Tuesday, December 27, 2011

Financial Stability Report: RBI

On 22 December, 2011 the Reserve Bank of India published the Financial Stability Report (FSR). The Report read in totality would suggest that though the Indian Economy (and especially the financial system) remains stable, there exists some disconcerting macroeconomic issues. The core issues include the Euro Zone Crisis, Slowdown in the US, inflation and elevated oil prices. The relevant portion of the report reads as under:

“Global risks have increased since the publication of the third FSR in June 2011. Heightened uncertainties arising from the deepening sovereign debt crisis in the Euro Area and slowdown in the US pose downside risks for the global economy and for India through trade and finance channels and, therefore, need to be monitored closely. External sector risks are likely to increase. Elevated oil prices also pose downside risks to global recovery and have significant implications for domestic inflation. The profit margin of the corporate sector has dipped, indicating its reduced pricing power in the face of rising raw material and interest costs, domestic and global.” (emphasis mine)

In so far as the financial markets are concerned, the report acknowledges that there has been a significant deterioration from June 2011 onwards and the situation could worsen further. The following portion is apposite:

“Systemic risks facing the global and domestic financial system have heightened of late. There is significant deterioration in financial market conditions, for both sovereign and non-sovereign sectors, as a result of downgrades by rating agencies and poor economic outlook. Funding markets for short and long term finance in most currencies have become stressed with financial and non-financial firms facing significant challenges in raising longer term funds. Financial markets are trading with a downward bias on the belief that effectiveness of monetary and fiscal intervention is considerably lower in advanced economies. High levels of volatility are unnerving market participants abroad. The fallout of these developments is starting to impact overseas borrowings by financial and non-financial firms in India. The Indian equity and foreign exchange markets witnessed large corrections attendant with high volatility. The resultant impact on investor sentiment has been offset partially through a recovery in Foreign Direct Investments (FDI) flows this year. Higher than expected government borrowings, coupled with loss in growth momentum, could stress domestic financial markets though.” (emphasis mine)

On the soundness and resilience of the financial institutions the report concludes that there has been an increase in Non Performing Assets (NPAs) especially sectors such as priority sector, retail, real estate and infrastructure. The relevant part reads as under:

“The recent regulatory prescriptions for European banks have brought in fears of deleveraging. The direct impact on Indian banks, though, is expected to be limited. The banking system remained sound with CRAR and core CRAR well above the regulatory minimum and NPA ratios that compared favourably with the major advanced countries as well as peer EMEs. Continuous decline in CRAR and deterioration in asset quality, however, indicated that the risks were rising for the banking sector; even as credit growth decelerated and slippages outpaced credit growth. The major sectors that contributed to the increasing trend in NPAs were the priority sector, retail, real estate and infrastructure. In the infrastructure segment, the power and telecom sectors saw increased impairments and restructuring. The banking stability map and indicator also depicted increase in vulnerabilities in the Indian banking sector (emphasis mine)

There have been mixed reactions on the report. Some commentators believe that the FSR is ‘reassuring’ whereas others argue that there exists a ‘brewing banking crisis’.

Monday, December 19, 2011

Recent Developments

The Companies Bill, 2011 has been introduced in the Lok Sabha. A copy of the bill is available here. Some aspects of the bill has been discussed here, herehere and here. The report of the parliamentary standing committee on finance which had carried out detailed deliberations on the Companies Bill, 2009 is available here.

SEBI has released a concept paper on regulation of investment advisors.As per the paper, the regulation intends to "regulate the activity of providing investment advisory services is various forms by a wide range of entities including independent financial advisors, banks, distributors, fund managers etc.".

On 12 October, 2011, the OECD's Centre for Tax Policy and Administration introduced a public discussion draft on proposed changes to the Commentary on Article 5 (Permanent Establishment) of the OECD Model Tax Convention. Public Comments are invited on the discussion draft before 10 February, 2012. 

Thursday, October 27, 2011

Legal Status of a Child Marriage: Madras HC Decides

Recently, a Full Bench of the Madras High Court decided on the legal status of a marriage concluded in contravention with the prohibition of Child Marriage Act, 2006. The Full Bench held that such a marriage was valid unless it is annulled by a competent court. The decision arose out of a Habeas Corpus petition filed by T Sivakumar, for the production before the court of his minor daughter. Against the petition, the minor daughter filed an affidavit stating that she had left her parental home on her own accord and married the Second Respondent. The Division Bench hearing the matter had doubts over the decision of a Division Bench of the Madras High Court in G Saravanan v the Commissioner of Policy, Trichy where it was held that child marriage was valid and the husband of the child was entitled to the child's custody. The following questions were referred to the Full Bench:

"(1) Whether a marriage contracted by a person with a female of less than 18 years could be said to be valid marriage and the custody of the said girl be given to the husband (if he is not in custody)?

(2) Whether a minor can be said to have reached the age of discretion and thereby walk away from the lawful guardianship of her parents and refuse to go in their custody?

(3) If yes, can she be kept in the protective custody of the State?

