Author name: CBCL

To Disclose or Not to Disclose: Use of TRESA in the Takeover Code, 2011

Capital Markets and Securities Law /

[By Urja Dhapre] The author is a second year student of Institute of Law, Nirma University, Gujarat. Introduction Recent trends in corporate control [i]have shown an increase in the use of unregulated Total Return Equity Swap Agreements (“TRESA”) to eschew disclosure norms while covertly building up stakes in listed companies. Regulators from around the globe are now recognizing the challenges in governance and market distortions that potentially arise from these agreements which may bestow hidden and morphable ownership in the shareholdings of a listed company. Effectively, TRESA gives the investor an upper hand in dropping a bombshell on the target company by launching a hostile takeover out of the blue. The effect of TRESA seems to be contrary to the objective behind the disclosure regulation which is not only to ensure transparency that “the target company is not taken by surprise”, but also to acquaint the shareholders of the target company about any potential change in control. This article highlights the approaches in different countries while dealing with TRESA and also visits the lacuna in Indian law pertaining to the disclosure regulation. The instrumentality of TRESA  These equity swaps are over the counter equity derivatives wherein one counter-party (“short party”) pays the other counter-party (“long party”) the total return of an underlying asset/shares including income that is generated from it along with the benefits in case the price of the asset appreciates over the life of the swap. In return, the long party is obligated to pay fixed floating payments and the amount by which the asset’s value has depreciated if its price reduces over the life of the swap. Effectively, the long party gains the economic exposure of the reference asset/shares without actually owning it. Similarly, hedge funds or Foreign Institutional Investors (“FIIs”) benefit from the avoidance of transactional costs associated with equity trades along with hedging their negative returns. These swaps can be either cash-settled, i.e., any value differences at the end of the relevant period of the swap are settled in cash or can be settled-in-kind, i.e., the short party has an obligation to transfer the reference asset to the long party upon termination of the arrangement. Treatment of TRESA in other jurisdictions Conventionally, market participants in the equity derivatives markets have not held TRESA as constituting a beneficial ownership in the underlying shares, since its aim is to merely decouple the voting control and the economic exposure in respect of the underlying shares. It is not an obligation but a market reality [ii]that the short party will further buy the reference shares as a hedge against its short position. Conversely, even if the holder of TRESA does not have any legal rights to acquire the shares or control the votes of the reference shares they are still able to influence the short party. This influence is witnessed by the long party’s ability to convert these underlying shares into actual shares by unwinding the swap. The regulators on either side of the Atlantic have approached disclosure norms very differently. Taking into account the global nature of the derivative market, a more uniform approach to disclosure of these instruments is highly desirable. In the past years, this decoupling has affected takeover battles and control of public companies in inter alia the U.S., the U.K., and New Zealand. The UK amended its Disclosure and Transparency Rules [amended (“DTR”) 5R] [iii]which triggers disclosure norms when an individual holds a financial instrument which renders an economic interest over the underlying shares. The new rules require that the holding of shares and relevant financial instruments be aggregated and disclosure be made when the aggregated holdings reach, exceed or fall below 3%, 4%, 5% and each 1% threshold thereafter up to 100% (amended DTR 5.1.2R).[iv]  Further, The U.S Securities and Exchange Commission’s (“SEC”) stance on beneficial ownership was brought out by the US district court’s ruling in CSX Corporation v. The Children’s Investment Fund Management (UK) LLP [v],wherein the Southern District declined to take a firm stand on whether the cash-settled, total return swaps constitute beneficial ownership, as a general matter, under Rule 13(d)-3(b) of the Securities Exchange Act, 1934, which “deems a person to be a beneficial owner if he uses any contract, arrangement, or device as part of a plan or scheme to evade the beneficial ownership reporting requirements.” Albeit, the court relied on a provision of that rule which attributes beneficial ownership of a security to any person who enters into an arrangement as part of a “plan or scheme to evade the reporting requirements of the disclosure norms”. The same was later re-affirmed by the circuit court of appeals.[vi] A diametrically opposite approach was followed in New Zealand as per the Ithaca (custodians) v. Perry Corporation’s[vii] case. The court here discussed in detail about the market reality of the short parties hedging their position which can bring the target company within the reach but not under the control of the long party. It held that such a reality does not constitute an agreement or understanding between the two parties and therefore, the long party will not come under the purview of disclosure norms. However, due to the paucity of evidence, the magnitude of this problem in New Zealand has not yet been raised, but the panel is still considering amendments in the present disclosure norms. TRESA in the Indian context  Under the Indian securities laws regime, disclosure norms are triggered under the helm of Regulation 29(1) [viii] of SEBI Substantial Acquisition of Shares and Takeovers, 2011 (“Takeover Code”). Regulation 29(1) of the Takeover Code requires the acquirer with an individual or combined shareholding with Persons Acting in Concert (“PAC”) of 5% or more in the target company to disclose these shareholdings. This regulation can be traced back to the Takeover Regulation Advisory Committee (“TRAC”) report [ix]which laid the foundation of the Takeover Code, 2011. The committee’s intent was to distinguish between the disclosure requirement of an individual holding and a group/concerted holding of any security or instrument that would entitle the acquirer to receive shares in

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Weighing the Impact of Abolition of DDT in Annual Budget 2020: Impact and Implications

