Author name: CBCL

The Fall of Wirecard: Lessons For India’s Fintechs

Leave a Comment / Banking Law, Contemporary Issues /

[By Manvi Khanna] The author is a student at National Law University Odisha, Cuttack. Introduction Technological innovation in the financial sector is transforming the way financial services are provided across the globe. The Indian financial sector is similarly on the cusp of change, as evidenced by the runaway success of the National Payments Corporation of India’s United Payments Interface (UPI) which recently crossed the hundred million user threshold to become the fastest adopted payments system in the world. It is important that this change, which comes with attendant risks, is accompanied by meaningful regulatory intervention, particularly for financial technology companies (fintechs) operating in the payments sphere. Against this backdrop, the recent fall of the once-successful payment processing German fintech, Wirecard AG (Wirecard), has some important lessons for India’s payments regulation. Fall of Wirecard: Factual Background Precipitated by an accounting report, Wirecard’s meteoric collapse saw the firm acknowledge balance sheet fiction and file for insolvency within a short span of two weeks. The multilayered scandal has sent shockwaves through the industry, with implications for all stakeholders. In particular, the German financial regulator, the BaFin, has faced heavy criticism in the aftermath of the scandal for failing to perform its supervisory duties, by ignoring multiple red flags raised against the company. The first raised in 2016 by short-sellers and the second  in 2019 through investigative reports by the Financial Times. Wirecard was one of the world’s leading providers of outsourcing solutions in relation to electronic payments and had a customer base of more than 25,000 across various industries. However, as a fintech that owned a bank, it was not always clear which regulator Wirecard fell under and who was responsible for its supervision– for instance, the BaFin insisted that it was responsible for the oversight of Wirecard’s banking arm and not its payment processing business. Illustrative of the harms of failed regulatory oversight and legal uncertainties, this loophole is being used to pass the blame amongst regulators in an effort to avoid accountability. Complexities in the Current Arrangement The scandal has also highlighted the complexities in regulating hybrid business models or “outsourcing arrangements” that are mushrooming at a pace quicker than the law. Outsourcing is an umbrella term that broadly denotes the practice of regulated financial entities outsourcing some of their functions to third parties, which may or may not be regulated. The frailty of these agreements, caused by interdependence and the severity of repercussions that arise from contractual breach, lead to more worrying issues of effective regulatory scrutiny. It is still unclear where these arrangements fit within the regulatory framework. These regulatory blind spots may pose a challenge to a sound fintech ecosystem. For instance, smaller fintechs outsourced functions such as card issuance to Wirecard, as they lacked the capacity to issue these products on their own. However, the negative experience with Wirecard could be the driving force behind business entities – both fintech and banks–becoming critical of outsourcing their core functions to payment processing fintechs due to the accompanying operational risks, causing great inconvenience as well as damage to the reputation of fintechs in general. There is a lesson here for Indian fintechs: interdependency between entities in a payments value chain as well as outsourced information technology functions are potential sources of vulnerability. It is therefore essential that these interlinked entities adopt resilient operational models, with viable business continuity and contingency plans in place. Indian Fintech Regulatory Framework Unlike traditional banks that have a defined set of regulators and are working directly under the supervision of the Reserve Bank of India, Fintechs are still functioning under a fragmented regulatory regime. The Payment System Participants are regulated by the Payment and Settlement Systems Act, 2007 and the Reserve Bank of India’s Prepaid Payment Instruments (PPIs) – Guidelines for Interoperability, 2018; NPCI Guidelines govern UPI Payments; Payment Banks function under RBI’s Guidelines for licensing of Payment Banks, 2014 and Operating Guidelines for Payment Banks, 2016 and Payment Intermediaries are regulated by RBI Guidelines on Regulation of Payment Aggregators and Payment Getaways, 2020. Additionally, the Anti Money Laundering Regulations and Data Privacy Laws are also applicable to them. In cases where a digital lender in India is licensed as an NBFC, key regulations governing NBFCs in turn become applicable to them. A lot of work is required to be done for providing requisite clarity and assistance to the fintechs in relation to regulatory compliance, which is otherwise complex and unclear. With regard to outsourcing, there is a compliance requirement in form of Guidelines on Outsourcing of Financial Services by Banks, 2006 and RBI Directions on Managing Risks and Code of Conduct in Outsourcing of Financial Services by Non-Banking Financial Companies, 2017 when they outsource their noncore activities and it provides for flexibility so that intervention can be made, however, the law for fintech, licensed neither as banks nor NBFCs is unclear, when they outsource any of their functions The Wirecard collapse demonstrates the dangers firms face that fall between regulatory cracks. It is important for us to tight seal the new laws we are coming up within a way such that the defaulters cannot bypass it. The Way Forward In the wake of the scandal, the UK has revamped rules governing its international payment sector and now requires careful scrutiny before third party providers are selected, in addition to requiring periodic reviews. Moreover, payments providers and e-money issuers in the UK, besides maintaining a record of funds received are also now required to maintain a “safeguarding account” for the customer money.  The rapid advancement of diverse fintech products offered along with the government’s support for digital payments has caused the Indian fintech space to flourish in the last few years. Insofar as regulation is concerned, it is necessary for the law to balance the risks arising from these new fintech entrants, alongside the need for innovation and competition. India does not have a consolidated set of guidelines tailored to fintechs but follows a more generic approach, making it a challenge for companies

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An Insight into SEBI’s Consultation Paper on Minimum Public Shareholding