(4) Whether in view of the provisions of Juvenile Justice (Care and Protection of Children) Act, 2000, a minor girl, who claims to have solemnized her marriage with another person would not be a juvenile in conflict with law and whether in violation of the procedure mandated by the Juvenile Justice (Care and Protection of Children) Act, 2000, the Court dealing with a Writ of Habeas Corpus, has the power to entrust the custody of the minor girl to a person, who contracted the marriage with the minor girl and thereby committed an office punishable under Section 18 of the Hindu Marriage Act and Section 9 of the Prohibition of Child Marriage Act, 2006 ? and

(5) Whether the principles of Sections 17 and 19(a) of the Guardians and Wards Act, 1890, could be imported to a case arising out of the alleged marriage of a minor girl, admittedly in contravention of the provisions of the Hindu Marriage Act?"

The Full Bench answered these questions as follows:

Nature of a marriage in Contravention of Prohibition of Child Marriage Act

"The marriage contracted by a person with a female of less than 18 years is voidable and the same shall be subsisting until it is annulled by a competent court under Section 3 of the Prohibition of Child Marriage Act. The said marriage is not a 'valid marriage' stricto sensu as per the classification but it is 'not invalid'. The male contracting party shall not enjoin all the rights which would otherwise emanate from a valid marriage stricto sensu, instead he will enjoin only limited rights."

Status of the Adult Husband vis-a-vis the Minor

The adult male contracting party to a child marriage with a female child shall not be the natural guardian of the female child in view of the implied repealing of Section 6(c) of the Hindu Minority and Guardianship Act, 1956."

"The male contracting party of a child marriage shall not be entitled for the custody of the female child whose marriage has been contracted by him even if the female child expresses her desire to go to his custody. However, as an interested person in the welfare of the minor girl, he may apply to the court to set her at liberty if she is illegally detained by anybody."

Legal Status of the Married Minor Girl

"A minor girl whose marriage has been contracted in violation of Section 3 of the Prohibition of Child Marriage Act is not an offender either under Section 9 of the Act or under Section 18 of the Hindu Marriage Act and so she is not a juvenile in conflict with law."

Rights of Parents vis-a-vis Married minor Girl

"The minor girl cannot be allowed to walk away from the legal guardianship of her parents. But, if she expresses her desire not to go with her parents, provided in the opinion of the court she has capacity to determine, the court cannot compel her to go to the custody of her parents and instead, the court may entrust her in the custody of a fit person subject to her volition."

"If the minor girl expresses her desire not to go with her parents, provided in the opinion of the court she has capacity to determine, the court may order her to be kept in a children home set up for children in need of care and protection under the provisions of the Juvenile Justice (Care and Protection) Act and at any cost she shall not be kept in a special home or observation home meant for juveniles in conflict with law established under the Juvenile Justice (Care and Protection) Act, 2000."

"Whether a minor girl has reached the age of discretion is a question of fact which the court has to decide based on the facts and circumstances of each case."

Considerations in a Habeas Corpus Petition Similar to the Instant Case

"In a habeas corpus proceeding, while granting custody of a minor girl, the court shall consider the paramount welfare including the safety of the minor girl not withstanding the legal right of the person who seeks custody and grant of custody in a habeas corpus proceeding shall not prejudice the legal rights of the parties to approach the civil court for appropriate relief."

"While considering the custody of a minor girl in a habeas corpus proceeding, the court may take into consideration the principles embodied in Sections 17 and 19(a) of the Guardians and Wards Act, 1890 for guidance."

Decision: Sivakumar v the Inspector of Police, Thiruvallur MANU/TN/3959/2011: 2011-5-LW 1

Tuesday, October 18, 2011

SAT Upholds SEBI Ruling in the Sahara Case

The Securities Appellate Tribunal has upheld SEBI's ruling in the Sahara Case. In line with SEBI's ruling, SAT has also found that optionally fully convertible debentures (OFCDs) issued by the two Sahara Group Companies ( SIRCL and SHICL) are securities and that the issue was a public issue requiring mandatory listing and that SEBI has the jurisdiction under the SEBI Act to deal with all kinds of companies, whether listed or not.

The SAT order is available here. The impugned SEBI order is available here.

Sunday, July 31, 2011

National Competition Policy

Shri Dharmendra Kumar committee which was constituted by the MCA for framing the National Competition Policy (NCP) has submitted a draft policy. At first blush one may question the rationale for a National Competition Policy considering that we have a Competition Law (Competition Act, 2002) already in place. Perhaps the answer to this ticklish question lies in the Raghavan Committee Report which observed as follows:

An effective competition policy promotes the creation of a business environment which improves static and dynamic efficiencies and leads to efficient resource allocation, and in which the abuse of market power is prevented mainly through competition. Where this is not possible, it requires the creation of a suitable regulatory framework for achieving efficiency. In addition, competition law prevents artificial entry barriers and facilitates market access and complements other competition promoting activities. Trade liberalisation alone is not sufficient to promote competition and there is a need for a separate competition policy

In other words Competition Law is only a subset of an overarching Competition Policy. Be that as it may, the committee lays down the NCP as under:

-Rule bound, fair, transparent and non discriminatory market regulatory procedures.