Taxation Law /

[By Ekta Jhanjhri] The author is a fourth year student at Institute of Law, Nirma University, Gujarat. Introduction Stimulating foreign equity investment in the Indian landscape has always been of prime importance to the Indian Government. Thus, the Hon’ble Finance Minister (“FM”) has proposed to abolish Dividend Distribution Tax (“DDT”) in the Budget Session for financial year 2020-21. In her budget speech, the Hon’ble FM has explained that the elimination of DDT is expected to increase the attractiveness of the Indian equity market, and provide relief to a large class of investors. The FM further claims that the measure is expected to result into revenue erosion of Rs.25000 crores. Though abolition of DDT has been extolled by the industry as well as from retail investors, the measure is viewed with suspicion by others. In this article, the author has attempted to put forth the industry concerns over payment of DDT and analyze the impact of elimination of DDT. Why DDT was in place and its evolution The concept of DDT was first introduced vide the Finance Act, 1997 through insertion of Section 115-O as a measure for easy tax collection and administration since it was difficult to track down the receipt of dividend income in the hands of thousands of shareholders. Thus, the then newly introduced provision mandated the domestic companies to pay DDT on dividend distributed, declared or paid by them.[i] Simultaneously, a new clause was added in the Income Tax Act, 1961 (“the Act”) which excluded the dividend income from the ambit of total income.[ii] The upshot was exemption of dividend income in the hands of shareholders, except those whose aggregate dividend income in a year exceeded Rs. 10 lakhs.[iii]  Furthermore, it intended to deter domestic companies from employing their surplus into distribution of dividend, rather plough them back into lucrative business prospects. However, the incidence of taxability of dividend income was again shifted to shareholders when the DDT was scrapped vide Finance Act, 2002. Interestingly, DDT was re-instituted through the Finance Act, 2003 and had been in force until 31st March, 2020 at an exorbitant effective rate of approximately 20.56% including surcharge and cess, falling as liability of the concerned company. The ebb and flow of DDT has been a bone of contention within the corporate sector. Concerns raised by the industry The corporate sector has expressed deep dismay when it comes to the payment of DDT. Firstly, it has been asserted that the imposition of DDT results into double taxation in two facets. From the perspective of shareholders: DDT was contemplated as an evil eye by the investors whose aggregate income from dividend exceeded Rs.10 lakh per year. Such investors faced an additional tax rate of 10% on their dividend income. It is thus argued that when the domestic company has already been subjected to DDT u/s 115-O, imposition of additional tax u/s 115-BBDA on such investors amounts to double taxation. From the perspective of corporates: The levy of DDT is considered to be a hex by the corporates. Let us understand this with the help of an example. A company has earned a profit before tax of Rs.100 and company pays corporate tax @ 25%. This makes the profit after tax of the company as Rs.75. The company then declares Rs.50 as dividends. As per Section 115-O, a company declaring or paying dividend, is required to pay DDT @ 15% along with applicable surcharge and cess. As discussed above, with applicable cess and surcharge, the effective rate becomes 20.56%. Thus, the company foots the bill of Rs.10.28 as DDT to the Government. This way the income of the company is taxed twice i.e. in the form corporate tax and DDT. Secondly, it is also argued that DDT is a blanket levy regardless of the tax slab in which a particular retail investor files its return. For instance, dividend income of a retail investor having total income less than Rs.10 lakhs, is taxed at a flat rate of approximately 20%. Even though the levy is on domestic company, the ultimate sufferer are the shareholders as they lose something out of their kitty. Thirdly, the levy of DDT has proved to be a double whammy for foreign investors: As per Section 115-O, neither the domestic company nor the shareholders are entitled to claim credit of DDT already paid under the said provision. Consequently, a foreign investor who is subject to taxation in a different jurisdiction has tax liability under that said jurisdiction subject to the respective tax treaty India has with such jurisdiction. This acts as a stumbling block for foreign investor to channelize their fund into Indian territory as it makes their return on investment uncompetitive. Fourthly, foreign companies receiving dividend from an Indian subsidiary will be able to avail the benefit of tax treaties as the requirement of shelling out DDT has been removed from Section 115A of the Act. The said provision levies tax @20% on dividend income received by foreign companies. Impact of Abolition of DDT The measure has received heterogenous response from the industry. The natural corollary of the abolition implies that the dividend income will now fall within the purview of total income and is taxable as per the applicable tax slab rate. Firstly, this comes as big sigh of relief for the disgruntled retail investors whose total income from dividends does not exceed Rs.10 lakhs. Secondly, the move has also calmed down the exasperated foreign investor as it addresses their woes of double whammy. These majorly include investors who file their tax returns in jurisdictions with which India has favorable tax treaties. However, the Finance Bill, 2020 proposes to omit the proviso,[iv] which excludes payment of dividend to non-resident from the operation of Tax Deducted at Source (“TDS”).[v] The immediate impact of such omission is that payment of dividend to non-resident is made subject to TDS. Thirdly, the proposed measure would result into additional chunk of income with the corporates to invest in lucrative business prospects. This is seen

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Ishrat Ali v. Cosmos Cooperative Bank: A Missed Opportunity by NCLAT to Advance the Jurisprudence of IBC, SARFAESI and Limitation Act

