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Submission of balance sheet and profit & loss account by NBFCs — Notification No. DNBS.217/CGM (US)-2010, dated 1-12-2010.

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Part D : company law


Changes relating to Company
Law for the period 15th Dcember, 2010 to 15th January, 2011.

63 Submission of balance
sheet and profit & loss account by NBFCs — Notification No. DNBS.217/CGM
(US)-2010, dated 1-12-2010.

The RBI has issued
Notification amending the non-banking financial (deposit Accepting) companies
Prudential Norms Direction, 2007 and non-banking financial (Non-Deposit
Accepting) companies Prudential Norms Direction, 2007 and providing that every
NBFC shall finalise its balance sheet and profit and loss account as on March 31
every year within a period of 3 months from the date to which it pertains. For
example, balance sheet as on March 31st of a year shall be finalised by June
30th of the year.

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Acceptance of third party address as correspondence address.

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Part D : company law


Changes relating to Company
Law for the period 15th Dcember, 2010 to 15th January, 2011.

62 Acceptance of third party
address as correspondence address.

SEBI vide Circular No. CIR/MRD/DP/37/2010,
dated 14-12-2010 based on representations received from intermediaries seeking
guidance and clarifications whether to accept and capture the address of some
person (third party) other than the beneficial owner (BO) as a correspondence
address in the details of the demat account of the BO. SEBI has clarified that
it has no objection to a BO authorising the captureto : of an address of the
third party as a correspondence address, provided that the Depository
Participant (DP) ensures that all prescribed ‘Know Your Client’ norms are
fulfilled for the third party also. The DP shall obtain proof of identity and
proof of address for the third party. The DP shall also ensures that the
customer due diligence norms as specified in the Rule 9 of Prevention of Money
Laundering Rules, 2005 are complied with in respect of the third party. SEBI has
also stated that the depository participant should further ensure that the
statement of transaction and holding are sent to the BO’s permanent address at
least once in a year. It is clarified that the above provision shall not apply
in case of PMS (Portfolio Management Service) clients.

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SEBI Notification No. LAD-NRO/GN/2010-11/21/29390, dated 10-12-2010.

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Part D : company law


Changes relating to Company
Law for the period 15th Dcember, 2010 to 15th January, 2011.

61 SEBI Notification No.
LAD-NRO/GN/2010-11/21/29390, dated 10-12-2010.

SEBI vide Notification No.
LAD-NRO/GN/2010-11/21/29390, dated 10-12-2010 has in terms of sub-regulation (1)
of Regulation 3 of the Securities and Exchange Board of India (Certification of
Associated Persons in the Securities Markets) Regulations, 2007 (the
Regulations) notified that the Board is empowered to require, by Notification,
any category of associated persons as defined in the Regulations to obtain
requisite certification(s).

2. Accordingly, it is
notified that with effect from the date of this Notification, the following
category of associated persons, i.e., persons associated with a registered
stock-broker/trading member/clearing member in recognised stock exchanges, who
are involved in, or deal with, any of the following, namely :

(a) assets or funds of
investors or clients,

(b) redressal of investor
grievances,

(c) internal control or
risk management, and

(d) activities having a
bearing on operational risk,

shall be required to have a
valid certification from the National Institute of Securities Markets (NISM) by
passing the NISM-Series-VII : Securities Operations and Risk Management
Certification Examination as mentioned in the NISM communiqué/Press Release NISM/Certification/Series-VII
: SORM/2010/01, dated November 11, 2010, read with Annexures-I and II thereto.

It is provided that the
stock-broker/trading member/clearing member shall ensure that all persons
associated with it and carrying on any activity specified in this paragraph as
on the date of this Notification obtain valid certification within two years
from the said date of Notification.

Provided further that a
stock-broker/trading member/clearing member who employs any associated persons
specified in this paragraph after the date of this Notification shall ensure
that the said associated persons obtain valid certification within one year from
the date of their employment.

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SEBI vide Notification No. LAD-NRO/GN/ 2010-11/22/30364, dated 21-12-2010, Foreign Venture Capital Investors (Amendment) Regulations, 2010 has further amended Foreign Venture Capital Investors, Regulations, 2000, to include after paragraph 9.

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Part D : company law


Changes relating to Company
Law for the period 15th Dcember, 2010 to 15th January, 2011.

60 SEBI vide Notification
No. LAD-NRO/GN/ 2010-11/22/30364, dated 21-12-2010, Foreign Venture Capital
Investors (Amendment) Regulations, 2010 has further amended Foreign Venture
Capital Investors, Regulations, 2000, to include after paragraph 9.

SEBI vide Notification No.
LAD-NRO/GN/ 2010-11/22/30364, dated 21-12-2010, Foreign Venture Capital
Investors (Amendment) Regulations, 2010 has further amended Foreign Venture
Capital Investors, Regulations, 2000, to include after paragraph 9 :

10. To furnish firm
commitment letter(s) from investors for contribution of an amount aggregating
to at least US$ 1 million.

11. To furnish copies of
the companies’ financial statements as well as those of the investors’ who
have provided firm commitment letter(s), for the financial year preceding the
one during which the application is being made.

12. To furnish name,
address, contact number and the e-mail address of all the directors of the
company.

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Amendments to SEBI Equity Listing Agreement — Circular No. CIR/CFD/DIL/10/2010, dated 16-12-2010.

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Part D : company law


Changes relating to Company
Law for the period 15th Dcember, 2010 to 15th January, 2011.

59 Amendments to SEBI Equity
Listing Agreement — Circular No. CIR/CFD/DIL/10/2010, dated 16-12-2010.

SEBI has issued a Circular
amending the Equity Listing Agreement with respect to various continuous
disclosures made by listed entities in relation to the following :

1. Amendments to Clause 35
— Disclosure relating to shareholding pattern

(a) Disclosure of
shareholding pattern prior to listing of securities

(b) Disclosure of
shareholding pattern of listed entities pursuant to material changes in the
capital structure

(c) Disclosure in respect
of depository receipts

2. Amendments to Clause
40A — Minimum public shareholding

3. Amendments to Clause 5A
— Uniform procedure for dealing with unclaimed shares

4. Amendment to Clause 20
& 22 — Corporate announcement

5. Amendment to Clause 21
— Notice period

6. Insertion of Clause 53
— Disclosures regarding agreements with the media companies

7. Insertion of Clause 54
— Maintenance of a website

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Comprehensive Guidelines on Over-the-Counter (OTC) Foreign Exchange Derivatives and Overseas Hedging of Commodity Price and Freight Risks

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Part C : RBI/FEMA


Given below are the
highlights of certain RBI Circulars.

58 A.P. (DIR Series)
Circular No. 32,

dated 28-12-2010

Comprehensive Guidelines on
Over-the-Counter (OTC) Foreign Exchange Derivatives and Overseas Hedging of
Commodity Price and Freight Risks

 

Annexed to this Circular are
Comprehensive Guidelines on Foreign Exchange Derivatives and Overseas Hedging of
Commodity Price and Freight Risks. These guidelines will come into effect from
February 01, 2011. In addition, the Comprehensive Guidelines on Derivatives
issued vide Circular DBOD.No.BP.BC. 86/21.04.157/2006-07, dated April 20, 2007
and subsequent amendments thereto would continue to apply to foreign exchange
derivatives.

The guidelines are divided
into the following seven sections :


I. Section A — Overview
of the guidelines

II. Section B —
Guidelines for per sons resident in India
(other than AD Category I banks)

III. Section C—
Guidelines for persons resi dent outside India

IV. Section D—
Guidelines for Authorised Dealers Category I

V. Section E— Guidelines
for Commodity Derivatives

VI. Section F—
Guidelines for Freight Derivatives

VII. Section G— Reports
to the Reserve Bank



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Asian Clearing Union (ACU) Mechanism — Indo-Iran Trade

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New Page 1

Part C : RBI/FEMA


Given below are the
highlights of certain RBI Circulars.

57 A.P. (DIR Series)
Circular No. 31,

dated 27-12-2010

Asian Clearing Union (ACU)
Mechanism — Indo-Iran Trade

 

This Circular provides that
all eligible current account transactions including trade transactions with Iran
should be settled in any permitted currency outside the ACU mechanism until
further notice. This has been done to mitigate the difficulties being
experienced by importers/exporters in payments to/receipts from Iran.

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Asian Clearing Union (ACU) Mechanism — Payments for import of oil or gas

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Part C : RBI/FEMA


Given below are the
highlights of certain RBI Circulars.

56 A.P. (DIR Series)
Circular No. 30,

dated 23-12-2010

Asian Clearing Union (ACU)
Mechanism — Payments for import of oil or gas

 

Presently, all eligible
current account transactions as defined by the Articles of Agreement of the
International Monetary Fund and the export/import transactions between the ACU
member countries on deferred payment terms, respectively, are to be routed
through the ACU mechanism.

This Circular provides that
henceforth payment for import of oil or gas must be settled in any permitted
currency outside the ACU mechanism.

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Use of International Debit Cards/Store Value Cards/Charge Cards/Smart Cards by resident Indians while on a visit outside India

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Part C : RBI/FEMA


Given below are the
highlights of certain RBI Circulars.

55 A.P. (DIR Series)
Circular No. 29,

dated 22-12-2010

Use of International Debit
Cards/Store Value Cards/Charge Cards/Smart Cards by resident Indians while on a
visit outside India

Presently, Banks are
required to submit a yearly statement on December 31 every year containing
details of International Debit Card holders who spend more than US $ 100,000 in
a calendar year.

This Circular informs RBI
decision to discontinue the submission of this Statement. Hence, Banks need not
submit the said Statement for the year ending December 31, 2010.

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Know Your Customer (KYC) norms/Anti-Money Laundering (AML) standards/Combating the Financing of Terrorism (CFT)/ Obligation of Authorised Persons under Prevention of Money Laundering Act, (PMLA), 2002, as amended by Prevention of Money Laundering (Amendme

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New Page 1

Part C : RBI/FEMA


Given below are the
highlights of certain RBI Circulars.

54 A.P. (DIR Series)
Circular No. 28,

dated 22-12-2010

A.P. (FL/RL Series) Circular
No. 9,

dated 22-12-2010

Know Your Customer (KYC)
norms/Anti-Money Laundering (AML) standards/Combating the Financing of Terrorism
(CFT)/ Obligation of Authorised Persons under Prevention of Money Laundering
Act, (PMLA), 2002, as amended by Prevention of Money Laundering (Amendment) Act,
2009 — Cross-Border Inward Remittance under Money Transfer Service Scheme

 

Attached to this Circular is
a Statement dated June 25, 2010 issued by the Financial Action Task Force (FATF)
which identifies certain jurisdictions which have strategic AML/CFT
deficiencies. The Statement calls upon the identified jurisdictions to complete
the implementation of their action plan within the time frame.

This Circular advices
Authorised Persons to consider the information contained the said Statement.

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Know Your Customer (KYC) norms/Anti-Money Laundering (AML) standards/Combating the Financing of Terrorism (CFT)/Obligation of Authorised Persons under Prevention of Money Laundering Act, (PMLA), 2002, as amended by Prevention of Money Laundering (Amendmen

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New Page 1

Part C : RBI/FEMA


Given below are the
highlights of certain RBI Circulars.

52 A.P. (DIR Series)
Circular No. 26,

dated 22-12-2010

A.P. (FL/RL Series) Circular
No. 7,

dated 22-12-2010

Know Your Customer (KYC)
norms/Anti-Money Laundering (AML) standards/Combating the Financing of Terrorism
(CFT)/Obligation of Authorised Persons under Prevention of Money Laundering Act,
(PMLA), 2002, as amended by Prevention of Money Laundering (Amendment) Act, 2009
— Cross-Border Inward Remittance under Money Transfer Service Scheme

Attached to this Circular is
a Statement dated June 25, 2010 issued by the Financial Action Task Force (FATF).
This Statement divides the strategic AML/CFT deficient jurisdictions into two
groups as under :

(a) Jurisdictions against
whom countermeasures are required to be applied to protect the international
financial system from the ongoing and substantial money laundering and
terrorist financing (ML/TF) risks — Iran.

(b) Jurisdictions with
strategic AML/CFT deficiencies that have not committed to an action plan
developed with the FATF to address key deficiencies as of June 2010 —
Democratic People’s Republic of Korea (DPRK), Sao Tome and Principe.

This Circular advices
Authorised Persons to take into account risks arising from the deficiencies in
AML/CFT regime of these countries, while entering into business relationships
and transactions with persons (including legal persons and other financial
institutions) from or in these countries/jurisdictions.

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New versions of Form 21A, Form 23AC and Form 23ACA

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New Page 2

Part D : company law


Changes relating to Company Law for the period November 15,
2010 to December 15, 2010.

40. New versions of Form 21A, Form 23AC and Form 23ACA

New versions of Form 21A, Form 23AC and Form 23ACA are
available on the MCA portal, effective December 5, 2010 and the same are
required to be used for filing after December 5, 2010.

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Status of action initiated against vanishing companies and its promoters/directors.

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Part D : company law


Changes relating to Company Law for the period November 15,
2010 to December 15, 2010.

39. Status of action initiated against vanishing companies
and its promoters/directors.

Status of action initiated against vanishing companies and
its promoters/directors under the provisions of the Companies Act, 1956 and
under the Indian Penal Code can be viewed at
http://www.mca.gov.in/Ministry/vanishing.html

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Suggestions on issues related to Convergence of Indian Accounting Standards with IFRS.

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New Page 2

Part D : company law


Changes relating to Company Law for the period November 15,
2010 to December 15, 2010.

38. Suggestions on issues related to Convergence of Indian
Accounting Standards with IFRS.

The Ministry of Corporate Affairs has invited suggestions on
issues related to Convergence of Indian Accounting Standards with IFRS to be
submitted by 20th December 2010.

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Reopening/revision of annual accounts after their adoption in the annual general meeting — General Circular No. 5/2010, dated 2-11-2010.

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Part D : company law


Changes relating to Company Law for the period November 15,
2010 to December 15, 2010.

36. Reopening/revision of annual accounts after their
adoption in the annual general meeting — General Circular No. 5/2010, dated
2-11-2010.

The Ministry, vide General Circular Number 1/2003 (F.No.
17/75/2002), dated 13-1-2003 had directed the grounds and manner in which
accounts can be re-opened/revised by companies and thereafter adopted by
shareholders.

It has now come to the notice of the Ministry that few
companies have been filing their annual accounts u/s.220 more than once
resulting into filing/availability of more than one such accounts in the
Registry for a particular financial year.

The matter has been examined in the Ministry in detail and it
has been concluded that keeping in view the provisions of S. 220 of the Act read
with the Ministry’s General Circular 1/2003, a Company cannot lay more than one
set of annual accounts for a particular financial year, unless it has
reopened/revised such annual accounts after their adoption in the Annual General
Meeting on the grounds specified in Ministry’s Circular No. 1/2003.

Accordingly, it is hereby directed that ROCs should keep a
watch on such kinds of repeat filings of annual accounts and such accounts
should not be accepted except in accordance with provisions of S. 220 read with
Ministry’s General Circular 1/2003.

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The MCA has revised Form DIN1 and Form DIN3 vide Notification GSR 849(E) dated 15-10-2010.

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Part D : company law


Changes relating to Company Law for the period November 15,
2010 to December 15, 2010.

35. The MCA has revised Form DIN1 and Form DIN3 vide
Notification GSR 849(E) dated 15-10-2010.




  •  In Form DIN 1, the following declaration is inserted “I
    also confirm that I am not restrained/disqualified/removed of, for being
    appointed as Director of a Company under the provisions of the Companies
    Act, 1956 including S. 203, S. 274 and S. 388E of the said Act. I further
    confirm that I have not been declared as proclaimed offender by any Economic
    Offence Court or Judicial Magistrate Court or High Court or any other Court”
    and


  •  In Form DIN-3, a verification as follows has been
    inserted “it is hereby confirmed that the appointed Director(s) whose
    particulars are given above has given a declaration to the Company that
    he/she is not restrained/disqualified/removed of, for being appointed as
    Director of a Company under the provisions of the Companies Act, 1956
    including S. 203, S. 274 and S. 388E of the said Act. It is also confirmed
    that the appointed Director(s) whose particulars are given above, has not
    been declared as proclaimed offender by any Economic Offence Court or
    Judicial Magistrate Court or High Court or any other Court.




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The MCA has revised Form 1 and Form 32 vide Notification GSR 848(E) dated 15-10-2010.

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Part D : company law


Changes relating to Company Law for the period November 15,
2010 to December 15, 2010.


34. The MCA has revised Form 1 and Form 32 vide Notification
GSR 848(E) dated 15-10-2010.



  •  In
    Form 1, the following has been inserted “Whether the subscriber has been
    convicted by any Court for any offence involving moral turpitude or economic
    or criminal offence or for any offences in connection with the promotion,
    formation or management of a Company Yes/No, if Yes provide Details.



  •  In
    Form 32, the following verification is inserted “4. It is also confirmed
    that the appointed Director(s) whose particulars are given above, has given
    a declaration to the Company that he/she has not been declared as proclaimed
    offender by any Economic Offence Court or Judicial Magistrate Court or High
    Court or any other Court.




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Certain general insurance business services exempted — Notification No. 58/2010-ST, dated 21-12-2010.

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Part B : INDIRECT
TAXES


SERVICE TAX UPDATE

50 Certain general insurance
business services exempted — Notification No. 58/2010-ST, dated 21-12-2010.

By this Notification,
taxable services in relation to general insurance business provided under the
Weather-based Crop Insurance Scheme or the Modified National Agricultural
Insurance Scheme, approved by the Government of India and implemented by the
Ministry of Agriculture, have been exempted.

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Transport services provided by Government Railways exempted — Notifications Nos. 55/2010-ST, 56/2010-ST & 57/2010-ST, all dated 21-12-2010.

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Part B : INDIRECT
TAXES


SERVICE TAX UPDATE

49 Transport services
provided by Government Railways exempted — Notifications Nos. 55/2010-ST,
56/2010-ST & 57/2010-ST, all dated 21-12-2010.

By these Notifications, levy
of service tax on taxable services as referred in S. 65(105)(zzzp) provided by
Government Railways to any person in relation to transport of goods by rail has
been deferred to 1st April 2011.

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Further amendments to Notification No. 24/2009-ST, dated 27-7-2009 — Notification No. 54/2010-ST, dated 21-12-2010.

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Part B : INDIRECT
TAXES


SERVICE TAX UPDATE

48 Further amendments to
Notification No. 24/2009-ST, dated 27-7-2009 — Notification No. 54/2010-ST,
dated 21-12-2010.

By this Notification,
earlier Notification No. 24/2009-ST, dated 27th July, 2009 has been further
amended whereby the exemption to taxable services of management, maintenance or
repair of roads is extended to management, maintenance or repair of bridges,
tunnels, dams, airports, railways and transport terminals.

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Taxable service of packaged or canned software exempted — Notification No. 53/2010-ST, dated 21-12-2010.

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Part B : INDIRECT
TAXES


SERVICE TAX UPDATE

47 Taxable service of
packaged or canned software exempted — Notification No. 53/2010-ST, dated
21-12-2010.

By this Notification, the
Central Government has exempted the taxable service referred to in item (v) of
S. 65(105)(zzzze) in respect of packaged or canned software, subject to the
following conditions :

(1) value of the said
goods domestically produced or imported for the purpose of levy of central
excise duty or additional duty of customs as the case may be has been
determined u/s.4A of the Central Excise Act, 1944 and

(2) (a) appropriate duties
of excise have been paid by manufacturer, duplicator or the person holding
copyright to software manufactured in India; or

(b) appropriate duties of
customs including the additional duty of customs have been paid by the
importer in respect of the software imported into India

(3) a declaration is made
by the service provider on the invoice that no amount in excess of the retail
sale price has been recovered from the customer.

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Notifications Nos. 02/2010-ST and 17/2010-ST, both dated 27-2-2010 rescinded — Notification No. 51/2010-ST and 52/2010-ST, both dated 21-12-2010.

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Part B : INDIRECT
TAXES


SERVICE TAX UPDATE

46 Notifications Nos.
02/2010-ST and 17/2010-ST, both dated 27-2-2010 rescinded — Notification No.
51/2010-ST and 52/2010-ST, both dated 21-12-2010.

By these Notifications, the
Central Govt. has rescinded the earlier Notifications Nos. 02/2010-ST &
17/2010-ST, both dated 27th February, 2010 which exempted the right to use
packaged or canned software, subject to specified conditions.

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Hire charges on installation of electricity meter in consumer’s premises exempted — Notification No. 131/13/2010-ST, dated 7-12-2010.

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Part B : INDIRECT
TAXES


SERVICE TAX UPDATE

45 Hire charges on
installation of electricity meter in consumer’s premises exempted — Notification
No. 131/13/2010-ST, dated 7-12-2010.

By this Notification, it has
been clarified that hire charges collected by electricity
transmission/distribution companies towards installation of electricity meters
at the premises of the consumers are exempt from service tax, since supply of
electricity meters is an essential activity having direct and close nexus with
transmission and distribution of electricity and that such service is covered by
the exemption Notification No. 11/2010-ST, dated 27-2-2010 and/or 32/2010-ST,
dated 22-6-2010.

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Amendment to Central Sales Tax Act, 1956 —Trade Circular 2T of 2011, dated 17-1-2011.

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Part B : INDIRECT
TAXES


 

MVAT UPDATE

44 Amendment to Central
Sales Tax Act, 1956 —Trade Circular 2T of 2011, dated 17-1-2011.

By this Circular salient
features of the amendments made by the Finance Act, 14 of 2010 to S. 6A of the
CST Act, 1956 have been explained.

Provisions of S. 6A(2) allow
the Assessing Authority to be satisied that no interstate sale has been
effected, apart from verifying the correctness of particulars furnished in Form
F before allowing claims of Branch Transfer.

New Ss.(3) has been added to
provide that the cases of interstate transfer of goods otherwise than by way of
sale can be reopened in the event of discovery of new facts for re-assessment by
the Assessing Authority or for revision by higher authority on the ground that
findings of the Assessing Authority are contrary to the law.

S. 18A of newly inserted
Chapter VA allows a person aggrieved by an order made u/s.6A(2) or (3) to appeal
to the highest Appellate Authority of the State against such an order.

The Ss.(1) of S. 20 has been
amended to provide for appeal to the Central Sales Tax Appellate Authority
against the Tribunal order in respect of issues relating to stock transfer or
consignment of goods insofar as it involves a dispute of inter-state nature.

The Ss.(1A) of S. 22 has
been amended to allow filing of appeal to the Appellate Authority under CST Act,
1956 without pre-deposit of amount that was required under earlier provisions.

New Ss.(1B) is inserted in
S. 22 empowering the Central Sales Tax Appellate Authority to issue directions
for refund of tax not due to that State or alternatively direct the State to
transfer refundable amount to the State to which CST is due.

Proviso to Ss.(2) of S. 25
is deleted so that the highest Appellate Authority shall not forward the cases
to first Appellate Authority.

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Mandatory e-returns for employers registered under Profession Tax Act, 1975 —Trade Circular 1T of 2011 under Profession Tax, dated 14-1-2011.

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Part B : INDIRECT
TAXES


MVAT UPDATE

43 Mandatory e-returns for
employers registered under Profession Tax Act, 1975 —Trade Circular 1T of 2011
under Profession Tax, dated 14-1-2011.

By this Circular, e-service
of filing e-returns for registered employers (PTRC holders) has been introduced.

By Notification issued on
26-11-2010 it was provided that from 1-2-2011, every PTRC holder whose tax
liability during the previous year was rupees twenty thousand or more shall
mandatorily file electronic return.

PTRC holders, eligible to
file quarterly or annual returns, may get themselves enrolled and file e-returns
voluntarily.

Detailed procedures for
enrolment for PTRC e-services and procedure for uploading PTRC e-returns are
explained in the Circular.

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Decisions of CIC

Part A : Decisions of CIC


Personal information — Sections 8(1)(j)

    Mr. Shailesh Gandhi, Information Commissioner in Central Information Commission has delivered a few very significant decisions covering some of the basic issues under the RTI Act. The said issues have been major areas of conflict in the operation of the RTI Act and which have resulted in denial of information from the public authorities to the citizens. One such issue is the interpretation of section 8(1)(j) dealing with exemption of ‘personal’ information, the disclosure of which has no relationship to any public activity or interest, or which would cause unwarranted invasion of the privacy of an individual.

    In this case, the applicant had sought certain information from the PIO of Government of NCT of Delhi, Home (General) Department in connection with issue of armed licences from January 2000 to December 2007. In reply, he was informed that no such records are managed by that department. The Appellate Authority, along with certain other observations, ruled that the information is exempt u/s.8(1)(j).

    Before the CIC, the PIO claimed that the information could not be given as it would intrude on the privacy of the applicants and the provisions of section 8(1)(j) exempt providing such information.

CIC’s decision :

    Words in a law should normally be given the meanings given in common language. In common language we would ascribe the adjective ‘personal’ to an attribute which applies to an individual and not to an institution or a corporate. From this it flows that ‘personal’ cannot be related to institutions, organisations or corporates. (Hence we could state that Section 8 (1) (j) cannot be applied when the information concerns institutions, organisations or corporates).

    The phrase “disclosure of which has no relationship to any public activity or interest” must be interpreted to mean the information must have some relationship to a public activity.

    Various public authorities in performing their functions routinely ask for ‘personal’ information from citizens, and this is clearly a public activity. When a person applies for a job, or gives information about himself to a public authority as an employee, or asks for permission, licence or authorisation, all these are public activities. Applying for an arms licence certainly falls in this category. As a matter of fact Section 4 (1) (b) (xiii) requires a suo moto publishing of ‘particulars of recipients of concessions, permits or authorisations granted by it.’

    Commenting on the phrase which states that releasing the information would lead to an unwanted intrusion of privacy, the decision states :

    “We can also look at this from another aspect. The State has no right to invade the privacy of an individual. There are some extraordinary situations where the State may be allowed to invade on the privacy of a citizen. In those circumstances special provisos of the law apply, always with certain safeguards. Therefore, it can be argued that where the State routinely obtains information from citizens, this information is in relationship to a public activity and will not be an intrusion on privacy.

    Certain human rights such as liberty, freedom of expression or right to life are universal and therefore would apply uniformly in all countries. However, the concept of ‘privacy’ is related to society and different societies would look at these differently. India has not codified this right so far, hence in balancing the Right to Information of citizens and the individual’s Right to Privacy, the citizen’s Right to Information would be given greater weightage.

    Therefore, we can accept that disclosure of information which is routinely collected by the public authority and routinely provided by individuals, would not be an invasion on the privacy of an individual and there will only be a few exceptions to this rule which might relate to information which is obtained by a Public Authority while using extraordinary powers such as in the case of a raid or phone-tapping. The applicant for a licence or permit or authorisation gives information of his own volition since he does not regard giving of this information as an intrusion on his privacy.”

    Based on the above reasoning, the CIC ruled that providing names of persons who applied for arms licences cannot be construed as an invasion of privacy and directed that information sought be provided.

    On reading the full decision of this case, I am wondering whether it should be possible to get information on the return of income of any third party under the RTI Act. In Mumbai, in one famous case reported in this column a few years before, the Department had rejected the application/appeal when one Mrs. Hoosenalli sought the information on the returns of income of Applause Bhansali Films Pvt. Ltd, the producer of the film : ‘BLACK’ (see BCAJ, July 2006 and earlier issues).

    [Mr. Jagvesh Kumar Sharma vs. Joint Secretary, Home & PIO, Home (General) Department, Government of NCT of Delhi : Decision No.CIC/WB/A/2008/00993/SG/2219, dated 16.03.2009].

Second case on section 8(1) (j) – Personal Information

    Mr. Mahesh Kumar Sharma (MKS) sought information to get certified copies of the documents under which NOC had been issued to Zile Singh for getting water connection.

    MKS claimed to be the son of said Mr. Zile Singh. Water connection is for the building which at the time of application was owned by Ms. Archana Sharma (Ms. A.S.). She is the daughter of Mr. Zile Singh. The PIO treated it as a third-party information and u/s.11 asked Ms. A.S. whether she has any objection in providing the information sought by Mr. MKS. It was objected by Ms. A.S., besides contesting the claim of Mr. MKS that he is the son of the late Mr. Zile Singh.

    Contentions of Ms. A.S. for objecting to the disclosure of the information to Mr. MKS are :

    1. The information has been given in a fiduciary relationship [Section 8(1)(e)].

    2. Disclosing it would be an intrusion on her privacy [section 8(1)(j)].

    3. Third party has the right to refuse to divulge with information relating to him and unless a large public interest can be established, the information will not be disclosed.

She also sought to justify her claim for denial of information by taking support from the judgment of the High Court of Gujarat, in Reliance Industries Ltd. vs. Gujarat State Information Commission & Others (covered in this column in Nov. & Dec. 2007 and January 2008). The Commission dealt with the above 3 grounds of objection as under:

o The information has been given in a fiduciary relationship. The third party is invoking the protection of Section 8(1)(e) of the RTI Act:

A fiduciary relationship is one where the key element is that the relationship is principally characterised by trust and the information is given for use only for the benefit of the giver. Here the information has been given as per the rules to get an authorisation to get a water connection from a public authority. The traditional definition of a fiduciary is a person who occupies a position of trust in relation to someone else, therefore requiring him to act for the latter’s benefit within the scope of that relationship. In business or law, we generally mean someone who has specific duties, such as – those that attend a particular profession or role, e.g., financial analyst or trustee. In the instant case a key element of the relationship between the applicant for a water connection and the Delhi [al Board certainly cannot be said to be primarily of trust by the applicant in the public authority, nor can it be said that the information was given for the benefit of the giver. The information was provided to get an authorisation    for a water connection. Accordingly, this submission    has no merit.

Disclosing it would be an intrusion on her privacy:

The third party is invoking the protection of Section 8(1)(j) of the RTI Act. On this point, same paras are stated as in the Order in the case reported as above dated 16th March 2009. Accordingly, this submission also has no merit.

Third party has the right to refuse to divulge information relating to him, and unless a larger public interest can be established, the information will not be disclosed :

No legal provision    has been  cited.

We will now look at the main contentions relied upon by the third party from the judgement of the Hon’ble Gujarat High Court:

a) It is necessary that a larger public interest must be justified and the purpose of the applicant and his profile and credentials looked at.

b) The Public Information Officer is charged with the duty to ensure that the Right does not become a tool in the hands of a busy body.

Right to Information is a fundamental right of citizens. The Act has elegantly and crisply defined its objective in Section 3 where it states “Subject to the provisions of this Act, all citizens shall have the right to information.”

The test of public interest is to be applied to give information, only if any of the exemptions of Section 8 apply. Even if the exemptions apply, the Act enjoins that if there is a larger Public interest, the information would still have to be given. There is no requirement in the Act of establishing any public interest for information to be obtained by the sovereign Citizen, nor is there any requirement to establish larger Public interest, unless an exemption is held to be valid. Insofar as looking at the credentials of the applicant is concerned, the lawmaker has categorically stated in Section 6(2), “An applicant making request for information shall not be required to give any reason for requesting the information or any other personal details except those that may be necessary for contacting him.” Thus, it is clear that the credentials of the applicant are of no relevance, and are not to be taken into account at all when giving the information. Truth remains truth and it is not important who accesses it. If there is a larger public interest in disclosing a truth, it is not relevant who gets it revealed to. Hence, we respectfully disagree with the contention of the Hon’ble Gujarat High Court.

Under this Act, providing information is the rule and denial an exception. Any attempt to constrict or deny information to the sovereign citizen of India without the explicit sanction of the law will be going against the rule of law. The citizen needs to give no reasons nor are his credentials to be checked for giving the information. If the third party objects to giving the information, the Public Information Officer must take his objections and see if any of the exemption clauses of Section 8(1) apply. If any of the exemption clauses apply, the PIa is then obliged to see if there is a larger public interest in disclosure. If none of the exemption clauses apply, information has to be given.

The third party’s objections made before the Commission about the exemptions of Section 8(1)(e)& (j)are disallowed. Hence, the information would have to be given.

[Mr. Mahesh Kumar Sharma vs. PI~, Delhi Jal Board, Govt. of NeT of Delhi: Decision No CIC/ AT / A/ 2008/01262/SG/2109 of 27.02.2009].


Part B : The RTI Act

Standing Committee of the Parliament on RTI Act, 2005 :

National Campaign for People’s Right to Information (NCPRI) has made a presentation before the above committee. Some of the items of the said presentation are worth noting to understand present deficiencies of the RTI Act.

In previous three issues of BCAJ, 7 items have been reported:

  •     Level of awareness
  •     Use and  misuse  of the RTI Act
  •     Reduction of 20-year period for keeping documents
  •     Voluntary  disclosures
  •     Changes  in Section  8
  •     Penalties
  •     Use of the RTI Act and  refusal  of information

Now  three  more  items  are being  reported:

  • Grievance    redressal

We believe that there is an urgent need to set up statutory public grievance commissions across the country, which have powers to redress grievances and to punish errant officials. A working model can be seen in Delhi, though it has limited powers. A draft legislation for such commissions has also been circulated by people’s movements to the Government.

Perhaps equally important, there is urgent need to take cognisance of the fact that RTI applicants, especially those belonging to the poorer and weaker segments of society, are being threatened, beaten and even killed for seeking information. RTI applicants and activists have been beaten up in many parts of the country, including Delhi. Efforts to dissuade people from exercising their fundamental right to information are a violation of both the spirit and the letter of the RTI Act. Therefore, Information Commissions should set up a system by which complaints of threats and violence related to the RTI are received and conveyed to the relevant authorities, and the action taken monitored and reported to the recommended RTI Council.

  • Application fee

We believe it is a good idea to have an application fee as it gives a greater sense of ownership to the applicant, and results in better recording of applications by public authorities, because of the necessity of issuing money receipts. However, we do not think that the amount should be raised above Rs. 10 for the moment. It would, along with penalties need to be subsequently revised upwards to reflect inflation.

Raising the fee would adversely affect the ability of the poor, many of whom do not have a BPL card even though they eminently deserve one to exercise their right to information. The belief that a higher fee might deter those who file a large number of applications is misconceived. Our study shows that most of these multiple applicants belong to urban areas and are relatively well off. It is, therefore, unlikely that even doubling or tripling the fee would discourage them, even if discouraging them were a desirable objective. However, raising the fee would certainly make it difficult for many of the poor to seek information.

  • Strengthening the RTI Act

At this point of the Act the most important step required from the Government is to ensure that there are extensive awareness campaigns and that all PIOs are trained and oriented to servicing the Act. Our study suggests that a large proportion of the PIOs are not trained in the RTI.Even those who have been trained need further training and need support materials like manuals and guides. Our study also revealed that over a third of the PIOsdid not even have a copy of the RTI Act.

There also needs to be regular monitoring of the functioning of the RTI Act. Towards this end, the Government needs to urgently set up a National Council for the Right to Information (along the lines of the NREGA Council). The minister in-charge of the nodal department in the Government of India could chair this council and members could include representatives of RTI movement, other prominent people from outside the Government, and secretaries of some of the critical departments.

The council could also have, as a permanent invitee, the Central Chief Information Commissioner, and as special invitees, other Chief Information Commissioners and Information Commissioners,on a rotation basis, from the Central and State Information Commissions.

This council should meet at least once in three months and review the functioning of the Act and of all its stakeholders. It should look into complaints and suggestions and advise the Government on corrective and additional measures required.

We also feel that little purpose is being served by insisting that a first appeal should be made in the department itself. Therefore, we suggest that the provision for a first appeal be deleted and applicants be allowed to directly appeal to the Information Commission.

The first appeal process should be replaced by a process where any refusal of information should be officially approved by a senior officer, and the senior officershould then also be liable for penalties if an offence is committed in refusing the information.

Also, we feel that nodal officers at various levels must be given the responsibility of monitoring the functioning of the RTI Act and take corrective action, where required. They must also report on the outcome of this monitoring to the Information Commission. Therefore, the Collector of each district and the secretary of each department should be given this role.


Part C : Other News

  • Padma Shri

If you know the right people, you could get Padma Shri as a gift, it seems.

Above  point  came out of RTI application    filed by a professor of a college to the Ministry of Home Affairs.

It appears that Jaipal Reddy, Union Urban Development Minister had recommended the name Dr. Sankara Reddy, a retired principal of Delhi’s Sri Venkateshwara College, as the said Principal had hired the wife of the Minister’s private secretary as professor of history even though there were other more deserving candidates.

CMS Rawat, President  of the Teachers’  Association, said  the hiring  of professor  Namita  was  a gross violation of university  guidelines.  “She only had an rMA degree and no teaching  experience.  There were candidates  who were PhDs, but Namita  got the job because of her husband’s  position.  She was initially hired on an ad hoc basis for four months, but she has been here for more  than  a year  now”.

It is also reported that during Sankara Reddy’s tenure, the college had been slapped with fines of over Rs.40 lakh for violating several building norms. Sankara had to oblige [aipal Reddy to get out of this mess. So he got the wife of Reddy’s private secretary a job with the college.

The college was also fined around Rs.27lakh by the ‘Electricity Department for misuse of power.

  • Health status of PM and the President

The Centre has refused to disclose information on PM’s and President’s health status, including details of medical expenses borne for the same, under the RTI Act, terming them as classified documents.

Refusing to divulge information on the health of all PMs to an RTI applicant, the Director, Emergency and Medical Relief said, “As the medical care scheme for the PM is a classified document, it is regretted that the information cannot be provided as per the exemption clause of the RTI Act.”

The President’s secretariat also rejected a similar RTI plea, asking for information on health status of the President.

  • Info on housing  co-op. Societies

Vijay Chauhan had asked 14 questions pertaining to housing societies – such as the names of societies where administrators had been appointed, names of deputy registrars who appointed the administrators and the tenure of administrators.

In his order, SIC Ramanand Tiwari said the RTI Act had its limitations. “It guarantees furnishing of available information. But as the appellant has prescribed a 14 point format and wants information of the whole department, this does not seem feasible.”

Surprisingly, State Chief Information Commissioner Suresh Joshi on the same point in January, 09 had ordered that the same information should be provided;

Tiwari relied on Section 7(9) of the Act for denying the information.

Shailesh Gandhi, Central Information Commissioner, is of the view that Section 7(9) does not permit the rejection of the application and only specifies that if the information could not be given in the format sought by the applicant, the PIO can provide the information in another format or give options like inspection of files. Section 7(9) cannot be used for denying information.

In this context, it may be noted that Mr. Tiwari faced a volley of grievances from RTI activists who participated in the discussion on the role of the Act and better governance at a seminar organised by Janhit Manch on 28.3.2009. While some of the queries questioned his Orders, in which he was reportedly soft on the PIOs, others related to his inaction against officers who disregarded SIC orders. Tiwari brushed aside most of the queries, saying they were ‘personal in nature’. Further, he stated: “I know there have been complaints like me being too soft on PIOs, but my disposal rate has been good. For me, the priority lies in providing information, but since the issue has been raised, I will try to improve and impose more penalties in future”.

  • Interesting report on RTI in Maharashtra in The Times of India

The  Right    to Information Act  (RTI) received a phenomenal response last year with 4.16 lakh queries being filed by citizens across the State.

The three -and-a-half-year-old Act has now become an effective weapon for lakhs of people who have been fighting to procure information. “Maharashtra has beaten all other States in the country and perhaps even the world, in the number of applications received” an exuberant State Chief Information Commissioner Suresh Joshi told TOL “There was a 33% increase in the number of RTI applications received by various Government organisations and public sector undertakings last year than that in 2007”.

The State Urban Development Department topped the list and received 1.04 lakh RTI queries. The queries usually relate to unauthorised construction permission for building proposals, assessments and establishment regulations. The Revenue Department, with 70,491applications came second on the list. People filed queries to procure details of land records from the Revenue Department as a lot of data still need to be updated and computerised.

The home department with 45,363 queries, came third. People began using the Act to find out the status of their FIRs and police investigations. In many instances, the police were forced to take action after the RTI query was filed.

The BMC received 46,967 applications filed by citizens on various local issues. The State Information Commission has penalised 256officers who had denied information and has levied a penalty of Rs.34.01 lakh over the past one year.

  • 4 members of the last Parliament break norms

In a reply to an RTIquery, the Lok Sabha Secretariat clearly said MPs travelling on official assignments should not seek five-star hotel comforts. But that is precisely what MPs N. N. Krishnadas (CPM), Jaisingrao Gaikwad Patil (NCP), Lal Mani Prasad (BSP) and Bhupendrasinh Solanki (BJP) were enjoying on November 26, when terrorists struck the Taj Hotel. The law makers were in Mumbai as part of a IS-member Lok Sabha Committee on Subordinate Legislation to hold meetings with the top brass of HPCL and other PSUs.

MPs had the nightmarish experience of the terror attack and had ducked under tables to escape bullets. The cost of board, lodging and transport of the panel during the tour is borne by the LS Secretariat as per the guidelines and not by PSUs, the RTI reply said.

  • Prime Minister’s  foreign travels

PM Manmohan Singh has run up a travel bill of Rs. 233.8crore for official foreign visits in the last five years, according to data released by the Government in response to an RTI query. His predecesor Atal Bihari Vajpayee spent Rs. 185.60 crore on foreign tours during 1999-2003, as per official data. The PM’s eight-day visit to Brazil and Cuba in Septemeber 2006 cost the exchequer Rs. 15.89crore and tops in foreign tour expenditure.

The seven-day visit to France, the US and Germany in September 2005 comes second with a travel expenditure of Rs. 13.4crore. The eight-day visit to the UK and the US came third with a travel bill of Rs. 11.9 crore.

A quick hop to neighbouring Dhaka for three days in November 2005 for a summit meeting of Saarc nations cost the taxpayers Rs. 3.70crore. The bill for his three-day tour of China last January was Rs. 6.80 crore.

And to think that such extravagant spending takes place in a country which ranks 94th in the Global Hunger Index of 119 countries as per the recent report brought out by the United Nations World Food Programme.

Decision of the Court

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Right to Information

Disclosure of assets of the judges of the Supreme Court

The full bench of the Delhi High Court, in the judgment
pronounced on 12.01.2010 upholding the single bench’s order, has held that the
Chief Justice of India comes within the purview of the Right to Information Act,
and that details of judges’ assets must be disclosed under the RTI Act. It has
gone to the extent of stating that even income-tax returns and medical records
of judges needed to be disclosed, if they serve public interest.

Two clauses of section 8(1) which are dealt with in this
order are: Clause (e) – whether information is held by the Chief Justice of
India in his fiduciary capacity and Clause (j) – whether the information is
personal to be exempt.

The Court held:

The CJI cannot be a fiduciary vis-à-vis the judges of the
Supreme Court. The judges of the Supreme Court hold independent office, and
there is no hierarchy in their judicial functions which places them on a
different plane than the CJI. The declarations are not furnished to the CJI in a
private relationship or as a trust, but in discharge of the constitutional
obligation to maintain higher standards and probity of judicial life, and are in
the larger public interest. In these circumstances, it cannot be held that the
assets information shared with the CJI by the judges of the Supreme Court, is
held by him in a fiduciary capacity, which if directed to be revealed, would
result in breach of such duty.

Accordingly, the court has held that section 8(1)(e) does not
cover asset declarations made by judges of the Supreme Court and held by the CJI.
The CJI does not hold such declarations in a fiduciary capacity or relationship.

In the present case, the particulars sought by the respondent
do not justify or warrant protection under section 8(1)(j), inasmuch as the only
information the applicant sought was whether the1997 Resolution was complied
with. That kind of innocuous


information does not warrant the protection granted by section 8(1)(j). The full
bench concurred with the view of the learned single judge that the contents of
asset declarations, pursuant to the 1997 Resolution, are entitled to be treated
as personal information, and may be accessed in accordance with the procedure
prescribed under section 8(1)(j); and that they are not otherwise subject to
disclosure. Therefore, as regards the contents of the declarations, whenever
applicants approach the authorities under the Act, they would have to satisfy
themselves under section 8(1)(j) that such disclosure is warranted in “larger
public interest”.

Some interesting excerpts from the judgement:

  • ‘The subject matter in
    hand involves questions of great importance concerning balance of rights of
    individuals and equities against the backdrop of paradigm changes brought
    about by the legislature through the Act ushering in an era of transparency,
    probity and accountability as also the increasing expectation of the civil
    society that the judicial organ, like all other public institutions, will also
    offer itself for public scrutiny.


  • ‘Information is the
    currency that every citizen requires to participate in life and the governance
    of society. In any democratic polity, greater the access, greater will be the
    responsiveness, and greater the restrictions, greater the feeling of
    powerlessness and alienation. Information is a basis for knowledge, which
    provokes thought, and without thinking process, there is no expression.
    “Knowledge” said James Madison, “will forever govern ignorance and people who
    mean to be their own governors must arm themselves with the power knowledge
    gives. A popular government without popular information or the means of
    obtaining it is but a prologue to farce or tragedy or perhaps both”. The
    citizens’ right to know the facts, the true facts, about the administration of
    the country is thus one of the pillars of a democratic State. And that is why
    the demand for openness in the government is increasingly growing in different
    parts of the world.


  • ‘The source of right to
    information does not emanate from the Right to Information Act. It is the
    right that emerges from the constitutional guarantees under Article 19(1)(a)
    as held by the Supreme Court in a catena of decisions. The Right to
    Information Act is not repository of the right to information. Its repository
    is the constitutional rights guaranteed under Article 19(1)(a). The Act is
    merely an instrument that lays down statutory procedure in the exercise of
    this right. Its overreaching purpose is to facilitate democracy by helping to
    ensure that citizens have the information required to participate meaningfully
    in the democratic process and to help the governors accountable to the
    governed. In construing such a statute the Court ought to give it the widest
    operation which its language will permit. The Court will also not readily read
    words which are not there and the introduction of which will restrict the
    rights of citizens for whose benefit the statute is intended.


  • ‘Having posed the question
    whether judicial ethics exist as such, Justice J.B Thomas had stated:

  • “We form a particular
    group in the community. We comprise a select part of an honourable profession.
    We are entrusted, day after day, with the exercise of considerable power. Its
    exercise has dramatic effects upon the lives and fortunes of those who come
    before us. Citizens cannot be sure that they or their fortunes will not some
    day depend upon our judgment. They will not wish such power to be reposed in
    anyone whose honesty, ability or personal standards are questionable. It is
    necessary for the continuity of the system of law as we know it, that there be
    standards of conduct, both in and out of court, which are designed to maintain
    confidence in those expectations.” (Judicial Ethics in Australia, Sydney, Law
    Book Company, 1988)


  •     ‘The right to information often collides with the right to privacy. The government stores a lot of information about individuals in its dossiers supplied by individuals in applications made for obtaining various licenses, permissions including passports, or through disclosures such as income tax returns or for census data. When an applicant seeks access to government records containing personal information concerning identifiable individuals, it is obvious that these two rights are capable of generating conflict. In some cases, this will involve disclosure of information pertaining to public officials. In others, it will involve disclosure of information concerning ordinary citizens. In each instance, the subject of the information can plausibly raise a privacy pro-tection concern. As one American writer said: one man’s freedom of information is another man’s invasion of privacy.

    •     ‘It was Edmund Burke who observed that “All persons possessing a portion of power ought to be strongly and awfully impressed with an idea that they act in trust and that they are to account for their conduct in that trust.” Accountability of the Judiciary cannot be seen in isolation. It must be viewed in the context of a general trend to render governors answerable to the people in ways that are transparent, accessible and effective. Behind this notion is a concept that the wielders of power – legislative, executive and judicial – are entrusted to perform their functions on condition that they account for their stewardship to the people who authorise them to exercise such power. Well defined and publicly known standards and procedures complement, rather than diminish, the notion of judicial independence. Democracy expects openness and openness is concomitant of free society. Sunlight is the best disinfectant.’


    [Secretary General, Supreme Court of India vs Subhash Chandra Agarwal: LPA No 501/ 2009: judgment pro-nounced on 12.01 2010: Delhi High Court FB]

    Part B:  The RTI Act

        Public Cause Research Foundation (PCRF) Report:

    PCRF (A Parivartan Initiative) is a public trust started by some RTI activists to encourage public information officers to think and act positively while dealing with RTI requests.

    If the PIO denies information under the RTI Act because he has done something wrong and wants to hide something, it is understandable. However, a large number of officers are rejecting informa-tion, not because they have something to hide, but because they are culturally oriented to say “No”. Often, one comes across officers who would say, “Why should I give information to him? Why is he asking for information? What will he do with this information? Who is he to question me?” These questions are reflective of a mindset with which our bureaucracy has been working for decades. They are simply not used to being questioned by the public.

    Likewise, RTI Awards seek to comparatively assess the performance of all information commissioners, so that the best practices could be highlighted. During 2009, PCRF studied 51,128 orders passed by various information commissions during the calendar year 2008 and received feedback from 8,400 appellants. The performance of each com-missioner was studied in great detail in term of disposals and pendencies, pro-disclosure attitude, compliance to his orders, deterrence impact and satisfaction ratio.

    The awards have been instituted in three categories: Information Commissioner (to felicitate an information commissioner who has enabled access to correct and complete information to maximum appellants and strictly enforced the RTI Act); Public Information Officer (to felicitate information officers who have provided complete and correct information with maximum number of RTI applications within the prescribed time limit); and citizens (to felicitate those citizens who created maximum public impact by using the RTI Act).
     

    The following is the executive summary of this awards exercise:

    The Right to Information (RTI) Awards was instituted in the year 2009. One of its objectives was to comparatively assess the performance of all information commissioners. For this purpose, the performance of each commissioner was studied in great detail. The study revealed a highly uneven implementation of the RTI Act across the country. It also highlighted the best practices which some commissioners may like to emulate.

        1. Methodology: For the purpose of this study, orders passed in 51,128 cases during 2008, by 72 Information Commissioners and 14 combined benches from 25 Information Commissions (barring Uttar Pradesh, Tamil Nadu and Sik-kim), were analyzed. We found that in 35,930 cases (i.e., 68% cases), orders were passed in favour of disclosure. We wrote letters to these 35,930 appellants. We also interviewed many of them on phone. We asked all of them one question: Did they finally get information after approaching the Information Commission? Finally, we received feedback from 8,400 appellants who shared with us their experiences with the Commission.

        2. Orders in Favour of Disclosures: Nationally, for every 100 appeals and complaints filed in Information Commissions, orders in favour of disclosure were passed in 68 cases. Information was denied in 22% of the cases and 10% of the cases were remanded back. Mr. Anil Joshi of Chhattisgarh, Mrs. Gangotri Kujur of Jharkhand, and the combined benches of Chhattisgarh passed 100% of the orders in favour of disclosures. A total of 34 commissioners passed more than 90% of the orders in favour of disclosures. Among the states, Assam, Chhattisgarh, Arunachal Pradesh, Punjab and Karnataka passed more than 90% of the orders in favour of disclosure. However, 10 commissioners and four states passed less than 50% of the orders in favour of disclosures, Mr. Naveen Kumar from Maharashtra and Mr. C D Arha from Andhra Pradesh were at the bottom of the list, with less than 20% of the orders in favour of disclosures.

        3. Compliance of Orders: However, a favourable order from the Information Commissioner does not translate into information. Nationally, just 38% of the pro-disclosure orders could actually be implemented. In the balance 62% cases, the people did not get information despite a favourable order. Arunachal Pradesh has done quite well on this score. They could get more than 90% of their orders implemented. In addition to Arunachal Pradesh, Mr. A Venkatratnam of Goa, Mrs. Gangotri Kujur of Jharkhand and the combined benches of Assam and Nagaland could get more than 70% of their orders implemented. However, on the lower side, 44 commissioners could get less than 40% of their orders implemented. Mr. R Dileep Reddy and Mr. C D Arha of Andhra Pradesh, Mr. M R Ranga of Haryana and Mr. M M Ansari, Mr. M L Sharma and Mr. S N Mishra of CIC could get less than 20% of their pro-disclosure orders complied with.

        4. Non-compliance: Many commissioners close a case after passing orders in favour of disclo-sure— without ensuring compliance thereof. The appellant has to struggle with the concerned public authority for a few months to get the order implemented. After writing several letters and making several visits to the public authority, when the order is still not complied with, he makes a complaint to the commission. Many appellants get tired and do not file complaints again. Even when a complaint is filed, the same comes up for hearing in its due course after a few months, because most of the commissions have huge pendencies, thus causing hardships to appellants. Mostly, the complaint is disposed of without a hearing and with a letter to the public authority to comply with the Commission’s earlier order. The public authority still does not obey the order. Even if a hearing takes place in the Commission, the case is again closed with directions to the officer to provide information rather than taking any penal action. Mostly, the order is again not complied with.

        5. Continuing Mandamus: Some states follow the practice of “continuing mandamus”. They do not close a case after passing orders, but post hearings subsequently for compliance thereof. The case is not closed till the appellant reports satisfaction. These are Punjab, Uttarakhand, Bihar, Orissa, Karnataka, Arunachal Pradesh, Gujarat and some commissioners like Mrs. Gangotri Kujur of Jharkhand, etc. Their compliance rates are better than other Commissioners and Commissions. However, the problem with most of them is that barring a few, they have been quite soft with officers. Repeated non-compliance is ignored. As a result, in some cases, several hearings take place spanning over several months which leads to attrition and tires out the appellants. When the appel-lant stops coming, the cases are closed with the assumption that the appellant might have received all information. Therefore, continuing mandamus needs to be coupled with strict enforcement.

        6. Arrest Warrants: Arunachal Pradesh is the first and the only Information Commission in the country to have issued bailable arrest warrants under section 18(3) of the RTI Act for non-compliance of the Commission’s orders. Non-compliance of their orders is treated as a complaint under section 18 of the RTI Act. Section 18(3) of the RTI Act empowers the Commission to issue bailable arrest warrants and seek production of documents. Arunachal Pradesh has used this section quite effectively to get its orders implemented. Other commissions across the country may also like to invoke their powers under this section to improve compliance.

        7. Disposals: Mr. Vijay Baburao Borge and Mr. Naveen Kumar have disposed the maximum number of cases: 383 and 333 respectively, per month. However, they achieved this disposal by rejecting or remanding back almost 80% of their cases without hearings. Mr. Shailesh Gandhi stood out by disposing 270 cases per month, in the first few months, and more than 400 cases per month later. He could bring down his pendency from 12 months to less than 2 months. At the lower end are the north-eastern states, who disposed very few cases, because they get few appeals. However, there are some commissioners who disposed very few cases despite huge pendencies. Commissioners who disposed less than 10 cases per month, despite huge pendencies, are Mr. Dileep Reddy of Andhra Pradesh, Mr. Arun Kumar Bhattacharya of West Bengal, late Shri G G Kambli of Goa and Mr. R K Angousana Singh of Manipur.

        8. Imposition of Penalties: The RTI Act mandates that every violation of the Act “shall” be penalised unless there was a reasonable cause on the part of the PIO. The penalty amount has to be deducted from the PIO’s salary. However, just 2.4% of the recorded violations across the country were penalised. In 74% cases of recorded vio-lations, the Hon’ble Information Commissioners did not even question the PIO as to whether there was a “reasonable cause” or not. The PIOs were questioned in just 26% cases through show cause notices. However, as many as 65% of these show cause notices remained pending at the end of the year. Some 23% notices were dropped because the Commissioners found the explanations and excuses presented by PIOs in these cases as “reasonable”. The combined benches of Orissa imposed penalties in almost 30% of pro-disclosure cases. As an individual Commissioner, Mr. D N Padhi of Orissa was at the top, even though he imposed penalties on less than 11% of pro-disclosure cases. There are six Commissioners who imposed penalties in more than 10% of pro-disclosure cases. Nearly 50 Commissioners and 11 Commissions, including the CIC, imposed penalties in less than 2% pro-disclosure cases. What was alarming was the fact that there were 29 Commissioners and three Commissions who did not impose even a single penalty despite thousands of recorded violations.

        9. Pendencies: Huge pendencies have become such a severe problem in some states that it takes more than a year for a case to come up for hearing if it were filed today. Some urgent steps need to be taken to address mounting pendencies. States with more than a year’s pendency are Orissa, Madhya Pradesh, Maharashtra, UP and some of the Commissioners at CIC. Strict imposition of penalties will have a direct bearing on the number of appeals re-ceived at the Commission. When the RTI Act came into effect, officers were scared of violating it because of its strong penal provisions. But when they saw that the penal provisions were not being strictly enforced, they started taking RTI lightly. If PIOs do not take RTI Act seriously, the number of appeals at Commissions will increase exponentially. Therefore, the inflow of cases to the Commission can be reduced with strict enforcement of penal provisions.

        10. State of Records: In many Commissions, the state of records is not very healthy. Many Commissions do not even know for sure how many cases they disposed. At different times, they gave us different figures of disposals. Many Commissions do not have copies of all orders. Uttar Pradesh claimed to have passed 22,658 orders during 2008. However, they said that they do not maintain copies of all orders. Tamil Nadu said they had passed more than 40,000 orders but provided us with only 900 orders.

        11. Missing Records: The trend of PIOs reporting records to be missing or lost seems to be on the rise. In many cases, this is treated as a legitimate excuse for denial of information. However, in some parts of the country, when the Commissioners threatened police action, suddenly these ‘missing’ records came out, which means that “missing records” was merely an excuse given by the PIOs to deny information. Mr. Vijay Kuvalekar of Maharashtra has been very successful in forcing PIOs to trace out records in many cases when he threatened police action.

        12. Arbitrary Commissioner Strength: Commissioners seem to be appointed by state governments without reference to the pendency of that Commission. On one hand, we came across states like Arunachal Pradesh that has five Commissioners for 43 appeals, and on the other hand, we have Gujarat that has one Commissioner for a pendency of almost 5,000 cases. It is important to formulate some guidelines that state how much pendency a Commissioner should be appointed.


Part C:  Others News

    Important Pronouncement by the Commission:

(Continuing from January 2010)

When Shailesh Gandhi, CIC, was in the BCAS office addressing RTI activists and journalists, he distributed a compilation of eight important and profound pronouncements by the Central Information Commission.

3. Reasons For Claiming Exemptions

Since Right to Information is a fundamental right of citizens, denial has to be only on the basis of the exemptions under section 8(1); and it is necessary to carefully explain the reasons of how any of the exemptions apply, when a PIO wishes to deny information on the basis of the exemptions. Merely quoting the subsection of section 8 is not adequate. Giving information is the rule and denial is an exception.

In the absence of any reasoning, the exemption under any clause of section 8(1) is held to have been applied without any basis.

4. Fiduciary

The traditional definition of ‘fiduciary’ implies that a person occupies a position of trust in relation to someone else, therefore, requiring him to act for the latter’s benefit within the scope of that relationship. In business or law, we generally mean someone who has specific duties, such as those that attend a particular profession or role, e.g., a financial analyst or trustee. The information must be given by the holder of information when there is a choice – as when a litigant goes to a particular lawyer, or a patient goes to particular doctor. It is also necessary that the principal character of the relationship is the trust placed by the provider of information in the person to whom the information is given. An equally important characteristic for the relation-ship to qualify as a fiduciary relationship is that the provider of information gives the information for using it for his benefit. When a committee is formed to give a report, the information provided by it in the report cannot be said to be given in a fiduciary relationship. All relationships usually have an element of trust, but all of them cannot be classified as fiduciary.

    University Grant Commissioner to be penalised!

In a wake of the deemed university controversy, the Central Information Commission has slammed the University Grants Commission (UGC) for lack of transparency in information on deemed universities.

Ruling that the UGC appeared to act as if the RTI Act did not apply to it, the information watchdog has awarded a compensation of Rs. 2,000 to an applicant and issued a show cause notice to the UGC for not responding within the stipulated 30-day period.

The Commission noted: “It is a very sad state of affairs that the UGC appears to be operating with-out any understanding of what is happening. The Commission has earlier also directed the UGC to put up various information under its section 4 obligations. The UGC has failed to comply with it.”

    President’s Foreign Tours

President Pratibha Patil managed to pull-off quite an austerity drive! She managed state visits to eight countries on a ridiculous expenditure of just Rs. 1.95 lakh. In response to the RTI application, the reply reveals that on state visits to Brazil-Mexico-Chile, Bhutan, Vietnam-Indonesia and Spain-Poland, Patil spent Rs. 12,878, Rs. 32,670, Rs. 66,364 and Rs. 83,339 respectively. This comes to a total of Rs. 1,95,251. The document said the expenses were incurred under the budget head “tour expenses”.

Chetan Kothari, the applicant, believes that the infor-mation provided is incomplete, false and malafide, and he has lodged a complaint with CIC against the PIO of Rashtrapati Bhavan.

    Padma Bhushan Award Challenged

Media persons Pritish Nandy and Vir Sanghvi have filed a RTI application with regard to the inclusion of Sant Singh Chatwal’s name for the Padma Bhushan award.

    Freedom of Information (FOI) Act, USA

ABC News filed a FOI application with the National Institute of Standards and Technology (NIST), USA which had investigated the collapse of the World Trade Centre Towers on 9/11, to get aerial photos of the dramatic collapse. The images were taken from a police helicopter — the only photographers allowed in the space near the towers on September 11, 2001. ABC said the NIST gave 2779 pictures on nine CDs. The photos are the core to understanding the visual phenomena of what was happening. ABC Network has posted 12 photos on its website.

    Advertisements by DAVP

The Directorate of Visual Publicity (DAVP) has issued 1,231 advertisements over January 1, 2008 to September 28, 2009, costing over Rs. 217 crores on behalf of ministries and government departments.

In a move that could further expose misuse of public funds by politicians for personal publicity, the Central Information Commission (CIC) has allowed disclosure of advertisements issued by the government over one year. The panel has allowed disclosure of details related to the number and cost of advertisements and those that have photographs of politicians.

ORDERS OF THE COURT & CIC

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Right to information

Part A : ORDERS OF THE COURT & CIC


S. 20 and S. 29 of the RTI Act :


A writ petition was filed before the Orissa High Court by the
PIO on whom the Orissa State Information Commissioner (SIC) had imposed penalty
of Rs.19250.

Under the RTI application, certain information applied for
was not furnished within 30 days. The applicant registered a complaint against
the PIO for this default with SIC. The PIO intimated that “since the information
regarding the rate of VAT on different commodities in Oriya version was not
available in the department, the information could not be supplied being not
available”. However, he admitted that since such information had not been
prepared and not available, it was his duty to at least intimate the applicant
about the fact of non-availability of the information sought for by him within
the stipulated time.

When the matter was taken up for hearing at SIC, the
complainant did not appear, but sent a letter to the State Commissioner to
permit him to withdraw the complaint. Even then, without permitting withdrawal
of the complaint, the Commission came to hold that the petitioner who was the
dealing assistant and one Trilochan Pradhan who was the section officer were
prima facie responsible for the delay. So holding, the Commission directed
issuance of notice only to the petitioner to show cause as to why penalty as per
provisions of S. 20(1) of the Right to Information Act, 2005 should not be
attracted. Pursuant to the notice dated 12-3-2007 issued to the petitioner, she
showed cause stating that though the letter was available to her on 22-5-2006,
the single file in which such applications were dealt with was made available to
her on 17-7-2006. Hence, there was delay. However, SIC imposed the penalty due
to the alleged reason that the petitioner had retained the file from 22-5-2006
to 26-8-2006 and was found responsible for delay of 77 days. The complainant had
sought for the Oriya version of the rate of VAT on different commodities
prevailing in Orissa and if Oriya version of the VAT rate chart was not in
existence with the public authority, a simple reply within the time line would
have sufficed. But in the instant case, a negative answer was given by the
referred PIO after a delay of 77 days, which cannot be lost sight of or
condoned.

Decision of the Court :


S. 20(1) of the Right to Information Act provides that where
the Information Commissioner at the time of deciding any complaint or appeal is
of the opinion that the PIO has, without any reasonable cause,

(1) refused to receive an application for information, or

(2) has not furnished information within the time specified
under Ss.(1) of S. 7, or

(3) malafidely denied the request for information, or

(4) knowingly given incorrect, incomplete or misleading
information, or

(5) destroyed information which was the subject of the
request, or

(6) obstructed in any manner in furnishing the information,

it shall impose a penalty of two hundred and fifty rupees
each day till the application is received or information is furnished, so
however, the total amount of such penalty shall not exceed rupees twenty-five
thousand.

Therefore, this power is to be exercised only at the time of
deciding any complaint or appeal. But in this case since the complainant did not
choose to appear and sought for withdrawal of the complaint, the complaint could
not have been proceeded with. In view of the above, proceeding with the
complaint in the absence of the complainant when he is not interested to proceed
with the same is not warranted under the law and, therefore, the Information
Commission has committed manifest error of law in proceeding with the complaint
after condoning the absence when he had already sought for withdrawal.

(Author’s Note : Readers may consider whether the above is the
correct decision)

[PIO v. Orissa Information Commission, WP(C) No. 1874 of
2008, decided on 22-7-2009
]

S. 8(1)(g), (h) and (j) :


Shri N. K. Bhasin made an RTI application to ICAI in respect
of the detailed verbatim proceedings of the Council of ICAI in the matter of
complaint by DGM, Bank of India [Reference No. 25-CA(88)/2002]. The CPIO
provided a reply on 17-9-2007, in which the final decision of the Council was
communicated to the appellant, but not the verbatim proceedings. The Appellate
Authority, in its order dated 12-11-2007, upheld the CPIO’s decision. Initially,
when this matter was heard by the Commission on 16-7-2008, a direction was
issued to the respondents to file their written submissions as well as the
appellant to file the counter, if any, for the Commission to process this matter
further. Accordingly, the CPIO filed his comments on 14-8-2008 and the appellant
his counter on 29-8-2008.

As the Order of the CIC is of interest to the members of our
profession, I reproduce verbatim 7 paras of the Order (as I had done in the
issue of April 2010) :

The main point brought out by the respondents is that ICAI
functions under an Act of the Parliament and the regulations framed under the
said Act specially mention the steps to be followed at every stage as well as
the information to be communicated to the parties concerned to any complaint
which the ICAI Council may be dealing with. These regulations require the
Council to specify/intimate only the prima facie opinion to the parties and not
the grounds on which such opinion is formed. No hearing is provided to the
parties at the time of forming of the prima facie opinion by the Council. The
findings of the Council are also communicated to the parties. It is, therefore,
the submission of the respondents that their statute itself makes a difference
between the prima facie opinion stage and the final stage and has provided for
the appropriate information to be given to the parties at their respective
stages. The application of the present applicant was dealt with under those
provisions.

It is the appellant’s submission that the information he has
sought was in a case which has already concluded and been closed. It is his case
that the information requested by him should be disclosed to him “blocking out
such portions of the document as would attract exemption u/s. 8(1)(g) and
u/s.8(1)(j) of the RTI Act, 2005 . . .” and the requested information could not
impede any process of investigation since no process is currently on.

The respondents were specifically asked to state as to what objection they could have to disclosure of the requested information to the appellant, especially when the matter is acknowledgedly a closed one and no investigation or enquiry is pending. They made reference to the ICAI Act and the regulations and stated that they were disinclined to provide to the appellant any documentation other than what the ICAI Act and the regulations entitled him to.

On consideration of both the submissions, it is my view that the respondents had not been able to specifically state as to how the requested information could be barred from disclosure, especially as no investigation to which it might relate is current. That excludes the purview of exemption — S. 8(1)(h) of the RTI Act. I do not see how S. 8(1)(g) or S. 8(1)(j) of the RTI Act would be applicable in the present case. The appellant has himself suggested that should the respondents consider parts of the disclosed information sensitive in terms of S. 8(1) of the RTI Act, they should be willing to block it out/sever it by invoking the provisions of S. 10(1) of the RTI Act and disclose the balance information to the appellant.

I find myself in agreement with the submission of the appellant. I do not see how any of the exemption Sections of the RTI Act would apply to the present information as requested by the appellant especially because this information pertains to an enquiry/ investigation which is already over and the matter stands closed. There is merit also in the appellant’s submission that the respondents should sever u/s.10(1) such portions of the information, which they might consider sensitive in terms of S. 8(1) of the RTI Act.

The respondents’ pleading that their disclosure of information was conditioned only by the provisions of the ICAI Act and the regulations and could not be decided under the RTI Act, cannot be accepted in view of S. 22 of the RTI Act (override Section).

In view of the above, it is directed that the requested information shall be disclosed to the appellant by the respondents/CPIO within two weeks of the receipt of this order. The respondents/CPIO may sever from the disclosed information such portions, which according to them, was sensitive and was likely to attract any of the provisions of the exemptions under the S. 8(1) of the RTI Act.

[Appellant : Shri N. K. Bhasin — Respondents : The Institute of Chartered Accountants of India, F.No. CIC/ AT/A/2008/00265 of 19-1-2010]


                                                      Part B: The RTI Act    

On 31-3-2010, Govt. of India, Ministry of Personnel, Public Grievances and Pensions, Department of Personnel & Training (DoPT) had a brainstorming with Civil Society Organisations (CSO). 22 NGOs from all over India were invited. 25 individuals participated : 3 from DoPT, 2 from CIC’s office and 20 representatives of CSOs (including author of this article).

The brainstorming/consultation was to seek inputs from representatives of Civil Society — especially those who had long-standing experience in promoting RTI so that the department could bring about the intended effective improvements in its functioning as well as that of the RTI regime.

As per the presentation of the Secretary of CIC, three basic issues are considered as critical to the successful implementation of the RTI Act and which need to be set right :

    Implementation of relevant provisions of S. 4 more seriously, innovatively and efficiently. He referred to a recent report of the Director General of National Archives, from which it can be made out that less than 10% of the public sector entities bothered to even report their compliance with the ‘Public Records Act, 1993’. Having a clear road map for streamlining the implementation of the Public Records Act and its operationalisation is crucial. (Note: Part B of r2i of May 2010 covers this subject).

    Meticulous study of the questions/information requests that are usually received by a PA and making all such information available suo motu go a long way in lessening the burden on citizens for getting the information they seek.

    Dissemination i.e., the manner in which infor-mation is made available proactively is crucial. Disclosure of information on websites is of limited or no value for the 90% populace which has no access to the Internet. Some out-of-the-box thinking for designing apt formats to address this issue is also called for.

Five members of CSOs (including Narayan Varma) were contacted in advance by the Deputy Secretary, RTI Division, DoPT and were requested to make the presentation of their views. They did so.

    Dr. Vijay Kumar (National Law School of India University, Bangalore) presented his views from an academic perspective. One of his suggestions was to set up the Ombudsman in the Information Commission for continuously seeking inputs and studying good practices as also for addressing the problems that Public Authorities may face in implementing the RTI Act, 2005.

    Nikhil Dey (MKSS) flagged the issue why the Information Commissions need to be ap-proached on such a large scale. Departments need to look inward to address the issue and overhaul the way they deal with proac-tive disclosure, processing of applications and disposing of first appeals. This would perhaps address the issue of so many of the Government’s own employees filing RTI applications. It will also bring about certain other much-needed reforms in the manner in which governments function.

On the whole, he felt, there was much to celebrate the RTI regime. Its success so far is a good reason to believe that there is no need for amending the Act. It is so important that representatives of the Government and of the CSOs shelve the adversarial positions that they tend to take in this regard and work hand-in-hand. It would be of great mutual help for them to meet more often — on a larger scale — and keep talking to each other.

    Dr. Shekhar Singh (NCPRI) stressed the need to spread RTI awareness in rural areas and to use multi-media approaches for the same. DoPT’s funding therefore needs to be streamlined accordingly. Each Public Authority should be asked by DoPT to have a PIO specifically designated to look after the updation of the Public Authority’s pro-active disclosure. Outsourcing the work of streamlining records management needs to be considered.

    Arvind Kejriwal (Parivartan) made a strong pitch for the National RTI Council. He also favoured involvement of a wider number of stakeholders and hence he proposed that the said National Council would discuss all problems related to RTI implementation and should be headed by the Minister and have 70% representation from CSOs and 15% each from Governments and Information Commissions.

    Narayan Varma (PCGT) urged that DoPT be-come more proactive in its functioning and strengthen the RTI regime. He questioned as to why FAQs from DoPT’s website remains deleted even after the friction on ‘file not-ings’ between DoPT and CIC is resolved. He said that DoPT’s Annual Report should clearly mention its work on RTI in a given year. He suggested that a ‘band of 200 RTI activists’ be constituted under the aegis of the earlier-proposed National Council or otherwise to propagate RTI all over India. There is a need to have very good trainers who can train others — Train the Trainers programme. He concluded saying that there has been good progress in RTI implementation, but what remains to be done is much more.

    The vision and mission of the Department of Personnel and Training was placed before the participants. The outline of the workshop was also explained. The participants then split into 4 random groups. Group I and III discussed the vision of the RTI regime and how to achieve that vision. For Group II and IV discussion was on the stakeholders and Governments as facilitators of the RTI regime.

Some of the points made out in the 4 groups were :

  •     Create simple formats for disclosing information both proactively and reactively

  •     Appoint a ‘dedicated PIO’, who can also be the Public Records Officer, as listed in the Public Records Act, 1993, combining the designation of PIO and Record Officer

  •     National RTI Council be formed

  •     ‘Transparency Day’ once a month for multi-stakeholder dialogue

  •     Joint campaigns and open houses facilitated by CSOs

  •     Social media campaigns — street plays, songs, etc. highlighting RTI Act’s benefits be organised

  •     Document best practices for dissemination

  •     Reliance on Article 256 of the Constitution (whereby the Central Government can give appropriate directions to the State Governments — including those directions for better implementation of Central Law).

    The Joint Secretary, DoPT wrapped up the proceedings summarising the presentations/ discussions in the previous sessions and pointed out that there was much agreement on the key issues faced by the RTI implementation regime even though there were variations in the solutions that were suggested. He also emphasised that the Government and the RTI activists were essentially working towards the same goal. He stated that the Government is fully commit-ted to the success of the RTI regime and that it would not do anything that would in any way dilute or weaken the RTI regime. He mentioned that this was a beginning of process of consultation.

                                                   

                                                  PART c :  OTHER NEWS

    BPL individuals misusing benefit provided to them in the RTI Act :

Proviso to S. 7(5) of the RTI Act states that fee prescribed u/s.(1) of S. 6 and u/s.(1) and (5) of S. 7 shall not be charged from the persons who are of below poverty line as may be determined by the appropriate Government.

In a bid to curb the misuse of free information under the RTI Act, the Maharashtra State Information Commissioner has recommended that not more than 100 page-photocopies should be given free of cost to those below the poverty line.

Chief Information Commissioner Suresh Joshi said the clause under which information is given free of cost to below poverty line persons, was being misused. He cited a case where a person below the poverty line sought information on the Krishna Valley Development Corporation right from its inception. The information ran into five lakh pages.