Leave a Comment / Capital Markets and Securities Law /

[By Abhinav Gupta and Aayush Khandelwal] The authors are students at National Law University, Jodhpur. Introduction The Securities and Exchange Board of India (‘SEBI’) on August 19, 2020, issued a consultation paper to rejig the threshold for minimum public shareholding (‘MPS’) in companies which have undergone a resolution process under the Insolvency and Bankruptcy Code, 2016 (‘IBC’) and seek to relist following the resolution process. To enable MPS compliance, the consultation paper also proposes relaxation in the lock-in requirements of the shareholding of the incoming investor or promoter. In this article, the authors provide an insight into the proposals put forth by SEBI and the rationale behind the same. Further, they undertake an analysis of the viability of the options so suggested by the SEBI. Existing Norms Governing MPS and Lock-In Requirements for Such Companies Every listed company has to maintain a minimum of twenty-five percent public shareholding as mandated by Rule 19A(1) of the Securities Contracts (Regulations) Rules, 1957 (‘SCRR’). This mandate is known as the ‘public float’ rule. SEBI vide an amendment in 2018 allowed buyer in a resolution plan to acquire more than seventy-five percent of shares in a company which is otherwise restricted due to the ‘public float’ rule (see Regulation 3(2) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011). However, as per rule 19A(5) of the SCRR, a company has to increase the public shareholding to twenty-five percent within three years if the public shareholding falls below twenty-five percent but is above ten percent, pursuant to the implementation of a resolution plan under the IBC. The rule further provides that if the public shareholding falls below ten percent then it must be increased to at least ten percent within eighteen months from the date of such fall. Further, the preferential issue of equity shares in terms of resolution plan approved under the IBC is exempted from complying with the provisions of Chapter V of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’). The only condition applicable is the lock-in period of one year (see Regulation 167(4) of the ICDR Regulations). This lock-in period implies that the shares issued pursuant to the resolution process cannot be sold by the shareholder for a period of one year from the date of trading approval. Proposals by SEBI SEBI has proposed the following suggestions in the consultation paper. Changing the period to achieve MPS: SEBI has suggested three options to rejig the threshold for MPS: Companies may be mandated to increase the public shareholding to ten percent within six months against the existing duration of eighteen months. They must increase the public shareholding to twenty-five percent within three years. Companies may be required to have at least five percent public shareholding at the time of relisting. They must increase the public shareholding to ten percent within twelve months, and twenty-five percent in the next twenty-four months. Companies may be required to have at least ten percent public shareholding at the time of relisting. They must increase the public shareholding to twenty-five percent within three years. Relaxation of the lock-in period: Another proposal by SEBI is to dilute the lock-in period requirement for the incoming investors. The rationale behind removing the period is that the lock-in period of one year on the equity shares of the incoming investor restricts the dilution of shares to comply with MPS norms. However, the relaxation of the lock-in requirement shall only to the extent which enables MPS compliance. Disclosures pursuant to the approval of the resolution plan: The consultation paper also proposes a standardized reporting framework pursuant to the approval of the resolution plan under the IBC. The proposed disclosure will incorporate detailed pre and post shareholding patterns, details of funds infused, creditors paid-off, additional liability on the incoming investors, the impact of the resolution plan on the existing shareholders, etc. Under the current provisions, the company is required to disclose only the salient features of the resolution plan approved under the IBC. SEBI is of the view that such additional disclosures may aid the public shareholders in the price discovery mechanism on re-listing of shares. An Analysis of the Proposals by SEBI Various relaxations to companies that have undergone the resolution process were given to facilitate the effective and timely resolution of the listed companies. The significant change in management during resolution proceedings prompted the regulator to ease certain norms and provide a suitable framework for compliance with securities law. However, such relaxations may sometime prove to be counterintuitive. For instance, the relaxation in the public float rule may lead to extremely low public shareholding which can be seen in the case of Ruchi Soya Industries Ltd. Post-resolution the public shareholding in Ruchi Soya Industries came down to a meager 0.97% and the share prices saw an increase of 8764% (from INR 17 to INR 1519). Such a low public shareholding raises concerns with respect to fairness and transparency, price manipulation, and the requirement of increased surveillance measures. Moreover, if a certain limited set of people hold most of the shares it would lead to manipulation or perpetration of other unethical activities in the securities market and limited participation in trading of shares resulting in demand and supply gap. This aligns with the observation of SEBI in the matter of E-land Apparel Ltd. that, “a dispersed shareholding structure is essential for the sustenance of a continuous market for listed securities to provide liquidity to the investors and to discover fair prices.” According to SEBI, these concerns can be tackled only after a minimum of ten percent of shares of a company are held by the public. For this reason, the regulator intends to lower down the relaxation period provided to achieve MPS. However, in our opinion, reducing the period to achieve MPS is concerning and poses a wide array of issues. The manner in which companies can achieve MPS is complex procedures. It may take time to issue shares to the public while complying with

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Extension of Limitation Period Under IBC: A Creditor’s Dilemma