Insolvency Law /

[By Ankit Tripathi] The author is an associate at Law Chambers of J. Sai Deepak. Recently, in the case of Ishrat Ali v. Cosmos Cooperative Bank Ltd. &Anr[i], the five judge bench of National Company Law Appellate Tribunal (“NCLAT”), departed from an earlier view taken by the three judge bench and held that action taken by a financial institution under Section 13(4) of the SARFAESI Act is not a proceeding before a court of law or a tribunal. Therefore, such proceeding shall not be taken into consideration for excluding the time period under Section 14(2) of the Limitation Act. The reasons for the decision or departure were not detailed by NCLAT. Through the blog post, the author will look into the background and history of the concomitant cases for an effective criticism of this judgment at hand. Background The three member bench of NCLAT in Sesh Nath Singh v. Baidyabati Sheoraphuli Cooperative Bank Ltd and Ors.[ii], held that if the financial creditor has instituted a bona fide application under the SARFAESI Act, 2002, then in such case, while computing the limitation period for filing Section 7 application under Insolvency and Bankruptcy Code, 2016 (“IBC”); as per Section 14(2) of the Limitation Act, 1963 the time which has been exhausted in the above proceedings shall be excluded since it would be held as if the financial creditor has been carrying another civil proceedings with due diligence. The three member bench of the NCLAT headed by then Chairperson during the proceedings of Ishrat Ali v. Cosmos Cooperative Bank Ltd. & Another doubted the correctness of the above judgment and thus referred the said judgment to a larger Bench of five judges to decide and settle the issue. Analysis As a matter of fact, the NCLAT was called upon to adjudicate upon the following three questions of law: Whether the action taken by a financial institution under Section 13(4) of the SARFAESI Act is a proceeding before a court of law or before a Tribunal? If any application is filed before the Debt Recovery Tribunal (“DRT”) against such action in terms of the SARFAESI Act, 2002, whether it can be held to be a proceeding moved before a wrong forum for computing the period of limitation under Section 14(2) of the Limitation Act? Whether the SARFAESI and DRT proceedings extend the period of limitation for filing the Section 7 and 9 applications under IBC? In the course of the present adjudication where the case involved certain interesting and contentious points pertaining to interplay of the SARFAESI Act, Limitation Act, and IBC, the tribunal had the opportunity to settle the law on the above legal issues. Considering the fact that it was reference bench of five judges, NCLAT had an added duty towards a more careful disposal of the reference with a proper reasoned order. A careful reading of the judgment provides that though NCLAT has conclusively and authoritatively answered the issues, it failed to provide reasoning for the same. Though the judgment cites and relies upon various other judgments of the Supreme Court, it has failed to inherently provide the application of those cases to the facts of the case at hand and answer the questions accordingly. In a way, the judgment does not create any new jurisprudence which it could have. Given that this was one of the most-awaited judgments of the NCLAT on the possible ambiguities arising due to overlap between the three statutes, it should have considered that reason is the heartbeat of every conclusion for producing clarity in an order and without the same, it becomes lifeless.[iii] The apex court has held in plethora of cases that absence of reasons renders the order indefensible/unsustainable particularly when the order is subject to further challenge before a higher forum.[iv] NCLAT relied upon the case of Jignesh Shah and Anr, v. Union of India and Anr[v] to hold that a suit for recovery based upon a cause of action that is within limitation cannot in any manner impact the separate and independent remedy of a winding-up proceeding. A close-up as well as aerial view of the findings of the NCLAT will highlight the fact that it has nothing new to support the above reference questions or add to existing jurisprudence. While nothing stops the court from relying upon any cases lest it should help in finding the conflict in the reference itself. In the latter part of the judgment, the tribunal laid down the bare provisions of Section 14 of the Limitation Act and Section 13(2) of the SARFAESI Act. Soon after reproducing the abovestated relevant sections, the tribunal blatantly held that the action taken by a financial institution under Section 13(4) of the SARFAESI Act is not a proceeding before a Court of Law and did not bother to substantiate this finding with a reason. To the contrary, it is clear that that there is no provision in IBC which excludes the applicability of Section 14 of the Limitation Act to an application submitted under Section 7 or 9 of IBC. It is understood that the tribunal has relied upon cases like Jignesh Shah and Gaurav Hargovindbhai Dave, but the tribunal should have been careful to the facts of the specific cases and should not apply the ratio blatantly to record a judgment. The facts in the above cited cases were different from the case in question, thus requiring a different contextual interpretation which the tribunal clearly failed to do. Whether SARFAESI proceedings constitute ‘Civil Proceeding’? The Hon’ble Supreme Court via its judgment in Commissioner of Income-Tax, Bombay & Anr. v. Ishwarlal Bhagwandas,[vi] held that a ‘civil proceeding’ is one in which a person seeks to enforce by appropriate relief the alleged infringement of his civil rights against another person, and if the claim is proved would result in the declaration express or implied of the right claimed and relief sought. The term “civil proceedings” as defined by the Apex Court includes all those proceedings in which a party contends a civil right

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Recognition of Solvent Proceedings: Dilemma in International Insolvency Law