“We charge Rs.2 per page. In this case, the fee would amount to Rs.10 lakh. I believe that those below the poverty line would not be interested in this kind of information. Someone was using the person to obtain information free of cost.” said Joshi.

He has recommended to the CM that if the information runs into several pages, the applicant be asked to inspect the documents and then ask for pages he wants photocopies of.

    UK opens Government data to public :

Britain’s Prime Minister David Cameron has thrown open Government data to the public as part of a radical plan to usher in more transparency in public affairs.

In a letter sent to all government departments, Mr. Cameron set out ambitious plans to open up data and set challenging deadliness to public bodies for publication of information on topics including crime, hospital infection and government spending.

He states : “Greater transparency is at the heart of our shared commitment to enable the public to hold politicians and public bodies to account; to reduce the deficit and deliver better value for money in public spending; and to realise significant economic benefits by enabling businesses and non-profit organisations to build innovative applications and websites using public data.”

    Housing for poor !

Aam admi always loses out to corrupt politicians. It is so sad. A whopping 85% of the flats meant for those from the economically weaker section have been usurped by our politicians. TOI has procured data through RTI application from the Urban Development Department that exposes the rampant misuse of the Chief Minister’s 5% discretionary housing quota scheme.

In 1976, the State Government initiated a housing scheme under the Chief Minister’s 5% discretionary quota which allowed citizens from the economically weaker section to apply for flats surrendered by developers in lieu of residential complexes constructed on Government land. According to the rules, each application must be thoroughly vetted by the State Urban Development Department before being approved by the Chief Minister.

Data accessed from the Urban Development Department shows that over the last 16 years, nearly 85% of the apartments have been given to Ministers, MLAs, MPs, their relatives and friends. TOI has in its possession a copy of the list of people who have been allotted flats under the Chief Minister’s discretionary housing quota scheme. Of the total 3,993 recipients, three-fourth (nearly 2,994) are from the Congress, the Shiv Sena, the BJP and the MNS.

Some of the political recipients have taken the flats in the names of their wives and children. Many sold off their apartments even before the completion of the mandatory five-year lock-in period, making a killing on the sale. A total of 142 flats were sold before the end of the lock-in period, in violation of rules framed by the Urban Development Department. Data shows that 1,008 flats have been resold with the allottees pocketing decent profits.

IS THERE NO ONE TO QUESTION SUCH ACTS ?

    Gay Professor :

In Indian Institute of Technology (Hyderabad), management sacked gay rights activist and faculty member Ashley Tellis, apparently uncomfortable with his sexual orientation. The academic, with around 20 years of experience, was shown the door recently, less than a year of joining IIT-H.

Tellis has filed a right to information application, seeking the reasons behind his sacking.

    Illegal garden in Navi Mumbai :

Civic activist Sandeep Thakur used the RTI Act to get facts from Navi Mumbai Municipal Corporations (NMMC). Facts are that CIDCO which built Navi Mumbai has spent Rs.12 crores to create a holding pond in Sector 10-A. It was because of this pond, Navi Mumbai escaped flooding when large parts of Mumbai went under water on July 26, 2005.

In 2008, NMMC filled up one-fifth of the pond to create a garden. This, despite the fact that there are two large public gardens just across the road.

In reply to the RTI application, the Chief Engineer of NMMC admitted that the garden was illegal. He promised last year that the pond would be restored to its original size in April that year. However, no action was taken. Things started moving only when Thakur filed a PIL in April this year asking the Court to direct the civic chief to restore the holding pond to its original capacity before monsoon.

On May 7, the High Court said it would like to know “who took the decision to develop the garden inside the holding pond” and directed the Commissioner to recover the money spent from that person. The Bench said the Commissioner would be held responsible in the matter. Commissioner Nahata has been ordered to file an affidavit before the hearing on July 20.

    Mumbai Mayor’s Fund :

Nobody knew that such a fund existed (Gerson da Cunha, founder of AGNI commented : I have never heard of it. This is one of BMC’s best-kept secret). Existence of such a fund got revealed when an RTI application was made to find out details about it. The Mayor’s fund, as per the RTI records, got a shot in the arm when Mayor R. T. Kadam (1995-1996) organised a programme for fund-raising which resulted in funds of over Rs.1.26 crore. Of this, a crore was kept in fixed deposit and the interest received was used to meet medical aid for the needy. However, the irony is that Mayors who succeeded Kadam only spent the money from the kitty towards medical aid, but did nothing to increase it. When Datta Dalvi, Mayor (2005-’07) exited office, the fund had a balance of over 50.80 lakh, other than the fixed deposit.

Surprisingly, though Dr. Shubha Raul, Mayor, (2007-’09), sanctioned the maximum medical aid of over Rs.50 lakh during her tenure, her contribution to the kitty was zero. At the end of her tenure, the balance corpus was just a paltry sum of over Rs.4 lakh.

The Mayor provides financial assistance to underprivileged patients suffering specifically from heart ailments, dialysis, brain tumor, tuberculosis and kidney ailments.

Shraddha Jadhav, the present Mayor informs that she has over Rs.1 crore in deposit and is utilising the interest received from it to meet public needs. On an average, Ms. Jadhav receives (daily) five to six applications for financial help and has a balance of over Rs.4 lakh in hand. Ms. Jadhav says that she plans to organise a few fund-raising events soon.

    Expenditure on newspapers by the Ministers :

An RTI inquiry reveals that the Maharashtra State Government spent over Rs.7.5 lakh from January 2009 to February 2010 on newspapers and magazines provided to the CM and Deputy CM besides various publicity departments of Mantralaya.

As per the information received in RTI reply, the CM’s office receives three copies of 24 newspapers daily including English and vernacular publications, while the Deputy CM’s office gets 19 newspapers in Marathi, Hindi and English. Interestingly, the office of the Director (Publicity) receives 33 sets of newspapers and magazines including Femina, Society and Stardust. Over 44 different newspapers and magazines are distributed in the news sections, making it highest subscriber amongst 16 departments in Mantralaya, followed by 40 publications that are received by Mantralaya library.

    Shailesh Gandhi goes digital :

Mr. Gandhi selected by the Central Government as a Central Information Commissioner in September 2008 has gone digital. His communication to me and others is very interesting. He states that digital record-keeping is definitely the way forward in any office — government or otherwise. It would promote transparency and accountability in the office and reduce corruption. Full communication is posted on www.bcasonline.org and www.pcgt.org.

SME Sector : Legal Overview

1. Introduction :

    1.1 The Small and Medium Enterprise (‘SME’) sector is the growth engine of the Indian economy. This sector is the fulcrum based on which the Indian economy would leapfrog into the next orbit. It also represents one of the largest employers in the country. As per some estimates, there are more than 12 million SMEs in the country, manufacturing over 8,000 different products and contributing about 9% of the GDP. Further, they also have a 35% share in Indian exports.

    1.2 However, inspite of these statistics, one must also bear in mind that the business mortality rate is also the highest amongst this sector. Hence, it is important that they get adequate support from the Government. Recognising their importance, the Government has enacted various legal provisions to safeguard them. This Article examines the different laws/provisions which deal with the SME sector.

2. MSME Act :

    2.1 The most important step taken was the enactment of the Micro, Small and Medium Enterprises Development Act, 2006 (‘MSME Act’). The Act was enacted recognising the need for a comprehensive Act to provide an appropriate legal framework to facilitate the growth and development of the SME sector and to enhance their competitiveness. This Act was officially notified in the Gazette on 18th July 2006.

    2.2 The Act applies to Micro, Small and Medium Enterprises. Before understanding these three definitions, let us understand the meaning of an ‘enterprise’. It means :

  •     an industrial undertaking/business concern/other establishment by any other name,

  •     which is engaged in the manufacture or production of goods pertaining to an industry specified in the Industries (Development and Regulations) Act; or

  •     which is engaged in providing or rendering any service.

    Thus, it can be a manufacturer SME or a service-sector SME. A third type of an SME would not be covered. For instance, would a kirana store (a small-time grocer) be covered under this definition ? In a sector where a vast percentage of the businesses are small-time traders, one wonders why the Act did not think of covering them. There is no definition of the terms service, manufacture and production. Further, the manufacturing activity should only be of those goods which are specified in the First Schedule to the IDRA Act. It is quite strange, that the Act sought to restrict manufacturing only to a limited type of goods and did not think it fit to enlarge the canvass to cover all types of production activity.

    However, the legal form of the enterprise is not relevant, i.e., it could be a sole proprietorship, partnership, LLP, company, HUF, society, AOP, any other legal entity, etc.

    2.3 Under the MSME Act, the Central Government has, vide Notification dated 29th September 2006, classified enterprises as given in table below :

    In calculating the investment in plant and machinery, the Government has notified certain items which should be excluded. Further, in the case of imported machinery, items such as, import duty, shipping charges, customs clearance charges and VAT should be taken into account.

2.4 There is a requirement of filing with certain designated authorities, a Memorandum known as “Entrepreneur’s Memorandum” as given below.
2.5 Where any supplier, which is a micro or a small enterprise and has filed the Memorandum, has supplied goods/rendered service to any buyer, then the buyer must make payment to him within the time agreed upon between them. The maximum duration for payment must be within 45 days from the day of acceptance. If the buyer does not pay as per this schedule, then he is liable to pay compound interest with monthly rests at thrice the bank rate notified by the RBI. Thus, the defaulter has perforce to pay interest for the period of delay at 3 times the bank rate of interest notified, from time to time, by RBI (which is presently 6% and three times thereof will be 18% p.a.) compounded with monthly rests, notwithstanding any condition to the contrary in the contract between the ‘buyer’ and the ‘supplier’. Medium enterprises are not eligible for this protection.

2.6 Disclosure in accounts:

2.6.1 S. 22 of the MSME Act requires every buyer, who is required to get his accounts audited under any law, to furnish the following information in his annual  accounts:

a) The principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier as at the end of the accounting year.

b) The amount of interest paid by the buyer in terms of S. 18, along with the amounts of the payment made to the supplier beyond the appointed day during each accounting year.

c) The amount of interest due and payable for the period of delay in making payment (which has been made but beyond the appointed day during the year) but without adding the interest specified under this Act.

d) The amount of interest accrued and remaining unpaid at the end of each accounting year.
    
e) The amount of further interest remaining due and payable even in the succeeding years, until such date when the interest dues are actually paid to the small enterprise, for the purpose of disallowance as a deductible expenditure u/ s.23 of the Act. This clause uses the words small enterprise. Does this mean that payments to a micro enterprise are not covered ‘by this clause?

The penalty for non-compliance is a fine which shall not be less than Rs. 10,000.

3. Schedule VI of Companies Act:

3.1 Schedule VI to the Companies Act, 1956 was also amended by Notification No. GSR 719(E)dated
16-11-2007. Part I dealing with the format of the Balance Sheet requires the following information to be provided under the heading ‘Sundry Creditors’ :

a) total outstanding dues of micro enterprises and small enterprises; and

b) total outstanding dues of creditors other than micro enterprises and small enterprises

3.2 Further, the Schedule also requires the following information (which is also required u/s.22 of the MSME Act) to be disclosed under the Notes  to Accounts  of the Company:

a) the principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier as at the end of each accounting year;

b) the amount  of interest  paid  by the buyer  in terms of S. 16 of the Micro, Small and Medium Enterprises Development Act, 2006, along with the amount of the payment made to the supplier beyond the appointed day during each accounting year;

c) the amount of interest due and payable for the period of delay in making payment (which has been made but beyond the appointed day dur-ing the year) but without adding the interest specified under the Micro, Small and Medium Enterprises Development Act, 2006;

(d)  the amount  of interest  accrued and remaining unpaid at the end of each accounting year; and

(e) the amount  of further  interest  remaining  due and payable even in the succeeding years, until such date when the interest dues as above are actually paid to the small enterprise, for the purpose of disallowance as a deductible expenditure u/s.23 of the Micro, Small and Medium Enterprises Development Act, 2006.

3.3  Saral    Schedule    VI:

3.3.1 The Ministry of Corporate Affairs has issued two drafts of revised Schedule VI for comments, namely Saral Schedule VI for Small and Medium Companies (SMCs) and other for Non Small and Medium Companies. ‘Small and Medium Sized Companies’ (SMCs) are defined in Rule 2(f) of Companies (Accounting Standards) Rules, 2006. SMCs are defined to mean a company which fulfills and satisfies the conditions mentioned here-under as at the end of the relevant reporting period:

i) whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India;

ii) which is not a bank, financial institution or an insurance c0mpany;

iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding reporting period;

iv) which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding reporting period; and

v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company.

3.3.2 The proposed ‘Saral Schedule VI’ to the Companies Act, 1956has been proposed to take care of the following  needs:

a) make it simple  and  user friendly  for SMCs

b) have minimum  disclosure  requirements

c) ensure that the accounts have compatibility and convergence with IFRS

d) users needs  are limited

4. Income-tax Act :

4.1 5.23 amends the Income-tax Act to provide that the amount of interest payable or paid by any buyer in accordance with the provisions of the Act, would not be allowed as a deduction for computing its income. Thus, in addition to the penal interest payable by the buyer, he will also have to bear the liability to income-tax thereon, as such interest on delayed payments to MSEs (whether already paid or remaining accrued due and payable) will be added to the taxable income of the buyer and subjected to income-tax, year after year, until it is finally paid to the affected supplier. Therefore, the only way for the buyers to avoid such interest and income-tax liability is to pay promptly the supplier’s bills.

4.2 In pursuance of the provisions of the MSMED Act, the CBDT has notified instructions to all assessing officers, vide their Instruction No. 12/2006 dated 14-12-2006, thereby directing them to implement:

a) The provisions u/s.22 of the said Act, which require the aforesaid disclosures, would enable the assessing officers to ascertain the correct amount of disallowance on account of interest payment or paid by the buyer, and

b) S. 23 of said Act lays down that the amount of interest payable or paid by any buyer under or in accordance with the provisions of MSME Act shall not be allowed as deduction in the computation of income.

4.3 Recently, Appendix II, in Form No. 3CD was amended by Notification No. 36/2009, dated 13-4-2009. A new item # 17A has been inserted, which requires the disclosure of the amount of interest inadmissible u/ s.23 of the Micro, Small and Medium Enterprises Development Act, 2006. Thus, by the amendment a duty is now cast also on the auditors of the (buyers) asses sees to reporting of any interest payable to such suppliers and the con-sequential disallowance of the same.

5. Role of CAs:
5.1 Chartered Accountants should bear in mind the requirements under the above laws while auditing the accounts of companies which have dealings with SMEs or which are SMEs themselves (once the Saral Schedule VI) is notified.

Real Estate Laws: Recent Developments-I

LawsI. Introduction

Can an LLP be an SEZ Developer under the Special Economic
Zone Act, 2005 ? S. 2(g) of this Act defines the term developer to mean a person
who has been granted a letter of approval. S. 2(v) of the Act defines a person
to include a company, a firm, an association of persons or body of individuals,
whether incorporated or not. An LLP is none of the above but it is a ‘body
corporate’. Again an amendment to the SEZ Act would be highly desirable to
accommodate LLPs.

II. Collector’s NOC

2.1 Some years ago, the collector woke up from slumber and
started demanding that sale of all apartments /offices situated in buildings
constructed on land leased by the collector, should be done only after obtaining
a prior ‘No Objection Certificate’ from him. It went without saying that this
NOC was given only after payment of the ‘Collector’s Charges’ which were based
on the area of the property transferred. Thus, an NOC was required for
transferring a flat on any of the collector’s lands, e.g., at Nariman Point,
Cuffe Parade, etc., and this was proving to be a hurdle for several property
transactions.

2.2 A few months ago, the Revenue and Forest Department
issued a circular which simplified the process of conveyance of immoveable
properties in the state. It stated that it is possible to register a property
without waiting for a no-objection certificate from the various authorities,
e.g., the collector, etc.

2.3 However, the collector’s circular was still valid and
subsisting. A recent Bombay High Court decision in the case of Mr. Aspi Chinoy v
State of Maharashtra, Writ Petition No. 713 of 2001, has quashed the impugned
circular of the collector. The court held that the state government does not
have the right to ask the petitioner to seek its prior approval before entering
into the transaction. Therefore, it does not have any power to demand any
premium before transferring the flat. The petition is allowed. Hence, no
permission, either of the state government or of the collector, is necessary. In
this case, the petitioner had paid the premium which had been demanded.
Accordingly, the amount of the premium was refunded with interest at the rate of
8% per annum from the date of deposit till refund, and payment was to be made
within a period of two weeks from the date of disposal of the writ petition.
This is a very good decision by the Bombay High Court. The court order does not
specify what happens to other flat owners who also have paid such premium; would
their premiums, collected by the collector, also be refunded?

III. Redevelopment of Housing Societies

3.1 A single judge of the Bombay High Court, in a very recent
decision delivered on 5th December, 2009, in the case of Acknur Constructions P
Ltd v Sweety Rajendra Agarwal & Others, Suit 1404 of 2009, held that even if one
member of a co-operative housing society objects to a redevelopment, then the
redevelopment would be stalled. In this case, a majority of the flat owners had
assented to the redevelopment but a small minority had objected to the same.
Actually, four out of its twelve members had objected to the development on
grounds that the redevelopment was not in the society’s interest. The developer
went to court seeking a stay on the objections of the minority and permission to
continue with the redevelopment work.

3.2 The High Court refused to permit the developer to
continue with the work. According to the court, the builder had failed to make
out a prima facie case that he could remove members or that the agreement was
binding on all members. Further, the developer has no higher right than that of
the society. It held that the activity should not compromise the rights of the
members and must always safeguard the existence of the society. It held that it
was difficult to contend that a minority in number cannot obstruct the
implementation of the development agreement. It also held that the co-operative
society movement is a socio-economic and moral movement to fulfill the
constitutional aim of distribution of wealth and is not a profit-making
activity.

3.3 In a subsequent decision of the larger bench (which
included the Chief Justice) of the Bombay High Court, in the case of Girish
Mulchand Mehta v Mahesh M Mehta, Appeal No 338 of 2009, delivered on 10th
December, 2009, the Bombay High Court has taken an exactly contrary view.

In this case, the court held that the general body of the
society is supreme and had taken a conscious decision to redevelop the building.
The general body of the society thus has also resolved to appoint the developer.
The members of the society were bound by the said decisions. The general body of
the society has approved the terms and conditions of the development agreement
by an overwhelming majority. Merely because the terms and conditions of the
development agreement are not acceptable to the appellants, who were a minority
(only two out of twelve members), that by itself cannot be the basis for not
abiding by the decision of the overwhelming majority of the general body of the
society. It further laid down a principle that that once a person becomes a
member of the cooperative society, he loses his individuality with the society
and he has no independent rights except those given to him by the statute and
bye-laws. The member has to speak through the society or rather the society
alone can act and speaks for him qua the rights and duties of the society as a
body. It is not open to the court to sit over the said wisdom of the general
body as an appellate authority. Merely because some a minority of members
disapprove of the decision, cannot be the basis to negate the decision of the
general body, unless it is shown that the decision was obtained by fraud or
misrepresentation or was opposed to some statutory prohibition. In this case,
the general body had taken a decision after due deliberations for over five
years to redevelop its property. Even with regard to the appointment of the
Respondent No.1 as the developer, the decision had been taken by the general
body of the society after examining the relative merits of the proposals
received from the developers and interviewing them. Thus, the court upheld the
majority’s verdict.

3.3 It is being respectfully submitted that the single judge’s decision needs a rethink and that the larger bench’s decision is more rational. Can one individual hold the entire society to ransom? If yes, then what is the meaning of a majority? What if one cankerous individual refuses in the hope of making some extra personal gains? Does not the principle of the socio-economic movement also require that col-lective good should be placed over individual gains and losses?

IV. Demolition of Illegal Construction

4.1    A very important decision was rendered by the Bombay High Court in the case of a writ petition filed by Sudhir M. Khandwala, Writ Petition No 1077 of 2007. The case pertained to the demolition of illegally constructed build-ings and the petition was filed by flat owners seeking respite from the BMC’s orders. The High Court refused to stay the demolition and refused to regularise the unauthorized construction.

4.2    The Division Bench held that while consider-ing such matters, not only the interests of the petitioners but also of those residing in the nearby areas should be taken into account. The court came down harshly on the petitioners and held that “….if they purchase flats without

bothering to make enquiries and seeking details of the construction, then they are themselves to blame. If they are carried away by the brochure and the public advertisements and do not make such inquiries they cannot turn around and seek assistance of the courts.”

4.3    The court further held that every application for regularisation is to be viewed on a case-to-case basis and that there is no blanket rule that allows all applications to automatically accepted and approved. Essential supplies like power, water and infrastructure are scarce and unauthorized construction adds to the burden on these facilities. Hence, the BMC can refuse to regularize a particular application. The court upheld the demolition order for 17 out of 24 floors.

4.4    This decision is a wake-up call for all flat buyers. It is very important for buyers to check whether or not the title documents of the building and various permissions are in order. A reputed solicitor’s certificate would be helpful. Further, while dealing with buildings constructed on forest land, CRZ land, etc., the buyers should be extra cautious.

    Registration Fees

5.1    The Maharashtra State Government has issued a notification a few weeks ago which states that the Rs. 30,000 cap on registration fees has been removed. Registration fees in the state were 1% of the fair market value of the property or Rs. 30,000, whichever was lower. Thus, even if the registration fees were coming to Rs. 1,00,000, they would be capped at Rs. 30,000. Accordingly, now, the combined amount of the stamp duty and registration fees would be 6% (5% + 1%) of the fair market value. The FMV would be computed as per the Stamp Duty Ready Reckoner. The state government had earlier issued a similar notification which was subsequently withdrawn.

5.2    Such a move by the government would act as a dampener to flat purchasers. Registration is a service by the government and not a tax. It is unfortunate that the government is us-ing registration of documents as a means of increasing the state’s revenue.

VI.  Information about Tenants

6.1    The Thane police has made it mandatory for owners of a home, club, hotel, hospital, etc., to give information about foreign nationals residing in their premises.

6.2    The owner of such premises is required to intimate the nearest police station about any foreigner arriving at their premises within 24 hours of their arrival. The police has issued this notification under Section 144 of the Criminal Procedure Code which empowers the issuance of such orders in urgent cases of nuisance or apprehended danger. Failure to do so may entail prosecution of the owners.
 

VII. Eviction of Tenant from Commercial Premises

7.1    The Supreme Court, in the case of Ashok Kumar vs. Ved Prakash (CA 8417 of 2009), has held that a tenant can be evicted from not only residential premises but also commercial premises to meet the bona fide requirements of the landlord for self-occupation. This was a case under S.13 of the Haryana Urban (Control of Rent and Eviction) Act, 1973. S.13 of this Act is as hereunder:

“Eviction of tenants-

  1)  A tenant in possession of a building or rented land shall not be evicted therefrom except in accordance with the provisions of this section.

 2)   A landlord may apply to the controller for an order directing the tenant to put the landlord in possession-

    b) in case of residential building, if-

    i) he requires it for own occupation, is not occupying another residential building in the urban area concerned and has not vacated such building without sufficient cause after the commencement of 1949 Act in the said urban area.”

7.2    In this case, the two courts had ordered eviction of the tenant/appellant from a shop constructed on the ground floor at a plot in Gurgaon district in Haryana.

However, the tenant challenged the eviction and the judgments of the two courts on the ground that under Section 13 of the Haryana Urban (Control of Rent and Eviction) Act, 1973, a tenant can be evicted only from residential premises.

7.3    The Supreme Court held that there cannot be any discrimination vis-a-vis residential and non-residential premises for evicting a tenant, as otherwise it would be a violation of Article 14 (equality before law) of the Constitution.

It dismissed the appeal filed by the tenant challenging the eviction order passed by the Rent Controller and affirmed by Punjab and Haryana High Court.

The apex court held that if the landlord is able to prove his bona fide needs, the tenant can be evicted not only from residential premises but also commercial premises.

This judgment would have far reaching con-sequences in all the states which have Rent Control Acts since almost all of them contain provisions similar to S.13 of this Act. S.16(1) of the Maharashtra Rent Control Act, 1999 provides that a landlord may recover possession if the premises are reasonably and bona fide required by the landlord for occupation by himself. The wordings used in this section are much broader than those under S.13 of the Haryana Act. Further, the definition of the word ‘premises’ in S.7 means ‘any building’. Hence, under the Maharashtra Act, a land-lord could have recovered possession even of a commercial property. The position has now become clearer by virtue of the Supreme Court’s decision.

Agricultural Land Laws – I : MLRC, 1966

Laws and Business

1. Introduction :


Land laws are a species in themselves. Even within land laws,
laws relating to agricultural land can be classified as a separate class. One
comes across numerous terms and concepts while dealing with agricultural land,
e.g., NA Land, Land Ceiling, Land used for bona fide industrial use, etc. It is
quite common for agricultural land to be converted into non-agricultural land
and being used for industrial purposes or being used for real estate
development. However, it is very important that the correct process is followed
while dealing with agricultural land or else there is a risk of land being
acquired by the Government. Several real estate developers have suffered because
the correct process was not followed. Through a series of articles over the next
few months, I propose to explain the important concepts under some of the key
laws relating to agricultural land.

Agricultural land in Maharashtra is governed by several Acts,
the prominent amongst them being the following :

(a) Maharashtra Land Revenue Code, 1966 applicable to the
State of Maharashtra.

(b) Bombay Tenancy and Agricultural Lands Act, 1948 —
applicable to the Bombay Area of the State of Maharashtra and State of
Gujarat, i.e., the whole of Maharashtra and Gujarat except Marathwada (Latur,
Nanded, Aurangabad) and Vidarbha (Nagpur, Akola, etc.) regions.

(c) Maharashtra Agricultural Lands (Ceiling on Holdings)
Act, 1961.





In this Article, we will look at the Maharashtra Land
Revenue Code, 1966 (‘Code’)
which deals with the law relating to
agricultural land and land revenue in the State. Land revenue is an important
source of revenue for State Governments.

2. Revenue areas and officers :


2.1 For ease of administration, the Government has u/s.4 of
the Code divided the State into various revenue areas.

2.2 Under the Act, the State is divided into divisions,
e.g., the city of Mumbai along with its suburbs constitutes one division.
Similarly, there is the Aurangabad Division, Pune Division, Nagpur Division,
etc.

Each division consists of one or more districts,
including the City of Mumbai. Each district may consist of one or more
sub-divisions.

Each sub-division may consist of one or more
talukas.


Each taluka consists of certain villages. A
village includes a town or city and all land belonging to a village, town or a
city.

A group of villages in a taluka constitutes a saza.
The saza may consist of up to eight and in some cases 15 villages. It is a
function of administrative convenience, population, etc.

2.3 Accordingly, the Government has created the following
revenue areas :

(a) Divisions

(b) Districts

(c) Sub-Divisions

(d) Talukas

(e) Sazas

(f) Revenue Circles

2.4 Based on the revenue areas, the Government has created a
hierarchy of various revenue officers for the administration of various matters,
for the assessment and collection of land revenue, for conducting surveys,
maintaining accounts, records, etc. The hierarchy of officers is as follows :

  •  Divisional Commissioner/Additional/Assistant Divisional Commissioner.


  •  District Collector/Additional/Deputy Collector which are appointed for
    each district and who is in charge of the revenue administration of a
    district.


  •  Taluka Tahsildar/Naib-Tahsildar/Additional Tahsildar in charge of each
    taluka and who is the chief officer entrusted with the revenue administration
    of a taluka.


  • Circle Officers/Inspectors for each Circle


  •  Talathis for each saza


  • Kotwals for each village or group of villages


The Code lays down the powers and functions of each type of
revenue officer.

3. Title of lands :


3.1 U/s.20, all public property, e.g., roads, bridges, etc.,
and land which is not the property of persons legally capable of holding
property
is declared to be the property of the State Government and
vests in it. Hence, any land which, under law, is not owned by any person, who
under law can own such property, would be the subject-matter of this Section.
The Collector is empowered to deal with and dispose of all such land in any
manner as he deems fit, subject to the Commissioner’s orders. Thus, any land
held by a person who, by virtue of any statute is capable of holding property in
its own name, e.g., by companies, major individuals, etc., would be excluded
from the operation of this Section. Thus, any land which is not the property of
others would vest in the State Government.

3.2 The Collector may by issuing a notice and following the
due process claim any property by or on behalf of the Government. This order is
subject to one appeal and revision under the Code.



4. Types of land and holders :



4.1 Land can be classified into two types :


(a) Alienated — means that which is revenue-free and
is owned by any person. Thus, no revenue is payable to the Government. This
would include land such as imans and watans.

(b) Unalienated — land other than alienated land.
This is the regular land which is subject to land revenue assessment.

4.2 The land holders can be classified as given in Table
below.

5.    Land records:
5.1 One of the important provisions dealt with by the Code is the maintenance of the Land Records in respect of various lands.

Table 1: Types of land holders

Type

Govt. Lessee

Tenant

Holder

Occupant

 

 

 

 

 

 

 

Meaning

Unalienated
land leased by

Lessee
of land includes

Person
holding

Person
holding

 

 

the Collector to any person

a mortgagee of tenant’s

alienated land

unalienated land and

 

 

on such terms as deemed fit

rights with possession,

 

excludes a tenant or

 

 

by the Collector

but not a lessee holding

 

a Government lessee

 

 

 

directly under the State

 

 

 

 

 

Government

 

 

 

 

 

 

 

 

 

Classes

Could
be classified

Occupants
are

 

 

as Class III

 

 

further divided into

 

 

 

 

 

Class I and Class

 

 

 

 

 

II depending upon

 

 

 

 

 

since when they are

 

 

 

 

 

holding the land

 

 

 

 

 

or the restrictions

 

 

 

 

 

placed upon their

 

 

 

 

 

holding

 

 

 

 

 

 

 

Whether-

Under
general law, a lease

No
express provision.

Yes,
since he is an

Yes,
S. 36 of the

 

Heritable

is inheritable. However, if

However, in Shriman-

absolute holder

Code provides for

 

 

the terms and conditions

tibai Nargude v. Bhimrao

 

the same

 

 

provide otherwise, then

Nargude, 2009 (1) Bom

 

 

 

 

the same would prevail

CR 265 it was held that it

 

 

 

 

 

is inheritable

 

 

 

 

 

 

 

 

 

5.2    Record of rights:

For every village a record of rights would be maintained which would contain the following particulars:
(a)    Names of all persons who are holders, occupants, owners, tenants, owners, mortagees of the land or assignees of the rent or revenue from it
(b)    Names of all Government lessees or tenants
(c)    Nature and extent of respective interest of such persons and the conditions or liabilities, if any
(d)    Revenue or rent payable by such persons

Thus, all rights, interests and liabilities qua a piece of land are recorded in one document. These records are maintained by the Talathi of each village.

5.3 If any person acquires any right by virtue of succession, survivorship, inheritance, purchase, partition, mortgage, gift, lease, etc., in any land, then he must give a notice of the same to the Talathi within three months of such event.

The Talathi would then enter such changes in a Register of Mutations which would alter the original record of rights.

5.4 Any person buying land especially in a rural or semi-urban area would be well advised to do a thorough title search by checking the Record of Rights, Register of Mutations, etc., which would show whether or not the land in question is an agricultural land, who is the owner, what important developments have taken place in respect of the land, etc.

5.5 In the next Article we shall look at the process for converting an agricultural land into a non-agricultural land.



Understanding Term Sheets

1. Introduction :

1.1 Open a newspaper and you would read about some or the other Private Equity (PE) funding or venture capital investment. PE funding is no longer restricted to unlisted or start-up companies, but even listed, well-established companies get funded by large PEs (e.g., the recent investment in Nagarjuna Construction) or even taken over by PEs (e.g., the acquisition of Gokaldas Exports by Blackstone Fund). The starting point of all such PE fundings, whether large or small, is a Term Sheet.

1.2 A ‘Term Sheet’ records the understanding arrived at between the Company, the Promoters and the PE, on the key decision areas for PE making the investment. A Term Sheet summarises the principal terms and conditions for proposed investment in the Company. It is subject to applicable regulatory requirements, satisfactory completion of due diligence and definitive documentation, and is not intended to be and is not an exhaustive description of the agreement, arrangement or understanding between the parties relating to the matters set out herein. It is succeeded by a due diligence (operational, legal and financial) and then by a Shareholders’ and/or Share Subscription Agreement. Ultimately, the provisions of the Shareholders’ Agreement are incorporated in the Articles of Association of the Company.

1.3 This Article analyses a standard Private Equity ‘Term Sheet’. However, it is clarified that this Term Sheet is by no means exhaustive and there can be several other clauses.

Real Estate Laws : Recent Developments

Law and Business

1. Introduction :


The last few months have witnessed a hectic activity on the
real estate front. Several important laws have been amended or enacted and
several crucial decisions have been rendered by the Supreme Court and the Bombay
High Court. Some of these amendments are good and some of these are not so good.
These amendments would have a major bearing on the way immovable property
transactions are carried out in the State of Maharashtra. This Article presents
an overview of these important enactments and cases.

2. MOFA : Deemed conveyance :


2.1 The Maharashtra Ownership Flat Act, 1963 (‘MOFA’) was
recently amended to provide that builders/developers must compulsorily make a
conveyance of the property to the co-operative housing society within a
stipulated period. If they fail to do so within the stipulated time, then the
designated competent authority, i.e., the District Deputy Registrar can
take action against the builder.

2.2 One of the important provisions of the amendment is that
the designated competent authority i.e., the District Deputy Registrar,
can take action against the builder for non-compliance. He can issue an
automatic conveyance (Unilateral Deemed Conveyance), whereby the rights will be
transferred to the society. As per the amendment, the punishment for a builder,
who fails to transfer the plot to the housing society, would be imprisonment for
a term from 6-12 months or a fine of Rs.10,000 to Rs.50,000 or both. He could
also be debarred from any construction project for five years.

2.3 However, certain grey areas remain in the amendment. The
law allows both the competent authority as well as the sub-registrar to issue
show-cause notices to the builder for not having executed conveyance. This
dichotomy of authorities may unnecessarily complicate matters and delay the
proceedings.

A sub-registrar can after giving the promoter a hearing come
to a conclusion contrary to the competent authority and thus refuse to register
the unilateral deemed conveyance. What happens next is unresolved.

2.4 The new law requires the competent authority to dispose
of all cases in six months, but strangely, it does not provide for the time
period within which the sub-registrar must issue the conveyance.

2.5 While it is a welcome step, as with all laws the proof of
the pudding lies in its successful implementation.

3. Registration process simplified :


3.1 A recent Circular of the Revenue and Forest Department
has simplified the process of registering conveyance of immoveable properties in
the State. Now, it is possible to register a property without waiting for a
no-objection certificate from the various authorities, e.g., Collector,
etc.

3.2 This Circular has its genesis in a Supreme Court decision
which has declared Section 22A of the Registration Act, 1908 as
unconstitutional. Section 22A casts an obligation to obtain ‘No Objection’
Certificates from various authorities such as the Collector, etc., to whom the
land belonged before registering a property. The Court also directed that no
registrar or sub-registrar of assurances could refuse registration under any
notifications issued under the provision.

3.3 Thus, now an NOC would not be required for transferring a
flat on collector’s land, e.g., in Nariman Point, Cuffe Parade. This
would speed up the registration process and would lead to greater voluntary
registration of property. This would automatically improve the title to the
property.

3.4 Another effect is that flat buyers requiring home loans
had to get their documents registered before availing the loan. Such buyers were
unable to obtain loans since registration was held up for want of NOCs. Now they
can avail of a loan as registration no longer requires an NOC.

In most cases the NOCs were time-consuming and sometimes led
to cancellation of the deal. This was especially true in the case of
transactions on Collector’s land, in areas like Nariman Point, etc. Other
permissions required were N.A. (Non-Agricultural) Permissions, BMC, etc.

3.5 Besides a speedier registration, one can also look
forward to less bureaucracy, fewer touts and reduced corruption in the
registration process. Such amendments are not only good for the real estate
sector, but good for administration. We often criticise the Government for old
outdated laws, this time kudos to the Government as it eliminates a
‘bottleneck’.

4. Buildings on forest land :


4.1 The Bombay High Court in a recent decision has held that
all development on more than 1,000 acres of land in the certain suburbs of
Mumbai is illegal, since the development was on forest land.

Over 125,000 flats spread over 120 acres are affected by the
Court’s decision. Both the existing developments and under-construction projects
would be affected by this Order. An SLP against the same is expected soon.

4.2 This case was moved by an NGO, Bombay Environmental
Action Group (BEAG), to protect the forest lands encroached upon by the
builders. Most of the disputed flats are in areas Kandivali, Borivali, Ghatkoper,
Bhandup, Mulund, Thane, etc. A Division Bench of Chief Justice Swatanter Kumar
and Justice S. C. Dharmadhikari dismissed about 19 petitions filed by the
builders.

4.3 The Government is now proposing to regularise all such
houses built on illegal lands by levying a one-time penalty. In the meanwhile,
the Registrar has a blacklist of survey numbers which fall within the illegally
developed areas. Registration of any transaction under these survey numbers is
being rejected. The sub-regsitrar’s offices have displayed all these blacklisted
survey numbers. Thus, a lot of flat owners and buyers are being inconvenienced
by this order. As a result, natural corollary property rates in the blacklisted
areas have crashed. The Forest Department is deciding upon its next course of
action, i.e., whether or not it should demolish these illegal
constructions.

4.4 The proposed action of the Government will bring relief to the affected persons.

5.  Use of extra FSI by builders:

5.1 A recent Bombay High Court Order has held that builders will no longer need the consent of existing flat owners if they have extra FSI on a plot and are planning to have additional buildings or structures if the new construction has all the necessary approvals from the municipal authorities. The consent of the flat owners would be needed only if the new construction results in alterations to the existing building or the construction as described in the flat purchase agreement executed between the flat buyer  and builder.

5.2 This order was passed by Justice A. M.’ Khanwilkar of the Bombay High Court in the case of Mehani Builders v. Jamuna Darshan Co-operative Housing Society Ltd. The society was objecting to the additional construction carried out by the builder by using extra FSI. The Court delivered its judgment under the Maharashtra Ownership of Flat Act (MOFA) 1963.

5.3 As per the judgment, the agreement should-very clearly mention the potential FSI utilisation. Further, developers must now construct their buildings in accordance to the plans and specifications and in accordance with the agreement entered into-by both parties and they should spell out how they propose to use any extra FSI.

5.4 Now construction of additional buildings is permissible so long as it is under the scheme or projects of development in the layout and subject to the relevant building rules or byelaws or development control rules. This is an order which would promote greater transparency in property transactions.

5.5 The Government should also incorporate this order also whilst regularsing development on forest land.

JURISDICTION IN MATTERS RELATING TO VIOLATIONS OF INTELLECTUAL PROPERTY RIGHTS INCLUDING IN CYBERSPACE

IPR Laws

Having considered what acts constitute infringement of a
registered trademark and copyright as also passing off, the next essential
question which arises is which Court would have the jurisdiction to try,
determine and dispose of a suit relating to the said issue. It may be
appreciated that apart from general rules of procedure which lay down the law
for the purposes of determining the jurisdiction of a Court, special provisions
are to be found in the Trade Marks Act, 1999 and the Copyright Act, 1957
(hereinafter referred to as the ‘Trade Marks Act’ and the ‘Copyright Act’,
respectively) which confer jurisdiction on additional fora. This month’s article
seeks to give an overview of the provisions which determine the jurisdiction of
a Court, in matters relating to violation of rights in trademarks and copyright,
with special reference to determining jurisdiction in respect of matters
relating to websites.

Code of Civil Procedure, 1908 :

The general rules for determining the jurisdiction of a Court
are to be found in S. 15 to S. 20 of the Code of Civil Procedure, 1908
(hereinafter referred to as ‘the CPC’). These provisions, inter alia, lay
down that in the first instance, a suit must be filed in the Court of the lowest
grade competent to try it. In suits for land, the same are to be filed where the
immovable property in dispute is situated. In other cases, the suit is to be
filed either where the defendant carries on business and/or actually and
voluntarily resides and/or works for gain or where the cause of action has
arisen. Hence, under the CPC, if an owner of copyright and/or registered
proprietor of a trademark wished to institute proceedings against an infringer,
he would be obliged to follow the infringer to wherever he resides and/or to the
place where the infringing goods are being sold. This would mean that, if
someone were selling goods bearing infringing trademark in a remote part of
Assam and only had an existence in that limited area, the proprietor of the
trade-mark, who may be situated in Kerala, would have to follow the said
infringer all the way to Assam and sue him there.

Special provisions :

In order to overcome this handicap/difficulty, certain
additional provisions for determining the jurisdiction of a Court are to be
found in the Trade Marks Act and the Copyright Act. S. 62 of the Copyright Act
and S. 134 of the Trade Marks Act, inter alia, allow a plaintiff i.e.,
the owner of the copyright and the registered proprietor of a trademark,
respectively, to initiate and file an action for infringement in the District
Court having jurisdiction to try the suit which shall include a District Court
within whose jurisdiction the person instituting the suit or proceeding actually
and voluntarily resides or carries on business or personally works for gain.

It may be noted that even though the provisions of S. 62 of
the Copyright Act have existed since 1957, no such provision was to be found in
the earlier Trade and Merchandise Marks Act, 1958. The Trade Marks Act
introduced such a provision for the first time in 1999. It may also be
appreciated that S. 134 of the Trade Marks Act allows a plaintiff to file a suit
where he actually and voluntarily resides or carries on business or works for
gain only in respect of the cause of action for infringement of registered
trademark and not for passing off. Hence, there could be situations where a
Court may have jurisdiction for the purposes of the cause of action of
infringement, but not for passing off. To illustrate, let us take a situation
where Hindustan Unilever Limited being the registered proprietor of the
trademark ‘DOVE’ having its registered office in Mumbai wants to sue a person
manufacturing and selling soaps, under an identical trademark, only in Ludhiana.
In such a case, since the defendant is neither itself present within the
jurisdiction of the Mumbai Courts, nor are its products available within Mumbai,
the plaintiff would be unable to file a suit for passing off in Mumbai. However,
in light of S. 134 of the Trade Marks Act, Hindustan Unilever Limited would be
entitled to file an action for infringement of its trademark in Mumbai. In such
cases at a practical level, the normal practice followed by lawyers in Mumbai,
would be to file a combined suit for both causes of action in Mumbai and then
seek leave under Clause XIV of the Letters Patent for joinder of causes of
action, thereby giving the Court at Mumbai jurisdiction to try, determine and
dispose of the suit in respect of both the causes of action. Clause XIV of the
Letters Patent is a provision whereby the Bombay High Court is empowered to
combine causes of action so as to, inter alia, avoid multiplicity of
proceedings.

Hence, in a matter relating to infringement of rights in a
trademark or copyright the above principles would apply for the purposes of
determining jurisdiction.

Websites :

The application of the above principles is relatively simple
in the real world, but causes quite a few problems when applied to the virtual
world or in cyberspace. In cases where the defendant is not resident within the
jurisdiction of the Court, but jurisdiction is sought to be fixed on the basis
that the cause of action has arisen within the jurisdiction of that Court,
several difficulties arise. It may be noted that in cases where the infringing
mark or work is found only on a website, the question which arises is under
which circumstances can it be said that a cause of action be said to have arisen
within the jurisdiction of that Court and under what circumstances can a Court
exercise jurisdiction over a website. This question has vexed lawyers and
jurists over the years as to in what circumstances can a Court exercise
jurisdiction over websites published on the worldwide web. Would the mere
accessibility of a website from within the territory of the Court confer
jurisdiction on that Court or is something further required to determine and
establish a cause of action. A website, under normal circumstances, would be
accessible to everyone in all countries. Hence, in such a case can it be said
that a cause of action arises in every jurisdiction, thereby allowing the
plaintiff to sue anywhere where the website is accessible.

This question of seminal importance has recently been
answered by a Division Bench of the Delhi High Court in Banyan Tree Holding
Private Limited v. A. Murali Krishna Reddy
1 wherein the matter
had been referred by a Learned Single Judge to the Division Bench to determine
the law applicable for determining jurisdiction over a website.

The facts of the said case were that neither the plaintiff nor the defendant had their offices within the jurisdiction of the Delhi High Court, but the suit for passing off was brought on the basis that the defendant’s website which used the impugned mark ‘Banyan Tree Retreat’ was accessible in Delhi through the website of the defendant which was not a passive website and was an interactive web-page. The concept of a passive website as against an interactive website has been evolved by Courts for the purpose of determining jurisdiction as will be evident from the following.

The Division Bench, in light of the above facts, formulated and answered the following question— What principles would apply to determine jurisdiction in passing off or infringement actions where the plaintiff was not carrying on business within the jurisdiction of the Court, but the defendant was hosting a website within the jurisdiction of that Court?

In order to answer this question, the Division Bench made a detailed analysis of the law as it stood in the U.S.A., U.K., Canada, Australia and India. The Division Bench examined how several theories have been propounded over the years for the purposes of determining jurisdiction in cyberspace.

A vast plethora of judgments of US Courts was considered on the subject and it was found that initially, the Courts in the USA used to apply the ‘Purposeful Availment’ theory which was later modified to the ‘Zippo Sliding Scale Test‘ which was thereafter modified to the ‘Effects Test.’

The Purposeful Availment theory was initially pro-pounded by the U.S. Supreme Court in International Shoe Co. v. Washington2, wherein it was held that in order to establish jurisdiction over a particular defendant the plaintiff had to show that the Defendant had minimum contacts in the forum State, i.e., the State in which the plaintiff desired to institute his action, and that the defendant must have purposefully availed of the privilege of conducting activities in the forum state. Under this theory, it was found that the Courts were tending to exercise jurisdiction over websites merely on the basis that they were accessible within the jurisdiction of the forum court. However, it was later clarified that the effect of creating a site may be felt nationwide or even worldwide but without more, it would not be an act purposefully directed towards the forum State3. This led to the concept of whether a website could be categorised to be a passive website or an interactive website and that the purposeful avail-ment theory would be satisfied only if the website were interactive to a degree that reveals specifically intended interaction with the residents of the forum state4.

Hence, questions then arose as to whether websites were passive or interactive and if interactive, what was the level of interactivity needed to establish jurisdiction. This led to the Zippo Sliding Scale test wherein the Court set out a three-pronged test being that the defendant must have minimum contacts with the forum state, the claim asserted must arise out of those contacts and that the exercise of jurisdiction must be reasonable5. The Courts, however, then felt that since almost all websites are interactive to a certain extent, a shift was necessary so as to examine in each case, the nature of the activity performed using the interactive website.

In light of the above, the effects test was pro-pounded in Calder v. Jones6 wherein it was held that for the purposes of determining jurisdiction, it was essential to identify where the effect of the website would be felt i.e., at whom and/or where was it targeted.

The effects test however, did not find favour in its application to trademark infringement cases since it was felt that the effects test as would be applicable to an individual would not be applicable to a corporation/company, since a company would not suffer harm in a particular geographic location in the same sense that an individual would7.

The Division Bench then summarised the law in the U.S.A. as being that a plaintiff would have to show that the defendant purposefully availed of the jurisdiction of the forum state by specifically targeting the customers within the forum state.

The Division Bench also considered the law in the U.K., Canada and Australia before dealing with the limited Indian law on the subject. A perusal of these foreign judgments explains the fact that mere access to a website would not confer jurisdiction on a Court and that something more would be needed.

It was in light of the above, that the judgment of a Single Judge of the Delhi High Court in Independent news Service Pvt. Ltd. v. India Broadcast Live LLC8 was referred to. The finding in that case was that in order to exercise jurisdiction over a website it was essential to show that the website was interactive and that the level of interactivity involved would also be relevant.

The Division Bench has, however, gone a step further after considering all the law on the subject and has, inter alia, laid down that:

“This Court holds that jurisdiction of the forum court does not get attracted merely on the basis of interactivity of the website which is accessible in the forum state. The degree of the interactivity apart, the nature of the activity permissible and whether it results in a commercial transaction has to be examined. For the ‘effects’ test to apply, the plaintiff must necessarily plead and show prima facie that the specific targeting of the forum state by the Defendant resulted in an injury or harm to the Plaintiff within the forum state. For the purposes of a passing off or an infringement action (where the plaintiff is not located within the jurisdiction of the court), the injurious effect on the plaintiffs business, goodwill or reputation within the forum State as a result of the defendant’s website being accessed in the forum State would have to be shown. Naturally therefore, this would require the presence of the Plaintiff in the forum state and not merely the possibility of such presence in the future. Secondly, to show that an injurious effect has been felt by the Plaintiff it would have to be shown that viewers in the forum state were specifically targeted. Therefore the ‘effects’ test would have to be applied in conjunction with the ‘sliding scale’ test to determine if the forum court has jurisdiction to try a suit concerning internet based disputes.”

Thus, it would be evident that in order to establish that a cause of action has arisen within the jurisdiction of a particular forum, it would be necessary for the Plaintiff to prima facie establish that the defendant’s website which contains the infringing material is specifically targeting customers within the forum state and that the same has caused injury or harm to the Plaintiff within the jurisdiction of that forum not merely whether a website is active or passive.

In my opinion, the above judgment, though lays down certain guiding principles as to how a court can exercise jurisdiction over infringing acts in cyberspace, it still leaves many questions unanswered such as what is the level of injury or harm necessary to establish jurisdiction or how is one to determine and identify cases of specific targeting, what would happen in cases where the targeting is of specific individuals who are normally resident in another forum but have accessed the website within a different forum, etc. These issues still remain unanswered and one can only hope that they will be answered in due course of time. The only solace is that a lamp has been handed down by the Division Bench, which will, hopefully, light the path as we walk along and lay down and make more specific the law on the subject.

Trade mark Licensing — Quality Control

IPR Laws“What’s in a name ? That which we call a rose, by any other name would smell as sweet.”
 — Juliet from Romeo and Juliet, Shakespeare.

Businessmen today may however choose to disagree with this oft-quoted Shakespearian view, for in the current era, a name as in trade marks or brand names is an extremely valuable asset. Companies, in fact, incur huge expenditure to promote, establish and protect their trade marks and also, in turn, reap benefits of the repute of their trade mark. To quote Mr. Pierre Cardin, “My name is more important than myself.”

A trade mark is normally exploited in two ways, firstly by the proprietor using the trade mark himself in respect of his goods or services and secondly, by the proprietor licensing the trade mark to others. For the purposes of this article, I shall be dealing primarily with the latter.

Licensing of Trade marks

    A trade mark licence has been defined as ‘a contractual arrangement whereby a trade mark owner permits another to use his trade mark, where but for the licence the other would be a trade mark infringer.’1 Therefore, licensing of a trade mark is a process whereby a trade mark owner allows, permits and/or authorises another entity the right to use the trade mark, subject to the terms and conditions specified in the licence.

    A trade mark licence could be exclusive or non-exclusive in nature. An exclusive licence is one where the licensee is allowed to use the trade mark to the exclusion of everyone else, whereas in case of a non-exclusive licensee there could be more than one licensee.

    The Trade Marks Act, 1999 (‘the Act’) does not contain a definition of a trade mark licence, however, it defines the term “permitted use”. Section 2(r) de-fines permitted use in relation to a registered trade mark to mean, inter alia, use by a registered user or use by a person other than the registered proprietor or registered user in relation to the goods and services, subject to other conditions mentioned therein.

    The Act defines a registered user to mean someone who is registered as such u/s.49 of the Act. A registered user, put simply, is also a licensee of a registered trade mark, but one who has been so registered under the Act. Such registration can give additional benefits to a registered user such as a right to institute infringement proceedings in his own name.

    It may be relevant to note that the definition of permitted use under the Act is broader than the definition of permitted use under the Trade and Merchandise Marks Act, 1958, whereunder only a registered user was recognised as being a permitted user. The new Act, however, clearly recognises use by a registered user or use by any person other than the registered user and the registered proprietor. Hence, statutorily a new category of permitted user has now been recognised. Licensing of unregistered trade marks is commonly known as common law licensing and is governed by the general principles of trade mark law and contract.

    Thus, in a nutshell a trade mark licence is an agreement whereby a trade mark owner (licensor) agrees and allows a licensee to use the trade mark for either manufacturing, distributing, selling, etc. products under the licensed trade mark. If not for the licence, use by any other person of a trade mark would be in violation of the trade mark owner’s rights in and to the trade mark.

    There are several important conditions that are to be considered whilst drafting a trade mark licence such as the specific goods in respect of which the trade mark is to be licensed, the territory of use, etc. One of the essential factors to be considered while licensing a trade mark is to ensure the maintenance of quality control and/or supervision by a licensor over his licensee in respect of the goods and/or services to be manufactured, sold and/or marketed under the licensed trade mark, for in the absence of such a provision and effective exercise thereof, certain adverse consequences, as are explained hereinafter, as to the licensed trade mark could follow.

Concept/Function of a Trade mark

    In order to appreciate the relevance and necessity of maintaining quality control and supervision by a licensor over a licensee, it would be helpful to understand the concept of a trade mark.

    Trade marks have evolved from being a strict badge of physical origin2 to being quality and source indicators,3 from being non licensable to being extensively licensed, etc.4

    The original purpose of trade marks was to indicate ownership. However, with the development of commercial trade, trade marks have come to serve a different function — identification of the source of goods offered for sale in the market place.5 The recognition of a trade mark as a special form of property right, based on the goodwill embodied in the mark, was integrally linked with the notion that the mark served to indicate the source of the goods.6

The Act defines a trade mark, inter alia, as being” a mark capable of being represented graphically and which is capable of distinguishing the goods or services of one person from those of others …. a mark used or proposed to be used in relation to goods or services for the purpose of indicating or so as to indicate a connection in the course of trade between the goods or services, as the case may be, and some person having the right, either as proprietor or by way of permitted use.’7

Thus, it may be appreciated that the primary function of a trade mark is, inter alia, to indicate a connection in the course of trade between the proprietor of the trade mark and his goods or services. Hence, a causal connection must be maintained between the goods or services and the proprietor of the trade mark. The reasoning and/ or rationale for maintaining this causal connection could be attributed to the fact that a trade mark indicates to a consumer the source from which the goods or services emanate and consequently, a certain quality as associated with that source and it is on this basis that the consumer buys certain trade-marked goods as opposed to others.

It  may be appreciated that  at early  common  law, trade mark proprietors generally were not permitted to licence their marks to others because trade marks were viewed solely as indicators of physical source of goods.8 However, trade mark licensing was subsequently sought to be permitted so long as the trade mark owner exercised control over the quality of the trade marked goods that were produced by the licensees.9 This is also reflected in a judgment of Lakshmanan J., wherein the Learned Judge has held that,

“These changes have been reflected in our statutory trade mark law in, for example, the broadening of the definition of a trade mark, in the recent provisions of assignment without goodwill and in the recognition in the registered user provisions that a trade mark can be licensed without causing deception or confusion, provided the owner of the trade mark retains control over the character and quality of the goods sold under the mark.”10

It may also be appreciated that the Hon’ble Supreme Court has held that licensing of a trade mark,

“is permissible, provided (i) the licensing does not result in causing confusion or deception among the public; (ii) it does not destroy the distinctiveness of the trade mark that is to say, the trade mark, before the public eye, continues to distinguish the goods connected with the proprietor of the mark from those connected with others; and (iii) a connection in the course of trade consistent with the definition of trade mark continues to exist between the goods and the proprietor of the mark.”11

Quality Control

Quality control and/or supervision of a licensee by a licensor is imperative so as to ensure that there is no confusion amongst the public as to the nature of the goods manufactured, sold and/or marketed under the trade mark. To illustrate, let us take a case where A has licensed his trade mark to Band C to manufacture and sell certain goods under his trade mark. Now, if A were not to maintain quality control and / or supervision over the goods manufactured by either B or C or both, a situation could arise where the goods manufactured by Bare of poorer quality than those manufactured by C or vice versa or that the goods are generally not of the quality which is associated with A. Thus, in such a situation, confusion and/or deception would arise in the market place which could be harmful to the consumers. It is in order to prevent such harm from arising to a consumer that the licensor is required to maintain quality control and/ or supervision over his licensee so as to ensure that a “connection in the course of trade” remains between himself and his goods or services. This protects consumers who rely on the quality statement made by a trade-marked product from being misled as to the quality of the product.

Further, it may be appreciated that in such a case the public would associate goods sold under the trade mark as emanating from A or in any event, as indicating that all the goods sold under the said trade mark since they emanate from a single source as being of identical quality, but since no effective control is being maintained by A i.e., the proprietor of the trade  mark,  this would  result  in the trade mark not being able to perform  one of its essential r    functions.  Consequently,   the  rights  in the  trade mark  would  get diluted/  diminished  as the trade mark would  no longer indicate  a connection  in the course   of  trade  or  provide   the  assurance   of consistent  quality.  Thus, it could be urged  that the licensor   has  abandoned    his  trade   mark  and therefore,  the trade mark is no longer distinctive  of his goods and hence, may be rectified and/or removed from the Register of Trade Marks.

Quality control must not be understood to mean that the goods or services must be of a high quality but that they must be of a consistent quality, since that is the assurance which a consumer relies on whilst availing himself of a particular trade-marked product or service.

It may also be noted that US Courts have constantly found that licensing without quality control or naked licensing is “a fraud on the public and unlawful”12 and “is inherently deceptive and constitutes an abandonment of all rights in the trade mark and results in cancellation of its registration.”13 Even in U.K., Courts have held that the grant of a bare licence (i.e., a licence without quality control) could result in the proprietor losing his rights in and to the trade mark.

The Act also empowers the Registrar of Trade Marks in this regard to vary or cancel the registration of a registered user on the ground that any stipulation in the agreement between the registered proprietor and the registered user regarding the quality of the goods or services in relation to which the trade mark is to be used is either not being enforced or complied with.14 This power may be exercised even suo mota by the Registrar.

Hence, it is urged that uncontrolled licensing or licensing without quality control also known as naked licensing (USA) or bare licensing (U.K.) can have negative effects on the licensor’s rights in and to the trade mark.

The Scandecor Judgment

It may be appreciated that Courts normally apply a per se rule to cases where absence of quality control is pleaded, that is, once a case is made out of absence of quality control, it is assumed that the trade mark has been abandoned and/or that the trade mark owner ceases to control the trade mark and hence, the same must be rectified and/or removed form the Register of Trade Marks. Thus, whilst applying a per se rule no further factual inquiry is necessary to establish whether the trade mark has actually been abandoned or whether it has lost its distinctiveness after the absence of quality control has been established.

A different view, however, has been taken by the House of Lords in the U.K. in the case of Scandecor Development AB v. Scandecor Marketing AB et al.15 The House of Lords, in the instant case, was dealing solely with use by an exclusive licensee and held in this regard that it was no longer appropriate to apply the per se rule, but that it would be more beneficial to adopt case by case analysis in such matters. Their Lordships held that customers do not rely on a legal guarantee of quality assurance, but rather on the trade mark owner’s economic interest in protecting his trade mark and hence, in the event of absence of quality control by the proprietor of the trade mark, a further enquiry should be made to determine whether or not the trade mark has actually been abandoned and / or lost its distinctiveness. It may be noted that the House of Lords does not hold that quality control is not necessary, but only holds that mere lack of it should not result in a presumptive finding of abandonment and that a further inquiry would be necessary in such case. Also it may be noted that the said judgment only dealt with the case of an exclusive licensee.

In light of the above, it must be appreciated that if effective quality control is not maintained by the licensor, adverse consequences as regards the distinctiveness of the trade mark would follow. Uncontrolled or naked licensing may result in the trade mark ceasing to function as a symbol of quality and may be deemed to be abandoned16 thus, possibly depriving a proprietor of his rights in and to the trade mark.

Developing a trade mark is an expensive and time-consuming process and a proprietor must be extremely weary of losing out on his reputation and goodwill on account of not maintaining the necessary control over a licensee as required by law.

Therefore, it is extremely important to maintain and exercise proper quality control and supervision over a licensee so as to ensure that the proprietor’s rights in and to his trade mark are not diluted nor deemed to be abandoned.

1 J. Gilson,Trademark Protection and Practice,Section6-3 (1984).
2 Scandecor Development AB v. Scandecor Marketing et al [2002] F.S.R. 122.
3 Law of Trade Marks by L. B. Sebastian (Fifth Edition), J. Thomas McCarthy, McCarthy on Trademarks and Unfair Competition.
4 Trade Mark Licensing (Second Edition) by Neil J. Wilkof and Daniel Burkitt.
S Trademark and Unfair Competition Law by J. C. Ginsburg, J. Litman and M.L. Kevlin.
6 Law of Trade Marks by L. B. Sebastian (Fifth Edition).
7 Section 2(1)(zb) of the Trade Marks Act, 1999.
8 J. Thomas McCarthy, McCarthy on Trademarks and Unfair Competition § 3:8.
9 J. Thomas McCarthy, McCarthy on Trademarks and Unfair Competition. § 3:9, 3:10, 18:42.
10 K. R. Jadayappa Mudaliar v. K. B. Venkatachalam (1990) 105 Mad. LW 720, also quoted in Fatima Tile Works v. Sudarshan Trading Co., AIR 1992 Mad. 12
11 Gujarat Bottling Co. v. Coca Cola Company, AIR 1995 SC 2372.
12 Societe Comptoir de L’Industrie Cotonniere Etablissements
Boussac v. Alexander’s Dep’t Stores, Inc. 299 F.2d 33.
13 Barcamerica Intern. USA Trust v. Tyfield Importers Inc. 289 F.3d589.
14. Section50 of the Trade Marks Act, 1999
15. [2002]F.S.R.122
16 Poole v. Kit Mfg. Co., 184 lJ.S.P.Q. 302; Stanfield v. Osborne Industries, Inc., 52 F.3d 867.

Trade mark Law: ‘Parody’

IPR LAWS

An interesting debate arises in light of the recent
controversy between the Tata Group and Greenpeace, India (‘Greenpeace’). The
facts leading to the controversy and a recent judgment of the Delhi High Court
were that Greenpeace, a non-profit organisation that seeks to promote
environmental causes, had started a campaign protesting the building of a port
in the Bhadruk District in Orissa. It was Greenpeace’s view, that the building
of the port would dishouse the Olive Ridley turtles found in the area as also
disturb the marine life in the vicinity. The Tata Group resisted the said
campaigning and asserted that they had already secured all necessary approvals
and permissions. Hence, in order to raise awareness about the plight of the
turtles, Greenpeace India, inter alia, hosted a game on their website known as
‘Turtle v. Tata1.’ The game is a pac man style game wherein
the role of the pac man is portrayed by a turtle and the demons are the symbol
of Tata chasing the turtle. It was in this context that Tata filed a claim in
the Delhi High Court on two grounds, firstly that the acts of Greenpeace were
defamatory in nature; and secondly, that by using the name Tata and the symbol
of Tata, Greenpeace had infringed the registered trade marks of Tata.

For the purposes of the present article, we are concerned
only with the second aspect of the claim, i.e., trade mark infringement and
whether such ‘parodic’ use of a trade mark would amount to infringement thereof.
The issue is a delicate one since it involves the balancing of two competing
private rights as also two competing public interests. The private rights are
obvious, one being the right to free speech and the other being the right in
property of the trade mark owner. The public interests, though may not be
evident immediately, do exist. The right to free speech is a fundamental right
guaranteed to every citizen under Article 19 of the Constitution of India, and
it is imperative in public interest that this fundamental right is not
restricted except to the limited extent as envisaged under the said Article
itself. On the other hand trade mark law apart from protecting the rights of an
individual in his property, does a more important function that of preventing
public confusion. Trade mark law seeks to protect the general public from the
confusion that may arise in case identical and/or deceptively similar marks are
used by different traders upon their goods in the market. Such confusion, if not
protected against, could lead to disastrous consequences — for example, where a
medicine for lowering blood pressure and a medicine for increasing blood
pressure are sold under identical and/or deceptively similar trade marks. Public
confusion in such a case could even be fatal.

It is in light of the above, that I propose to examine the
law relating to use of trade marks in parodies and to what extent can a
citizen’s right to free speech be extended, can it be allowed even if it
violates someone else’s property rights or must it be curtailed as being a
reasonable restriction and/or to put it differently does a trade mark
registration prevent all further usage of the trade mark by any other person.

In order to examine this issue, reference may be made to
Article 19 of the Constitution of India and section 29 of the Trade marks Act,
1999, each of which, inter alia, provide as under:

Constitution :

“19. Protection of certain rights regarding freedom of
speech, etc.


(1) All citizens shall have the right

(a) to freedom of speech and expression;

(b) – (g) xxxxxx

(2) Nothing in sub-clause (a) of clause (1) shall affect
the operation of any existing law, or prevent the State from making any law,
in-so-far as such law imposes reasonable restrictions on the exercise of the
right conferred by the said sub-clause in the interests of the sovereignty
and integrity of India, the security of the State, friendly relations with
foreign States, public order, decency or morality or in relation to contempt
of court, defamation or incitement to an offence.”



Trade marks Act, 1999:

“29. Infringement of registered trade marks. —


(1) A registered trade mark is infringed by a person who,
not being a registered proprietor or a person using by way of permitted use,
uses in the course of trade, a mark which is identical with, or deceptively
similar to, the trade mark in relation to goods or services in respect of
which the trade mark is registered, and in such manner as to render the use
of the mark likely to be taken as being used as a trade mark.

(4) A registered trade mark is infringed by
a person who, not being a registered proprietor or a person using by way of
permitted use, uses in the course of trade, a mark which —

(a) is identical with or similar to the registered
trade mark; and

(b) is used in relation to goods or services which are
not similar to those for which the trade mark is registered; and

(c) the registered trade mark has a reputation in India
and the use of the mark without due cause, takes unfair advantage of or is
detrimental to, the distinctive character or repute of the registered
trade mark.”



A bare reading of section 29 would show that use of a
registered trade mark as a trade mark by any person other than the registered
proprietor of a trade mark without the consent of the owner would amount to an
infringement thereof. Hence, in the instant case, it was argued by the Tata
Group that use of their registered trade mark and symbol by Greenpeace was in
violation of their rights and amounted to infringement of registered trade
marks. Greenpeace took the defence that the use of the trade marks was merely in
a parodic sense and not for any other purpose. Greenpeace urged that the use of
a trade mark in a parody would fall within section 29(4) of the Trade marks Act,
1999 and hence, would not amount to an infringement. Greenpeace contended that
their use was not ‘without due cause’ and hence, they had not infringed the
registered trade marks.

At this juncture, before alluding to the ratio decidendi of
the Delhi High Court in the above matter, I would like to, as a background,
explain what is a parody and draw attention to a few judgments of the American
Courts, wherein the issue of use of a trade mark in a parodic sense has been
considered and dealt with.

It may be appreciated that in the USA the right to freedom of speech guaranteed under the First Amendment to the American Constitution is absolute as compared to the conditional right to freedom of speech granted under the Indian Constitution2. Hence, the considerations weighing with the American Courts vis-à-vis the freedom of speech would not be entirely analogous.

A parody as defined by Wikipedia is “is a work created to mock, comment on, or make fun at an original work, its subject, author, style, or some other target, by means of humorous, satiric or ironic imitation.3”

The Second Circuit has in the case of Cliff Notes Inc. v. Bantam Doubleday Dell Publishing Group Inc.4 succinctly explained the purpose of a parody as being “A parody must convey two simultaneous and contradictory messages: that it is the original but also that it is not the original and is instead a parody.” The Second Circuit also pointed out that if a parody which only performed the first function, it would be subject to trade mark law since it could lead to consumer confusion. The Court held that the principal issue that ought to be decided in such a case was how to strike a balance between the two competing considerations of allowing artistic expression and preventing consumer confusion.

Music International5, the Ninth Circuit dealt with a claim by Mattel for the use of its trade mark ‘Barbie’ by the music group Aqua in their song entitled ‘Barbie Girl.’ The lyrics of the song made references to the trade mark ‘Barbie’ and it was this use of the trade mark ‘Barbie’ which was considered, inter alia, an infringement by Mattel. The Ninth Circuit, after considering the manner of use and the nature of the use of the trade mark in the song, held that there was no infringement. The Ninth Circuit made several interesting observations with respect to the conflict between the rights granted under the First Amendment (right to free speech) and to the rights of a trade mark owner. The Ninth Circuit observed, inter alia, as under:

“The First Amendment may offer little protection for a competitor who labels its commercial goods with a confusingly similar mark, but trade mark rights do not entitle the owner to quash an unauthorised use of the mark by another who is communicating ideas or expressing points of view. Were we to ignore the expressive value that some marks assume, trade mark rights would grow to encroach upon the zone protected by the First Amendment. When unauthorised use of another’s mark is part of a communicative message and not a source identifier, the First Amendment is implicated in opposition to the trade mark right. Simply put, the trade mark owner does not have the right to control public discourse whenever the public imbues his mark with a meaning beyond its source identifying function. It is the source identifying function which trade mark law protects, and nothing more.”

The Ninth Circuit, in order to adjudicate the dis-pute, applied the test as to whether the use of the trade mark was misleading to the source or content of the work or did it have artistic relevance to the underlying work. The Court held that the use of ‘Barbie’ by the defendants was not misleading as to the source and hence, no case for infringement was made out.

One more    interesting judgment of the American Courts in this regard is the case of Mutual of Omaha Insurance Co. v. Novak6 wherein the alleged infringing acts were the use by Novak of the trade marks of Mutual of Omaha Insurance Co. on T-shirts. The registered trade mark of the Mutual of Omaha Co. was ‘Mutual of Omaha’, used in respect of its insurance services. Novak started using a similar design with the trade mark ‘Mutant of Omaha’ and a sign below that which read as ‘Nuclear Holocaust Insurance.’ In this case, the defence of parodic use was negated by the majority on the grounds that the protection af-forded by the First Amendment does not give a licence to infringe someone else’s property rights; and that since there were several other avenues of communication available to Novak, such as an editorial parody in a book, magazine or film, such use in violation of the rights of Mutual of Omaha Insurance Co. must be injuncted. Justice Heaney, however, dissented and considered that the majority judgment had failed to recognise and protect the rights of Novak under the First Amendment.

In India, on the other hand, there have not been too many judicial pronouncements on parody as a defence in a trade mark infringement action. One of the few earlier judgments is in the case of Pepsico Inc v. Hindustan Coca Cola Ltd.7, wherein the Delhi High Court recognised in passing that a parody would not be an infringement and held that, “Similarly, use of the phrase in the commer-cial advertisement “Yeh Dil Mange No More” can at best be mocking or parodying in the context it is used, but does not amount to infringement of trade mark of the appellant.”

However, now Justice Ravindra Bhat has in his judgment in Tata Sons Ltd. v. Greenpeace 8 dealt with and discussed the subject of parodies in some detail. Justice Bhat based his judgment primarily on the judgment of the South African Constitutional Court in case of Laugh It off Promotions CC v. Freedom of Expression Institute9, which was a case where the Defendant had sought to market T-shirts bearing parodied images of trade marks of several corporate giants. This was objected to by South African Breweries, one of the corporate giants whose trade marks had been parodied upon on the defendant’s T-shirts. It was in these facts that the Court was pleased to hold as under:

“76. Parody is inherently paradoxical. Good parody is both original and parasitic, simultaneously creative and derivative. The relationship between the trade mark and the parody is that if the parody does not take enough from the original trade mark, the audience will not be able to recognise the trade mark and therefore, not be able to understand the humour. Conversely, if the parody takes too much it could be considered infringing based upon the fact that there is too much theft and too little originality, regardless of how funny the parody is.

    Parody is appropriation and imitation, but of a kind involving a deliberate dislocation. Above all, parody presumes the authority and currency of the object work or form. It keeps the image of the original in the eye of the beholder and relies on the ability of the audience to recognise, with whatever degree of precision, the parodied work or text, and to interpret or ‘decode’ the allusion; in this sense the audience shares in a variety of ways the creation of the parody with the parodist. Unlike the plagiarist whose intention is to deceive, the parodist relies on the audience’s awareness of the target work or genre; in turn, the complicity of the audience is a sine qua non of its enjoyment.

    The question to be asked is whether, looking at the facts as a whole, and analysing them in their specific context, an independent observer who is sensitive to both the free speech values of the Constitution and the property protection objectives of trade mark law, would say that the harm done by the parody to the property interests of the trade mark owner outweighs the free speech interests involved. The balancing of interests must be based on the evidence on record, supplemented by such knowledge of how the world works as every judge may be presumed to have. Furthermore, although the parody will be evaluated in the austere atmosphere of the Court, the text concerned (whether visual or verbal or both) should be analysed in terms of its significance and impact it had (or was likely to have), in the actual setting in which it was communicated.

    It seems to me that what is in issue is not the limitation of a right, but the balancing of competing rights. The present case does not require us to make any determinations on that matter. But it would appear once all the relevant facts are established, it should not make any difference in principle whether the case is seen as a property rights limitation on free speech, or a free speech limitation on property rights. At the end of the day this will be an area where nuanced and proportionate balancing in a context specific and fact-sensitive character will be decisive, and not formal classification based on bright lines.

In sum, while a defendant’s use of a parody as a mark does not support a ‘fair se’ defence, it may be considered in determining whether the Plaintiff-owner of a famous mark has proved its claim that the defendant’s use of a parody mark is likely to impair the distinctiveness of the famous mark.”

It was based on the above reasoning and in light of the facts that Justice Bhat was pleased to hold that Greenpeace’s actions did not amount to an infringement and held, inter alia, as under:

“42. The above analysis would show that the use of a trade mark, as the object of a critical comment, or even attack, does not necessarily result in infringement. Sometimes the same mark may be used, as in Esso; sometimes it may be a parody (like in Laugh it Off and Louis Vuitton). If the user’s intention is to focus on some activity of the trade mark owners, and is ‘denominative’, drawing attention of the reader or viewer to the activity, such use can prima facie constitute ‘due cause’ u/s.29(4), which would disentitle the Plaintiff to a temporary injunction, as in this case. The use of TATA, and the `T’ device or logo, is clearly denominative. Similarly, describing the Tatas as having demonic attributes is hyperbolic and parodic. Through the medium of the game, the defendants seek to convey their concern and criticism of the project and its perceived impact on the turtles habitat. The Court cannot annoint itself as a literary critic, to judge the efficacy of use of such medium, nor can it don the robes of a censor. It merely patrols the boundaries of free speech, and in exceptional cases, issues injunctions by applying Bonnard principle.”

I firmly believe that Justice Bhat’s judgment is a step forward in the right direction. However, each case would have to be judged on its own merits. A perusal of the above judgments reveals as to how Courts have so far sought to balance the two competing interests in cases of parodies involving registered trade marks. In my opinion, this is a very sensitive matter and the line of distinction very fine between the two competing public interests. Courts will need to exercise their judicial discretion in every case to determine whether the use of a trade mark in a parody is promoting public interest in terms of establishing free speech or would it be reasonable to restrict the same since it is in fact harming public interest by causing public confusion as also violating the rights of an individual trade mark owner.