-Independence of the regulatory body.

-Establishing a ‘level playing field’ for both the government enterprises and the private sector.

-Fair pricing of public utilities and third party access to ‘essential facilities’. In other words it requires the dominant infrastructure owners (electricity, communications etc.) to grant to third parties access to their infrastructure on reasonable and competitive terms and conditions.

-Promotion of competition through regional, national and international co-operation.

The draft policy also mandates the Central and the State Government to undertake a Competition Impact Assessment of the existing policies, statutes, regulation that prima facie undermines competition (an illustrative list of parameters for conducting Competition Impact Assessment has been provided). Further for the implementation of the policy the government is mandated to set up a National Competition Policy Council (NCPC). The role of the NCPC is primarily to provide technical assistance in conducting the Competition Impact Assessment.

The NCP is indeed a necessary and welcome move. However, one may question the legal relevance of such policies i.e. extent to which they are legally enforceable. 

Friday, July 29, 2011

Takeover Code Revamp: Update

In a recent board meeting SEBI considered and accepted most of the recommendations of the TRAC. Some of the major recommendations that has been accepted by SEBI includes the following:

-Initial trigger threshold increased to 25 % from the existing 15 %

-scrapping of non compete fee. (the issue of non compete fee has been discussed on this blog previously and is available here and here)

-In cases of competitive offers, the successful bidder can acquire shares of other bidder(s) after the offer period without attracting open offer obligations.

-Voluntary offers have been introduced subject to certain conditions.

-A recommendation on the offer by the Board of Target Company has been made mandatory.

The two important recommendations that has not been accepted in totality are:

-offer size increased from a minimum 20% to 26% of the total issued capital. It is to be noted that TRAC had recommended an offer size of 100%.

-existing definition of 'control' retained. TRAC had proposed a broader definition of 'control' i.e. not just the right but also the ability to manage the company and appoint majority directors.

A summary and initial reaction on the development is available here.

Saturday, July 16, 2011

Convertible Debentures: New Rules

The 2011 rules are more or less similar to the 1977 rules albeit one significant difference. As per the 2011 rules a public financial institution or a bank can now only convert all or any part of the debentures, if (a) the company has defaulted in the repayment of, or payment of interest on, such loans and debentures; and (b) the bank or public financial institution has given the company a notice of its intention to convert the debentures at least 30 days prior to the intended date of conversion.     

Thursday, July 7, 2011

Micro Finance Institutions: Draft Bill

Micro Financial Institutions (MFIs) are entities which provide small credits to individual(s) or groups. Typically MFIs provide micro credit facilities, assist in remittance of funds, provide pension and insurance services etc. MFIs do not strictly fall within the category of a banking company or a co operative society engaged primarily in agricultural operation or industrial activity. The MFIs are seen more as an extended arm of the banking system which provides credit or other financial services to the poor households and their micro enterprises.

Last year the Andhra Pradesh Government introduced the Micro Finance Institutions (Regulations and Money Lending) Act, 2010 which had thrown the industry into crisis by imposing several restrictions. As a result the Reserve Bank of India appointed an expert committee lead by Y.H. Malegam. The Malegam Committee submitted its report on January 19, 2011 and based on the recommendations of the committee the government has introduced the Micro Finance Institutions (Development and Regulation) Bill, 2011. The object of the bill is “to provide a formal statutory framework for the promotion, development, regulation and orderly growth of the micro finance sector and thereby to facilitate universal access to integrated financial services for the unbanked population.”

Some of the salient features of the Bill are as follows:

-Establishing a Micro Finance Development Council which will advice and assist the government in framing policies for the sector. The bill also seeks to establish a State Advisory Council.

-The MFIs can only operate business after obtaining a certificate of registration from the Reserve Bank of India. The existing MFIs will also have to apply for the registration within three months from the commencement of the Act.

-Any MFI which becomes ‘systemically important’ will have to convert its institution into a Company registered under the Companies Act, 1956. An MFI can become ‘systemically important’ if it deploys a certain amount of funds for providing micro credit to a minimum number of clients. The exact figures relating to the amount and the clients are not specified in the bill and rightly so. The RBI has been delegated the power to frame rules in this regard.

-The Bill gives wide powers to the RBI. Some of the specific powers conferred on the RBI are (i) to formulate policies (ii) to prescribe minimum standards required to be followed by MFIs in relation to method of operation, recovery, management and governance (iii) calling for information and data from the MFIs, among others.

-Any restructuring of the MFIs will require the prior approval of the RBI.

-The Bill mandates the establishment of a Micro Finance Development Fund. The fund will be applied towards providing the MFIs with financial assistance.

-The Bill once it comes into force will override the provisions of all other existing laws. Further, the Bill provides that any MFI registered with the RBI under the provisions of this Act (now bill) will not be treated as a money lender for the purposes of any state enactment. In effect this implies quite clearly that the Andhra Pradesh Micro Finance Institutions (Regulations and Money Lending) Act, 2010 would not be applicable to the MFIs holding a certificate of registration under the provision of this Act/Bill.