Leave a Comment / Insolvency Law /

[By Prashansa M. Agrawal] The author is an Advocate practicing in the High Court of Bombay. Recently, in the judgment dated 14th August 2020 in Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries Pvt. Ltd. & Anr., the Supreme Court decided that the application filed by the financial creditor therein was not barred by limitation. While pronouncing the decision, the Supreme Court reasserted the settled aspects of limitation under the Insolvency and Bankruptcy Code, 2016 (“the Code”) in reference to its earlier landmark judgments. At the same time, the Supreme Court touched upon a slightly different and disputed position with respect to the applicability of Section 18 of the Limitation Act to the Code― which has come up before the Supreme Court for the first in the instant case. In this article, the author analyses the landmark judgments on the limitation period under the Code along with a few disputed judgments on Section 18, in order to assess the stand of the Supreme Court in the instant case. Background The legislature sought to answer the ever-looming question of ‘limitation’ under the Insolvency and Bankruptcy Code, 2016 (“the Code”) by incorporating Section 238A in the Code by way of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 which applies provisions of the Limitation Act (“the Act”) to the proceedings before National Company Law Tribunal (“NCLT”) and National Company Law Appellate Tribunal (“NCLAT”) Consequently, the question of retrospective application of Section 238A arose before the Supreme Court in B.K. Educational Services Private Limited v.Parag Gupta and Associates. The Apex Court held that limitation provisions were applicable to the Code from its very inception. Therefore, it was construed that Section 238A only clarifies the said position and is applicable retrospectively. Thus, as per the judgment in B.K. Education(supra), the right to sue accrues when the default occurs, which lasts for three years to be computed from the date of default. After the said period, an application under the Code would be barred under Article 137 of the Act except when the delay is explained and condoned as per Article 5. However, there arose ambiguities with regard to other ways of extending the prescribed limitation period of three years. One such ambiguity relates to the applicability of Section 18 of the Act to the Code which came for consideration before the Apex Court in the case of Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries Pvt. Ltd. & Anr. As per Section 18, when a party against whom a property or right is being claimed acknowledges the liability during the subsistence of the limitation period prescribed for a suit or application in respect of such property or right i.e. 3 years under the Code, a fresh period of limitation shall be computed from the date of such acknowledgment. The contention, ‘Whether or not Section 18 pushes the date of default under the Code’ has been addressed in a few judgments over the years as provided below- Prior to the Instant Case In Fernas Construction India Pvt. Ltd. v. RVR Projects Pvt. Ltd., the National Company Law Appellate Tribunal (“NCLAT”) held that Section 18 in Part I of the Act would not apply to an application under the Code as such an application is neither a suit nor can be regarded as a recovery proceeding. Thereafter in Jignesh Shah & Anr. v. Union of India & Anr., the question before the Supreme Court was whether a prior suit for recovery extends the limitation period for filing a subsequent winding-up petition. The Supreme Court answered the aforementioned in negative and remarked that the limitation period can only be extended by the provisions under the Limitation Act such as by way of Section 18 of the Act. Relying on the aforementioned judgment of the Supreme Court, the NCLAT in Sh G. Eswara Rao v.. Stressed Assets Stabilisation Fund and Others held that the period of limitation under the Code commences from the date of default and this date of default can be forwarded to a future date only under Section 18 of the Act. In light of the judgments in Jignesh Shah (supra) and Sh. G Eswara Rao (supra), the financial creditor in the instant case argued the applicability of Section 18 which was not accepted by the Supreme Court as explained below. Obiter Dictum of the Instant Case The Supreme Court clarified that the illustrative reference to Section 18 in Jignesh Shah(supra) was only with respect to suits or other proceedings, wherever it could apply. It further emphasized that the said observations in Jignesh Shah (supra) do not alter the settled position in B.K. Education(supra) i.e. an application under Section 7 (i.e. by a financial creditor) under the Code is time-barred after 3 years from the date of default except when the delay is condoned under Article 5. The Supreme Court further observed that even while assuming that Section 18 is, in fact, applicable for extension of the limitation period for an application under the Code, the same would not come to the rescue of the applicant creditor in the instant case as no suggestion of any acknowledgment as required under Section 18 has been made. It was thus observed that limitation is a mixed question of fact and law which requires the pleader to produce the necessary facts and evidence in order to argue that a particular provision is applicable to extend the prescribed limitation period. In light of the above observations, the Supreme Court decided that the application filed by the financial creditor was barred by limitation. Conclusion and Analysis The instant case certainly creates a doubtful situation around the applicability of Section 18 to the Code, causing dilemma to a number of creditors. In order to understand the position of Section 18 vis-a-vis an application under the Code, it is imperative to note that the phrase ‘suits or applications’ appears under Section 18, as opposed to Article 62 of the Act relating to mortgages which only contains the word ‘suits’ and

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Remedies available to the Creditor against Guarantors under IBC