One cannot overemphasise the importance and relevance of the present issue, since it involves a balancing act between two competing public interests and not just private interests. Admittedly, the case when filed by a trade mark owner would be to protect his own private interest in property but the underlying fact is that Courts will be called upon to consider and/or must consider the public interests involved. The freedom of speech as against the disastrous consequences which could arise out of public confusion need to be assessed and balanced in each case. Hence, it is essential that an effective rule and/or law is developed to guide the Courts in such matters. An official recognition to parodies would also be beneficial. The Copyright Act, 1957 does protect work published for the purpose of fair comment and criticism. I think it would be advisable to introduce a suitably moulded provision in the Trade marks Act, 1999 as well.

Infringement vs. Passing – off

IPR Laws

This month’s article seeks to explain a fundamental aspect of
the law on trademarks, the distinction between an action for infringement of a
registered trademark and an action for passing off. Whilst the former is a
statutory wrong the latter is a tort under common law. This distinction is
crucial for any trademark owner to strategise the maintenance of their trademark
portfolios.

A trademark is a mark which connects the goods and/or
services of a person with that person in the course of trade and thereby
distinguishes it from the goods and/or services of others. The Trade Marks Act,
1999 (‘the Act’) more specifically defines a trademark, inter alia, as a mark
capable of being represented graphically and which is capable of distinguishing
the goods or services of one person from those of others.1 Therefore,
a mark in order to be a trademark need not necessarily be registered. A
trademark may also either be used or proposed to be used. These factors as to
whether a trademark is used and/or registered are factors relevant for
determining whether an action for infringement of trademark and/or an action for
passing off may be instituted.

I shall initially explain what is meant by infringement of a
registered trademark and passing off, respectively, and then proceed to deal
with the broad distinctions.

Infringement of Registered Trademark :

Chapter IV of the Act deals with the effect of registration
of a trademark. The Act specifically provides that no proceedings for
infringement of an unregistered trademark may be instituted thereby clarifying
that an action for infringement can only be taken in respect of a registered
trademark. In fact, a right granted on registration is the right to take
recourse to infringement proceedings.2 The Act also clarifies that an
action for passing off will not be affected by the Act.3

S. 29 of the Act deals with and identifies the acts that
would constitute infringement of a registered trademark. The Section seeks to
protect a registered trademark and/or a mark deceptively similar thereto from
being exploited and/or used by an unauthorised person so as to defeat the rights
of the registered proprietor of the trademark of being entitled to exclusively
use the registered trademark. The scope and ambit of acts constituting
infringement has been substantially broadened under the present Act by bringing
in concepts like dilution of trademark, erosion of distinctive character of the
trademark, parallel importation and damage to reputation, etc.

The statutory law relating to infringement of trade-marks is
based on the same fundamental idea as the law relating to passing off. But it
differs from that law in two particulars, namely, (1) it is concerned only with
one method of passing off, namely, the use of a trademark and (2) the statutory
protection is absolute in the sense that once a mark is shown to offend, the
user of it cannot escape by showing that by using something outside the actual
mark itself he has distinguished the goods from those of the registered
proprietor.4

In an infringement action, the plaintiff is, ordinarily, only
required to prove that the defendant is using the registered trademark and/or a
mark deceptively similar thereto in respect of the same goods or services cause
that would be enough to show a violation of the rights conferred on the
registered proprietor. Infringement consists in using the mark per se as a
trademark and therefore, any other distinguishing factors that may be employed
by a defendant may not be relevant in an infringement proceeding.

Any person trespassing on the rights conferred by
registration of a trademark infringes the registered trademark. The rights
conferred by registration in a particular case must be determined in the context
of any restrictive conditions or limitations entered on the Register of Trade
Marks at the time of registration of the mark.

Infringement proceedings, thus, enable a registered
proprietor to prevent any unauthorised person from using his trademark and/or
mark deceptively similar thereto in respect of similar goods or services or as
contemplated u/s.29 of the Act.

Passing off :

On the other hand, the object of the law of passing off is to
protect some form of property — usually the goodwill of the plaintiff in his
business or his goods or his services or in the work which he produces. The
trademark represents the reputation and goodwill of a business and/or the goods
and/or the services. For example, the goods sold by ‘Nike’ are considered to be
of superior quality and have an immense reputation in the market. The goods sold
under the trademark ‘Nike’ carry immense value on the basis of the fact that
they bear the ‘Nike’ trademark. If the same goods were sold without the said
trademark thereon, they would not be as valuable.

Passing off is a form of tort of deceit and/or
misrepresentation. To put it in a nutshell, passing off is a tort whereby one
person tries to pass off his goods and/or services as and for the goods and/or
services of another. Passing off in effect is also a form of unfair competition.
It is a common law remedy and has been built entirely on the basis of case law.

In Halsbury’s Laws of England, 4th Edn., Volume 48, para 144
at page 98, the essentials of the cause of action for passing off, as restated
by the House of Lords in Erven Warnink B. V. v. J. Townend & Sons, 1980 R.P.C.
31, are set out as follows :

“(1) a misrepresentation

(2) made by a trader in the course of trade

(3) to prospective customers of his or ultimate consumers
of goods or services supplied by him

(4) which is calculated to injure the business or goodwill
of another trader, in the sense that this is a reasonably foreseeable
consequence, and

(5) which causes actual damage to a business or goodwill of
the trader by whom the action is brought or, in a quia timet action, will
probably do so.”

The aforequoted dictum of Lord Diplock is the locus
classicus
on the subject and succinctly explains what is meant by the tort
of passing off.

Therefore, it may be noted that in order to enable the owner
of a trademark to sue for passing off, he would be required to show in the first
instance that the trademark is associated by members of the trade and public
solely and exclusively with the services rendered and/or goods sold by him and
that some other person by using an identical and/or deceptively similar mark in
respect of similar services and/or goods is trying to pass off his goods and/or
services as and for the goods and/or services of the owner. Confusion and
deception in the course of trade would be essential to an action in passing off.

It is common understanding that an action for passing off cannot be instituted in respect of an unused trademark, however the same is incorrect. For in a given situation passing off may even be instituted in respect of a trademark which has not been used in the market, but which has acquired reputation and goodwill on the basis of other factors such as publicity, advertisements, etc. and has therefore, come to be associated solely with the owner of the trademark.5

Distinction :

The distinction between an infringement action and a passing off action is important. As explained above, both operate in different spheres. Hence, to illustrate there could even be a situation where a registered proprietor (Plaintiff) files a suit for infringement and the defendant files a suit for passing off against the same plaintiff. This would happen in a case the defendant has a prior user of the trademark but a subsequent registration.

The issues involved in an action for infringement and an action for passing off are different and distinct. In an action for infringement the basic issue would generally be whether the registered trademark and the infringing mark are identical and/or deceptively similar and whether or not they are being used in respect of similar goods and/or services. However, in an action for passing off, in the first instance the plaintiff would have to show that the said trademark is associated solely and exclusively with his services and/or goods and that use by the defendant of such mark would cause confusion and/or deception in the course of trade and thereby people would end up buying and/or procuring the goods and/or services of the defendant thinking they were of the plaintiff. Such acts would cause wrongful loss and harm to the plaintiff.

The Supreme Court has succinctly highlighted major differences between the two remedies and the approaches involved in an action for infringement and an action for passing of in the landmark judgment of Ruston Hornsby v. Zamindara Engineering, AIR 1970 SC 1649, wherein it has laid down, inter alia, as under :

“It very often happens that although the defendant is not using the trademark of the plaintiff, the get-up of the defendant’s goods may be so much like the plaintiff’s that a clear case of passing off would be proved. It is on the contrary conceivable that although the defendant may be using the plaintiff’s mark, the get-up of the defendant’s goods may be so different from the get-up of the plaintiffs goods and the prices also may be so different that there would be no probability of deception of the public. Nevertheless, in an action on the trademark, that is to say, in an infringement action, an injunction would issue as soon as it is proved that the defendant is improperly using the plaintiff’s mark.

The action for infringement is a statutory right. . . . .
On the other hand the gist of a passing off action is that A is not entitled to represent his goods as the goods of B, but it is not necessary for B to prove that A did this knowingly or with any intent to deceive. It is enough that the get-up of B’s goods has become distinctive of them and that there is a probability of confusion between them and the goods of A. No case of actual deception, nor any actual damage need be proved.”

Another important factor of distinction is the fact that under the Act, a registered proprietor is granted an additional right to institute an action for infringement of trademark where the plaintiff’s office is situate. This provision was introduced to enable the registered proprietors take appropriate proceedings against infringers without having to follow them to every corner of the country. On the other hand, however, passing off being a common law remedy, the jurisdiction of a Court to take cognizance of the same would be in accordance with the normal rules of jurisdiction as laid down in the Code of Civil Procedure, 1908 and/or the relevant Letters Patent i.e., either where the defendant resides or carries on business or where the cause of action has arisen, etc.

To illustrate the above points of distinction, take a situation where a trader in pens is the registered proprietor of a trademark ‘KODAK’ (word per se) and has been using the same for the last decade on a yellow and red background in respect of his pens. The defendant is using the trademark ‘TODAT’ in respect of his pens on a white and green background. In such a case for the purposes of an infringement action the Court would only consider whether the trademarks KODAK and TODAT are identical and/ or deceptively similar, since the goods are identical. On the other hand, for the purposes of an action of passing off, the Court would have to consider the entirety of the package including the difference in colour schemes, nature of consumers, packaging, etc. and consider whether on an appraisal of the entire evidence it can be proved that the consumers would be confused and/or deceived into buying the pens of the defendant on the belief that they were somehow connected with the plaintiffs.

In the aforesaid illustration let us assume that the pens are sold by both traders on a red and yellow background but the trademarks involved are the registered trademark KODAK (word per se) and the unregistered trademark PILOT. In such a case even though the trademarks per se are different, an action in passing off may still lie if by colour scheme, packaging, trademark being written in small letters, etc. the consumer and general public would be confused and/or deceived into buying the defendants pens on the belief that they emanate from the plaintiff.

A perusal of the above would evince the fact that the two wrongs are different. Therefore, it is essential for owners of trademarks to understand that even if their trademark is not registered, they may still maintain an action in passing off. In fact, in a given case a trader who may not have used the trademark in the Indian market, but whose trademark has acquired a transborder reputation in India may maintain an action in passing off. A situation may also arise where even if a trademark is registered, use of the same may be restrained by a prior user of the trademark.

Therefore, there can be no general answer as to which proceeding is better and/or preferred and the course of action and must be determined on a case-by-case basis.

Copyright Law — The test of originality

“Thou shall not steal”

— The Ten Commandments

The Eighth Commandment of Christianity but the first of the copyright law. It is believed that the moral basis for copyright law derives its source from this Eighth Commandment1.

Copyright law deals with providing rights in respect of certain works which it recognises as being the intellectual creations of their authors and seeks to protect the rights of the authors and/or the owners in respect of such works. The reason why there is a need for the law of copyright has been succinctly explained by Chinappa Reddy J. in Gramophone Co. v. Birender Bahadur Pandey2, wherein he stated that :

“An artistic, literary or musical work is the brainchild of the author, the fruit of his labour and so, considered to be his property. So highly is it prized by all civilised nations that it is thought worthy of protection by national laws and international conventions.”

Copyright is a statutory right and exists only in the works which qualify for protection under the Copyright Act, 1957 (hereinafter referred to as ‘the Act’). Copyright grants to the owner and/or the author of a work a bundle of rights in respect of the work as are enumerated in S. 14 of the Act.

Relevant provisions of the Act :

    At the outset, it would be instructive to note what is meant by the term ‘work.’ As defined in S. 2(y) of the Act, a work means either a literary, dramatic, musical or artistic work or a cinematograph film or a sound recording. Thus, these are the works in respect of which copyright may subsist. It may be noted that each of these kinds of works are further defined and explained in the Interpretation Clause of the Act.

    However, not all literary or artistic works can claim to have copyright, but only those which comply with the requirement of S. 13 of the Act.

    S. 13 of the Act, inter alia, provides as under :

    “Works in which copyright subsist.

    (1) Subject to the provisions of this Section and other provisions of this Act, copyright shall subsist throughout India in the following classes of works, that is to say —

    (a) original literary, dramatic, musical and artistic works;

    (b) Cinematograph films; and

    (c) Sound recording.”

    In light of the above, it may be appreciated that a literary, dramatic, musical or artistic work to qualify for copyright protection must be original. Originality remains the sine qua non of copyright; accordingly, copyright protection may extend only to those components of a work that are original to the author3.

    It is in this scenario, that the question arises as to what is the standard of originality required to obtain copyright protection. This has been a vexed question over the years to which the Courts have applied different standards.

    At the outset, it may be appreciated that the said question has been recently considered by the Apex Court in Eastern Book Company v. D. B. Modak4 (hereinafter referred to as ‘the Eastern Book case’) wherein the Apex Court was dealing with the issue of copyright in the text of the copy-edited judgments of the Supreme Court as reported in the law report ‘Supreme Court Cases’ and whether the said copy-edited judgments were original literary works entitled to copyright protection. The Apex Court classified the copy-edited judgments as a form of secondary or derivative works, i.e., those literary works which are based on existing subject matter.

    It is in this context, that the tests to judge originality are being outlined, as have been applied over the years and as are identified in the Eastern Book Case and what is the test to be applied to judge originality now, has been laid down by the Supreme Court.

Sweat of the brow :

    The first test identified before the Supreme Court with respect to identifying which works are capable of copyright protection was the ‘sweat of the brow’ or the ‘industriousness approach’ test. A plethora of judgments were cited in support of this theory by the petitioners, i.e., the Eastern Book Company to support the proposition that copyright does subsist in the copy-edited text of judgments of the Supreme Court. This approach is based on the proposition that a work that has originated from the author, is more than a mere copy of the original work, would be sufficient to generate copyright5. The underlying notion being to reward the hard work that goes into the creation of the work6.

    The United States Supreme Court in the Feist Case7 observed that the classic formulation of the sweat of the brow theory is to be found in the following passage from Jeweler’s Circular Publishing Co.

    “The right to copyright a book upon which one has expended labour in its preparation does not depend upon whether the materials which he has collected consist or not of matters which are publici juris, or whether such materials show literary skill or originality, either in thought or in language, or anything more than industrious collection.”

    Thus, all that was required under this approach was to examine whether any skill, labour and capital had been expended in the creation of the work and that it was not a copy of another work. Once these two criteria were satisfied the work would be entitled to copyright protection.

Creativity standard/non-obviousness:

The other test identified by the Apex Court in the Eastern Book case is the creativity standard or the non-obviousness standard whereby a Court would be called upon to inquire whether the work possesses a certain degree of creativity and non-obviousness and is therefore novel so as to be entitled to copyright protection.8 This approach, however, seems to raise the bar of originality to an extremely high level, which is more befitting of patent law rather than copyright law.

Skill and judgment test:

In light of the said divergent approaches, the Supreme Court in the Eastern Book 9 case, after analysing, inter alia, the United States Supreme Court’s judgment in Feist Publications Inc. v. Rural Telephone Seroices10 and the Canadian Supreme Court’s judgment in CCH Canadian Ltd. v. Law Society of Upper Canada11 has propounded a middle path, consistent with the view of the Canadian Supreme Court, to judging originality which is not as low as the sweat of the brow standard, nor as high as the creativity standard. The Apex Court held that,

“Thus, the Canadian Supreme Court is of the view that to claim copyright in a compilation, the author must produce a material with exercise of his skill and judgment which may not be creativity in the sense that it is not novel or non-obvious, but at the sametime it is not the product of merely labour and capital.12”

Thus, according to the Supreme Court the test for judging originality would be to enquire whether the work has been created by skill and judgment and has the flavour of the minimum requirement of creativity. The work should not be produced merely by labour and capital but by skill and judgment and must have a minimal degree of creativity. Applying this test the Supreme Court in the instant case, held that the copy-edited judgments did not touch the standard of creativity required for copyright.”

Conclusion:
There was a need to reconsider the tests to be applied since, by applying the sweat of the brow test, Courts were recognising copyright in almost every work. Therefore, a slightly higher standard was required, for in essence, copyright being a part of intellectual property laws seeks to protect the intellectual creations and inputs and not every input. Hence, to that extent replacing of the words ‘skill, labour and capital’ with ‘skill and judgment’ seems to denote a paradigm shift from mere physical or mechanical exercise to a more mental exercise.

However, the test raises several new questions such as what is the minimum level of creativity that is now to be found to show that a work is copyrightable? what exactly is meant by the words skill and judgment, etc. ? The Courts will have to evolve further sub-rules or sub-tests to fortify and clarify the ‘skill and judgment’ test laid down by the Apex Court.

To highlight the Apex Court’s own interpretation of this test, it may be noted that the Apex Court held that the copy-edited judgments did not meet the standard of creativity and hence, were not capable of copyright creation. However, the Apex Court also held that the inputs of segregating paragraphs and numbering them as also indicating which judges have concurred and/or dissented were copy-rightable as these changes required the input of skill and judgment and they had a flavour of a minimum amount of creativity.

However, the Apex Court may want to reconsider some of its findings such as, for example, its finding that insertion of details as to consenting and dissenting judges has a minimum amount of creativity and that copyright would subsist in the same. For in such a case, the creativity could at the most be said to lie in the idea to identify and alter the text of the judgment to show where a judge has dissented or concurred, whereas the expression thereof is in terms of phrases commonly used such as ‘concurring’ or ‘partly concurring’, etc. It is well-settled law as has been laid down since 1978, by the Apex Court in R. G. Anand v. Delux Films14 that copyright only exists in the expression and not in the idea. Therefore, my view would be that the phrases used i.e., the expression of the idea are standard phrases used commonly, which subject to other factors such as whether a word or two words can be a literary work in itself or even qualify as a derivative work, cannot be said to possess any level of creativity and cannot be copyrighted by anyone person.

The phrases ‘concurring’ and/or ‘partly concuring’, etc. would not, despite the possibility of a high level of skill and judgment in deciding where to insert these phrases, meet the test of the minimum amount of creativity, as in judging the originality of a work what must be looked at is the expression and not the idea.

Thus, to conclude, I would submit that the test as laid down is a positive step forward and was required to raise the standard beyond the mere sweat of the brow test. However, it is essential that Courts interpret it in the true sense by applying all the factors involved as have been identified by the Canadian Supreme Court and not in the manner as interpreted by our Apex Court primarily identifying only skill and judgment. In order to enable to the new approach to work effectively, the creases will need to be ironed out.

1 Lord Atkinson in Macmillan v. Cooper (1924) 40 TLR 186
2 AIR 1984 SC 667
3 Feist Publications Inc. v. Rural Telephone Service, 499 V.S. 340
4 2008 (36) PTC 1
5 Eastern Book Company v. D. B. Modak, 2008 (36) PTC 1
6 Feist Publications Inc. v. Rural Telephone Service, 499 U.S. 340
7 499 U.S. 340
8 Eastern Book Company v. D. B. Modak, 2008 (36) PTC 1
9 2008 (36) PTC 1
10 499 U.S. 340
11 .2004 (1) SCR 339 (Canada)
12 Eastern Book Company v. D. B. Modak, 2008 (36) PTC 1
13 Eastern Book Company v. D. B. Modak, 2008 (36) PTC 1
14  AIR 1978 se 1613

ORDERS OF CIC/SICs

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Part A : ORDERS OF CIC/SICs


 

 
S. 2(h) of the RTI Act — Public Authority :


Different High Courts in a number of cases have decided
whether a particular body or institution is a Public Authority or not u/s.2(h)
of the Act. Hereunder are listed some of the decisions :

l
Decision of the High Court of Karnataka :


Textile Co-operative Bank is provided aid or assistance by
the State Government for the benefit of the weavers, who may be members of the
Bank in respect of loans availed by them. On these facts, it could not be held
that the said aid or assistance is provided to the Bank. Accordingly, the Bank
is not a non-Government organisation substantially financed by the State
Government. Hence, it is not covered under clause (d)(ii) of S. 2(h), and is not
a Public Authority. [Textile Co-op. Bank Ltd. v. the Karnataka Information
Commission & Others,
W.P. No. 20004 of 2007 (GM-RES) and C.W.P. No. 18599 of 2007 (GM-RES) decided on
17-2-2010, (2010 (1) ID 521)]

l Single
Bench decision of Bombay High Court :


There is no direct or indirect control by the State
Government over the affairs of Dr. Panjabrao Deshmukh Urban Co-operative Bank
Ltd. The control was not deep or pervasive.

Hence the said Bank was not covered within the meaning of S.
2(h) of the RTI Act. [AIR 2009 Bombay 75, (2009 (2) ID 156)]

l
Division Bench decision of Punjab & Haryana High Court :


The Court held “A perusal of the definition of ‘public
authority’ shows that ‘public authority’ would mean any authority or body or
institution established or constituted apart from other things by the
Notification issued by an order made by the appropriate Government. It is to
include even any body owned, controlled or substantially financed or
non-Government Organisation substantially financed directly or indirectly by the
funds provided by the appropriate Government. It is undisputed that the
petitioners are receiving substantially grant-in-aid from the Chandigarh
Administration. Once a body is substantially financed by the Government, the
functions of such body partake the character of ‘public authority’. The
petitioner has claimed that they are getting only 45% grant-in-aid after
admitting that initially the grant-in-aid paid to them was to the extent of 95%.
If on account of policy of the Government the grant-in-aid to the extent of 95%
which was given initially allowing the petitioner to build up its own
infrastructure and reducing the grant-in-aid later would not result into an
argument that no substantial grant-in-aid is received and therefore it could not
be regarded as ‘public authority’. Therefore, the Court did not find any
substance in the stand taken by the petitioner that it is not a ‘public
authority’ “

[D.A.V. College Trust & Management Society & Ors. v.
Director of Public Instruction & Ors.,
AIR 2008 (Pb& Hry.) 117; (2008 (2) ID
382)]

l
Single Bench decision of High Court of Allahabad :

The question for consideration was whether the petitioner,
which is a Girls High School, recognised and receiving grant-in-aid from the
State Government, is a ‘public authority’ as defined u/s.2(h) of the RTI Act.

The Court held as follows : “In my opinion, whenever there is
even an iota of nexus regarding control and finance of public authority over the
activity of a private body or institution or an organisation, etc. the same
would fall under the provisions of S. 2(h) of the Act. The provisions of the Act
have to be read in consonance and in harmony with its objects and reasons given
in the Act which have to be given widest meaning in order to ensure that
unscrupulous persons do not get benefits of concealment of their illegal
activities or illegal acts by being exempted under the Act and are able to hide
everything from the public. The working of any such organisation or institution
of any such private body owned or under control of public authority shall be
amenable to the Right to Information Act. The petitioner being an institution
recognised under the provisions of the U.P. High School and Intermediate
Education Act, 1929 and receiving grant-in-aid from the State Government is
therefore, covered under the aforesaid Act.”

[Dhara Singh Girls High School Ghaziabad v. State of Utta
Pradesh & Ors.,
AIR 2008 Allahabad 92; (2008 (2) ID 179)]

l
The High Court of Orissa :


The Court was considering the case of Southern Electricity
Supply Company of Orissa Ltd. (the Company) which is a subsidiary of Grid
Organisation of Orissa Ltd. (GRIDCO) which is a wholly-owned Government Company.
Submission of the Company was that it is a public limited company and hence it
is not a ‘public authority’ as defined in S. 2(h) of the RTI Act. The Court held
that u/s.2(h) even non-Government organisation substantially financed directly
or indirectly by the funds provided by the appropriate Government would come
within the ambit of Public Authority. Admittedly the petitioner company is a
subsidiary of GRIDCO, wholly-owned Government Company, it is governed by the
different rules and regulations framed by the State Government, the rate of
tariff is regulated by the Orissa Electricity Reforms Act. Moreover, this
distribution company, and three similar other companies, are discharging
governmental function of distribution and supply of electricity to the people of
the State, which is an essential public duty.

All these go to show that the State Government has a deep and
pervasive control over the petitioner company and such control is not mere
regulatory. In view of the above, the Court came to the conclusion that the said
company falls within the definition of Public Authority as defined u/s. 2(h) of
the RTI Act. [Southern Electricity Supply Company of Orissa Ltd v. State of
Orissa and Others,
W.P.(C) No. 8698 of 2006 decided on 9-12-2009; (2010 (1)
ID 524)]

 
S. 2(f) — ‘Information’ :


The writ petitioners, The Institute of Chartered Accountants of India (ICAI), claim to be aggrieved by an order of the Central Information Commission (CIC), dated 23-12-2008 to the extent that the Commission directed disclosure of the applicant complainant’s answer sheet to the information applicant. The applicant had elicited various kinds of information, including a copy of the answer sheet of the examination attempted by him. The Assistant Solicitor General who appeared on behalf of ICAI contended that the question as to the right to information and the right of the class of individuals who attempt examinations to access their answer sheets is squarely covered by the rulings of the Supreme Court in Secretary, West Bengal Council for Higher Secondary Education v. Ayan Das, [2007 (8) SCC 242] and President, Board of Secondary Education, Orissa & Anr. v. D. Suvankar & Anr., [2007 (1) SCC 603].

The argument was that the interpretation placed by the Supreme Court unalterably fixed the character of the right, in the sense that the declarations exclude the right of a candidate participating in the examination process to access information about the examination process by demanding copies of answer sheets. The subsidiary argument made by the ASG was that the right to seek answer sheets, if at all, could be claimed as part of Article 19(1)(a) of the Constitution and since the Supreme Court excluded that possibility, having regard to the objects of the RTI Act, i.e., effectuation of provisions of the right to freedom of expression and information, the possibility of accessing such class of information stands excluded from the right to freedom of expression.

The Court stated that under the scheme of the enactment, all classes of information except those which are explicitly exempted from disclosure u/s.8 have to be revealed. The exemption regime is itself broad and covers various diverse matters, including commercial information, trade secrets and so on. The information authorities set up under the enactment are empowered by S. 10 to sever such information which should not be disclosed from such class of information. The Court then stated as under : “The argument of the petitioner that since the Supreme Court declared the law in such matters, and that candidates who seek copies of answer sheet cannot claim it as a matter of right, is unpersuasive.”

The Supreme Court’s decisions were similar in both the instances; in Ayan Das case and D. Suvankar case, the context was wide directions by the High Court, requiring revaluation/re-verification (in the Suvankar case) and direction to reassess through another examiner in Ayan Das’s case. There is no discussion or mention of the RTI Act. Concededly, the judgments were not examining information application under the RTI Act. Yet, a close scrutiny of the facts mentioned in both the judgments reveals that the claims were not premised on any of the provisions of the enactment. Apparently, they were in the context of writ petitions filed before the High Court. The judgments, therefore, have to be read in their terms, and in the contextual setting. There is no gain saying that the judgments of the Supreme Court on an issue constitute law declared under Article 141 of the Constitution. Yet, the judgments are in the context of what is declared and what is not declared.

The ‘unarticulated’ argument of no right under Article 19(1)(a) by the learned ASG cannot, therefore, be accepted. Doing so would mean that this Court would be reading into the two judgments on the intention to overbear the provisions of the RTI Act; a result too startling to accept. As regards the second contention that since the Supreme Court held that there is no right to claim disclosure of answer sheets or copies, and the same is not part of the Right to Freedom of Expression and, therefore, implicitly excluded from the RTI Act; this contention too cannot be accepted.

The mere fact that the statement of objects of, or the long title to the RTI Act mentions that it is a practical regime of the right to information for citizens, would not mean that a cribbed interpretation has to be placed on its provisions, on the same notion of implicit exclusion of that which would legitimately fall within Article 19(1)(a). No rule of interpretation or judgment of the Supreme Court was discussed or relied on the point that the ruling in Suvankar’s case excluded the right to access answer sheets, which would otherwise fall within the expression and, therefore, would fall within the purview of the RTI Act.

The interpretation canvassed would lead to startling consequences when in the absence of enacted law under Article 19(2), the Court would be legislating, as it were, without the possibility of such exclusion being tested in Courts. A salutary rule of interpreting the Constitution is that fundamental rights should be construed broadly, to enable citizens to enjoy them [Ahmedabad St. Xavier’s College Society v. State of Gujarat, (1974) (1) SCC 717]; Dr. Pradeep Jain v. Union of India, (1984) (3) SCC 654]. In any event, the Act confers positive rights which can be enforced through its mechanism.

This Court should be extremely slow in interpreting such rights, dealing with personal liberties and freedoms on the basis of some inarticulate premise of a judgment. For the above reasons the Delhi High Court dismissed the writ petition and held the same to be misconceived.

[ICAI v. Central Information Commission & Anr., W.P. (C) 8529/2009 decided on 30-4-2009; (2010 (1) ID 587)]

                                                         PART B : THE RTI ACT 2005

5th CIC Annual Convention, 2010:

Central Information Commission held a 5th Annual Convention, 2010 on 13th and 14th September 2010 at DRDO Bhavan, New Delhi. I was invited by the Commission to attend the same and have actively participated there. Sessions were very well conducted and provided a tlot of information on the development of RTI in India and the road ahead. Theme of the Convention was: ‘RTI: Challenges and Opportunities’. In coming few issues, I shall provide details thereof. To start with, I reproduce the keynote remarks of Shri Gopalkrishna Gandhi at the inaugural session, some being the highlight of the Convention:

After the IPC, the FIR and PIL, the best known three-letter acronym in Indian Governance is RTI. I think it has overtaken the others in frequency of use outside the agencies of law enforcement. And it engenders as much awe as IPC, FIR and PIL. It also generates, as PIL does, but even more so, two reactions : The first is admiration amongst its users or potential users. Ki aisaa ek baraa hathiyaar hamaare haathon mein aayaa hai.

The second is apprehension amongst those it targets or is likely to target. Ki humen dhake huaa pardaa ab khul gayaa hai. The first reaction, the reaction of admiration, is a good and wholesome reaction. Kyuunki qaanuun barhiyaa hai, bahaadur hai, har pradesh mein laguu ho gayaa hai.

RTI Act ab jan chukaa hai. Aaj uskii pehchaan hai, shaharon mein hi nahiin, chhote nagaron aur dehaat mein bhii. Haalaanki kuchh pradeshon mein vah mazbuti se aage barha hai aur kuchh aur pradeshon mein ab bhi ladkhadaate hue chaltaa hai.

Qaanuun-hukumat-awaam kaa is tarah ek honaa bahut achhi baat hai, which has to be admired. Lekin duusraa reaction jo hai, apprehension vaalaa, vah intahaa ghalat aur buraa hai. The Right to Information must never be allowed to degenerate into the Right to Bully, or into a form of vigilantism. Kyunki vah qanuun jo darr paidaa kartaa hai, vah iktarfaa hotaa hai, vah vishvaas, bharosaa, aitbaar nahiin barhaataa hai. Aur aaj humko vishvaas, aitbaar ki sakht zururat hai.

AAj RTI ko aaye paanch saal ho gaye hain. Humko aaj uske prabhaav oar, uske asar par, ghaur karnaa chaahiye. Kyaa hai uskaa asar ? RTI mein ek bare aandolan ki fateh hui hai. Aur uskaa shreyas sabse pahle jaataa hai Aruna Roy ko, jinhone Rajasthan mein RTI ki zaruurat mahsuus kari aur phir uske liye aandolan shuru kiyaa, aur uske liye logon kaa samarthan praapt kiyaa.

Andolanon ko logon kaa samarthan tab hi haasil hotaa hai jab logon ko us andolan mein tuk, tark, aur tathya dikhe. Varnaa nahin. Is qanuun ne hazaaron ke dil ujaagar kiye hain. Is qanuun ne kaiyon ko insaaf dilaayaa hai, kai ghaflaton, ghalatiyon, ghus aur ghor anyaayon ka is qanun ne muquabilaa kiyaa hai. Lekin phir bhii RTI ko aaj bhii ek smarthan kii, support aur backing ki zaruurat hai.

Aaj bhi RTI ke qaanuun banjaane ke baad bhi usko yah kyuun chaahiye ? Vajah yah hai : Yah qanuun kaiyon ke kaanon tak pahunchaa hai, kai hazaaron, lakhon kaanon tak pahunchaa hai, lekin phir bhi kai auron — karoron — ke kaanon ke upar se sarsaraataa huaa pravesh kar gayaa hai daftaron mein. Is baat mein vaise koi kharaabi nahiin. Daftaron ke binaa koi qanuun nahin chaltaa. Lekin daftaron kaa ek ajib tariqaa hotaa hai. Ve qanuunon ko apne kuuchon mein mehmaan banaa dete hain.

Daftaron ki koshish hoti hai ki qanuunon ko kam se kam taqliif ho, ziyaada se ziyaada aaraam miley. Lekin RTI aaraam ke liye nahiin banaa hai. Vah kaam ke liye banaa hai. Usko mehnat chaahiye, raahat nahiin. Daftaron ko RTI se darnaa nahin chaahiye, us se khisakne kii koshish nahiin karnii chaahiye. Mein sarkaari prabandhakon ko kahungaa ki RTI se ek ho jaayiye, usko apnaayiye, uski madad se haqiqat ko pahchaaniye, usko durust kariye. Jab bhii RTI ki tahat public se koi savaal aataa hai sarkaari daftaron ko uskaa svaagat karnaa chaahiye aur uskaa puraa, sahi, aur sachchaa javaab buland aavaaz mein denaa chaahiye.

It is not just RTI’s great good fortune, but India’s that a person of the veracity of Wajahat Habibullah has been India’s first Chief Information Commissioner. He has set RTI on track, set the RTI-Government equation on track. The Chief Information Commissioners in the States have also been working extremely hard, often with inadequate infrastructure, often as single Commissioners, and often without that continual backing from the State Administration that is required. I would like to congratulate all of them on this occasion for what they have achieved. They, with the Lok Ayuktas, and the State Commissions for Human Rights are Institutions of Conscience, They are, what may be called, the Zameer-e -Hind. Pradeshon mein jo commissioner aur PIOs bane hain, unko Rajya sarkaaron se saari suvidhayen aur sammaan milne chaahiye. RTI ki adhikaariyon ko iske liye intezaar karnaa pare yah sarkaari chhabi ke liye thiik nahiin.

RTI mein gopaniyataa kaa ek aham savaal hai. Is se sarkaaron ko kuchh bechainii hoti hai. RTI Act mein gopaniyataa kii surakshaa hui hai. Honi chahiye. Jaise hum hain, vaisa hi desh hai. Humen hum sab ko — kuchh maamlon mein gopaniyataa kii zuruurat hotii hai. Kuchh rishte aise hote hain, jahaan gopaniyataa zuruuri hoti hai. Sarkar aur desh ke rishton mein bhii kuchh aise lamhe aate hain, jahaan gopaniiyataa aavashyak ban jaatii hai. Vaisii gopaniyata kuchh nazaakaton kii hifaazat ke liye hotii hain. Khulepan— transparency — ka yah matlab nahiin ki hum aisii nazaakaton ko bhuul jaayen.

I would certainly include in these the confidential communications between a head of State and head of Government, both at the Centre and in the State. At the same time I would say that whenever an occasion arises when a head of State and head of Government share thoughts on matters of public importance, they must simultaneously take the public into confidence and place in the public domain, an operative summary of their discussions or correspondence to obviate speculation.

File notings kii baat aatii hai. Is par bhii bechainiyaan rahiin hain aur Chief Information Commissioner sahib kii is par aham ruling bhii aayii hai. Main sirf itnaa kah duun ki afsaron or saare note-writers ko notings likhte vaqt muddon par sochnaa chaahiye, haqiqat ko dhyaan mein rakhnaa chaahiye, qanuun ko dhyaan mein rakhnaa chahiye. Notes yah soch kar na likhiye ki ‘kahiin aage jaa kar RTI vaalii taqlioif na ho jaaye’. Aur na hi aisii notes likhne kii koshish kiijiye jis se ki RTI ke taramandal mein aap ek chamaktaa sitaaraa ban jaaen.

The RTI Act should not make note files monosyllabic or laconic, nor should it encourage prolixity in the hope of ‘RTI immortality’. Bureaucracy RTI ke maamle mein apne puraane mindset se abhi baahar aanaa siikh rahii hai. Sadiyon se afsaron ne thakur-suhaati sunii hai, maai-baapii, hukum-huzuurii dekhii hai. Unhe bataayaa gayaa hai ki savaal afsar baithe hue karegaa, javaab uske samne kharaa huaa insaan degaa. Aaj jab afsar RTI ke learner hai, aur RTI shikshak, to unko yah mat kahiye ‘chal utth, khare ho’. Yaa ‘chal utth, sar par khare ho’. Afsar aaj ek baraa pahluu siikh rahaa hai, vishvasaniya aur transparent RTI-compliant shaasan mein, siirshaasan mein nahiin. Gandhiji in Decemeber 30, 1926 ke din ‘Young India’ mein likhaa thaa: “Those who seek justice must come with clean hands”.

‘Clean hands’ means that those using the Act must use it responsibly. The architects and engineers and the persons running the Act should make users of the Act realise the difference between stressing and straining a point, between portraying and exaggerating a situation and between emphasising and magnifying a problem. RTI adherents and users should encourage serious questions and discourage frivolous or malicious ones. I have heard of persons who have been unsuccessful in interviews promptly doing an RTI to challenge the procedures of the appointing authorities, thereby paralysing the functioning of those bodies. A good instrument can be misused.

RTI’s protectors must not let that happen. The RTI Act is a potential remedy for discontent. It should not become a weapon in the hands of malcontents. Discontent in India is a reality. Malcontents in India are no less so. A strict and disciplinarian head-of-office can be bullied by RTI threats. This bullying can be lethal if it is based on deliberate distortions of facts and if it is based on half truths. Even a ‘truth’, a ‘fact’, can sometimes be misused. William Blake
famously said : ‘A truth told with bad intent beats all the lies you can invent’. RTI protectors and NGOs must be mindful of that. RTI should not be used to hurt anyone or anything, except opaqueness. RTI Act afsaron ko haqiqat kii dhuul se vaaqif karne ko hai, uski naak dhuul mein ragadne ke liye nahiin.

Today, RTI is facing probably its greatest challenge. So effective has it become, so rich in results, so amazingly potent that those with something to hide are afraid of it. Fear is a cousin of panic. And so we hear of those who have had the courage to use RTI against the powerful and the entrenched have had to pay dearly for their courage, even with their lives.

This is intolerable. If it is true that the unnatural death of persons who have filed RTI applications is connected with their RTI action, the law-enforcers have to visit the guilty with the speed of light and, under due process, bring the guilty demonstrably to account. And politics should be allowed to play no role in the proceedings. It is as imperative to keep politics out of RTI as it is to keep it out of the judiciary.

In fact, even more so because over the decades the judiciary has built up systems to safeguard its space; RTI establishments are yet to do so. Those who have died in the course of RTI work are martyrs to more than the Right to Information; they are martyrs to transparent and good governance and the rule of law. They are martyrs to the cause of a civilised and liberal rule of law. RTI Act ne logon ko aavaaz dilaayii hai, divaaron ko sunne par majbuur kiyaa hai. Surdas ke shabdon mein: Jaake kripa, Pangu giri langhai, Andhau ko sab kachhu darisaaii, Bahirau sune, guung puni bolai, Ranka chale sir chhatra dharaayii.
    
                                            

                                               PART C:  Informatton on & Around

    SIC’s validity under cloud:

S. 15 of the RTI Act provides that every State Government shall by Notification in the Official Gazette constitute a body to be known as State Information Commission to exercise powers conferred, etc. under the RTI Act. Even after 5 years since the RTI Act, 2005 came into existence, the Maharashtra State Government has not issued such Notification. Technically, all the orders by the Information Commission will be illegal and have no force of law. What a state of affairs !

    SRA biggest job attraction:

The Slum Rehabilitation Authority, building proposal, vigilance and development planning departments are the most lucrative, hence the most sought-after postings in the Brihanmumbai Municipal Corporation as revealed under the RTI application. According to the information sought by RTI activist Anil Galgali, BMC officials, chiefly engineers are asking for prime postings in these four departments of the Corporation. Further, in order to get postings in these departments, these officials have approached various politicians seeking letters of recommendation from them. According to the RTI reply, the officials seeking the postings have not only got recommendation from state politicians, but also Union Ministers. The SRA, building proposal, vigilance and development planning departments deal with builders who are ready to give big money so that their proposals are passed by the BMC. Further, many transactions take place under the table in these departments.

    SIC’s orders being challenged by the Government:

In a first case of its kind after the landmark Right to Information Act came into force five years ago, the Congress-led Democratic Front Government has refused to implement Chief Information Commissioner Suresh Joshi’s order to provide information to controversial bureaucrat V. M. Lal. Lal had filed an application under RTI before the GAD Public Information officer. He sought specific copies of the notings made by the concerned Department on the ongoing probe against him. A probe was conducted against him by veteran bureaucrat Asoke Basak. Lal’s contention was that Basak had given him a clean chit in all the eight charges. He alleged that on the basis of certain notings in his file, GAD did not agree with the findings of Basak and ultimately it recommended a punishment to him. In his application Lal had asked for all relevant notings and documents. The PIO took the view that since no final decision was taken the entire process remains incomplete. According to provisions of the RTI Act it was not binding on the PIO to provide the information sought. We have received CIC Suresh Joshi’s order to provide information to Lal. In our opinion the order is bad in law. If we implement the order, it will have an adverse impact on the administration. “As per the opinion expressed by the law and judiciary department, now we are moving the High Court against the CIC order,” said a senior official.

    Mhada’s duties:

The Maharashtra Housing and Area Development Authority (Mhada) is duty-bound under the law to give the owner of a repaired building an opportunity to claim a compensation if the value of the debris (mostly Burma teak) turns out to be more than the cost of repairs. RTI query revealed that the relevant rule providing for this point is mostly not observed. There are around 16,000 buildings in Ctentral Mumbai that are more than 70 years old and in dire need of repairs. However, landlords are generally not interested in spending any money on them. The tenants of such buildings pay Mhada a cess in lieu of which it undertakes repairs through its repairs board. Many of these buildings were built from stone/bricks and wood. The wood is largely in good condition and fetches a very high price in the market. Going by the law, the wood becomes the property of the repairs board. However, after repair it is supposed to give a formal notice to the landlord that he may submit a claim for compensation if he feels that the cost of the wood is more than the cost of repair. RTI activist Milind Mulay found out that though 1,740 buildings were repaired using the cess and MLA/MLC fund between April 1, 2006 and November 14, 2009, not a single landlord was given this notice. It is surprising how senior officers who sign the file before releasing payment to the contractor do not notice the violation of their own rule.

    `26 lakh vanished:

Nearly `26 lakh collected by the BEST to provide relief after 1971 Bangladesh war seems to have vanished into thin air. The BEST had collected the amount from bus commuters as the Bangladesh Refugee Relief Surcharge from 1971-73 and the Scarcity Relief Surcharge in 1973-74. However, neither the BEST nor the Transport Commissioner’s office where it claims to have deposited the money has any information on how the money was spent. This was revealed when RTI activist Manoranjan Roy filed an application asking the BEST how much money was collected as surcharge and where it wasspent. The BEST revealed that it had collected `13.85 lakh under the head of ‘Bangladesh Refugee Relief Surcharge’ from December 1971 to March 1973 and a sum of `12.94 lakh under the head of ‘Scarcity Relief Surcharge’ from April 1973 to March 1974. However, the BEST said that it had deposited the money with the transport department as the sum is collected on behalf of the Government of Maharashtra and was being remitted to the office of the Transport Commissioner every month. When Roy filed an RTI with the Transport Commis-sioner’s office, the department admitted that such surcharges imposed by the BEST were deposited with it, but said it had no record of the `26 lakh. Roy has now filed a PIL, demanding an inquiry into the management of funds by BEST.

    `45 crore vanished:

Bet you did not know this — every time you pay for your local train ticket fare you end up paying a fraction of the amount as ‘safety charges’. Central Railway (CR) collected `45 crore as safety charges during 2008-2009. However, they have no idea as to how this money has been utilised. The safety charge is collected to provide safety to passengers and other amenities. It includes construction of flyovers at unmanned railway crossings, boundary walls, purchasing safety devices for track maintenance, track replacements, putting posters on railway-crossing gate and signalling equipment. Kalbadevi-based social activist, Pravin Tripathi, had filed a Right to Information application seeking details about the safety charges collection of 2008-2009. CR replied to him saying: “The details of used-up money collected as safety charges `45,45,73,426 (for 2008-2009) is not available in this office, hence cannot be provided.” “Railways should have provided me details about the usage of safety charges collected but they failed to. I think it’s because the amount has not been used for passengers and they should, therefore, return this amount to passengers,” Tripathi told MID-DAY. “If a year’s collection works out to `45 crore, for 10 years it may add up to around `450 crore. The railways should furnish details about our money, there is no passenger safety at stations, no ambulance, no first-aid box at stations”, said Tripathi. Do you know that approximately 37 lakh people commute on the Central Railway every day?

    Private schools now fall within RTI Act ambit:

The CIC has ruled that private educational institutions— whether government-funded bodies, and issues related to their management and regulation come under the ambit of the Right to Information.

    File notings being shielded:

Bureaucrats manage to hide file notings on all files and petitions processed at Andhra Pradesh State Secretariat. They use stick-notes (post-its) on all files in the State Secretariat as these can be removed in case of an RTI query, leaving no trace of favoritism. There’s colour coding too. A particular colour means a particular minister is perusing the file (with a vested interest). Also, ink colour indicates the sign of approval or otherwise, etc. Any noting in black usually means negative, blue means neutral, green means clear and magenta means relaxation of rules!

Securities Laws : A Tale of Two Amendments — Recent controversial amendments by SEBI

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Part A : CIC’s decisions



Very interesting and significant issue before CIC :


The applicant, Shri Arun Agrawal, has sought following
information from CPIO, Ministry of Law and Justice :

“Entire file containing papers along with notings, etc.
relating to the appointment and scope of the brief of special envoy Shri
Virendra Dayal to obtain papers relating to Volcker Report and his report to
the Ministry after meeting the UN officials.”


The application was transferred to the Ministry of External
Affairs and then to the Prime Minister’s Office and then to the Ministry of
Finance, Department of Revenue. Everybody denied having such a file in their
office.

The appellant’s prayer before CIC are :

“It appears reasonable to conclude that the Special Envoy
and the Enforcement Directorate deliberately did not collect the documents for
contract M/09/35, M/10/17 and M/11/25 by which allotments were made to
Reliance Petroleum on payment of illegal surcharge.

It is for this reason that the documents are sought and it
is for this reason that the Government has invoked the provisions of Clause
8(1)(a) of the RTI Act 2005.”


On account of the Volcker Report, Shri Natwar Singh had to
resign as the Foreign Minister. Allegation of Shri Arun Agrawal is as follows :

“Documents from the Volcker report establish that Reliance
was a non-contractual beneficiary for lifting five times more oil than shown
to have been lifted by Congress and Natwar Singh combined. It figures in every
table of the oil for food programme report of the U.N., in which the names of
the Congress and Natwar figure (Annexure A — the five tables in which Indian
entity figures). The contract nos. for Reliance Petroleum in which it figured
as non-contractual beneficiary and paid illegal surcharge were M/09/35,
M/10/17 and M/11/25.

The Government deliberately did not refer the said
contracts in which Reliance Petroleum was the non-contractual beneficiary
(according to the Volcker Report) while referring the non-contractual
beneficiary contract No. M/10/57 of Congress Party and contract No. M/09/54 of
Natwar Singh, to the Pathak Inquiry Authority for reasons well known.”


To determine this issue, CIC decided to examine the Virendra
Dayal Report and find out who holds this report. All the three parties have
denied having such report in their records. It was then gathered that probably
the Directorate of Enforcement (DoE) holds this report. The said DoE informed
that they fall under the 2nd schedule of the RTI Act and hence exempt to
disclose information. DoE further volunteered to say that the matter is under
investigation and therefore exempt u/s.8(1)(h) of the RTI Act.

The question that is now to be determined by CIC is as to
whether an exemption claimed u/s.24(1) in this manner can be acceptable by a
quasi-judicial authority acting under a Statute (i.e., CIC).

Under the circumstances, the Commission decided to call for a
report from the Directorate of Enforcement which has to be submitted within 7
days from the date of receipt of the Order affirming :

(i) whether the information asked for by the applicant,
i.e.,
entire file containing papers along with notings, etc. relating to
the appointment, scope of brief of special envoy, Shri Virendra Dayal, to
obtain papers relating to Volcker Report and his report to the Ministry after
meeting the UN officials is held by them or not ?

(ii) to file their written submissions as to why this
Commission should not order its disclosure under the First Proviso to S. 24(1)
of the Act ?


In (ii) above, if the plea is taken that the information
cannot be disclosed u/s.8(1)(h), the Directorate will submit reasons for the
same as required by the Delhi High Court in cases of this nature in W.P.(C) No.
3114/2007 — Shri Bhagat Singh v. Chief Information Commissioner and Ors.

This decision is made on 15-9-2008. We wait anxiously to find
out what is finally determined in this case — both as to corruption charge on
Reliance Petroleum and the powers of CIC v. the Protection u/s.24(1) of the
RTI Act
.

[Shri Arun Agrawal v. PMO, No. 2nd Adjunct to Appeal
No. CIC/WB/A/2007/00417, dated 15-9-2008]



  •  Multiple RTI applications :


The appellant, Shri Ajay Sharma asked for huge information to
Hindustan Petroleum Corporation Limited through different RTI applications
related to sanctioned strength of employees at different levels and the details
of functioning of canteen.

The information asked for has been denied stating that it is
not in public interest.

Decision :

On perusal of the documents submitted by the parties, it is noted that both the parties have erred. The appellant has unnecessarily submitted multiple applications for seeking information relating to canteen and staffing pattern, which are not confidential. The appellant should have asked for the information through a single application and also submitted only one appeal before the Commission against the decision of the respondent, which could have economised the resources in seeking and providing the information. Likewise, the CPIO could have given a comprehensive response in respect of all the appeals, rather then giving an identical reply in all the cases.

In view of the foregoing, the appellant is advised to prepare a comprehensive list of required information and resubmit to the CPIO, who should provide a pointwise response and thus furnish the information on the basis of available records within 15 working days from the date of receipt of fresh application. If any information is to be denied, the reasons for doing so should clearly be indicated for review, if necessary, by the Commission. The applicant should be free to seek inspection of relevant records and files so as to clearly specify the required information.

CIC also made a remark that a large amount of information asked for should be put in public domain in compliance of with S. 4(1) of the RTI Act.

[Shri Ajay Sharma v. HPCL, decision No. 3199/ IC(A)/2008, dated 1-9-2008]


Part B : The RTI Act

Attempt is being made that in this part besides reporting on the development and discussions on RTI Act at various forums, some Courts’ decisions be reported. Herewith that beginning:

S. 8(1)(j) :

Issue:

Whether information disclosing the names of the persons including address and amount, who have received more than Rs.1 lac from the Chief Minister Discretionary Fund can be given to the information seeker or it is an information, which stands exempted u/s.8(1)G) of the Act.

Held:

That the information asked for is not an information which is covered u/s.8(1)(j), nor does it stand exempted otherwise.

S.11:

Issue:

When beneficiary of the grant from Chief Minister’s Discretionary Fund is under an obligation to use the money so paid for the very same purpose, for which it has been paid – with the obligation upon the beneficiary to return the unused money in one go, and that too within the prescribed period, for which utilisation certificate has to be furnished by the District Magistrate after necessary verification – can it be said that it is an information which can seek confidentiality within meaning of S. 11 of the Act or can be treated as confidential by the beneficiary, treating it to be a third-party information.

Held: No

[PlO, Chief Minister Office v. SIC, UP and Others, decided on 1-7-2008 by the High Court of Allahabad]

Part C : Other News

• Seam in PM’s and CM’s special relief packages:

RTI application has revealed that a six-time former MP and relatives of a sitting MLA besides several former MLAs are among the well-off people who have helped themselves to the relief measures meant for poor, bereaved families in Yavatmal district, the epicenter of the farmers’ suicides.

The revelations point to large-scale corruption and irregularities in the implementation of the schemes. The schemes were meant to help the near and dear ones of those indebted farmers who were the sole breadwinners of their families and who had ended their lives, or other BPL families living along the State dairy’s milk procurement route. Its purpose was to enable the distressed families to supplement their income as farming had become uneconomical in this mainly unirrigated cotton-growing region.

• Dwindling number of tigers in Maharashtra’s forests:

The Times of India invoked the Right to Information Act to find out how much time the field directors spent on the field and found out that, on an average, they spent just 50 days a year inside forests. This has had a disastrous effect on wildlife management, say former forest officials and environmentalists, and may be one of the reasons that have led to the dwindling number of tigers in Maharashtra’s forests.

•  Medical  Insurance  card:

Allwyn Ribeiro was most irked when he was turned away for the nth time by the Government Hospital at Byculla, Mumbai. The 43-year-old office superintendent for Central Railways had made three earlier trips to the hospital to collect his medical insurance card.

Frustrated,  on the advice of an RTI activist, Ribeiro filed RTI application  and asked the Public Information Officer of the Byculla  hospital  about:  (a) the progress  of his file, and  (b) how many  such applications  they had  processed  in the last six months. He hardly expected his application to prompt such efficacy. “The very next day I received a call from the hospital to say ‘Come, pick up your card’,” says Ribeiro, who now swears by the effectiveness of the RTI Act.

• Four new Central Information Commissioners (CIC) :

Present CIC has five Commissioners including the Chief CIC. In this month (September) 4 more CICs are appointed:

Most interesting and unexpected, is the appointment of Shailesh Gandhi. He can be ranked as one of the most senior and effective RTI activists in the country. Entire RTI-activists’ community is looking forward to great performance by him, especially, in reduction of pendency of appeals in CIC office.

• UTI under RTI ?
The Bombay High Court has stayed the Central Information Commission (CIC)’s Order on the applicability of the Right to Information Act, 2005 on UTI Asset Management Company. UTI Mutual Fund and UTI Trustee Company have filed a writ petition challenging the CIC’s Order.

CIC had ruled that “Even though there is no specific provision in the RTI Act that a body owned, controlled or substantially funded by another public authority is also a public authority, yet from the purpose and object of the RTI Act, it is crystal clear that there should be transparency in the functioning of any institution, in which public money is deployed. The four sponsors are public authorities and when they, in turn, own another entity, such an entity has to be treated as a public authority.

Economic Times reports on RTI :

A very well-written article appeared in The Economic Times on 19-9-2008 written by two journalists. Extract from it :

What could a labourer running from pillar to post for his ration card, a student waiting eagerly for his passport, a housewife struggling without water supply or a senior citizen suffering due to pollution caused by an unauthorised factory near his residence have in common? The Right to Information (RTI) Act – the salvation for these diverse problems.

A notable achievement of the UPA Government along with the Rural Employment Guarantee Scheme, this key to information has empowered the aam aadmi to fight the formidable fortress of secrecy that enabled unscrupulous babus to shirk work and breed corruption. RTI is no magic that can make corruption vanish in a jiffy, but it has put the fear of scrutiny firmly in the minds of Government employees. Gone is the air of confidence that enabled the corrupt in the Government to demand ‘speed money’ openly without any apprehension of being caught. The experience till now suggests that most Government departments attempt to clear pending work when they are questioned and responsibility is fixed.

Part A : CIC’s decisions, Part B : The RTI Act, Part C : Other News

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Delay in reply by PIO
and change of stand, etc. :


Three interesting points are decided in CIC’s decision dated
30-4-2008 in the matter of Shri Deepak H. Chhabria of Mumbai v. Ministry of
Overseas Indian Affairs
.

In Shri Chhabria’s RTI application, he wanted to know whether
a demand draft of Rs.25,000 sent by the Employment Promotion Council of Indian
Personnel, Mumbai, was encashed by the Ministry for renewal of RC for 25 years,
etc.

1.1 RTI application filed on 8 March, 2007 was first replied
by the PIO on 21 June, 2007, i.e., a delay of more than two months,
beyond the period (one month) stipulated for reply in the RTI Act.

1.2 The Commission, therefore, decided to issue a show-cause
notice as to why penalty should not be levied for this delay under Section 20(1)
of the Act.

2.1 In the first reply given, the respondents informed the
appellant that they were collecting the information which would be supplied to
him. However, later through a letter of 14 August 2007, they informed the
appellant that they regarded the information asked for as third-party
information.

2.2 The Commission was sorry to see this change of stand of
the respondents. The Commission examined the issue and came to the conclusion
that even though the information asked is about others than the appellant who
filed the application, in view of the public interest involved in the case, this
cannot be regarded as third-party information. The matter, obviously, involves
and affects a lot of persons. It, therefore, directed the respondents to
disclose all the documents/files on the subject to the appellant by 21 May 2008.

3.1 The Commission also noticed that the replies received by
the appellant from the respondents were signed neither by the PIO, nor by the
Appellate Authority but other officials in the Department.

3.2 The Commission warned the respondents to henceforth
ensure that provisions of the Act are adhered to in letter and spirit and that
response to the RTI applications and appeals are signed by the PIO and the
Appellate Authority, respectively. They were also directed to mention the name
of the Appellate Authority while making the first response to the RTI
application.

(No. CIC/OK/A/2007/01297 decided on 30-4- 2008)




Inspection of files
where investigation is in process :


This is the case of one Shri Dhirendra Krishna. In this case
the decision was given on 29-2-2008. In the said decision, while quoting from
the judgment of the Delhi High Court in Shri Bhagat Singh v. Chief
Information Commissioner & Ors.,
(Refer BCAJ, May 08) the Commission had
concluded as follows :

“To enable us, therefore, to examine as to the manner in
which inspection of the concerned file will impede the process of prosecution
in this case, if at all, particularly since this process has been pending for
so long, the concerned file will be submitted to us for our inspection on
2-5-2008 at 4.00 p.m. in the office premises of the CBI.”


The inspection was shifted to the CIC’s office. In the
submissions, CBI’s representative submitted a statement of details of Court
hearings. The same were from 27-1-2000 to 26-3-2008, next hearing fixed on
2-9-2008. As many as 17 hearings had taken place along with number of
adjournments from time to time.

The CBI representative submitted that the failure to frame
charges was not a result of any resistance on the part of the prosecution, he
submitted that in this case the appellant together with other co-accused in the
same case have sought discharge first in the Trial Court and then from the High
Court, but their discharge applications have been dismissed. He further
submitted that whereas they have brought all the relevant records for the
inspection, they have no difficulty in allowing inspection of any record held by
them in relation to the case of appellant Shri Dhirendra Krishna, whether relied
upon and therefore filed before the Trial Court or indeed records that have not
been filed and have not been relied upon, which appellant Shri Dhirendra Krishna
has in his appeal before us and subsequent representations repeatedly claimed to
exist by pleading that such records will assist him in contesting the case.
These are open for inspection by appellant Shri Dhirendra Krishna. With this
therefore, respondents have in fact, withdrawn the exemption from disclosure
sought u/s.8(1)(h), agreeing to inspection which will include any record of
which a list was handed over to the appellant Shri Dhirendra Krishna with a copy
retained on the CIC’s record in the hearing on 22-2-2008.

It is difficult to imagine why the CBI changed its stand, may
be after coming to know of the contents of the judgment of the High Court of
Delhi as reported in May 2008 issue of BCAJ.

Part B : The RTI Act


Part II of Chapter 5 of the Annual Report 2005-06 as
published by the Central Information Commission deals with suggestions for
reforms.

Clause (g) of S. 25(3) mandates that each such report shall
state :

(g) recommendations for reform, including recommendations
in respect of the particular public authorities for the development,
improvement, modernisation, reform or amendment to this Act or other
legislation or common law or any other matter relevant for operating the right
to access information.

In this part, the Commission has listed suggestions received
from different public authorities for reforming the Act to ensure better
implementation. Some of such reforms suggested are :

Public Information Officers should be provided with supporting staff and other infrastructure such as computer, printer, space for staff, etc.

Time limit for destroying old files be re-evaluated and re-fixed and that clarifications should be issued regarding entitlement of the questioner to very old records, which will not help the public.

A specific amendment may be made in the RTI Act with reference to the period up to which in-formation can be requested/furnished.

The fee be increased for detailed information covering large periods of time, which is sought in a format in which the information is generally not maintained by Ministries/Departments.

This suggestion is given by several public authorities as they feel that this is a lacuna, which needs to be taken care of to discourage frivolous and superfluous requests under the Act.

Several  public  authorities  want  some  sort  of exemption  from  the purview  of the Act. For example, while the Union Public Services Commission (UPSC, Ministry of Personnel, Public Grievances & Pensions) requested exemption from disclosure of information relating to examination and recruitment/ appointment cases, the DMRC requested __ general exemption as it is undertaking a time-bound exercise of completing the Delhi Metro.

 The Supreme  Court  of India  (Ministry of Law , Justice) has sought exemption from the Act for any information, which, in the opinion of the Chief Justice of India or his nominee, may adversely affect or interfere or tend to interfere with the independence of the judiciary or administration of justice.

“‘.. The Supreme Court of India has suggested that a decision by the Chief Justice of India under the Act should not be subjected to further appeal. It has suggested adding the following proviso to S. 19(3) :

“Provided further that the second appeal arising out of the Order passed by an officer of the Supreme Court of India inferior in rank to Registrar General of the Supreme Court of India shall lie before the Registrar General of the Supreme Court of India”.

Some public authorities have suggested that provisions of the RTI Act be extended to cover private sector as well or exemption be considered for public sector undertakings in the same field, like banks, insurance companies, Sail v. Tata Steel, RIL v. ONGe, etc.

Canara Bank (Ministry of Finance) has suggested making the application fee mandatory for appeals as well.

The CBI has observed that if the immediate Appellate Authority has also rejected a request for information, it is not fair to penalise the Central Public Information Officer alone for not providing the information.

    Many suggestions have been received for safe-guards to be built into the Act, such as :

  •     Safeguards to discourage those who request personal information,


  •     Safeguards  to ensure  that  the Act does not become a tool in the hands of delinquent employees to serve their own interests,


  • Requested the inclusion of provisions to check the bona fide of the requester and to refuse information to those who are not directly concerned with it or might use it for promoting their own business interests or may misuse it.


The time frame of one month for replying to queries may be increased, the number of questions in a single representation may be restricted to only one; suitable amendment may be made in the Act, so as to specify / curtail the number of applications an applicant can make on the same issue.

In conclusion, the report states that the stocktaking of the implementation of the Act reveals that more still needs to be done.

These include:

  • Proper indexing and computerisation of records for regular and consistent publishing on the website of the public authority, so that members of the public do not need to personally file an application or VISitthe official to seek information.


  • Public authorities must also begin to use open access software such as Wiki or Plone to upload information that they have disclosed to citizens under RTI on their website. They could initially upload only the information which is most requested by citizens, and steadily, say, within the next 12 months, move towards a system where all information that is requested is automatically made public, unless it falls under the exempted category.


  • Finally, an attitudinal change is needed among public officials who still believe that they have a monopoly over records and resent the public’s demand for ‘too much’ information for ‘too less’ a fee.


  • Public authorities must attempt to make the Act as citizen-friendly as possible rather than pitch for exemption from its purview. Initiatives such as the ones listed above would be more in line with the letter and intent of the Act, which has placed on public authorities the onus of its effective implementation.


Part C : Other News


Government’s    apathy    for RTI Act:

‘Mint’ under  the feature  ‘Our View’ has made very revealing  remarks  on the Government’s  apathy  to ‘f’  spread  awareness  of the RTI Act, even though  the Act mandates it to do it. ‘Mint’ writes:

“The contrast is a stark one. While cricket fans are endlessly reminded through TV spots about the Governments’ flagship Bharat Nirman programme, there is no attempt to publicise the provisions of the landmark Right to Information Act, 2005. Why? Because the former is a potential vote winner, while the latter is politically useless and a bureaucratic nightmare.”

•  Judiciary  under  RTI Act:

After the speaker of Loksabha (reported in BCAJ May issue) now, the former Chief Justice of India, J. S. Verma has commented on the issue of the coverage of the Courts under the RTI Act.

In reply to the question: How do you view CJI K. G. Balakrishnan’s controversial statement that being a constitutional office holder he was not answerable under RTI ?

He replies: In a democracy, no one is unaccountable. The mode of enforcement of accountability may, can and should vary according to the nature and position of the public functionary. The CJI is no exception to this rule. The Constitution provides for his removal, which is the ultimate form of accountability. He is accountable even for his judicial functioning. He has to hear cases in open Court and give reasoned decisions which are subject to public scrutiny. So, where is the scope to suggest that he can’t be accountable for his administrative functioning?

Further, in reply to the question: Doesn’t the judiciary’s hostility to RTI make a mockery of the three resolutions of judicial accountability passed by the SC Judges under your leadership?

His reply  is : When  those  three  resolutions were unanimously adopted on May 7, 1997, I did hope that they would be institutionalised in due course. Much as I admire the SC ruling that every political candidate should disclose his antecedents, I cannot imagine how a judge can hold others to a standard he does not apply to himself.

It appears that CJI, Mr. Balakrishnan, still maintains that CJI is not ‘a public authority’ within the meaning of the RTI Act.

It is now learnt that undeterred by the Chief Justice of India’s assertion that he does not come under the Right to Information (RTI) Act, the Central Information Commission (CIC) has decided to take up the issue in a Full-Bench hearing soon.

The issue is likely to come up before the Supreme Court breaks for recess. The issue comes at a time when the CJI has mellowed down from his earlier stance and said that his office is that of a public servant. “The CJI is a constitutional authority. RTI does not cover constitutional authorities”, the CJI had recently remarked. In a statement later, he clarified that he was a public servant and the issue of being governed under the Act was debatable.

•  Interesting incident in SIC’s  office:

Hussain, an Indian Forest Service officer of the 1980 batch, was appointed Secretary to the Maharashtra Information Commission a year ago. On one day in May, when Hussain reached the office, he was told that he had already been relieved and that he should get in touch with his parent (forest) department for his new assignment. According to reports, Buldhana collector Vasant Poreddiwar has taken over as the new Secretary of the Commission.

Hussain had been busy organising a one-day meeting of Chief Information Commissioners at Pune. After the meeting, when he reached his office in the New Administrative Building across Mantralaya, he saw Poreddiwar already occupying his office. He was then informed that he had been repatriated to his parent (forest) department. It was a mockery of the Right to Information Act. The CIC, which decides on applications under the RTI, failed to inform Hussain that he had been transferred.

•  Does  R in RTI mean ‘RedressaI’?:

One RTI activist writes: The Right to Information Act, in its second year, can well be christened the Redressal through Information Act. For, in an un-recorded trend, the 2005 law, meant to empower citizens with details of Government decisions, is now being increasingly used as a means of redressal of grievances.

Chief Information Commissioner Wajahat Habibullah says that the use of RTI as a grievance-redressal mechanism was not totally unexpected, at least by activist groups. It is noticed that RTI now is being largely used for getting details of delayed. passports, ration cards, denial of pensions and son. While the CIC is clear on the purpose of RTI, in such cases where there is a violation of rules or law, citizens certainly can be helped. The pattern of redressal grievances is picking up in the country. Some of the instances are :

  • A resident of Jhansi got details of what he al-leged was the forged DNA fingerprinting report of his 5-year old son, which his wife had got done.


  •  An appellant got details of the computation of his pensionary benefits denied to him for the last 10 years.   


  • The North-Eastern Railways was asked to furnish all information to an applicant relating to” recruitment and promotion of engineers, since . he had alleged malpractices in promotion of staff .


  • The Municipal Corporation of Delhi was asked to respond in 10 days to an applicant who had for long been seeking information regarding permissible limits for construction on a plot.


  •  A group of appellants from Varanasi filed a complaint against the Ministry of Textiles, since they were aggrieved with non-implementation of; health-insurance scheme for weavers. The Ministry was asked to settle the grievances within a month.


  • The CIC made a “strong recommendation” to the Delhi Development Authority (DDA) to allot a plot under the Janata category in Rohini, since the applicant’s allotment number was wrongly quoted by the bank and the allotment cancelled. “This amounts to denial of the right of a member of the public and also denial of natural justice,” the CIC order noted.


  • The Employees Provident Fund Organisation was ordered to return Rs.625 deducted from an applicant’s subsistence allowance to be paid to -: the Prime Minister’s Relief Fund, since it was done without taking his consent.


RTI exposes nepotism  in Kerala Government:

RTI query has put Kerala’s left Government in a spot, inviting charges of promoting nepotism and also raising questions about the CPM’s stand on ethics in public life.

At the  centre  of the  storm  is Kerala  Health Minister P. K. Sreemathi,  who has inducted  her daughter-in-law   Dhanya  M. Nair  into her personal  staff. This was  revealed  by the  General ;.,Administration   Department  in response  to RTI query  seeking  details  of Sreemathi’s  personal staff. The request  was  filed by AIADMK State Secretary Sreenivasan Venugopal.

In reply, Venugopal got a list of 22 names including Dhanya, who is married to Sreemathi’s son. She had joined the staff as a clerk and was only recently promoted to the post of additional personal assistant.  Her salary works  out to around Rs. 17,000 p.m. Dhanya  will also be eligible for pension  once she completes 2 years in her post.

Delays in appeals before Central Information Commission and the State Information Commissions:

Almost everywhere it has been a sorry state of affairs. Recently, it has come to the public notice that in UP, more than half of over 9000 appeals and complaints made are pending. Out of 9946 appeals and complaints received in UP SIC’S office during 2006-07, as at the end of March 2008, 4088 appeals and complaints have remained pending .

CIC’s Press  Release:

To foster the spirit of ‘share  & care’ amongst  the stakeholders,  the Central  Information  Commission  has  provided   a platform   on  its website

where the public authorities/Central Government Ministries/Departments can post what they consider a ‘Best Practice’ with regard to implementation of the RTI in their set-up. The enlight- I ened citizens among us who want to publicly acknowledge and recognise the ‘heroes’ amongst the public authorities who they consider to have innovated a procedure in their organisations or improved on the existing ones, so as to make the accessibility of information hassle-free to the larger masses may also share their experience and what they liked about the practice in the public authority, so that it could be replicated and/ or further improved.

Arbitration & Other Laws

Laws and Business

Introduction :

An arbitration is always a fall out of disputes. Disputes
occur for various reasons and under various laws. Hence, while dealing with an
arbitration, one needs to keep in mind the provisions of the other laws. They
more often than not, would have a bearing upon the arbitration proceedings or
the award or the validity of the same. One must always remember that an
arbitration is not an island by itself. It draws on and feeds on other laws.



2. Arbitration &
Company Law :


One of the foremost questions which arises is the necessity
for a company to have an arbitration clause in its memorandum of association. It
is not an object of a company to refer matters to Arbitration but it is a power.
Hence, it is not necessary for a company to have an arbitration clause in its
memorandum of association, but it is definitely advisable.

The next question which arises is who can refer a matter for
arbitration on behalf of a company. A variety of persons can refer a dispute to
arbitration :

  •       Board of Directors


  •      Managing Director


  •      Any Committee/Executive specifically authorised by the Board to do so


  •      Any Power of Attorney holder of the Company.





However, this would be subject to any express provisions on
this aspect in of memorandum and articles of association.

2.3 Disputes which are typical to a company and which can be
referred to ‘arbitration’ may include those arising on account of :

  •    Oppression & Mismanagement


  •  Shareholders’/Joint Venture Agreement


  •  Share Subscription Agreement


  •  Agreements with VCs/Private Equity

Oppression & Mismanagement :


S. 397 and S. 398 of the Companies Act provide for a petition to the Company
Law Board in all cases of oppression of minority by majority and mismanagement
of the affairs of the company by the majority. The question that arises, is can
the agreement between parties provide that the same would be referred to
arbitration ?

S. 8 and S. 45 of the Arbitration and Conciliation Act, 1996
provide that a judicial authority before which an action is brought in a matter
which is the subject of an arbitration agreement shall, if a party so applies
not later than when submitting his first statement on the substance of the
dispute, refer the parties to arbitration. Further, notwithstanding anything
contained in the Code of Civil Procedure, 1908, a judicial authority, when
seized of an action in a matter in respect of which the parties have made an
agreement, shall, at the request of one of the parties or any person claiming
through or under him, refer the parties to arbitration, unless it finds that the
said agreement is null and void, inoperative or incapable of being performed.
The CLB has exclusive jurisdiction for all matters u/s.397 and u/s.398 but that
does not preclude reference to arbitration. Thus, S. 8 and S. 45 are mandatory
provisions and if the petition matters are within the scope of the arbitration
agreement, then the CLB is bound to refer the issues to arbitration.

However, the CLB cannot order a reference to arbitration
unless a party to the proceedings applies for the same — EIH Ltd. v. Mashobra
Resort, 119 Comp. Cases 993 (CLB). If the oppression petition is contested by
the parties on merits without reference to arbitration, then the CLB would not
grant any stay against the petition — Suresh Jain v. Hindustan Ferro, 96 Comp.
Cases 507 (CLB).

The CLB will decide all matters of oppression and
mismanagement even which are outside the scope of the arbitration agreement —
Khandwala Securities Ltd. v. Kowa Spinning Ltd., 97 Comp. Cases 632 (CLB).

Joint venture/Shareholders’ agreement :


JV/shareholders’ agreements provide for the ‘Management and
Conduct of Business’ of a Company. A usual clause found in such agreements is
that all disputes would be referred to arbitration. A question which arises is
that can the company also be made a party to the arbitration along with the JV
partners/shareholders ?

Articles of association are the regulations which bind a
company and its shareholders. Only if the provisions of arbitration are
incorporated in the articles of association, can the company be made a party to
such proceedings :

  •  Shanti Prasad v. Kalinga Tubes, (1965) 35 Comp. Cases 351 (SC)


  •  V. B. Rangaraj v. V. B. Gopalkrishnan, (1992) 73 Comp. Cases 201 (SC)


  • B. K. Shah v. Magotteaux Int., 111 Comp. Cases 220 (CLB)







A transfer of shares pursuant to an arbitration award is not
a case of a transfer, but it is a transmission of shares by operation of law.
Thus, it falls under the second proviso to S. 108 of the Companies Act and does
not require a transfer form for the company to register the transfer of shares.
The transfer in such a case is not based upon the volition of the parties, but
by operation of law — Dinesh Nagindas Shah v. Pankaj Aluminium Industries P.
Ltd., 102 SCL 161 (Bom.).