The Bill is of immense socio economic importance. The views of the Industry and further analysis of the Bill is available on live mint and the Wall Street Journal.

Tuesday, July 5, 2011

Pledge of Shares, FDI

In recent times Government/RBI has made several attempts to liberalize, rationalize and simplify the processes associated with FDI flows to India and reduce the transaction time. In furtherance of this, the RBI vide a circular dated May 2, 2011 has delegated its powers to AD Category-I banks to allow non resident investors to pledge their shares held in an Indian Company, subject to certain conditions. The conditions prescribed are as follows:

In case shares are pledged in favour of an Indian bank the following conditions are applicable:

  1. In case of invocation of pledge, the transfer of shares should be in accordance with the FDI Policy existing at the time of creation of pledge.
  2. A declaration from the statutory auditor that the loan proceeds would be applied for the declared bona fide  business purpose.
  3. The Indian company whose shares are pledged will have to comply with the SEBI disclosure norms. In other words the Indian Company would have to comply with Regulation 8A of the Takeover Code and Clause 35/41 of the Listing Agreement.  
  4. The lender bank will have to comply with the provisions of S. 19 of the Banking Regulation act, 1949. In other words the lender bank cannot hold shares as a pledge of an amount exceeding thirty percent paid up share capital of that company or thirty percent of its own paid up share capital and reserves, whichever is less.
In case shares are pledged in favour of an overseas bank the following conditions are applicable:

  1. Loan is utilized for genuine business purpose overseas and not for any investments either directly or indirectly in India.
  2. Overseas investment should not result in any capital inflow into India.
  3. In case of invocation of pledge, the transfer of shares should be in accordance with the FDI Policy existing at the time of creation of pledge.
  4. A declaration from the statutory auditor that the loan proceeds would be applied for the declared bona fide business purpose.

A VCCIRCLE article analyzes the effect of the circular in detail. On a parting note though, the circular comes at a time when pledging of shares may not be commercially viable due to the prevailing market prices of these shares.

Monday, June 20, 2011

Rights Issue, Unsecured Loan Adjustment

In SRM Energy Limited v. SEBI, SAT has adjudicated upon the issue of adjustment of unsecured loans against the price to be paid for the shares allotted in the rights issue. The brief facts of the case are as follows. The appellant company borrowed a certain sum of money from the promoter group upon an oral understanding that if and when the appellant company came out with a rights issue, the unsecured loans would be adjusted against the share price. Subsequently, the appellant company came out with a rights issue and further sought to give effect to the aforementioned oral understanding entered into with the promoter group.

SEBI objected to such an adjustment on the ground that the unsecured loan advanced by the promoter group did not comply with the conditions prescribed u/s 81(3) of the Companies Act, 1956 [hereinafter “the Act”]. On the other hand the appellant company argued that shares were proposed to be allotted in accordance with the provisions of S. 81(1) of the Act and that the conditions incorporated in S. 81(3) were not applicable to the dispute in question. Before discussing the ruling of SAT, it is only appropriate to discuss the relevant provisions of the Act.

S. 81(1) of the Act empowers the Board to issue shares to the existing body of shareholders of the company in the same proportion in which they already hold shares of the company, without any special resolution or government approval. S. 81(1A) further empowers the Board to issue shares to non existing shareholders. However, as a condition precedent, such an issue has to approved by the shareholders vide a special resolution. S. 81(3) stipulates that S. 81 would not apply (a) to a private company (b) when the loans/debentures have a stipulation attached thereto that the lender will be entitled to exercise an option to convert the loans/debentures into shares at a future date. Such a conversion is however subject to two conditions (a) the terms of the loan has to be approved by the central government or is in conformity with the rules made in this behalf; and (b) a special resolution has to passed by the shareholders sanctioning the terms of the loan. 

SAT, while taking a pragmatic view allowed the adjustment. The reasoning adopted by SAT was that the entire transaction fell within the purview of S. 81(1) of the Act in that the additional shares were sought to be issued to the existing body of shareholders in the same proportion and that the transaction was not a mere conversion of debt into equity in the strict sense. Additionally, SAT noticed that as per the terms of the loan it was open for the promoter group to demand the immediate payment of the loans from the appellant company and hence, it was meaningless for the promoters to first demand the payment of the loan and then forward the very same amount towards the price of the shares allotted in the rights issue. 

Sunday, June 12, 2011

Non Compete Fee, Takeover Code: Part 2

In my previous post I had briefly discussed the concept of non-compete fees and the legal issues surrounding it. In this post I shall discuss the prevailing position of law with regard to non-compete fees. The present position of law is clearly articulated in E Land Fashion China Holdings Limited v. Securities Exchange Board of India wherein the SAT while reversing the order of SEBI allowed the acquirer to pay the additional non compete fees to the exiting promoters.