Insolvency Law /

[By Daksh Aggarwal] The author is a second year student of Campus Law Centre, Faculty of Law, University of Delhi. Prefatory The unification of markets and interconnected commercial transactions has necessitated significant need for common law governing business deals. The United Nations Commission on International Trade Law (“UNCITRAL”) Model law on Cross-Border Insolvency (“Model Law”), adopted in 1997, is designed to harmonise insolvency laws of various jurisdictions of the world and is internationally accepted as a unified restructuring framework by a number of states, including sophisticated economies. The Model Law is applied when the assets of the Corporate Debtor (“CD”) are located in foreign states or where the creditors of the CD reside in states other than the jurisdiction, in which the main insolvency proceedings are taking place against the CD. The major objective of the Model Law is to promote cooperation and coordination between courts and other competent authorities in cross-border parallel insolvency proceedings. The Model Law was substantially implemented in the United Kingdom through the Cross-Border Insolvency Regulations 2006 (“CBIR”). The CBIR, in consonance with Chapter III of the Model Law, intends to provide for the coordination of a British insolvency proceeding and foreign proceedings concerned with the same debtor. Recently, in Michael carter v. Roy Bailey and Keiran Hutchison (as foreign representatives of Sturgeon Central Asia Balanced Fund Ltd) (“Sturgeon Central Asia Case”), the Hon’ble England and Wales High Court (“Court”) interpreted the stated purpose and object of the Model Law and opined that solvent proceedings do not fall within the category of ‘foreign proceedings’ as defined under the CBIR. Apparently, the judgment contrasts with the approach adopted by the United States court which implemented the Model Law and recognised Australian solvent liquidation proceeding under Chapter 15 of the US Bankruptcy Code. The English court deviated from the well settled international judicial dictum and demonstrated divergence of the United Kingdom and the US on abstruse question of law dealing with cross-border recognition of solvent proceeding as a foreign proceeding. In this blog piece, the author aims to dissect the ‘legally unsound reasoning’ of the UK judgment and its troublesome interpretation of the international insolvency law. Legal scrutiny of the judgment The baffling conundrum that the Court in the Sturgeon Central Asia Case faced was whether a just and equitable winding-up of a solvent company would fall within the scope of a ‘foreign proceeding’ for the purposes of the Model Law and the CBIR. According to Article 2(a) of the Model Law, ‘foreign proceeding’ refers to a collective judicial or administrative proceeding in a foreign State pursuant to a law relating to insolvency, for the purpose of reorganization or liquidation.[i] It must be noted that the Model Law is set out in Schedule 1 to the CBIR and hence the same definition of ‘foreign proceedings’ substantially applies to Great Britain. The perspicuous explanation to Article 2(a) insists that the entity would fall under the said article of the Model Law only if the debtor is insolvent or in severe financial distress.[ii] The true meaning and connotation of ‘foreign proceeding’ has been interpreted by various judicial pronouncements. In In Re Stanford International Bank Ltd Case [2010] Bus LR 1270, the English and Wales Court of Appeal (Civil Division) categorically held that the winding-up of a company on the just and equitable grounds includes insolvency in conventional terms. The court, while considering the liquidation of an Antiguan corporation, also opined that the ultimate purpose of the law governing the process of recognition of ‘solvent proceedings’ as ‘foreign proceedings’ is liquidation. The court also observed that the liquidation of a solvent entity incorporated with the objective to carry on international trade or business on just and equitable grounds would be termed as a foreign proceeding. An even wider interpretation was adopted by the US Court in In Re Betcorp Ltd (2009) 400 BR 266. The court, impliedly, held that even solvent companies could fall within the scope of ‘financial distress companies’. The court also elucidated that the voluntary liquidation of an Australian company under the Australian Corporation Act was a collective proceeding, in that it considered the rights and obligations of all creditors and hence recognised the collective proceeding as a ‘foreign main proceeding’.[iii] However, the Court in the Sturgeon Central Asia Case conflicted with the aforementioned precedents and restricted the scope of foreign proceedings. The Court explicitly held that since Sturgeon (Bermudan incorporated investment corporation) was not insolvent or in financial distress, the solvent liquidation of the company cannot be identified under the wide umbrella of ‘foreign proceedings’ as per the Model Law and the CBIR. The Court, indubitably, employed the purposive approach and narrowed the purview of previously existing “universal rule of recognizing voluntary insolvency proceedings as foreign proceedings”. In May 2019, Hon’ble Mrs. Justice Falk assessed the application made by the liquidators of Sturgeon Central Asia Balanced Fund Ltd and held that recognition of proceedings as foreign proceedings was intended to be made available in circumstances where the insolvency of an entity has not yet been established. However, in January 2020, the Hon’ble Insolvent and Companies Court (“ICC”) Judge Briggs overruled the judgment delivered by Mrs Justice Falk and concluded that the voluntary solvent proceeding which does not aim to restructure the financial affairs of an entity, but is more focused in dissolving the legal status of the concerned entity cannot be recognized as a foreign proceeding for the purpose of Article 2 of the Model Law. The Hon’ble ICC judge passed the judgment without mulling over severe legal consequences. The UK courts now also shoulder responsibility for defining an ambiguous term- ‘financial distress’ or its threshold. The judgment delivered by the Hon’ble ICC Judge raises an essential question of whether the English courts would take up an inquisitorial legal system and investigate into the insolvency of companies when considering future applications for recognition of foreign proceedings to draw a visible line between ‘financial distress’ and ‘solvent liquidation’. The judgment brings up a perplexing problem of law in

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The Curious Case of Karvy:  SEBI’s Tale of Investor Protection? 

