Company Law

[By Anubhav Patidar & Sarthika Singhal] The authors are students of Narsee Monjee Insititute of Management Studies.   INTRODUCTION  The Indian financial market has witnessed tremendous growth anchored on the principles of transparency and ease of doing business promoted by the Government of India. Historical inefficiencies in the physical aspect of the trading system of the securities market have come to light. Securities and Exchange Board of India (“SEBI”) in its 2004 report titled ‘Report of the Group on Reduction of Demat Charges’1 highlighted the risks associated in dealing with physical shares, i.e., theft, forgery, loss and damage.   Pursuant to the threats posed by physical certificate trading in private, regulators mandated compulsory dematerialization for private companies. In accordance with the powers granted by Section 292 read with Section 469 of the Companies Act, 20133 (“Act”), the Ministry of Corporate Affairs (“MCA”) introduced this amendment to the to the Companies [Prospectus and Allotment of Securities (“PAS Amendment”)] Rules, 2014 on October 27, 2023.   Dematerialization refers to the process through which tangible share certificates of an investor are converted into an equivalent number of securities in electronic format.   This article deals with the intricacies of the PAS Amendment Rules 2023, analyze the background and the rationale behind the amendment, understand its impact on market players and then highlighting certain concerns associated with it.  MCA Notification  Under the amended rules, every private company must compulsorily dematerialize all its securities with immediate effect. The companies are granted an 18 month-timeline from the closure of the financial year in which they cease to be a non-small private company to adhere to this amendment.4 For instance, if a company seizes to be a small company at any time during the financial year 23–24, 18 month-timeline triggers from 31 March 2024, and be complied is required by 30 September 2025.  Two specific categories are exempted from this mandate. First, the amendment does not apply to small companies5, defined as private companies with a paid-up share capital of INR 4 crores or below and a turnover of INR 40 crores or below. Additionally, government companies are excluded6, acknowledging the distinct regulatory framework applicable to these entities.  RATIONALE BEHIND MANDATORY DEMATERIALIZATION  The rationale to implement dematerialization for private companies is to unveil the opaque realms of asset ownership in the private sector. This initiative aims to enhance efficiency, transparency, and security within the private sector, ultimately benefiting both companies and investors.  Private companies, characterized by a restricted shareholder base and minimal regulatory scrutiny owing to their absence from public markets, have long operated under a shroud of secrecy. This opacity has provided fertile grounds for various illicit practices, spanning from tax evasions to financial deceit, often facilitated by the presence of shell companies – with no significant assets or operations.   Transitioning to dematerialization requires a private company to register with one of India’s two depositories and be allocated a securities identification number (“ISIN”) that will be used to track shares and other securities issued by the company. Shareholders will need to open a ‘demat account’ showing identification proof. Demat accounts would have to be compulsorily linked to permanent account numbers (“PAN”), and bank account.7 Any sale or purchase of shares of a private company will reflect in the demat account records. With shares held and exchanged through depository accounts, ownership rights become unequivocally clear, rendering it significantly challenging to engage in fraudulent activities such as clandestine ownership or fabricated transfers.  Further, private company ownership information will come handy to market regulators like SEBI. Regulators can effectively track and scrutinize transactions, facilitating prompt detection and prevention of non-compliance. This heightened level of regulatory scrutiny will act as a deterrent to illicit activities, fostering a more compliant and transparent securities market environment.  Impact on Companies  The financial burdens on the private companies are expected to get fortified since there is a fee component associated with demat accounts. Moreover, Private companies have to hire additional people to look after the compliance of dematerlialization process. Opening these accounts is merely the tip of the iceberg; ongoing expenses like annual maintenance fees add to the burden. Additionally, complying with regulatory requirements, such as upgrading technology and infrastructure, for dematerialization entails additional costs. This requires companies to allocate significant resources to ensure seamless compliance and effectively manage the financial implications of dematerialization.  While the wholly-owned subsidiaries (WoS) of unlisted public companies received exemptions from dematerialization requirements in the 2018 Amendment Rules exempted, the same leniency doesn’t extend to WoS of private companies under the Amended PAS Rules. If a private company subsidiary falls under the umbrella of another private entity, it must adhere to dematerialization regulations. However, if the subsidiary operates under a public company, thereby retaining its status as a deemed public company, it remains exempt from the 2018 amendment to the Rules.  