The appellant entered into a share subscription agreement and a share purchase agreement with the target company and its promoters whereby it was inter alia agreed that the appellant would acquire 51% of the equity capital of the target Company at a price of Rs. 75 per share inclusive of a non-compete fee of Rs. 15 per share. The appellant and the target company and its promoters also executed a shareholders agreement. Since, the equity shares acquired by the appellant pursuant to the aforesaid agreements were in excess of 15% of the voting rights in the target company, the provisions of Regulation 10 and 12 of the Securities and Exchange Board (Substantial Acquisition of Shares and Takeovers) Regulation 1997 [Hereinafter “takeover code”] got triggered. Accordingly, the appellant made an open offer to acquire 20% of the voting capital of the target company at a price of Rs. 60 per share. The offer price did not include the additional Rs. 15 which was offered to the promoter group. Thereafter, SEBI directed the appellant to add  the non-compete fee paid to the promoters to the offer price.                                         
SEBI's Contention

SEBI argued that the non compete fee should be added to the offer price as (i) the existing promoters were still continuing to hold substantial shares (post offer shareholding) in the company and that they were not exiting completely (ii) the promoters had the right to appoint two directors and jointly select two independent directors in the company (iii) the shares of the promoters had a lock in period of 3 years i.e. the promoters were not entitled to transfer their shares without the written approval of the acquirer. The crux of SEBI's argument was that the exiting promoters even post offer would continue to hold substantial shares in the company and also control the company. In such a scenario, SEBI argued, it was unlikely that the promoters would totally exit the target company and offer competition.

SAT's Ruling

The SAT allowed the payment of the non compete fee to the promoters of the target company on the ground that the promoters had the experience and expertise to compete with the target company at a future point in time. In arriving at this conclusion SAT heavily relied on its earlier ruling in Tata Tea Ltd. v. Securities Exchange Board of India. In tata tea the tribunal had held that if the payment of non compete is based on a strong business rationale and is not a mere tool to reduce the cost of acquisition to discriminate against the public shareholders, the Board or the tribunal is not entitled to intervene.


It is now fairly well settled that an acquirer is entitled to pay the promoter group of the target company an additional non-compete fee. However the non-compete fee can only to paid when there is a “lurking fear of competition”. The question as to what amounts to “lurking fear of competition” is a factual one and will have to be determined on a case to case basis. Additionally, the validity of a non-compete fee is not dependent on the extent of the threat of competition from the selling promoters i.e. even if the threat is remote it is not open for the Board or even the tribunal to intervene. The Board can intervene only when the non-compete fee is used as a design to reduce the cost of acquisition to discriminate against the public shareholders.

Although the controversy surrounding non-compete fee and the takeover code is clear (at least for the time being), several commentators (here and here) believe that non-compete agreements are in violation of S. 27 of the Indian Contract Act, 1872. The commentators argue that a SEBI Regulation cannot allow what the parliament expressly prohibits.      


Saturday, June 4, 2011

Preferential Allotment/Private Placement, New Rules

Recently the MCA released the Draft Unlisted Companies (Preferential Allotment) Rules, 2011. The draft rules seeks to substitute the Unlisted Companies (Preferential Allotment) Rules, 2003. The Draft rules inter alia requires more disclosures and also mandates the securities to be kept in a demat form. Here is a comparative table of both the rules:

Current 2003 Rules
Proposed 2011 Rules
Applies only to unlisted public companies in respect of preferential issue of equity shares, fully convertible debentures, partly convertible debentures or any other financial instrument which would be convertible into or exchanged with equity share at a later date.
Special Resolution
The issue of shares can be only made, if (i) the AoA of the company authorizes to do so and (ii) a special resolution is passed at the general meeting authorizing the allotment. The special resolution has to acted upon within a period of 12 months.
Additional Requirements

The company has to make disclosures in the offer document as prescribed.

The offer document has to be approved by way of a special resolution.

Both the copy of the special resolution and the offer document has to be filed with the RoC.

Condition for the issue of Private Placement
Does not prescribe any such condition.
The following conditions are prescribed:

Not more than 30 day gap between opening and closing of the issue.

Minimum 60 days gap between two issues.

Any financial instrument which is convertible into equity shares at a later date and resulting into a cumulative amount of Rs. 5 Crores or more will require the prior approval of the central government.

After the issue, the company has to file a return of allotment with the RoC within 30 days.
Dematerialization of Securities
No such requirement
All securities issued under preferential allotment or private placement has to be kept in a demat form.
Compliance Certificate
A Similar audit certificate was only required to be placed before the shareholders.
The compliance certificate has to be filed with the RoC.
Disclosures in the offer document
Not applicable. However disclosures are to be made in the explanatory statement to the notice for the general meeting.
The 2003 rules only prescribed that the object of the issue had to be disclosed. The 2011 rules requires disclosures with regard to the object of the issue, brief detail of the project and statutory clearances required and obtained for the project. Apart from this the two rules are more or less the same in this regard.