A Single Judge of the Bombay High Court in the case of Western Maharashtra Development Corporation v. Bajaj Auto Ltd., reported in (2010) 154 Comp. Cases 593 (Bom.), had ruled that an Arbitration Tribunal had no jurisdiction to give an award on the basis of a Shareholders’ Agreement containing restrictive clauses in the SHA. This was because the SHA itself was invalid, since the articles of a public company could not contain clauses restricting the transfer of shares and it was contrary to S. 108 of the Companies Act, 1956. Hence, the arbitration agreement which was founded on the SHA was void. The Arbitrator had ignored the express provision of S. 108 and lost sight of the very concept of free transferability of shares of a public limited company. Hence, his award was set aside. Very recently, a two-Member Bench of the Bombay High Court, in the case of Messer Holdings Ltd. v. Shyam Ruia and Others, (Appeal No. 855 of 2003) has overruled this decision of the Single Judge of the Bombay High Court. Hence, as the position now stands, an arbitration award dealing with restrictive clauses in a public limited company would be valid. This is a very important judgment since almost all PE/VC/ JV agreements as well as shareholders’ agreements contain such clauses. Thus, if any dispute arises on these clauses, the parties can apply for arbitration.


Winding-up petitions :

Can a petition for winding-up of a company u/s.433 of the Companies Act be referred to arbitration? Various decisions have held that an arbitration clause does not oust jurisdiction of a Court for winding-up petitions. Only disputes are referable to arbitration. A petition for winding-up is not an ‘action’. The power to order a winding-up is only under the Companies Act and only with the High Court. The Supreme Court in the case of Haryana Telecom v. Sterlite Industries Ltd., 97 Comp. Cases 683 (SC), has held that a claim in a petition for winding-up is not for money. Hence, no reference to arbitration can be made for winding-up of a company. Further, arbitration proceedings are not a bar to winding-up petitions — ABG Heavy Ind. v. Hindustan Shipyard, (2001) 105 Comp. Cases 413 (Bom.).

In Hewlett Packard v. BPL Net Com, (2002) 110 Comp. Cases 575 (Kar.), the Court held that if there is an arbitration clause in an agreement, the Court can yet entertain a winding-up petition as per its discretion. There is no automatic stay on winding-up merely because the subject-matter of dispute carries an arbitration clause. An arbitration agreement is binding on a company even after a winding-up petition. The legal status of the company continues till the company is dissolved. The only change is that instead of the Board of Directors the Liquidator steps into its shoes :

  •     Goetze India v. Pure Drinks, (1999) 3 Comp. LJ. 68 & (1994) 80 Comp. Cases 363 (P&H)

  •     Maruti Ltd. v. B. G. Shirke & Co., (1981) 51 Comp. Cases 11 (P&H)

    446 of the Companies Act provides that once an order for winding-up is made, no suit/legal proceeding can be initiated against the company unless permission of Court is taken. Proceedings would also include ‘arbitration proceedings’. Thus, the leave of the Court would be required to commence arbitration proceedings against such a company — British India Corp. v. S.S. & T. Machinery, (2001) 106 Comp. Cases 467 (Kar.). The Court can declare an arbitration/ award to be null if done without its permission. Permission of the Court ordering winding-up is a must. Even a third party can plead that arbitration is null if no Court permission was obtained — Vasantha Ramanan v. Official Liquidator, (2003) 114 Comp. Cases 747 (Mad.).

VC/Private Equity Agreement :

These agreements always provide for a Deadlock Resolution between the Management Team and Venture Capital Funds. The usual clause provides that :

  •     The disputes would be first resolved through friendly consultations.

  •     If the disputes are yet not resolved, then arbitration would be the exclusive means of resolving any dispute.

Arbitration and HUF :

A question which arises is that who has power to refer to arbitration on behalf of an HUF? The father/ manager/karta has power to refer disputes relating to joint family property to arbitration, provided reference is for the benefit of the family — Shantilal v. Munshilal, (1932) 56 AIR 595 (Bom). Other members of the HUF are bound by the reference and the award made thereon — Balaji v. Nana, (1903) 27 Bom 287.

An agreement between HUF members to appoint arbitrators for partition amounts to a severance of the joint status of the HUF from the date of the agreement — Kashinathsa v. Narsingsa, AIR 1961 SC 1077.

An arbitration award is liable to ‘stamp duty’ of Rs.100 under the Bombay Stamp Act, 1958. An award is defined as a decision in writing of an Arbitrator/ Umpire made on reference for submitting differences, not being an award directing a partition.

However, if it is an instrument of partition, then the duty is different. An instrument of partition includes an award by an a arbitrator directing a partition. The duty on the same is levied @ 2% on the market value of the separated share of the property. Thus, the value on which stamp duty is levied is the total market value of the property less the largest share partitioned. If all shares are equal, then deduct any one share.

Arbitration and registration :

Earlier there was a controversy on whether an ‘arbitration award’ needed to be registered under the Registration Act, 1908. However, the Supreme Court’s decisions in Sardar Singh v. Smt. Krishna Devi, AIR 1955 SC 491, Kashinathsa v. Narsingsa, AIR 1961 SC 1077, M. Chelamayya v. M. Venkatratanam, AIR 1972 SC 1121 have clarified the position as follows :

    a) If the award creates right, title and interest in immovable property, then registration is compulsory.

    b) If it is a mere declaration of a pre-existing rights or reference to past partition and not creating right in praesenti — then ‘no registration’ is required.

    c) An ‘unregistered award’ which affects or purports to affect right, title or interest in any immovable property is inadmissible as evidence.

    d) However, an unregistered award is a valid award and not a waste paper. It creates rights and obligations between the parties.

In Akbarali v. Mumtaz Hussain, AIR 1987 Bom. 39 it was held that if a right is claimed under the award or is to be enforced by way of a suit, then registration of the award is a must. In Harendra Mehta v. Mukesh Mehta, (1999) 97 Comp. Case 265 (SC), it was held that foreign awards need not be registered.

In Satish Kumar v. Surinder Kaur, AIR 1970 SC 833, the Court held that if the award affects the partition of immovable property, then it requires registration.

Conclusion:

Whether a CA appears as a representative of one of the parties as an advisor, as an arbitrator, as a valuer or as an expert, he must always bear in mind the interplay of other laws on the award. A slip-up on any one law may render the award ineffective/ unenforceable. One is reminded of Humbert Wolfe’s golden quote :

“Making innumerable statutes, men
Merely confuse what God achieved in ten ! !”

Stamp duty on conveyances — Across India

PROBATES

Laws and Business

I.
Meaning :


Where
there is a Will, there is a Relative,

Where there is a Relative,
there is a Dispute,

And where there is a
Dispute, there is a Probate

The above quote is the
reality of several succession/inheritance cases. A probate means the copy of the
will certified by the seal of a Court. Probate of a will establishes the
authenticity and finality of a will and validates all the acts of the executors.
It conclusively proves the validity of the will and after a probate has been
granted, no claim can be raised about the genuineness or otherwise of the will.
A probate is different from a succession certificate. A succession certificate
is issued by a Court when a person dies intestate, i.e., without making a
will. Thus, a probate is granted by a Court only when a will is in place, while
a succession certificate is granted only if a will has not been made.

II.
Necessity :


According to the Indian
Succession Act, no right as an executor or a legatee can be established in any
Court unless a Court has granted a probate of the will under which the right is
claimed. This provision applies to all Christians and to those Hindus, Sikhs,
Jains and Buddhists who are/whose immovable properties are situated, within the
territory of West Bengal or the Presidency Towns of Madras and Bombay. Thus, for
Hindus, Sikhs, Jains and Buddhists who are/whose immovable properties are
situated outside the territories of West Bengal or the Presidency Towns of
Madras and Bombay, a probate is not required. It also applies to Parsis who
are/whose immovable properties are situated within limits of the High Courts of
Calcutta, Madras and Bombay. However, absence of a probate does not debar
the executor from dealing with the estate.

III.
Procedure :


3.1 To obtain a probate, an
application needs to be made to the relevant Court along with the will. The
executor has to disclose the names and addresses of the heirs of the deceased.
Once the Court receives the application for a probate, it would invite
objections, if any, from the relatives of the deceased.

3.2 The Court would also
place a public notice in a newspaper for public comments. The petitioner would
also have to satisfy the Court about the proof of death of the testator and the
proof of the will. Proof of death could be in the form of a death certificate.
However, in the case of a person who is missing or has disappeared, it may
become difficult to prove the death. U/s.108 of the Indian Evidence Act, 1872,
any person who is unheard of or missing for a period of seven years by those who
would have naturally heard of him if he had been alive, is presumed to be dead
unless otherwise proved.

3.3 On being satisfied that
the will is indeed genuine, the Court would grant a probate (a specimen of the
probate is given in the Act) under its seal. The probate would be granted in
favour of the executor/s named under the will. The Supreme Court has held in the
cases of Lalitaben Jayantilal Popat v. Pragnaben J. Kataria, (2008) 15
SCC 365 and Syed Askari Hadi Ali v. State, (2009) 5 SCC 528, that while
granting a probate, the Court must not only consider the genuineness of the
will, but also the explanation given by the parties to all suspicious
circumstances surrounding thereto along with proof in support of the same. The
onus of proving the will is on the propounder. The propounder has to prove the
legality of the execution and genuineness of the said will by proving absence of
suspicious circumstances surrounding the will and also by proving the
testamentary capacity and the signature of the testator. When there are
suspicious circumstances the onus is also on the propounder to explain them to
the Court’s satisfaction and only when such onus is discharged, would the Court
accept the will — K. Laxman v T. Padmini, (2009) 1 SCC 354.

It may be noted that a mere
fact that a nomination has been made would have no impact on the probate since
the nominee is only a stop-gap arrangement till such time as the actual legal
heir is given the estate of the deceased.

IV.
Opposition :


If any relative, heir of the
deceased or other person feels aggrieved by the grant of a probate, then he must
file a caveat before the Court opposing the will. Once a caveat has been filed,
the Courts would hear the aggrieved party and he would have to prove that he
would have a share in the estate of the testator if he had died intestate.

V.
Why does one need a probate ?


5.1 One of the
questions which almost always arises in the case of a will, is ‘why is the
probate required ?’ A probate is a certificate from the High Court certifying
the genuineness and finality of the will. It is the final word on whether the
will is genuine or it has been obtained by fraud, coercion, etc.

5.2 Some of the reasons why
a probate is required are as follows :

(a) It is necessary to
prove the legal right of a legatee under a will in a Court.

(b) Some listed/limited
companies insist on a probate for transmission of shares.

© Similarly, some
co-operative housing societies insist on a probate for transmission of a flat.

(d) The Registrar of
Sub-Assurances would insist on a probate usually for registration of immovable
properties.

However, it would not be correct to say that no transfer can take place without a probate. There are several companies, societies, etc., which do transfer shares, flats, etc., even in the absence of a probate. They may, as a precaution, insist upon a release deed from the other heirs in favour of the legatee who is the transferee. Sometimes, the company/society also asks for an indemnity from the legatee in its favour against any possible claims/law suits from the other heirs of the deceased.

VI. Special factors:

Some of the rules in respect of obtaining a probate are as under:

    a) For obtaining a probate, the applicable court fee stamp would be payable as per the rates prescribed in different states. For instance, for obtaining a probate in the city of Mumbai, the application has to be made to the Bombay High Court and the court fee rates prescribed under the Bombay Court-Fees Act, 1959 would apply which are as follows:

    b) A probate cannot be granted to a minor or a person of unsound mind.

    c) If there are more than one executors, then the probate can be granted to all of them simultaneously or at different times.

    d) If a will is lost since the testator’s death or it has been destroyed by accident and not due to any act of the testator and a copy of the will has been preserved, then a probate may be granted on the basis of such a copy until the original or an authenticated copy has been produced. If a copy of the will has not been made or a draft has not been preserved, then a probate can be granted of its contents or of its substance, if the same can be proved by evidence.

    e) A probate petition requires the following contents:

    i) A copy of the will or the contents of the will in case the will has been lost, mislaid, destroyed, etc.
    ii) The time of the testator’s death — a proof of death would be helpful.

    iii) A statement that the will is the last will and testament of the deceased and that it was duly executed.

    iv) The amount of assets which may come to the petitioner and the value for the purposes of computing the court fees.

    v) A statement that the petitioner is the executor of the will.

    vi) That the deceased had a fixed place of residence or some property within the jurisdiction of the judge where the application is moved.

    vii) It must be verified by at least one of the witnesses to the will. It must be signed and verified by the petitioner and his lawyer.

VII. Succession certificate:
A succession certificate is a certificate granted by a High Court in respect of any debt due to the deceased or securities owned by him. In case the deceased died living behind a will, which only empowered the beneficiaries to collect his debts and securities, then the courts would grant a succession certificate instead of a probate. It merely empowers the grantee to collect the debts owed to the deceased.

VIII. Chartered Accountant/Auditor’s Duty:

Normally, a CA in his capacity as an Auditor is not directly involved with wills and succession issues. Nevertheless, a CA can provide a lot of value added services to his clients if he is aware of the law in this respect. He can be of great assistance to his clients in cases of succession planning and estate planning. It is an area where he can assist his client and avoid unnecessary litigation amongst heirs. CAs in today’s environment, in addition to being business and financial consultants, are also family advisors.

DOMESTIC ARBITRATION

Laws and Business1.
Introduction :

1.1 Arbitration is one of
the oldest dispute resolution systems across the world. Even in India,
arbitration has been in existence from ancient times. Considering the time it
takes in India for a Court case to be resolved, the importance of arbitration
has increased manifold in the last few years. Almost all types of civil disputes
can be subjected to arbitration, such as disputes in relation to joint ventures,
infrastructure projects, concession agreements with the Government, property
matters, etc.

1.2 The Arbitration and
Conciliation Act, 1996 (‘the Act’) totally revamped the law in relation to
arbitrations in India. The Act replaces the Arbitration Act, 1940. Let us
examine the process in relation to an arbitration under the 1996 Act.

1.3 An arbitration means any
arbitration whether or not administered by permanent arbitral institution.

1.4 This Article gives a
bird’s-eye view of some of the important features of ‘arbitration’.



2.
Arbitration Agreement :


2.1 An Arbitration Agreement
means an agreement by the parties to submit to arbitration all or certain
disputes which have arisen or which may arise between them in respect of a
defined legal relationship, whether contractual or not. An arbitration agreement
should be in writing and signed by both the parties. There is no prescribed form
for the same. It could also be by way of an exchange of letters, telex,
telegram, etc. The reference in a ‘contract document’ containing an arbitration
clause constitutes an arbitration agreement as that arbitration clause is part
of the contract.

2.2 The Arbitration
Agreement is the starting point by which parties refer disputes to arbitration.
Since it is an agreement, the provisions of the Indian Contract Act, 1872 must
also be borne in mind. Thus, provisions, such as capacity of parties to
contract, agreements opposed to public policy, etc., should be considered.

2.3 Salient features of an
Arbitration Agreement :


(a) The intention for
reference to arbitration must be clear and unambiguous.

(b) It should mention :

(i) the place/venue of
arbitration

(ii) the law which would
be followed

(iii) the procedure for
appointing
arbitrators

(iv) the language in
which the arbitration proceedings will be conducted



Full freedom is accorded to
the parties in selecting the above features. In addition, the agreement may also
lay down the procedure for conducting arbitration proceedings, use of experts,
etc.

2.4 An arbitration agreement
is not discharged by the death of one of the parties and his legal
representatives would step into the shoes of the deceased party.

2.5 The arbitration
agreement may also provide that arbitration would be the only dispute resolution
mechanism and none of the parties will approach any Court for resolving the
dispute.



3.
Arbitrators :


3.1 The parties can decide
on the number of arbitrators to be appointed, provided that the number of
arbitrators is not an even number. Thus, they could be 1, 3, 5, etc. If the
agreement is silent, then the Act provides for a sole arbitrator. Usually, an
arbitral tribunal consist of 3 arbitrators with each party appointing one
arbitrator and the two appointed arbitrators jointly appointing the third
arbitrator, who is known as the presiding arbitrator.

3.2 There is no
specification as to who can be appointed as an arbitrator. However, it is
preferable that he should be a man of commerce, law, or having expertise in the
field of dispute resolution and he should be someone who is perceived to be fair
and impartial to all parties. Usually, advocates, chartered accountants,
chartered engineers, bankers, and retired judges, etc. are appointed as
arbitrators.

3.3 If there is a failure to
appoint arbitrators, then the Chief Justice of the High Court has powers to
appoint an arbitrator under the Act.

3.4 Before accepting
appointment, the arbitrator must disclose to the parties any matters which are
likely to give rise to justifiable doubts about his independence or
impartiality. Similarly, the appointment of an arbitrator may be challenged on
grounds that there are circumstances which give rise to justifiable doubts about
his independence or impartiality. A challenge can also be made on grounds that
he does not possess the qualifications agreed to by the parties.



4.
Procedure of arbitration :


4.1 The arbitration tribunal
is not bound by the Code of Civil Procedure, 1908 or the Indian Evidence Act,
1872. The parties are, and failing them the tribunal, is free to determine the
procedure to be followed. In the absence of defined or agreed procedure.

4.2 The arbitral tribunal
would issue notice of hearing to the parties.

4.3 The parties would make their written and/ or oral submissions. The parties must submit their statement of claim and defence. They can also rely on various documents and evidence in support of their claims and defence. They may also rely on and submit expert testimony if so permitted by the tribunal or agreed upon by the parties. The other party may file rebuttal submissions against the expert testimony.

4.4 The arbitrator is bound to observe the principles of natural justice whilst conducting the proceedings. He must give an equal opportunity of being heard to both parties.

4.5 The arbitrator may also prescribe certain deposit for the costs of arbitration which both parties have to pay.

    5. Award:

5.1 The award shall be in writing, state its date and place of making. It must be signed by the arbitrator.

5.2 The reasons on the basis of which award was passed, shall be recorded unless the parties agree otherwise. The sum awarded may include ‘interest’ if the claimant is entitled to interest either under the agreement or the arbitration agreement.

5.3 It must provide for the costs and which party would bear them. Costs would include costs relating to fees and expenses of the arbitrators and witnesses, legal fees, administration and other costs in connection with the arbitration proceedings.

5.4 A signed copy of the award must be delivered to each party. Within 30 days from the receipt of an award by a party, the party may request the arbitration tribunal to correct any errors in the award.

5.5 The arbitrator can also make an interim arbitral award.

5.6 The award is final and binding on the parties and it can be enforced under the Code of Civil Procedure, 1908 in the same manner as if it is a decree of the Court. However, this is subject to award not being be challenged and set aside by the Court.

    6. Setting aside of an award:

6.1 The Court would set aside an award in the following cases:

    a. The party was under some incapacity.
    b. The arbitration agreement is invalid.
    c. The party was not given proper notice of hearing or was unable to present its case.
    d. The award deals with a dispute not contemplated by the agreement or contains matters beyond the scope of the agreement.
    e. The award is in conflict with the public policy.
    f. The composition of arbitral tribunal was not in accordance with the arbitration agreement.

6.2 An application for setting aside the award may be made to the Court u/s.34 of the Act. It must be made within 3 months from the receipt of the award. The Court may grant an additional 30 days in some circumstances.

    7. Role of CAs:

7.1 CAs can play a very important role in arbitration proceedings of their clients. They can make submissions on behalf of their clients or appear as an expert and give testimony on subjects, such as valuation, accounting, etc., or can even preside as an arbitrator. They can get empanelled with Chambers of Commerce, such as IMC, CII, etc., as arbitrators. Considering the slow pace of court litigation, CAs should advise their clients to strongly consider arbitration as a dispute resolution mechanism. They could also advise the clients whilst reviewing contracts during the course of audit to have an ‘arbitration agreement’ unless an arbitration clause is already included in the contract.

Legal compliance — Directors’ responsibility — Part 2

Laws and Business

Last month we examined the various laws under which a company
can be liable and thus, the directors can also be held responsible. Let us now
examine situations in which directors can be held responsible and the safeguards
they can take.


1. What is the meaning of the terms

‘Connivance, Neglect and Consent’ ?

Since the terms ‘connivance’, ‘neglect’ and ‘consent’ are
very important and often find mention in various statutes while defining
directors’ responsibilities, it is very essential to understand their meaning.
These words are defined by various judicial decisions and dictionaries as
follows :




1.1 Connivance :

(a) “A figurative expression, meaning voluntary blindness to some present act or conduct, to something going on before the eyes, and is inapplicable to anything past or future; an agreement or consent, directly or indirectly given that something unlawful shall be done by another; consent; passive consent; voluntary oversight

To constitute ‘connivance’ something more than mere negligence is necessary. Pothi Gollari v. Ghanni Modal, AIR 1963 Ori 60″.

(The Law Lexicon, P. Ramanatha Aiyar, 2nd Edition, Wadhwa & Co.)

(b) “The secret or indirect consent or permission of one person to the commission of an unlawful or criminal act by another. A winking at; voluntary blindness; an intentional failure to discover or prevent the wrong; forbearance or passive consent. Pierce v. Crisp, 260 Ky. 519, 86 S.W. 2nd 293, 296.”

(Black’s Law Dictionary, 6th Edition, West Publishing Co.)

(c) “The Act of conniving — to encourage or assent to a wrong by silence or feigned ignorance; knowledge of a wrongful or criminal act during its occurrence”

(Webster’s Collegiate Dictionary, 2002 Edition, Trident Press Int.)

(d) “Secretly allow a wrongdoing”

(The Concise Oxford Dictionary, 10th Edition, Oxford University Press)

(e) “Pretended ignorance or secret encouragement of wrongdoing; knowledge or encouragement of a wrongdoing without participation in it; avoid noticing something wrong; give aid to wrongdoing by not telling of it;”

(The World Book Dictionary, World Book, Inc.)

1.2 Neglect :

(a) “May mean to omit, fail or forbear to do a thing that can be done or that is required to be done, but it may also import an absence of care or attention in the doing or omission of a given act. And it may mean a designed refusal, indifference or unwillingness to perform one’s duty. In Re. Perkins, 234 Mo. App. 716, 117 S.W. 2d 686, 692.”

(Black’s Law Dictionary, 6th Edition, West Publishing Co.)

(b) “A failure to do what is required; omission, forbearance to do anything that can be done or that requires to be done; the omission to do or perform some work, duty or act; the omission or disregard of some duty; the omission from carelessness to do something that can be done and that ought to be done; negligence. Neglect to do a thing means to omit to do a duty which the party is able to do. King v. Burrell, 12A.&E.468.468.

The word ‘neglect’ is wide enough to cover erosion of the kind indulged in by the petitioner. (It certainly cannot mean that a person on whom a notice has been served can only be prosecuted if he fails to give any reply at all and that any sort of reply to the notice, however inadequate or evasive, is sufficient to avert the prosecution for failure to comply with the terms of the notice.) Pirthi Raj v. The State, AIR 1958 Pun 396, 397.

To disregard; to pay little or no attention to; to fail to perform, render, discharge (a duty) to take (a precaution).

The word ‘neglect’ means ‘gross neglect’, wilful, intentional, culpable or flagrant disregard of duties. Baburao Vishwanath Mathpati v. State, AIR 1996 Bom 227, 231 (DB), Maharashtra Municipal Councils Act Act”

(The Law Lexicon, P. Ramanatha Aiyar, 2nd Edition, Wadhwa & Co.)

(c) “To neglect doing is the omission to do some duty which the party is able to do (per Patterson J. King v. Burrell, 12A & E, 468)”

(Stroud’s Judicial Dictionary, 5th Edition, Sweet & Maxwell Ltd.)

(d) “To disregard; ignore; To fail to give proper attention to or to take proper care of; Habitual want of attention or care”

(Webster’s Collegiate Dictionary, 2002 Edition, Trident Press Int.)

(e) “Fail to give proper care or attention to; fail to do something”

(The Concise Oxford Dictionary, 10th Edition, Oxford University Press)

(f) “To give too little care or attention to”

(The World Book Dictionary, World Book, Inc.)

1.3 Consent :

(a) “(In the Contract Act) Two or more persons are said to consent when they agree upon the same thing in the same sense.”

‘Consent’ is an act of reason, accompanied with deliberation, the mind weighing, as in a balance, the good and evil on each side. Where a consent is given substantially, the Court does not look very minutely into the form in which it is given” (Per Stirling, J., Re Smith, 59 LJ Ch 284.)

“You cannot consent to a thing unless you have knowledge of it” Jessel, M.R., Ex parte Ford; In Re Caughey, (1876) LR 1 CD 528.

‘Consent’ must imply a knowledge of the necessary facts and materials which leads to the consent, consent cannot be given in the abstract or in vacuo : Walchandnagar Industries Ltd. v. Ratanchand Khimchand Motishaw, AIR 1953 Bom 285.

‘Consent’ must imply a knowledge of the necessary facts and materials which leads to the consent, consent cannot be given in the abstract or in vacuo: Walchandnagar Industries Ltd. v. Ratanchand Khimchand Motishaw, AIR 1953 Bom 285.

Consent and assent. ‘Consent’ in law means an affirmative, positive act and ‘assent’ means passivity or inaction: S. Raghbir Singh Sandhawalla v. The Commissioner of Income-tax, AIR 1958 Pun 250, 252.

Connivance is also consent in the legal sense. ‘To consent’ means according to the Concise Oxford Dictionary, ‘to acquiesce’ or ‘to agree’ To connive’ at a thing means, to wink at it. The word’ connive’ is only used in connection with a thing which is, unlawful or immoral which one ought to oppose. It implies knowledge and lack of opposition where there is a duty to oppose. Sheopat Singh v. Narishchandra, AIR 1958 Raj 324, 332. [Representation of the People Act, 1951, S. 100].”

(The Law Lexicon, P. Ramanatha Aiyar, 2nd Edition, Wadhwa & Co.)

a) “Consent. A concurrence of wills. Voluntarily yielding the will to the proposition of another; acquiescence or compliance therewith. Agreement; approval; permission; the act or result of coming into harmony or accord. Consent is an act of reason, accompanied with deliberation, the mind weighing as in a balance the good or evil on each side. It means voluntary agreement by a person in the possession and exercise of sufficient mental capacity to make an intelligent choice to do something proposed by another. It supposes a physical power to act, a moral power of acting, and a serious, determined, and free use of these powers. Consent is implied in every agreement. It is an act unclouded by fraud, duress, or sometimes even mistake.”

(Black’s Law Dictionary, 6th Edition, West Publishing Co.)

c) “Consent is an act of reason, accompanied by deliberation, the mind weighing, as in balance, the good and evil on each side.”
(Stroud’s Judicial Dictionary, 5th Edition, Sweet & Maxwell Ltd.)

d) “A voluntary yielding to what is proposed or desired by another; acquiescence; Agreement in opinion or sentiment”
(Webster’s Collegiate Dictionary, 2002 Edition, Trident Press Int.)

e) “Permission;  agree to do something”
(The Concise Oxford Dictionary, 10th Edition, Oxford University Press)

2. Supreme Court  decision:

2.1 The Supreme Court has passed a landmark decision under the Negotiable Instruments Act in the case of S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla, 2005 8 SCC 89. Although this is a judgment under the Negotiable Instruments Act, it has several far reaching consequences and its ratio descendi can be applied under various other statutes which affix a vicarious criminal liability on directors in respect of offences committed by a company.

2.2 In this case, the Court was posed with important questions regarding the criminal liability of directors of a company in case of dishonour of a cheque issued by such company. Ultimately the Supreme Court answered the queries posed to it as under:

(a) It is necessary to specifically aver in a complaint under the Negotiable Instruments Act that at the time the offence was committed, the person accused was in-charge of and responsible for the conduct of business of the company. This averment is an essential requirement of the Negotiable Instruments Act and has to be made in a complaint. Without this averment being made in a complaint, the requirements cannot be said to be satisfied.

(b) Merely being a director of a company is not sufficient to make the person liable under the Negotiable Instruments Act. A director in a company cannot be deemed to be in-charge of and responsible to the company for conduct of its business. The requirement of the Negotiable Instruments Act is that the person sought to be made liable should be in-charge of and responsible for the conduct of the business of the company at the relevant time. This has to be averred as a fact, as there is no deemed liability of a director in such cases.

(c) A Managing Director or a Joint Managing Director would be in-charge of the company and responsible to the company for conduct of its business. Holders of such positions in a company become liable under the Negotiable Instruments Act. Merely by virtue of being a Managing Director or Joint Managing Director, these persons are in-charge of and responsible for the conduct of business of the company. Therefore, they get covered under the Negotiable Instruments Act. So far as signatory of a cheque which is dishonoured is concerned, he is clearly responsible for the dishonour and will be covered.

3. What can Directors do to safeguard their interests?

3.1 The vexed question which thus arises is, what can Directors do to safeguard their interests and ensure that they are not made personally liable for any defaults by the company?

3.2 One of the first things which the Board of Directors must ensure is that the company has a system for compliance with all the applicable laws. The company must have a written Compliance Manual enlisting all the laws applicable to it, which it must comply with and also who from the company is responsible for ensuring compliance with the same.

Further, the laws must be bifurcated into those which are critical to the survival of the company and those which although are not so crucial must be complied with. For instance, compliance with Food & Drug Administration Law is paramount for a pharmaceutical company. Similarly, compliance with the SEBI Merchant Banker Regulations .are critical for the existence of a merchant banker. Any serious lapse in such laws may result in the company’s registration being suspended or even permanently cancelled. There have been several recent instances where certificates of SEBI intermediaries have been suspended for not complying with the Code of Conduct or the conditions of registration.

The Manual may contain the important provisions with a reference to the relevant sections, rules, notifications, circulars, important case laws, etc., so that the user can refer to the same. It may be segregated into various sections, for instance, Corporate laws, SEBI Regulations, etc. It should be updated on a regular basis, so that the users do not refer to outdated material. The Referencer published by the BCAS is a very good starting point for preparing a Compliance Manual.

The optimum utility of the Manual would be if it is prepared by an outsider, i.e., not someone from within the company. A CA or a lawyer can be entrusted with this assignment. This is necessary because in several transactions there is a cross-influence of laws. For instance, in case of a loan given by a company to a related entity, the provisions of the Companies Act (e.g., S. 295), the Income-tax Act [e.g., S. 2(22)(e)], FEMA (if the recipient is a non-resident), etc. would have to be considered. In such situations, it is better if an independent professional prepares a comprehensive Manual. There must also be certain Red Flag Transactions, i.e., before such transactions are to be entered into, the Company Secretary or the Legal head must be consulted. A list of the Red Flag Transactions should also be circulated to the Head of the Accounts, so that his department should not process such transactions without receiving the prior approval of the legal department. A classic example of a Red Flag Transaction would be an inter-company investment within the group. In several cases it is observed that the listed company funds the private limited companies within the group by way of loans or investment. In all such cases, the concurrence of the legal department should be obtained before executing the transaction. Thus, the Accounts department should not write a cheque or pass an entry till it has been cleared by the legal cell.

3.3 The company must appoint a compliance officer to ensure compliance with various applicable laws and regulations. He must be a person who is well-versed with the legal and commercial fields, say, a Chartered Accountant, a Lawyer, a Company Secretary, etc. At every Board Meeting, the Compliance Officer should be asked to table a Compliance Certificate certifying compliance with all laws. This should also be preferably signed by the Managing Director and/ or the Whole-Time Directors and must be backed up with supporting certificates from various departmental heads who are responsible for compliance with individual laws. For instance, the Head of Administration can be asked to certify compliance with the Shops and Establishments Act; similarly, the Factory Head can be asked to certify compliance with pollution/ effluent control regulations, etc. This way the Directors can demonstrate that they have not failed in their duty of setting up a competent system for ensuring legal compliance. Whenever in doubt, the company should not hesitate to obtain an opinion from an appropriate CA or a lawyer. It is better to be cautious than to act in haste  and make  everyone repent  at leisure.

In addition to the Compliance Certificate, the CEO / MD and the various Departmental Heads along with the Legal Head/Company Secretary must be asked to table an Action Taken Report at each Board meeting. This Report must list down regulatory lapses, problems, issues which had arisen at the last meeting and the action taken by the company on the same. Quite often what happens is that niggling issues are swept under the rug and they come to the fore only once they have blossomed into full-fledged calamities. In this way, the Independent Directors can keep a track of the problems as they arise and the actions taken by the company and thereby nip a problem in the bud.

3.4 Another aspect which a good compliance system must have is a mechanism which provides for “what to do in case a default arises ?” Quite often, a small problem snowballs into a major crisis. Hence, if violations and lapses are tackled at an initial stage itself, then there might not be major problems at a later stage. The Compliance Officer and/or the Managing Director or some other Executive Director must be informed about all such compliance lapses and this must be followed up with immediate corrective action and expert professional aid.

Item 15 of Annexure-IA to Cl.49 of the Stock Exchange Listing Agreement, which provides for items which must be placed before the Board of Directors includes, “Non-compliance of any regulatory, statutory nature”.

3.5 It may be a good move to seek expert certifications on all important compliance matters, e.g., a periodic certificate from an outside consultant on matters of pollution control. Several listed companies have started obtaining certificates from practising company secretaries on compliances with various corporate laws. This is a step in the right direction and needs to be beefed-up with similar certificates in other areas of compliance.

3.6 Other important areas which the Directors need to monitor are of protecting and preserving the title of the company’s assets. Especially at the time of acquisition of assets, such as immovable properties, they should ensure the obtaining of a title search, proper conveyance/ adequate documentation, payment of appropriate stamp duty, registration, if required, etc. Similarly, the protection of intellectual capital of the company in the form of patents, copyrights, trademarks, designs, etc. is very essential. Proper steps must be taken in this regard to ensure that these IPRs are valid and subsisting. To ensure preservation of assets, the Directors must ensure that there is an appropriate system which addresses issues, such as payment of taxes, compliance with conditions of lease deeds, adequate insurance, etc.

3.7 Independent Directors have a vital role to play in ensuring that the company complies with all applicable laws. In case of defaults, they may be saddled with penalties and prosecutions for offences which they have never committed or were never even aware about. Hence, they should at every Board Meeting ask intelligent questions about the state of the company’s legal department, the compliance policies and procedures. If they feel that the company is taking a wrong view on certain issues or has wrongly interpreted certain provisions, they may insist upon a second opinion.

4. Epilogue:

4.1 To conclude, it must be remembered that compliance with laws and regulations is a journey and not a destination. It is more a question of a mindset which must percolate through the organisation right from the top, i.e., the Board of Directors all the way down to the lowest rank and file. Once the company imbibes a compliance culture, it would become second nature to the executives. Several companies have an attitude that they would tackle the problem only if and when it arises. Such a shortsighted fire-fighting approach is detrimental to the interests of all the stakeholders in the long run. It may yield some results in the short term, but once the law of averages catches up, there would be serious trouble. Hence, the top management must instill a ‘zero-tolerance’ attitude within the organisation towards legal lapses.

4.2 One can only wish that just as companies strive for prestigious Quality Certifications, such as ISO: 9001, ISO: 9002, etc., they would also strive for similar standards in the field of Regulatory Compliance.

4.3 It must also be reckoned that one of the tenets of ‘Corporate governance’ is to conduct business according to the laws of the land – hence to do this awareness of applicable laws is essential. An attempt has been made in this write-up to bring awareness of the consequences of non-compliance. It is also clarified that the list of laws applicable given here in above is not exhaustive and the directors must obtain from the management the list of applicable laws and record the same in the minutes. This list should be annually reviewed in view of the fact that new laws are being enacted and existing laws amended on a continuous basis at times without realising economic and social consequences.

Penalties and prosecution under the Companies Act

Development Control Regulations

Laws and Business

1. Introduction :


1.1 The erstwhile Press Note 2 of 2005 and para 5.23 of the
current Circular 1 of 2010 on Foreign Direct Investment issued by the Ministry
of Commerce are some of the most contentious Press Notes. S. 80-IB(10) of the
Income-tax Act, 1961 has given rise to some of the most interesting issues.
Article 25 of Schedule I to the Bombay Stamp Act, 1958 witnesses the maximum
debate. What do all these laws have in common ? They all deal with Real
Estate
! ! If there was a competition for the one sector in India which is
regulated by the maximum laws, then Real Estate would win hands down. It is
regulated by several laws, both Central and State and often there is no
co-ordination of definitions used under one law with those under another law.
This leads to confusion, ambiguity and litigation.

1.2 The Development Control Regulations for Greater Bombay,
1991 (‘the DC Regulations’) are one of the several laws which impact real
estate development in Maharashtra. These Regulations have been framed under the
Maharashtra Regional and Town Planning Act, 1966 (‘the MRTP Act’). As the
name suggests, these Regulations are applicable only for the city and suburbs of
Mumbai. The MRTP Act provides for the town planning and the development of land
for public purposes within the State of Maharashtra.

1.3 The importance of these Regulations stems from the fact
that they define several terms which are not defined elsewhere under other laws,
but are nevertheless used under those laws. Thus, the definitions under these
Regulations could serve as a guide in dealing with complexities under those
laws. This Article examines some of the key provisions of the DC Regulations.

2. Important definitions :


2.1 The DC Regulations lay down some important definitions
which one often comes across when dealing with real estate.

2.2 Building — A building means a structure
constructed with any materials for any purpose. The definition also includes a
part of a building. This is the most important definition since a good part of
the DC Regulations revolve around the construction of buildings. Thus, the term
‘building’ includes, those used for residential, office, educational, etc.,
purposes. A high-rise building is defined to mean a building which has a height
of 24 meters or more above the surrounding ground level.

2.3 Built-up area — It means the area covered
by a building on all floors including the cantilevered portion, if any. A
cantilever in common parlance means a projecting structure, such as a beam, that
is supported at one end and carries a load at the other end or along its length,
e.g., a beam supporting a balcony. Areas specifically excluded are not
counted for built-up area calculations.

2.3.1 Some of the exclusions from the definition of built-up
area are :


    (a) Basement area which may be used for parking, storage, bank deposits, housing equipment used for servicing the building, electric sub-station, etc. The basement area cannot exceed the lower of twice the plinth area of the building or the plot area.

    (b) Covered parking spaces as specified in the DC Regulations.

    (c) Balcony areas provided they are not more than 10% of the floor area from which they project.

    (d) Areas for recreational open spaces such as elevated/underground water reservoirs, electric sub-stations, pump houses, pavilions, gymnasiums, club houses, other sports and recreation facilities, swimming pools, etc.

    (e) Certain types of features permitted in open spaces, such as sanitary blocks, covered parking spaces, pump room, meter room, water tank, dustbins, plant nursery, etc.

    (f) Area covered by certain types of stair-case rooms, lift rooms, passages, etc.





2.3.2 The definition of this term is useful not only under
the DC Regulations, but also under the Stamp Act. Stamp duty on a conveyance is
payable on the built-up area of the property transferred. As per the Stamp Duty
Ready Reckoner if the built-up area is unascertainable it is presumed to be 20%
more than the carpet area.

2.3.3 For the purposes of FDI in real estate, the minimum
built-up area must be 50,000 sq. mts. The issue which arises here is that what
is the meaning of the term ‘built up area’ ? The DIPP Circular does not
define this term. One of the conditions under the Circular is that the project
shall conform to the norms and standards, including land use requirements and
provision of community amenities and common facilities, as laid down in the
applicable building control regulations, bye-laws, rules, and other regulations
of the State Government/Municipal/Local Body concerned. Hence, it stands to
reason that the definition of this term should be understood in the context of
which it is approved by the Municipal/Local Authority which sanctions the
building plans. E.g., land development in the city of Mumbai is regulated
by the Development Control Regulations of 1991. Thus, if the DC Regulations
treat something as a part of the built-up area, then it stands to reason that
the same should be so counted even for the purposes of reckoning whether the
project is FDI compliant.

2.4 Carpet area — This is the net usable floor
area within a building excluding area covered by walls. It also excludes any
area specifically excluded from computation of the floor space index. The
Maharashtra Ownership of Flats Act, 1963 requires every Flat Ownership Agreement
and every advertisement for the project to mention the carpet area of the flat
sold.

2.5 FSI — The term FSI means Floor Space Index.
FSI has been defined under the Regulations to mean the quotient of the ratio of
the combined gross floor area of all floors in a building to the total area of
the plot. However, the areas which are specifically exempted under the
Regulations are excluded from the computation of the FSI. Thus, FSI would be
computed as under :

Total Covered Area on all floors

Total Plot Area

Hence, the FSI quotient denotes the total constructed area
which is possible on a given plot of land. For instance, if the area of a plot
of land is 100 sq. mts. and the prevailing FSI quotient for that area is 1.33,
then the total possible constructed area on that plot would be 1,330 sq. mts.
The FSI computation and the permissible FSI varies depending upon the location
of the plot, the nature of intended use, etc. For instance, additional FSI is
allowed for Slum Rehabilitation Projects, redevelopment of cessed buildings,
hotels, etc.

2.6 Plinth — One often comes across this term in the real estate sector. It means the portion of the structure between the surface of the surrounding ground and the surface of the floor immediately above the ground. Plinth area on the other hand means the built-up covered area measured at the floor level of the basement or any other storey.

2.7 Plot means a parcel or piece of land which is enclosed by definite boundaries.

    Construction process:

3.1 In a variety of laws, such as S. 80-IB(10), Circular 1/2010 issued by the DIPP, etc., one comes across terms like the commencement of the project, completion of the project, obtaining of all statutory approvals, etc. Hence, it becomes important to understand the process involved in constructing a project, what steps are involved and what approvals are required.

3.2 Given below is a brief description of the processes and the approvals/certificates required for projects in Mumbai:
   a) Plan submission: The initial plan is submitted to?the?BMC?to?obtain a No Objection Certificate or approval based on guidelines laid down under the DC Regulations. A notice is to be given to the BMC along with a host of prescribed documents, such as the title documents, site plans, layout plan, building plan, etc.

 b)   Intimation of disapproval: This permission is an in-principle approval with respect to the plans submitted subject to conditions set out in the plans. The Intimation of Disapproval or IOD is worded in a very unique fashion. It gives an impression that the development has not been approved. However, actually it means that the development would be approved if the objections specified therein are addressed. Following compliance with these conditions, a Commencement Certificate is granted at various stages set out in the conditions. The IOD allows the developer to vacate and rehabilitate existing tenants and demolish existing structures. The developer is required to submit drawings of the proposed building for a project, together with details of the plot survey and survey drawings to the concerned planning authority.

 c)   Commencement certificate: The CC is required to commence work. The builder submits various documents as evidence of compliance of the conditions set out in the plans delivered with respect to intimation of disapproval at the time of applying for this certificate. Examples of such documents include no objection certificates from relevant authorities for cutting trees, from the Airport Authority of India for height clearance with respect to airport distance, structural design and drawings submissions and temporary structure permissions. Further, approvals for parking layout and a soil investigation report, for example, are also required to be in place at the time this application is made for obtaining a commencement certificate up to the plinth level. The CC is valid for 4 years, but needs to be renewed every year.

 d)   Further/full commencement certificate: This certificate is an endorsement with respect to the commencement certificate. This endorsement to undertake construction above the plinth level for which there are formal inspections by the officials of the BMC. It may be obtained either in phases or at one time for the entire project.

    e) Building Completion/Occupancy certificate: The Occupancy Certificate or OC is granted on the completion of the project and is required for occupants to move into their respective apartments. Some of the documents required to obtain this approval are?: a Structural Completion Certificate, a Lift Completion Certificate, a No Objection from the Fire Department and a Storm Water Drain Compliance Certificate. On receipt of these documents, the BMC inspects the work and issues a Certificate of Acceptance of the Completion of the Work. Once this Certificate is received, the builder submits the Development Completion Certificate along with the completion plan to the BMC. If the BMC is satisfied that there is no deviation from the sanctioned plans, then it grants an OC within 21 days or it may refuse to grant the OC. There are a good number of buildings in Mumbai where even though all flats are sold, the OC has not been obtained. The grant of the OC signifies the completion of the project.

   f)  Permanent electricity and water connection: This certificate is obtained after the occupancy certificate has been awarded.

    Consequences of violation:

4.1 In cases of DC Regulation violations, i.e., where the constructed area exceeds the maximum FSI permissible under the Regulations and/or allowed under the DRC, the BMC has power to demolish the illegal construction. It can also recover the costs of such demolition from the accused. In addition, a penalty for unauthorised development/use of a property otherwise than for the purpose it was planned may be imposed in the form of an imprisonment and a fine.

4.2 A very famous case in this respect is that of Pratibha Co-operative Housing Society Ltd. where the Society violated the FSI laws by constructing an unauthorised additional area of up to 24,000 sq.ft, equivalent to 8 additional areas. Ultimately, the matter went to the Supreme Court which upheld the demolition of the illegally constructed floors. While concluding the Supreme Court observed that “this case should be a pointer to all the builders that making of unauthorised construction never pays and is against the interest of society at large”.

4.3 Recently, an important decision was rendered by the Bombay High Court in the case of a writ petition filed by Sudhir M. Khandwala, writ petition No. 1077 of 2007. The case pertained to the demolition of illegally constructed Gaurav Gagan building and the petition was filed by the flat owners seeking re-spite from the BMC’s Orders. The High Court refused to stay the demolition and refused to regularise the unauthorised construction.

Dissolution of a Partnership Firm : SC Decision

I. Introduction

    1.1 The Indian Partnership Act, 1932 (‘the Act’) provides for registration of partnership firms with the Registrar of Firms. Registration under the Act is voluntary and not compulsory as in England. However, u/s. 69 of the Act, in the case of firms which are unregistered, the partners of the firm cannot file any suit in a Court. Thus, this is a disability for all unregistered firms.

    1.2 In spite of the above disability, the partner of an unregistered firm is entitled to sue for dissolution of the firm. This position was amended in the State of Maharashtra by the introduction of S.69(2A) and S.69(3)(a). Hence, partners of an unregistered firm in the State of Maharashtra, could not even sue for the dissolution of the firm or for realisation of the property of a dissolved firm.

    1.3 This amendment in Maharashtra caused a great deal of hurdles for partners of unregistered firms and was challenged as being unconstitutional. The Bombay High Court upheld the validity of this amendment. Recently, the Supreme Court, in the case of V. Subramaniam v. Rajesh Raghuvendra Rao, Civil Appeal No. 7438 of 2000 decided on 20th March, 2009, had an occasion to consider the Constitutional validity of this important amendment. This article analyses this important judgment and the principles laid down therein.

II. Existing Legal Position

    2.1 S.69 of the Act provides as under :

        “69. Effect of non-registration — (1) No suit to enforce a right arising from a contract or conferred by this Act shall be instituted in any Court by or on behalf of any person suing as a partner in a firm against the firm or any person alleged to be or to have been a partner in the firm unless the firm is registered and the person suing is or has been shown in the Register of Firms as a partner in the firm.

        (2) No suits to enforce a right arising from a contract shall be instituted in any Court by or on behalf of a firm against any third party unless the firm is registered and the persons suing are or have been shown in the Register of Firms as partners in the firm.

        (3) The provisions of sub-sections (1) and (2) shall apply also to a claim of set-off or other proceeding to enforce a right arising from a contract, but shall not affect —

            (a) the enforcement of any right to sue for the dissolution of a firm or for accounts of a dissolved firm, or any right or power to realise the property of a dissolved firm; or

            (b) the powers of an official assignee, receiver or Court under the Presidency-towns Insolvency Act, 1909 (3 of 1909), or the Provincial Insolvency Act, 1920 (5 of 1920), to realise the property of an insolvent partner.”

    2.2 The Maharashtra Amendment Act of 1984 inserted sub-section 2A in s.69 with effect from 1st January, 1985 which read as follows :

        “(2-A) No suit to enforce any right for the dissolution of a firm or for accounts of a dissolved firm or any right or power to realise the property of a dissolved firm shall be instituted in any Court by or on behalf of any person suing as a partner in a firm against the firm or any person alleged to be or to have been a partner in the firm, unless the firm is registered and the person suing is or has been shown in the Register of Firms as a partner in the firm.

        Provided that the requirement of registration of firm under this sub-section shall not apply to the suits or proceedings instituted by the heirs or legal representatives of the deceased partner of a firm for accounts of a dissolved firm or to realise the property of a dissolved firm.”

        It also replaced the aforesaid clause (a) of subs-section 3 of S.69 of the Act and the amended S.69(3) read as follows :

        “(3) The provisions of sub-sections (1), (2) and (2-A) shall apply also to a claim of set-off or other proceeding to enforce a right arising from a contract, but shall not affect —

        (a) the firms constituted for a duration up to six months or with a capital up to two thousand rupees; or”

    2.3 The net effect of the amendments in the State of Maharashtra were as follows :

        (a) A partner in an unregistered partnership firm could not file a suit for :

        (i) dissolution of the firm; or

        (ii) accounts of a dissolved firm; or

        (iii) realising the properties of a dissolved firm.

        (b) The only exception when he could do so was where the firm was only 6 months old or its capital was up to Rs. 2,000 only.

Thus, a partnership firm could come into existence without being registered, but it could not go out of existence (dissolved) since it was not registered.

III. Principles laid down by the SC

    3.1 The Bombay High Court had upheld the validity of the above provision which prevented a partner of an unregistered firm from suing for dissolution. Aggrieved by this decision, the appellant, V. Subramaniam, preferred an appeal before the Supreme Court. The Supreme Court laid down various important principles in its judgment.

    3.2 Firm not a separate legal entity

    The Court observed that unlike in the case of a company, a firm is not a separate legal entity and it does not have a personality distinct from its partners. The registration of a firm also does not give it the status of an artificial juridical person. The partners are the real owners of the firm’s property. The property belongs to the partners. This position is distinct from that in the case of a company.

3.3 Constitutional validity

3.3.1 The Supreme Court held that Art. 300A of the Constitution states that no person shall be deprived of his property except by authority of law. Sub-section 2A deprived a partner from his share in the property of the firm and that too without any compensation. The Court observed the various ways in which deprivation of property can take place by :

(a) Destruction   of property   as held  in Chiranjit  Lal Chowdhuri  vs. UOI, AIR
1951 SC 41.

b) Confiscation   of property  as held  in Ananda Behera vs. State of Orissa, AIR 1956 SC 17.

c) Revocation of a proprietary right granted by a ‘private proprietor’ as held in Virendra Singh vs. State of U.P., AIR 1954 SC 447.

d) Seizure of goods as held in Wazir Chand vs. State of H.P., AIR 1954SC 415 or seizure of immovable property as held in Virendra Singh vs. State of U.P., AIR 1954 SC 447.

e) By assumption of control of a business in exercise of the ‘police power’ of a State as per the decision in Virendra Singh vs. State of U.P.

f) A municipal  authority,  which,  under statutory powers, pulls down dangerous premises as per the decision in Nathubhai Dhulaji vs. Municipal Corporation, AIR 1959 Born. 332.

g) An insolvent being divested of his property as per the decision in Vajrapuri Naidu, N. vs. New Theatres, Carnatic Talkies Ltd., 1959(2) MLJ 469.

3.3.2 The Court also held that the amendment was violative of Art.14 of the Constitution which guarantees the right to equality. Under the present law, partners of an unregistered firm were placed on an unequal footing vis-a-vis partners of a registered firm. Further, the amendment was ultra vires Art, 19(1)(g) which guaranteed all persons the right to practise any profession or trade. The State was empowered to reasonable restrictions on this right. However, a reasonable restriction meant that the limitation should not be arbitrary or unjust or excessive. A proper balance should be struck between the restriction and the fundamental right of freedom granted by Art. 19. A law is invalid if it is arbitrary and of excessive nature and goes beyond what is in public interest as held by the Supreme Court in Maneka Gandhi vs. UOI, AIR 1978 SC 597.

3.3.3 The Court observed that the amendments were crippling in nature. It would have the effect that the partnership cannot be put to an end by filing a suit for dissolution. It may happen that a dishonest partner who was in control of the business or if he is stronger than the rest, can deprive the other partners of their dues from the firm. This would be extremely unjust and unfair. The Court observed that the Section created a situation, where businessmen will be very reluctant to enter into unregistered firms since they would not be able to dissolve the firm and get back the money which they have got in the firm.

IV. Conclusion

The Court ultimately held that the amendment was ultra vires of Art. 14, 19(1)(g) and 300A of the Constitution and hence, it was struck down as being unconstitutional. Accordingly, the Act in Maharashtra should now be read as if it does not contain sub-section (2A) and the revised clause (a). Thus, a partner of an unregistered firm can now sue for dissolution or for accounts or for property of such a firm.

AGRICULTURAL LAND LAWS : BTALA, 1948

Laws and Business

(In this Article, we continue with our study of the
Bombay Tenancy and Agricultural Lands Act, 1948 (‘Act’)
which deals with
certain aspects of the law relating to agricultural lands in the State of
Maharashtra.)


Transfers to non-agriculturists :


U/s.63 of the Act, any transfer, i.e., sale, gift,
exchange, lease, mortgage with possession of agricultural land in favour of any
non-agriculturist is not be valid unless it is in accordance with the provisions
of the Act. The terms sale, gift, exchange and mortgage are not defined in this
Act and hence, the definitions given under the Transfer of Property Act, 1882
would apply.

This section could be regarded as one of the most vital
provisions of this Act since it regulates transactions of agricultural land
involving non-agriculturists. Even if a person is an agriculturist of another
State, say Punjab, and he wishes to buy agricultural land in Maharashtra, then
section 63 would apply. An important exception to the provisions of section 63
would be in the case of succession to agricultural land by a non-agriculturist.
Thus, if the legal heirs of an agriculturist are non-agriculturists or if the
legatees under his will are non-agriculturists, even then the succession/bequest
in their favour would be valid. In law, succession to property cannot lie in a
vacuum and the BTALA would not override succession laws [refer Ghanshyambhai
v. State of Gujarat,
(1999) 2 Guj. LR 1061].

Similarly, any transfer in favour of an agriculturist of any
land exceeding the ceilings fixed under the Maharashtra Agricultural Lands
(Ceiling on Holdings) Act, 1961 (which we would be examining in subsequent
Articles)
is not valid unless it is in accordance with the provisions of the
Act.

The above transfers can be done with the prior permission of
the Collector, subject to such conditions as he deems fit. However, he would not
grant such a permission if the buyer is a non-agriculturist and his income from
other sources is more than Rs.5,000 per year.

Some of the conditions under which the Collector would grant
permission for the transfer of an agricultural land are as follows :

(i) the land is required for non-agricultural purposes; or

(ii) the land is required for the benefit of an
industrial/commercial/educational/charitable undertaking; or

(iii) the land is being sold in execution of a decree of a
Civil Court for arrears of land revenue; or

(iv) the land is being gifted by way of a trust or
otherwise bona fide by the owner in favour of his family member.

Once the permission has been granted by the Collector it must
be acted upon within one year, unless extended by the Collector up to a maximum
period of five years.

If a land is transferred in violation of section 63, then
u/s.84C the transfer becomes invalid on an Order so made by the Mamlatdar. If
the parties give an undertaking that they would restore the land to its original
position within three months, then the transfer does not become invalid.

Once such an Order is passed by the Mamlatdar, the land vests
in the State Government. The amount received by the transferor for selling the
land shall be deemed to be forfeited in favour of the State. Further, the
Mamlatdar would determine the reasonable price of the land and grant the land on
a new tenure on payment of occupancy price equal to the reasonable price so
determined. The reasonable price would not be lower than 20 times the land
assessment and not more than 200 times the land assessment. Further, it would
include, the value of any structures, wells, permanent fixtures, etc., on the
land.

Transfer of land to non-agriculturists for bona fide
industrial use :


U/s.63-1A of the Act, transfer of land in favour of a
non-agriculturist without the Collector’s permission is permissible in the
following two cases :


(i) it is for a bona fide industrial use; or

(ii) it is for a special township project.




The other conditions for the above are that :


(a) the Development Control Regulations permits such an
industrial use; or

(b) the land is located within an industrial zone under
any plan prepared under the Maharashtra Regional & Town Planning Act, 1966
or any other applicable similar law; or

(c) the land is located within the area taken over by a
private developer for a special township project.


In case the total area of the land so proposed to be used
exceeds 10 hectares/25 acres, then the prior permission of the Development
Commissioner (Industries) would be required. Thus, if the purchaser of the
agricultural land is a company which desires to undertake a special township
project and it wants Foreign Direct Investment (FDI) for the same, then it would
have to ensure that the size of the plot is 25 acres or more. In such a case, it
would need the prior approval of the Development Commissioner of Industries for
first acquiring such an agricultural land.

The purchaser of the land for the above purposes must put it
to the industrial use within 15 years from the date of purchase or else the
seller has the right to repurchase the land at the price at which he sold it.
Till 2004, the limit was five years and it was extended to 15 years by the
Maharashtra Tenancy and Agricultural Laws (Amendment) Act, 2004. If the
purchaser was holding the land in 2004 and had failed to put it to use within
five years of purchase, then he can put it to industrial use within the
remaining period out of 15 years, subject to payment of certain non-agricultural
tax.


Bona fide industrial use :


Agricultural land can be purchased without approval if it is
for a bona fide industrial use which has been defined under the Act to
mean the following :

  • activity of manufacturing,

  •  processing of goods,

  •  handicrafts,

  •  activity of industrial business or enterprise,

  •  tourism activity within notified tourist places/hill stations,

  •  construction of industrial building   

  • construction of industrial buildings used for manufacturing process or power projects or ancillary industrial use, such as R&D, godown, canteens, providing housing to workers of industry,

  •     establishment of an industrial estate/co-operative industrial estate/service industry/ cottage industry units.


Special township project:

Agricultural land can also be purchased without the approval of the Collector if it is for constructing a special township project as per the Rules framed under the Maharashtra Regional and Town Planning Act, 1966. Although, in such cases apart from the permission of the Collector, special township projects require a host of other regulatory clearances, as high as 30- 35 approvals. Some of the key requirements for a special township project are as follows:

  •     It should be an integrated township
  •     The minimum area to be developed must be 100 acres for which norms and standards are to be followed as per the local byelaws. If there are no such local byelaws, then a minimum of 2,000 dwelling units for 10,000 people must be developed. The housing component must constitute at least 60% of the total area.
  •     The township must provide for a school, shopping, community centres, medical services, etc. Around 20% of the area must be designated for recreational spaces and an additional 5% for amenities.
  •     The developer must provide for basic infrastructure and public utilities. There must be a water provision of 140 litres per person.

Construction and real estate development other than what is specified above is not covered. Thus, the Collector’s permission would be required for the same.

A special township project is eligible for various sops and benefits under the Maharashtra Housing Policy. Some of the benefits are as follows:

  •     Non-agricultural permission is automatic.

  •     Government land falling under the township area shall be leased out to the developer at the current market rate.
  •     The condition that only agriculturists will be eligible to buy agricultural land is not applicable within the special township area.
  •     There is no ceiling limit for holding agricultural land by the developer of such special township project.

  •     Floating FSI is available within the township. Thus, the unused FSI of one plot can be used anywhere in the whole project.

  •     A stamp duty concession is available compared to the prevailing rate.

  •     It is partially exempted from payment of scrutiny fee while processing the development proposal.

  •     It is eligible for a 50% concession in payment of development charges.

In addition, special township projects are also eligible for external commercial borrowings under the FEMA Regulations.


Significance of Act:

This Act is very important to industry at large since it lays down the circumstances under which company/non-agriculturist can buy agricultural land. The management of companies dealing with or in agricultural land would be well advised to pay heed to the provisions of this Act or else they face the risk of losing the land altogether.


Limitation period for economic offences

Laws and Business

1. Introduction :


The Code of Criminal Procedure, 1973, (‘the Code’) provides
for the method and manner in which criminal cases, prosecutions, etc. would be
tried in the Courts. The Code also provides for the limitation period after
which the Courts would not entertain any prosecutions in respect of certain
offences (including economic offences) under various Acts. The Code also
provides for certain exceptions to these provisions, i.e., cases in which
the period of limitation does not apply. These provisions are very important,
especially, in light of the fact that recently, the Department of Company
Affairs, the SEBI, etc., have started launching prosecutions on a large scale.
This Article examines these provisions.


2. Limitation Period for certain Offences :


2.1 Under the provisions of Chapter XXXVI of the Code, the
period of limitation in respect of taking action under various enactments has
been provided. The object of enunciating a bar on prosecutions was explained by
the Apex Court in its decision in the case of State of Punjab v. Sarwan
Singh,
AIR 1981 SC 722. The Supreme Court held that the object in putting a
time limitation on prosecution is clearly to prevent parties from filing of
vexatious and belated prosecutions.

2.2 Definitions :


2.2.1 S. 467 provides that the ‘period of limitation’
means the period specified in S. 468 for taking cognizance of an offence.

2.2.2 Although S. 190 provides that a Magistrate of the first
class would take cognizance of any offence on receipt of a complaint of facts or
a report from the Police, the Code does not define the term anywhere. The term
‘cognizance’ may be defined to mean the judicial recognition or the
judicial notice of any cause of action. According to the Supreme Court in the
case of Darshan Singh, cognizance takes place at a point when a
Magistrate first takes judicial notice of an offence.

2.3 Specified periods :


S. 468 provides the periods of limitation after the expiry of
which a Court shall not take cognizance of an offence. These periods are :

(a) 6 months, if the offence is punishable with fine only,
e.g., S. 299 of the Companies Act, specifies a fine of up to Rs.50,000.

(b) 1 year, if the offence is punishable with imprisonment
for a term not exceeding 1 year, e.g., S. 292A of the Companies Act
specifies a term of up to 1 year for failure to constitute an Audit Committee.

(c) 3 years, if the offence is punishable with imprisonment
for a term exceeding one year, but not exceeding 3 years, e.g., S. 77A
of the Companies Act specifies a term of up to 2 years for buying back of
securities otherwise than in the manner prescribed u/s.77A.


When two or more offences are tried together, the period of
limitation shall be determined with reference to offence for which punishment is
more severe or where the punishment is most severe. It may be noted that no
provision has been made in case of offences punishable with more than 3 years.
Thus, S. 468 would not apply to such cases of offences.

2.4 Inapplicability of S. 468 :


The above limitation period specified in S. 468 has been made
inapplicable to certain economic offences by the Economic Offences
(Inapplicability of Limitation) Act, 1974
. Any offence under an Act or any
provisions thereof, specified in the Schedule to this Act is not affected by the
period of limitation specified in S. 468. Some of the important Acts specified
in the Schedule are as under :

(a) The Income-Tax Act, 1961

(b) The Interest Tax Act, 1974

(c) The Wealth-tax Act, 1957

(d) The Central Sales Tax Act, 1956

(e) The Central Excises and Salt Act, 1944 (now known as
the Central Excise Act, 1944)

(f) The Customs Act, 1962

(g) The Foreign Exchange Regulation Act, 1973 (it may be
noted that the Schedule has not been amended to include the Foreign Exchange
Management Act, 1999). S. 49(3) of the FEMA provided for a limitation period
of 2 years from the date of its commencement for any Court/officer to take
cognizance of an offence committed under FERA. This period expired on 1st May
2002.

(h) The Capital Issues (Control) Act, 1947 (it may be noted
that the Schedule has not been amended to include the Securities & Exchange
Board of India Act, 1992)

(i) The Indian Stamp Act, 1899

(j) The Industries (Development and Regulation) Act, 1951

2.5 Maharashtra State Amendments :


In addition, in the State of Maharashtra, by virtue of the
Maharashtra Taxation Laws Offences (Extension of Period of Limitation) Act,
1977,
Chapter XXXVI of the Code has been made inapplicable to any offences
punishable under the following Acts :

(a) The Bombay Sales Tax Act, 1959

(b) The Maharashtra State Tax on Professions, Trades,
Callings and Employments Act, 1975

Further, by virtue of the Maharashtra Taxation Laws
Offences (Extension of Period of Limitation) Act, 1981,
the period of
limitation in the State of Maharashtra, in respect of offences under certain
Acts has been extended to the time specified therein instead of the time
specified in S. 468 of the Code. The extended period of limitation for these
offences is as under :

(a) 3 years where the total amount of tax or duty involved
in the case of the said offence is Rs.25,000 or more; and

(b) 1 year in all other cases

An important Act to which this extended period applies is the
Bombay Stamp Act, 1958.

2.6 Computation of the period :


The period of limitation u/s.469 of the Code, commences :


(a) on the date of the offence; or

(b) where the commission of the offence was not known to the person aggrieved by the offence or to any police officer or the identity of the offender is unknown :

2.7 Continuing offence:

S. 472 provides that for a continuing offence, a fresh period of limitation begins to run at every moment of the time during which the offence continues. The term continuing offence has not been defined and thus, one must depend upon the language of the Act. In Maya Rani Punj v. CIT, 157 IT 330 (SC), the Supreme Court observed that if a duty continued from day to day, then its non-performance from day to day was a continuing wrong. The Madras High Court’s decision in the case of C. K. Ranganthan v. ROC, 45 SCL 500 (Mad.) has held that an offence u/s.211(7) of the Companies Act, 1956, i.e., relating to non-compliance of the balance sheet and profit loss account with the requirements of S. 211 and Schedule VI, is not a continuing offence. It is a one-time offence and there is a period of limitation which must be filed within one year as per S. 468(2)(b) of the Code. The Court further held that non-compliance of financial statements with the requirements of Schedule VI gives rise to a single default and to a single punishment. The provision does not contemplate that the obligation to secure compliance continues from day-to-day until the compliance is actually met, nor does it provide that continuance of business without securing compliance becomes a continuing offence. The Court also held, relying upon its earlier decision in the case of Asst. ROC v. H. C. Kothari, 75 Compo Cas. 688 (Mad), that the ROC was deemed to have knowledge of the offence when the statements were received by him. Hence, the period of limitation of one year would also commence from such date.

3. Auditor’s duty:

The Auditor can provide value added services to his clients by enlightening them about the periods of limitation in respect of any likely prosecutions against them or any suits which they have preferred against any person. He should enquire during the course of his audit as to whether any prosecution proceedings have been launched against the auditee or its officers and what would be the consequences. This becomes very important when dealing with offences under the Companies Act, Rent Act, Bombay Stamp Act, Registration Act, etc. It needs to be repeated and noted that the audit is basically under the relevant law applicable to an entity and an auditor is not an expert on all laws relevant to business operations of an entity. All that is required of him is exercise  of ‘due  care’.

Real Estate Laws: Recent Developments-II

Laws and BusinessI. Stamp Duty Ready Reckoner 2010


1.1 The State Government has issued the Ready Reckoner for
computing the Fair Market Values for immovable property in Maharashtra for the
year 2010. As expected, the property rates in Mumbai have been increased by
10-20% compared to last year. The state government expects to mobilise Rs.
5,075 crore as revenue through stamp duty and registration fee by the end of
2009-10 and hence, it has hiked the rates to achieve its target. Stamp duty is
only second to VAT in terms of revenue earners for the State of Maharashtra.
Even though on one hand, the State has reduced the peak duty rate to 5% when
compared to other States, it has on the other hand, consistently increased the
Reckoner rates which have more than compensated for the fall in duty rates.
Thus, the State has been able to increase its Stamp Duty revenue year after
year. Readers may be interested to know that as far back as in 1993, the State
Government had given an undertaking before the Bombay High Court in the case
of Ashok Bansilal Mutha v State of Maharashtra & Ors. (Contempt Petition No.
28 of 1993), that it will not use the Ready Reckoner for calculating stamp
duty. In spite of this, the Sub-registrars always insist upon payment of duty
as per the Reckoner.

1.2 There are no changes in the Valuation Guidelines. The
rates mentioned in the Reckoner are on a per square metre of built-up area
basis, i.e., the same as previous years. There were news reports that the
Reckoner would be aligned with the amendment to the Maharashtra Ownership Flat
Act and that henceforth the property rates would be on a carpet area basis.
This would have enabled parity between the Flat Ownership Agreement and the
Reckoner rates. However, the 2010 Reckoner continues with the built-up area
pricing only. All other valuation parameters are the same as before.

1.3 When one considers the hike in the registration fee
along with the hike in the Reckoner rates, it is a double whammy for property
buyers. It is high time that the Ministry of Urban Development, along with the
Ministry of Housing and Urban Poverty Alleviation crack the whip by
threatening to refuse disbursement of funds to the State under the Jawaharlal
Nehru National Urban Renewal Mission (JNNURM). Only then can we expect some
relief and rationalisation of stamp duty rates and /or property values.


II.
Property Tax Calculation




2.1 Currently, the BMC levies a property tax based on the
Rateable Value of flats. Under the rateable value system, property tax is
based on the expected rent which a property can fetch. In the case of owner
occupied properties, the rateable value is arrived at on the basis of a
schedule of rates prepared by the BMC for different buildings. In these rates,
what is noteworthy is that newer buildings have a higher rateable value as
compared to older buildings. Accordingly, newer buildings, no matter where
located, would pay a higher tax as compared to older buildings, no matter
where located. Accordingly, a new building in Dahisar would pay higher
property tax as compared to an old building in Cuffe Parade.

2.2 To rectify this anomaly and in a bid to earn more
revenue, the BMC has devised the Capital Value System of levying property tax.
This new method is to be implemented from the next financial year, i.e., from
1st April, 2010. Under the Capital Value taxation, property tax will be levied
based on the current market value of the property and not on the basis of the
erstwhile rateable value.

2.2.1 To arrive at the market value, the rates given in the
Stamp Duty Ready Reckoner are sought to be used. Once the market value is
determined on this basis, it would remain frozen for 5 years. Thus, if the
Reckoner Rates for 2010 are adopted on 1st April 2010, then they would
continue till 31st March 2015.

2.2.2 The rate of property tax would be decided every year
by the BMC in its Annual Budget. It is expected to be 0.30% to 0.45% of the
Capital Value of the Property. for example, if the Capital value of a flat at
Churchgate is Rs. 2,00,00,000, then the property tax @ 0.45% will be Rs.
90,000 per annum.

2.2.3 In computing the property tax, various factors need
to be borne in mind, such as, carpet area, use of the property, etc. In a
subsequent Article, we will examine the Capital Value System in greater depth.

2.2.4 After an increase in Reckoner Rates, removal of the
cap on registration fees, flat buyers / owners in Mumbai have been gifted one
more exploitive tax by the Government in 2010. The New Year could not have
gotten off to a better start for the real estate sector!


III. Stamp Duty on Agreements not provided for



3.1 A few years ago, Schedule I to the Bombay Stamp Act was
amended to introduce Art. 5(h) (A) which provides for a duty on any Agreement
not otherwise provided for under the Schedule and creating any obligation,
right or interest and having a monetary value. The duty was 0.1%.

Thus, all Agreements which created a monetary obligation or
an interest and which were not otherwise covered under the Act were chargeable
with duty under this Article. These included Share Subscription Agreements for
PE Funding, etc.

3.2 The 2009 Amendment Act has increased the duty under
this Article. Accordingly, the stamp duty would be 0.1% in case the value of
the agreement is Rs. 10 lakhs or less. In the case of an agreement which
exceeds Rs. 10 lakhs in value, the duty would now be @ 0.2% of the amount
agreed in the contract. E.g., in case a real estate fund agrees to invest Rs.
100 crores in a real estate project, the Share Subscription Agreement would
now be stamped with a duty of Rs. 20 lakhs.

Accounting Frauds : Prosecution under IPC

Laws and Business

1. Introduction :


1.1 Accounting frauds and scams, from being rare, are
becoming a norm. India has also had its share of frauds. Corporate India is yet
reeling from the recent case of Satyam Computers, an instance where the
promoters, CFO and auditors have been taken into ‘custody’. At a time like this,
it is relevant to consider penalties prescribed under the Indian laws for such
frauds.

1.2 Punishment for offences relating to accounting fraud,
forgery, etc., in case of companies are prescribed under two Statutes — the
Companies Act, 1956 and the Indian Penal Code, 1860 (‘the Code’).
Criminal Law in India is mainly governed by two major Acts : the Indian Penal
Code, 1860 and the Criminal Procedure Code, 1973. While the Indian Penal Code
deals with what can be considered as an offence and the punishment for various
offences, the Criminal Procedure Code, 1973 prescribes procedures and
formalities which must be followed in trying an offence.

1.3 As chartered accountants we rarely bother about criminal
law . . . However, Satyam’s case indicates that sometimes willingly or
unwillingly, we may become a party to criminal proceedings. Hence, it becomes
necessary to at least have a fair understanding about the basics of criminal
law. Further, even in cases of economic offences, criminal cases may be
initiated against companies, its officers and businessmen. In such an event it
would be of great assistance if we have some knowledge of criminal law. This
article examines some of the punishments prescribed under the Code for
accounting frauds
. Some of the sections herein examined are those which form
part of the chargesheet filed by the Police in Satyam’s case.

2. Falsification of Accounts (S. 477-A) :


2.1 S. 477-A of the Code expressly deals with
Falsification of Accounts
. It makes falsification of books and accounts
punishable. It also makes the act of making false entries or
omitting or altering any false entry punishable.

2.2 S. 477-A deals with the following two types of distinct
offences :


à
Falsification of accounts


à
Making of false entries



2.3
Falsification of Accounts :




à
The offender must be a clerk, officer or a servant.


à
He must have acted willfully and with an intent to defraud.


à
He must either destroy, alter, mutilate, falsify any book, electronic record,
paper, writing, valuable security, or account.


à
The above-mentioned documents must be of his employer.




2.4
Making False Entries :




à
The offender must be a clerk, officer or a servant.


à
He must have acted willfully and with an intent to defraud


à
He makes/abets any false entry or omits/ alters/abets the making of any
entry from any book, electronic record, paper, writing, valuable security, or
account.



2.5 The punishment for both the above-mentioned type of
offences is an imprisonment up to 7 years and/or a fine. The offence is a
non-cognisable offence under the Criminal Procedure Code. A non-cognisable
offence would mean one where the police can arrest only on the basis of a
warrant issued by a Magistrate. The police cannot arrest an accused merely on
the basis of a complaint, etc., like they can in the case of grievous crimes,
such as murder. The accused can get a bail against this offence.

2.6 For a charge u/s.477-A, it is not necessary to
show the following evidence that :


à
any particular person was defrauded. A general intent to defraud is enough.


à
any specific sum of money was involved.


à
the offence was committed on a particular date.



2.7 The person charged of the offence — the offender — must
be either a clerk, officer or a servant. Any other person is not covered by S.
477-A. The person must be employed by the employer in either of three
capacities. There must be an employer-employee relationship Hari
Prasad v. State of UP,
1953 Cr. Lj 1496 (All). It has been held that
if a partner of a firm also has dual responsibilities to manage the business, or
write up the firm’s accounts, then he would be covered under this Section and
can be prosecuted for any such offence. A working director/managing director
would be a servant of his employer, i.e., the company.

2.8 Intention to defraud is essential to attract this
Section. Thus, something which is not true must be passed off as true with an
intention to cause some kind of injury to property. Two essential elements are,
deceit and injury. Hence, either there must be a suppression of the
truth
or there must be a suggestion of a lie.