Leave a Comment / Insolvency Law /

[By Amay Bahri] The author is a student at the National Law University, Delhi. Like any new legislation which is introduced, even the Insolvency and Bankruptcy Code 2016 (hereinafter ‘IBC’ or ‘the code’) has been marred by litigation since its inception. One of the more recent discussions on IBC is regarding the power of the creditor against guarantors of a corporate debtor. This discussion becomes all the more relevant after the introduction of new rules and regulations for governing the insolvency of personal guarantors. These new rules and regulations allow the creditor to initiate insolvency proceedings against the personal guarantor, however, there are still unresolved issues regarding the powers of the creditor to have legal recourse against the guarantor when the principal debtor is unable to pay debts. To iron out these unresolved issues, we refer to the already established precedents relating to corporate guarantors. Though corporate and personal guarantors are different to the extent of their liability, there appears to be no distinction or any reason for the distinction in their treatment within the code; thus the developed jurisprudence surrounding the rights against corporate guarantors can be applied to the personal guarantor. One of the objectives mentioned in the preamble to the Insolvency and Bankruptcy Code is that the code seeks to balance of interest of stakeholders. The code marks a paradigm shift from a regime of unaccountable corporates to adopting a realistic approach where commercially unviable companies would close shop. Upon such shift, the code has adopted a creditor centric approach, wherein wide powers to institute the insolvency proceedings are vested with the creditors. The concept of a guarantee is rooted in the Indian Contract Act, thus the powers of the creditor under IBC are to be exercised keeping in mind the principles of guarantee under the Indian Contract Act. There are two distinct issues that arise here, first regarding the power of the creditor to recover after acceptance of the resolution plan; and second regarding the power of the creditor to proceed against the guarantor when insolvency proceedings against corporate debtor have been initiated but the resolution plan has not been accepted. Against this backdrop, the author seeks to discuss the recovery mechanisms available to the creditor against the guarantor a) after the acceptance of the resolution plan and b) when the corporate debtor is under CIRP. The author shall then provide his own conclusion as to the flaws in the recovery mechanism and the way forward. Power of the creditor to recover after Acceptance of Resolution Plan According to the IBC, the acceptance of the resolution plan by the Committee of Creditors (CoC) and approval of the same by the adjudicatory body brings the insolvency proceedings to an end. As per section 31 of the IBC, such an accepted resolution plan determines the full and final liability of the principal debtor. The IBC does not directly deal with the liabilities of a guarantor; neither does it bar the creditor to institute proceedings against the guarantor of the debt. Guarantors seek to protect themselves from the claims of recovery of debt amount by applying the provisions of the Indian Contract Act. These provisions are Section 133 and 134 of the Indian Contract Act. Section 133 provides that a surety is discharged of the debt if there is variance in the terms of the contract without the consent of the surety. The resolution plan can be seen as a variance of terms without the consent of the guarantor, thus the guarantor should be absolved from its liability. However, section 31(1) of the IBC makes the resolution binding on the guarantor, thus countering such claims of the guarantor and making the guarantor liable to bear the liability. Turning to section 134 of the Contract Act, the provision provides that any act which relieves the principal debtor of its obligation to pay will also discharge the surety of its obligation for such a debt. Applying section 134 would be erroneous since a crucial ingredient to satisfy the requirements of this section is that the agreement to discharge the principal debtor of the debt was reached through their own volition and not due to any operation of law. By approval of the resolution plan, the corporate debtor is discharged of its obligations to make a payment, but this discharge is due to the application of the law. Since the crux of section 134 is not satisfied, the said section cannot be invoked to discharge the guarantor of their obligation to pay. Hence, the guarantor is bound to pay the unpaid amount of debt, after the acceptance of the resolution plan and the creditor can take legal actions against the guarantor. One complication that arises out of this arrangement is whether the right to subrogation survives after acceptance of the resolution plan. This was answered in negative, in the case of Essar Steel case but this does not seem to be the final position of law. The right to subrogation would entitle the guarantor to recover the amount of debt paid to the creditor as the guarantor would then step into the shoes of the creditor to claim the amount paid. The holding of Essar Steel is a huge blow to the rights of the guarantor as the judgment has done away with a right to subrogation, which is not only a statutory right under the Indian Contract Act, but also a principle of natural justice. Considering this decision not only impacts the inherent rights of guarantors, but also has adverse impacts on the market economy; the decision of Essar Steel relegating subrogation right requires reconsideration. Power of the creditor to proceed against the guarantor when the debtor is under CIRP As per the Indian Contract Act, the liability of a guarantor and that of the principal debtor are co-extensive, thus a creditor is not obligated to expend the legal remedies against the principal debtor before making a claim against the guarantor and can sue either of them for the debt

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CCI’s Search For A Uniform Standard of Forming a Prima Facie Violation

Leave a Comment / Competition Law /

[By Mahima Chhabrani] The author is a student at West Bengal National University of Juridical Sciences, Kolkata (WBNUJS). Introduction Section 26(1) of the Competition Act, 2002 (hereinafter Act) confers power on the Competition Commission of India (hereinafter CCI) to order an investigation when it finds prima facie contravention of the Act. The said investigation is in no way final but a mere departmental inquiry to dig deeper into the case.[i] Furthermore, before passing the order of investigation to the Director-General (hereinafter DG), the CCI, in most cases, relies on the information produced by the Informant in forming a prima facie opinion.  The aim of this article is to determine who has a duty to discharge the burden of proof, the Informant, or the Respondent, analyzing whether CCI has adopted a uniform standard of proof to determine prima facie violation. Standard of Proof of ‘Prima Facie’ Violation In this part of the article, the author has analyzed the approach of CCI in placing its reliance on the evidence to direct an investigation or close the case that comes before it, under section 26(1) and 26(2) of the Act respectively. It is well settled that on receiving information and documents from the Informant, the CCI cannot evaluate and analyze the evidence on its merit.[ii] This can only be done after the DG submits a detailed report of investigation to the CCI.[iii] Therefore, it is imperative to understand the concept of a prima facie violation and the procedure by which the CCI evaluates complaints. An Appellate Tribunal gave an important ruling in the case of Reprographic India vs. CCI[iv] where it was held that it is necessary for the Informant to “…demonstrate substance in the allegations…” in order to initiate an investigation and that hurling bald accusations would not fall within the ambit of a prima facie violation.[v] The interpretation of this ruling makes it clear that the burden of proof lies on the Informant at this initial stage. In another case of Maruti Suzuki,[vi] the CCI took an opposite view in which an anonymous mail was sent to CCI alleging Maruti Suzuki’s involvement in anti-competitive practices.[vii] The CCI took a suo moto cognizance and thereby shifted the burden of proof on the OP for its failure to mention the reasons for the imposition of penalties only for the violation of guidelines.[viii] A plain reading of the above two cases in conjunction suggests that CCI has a divergent approach in forming a prima facie opinion. Although the Reprographic India case was in the right direction, the ruling does not explain what this ‘discharging of proof’ and ‘substance in the allegations’ by the Informants mean. The lacunae in the ruling of the Reprographic India[ix] case can be seen to be carried forward in a recent case of Delhi Vyapar[x] that came before the CCI. In this case, the Informant alleged contravention of section 3(4) read with section 3(1) of the Act. In order to find out a prima facie existence of vertical agreements between the MNCs (Amazon and Flipkart) with their affiliated traders respectively, CCI relied on the screenshots of the SMSes adduced by the Informant and on that basis, it launched an investigation against Amazon. It did not give an opportunity to Amazon to present its objections against the evidence produced by the Informant. It is surprising that Amazon filed a suit in the Karnataka High Court and claimed that the subject matter in the SMSes is not mobile phones as alleged by the Informant but fitness equipment.[xi] When such an objection related to the veracity of the subject matter of the evidence is raised by the OP, it raises some serious doubts about the mechanism adopted by the CCI in basing its reliance on the information given by the Informant. This case, prima facie, required an in-depth assessment and screening process for the evidence provided. This screening was regarding the veracity of the adduced evidence by the Informant which is well within the power of the CCI, therefore the CCI could go into the merits of the evidence. It is indicative of the fact that there needs to be a standard mechanism that CCI should be mandated to rely on to determine the prima facie violation of the provisions of the Act. Another noteworthy point is that in the case of All India Online Vendors Association[xii], the complaint was filed on similar grounds, but the CCI did not find any prima violation, hence closed the matter under 26(2). In this case, the CCI took a very lenient approach while closing the matter by stating the reason that the e-commerce ecosystem was a nascent area that is still developing against a more aggressive stance as was seen in the Delhi Vyapar[xiii] case. In this case, the CCI closed the matter without stating the substance in the allegation and the reasons for finding a prima facie case. Stating the reasons briefly regarding the reliance on the evidence before ordering an investigation is a ‘sine qua non’ under section 19  and 26 of the Act as it shows a careful application of ‘judicial mind’ by the CCI.[xiv] The ruling of Reprographic India[xv] case was not applied in the case at hand. These deviations in approaches raise doubts in the methodology and process by which CCI looks into the complaints. Therefore, it is imperative that to avoid such contradictions in the stance taken by the CCI, the term ‘substantiated allegations’ be defined. Once this term is defined, a certain level of uniformity in the process of filtering the evidence and relying on it while screening a complaint received by an Informant. This becomes a very crucial step as this step is the deciding factor in forming a prima facie for investigation. This will further help fix the problem discussed above that arose in cases where complaints in two different cases were filed on similar grounds. However, CCI took two completely different unjustified stances. Conclusion From the above discussion, it is clear that CCI has not