It is quite clear that the new rules, if they become operational, would increase the compliance burden on the companies. It will also increase the paper work and possibly the transaction cost. Moreover, fund raising through the issue of convertible financial instruments would be hit severely as now all such transactions resulting into a cumulative amount of Rs. 5 Crores or more will require Central Government approval.

The rationale for these new rules is unclear. However, initial reports suggest that the rules are a fallout of the Sahara-Sebi Controversy.

Wednesday, June 1, 2011

Non Compete Fee, Takeover Code: Part 1

Non Compete Fee is fees that is paid to the selling promoter(s) so that they do not re enter the same business and pose a threat to the acquired Company. This fee is not included in the offer price made to the public shareholders. For e.g., the acquirer pays Rs. 75 per share to the promoters and an additional Rs. 15 per share as non compete fee i.e. the promoters are paid a total of Rs. 90 per share whereas the offer price made to the public shareholders is only Rs. 75 per share.

In principle there is nothing in either the Takeover Code or any other related legislation that bars an acquirer from paying an additional non-compete fee to the promoter(s). On the contrary, in recent years SEBI has approved several transactions (here and here) where the promoter group was paid a higher price per share compared to the public shareholders. The higher price being justified as a non-compete fee.  The takeover code, however, imposes a restriction on the acquirer in that the non-compete fee cannot exceed 25% of the price offered to shareholders in the open offer.

Allowing the acquirer to pay an additional non-compete fee has several commercial justifications. However such additional payments have to be regulated inorder to ensure that the public shareholders are not discriminated against unfairly. In other words SEBI has to ensure (which it has in several instances) that the non-compete fee is paid by the acquirer only when there is an actual threat of the selling promoter re entering into the business. The non-compete fee is not justified when say, even after the acquisition the promoter continues to be a co promoter or the board of directors of the acquired company has equal representation from the selling promoter and the acquirer. Ultimately whether the payment of non-compete fee is justified or not depends on the facts and circumstances of a particular case.

Interestingly the TRAC Report recommends that the non-compete fee should be completely done away with.  The following observations of the TRAC are apposite:

“4.9.4 The Committee concluded that in keeping with the spirit of equal treatment  for all shareholders, and the scope for abuse of non-compete payments, the  Takeover Regulations ought to be explicit that consideration paid for the  shares in any form to the selling shareholder and his affiliates, concurrent with the purchase of shares, whether termed as ―control premium, or ―non-compete fees or otherwise must be added to the negotiated price per share for the purpose of determining open offer pricing.

4.9.5 The Committee concluded that once the extant exemption in respect of non-compete fee is deleted from the Takeover Regulations, and it is clearly articulated that apart from the share acquisition agreement, consideration in any form inclusive of all ancillary and collateral agreements shall form part of the negotiated price, it is in the selling shareholders‘ interests to ensure that the negotiated price truly reflects the value of the scrip fairly. Since this negotiated price in any case would be one of the parameters for fixing the offer price, if such price were higher than other proposed parameters, all shareholders will get the same negotiated price.”

In a subsequent post we will discuss the recent ruling of SAT in E-Land Fashion China holdings Limited and other related judgments inorder to ascertain the prevailing jurisprudence on non-compete fees. 

Sunday, May 29, 2011

Overseas Direct Investment, Liberalization/Rationalization

The RBI vide a recent circular, dated May 27, 2011 has made certain changes to the prevailing ODI Regulations. The objective is to provide operational flexibility to Indian Corporates having investment abroad. Some of the changes brought about are with respect to:

(i)  Performance Guarantees issued by the Indian Party.

(ii) Restructuring of the balance sheet of the overseas entity involving write-off of capital and    receivables.

(iii) Disinvestment by the Indian Parties of their stake in an overseas JV/WOS involving write-off.

(iv) Issue of guarantee by an  Indian Party to step down subsidiary of JV /WOS under general  permission.

The Business Standard dated May 28, 2011 reports the reaction of Corporate India to the above mentioned changes.    

Wednesday, May 11, 2011

Links of Interest

A recent article in livemint discusses the taxation of commodity derivatives.

The Karnataka High Court had an occasion to adjudicate on a Vodafone like case. The judgement is available here.

The Firm discusses the legal challenges and issues surrounding Slump Sales. There has been some debate in recent times over slump sales especially when the sale involves a core area of business. The recent divestment by Kanoria Chemicals of its Chloro Chemical Division (CCD) to Adiya Birla Chemicals (India) Limited (ABCIL) is an example of such a sale. 

Monday, March 28, 2011

Enforcement of Foreign Award, Public Policy: Penn Racquet

A recent post on the Kluwer Arbitartion Blog whilst discussing the recent judgment of the Delhi High Court in Penn Racquet Sports v. Mayor International Limited has sought to argue that the Delhi High Court has taken a contrary approach (according to the post, rightly so) to that of the supreme Court in ONGC v. Saw Pipes Limited ((2003)5 SCC 705). The Kluwer post argues that in Penn Racquet the court has attempted to assign a narrow meaning to the term “Public Policy” as opposed to a wider meaning assigned to the same by the Supreme Court in Saw Pipes. In this post I shall attempt to demonstrate that the abovementioned interpretation of the ruling in Penn Racquet is incorrect.