2.9 An important principle to note is that the sanction of the Company Court is not needed for prosecuting the managing director of a company in liquidation for an offence u/s.477-A of the Code. The Companies Act does not impact proceedings instituted by the Liquidator – C. Hanumantha Rao v. T. S. Rama Rao, AIR 1961 AP 493.

3. Forgery  (S. 465) :

3.1 S. 465 punishes an act of forgery with a term of up to 2 years and/ or fine.

3.2 The term forgery    is defined  in S. 463 to mean:

  • the act of making a false document or part I thereof

  • with  an intent  to :

  • cause damage or injury to a person or to the public
  • support any claim or title
  • cause any person to part with any property
  • cause any person to enter into any contract
  • commit fraud

3.3 Forgery takes place only when a false document is made with an intent of causing damage or injury to any person. A false document is one where the person making it does so with the intention that it appears to have been made by another person.
 
4. Forgery  of a Valuable Security (S. 467) :

4.1 S. 467 of the Code deals with an offence of a forgery of a valuable security. The important facets of this Section are as follows:

  • there must  be a forgery.

  • it must be in respect of a valuable security, or must give authority to a person to make or transfer a valuable security or to receive principal, interest or dividend thereon. A valuable security is a document whereby any legal rights are created, extended, transferred, extinguished, released, etc. In Hari Prasad v. State of UP, 1953 Cr. Lj 1496 (All), it was held that account books containing entries which are not signed by any party are not valuable security.

  • it could also be in respect of a document acknowledging the payment or money or a receipt.

4.2 The punishment for the offence is imprisonment for life or with imprisonment for a term of up to 10 years. It also attracts a fine.

5. Forgery  for Cheating (S. 468) :

5.1 S. 468 punishes a ‘forgery’ which is done for the purposes of cheating. It covers a forgery of a document or an electronic record which is done with the intention that such document/record shall be used for cheating. Falsification of books of accounts for the purposes of cheating are covered under this Section – Banessur Biswas (1872) 18 WR (Cr) 46.

5.2 S.415 definesthe term  ‘cheating’ as follows:

There must be a deceit of a person by fraudulent or dishonest means.

As a result of such deceit, the other person must either:

  • deliver  property to another  person;  or
  • consent to retention of property by another person; or
  • do or omit to do anything which he would not do

The above act or omission must cause damage or harm to mind, body, reputation or property of the person.

In the above case, the offender who deceives is said to cheat the other person.

5.3 It is noteworthy that the Section states the of-fender must have an intention of cheating while committing the forgery. Actual cheating or the fact that someone has indeed been cheated is not material to attract this Section. It is required to prove that the document has been forged by the accused and the accused did so with an intention of cheating.

5.4 The punishment prescribed for such an offence u/s.417 is imprisonment of up to 7 years and also fine. This offence is also a non-cognisable offence punishable by a Magistrate.

6. Using a Forged Document as a Genuine Document (5. 471) :

6.1 According to the provisions of S. 471, if any person fraudulently or dishonestly uses any document or an electronic record as genuine when he knows or believes that the same is actually a forged document/record, then he is punishable as if he had actually forged the same.

6.2 This Section does not prescribe any penalty for the offence, but treats it as a case of a forgery. Thus, it is essential to first see whether the document is indeed a forged document. If yes, then S. 471 can be applied. The onus is on the prosecution to demonstrate that the document is forged and that the offender knew about the forgery and yet used the same as an original document in either a fraudulent or dishonest manner.

7. Cheating to cause wrongful loss (5. 418) :

7.1 S. 418 of the Code is attracted if the following conditions are satisfied:

  • the offender was under an obligation imposed by law or legal contract to protect the interest of a person.

  • the offender actually cheated a person.

  • the offender cheated with the knowledge that he is likely to cause wrongful loss to the person cheated.

7.2 S. 418 applies to people who are entrusted with the responsibility of protecting other’s interest under a legal/contractual obligation. These include, bankers, trustees, advocates, etc. In one case the directors and accountant were accused of preparing a false balance sheet to mislead the public to induce them to deposit money with the bank. They were held to be liable of an offence under this Section. In the very old case of Giles Seddon v. S. J. Loane, (1910) 11 CrLj 624, the Madras High Court held that the mere fact that the balance sheet was false was not adequate to attract the provisions of this Section. The guilty knowledge of the director cannot be presumed from the mere fact that he authorised the issue of a balance sheet containing false entries but must be decided on a consideration of all the facts and circumstances, e.g., the nature of the false statements, the materiality of the amounts involved in the false entries, the ease or difficulty with which their truth or falsity could be ascertained, the course of business of the company, the position, individual standing of the directors, etc. The Court further held that mere mistakes in the classification of a debt as doubtful or bad is a matter on which experts might differ and that by itself does not warrant a case for cheating. There must exist some other corroborative evidence to show that all this was intended to be a part of a larger scheme of things conceived to deceive and cheat people. The same would even apply to a misrepresentation by way of an omission. In this case, debts due by directors were not dis-closed separately.

This is a very old judgment, almost 100 years old, and one wonders how the Courts of today would view the principles enunciated therein ?

8. Cheating  to induce  delivery  of property (S. 420):

8.1 If cheating is done with an intention of dishonestly inducing the person deceived to deliver any property to any person, or to make alter or destroy a valuable security, then it is punishable u/s.420 of the Code. S. 420 of the Code is one of the more popular Sections of the IPC and one which is known even by laymen. What is necessary is that the act of cheating (as defined in S. 415) must be done to induce the person cheated to part with his property.

8.2  S. 420 is different in its application from S. 417 simple cheating. In the case of a simple cheating, there is no delivery of property, whereas it is an essential ingredient of S. 420.

8.3 An act of issuing a cheque when there are insufficient funds in the payer’s bank account would also constitute an offence punishable u/ s.420 if it can be demonstrated that the cheque caused deception from inception. In such a case, the act would be punishable under the Negotiable Instruments Act as well as S. 420 of the IPC.

8.4 This offence is punishable with an imprisonment of a term which extends up to 7 years and also fine.

9. Criminal Breach  of Trust (5. 409) :

9.1 Certain categories of people are guilty of an offence u/ s.409 of criminal breach of trust if they being entrusted with any property have committed a criminal breach of trust in respect of the same. The categories covered includes 7 classes – public servants, bankers, brokers, factors, merchants, attorneys and agents. Such people are considered to be men of trust in whose control people entrust property. If they commit a criminal breach of trust, they are guilty u/s.409. A criminal breach of trust happens when a custodian of a property converts it to his own use or misappropriates the same for his use or dishonestly uses that property in violation of any law or contract. For example, an agent who is entrusted with his principal’s funds with instructions to only invest them in mutual funds, invests the funds in his family companies, he is guilty of criminal breach of trust. Similarly, if an advocate is an escrow account holder for a transaction and instead of investing the money in instruments instructed by the party, he invests them in his own firm, he would be guilty under this Section.

9.2 A question which arises is whether a director can be covered under this section, i.e., can he be treated as an agent of the company and covered by S. 409 if he misappropriates the property? In the case of R. K. Dalmia v. Delhi Administration, 32 Comp Cas 699 (SC), the Supreme Court held that funds which a company has in its bank account are property of the company within the meaning of the Code and persons having power to operate on that account will be guilty of criminal breach of trust if by operating on that account funds are misappropriated. Further, a director is an agent as well as a trustee of a company within the meaning of S. 409 of the Code and thus, if a director has misappropriated the company’s property, then he too can be covered by this Section.

10. Directors’ responsibilities:

10.1 The number of prosecution cases involving companies has increased recently. There is an increasing need for directors, including independent directors to be aware of the prosecution possible under Criminal Law.

10.2 Being aware  of consequences under the law would make them more diligent and vigilant in the discharge  of their  duties.

ENVIRONMENTAL LAWS

Laws and Business

1. Introduction :


1.1 The environment in which businesses operate is extremely
important and valuable. If it is not preserved it would be lost forever since it
is rapidly depleting. Pollution of the environment is one of the main culprits.
Pollution could be of air, water, noise and could be caused by sewage,
effluents, waste, bio-medical waste, release of chemicals or smoke, etc. in the
air, noxious chemicals, etc.

1.2 Businesses need to follow the principle of sustainable
development and have legal and moral responsibility towards preserving the
environment. To protect and preserve the environment, the Government has enacted
various laws. Let us briefly examine some of the important Central enactments on
this subject.

1.3 The Courts are also taking a very strict view when it
comes to violation of environmental laws and have not hesitated in prosecuting
directors responsible along with offending companies. A recent judgment of the
Supreme Court in the case of UP Pollution Control Board v. Dr. B. K. Modi,
(2009) 2 SCC 147, has examined this issue in the context of discharge of
pollutants by a company in the river. The company, Modi Carpets was prosecuted
by the Board for discharging noxious effluents in the Sai River. The Pollution
Control Board also filed a criminal complaint against the Directors and MD. The
Allahabad High Court quashed the operation of the complaint against the MD by
holding that there was no material to prove that he was responsible for the
daily conduct of the business or that the offence was committed by his consent
or connivance. The SC referred to its earlier decision in the case of UP
Pollution Control Board v. Mohan Meakins Ltd., (2000) 3 SCC 745. In that case
also, the Directors were sought to be prosecuted for discharge of effluents by
the company in a river. In that case, the SC observed that in view of the
specific averments in the complaint against the Directors, the prosecution of
the Directors was permitted. The SC further observed in the impugned case, that
in matters of public health, the Courts cannot afford to take matters lightly.
All persons big or small should share the parliamentary concern over the
escalating pollution levels. Those who discharge effluents in the environment
should be dealt with sternly, irrespective of technicalities. Hence, the Court
ruled that the Magistrate should proceed with the complaint against the MD and
declined to quash the proceedings against him. Thus, compliance with
environmental laws has become extremely important.


2. Environment
(Protection) Act, 1986 :


2.1 This is a general Act which deals with
the protection and improvement of the environment. Although there were specific
Acts which dealt with air, water, and other pollution, the need was felt for a
general Act which would cover other environmental hazards which were left out.
The Act fixes responsibilities on persons carrying out industrial operations or
those who handle hazardous substances to comply with prescribed safety standards
and also to control and prevent pollution arising from the same. The Government
lays down various standards for the same under the Act and also requires the
filing of information, inspections, etc.


2.2 Definitions :


The Act defines the term environment to include water, air
and land and the inter-relationship which exists among and between water, air
and land and human beings, other living creatures, plants, micro-organisms and
property.


An environmental pollutant is any solid, liquid or
gaseous substance present in such concentration as may be or tend to be
injurious to the environment.

The all important term ‘environmental pollution’ means
the presence of any environmental pollutant in the environment.

A hazardous substance means any substance or
preparation which by reason of its chemical or physico-chemical properties or
handling is liable to cause harm to human beings, other living creatures,
micro-organisms, property or the environment.


2.3 Obligations :


2.3.1 The Act lays down various obligations on industries,
factories, etc. It prohibits the carrying on of any industry, operation or
process which discharges or emits any environmental pollutant in excess of the
prescribed standards. The standards are prescribed under the Environmental
Protection Rules, 1986. Further, no person can handle any hazardous substance
otherwise than in accordance with the prescribed safety standards.

2.3.2 If the discharge of any pollutant is or is likely to be
in excess of the prescribed standards, then the person responsible should take
steps for prevention or mitigation of the pollution and should also furnish
certain prescribed information to the authorities of the same. The authorities
would then take such remedial measures as are necessary, at the cost of the
polluter.

2.3.3 The Act prescribes for powers of entry, inspection,
examination, testing, searching, etc. of any place in connection with the
prevention of environmental pollution. The person so authorised can take samples
of air, water, soil or other substances for this purpose. However, he needs to
comply with the procedure prescribed in this respect.

2.3.4 The Act also empowers the Government to establish
environmental laboratories for carrying out certain inspection, testing,
analysis, functions under the Act.


2.4 Penalties :


Whoever contravenes any provisions of the Act or Rules, is
punishable with imprisonment up to five years or with a fine up to Rs.1 lakh or
both. Continuing defaults attract a fine of Rs.5,000 per day. Where the
contravention continues beyond a period of one year from conviction, the
punishment is an imprisonment of up to seven years.


2.5 Environmental
clearance :


The Government is empowered to prohibit or restrict the
location of industries, operations, in certain areas keeping in mind maximum
allowable limits of concentration of environmental pollutants, the climatic
features, the net adverse environmental impact, the proximity of the proposed
project to protected areas, etc.


2.6 Environmental
audit :


Every person carrying on an industry, operation or process
requiring consent under the Water Pollution Act, Air Pollution Act, and the
Hazardous Wastes Rules must submit an environmental statement for every
financial year to the State Pollution Control Board.


2.7 Rules :


The following Rules have been framed under the Act :

    a) Environmental (Protection) Rules, 1986

    b) Hazardous Wastes (Management and Handling) Rules, 1989

    c) Manufacture, Storage and Import of Hazardous Chemicals Rules, 1989

    d) Manufacture, Use, Import, Export and Storage of Hazardous Micro-Organisms/Genetically Engineered Organisms or Cells Rules, 1989

    e) Chemical Accidents (Emergency Planning, Preparedness and Response) Rules, 1996

    f) Bio-Medical Waste (Management and Handling) Rules, 1998

    g) Plastics Manufacture Sale and Usage Rules, 1999

    h) Noise Pollution (Regulation and Control) Rules, 2000

    i) Ozone Depleting Substances (Regulation and Control) Rules, 2000

    j) Municipal Solid Wastes (Management and Handling) Rules, 2000

    k) Batteries (Management and Handling) Rules, 2001

    l) Hazardous Wastes (Management, Handling and Transboundary Movement) Rules, 2008
    
3. Air (Prevention and Control of Pollution) Act, 1981 :

3.1 This is a specific Act dealing with prevention, control and abatement of air pollution.

3.2  Definitions :

Air pollutant means any solid, liquid or gaseous substance including noise which is present in the atmosphere in such concentration as may be or tend to be injurious to human beings or living creatures or plants or property or environment.

Air Pollution means the presence of any air pollutant in the atmosphere.

Emission means any solid, liquid or gaseous substance coming out of any chimney duct or other outlet.

3.3 The Act provides for establishing Central and State Pollution Control Boards for prevention of air pollution. The same Boards also serve as Boards for water pollution. The Central Boards can establish or recognise laboratories to assist the Board in carrying out its functions. The State Boards lay down standards for emission of air pollutants into the atmosphere from industrial plants and automobiles or for the discharge of any air pollutant into the atmosphere from any other source.

3.4    Prevention and control of air pollution :
3.4.1 The State Government may, after consultation with the State Board, declare any area or areas within the State as air pollution control areas for the purposes of the Act. If the State Government is of opinion that the use of any fuel, other than an approved fuel, in any air pollution control area may cause air pollution, then it may prohibit the use of such fuel in such area. It can also direct that no appliance, other than approved appliances, shall be used in the premises situated in an air pollution control area.

3.4.2 With a view to ensuring that the standards for emission of air pollutants from automobiles laid down by the State Board are complied with, the State Government shall give such instructions as are necessary to the concerned authority in charge of registration of motor vehicles under the Motor Vehicles Act, 1939.

3.4.3 No person shall, without the previous consent of the State Board, establish or operate any industrial plant in an air pollution control area.

3.4.4 No person operating any industrial plant, in any air pollution control area shall discharge or cause or permit to be discharged the emission of any air pollutant in excess of the standards laid down by the State Board.

3.4.5 If the emission of any air pollutant, is or is likely to be in excess of the standards laid down by the State Board by reason of any person operating an industrial plant or otherwise in any air pollution control area, then the Board may make an application to Court for restraining such person from emitting such air pollutant.

3.4.6 The Act gives powers to the State Board to authorise any person for entry, inspection, examination, testing, searching, etc. of any place in connection with the prevention of air pollution. The person so authorised can also take samples. However, he needs to comply with the procedure prescribed in this respect.

3.5    Penalties :

Failure to comply with the key provisions of the Act attracts a penalty in respect of each such failure, or imprisonment for a term which shall not be less than one year and six months but which may extend to six years and with fine, and in case the failure continues, with an additional fine which may extend to Rs. 5,000 for every day during which such failure continues after the conviction for the first such failure. If the failure continues beyond a period of one year after the date of conviction, the offender shall be punishable with imprisonment for a term which shall not be less than two years but which may extend to seven years and with fine.

    4. Water (Prevention and Control of Pollution) Act, 1974 :

4.1 This Act seeks to prevent and control water pollution and for maintaining or restoring the wholesomeness of water.

4.2  Definitions :

‘Pollution’ means such contamination of water or such alteration of the physical, chemical or biological properties of water or such discharge of any sewage or trade effluent or of any other liquid, gaseous or solid substance into water (whether directly or indirectly) as may, or is likely to, create a nuisance or render such water harmful or injurious to public health or safety, or to domestic, commercial, industrial, agricultural or other legitimate uses, or to the life and health of animals or plants or of acquatic organisms.

‘Sewage Effluent’ means effluent from any sewerage system or sewage disposal works and includes sullage from open drains.

‘Sewer’ means any conduit pipe or channel, open or closed, carrying sewage or trade effluent.

‘Trade Effluent’ includes any liquid, gaseous or solid substance which is discharged from any premises used for carrying on any industry, operation or process or treatment and disposal system, other than domestic sewage.

4.3 The Act provides for establishing Central and State Pollution Control Boards for prevention of water pollution. The Central Boards can establish or recognise laboratories to assist the Board in carrying out its functions. The State Boards lay down standards for sewage and trade effluents and for the quality of receiving waters, works for the purification thereof and the system for the disposal of sewage or trade effluents.

4.4 Prevention of water pollution :

The State Government can restrict the application of the Act to certain areas, known as Water Pollution Prevention and Control area. No person shall cause any poisonous, noxious or polluting matter to enter into any stream or well or sewer or on land.

The State Board may make surveys of any area and gauge and keep records of the flow or volume and other characteristics of any stream or well in such area. A State Board may give directions requiring any person who in its opinion is abstracting water from any such stream or well in the area in quantities which are substantial in relation to the flow or volume of that stream or well or is discharging sewage or trade effluent into any such stream or well, to give such information as to the abstraction or the discharge at such times and in such form as may be specified in the directions.

The  State  Board  is  empowered  to  samples  of effluents or sewage or trade effluents. The Act gives powers to the State Board to authorise any person for entry, inspection, examination, testing, searching, etc. of any place in connection with the prevention of water pollution.


4.5 No person shall, without the previous consent of the State Board :

    a) Establish or take any steps to establish any industry, operation or process, or any treatment and disposal system or any extension or addition thereto, which is likely to discharge sewage or trade effluent into a stream or well or sewer or on land.

    b) Bring into use any new or altered outlet for the discharge of sewage.

    c) Begin to make any new discharge of sewage.

The Act lays down the procedure for the same.

4.6 Penalties :

Whoever fails to comply with any directions on information about abstraction of water or discharge of effluence or information regarding construction, installation or operation of any establishment of or any disposal system shall, on conviction, be punishable with imprisonment for a term which may extend to 3 months or with fine which may extend to Rs.10,000 or with both and in case the failure continues, with an additional fine which may extend to Rs.5,000 for every day during which such failure continues after the conviction for the first such failure.

Certain other offences are punishable with imprisonment for a period ranging from 18 months to 6 years and with fine. Continuing offences attract a fine of Rs.5,000 per day. Where such a failure continues beyond one year, the offender can be punished with imprisonment for a term of 2 to 7 years.

    5. Director’s responsibilities :

5.1 The Board of Directors should enquire of the company’s compliance with the environmental laws. This especially true in the case of industries where environmental law compliance is critical to the survival of the entity. The recent example of the oil spill by British Petroleum in the Gulf of Mexico is an example in this direction. The issue has escalated into a high-profile political issue and could end up causing substantial losses to BP.

5.2 The company must designate a Compliance Officer to ensure compliance with various environmental laws. He must be a person who is well versed with the legal and commercial field. At every Board Meeting, the Compliance Officer should be asked to table a Compliance Certificate certifying compliance with all environmental laws. This should also be preferably signed by the Managing Director and/or the Whole-Time Directors and must be backed up with supporting certificates from various departmental heads who are responsible for compliance at an operational level.

    6. Auditor’s duty :
6.1  In case the Auditor comes across a serious violation of environmental laws, then he should consider obtaining an opinion on its validity and/ or appropriate disclosure in the accounts and his report. In case of a hazardous chemical company, a serious lapse of an environmental law can make or mar the future of the company. In some cases, it could affect the ‘going concern concept’ of the company.

6.2 It needs to be repeated and noted that the audit is basically under the relevant law applicable to an entity and an auditor is not an expert on all laws relevant to business operations of an entity. All that is required of him is exercise of ‘due care’. By broadening his peripheral knowledge, the Auditor can make intelligent enquiries and thereby add value to his services.

Competition Law

I. Introduction

    India has embraced globalisation and liberalisation by throwing open its doors for large corporate houses, both Indian and foreign. Earlier restrictions have been removed, barriers reduced, etc. Even the Monopolies and Restrictive Trade Practices Act which, for quite some time, was the bane of the Indian Industry has been watered down to near insignificance. It is in this background that the Parliament thought it fit to introduce a legislation to curb monopolies and promote competition. Competition is essential for the working of any economy to reduce economic inequalities. The Competition Act, 2002 (‘the Act’) is a step in this direction. The Act contains two aspects, one dealing with anti-competitive agreements, abuse of dominant position, etc., and the other dealing with the regulation of certain business combinations, such as mergers, acquisitions, etc. which have an adverse effect on competition. Recently, the Government has appointed the Chairman and two members of the Commission. The Commission is expected to begin hearings on matters of anti-competitive agreements and abuse of dominant positions soon. This Article deals with some of the salient features of the Act dealing with the regulation of business combinations. The provisions of the Act have overriding effect on any other inconsistent statute, e.g., Companies Act, Stamp Duty, FEMA, etc.

II. Background

    2.1 Many countries such as the USA have an Anti-trust Law which aims at preventing monopolies and mega mergers which impede competition. These laws need to be also considered while structuring a cross-border merger. In UK, mergers and acquisitions may need the approval of the Monopolies and Mergers Commission. For instance, in the USA certain business combinations require filings and clearances with the Federal Trade Commission (FTC) or Department of Justice (DOJ) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the HSR Act). The HSR Act requires parties to a merger to file certain information before the FTC and the DOJ before the merger proceeds. There is a minimum waiting period after filing the information with these agencies.

    For instance, the acquisition of Honeywell by GE, ran into various problems under the Anti-trust provisions especially with the European Union. It was probably one of the rare acquisitions in which Mr. Jack Welch failed.

    2.2 The U.K. Competition Act, 1998 is also a legislation in this direction. Similar provisions exist under the European Commission Regulations.

    2.3 The Act seeks to ensure fair competition in India by the creation of a Competition Commission of India. The Commission would have a Principal Bench and several Additional Benches, including Merger Benches.

III. Business Combinations

    3.1 Ss. 5 and 6 of the Act deal with the regulation of certain business combinations. While s. 5 defines the combinations which are covered within the purview of the Act, s. 6 lays down the regulations which would apply to such business combinations.

    3.2 Combinations covered by s. 5

        In certain cases the :

        (i) acquisition of any enterprise(s) by any person(s); or

        (ii) merger/amalgamation of enterprises

        shall be treated as a combination of such enterprises and persons (in case of an acquisition) or enterprises (in case of an merger/amalgamation). These cases are as stated hereunder.

    3.3 Acquisitions treated as combinations

    Any ‘Acquisition’ where :

    (a) the Acquirer and the Target Enterprise (i.e., whose control, shares, voting rights or assets are being acquired) jointly have :

    (i) in India assets of a value exceeding Rs.1,000 crores; or

    in India a turnover of a value exceeding Rs.3,000 crores; or

    (ii) in India or abroad, in aggregate :

    (A) assets of a value exceeding US$ 500 million; or

    (B) turnover of a value exceeding US$1,500 million

    (b) the group to which the Target Enterprise would belong post-acquisition would jointly have :

    (i) in India assets of a value exceeding Rs. 4,000 crores; or

    in India a turnover of a value exceeding Rs. 12,000 crores; or

    (ii) in India or abroad, in aggregate :

    (A) assets of a value exceeding US$ 2 billion; or

    (B) turnover of a value exceeding US$6 billion

    Any acquisition of control by a person over an enterprise in a case where he already has direct or indirect control over another similar enterprise which is engaged in the production, distribution or trading of similar/identical/substitutable goods or services, if :

    (a) the Acquirer and the Target Enterprise jointly have :

    (i) in India assets of a value exceeding Rs. 1,000 crores; or

    in India a turnover of a value exceeding Rs. 3,000 crores; or

    (ii) in India or abroad, in aggregate :

    (A) assets of a value exceeding US$ 500 million; or

    (B) turnover of a value exceeding US$1,500 million

    (b) the group to which the Target Enterprise would belong post-acquisition would jointly have :

    (i) in India assets of a value exceeding Rs. 4,000 crores; or

    in India a turnover of a value exceeding Rs. 12,000 crores; or

    (ii) in India or abroad, in aggregate :

    (A) assets of a value exceeding US$ 2 billion; or

    (B) turnover of a value exceeding US$ 6 billion

Any Merger  or Amalgamation    in which:

a) the merged  enterprise  would  have:

i) in India assets of a value exceeding Rs. 1,000 crores; or
in India a turnover of a value exceeding Rs. 3,000 crores; or

ii) in India  or abroad,  in aggregate:

    A) assets of a value exceeding US$ 500 million; or
    B) turnover of a value exceeding US$l,500 million

b) the group to which the merged enterprise would belong post-merger would have:

i) in India assets of a value exceeding Rs. 4,000 crores; or
in India a turnover of a value exceeding Rs. 12,000 crores; or

ii) in India  or abroad,  in aggregate:

    A) assets of a value exceeding US$ 2 billion; or

    B) turnover of a value exceeding US$ 6 billion

3.4 The Value of the assets are to be computed as under:

Book Value of the Assets as per the last Audited Accounts

(-) Depreciation

(+) Value of Intangible  assets such as value of

brand,goodwill, copyright/patent/ registered trademark / designs / registered user /permitted use, etc.

The last audited accounts means those pertaining to the financial year immediately prior to the financial year in which the date of the proposed merger falls. Interestingly, a similar provision has not been drafted in case of acquisitions.

3.5 Definitions

The Act defines certain terms which are used in

s.5 and s.6. These are as follows:

a) Acquisition means directly or indirectly acquiring or agreeing to acquire:

    i) shares, voting rights or assets of any enterprise; or
    ii) control over management or control over assets of any enterprise.

b) Control includes controlling the affairs or management by :

    i) one or more enterprises, either jointly or singly, over another enterprise or group; or

    ii) one or more groups, either jointly or Singly, over another ern-r pr ise or group.

c) Group means two or more enterprises which directly or indirectly are in a position to:

    i) exercise 26% or more voting in the other enterprise; or
    ii) appoint more than 50% of the Board of Directors in the other enterprise; or
    iii) control the management or affairs of the other enterprise.

d) Enterprise  means:

    i) a person or a Government department engaged in any activity (including profession or occupation).

    ii) of production/ storage/ distribution/ supply / acquisition/ control of articles or goods or providing services.

    iii) investment or the business of acquiring, holding, underwriting or dealing with any securities of any other body corporate

    iv) either directly or indirectly through its uni ts / divisions / subsidiaries.

    e) Person has been defined to include an individual, HUF, firm, company, AOP /BOl, corporation, body corporate incorporated abroad, co-operative society, local authority and every artificial juridical person.

    f) Shares means shares carrying voting rights and includes:

    (i) any  security   which  carries   voting rights; stock unless otherwise distinguished. Thus, preference shares would not be covered.

IV. Regulation of Business Combinations

4.1 No person or enterprise can enter into a combination which causes an appreciable adverse effect on competition within the relevant market in India and if they do then such a combination shall be void. Such agreements are known as Anti-competitive Agreements. For this purpose the term relevant market means the market which may be determined by the Commission with reference to the relevant product market or the relevant geographical market of both markets. Relevant geographic market means a market comprising the area in which the conditions of combination of supply of goods or provision of services or demand for the same are distinctly homogenous and can be distinguished from the conditions prevailing in the neighbouring areas. Relevant product market means a market comprising all those products or services which are regarded as interchangeable or substitutable by the consumer. However, these provisions do not apply to any share subscription or acquisition by a Fl, Bank, VC Fund pursuant to a loan agreement. The Central Government has power to exempt any class of enterprises in public interest.

4.2 Any person or enterprise which proposes to enter into a combination, must give a notice to the Competition Commission, in the prescribed form disclosing the details of the proposed combination, within 30 days of :

    a) the approval of the proposal relating to the merger or amalgamation, by the board of directors of the enterprises concerned with such merger or amalgamation;

    b) the execution of any agreement or other document for an acquisition or acquiring of control.

After giving the Notice, for a period of 210 days thereof, the combination will not come into effect. Hence, the minimum waiting period is 210 days from the date of the Notice. Such a long waiting period is not only unusual compared to international anti-trust statutes but also undesirable.

The Commission shall inquire:

    a) whether the disclosure made in the notice is correct;

    b) whether the combination has, or is likely to have, an appreciable adverse effect on competition.

4.3 On receipt of the above Notice, the Commission shall or alternatively it may suo moto if it is of the opinion that the combination is likely to cause, an appreciable adverse effect on competition within the relevant market in India, issue a show cause notice to the parties to respond within 30 days of the receipt as to why an investigation in respect of such combination should not be conducted. Any person may also complain to the Commission that a proposed combination is likely to cause an appreciable adverse effect on competition or that it would abuse its dominant position.

4.4 In case the Commission is prima facie of the opinion that the combination has such an adverse effect, it shall, within 7 days from the date of receipt of the response direct the parties to publish details of the combination within 10 working days for bringing the combination to the knowledge or information of the public and persons affected by such combination. Any objection must be filed within 15 days. The Commission has power to call for further information.

4.5 Under section 31, the Commission has power to accept, reject or accept subject to modifications the combination. In all cases where the Commission is of the opinion that the combination has an appreciable adverse effect on competition it has powers to order that:

    a) the acquisition;

    b) the acquiring  of control;  or

    c) the merger  or amalgamation

shall not be given effect to. This provision is quite unusual as it gives the Commission powers to undo even a Court approved scheme of merger. Keeping in mind the fact that a merger scheme involves payment of stamp duty and consists of such other issues it would be quite interesting to learn how the merger would be undone.
 

4.6 The Commission has a maximum of 210 days to pass its Order in the absence of which it is deemed to have approved the Combination.

4.7 An appeal against the order of the Commission lies directly before the Supreme Court.

4.8 Concession under Regulations

The Draft Regulations issued by the Competition Commission of India have held that certain combinations are not likely to cause an appreciable adverse effect on competition in India and hence, they would be exempted from applying to the CCl. Some of the important combinations proposed to be exempted include:

i) an acquisition of shares or voting rights by the parties, solely as an investment or in the ordinary course of business, of not more than 15% of the total shares or voting rights of the company;

ii) an acquisition of assets by the parties, not directly related to the business activity of the acquirer or made solely as an investment or in the ordinary course of business, not leading to control of the enterprise whose assets are being acquired except in certain cases;

iii) an Acquisition of or Acquiring Of Control or Merger or Amalgamation, where the assets or turnover of Rs.1,OOOcrores or Rs.3,OOO crores respectively, does not include assets of Rs.200 crores or turnover of Rs.600 crores, respectively, of each of at least two of the parties to the combination; or

iv) an acquisition of or acquiring of control or merger or amalgamation, where the minimum assets or turnover, in India, of Rs.500 crores or Rs.1,500 respectively, does not include assets of Rs.200 crores or turnover of Rs.600 crores, respectively, of each of at least two of the parties to the combination;

Thus, several overseas acquisitions by Indian companies of Foreign Companies which do not have any presence in India would not be covered within the purview of the CCL This is a welcome step towards encouraging overseas buyouts. For example, the acquisition by Tata Motors of Jagaur of UK, would not fall within the CCI’s purview, since Jaguar does not have any presence in India and the Rules provide that both the parties must have at least Rs.600 crores of turnover in India.

4.9 Till the draft regulations get finalised and the operative sections for regulation of business combinations get notified by the Government, the Commission cannot entertain any hearings in respect of business combinations. Hence, till such time, these provisions would not have any effect.

V. Directors’ Responsibilities

5.1 Under the provisions of the Act, where the person committing any offence is a company, then every person who at the time of the offence was responsible for the conduct of the business of the company as well as the company would be directly liable to be punished.

5.2 Further, any director with whose connivance, neglect or active consent any offence has been committed by the company, shall also be deemed to be guilty of the offence and shall be liable to be proceeded against and punished.

VI. Role of CAs

6.1 Chartered Accountants are authorised to appear before the Commission to represent the Complainant or the Defendant. This is a new area of practice for Chartered Accountants as the number of mergers and acquisitions which India is witnessing is only the tip of the iceberg.

6.2 In case of mergers or acquisitions of the auditee which satisfy the above tests and thus, fall within the purview of the Commission, the CA in his capacity as the Auditor should alert his client about the provisions of the Act and the action which can be taken by the Commission under the Act. By broadening his peripheral knowledge, the Auditor can make intelligent enquiries and thereby provide value added services to his client.

Real Estate Laws : Recent developments — Part II

Laws and Business

1. Introduction :


Last month, we examined some of the recent developments
pertaining to real estate in Mumbai and in India. This Article examines some
more developments which would have a far-reaching impact on property
transactions.

2. ULCRA repeal :


2.1 A few months ago, the State Government of Maharashtra
finally repealed the dreaded Urban Land Ceiling & Regulation Act (ULCRA).
Estimates say that this would release as much as 30,000 acres of land in Mumbai
alone. Several large land owning trusts are expected to benefit. Several lands
owned by mills such as NTC are expected to benefit.

2.2 The Government was under pressure to repeal ULCRA, since
the Centre had set a deadline of March 2008 to do so or else it could not access
over Rs.17,600 crore of funds under the Jawaharlal Nehru National Urban Renewal
Mission.

2.3 The Government is now toying with the idea of replacing
ULCRA with a vacant property tax. One can only hope such legislations do not see
the light of the day.

3. Increase in FSI in suburbs :


3.1 The State’s Finance Minister has in his budget speech
announced that the base FSI in the Mumbai suburban district would be increased
from 1 to 1.33 and brought on par with the FSI permissible in the island city.
The additional 0.33 FSI would have to be purchased as per the ready reckoner
rate for the area. Thus, instead of a developer constructing a building in the
suburbs by using 1.00 FSI and loading another FSI of 1.00 by buying Transfer of
Development Rights (TDR) from the market, as per the new proposal, the builder
would buy lesser TDR by 0.33%. Thus, builder can now purchase 1.33% from the
Government as FSI and only the balance 0.67% as TDR. This means more funds to
the Government. The maximum cap of FSI 2 for projects in the suburbs still
remains.

3.2 From a developer’s perspective, the cost advantage is
negligible, since the FSI rates are more or less comparable with TDR rates.
Further, the overall cap of 2.00 does not increase the overall supply of land,
it only substitutes one source (TDR) for another (FSI).

4. NOC for rented flats


4.1 The Supreme Court’s decision in the case of Mont Blanc
Co-operative Housing Society Ltd. has upheld the constitutional validity of the
State Government’s Notification dated 1st August 2001 that Non-Occupancy Charges
(NOC) levied by a society cannot exceed 10% of the service charges. Thus, a
housing society cannot charge more than 10% of the service charges in case of a
flat which has been rented out by its member. This was a vexed issue with
societies levying NOCs based on their own whims and fancies. In several areas
such as South Mumbai, the societies collected exorbitant amounts for flats
rented to consulates and corporates. For instance, in some case if the monthly
rent was Rs.10,000 and the maintenance charges were Rs.1,000, the Society
demanded 20% of that or Rs.2,000 as NOC. This was even higher than the
maintenance charges levied by the society.

4.2 The Supreme Court has granted temporary
relief to the Mont Blanc Society, allowing them to col-lect non-occupancy
charges at the rate of 10% of gross earnings of members till the final disposal
of the petition. All other societies in Maharashtra will have to adhere to the
Notification, and charge not more than 10% of the service charges, excluding BMC
taxes. The Notification had been issued u/s. 79A of the Maharashtra Co-operative
Societies Act, 1960.

5. Stamp Duty proposals :


5.1 The Maharashtra Government has once again decided to milk
its favourite cash cow, the Stamp Act. As per the revised estimates for 2007-08,
the Government is expected to net Rs.8,000 cr. from stamp duties alone and this
figure is estimated to cross Rs.9,600 crores for the year 2008-09.

5.2 Currently, development agreements and power of attorney
for development attract Stamp Duty @1% of the fair market value of the property
involved. Now Stamp Duty on these documents would be levied on rates as
applicable on a conveyance, i.e., @ 5%. Thus, the Government is equating
development agreements with conveyance deeds. It is submitted that this is not a
welcome amendment, since a DA cannot be equated with a conveyance.

5.3 Earlier, any power of attorney authorising the holder to
sell immovable property, if not given for a consideration, was chargeable with
Stamp Duty only at Rs.100. Now any power of attorney authorising the holder to
sell immovable property, whether or not given for a consideration, is
chargeable with Stamp Duty @ 5% of the market value of the property. A rebate of
this duty paid would be given while calculating the Stamp Duty on a conveyance
executed pursuant to the power of attorney between the donor and the holder of
the power.

An exception has been made for a power of attorney given to
close relatives, such as parents, spouse, children, grand children, siblings,
etc., authorising them to sell immovable property. In such cases, the duty would
be restricted to Rs.500. Hence, consider a situation where the owner of a
property is a non-resident in London. He has no family members in Mumbai and
wants to sell his property and hence, gives a power of attorney to his friend in
Mumbai. Obviously, this would be without consideration. This would now attract
duty @ 5% of the market value of the property. Is this fair ?

5.4 Presently, if after purchasing a flat from a developer it
is resold within 3 years of the date of agreement then while paying the duty on
the second agreement, credit is given of the duty paid on the first agreement.
Now this concessional period has been reduced to one year. Hence, now, if after
purchasing a flat from a developer it is resold within a period of one year of
the date of agreement, only then while paying the duty on the second agreement,
credit would be given of the Stamp Duty paid on the first agreement.

5.5 As a consequential amendment to the deemed conveyance amendment (see para 5.2 above), it is proposed to introduce an amnesty scheme in order to provide for concessional Stamp Duty on the conveyance of the underlying land, since if the building has been purchased some time back, then it would be unjust to collect Stamp Duty at present rates. Details of this amnesty scheme would be notified soon.

5.6 Like in other taxes, e-payment would soon be possible for Stamp Duty also. An e-Payment Gateway would be made available to the taxpayers. This will enable them to pay taxes conveniently at any time and from anywhere through Internet. The amendments which are required to be made to the rules under different tax laws, will be carried out in this year.

6. Sale of stilt  parkings:

6.1 The Bombay High Court recently in the case of Panchali Cooperative Housing Society Ltd. at Dahisar held that the builder, NL Builders Pvt. Ltd., had no right to sell stilt parking areas in the society to outsiders. The Court dismissed the builders’ petition claiming that his right in the property developed by him is absolute. The builder had claimed that he had a right to sell that portion of the property that remained unsold, i.e., some of the stilt parking slots.

The Court held that as per the Maharashtra Ownership Flats Act, 1963, once the builder conveys the property to the society, and it is registered, the property belongs to the society.

6.2 This judgment settles an important principle regarding the rights of a society and a builder.

7. MOFA:    Sale on carpet area basis:

7.1 The latest amendment in the real estate laws is a change to the Maharashtra Ownership Flats Act, 1963 (MOFA). Builders would now no longer be able to sell flats to buyers on the basis of the super built-up area. The amendment provides that builders must sell flats on the basis of the carpet area.

7.2 Builders normally sell flats on the basis of super built-up area or built-up area. The differences between the three types of areas are as follows:

Carpet Area : It is the internal area of a flat. It is the wall-to-wall area of the flat.

Built-up Area: It covers  walls  and balcony  also.

Super Built-up Area: It includes the lobby, passage, elevators, fire fighting area along with the total utility. In other words, it covers common areas too. Sometimes, even the garden is included.

In some cases, the built-up area is 20% of the carpet area and the super built-up area is as high as 40% of the carpet area. However, these figures are subjective and vary from builder to builder and in some cases even building to building. Thus, there is a great deal of confusion in the flat purchasers’ minds who are often unable to understand the exact difference between carpet area, built-up area and super built-up area of a flat. The amendment would remove all such ambiguities. Any violation of this act can mean a 3-year imprisonment for the builder/promoter, proposed as per S. 13(A) of the Act.

7.3 While the amendment provides that developers can “sell the flat on the basis of the carpet area only”, they may separately charge for the common areas and facilities in proportion to the carpet area of the flat. Hence,  they  can continue  to charge  for common  areas  and  facilities  like staircases,  lobby and lift as per the super  built-up area concept.  The only caveat is that the buyer must be made aware of the cost of the carpet area, which is the net usable wall-to-wall area of the flat.

8. Reverse    mortgage    scheme:

8.1 A few months ago, National Housing Bank (NHB), the housing finance regulator, announced the final operational guidelines on reverse mortgages. A reverse mortgage product seeks to monetise the house as an asset and specifically the owner’s equity in the house. The scheme involves senior citizen borrowers mortgaging their property to a lender, who makes periodic payments to borrowers during their lifetime.

8.2 A senior citizen who is living in his own house may obtain a reverse mortgage loan (RML) and have a recurring income by mortgaging his house to banks or other financial institutions. He can also be a joint borrower with his spouse, provided at least one of the borrowers is above 60 years. Thus, the minimum age limit for availing this scheme is 60 years.

The draft guidelines provided that in case of married couples being eligible as joint borrowers, both of them must be above the age of 60 years, but that has now been relaxed to include those couples where at least one of the borrowers is 60.

8.3 In the event of the death of the husband who may be the owner of the property, the wife – who may be a co borrower but not co-owner – will receive income. The lender will not evict the wife, but will modify the cash flow.

8.4 The recent Finance Act, 2008 has clarified that any transfer of a capital asset under a scheme of reverse mortgage would not be chargeable as capital gains. Further, the loan amount received by the borrower will not be included in the total income. The changes made in respect of ‘reverse mortgages’ have clarified doubts and has made the scheme workable.

Shops & Establishments Act

Laws and Business

1. Introduction :


1.1 The Bombay Shops and Establishments Act, 1948 (‘the
Act’
) regulates the conditions or work and employment in shops, commercial
establishments, residential hotels, restaurants, theatres, other places of
public amusement or entertainment. It applies to the whole of Maharashtra.

1.2 The Act operates in municipal areas specified in Schedule
I to the Act. However, the State Government has power u/s.4 to exempt all or any
of the provisions of the Act to any establishment, employees or other persons.

2. Definitions :


2.1 Establishment — A shop, commercial
establishment, residential hotel, restaurant, theatre, other place of public
amusement or entertainment to which the Act applies and any other establishment
which is notified by the State Government.

2.2 Commercial establishment — It means an
establishment which carries on any business, trade or profession or any work in
connection with or incidental or ancillary thereto. The following establishments
are included within the definition of the term commercial establishment :

  • Legal practitioner —
    However, the same has been held to be invalid and has been struck down by the
    decision in the case of N. K. Fuladi v. State of Maharashtra, 1985 1 LLJ 512 (Bom.)


  • Medical practitioner


  • Architect


  • Engineer


  • Accountant — However, the
    same has been held to be invalid and has been struck down by the decision in
    the case of A. F. Ferguson & Co. v. State of Maharashtra (Bom.)


  • Tax consultant


  • Any other technical or
    professional consultant


2.3 Employer — means a person having owning or having
ultimate control over the affairs of an establishment.

3. Registration :


3.1 Every establishment to which the Act applies must apply
for registration with the inspectors designated under the Act within the
specified time. The application must be made in the prescribed form along with
the prescribed fees.

3.2 The inspector would on being satisfied about the
application, register the establishment and issue a certificate of registration
to the employer. This certificate needs to be renewed every year.

3.3 Any change in the particulars submitted while making the
application must be communicated to the inspector by the establishment. Further,
within 10 days of closure of the establishment, the employer must communicate
such fact to the inspector and get his certificate cancelled.

4. Regulation of establishments :


4.1 The Act lays down the opening and closing hours of shops
and commercial establishments. For instance, no commercial establishment can be
opened earlier than 8.30 a.m. and close later than 9.30 p.m. It also empowers
the State Government to modify the same for different classes of shops and
commercial establishments. Offices which work “It also specifies that no
employee can be made to work for more than 9 hours per day and 48 hours in any
week.

4.2 Every shop and commercial establishment must remain
closed for one day in a week, e.g., a Sunday. The employee cannot be called for
work on this day and must be paid his salaries as if he has attended office on
that day.

4.3 The Act also prescribes similar rules for residential
hotels, restaurants, theatres or other places of public amusement or
entertainment.

4.4 Anybody who is between 15 and 17 years of age is
considered to be a young person. No young person can be required or allowed to
work, whether as an employee or otherwise, in any establishment

(a) after 7.00 p.m.

(b) for more than 6 hours in any day; and

(c) if the work involves danger to life, health or morals.





Women cannot be allowed to work in any establishment after
9.30 p.m.

4.5 Every employee, who has worked for at least 3 months in a
year, shall be entitled to leave of 5 days for every 60 days of service during
the year. However, if he has worked for at least 240 days in a year, then he is
entitled to 21 days leave. Further, he would be entitled to additional holidays
on certain days, such as 26th January, 15th August, etc. An employee is
prohibited from working when he is given a holiday or is on leave as per the
provisions of the Act.

4.6 If an employer wants to terminate the services of any
employee who has been working for a continuous period of one year or more, then
he needs to give him a notice period of 30 days. If this is not done, then the
termination is bad in law and the employee can claim reinstatement with full
wages. However, this provision would not apply in case of a termination due to
misconduct.

4.7 It should be remembered that the State can, on an
application, exempt the operation of the above provisions to any establishment
or employee. For instance various 5-star hotels have got exemptions from the
provisions of S. 33 which mandate that women cannot work after 9 p.m. However,
various conditions have been imposed while granting such an exemption.
Similarly, BPOs have got exemptions from some of the provisions pertaining to
working hours, etc.

5. Application of other laws :


5.1 The State Government may prescribe that the Payment of
Wages Act, 1936 shall apply to any class of establishments or employees to which
this Act applies.

5.2 The provisions of the Industrial Employment (Standing
Orders) Act, 1946 apply to any establishment to which this Act applies as long
as it employs more than 50 employees.

5.3 The State Government may prescribe that the Maternity Benefit Act, 1961 would apply to any establishment to which this Act applies.

    6. Health & Safety :

6.1 Every establishment shall be kept clean and have proper ventilation. It must be sufficiently lit during all working hours. The Act prescribes standards for the same.

6.2 Every establishment must take precautions against fire. Further, certain types of establishments must also maintain a first-aid kit.

    7. Registers & inspection :

7.1 The Act requires establishments to maintain such registers and records and display such notices as may be prescribed. The rules framed under the Act require every establishment’s name board to be in Marathi in addition to any other language. However, the lettering of the Marathi script should be of the same size as that of the other language.

7.2 The inspectors appointed under this act have power of entering and inspecting any establishment, examine the prescribed registers and records, take evidence of any persons he considers necessary.

7.3 The Act prescribes various penalties for contravention of the provisions of the Act. For instance, S. 52 lays down the penalties for contravening a majority of the provisions of the Act. It specifies a penalty of Rs.1,000 to 5,000 for each offence. There is also an enhanced penalty for repeat offenders who have already been convicted under the Act.

    Role of a CA :

A CA can make his clients about the provisions of this Act and enlighten them about the requirements of compliance with the Act. This would be a value-added service which he can provide to his clients. He can also undertake a compliance audit for his clients. By broadening his peripheral knowledge, a CA can add value to his services.

Agricultural land Laws : MLRC, 1966

Part 2

(In this Article, we continue our examination of the Maharashtra Land Revenue Code, 1966 (‘Code’) which deals with the law relating to agricultural land and land revenue in the State of Maharashtra.)

1. Uses of land:

1.1 The holder of any land which is assessed or held for agricultural purposes is entitled to himself or through his agents to erect farm buildings, wells, or make any other improvements for better cultivation of the land. Interestingly, the Code does not define the term ‘agricultural’. Reference may be made to the definition under various other Land Laws. Activities such as, horticulture, crop farming, grazing, dairy farming, poultry farming, livestock breeding, etc., would generally be covered under this definition. It is a matter of fact whether a particular land can be said to be used for agricultural operations or not.

1.2 Before commencing construction or renovation of any farm building on lands located in cities, certain types of municipal corporations, etc., the holder requires the prior permission of the Collector for such work. The permission is granted subject to certain conditions.

1.3 Without the prior permission of the Collector:

    (a) No land which is used for agricultural purpose can be used for any non-agricultural purpose;

    (b) No land which is used for one non-agricultural purpose can be used for any other non-agricultural purpose;

    (c) No land which is used for one non-agricultural purpose can be used for the same purpose but in relaxation of any conditions imposed;

Land which is used for non-agricultural purpose is popularly known as ‘N.A. Land’. The Maharashtra Land Revenue (Conversion of Use of Land and Non-Agricultural Assessment) Rules, 1969 need to be complied with for converting an Agricultural Land into NA Land.

1.4 Procedure for conversion into N.A. Land:

    (a) An applicant who desires to convert agricultural land into N.A. Land must make an application to the Collector for permission in the prescribed form and in the prescribed manner.

    (b) The Collector must acknowledge the application within 7 days.

    (c) The Collector may refuse the permission or grant it on such terms and conditions as he deems fit.

    (d) In cases where the Collector fails to take any action within 90 days of the acknowledge-ment or within 90 days of receipt (if no acknowledgement is also granted, then the permission applied for is deemed to be granted).

    (e) Once the permission is granted, the applicant must inform the Tahsildar about the change of user of the land within 30 days in the prescribed format.

    (f) Once the land is permitted to be made into N.A., a sanad is granted by the Collector to the holder of the land.

    (g) Once permission is granted for N.A. use, such use must be commenced within one year of the date of the Collector’s Order.

    (h) Where permission is granted for construction of a structure to be used for a non-agricultural purpose, then the provisions of the Maharashtra Land Revenue (Conversion of Use of Land and Non-Agricultural Assessment) Rules, 1969 need to be complied with in this respect. These include provisions on the minimum open space to be maintained, the number of storeys to be constructed, the size of the building, the plinth area, the dimensions of a room used for residential purposes, types of building material to be used, construction of cess-pools, stables, privies, etc.

In the case of Jamunabai P. Shah v. Bajirao Kalbor, 1995 (1) Mah. LJ 143, it was held that NA use commences from the date on which the land is in fact put to non-agricultural use and not from the date of permission by the Collector.

1.5 Bona fide Industrial Use of Land:

1.5.1 In the following cases prior permission is not required for conversion of the use of agricultural land:

    (a) If land is situated within the industrial zone of a development plan prepared under the Maharashtra Regional and Town Planning Act, 1966; or

    (b) If the land is situated within the area where no plan exists for a bona fide industrial use; or

    (c) If the land is situated within the area undertaken by a private developer for a special township project.

When land is so used, a sanad shall be granted in the prescribed form.

1.5.2 The conditions to be complied in this respect are as follows:

    (a) The user has clear and proper access to such land

    (b) The land should not be reserved for any public purpose

    (c) The bona fide industrial use/township project does not conflict with any development plan of the State

    (d) It is not a land notified for acquisition by the State

    (e) The industry/project is not within 30 metres of any railway line or 15 metres of any high voltage transmission line.

    (f) No Central/State/Local laws are being contravened.

1.5.3 The following activities are treated as being of bona fide industrial purpose:

  •  Manufacture, preservation or processing of goods

  •  Handicraft

  •  Industrial business or enterprise, carried on by any person

  •     Construction of industrial buildings used for the manufacturing process or purpose. It should be noted that construction and real estate development per se are not permitted activities

  •     Power projects

    Ancillary industrial usages like:

  •     Research and development
  •     Godown
  •     Canteen
  •     Office building of the industry concerned
  • providing housing accommodation to the workers of the industry concerned
  • Establishment of an industrial estate includ ing co-operative industrial estate, service industry, cottage industry, gra-modyog units or gramodyog Vasahats

1.5.4 A special township project means one which is framed under the Regulations for Development of Special Township under the MRTP Act, 1966.

1.5.5 Whenever any agricultural land is converted into N.A. Land or is used for a bona fide industrial use, then the holder is liable to pay a Conversion Tax. This tax is equal to 5 times the non-agricultural assessment of the land.

1.5.6 Any person who contravenes the provision of change of use of land would be liable to pay non-agricultural assessment. Further, he would be liable to such fine as the Collector determines. He would also be liable to restore the land to its original use or carry out such actions as the Collector determines in respect to the land. In certain circumstances, the Collector has power to regularise unauthorised use of land, subject to the following conditions :

(a)    the holder pays the applicable Conversion Tax.

(b)    the holder pays the N.A. assessment with reference to the altered use since commencement of that use.

(c)    he pays such fine not exceeding 40 times the N.A. assessment as the Collector may determine.

(d)    he abides by all conditions imposed by the Collector.

It may also be noted that under the Foreign Ex-change Management Act and Regulations issued thereunder, an Indian company cannot raise Foreign Direct Investment for acquiring agricultural lands with an intention of subsequently making them N.A. Lands. Recently, a large real estate developer was questioned by the Enforcement Directorate/RBI for using FDI proceeds for buying agricultural lands.

2.    Land revenue:

2.1 All agricultural and non-agricultural land is subject to land revenue.

2.2 Land revenue is assessed with reference to the use of the land:

(a)    for the purpose of agriculture,
(b)    for the purpose of residence,

(c)    for the purpose of industry,

(d)    for the purpose of commerce,

(e)    for any other purpose.

2.3 Non-agricultural assessment of lands :

2.3.1 N.A. assessment of lands is determined with reference to the use which such land is put to and whether it is situated in urban or non-urban areas.

2.3.2 The Collector would classify the villages in non-urban areas into Class-I and Class-II after considering the market values of the land, their situation, the non-agricultural purpose for which they are used, their advantages, disadvantages, etc. Class-I N.A. lands are assessable at a rate not exceeding 10 paise per square metre per year, while for Class -II N.A. lands the rate is not exceeding 5 paise per square metre per year.

2.3.3 In the case of N.A. assessment in urban areas, the Collector would divide them into blocks on the basis of the market value of lands, their N.A. use, advantages, disadvantages, etc. The N.A. assessment of such lands cannot exceed 3% of the full market value. The term full market value means:

Market Value of the Land

+ Capitalised Assessment

Capitalised Assessment means an amount equal to 16 times the assessment on the land for the time being in force. The full market value is estimated on the basis of sales, leases, land acquisition awards, etc., which have taken place in a period of five years immediately preceding the year in which the standard rate for N.A. assessment is being fixed (see para 6.3.4 below).

2.3.4 The Collector has powers to fix the rate of N.A. assessment per square metre of land in each block or urban area. Such rate is called the ‘the standard rate of non-agricultural assessment’ and is fixed as a percentage of the full market value. Each standard rate remains in force for a block of five years. In the year 2002, the Code was amended to provide that the non-agricultural assessment for the guaranteed period of five years commencing from 1st August 2001 shall not exceed:

(a)    thrice the non-agricultural assessment rate of 1991 for land in a municipality and twice such rate for other lands in cases which are already assessed for non-agricultural purposes; and

(b)    six times the non-agricultural assessment rate of 1991 for land in a municipality and four times such rate for other lands for cases to be assessed for non-agricultural purposes.

The rate of assessment, depending upon the type of land use, is as follows:

2.3.5 The method of computing the standard rate is as follows:

(a)    The Collector first estimates the full market value of non-agricultural land in each block of land separately for each of the five years immediately preceding the year for which standard rate is being worked out.

(b)    He then determines the full market value per square metre of land in each block of land.

(c)    The standard rate of non-agricultural assessment per square metre of land in each block = 3% of the full market value per square metre of land.

(d)    These rates are to be approved by the State Government. They are then published in the Official Gazette and they come into force from the date of publication.

3.    Recovery of land revenue:

3.1 Chapter XI of the Code is a very important Chapter since it provides for the manner of recovery of land revenue. The claims of the State Government have precedence over all other debts, claims, etc., against any land. If the land revenue due is not paid by the prescribed dates, then it becomes an arrear of land revenue and the person responsible for its payment becomes a defaulter. In several Acts one comes across the phrase ‘all sums required to be paid under this Act may be recovered as an arrear of land revenue’. For instance, S. 46 of the Bombay Stamp Act, 1958 empowers the Collector to recover any duties or sums due under that Act as if they were an arrear of land revenue. Hence, it is important to understand what is the process prescribed for the recovery of land revenue under the Code.

3.2 The process of recovery of land revenue specified u/s.176 of the Code may be briefly described as follows:

(a)    by serving a written notice on the defaulter

(b)    by forfeiture of his occupancy

(c)    by selling his movable property, other than certain necessary personal effects, tools of an artisan, articles for religious endowments

(d)    by attaching and selling his immovable property, other than houses belonging to an agriculturist and occupied by him

(e)    by arresting and imprisoning him. The arrest process would be stayed if the defaulter furnishes adequate security to the Collector.

(To be continued)

General Clauses Act

Laws and Business

1. Introduction :


The General Clauses Act, 1897 (‘the Act’) is a unique
Act in the sense that its utility lies in the interpretation of other
enactments. Interpretation of statutes is a vexed issue which professionals in
general and tax practitioners in particular face time and again. The Act throws
light on some of these issues. This Article discusses the important provisions
of this unique Act.

2. Definitions :


S. 2 of the Act defines certain important terms. However,
unlike definitions in other acts, these definitions apply to all Central Acts
and Regulations made after March 1897 unless there is anything repugnant in the
subject or context. Some of the important terms defined by S. 2 are as follows :

2.1 The term Act when used with reference to an
offence or a civil wrong, shall include a series of acts, and words which refer
to acts done, extend also to illegal omissions.


2.2 The term affidavit includes an affirmation and
declaration in the case of persons by law allowed to affirm or declare instead
of swearing.

2.3 The term commencement, when used with reference to
an Act or Regulation, shall mean the day on which the Act or Regulation comes
into force.

2.4 The term Document includes any matter written,
expressed or described upon any substance by means of letters, figures or marks,
or by more than one of those means which is intended to be used or which may be
used, for the purpose of recording that matter. This definition is of particular
importance under the Stamp Acts, Registration Act, etc. Other enactments which
define the term document are the Indian Evidence Act, 1872 and the Indian Penal
Code. These two Acts also contain a similar definition of the term ‘document’.

2.5 The term financial year means the year commencing
on the first day of April;

2.6 A thing shall be deemed to be done in good faith
where it is in fact done honestly, whether it is done negligently or not.

2.7 The term immovable property has been defined to
include land, benefits to arise out of land and things attached to the earth, or
permanently fastened to anything attached to the earth. This is a very important
definition which is relevant for various Acts such as the Stamp Acts, Sale of
Goods Act, Sales Tax Acts, Registration Act, Central Excise Act, etc. The Bombay
Stamp Act has incorporated this definition in the Act itself. The two leading
decisions on this definition are those of the Supreme Court in the case of
Sirpur Paper Mills
(1998) 1 SCC 400 and the recent case of Duncan’s
Industries
(2000) 1 SCC 633. The Central Board of Excise and Customs
has issued an order u/s.37B of the Central Excise
Act, 1944 (Order No. 58/1/2002-CX, dated 15-1-2002) wherein after considering
seven Supreme Court decisions including the two mentioned above, the CBEC has
explained its position on when is a property immovable or movable. Moveable
property
is defined to mean property of every description, except immovable
property. These two definitions apply to all Central Acts made after January,
1868.

2.8 Local authority is defined to mean a municipal
committee, district board, body of port commissioners or other authority legally
entitled to, or entrusted by the Government with, the control or management of a
municipal or local fund. Various decisions have held that the following
authorities are covered within the definition of a local authority — a Village
Panchayat, a Port Trust, a University, a State Road Transport Corporation, a
Dock Labour Board, a Metropolitan Development Authority, a Cantonment Board, a
Tahsildar, a District School Board, etc.

2.9 An offence means any act or omission made
punishable by any law. If an act done is made punishable by law, it is an
offence. Similarly, an offence is committed if an omission is made by a person
and that omission is punishable.

2.10 A person is defined as including any company or
association or body of individuals, whether incorporated or not.

2.11 A rule means a rule made in exercise of a power
conferred by any enactment, and includes a regulation made as a rule under any
enactment.

2.12 The term sign with its grammatical variations and
cognate expressions, shall, with reference to a person who is unable to write
his name, include mark, with its grammatical variations and cognate expressions.

2.13 The term son, in the case of anyone whose
personal law permits adoption, includes an adopted son; similarly, father,
in the case of anyone whose personal law permits adoption, includes an adoptive
father.

2.14 A will includes a codicil and every writing
making a voluntary posthumous disposition of property.

2.15 A year means a year computed according to the
British calendar.

3. General Rules of Construction :


3.1 Unless provided otherwise, any central Act comes into
force from the day it receives the assent of the President.

3.2 Repeal of Acts :


3.2.1 S. 6 to S. 8 deal with repealed acts and their
effects. S. 6 provides that in case any Central Act or Regulation is repealed by
any subsequent law, then, unless a different intention appears, the repeal shall
not :

(a) revive anything not in force or existing at the time at
which the repeal takes effect; or

(b) affect the previous operation of any repealed act or
anything duly done or suffered thereunder; or

(c) affect any right, privilege, obligation or liability
acquired, accrued or incurred under the repealed act; or

(d) affect any penalty, forfeiture or punishment incurred
in respect of any offence committed against the repealed act; or

(e) affect any investigation, legal proceeding or remedy in
respect of any such right, privilege, obligation, liability, penalty,
forfeiture or punishment aforesaid.


Further, any such investigation, legal proceeding or remedy,
may be instituted, continued or enforced, and any such penalty, forfeiture,
liability or punishment may be imposed as if the repealing Act or Regulation had
not been passed.

Two decisions of the Constitution Benches of the Supreme Court in the cases of Rayala Corpn. (P) Ltd. and M. R. Pratap, (1969) 2 SCC 412 and Kolhapur Canesugar Works Ltd., (2000) 2 SCC 536 have observed that there is a difference between’ omission’ of a statute and its ‘repeal’ and S. 6 of the Act applies to a repealed Section and not to one which has been omitted. The Apex Court in Kolhapur’s case held that repeal of a statute or deletion of a provision, unless covered by S. 6(1) of the Act or a saving provision, totally obliterates it from the statute book and the proceedings pending thereunder stand discontinued. These judgments were recently followed in another decision of the Supreme Court in the case of General Finance Co. v. Asst. CIT, 124 Taxman 432 (SC). The Apex Court held that the principle underlying S. 6 of the Act as saving the right to initiate proceedings for liabilities incurred during the currency of an act will not apply to omission of a provision in an act but only to repeal, because an omission is different from a repeal. Hence, while dealing with a case for prosecution for non-compliance u/s.269SS of the Income-tax Act, 1961, the Court held that as S. 276DD which dealt with prosecution for offences u/ s.269SS had been omitted (and not repealed) from the statute books, and prosecution could not be launched or continued by invoking S. 6 of the General Clauses Act after its omission. Hence, the prosecution proceedings were quashed.

3.2.2 Any Act which repeals any other enactment by which the text of any Act or Regulation was amended by the express omission, insertion or sub-stitution of any matter, then, unless a different intention appears, the repeal shall not affect the continuance of any such amendment made by the enactment so repealed and in operation at the time of such repeal. This Section refers to textual amendments and clarifies the effect of repeal of amending statutes. It is a well-settled law that the repeal of a statute does not repeal such portion of the statute as has been incorporated into another statute. Even if the original Act is repealed, the incorporated Sections still operate in the later Act. When a sub-sequent Act amends an earlier one in such a manner as to incorporate itself in the earlier one, then the earlier Act must be read and construed as if the altered words had been written into the earlier Act and the old words are cancelled, so that there is no need for a reference to the amending Act.

3.2.3 In order to revive any enactment which has been wholly or partially repealed, the purpose to do so must be expressly stated in the Act.

3.2.4 Any act which repeals and re-enacts, with or without modification, any provision of a former enactment, then references in any other enactment or in any instrument to the provision so repealed shall, unless a different intention appears, be construed as references to the re-enacted provision. In Mahindra & Mahindra v. UOI, AIR 1979 SC 798 it was held that if a provision of one statute is incorporated in another, any subsequent amendment in the former statute or even its total repeal, would not affect the provision as incorporated in the latter statute. In Gauri Shankar Gaur v. State of UP, AIR 1994 SC 169, it was held that if a later Act merely makes a reference to the earlier Act, it is only by way of a reference and all amendments, repeals, new law subsequently made will have effect, unless its operation is saved by this provision.

3.2.5 Where any Act or Regulation is repealed and re-enacted, then, any Notification, order, scheme, rule, form, or bye-law made or issued under the re-pealed Act or Regulation, shall, insofar as it is not inconsistent with the provisions re-enacted, continue to be in force, and be deemed to have been made or issued under the provisions so re-enacted.

3.3 S. 9 deals with the commencement and completion of time. It states that for the purpose of excluding the first in a series of days or any such period, it is sufficient if the Act uses the word ‘from’ and for including the last in a series of days or any such period of time to use the word ‘to’. Thus, if an Act uses the word ‘from’, then the first day should not be counted and if it uses the word ‘to’, then the last day should be included. Thus, in the case of Cartwright v. Mac Cormack, (1963) 1 All ER 11,where an insurance policy was issued for ‘IS days from the commencement of the policy’, it was held that the first day was excluded and the policy commenced from midnight  of that  day. In Union Bank Official Liquidator  v. Padmanabha  Menon,  AIR 1955 NUC 1824, an application  had  to be made  within  three years from the date of appointment  of the liquidator and in computing  that period,  the first day was to be excluded.  It was held that the principle  of S. 9 does not apply only when the words ‘from’ and ‘to’ are used in a statute. It only indicates that if the first day has been excluded, it is sufficient to use the word’ from’ and if the last day is to be included the word to be used is ‘to’.

3.4 According to S. ID, in case any Act requires something to be done in any Court or office on a particular day, and the same is closed on that day or on the last day of a period, then the action may be done on the next working day. However, this does not apply in cases where the Limitation Act applies. The object is to enable a person to do on the next working day what he could have done on a holiday. Thus, an act of the Court should not prejudice a person’s legal remedy, as the law does not compel the performance of an impossibility. There is a cleavage of judicial decisions over whether S. 10 applies to decrees and orders of the Courts. According to one school of thought, the Section applies and hence, if the time specified by the decree for doing something, say a payment, falls on a holiday, then the money can be deposited on the next working day. However, the other view is that S. 10 only applies to a case in which an act is allowed to be done by an Act, and not to an act to be done under a decree. If the payment is not done on the specified date since the day was a holiday, the decree can be executed. In this respect, the Supreme Court’s decision in the case of C. F. Angadi v. Y. S. Hirannayya (1972) 1 SCC 191 is relevant. The Apex Court held that where a party to a consent decree is given time to do an act on a day and he fails to do so on account of impossibility of performance, but he does on the next practicable day, then it must be held that the act was done in time and in terms of the consent decree. It is submitted that this is the more rational view. In an interesting decision in the case of Dharmsi Morarji Chemicals v. Occhavlal Hargovaindas Shah, AIR 1927 Bom. 480, a suit was to be filed and the due date for filing the suit (3 years from the date of payment) under the Limitation Act expired on 20th April. However, the suit was filed only in June. The Court ignored the delay, because in the interim period the High Court was closed on account of its annual summer vacation. It was held that if an act of a party is delayed on account of an act of the Court, then he is entitled to an extension over that period during which he is delayed by the Court’s action.

3.5 S. 11 states that distance, for the purposes of any Act, is to be measured in a straight line on a horizontal plain, unless a contrary intention appears from the statute.  In Rex v. [okhu, AIR 1948 All 299, it was held that where the words used in an Act were ‘within the distance of two miles from the limits of a public ferry’, there was no reason why the distance contemplated should not be the shortest distance between the two points. This principle is also helpful under the Income-tax Act for determining whether a land is an urban agricultural land or a rural agricultural land. S. 2(14)(iii) of the Income-tax Act excludes an agricultural land from the definition of a capital asset if it is more than within 8 kilometers from the local limits of any municipality.

3.6 U/s.12, where any Act specifies any Customs/ Excise duty is to be based on any given quantity, e.g., weight, measure, value, etc. of the goods, then a similar duty is leviable according to the same rate on a pro rata basis on a greater or lesser quantity of goods.

3.7 S. 13 states that words in masculine gender would be deemed to include females and words in singular shall include the plural and vice versa. However, both these provisions apply provided they are not repugnant to the subject or the context. In E. Alfred v. First Addl. ITO, Salem, AIR 1958 Mad, it was held that the liability under the Income-tax imposed on the legal representative of a deceased attaches itself to all the legal representatives of the deceased. As per S. 13(2) of the General Clauses Act, the word ‘singular’ includes the plural and hence, when there are many representatives within the knowledge of the ITO, all of them must be served with notices. In the case of Vijaya Manohar Arbat v. Kashirao Sawai (1987) 2 SCC 278, the Court held that the expression ‘his father or mother’ in the Code of Criminal Procedure is not confined only to the father or mother of a son, but also applies to the parents of a daughter. Accordingly, the daughter has an obligation even after marriage to maintain her parents if they are unable to do so. A daughter after her marriage does not cease to be a daughter of her parents. However, the Supreme Court in the case of Dhandhania Kedia v. CIT, AIR 1959 SC 219, held that this Section can be applied only when there is nothing to the contrary Where the words of the Income-tax Act are Clear, then there is no room for application of this Section.

4. Orders, Rules:

4.1 Whenever a power to issue any Notification, order, scheme, rule, form, or bye-law is conferred, then the power includes the power to add to, amend,  vary or  rescind the same.

4.2 In case any Act or Regulation which is not to come into force immediately on its passing, confers a power to make rules or bye-laws, or to issue orders with respect to various matters, then that power may be exercised at any time after the passing of the Act or Regulation. However, the rules, bye-laws or orders so made or issued shall not take effect till the commencement of the Act or Regulation.

4.3 In case a power to make rules or bye-laws is conditional upon the same being made after their previous publication, then the following provisions would apply:

a) first a draft of the proposed rules or bye-laws would be published in the prescribed manner for the information of persons likely to be affected.

b) the draft should include a notice specifying a date on or after which the draft will be taken into consideration;

c) the rule-making and sanctioning authority shall consider any objection or suggestion with respect to the draft;

d) once the rule or bye-laws purported to have been made in exercise of a power to make rules or bye-laws are published in the Gazette, then it shall be conclusive proof that the same have been duly made.

5. Others:

5.1 S. 63 to S. 70 of the Indian Penal Code and the provisions of the Code of Criminal Procedure in relation to the issue and the execution of warrants for the levy of fines shall apply to all fines imposed under any Act, Regulation, rule or bye-law, unless provided otherwise. This provision is based on the Rule of Convenience, i.e., there is a uniform procedure for all enactments to be followed for recovery of fines, unless the statute itself provides another mode.

5.2 In case an act or omission is an offence under two or more Acts, then the offender shall be liable to be prosecuted and punished under either or any of those enactments, but he shall not be liable to be punished twice for the same offence. Thus, where an act is an offence under two or more enactments, the offender cannot be punished twice for the same offence.

5.3 Where any Act or Regulation authorises or requires any document to be served by post, the service shall be deemed to be effected by properly addressing, pre-paying and posting by registered post, a letter containing the document, and, unless the contrary is proved, to have been effected at the time at which the letter would be delivered in the ordinary course of post. Thus, a uniform procedure has been laid down in all cases requiring service of notice by post. However, this proposition may be rebutted by providing evidence to show that actually there was no service of notice. In a case where a notice was served for specific performance of an Agreement by a Registered AD and returned un-served due to alleged refusal, it was held that the Notice must be deemed to have been served – Bhabhia Devi v. P. Yadav, (1997) 3 SCC 631. In the following cases it was held that the notice is deemed to have been duly served: Shimla Development Authority v. Santosh Sharma, (1997) 2 SCC 637 (Notice sent by Registered AD, but neither the unserved notice nor the AD card was received); State of Kerala v. VTK Udaya, 1995 Suppl. (3) SCC 518 (Notice returned with endorsement ‘not known’); Harcharan Sing v. Shiv Rani, AIR 1981 SC 1284 (Addressee refused to accept letter).

5.4 Any enactment may be cited by reference to the title or short title by reference to the number and year thereof, and any provision in an enactment may be cited by reference to the Section or sub-section of the enactment in which the provision is contained. Any Act or Regulation in which a description or citation of a portion of another enactment is made shall be construed as including the word, Section or other part mentioned or referred to as forming the beginning and as forming the end of the portion comprised in the description or citation.

6. Conclusion:

The Courts have, in innumerable pronouncements, held that if a term is not defined in a particular Act, Rule, etc., then the definition given in the General Clauses Act will prevail. For instance, in the case of Karam Chand Thapar, AIR 1961 SC 838, the Supreme Court held that the purpose of the Act is to place in a single Act provisions as regards definitions of words  and legal principles  of interpretation  which would  otherwise  have to be incorporated  in many Acts and Regulations.  The definition  and the rules of interpretation  contained in the Act have to be read in every other statute  governed  by it. Similarly, in Dulichand Laxminarayan, 29 ITR 535 (SC), it was held that the definitions given in S. 3 of the Act apply when there is nothing repugnant in the subject or the context.

Hence, knowledge of the basic provisions/principles of the General Clauses Act will assist the Auditor not only in interpreting the provisions of the Corporate and Tax Laws, but also in adding value to his advisory services.

Agricultural land laws : btala, 1948

 1. Introduction:

In the previous two articles, we examined the Maharashtra Land Revenue Code, 1966. We continue with our study of laws pertaining to agricultural lands in the State of Maharashtra by examining Acts which impose a ceiling on agricultural land. Agricultural land ceiling and use in Maharashtra is governed by the following two Acts :

(a) Bombay Tenancy and Agricultural Lands Act, 1948 (‘BTALA’)

(b) Maharashtra Agricultural Lands (Ceiling on Holdings) Act, 1961.