Impact on Foreign Investors  The impact of dematerialization on foreign investors in Indian private companies presents both short-term challenges and long-term benefits. This documentation and procedural requirements may lengthen investment timelines and incur additional costs, posing a potential deterrent to foreign investment. Moreover, shareholders must furnish extensive details regarding their constitution, ownership, and stakeholder agreements, which could raise concerns for foreign funds. Once the demat account is established, the administrative burdens associated with traditional paper-based transactions are eliminated. Dematerialization ensures smoother, safer, and faster transactions for foreign investors, enhancing the efficiency and attractiveness of investing in Indian private companies. Therefore, while the initial setup may pose challenges, the transition to dematerialization ultimately enhances the investment landscape for foreign investors in the Indian market.  AFTERMATH OF AMENDEMENT: CHALLENGES AND WAY FORWARD  Navigating the transition towards mandatory dematerialization in private limited companies presents considerable hurdles, requiring strategic solutions for effective implementation.  Firstly, the technical complexities encountered by shareholders, often acts as a deterrent to the adoption of dematerialization. However, by providing intuitive interfaces and dedicated technical assistance, companies can empower shareholders to navigate the process with enhanced ease and assurance, thereby facilitating a smoother transition.  Moreover, the cybersecurity concerns presents yet another

[By RS Sanjanaa & Sahil Agarwal] The authors are students of Symbiosis Law School, Pune and Government Law College, Mumbai respectively.   [I.] Introduction  The Indian Government has allowed public companies to directly list and issue their equity shares on international exchanges. This move is aimed at bolstering the Indian economy by allowing companies (especially start-ups and technology companies) to access global markets for the purpose of raising foreign capital at favorable valuations.   For the purpose of allowing direct listing of equity shares at international exchanges, the Government has notified the amendment to Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’) and the Companies (Listing of equity shares in permissible jurisdictions) Rules, 2024 (‘LEAP Rules’). In addition to this, Frequently Asked Questions have also been released pertaining to the Direct Listing Scheme.   In this post, the authors aim to explore the intricacies of the new framework, its development, implications on Indian companies, key challenges with the new framework, and recommendations.   [II.] Overview  [II.A.] Background  Direct listing is essentially one of the two ways in which a company can raise capital by listing its shares on an exchange. The other being an Initial Public Offer (‘IPO’). In a direct listing, the company does not issue any new shares and lists the already existing shares allowing the existing shareholders to trade them via an exchange.   Earlier, Indian companies were allowed to raise foreign capital for their shares only via the route of depository receipts (‘DR’). In order to ease the process of raising foreign funds and to allow direct listing, the Government vide Companies (Amendment) Act, 2020 amended Section 23 of the Companies Act, 2013  and allowed public companies to issue securities for the purposes of listing on permitted stock exchanges in permissible foreign jurisdictions. This change was brought into effect on October 30, 2023. In furtherance to the above, the LEAP Rules were introduced and the NDI Rules were amended. In the meanwhile, the Securities and Exchange Board of India (‘SEBI’) is expected to release its operational guidelines pertaining to direct listing of companies already listed in India.  [II.B.] Key Features  [II.B.1.] LEAP Rules   As per the First Schedule of LEAP Rules, GIFT International Financial Services Centre (‘GIFT IFSC’) has been prescribed as the permissible jurisdiction; and India International Exchange NSE and India International Exchange as the two permissible exchanges. The provisions of the LEAP Rules shall apply to both unlisted and listed Indian public companies which shall be permitted to list on the permissible jurisdiction. Further, as per Rule 4(5) of the LEAP Rules, companies are mandated to stay in compliance with  Indian Accounting Standards (in addition to any other accounting standards as may be prescribed by the foreign regulator) even after the shares are listed in  permissible jurisdictions.  Rule 5 of the LEAP Rules prescribes for certain kinds of companies which shall be deemed to be ineligible for the purposes of direct listing such as a Section 8 company, a company limited by guarantee and also having share capital, one having a negative net worth, among others.  [II.B.2.] NDI Rules  As per Schedule XI of the NDI Rules, the investment in Indian companies vide such direct listings shall be considered foreign investment for the purposes of foreign exchange laws and shall be subject to the sectoral caps for foreign investment as provided under Schedule I of the NDI Rules. Furthermore, any person resident outside India shall be a permissible holder of such equity shares. In essence, Indian residents are debarred from trading/investing in shares listed in permissible jurisdictions. These permissible holders shall be permitted to invest up to the limit prescribed for the foreign portfolio investors under the NDI Rules (i.e., 10%).  [III.] Critical Analysis  [III.A.] Assessing the Merits  Prior to this amendment, companies were only allowed to raise foreign currency capital primarily through issuing DR. Now with the government expressing its intent to permit the direct listing of Indian companies on international exchanges, this present move is a welcome change towards achieving that.   This would enhance the valuation of companies that are listed  on the international exchanges. It raises global investor confidence by signaling ambitions of tapping into a new pool of capital and subjecting them to more transparency obligations. For instance, until 2007 Alibaba was only listed on the Hong Kong Stock Exchange. When it decided to list on the New York Stock Exchange (‘NYSE’), the IPO raised $21.8 billion leading to enhanced valuation of $231 billion. This further diversifies the investor base with a broader range of risk appetites and reduced dependence on domestic markets.   The range of motion also increases when it comes to deals such as mergers and acquisitions of foreign companies. For instance, having U.S. dollar denominated shares simplifies any deal with a U.S. business. Additionally, listing on an international exchange also promotes strategic deals or partnerships with foreign firms through greater market recognition.   Sectors such as technology and start-ups will significantly benefit from this especially since FDI in the technology sector witnessed a 336% rise in April-September 2020. When Spotify (a Swedish company) went public on the NYSE, it closed at $26.5 billion on its first day of direct listing at the NYSE and has since grown over $7 billion with several of its majority investors coming from the U.S. such as Morgan Stanley and Universal Music Group. Additionally, it gave the most detailed disclosure a company has ever given about its business owing to higher transparency obligations. Even established companies operating in other sectors will benefit from this existing demand pool of foreign investors.   From the perspective of investors, investing in Indian companies in GIFT IFSC provides immense tax benefits than a DR route including exemptions on capital gains from the transfer of equity shares in GIFT IFSC. Moreover, it eliminates currency risk for the investors as the stocks are traded on foreign currency. This also facilitates easier cross-border investment allowing even non-resident Indians and entities from land bordering countries to invest pursuant to government approval.  Additionally, as stated

[By Rajan Thakkar & Manasvi Verma] The authors are students of Gujarat National Law University, Gandhinagar.   Introduction Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006 imposes a liability on the buyer companies to make the payment to their suppliers within the period mentioned under Section 15[i] of the Act and upon failure of the same, according to Section 16[ii] of the Act, the buyer company is required to pay compound interest with monthly rests on the due amount at three times the bank rate notified by the Reserve Bank of India. However, certain obscurities have surfaced in cases when the buyer company is unaware of the MSME status of the seller and when the supplier fails to raise any claims for the outstanding amount leaving the buyer unaware of the outstanding dues. These ambiguities can leave companies financially drained as a result of supplier oversight. This article analyses the shortcomings of the current regime for delayed payments and presents somewhat of a rough pathway for the companies to safeguard themselves from unforeseen consequences of such situations. Legislative Intent: Ensuring timely Payment to Suppliers To understand the implications of these provisions in such situations, it is important to first examine the intent behind the concerned provisions. The legislative intent at the time of the passing of the act was to make improvements in the Interest Act 1993[iii] and to incorporate its provision in MSMED Act 2006; replacing and improving the then existing 1993 Act. One of the changes that was made was that the maximum period for payment by agreement was reduced (from 120 days to 45 days) in comparison to the Interest Act. It was evident that the legislature wanted to make moves to mandate the buyer companies to make timely payments for goods and services provided by micro and small enterprise suppliers. Such additions were made in Section 15 and the penalty for the default was provided under Section 16. Section 15 mandates that in no case, the agreement for the period of payment can exceed the statutory period. It reads,“…..the buyer shall make payment therefor on or before the date agreed upon between him and the supplier in writing…..in no case the period agreed upon between the supplier and the buyer in writing shall exceed forty-five days….”. . According to Section 16, the buyer will be liable to pay the compound interest notwithstanding any agreement or any law in force upon a failure to make the payment as mandated under Section 15 of the Act. To simplify this, both the sections are standing glued to each other, and if section 15 falls, so will section 16, and the Hon’ble Supreme Court has also observed in the case of Silpi Industries v. Kerala SRTC[iv] that the MSMED Act is a special legislation and would have an overriding effect over any other statute in force at the time. Therefore, no forces of other statutes or any agreements between the buyer company and the supplier can save the buyer company from this strict liability. This liability often comes as a surprise to the buyer companies due to some lacunas that are left out. No duty of the seller to raise a claim for outstanding dues. There is no default