Capital Markets and Securities Law /

[By Arnav Maru] The author is a fourth year student of Maharashtra National Law University, Mumbai. Background Karvy Stock Broking Limited (“Karvy”), a registered stockbroker, recently found itself in the crosshairs of the Securities and Exchange Board of India (“SEBI”) for perpetrating one of the biggest cases of financial misconduct involving misuse of client securities. Karvy was founded in 1995 with its head office in Hyderabad and had a net worth of over Rs. 650 crores as of March 2019. It served over 12 lakh clients, of which at least 300,000 were active clients. The fraud affected around 95,000 of its clients and involved a massive sum of Rs. 2,300 crores. While the fraud in question is not the first of its kind, the sheer magnitude of the amount involved makes it extremely relevant. This post will talk about the fraud under three major headings: understanding the law involved, how this law was subverted in the present case, SEBI’s action, and its effect on the various stakeholders. Understanding the law involved Put briefly, Karvy misused securities lying in dormant and unpaid accounts of its clients to pledge them with five lenders to secure loans of Rs. 2400 crore. This transaction was executed through a misuse of the power of attorney granted by clients in favour of Karvy. Securities of clients availing the margin trading facility with Karvy were majorly affected. A brief overview of the law regulating the use of power of attorney and the securities held in unpaid and margin trading accounts is outlined in the following paragraphs. A power of attorney (“PoA”) is executed by the client in favor of the stockbroker/depository participant to authorize the broker to operate the client’s demat account and bank account to facilitate the delivery of shares and pay-in/pay-out of funds. This may be a general PoA (one that grants a blanket authority), or a specific one (only confers authority for limited and outlined purpose). The PoA provided to brokers is specific and is for the trade settlements. Its use is limited to the transfer of securities from the demat account of the client for authorized purposes. SEBI, in its circular dated April 23, 2019 [i] laid down guidelines for the execution of PoA by the clients in favour of the stockbroker after noting irregularities and misuse of the document. Brokers were mandatorily asking clients to execute irrevocable and general PoAs in their favour, and then using them to execute unauthorized trades in their client’s names. SEBI mandated brokers and depository participants to comply with the guidelines laid down. SEBI limited the scope of the PoA to, first, the transfer of securities held in the beneficial owner account of the client towards stock exchange related margin and delivery obligations, second, pledging of the securities in favour of stock broker for the limited purpose of meeting the margin requirements, and third, to apply for various products like mutual funds, public issues, rights, etc. pursuant to the instructions of the client. Furthermore, it explicitly prohibited PoAs that facilitated off market trades, a charge that Karvy has been found guilty of. The usage of pool accounts and margin trading facility is common practice in the securities market. A pool account is a demat account of the stockbroker, which is used to facilitate pay-in and pay-out obligations. A pool account of a brokering firm typically includes unpaid securities (brought using a margin and not yet paid for by the client) and securities brought by clients not yet transferred to their demat accounts. When a client makes a purchase of shares, the clearing corporation sends it to the pool account of the broker, who has to then transfer it to the demat account of the client as per prevailing SEBI guidelines. Lastly, a margin trading account is one where the broker lends money to the client to enable him to purchase shares. This loan is collateralized by the shares that the client purchases, and comes with a periodic interest rate. The amount that the broker lends to a client may come from a bank that lends money to the broker. Client’s shares pledged with the broker could be validly pledged with the banks as a security until recently. SEBI, vide its circular dated June 20, 2019 [ii] restricted brokering firms from pledging client securities as collaterals even with a due authorization from the client. The most serious wrongdoing on part of Karvy was an illegal pledging of this sort. Facts of the case The National Stock Exchange (“NSE”) conducted a limited purpose inspection of Karvy upon noticing certain irregularities in pledging of client securities. This inspection was conducted on August 19, 2019 for a period starting from January 1, 2019 and a preliminary report was submitted to SEBI on November 22, 2019. SEBI, on the same day, through whole time member Anant Barua, pronounced an order [iii] highlighting the findings of the report and the entire misfeasance by Karvy. The first fault noticed by NSE on part of Karvy was the non-reporting of a depository participant account in its filings. Second, Karvy transferred the funds raised by pledging client securities to six of its own bank accounts, rather than the accounts of its clients, and further did not report these six accounts as it was required to. The order stated that the securities pledged by Karvy to the lenders belonged to its clients and therefore should not have been pledged as collaterals. SEBI highlighted a series of circulars that lay down client securities are not be used for any purpose other than for meeting client margin requirements. As stated earlier, this position was further made stringent when any pledging of client securities was barred, even with an express permission from the client. How do PoAs and the use of margin trading and pool accounts fit into the above stated facts? As is the business practice, and as has been highlighted above, the securities brought by clients are first transferred into the pool accounts of the stockbroker and then subsequently into

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Supreme Court on Preferential Transactions and Related Parties Under IBC

Insolvency Law /

[By Vatsal Patel] The author is a fourth year student of Institute of Law, Nirma University. Introduction The Insolvency and Bankruptcy Code, 2016 (“IBC”) has been a game-changer in the field of corporate bankruptcy in India. Though, there is still scepticism, looming over the IBC’s economic significance with a lot of companies going into liquidation as opposed to the intended corporate revival,[i] there is no doubt that the IBC has provided for a clear and robust guiding mechanism during the Corporate Insolvency Resolution Process (“CIRP”).[ii] Recently, the Supreme Court of India in the case of Anuj Jain v. Axis Bank,[iii] commonly referred to as the “Jaypee Case”, further outlined the powers of the Resolution Professional (“RP”) in terms of handling of various claims and transactions submitted by the Committee of Creditors (“CoC”). The Court further clarified the application of different provisions of the IBC which till now had not been suitably expounded. The piece aims to discuss in detail this judgement of the Supreme Court; and explain why the reasoning of the Court is correct and should serve as a guide for all future decisions. Factual Matrix Jaypee Infratech Ltd. (“JIL”), the corporate debtor in the present case is undergoing CIRP due to the committal of a default.[iv] Jaiprakash Associates Ltd. (“JAL”) the holding co. of JIL, has approximately 71.64 % equity in JIL.[v] Before the initiation of the CIRP, JIL, the subsidiary company had mortgaged certain parcels of land in favour of the lenders of JAL, the parent company in furtherance of the benefit to the parent company.[vi] This was despite the fact that JIL was itself undergoing a financial crunch, and was unable to pay up its own debts.[vii] Why was this problematic? The reason it was problematic was because of these transactions, certain creditors of the parent company would be favoured in the distribution of assets as per waterfall mechanism laid down in Section 53 of IBC, wherein their claim would be satisfied before, in the order of priority, as compared to the claims of other claimants who are otherwise similarly placed. The Interim Resolution Professional (“IRP”) i.e. Anuj Jain, bound by Section 25(2)(j) of IBC and armed with the objective of ensuring parity between all the creditors, filed an application seeking to set-aside all these transactions as being violative of Sections 43, 45, 49 and 66 of IBC. While the NCLT ruled in favour of the IRP, the NCLAT reversed this decision in favour of Respondents in the present case,  the primarily lenders of JAL. Analysis of the judgment The judgment of the Supreme Court, for the purposes of this piece, is coherently segmented into two parts – firstly, it discusses the contours of Section 43 IBC and its application it to the facts of the present case; and secondly, it distinguishes the application of Section 43 IBC from that of Sections 45, 49 and 66 IBC. The judgment also adjudicates upon the existence of a financial debt in cases wherein a mortgage is created by a corporate debtor in favour of a third party.[viii] However, the same has not been discussed by the author in this blog post. Contours of Section 43 of IBC Section 43 IBC is concerned with two things – preferential transaction and relevant time.[ix] To simplify, if the liquidator or RP is of the opinion that at a relevant time, a preference has been given by corporate debtor to a particular creditor in certain transactions, the liquidator or the RP shall be bound to make an application under Section 44 IBC for setting aside such a transaction.[x] After going through various interpretations of “preference”,[xi] the Court held “preferential transaction” as: “being the transaction where an insolvent debtor makes transfer to or for the benefit of a creditor so that such beneficiary would receive more than what it would have otherwise received through the distribution of bankruptcy estate.” [xii] In relation to “relevant time”, the Court observed that it is normal to have a longer look-back period in case of a related party, and a shorter one in case of an unconnected party.[xiii] The Court further observed that a strict construction should be given to Section 43 but only after giving of apposite consideration to the underlying principles and objectives of IBC.[xiv] Thereafter, the Court devised a step-by-step process which must be applied by the RP (initially) and Tribunals (upon an application under Section 44 IBC) to see whether a transaction is hit by Section 43. These steps are as follows: Firstly, whether the transfer by way of transaction is for the benefit of the surety or guarantor in furtherance of an antecedent financial liability of corporate debtor [Section 43(2)(a) IBC]; Secondly, whether such a transactions puts the surety or guarantor at a beneficial position than in case of a distribution of assets as per Section 53 IBC [Section 43(2)(b) IBC]; Thirdly, whether the transaction was made two years prior in the case of a “related party”[xv] or one year otherwise [Section 43(4) IBC]; and Fourthly, whether such transaction is not and “excluded transaction” as per Section 43(3) IBC.[xvi] In its essence, the Court meant for a transaction to be a “preferential transaction” under IBC if the ingredients of clause 2 and 4 of Section 43 IBC are satisfied, and it is not protected by clause 3 of Section 43 IBC. The Court by formulating this test made it easier for the RPs and Tribunals to adjudicate upon the existence of a “preferential transaction”. Now, they need not interpret Section 43 in a broad manner but are only required to mechanically follow the stipulated steps. This brings in a greater degree of certainty in the CIRP. However, what is more important is that the Supreme Court applied it aptly to the facts of the present case. The Court began by holding that the non-existence of a creditor-debtor relationship between the lenders and corporate-debtor is not of significance because the ultimate benefit flowed to its parent co. i.e. JAL,[xvii] who is a “related