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Applicability of the Penalty Doctrine to Primary Obligations – an Indian Perspective

Leave a Comment / Contract Law /

[By Tvishi Pant and Alefiyah Shipchandler] Tvishi is a student at ILS Law College, Pune and Alefiyah is an associate at Keystone Partners, Mumbai. Introduction Contract law allows parties to stipulate a certain sum payable upon breach of a contract. Section 74 (“S. 74”) of the Indian Contract Act, 1872 (the “Act”) provides for the payment of liquidated damages by a defaulting party upon breach of contract. Although the law surrounding the parameters of S. 74 is largely settled, there remain slight uncertainties in the scope of its applicability to scenarios where there has been no breach of contract. Background – The Penalty Doctrine The ‘penalty doctrine’ has its origin in equity. Broadly stated, it suggests that a clause providing for payment of a sum of money upon breach of contract may be unenforceable if it goes so far beyond the measure of compensation that it appears to be a penalty. The basic understanding of this doctrine has its roots in the case of Dunlop Pneumatic. This judgment laid down that if a particular sum is payable upon the breach of a contract, it would be regarded as a penalty if it “exceeds what can be regarded as a genuine pre-estimate of the damage likely to be caused by the breach”. The penalty doctrine, thus, resulted in the formulation of a fundamental distinction between a ‘penalty’ and a ‘genuine and reasonable pre-estimate of damages’. Where an amount is named in a contract as liquidated damages, the party complaining of a breach will be entitled to receive a liquidated amount of reasonable compensation,      provided it is a genuine pre-estimate of damages. In other cases, only reasonable compensation will become payable which will not exceed the liquidated amount so stated. The Supreme Court of India has time and again interpreted S. 74 of the Act in line with the aforementioned formulation of the penalty doctrine, and hence has allowed liquidated sums to be taken into consideration as the measure of reasonable compensation, where it is not in the nature of a penalty. Application of S. 74 in Non- Breaches A pertinent question which has time and again arisen, and largely remains unanswered, is whether such relief against unreasonable penalty clauses will be available to parties even where the event triggering the penalty is not a breach of contract. Contractual clauses contemplating both scenarios, by way of illustration, are as under: Clause A – Occurrence of a breach “We agree to pay for ABC Ltd. a sum of Rs. 100/-. for each and every product, good or item sold or offered in breach of this agreement, as and by way of liquidated damages and not as a penalty.” Clause B – Occurrence of an event other than a breach “If you request a withdrawal or payment from your account which would overdraw your account, XYZ Bank may allow the withdrawal or payment to be made on the condition that  Rs. 50,000/- may be charged for XYZ Bank agreeing to honor the transaction which resulted in the overdrawn amount. This amount will be debited to your account.” As is evident from the heading of S. 74, it is certainly attracted to Clause A, which contemplates a breach. It is, thus, necessary to assess the viability of extending its scope to deal with events other than breaches as well, such as Clause B. Application of the Doctrine in Foreign Jurisdictions Australia Up until 2015, Australian Courts had held that the penalty doctrine was limited to stipulations that were triggered on breaches of contract. However, in 2015, the  Andrews case marked a significant departure from this law. The Court reasoned that historically, the “conditions” that triggered payment of a sum were not always breaches of existing contractual obligations. It was essentially held that the penalty doctrine was not limited in application to stipulations involving breaches of contract and that the event that triggered payment need not be restricted to a breach, in order to assess its position under the penalty doctrine. This judgment was affirmed by the Australian High Court in 2016, in Paciocco. It is arguable that such an approach opens doors to an uncontrollably wide jurisdiction over contractual freedom and autonomy, by which simple matters of commercial prudence (or even lack thereof) fall within the purview of judicial inspection. United Kingdom The position in the United Kingdom has largely remained unchanged. One of the first few cases dealing with this question was Export Credits, where it was held that it has never been for the Court to relieve a party from the consequences of what may prove to be an onerous or commercially imprudent bargain. In 2015, the Supreme Court’s judgment in Cavendish made a very important distinction between ‘primary obligations’ and ‘secondary/ accessory obligations’ for the purposes of determining whether the penalty doctrine applied where there has been no breach of contract. The Court held that, “The penalty rule regulates only the remedies available for breach of a party’s primary obligations, not the primary obligations themselves.”[i] While the Court did not categorically lay down the difference between such ‘primary’ and ‘secondary’ obligations, it appears to have proceeded on the assumption that a ‘primary’ obligation is one which is fundamental to the performance of a contract, and that the breach of such ‘primary’ obligation will give rise to a ‘secondary’ obligation to pay a certain amount to the innocent party as and by way of relief. The Court thus held that, “This means that in some cases the application of the penalty rule may depend on how the relevant obligation is framed in the instrument, i.e., whether it is mentioned as a conditional primary obligation or a secondary obligation providing a contractual alternative to damages at law. Thus, where a contract contains an obligation on one party to perform an act, and also provides that, if he does not perform it, he will pay the other party a specified sum of money, the obligation to pay the specified sum is a secondary obligation