duty of the supplier to raise any claims or send any notices before the right u/s 16 of the actuates. Against this backdrop, the buyers might want to explore avenues to restrict their liability u/s 16 by agreements by requiring the suppliers to raise claims regarding outstanding amounts. However, no such option is left open to the buyer companies under the act since the statutory mandate is to make the payment in the period mentioned under section 15 and upon failure, “notwithstanding any agreement or any other law” in the time being, the interest under section 16 will kick in. No Duty of the seller to Notify the buyer company about the Supplier status. The act doesn’t mandate that the seller is required to notify the buyer companies about their supplier status. Liability can be imposed u/s 15 and 16 merely if the seller company is a supplier under the definition of Section 2(n) of the MSMED Act[v]and therefore, irrespective of the disclosure made by the supplier regarding its status, the liability of the buyer company may arise. To give a practical example of how this problem can materialize, let’s say a buyer company agrees with a vendor at a time when the vendor doesn’t have a supplier status under the MSMED Act and the period for payment for the goods/services exceeds the period described under the section 15. On a later date, the vendor acquires a supplier status under the act and keeps supplying the goods/services to the buyer company under the pre-existing contract without notifying the buyer company about the change in status. Upon default or after the lapse of the statutory period u/s 15, the buyer company might be caught with surprise for having to pay exorbitant statutory dues and finding that the existing contract has been rendered infructuous. Accompanying Liabilities of the Buyer Company upon Non Compliance with the Disclosure Requirements Thus far, we have explored how unforeseen financial burden can be placed on the buyer company in the form of interest rate in cases wherein the buyer company is either aloof of any outstanding dues or the supplier status of the seller. However, the repercussions of this aloofness are far reaching and not confined to the compound interest u/s 16 of the MSMED Act. The buyer company and its executives can have to bear additional penalties upon non disclosure of such unknown/undemanded outstanding payments. The repercussions of such a strict disclosure requirement can be understood by referring to the relevant provisions of the MSMED Act r/w the penalising provision of the Companies Act 2013. Under Section 22 of the MSMED Act[vi], it is mandatory for a buyer company, who engages in the acquisition of goods or procurement of services from a supplier to undergo an

[By Devanshi Shukla] The author is a student of MNLU Aurangabad.   Introduction  Nomination as a process involves selecting another person as a legal nominee or representative by a person during his lifetime in respect of specific assets or properties. In the recent case of Shakti Yezdani & Anr. v. Jayanand Jayant Salgaonkar & Ors, the Supreme Court offered clarification on the status of nominees as nominated under Section 109A of the erstwhile Companies Act, 1956 (‘Act’) in the context of succession laws. The Court emphasized that nomination under the Act should not be viewed as an alternative method of succession. This blog seeks to delve into a comprehensive analysis of the judgment and explore its current implications.  Facts  Jayant Shivram Salgaonkar (‘testator’) had executed a will for the devolution of his properties upon his legal heirs. In addition to the properties mentioned in the will, he had fixed deposits (‘FDs’) and mutual funds (‘MFs’) for which he had made nominations. Following his demise, the legal heirs filed a suit for the administration of his properties. The nominees contested this arguing that the FDs and MFs absolutely vested in them, citing their nomination under the Act. A single judge of the Bombay High Court rejected the contentions put forth by the nominees stating that the appointed nominee retains ownership of the shares/securities in a fiduciary role and is responsible for addressing any claims within the framework of succession law. On appeal, the Division Bench held that the view taken in Harsha Nitin Kokate v. The Saraswat Co-operative Bank Limited and Others was per incuriam and made it clear that nominees were not entitled to the absolute ownership of the properties. Subsequently, the appellants filed an appeal in the Supreme Court.   Issues at hand  The Supreme Court deliberated on the following issues:  What is the aim behind the introduction of provisions concerning ‘nomination’ into the Act?  What is the understanding of the concept of ‘nomination’ under the Act and in relation to the law of succession?  What are the consequences of the term ‘vest’ and the non-obstante clause as employed in Section 109A of the Act and under Bye-Law 9.11.1 of The Depositories Act, 1996?  Observations made by the Court  Object behind the introduction of Section 109A under the Act  The Court observed that the Companies Act, 1956 was introduced to deal with the “incorporation, regulation and winding up of corporations”. Additionally, the primary intent behind introducing Section 109A and 109B by the Amendment of 1999 was to provide momentum to investment in the corporate sector and not to deal with succession. The provision of nomination was introduced to lessen the burden of legal heirs and also to foster a wholesome environment for corporate investment in the country. The Court held that there was lack of any material to show that the Amendment intended to provide absolute ownership of the property to the nominee.   