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Better Late Than Early? On Objections To Compromises & Arrangements

Company Law /

[By Anchit Jasuja and Preksha Mehndiratta] The authors are second year students of Gujarat National Law University, Gujarat. The sanction of a scheme or arrangement under the Companies Act, 2013 (“Act”) cannot be done without the sanction of the National Company Law Tribunal (“NCLT”) under its supervisory jurisdiction. However, if a shareholder or creditor has any grievance with respect to the scheme, he may approach the NCLT to file the objections provided that he has the requisite qualifications. Though the Act is clear as to who may file objections against the scheme, there remains ambiguity as to the stage at which objections, if any can be filed. Who can file? The Act only allows the filing of objections by shareholders and creditors if they meet the requisite criteria laid in the proviso of Section 230(4)[i] which is at least 10% of the shareholding for shareholders and at least 5% of the outstanding debt for creditors. Even when the Companies Act, 1956 was in force and there was no statutory criteria for locus standi, the courts have recognized in cases such as Indian Metal and Ferro Alloys Ltd. [ii]that a person, who has no interest in the company as a shareholder or a creditor, cannot file objections before a company court. With the coming of the Act, provision for locus standi was added. However, the proviso and rather the entire act is silent about the time of filing such objections. Judicial approach to appropriate time for filing objections The confusion with respect to the appropriate time to file objections is evidenced by contradictory judgements given by courts of law. In the case of Landesbank Badenurttemberg v. Nova Petrochemicals Ltd., [iii]which predates Section 230(4) of the Act and its proviso, when the issue raised was alleged non-disclosure of material interests and objections, the Gujarat High Court held them to be premature and ordered them to be raised up at the floor of meetings. The court reasoned that since the objections could be raised at the meeting or even when the application to the court was filed for sanction, therefore, there is no reason for the court to consider objections at the stage when the meeting has not been convened. In a contrary view, the Gujarat High Court in another case allowed objections to a scheme even before the court passed orders for the conduct of meetings of shareholders and creditors. [iv] When a case with similar facts came before the Supreme Court in Rainbow Denim Ltd. v. Rama Petrochemicals Ltd. [v], the court did not allow the appeal from the order of the supervisory court and directed it to reject the objections until the meeting has been convened, thus, implicitly rejecting the objections for being filed at an early stage. Though what must be noted is that none of the cases on the issue explained the legal basis for either rejecting or accepting the objections against a scheme before convening the meeting of the shareholders and/or creditors. Legislative intent and analysis Since the power to file objections has been given in a proviso to Section 230(4), therefore it has to be seen and read in the context of that proviso. Firstly, it has to be noted that the proviso cannot be disconnected from the enactment it follows and has to be read together with it. In other words, a proviso does not travel beyond the provision for which it is a proviso.[vi] This is because it is assumed that the legislature would not have added a proviso under a Section if that proviso had nothing to do with the Section. Therefore, since the proviso in Section 230(4) follows the procedure for voting, the proviso cannot be disconnected from the voting procedure. Secondly, the proviso is made as an exception to something out of the enactment or to qualify something enacted therein which would otherwise be outside the purview of the enactment.[vii] Furthermore, it has been stated that the cardinal rule of interpretation of a proviso is that the proviso only operates in the area of law encompassed by the main provision. It creates an exception to the main provision under which it operates and no other.[viii] Therefore, it is only natural to interpret that the main enactment, i.e., the voting procedure is to be followed in most cases, but in special cases when that voting procedure fails to address the concerns of the shareholders or creditors, then objections may be filed. Thirdly, the proviso cannot swallow the general rule. [ix] Which means that even if there is an exception to the voting procedure, i.e., filing of the objections, that exception cannot be used to wholly subvert the procedure established to get a scheme approved by a meeting of creditors or shareholders. The scheme that emerges from the interpretation of the locus standi provision is that a voting procedure has to be adopted, which would be a tool to address concerns of shareholders and creditors for which they might object and when that procedure fails to achieve its purpose of addressing the concerns, then special circumstances arise where objections may be filed before the NCLT. Additionally, since the proviso cannot swallow the main enactment, thus the power to file objections is to be read as a power which does not exist as a right and can only be materialized when the main enactment fails its purpose, i.e., when voting fails to address the concerns of the shareholders and creditors. Such an approach would also be in line with expediting the process of approval of a scheme or compromise, since it would eliminate any possibilities of the involvement of the NCLT in addressing the concerns of the shareholders and creditors, when that can be done by the company itself. This would not only benefit the company, but would also reduce the burden on the tribunals. This approach would also synchronise the legislative policy with regard to filing of objections since the NCLT regularly takes into account the chairman’s report of the meeting of