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The Desideratum of Synergizing Competition Law with Consumer Protection: ACCC v. Kogan

Leave a Comment / Competition Law, Contemporary Issues /

[By Naman Katyal] The author is a student at Gujarat National Law University. In an interesting decision, the Federal Court of Australia in Australian Competition and Consumer Commission v. Kogan Australia Pty Ltd (17 July 2020) has ruled that the act of inflating product prices prior to a sales promotion constituted misleading and deceptive conduct. This ruling comes against the backdrop of the Australian Competition and Consumer Commission’s (‘The ACCC’) finding that Kogan Australia Pvt. Ltd. (‘Kogan’), an Australian e-retailer was engaged in making false representations about a discount promotion in 2018. Consequently, the ACCC instituted proceedings against Kogan in the Federal Court for misleading consumers in contravention of the Australian Consumer Law, Schedule 2 to the Competition and Consumer Act, 2010. In this article, the author provides an analytical account of the aforementioned judgment. Further, the author argues that unfair trade practices such as the one discussed above, not only violate consumer rights but also have an adverse bearing on the competition in the market. Additionally, it is argued that the absence of a unified consumer and competition law regulator in India, which practice is a departure from the established practice of incorporating a unified regulator followed in other major jurisdictions, does little good for consumer welfare, the endmost goal of both, competition law and consumer law. Factual Matrix Kogan, the respondent, carried out an online sales promotion in 2018, offering a 10% discount on prices of listed products for consumers who entered a previously advertised promotion code at checkout. However, 621 of the 78,111 listed products (‘affected products’) saw a price increase a day prior to the commencement of the sale, in many cases by at least 10%, and a subsequent price decrease two days after the end of the sale, in many cases by at least 10%. This practice according to the ACCC constituted a violation of sections 18(1) and 29(1)(i) of the Australian Consumer Law, Schedule 2 to the Competition and Consumer Act, 2010 which proscribe the adoption of misleading or deceptive trade practices. To reason its submissions, the ACCC relied on the representations made by Kogan in the course of advertising the sale. According to the ACCC, the representations conveyed that a consumer who purchased an affected product using the advertised code during the sale period would receive a 10% discount on the price at which that product was previously offered or would be offered for sale in the future. However, contrary to the representation, a consumer who purchased an affected product using the advertised code did not receive a 10% discount off the price at which that product was available for sale for a reasonable time before and after the promotion. On the other side, Kogan’s defense predominantly rested on lamenting the “reasonable period” approach adopted by the ACCC. Per this approach, the ACCC fixed a two-week time period before and after the sales promotion for comparing the prices of the affected products to gauge the extent of variation in product prices. This approach according to Kogan was arbitrary and unsupported by evidence. Further, Kogan maintained that by representing that a consumer who applies the advertised code would receive a 10% discount off the listed prices, it conveyed that the 10% discount would be applicable to the current advertised price of the product and not a price which was previously offered. The Decision The context in which Kogan made the promotional statements was the foundational issue addressed by the Federal Court. The genesis of this issue was a result of Kogan’s contention that the offered discount ought to be considered on the price available at checkout and not a price that was offered prior to or after the sales promotion. According to the court, the promotional statements relied upon by Kogan to advertise the promotion made the ordinary and reasonable member of the relevant consumer class to conclude that the current advertised price was the price at which the product had been available for sale before the promotion. Consequently, any discount made available would be over and above the price at which the product had been available for sale before the promotion. Further, the court also observed that the promotion was time-specific and therefore, it was evident that the consumers would have understood that there was a limited opportunity to obtain the reduced price and the prices would not decrease during a reasonable period after the end of the sale. On Kogan’s contentions concerning the ACCC’s definition of “reasonable period”, the court ruled that the two-week time period before and after the sales promotion adopted by the ACCC was reasonable and well-reasoned. The court also noted that the object behind delineating a fixed period was only to capture the expectations of reasonable consumers that a reduction in prices be a genuine reduction, from the price at which products were available for sale before the promotion. Finally, on the question, whether the representations made by Kogan were false or misleading, the court rejected Kogan’s defence that ACCC’s case was based on a “de minimis product set” and it ought to be rejected since the affected products constituted a mere 0.8% of the 78,111 products on the Kogan website. The court observed that the fact there may have been a genuine discount obtained by a large number of the target audience consumers did not gainsay that the representations were false or misleading. Analysis The Competition Commission of India (‘CCI’) although has been vested with the duty to protect the interests of the consumers along with eliminating practices having an appreciable adverse effect on competition (‘AAEC’) under section 18 of the Competition Act but the focus of the commission has largely been on the latter. Two justifications look plausible behind the embracement of this policy path. Firstly, the term “protect the interests of the consumers” can be subjected to wide interpretations to even include consumer law issues having a nugatory effect on competition in the market. A more proactive approach concerning consumer law violations could open flood