Concept of ‘nomination’ under the Companies Act, 1956 and its connection to the law of succession  The Court referred to the concept of ‘nomination’ as enumerated by various courts under varied legislations (such as the Government Savings Certificate Act, 1959). It was asserted that due to the lack of a universally accepted definition and interpretation regarding the rights and ownership of a nominee concerning the relevant property, the Court would rely on the commonly understood meanings. The Court acknowledged that the Act does not envision a “statutory testament” that supersedes the laws of succession. It does not concern itself with the laws of succession. Nomination under the Act is not put through the same strict requirements as those applicable to the creation and validity of a will under succession laws.  Implications of the term ‘vest’ and the non-obstante clause as used under Section 109A of the Companies Act, 1956 and Bye-Law 9.11.1 of The Depositories Act, 1996   The Court held that the term ‘vest’ can have multiple meanings according to the context in which the word has been used in a provision or legislation and mere usage of the term does not give absolute entitlement over the subject matter. Similarly, it was acknowledged that the non- obstante clause also is to be understood in the context of the object and scheme of the legislation under consideration. Further, the Court stated that the term ‘vest’ has to be understood in line with Section 211 of the Indian Succession Act, 1925. Under Section 211, ‘vest’ does not entitle the administrator or executor with ownership but only entitles him to hold the property until it is distributed among the legal heirs. Section 109A of the erstwhile Act was said to address the vesting of shares or debentures from a holder to their nominee in the event of the holder’s death.. The non-obstante clause temporarily vests securities unto a nominee, to the exclusion of others to help the company in discharging its liability regarding various claims put forth by the successors of the deceased shareholders until the successors have resolved matters and are ready for the transfer of the securities.  Bye-law 9.11.1 under the Depositories Act, 1996 also provides for nomination by shareholders. Similar to Section 109A, the term ‘vesting’ here is used only in a limited context. The non-obstante clause has only been included here to facilitate the depository to handle the securities in the event of the demise of the shareholder.  Analysis & Conclusion  The judgement plays a crucial role in delineating the rights of the nominees as nominated under Section 109A of the Act. The Supreme Court has effectively negated the view held by it in Aruna Oswal v. Pankaj Oswal & Ors. wherein it was stated that the non-obstante clause employed under Section 72(3) of the Companies Act, 2013 which is pari materia to Section 109A makes the vesting of shares unto the nominee absolute. The legal stance taken by the Apex Court aligns the rights of the nominee with those of the heirs in their respective situations, offering a method to facilitate the seamless

[By Divyansh Bhatnagar & K Prashant Agrawal] The authors are students of Damodaram Sanjivayya National Law University.   Introduction The concepts of Related Party and Shadow Director and the implications of the phraseology “any person in whose advice, directions, or instruction the Board of Directors of a Company is accustomed to act” involves jurisprudence of utmost relevance to corporate law in India and foreign jurisdictions. The jurisprudence of the phrase has abundantly been utilized in corporate law legislations in India, namely the Companies Acts of 1956 and 2013 as well as the IBC, 2016. It is also evident in foreign jurisdictions, such as the UK Companies Act of 1948, the Australian Corporate Act, 2001, and the Singapore Companies Act, 2006. Sec. 5 of the Companies Act, 1956 establishes the meaning of “officer who is in default”. The section mentions that any person under whose directions or instructions the Board of Directors of the company is accustomed to act may be designated an officer who is in default and shall be liable to any punishment or penalty where a company undertakes such illegal or noncompliant acts. Similarly, Sec. 2(69) of the Companies Act, 2013, defines who a “promoter” is, states “in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act. Similar usage of the phrase is found in definitions of “officer”, “officer in default”, and “Related Party” under Sec. 2(59), (60), & (76) respectively of the Companies Act, 2013. The concept of a related party is of utmost importance to understanding the intention behind these provisions. Related Party The definition of “related party” is broad, both concerning an individual and with regard to a business, therefore identifying the parties included would need careful consideration. A company’s KMPs as well as some relatives are considered related parties. Companies must make sure that a procedure for updating the related parties list is set up with consideration for any potential external modifications. For instance, in order to guarantee that all subsidiaries comply and adhere, any modifications to a holding company’s KMPs must be informed to all of them. Although the majority of the definition of a related party is fairly clear-cut, one must exercise discretion when interpreting the term person to refer to someone whose advice, directions, or instructions a director or manager is “accustomed