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Reinstatement of Mr. Cyrus P. Mistry: Analysing NCLAT’s Contested Order

Company Law /

[By Prakhar Khandelwal] The author is a third year student of National Law Institute University, Bhopal. The National Company Law Appellate Tribunal’s (“NCLAT”) order dated 18 December 2019 (an appeal against which is pending before the Supreme Court) directed Tata Sons to reinstate Mr. Cyrus Pallonji Mistry as their Executive Chairman of the Board and as a director on the boards of Tata Sons and other group companies. Under Section 244 of the Companies Act, 2013 (“Act”), a waiver for an application under Section 241 of the Act was granted to Mr. Mistry, on account of Shapoorji Pallonji Group’s investment of Rs.1,00,000 crores out of total investment in Tata Sons’ of Rs. 6,00,000 crores. Subsequently, the application was accepted under Sections 241 and 242 of the Act alleging prejudicial and oppressional acts of the majority shareholders (The Tatas). Mr. Mistry then moved the NCLAT, Delhi Bench against National Company Law Tribunal’s (“NCLT”) order pronounced in favour of the Tata Sons. The Board of Directors (“BoD”) of Tata Sons includes 9 directors (1 Executive Chairman, 3 Nominee Directors nominated by Tata Trusts and 5 independent directors), which takes decisions by the way of a majority. The Tribunal adjudicated on various points of contention: A.       Legitimate Expectations The counsel for Mr. Mistry (Appellants) contended that there has been a pre-existing relationship for over 50 years, based on mutual trust and confidence between SP Group and Tata Group, on business as well as personal levels. Such a non-formal relationship, which is a result of “factors outside of pure economic factors”[i], results in a “legitimate expectation of being treated in a mutually just & fair manner.”[ii] The Tribunal concurred with Tata’s contention that the concept of ‘legitimate expectation’ is not recognized under Sec.241 and 242 of the Act and therefore not applicable to the instant case. B.       Affirmative Voting Power akin to Veto Right  The appellants further contended that Articles 121 & 121A of the Articles of Association (AoA) of the company confer affirmative voting power to the Nominee Directors on the Board, subject to the condition that such a decision is required to be taken by a majority of the Board. This, in essence, gives veto power to the Nominee Directors, and indirectly to Tata Trusts in every decision of the Board.  Before the Tribunal, even Mr. Ratan N. Tata and Mr. N.A. Soonawala themselves took a specific plea that Articles 121 and 121A mandated a ‘prior consultation’ and ‘pre-clearance’ from them.[iii] The Tatas contention that a mere affirmative right, which is permissible by law, does not constitute veto Power as it does not confer any special rights to ensure Board approval was discarded by the Tribunal on account of their vote’s indispensability in all matters. C.       Reasons for Removal The removal of Mr. Mistry was inter alia linked to his alleged lack of performance which had never been deliberated upon by the BoD prior to his removal, as evidenced by the minutes of various meetings placed on record. Three months prior to his removal, the Nomination and Remuneration Committee(“NRC”)formed under Section 178 of the Act which also included a nominee director of Tata Trusts to the Board had lauded his performance and recommended a pay hike to Mr. Mistry. The recommendation was unanimously endorsed by the BoD. The Appellants contended that sudden removal of Mr. Mistry on the alleged ground of ‘lack of performance’ was a result of Mr. Mistry’s inquiries into legacy hotspots and the subsequent decisions made by him for the benefit of Tata Sons, instead of the Tata Trusts (held by the Tatas). The NCLAT accepted the submission that Mr. Mistry’s alleged lack of performance had indeed never been discussed or deliberated upon prior to his removal. D.       Lack of independent judgement Under Section 166 of the Act, the Directors are under a fiduciary duty to be independent in their judgement. The Tribunal held that a stark change in the Board’s opinion pertaining to the performance of Mr. Mistry within three months from the recommendation of the NRC clearly shows that the judgement was influenced by the majority shareholder i.e. Tata Trusts. The Tribunal also recognised the existence of a lack of clarity in the decision-making process of the Board as was evident from the email exchanges between Mr. Mistry and Mr. Tata. E.       Public to Private Company The Tribunal held that before the filing of the instant appeal, the conversion of Tata Sons from a public to a private company in accordance with General Circular No. 15/2013 dated 13.09.2013 and Notification dated 12.10.2013 cannot override the substantive provisions of Section 14 of the Act mandatorily requiring Tribunal’s approval for such conversion from public to private company. Thereby, such fiction of ‘deemed conversion’ was held to be illegal and in contravention with law. Analysing the decision of NCLAT A.       Corporate Democracy vs. Corporate Governance The Supreme Court of India in LIC of India v. Escorts Ltd. upheld the sovereign prerogative of the company along with its shareholders to appoint or remove a director from office without an obligation to provide reasons for their removal under ‘Corporate Democracy’.[iv] It further upheld the ratio in Ebrahimi case[v] wherein the Supreme Court recognised the absolute right of general meeting to remove the directors.[vi] Under principles of Corporate Governance, the Board is accountable to the shareholders. Corporate Governance is, therefore, corollary to the concept of corporate democracy. The procedure followed for removal of Mr. Mistry was in compliance with the provision of the AoA of Tata Sons. Such a decision by the BoD and shareholders of the Company regarding its matters of internal corporate affairs are governed by principles of ‘Corporate Democracy’ and cannot be superseded by the way of judicial interference B.       The supremacy of Articles of Association A company’s AOA definesa company’s nature, objective and forms part of the company’s constitution along with the MoA. In World Phone India Pvt case, the Shareholder’s Agreement conferring affirmative rights was held to be non-binding on the company and its shareholders

