied on the gross tax liability. Such views have also been upheld in the Madras HC ruling in “M/s. Refex Industries Limited v. Assistant Commissioner of CGST”, wherein it was noted that “The amendment introduced to section 50 is clarificatory in nature and therefore, retrospective”. The Delhi & Orissa High Courts also fortified this line of argument when they stayed a recovery of interest on the gross tax liability. These rulings call

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The Liability of Cab Aggregators in India vis-à-vis their Consumers

Contemporary Issues, Contract Law /

[By Suyash Tiwari and Prakul Khera] Suyash is a student at the Hidayatullah National Law University, Raipur, and Prakul is a student at the Institute of Law Nirma University, Ahmedabad. The reputation of ride-hailing platforms like Uber has been marred with a plethora of cases involving sexual assault and negligence of its drivers. The case in the Indian context is no less different. These platforms are operating under such a regulatory grey area that they easily evade liability for the acts of drivers. The Motor Vehicles (Amendment) Act, 2019 introduced the term aggregator for these platforms which defines them as “digital intermediary or marketplace for a passenger to connect with a driver for the purpose of transportation”. This provision brought such platforms under the purview of the Motor Vehicles Act, 1988. However, the only body of law that governs the employment status of drivers engaged with these platforms is the terms and conditions of these aggregators. These terms and conditions that a user agrees to avail the services of these platforms provide that the drivers are independent third-party contractors and not employees of the company. Since the principle of vicarious liability doesn’t apply to independent contractors,[i] such clauses exempt the liability of these aggregators in case of any mishap. In the current article, the authors advocate for the liability of such aggregators for the acts of drivers.  Control test obsolete in the modern economy Under the control test, the employment status is determined not only through the control of the employer in directing what work is to be done but also through the control exercised over the manner of doing work. [ii]However, In Silver Jubilee Tailoring House v. Chief Inspector of Shops, the Supreme Court of India held that the control test can’t be treated as an exclusive one for distinguishing a ‘contract of service’ from ‘contract for service’ and it would be more reasonable to examine all the factors that constitute the case in hand. It was further opined that it would be unrealistic to apply the test of control in many skilled employments for determining the existence of a master-servant relationship. Therefore this test can’t be treated as a precise one for ascertaining the employment status of the drivers. A progressive test was propounded in Stevenson Jordan and Harrison Ltd. v. Macdonald and Evens. It was held that a person is under a contract of service when the work performed by him is an integral part of the business, whereas the person is under a contract for service when the work is ancillary to the main business. The rationale for using this test is that the functions which constitute a contract of service are the sole source of revenue for a corporation. Since transportation is an integral part of the business and constitutes a major source of revenue, the drivers should be treated as employees of the aggregators Position in other jurisdictions In 2015 a United States District Court for the District of Columbia in Erik Search v. Uber, where the driver had stabbed a rider, made Uber liable to pay damages. The court relied on the apparent agency theory which stems from the so-called duck test. According to this test, “if it walks like a duck, swims like a duck, and quacks like a duck, it’s a duck.” The rationale that stems from this test is that liability can be imputed to the principal if he, through his words whether written or spoken or any other conduct makes a third party believe that he has consented to the acts done on his behalf by the apparent agent. Hence the perception of a third party with respect to the agent’s authority is significant in determining the liability. Therefore, taking into account the way Uber functions, the court held that the riders were under a reasonable belief that the drivers were indeed the employees. Similarly, in Doe v. Uber Techs., Inc., where the driver had raped a consumer, the District Court for the Northern District of California held that drivers were employees and Uber was vicariously liable for their conduct. While holding so, the Court relied on a set of the factual matrix. These include, inter alia, the fact that the drivers can’t negotiate the fares and the same are set by Uber without any input from the driver. Further Uber has the authority to alter the amount being charged from customers if the driver takes a circuitous route. Thirdly, control over customer contact information lies with Uber. The drivers have to accept all rides requests when logged into the application or else they have to face disciplinary actions. Lastly Uber retains the right to terminate drivers at will. In Uber France v. M. A. X, the Court of Cassation (the highest court in France) classified the drivers as employees and not self-employed. The Court laid down a three-limb test to categorize a person as self-employed. Under this test, if the person can build his own client base, fix the tariff to be charged on his own, and set the terms and conditions for providing the service, only then, one can be classified as self-employed. Further, according to the Court, as the drivers were following orders from Uber, there was a relationship of subordination between the Company and the drivers. The High Court of Australia in Hollis v. Vabu Pvt. Ltd. held that persons employed as bicycle couriers by Courier Company under a ‘contract for service’ who owned their bicycles and also bore the expenses of running them, were employees. The court relied on the fact that their uniforms bore the logo of the company which represented to the general public that they were employees. As Lord Peace stated in Imperial Chemical Industries Ltd v Shatwell “the law of vicarious liability has evolved from social convenience and rough justice and not from any clear logical or legal principle.” Therefore, the Indian courts must take into consideration the principles evolved by the foreign courts as they reflect an approach

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