to act” upon. The 2013 Act does not introduce the idea of being “accustomed to act.” A person who imparts the advice, instructions, or orders that a director, manager, or the board is used to acting upon is commonly referred to as a “shadow director.” A similar idea was present in the 1956 Act. Shadow Directors The primary purpose of the law’s reference to “shadow directors” is to designate individuals whose instructions the board of a firm is customarily following. Shadow directors are individuals who are not technically appointed to the board but who still have the ability to exert absentee control over the board due to their ownership of shares or advantageous control over the business. Such a person is a “deemed director” even though they do not officially possess the title of director. Accordingly, related parties would include a ‘shadow director’ i.e., any person under whose advice, directions, or instructions the company’s director or manager or board of directors is accustomed to act. It is necessary to demonstrate that the company’s directors followed the ‘alleged’ shadow director’s instructions rather than using their discretion or judgment in order to establish shadow directorship. The phrase “accustomed to act” calls for general behavior from the directors, demonstrating that they routinely follow the guidelines or orders of the relevant third party (the “shadow director”). The concept appears to be to hold accountable (as “related parties”) those individuals who actually control the company and are able to direct its affairs by designating as directors their own delegates or individuals who are subservient to them. The term is intended to identify those, other than professional advisers, with real influence over corporate affairs. Judicial Interpretation & Application Judicial pronouncements by the Indian courts and tribunals, although relatively few, have been able to effectively interpret and help further demonstrate the application of the phrase and interpretation of related concepts in the Indian context. In the case of Raj Chawla v. SEBI,[i] the Delhi High Court quashed a criminal complaint against the petitioner. He was not found to be in a position where he could control corporate affairs as a director or as an executive of the company, and he was not found to be a person under whose advice, directions, or instructions the company was accustomed to act at the time the company conducted the incriminating act. In Re: Issuance of Optionally Fully Convertible Debentures by Sahara India Real Estate Corporation Limited and Ors.,[ii] a Sahara India Group company had issued a red herring prospectus following which Mr. Subrata Roy Sahara was served a Show Cause Notice for the same. He contested the notice by stating that since he was neither in a directorial nor a managerial position in the company in question. However, SEBI held that Mr. Sahara, apart from being the founder of the Sahara Group, was a major Shareholder in the company. Hence, he was adjudged to be a person in whose directions or instructions the Board of Directors of the Company was accustomed to act and, therefore, he falls within the ambit of “Officer in default.” In the case of Cyrus Investments v. Tata Sons & Ors.,[iii] the NCLT while determining whether Mr. Tata could be referred to as the “Shadow Director” interpreted the term and mentioned how it was slightly differing from “Officer in Default”. The NCLT stated that the term “shadow director” itself suggests that the individual in question is one who subtly induces another person to act in a way that is against the law or otherwise prohibited. Consequently, the idea of a “shadow director” cannot be compared to the recommendations and counsel offered by Mr. Tata. Moreover,

[By Tamanna Das Patnaik] The author is a student of National Law University, Odisha.   Introduction Financial Market Infrastructures (FMIs) play a vital role in the economy. They serve as coordinating mechanisms and bring a network of counterparties together for the efficient operation of financial markets. Clearing Corporations (CCs) are one such important category of FMIs that deal with the clearing and settlement of transactions, management of counterparty credit risks and protection of transactional systems. Given the vital role that they play, it becomes essential to maintain vigilant oversight over these entities. Regular reforms and timely adjustments are continuously required to avert any potential systemic risks. In light of the same, on July 20, 2023, the Securities and Exchange Board of India (SEBI) released a consultation paper titled ‘Prudential Norms for Clearing Corporations’. In the course of their usual business operations, CCs interact with various bank and non-bank entities, through deposits of their own funds, or collaterals like Fixed Deposits, Bank Guarantees, stock or debt instruments etc. This makes them susceptible to credit concentration risks arising from over-reliance on a single party. Thus, if there is any imbalance in the solvency or stability of that counterparty, it will significantly affect the CC and in turn, the entire financial system. The Consultation Paper aims to minimize such exposure and concentration risk of CCs by the means of adequate diversification and liquidity. Current regime The existing guidelines rely on a vague set of principles, which makes their supervision and enforcement difficult. CCs are required to frame an Investment Policy, the foundation of which must give the greatest priority to safety and reduction of market risks. This entails them tailoring their investment strategy and