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Private International Law: Bombay HC Delineates its Scope in International Tax Matters

Leave a Comment / Uncategorized /

[By Kajal Singh and Nikunj Maheshwar] The authors are students at Institute of Law, Nirma University. Introduction In the backdrop of divergent national laws and broadly worded treaties, Private International Law (PIL) helps in deciding the choice of law, jurisdiction and enforcement of judgements between the sovereign states.[i] While the application of PIL in matters concerning family and property have attained some certainty, the world at large remains divided on its application in matters concerning tax and revenue.[ii] Axiomatically, because tax laws vary in accordance with disparate interests of countries and wherein domestic courts are vested with exclusive jurisdiction to decide matters pertaining to them. Recently, the Bombay High Court (HC) in the case of Aberdeen Asia Pacific Including Japan Equity Fund v. Deputy Commissioner of Income Tax[iii] (Aberdeen) was to decide the applicability of PIL to an international tax matter. The HC opined that in absence of any deeming fiction in the Indian Income Tax Act, 1961 (the ITA) the principles of PIL will apply in determining the status of the foreign entity and its liability under the ITA. The authors in the subsequent discussion will analyse the judgement and highlight its significance in the realm of international tax matters. Facts of the Case In 2010, Aberdeen Delaware Business Trust (Trust), which had been incorporated in accordance with laws of Delaware, USA converted into Aberdeen Institutional Commingled Funds LLC (AICFL), a limited liability company (LLC). As a sequitur, all its sub-trusts also converted into sub-funds or series of AICFL. The Delaware laws provided that any trust may be converted into an LLC and on such conversion, only the legal status of the entity will change. Further, for all other purposes, it will be treated as the erstwhile trust. Post reorganization, the sub-funds decided to carry forward the losses which were incurred by the sub-trusts prior to the conversion. Pertinently, the ITA provides for carry forward of losses subject to certain conditions in cases wherein the company undergoes a change in its legal form. However, the ITA has no specific provision which speaks of the taxability of a trust converted into an LLC. Subsequently, seeking clarification on whether the sub-funds created post-conversion can carry forward the losses incurred by sub-trusts, AICFL filed an application before the Authority of Advance Ruling (AAR). The AAR observed that the sub-funds will not be allowed to carry forward the losses. Pursuant to the AAR’s ruling, AICFL appealed before the HC. The HC rejected the petition on technical grounds but on the substantive issue held that the reorganization (para 21) of the trust shall be dealt in accordance with the laws of Delaware. Despite this observation of the HC, the tax department, under section 148 of the ITA, initiated reassessment proceeding against the sub-funds. Consequently, the sub-funds challenged these proceedings before the HC. Arguments and the Judgment Revenue authorities argued that AICFL was never an assessee in India and the erstwhile trust has ceased to exist. Unlike in Delaware, an entity’s change in its legal form will lead to the formation of a new entity in India. Accordingly, the new entity so formed will be allotted a different PAN number. Thus, losses incurred by the sub-trusts cannot be allowed to be carried forward in the name of a new entity. Additionally, under section 70 of ITA, only an assessee who has previously filed an income tax return in India is allowed to carry forward its losses. Essentially, AICFL is a new entity formed and has never filed an income tax return in India and thus, in accordance with section 70 is disallowed to carry forward the losses. Per contra, the petitioners argued that in absence of any deeming fiction in Indian law which speaks of the taxability of such a conversion, the same should be determined in accordance with the principle of lex domicilii, i.e. the law of the country or place where the trust was incorporated. Thus, since the trust was incorporated, in accordance with the laws of Delaware the conversion is essentially a change in its status and not the formation of a new entity. The HC adverting to the argument of lex domicilii followed the lead of the Supreme Court (SC) in the case of Technip SA v. SMS Holdings[iv] (Technip SA), upheld the application of the principle and passed confirmed that the LLC will be treated as the erstwhile trust and would thus, be allowed to carry forward its losses. Analysis The Supreme Court of UK in the case of Kuwait Airways Corporation v Iraqi Airways Co[v] (Kuwait Airways) opined that in cases involving foreign elements and parties, more weightage must be accorded to the laws of another country irrespective of them being different from the laws of the forum court. To appreciate the judgments, it is relevant to revisit the case of Technip SA, wherein the jurisprudence laid in Kuwait Airways was made the law of the land. In the instant matter, Technip, a French company acquired control over another French company, Coflexip which had under its control Seamec, a listed Indian company. The SC was to decide whether Indian or French law will apply in determining the date on which Technip acquired control of Seamec. The SC held that as per PIL, the question of legal status must be determined according to the law of the land, where the entity/person was incorporated unless it is contrary to public policy. Elaborating upon the same, the court held that merely because laws of two sovereign states are different will not make them ipso facto contrary to public policy; rather they will have to be tested on the touchstone of morality and justice. Adverting to another ruling of M/s Citicorp trustee Company Ltd. v. Commissioner[vi] were in the AAR, was to determine the taxability of a UK based trust that converted into a company. It observed that neither the Indian tax laws nor the Double Tax Avoidance Agreement between India and the UK discussed about the taxability of entities in event