This Article gives a bird’s-eye view of the BTALA (also ‘the Act’). This Act is relevant to companies since it lays down the situations under which an agricultural land can be transferred to a non-agriculturist. This would be relevant to ascertain how and when can a company acquire agricultural land. If a Company acquires agricultural land in contravention of the Act, it can have serious consequences. The prohibition on companies acquiring agricultural land is also found under other laws. For instance, sometime ago, the Enforcement Directorate raided the offices of a large real estate developer company since it had acquired agricultural land with the proceeds of Foreign Direct Investment.

2. Applicability:

2.1 The Act is applicable to the Bombay Area of the State of Maharashtra. The Bombay Re-organisation Act, 1960 divided the State of Bombay into two parts, namely, Maharashtra and Gujarat. Thus, the BTALA is in force in the whole of Maharashtra except the Marathwada (Latur, Nanded, Aurangabad) and Vidarbha (Nagpur, Akola, etc.) regions.

2.2 The Act seeks to govern the relationships between tenants and landlords of agricultural lands. Further, it lays down the law in respect to fixation of rent, rights of tenants, etc. Thus, it is similar to the Maharashtra Rent Control Act, 1999.

3. Definitions:

3.1 The Act defines the term ‘agriculture’ to include the following :

(a) horticulture

(b) raising of crops, grass or garden produce

(c) the use by an agriculturist of his land for cattle grazing

(d) the use of any land for the purposes of rab manure

However, it states that the following are not agriculture :

(a) allied pursuits

(b) cutting of wood alone

Since the definition is an inclusive one, it retains its common parlance meaning as well as something more — Official Asssignee v. Maheshri Firm of Chandulal, 71 IC 657.

This is a definition which has been the series of a spate of controversies. Even under other Acts such as the Income-tax Act, there are several decisions on what constitutes agriculture. The decision of the Supreme Court in the case of CIT v. Benoy Kumar Sahas Roy, AIR 1957 SC 768 is relevant in this respect. It held that the term agriculture cannot be disassociated from the primary significance thereof, which is cultivation of the land and even though it can be extended in the manner both in regard to the process of agriculture and the products which are raised upon the land, there is no warrant for extending it to the land.

The expression emphasises the cultivation of land. Any operation which has something to do with the land, any operation which helps the land to yield the fruits or its crops, any operation which proves the natural produce of the land, may come within the expression — N. G. Desai v. State of Bombay, 57 Bom. LR 199.

3.2 The term ‘agriculturist’ is defined to mean someone who cultivates land personally.

4. Tenant:

4.1 A tenant is defined to mean a person who holds land on lease and includes :

(a) A person who is deemed to be a tenant u/s.4

(b) A person who is a protected tenant; and

(c) A person who is a permanent tenant

4.2 A permanent tenant means one who was considered accordingly prior to 1955 or someone whose commencement or duration of tenancy cannot be satisfactorily proved by reason of antiquity.

4.3 Deemed tenant:

4.3.1 A person lawfully cultivating any land belonging to another person is deemed to be a tenant if such land is not cultivated personally by the owner. Further, such a person should not be a part of the owner’s family or be his servant or be a mortgagee in possession.

4.3.2 Lawful cultivation is of prime importance and hence, the landlord must have placed his tenant in lawful possession of the land. If a litigation is pending in respect of the title to the land, cultivation on that land would not be lawful.

4.3.3 Land is said to be cultivated personally if a land is cultivated on one’s own account by :

(a) one’s own labour. An agriculturist lady continues to be so even after her marriage and she can continue her occupation as an agriculturist — Babib Doshi v. Dy. Collector, 1986 CLH 845. The cultivation must not be as an agent of the owner.

(b) by labour of family members, i.e., spouse, children or siblings in case of a joint family. A joint family is defined to mean an HUF and in case of other communities, a group or unit the members of which are by custom joint in estate or residence. In one case, even a married sister living with her husband has been regarded as a part of the family — Case No. 8953 O/154 of 1954.

(c) by hired servants or workers under personal supervision.

(d) cultivation through an agency on behalf of the juristic person does not come within the meaning of the words to cultivate personally in S. 2(b). An idol or juridical person is not capable of cultivating personally

— Shri Kalanka Devi Sansthan Patur v. Pandu Marotti, 1963 Mah LJ 249

4.3.4 A relative of a landlord does not automatically become a deemed tenant unless the relationship of landlord and tenant is proved — Smt. Amtibai Jesangbai v. Patel Purshottamdas, AIR 1983 (Guj.) 84.

4.3.5 The onus is on the person who alleges that he is a tenant to demonstrate that he is a tenant. All persons other than those specifically excluded and who are lawfully cultivating land belonging to others are deemed to be tenants.

4.3.6 If a person is cultivating a land under an Agreement of Sale he does not become a deemed tenant
— Ambalal v. Mangalbai, (1978) 19 GLR 799.

4.4 A protected tenant means one who has been afforded such protection under the earlier Tenancy Act of 1939.

5.    Ceiling Area:
5.1 Ceiling Area means the area of land fixed as ceiling area u/s.5 or u/s.7 in relation to land held as an owner or a tenant. It may be noted that this ceiling is different and separate from the ceiling fixed under the Maharashtra Agricultural Lands (Ceiling on Holdings) Act, 1961. The objective of fixing a ceiling is to give each family a fair amount of subsistence, secondly to arrive at the economic unit or cultivation and thirdly to enable larger cultivation areas to those who can afford them in-sofar as it does not hamper equitable distribution of land.

5.2 The ceiling, depending upon the type of land, is as follows:

  •         48 acres of jirayat land, i.e., dry crop land

  •         24 acres of seasonally irrigated land or paddy or rice land

  •         12 acres of perennially irrigated land
  •         If the land consists of a combination of the above, then the ceiling shall be determined as follows:

1 acre of perennially irrigated land = 2 acres of seasonally irrigated land/paddy land = 4 acres of jirayat land

Warkas land, i.e., land used for rab manure for rice cultivation is to be excluded. Further, potkahraba land, i.e., one which is not fit for cultivation is not to be included in computing the land.

5.3 The Economic Holding is as follows:

  •         16 acres of jirayat land

  •         8 acres of seasonally irrigated land or paddy or rice land

  •         4 acres of perennially irrigated land

        If the land consists of a combination of the above, then the ceiling shall be determined as specified for ceiling computation.

While people should be allowed to own land to the maximum extent possible, the cultivators must be given enough to at least maintain themselves and their family’s proper standard of living. This is taken care of by economic holding.

6.    Rent control and tenancy protection:

6.1 The Act contains provisions for the following:

(a)    Fixing the minimum and maximum rent for agricultural land
(b)    Fixing the rent by the mamltadar for different classes of land situate in a village
(c)    Liability of tenant to pay land revenue, irrigation cess and certain other cesses
(d)    Termination of tenancy under certain cases, such as, non-payment of rent, unlawful assignment/sub-letting, permanently damaging the land, etc.
(e)    Surrender of tenancy by the landlord
(f)    Provisions for dwelling houses of tenants
(g)    Tenants right to certain trees planted by him and produce thereon
(h)    Prohibition on a tenant from sub-dividing, sub-letting or assigning the land
(i)    The landlord is entitled to recover possession of the land if he requires it bona fide for cultivation personally or for any non-agricultural purpose. However, the landlord needs to give a notice to the tenant for the same.

Partnership Firm — Stamp Duty Issues

Laws and Business

1. Introduction :


1.1 Partnership is probably the oldest form of doing
business. Even today, a majority of the businesses in India are organised as a
‘partnership’.

1.2 Stamp duty is an important source of revenue for the
Maharashtra Government.

1.3 This article deals with some issues relating to stamp
duty, which are peculiar to partnership.

2. Charge of stamp duty :


2.1 The Bombay Stamp Act, 1958 (‘the Act’), which is
applicable to the State of Maharashtra, levies stamp duty u/s.3 of the Act,
which reads as follows :

“3. Instrument chargeable with duty


Subject to the provisions of this Act and the exemptions
contained in Schedule I, the following instruments shall be chargeable with
duty of the amount indicated in Schedule I as the proper duty therefor
respectively, that is to say :

(a) every instrument mentioned in Schedule I, which is
executed in the State . . . . . . ;

(b) every instrument mentioned in Schedule I,
which . . . . . ., is executed out of the State . . . ., relates to any
property situate, or to any matter or thing done or to be done in this State
and is received in this State :”


From the analysis of S. 3, the following points emerge :

(a) The stamp duty is leviable on an instrument and
not on a transaction.

(b) The stamp duty is leviable only on those instruments
which are mentioned in Schedule I to the Act.

(c) The stamp duty is leviable on the instrument if it is
executed in the State of Maharashtra or on the instrument which, though
executed outside the State of Maharashtra, relates to any property situate, or
to any matter or thing done or to be done in the State and is received in the
State. Hence, for example, even if the instrument of partnership is executed
outside the State of Maharashtra, but if the partnership is located in
Maharashtra, and the instrument of partnership is received in Maharashtra,
then it would be subject to stamp duty under the Act.

(d) The charge of stamp duty is subject to the provisions
of this Act and the exemptions contained in Schedule I.


2.2 Instrument :


The term ‘instrument’ is defined in S. 2(1) of the Act as
follows :

“(1) ‘instrument’ includes every document by which any
right or liability is, or purports to be, created, transferred, limited,
extended, extinguished or recorded, but does not include a bill of exchange,
cheque, promissory note, bill of lading, letter of credit, policy of
insurance, transfer of share, debenture, proxy and receipt.”


Stamp duty is leviable only on a written document which falls
within the definition of instrument.

2.3 Schedule I :


Since stamp duty is levied only on the instruments specified
in Schedule I, let us look at Schedule I. Only Article 47 of Schedule I
specifically provides for levy of stamp duty on partnership.

2.4 The term ‘instrument of partnership’ and the term
‘partnership’ have not been defined in the Act.
Hence, the term ‘partnership’ would have to be under-stood as defined in the
Indian Partnership Act, 1932.

3. Stamp duty on formation of partnership :


3.1 Stamp duty on formation of partnership is levied under
Article 47(1).

3.2 According to that Article, the stamp duty on the
instrument of partnership or the deed of partnership depends upon the capital
contribution
made by the partners as explained below :

(a) If the capital contribution is made only by
way of cash,
then the minimum amount of stamp duty is Rs.500. Where the
contribution brought in cash is in excess of Rs.50,000, the stamp duty is
Rs.500 for every Rs.50,000 or part thereof. However, the maximum amount of
stamp duty payable is Rs.5,000. In other words, if the capital ranges from
Rs.50,000 to Rs.500,000, the stamp duty would range from Rs.500 to Rs.5,000.
If the capital contributed in cash is in excess of Rs.500,000, then the stamp
duty payable would be the maximum amount of Rs.5,000.

(b) Where capital contributed by partners is
by way of property other than
cash,
then the stamp duty payable is
that leviable on a conveyance under Article 25.


3.3 Article 25 :


Since Article 25 is made applicable to partnership, the
relevant provisions of Article 25 are summarised below :


Clause (a) levies stamp duty on movable
property @ 3%.



Clause (b) levies stamp duty on immovable
property.
The stamp duty depends upon the location of the property, that is,
whether it is in a rural area or in an urban area and also upon the class of
municipality. The stamp duty for the city of Mumbai, is 5%.


Clause (c) provides that if it relates to both movable
and immovable property, then stamp duty will be payable at rates specified in
clauses (a) and (b), respectively. In other words, in respect of movable
property at 3% and in respect of immovable property at the rates applicable
under clause (b).


Clause (d) has two sub-clauses and both apply only to
residential premises
and provide a concessional slab-rate levy in the case
of flats in a co-operative housing society.

4. Admission of partner or additional capital by
partners :


4.1 Since admission of a partner requires a fresh instrument of partnership, the question of payment of stamp duty under Article 47 would arise. However, it would be restricted only to the share of contribution brought in by the incoming partner or additional contribution brought in by the existing partners. If the incoming partner does not bring in any capital, stamp duty payable would be the minimum sum of Rs. 500.
 
4.2 If in an existing partnership, additional capital is brought in by one or more partners, whether it would attract stamp duty under Article 47(1) ? It is submitted that if a fresh partnership deed is not executed, then stamp duty is not payable, otherwise it would be payable only on the additional capital. The following decisions under the Income-tax Act have held that a registered document is not required when a partner introduces his immovable property into a partnership firm as his capital contribution, but a registered document is required when a partner wants to withdraw an immovable property from the firm:

    a) Abdul Kareemia & Bros. v. CIT, (1984) 145 ITR 442 (AP)

    b) CIT v. S. R. Uppal, (1989) 180 ITR 285 (Punj. & Har.)

    c) Ram Narain & Bros. v. CIT, (1969) 73 ITR 423 (All.)

    d) Janson v. CIT, (1985) 154 ITR 432 (Kar.)

    e) CIT v. Palaniappa Enterprises, (1984) 150 ITR 237 (Mad.)

5. Retirement of a partner or dissolution of partnership:

5.1 Earlier there was no express provision for levy of stamp duty in the case of retirement of a partner. Now, it is expressly provided, and the stamp duty payable is the same as in the case of the dissolution discussed below.

5.2 Where on dissolution of a partnership (or on retirement of a partner), any property is taken as his share by a partner other than a partner who brought in that property as his share of contribution in the partnership, stamp duty is payable as on a conveyance under Article 25, clauses (a) to (d), on the market value of the property so taken by a partner. In any other case, the stamp duty of only Rs.200 is payable.

5.3 The implications of these provisions are as follows:

a) If a partner has introduced certain property in partnership and on dissolution of the partnership or on his retirement from that partnership, he takes that property, then the stamp duty of only Rs. 200 would be payable.

b) If a partner  has introduced  certain property  in partnership and on dissolution of the partnership or on retirement of another partner from that partnership, that partner takes the property, then the stamp duty as is leviable on a conveyance under Article 25 would be payable. Hence, if the property is an immovable property, then the stamp duty would be 5% as explained above.

 If the property is a movable property, then the stamp duty would be payable at the rate of 3%.

c) If the property acquired by the firm itself has been given to a partner on retirement or dissolution, then stamp duty of only Rs.200 is payable.

5.4 An issue arises in the case of a simultaneous admission-cum-retirement of partners done by the same deed, would the stamp duty be payable on the amount brought in by the incoming partner (gross amount) or this amount should be net of the withdrawals ? S. 5 of the Act states that if an instrument relates to several distinct matters, it shall be chargeable with the aggregate amount of duties with which separate instruments each relating to separate matters would have been chargeable under the Act. Hence, the stamp duty on the instrument of partnership should be payable with reference to the gross amount brought in by the incoming partner and should not be with reference to the net amount. In addition, the stamp duty would be payable also as on a deed of retirement, under Article 47(2).

6. Arrangements resembling a partnership:

6.1 In several cases, the owner and the builder enter into a profit-sharing arrangement, which is quite similar to that under a partnership. An issue in such a case would be, whether the arrangement is one of a Development Rights Agreement or is a partnership? The stamp duty consequences on the owner and the developer would vary depending upon the nature of the arrangement.

6.2 S. 4 of the Partnership Act defines a partnership as “the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all”.

Thus, a partnership    must  contain  three elements:

a) there must be an agreement entered into by all the persons concerned;
    
b) the agreement must be to share the profits of a business; and

c) the business must be carried on by all or any of the persons concerned, acting for all.
 

6.3 Element of profit sharing:

Thus, sharing of profits is an essential element. The instrument must demonstrate that what is happening in effect is that the net profits are being shared and not the gross returns. Various English decisions such as J. Lyons & Co. v. Knowles (1943) 1 KB 366 (CA) have held that a mere agreement to share gross returns of any property would be very little evidence of a partnership between them and there is much less possibility of there being a partnership between them. In certain English cases such as, Cox v. Coulson (1916) 2 KB 177 (lessee of a theatre and manager of a theatrical company) French v. Styring (1892) 2 CBNS 357, (joint owners of a race horse – expenses jointly borne)]; it was held that the mere circumstance of their sharing gross returns would be very little evidence of the existence of partnership.

In Sutton & Co. v. Gray, (1894) 1 QB 285, S a share-broker entered into an agreement with G, a sub-broker, that G should introduce his clients to S, receive half the brokerage in respect of the transactions of such clients put through on the exchange by S and should bear the losses in respect thereof; it was held that this did not create partnership between Sand G as no partnership was intended, and that the agreement was merely to divide gross returns and not profits of a common business.

b) Further, S. 6 of the Partnership Act is also relevant. It provides that the sharing of profits or of gross returns arising from property by persons holding a joint or common interest in the property does not of itself make such persons partners.

The relevant  extracts  are given below:

“6. Mode of determining existence of partnership.  In determining whether a group of persons is or is not a firm, or whether a person is or is not a partner in a firm, regard shall be had to the real relation between the parties, as shown by all relevant facts taken together.

Explanation 1. – The sharing of profits or of gross returns arising from property by persons holding a joint or common interest in that property does not of itself make such persons partners.

Explanation II. – the receipt by a person of a share of the profits of a business, or of a payment contingent upon the earning of profits or varying with the profits earned by a business, does not of itself make him a partner with the persons carrying on the business; and, in particular, the receipt of such share or payment

a) by lender of money to person engaged or about to engage in any business,

b) by a servant  or agent  as remuneration,

c) by the widow or child of a deceased partner, as annuity, or

d) by a previous owner or part-owner of the business, as consideration for the sale of the goodwill or share thereof,

does not of itself make the receiver a partner with the persons carrying on the business.

c) A relevant case in this respect is the decision of the Madras High Court in the case of Vijaya Traders, 218 ITR 83 (Mad). In this case, a construction partnership was entered into between two persons, wherein one partner S contributed land while the other was solely responsible for construction and finance. S was immune to all losses and was given a guaranteed return as her share of profits. The other partner who was the managing partner was to bear all losses. The Court held that the relationship is similar to the Explanation 1 to S. 5 and there were good reasons to think that the property assigned to the firm was accepted on the terms of the guaranteed return out of the profits of the firm and she was immune to all losses. The relationship between them was close to that of lessee and lessor and almost constituted a relationship of licensee and licensor and was not a valid partnership.

d) The profit sharing need not always be a percentage share in the profits and it can also be a fixed sum payable to some of the partners. This would not invalidate the concept of a valid partnership. The shares do not always need to be stated in proportion to the profits. – Raghunandan Nanu Kotharev. Hormasji Bamji, AIR 1927 Born. 187 and CIT v. J. K. Doshi and Co., 176 ITR 371 (Born).

6.4 Mutual  agency concept:

6.4.1 Mutual agency is also a key condition of the partnership. Each partner is an agent of the firm and of the other partners. The business must be carried on by all or any partner on behalf of all.

6.4.2 What would constitute a mutual agency is a question of fact. For instance, in the case of K. D. Kamath & Co., 82 ITR 680 (SC), the Court held that control and management of the business of the firm can be left by agreement between the parties in the hands of one partner to be exercised on behalf of all the partners.

Consequently, in the case of M. P. Davis, 35 ITR 803 (SC), it was held that the provisions of the deed taken along with the conduct of the parties clearly indicated that it was not the intention of parties to bring about the relationship of partners, but they only intended to continue under the cloak of a partnership the pre-existing and real relationship of master and servant. The sharing of profits or the provision for payment of remuneration contingent upon the making of profits or varying with the profits did not itself create a partnership.

6.4.3 The Bombay High Court in the case of Sanjay Kanubhai Patel, 2004 (6) Bom C.R. 94 had an occasion to directly deal with this issue. The Court after reviewing the Development Rights Agreement, held that it is settled law that in order to constitute a valid partnership, three ingredients are essential. There must be a valid agreement between the parties, it must be to share profits of the business and the business must be carried on by all or any of them acting for all. The third ingredient relates to the existence of mutual agency between the concerned parties inter se. The Court held that merely because an agreement provided for profit sharing, it would not constitute a partnership in the absence of mutual agency.

6.5 AOP v. Partnership:

If, instead of a partnership, an association of persons is selected as an entity for the development business, then there could be some issues from a stamp duty perspective. The Bombay Stamp Act (Article 47) contains an express provision for levying stamp duty on introduction of property in the firm by way of capital contribution by a partner. However, there is no provision for introduction of property by way of capital contribution in an AOP by a member. The moot point which arises in this case is, whether Article 25 levying stamp duty (@5%) on a conveyance would apply or Article 5(h)(B) would apply under which the stamp duty would be Rs.100 only.

6.6 From the above discussions, it would be clear that a proper structuring of the transaction and a proper drafting of the relevant documents is essential to achieve the desired results.

Penalties and prosecution under the Companies Act – Part 2

Laws and Business

1. Compounding of Offences :


1.1 In the last Issue we examined the penalties and
prosecution prescribed under the Companies Act, 1956. One of the remedies
against prosecution prescribed in the Act is ‘compounding of offences’.
For certain offences, compounding is possible, whereas for some other offences,
compounding is not possible. Compounding refers to a process whereby for an
offence in respect of which prosecution is launched against the
directors/officers, the authority only levies a monetary penalty. ‘Compounding’
is also known as ‘composition of offences’. ‘Composition’ means a compromise and
means condonation of an offence in exchange for money. In other words,
punishment and prosecution/imprisonment is converted into a fine. The Act
expressly deals with compounding in S. 621A.

1.2 S. 621A overrides anything contained in the Code of
Criminal Procedure. It applies to offences committed by a company or its
officers. In Usha (India) Ltd., In re, 85 Comp. Cases, 581 (CLB),
it was held that the presence of a non-obstante clause in S. 621A
overrides the Cr.PC. Thus, the jurisdiction granted to the CLB in regard to
compounding is independent of any provision in the Cr.PC. Even if a matter lay
before the High Court for quashing the criminal proceedings, it had nothing to
do with compounding. Compounding proceedings are independent of any criminal
proceedings for the same alleged offence.

However, two types of offences are not compoundable.
These are :

(a) For which the punishment is imprisonment only; and

(b) For which the punishment is imprisonment and
fine.

Thus, the Act deems these two types of offences as serious
and hence, no compounding is prescribed. In addition to the above two
categories, compounding cannot be done for a subsequent same offence committed
within 3 years. In other words, a repeat offence committed after 3 years of
compounding of the offence is treated as a new offence.

1.3 The sum payable for compounding cannot exceed the maximum
fine imposable.

2. Procedure :


2.1 The procedure for compounding is as follows :

(a) It can be done at any stage — before or after launch of
proceedings. There are several cases when after being issued ‘Show Cause’
notice companies voluntarily go in for compounding out of abundant caution to
buy peace and avoid litigation. Thus, like anticipatory bail, anticipatory
compounding is possible. Compounding of offences acts as a bar against
prosecution if it is done before the institution of the prosecution —
Reliance Industries Ltd., In re,
89 Comp. Cases 465 (CLB). It should
however, be borne in mind that the power to compound offences vested in the
CLB is a discretionary power — Ritesh Polyesters Ltd., 123 Comp. Cases
348 (CLB). Thus, it is not an automatic privilege granted by merely applying
for compounding. If a prosecution has
ended in a conviction and if the accused has ap-pealed against the punishment,
he may yet file a compounding application while the appeal is pending and if
he is successful, he would not have to suffer the sentence awarded —
Chottey Singh v. State of UP,
1980 Cr. LJ 583 (All).

(b) The appropriate authority for compounding is the
Company Law Board. However, in cases where the maximum fine does not exceed Rs.
50,000, the Regional Director is also empowered to compound. Thus, the RD can
only compound those offences where the punishment is only by way of a fine.
The Companies Amendment Act, 2002 proposes to substitute the appropriate
authority with the Central Government. However, the official date for this
change has not yet been notified.

(c) The application for compounding should be made to the
ROC who would then forward the same to the CLB/RD along with his comments. As
per Rule 20B of the Companies (Central Government’s General Rules and Forms,
1956) the application to the ROC should be made in e-Form 61.


The Company Law Board Regulations, 1991 state that an
application to CLB should be filed in Form No. 3 of the said Regulations. The
detailed application as per these Regulations should be attached to the e-Form
61. However, no such Form has been prescribed for an application to the RD.
The Company Law Board Regulations, 1991 do not state whether the Form should
be filed separately for each of the notices and hence, it is possible to file
a consolidated Form No. 3 for a company and all its directors/officers.

(d) Further, the Section also empowers the Court to
compound any offence which is compoundable by the CLB/RD. Further, while
allowing a compounding application, the Court has to follow the procedure laid
down under the Cr.PC. Thus, there is a concurrent jurisdiction for compounding
with the CLB and the Court. However, the procedure under Cr.PC laid down
u/s.621A(7) is not applicable when the compounding application is made before
the CLB. The CLB is not bound to follow any procedure, nor does it have to
obtain the permission of the Court at any stage. An appeal lies against its
order to the High Court. Thus, there is an option to a party to get
compounding done by the Criminal Court with the prior sanction of the Court or
get it done by the CLB without any prior permission and without following any
procedure — Hoffland Finance Ltd., In re, 90 Comp. Cases, 38 (CLB).
This view was also upheld by the Delhi High Court in the case of VLS
Finance Ltd. v. UOI,
123 Comp. Cases 433 (Del.) wherein it held the
compounding powers of the CLB u/s.621A(1) and of the Court u/s.621(7) are
parallel and one power is not dependent upon the other. The CLB can compound
even if the prosecution is pending in a Criminal Court.

(e) The compounding application should be in detail and
should lay down for each allegation — the facts, allegation and submissions.
Chartered Accountants are familiar with filing paper books before the ITAT and
they may use similar formats before the CLB.

2.2 In addition, the following guidelines issued by the DCA
are also relevant :


(a) The CLB/RD may ask for any officer to file a return or other documents within a specified time and non-compliance of this order is a punishable offence with fine of up to Rs.50,000 and/or a term of up to 6 months.

(b) More than one offence under one charging Section can be compounded at a time.

(c) In the case of a company, the composition fee shall be paid from its own funds while in the case of directors it shall be paid from director’s personal funds.

2.3 In the case of offences committed by a company fits directors when the company is under Court-approved liquidation, the DCA’s views as regards compounding applications are as follows:

a) There is no bar to any compounding application by the directors merely because the company is in winding-up.

b) Such compounding application for the directors does not require the prior approval of the Company Court.

c) However, compounding of proceedings against a company will not be permissible in view of S.446.

3. CLB’s order:

3.1 If the CLBdeems the case as fit for compounding, then it would pass an order to that effect. Some of the factors considered by the CLB include:

a) While compounding offences, it would consider the nature of the offence and the financial position of the company as well as the continuance of the default while determining the composition fee. It would ensure that having compounded the offence the same violation does not continue. It would also consider whether the application is an anticipatory one or in response to a prosecution being launched. In the case of Otto Burlingtons Mail Order P. Ltd., In re., 96 Comp. Cases, 525(CLB),the CLB considered all these factors while dealing with a compounding application for failure to obtain the Central Government’s approval u/s. 297. It observed that since the default was for several days, the penalty was large. Further, the offence was not a continuing one. Lastly,it was a voluntary application without fear of a prosecution. Hence, the CLB allowed the compounding application.

d) Similarly,in the case of First Leasing Co. of India Ltd., 42 SCL 65 (CLB), the application was allowed since the company had rectified the defaults u/s.211, u/s.217 and u/s.295, and had inadvertently committed the offences.

c) In a case where the company did not attach the balance sheet of the subsidiary along with the holding company due to non-finalisation of the subsidiary’s accounts and there was no willful omission, the CLB compounded the offence – Shaw Wallace and Co. Ltd., (2000) CLC 2008 (CLB).

d) However, in the case of General Produce Company Ltd. In re, 81 Comp. Cases 570 (CLB), since the accounts were not filed, delay was not rectified, company’s registered address was incorrect, directors stated that they were not directors and yet they signed compounding applications, the CLB rejected the compounding applications.

e) In a violation u/s.297, the quantity of goods involved in contracts with interested directors was negligible and hence, compounding was allowed with going into the merits of the case – Dintex Dyechem Lid., 104 Comp. Cases 735 (CLB).

3.2 If the CLB does not pass a speaking and reasoned order, but merely permits the composition on payment of a fee, the question which arises is whether such an order can be challenged before the High Court as being bad in law. The Delhi High Court had an occasion to deal with such a matter in the case of VLS Finance Ltd. v. UOI, 123 Comp. Cases 433 (Del.) wherein it held the if the order indicates that the provisions of S. 621A were followed and if after being satisfied with the facts and circumstances, the CLB exercises the power vested in it by S. 621A, then merely because they have not given reasons for their conclusion, cannot be a ground for challenging the order.

3.3 Once compounding is done, either the prosecution cannot be launched or if it has been launched, it cannot be continued further and the accused is discharged. There is an automatic vacation of prosecution.

3.4 An appeal lies against the CLB’s order to the High Court. A shareholder is also entitled to file an appeal against the CLB’s order and it is not correct to say that he has no locus standi in such an order. He can file a complaint before a Court u/ s.621 regarding the offence and hence, he is also entitled to appeal against the CLB’s Order – VLS Finance Ltd. v. UOI, 123 Comp. Cases 433 (Del.).

4. Role of CAs:

4.1 Compounding is an avenue which companies should pursue to avoid litigation and prosecution. Chartered Accountants can play a very active role in guiding  their clients on the process and benefits of compounding.

Corporatisation of Firms

Laws and Business

1. Introduction :


1.1 Partnership firms and sole proprietary concerns have been
and continue to be one of the most popular business entities in India. However,
concerns of growth, limited liability, expansion, private equity funding,
foreign investment, etc., have forced even the staunchest supporters of these
business entities to consider a company structure. Some of the biggest benefits
of a corporate structure are limited liability, perpetual existence, a body
corporate, etc.

1.2 In the light of this background, let us examine how a
firm can be converted into a company. Further, what are the issues in this
connection.

1.3 Two routes :


There are two alternative options by which a firm can be
converted into a company :


(a) Conversion under Part IX of the Companies Act, 1956

(b) Sale of the business by the firm to a company and
claiming of exemption u/s.47(xiii) of the Income-tax Act.


2. Conversion under Part IX of Companies Act :



2.1 Steps to be
taken :





(a) One of the options available for converting a firm
into a company, is a conversion under Part IX of the Companies Act. Here the
firm is converted into a limited company by registering it under Part IX of
the Companies Act, 1956.

(b) Some of the important steps to be taken in this
respect, include :

(i) Increasing the number of partners from 3 to a
minimum of 7, since the company to be registered should have a minimum of
7 members

(ii) Restructuring the Partnership Deed keeping in mind
the requirements of Part IX of the Companies Act, 1956

(iii) Applying to the ROC for Registration under Part
IX along with the applicable fees

(iv) Obtaining the Certificate of Registration as a
company from the ROC

(v) Issuing the equity shares to the erstwhile partners

(vi) Intimating the Registrar of Firms

(c) Upon conversion of the firm into a limited company,
the partners of the firm at the time of conversion will become the
shareholders of the company.


2.2 No Stamp Duty :


A conversion under Part IX of the Companies Act, 1956 would
not attract any incidence of Stamp Duty, as under Part IX, there is a
statutory vesting
of the assets of the firm in the company and there is no
transfer. This view is supported by the decisions in the case of Vali
Pattabhirama Rao, 60 Comp. Cases 568 (AP) and Rama Sundari Ray v. Syamendra Lal
Ray, ILR (1947) 2 Cal. 1, which state that under Part IX, there is a statutory
vesting of the assets of the firm in the company and there is no transfer.
Therefore, there is no conveyance and hence, no incidence of Stamp Duty.

2.3 No Capital Gains Tax :


A conversion under Part IX of the Companies Act, 1956 would
not attract any incidence of Capital Gains Tax, as under Part IX, there is a
statutory vesting of the assets of the firm in the company and there is no
transfer or distribution of capital asset as envisaged by S. 45(1) or S. 45(4).
This view is supported by the decision in the case of Texspin Engineering and
Manufacturing Works, 263 ITR 345 (Bom.), which states that under Part IX, there
is a statutory vesting of the assets of the firm in the company and there is no
transfer. As per
S. 45(4), transfer should be on account of dissolution of the firm which is not
the case here. Hence, the liability to pay Capital Gains Tax would not arise.

2.4 Sale of shares :


Once the firm is converted into a limited company under Part
IX, the shareholders of that company can sell their shares at any time to anyone
without holding it for a certain minimum period. The condition u/s.47A of the
Income-tax Act, 1961 that 50% of the shareholders must continue to hold the
shares for a minimum period of five years does not apply to a conversion under
Part IX of the Companies Act. This condition only applies to the second mode of
conversion, i.e., a sale of the business by the firm to a company and the
partners claiming exemption u/s.47(xiii) of the Income-tax Act. This proposition
has also been laid down by the AAR’s recent decision in the case of Unicore
Finance Luxembourg, 189 Taxman 250(AAR).

2.5 Tenancies :


An interesting issue arises in the case of conversion of a
partnership firm which is a tenant into a company under Part IX of the Companies
Act, 1956. Various High Court decisions mentioned earlier have held that under
Part IX, there is a statutory vesting of the assets of the firm in the company
and there is no transfer. Thus, a conversion under Part IX of the Companies Act,
1956 would not be treated as a transfer, since there is a statutory vesting of
the assets of the firm in the company. Hence, there is a good case for holding
that there would not be a transfer of tenancy or an illegal subletting of
tenancy.

3. Sale of
business :



3.1
Steps :


The firm would make a slump sale of its business as a going
concern or a lock, stock and barrel sale to the company. In return for the same,
the company would issue shares to the partners of the firm.

3.2 Capital Gains Tax :


The sale by the firm would be taxable u/s.50B of the
Income-tax Act as capital gains. However, S. 47(xiii) of the Income-tax Act
exempts the gains arising from the transfer of any capital asset by a firm to a
company as a result of the succession of the firm by a company in the business
carried on by the firm. The conditions to be satisfied for availing this
exemption are as follows :


(a) all the partners of the firm must become shareholders
in the company in the same proportion as their capital;

(b) the aggregate shareholding of the partners in the
company must be at least 50% and it must so continue for 5 years from the
date of the succession;

(c) the partners do not receive any other consideration
for the sale from the company; and

(d) all the assets and liabilities of the firm become the
assets and liabilities of the company.


If these conditions are satisfied, then the gain on sale would be exempt. However, if any of these conditions are violated, then S. 47A of the Income-tax Act provides that gains which were exempt would become taxable in the company’s hands in the year of violation of conditions.

3.2 Stamp Duty :

Stamp duty as on a conveyance would be levied on the slump sale on the net value of the undertaking after reducing the liabilities from the total assets. For this purpose, it would be necessary to bifurcate the assets into movable and immovable assets. The immovable assets would require an instrument of transfer and would have to be registered. However, the movable assets may be transferred by delivery and possession without an instrument of transfer. If no instrument is executed for the movable assets, then there would not be any Stamp Duty incidence on their transfer.

3.3 Other :

One of the more contentious issues would be under the Rent Act in regard to the change in the tenancies of the firm. On a slump sale, the landlord can contend that there is an illegal subletting or assignment and hence, he can terminate the tenancy. It may be noted that the earlier Bombay Rent Act contained a provision that if the tenancies were transferred along with the sale of the business as a going concern and the goodwill and stock-in-trade of the business, then the transfer was not illegal. However, such a provision is not found under the current Maharashtra Rent Control Act, 1999.

Proposed recast of Takeover Regulations

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Securities Laws

(1) The SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 1997 (‘the Regulations’ or
‘the Takeover Regulations’) are, at first impression, a set of Regulations that
has a fairly narrow applicability as they would seem to apply to the occasional
event of company takeovers. However, in reality, the scope of the Regulations is
far broader. They apply in a multitude of situations such as investments by
major investors, regular disclosures, inter-se transfers, sharing of control and
so on. The Regulations were originally notified in 1994 and then replaced by a
fresh set in 1997. Thereafter, there have been several amendments to them.

(2) However, particularly
considering the stakes involved and the wider application, many of the
provisions had to be tested and interpreted repeatedly and several times. This
required appeal to the Supreme Court. Further, the repetitive and sporadic
amendments made the Regulations complex. It was also felt that these amendments
were fire-fighting measures to meet rather than a considered overview of the
whole subject.

(3) SEBI thus set up a
Committee with very learned members from a range of background to reconsider the
Regulations in light of experience of more than a decade and in light of several
complaints and contentious issues. The Committee, after due deliberations and
inviting comments from all concerned, submitted its Report on 19th July 2010
making major recommendations for amending the Takeover code.

(4) The Report is quite
detailed and it not only contains the recommendations for amendments but also
provides a draft of the proposed and rewritten Regulations. Thus, even in legal
terms, it is possible to see what the exact proposed amendments and examine
their implications.

(5) It is worth considering
some important recommendations here since it would help us understand the
existing Regulations better and would also give a glimpse of things to come.
However, while the Report is quite detailed and makes numerous recommendations,
only certain important aspects are discussed here, though we can consider the
amendments in far more detail when they are actually made.

(6)
Increase of threshold limit from 15% to 25% :


(a) Presently, if a person
acquires 15% or more shares in a company, then he is required to make an open
offer for another 20%. Earlier, this threshold limit was 10%. Now, it is
proposed to increase it to 25%. Thus, acquisitions till such holding will only
require disclosures at various stages but no open offer. The increased threshold
would make things easier for large investors such as private equity funds. A
concern widely expressed, however, is that this will make it easier for
‘predators’ to increase their holdings to a larger extent and threaten existing
promoters. However, I do not see what is wrong in an outside investor increasing
his stake, even if the existing Promoters feel threatened. An existing Promoter
seeking to retain his control may well ensure that he invests sufficiently in
the company so as to retain control.

(b) The 25% limit is
apparently derived from the limit beyond which it may be possible to veto
special resolutions. Of course, this is only theoretically true. In practice, a
25% holding would be almost always more than 25% since at least some
shareholders would not come to the meeting and/or would not vote.

(c) A practical significance
of this increase in limit is that significant shareholders below 25% can now
increase their holding up to 24% without having to make an open offer.

(7)
Requirement of making 100% open offer :


(a) It is proposed that the
acquirer making an open offer should offer to buy 100% of the shares held by the
public shareholders instead of the existing just 20% of the capital from the
public shareholders. Thus, for example, if an acquirer acquires the Promoters’
holding of 40% of the share capital, then under existing Regulations, he would
be required to make an offer of another 20% of the share capital from the public
shareholders. If the public response is higher than the offered quantity, the
acceptance is on a proportionate basis. To give an example, if the response is
of 40%, then only half of the shares offered by every such public shareholder
would be accepted.

(b) Under the proposed
Regulations, the offeror would be required to acquire all the shares offered.

(c) This proposal is
strongly criticised on the ground that it would increase the cost of acquisition
since, at least theoretically, the offeror would have be ready to pay for 100%
of the share capital of the company. However, on another plane, it is not
difficult to see the logic and benefit of such a requirement. The existing
requirement allows the Promoters to sell the whole of his shareholding but the
public gets a chance to sell only a lesser quantity of their shares. Often,
takeover of companies are at a price that is at a premium over the ruling market
price. In such a case, the Promoters get the full price for their shares but
shareholders get a partial benefit only. The price of the shares in the market
often falls to the pre-takeover position.

(d) The proposed amendment
thus restores the balance and allows the public also to get the benefit of the
higher price.

(e) Skeptics have also
pointed out that the concern that there would be a higher response than the
existing 20% is theoretical and is not borne out of past experience. In other
words, in the past too, only in a few cases, the response from the public was
more than such 20%.

On the other hand, the
seamless delisting procedure may encourage multinationals to convert their
existing subsidiaries or new acquisitions into wholly-owned subsidiaries. If
this is not done at a fair price, then this could be an unhealthy trend and
deprives the Indian shareholder of sharing in the growth of the target. Thus
these provisions as well as related delisting and buyback provisions need to be
reconsidered.

(8) Voluntary open offer:


    If an acquirer triggers off any of the thresholds requiring a mandatory open offer, he has to offer to acquire 100% of the shares held by the public. However, in case the open offer is purely voluntary, then there is a special dispensation proposed. The acquirer can offer to acquire at least 10% of the equity share capital by way of a voluntary open offer. In such a case, the acquirer would acquire only that extent of shares that are offered within the limit he has proposed. In case of excess response, he would accept proportionately.


    Minimum public shareholding:

    An issue that comes up repetitively and is unfortunately covered by a diverse of provisions of law is that relating to the minimum public shareholding. It is worth reviewing the conceptual issue involved here. When a company makes a public issue, the law requires that a certain minimum percentage of the capital be issued to the public. This percentage has changed over a period of time and hence there are listed companies having differing initial public shareholding. In other words, different companies listed today on the stock exchanges have been subjected to differing initial public holding requirement. The matter is further complicated by the fact that owing to poor legal drafting and legal requirements, the holding of the public in numerous cases has fallen below even such initial public shareholding requirement. Where the public shareholding is very low, the purpose of listing may be lost.

    Over several years now, the government as well as SEBI has been making attempts to ensure that the companies, whose public shareholding is below a specified minimum holding, increase such holding to such minimum level. These attempts have been generally unsuccessful.

    However, while attempts continue to get all listed companies have a minimum specified public shareholding, in the meantime, steps are also taken to ensure that the existing situation does not get worse. That is to say, that existing companies do not cross this minimum shareholding limit and if they have already crossed such limit, they do not go further.

    One such situation where public shareholding can cross such limit is in case of a mandatory open offer under the Takeover Regulations. To take an example, if an acquirer acquires the Promoters’ holding of 60%, then he is required to make an open offer of 20%. The post-open offer holding could thus go to 80%. The Regulations thus provide that in such a case, since the maximum limit of 75% is breached, the acquirer should dilute his holding in the specified manner to at least 75%.

    Under the Report, the recommendation creates a situation where in every case, there is a chance of this limit being breached. The recommendation is that 100% of the public shareholding should be offered to be acquired.

    The Report suggests a better solution to the problem. Firstly, it states that in case the limit is breached, then the acquirer shall scale down his acquisitions from the Promoters as well as the public proportionately, so that the final share-holding of the acquirer is not more than the maximum permissible percentage.

    The alternative situation allowed is a case of delisting where the acquirer may actively pursue delisting of the shares. In such a situation he is permitted to acquire and retain shares beyond this limit. However, this is provided that he actually gets enough shares that are cumulatively beyond the 90% minimum holding required to permit delisting of the shares. If this limit is not reached, delisting is not permitted and the acquirer is required to scale down his acquisitions accordingly.

    A valid criticism against this proposal is that it permits direct delisting and to some extent circumvents the normal delisting requirements. Under the current Regulations, there is an elaborate procedure for delisting whereby the offer price has to be worked out in a certain manner and approval from the shareholders is also required as per the prescribed majority and manner. Further, though the proposal is well intended, it does not alleviate the existing complexity of multiple provisions of law dealing with the same issue.

    Having said this, in fairness, it must be also said that the Committee had to cover a situation where the maximum limit would be breached and within the scope of its mandate it has offered a reasonable compromise. However, ideally, SEBI should separate this issue and provide for a comprehensive solution at one place.

    Creeping acquisitions:

    Finally, an area that has seen numerous amendments in the past with the result that there is a complex set of provisions governing creeping acquisition. As readers may be aware, persons holding more than the threshold limit are permitted to increase their holdings by a specified percentage every year. In other words, they can increase their holding in a creeping manner without requiring an open offer.

    The Report seeks to simplify the provisions relating to creeping acquisitions considerably. Firstly, a uniform creeping acquisition of 5% per annum for all persons having holding between 25% and 75% is proposed. Thus, the elaborate set of existing provisions governing creeping acquisition at various percentages is sought to be dropped. Secondly, even the complications, explicit and implicit, relating to how this creeping acquisition would be counted, are clarified.

    Conclusion:

    It seems to me that the Takeover Regulations are given an importance in the media that is far disproportionate to its actual relevance. There are other serious issues such as insider trading, price manipulation, corporate governance, etc. that need more attention. Having said that, the Takeover Regulations also have relevance directly or indirectly in many areas. Rarely can any financial restructuring, investment, etc. in relation to listed companies be soundly worked out unless the provisions of the Takeover Regulations are kept in mind. Thus, the auditors and even other Chartered Accountants who have some or the other concern with listed companies would need to keep track of these Regulations and amendments thereto.

SEBI order on share warrants and amendments relating to creeping acquisitions

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Securities Laws

(1) In this article, two recent developments in the field of
Securities Laws are covered. One relates to clarifications issued by SEBI on
creeping acquisitions under the Takeover Regulations. The other relates to a
public interest litigation petition in relation to issue of Share Warrants
particularly to Promoters and SEBI’s order on the matter pursuant to directions
of the Bombay High Court. Let us consider the clarifications relating to
creeping acquisitions first.

(2) Readers may recollect that SEBI had amended the Takeover
Regulations in October 2008 and permitted an aggregate maximum of 5% creeping
acquisition of shares under the Takeover Regulations for acquirers who held
shares between 55-75%. It may also be recollected that in the normal course,
persons holding substantial shares in a listed company of more than 15% can
acquire another 5% shares in a financial year. However, this is possible only so
long as cumulative holding is 55%. SEBI had allowed in October 2008 what was
felt to be a temporary measure to allow holders to acquire another 5%, even
beyond 5%, considering the reces-sionary phase of the capital market at that
time. Ap-parently, there were certain areas where clarifications were needed and
now, after about 10 months, after the fact that the Sensex has almost doubled,
SEBI has issued a Circular dated August 6, 2009, clarifying on some issues
relating to the amendment. Some comments on the clarifications made :

(a) The clarifying Circular is issued under Regulation 5 of
the Takeover Regulations, which permits SEBI to, inter alia, issue
directions to remove difficulties in interpretation. S. 11 of the SEBI Act is
also relied on.

(b) It is seen that some of the interpretations given go
clearly beyond the plain wording and meaning of the dispensation given in
October 2008. It is possible that in the future, a legal issue may come up
whether such ‘clarification’ can go beyond the express and unambiguous wording
of the Regulations. An example of this is given later herein.

(c) It is clarified that the 5% acquisition may be made in
one or more tranches. Thus, the acquisitions can be made in one or more
tranches so long as the aggregate is not more than 5%.

(d) Further, the acquisitions need not be made in a single
financial year — it can be made any time in as many tranches as found
convenient.

(e) For calculating the 5% acquisitions, sales cannot be
netted off. Thus, only gross purchases would be counted. For example, the
acquirer cannot purchase 4%, then sell 3% and then acquire another 4% and
claim that the net purchases are within the 5% limit. This is not really
brought out by the plain reading of the amendment though, one must accept,
this is the well-accepted interpretation for other similar clauses.

(f) The cumulative holding of the acquirer cannot exceed
75%. Thus, a person holding, say, 73% can acquire only a further 2%.

(g) The cumulative holding limit of 75% is irrespective of
the minimum public shareholding that is required to be maintained under the
Listing Agreement. Thus, e.g., in respect of a company having a 10%
minimum public shareholding, the upper limit for this Regulation will still be
75% and not 90%.

(3) Public interest litigation relating to abuse of Share
Warrants and SEBI Order pursuant to the Bombay High Court decision :

(a) I had written earlier in the BCAJ issue of April 2009,
particularly on the inequity relating to Share Warrants. Essentially, I had
argued that Share Warrants were heavily being misused by Promoters. They
allotted, almost exclusively to themselves, Share Warrants at a price and
terms that appeared to be absurdly below their fair value. Had a really
independent Board been deciding the issue in each case, the Companies would
almost never have allotted Share Warrants to an outsider on such sweet
terms. Issuing Share Warrants to Promoters in this manner causes serious loss
to the Company and its non-Promoter, i.e., public, shareholders.

(b) Of course, while this issue was a concern for many
years, the article referred to earlier was in connection with the amendment by
SEBI of its DIP Guidelines in February 2009, whereby the upfront
non-refundable amount payable on Share Warrants was increased from 10% to 25%
of the Conversion Price.

(c) It did not help, hence promoters of numerous companies
gladly allowed their Share Warrants to lapse considering that the market price
had fallen far below the Conversion Price of the Share Warrants and thus
forfeited their 10% deposit. Many of them actually issued fresh Share Warrants
paying the higher 25% deposit but on a Conversion Price that was far lower.

(d) A public interest litigation was filed by Rajkot Saher/Jilla
Grahak Suraksha Mandal in the Bombay High Court and the Hon’ble Court had
directed SEBI vide order dated June 18th 2009 to hear the petitioner and pass
appropriate orders within 6 weeks of the order. SEBI has passed an order dated
July 30, 2009 on the matter.

(e) SEBI’s order dated July 30, 2009 is available on SEBI
website. In this 23-page order, SEBI has essentially concluded that there is
nothing wrong in the current law and safeguards :



  • if
    Promoters have allowed their Share Warrants and deposits to lapse, and



  •  if
    they acquired fresh warrants by paying higher upfront deposits.


(f) Readers may go through this 23-page order for more
detailed reasoning; however, I offer quick comments on some
observations/decisions of SEBI.

1. SEBI, justifying the low 10% deposit amount on Share
Warrants, says “I also note that in other jurisdictions, the option premium is
generally in the range of 10% to 15% for trading of long dated options.”. I
find this justification difficult to accept in the Indian context. The basic
important elements of the Black-Scholes option valuation formula (who, I
believe, got the Nobel Prize for this) are interest rates and volatility. Is
it plausible that interest, in India, is only 10% for a total period of 18
months? It is even less plausible — in fact consistently found untrue in every
option valuation I have come across — to believe that the volatility is 10%
over an 18 month period. And mind you, option value is at least the total of
the interest and volatility (and a few other factors).

2. Then, SEBI says that, from just 8 companies listed, a sum of Rs.1515 crores received as deposits from Promoters have been forfeited when they did not exercise the Share Warrants. SEBI seems to imply that far from the Company and the public losing, the Company has actually gained such a huge amount – it says – “it may be incorrect to argue that the Promoters stand to gain at the cost of the Company and its shareholders.” But is not the reality exactly the opposite? In fact, this shows that the companies granted options to exercise Rs. 15150 crores since the deposit amount is just 10%.

3. Further, of these Rs.1515 crores, effectively a significant portion goes back to the Promoters to the extent of their holding in the Company. If the average holding is, say, 50%, then Rs.758 crores goes back effectively to the Promoters!

4. SEBI then  goes on to say,

“It is also noted that of the 4934 listed companies, there had been 1108 preferential allotments since April 2007, of which only 360 were preferential allotments of warrants. Out of the said 360 cases, there were only 100 companies where promoters did not fully exercise the option on the warrants issued to them. Considering the total number of listed companies and number of preferential allotments made during the above period, it is seen that the instances of reissue of warrants to the promoters have not been significant or frequent.”

5. Again, I find it disturbing that as many as 360 companies allotted Share Warrants apparently to Promoters since April 2007. Further, in as many as 100 companies, the Promoters allowed their deposits and Share Warrants to lapse. While the 8 companies referred to ear-Her may be the larger of these companies, note that in just 8 companies, the amount lapsed was totally Rs.1515 crores!

6. On the issue raised by the petitioner that ‘issue of further securities should be only against full payment’, SEBI says, “the same would discourage the companies to raise funds through the allotment of warrants and also indirectly restrict the issue of capital to only shares of the company. Considering the nature of the said instruments (warrants) and the fact that only a few instances (as brought out in Para 10 above) were noticed where the warrants issued to the Promoters had not been exercised, it would be a retrograde step to disable a product which is accepted universally as a fund-raising tool. Such a restriction on issuance of warrants may also deprive the operational and capital structuring flexibility for Indian companies.” I find it difficult to believe that there would be anything wrong in prohibiting the issue of Share Warrants at a mere 10/25% deposit exclusively to Promoters – I find it even more difficult to believe it would be a retrograde step and would “deprive the operational and capital structuring flexibility for Indian companies”. What is wrong with a demand that if Share Warrants are to be issued, issue them to all shareholders – let each shareholder decide whether he wants to subscribe or not? Why are Promoters being preferred and given an exclusive deal and why banning such exclusive sweet deals will be a retrograde step?
    
7. In the end, SEBI does not find that the circumstances warrant any immediate ban and on a related aspect has stated that it “initiates a consultative process …. to suggest policy changes, if required …. “,

Conclusion:

All in all, while I personally feel SEBI has missed an opportunity to carry out a complete rehaul, it is also true that SEBI on its own cannot prevent mis-use of such instruments by the Promoters. The Promoters should remember that they would suffer in the long run if they lose their credibility and loss of credibility will eventually impact the capital market as a whole. Having said that, I raise a question:

‘Isn’t retaining and restoring the credibility of the capital market the function of SEBI?’

I feel SEBI has failed so far as the question of issue of Share Warrants to Promoters is concerned.

SUPREME COURT ON PUNISHMENT UNDER SECURITIES LAWS — Prohibition to access securities markets is only a procedural direction

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Securities Laws

(1) The Supreme Court has
recently laid down a principle in securities laws that can have far-reaching
effects for existing and future cases. Essentially, it has held that prohibiting
a person from operating in the securities markets is not a ‘punishment’, nor is
it a penalty. That being so, even if SEBI did not have power to so prohibit when
the act complained of took place, and though such power was derived many years
later, such prohibition can still be made for such act. Undoubtedly, this is
because of the peculiar nature of securities laws and their objectives.
Nevertheless, this decision requires us to view securities laws in a different
light and in a special way and hence this decision, though a few months old now,
is worth discussing.

(2) In an extreme sense (and
even to exaggerate a little), SEBI now does not need powers to punish. A change
in the law is sufficient to cover even old violations. Now, SEBI cannot complain
that it does not have enough teeth to deal with wrongdoers !

(3) Let us summarise the
issues involved first. The law gives powers to SEBI to issue various types of
orders against persons who are found to have violated any of the securities
laws. As it happens with experience, the Parliament modifies from time to time
the law and thus the powers may get enhanced or modified later on. Will SEBI be
able to use such enhanced powers even in respect of violations prior to such
amendment ? Will the constitutional protection under Article 20 against
retrospective amendment of law providing for punishment in respect of offences
be available in such a case ? The Supreme Court has answered this question in
the positive in the context of securities laws in the matter of SEBI v. Ajay
Agarwal
.

(4) A brief review of the
facts as stated in the decision is first made. The chronology of events would
particularly need to be noted, since they have direct bearing on the issues
raised and the final decision of the Court.

(5) It appears that the
respondent is the promoter of a company (Appellant is SEBI) that made a public
issue. Without going into more details, it can be summarised that, as per the
decision, there was a factual finding that there were certain material
false statements in the prospectus
for the public issue. Pursuant to this,
SEBI held inquiries and after proceedings SEBI passed the final order (‘the
Order’) in 2004.

(6) The chronology of
important events is as follows. The company issued a prospectus in October 1993
and the public issue was made in November 1993. Thereafter, certain incorrect
statements were found in the prospectus relating to disclosures of pledge of
shareholding of the promoters, dividends, etc. Apparently, these were not
disputed. Finally, SEBI passed an order debarring the respondent from buying,
selling, etc. in the securities markets for 5 years.

(7) This order finally
reached the Supreme Court. The essential issue was, since the order was passed
under certain provisions of the SEBI Act that came into force only in 2002,
whether an order could be made in respect of violations committed in 1993.
SEBI’s point was that the order was passed in 2004, i.e., after the law
was amended. It may be added that there were some prior proceedings and issues
but the Supreme Court was concerned with the final order passed in 2004.

(8) This raises a
fundamental constitutional issue (in the words of the Supreme Court) “the right
of a person not to be convicted of any offence except for violation of a law in
force at the time of the commission of the act charged as an offence and not to
be subject to a penalty greater than that which might have been inflicted under
the law in force at the time of commission of the offence”.

(9) The Supreme Court noted
that for this protection under Article 20 to be available, first, there has to
be an offence and, secondly, such offence should be subject to a
penalty.

(10) The Supreme Court noted
that the respondent was not subjected to any penalty. The Supreme Court first
observed, :

“In the instant case, the
respondent has not been held guilty of committing any offence nor has he been
subjected to any penalty. He has merely been restrained by an order for a
period of five years from associating with any corporate body in accessing the
securities market and also has been prohibited from buying, selling or dealing
in securities for a period of five years.”

(11) Then, the Supreme Court
turned to the issue whether the violation in respect of which SEBI had passed
the order was an ‘offence’ as defined in law. The Supreme Court held as
follows :

“The word ‘offence’ under
Article 20 sub-clause (1) of the Constitution has not been defined under the
Constitution. But Article 367 of the Constitution states that unless the
context otherwise requires, the General Clauses Act, 1897 shall apply for the
interpretation of the Constitution, as it does for the interpretation of an
Act.

If we look at the
definition of ‘offence’ under the General Clauses Act, 1897 it shall mean any
act or an omission made punishable by any law for the time being in force.
Therefore, the order of restrain for a specified period cannot be equated with
punishment for an offence as has been defined under the General Clauses Act.”

(12) The Supreme Court then
analysed the history and object of the SEBI Act and observed as follows :

“If we look at the legislative intent for enacting the said Act, it transpires that the same was enacted to achieve the twin purposes of promoting orderly and healthy growth of securities market and for protecting the interest of the investors. The requirement of such an enactment was felt in view of substantial growth in the capital market by increasing participation of the investors. In fact such enactment was necessary in order to ensure the confidence of the investors in the capital market by giving them some protection.

40. The said Act is pre-eminently a social welfare legislation seeking to protect the interests of common men who are small investors.

41. It is a well-known canon of construction that when the Court is called upon to interpret provisions of a social welfare legislation, the paramount duty of the Court is to adopt such an interpretation as to further the purposes of law and if possible eschew the one which frustrates it.

    42.Keeping this principle in mind if we analyse some of the provisions of the Act, it appears that the Board has been established u/s.3 as a body corporate and the powers and functions of the Board have been clearly stated in Chapter IV and u/s.11 of the said Act.”

    13. Then the Court considered the real nature of the powers that enabled SEBI to pass such an order of restraint. The Court held that this was a procedural Section and any procedural Section can apply to pending as well as future proceedings. The Supreme Court observed:

“Provisions of S. 11-B being procedural in nature can be applied retrospectively…  The Appellate Tribunal made a manifest error by not appreciating that S. 11-B is procedural in nature. It is a time- honoured principle if the law affects matters of procedure, then prima facie it applies to all actions, pending as well as future.”

    14. Thus, the Supreme Court upheld the order of SEBI restraining the respondent in the manner stated earlier.

    15. One observation of the Supreme Court, though may be held as obiter dicta, is still worth noting as it could be taken in an extreme sense by SEBI and applied in its proceedings. It is stated in paragraph 37 of the order of the Supreme Court that:

“Even if penalty is imposed after an adjudicatory proceeding, person on whom such penalty is imposed cannot be called an accused.”.

This statement is not taken further to a logical conclusion perhaps because this was not the issue before the Court. But it would be interesting to see how SEBI views this statement in its later decisions. One can imagine that even if power to levy penalties through adjudicatory orders is procedural, then the powers of SEBI would be even stronger and more discretionary and with lesser safeguards than one would expect.

    16. To conclude, the Supreme Court has laid an important precedent not just in terms of the subject matter of this decision, but also in the approach towards interpretation of securities laws and how securities laws should be treated differently. Securities laws, thus, is well on its way to becoming a special and very distinct subject by itself to which many general rules of interpretation may not apply.

Aiding investor litigation — SEBI provides financial aid to help investors obtain compensation

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Securities Laws

(1) SEBI will now financially help investors to proceed
legally against companies to obtain compensation for losses they may have
suffered or to pursue other claims. Recently, on August 11, 2009, it issued SEBI
(Aid for Legal Proceedings) Guidelines, 2009. These guidelines should be read in
the context of the earlier SEBI (Investor Protection and Education Fund)
Regulations, 2009 (‘the Regulations’) notified earlier that form the base of
these Guidelines since it is from this Fund that SEBI would provide financial
aid for legal proceedings.

(2) Let us understand a little of the background of these
‘guidelines’ since not only it would help one appreciate the need and
eligibility of such legal aid but it would also hopefully clear some confusion
arising from certain over-technical reading of these ‘guidelines’ that has been
reported at various places. Views have been expressed on the basis of such
technical reading that these ‘guidelines’ are still-born and cannot help anyone.
I believe there are reasons to believe this is not so and I will try to explain
the reasons for such belief.

(3) Typically investors are small and scattered.
Individually, they do not have the financial motivation, expertise and finally
the morale to fight against huge companies. But just as five fingers make a
fist, investors could get together to fight for their rights. And a good way to
get going together is by forming investors associations or becoming members of
such associations. SEBI has encouraged formation of such associations by
providing recognition to them. It is reported recently that there are about 23
such associations though some are reported to have dubious/political background.
SEBI has also encouraged them further by providing, by these Guidelines, that it
will provide legal aid if such associations (‘Associations’) propose to act
against the companies at fault on behalf of investors.

(4) These Guidelines read with the Regulations lay down
certain types of matters such as misstatements in connection with sale of
securities, non-payment of dividends, non-delivery of securities and so on. If
certain specified conditions are specified, SEBI would grant legal aid for legal
proceedings.

(5) But, you may ask, why should investors be made to take
legal action even if through Associations and even if aided? Why should not SEBI
take action itself — because investor protection is raison d’être for SEBI (to
use a fancy word — J — to mean SEBI’s reason for existence)? And I think the
answer to this, as explained in more detail later herein, also should clarify
the confusion that these Guidelines are ineffective and are not required.
Briefly, I think the intention is that SEBI would typically take penal action to
punish legal violations. It may even take action in appropriate cases to ensure
that losses to investors are compensated. However, there may be cases where
direct action by investors against companies is more appropriate and it is this
category of cases for which legal aid is proposed to be given.

(6) Let us now review these Guidelines in some detail and
before doing so let us summarise them first. There may be some cause for action
by investors because of defaults, omissions, etc. by companies. Associations may
seek to take action against such entities on behalf of investors. If at least
1000 investors are affected and if the defaults, etc. are of the specified type,
then SEBI may grant a limited legal aid for the specified expenses for such
legal proceedings.

(7) What type of defaults, omissions, etc. are covered ?



(a) The Regulations lay down various such defaults and it is worth reviewing them directly as so laid down in these Regulations :

‘legal proceedings’ means any proceedings before a court or tribunal where one thousand or more investors are affected or likely to be affected by :

(i) mis-statement, misrepresentation or omission in connection with the issue, sale or purchase of securities;

(ii) non-receipt of securities allotted or refund of application monies paid by them;

(iii) non-payment of dividend;

(iv) default in redemption of securities or in payment of interest in terms of the offer document;

(v) fraudulent and unfair trade practices or market manipulation;

(vi) such other market misconduct which in the opinion of the Board may be deemed appropriate;

but does not include any proceeding where the Board is a party or where the Board has initiated any enforcement action;

(b) The Investors and the Associations would have to review whether their grievance is covered by the above list. Of course, such grievance should also give a cause for action in Court/Tribunal under some law. It is only such defaults, etc. that legal aid can be given. The list is not exhaustive though and SEBI may cover other market misconduct as it may deem appropriate.

(c) A concern has been repeatedly expressed by various authors that most of these above defaults would normally result in SEBI also taking penal action or SEBI is a party to certain proceedings. In view of this and in view of the last few words of the above clause, it is argued, no aid is possible at all. Therefore, it is stated, that these Guidelines are still-born and no one would be eligible to legal aid.

(1) However, is this really so ? Perhaps not. Note that the term ‘proceeding’ is referred to in the earlier part of the clause also. Legal proceedings have been referred to in the clause and then it is stated that if SEBI is a party to such proceedings then such proceedings are not covered. Obviously, if the action is by the Association directly against the errant company without SEBI being made a party, then such proceedings are still eligible. I don’t think there is scope for arguing that ‘proceedings’ should mean any proceedings and could therefore cover even penal proceedings. Both these proceedings would be under different laws and for different intention and results. One is intended to be a direct action for compensation and the other is for punishing the entity.

2) Secondly, if SEBI has initiated penal proceeding against the errant entity, would this mean that SEBI has taken ‘enforcement’ action? According to me, this is not so. Firstly, if one reads the clause carefully, the enforcement action is qualified by the word ‘proceeding’ which, as we saw earlier, should mean proceeding in a court or tribunal. Further, I think it is possible to take a view that ‘enforcement’ proceedings should be different from penal proceedings. If, e.g., SEBI itself has initiated action to enforce a provision of law for compensating investors, then there cannot be multiple proceedings. However, if SEBI has taken action to penalise an errant entity, such action should not be deemed to be an “enforcement” action. Having said that, it must also be conceded that the clause could have been worded better.

(8) Who is eligible to claim legal aid?

a) The legal aid would not be given to individual investors but to ‘Investor Associations’. Thus, Investors will have to approach an Associations or alternatively such Associations may suo motu seek to initiate proceedings.

b) It is given on a first come first served basis! Obviously, there is a need to prevent multiple proceedings and finance of such proceedings but this is a simplistic solution.

c) The Associations would need to establish or provide the following data to be eligible for legal aid:

    i) that the Investors relied on such misstatement, etc.

    ii) that the Investors suffered loss on account of such reliance.

    iii) that at least 1000 investors are affected. In a sense, this would limit the scope of action. Having said that, this does not mean that at least 1000 Investors should have complained and agreed to such action.

9. What type of expenses are covered and to what extent?

    a) Expenses of court, advocates and related expenditure are eligible for aid.

    b) The limit of aid is Rs.20 lakhs if the proceedings are before the Supreme Court and Rs.10 lakhs otherwise.

    c) Further, the limit is also of 75% of the amount incurred.

    d) The aid is for expenses  only.

    e) Prior clearance of estimate, etc. from SEBI is a must for claims.

10. Miscellaneous:

a) There is no time limit within which SEBI will intimate whether it will or will not grant aid though, to be fair, such criticism may be premature and one may hope that disposal of application is expeditious. However, SEBI, the ‘guidelines’ say, will endeavor to pay the claims within 15 days of the receipt of account.

b) In India, there is no single law that provides for compensation to Investors for defaults by companies, etc. In fact, even the SEBI Act, Regulations, etc. do not provide for such action. Indeed, jurisdiction of Courts is barred and only SEBI can initiate action. Here, I may add that such bar is only for matters covered under the SEBI Act and not for direct action for compensation by Investors/ Associations. There have been reports and views that since there is a bar on such direct action, it would mean that these Guidelines have no relevance. However, I respectfully submit that this is not so. The bar against direct action for violation of the law is for such limited purposes only.

c) A concern has been expressed that SEBI may get handicapped if it finances such proceedings and thereby does not take action itself. Thereby, It may give a Signal that it has no powers. As I stated earlier, this should not be so. The penal action that SEBI can take is different from action for compensation that Associations may take. I think even if SEBI has lost in its penal proceedings, the Investors case is not automatically lost. The standards of proof that SEBI has to fulfill for a penal action are obviously far higher than a civil action requires.

Conclusion:

All in all, I think the’ guidelines’ are misunderstood and are being prematurely written off as ineffective. In letter and spirit, they represent a good start and give some scope for promoting taking of action. It is true that in practice they may be misused. e.g., the ‘first-come-first-served’ rule may be misused whereby an Association with an half-hearted interest may still block action by others. The limit on aid – absolute as well as of percentage – may sound unrealistically low though. Having said that, there are several good features in the ‘guidelines’ and one should wait to see how the ‘guidelines’ work in practice.

ACHIEVING ‘OTHER OBJECTIVES’ THROUGH DEMERGERS — High Court disallows achieving of certain other objects through schemes of restructuring

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Securities Laws

(1) Companies carry out
restructuring by various methods and the popular method is by carrying out a
scheme of restructuring u/s.390-u/s.394 of the Companies Act, 1956 with the
approval of the Court. While this route is quite a complicated procedure
involving numerous and time-consuming steps, there are several advantages not
only under the Companies Act, 1956, but also under various other laws including
securities laws, the Income-tax Act, 1961, stamp duty, etc. The important thing
is that the Court considering the scheme is said to be a ‘single-window’, under
which several approvals can be received without going to various other forums
and authorities. Further, this single-window channel gives approval under
different laws.

(2) Other bodies including
SEBI, etc., do not interfere with the directions of the Court and the
transaction is exempt under certain laws. For example, if allotment of shares is
made under a scheme of amalgamation or demerger, the acquisition of the shares
is exempt from the requirements of the provisions relating to open offer under
the SEBI Takeover Regulations.

(3) This single-window
service, however, in recent times, has apparently been misused. Forced buyback
of shares has been carried out by a company at predetermined price without any
choice being given to the shareholders. Such schemes have also been used for
accounting of certain transactions in a manner which, according to, Accounting
Standards and prudent accounting policies would not have been allowed.

(4) However, recently, a
decision of the Calcutta High Court has partly reversed this trend and rejected
a scheme of demerger on, inter alia, grounds that certain transactions
were proposed to be carried out as part of the scheme without compliance of the
other provisions of law. Thus, the Court did not sanction a scheme that went
beyond the original intention and was apparently formulated to avoid several
provisions of not just the Companies Act, 1956, but also of other laws — J.
K. Agri Genetics Limited v. Florence Alumina Ltd.,
[(2010) 102 SCL 495
(Cal.)].

(5) This is a case where the
petitioners had proposed a scheme of demerger. There were several points of
dispute including whether votes of certain persons who objected to the scheme
were validly considered or not. However, the areas of disputes which are the
focus of this article related to certain transactions being carried out as a
part of the scheme of demerger and which would have resulted in certain acts
being carried out that were beyond the inherent nature of a scheme of demerger.
Further, the scheme of demerger would have resulted in allotment of shares to
the promoters out of turn and without compliance with the relevant provisions of
the Companies Act, 1956, and of the Securities Laws.

(6) It may be clarified that
in the normal course, such an allotment of shares does happen as part of a
scheme of restructuring, including merger/demerger. Such an allotment of shares
is taken as part of the single-window facility and additional approval or
compliance as envisaged under other provisions of the Companies Act, 1956, or
Securities Laws is not required. However, in the present case, the facts were
peculiar and it appeared that the allotment was strictly not a part of the
scheme of demerger. It appears that the allotment of shares was not an inherent
part of the demerger and it was introduced in the scheme just to take advantage
of the benefits available to transactions covered in a scheme.

(7) The following are some
observations of the Court while rejecting the scheme :

“The scheme, sanction of
which is sought, seeks demerger of the seed division from the investment
division. This does not, however, seem to be the sole purpose of the scheme.
It also seeks conversion of the Zero Coupon Redeemable Preference Shares (ZCRPS)
and Zero Coupon Non-Convertible Bonds (ZCNCB) given under the 2003 scheme.”

“By such conversion, J. K.
Industries Ltd. (JKIL), the promoter-company, acquires shares in Florence
Alumina Ltd. (FAL), the applicant No. 2, whereby its shareholding increases.
This increase will not benefit any shareholder except the promoters. Therefore
the conversion contemplated will benefit the promoters and none else. This
cannot be the intention of the propounders of the scheme.”

(8) The Court also found
that the conversion of certain bonds and preference shares were at such terms
that were unacceptable and not in the overall interests of persons other than
the promoters. The Court reviewed these proposals and did not find them
something that a prudent person acting at arm’s length would do. The Court
noted :

“6.10 The Bonds and
Preference Shares were to be redeemed over a period of time. In fact the Bonds
were to be redeemed in 5 instalments. The 1st instalment was to be redeemed on
the expiry of the 4th year, i.e. 1-4-2006 till the 8th year, i.e.
1-4-2010. The appointed date of the instant Scheme is 1-4-2005, i.e.
prior to 1-4-2006 and will take effect from 1-4-2005 if sanctioned.

6.11 The 1st instalment in
respect of the Preference Shares was to be paid on the expiry of the 8th
instalment (i.e. 2010).

6.12 By virtue of the
conversion, the said Bonds and Preference Shares are being redeemed much
before the time specified and the present day discounted value ought to have
been considered. This has also not been done.

6.13 This is relevant as
no prudent businessman while considering the commercial aspect of the Scheme
in his wisdom would have proposed a Scheme without considering the discounting
aspect. Furthermore, such a Scheme could also not have been approved by a
prudent businessman cloaked with commercial wisdom unless such men approving
were nothing but ‘yes-men’ of the Transferor Company, Transferee Company and
Promoter Company.

    It may be recollected that schemes of restructur-ing by listed companies are required to be submitted to the stock exchanges concerned for approval before filing the same for approval of the Court. The Court also reviewed the nature and purpose of such grant of approval by the stock exchange. It highlighted the limited scope of review that the stock exchange carries out. In the words of the Court?:

“6.14 In the Supplementary Affidavit filed, the reason given for conversion is the decision of the Bombay Stock Exchange. The application filed before the Bombay Stock Exchange was only in respect of the Listing agreement. Therefore, the Scheme has been examined by the Bombay Stock Exchange only for the purpose of approving listing on the Stock Exchange and for no other purpose. The said approval is also subject to certain relax-ation granted by SEBI under the 1957 Rules.”

    The Court then found that the scheme was intended to benefit the promoters and the
Court gave the following detailed reasoning and precedents to reject the scheme and thus deny sanction to it?:

“6.17 A Scheme is aimed at not adversely affect-ing the share-holders or creditors and, therefore, is placed before the class of share-holder (equity or preference). If the opinion of the share-holder was not needed, the Scheme could have been accepted without their approval. In the instant case the Scheme is not intended to benefit the share-holder but it’s promoters.

6.18 Single window clearance though accepted in P.M.P. Auto Industries Ltd.’s case (supra) and followed in subsequent decisions, will not be applicable in the instant case as by virtue of the conversion further shares are being allotted to JKIL and for this purpose, the special procedure laid down in S. 81(1A) ought to have been followed.

6.19 The single window clearance contemplated will only apply if the alteration is restricted to the structural changes of the Company for implementation of the Scheme. The issuance of shares for purposes of increasing the share capital is not such alteration and the procedure laid u/s.81(1A) of the Companies Act ought to have been followed and, thereafter, the Scheme sanctioned. No copy of the resolution taken u/s.81(1A) of the 1956 Act has been produced.

6.20 As the single window clearance theory has no application in the instant case the decisions cited in respect thereof can also have no application.

6.21 As held in Miheer H. Mafatlal’s case (supra) and Bedrock Ltd.’s case (supra) that the sanctioning Court while ascertaining the real purpose underlying the Scheme can judiciously x-ray the same and not function as a rubber-stamp or post office, but must satisfy itself that the Scheme is genuine and bona fide and in the interest of the creditor or shareholder and in doing so the Scheme, to the extent it promotes conversion, is not just, fair or bona fide.

6.22 In 1960(1) AER 772, the objection was rejected as no unfairness could be established. Such is not the case here as the conversion will only benefit the promoter share-holder and none-else.