focusing on a particular set of allowed instruments, such as Fixed Deposits made at banks with more than INR 500 crore net worth and A1 or equivalent rating, Central Government Securities, Liquid schemes of debt mutual funds and Overnight Funds. However, the total amount invested in Liquid Funds and Overnight Funds have to be restricted to 10% of the CC’s total investible resources. Furthermore, adherence to exposure limits is also compulsory. According to the guidelines, the CC’s overall exposure to debt or equity securities of any company cannot be greater than 15% of its total liquid assets. Moreover bonds, considered as non-cash components, must be limited to a maximum of 10% of the clearing member’s total liquid assets. Proposed changes The proposed norms aim to closely oversee the exposure of CCs by presenting a comprehensive list of the type of exposures that require monitoring. This list comprises of the CC’s own funds and core Settlement Guarantee Fund (SGF) with a bank, balances with the bank acting as a clearing bank, fixed deposits (FDs) and bank guarantees (BGs) lien, pledged or re-pledged equity shares, debt instruments and mutual funds and lastly, exposure through economically reliant subsidiaries. The selection criteria for banks have also been made more well-defined. Assessment of financials, capital adequacy and credit worthiness are pre-requisites. Only banks with a minimum net worth of more than INR 5000 crore, unsupported long-term rating of AA or above and fulfilment of capital adequacy requirements given by the Reserve Bank of India (RBI) are eligible for exposure via cash, FDs and BGs. Investment is allowed only in specific financial instruments like FDs, treasury bills, government securities and liquid mutual funds. Further, in case the bank’s rating downgrades from the specified criteria, CCs have to adjust the exposure within three months of such occurrence. Coming to credit rating impacting the selection of a bank, a balance must be maintained between liquidity and diversification. Exposure to banks with credit rating AAA and between AAA to AA should be capped at 15% and 10% of the average daily exposure of the past three months respectively. An extra 5% exposure will be afforded to CCs only in exceptional circumstances, provided they undertake action to reduce the same within permissible limits within three months. Additionally, exposure concerning equity and debt instruments provided by a single clearing member (CM) should be within 15%, in both cash and F&O segments. Acquisition of collateral from CMs should not occur through bespoke transactions or comprise of FDs, BGs or debt or equity instruments issued by them themselves or their associates. Exposure to such corporate bonds should also be subject to the issuer’s credit rating. As a matter of prudence, total daily exposure should never surpass 20% of the total exposure and overall exposure limits should be lowered proportionally if there is a fall in credit rating. Periodic objectives should be integrated in the internal policies of CCs to ensure adherence to the exposure limits. Real-time monitoring of exposure and a buffer of limits to ensure that it stays within the specified limits without encountering operational challenges should be made certain. The guidelines also give out a list of timelines for the smooth implementation of the above measures in a phased manner. The dichotomy between preserving the autonomy of CCs and having a pre-determined list There are several benefits of letting CCs devise their own criteria for selection of banks. Each CC has its own distinct risk tolerance threshold and method of operation. Given this diversity, a predefined list by RBI or SEBI outlining permissible banks may prove to be ineffective. Thus, allowing CCs to formulate their own criteria for selection will ensure that their risk management policies respond better and more promptly to address the changing market conditions and associated risks. In such cases, a one-size-fits-all approach can prove to be detrimental. On the contrary, a predetermined list by regulatory bodies like RBI or SEBI can guarantee a standard process of creating a level playing field and setting a benchmark of creditworthiness that all banks strive to achieve, thereby enhancing the overall health of the financial system. The list will also ensure that all banks are assessed based on a common set of criteria, reducing potential inconsistencies and guaranteeing a uniform risk assessment process. It will also simplify regulatory oversight and

[By Chaitanya Gupta] The author is a student of Jindal Global Law School.   Introduction Related parties are important to corporate transactions because the parties have a pre-existing special relationship. Such transactions include business deals, series of contracts, etc. These relationships that exist prior to the transaction may appear in the form of parent-affiliate companies, parent-subsidiary companies, transactions between family members, and others. Usually, such transactions are employed for illegal, profit-making purposes, like fraudulently diverting resources and earnings (tunnelling). It can have severe consequences like affect shareholder dividends/profits, create a negative perception about the company’s governance, and hamper the growth of the company. Nevertheless, in certain circumstances, RPTs can benefit the company. Oftentimes, RPTs can cut transaction costs and creating operational efficiency. In fact, in some cases it has been observed that companies operating in groups, can save on operational costs, share risks, and improve