Before discussing the ruling of the Delhi High Court on the term “public policy”, it would be appropriate to discuss the relevant facts and the contentions of the parties. Penn Racquet Sports (“decree holder”), a company incorporated in the United States had entered into a Trademark License Agreement (“TLA”) with Mayor International Limited (“judgment debtor”), a Company incorporated in India, whereunder the decree holder had granted the judgment debtor license to use the trademark “Penn” for use in certain territories and for certain products. In consideration of the license the judgment debtor agreed to pay an annual royalty to the decree holder. The dispute arose when the judgment debtor refused to pay the annual royalty on the ground that the decree holder had breached the contract by granting a similar license to Nebus Loyalty Limited (“Nebus”). Subsequently the dispute was referred to arbitration and thereafter the decree holder obtained an award in his favour. It is for the enforcement of this award that the decree holder preferred the present enforcement application u/s 47 of the Arbitration and Conciliation Act (“Act”). Needless to state, the judgment debtor challenged the enforcement of the award u/s 48 of the Act.

The judgment debtor contented before the Delhi High Court that the impugned award was against public policy as (i) the award was against the express terms of the contract which rendered it patently illegal and (ii) the arbitral tribunal refused to entertain the counter claim of the judgment debtor, denying it an opportunity to present its case. The judgment debtor relied on Venture Global Engineering v. Satyam Computer Services Limited (AIR 2008 SC 1061) to contend that the foreign award is subject to challenge u/s 34 of the Act, and then relied on Saw Pipes to contend that since the award was patently illegal it could not be enforced. Contrarily, the decree holder contented that while enforcing an award u/s 47-49 of the Act, the court is not mandated to adjudicate on the merits of the dispute. The decree holder further contended that the law laid down in Saw Pipes is only applicable to domestic awards and that the term “Public Policy” has a different connotation u/s 48(2)(b) to that in S. 34(2)(b)(ii) of the Act.

The Delhi High Court upholding the contention(s) of the decree holder, held that the term “public policy” in S. 48(2)(b) of the Act carries a narrower meaning when compared to the meaning assigned to the same term u/s 34(2)(b)(ii) of the Act. The court relied on the Supreme Court decision in Furest Day Lawson v. Jindal Exports (AIR 2001 SC 2293) and its own decision in Jindal Exports v. Furest Day Lawson to hold that a narrow meaning must be given to the term “public policy” u/s 48(2)(b) and only when the most “basic notions of morality and justice” are violated should the court refuse the enforcement of the foreign award. Having drawn a distinction between s. 48(2)(b) and s. 34(2)(b)(ii), as far the tem “public policy” is concerned, the court further seems to have agreed that the ratio of Venture Global was not applicable to the present case as the substantive law governing the contract was not Indian Law (arguably suggesting an implied exclusion of Part I of the Act).             

On a close scrutiny the Delhi High Court’s judgment in Penn Racquet may arguably be in conflict with the ruling in Venture Global, wherein the Supreme Court had held that there is no distinction between s. 34 and s. 48. However, it is incorrect to argue that it tried to assign a narrow meaning to the term “public policy” u/s 34 (which would be the natural conclusion, if one was to argue that the Delhi High Court deviated from the ruling in Saw Pipes). In essence the Delhi High Court never went into scope and ambit of the term “Public Policy” u/s 34 and rightly so. On the contrary, the Court seems to have followed Saw Pipes. In Saw Pipes the appellant had argued that the narrow meaning assigned to the term “public policy” in Renusagar was in context to the fact that the question involved in that case was with regard to the execution of the award which had attained finality. It was further argued that the scheme of S. 34 which deals with setting aside of arbitral award and S. 48 which deals with enforcement of arbitral award are not identical (para. 20). The Supreme Court in Saw Pipes responded to the above argument in the following manner:

The aforesaid submission of the learned senior counsel requires to be accepted. From the judgments discussed above, it can be held that the term 'public policy of India' is required to be interpreted in the context of the jurisdiction of the Court where the validity of award is challenged before it becomes final and executable. The concept of enforcement of the award after it becomes final is different and the jurisdiction of the Court at that stage could be limited. Similar is the position with regard to the execution of a decree. It is settled law as well as it is provided under Code of Civil Procedure that once the decree has attained finality, in an execution proceeding, it may be challenged only on limited grounds such as the decree being without jurisdiction or nullity. But in a case where the judgment and decree is challenged before the Appellate Court or the Court exercising revisional jurisdiction, the jurisdiction of such Court would be wider.” (para. 22)(emphasis mine) 

In conclusion it is submitted that Penn Racquet does not in essence deviate from the trend that has been pursued by Indian Courts on previous occasions in relation to challenge or enforcement of awards in general and the term “public policy” in particular.

Sunday, March 20, 2011

Mandatory CSR: Useful Links

There has been a lot of debate over the government's proposal to make a mandatory spend of 2% on Corporate Social Responsibility ("CSR"). The posts here and here give a brief overview of the proposal and the issues involved therein. One of the principal contentions raised by the corporates is that a mandatory CSR is akin to tax and in essence dilutes the whole concept of CSR.