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Scope of Settlement Agreement Under IBC: Elucidating The Fate of Corporation in the Pandemic

Leave a Comment / Insolvency Law /

[By Jyotiranjan Mallick and Sai Akanksh Deekonda] The authors are students at the National Law Institute University, Bhopal. Introduction The current Pandemic has affected the economy by disrupting the demand and supply chain. It has exacerbated the situation by bringing financial institutions on its knees, owing to the increase in non-performing assets, and default by corporations. Policies are being introduced around the world to protect the state of the economy. It includes “reducing the interest rates” or by introducing “economic stimulus” to balance the economic disruption. The Government of India introduced the ‘Aatmanirbhar’ plan under which it has proposed Rs. 3 lakh crores Collateral-free Automatic Loans for Businesses, including Medium and Small Enterprises. Further, to protect corporations, from facing the brunt of unnecessary liquidation, the government, introduced the Insolvency and Bankruptcy Code (“I&B Code”) Amendment Ordinance, 2020, through which, it has suspended the initiation of the Corporate Insolvency Resolution Process (“CIRP”) for all defaults under section 7, 8, and 9 of I&B Code for 6 months, after 25th March 2020. In a step further, National Company Law Appellate Tribunal (“NCLAT”) in Vivek Bansal v. Burda Druck Pvt Ltd, has allowed the parties, to exit the CIRP midway, and settle through an agreement. This comes as a relief for corporate debtors, who are already in the process of resolution. In this article, we will analyse whether broadening the scope of a settlement agreement is favourable in the current crisis, and what changes can be implemented to further improve the process. A Brief Look at the Case The CIRP was initiated by an operational creditor, Vivek Bansal. The National Company Law Tribunal (“NCLT”) New Delhi Bench, in its order, appointed an Interim Resolution Professional (“IRP”) and a moratorium was imposed on the corporate debtor, However, after the order, the parties settled their dispute through an agreement, and an appeal was filed to NCLAT by Bansal, to allow them to exit the CIRP so that they can act upon the settlement. The NCLAT using its inherent power under Rule 11 of NCLAT Rules 2016 (“Rule-I”) set aside the order of NCLT and permitted the parties to exit the CIRP. Background of ‘settlement agreement under I&B Code’ To settle through an agreement, the parties first have to withdraw their application filed before the adjudicating authority, under Rule 8 of The Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 (“Rule-II”). However, during the initial phase of the enactment of the I&B Code, the scope of the settlement was highly limited, as Rule 8  of Rule-II, only permits the withdrawal of application before its admission to the NCLT. Ergo, if parties wanted to settle after the admission of the application, the NCLT used to apply Rule 8 and discard such settlement. As a result, appeals started mounting in the Supreme Court, to provide the requisite relief. In Lokhandwala Kataria Limited v. Nisus Finance Managers LLP, the apex court refused to interfere with the decision of NCLAT where it rejected the settlement reached between the parties after the application has been admitted by the NCLT. The NCLAT here refused to use its inherent powers under Rule 11 of Rule-1since the same wasn’t adopted for the I&B Code. Following this, the Apex court in Uttara Foods Pvt Ltd. v. Mona Parachem directed the competent authority to make changes in the code through which the NCLT/NCLAT may allow such settlement, which would restrict unnecessary appeal filed before the Apex court. The Insolvency Law Committee discussed this issue; following which section 12 A was inserted in the code, by IBC (Second Amendment) Act, 2018. Section 12 A gives the power to the adjudicating authority to allow such settlement when it gets the support of at least 90% voting share of the Committee of Creditors (“COC”). In Swiss Ribbons v. Union of India, the apex court observed that even if CoC hasn’t been constituted, the NCLAT may allow the settlement agreement using its inherent power under Rule 11 of the Rule-I. Hence, this judgment extended the scope of inherent powers under Rule 11 to matters under the I&B Code.  The NCLAT in the Vivek Bansal’s case allowed the settlement following this observation in Swiss Ribbons. What Makes the Settlement Agreement Favorable in the Current Crisis Since the inception of the I&B Code, a huge chunk of cases is still pending for resolution. The average time taken for the resolution of completed cases took around 375 days, which is way more than 330 days limit as set by the code. The delay in results and monetary loss makes alternatives like settlement a suitable option. The pandemic has caused India’s economic growth and activities to shrink by 45%., this has made the scope of settlement even more favorable. To understand this, one has to look at the recovery mechanism under CIRP. If a corporate debtor defaults, then CIRP can be initiated. In case, a corporate debtor fails to pay the debt, then the company is either restructured by taking over its management or is liquidated. However, due to the economic turmoil, it is neither beneficial for the creditors to take over the management of the company, as businesses are in complete distress, nor the current market is favorable for liquidation which is considered to be the last resort under I&B Code. As a result, creditors are resorting to settlement. The IBC ordinance 2020, has suspended the initiation of CIRP for any default after 25th March for 6 months. This means that CIRP cannot be initiated, for any default by a corporation within this period. The implication would make it more favorable, even for financial creditors to follow a settlement, which wasn’t earlier preferred, owing to the institutional formalities and the nature of lending. The crisis has made the courts to give flexibility even in terms of the time limit set for such settlement. In a recent verdict of ES Krishnamurthy v. Bharath Hitech Builders, NCLAT observed that considering the present crisis; a concession can be given to the corporate debtors to

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