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The Curious Case of Post-Award Interim Measures

Arbitration Law /

[By Mrudula Dixit] The author is a fourth year student of Symbiosis Law School, Pune. Introduction There are a few peculiar provisions in the Arbitration and Conciliation Act, 1996 (“Act”)[i] which stand out for instance Section 9 of the Act. Section 9 states that an interim measure can be granted by a court before, during or after making of the arbitral award at the instance of the party making an application. Section 9 is different in one aspect – it allows for the grant of an interim measure after the pronouncement of the final arbitral award as well. The parties can apply under Section 9 after the final award is granted but before it is enforced as per Section 36 of the Act.  This provision in the Indian law is a deviation from the UNCITRAL Model Law on International Commercial Arbitration which does not contain any post-award interim measure. Thus, in India, the parties have been granted a small window of opportunity to effectively secure their award or protect their interests. Further Section 36 of the Act clarifies that when the time for making an application to set aside the arbitral award under Section 34 has expired [i.e 3 months from the date of announcement of the award], then such final award can be enforced in accordance with the provisions of the Code of Civil Procedure, 1908 (‘Code’).[ii]  Though this part of the provision has been explicitly included in the impugned Section, its interpretation and practical application remains controversial. Recently, in November 2019, the Supreme Court made certain observations on this aspect in the case of Hindustan Construction Company Limited & Anr v. Union of India (‘HCC’).[iii] Here the primary question for consideration was whether Section 87 of the Act is liable to be struck down as ‘manifestly arbitrary’. Section 87 of the Act states that amendments made to the Act by the Arbitration and Conciliation (Amendment) Act, 2015 would not apply to court proceedings arising out of or in relation to such arbitral proceedings irrespective of whether such court proceedings were commenced prior to or after commencement of 2015 Amendment Act. What is of relevance for the purpose of this Blog is not the wider question of law posed before the Apex Court but rather an ancillary observation made by Justice Rohinton Nariman in the judgment. He accepted the ratio previously laid down in two cases before the Bombay High Court and succinctly stated that Section 9 allows a party to secure the final arbitral award via an application for interim measure.  In view of the decision, this Blog aims at summarizing the jurisprudence of Section 9 and post-award interim measures. Further, it also seeks to analyse its implications of the same on Sections 34 and 36 of the Act. Jurisprudence As mentioned above, in course of the judgment, Justice Nariman made certain remarks about the interpretation of Section 36 of the Act. He carefully delineated the nexus between Sections 9, 34 and 36 before concluding that Section 36 does not prohibit grant of stay of a money decree under the Code. As he elucidated the scope of Section 9, he relied on a pivotal case, namely Dirk India Pvt. Ltd v. Maharashtra State Power Generation Co. Ltd. (“Dirk India“).[iv] Dirk India was the first judgment to bolster the legislative intent of granting an ‘interim’ relief at a post-award stage. The Bombay High Court was faced with the issue of determining whether a party which has lost in an arbitral proceeding can make an application under Section 9 post-award. Justice Chandrachud reiterated the words of the Section 9 and held in paragraph 12 that; ‘When [interim relief is] sought after an arbitral award is made but before it is enforced, the measure of protection is intended to safeguard the fruit of the proceedings until the eventual enforcement of the award. Here again the measure of protection is a step in aid of enforcement. It is intended to ensure that enforcement of the award results in a realisable claim and that the award is not rendered illusory by dealings that would put the subject of the award beyond the pale of enforcement.’ The decision made by the court in Dirk India effectively meant that post-award interim measure can only be sought by an Award–Creditor and not by the Award–Debtor. Dirk India was relied upon by Justice G.S Kulkarni in March 2019, in the case of Mahyco Monsanto Biotech (India) Pvt. Ltd. v. Nuziveedu Seeds Ltd.[v] The Petitioner in this case had made an application under Section 9 of the Act after he had succeeded in his claim before the Arbitral Tribunal. The tribunal, by majority, had granted the petitioner a sum of Rs. 117 Crores which the petitioner wished to secure before enforcement under Section 36. Justice Kulkarni relied heavily on Dirk India and held that the law is set in that regard. He reiterated the settled position by stating that post-award interim measures ensure that the award is not illusive or avoidable. The position laid down in these two cases of the Bombay High Court have been reinforced by the Supreme Court in HCC. Analysis of the judgments    The observations of the Author are: When an Award–Creditor approaches the court under Section 9 to secure the award, it acts on a presumption that the Award–Debtor will prefer an application to set aside the arbitral award under Section 34 of the Act. Moreover, when Section 34 is read together with Section 36, an arbitral award cannot be enforced until and unless the 90 days’ period expires or the application under Section 34 has been duly disposed of. Because of this obvious paradox, the pre-emptive right to secure the award, bestowed upon the Award–Creditor by the interpretation of Section 9 in Dirk India, is likely to prejudice the party affected by the arbitral award as it takes away its 3-month window given by law. As a way of a corollary, the ‘remedy’ under Section 34(4) which gives power to

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