Today's Business Standard has an interesting article supporting the government's proposal of a mandatory CSR. 


Saturday, March 5, 2011

S. 5&6 of the Competition Act Notified

The Ministry of Corporate Affairs ("MCA') has notified S. 5 & 6 of the Competition Act, 2002. This inter alia means that the Competition Commission of India ("CCI") will now have the power to monitor Mergers&Acquisitions. The notification is available here.

In this regard the CCI has also made draft regulations. The draft regulation is available here.

Thursday, March 3, 2011

Parliament's Power to Enact Laws Having Extra Territorial Operation

In a recent judgement of the Honorable Supreme Court of India in GVK Industries Ltd. v. ITO ( 01.03.2011) the issue relating to the extent to which laws enacted by Parliament can have extra territorial effect under Article 245 of the Constitution of India, has been elaborately discussed. 

The summary of the judgement is available here

Tuesday, February 22, 2011

Regulations to Facilitate Overseas Acquisitions: CII

The Confederation of Indian Industry ("CII") has urged the Government of India to bring forth regulatory changes which would facilitate Overseas Acquisitions. In a memorandum submitted to the DIPP, CII has submitted that the regulatory framework in India hinders Indian Multinationals to pursue global acquisitions. Some of the concerns and suggestions put forth by the CII, in this regard, are:

"A provision is proposed in the Companies Bill 2009 that would restrict the number of step down subsidiaries. This would be a major impediment towards overseas acquisitions by Indian companies. Very often the foreign company to be acquired already has more than one level of subsidiaries and for effecting the acquisition, the Indian company may need to create a SPV which could be a subsidiary of a subsidiary. However, if the Companies Bill is enacted with this restriction, it would prove to be a major hurdle for aspiring Indian companies, which are planning overseas acquisitions."(emphasis mine)

"For investing in the target company, in excess of 60% of its net worth or 100% of its free reserves, the company requires prior shareholders approval. This necessitates disclosure of vital details about the proposed acquisition company to the shareholders, including the price being paid. As a result, sensitive and confidential information, which could be of critical importance to competing bidders, becomes available in the public domain even prior to submitting a bid to the target company."(emphasis mine)

"The Competition Act, 2002 also mandates merger regulation. While the relevant provisions of the Act have not yet been notified; once the process is initiated, the process would conflict with provisions under Companies Act, SEBI’s Preferential Allotment Guidelines, the Takeover Code and the Guidelines issued by DoT for the Telcom sector. This would result in unnecessary references to the Regulator and/or Govt and in some case, litigations. These aspects should be carefully considered before notification of the sections relation to merger regulation by CCI."

The full contents of the memorandum is available here.

Thursday, February 17, 2011

S. 11 of the Arbitration Act, 1996: Is the Law Finally Clear!

S. 11 of the Arbitration and Conciliation Act, 1996 (Hereinafter “the Act”) has given rise to a great deal of controversy. There is catena of decisions of the Supreme Court wherein the Apex Court has examined the nature and scope of the enquiry and the jurisdiction of the Chief Justice or his designate while dealing with petitions under Section 11 of the Act. In Alva Aluminium Ltd., Bangkok v. Gabriel India Limited (16.11.2010), the Supreme Court has once again reiterated the law on this subject. The Court in ALVA cited with approval the judgment of the Supreme Court in National Insurance Co. Ltd. v. Boghara Polyfab (P) Ltd. (2009(1) SCC 267) wherein the Apex Court had categorized the issue(s) that may arise for consideration before the Chief Justice or his designate in a petition under Section 11 of the Act. In Boghara Polyfab the Court had stated the following proposition of law:

1. The issues (first category) which the Chief Justice/his designate will have to decide are:

(a) Whether the party making the application has approached the appropriate High Court.

(b) Whether there is an arbitration agreement and whether the party who has applied under Section 11 of the Act, is a party to such an agreement.

2. The issues (second category) which the Chief Justice/his designate may choose to decide (or leave them to the decision of the Arbitral Tribunal) are:

(a) Whether the claim is a dead (long-barred) claim or a live claim.

(b) Whether the parties have concluded the contract/transaction by recording satisfaction of their mutual rights and obligation or by receiving the final payment without objection.

3. The issues (third category) which the Chief Justice/his designate should leave exclusively to the Arbitral Tribunal are:

(a) Whether a claim made falls within the arbitration Clause (as for example, a matter which is reserved for final decision of a departmental authority and excepted or excluded from arbitration).

(b) Merits or any claim involved in the arbitration.”

The other decisions of the Supreme Court which have enunciated the law on this subject are mentioned hereunder:    

  • A.P.Tourism Development Corporation v. Pampa Hotels Ltd., 2010 (5) SCC 425
  • SBP. v. Patel Engineering Ltd., AIR 2006 SC 540
  • Shivnath Rai v. Gaffar, AIR 2008 SC 1906