6.23 The conversion is intended to promote the interest of JKIL which is a separate class and a meeting of such class ought to have been called as held in 1975(3) AER 382 to ascertain the intention of its shareholders with regard to acceptance of the arrangement. This, according to 1975(3) AER 382, is fatal to the arrangement and there is no reason to differ therefrom.” (emphasis supplied)

    To conclude, the Court has laid down several useful principles as precedent for the future. Schemes have to be focussed on the main intention of the provisions relating to restructuring and they cannot be used to achieve other objectives, particularly if they are against the interests of others having a say in the matter. The Court confirmed that it will examine whether the scheme will be one which a commercial and prudent man would approve and for this purpose, it would even go into the financial calculations involved. The scheme cannot be used to circumvent (at least on these particular facts) the provisions of S. 81(1A) and other provisions of law. This decision along with certain other initiatives by SEBI should help in reducing misuse of schemes of restructuring.

Prosecution under Securities Laws

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Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .


(1) Under Securities Laws, for violation of provisions, there
is a wide variety of actions that can be taken. Typically, there is adjudication
coupled with penalty. For registered intermediaries, their registration can also
be suspended or cancelled or they may be censured. Other actions include
debarring persons from accessing the capital market or otherwise dealing in
securities for a specified period. Specific directions to remedy the wrong
committed may also be given. However, the strongest action would be to initiate
prosecution which could lead to imprisonment.

(2) Malpractices in capital markets can virtually ruin lives
of those affected. It is no wonder that the law provides imprisonment for
violation of laws, apart from penalties and other consequences. What are the
violations of Securities Laws that can result in imprisonment ? What are the
pre-requisites ? Can one voluntarily come forward and settle his crime and avoid
imprisonment ? These and some incidental questions are considered in this
article.

(3) Securities Laws, for this article, means the SEBI Act,
the Securities Contracts (Regulation) Act and the Depositories Act. As will also
be seen later, violations of Regulations and Rules issued thereunder also invite
prosecutions and hence Securities Laws would cover these Regulations and Rules
also.

(4) Also, if one sees the pattern and scheme of provisions
relating to prosecution, the basic provisions are almost identically worded in
the three principal statutes. Hence, the provisions of only one of the statutes,
viz., the SEBI Act (‘the Act’), are discussed and this discussion will
equally apply to the other statutes.

(5) Essentially, the scheme, strangely, of the provisions is
that heavy punishment is provided for violation of any and every of the
provisions of the Act and Regulations and Rules issued thereunder.
To bring the point more into force, any violation of the Securities Laws can
result up to the maximum punishment and no demarcation is made between violation
of different points. Punishment is apart from the penalty and other action. It
is possible to ‘compound’ the prosecution proceedings by paying a monetary sum.
One could also apply for immunity by following an elaborate procedure.

6.1 Let us consider the basic Section — S. 24 of the Act —
which provides for such punishment and which reads as follows :

24. Offences :


(1) Without prejudice to any award of penalty by the
adjudicating officer under this Act, if any person contravenes or attempts to
contravene or abets the contravention of the provisions of this Act or of any
rules or regulations made thereunder, he shall be punishable with imprisonment
for a term which may extend to ten years, or with fine, which may extend to
twenty-five crore rupees or with both.

(2) If any person fails to pay the penalty imposed by the
adjudicating officer or fails to comply with any of his directions or orders, he
shall be punishable with imprisonment for a term which shall not be less than
one month but which may extend to ten years or with fine, which may extend to
twenty-five crore rupees or with both.



6.2 Any and every contravention of the provisions of the Act
or of Regulations or of Rules made thereunder is deemed to be an offence. I am
reminded of an old Gujarati saying — Andheri Nagri, Gandu Raja, Takke sher bhaji,
Takke sher khaja — meaning, in a town with a mad and blind ruler, vegetables and
sweets are priced equally. What is implied in the present context is that there
is no distinction made between the nature and severity of the violations and a
common punishment is provided for all violations. Any violation of any
provisions of the Act, Regulations or Rules invites imprisonment up to 10 years
or a fine up to Rs.25 crores or with both.

6.3 It needs to be noted that it is not violation of the
statutes and Rules and Regulations issued thereunder that invite such punishment
but mere violation of even the directions or orders of the Adjudicating Officer
would invite additional punishment of similar nature. Thus, even if one does not
pay the penalty levied, punishment is possible under this Section. Of course, it
is very likely that the Court will levy appropriate punishment taking into
account the nature of the violation and other factors.

6.4 Typically, in many other statutes, we find differing
punishment varying with the seriousness of the violation. For example, under
provisions relating to non-banking financial companies in the Reserve Bank of
India Act, some violations are punishable with fine only, some with imprisonment
or with fine, but if the requirement of non-registration as NBFC is violated,
there is a minimum imprisonment of at least one year and fine. Such
differentiating punishment is missing in Securities Laws. This is despite the
fact that these provisions were substantially amended in 2002 — that is 10 years
after their original enactment.

6.5 Any attempt to violate the Securities Laws or any
abetment thereof also invites the same punishment. To put in other words, an
unsuccessful attempt to violate or assistance in the violation is put in the
same category as a successful violation. Again, the Court may levy different
punishment for attempts or abetment, depending upon the actual facts.

7. Compounding of offences :


Simplified a little, compounding of offences means coming. forward and settling the violation through a monetary fine with the approval of SEBI and the Court/Securities Appellate Tribunal. SEBI had notified last year Guidelines for compounding of offences, alongwith those for consent orders for other proceedings. These Guidelines were discussed earlier herein and there have been numerous orders under these Guidelines. SEBI has set up an independent High Powered’ Advisory Committee which facilitates the process. The prosecution proceedings are likely to be a long-drawn process consuming time, effort of and cost to both sides. It may make sense to settle the matter by payment of a monetary fine. For the accused, it saves cost and effort involved in litigation and he is also absolved from punishment. For SEBI, it achieves the objective of ensuring that the violator is punished with fine which may also act as deterrent for others and saving in time and effort. Unless one of the parties feels that it has a very strong case or unless for either of them it is a matter of principle in a particular matter which impels not to settle, it is always worth considering this option of compounding. Importantly, an application to compound an offence can be made at any stage – even before formal proceedings have commenced. Obviously, the later the matter is taken up by the accused, the higher would be the compounding fee. The amount recovered through settlement is paid to the Government of India and not SEBI.

8. Application for immunity:

A person can also apply for immunity from prosecution and penalty by making a full and true disclosure of the alleged violation. The immunity is granted by the Central Government on the recommendation of SEBI. An important difference between compounding and immunity is that immunity has to be granted before commencement of proceedings for prosecution.

9. Unique features of prosecution proceedings as compared to adjudication, enquiry and other proceedings:

9.1 Detailed discussion or even summary of prosecution proceedings generally is beyond the scope of this article. However, some features can be high-lighted. It must be noted that it is not necessary that the features described here relating to prosecution proceedings in general would necessarily apply in their full effect to prosecution proceedings under Securities Laws. Securities Laws are different from purely criminal statutes such as the Indian Penal Code and other statutes such as the Companies Act, 1956. Further, Securities Laws unfortunately do not lay down in more detail the factors relevant for consideration in prosecution proceedings. Hence, time and judicial precedents will tell us more how these principles would be applied.

9.2 Mens Rea, or guilty state of mind, is normally a necessary ingredient in an offence and it is submitted that it would have to be proved in prosecution proceedings under Securities Laws.

(i)    The Supreme Court observed in Swedish Match AB and Anr. v. SEBI and Anr., [(2004) 11 SCC 641] as follows:

“The provisions of S. 15-H of the Act mandate that a penalty of rupees twenty five crores may be imposed. The Board does not have any discretion in the matter and, thus the adjudication proceeding is a mere formality. Imposition of penalty upon the appellant would, thus, be a foregone conclusion. Only in the criminal proceedings initiated against the appellants, existence of mens rea on the part of the appellants will come up for consideration.” (emphasis supplied)

(ii)    These remarks may appear to be obiter dicta since the matter related to appeal in respect of adjudication proceedings and the issue was whether mens rea was a necessary ingredient in such adjudication proceedings. However, still, they do throw some light.

9.3 The following observations of the  Bombay High Court in SEBI v. Cabot International Capital Corporation, (2005) 123 Comp. Cases 841 (Born), cited by the Supreme Court in Swedish Match’s case cited above, on mens rea are relevant and are are summarised below:

(1)    Mens rea is an essential or sine qua non for criminal offence.

(2)    Strait-jacket formula of mens rea cannot be blindly followed in each and every case. Scheme of particular statute may be diluted in a given case.

(3)    If, from the scheme, object and words used in the statute, it appears that the proceedings for imposition of the penalty are adjudicatory in nature, in contradistinction to criminal or quasi-criminal proceedings, the determination is of the breach of the civil obligation by the offender. The word ‘penalty’ by itself will not be determinative to conclude the nature of proceedings being criminal or quasi-criminal.

(4)    The relevant considerations being the nature of the functions being discharged by the authority and the determination of the liability of the contravener and the delinquency.

(5)    Mens rea is not essential element for imposing penalty for breach of civil obligations or liabilities.

(6)    There can be two distinct liabilities, civil and criminal under the same Act.

9.4 The prosecution proceedings are before the Court while adjudication and other proceedings are before SEBI.

Arguably, the principle that the accused is innocent till found guilty would apply more strongly in prosecution proceedings under Securities Laws as compared to adjudication and similar proceedings. As the Latin maxim goes, Actus non facit reum, nisi mens sit rea. A man is responsible, not for his acts in themselves, but for his acts coupled with mens rea or guilty mind with which he does them.

10. Offences by companies:

(a) S. 27 deals with offences by companies and which of the directors, persons in charge, etc. would be deemed to be guilty of the offence and under what circumstances they can claim immunity, that is they are not liable. The wording of this Section is fairly standard and similar to corresponding provisions in most other statutes and hence not discussed here further.

Conclusion:

It is often forgotten how broad the definition of offences is and how harsh the punishment can be. Despite this, one often also gets a feeling that securities laws violations are not getting adequately punished. Perhaps the reason is the long-drawn and difficult process of prosecution and proving the offence, particularly since the parties involved are educated and well advised. Perhaps also that the punishment levied in such offences is not given the required publicity. Perhaps, there is also the cavalier approach of the law-makers to such offences as is seen by the poor attention paid to drafting of the provisions leading to numerous anomalies. The result is such strict provisions do not always act as a deterrent as they ought to. The challenge before both the law-maker and the law enforcer is to make the law simple prescribe punishment and enforce the law whilst understanding realities of business strictly, so that the law not only acts as a deterrent but is respected. The challenge to the citizen is to understand the complexities in the law – a tough call.

Consent Orders to settle violations of Securities Laws — A review on completion of two years

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Securities Laws

1) April 2009 marks the second anniversary of the Guidelines
issued in April 2007 (referred to herein as ‘the Scheme’) issued by SEBI to help
quickly settle proceedings initiated against parties for violations of specified
provisions. The Scheme has been discussed several times earlier in this column
— firstly at the time of its introduction and, later, highlighting a few cases
settled.

2) It may be recollected that the Scheme is essentially
intended to help settle existing or potential proceedings for alleged violations
of specified securities laws. A person facing or anticipating to face
proceedings for alleged violations could simply come forward with an offer to
settle the case by way of a Consent Order to be passed by SEBI. A Chapter of
this Scheme covers compounding of offences, but here, the Consent Order Scheme
is discussed. It may be recollected that the inspiration for this Scheme was the
US Model where more than 90% of cases are settled in such a manner.

3) The author intends to review :

  •      How has the Scheme fared in the 2 years of its existence ?

  •      What type of ‘consent orders’ have been passed ?

4) Such a review is important to :

  •      help parties who are contemplating to avail of the Scheme.

  •      assist those who may contemplate availing of the Scheme in future.

  •     make people aware of the fact that such a Scheme exists.

5) A review will also help to know what type of cases are
typically being settled and in what manner. Obviously, precedents have value as
they would be normally followed in similar cases. Thus, parties may know what is
the likelihood of their cases being settled and at what costs. A good example is
of cases in the recent IPO scam where it was alleged that certain parties made
fictitious/benami applicants. The cases settled clearly specify the manner in
which cases are settled. Even more important, cases not settled but in respect
of which the party preferred to continue the proceedings before SEBI also show
the type of penalty and other action taken by SEBI.

6) Apart from this, from a policy perspective, it is worth
considering whether the qualitative objectives of the Scheme were also achieved
and whether, in particular, the cases settled are the type of cases that merited
settlement and also whether the settlement process is fair.

7) It may be worth quickly reviewing the Scheme and its very
broad procedure. Any person who faces or expects to face any proceedings by SEBI
for any violation of specified provisions of Securities Laws (such as the SEBI
Act, Regulations issued there-under, etc.) can make use of this Scheme. The
person would have to come forward to settle the matter and give its offer for
settlement. The offer is to be made to the High Powered Advisory Committee, a
Committee formed of 3 independent members and headed by a retired Judge. The
procedure for making an application under the Scheme and the actual proceedings
are fairly simple and non-legalistic. The role of the HPAC is to impartially
review the status of the matter and also give its recommendation to SEBI. In
practice, the HPAC goes a step further and attempts to facilitate the settlement
itself. One often gets a pleasant surprise in the proceedings when one gets
friendly support from the HPAC itself which points out the weaknesses of SEBI’s
case in an attempt to persuade SEBI to come forward to a reasonable settlement.
Of course, a party trying to get away cheaply may also be reprimanded, albeit
gently, and the risks of allowing the application for Consent Order being
rejected are also highlighted. When and if a settlement is reached, the party is
asked to deposit the settlement amount and a Consent Order is passed. Usually,
this means the end of the existing, potential and even related proceedings in
connection with the alleged violation.

8) An important thing to note is that it is not necessary
that the parties opting for settlement under the Consent Order should admit
any of the allegations — in fact, settlement does not mean admission of guilt
.
Often, the issue is buying peace at a cost which otherwise may be incurred in
fighting and pursuing the matter. One could take the example of crossing a
traffic signal and the Traffic Police alleging that we have crossed when the
signal was red. It is possible that the sheer nuisance value of fighting the
matter in Court may not be worth it and a smaller fine accepted may be found to
be an expedient alternative.

9) How has this Scheme fared in the last 2 years ? By any
benchmark, it is a success
. In the first three months of 2009, around 90
cases have been settled through consent orders, while in 2008 more than 250
cases were settled. A sum of more than Rs. 10 crores is reported to have been
collected through the process. Also, a substantial portion of this amount
relates to the ‘disgorgement’ of the profits made by persons in the alleged IPO
scam.

10) Cases have been settled irrespective of the level at
which they were pending — whether at the very initial stage of investigation or
adjudication or when they were pending before the Securities Appellate Tribunal
or even when they were pending before the Supreme Court.

11) The type of cases that have been settled reveal that
violations were varied, for example :

  •     technical violations

  •      serious cases of fraud and price manipulation

  •      information filed beyond the prescribed time, say, under the SEBI Takeover Regulations

  •     allegations of insider trading

  •     serious ‘allegation’ of price manipulations including synchronised or circular or false trading.

12) Settling allegations under the Scheme is not a stigmatic
or shameful act that would bring a sense of dishonour or even a need of
justification. There are at least two important reasons for this. Firstly, the
allegation being settled may not necessarily be one of a serious nature.
Secondly, as stated earlier, there is no requirement of admitting any violation.
Cases are settled not because the parties necessarily feel that they are guilty,
but often the objective is to avoid the tortuously long and expensive
proceedings. The result is that persons who have taken benefit of the Scheme and
settled cases include many very well-known companies. These include ING Vysya
Bank, UBS Emerging Markets Equity Relationship Fund, Thomas Cook (India)
Limited, J. P. Morgan Indian Investment Trust, HDFC Bank Limited, DSP Merrill
Lynch Limited, Apollo Tyres Limited, etc., as can be seen from the published
orders.

13) Another noteworthy experience is that the settlement process is quite fast and very often it is completed and closed within a period of a few months of making the application. Contrast this with the fact that proceedings for many matters that are more than 5 years old are being initiated now.

14) Then there is another area of observation. Settlement is normally made by offering a sum of money as settlement charges. However, in some cases, administrative charges have also been agreed to be paid as part of the settlement. Interestingly, the offer may also be in ‘kind’ in the sense that a party may agree not to access the capital markets for a specified period of time. Particularly in IPO cases, parties have offered the amount of profits made by way of disgorgement. This not only helped the amount of profits made being disgorged but the controversy as to whether SEBI could legitimately disgorge such profits is also avoided.

15) The Consent Order Scheme, without exaggerating, can thus be accepted to be a fairly good success. What are the criticisms levelled against the Scheme?

16) A major criticism is that serious cases relating to fraud and price manipulation are also settled. Allegations of false trading, etc. or other types of fraudulent activities or price manipulation, or the recent IPO scam, etc. are some examples of matters settled through Consent Orders.

17) The question is whether such cases should at all be settled and that too in some cases by paying the profits made with or without nominal extra legal charges. Would not such a practice create an absence of fear of law amongst would-be scamsters that the worse that can happen to them is that the profits would be lost and that too if they are caught in the act? Clearly, there is some basis for this concern.

18) The other side is that it may be very difficult in some of such cases to get a guilty verdict, considering also the prolonged legal proceedings involved, and considering that in some cases, evidence may not easily be forthcoming. Some of such cases may also be of a time when the prevailing law was not comprehensive to cover the transactions and or effective enough to provide deterrent punishment.

19) Another thought is whether such a continuing settlement Scheme is desirable. It literally:

1. creates a forum for avoidance of the regular proceedings to punish violations and it creates an almost assured way of facing reduced punishment.

2. diverts attention from the complexities of such laws and procedures and its reform.

However, we should not forget that such Schemes arise also because of complexities in the law relating to its enforcement.

20) Another concern is that the Consent Orders are not detailed enough. Typically, the order is of just one or two pages which merely refer very briefly to the allegations. There is no detailed background of the allegations, facts, etc. given. No reasoning is also given why the particular matter was settled and why it was settled at the amount at which it was settled.

21) All in all, though, the Scheme has received the success it deserves. It helps reduce the backlog of cases keeping SEBI free to focus on serious cases. It also helps parties bring the issue to a quick end particularly where it is technical.

Pushing corporate governance through mutual funds — SEBI’s recent circular creates unique dilemmas for listed companies

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Securities Laws

SEBI recently made an innocuous appearing requirement for
mutual funds that has far-reaching implications on listed companies and on the
mutual funds. Simply stated, the SEBI Circular (SEBI/IMD/CIR No. 18/198647/2010,
dated March 15, 2010) now requires mutual funds to disclose in their annual
report as to how they voted at general meetings in respect of each of the shares
held by them in respect of specified matters. There are a few other connected
requirements.

As will be seen, these requirements have equal — if not more
— implications on the listed companies wherein shares are held. But let us first
outline the requirements. Incidentally, this article discusses only the
requirements relating to ‘corporate governance’ in the Circular and not other
requirements relating to ASBA, brokerage and commission, etc.

Firstly, it is required that the Asset Management Companies
(‘the AMCs’), i.e., the entities that manage the mutual funds, should disclose
‘their general policies and procedures for exercising the voting rights in
respect of shares held by them’. This disclosure is to be given on the website
of the AMC as well as in the annual report distributed to the unit-holders for
the financial year 2010-11 and onwards.

Secondly, disclosures in a similar manner and timing are to
be given of the ‘actual exercise’ of the proxy votes at general meetings of such
investee companies in respect of the following matters :

(a) Corporate governance matters, including changes in the
state of incorporation, merger and other corporate restructuring, and
anti-takeover provisions.

(b) Changes to capital structure, including increases and
decreases of capital and preferred stock issuances.

(c) Stock option plans and other management compensation
issues.

(d) Social and corporate responsibility issues.

(e) Appointment and removal of directors.

(f) Any other issue that may affect the interest of the
shareholders in general and interest of the unit-holders in particular.

The first annual report in which such disclosure is required
to be made is away more than a year from now and hence it may appear that the
implications would be realised/felt at that time. However, that may not be true
for at least two reasons.

(a) Firstly, since it is now mandated that such disclosures
have to be made, and since public disclosures often result in immediate public
scrutiny, the AMCs/mutual funds should today start considering as to how they
should vote.

(b) Secondly, while the schedule for disclosure in the annual
report is clear enough, the timing for disclosure on the website is not. Is such
disclosure required immediately, or as and when the vote is cast ?

(c) Thirdly, just as the mutual fund is now immediately
concerned with how it would vote, the investee company would also face the
implications of :

  • a possibly changed
    approach to voting by the mutual fund; and


  • disclosure of how a
    mutual fund shareholder voted at its general meetings.


Having outlined the requirements, let us consider some issues
in some detail.

This requirement is not, unlike what has been incorrectly
reported in the press, a new or even ‘innovative’ one. In fact, it is a
requirement simply copied — a copy of a good, even if a little inappropriate,
requirement — from the west where this is a fairly standard requirement. This
requirement is extensively discussed in most corporate governance reports (see
for example the Hample Committee Report). What is more, many large institutional
shareholders in western countries publicly declare, in great detail, their
voting policies. Even, statutorily, in 2003 the SEC of USA has mandated a
similar requirement.

However, is this requirement appropriate to India — or, more
specifically, does it have such important consequences in India as it has in
western countries ? Indeed, any step towards making listed companies and their
Promoters more accountable to shareholders and otherwise raising the levels of
corporate governance are obviously welcome. However, this requirement continues
to reflect the approach in India of adopting western practices where the facts
are different. In the west, the mutual funds and other institutional
shareholders hold a significant stake in such companies and hence can easily bar
proposals of management as according to the Hample Committee report which is
almost two decades old, institutional shareholders held more than 60% of the
shares in listed companies. The shareholding of the Promoters/management in the
west was usually below 10%. The situation in India is different (almost
opposite) where the Promoters clearly dominate the shareholding, usually with a
clear majority holding. Even if mutual funds participate and even vote against,
the mutual fund vote cannot reject a proposal. The situation is similar to
wagging of its tail by the dog — the difference is that in the western
countries, the dog is the institutional shareholder who can wag the tail, i.e., the Promoters. In India, the mutual
funds are the tail and they can hardly wag the dog !

Interestingly, this is one of the first of ‘external’
corporate governance requirements in the sense that it applies to a person other
than the listed company itself. Clause 49 had this limitation of scope purely on
account of its placement in the listing agreement that applies only to the
listed company.

These requirements apply only to AMCs/mutual funds. But these
are not the only collective investment vehicles in India and others include
insurance companies, FIIs, NBFCs, etc. This limited scope is obviously because
SEBI does not have jurisdiction over other entities. One will have to see
whether the respective authority governing such other institutional investors
will also issue similar requirements.

The spirit behind such requirement is obviously to make
mutual funds active investors. As the SEBI Circular states — “It was felt that
mutual funds should play an active role in ensuring better corporate governance
of listed companies”. The disclosure requirement is an indirect pressure to
ensure that they are actively involved in important issues relating to the
company since their votes would now be disclosed.

However, at the cost of repetition, while this may make sense in a situation where such institutional shareholders dominate the holding, it is meaning-less in a Promoter-dominated company. True, there have been some cases where serious opposition by major shareholder has helped. However, there is a tendency to point out the finger-countable cases where exceptional interest taken in the rare public-shareholder dominated company and conclude that such exceptions prove the rule that there is a lot of scope for shareholder activism in India.

Also SEBI has not mandated that mutual funds should vote. It has just required such institutions using public money to disclose whether and how they are voting. But this transparency is sufficient to put them on guard.

One wonders whether this can have negative effect. Isn’t it likely that many mutual funds may want to play extra safe and oppose, at least by casting a vote against every resolution that could possibly be slightly or potentially controversial ? Their vote may not make a difference to the out-come, but such a step may help them avoid controversy later on. A vote cast may be viewed critically later by the media and others though with the benefit of hindsight. Of course, some mutual funds may want to remain objective and not act in this manner, but obviously there would be a subtle pressure to play safe. On the other side, companies who are at the receiving end may find it a little embarrassing to explain why certain mutual funds voted against their proposals.

Of course, it was not that mutual funds presently do not participate. Actually, often, many companies sound off institutional investors informally (though often the spirit, if not the letter, of insider trading regulations may be violated) what views they have in respect of major proposals, even where the Promoters command a significant stake. Thus, often, the mutual funds would have already given their views and hence may not bother to participate further or vote. This may now change.

In the end, in a little lighter vein, I wonder whether the requirements could and should end with mutual funds. After all, the technique of achieving the objective of entities that have public involvement through disclosure could apply to other persons too. For example, would it not make sense to require Independent Directors to also disclose the votes that they cast on important matters ? ! While one may argue that Board Meetings where they cast their vote are confidential events, this may also be a way in which there is pressure and accountability on these directors who are in a situation similar in some respects to mutual funds.

Recent amendments relating to Corporate Governance

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Securities LawsThis series of articles
introducing securities laws for listed companies to the lay reader continues . .
.


Developments in securities laws are churned out through many sources — decisions of SEBI through decisions of its Adjudicating Officers/Whole-time Members, of the Securities Appellate Tribunal, through Informal Guidance, through Circulars, amendments of Regulations and so on and on, not to speak of relatively rarer amendments in the parent enactments themselves. It is then worth reviewing, from time to time, some of these important amendments to update our knowledge. Let us consider here one very recent development (as per SEBI’s Circular of 8th April 2008) that has far reaching implications. This Circular amends the corporate governance requirements as contained in Clause 49 of the Listing Agreement.

Let us first consider a quick background of the scheme of
corporate governance through the Listing Agreement.


Clause 49 of the Listing Agreement :

As readers would be aware, provisions relating to Corporate
Governance for Listed Companies are mainly contained in Clause 49 of the Listing
Agreement. Wisely or otherwise, in India, for Listed Companies, the principal
provisions relating to Corporate Governance are contained neither in an
enactment, nor in any subordinate law such as Regulations or Rules, but in the
Listing Agreement. What is the real status of the Listing Agreement as a law can
itself be the subject of a lengthy article. Two comments are, however, only made
here. Firstly, the Listing Agreement allows for quick amendment with a simple
direction to the stock exchanges by SEBI being sufficient. Secondly, however,
though purists will continue to question its status of ‘law’, where
non-compliance could have punitive consequences, in practice, there are several
real and serious consequences possible for a Listed Company for its violation.
Hence, it is assumed that listed companies will give this Clause of the Listing
Agreement all the seriousness any law deserves.

Clause 49 contains a myriad of requirements, many of which
are modelled on the UK and US models.

Independent Directors :

A pillar (though unduly emphasised in India) of Corporate
Governance is the concept of Independent Directors. The logic of having
Independent Directors is not far to see. The promoters or management of the
company control a company in most aspects. If there are persons who are not
connected with the promoters and are otherwise unbiased and have no conflicting
interest, they may be able to see the decisions of the promoter or management
from an independent context rather than from the Promoters’ self-interest. Thus,
the requirement of Independent Directors. The issue of the number and proportion
of Independent Directors has generated a lot of debate. Initially, the Western
model was almost blindly copied. However, over a period of time, some changes
have been made to suit Indian conditions. Prior to the recent amendment, and
very broadly stated, the requirement relating to the number of Independent
Directors was broadly as follows.

If the Company had an Executive Chairman, the Company should
have at least one-half of its Board consisting of Independent Directors. If not,
the corresponding ratio should be at least one-third. There are refinements to
these and other requirements and clarifications also, but this aspect is
focussed in this article, since that is the principal subject of the amendment.

Independent Directors to be at least 50% of the Board in case
of Promoter non-executive Chairman :

It is now provided where, even if the Chairman is
non-executive
, if he is related or connected to the promoters in the
specified manner, then the ratio of Independent Directors of the total Board
size would have to be at least 50%.

The text of the new proviso creating this requirement is
given below :

“Provided that where the non-executive Chairman is a
promoter of the company or is related to any promoter or person occupying
management positions at the Board level or at one level below the Board, at
least one-half of the Board of the company shall consist of independent
directors.”


This amendment has far-reaching implications. In my view, the
amendment has been unduly glorified by the press and others, and on the other
hand its unfair side has not been seen. There is often a strong taboo in the
minds that as soon as ‘investor protection’ is stated as the intent of a
proposal, it becomes sacrosanct, forgetting for a time that promoters are as
much investors as any other — and more often than not, they hold more than half
of the share capital of a company. However, let us consider various implications
of this amendment.

Who is a ‘non-executive’ Chairman ?

The term ‘non-executive’, though not defined, is well
understood. It is obviously the opposite of a ‘executive’ director. Typically,
an Executive Director is a working director having executive responsibilities,
for example, a Whole-time Director such as a Finance Director is an Executive
Director. An Executive Director generally has his source of livelihood or at
least a material source of earnings from the Company. It would be safe to
conclude, though not so specifically laid down in the Clause, that a
non-executive director is, by definition, not independent.

Who is an ‘independent’ director ?

This term is easy to grasp, but difficult to define. Clause 49 attempts an elaborate definition of this term, but it is not proposed to analyse it here. A simple way to understand it is that an Independent Director should have at least two qualities. He should not be related or connected in specified ways to the Promoters. He should also not have financial or other specified relations with the Company. Thus, it is important to note that he has to be independent not only with regard to the Promoters but also with regard to the Company. To give an example of the latter connection, if he holds 2% or more of the voting shares, he is not an Independent Director.
 
Chairman    – executive, non-executive, etc. :

An analysis of some of the ills in companies in the West showed that when the posts of the Chairman and the Chief Executive Officer were combined and held by the same person, there was undue concentration of power giving scope for misuse and domination of the Board and the Company. Thus, a serious thought was given in Western countries as to how to create a balance to this power centre. The thinking was that if these two posts were combined, there should be sufficient number of Independent Directors.

This concept was also adopted in India and till the recent amendment of April 2008, it was provided that where there was an Executive Chairman, at least half of the Board should consist of Independent Directors.

However, at least as per the Indian Company Law, the Chairman, solely by virtue of this post, has few significant powers. He is more of a titular head. One power sometimes forgotten is that he may have a casting vote and thus, where the votes are equally balanced, he gets an extra vote to settle the decision. However, even this can be easily taken away. Thus, except for certain powers, mostly administrative, he is like any other director and has just one vote on the Board.

Of course, the intangible impact of a Chairman cannot be underrated. Normally, it is difficult to convince the Promoter Group to have an external director as a Chairman. Even the shareholders and others would like to see the head of the Promoter Group as ‘Chairman’. Imagine an Anil Ambani group company without Anil Ambani as Chairman, or the Reliance Industries group without Mukesh Ambani as Chairman, the Tata Group without Ratan Tata and the Baja] Auto group without Rahul Bajaj as Chairman and so on.

Who is a ‘Promoter-connected’ Chairman:

The amendment now places an Executive Chairman at par with a Chairman who is connected with the Promoters or the management.

Under the following circumstances, the Chairman would become, what I have loosely termed as, Promoter-connected Chairman:

  • If he is a Promoter.

  • If he is related  to any Promoter.

  • If he is related to a person occupying a management position at the Board level or one level below the Board.


Some comments and implications of the amendment:

I believe the implications  of this amendment  could be very far reaching.  While I do not have statistics with me, typically, normally  a Listed Company  in India is promoter-controlled,   the Chairman  is from the Promoters’  Group.  The first implication  would be that  all these  companies  would  have  to get a non-promoter  Chairman  or increase the number  of Independent Directors  to at least 50%.

It could be easy and simplistic to comment that, since the Chairman is only a titular head, the Board could simply appoint one of its existing Independent Directors as Chairman and solve the problem. After all, we Indians  are supposed  to be practical people!  However,  apart  from  some  factors  discussed  earlier,  prestige,   ego  and  similar  issues would also play their role. Hence, the change would require  a change  in ‘mindset’.

The amendments made by this Circular of SEBI dated 8th April 2008 have been brought forth with immediate force. The Circular of SEBI directs stock exchanges to amend the Listing Agreements to make these changes and no time has been given for making the changes by the companies in their Board. As this article goes to press, though, I could not lay my hands on the notifications of leading stock exchanges such as BSE and NSE amending the Listing Agreement.

Other  amendments    made by the  Circular:

There are a few other amendments made by the said Circular of SEBI. For example, it is now required that a vacancy in the post of an Independent Director should be filled within 180 days. In a way, it is tightening of the norms since apparently some companies used to delay the appointment indefinitely. However, looked at in another way, the amendment now gives a reasonable time of about six months  to get a new  Independent Director .

There are few other changes including changes in the non-mandatory requirement.

Conclusion:

Listed companies would thus  need  to consider  on how to restructure their Boards to come into line with the new requirements. I would dare comment that many Chartered Accountants will benefit by being appointed as Independent Directors since many companies would still want their Chairman to be from the Promoters Group. However, in other cases, Chartered Accountants also have a chance of being appointed as the Chairman of the Board. This is both an opportunity and challenge to the ‘professionals’, particularly Chartered Accountants.

Core Investment Companies — large promoter holding companies now require registration and compliance

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Securities Laws

Promoters of listed companies may have cause both for some
relief and some worry with the recent and almost quiet notification of the
directions relating to Core Investment Companies (CICs) by the Reserve Bank of
India. Essentially, investment companies fulfilling certain conditions of size
and outside borrowings are now specifically required to be registered as
non-banking financial companies (NBFCs).

It is worth discussing first a short background here.
Promoters of listed companies (and even others) often hold shares of such listed
companies through investment companies for various reasons. In 1997, the Reserve
Bank of India Act was amended and it was required that NBFCs, as defined, should
be registered. There have been two views whether pure investment companies,
which just hold securities and do not deal in them, were also required to be
registered. Thus, several such companies did not register on this ground.
Further, on a case-to-case basis, several such companies were even exempted by
the Reserve Bank of India. On the other hand, numerous investment companies, it
appears, just neglected or defaulted in applying for registration. Now, the
Reserve Bank of India has defined such investment companies as Core Investment
Companies, and requires them to be registered even if they were earlier granted
exemption by the Reserve Bank of India.

The Core Investment Companies (Reserve Bank) Directions, 2011
were notified on 5th January 2011. Certain related notifications were also
issued. Important provisions of these Directions are discussed in the following
paragraphs.

What are CICs ?

The Directions define CICs. CICs are essentially companies
that carry on the business of acquiring securities and further satisfy certain
conditions. Firstly, at least 90% of their total assets should consist of
shares, debentures, loans, etc., in ‘group companies’. Secondly of the total
assets, at least 60% should consist of either equity shares or debentures,
compulsorily convertible into equity shares within 10 years of issue, of ‘group
companies’. Thirdly such companies should not trade in securities except through
block sales of securities in the specified manner. Finally, they should not
carry on any other financial activity except investment in bank deposits, money
market instruments, etc.

Which CICs are required to be registered ?

A CIC is required to be registered if, firstly, it has total
assets of at least Rs. 100 crores. Secondly, it should have raised or should be
holding ‘public funds’. Public funds are inclusively defined and particularly
include debentures, public deposits, inter-corporate deposits and bank finance.
However, debentures compulsorily convertible into equity shares within 10 years
of issue are not included. Such CICs are called systemically important CICs
(referred to herein as CICs only).

It is important to note that even the separate assets of
other ‘companies in the group’, as defined, are to be considered while
determining whether the CIC has the required minimum Rs.100 crores of total
assets or not. Thus, effectively, the aggregate assets of group companies are to
be counted to determine whether the concerned investment company is a CIC or
not.

Separate category of such CICs:

Such CICs are known by a separate category now, viz.,
CIC-ND-SI.

When is application for such registration required to be made ?

Existing CICs are required to apply within a period of six
months from the date of notification of the Directions. Till their applications
are disposed of by the Reserve Bank of India, they can continue to carry on
their business as CIC. Companies that become CICs after the date of the
Directions are required to apply within three months of becoming a CIC.

Minimum net owned funds :

NBFCs are required to have and maintain a minimum amount of
net owned funds as defined in the Reserve Bank of India Act. However, the
formula for calculation of net owned funds (NOF) is such that for holding
investment companies, the NOF often cannot be attained. This is particularly
because of an inherent feature of such investment companies that they, by
definition, invest in ‘group companies’, while the formula for calculating net
owned funds require deduction of most part of such group investments from the
‘net owned funds’. In fact, it is often found that by this calculation, even a
high positive net worth company has negative ‘net owned funds’. It is now
notified and clarified that such CICs shall not be required to have the NOF.

Minimum capital requirements :

An important reason for bringing even
non-deposit-accepting large NBFCs into the requirement of registration and
supervision is that such companies should not leverage too much and put
themselves and perhaps the market at risk. Thus, a minimum capital adequacy
requirement has been prescribed. As regards CICs, it is required that they
should have a minimum adjusted net worth that is at least 30% of the
risk-weighted on-balance sheet and specified off-balance sheet assets.

The definition of terms such as ‘adjusted net worth’ and the
formula for calculation of risk-weighted assets have been prescribed.
Essentially, the adjusted net worth includes the ‘owned funds’ but adjusted by
100% of unrealised depreciation/50% of unrealised appreciation in the book value
of quoted investments calculated in the specified manner.

Maximum debt-equity ratio :

CICs are required to have and maintain a maximum debt-equity
ratio of 2.5 as calculated in the specified manner. Essentially stated, this is
the ratio of outside liabilities to adjusted net worth, both terms as
elaborately defined in the Directions.

Outside liabilities for this purpose mean the total
liabilities appearing on the liabilities side of the balance sheet, but exclude
the following :


(i) Paid up capital

(ii) Reserves and surplus

(iii) Instruments compulsorily convertible into equity
shares within a period not exceeding 10 years from the date of issue.


However, it is to be noted that all forms of debt and
obligations having the characteristics of debt are included. In particular,
guarantees issued, whether appearing on the balance sheet or not, are also
included.

This term is thus to be contrasted with the other similar
term, though used for a different purpose, and that is ‘public funds’.

Annual auditors’ compliance certificate :

CICs are required to submit annually a certificate from their
statutory auditors of compliance with the Directions. This certificate has to be
submitted within one month of the finalisation of the balance sheet of the CIC.

What are group companies?

As stated earlier, the assets of companies in the group are also to be considered for determining whether the minimum size of total assets of Rs. 100 crores has been reached or not. The term ‘companies in the group’ has been very widely defined and thus includes the following:
    i) Subsidiary-parent (defined in terms of AS-21)

    ii) Joint ventures (defined in terms of AS-27)

    iii) Associates (defined in terms of AS-23)

    iv) Promoter-promotee [as provided in the SEBI (Acquisition of Shares and Takeover) Regulations, 1997] for listed companies,
    v) related parties (defined in terms of AS-18)

    vi) Companies having common brand name

    vii) Having investment in equity shares of 20% and above.

Some areas requiring clarity:

There are several questions that need clearer answers and some of these are as follows:
    1. What is the status of a holding investment company that does not have the minimum assets, calculated in the prescribed manner, of Rs.100 crores??

Whether such company, if not yet registered, is not required to be registered?

The Reserve Bank of India has issued simultaneous notifications giving certain exemptions, but a more express and clear exemption would clarify such issues with greater finality.

    2. What would be the implications if a CIC is not in complying with the various requirements such as minimum capital adequacy, debt-equity ratio, etc. of these newly notified Directions?? By what time will it be required to be in compliance with such conditions?

    3. A question related to the earlier one is whether the requirements relating to, say, having minimum 90% investments in group companies mandatory for registration or mandatory conditions after registration. The intention appears to be that if a CIC is required to be registered, then they should ensure that their asset profile consists investments in group companies only as per the specified formula. One will have to see in practiced, how the Reserve Bank of India deals with such matter.

    4. It is seen that many of the related directions, circulars, etc., are presently prescribed, keeping in mind the regular categories of NBFCs such as loan, investment, etc. The CIC-ND-SI is clearly a separate category of NBFCs and hence these other directions would have to be amended to ensure coverage of such CICs as well, of course with suitable modifications where required. For example, the Directions to Auditors of 2008 would need appropriate amendments to cover such CICs.

    5. Can existing registered holding companies shift to this new category? As discussed earlier, many existing holding investment companies may be finding it difficult to maintain capital adequacy and other ratios. However, they may be already registered as investment companies, but surely they would like to obtain the benefit of the diluted requirements if they otherwise qualify for being registered as CICs. The Directions do not provide for shifting of registration from being an ordinary registered investment company to a CIC. It is hoped that in keeping with the spirit of these Directions, the Reserve Bank of India allows shifting of such registration.

Conclusion:

These new Directions will require several promoter groups, particularly of listed companies, to check whether their holding companies need compliance of these Directions in the form for registration. Further, they will need to make a plan of restructuring the capital and finances of such companies to ensure that they fall within the framework of the new Directions.

Promoter – to be or not to be? – the identity crisis of Promoters resolved partly by a recent SAT decision

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Securities Laws

This series of articles, introducing securities laws for
listed companies to the lay reader continues…




When is a person a Promoter of a listed company? When is he
not? What are the liabilities and disabilities of a Promoter that a person
connected with a listed company should know? Would a mere executive director
be a Promoter? Would a financial or strategic investor be a Promoter? Would
relatives of an existing Promoter be considered as Promoters? Would a
significant shareholding be the deciding factor? Would holding more shares
than the Promoter make a person a Promoter? These issues are of general
interest but they have come into sharper focus in the light of a recent
decision of the Securities Appellate Tribunal (“the SAT”) in the case of
Subhkam Ventures (I) Private Limited v. SEBI – Appeal No, 8 of 2009, order
dated 15th January 2010. In this decision, the SAT has considered a situation
where the issue was whether a private equity investor holding significant
quantity of shares and having certain rights was a ‘Promoter’.

Being a Promoter is a status that, in recent times, creates
more obligations than rights or advantages. The term Promoter, as we will see
in more detail later on, is really a result of being in control of a company.
However, it is a result and the fact that a person may be a promoter does not
give any right of control. Once a person is a Promoter, he faces several
handicaps – for example:-

1. if shares are allotted to him on a preferential basis,
lock-in period is higher.

2. he cannot increase his holding beyond a general
percentage (this restriction is for any significant shareholder but in
practice, would apply mainly to Promoters).

3. he cannot be granted ESOPs.

4. he will be counted for restriction on the number of
non-independent directors.

In addition, there are many disclosure requirements of his
holdings, his share pledges, etc. The irony is that though the Promoter in
India is in de facto and generally de jure control of a company, there are no
specific provisions holding the Promoter directly responsible. However, there
is a general provision holding a ‘person in control’ responsible for violation
by companies but it is a general provision and there is nothing specific
holding Promoters responsible for non-compliance or violation of laws.

Thus, there are sound reasons for a person to be hesitant
at being classified as a Promoter. Non-executive independent directors would
by definition not be Promoters and thus, they can avoid this categorisation.
The problem may be difficult for other non-executive directors, particularly
those who are nominees of the Promoters though not part of the Promoter Group.

There is a unique category of persons who are ex-promoters.
These include persons who have handed over control of the company to a new
Promoter but continue to hold significant shares. A category that is also not
infrequent is when a Promoter Group partitions and one branch gets control of
the company while the other holds shares but does not participate in control.
In an old case involving the Modi family/Modipon Limited

(Appeal No. 34/2001),
the Securities Appellate Tribunal held on the facts that a brother and his
group who were originally part of the Promoter Group were no more part of the
current Promoter Group, since they had separated and did not participate in
control.

However, recently, a more significant problem is faced by
persons who are significant investors in a company such as private equity
investors or similar financial investors. The category of ex-promoters may, on
facts, also fall in this group since they often retain significant holding and
also have certain contractual rights of representation and share decision
making power.

Would such persons be deemed to be in “control” of a
company or in joint control with the “main” Promoters?

The SAT had to consider a typical case and thus, we now
have the benefit of fairly detailed principles that have been laid down in
this decision. It must be clarified that SAT, in this case, had to decide
whether a person had acquired “control” and it can be seen that this issue is
substantially identical in determining ‘whether a person is a Promoter’. This
is because a person becomes a Promoter if he acquires “control”.

The facts of the case were that Subhkam, that has been
described as a private equity investor (“the PE Investor”), took a significant
24.26% stake in a listed company. As required under the Takeover Regulations,
for a person taking a 15% or higher stake, it made an open offer for another
20% shares. The terms of acquisition of shares by the PE Investor in the
listed company were that the PE Investor had certain rights. The significant
ones worth highlighting include the right to nominate a director, right of
consultation for appointment of certain senior officials, and a veto power in
the taking of certain specified acquired decisions. The issue was whether, by
virtue of such rights, the PE Investor had control and was thereby a Promoter.

Interestingly, the agreement giving the PE Investor such
rights specifically stated that the PE Investor was not a Promoter or in
control of the company.

The issue arose in a peculiar context. Subhkam had made an
open offer and in the draft letter of offer, it had specified itself only as a
financial investor. It specifically did not make an open offer under
Regulation 12 of the Takeover Regulations, which is attracted when a person
acquires control. However, SEBI, after much discussions, directed it to make
an open offer under Regulation 12 also. This direction was the subject matter
of appeal.

Incidentally, Regulation 12 requires open offer to be made by a person acquiring control in a listed company, irrespective of any acquisition of shares by him.

The SAT meticulously analysed important provisions of the agreement and also in the process, laid down important principles of determination of when a person is said to be in control of a listed company.

It is worth considering the exact wording of the definition of “control” under the SEBI Takeover Regulations:-

    “control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner;

The SAT considered the above definition and observed:-

“This definition is an inclusive one and not exhaustive and it has two distinct and separate features: i) the right to appoint majority of directors or, ii) the ability to control the management or policy decisions by various means referred to in the definition. This control of management or policy decisions could be by virtue of shareholding or management rights or shareholders agreement or voting agreements or in any other manner.” Having considered the above, the SAT then went on to give a detailed description of what constitutes control and under what circumstances:-

“Control, according to the definition, is a pro-active and not a reactive power. It is a power by which an acquirer can command the target company to do what he wants it to do. Control really means creating or controlling a situation by taking the initiative. Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. In that event, the acquirer is only reacting rather than taking the initiative. It is a positive power and not a negative power. In a board managed company, it is the board of directors that is in control. If an acquirer were to have power to appoint a majority of directors, it is obvious that he would be in control of the company but that is not the only way to be in control. If an acquirer were to control the management or policy decisions of a company, he would be in control. This could happen by virtue of his shareholding or management rights or by reason of shareholders agreements or voting agreements or in any other manner. The test really is whether the acquirer is in the driving seat. To extend the metaphor further, the question would be whether he controls the steering, accelerator, the gears and the brakes. If the answer to these questions is in the affirmative, then he alone would be in control of the company. In other words, the question to be asked in each case would be whether the acquirer is the driving force behind the company and whether he is the one providing motion to the organization. If yes, he is in control but not otherwise. In short, control means effective control.”

Having laid down what constitutes control, it examined the rights of the PE Investor in light of the agreement. It particularly stated that grant of rights to a significant investor can be expected since he would be likely to safeguard his investment. It held that having one nominee on the Board does not amount to having control.

The SAT analysed the provisions that give “veto rights” under certain circumstances to the PE Investor. If the company proposed to take certain acts as described in the agreement, which are typically significant and out of the normal course of business, the affirmative vote of the PE Investor was necessary. Would such a right mean that the PE Investor had acquired control? The SAT held that it did not. It observed:-

“The list of matters provided in clauses 9(a) to 9(o) are not in the nature of day to day operational control over the business of the target company. So also, they are not in the nature of control over either the management or policy decisions of the target company. These provisions merely enable the acquirer to oppose a proposal and not carry any proposal on its bidding… The mere fact that any such amendment requires an affirmative vote from the appellant is again indicative of the fact that it wants to protect its investment and that the basic structure of the company is not altered without its knowledge and approval. By no stretch of logic, can such an affirmative vote confer control over the day to day working of the company.”

Accordingly, the SAT held that the PE Investor had not acquired control and therefore was not required to make an open offer under Regulation 12. Curiously, the PE Investor would have held, if the open offer to acquire 20% was wholly successful, 44.26% shares, that would have been far more than the holding of the Promoters.

The decision was of course on facts. Often, depending upon situations, resulting also from the bargaining power of the investee company, the rights obtained may be more or less. The answer may be different. However, the general principles laid down by SAT can surely help in resolving situations such as these that are relatively quite common.

Pledge of shares by promoters

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Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .


(1) SEBI has recently made disclosure of shares pledged by
Promoters compulsory. The requirements have come into effect from 28th January
2009 but the disclosures are to be made in stages/events and actually in more
than one way. As it is a new and continuing requirement it is important to
discuss the same. I expect these requirements to continuously evolve in the near
future. The impact on the market value of some scripts where promoters have
pledged a part of their holding has been negative.

(2) While SEBI has not stated the reason for introducing this
amendment, it perhaps does not need to, considering the heated discussion in the
press on the Satyam episode where the Promoters had pledged their shares which
in turn were sold by pledgees on invocation of the pledge and/or failure of the
promoter to provide additional margin. Most of such sales were made long before
the disclosure of the alleged scam when the prices were still high. The common
investor in India normally considers the stake of the Promoters in a company as
an important factor. The investors were outraged not only because the Promoters
had effectively encashed their holdings, but also by the consequent crash in the
price of shares.

(3) SEBI has acted in haste to prevent more Satyams, by
introducing disclosure requirements. It is a fact that this new requirement is
definitely useful and some rightfully argue that it was long overdue.

(4) Let us now examine the actual wording of the requirement.
I repeat that while earlier there was no requirement to disclose pledge of
shares by promoters, now the requirements are multiple overlapping and even at
times inconsistent. Let us first summarise the regulatory provisions :

(a) A new Regulation 8A has been inserted in the SEBI
Takeover Regulations. This regulation requires promoters to disclose to the
Company the details of shares pledged by them and the Company is required in
turn to intimate the same to the stock exchanges.

(b) Clause 35 of the Listing Agreement that requires
disclosure of shareholding pattern to be
intimated to the stock exchange has been amended
to include disclosure of shares held by Promoters that are pledged or
otherwise encumbered.

(c) Similarly, Clause 41 which requires publishing of
periodical results has been amended to also include the details of shares
pledged/encumbered by Promoters.


(5) These amendments though are stated to be with immediate
effect, have effectively differing applicability dates in terms of individual
requirements. However, before we go into these individual requirements, let us
consider some terms :

(a) Disclosure is to be made by Promoters and persons
belonging to the Promoter Group
. For this purpose, it has been stated that
the definition under Clause 40A of the Listing Agreement is to be followed.
This clause, in turn, refers to the definition of these terms under the SEBI
DIP Guidelines, but modifies that definition a little. For this article, the
collective term ‘Promoters’ is used to cover all of them.

(b) Disclosure is required of shares pledged. These
refer to shares of the listed company and not shares of any investment or
holding company through
which the Promoters may hold shares. This is seen
as a loophole that results in an incomplete picture of the effective
encumbrance of Promoters’ holding. Having said that, it is also true that in
many cases, lenders typically prefer pledge of shares of the listed company
itself as they can be easily sold and monies realised, instead of shares of
the holding company for which the process may be longer. Thus, the loophole in
reality, to a large extent is non-existent.

(c) Disclosure is to be of shares that are pledged
or otherwise encumbered. There is an inconsistency in the scheme of the
different provisions whereby for one set of provisions, the disclosure is to
be made of shares ‘pledged’ and for others, disclosure is also required of
shares ‘otherwise encumbered’ or just ‘encumbered’. These terms being common
legal terms are relatively easily understood, but if one goes into a detailed
analysis, which space constraints do not permit, there are indeed
complexities. For example, shares can be in paper form and dematerialised form
and the pledge of either of them can be in different manner. Also, shares can
be ‘encumbered’ in many ways and indeed there can be many ways in which
restrictions can be placed on the shares that may amount to encumbrance.

(6) Disclosure under the takeover regulations :


(a) A new Regulation 8A has been inserted to require
disclosure of ‘shares pledged’.

(b) There is a transitional requirement to cover pledges
existing on the date when the amendment came into effect. There is some
controversy as to when can the amendment be said to have come into effect, but
the conservative view is that the regulation has come into effect from 28th
January 2009. This date is important for the initial period of disclosure. It
is unfortunate that SEBI has not been more specific about the effective date.

(c) The Promoters have to intimate the details of the
pledged shares, in the prescribed format, to the listed Company within 7
working days of the amendment. The Company, in turn, has to inform the stock
exchanges where the shares of the Company are listed, within 7 working days of
receipt of information from promoters. However, this is to be done only if
during a calendar quarter, the cumulative quantity of shares pledged is at
least 25000 or 1% of the total shareholding/voting rights.

(d) For further pledges, the Promoters have to inform
within 7 working days of creation or invocation of pledge. The Company, in the
manner similar to the above, informs the stock exchanges of such further
pledges or invocation of the pledge.

7) Disclosure under amended Clauses 35/41 of the Listing Agreement:

a) These amended Clauses require disclosures of Promoters’ shares that are pledged or otherwise encumbered. Suitable formats have been provided for this.

b) The disclosures will be on a quarterly basis starting from the quarter ending March 2009.

c) Regulation 8A of the Takeover Regulations requires disclosure of pledged shares only by the Promoters of the company. How will the company then know what shares are ‘encumbered’ ? This may sound to be a lacuna, but perhaps a better view is upholding the spirit and that the Promoters should still inform of shares that are ‘encumbered’ also. The Promoters are in control of the company. The requirement is on the company to disclose the shares encumbered by the Promoters. The Promoters cannot claim that, on the one hand they are in control of the company and, on the other hand the company is a separate entity that should be treated as an entity independent for this purpose. Of course, SEBI could clarify the requirements to avoid confusion.

8) In conclusion, recollect the oft-quoted comment of Warren Buffet that:

“You only find out who is swimming naked when the tide goes out”.   

When Promoters pledge a substantial portion of their shares, they expose themselves and the company they control (and thereby the shareholders) to serious risks especially when there is a downturn.

The disclosures pursuant to these amendments  will :

  • help bringing out more clearly the holding of Promoters at risk.
  • bring in more transparency in the corporate world.

There is considerable discussion in the media that SEBI should mandate disclosure of end use of funds raised by pledge of shares. This information, in the opinion of the author, could be very relevant and indica te the risks being taken by the promoters which could impact the operations of the company whose shares have been ‘pledged’ or ‘encumbered’.

END TO ACCOUNTING ‘FLEXIBILITY’ IN CORPORATE RESTRUCTURING ? — Amends to The Listing Agreement

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Securities Laws

SEBI has sought to limit certain accounting ‘flexibility’ in
mergers, demergers and other restructuring. SEBI has done this by issuing a
Circular directing an amendment to the listing agreement. The focus of the
amendment is on certain deviations from Accounting Standards commonly carried
out as part of schemes of mergers, demergers, reduction of capital, etc.

SEBI has sought to attain this objective indirectly and, one
could even say cleverly, and with apparently more effect than it would have done
it directly. It has also attempted to kill several birds with one stone. Or has
SEBI attempted too much and ended up with a provision with limited effect?

In essence, SEBI has required that companies proposing
certain schemes of mergers, demergers, etc. shall submit, in advance, a
certificate from their auditors that the matters contemplated in the scheme are
in compliance with Accounting Standards.

Let us consider some background.

First, let us consider mergers and demergers. Schemes of
mergers, demergers, etc. provide for transfer of assets and liabilities and/or
for other matters. The implications of accounting for amalgamations are
substantial enough to warrant a separate Accounting Standard 14 on Accounting
for Amalgamations.

While AS-14 deals with several matters, it makes a special
provision for treatment of Reserves. It states that if the scheme provides for
treatment of reserves otherwise than what the AS requires, the scheme should be
followed, but certain disclosures should be made particularly about what would
be the effect if the AS was followed. In other words, deviations would be
possible but through disclosure. Thus, the scheme would, to that extent,
override the Accounting Standard, subject to the safeguard of disclosure.

In fact, as a general principle, we know that ICAI’s
Accounting Standards do not override provisions of law. As paragraphs 4.1 and
4.2 of the Preface to the Statements on Accounting Standards says, in case of
inconsistency, the provisions of law will prevail. However, in such a case, the
ICAI will determine the extent of disclosure required in the financial
statements and the auditors report. See also the general ‘Announcement’ of the
ICAI on the implications of a Court/Tribunal order sanctioning an accounting
treatment which is different from that prescribed by an Accounting Standard
which is highlighted later.

It is quite common then that such schemes provide for an
alternate accounting treatment of reserves, etc. and Courts usually approve
them. Thus, there is a fairly widespread practice of what I would call
‘deviations through disclosure’
.

The SEBI amendment also covers other forms of restructuring
such as capital reduction. Even under such schemes, inter alia, capital reserves
such as securities premium and capital redemption reserves can be used for
purposes which otherwise are not allowed. Moreover, as we will see in the Bombay
High Court’s decision in Hindalco’s restructuring case, such schemes may go
beyond mere freeing up of the capital reserves. They may even provide for
debit of certain expenses to such reserves where such debit may otherwise
(allegedly in that case) not be permissible under the Accounting Standards.

Of course, it is not as if all such deviations are
necessarily attempts to avoid the spirit of the Accounting Standards and, very
often, the intention may be bona fide including avoidance of some archaic
provisions of law or simply to give a better picture of the underlying
commercial reality. There is also at least the small safeguard of disclosure.
However, it is also true that, particularly as we will see in case of other
restructuring such as reduction of capital, this was also seen to be an almost
carte blanche power.

SEBI has pointed out in the Circular that in some recent
schemes filed before the High Courts, the accounting treatment of ‘various
items’ is not in accordance with the applicable Accounting Standards (‘AS’). To
stop this, it has introduced the requirement of auditors’ certificate that the
scheme is in compliance with Accounting Standards. More importantly, the actual
amendment further provides that a mere disclosure as permitted under AS-14
giving certain details relating to a departure from the AS is not sufficient.


The amendment, as I said earlier, is clever. No regulation
has been laid down (which would have required certain law-making procedures to
be followed) to make such requirement. Nor has SEBI needed to plead to the MCA
to amend its rules relating to Accounting Standards. Indeed, no substantive
requirement has been made at all even in the listing agreement to follow the
Accounting Standards. Instead, a simple procedural requirement is made
that the auditors’ certificate will be obtained — in advance — stating that
Accounting Standards have been complied with in respect of matters covered in
the scheme. And further, the usual route of deviating by disclosing would not
be permitted.


Does this stop the accounting ‘flexibility’ through such
schemes ?

The amendment does make the listed company indirectly comply
with Accounting Standards and the specific requirement that deviation through
disclosure is not permitted makes it even more effective.

Note several implications and limitations though.

The auditors’ certificate is required for compliance of all
Accounting Standards and not merely Accounting Standard-14.

Secondly, the certificate is required for all types of
schemes
— whether of mergers,
demergers, reduction of capital, etc. — in fact, all scheme/petitions to
be filed before any Court or Tribunal u/s.391, u/s.394 and u/s.101 of the
Companies Act, 1956. AS-14 is, of course, applicable only to amalgamations and
not to other type of schemes. Courts have also held that the said AS-14 applies
only to amalgamations and hence its applicability cannot be raised in other
schemes [see, e.g., Gallops Reality’s case 150 Comp. Cas. 596 (Guj.)]. However,
where other Accounting Standards apply to the particular transactions in a
scheme, the certificate would cover them too.

Having said that, the requirement applies only to compliance
of Accounting Standards and not to accounting of transactions where Accounting
Standards do not apply.

Further, if certain restructuring of reserves is carried out
under a statutory provision, the clause cannot apply. A good example is
restructuring of capital reserves such as share premium or other similar capital
surpluses. Even though SEBI has sought to cover schemes involving reduction of
capital, it is arguable that since the accounting of share premium is strictly
not covered by Accounting Standards, the new provisions will not apply.

Consider another aspect that is not touched by the Accounting Standards and therefore remains untouched by the amendment. If a reserve is treated as a ‘capital reserve’ as so required by the AS, does that, by itself, make it a ‘capital reserve’ for the purposes of the Companies Act, 1956, particularly for the provisions relating to reduction of capital

    Thus, for example, would such reserve would become thereby at par with ‘Share Premium’ ? To take it further, would it make at par with ‘Revaluation Reserve’ — particularly when, in reality, its source may be revaluation ? Would the statutory restrictions relating to dividends, bonus shares, etc. apply to such a reserve ? I believe that this would continue to remain a grey area even after this amendment.

Then there is a larger issue and this can be explained by a case study in the form of a recent Bombay High Court decision in the case of Hindalco Industries Limited (2009) 94 SCL 1 (Bom.). In this case, to summarise the essence, the company proposed a scheme of restructuring u/s.391 of the Companies Act, 1956, under which the Securities Premium Account of the company would be transferred to a ‘Reconstruction Reserve Account’. To this account, certain specified expenses and losses would be debited. The question was, if such adjustment was otherwise not in compliance with Accounting Standards, whether such a scheme could be permitted and generally whether non-compliance with accounting standards was permissible.

    Essentially, the Court stated that, firstly, the provisions of S. 211(3A)-(3C), while they do create a requirement of compliance with accounting standards, do also provide that where they are not followed, certain disclosures shall be made. In other words, it held that there is also a form of ‘deviation through disclosure’ possible.

    The Court also referred to ICAI’s ‘Announcement on Disclosures in cases where a Court/Tribunal makes an order sanctioning an accounting treatment which is different from that prescribed by an Accounting Standard’. This substantive part of this Announcement reads as under :

Paragraph 4.2 of the ‘Preface to the Statements of Accounting Standards’ (revised 2004) provides as under :

“4.2 The Accounting Standards by their very nature cannot and do not override the local regulations which govern the preparation and presentation of financial statements in the country. However, the ICAI will determine the extent of disclosure to be made in financial statements and the auditor’s report thereon. Such disclosure may be by way of appropriate notes explaining the treatment of particular items. Such explanatory notes will be only in the nature of clarification and therefore need not be treated as adverse comments on the related financial statements.”

In the case of companies, S. 211(3B) of the Companies Act, 1956, provides that “Where the profit and loss account and the balance sheet of the company do not comply with the Accounting Standards, such companies shall disclose in its profit and loss account and balance sheet, the following, namely :

  a)  the deviation from the accounting standards;

  b)  the reasons for such deviation; and

    c) the financial effect, if any, arising due to such deviation.”

In view of the above, if an item in the financial statements of a company is treated differently pursuant to an order made by the Court/Tribunal, as compared to the treatment required by an Accounting Standard, following disclosures should be made in the financial statements of the year in which different treatment has been given :
  (1)  A description of the accounting treatment made along with the reason that the same has been adopted because of the Court/Tribunal Order.
  (2)  Description of the difference between the accounting treatment prescribed in the Accounting Standard and that followed by the company.
  (3)  The financial impact, if any, arising due to such a difference.It is recommended that the above disclosures should be made by enterprises other than companies also in similar situations.

  (c)  The question then is whether this decision is now overridden by the SEBI amendment ? The answer does not seem to be wholly clear. One view can be that the company has to obtain an auditor’s report stating that the Scheme is in compliance of the Accounting Standards. If it can be held on the facts that the scheme is not and therefore the auditor’s certificate states so accordingly, then, despite the aforesaid decision, the requirement would not be complied with. The other view can be that since SEBI has specifically stated that ‘deviation through disclosure’ of only the specified requirements of   AS-14  would not be permitted and therefore, in case of ‘deviation through disclosure’ for other Accounting Standards remains open.
  (i)  Incidentally, there can also be two views whether, particularly in light of the Supreme Court’s decision in J. K. Industries v. UOI, (2007) 80 Comp. Cas. 415 (SC), whether the aforesaid decision in Hindalco’s case is, with respect, correct. This is specifically on the Bombay High Court’s view that ‘deviation through disclosure’ is permissible and that, in that sense, the Accounting Standards are not strictly mandatory. However, this controversy is best left open here and may be a subject of a separate discussion.

In the end, it is seen that SEBI’s shot, howsoever well intended, has limited effect. It has limited cover-age of types of transactions and schemes. It does not cover all types of reserves — indeed, in practice, it may not cover statutory reserves such as share premium, etc. and the impact on other reserves is also limited. With slightly better wording, it could have covered assuredly even covered matters other than treatment of reserves.

However, the amendment is likely to bring a partial end to the route of deviation through disclosure.

SEBI has thus attempted to hit several birds with one stone, but apparently it has brushed, not even hit, one bird, but that, I guess, is better than nothing.

Recent Decisions of SAT

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Securities LawsThis series of
articles introducing securities laws for listed companies to the lay reader
continues . . .

1. The decisions of SAT, the Securities Appellate Tribunal,
are important because they not only reveal the securities laws in a better light
by giving interpretations on issues, but they also give a certain level of
finality to such interpretations since the next and last stop after SAT through
appeal is the Supreme Court. Hence, it is worth considering some recent
decisions of the Hon’ble SAT.

2.1 Whether non-compete fees can be considered as part of
open offer price
[Shri Sukumar Chand Jain v. SEBI and others, (Appeal
No. 25 of 2008, date of decision 10th April 2008)] :

(a) This was a case of acquisition of controlling interest in
a Listed Company and the issue was the open offer price that should be paid to
the public shareholders. While there are certain other facts of the case, the
short issue here was whether non-compete fees paid to the erstwhile promoters
should be included in the open offer price to be paid to the shareholders.

(b) It appears that the Acquirer had acquired the shares of
the Listed Company from the existing Promoters at a certain price. However, a
significant amount was also paid to the erstwhile Promoters as ‘non-compete
fee’.

(c) The appellant was aggrieved by the fact that the
non-compete fee was not included in the open offer price and he claimed that the
existing Promoters who sold their shares effectively got a higher price than the
minority public shareholders. He prayed to SEBI to require the Offerer to
increase the open offer price by including the ‘non-compete’ component.

(d) Initially, SEBI agreed to the plea and gave appropriate
directions to the Offerer. However, on personal hearing and representation, SEBI
agreed that since the non-compete fee was not more than 25% of the open offer
price, it was covered by Regulation 20(4) read with Regulation 20(8) and hence
it need not be added to the open offer price. It needs to be noted that the
Regulations do permit a certain level of non-compete fee to be paid without the
same being required to be considered for computing the open offer price.

(e) The appellant appealed to SAT against the order of SEBI.

(f) Interestingly, SAT focussed on the issue of the bona
fides of the appellant rather than the merits of the case and finally concluded,
as discussed below, that mainly since the appellant had not come with clean
hands, relief could not be given. It must be emphasised though that prima
facie
the order of SEBI of not including the non-compete fees did have merit
— the only point is that this aspect was not considered in order of SAT.

(g) However, this decision is important owing to the fact
that often so-called ‘arbitrageurs’ enter into a company just before or
immediately after an open offer. They believe that they would profit either from
the open offer, which they predict would be higher than their purchase price, or
that because of such open offer, the market price would otherwise rise. Millions
of dollars were made by such arbitrageurs (such as Ivan Boesky) in the US. The
problem is that the prediction of such arbitrageurs may go wrong and then they
try to use some means or the other to compensate themselves. It is seen in the
US that at times they ‘greenmail’ the Company or the Promoters by requiring them
to buy their shares or they may resort even to litigation to get the open offer
price increased. I hasten to clarify that I do not claim that this was so in the
present case. However, SAT had strong words and grounds for rejecting the claim
of the appellant.

(h) The SAT observed that “We are inclined to agree with him
(the Offerer’s counsel) and the reason for this is that we are not satisfied
with the bona fides of the appellant in filing the present appeal.” The
appellant had claimed that the Offerer was not offering a fair price to the
shareholders by not including the non-compete fee. However, the SAT
stated that it could not understand why the appellant bought the shares after
the open offer announcement was made. In other words, the appellant did not hold
shares as on the date of the announcement but acquired shares thereafter.

(i) The SAT also noted that not only did he acquire shares
after the announcement, but the appellant also actively traded in the shares of
the Company thereafter and even increased his final holding. The Hon’ble SAT
commented, “Obviously, the appellant had purchased the shares only to litigate
with the target company.”.

(j) Hence, SAT concluded, “We are satisfied that he has not
approached the Tribunal with clean hands and must fail on this short ground”.

(k) The SAT also noted that the appellant had unconditionally
offered his shares to the Offerer pursuant to the open offer, hence, he could
not thereafter claim a higher price. The SAT commented, “In view of this conduct
of the appellant, he is estopped from challenging the purchase made by the
acquirer nor can he claim a higher price. As already observed, if he was not
satisfied from the beginning as to the price offered by the acquirer, then why
did he offer his shares unconditionally. Having done so, he has to be non-suited
on this ground.”.

(l) Finally, the SAT dismissed the appeal, stating that it
had not gone into the merits of the appeal.

2.2 While the decision is interesting and brings into
light interesting aspects of Offerer, the following comments are respectfully
offered :


(1) The mere fact that a person has entered after the
announcement or that he may have traded in the shares after the announcement
should not be held against him. In the US, though there have been excesses, such
arbitrageurs have been found to perform an important function in
price-discovery. Often, other shareholders have got a better price because of
active interest taken by arbitrageurs. Whatever the case may be, the mere fact
that a person is an arbitrageur does not make him, per se, a person with
mala fide intentions and in any case such activities are not illegal and in fact
are, in principle, at par with speculators in general. Having said that, though,
it must also be noted that SAT recorded a finding that the appellant bought the
shares only to litigate.

(2) the mere fact that certain inconvenience may result if the higher price had to be offered to all shareholders, should not be a reason to reject the appeal. It was found that a large number of shareholders did not offer the shares pursuant to the open offer. Thus, there would be a dilemma as to whom the difference in price could be paid. That was another ground on which the appeal was rejected. However, it is respectfully submitted that this problem could have been solved in many ways. In any case, assuming for a moment that the claim for a higher price was justified, then it would have been the fault of the Offerer of not having offered the correct price. He could be made to give a revised offer and shareholders given a fresh chance to offer their shares.

3) However, it must be noted that, though the SAT did not go into the merits of the case and that is whether the non-compete consideration should have been added to the open offer price, prima facie, Regulation 20(8) does permit payment of non-compete consideration up to 25% of the open offer price. SEBI apparently concluded that this limit was not exceeded. Hence, though the SAT did not go into the merits and correctness of this fact, perhaps this was not needed.

3. Then there are two other decisions worth noting for the strong words used by the Hon’ble SAT on the attitude of SEBI causing injustice to the parties concerned. The SAT awarded hefty costs. The decisions are:

3.1 Delay in listing of additional shares issued allegedly on account of acts and omissions of SEBI and the stock exchange – Palco Metals Limited v. (1) The Ahmedabad Stock Exchange -r Limited and (2) SEBI (Appeal No.4 of 2007, decision dated 16th April 2008)

a) The facts are interesting and not uncommon and in essence reflect the endless to and fro pass-ing of the file relating to the listing of the shares of the Company that were allotted to certain shareholders.

While the facts are complicated, it can be stated that essentially, the issue was the huge delay by the stock exchange and SEBI in listing certain shares allotted by the Company. The listing of the Company was suspended in 1993 on account of non payment of listing fees. However, the listing was restored in 1997 and immediately thereafter, the Company made a preferential allotment of shares.

m) The listing of such shares allotted remained pending on account of certain to-and-fro claims and passing of the file between SEBI and the stock exchange. Claims made for not listing the shares were found to be vague and baseless by SAT,because non-compliance was alleged without specifying any particular provision.

n) SAT made certain strong remarks against SEBI and the stock exchange; some of the observations are reproduced:

“The Board and the exchange should realise the loss suffered by the shareholders of the company who have been deprived of the opportunity to trade their shares in the market. This is not the way to protect their interests.”

……….

Before concluding, we may mention that the exchange has not put in appearance despite service and we have had no assistance from its side. The Board, as usual, has taken the stand that the issue is between the appellant and the concerned stock exchange, though earlier it had not permitted the exchange to allow list-ing.”

o) The SAT finally ordered that the shares should be granted listing within 2 weeks of its order. It also awarded costs of Rs.1lakh to be shared equally by SEBI and the stock exchange.

5. Is the Managing Director a whole-time director? ! – Vyas Securities Pvt. Ltd. and Another v. SEBI, (Appeal No. 165 of 2007, decision dated 3rd April 2008)

p) This decision is less on the facts or the law and more .on the peculiar and allegedly arbitrary attitude of SEBI. In fact, the Hon’ble SAT begins its decision with the words, “This case is yet another instance of how arbitrary the Securities and Exchange Board of India could be when it comes to dealing with the market intermediaries. We say so because the facts of the case speak for themselves.”.

q) The facts are not very complicated. Essentially, the appellant was a broking company that was converted to a corporate entity from a non-corporate individual broking entity. The issue was whether the corporate entity would get continuity in terms of payment of fees to SEBI. SEBI had permitted such continuity on corporatisation on, inter alia, the condition that the erstwhile broker-individual should act as the whole-time director of the converted corporate entity for 3 years.

r) As per the decision, SEBI apparently claimed that such individual was only the Chairman and Managing Director and not the whole-time Director! ! Thus, the exemption should not be given and the corporate entity should be made to pay fees that the broker-individual had effectively already paid. Of course, there were certain alleged discrepancies that were put forth as grounds for rejection of such claim (such as discrepancies regarding date/time of meetings which SEBI felt pointed towards ma-nipulation of documents), but this contention was found to be very unreasonable by SAT.

s) SAT resolved the other discrepancies relating to dates and genuineness of the documents by other documents and legal reasoning. It also noted that SEBI itself had granted exemption in similar cases.

t) On the issue whether legally and in facts, the director was also the Whole-time Director of the Company, the SAT observed as follows:

“Now when we look at the proceedings as recorded, it is not in dispute that Pradyuman was appointed the Managing Director and Chairman of the company by two separate resolutions in the Board meeting held on 31-7-1998. As a managing director he cannot but be a whole-time director of the company.

The term Managing Director has been defined in S. 2(26) of the Companies Act and it means a Director who by virtue of an agreement with the company or of a resolution passed by the company by its Board of Directors or by virtue of its memorandum of Articles of Association is entrusted with substantial powers of management which would not otherwise be exercisable by him. There was no other claim set up by any other person to the managing directorship of the company and we see no reason for the Deputy General Manager to have doubted that fact. In view of this, she should have accepted the claim of the company.

u) Allowing the appeal with costs, the Hon’ble SAT concluded as follows:

“For the reasons recorded above and while expressing our displeasure in regard to the manner in which the Deputy General Manager has conducted the proceedings, we allow the appeal and set aside the impugned order. The appellants will have their costs which are assessed at Rs.50,000.”

The SEBI Pyramid Order — A fascinating case study of greed, high-tech investigation and weak laws

1) The recent SEBI order in the matter of Pyramid makes a fascinating read from many angles —the sheer brazenness of the fraud, the portrayal of the alleged main culprit almost as a hero by the press, the alleged direct involvement of senior journalists from leading newspapers, the way in which many investors, including funds, succumbed to the greed and fell for the scam, and so on. Above all, the most amazing aspect is the meticulous, high-tech investigation done by SEBI — said to be under an IPS officer specially appointed for this purpose — in which every step of the scam was meticulously investigated and documen-ted, for example, the actual physical location and movements of the alleged prime culprits were tracked through mobile tower records as to where they were, whom they met and whom they called or SMSed. There are many more such interesting details in this case, some of which are highlighted here. However, I would recommend to the readers to go through this 54 page order available on SEBI’s website.