productivity. RPTs in India In India, there is a peculiar pattern of ownership, i.e., a high concentration of ownership in the hands of particular individuals or families, and a large number of companies that are grouped under the ownership of one family or particular individuals. Thus, one promoter group often owns a group of companies. This pattern is bound to create conflicts between this promoter group and the minority shareholders. The rationale behind such conflicts is that the promoter groups tend to divert resources and profits for their benefit, so as to avoid proportional distribution of profits. The most common way to achieve this is to engage in ‘self-dealing transactions’, wherein finances are driven towards another company owned by the promoter group. Latest disclosure requirements and its problems The Indian corporate law regime qua RPTs is captured in Ss.2(76) and 188 of the Companies Act 2013. This regime is extended by SEBI’s Listing Obligations and Disclosure Requirements (LODR) 2015, the amendment of which came in force on April 2022 and 2023. It was formulated to incorporate the recommendations made by the Working Group Report of January 2020. One of the significant changes made is that RPTs require prior shareholder approval, as opposed to ex post facto approval. The primary argument of this article is to determine if SEBI cast the net too wide with the current disclosure requirements. Definition of ‘RPTs’ As per the latest LODR, the definitions of ‘related parties’ and RPTs were expanded, and the threshold of transaction value for shareholder approval was lowered. A related party thus includes a person/entity in possession of 20% equity shares or above, either directly, or on a beneficial interest basis. This 20% threshold fell down to 10% on 01.04.2023. Such a pure shareholding threshold to determine who is a related party precludes them from approving the transaction and would disenfranchise several investors. Financial investors like LIC, and the Indian Government would not be exempt from this disenfranchisement if they crossed these thresholds. The chances that investors will get disenfranchised double when the threshold goes down to 10%. This reduction arguably has no legal basis. The 20% threshold was grounded in the rationale of the Working Group Report, to deter shareholders with ‘significant influence’ from voting on material RPTs, and this Report does not endorse the further reduction to 10%. Nevertheless, some transactions have been exempted under these new guidelines. Transactions that directly and equally affect all shareholders or investors will not come under the fold of RPTs. However, the Reg.2(1)(zc) provides a finite list of such exempted transactions, viz., rights or bonus issue, buy-back of securities, dividend payment, and consolidation of securities. This change brings routine transactions under the purview of material transactions that require shareholder approval and/or audit committee scrutiny. Thus, transactions in the ordinary course of business, between affiliate companies of a large group or conglomerate are also scrutinised. This subjects routine transactions to auditory approvals, which not only obstructs the transaction but also unnecessarily burdens the audit committee. Even instances of real estate transactions that occur at below fair market value, while may trigger alarms of an abusive RPT; are a day-to-day transaction within conglomerates to promote struggling companies. While this may be a fair trade-off to create excessive audit scrutiny, lest an abusive RPT slips through the cracks, the additional burden on the committee creates an environment where all transactions do not get sufficient deliberation. Even though the exempted transactions are exhaustively listed, it raises uncertainty about other corporate actions and, whether transactions other than those exempted require prior shareholder approval or auditory scrutiny? The 1000 crore threshold These regulations have also stipulated a new monetary threshold of INR 1000 crore. RPTs that are beyond this limit need to be reported, so as to be subject to shareholder scrutiny. This new threshold is an absolute limit compared to the erstwhile provision, which had a threshold of 10% of the annual turnover of the company. This threshold can arguably be ultra vires of As.14 and 19(1)(g) of the Constitution. By virtue of the SEBI Act, SEBI will come under the definition of ‘the State’ as under A.12, and therefore its actions would be amenable to challenges of fundamental rights violation. The Khoday Distilleries case provides that regulations, specifically delegated legislations, can be struck down for being ‘manifestly arbitrary’ on the anvil of A.14. In fact, such delegated legislations are accorded less immunity than statutes of the legislature. Per Om Kumar, ‘non-classification arbitrariness’ is assessed under the ‘proportionality test’, and ‘classification arbitrariness’ is assessed under ‘Wednesbury principles’. The former tests if the means adopted are proportional to achieve the desired object, and the latter determines if the means share a sufficient nexus with the object. In the context of SEBI trying to protect the interests of minority shareholders and maintaining high standards of corporate governance, does this threshold create a disproportionate impact on large listed companies, thereby making it arbitrary? While it can be claimed that the aim of ensuring rights to minority shareholders and the maintenance of corporate governance could be achieved by scrutinising transactions that would not have been examined previously,