2) One may wonder why such an order did not receive the wide publicity it deserved. The cynic in me believes that this was because journalists (including an ex-journalist) of a leading business and other newspapers were allegedly to be directly involved — in fact, one of them has been arrested.

3) The case has lessons for both companies and professionals. The high tech atmosphere we are living in ensures that the way in which we interact — through calls and SMS, through emails and even physical movements can be meticulously documented and unravelled. Bank accounts and their transactions, stock market transactions, share transfers through depositories are all through electronic mode and the details of which can be instantly unravelled in detail. What is worse, one may be put on the defensive even if calls, SMS or even stock markets transactions happened unknowingly with parties who are later found to be scamsters. The technology of recording, satellite tracking, mobile call records, etc. may raise embarrassing questions and instead of the regulator being required to prove guilt, the onus may shift on the accused simply on basis of these records.

4) The case will also have repercussions under securities and other laws. The issues are :

  •  how far such electronic data — in several new forms including physical locations of persons based on the location of their mobile phone —can be held to be admissible evidence.
  •  whether under the applicable laws, particularly the securities laws administered by SEBI, such data is sufficient to hold a person guilty.

It need to be noted that, even as I write this article, the person whom SEBI alleges to be the prime accused/mastermind is still not arrested and reportedly, SEBI is consulting senior criminal lawyers as to whether SEBI has the power to arrest him. Probably, the reason is that even this meticulous investigation has not been able to bring up evidence that would prove, to the level demanded by criminal law, his involvement.

5) Let us then go straight into the case. Let us start with what has been stated to have happened. I may add a caveat here that this article is intended to be an academic exercise to understand more of securities laws through the Order as a case study. Hence, the correctness or otherwise of the statements made in the Order are not known and are simply assumed to be correct to help focus on the interesting issues involved. Further, the Order itself is interim and without giving the parties a benefit of a reply or hearing. To make this article readable, I have avoided the use of the word ‘allegedly’ ad nauseam throughout this article but it should be read into every statement.

6) Pyramid Saimira Theatre Limited is a listed company. Its background is not relevant here except that there were 2 promoter groups represented by Mr. P. S. Saminathan and Mr. Nirmal Kotecha. Some shares were transferred between the two groups which would have triggered an open offer. However, before SEBI could examine the matter and give a direction, a forged SEBI order was served on the Company and its Promoters. As per this order, Mr. Saminathan was required to make an open offer within 14 days at a price of Rs. 250, when the ruling market price was around Rs. 70 — a fraction of such open offer price —and that too was allegedly manipulated.

7) One can expect the sheer temptation to buy shares at the ruling price of around Rs. 70 with a hope of getting the SEBI-ordered price of Rs. 250 or at least a modest and quick appreciation by selling at a higher price. As the proverbial fools rushed in to buy (including several funds), Mr. Nirmal Kotecha and his alleged associates started selling — and selling as if there was no tomorrow. He sold almost the whole of his stake as Promoter — he started selling when the price was Rs. 70-80 and went on selling when the price fell as the fact that the SEBI letter was a forgery came to be known.

8) The resultant investigation revealed a meticulously timed conspiracy. A letter on a letterhead identical to SEBI’s was couriered by an ex-journalist. The courier company was directed to serve the letter not in the normal course but on a specific day. Accounts were opened with several brokers and preparations made to dump the shares at the time when such letter was served and the news was made public. And then the shares were thus sold as if in a torrent. As per the Order, Nirmal Kotecha himself and through associated entities sold 70.99 lakhs shares.

9) Further investigation showed that the facts were even murkier. The price of about Rs. 75 was itself a jacked-up price by Nirmal Kotecha allegedly using several front persons to engage in circular/fictitious trades. The front persons used were, as SEBI found out, very poor persons staying in the distant suburbs of Mumbai. These persons, with nil or nominal income, traded in lakhs of shares of Pyramid. Interestingly, when SEBI visited one of such persons — an impoverished engineering student — he admitted that he had no knowledge of the trading and that blank signed documents of various types were obtained from him. Shockingly, while this interview was in progress, Nirmal Kotecha barged in and asked him to stop giving the statement and modify the earlier statement. Resultantly, he stopped giving the statement. SEBI has filed police complaint against Nirmal Kotecha for such obstruction.

10. The high tech investigation of SEBI to unravel some aspects of the conspiracy is something to admire and appreciate. The forged letter was allegedly issued by an ex-journalist who, alongwith certain other journalist colleagues, arranged for wide publicity of the letter. SEBI tracked the exact movements of Nirmal Kotecha and these persons by using the mobile tower data of their mobiles. It traced them to exact locations during the critical period when the fraud was happening – near a temple in Dadar and in a reputed restaurant in Dadar. It was found that these persons had been in this hotel for a specified period together. It was then found that two of such persons proceeded to go towards Dalal Street.

11. Calls made by such persons during such periods were traced with the length of the calls noted. The sequence of calls was also used to construct the underlying conspiracy at it happened. Interestingly, the mobile number of the Company Secretary of Pyramid was given to some journalists who wanted to confirm the correctness of the information. The Company Secretary said that he had no knowledge of the SEBI letter. Yet another number of another Company Secretary of Pyramid group was given. It turned out that the number actually was in the name of another person and did not belong to the other Company Secretary. Such person took the calls and confirmed the information. The Company Secretary to whom such journalists assumed they were talking denied receiving any such call. The person who took the calls is not traceable.

12. Email exchanges of concerned parties were also meticulously traced to know particularly how publicity was organised for the forged letter.

13. It will be interesting to see as to what extent the data of this sophisticated investigation in the form of call logs, actual physical locations of mobiles, etc. are admissible as evidence in law and useful to pinpoint the guilt, particularly for prosecution.

14. SEBI has also uncovered other information relating to the case. It appears that huge withdrawals and deposits of cash were made in accounts allegedly connected to Nirmal Kotecha. The fronts through whom Nirmal Kotecha dealt with also received huge loans from certain persons who also are allegedly connected with Nirmal Kotecha. These loans were alleged to have been arranged by a Chartered Accountant.

15. The investigation led to earlier years and it was found that the seeds of the conspiracy were sown much earlier around when shares in Pyramid were allotted to Nirmal Kotecha. The merchant banker who carried out several assignments for Pyramid also gave a buy recommendation for the shares of Pyramid giving a very high target price – far higher than recommendations by other analysts.

16. Even the purchase of shares between the two Promoters which would have triggered the open offer was alleged to be fictitious.

17. SEBI has vide its interim Order banned almost 250 entities in various manner till further directions. Generally, these entities have been banned from buying/selling in the capital markets. Curiously, the fronts – the pathetically poor persons – have also been barred from buying/selling. The merchant banker who gave a buy recommendation for Pyramid has beenbanned from giving further recommendations. One of the brokers who opened the accounts of Nirmal Kotecha and his fronts has been barred from accepting new clients.

18. The investigation also shatters some illusions of an independent press. Several existing and past journalists are alleged to have been directly involved in the scam. The Order said that one of them agreed to carry out his part for, what he admitted, a sum of Rs. 10,000. They also used their contacts with other newspapers and parties to publicise this letter and even coordinated with Nirmal Kotecha to arrange for confirmations from officials of the Company. Sadly, but perhaps expectedly, the Order received disproportionately less coverage. A leading business newspaper whose Assistant Editor was accused of being directly part of the scam published a brief article reporting the Order and adding a cryptic sentence that the journalist was under investigation. What is even more curious is the creation by the press of a hero-like halo around Nirmal Kotecha, tracing his ambitions and role-models and how a person coming from a very modest background managed to reach a net worth of Rs. 500 crores at the age of 36 years. His alleged modus operandi of making huge monies buying into shares of otherwise dud companies at low prices and then rigging up the price for offloading such shares has almost been glorified.

19. One cannot also help wondering at the motivations and the expectations of the perpetrators of the scam. How did they believe that they could get away with such a brazen scam of issuing a forged SEBI letter that SEBI was bound to immediately deny issuing? One can accept that they did not expect that their physical movements and calls would be traced with such sophistication and precision. But, how did they believe that their earlier trading and subsequent sales would not be tracked?

In short, is there a faith of such individuals in the defective legal system and its enforcement and perhaps even the corruption that they can expect to get away with such transactions? To repeat, as of writing this article, the person whom SEBI alleges to be the mastermind and main beneficiary has yet to be arrested. It is also to be seen whether such persons would be allowed to use the Consent Order mechanism and escape severe punishment.

20.  This case also, particularly as it develops, would become a case study for a student in securities laws since there would be numerous provisions that would be found to have been violated. These would include provisions relating to price manipulation, false trading, Insider Trading, code of conduct of stock brokers and merchant bankers, and so on. This is apart from, of course, other laws such as the Indian Penal Code.

Legal compliance — Directors’ responsibility

Laws and Business

1. Introduction :


1.1 In India, we are surrounded by a plethora of laws and
regulations. Being in business is not easy and there is a multitude of legal
obligations and reporting requirements. It is in this backdrop that a business
must consider and study the relevance of several laws which could turn out to be
decisive to the success of a business. Non-compliance with certain laws may
affect the very substratum of the business or the going concern concept of an
entity.

1.2 A company is an inanimate body and it functions through
its Board of Directors. The Directors are the brain and the heart of the
company. The Directors have been vested with wide powers under the Companies
Act, 1956. However, as powers and responsibilities are two sides of the same
coin, the Directors also have several and vicarious responsibilities. It is well
known that Directors owe a fiduciary responsibility to the company and its
shareholders as they are Trustees and Agents of the company.

1.3 The Companies Act contains several express provisions
dealing with the responsibility of Directors — the Act prescribes that in case
of certain offences by the company, the Directors are personally liable. For
instance, in several Sections, the Companies Act provides that the company and
every ‘officer in default’ shall be liable for punishment and/or
prosecution. S. 5 of the Act defines the term ‘officer in default’ to mean the
Managing Director and any Director so specified, and failing both, all the
Directors of the Board. However, if the Director can demonstrate that he had
entrusted responsibility of overseeing the compliance to a competent and
reliable person, then he would be able to use this as a defence. S. 211 of the
Act is one such Section which expressly makes such a provision. Thus, it all
boils down to a question of fact as to whether the Director was negligent in his
duties and hence, punishable for the offence.

2. Are Directors responsible under laws other than the Companies Act ?


2.1 The Companies Act is only one of the several laws which
impact a company. A company is also liable for complying with several other laws
which directly or indirectly impact its operations. Directors being the organ
through which a company functions they are also responsible for ensuring that
the company complies with the responsibilities and obligations mandated by the
relevant enactments. The important laws concerning a company in addition to the
all-important Companies Act, 1956, can be classified as under :



  • Commercial Laws



  • Immovable and Intellectual Property Laws



  •  Financial & Capital Market Laws



  • Labour Laws



  • Taxation Laws



  • Others



2.2 Some of the important laws under each of the above
include :

(A)
Commercial Laws :

  •  Indian Contract Act
  •  Limitation Act
  •  Benami Transactions (Prohibition) Act
  •  Arbitration and Conciliation Act
  •  Negotiable Instruments Act
  •  Information Technology Act
  •  The Competition Act


2.3 Immovable and Intellectual Property Laws :

  • Bombay/Indian Stamp Act
  •  Registration Act
  •  State Property laws, if the company is a real estate developer, such as, the Development Control Regulations, Maharashtra Flat Ownership Act, etc.
  •  Trademarks Law
  • Patents Law
  • Copyrights Law
  • Geographical Designs Act
  •  Rent Act


2.4 Financial & Capital Market Laws:

  • SEBIDIP Guidelines – for a company coming out with a public issue


  • SEBI Insider  Trading  Regulations


  • SEBI (ESOP) Guidelines


  • SEBI (Buyback of Shares) Regulations


  • Regulations for Capital Market Intermediaries, if the company is one, e.g., the company is a stockbroker


  • Listing agreement


  • Foreign Exchange Management Act and Regulations

2.5 Labour  Laws:

  • Payment  of Bonus Act
  • Payment  of Gratuity  Act
  • Employees’ Provident Funds & Miscellaneous Provisions Act
  • Minimum  Wages Act
  • Workmen’s Compensation Act
  • Employee Pension Scheme
  • Employees State Insurance Act
  • Industrial Disputes Act
  • Payment of Wages Act
  • Factories Act
  • Employers’ Liability Act
  • Employment Exchanges (Compulsory notification of vacancies) Act
  • Equal Remuneration Act
  • The Maternity Benefit Act


2.6  Taxation Laws:

  • Income-tax  Act
  • Central  Excise Act
  • Customs  Act
  • Value Added  Tax/Sales  Tax
  • Service Tax/Finance Act
  • Central Sales Tax


2.7  Others:

  • Sector Specific Laws, e.g., Drugs and Cosmetics Act, Drug Price Control Order, Narcotic Drugs and Psychotropic Substances Act for Pharma Sector, Cinematograph Act for Media Sector, etc.
  • Air Pollution Act, Water Pollution Act, Environment Protection Act, etc.
  • Shops and  Establishments Act


3. There can be no quarrel against the proposition that a company can be proceeded against in criminal proceedings even where the imposition of sentence is provided for. That law is laid down in Standard Chartered Bank & Others v. Directorate of Enforcement & Ors., [(2005) 4 SCC 530]. However, that case does not state that the company alone should be prosecuted. Hence, in the case of a company not only the company, but also the Directors can be personally proceeded against and punished. We are all familiar with the Directors’ responsibility u/s.138 of the Negotiable Instruments Act dealing with dishonouring of a cheque. The consequence u/ s.138 is imprisonment and there is no provision even for exempting professional and independent Directors of the company, who are in no way connected with the day-to-day management of a company. However, there are judicial decisions whiCn have taken a reasonable interpretation on this enactment but harassment continues. Thus, Director’s responsibilities are extremely onerous and it is often said that being a company’s Director is like wearing the proverbial ‘Crown of Thorns’.

4. Many laws provide that where the person committing any offence is a company, then every person who at the time of the offence was responsible for the conduct of the business of the company would be liable to be punished. Further, any director with whose connivance, neglect or active con-sent any offence has been committed by the cornpany, shall also be deemed to be guilty of the offence and shall be liable to be directly proceeded against and punished. It is important to understand the meaning of the terms, such as connivance, neglect and consent.

(….To be continued)




Real Estate Act

1. Introduction :

    1.1 In September 2009, the Ministry of Housing & Urban Poverty Alleviation, Government of India, introduced the draft of the Real Estate (Regulation of Development) Act (‘the Act’). It is expected that the Ministry would finalise this Act sooner than later. This article gives an overview of this all-important act for the real estate industry.

    1.2 The Act proposes to introduce a radical change in the real estate industry — for the first time a Real Estate Regulatory Authority would be constituted to regulate, control and promote planned and healthy development and construction, sale, transfer and management of residential properties. It aims to protect the public interest vis-à-vis real estate developers and also to facilitate the smooth and speedy construction and maintenance of residential properties. Thus, just as the capital markets have a regulator in the form of SEBI, the banking industry has RBI, the real estate sector would also have an authority. A reading of the Act shows that this is likely to be a State Act with each State having its own Regulator.

2. RERA :

    2.1 A Real Estate Regulatory Authority (‘RERA’) would be constituted under the Act. It will consist of a Chairman and two Members. The Chairperson must be a person of the post of the Principal Secretary to the State Government while the Members must be persons with expert knowledge in law, finance, management, urban development, etc. The RERA would have various powers and rights.

    2.2 The Act also constitutes a Real Estate Appellate Tribunal to adjudicate any dispute and hear and dispose of appeal against any direction, decision or order of the RERA under the Act. The Tribunal will consist of a Chairman and two Members. The
    Chairperson must be a Judge of a High Court while the Members must have held the post of the  Principal Secretary to the State Government or must be persons with expert knowledge in law, finance, management, urban development, etc.

3. Application of the Act :

    3.1 Although the Regulator would be known as the Real Estate Regulatory Authority, it is important to note that the Act does not apply to all types of property development. It only applies to the construction of the following properties :

(a) Construction of apartments : An apartment is defined to mean a dwelling unit by any name which is a separate and self-contained part of any property located in a residential building. Thus, only construction of residential buildings would be covered. A building constructed only for commercial, industrial, office, retail purposes, would not be covered. However, in certain cases this Act would not apply (see para 4.1 below).

(b) Construction of a colony : A colony has been defined to mean an area of land divided or proposed to be divided into plots or flats for residential, commercial or industrial purpose. Thus, if a colony is to be constructed, then it can include buildings constructed for commercial, industrial, office, retail purposes, etc. However, in certain cases this Act would not apply (see para 4.1 below).

    3.2 The Act applies to a promoter, meaning :

(a) a person who constructs a residential building consisting of apartments, for the purpose of selling all or some of the apartments to other persons; or

(b) a person who develops a colony for the
purpose of selling to other persons all or some of the plots, whether with or without structures thereon.

4. Registration of Project :

    4.1 The Act provides that a promoter shall not develop land into a colony of plots or construct a building for marketing all or some of the apartments, without registering such project with the RERA. It is important to note that the registration is required qua a project and not qua a developer. Thus, one developer would need to register each and every project to be undertaken by him. However, registration is not required if the number of apartments to be constructed does not exceed four or if the area of the colony’s land to be constructed does not exceed 1,000 square metres (10,764 square feet) or if the number of apartments does not exceed four.

    4.2 For making an application for registration, the promoter needs to apply in the prescribed form, submit all the relevant documents and pay the prescribed fees. One of the documents to be submitted is a copy of the approval and sanction from the Competent Authority, obtained in accordance with the building regulations. This means that the application can only be made after the developer receives the IOD/CC for the project and not before that.

    4.3 If the RERA does not take any action on the application within 30 days, then it is deemed to have granted its approval. In case, the RERA refuses to grant registration, then it must first give a hearing to the applicant.

    4.4 Each registration is valid for three years and can be renewed if the project completion time has been extended for reasons beyond the promoter’s control. A total of two renewals of one year each can be granted. Thus, the maximum time for one registration can be five years.

    4.5 The promoter is also required to make an application for allotment of a password on the RERA’s website. If the project has been registered by RERA, then it will also grant a password to the promoter.

    4.6 The Act provides an imprisonment of up to 3 years and/or a monetary penalty for non-registration of a project.

LISTED COMPANIES REQUIRED TO INCREASE AND MAINTAIN 25% PUBLIC SHAREHOLDING

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Securities Laws

A recent amendment dated 4th June 2010 to the Securities
Contracts (Regulation) Rules, 1957 (‘the Rules’) requires that existing
companies whose public shareholding is less than 25%, shall increase such
holding to that level in a phased manner. For companies seeking listing for the
first time, the initial level of public holding would need to be at least 25%
with one exception discussed later herein.

This amendment is not a major policy change except that it is
one more effort — in the background of consistent earlier failures — to increase
the public holding to 25%. However, one change — and effectively it is a major
change at least in terms of impact on capital markets — is that now even the
government companies would be required to attain and maintain 25% public
holding.

It will have to be seen whether this fresh attempt is
successful in achieving the objective. If it is, a substantial quantity of
equity shares would flow into the market raising funds, as per some reports, of
nearly Rs.2 lakh crores over a period of the next few years. However, as we will
see later on, the provision relating to public shareholding is mentioned at
multiple places and unfortunately this is an amendment of just one provision of
law, leaving others untouched resulting in overlap, contradiction and confusion.

While a detailed historical analysis of this issue may not be
of interest here, generally, it can be stated that the level of public holding
has been the subject of continuous change. At an early stage the level of public
holding required was 60%, then it was 25% and an exception was made for a group
of industries, particularly emerging ones such as software, etc., to allow 10%
public holding. There were also some conditions and exceptions to these
holdings.

Note also that there was a distinction in the provisions for
minimum public holding at the time of public issue and minimum public
shareholding thereafter. The problem gets complicated not only because these
requirements at these two stages were different, but also that the regulators
was different. The initial listing requirement is prescribed by
the Central Government through ‘Rules’, while the continuing listing
requirements are prescribed by SEBI through the listing agreement and other
regulations.

The situation in law and facts today is thus as follows. The
old Rules prescribed initial listing requirements and while it generally
required a minimum initial public issue of 25%, under certain situations, such
issue could be of just 10%. Logically, the provisions of law, though prescribed
by SEBI, should state that after the public issue, the company should maintain
these respective percentages. However, partly on account of changing policies
and partly on account of poor drafting, the requirements of law as contained
particularly in the listing agreement are ambiguous. Essentially, the intention
was that not only the 25/10% public shareholding should be maintained, but that
even those companies who had a lower public shareholding for any reason should
also raise their holding to such percentages. In practice, owing to poor
drafting, poor enforcement, practical problems, keeping exceptions, etc., this
was not achieved.

Thus, to reiterate, the objective of the law-makers was to
ensure that the public holding should be of a reasonable minimum level so as to
serve the purposes of listing. The amended law now provides that this minimum
level is 25% uniformly for all companies. The intention also is that the
ambiguities in the provisions be eliminated partly by better drafting and partly
by simplifying by not allowing any exceptions to this Rule.

In the light of general discussion as above, let us now
consider the amendments made.


(a) The term ‘public shareholding’ is defined and it
would mean the holding of persons other than (i) Promoters and the Promoter
Group (both defined as per the SEBI (ICDR) Regulations, 2009 (ii)
subsidiaries and associates of the company.

(i) The ‘public shareholding’ is intended to be of
equity shares. However, this is not well brought out. The requirements of
initial public issue cover both the issue of equity shares as well as the
convertible debentures, but the requirements of continuing public
shareholding thereafter refer only to equity shares.

(b) At least 25% of all public issues of equity shares
and convertible debentures under an offer document shall be to the public
shareholders.

(i) An exception to the above is that if the post-offer
market capitalisation calculated with reference to the offer price is at
least Rs.4000 crores, then a 10% issue is sufficient. However, even such
companies would be required to increase the public shareholding to at
least 25% in a phased manner, with at least 5% every year till this 25% is
reached.

(c) All existing listed companies are required to
maintain 25% public shareholding. Those companies that do not have such
minimum 25% public shareholding are required to increase the public
shareholding by at least 5% every year till such 25% public shareholding is
reached. Thus, the intention is that within a maximum period of 5 years, all
companies should have at least 25% public shareholding.

(d) The provision enabling exceptions to be made for
government companies has been omitted. This is a significant amendment. As
per some press reports, to achieve 25% public holding, almost 85% of the
fresh issue of shares would be by the ‘government companies’.


A clear time frame to achieve 25% public shareholding has
been prescribed. However, what happens if the company does not comply with such
requirement for any reason ?

(i) There is no specific provision in the Securities
Contracts (Regulation) Act, 1956, dealing with violation of this new Rule 19A.
It appears that the following could be the consequences :


  • A
    penalty of up to Rs.1 crore.



  • Imprisonment up to 10 years or a fine up to Rs.25 crores or both.



  • Suspension of listing/delisting may also be possible.



(ii) Of course, the usual provisions governing
penalty/prosecution would apply. For example, the facility of compounding of
the violation would be available.

Now let us see some of the concerns with regard to the
amendment.

A major puzzle is that the provisions of Clause 40A of the listing agreement have not been repealed/ modified. It can be seen that this is the provision, howsoever defective, that specifically deals with requirement of increasing the public holding to the specified levels. As can also be seen, this Clause is plainly contradictory with the new requirements. For example, the new requirement requires all companies to maintain/increase their public holding to a common 25%, while Clause 40A has many exceptions. In fact, the scheme of the law till now was simple that is the Rules dealt with ‘initial listing’ while ‘continuing listing’ was dealt with by the listing agreement. However, now there is overlap that does not serve any purpose. While one could technically take a view that a later provision of law overrides an earlier one, this can hardly be a happy approach to take either for the company or even for SEBI.

Unlike the existing Clause 40A, there is no provision for an exception or extension. No exception is given to any type of company. No power is also given to SEBI or the stock exchanges to make any exception or granting any extension to the time schedule for raising public holding.

A major concern is how can the public shareholding be increased?? What are the permissible methods — or, to put it the other way, are any methods prohibited?? SEBI has been authorised to specify the manner in which the public shareholding shall be increased. The common methods may be a fresh public issue, offer for sale by the Promoters, offloading of shares by Promoters in the open market or through off-market deals, etc. One will have to wait for SEBI to prescribe these methods.

The scheme of having a minimum public shareholding has to be built in not only in the Rules and the listing agreement but also in other provisions of law such as the ‘Takeover Regulations’. These will also need amendment to achieve 25% public shareholding.

For the record, it may be recollected that the definition of ‘public’ itself was criticised. It was stated that the inclusion of FIIs, etc. in public effectively resulted in the net holding of the remaining ‘actual public’ to be quite small. Thus, removing such entities from this category was seriously considered. However, no such exclusion has been made and thus holding of FIIs, NRIs, FIs, etc. would be included in ‘public’ shareholding.

It is seen from various published reports that basically companies that would be affected would be the large government companies. In fact, these reports estimate that almost all of the issues in terms of amount would come from such companies. However, it is also true that such companies have not always been found to be wholly compliant with listing requirements. For example, many of government companies have not yet complied with the requirements of ‘corporate governance’. SEBI

has actually passed orders recording this and while it has not awarded any punishment, the orders have highlighted the plight of companies which are effectively at mercy of the government.

Companies that made a public issue of 10% in recent years can rightly air a grievance that had they known that they would be required to make a 25% public issue, they would not have made a public issue in the first place. I think this is a serious and a fair concern and an exception would have to be made for such companies. Having made a public issue of, say, 10%, they can now neither stay, nor exit easily without causing problems to many. To put it simply, they cannot delist and they cannot dilute?!

In conclusion, it appears that unless the new provision is strictly implemented and enforced, it would be merely another half-hearted paper attempt. Newspapers are already reporting that the Finance Ministry is considering tweaking with the new rules. If this happens, it will be another instance of lack of co-ordination between the Government and the Regulator, and perhaps yet another attempt and opportunity going waste.

Delisting of Shares — The newly notified regulations

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Securities Laws

1) SEBI has, on 10.6.2009, notified new Regulations
relating to delisting of equity shares of listed companies. Essentially, they
provide for a detailed procedure for delisting and certain safeguards for public
shareholders. The new Regulations replace the earlier SEBI Guidelines of 2003.

2) The Regulations provide for different ways in which
delisting can take place. The most common one would be where it is voluntary and
initiated by the company and the promoters. Then there is a fast track but,
again, voluntary, delisting of defined ‘small’ companies. Under certain
circumstances, there can also be compulsory delisting. Finally, there are
residuary cases such as of BIFR companies, companies in winding up, etc.

3) Delisting means removal of listing of equity shares from
recognised stock exchanges. Thus, shareholders do not have any more a ready
market for their shares. Almost all shareholders — at least all the public
shareholders — buy shares on the assurance that there is continued listing.
Indeed, at the time of a public issue, the law requires that if listing does not
take place soon thereafter, the monies raised have to be refunded.

4) Listing provides significant advantages. There is a ready
market for the shares and this itself adds to the intrinsic value of a share.
Ready market provided by listing results in a better price since there are more
persons competing to buy the shares. Such wide and ready market also adds
further value to the shares on account of sheer liquidity whereby share-holders
can get virtually instant cash by selling their shares.

5) Listing is obviously advantageous to the company too as
funds can be raised easily and at a relatively lesser cost. However, the flip-
side is that there can be considerable costs and inconvenience requiring
compliance with SEBI requirements and corporate governance regulations. Hence,
companies look at delisting as an option. There are also many other reasons for
the company to consider delisting.

6) Considering space constraints, we would consider here
mainly, and even that too briefly, the Regulations where Promoters initiate
delisting
.

7) Under the new Regulations, the procedure for voluntary
delisting is even more complicated and costly than earlier. It can be summarised
as follows :

a) The first step is taking approval of the Board and then
of the shareholders. There are 3 special features to be noted for the
shareholder approval. Firstly, the approval is required through postal ballot,
thus ensuring wide participation of share-holders. Secondly, the approval
needs a special resolution. Thus, at least 75% of those who vote have to vote
in favour of delisting. Finally, of the votes cast by public shareholders, at
least 2/3rds have to vote in favour. This is a new and interesting requirement
as it ensures potentially unfair and unpopular delisting proposals get nipped
in the bud.

b) The next step is taking in principle approval of stock
exchanges. This step will ensure that the broad feasibility of the proposal of
delisting would be tested relatively early. In fact, it could have been the
first step to ensure a basic test. The application has to be disposed of
within 30 days of receiving an application complete in all respects.

c) Then, the Promoters have to initiate the exit offer to
public shareholders within one year of the special resolution. This means that
the Promoters have to offer to buy shares of the public shareholders. ‘Public
shareholders’ means essentially share-holders other than the Promoters. This
is a sensible requirement as it allows the public shareholders to get their
monies rather than get stuck with illiquid shares.

The ‘offer price’ has to be at least the ‘base price’ that
is derived by a formula that takes into account quoted prices of the recent
past. However, this price is fortunately not binding. With this price as the
base, a procedure of book building is initiated where the public shareholders
quote the price at which they are willing to sell. If the prices and
quantities offered are such that the Promoters are willing and able to buy
either 50% of the total public holding or increase their holding to at least
90%, and they agree to do so, then the delisting is successful. If not, the
process fails.

d) However, it does not mean that the remaining
shareholders find their shares irrevocably illiquid. The Regulations require
that the Promoters should, over a further period of at least one year, buy the
remaining shares, if offered, at the same price.


• Using the
market price as benchmark for the offer price is defective and unfair to the
shareholders. Listing gives a signifcant premium to the shares. Conversely,
news of delisting results in the quoted price reaching nearer to the value
of an unlisted share. Since the formula for the base price relies on quoted
prices, the shareholders are thus deprived of a fair price.


e) In ‘book building’, there is obvious scope for
manipulation by both sides. The Promoters may line up some friendly public
shareholders to reach any one of the magic cut-off limit as above. On the
other side, shareholders may be tempted to ask for unduly high price and even
rigging and cartelisation has been alleged frequently in the past. There is no
downside for them obviously since even if they fail and if there are enough
shareholders offering a lower price, they can always get this price over the
next one year as the Regulations require the Promoter to keep the offer open
for another one year. Of course if too many shareholders do this, the
Promoters may simply exercise their option to withdraw.

f) SEBI has attempted to make the process fair and free of
manipulation. In particular, there are specific provisions providing that
there is no manipulation, fraud, deceit, etc. in the process by the Promoter
or any person.


8) Fast-track delisting of ‘small’ companies :


a) Special provisions are made for ‘small’ companies satisfying certain conditions and a relatively faster process is provided for delisting of shares of ‘small’ companies.

b) The basic benefit given is that the elaborate procedure for giving an exit offer would not apply and while such an exit offer still needs to be given, a faster and simpler procedure is provided for.

c) Small companies for this purpose would mean two types of companies :
    

  • In the first type, there would be a company with a paid-up capital up to Rs. 1 crore and whose equity shares were not traded at all in any recognised stock exchange in the preceding one year.

  •     In the second type, there are 300 or lesser number of public shareholders and the paid-up value of shares held by such public shareholders does not exceed Rs. 1 crore.

d) Instead of the elaborate procedure for exit offer, a shorter process is provided for. An exit offer price is determined in consultation with a merchant banker. The offer is conveyed to the public share-holders. 90% of the public shareholders (Regulations are not clear but presumably 90% refers to value and not the number of public shareholders) need to agree either to sell their shares at the offer price or to continue to remain shareholders post-delisting. The offer document would also state that their agreement also includes an agreement to waive the book-building process for price-discovery.

9) Compulsory  delisting :

a) Certain grounds for compulsory delisting may be prescribed by rules made pursuant to Section 21A of the Securities Contracts (Regulation) Act, 1956. Needless to add, there would need to exist strong grounds to do this and where the continuance of listing may be found to be more harmful than delisting and consequent loss of market for the shares.

b) Apart from existence of such serious grounds, the decision for compulsory delisting is to be taken by a panel of the stock exchange, consisting of 5 members including a representative of small investors.

c) Compulsory delisting does not mean that the Promoters escape the requirement of buying out the public shareholders. A fair price of the shares is worked out and the Promoter is required to pay such price to the public shareholders to acquire their shares. The Regulations do not provide for a time limit for carrying out such purchase. That apart, the Company, its Promoters and all companies promoted by them, and whole-time directors would be debarred from accessing the capital market or seek listing of their shares for ten years after delisting. One wonders, though, whether this requirement can be enforced in practice since typically the Promoters of companies facing such serious charges may default even on these further requirements.

Poser: Whole-time director could be an employee holding stock options or having a small holding, who could change his job. How will this requirement impact him and  the company  he joins?

10. Miscellaneous  provisions  and points:

a) Two stock exchanges – BSE and NSE for now – are specified as nationwide stock exchanges. If delisting is sought from other than these and where listing continues on one or both of such exchanges, the process is simpler and, importantly, the require-ment of making an exit offer is waived.

b)  If  delisting   is  pursuant to  a  scheme sanctioned by BIFRand if such scheme lays down the procedure for delisting or provides for an exit option to the public shareholders, then the Regulations shall not apply.

c) A minimum period of 3 years should have passed after listing before an application can be made for delisting.

d) A peculiar feature of the Regulations is that the exit offer is required to be given by the Promoters. No funds of the Company shall be used directly or indirectly. Buyback of shares as a means of delisting is specifically prohibited. This is strange and even absurd. Delisting is the reverse of listing. In case of listing, usually, it is the Company that issues shares to the public and receives monies for such issue. In case of delisting, the process ought to be the opposite – the Company should repay the monies back to the shareholders. If, during listing, the Promoters do not get any money, how can they be expected to raise money to buyout the public shareholders? Also, delisting does not recognise a professionally managed company where. there are no Promoters. Does that mean that shares of such companies cannot be voluntarily delisted ?

e) Under the exit offer, the Promoter is required to place 100% of the minimum offer consideration in escrow in cash by way of bank guarantee. Even after buying out the shareholders who offer their shares in the first round, the Promoter will need to maintain the escrow to provide for the remaining shareholders who have option to offer for a period of one year. This is sensible new requirement but, for the Promoters, this results in blocking of funds or maintenance of bank guarantee for one year.

Conclusion:

a) Reading the Regulations, one wonders whether SEBI thinks complexity is equivalent to comprehensiveness. While many provisions are made in enormous detail, some principle and vital issues are ignored. The pricing formula continues to be unfair as Promoters can literally offer the shareholders the option of the proverbial devil and deep sea – either accept the offer price or get your shares delisted (even the middle ground of rejection of delisting suffers from the company’s shares being under the stigma of potential delisting and thus quite possibly under-quoted). On the other side, forcing the Promoters to raise funds from outside the Company for delisting is inappropriate and is a breeding ground of corruption. The Regulations also effectively punish compliant companies making them undergo the elabora te procedure and payment for the exit offer while ‘vanishing’ companies escape both the procedure as well as the payment. Thus, while one recognises the thoughtful small touches at many places, the Regulations, that have come after more than a decade of consideration, disappoint as a whole.

Public Issue of Securitised Instruments — the new SEBI Regulations

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Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .


(1) Background :


(a) SEBI has finally notified the regulatory scheme for
public issue and listing of securitised instruments. While we will review these
Regulations later herein, it is worth considering, very briefly, the background
of ‘securitised instruments’.

(b) The Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002 (often referred to as SARFESI Act
or, simply, the Securitisation Act) is known more for the powers that
particularly institutional lenders are given under this Act to recover their
dues. The other half of this Act is securitisation of assets.

(c) While I am sure that readers are familiar with this term,
a quick description of securitisation may be worthwhile. To take a typical
example, a lender may have debts of various kinds arising out of loans granted
by it. The debts may be payable over a long period of time.. For rotation of
these funds or for other reasons, the lender may want to assign these debts to a
buyer who then simply collects the debts. Such buyer, in turn, may be a person
with his own money or, more often, raises monies from investors who may be
interested in relatively safer returns. This process can be loosely
referred to as securitisation. Effectively, securities are issued to the
investors towards their interests in the debt so bought.

(d) The buyer may invest his own money or raise monies from
private investors. However, a bigger source of money may be the public for
various reasons. Firstly, the public may be interested in safe returns from
securities. The returns may be relatively higher than other instruments.
Properly securitised and issued in small amounts, such instruments may become
attractive to the public. However, issue to the public requires necessary legal
provisions of investor protection and it is at this stage SEBI steps in. SEBI
has to ensure that the process of issue to the public of such instruments is
transparent, with full and fair disclosures and after the issue, the interests
of the investors are safeguarded. Also, the monies received are managed by
registered intermediaries.

(e) Thus, SEBI has recently, on 26th May 2008, notified the
Securities and Exchange Board of India (Public Offer and Listing of Securitised
Debt Instruments) Regulations, 2008 (‘the Regulations’) which contain very
detailed provisions relating to issue and listing of such instruments. It is
worth reviewing these new though quite specialised Regulations.

(2) Scheme of the Regulations :


(a) The Regulations seek to make comprehensive provisions
relating to the formation, constitution and structuring, etc. of an entity
issuing securitised instruments, called ‘Special Purpose Distinct Entity’ (‘SPDI’)
in the Regulations. The Regulations provide for : How and in what form would
such a SPDI be formed and structured, what type of Securitised Debt Instruments
(‘SDI’) they can issue, what would be the disclosures, and how it would be
managed, etc.

(b) The structure of SPDI can be loosely compared with the
structure for mutual funds though SPDI seems to have lesser flexibility. SPDIs
and instruments issued by them are comparable with mutual funds in the sense
that the investments are made effectively on behalf of the unit holders and
managed by persons on behalf of such investors. The essential difference is that
these Regulations focus on a very specialised type of securitisation and hence
make very specific requirements for them.

(c) It would be also worth describing the process involved in
the securitisation of debt and thereafter making a public issue of SDI and
related matters. There would be a Sponsor who would establish an SPDI. The SPDI
has to be in the form of a Trust. There would be Trustees who would manage the
SPDI and carry out other related functions. There would be an Originator who
assigns certain debts to the SPDI. The SPDI would then issue the SDI to the
public under a Scheme and then list such SDI on the stock exchange. The SPDI
would then collect dues in respect of the debts so acquired and distribute such
monies, after deducting costs, to the investors. The investors, in turn, may
hold the SDI and enjoy the steady returns or they may at any time sell the SDI
on the stock exchange at which they are listed at the prevailing market price.
The Scheme would come to an end normally when all the debts are recovered and
the investors are fully paid off.

(d) With this very broad overview of the Regulations, let us
look at some interesting aspects of the Regulations.

(3) Trustees :


(a) The Trustees have perhaps the greatest of responsibility
under the Regulations. They have to take great care while acquiring the
specified debts and particularly ensure that these debts are recoverable,
enforceable and also assignable to SPDI. They have to make the requisite
disclosures in the offer document. They have to manage the debts and recover
them and distribute the proceeds to the investors. They have personal and direct
responsibility in case of contraventions. Having said that, though the
responsibilities cannot be understated, it also appears that each of these
obligations is not absolute, but the intention is more of preventing negligence
and fraud. If, for example, there are bad debts beyond the control and
reasonable foresight
of the Trustees, they would not be held
responsible.

(b)    Interestingly, the Trustees need not necessarily be Trustees registered as such intermediaries with SEBI.However, they would require to be registered with SEBI under these Regulations if they are not so registered otherwise as Trustees. Certain other entities would also not require such registration under the Regulations. Thus, a person can get himself registered as a Trustee under these Regulations and qualify to manage the SPDI.The Trustee can also be a corporate entity.

(c)    The requirements of registration under these Regulations are elaborate and are similar to registration of other intermediaries.

(4)    Debts or receivables  that can be acquired:

(a)    These would be the core assets of the SPDI just as shares and other specified securities are the core assets of mutual funds. However, the definition of these debts that can be acquired by SPDI is quite narrow and would include items such as mortgage debt, financial assets as defined in the Securitisation Act, etc.

(5) SPDI:

(a)    This is the entity, a Trust, that would acquire debts and issue securities to investors. The SPDI has to be quite specialised – in fact, it practically cannot do any other activity except of securitisation. The reason is obvious. The objective is to acquire a chunk of debts and then issue instruments to investors representing an appropriate interest in these debts. The SPDI would then only manage and recover these debts. If it does any other activity, and if there is any loss, the investors would suffer since the loss would go to reduce the debts. However, certain passive investment of surplus monies is, for example, allowed.

(b)    There is an entity termed ‘Servicer’ who can do/be given the job of collecting the debts and distributing the proceeds to the investors. Strangely,it is not required that such ‘Servicer’ should be a registered intermediary. In my opinion a person who could be given the control of all the assets of the SPDI for collection and even the further distribution to the investors should be registered with SEBI for proper control.

(6)    Scheme:

(a)    As in the case of mutual funds, the SPDI can frame schemes pursuant to which it can issue SDI to the investors. Thus, there can be multiple schemes. This also means that recovery of one lot of debts and repayment in full to the investors would not mean the end of the SPDI itself.The SPDI can issue securities under another scheme. In fact, it can issue securities under multiple schemes. Again, quite obviously, each of the schemes would have to be kept segregated in all respects.

(b)    Each scheme would have its own disclosures ~ and features which would have to be complied with regard to that particular scheme.

(7) Accounts and Audit:

(a)    The SPDI would be a Trust and thus would not be subject to the normal requirements of accounts and audit as, for example, companies are subject to. Thus, the Regulations make specific though quite general and broad requirements relating to accounting and audit. The Regulations also require compliance of Guidance Notes issued by the Institute of Chartered Accountants of India.

(8) Dematerialisation:

(a)    The SDI issued should be capable of dematerialisation. However, at the option of the investor, securities in physical form can also be issued.

(9)    Credit rating:

(a)    Where the core assets are debts, credit rating is required as this helps in the assessment of the risk being assumed by the investor.

(b)    The SPDI would have to obtain at least two credit ratings. Interestingly, it will have to disclose all the credit ratings obtained by it and not just the ones it found acceptable. Thus, the SPDI can go shopping for credit ratings, but SPDI will have to disclose all the ratings received.

(c)    Having said that, no minimum credit rating has been prescribed for the issue of SDI as for example is the case in case of deposits issued by NBFCs. Apparently, the objective may be that it would be up to the investor to balance the credit rating received with the return expected and take his decision accordingly. Hence, in line with the logic of the above, no maximum rate of return is prescribed as so provided for NBFCs.

(d)    The credit rating would have to be reviewed periodically, but not later than a period of one year from the previous rating.

(10) Miscellaneous provisions:

(a)    There are elaborate provisions for inspection of the accounts, records, etc. In case violations are found, there are specific provisions in the Regulations themselves. Further the general provisions in the SEBI Act and the Securities Contracts (Regulation) Act to penalise the violations would also be applicable.

(b)    There are provisions relating to minimum sub-scription, underwriting, etc. which are conceptually similar to the public issue of securities.

(c)    The SDI would have to be listed and where they are not listed, the amounts raised would have to be refunded. However, it appears that no time limit is specifically provided for the time within which the SDI should be listed.

(11) Conclusion:

(a) One could argue that SEBI has been proactive in issuing regulations even when the instrument is not popular – for example – the regulations relating to buyback were issued in 1998and they were barely used for some years. Presently, the global economy is suffering from the sub-prime crisis and securitised assets are said to be the major culprit. Hence, perhaps investors may be frightened of such assets. Having said that, securitised instruments offer an otherwise well-developed alternative to investors for investments. I am sure that sooner or later these instruments will gain popularity in India.

(b) The Regulations also show a level of maturity in the sense that many of the problems faced by SEBIover the past few years have been addressed. Of course, this is perhaps another reason that the Regulations are unduly complex! The coming years will show the fate of the innovative and sophisticated instruments. In India it will be a learning experience for both the investors and their advisors and of course for the auditors.

Whether issue of shares to persons or more is a public issue — recent controversial decision of SEBI

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Securities Laws

Is issue of shares by a
company to 50 persons or more a public issue requiring compliance with various
requirements, procedures, etc. ? Recently SEBI passed an order (‘the Order’) in
regard to certain companies of the Sahara Group and decided on this and certain
other issues. This decision can have far-reaching implications.

As per press reports,
however, a stay has been granted by the Allahabad High Court. That being said,
it appears that the basic findings of law have not yet been examined by the
Court. The object here in any case is not to consider whether the allegations or
the ‘findings’ of facts by SEBI are correct or not. The exercise here is to
determine what conclusions in the law did SEBI reach and what implications the
same can have.

In essence, the allegations
were that two companies of the Sahara Group raised large funds (just one company
raised nearly Rs.5000 crore) through issue of Optionally Fully Convertible
Debentures (‘OFCDs’). Also, allegedly, the cost of the projects for which these
OFCDs were issued was Rs.20,000 crore for each company. SEBI came across this
accidentally whilst examining a Red Herring Prospectus filed by another company
of the Sahara Group. SEBI sought various details from these two companies who
had issued the OFCDs to determine whether the issue was a ‘public issue’. The
two companies made certain submissions with regard to the information sought,
but in essence they inter alia stated that SEBI had no jurisdiction in
the matter as the matter was being examined by the Ministry of Company Affairs.

Since SEBI did not receive
the information it asked for, it compiled certain information as available on
the MCA website. It found out, for example, that the OFCDs were issued of
amounts between Rs.5,000 to Rs.24,000. Since specific information was not
available from the company, SEBI extrapolated that the number of persons to whom
such OFCDs of an amount of around Rs.5000 crore in just one company were issued
must be large, but in any case not less than 50 persons.

SEBI alleged that in view of
the provisions of S. 67(3) of the Companies Act, 1956, the issue of OFCDs
amounted to a public issue requiring compliance with the provisions relating to
public issue including the Companies Act, 1956, as well as the SEBI (ICDR)
Regulations, 2009. The companies stated (on the basis of legal opinions
obtained) that these provisions did not apply and hence there was no question of
compliance.

At this stage, a broad
description of the scheme of provisions may be in order. The Companies Act,
1956, as duly aligned with the provisions of the SEBI Act and the SEBI (ICDR)
Regulations, 2000 (‘the Regulations’) essentially requires that an issue of
shares can be on a ‘private placement’ basis or a public issue. Loosely stated,
in case of a private placement, a selected group of people are approached for
subscription of the securities. The issue of securities is restricted to them
and the ‘right’ to subscribe, generally speaking, is not transferable. In case
of a public issue, however, persons beyond this known group are approached for
such subscription. The scheme of the law intends that if such a wider issue is
made public, certain procedures and restrictions in regards to the interests of
investors should be followed. These would include certain mandatory disclosures
regarding the company, listing of the securities to ensure easy transferability,
etc. These provisions are formalised in certain provisions of the Companies Act,
1956, and the SEBI Act, Regulations, etc.

Let us first consider the
provisions of S. 67(3) which is one of the central points to this controversy.
Essentially, as readers are aware, S. 67 seeks to ‘deem’ certain issues of
securities as issues to the public. The Section is reproduced below for ready
reference (emphasis supplied in this section and in other extracts later herein)
:

“67. Construction of
references to of fering shares or debentures to the public, etc.


Any reference in this Act or
in the articles of a company to offering shares or debentures to the public
shall, subject to any provision to the contrary contained in this Act and
subject also to the provisions of Ss.(3) and Ss.(4), be construed as including a
reference to offering them to any section of the public, whether selected as
members or debenture holders of the company concerned or as clients of the
person issuing the prospectus or in any other manner.

Any reference in this Act or
in the articles of a company to invite the public to subscribe for shares or
debentures shall, subject as aforesaid, be construed as including a reference to
invitations to subscribe for them extended to any section of the public, whether
selected as members or debenture holders of the company concerned or as clients
of the person issuing the prospectus or in any other manner.

No offer or invitation shall
be treated as made to the public by virtue of Ss.(1) or Ss.(2), as the case may
be, if the offer or invitation can properly be regarded, in all circumstances —

as not being calculated to
result, directly
or indirectly, in the shares or debentures becoming available for subscription
or purchase by persons other than those receiving the offer or invitation; or

otherwise as being a
domestic concern of the persons making and receiving the offer or invitation.


Provided that nothing
contained in this sub-section shall apply in a case where the offer or
invitation to subscribe for shares or debentures is made to fifty persons or
more :”

The question was whether the
issue by the Sahara Group companies was an issue to the public in terms of S.
67(3). SEBI observed and held as follows in its Order :

“14.    In order to curb the companies from offering shares and debentures to a wider group of people by disguising it as ‘domestic concern’, vide the Companies (Amendment) Act, 2000, with effect from December 13, 2000, a proviso was inserted to S. 67(3) stating that nothing contained therein shall apply in a case where the offer or invitation to subscribe for shares or debentures is made to fifty persons or more. Therefore, if an offer is made to fifty or more persons, it would be deemed to be a public issue, even if it is of ‘domestic concern’ or shown that “the shares or debentures are not available for subscription or purchase by persons other than those receiving the offer or invitation”. First proviso to S. 67(3) of the Act is as clear as that. In other words, even if an issue is made by way of private placement to fifty or more persons, it would be deemed to be a public issue, irrespective of whether it was offered to public at large or to just a section of the public chosen, in whatever manner.”

Curiously, SEBI has held that “even if an issue is made by way of private placement to fifty or more persons, it would be deemed to be a public issue, irrespective of whether it was offered to the public at large or to just a section of the public chosen, in whatever manner.” This statement can have far reaching implications. It is possible that many public companies make such a private placement of securities to more than 50 persons and in such a case, as per this ruling, the provisions of S. 67(3) would be per se attracted and the provisions relating to public issue would have to be complied with.

SEBI further explained the reasoning of its ruling as follows:
“15.    The intention of the Legislature, more specifically as evinced in the amendment to the Act referred to above, is very clear that any and all mobilisation of funds from a group of investors, fifty or more in number should be classified as a ‘public issue’ and consequently be accorded all the safeguards provided, that typically accompanies the safety and protection accorded to their funds, in law. In view of the above, the contention of the companies that the OFCDs are issued by way of private placement basis to friends, associates, group companies, workers/employees and other individuals who are associated/affiliated or connected in any manner with Sahara India Group of Companies, would not give it a different colour. The rigour of the procedures enshrined in law, for the protection of investors who subscribe to an issue of securities would have to be preserved in toto. Though, the companies have stated that the offer was made on private placement to a select group, they could not provide any details of the group despite the fact that SEBI has issued summons seeking such information. This would lead to an adverse inference that they were offering OFCDs to fifty or more persons.”

Another contention raised by the companies was that the provisions of S. 67(3) should not apply to them since they had passed a resolution u/s.81(1A) for the issue of the OFCDs. This contention was rejected by SEBI stating the following:

“The companies, on the basis of the legal opinion received by them, have stated that they had passed the resolution u/s.81(1A) of the Act (which states that further shares may be offered to any persons in any manner whatsoever) and that their offer to a select set of persons should not be construed as a public offer. S. 81(1A) of the Act cannot have an overriding effect on the provisions relating to public issue, specified in the Act. S. 81 of the Act deals with further issue of securities and only gives pre-emptive rights to the existing shareholders of a company so that the subsequent offer of securities have to be offered to them as their ‘rights’. S. 81(1A) is only an exception to the said rule, subject to the procedural requirements contained therein. However, any further issue of capital, even pursuant to a resolution made u/s.81(1A) of the Act, is subject to the provisions of Part III of the Act, if the offer is made to fifty persons or more. Hence, the views submitted in the legal opinion that since the companies had passed resolutions u/s.81(1A) of the Act, the issuance of shares/debentures to a select group (however large, they may be), ceases to be an offer to the public, is devoid of any legal basis and hence cannot be accepted. It is quite obvious from a reading of S. 81(1A) that it was never intended to dilute the provisions of the Act relating to the definition of public issues. Whether an issue is a public or not is to be decided on the basis of S. 67 of the Act. As stated above in this Order, the first proviso to S. 67(3) of the Act makes it very clear that any offer or invitation to subscribe of shares or debentures to fifty persons or more should be treated as a public issue.”

The other contention of the companies was that S. 60B(9) effectively allows for a system where the Red Herring Prospectus needs to be filed only with the Registrar of Companies and once this is done, no other procedure is to be followed if the intention is not to get the shares of the company listed. SEBI rejected this argument too, stating that this would go counter to the scheme of provisions relating to public issue of shares and listing. SEBI held that as soon as the shares are offered to the public, the intention to list or not to list becomes irrelevant. The company has to list their shares and since this is mandatory, an attempt to take shelter u/s.60B(9) on claim that it never intended to list will not help.

An argument that was also made was that the is-sue was made that on a ‘private placement’ basis to friends, group companies, etc. and particularly to ‘other individuals who are associated/affiliated or connected in any manner with Sahara India Group of Companies’. SEBI had made a finding that apart from a declaration obtained that a particular subscriber was ‘associated’ with the Sahara Group, no other association was established. On this and other grounds discussed above, SEBI did not ac-cept that this did not amount to a public issue.

SEBI also considered the fact that they filed a prospectus with the Registrar supporting the view that the companies intended to raise funds from the public.

SEBI drew attention to S. 73(4) of the Companies Act, 1956, which provides that any condition that binds an applicant into making waiver of the requirement of that Section is null and void. Hence, listing was mandatory and it cannot be the subject matter of any ‘intention’ once the basic conditions are attracted.

As discussed, the Order may be considered by the Court on various grounds. One will have to see whether the Court disposes the petition only on the issue of jurisdiction or whether even the issue and ruling on S. 67(3), S. 81(1A) and S. 60B are also decided upon. For companies seeking to issue shares to 50 persons or more, this Order of SEBI has to be considered and the further developments in Court to be closely watched.


The CII Corporate Governance Code — a fresh and realistic approach — and a glimpse of things to come

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Securities Laws

(1) The Confederation of Indian Industry (CII) has issued a
draft Corporate Governance Code (‘the Code’). The Code has importance for
certain reasons. The fact that the topmost of thinkers, who are usually
associated with drafting of such Codes or law, makes it almost certain that it
will receive wide acceptance and get included in forthcoming amendments in law.
Those thinkers amongst others include Naresh Chandra, Dr. J. J. Irani, our past
President Y. H. Malegam.

(2) The Code represents a fresh and innovative approach and
after almost a decade of trial and error where mostly foreign models were
adopted, this Code now takes into account some essential unique features of
Indian listed companies.

(3) The Code however, comes at a time when the concept of
corporate governance is being viewed with cynicism. Both Enron and Satyam were
perfect and award-winning companies for adopting best corporate governance
model. Everything was done right in having the finest and reputed persons as
Independent Directors, members of Audit Committee, to having top audit firms,
etc. — and everything went horribly wrong.

(4) What I find special is that the Code finally recognises
that India has unique features. Most of Indian companies are promoter-controlled
and managed with the Promoters having either
substantial or majority holding. This is in contrast with US and other Western
companies where the holding of the management is often in single digit and even
this holding is not concentrated in a single family
or group but is often dispersed. The Code specifically comments that in India,
typically, the Promoter Group/family holds at least 50% of the voting capital.
With such dominant promoter holding and control the problems and issues of
governance are very different from companies where the Promoter holding is
barely a small percentage. Hence, if the problems are different, the solutions
have to be different. Adopting Western Corporate Governance models and concepts
make them not only inappropriate in the Indian context, but creates resistance
and results only in paper acceptance. This ‘box-ticking’ acceptance, in the
author’s view creates a false sense of assurance. A good example of such
difference relates to the recom-mendation of having separate offices of Chairman
and CEO. In Western countries, the CEO typically does not belong to a Promoter
group and there is a need to have a check on him, since it is often found that
malpractices originate from this office. If the CEO is also the Chairman,
considerable power gets concentrated in one person as compared to other
directors and officers. In India, the power is concentrated with the Promoters
and the CEO and Chairman are often from the Promoter group and, if not, they are
often effectively nominated by such group. Requiring that these two offices are
separated in India, firstly, does not serve any purpose and, secondly, creates
practical problems of requiring a non-promoter as ‘Chairman’ which could be
counter-productive. Take an example of, say, a company such as Bajaj Auto or
Reliance Industries. The company would be forced to have a Chairman
from the non-promoter group. The CII Code recog-nises this anomaly and unique
Indian conditions and notes that this does not make total sense in India. At the
end, though, it makes a compromise and instead of recom-mending that the present
requirement be wholly dropped, it only suggests that wherever possible, the two
offices should be separated.

(5) Having said that, the CII Code strangely contradicts
itself and instead of consistently taking a total Indian approach, the Code, for
several important requirements, recognises the Indian differences but still,
recommends following of foreign models.

(6) Let us now examine some important requirements of the
Code.

(7)
The Code is voluntary :




(a) The CII Code clearly specifies that it is voluntary and
it is up to the Company to decide whether and how much to follow its
recommendations. Of course, one could argue that this is a spacious point
since CII does not have any statutory authority to enforce the Code. But the
point makes sense on a different footing since the intention is that the Code
be enshrined in law, the acceptance may be mandatory. The danger is and will
always remain that mandated Governance Codes are often followed only in the
letter. Hence, in the author’s view the code though voluntary should be based
on the concept of ‘comply or explain’.

(b) While keeping the Code voluntary is commendable, it
needs to be reckoned that the code is not meant for mere quiet internal
adoption but is for public knowledge. Hence the concept of ‘comply or
explain’, because the public should know its ethical practices. In case the
company adopts, in my opinion, it gains reputation which eventually helps it
‘commercially’.

(c) In the absence of ‘comply or explain’ model there would
be uneven reporting. It is not as if the choice is that the Code can be
adopted wholly or rejected wholly. The Company may adopt it wholly. The
Company may adopt only some of the recommendations. The Company
may even adopt a modified version. The public should know the reasons for
non-adoption. Good governance requires transparency in reporting.

Appointment of Independent Directors :

(d) The Code attempts to meet the serious dilemma of the
manner of appointment of Independent Directors. The issue faced is how to make
the Independent Director really independent even for appointment. If the
Independent Director’s appointment is left to the Promoters, the purpose may
be lost.

(e) For this requirement, however, the Code does not take a
fresh approach. The Code leaves the present concept of having a Nomination
Committee as it is and merely provides for certain procedural requirements of
evaluation of Independent Directors.


Duties, liabilities and remuneration of Independent Directors :



(f) The Code recognises the present problem that while a relatively new concept of Independent Director has been introduced for adoption by all listed companies, there are no special provisions for their rights, duties, and remuneration.

g) Perhaps realising that the law may or may not make provisions for these matters and makes a unique suggestion of making the obligations, duties, etc. contractual by appointment letters. The Code further makes an interesting requirement that the details of this appointment letter be disclosed to the shareholders at the time of their appointment.

h) Thus, the duties and obligations will not only be transparent, but to a certain degree can even be enforced, albeit through the Company. In a way, this requirement fills in the lacuna in law.

Remuneration of Independent Directors :

i) The Code recognises a special problem in India and that is the statutory limits on managerial remuneration. As may be recollected, in India, the maximum remuneration is linked as a percentage of profits, though certain minimum remuneration can be paid under certain circumstances. This archaic requirement creates problems even for Independent Directors since particularly for loss-making companies or companies with inadequate profits, payment of reasonable remuneration may become difficult. The Code recommends that the law be amended to make suitable exceptions.

j) Of course, the remuneration issue is anomalous from a different angle. Pay too less remuneration and the Independent Director is not available even for appointment. Pay too much and the Independent Director loses his independence! Actually, the root problem also is that the remuneration is effectively decided by the Promoters, but this issue is not seriously addressed by the Code.

Audit Committee :

The Code rightly says that the recent amendment in clause 49, whereby only the majority of the Audit Committee members need to be Independent Directors, is unwarranted. Thus, the Code makes a valid suggestion that the Audit Committee should consist only of Independent Directors.

Another important recommendation is that all related party transactions should be pre-approved by the Audit Committee.

Auditors :

There are several recommendations in respect of Auditors that may be found radical but realistic also. There are numerous requirements made and a more detailed study would be required. A few of the requirements are highlighted.

The Code recognises audit firms often have networking arrangement or relations with group or other entities that render non-audit services. When such group entities render non-audit services, the independence of the audit firm may be compromised and at the very least, the fees paid to such firms should be taken into account while determining whether the audit firm is independent and for disclosure and limits on such other revenue by such related entities.

The Code also recognises that if the audit firm is unduly dependent on one group for its fees, then its independence could be lost. The Code places, however, a fairly low benchmark of 10% of the total revenues of the audit firm for calculation whether the firm is dependent on a group.

The Code also suggests a requirement of ‘audit partner rotation’ and also of the audit team.

The Code makes the radical requirement of creating unlimited auditor liability and also specifically makes the requirement that all the partners of the audit firm and not merely the signing partner should have unlimited liability. If the audit firm is a limited liability partnership, still, the Code says, the audit partner should have unlimited liability for at least the audit under question. One will have to see how far this recommendation will be effective unless statutory provisions and not mere corporate governance codes or even contractual terms seek to create such unlimited liability.

Then the Code raises issue regarding the numerous disclaimers and varying drafting of qualifications in the audit report. The Code recommends that the ICAI involve outside nominees, particularly government representative, and come out with requirements to avoid this.

There are several other recommendations in the Code. While suffering on some counts, the Code attempts to inject some fresh life and practical use-fulness in corporate governance requirements.

Insider Trading — Recent Amendments — Six-month lock-in on directors/officers and total ban on derivatives and many ‘outsiders’ now insiders

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Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .


(1) Directors and officers of listed companies cannot now
carry out reverse trades for six months if they buy or sell even one share. They
cannot also at all hold any positions in derivatives. Moreover, any person who
receives any inside information now is an insider and apparently the requirement
of having connection with the company or a ‘real’ insider is now no longer
required. These are some of the far-reaching but poorly publicised amendments
which have been recently made to the SEBI
Insider Trading Regulations, 1992 (‘the Regulations’).

(2) Let us consider some of these amendments made vide the
Notification dated 19th November 2008.


(3)
Insiders and Outsiders — any person receiving or having access to insider
information is now automatically an insider





(a) An important amendment is to the definition of
‘insider’. No word has been added or deleted, but by dropping a comma and
breaking the definition into two parts, a significant change has been made.

(b) Before the amendment, an Insider had to, firstly,
be a person connected or deemed to be connected to the Company. Such
connected person should then either be reasonably expected to have
access to unpublished price-sensitive information (‘UPSI’) or should
have received it or had access to it.

(c) This definition was ambiguous. A person merely
receiving UPSI or merely having access to it could also be said to be an
Insider, as per one interpretation. It is probably this ambiguity that the
amendment tackles, though by changing the definition upside down !

(d) Now, the amendment says that an Insider is :

(i) a person connected or deemed to be connected to the
Company and who can be reasonably expected to have access to UPSI. OR

(ii) a person who receives or has access to UPSI.

(e) Thus, a new category of what one could call deemed
insiders has been created.

(f) Readers may recollect the classic case of the printer
of company documents who used the price-sensitive information in such
documents to deal in their shares and make profit (United States v.
Chiarella,
445 US 222). Of course, the Supreme Court acquitted this
printer, since from what little I recollect, the allegation was that he
violated fiduciary duty to shareholders of the target Company and the Court
held that he did not. A version of this case was also fictionalised by the
best-selling novelist Lawrence Sanders in his novel “Timothy’s Game”. Such a
printer would though be an Insider in India as per this amended definition, so
would any other person who receives or has access to UPSI.

(g) In practice, such a broad definition may cause
problems. Taken to its extreme, would even a hard-working analyst who takes a
lot of effort and puts 2 and 2 and 2 and 2 together and counts 8, also become
an Insider, since he now has access to UPSI ? I feel that the answer is no for
various reasons, but the law could have said that a link with the company is
specifically required. This may even have also been intended, since the words
used are that such persons should have ‘received’ or ‘had access to’ UPSI.



(4)
Dependents of Insiders also covered for certain purposes





(a) Listed companies and certain other persons are required
to frame a code of internal procedures intended to prevent Insider Trading
(‘the Code’). The Code should be framed ‘as near thereto the Model Code’
provided. It is now provided that the framing of the Code as near to
such model should be ‘without diluting it in any manner’. Further, the
Company should ‘ensure compliance of the same’.

(b) Disclosures of holding and changes therein are now
required in respect of even dependents (as defined by the Company) of the
directors or officers of the listed company. Disclosure of such changes is now
also required to be made to the stock exchanges. Disclosure of holdings in
derivatives is also to be made when a person becomes a director or officer.


(5)
Total ban on further opposite trades for six months/total ban on derivatives



(a) The Model Code itself has been amended. There are two major changes.

(b) Clause 4.2 of the Model Code has been amended. As per this amended clause, directors/officers/designated employees, who buy or sell shares, cannot now carry out a reverse transaction for six months. Thus, if such person buys even 1 share, he cannot sell any shares for six months and if he sells even one share, he cannot buy any shares for six months. Further, such persons cannot deal, at all, in derivatives of the Company. This bar is over and above the general prohibition on insider dealing.

(i) The devil in me tells me that the ban is only on such directors, etc. and the dependents of such persons are not affected by such ban ! Of course, such dependents may have to answer to the charge of Insider Dealing generally.

(ii) This bar also does not apply to Promoters ! ! ! This is absurd. Of course those Promoters who are directors, officers or designated employees would face the bar. So also, the prohibition on Insider Trading generally would continue to apply.

(iii) The bar also does not apply to other Insiders.

(c) This bar on such transactions is total. There are no circumstances’ – whether of urgent need or otherwise – under which the bar can be lifted. There is also no provision under which even SEBI could grant exemption.

(d) An interesting question arises. Does the bar apply also to shares acquired through exercise of employees’ stock options or under a Share Purchase Scheme? This can be seen in two ways. If such a person has sold shares, can he acquire shares under an ESOPs scheme in the next six months? Alternatively, if he has acquired shares under an ESOPs scheme, can he sell shares in the next six months?

(i) The crucial word to examine is ‘buy’. I think there is a good case to argue that the word ‘buy’ would include shares acquired under an ESOP scheme. However, I still think that shares acquired under ESOP schemes are not intended to be covered. Consider a related bar on shares acquired through an IPO. The existing clause, continued without any change, requires shares acquired by such persons through IPO should be held for at least 30 days. Obviously, if the intention was to cover shares bought in any manner, then such a separate bar was not required at all. I know the provisions are not happily worded. I also know it could be argued that the 30-day lock-in for IPO acquired  shares is meant  to be a special case. However, taking all things into account, perhaps the intention is not to cover shares acquired under ESOP schemes.

6. No penal consequences for violating the new trading restrictions on Insiders?

(a) As discussed earlier, directors, etc. are barred from carrying out opposite transactions for six months and holding positions in derivatives (let us call such transactions as ‘Specified Transactions’).

(b) The question is what are the consequences of violation of these two restrictions?

(c) The SEBI Act provides for severe punishment for Insider Trading. U/s.15G, the specified acts by an Insider attract a penalty of Rs. 25 crores or 3 times the profits made from Insider Trading, whichever is higher. U/ s.24, violation of the Regulations could result in imprisonment up to 10 years or a fine of up to RS. 25 crores or both. There can be other consequences also.

(d) Would any of such consequences be attracted for violating the bar on carrying out such Specified Transactions – i.e., such opposite transactions or derivatives? The answer seems to be No.

(e) Violations of the Code are to be punished by the company internally and the Model Code suggests that they ‘may be penalised and appropriate action may be taken by the company’. The violators shall also be ‘subject to disciplinary action by the company, which may include wage freeze, suspension, ineligible for future participation in employee stock option plans, etc.’.

(f) Beyond this, it appears that SEBI cannot levy the said penalties of RS.25 crores, etc. or prosecute and get such person imprisoned, etc. The reason is the peculiar placement of the amendments. The bar on Specified Transactions is contained in the Model Code. Regulation 12 merely requires listed companies and other entities to ‘frame’ and ‘enforce’ a Code on the lines of the Model Code. There is no requirement in the Act or the Regulations that the Code so made should be followed. While an obligation and enforcement relation has been created between the company, etc. and such persons, no such obligation or enforcement relation has been created between SEBI and such persons.

(g) If, e.g., the company does not frame the Code of Conduct as prescribed, SEBI can levy penalties, and take other penal and other action. Further, if a company does not enforce the Code, then also such penal consequences would follow. But the Regulations do not go further and require that the Code so framed should also be complied with by the directors, etc.

(h) Is this intentional or is it an unintentional drafting lapse? On first impression, one could be tempted to consider that this is intentional. The Consultative Paper on proposed amendments to Insider Trading of March 2008 did consider the requirements of the Model Code to be akin to corporate governance requirements. In fact, it discussed that disclosure of non-compliance was perhaps a better way to punish a company economically through the markets. It also recommended dilution of the punitive requirements. Effectively, it appeared to suggest a change in approach. However, even considering these original thoughts, it still appears to me that it is not intended by SEBI that such violations should not attract penal conse-quences.

(i) I think it is not only an unintentional  lapse and this also arises on account of an improper appreciation of the structure of the Regulations. SEBI has all along assumed that violations of the Code as framed by the Company are not only punishable with monetary penalties and directions, but also subject to prosecution. In the aforesaid Consultative Paper of March 2008, SEBI recommended that the violations of the Code should not result in imprisonment. It further said that “other powers of monetary penalties and directions should be continued”. Thus, SEBI assumed that the violations already attracted all these penal consequences.

(j) On this erroneous presumption, perhaps, SEBI placed the bar on the Specified Transactions in the Model Code.

(k) But where is the provision, in the Act or the Regulations, saying that violations of the Code will attract such penal consequences? No-where, I think.

(l) Thus, by possibly an unintentional drafting lapse, the bar on the Specified Transactions will not attract the penalties, prosecution, etc. Taking this further, even violation of the 30-day lock-in for shares acquired in IPO or, for that matter, violation of any other provision of the Code, would not attract such punishment.

(m) Of course, this does not mean that such persons can merrily carry out Insider Trading as defined – i.e., trade in shares on the basis of unpublished price-sensitive information or communicate such information, etc. Also, persons violating the bars on ‘specified transactions’ would also face, as discussed above, action by the company for violation of the Code.

(7) There are a few other amendments and issues, but considering space constraints, only certain important amendments have been discussed.

(8) A common thread amongst these amendments appears to be that SEBI seems to have preferred a total ban and also creating a ‘deemed category’ of insiders without leaving any scope for subjective exemptions. While the merits of such an approach could be debated, it is likely that at least in the short run, many persons may unwittingly carry out ‘Insider Trading’ as so now widely defined – in terms of persons as well as transactions. This is the sad consequence of the poorly publicised and arbitrary amendments.

Appealing Against Rejection of Takeover Exemption

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Securities Laws

A recent decision of the
Securities Appellate Tribunal (‘SAT’) has perhaps for the first time reversed a
SEBI Order refusing to grant an exemption from an open offer. Such exemption, as
will be explained later, is a discretionary one from the otherwise mandatory
open offer under the SEBI Takeover Regulations. This decision is in the case of
Dr. Arvindkumar B. Shah (HUF) v. SEBI, (2010) 104 SCL 559 (SAT-Mum.). To me, it
is also an important and perhaps controversial precedent of SAT deciding on the
merits of SEBI’s decision in such a case.

To briefly review the
relevant law and scheme of the Regulations as relevant to the present case, it
may be recollected that the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997 (‘the Regulations’) require an open offer to be
made by certain persons typically in certain cases of acquisition of shares of
listed companies. Such persons, generally stated, are required to offer to
acquire at least 20% of the shares held by the public. This is usually when they
make substantial acquisition of shares. This open offer is mandatory though
there are certain statutorily exempted acquisitions. However, between these two
extremes, a mechanism has been provided to grant discretionary exemption on a
case-to-case basis. The mechanism involves a Takeover Panel which is really an
independent committee that reviews each application and renders its
recommendation to SEBI. SEBI then considers the recommendation and then applies
its own discretion again and grants or rejects exemption (irrespective of the
recommendation).

In the light of this scheme
of Regulations, let us consider, first very broadly, the facts of the present
case.

The applicant company sought
to set up a plant to manufacture certain pharmaceutical products. For this
purpose, a large amount of funds was to be raised from lenders who made it a
condition of their lending that a sum of Rs.50 crores shall also be raised as
equity. The company had various alternatives of raising the equity in the form
of rights issue, preferential issue, etc. At the end, in consultation with the
Promoters, the company decided to issue shares on a preferential basis to the
Promoters and persons acting in concert. Essentially, the important consequence
was that post such preferential issue, the holding of the Promoters and persons
acting in concert (referred to together as ‘Promoters’ herein) would increase
from 25.32% to 45.91%. Regulation 11 of the Regulations provide that an acquirer
holding 15% or more of shares or voting rights can, to simplify a little,
acquire further shares only up to 5% in a financial year. Clearly, the acquirers
would in the normal course be required to make an open offer if the acquisition
was of more than 5% of the shares.

The company obtained the
required approvals under the Companies Act, 1956, which particularly required
approval of the shareholders by way of a special resolution through a postal
ballot. In the postal ballot, only about 10% (in number) of the shareholders
sent in their votes but of those who so voted, 99.10% voted in favour of the
resolution.

The Promoters then applied
to the Takeover Panel for exemption from the open offer. The Panel, after due
consideration, recommended grant of exemption. SEBI, however, considered the
matter and refused to grant the exemption.

The main reasons cited by
SEBI were that, firstly, the company could have raised the funds through a
rights issue where all the shareholders could have benefited. If the
shareholders did not subscribe, then of course, the Promoters could subscribe
and cover up the shortfall. Secondly, if an exemption was granted, the public
shareholders would lose the benefit of an exit. Thirdly, SEBI stated that
usually it grants exemption in such cases if the company is a sick/turnaround
company and the infusion of funds is under a Corporate Debt Restructuring (CDR)
package or similar situation. In view of this, SEBI refused to grant the
exemption.

The company appealed against
this decision to the SAT. The SAT allowed the appeal and granted the exemption.

Firstly, the SAT found fault
in SEBI’s view that the company could have raised the funds by a rights issue.
The SAT felt that SEBI should not advise a company on which alternative it could
use to raise funds. It observed, :

“The whole-time member has
found fault with the target company for not raising the funds through a rights
issue as, according to him, the method of preferential allotment denied to the
shareholders an equal opportunity in the fund raising exercise. He appears to be
of the view that since the shareholders had been denied that opportunity, they
be given an exit option through an open offer by declining the exemption. He is
totally wrong in his approach and perception of the shareholders’ interests.
First of all, it is not for the Board to advise or insist on any company as to
how and in what manner it should raise its further equity capital when the law
gives the aforesaid three options to a company . . . . the target company and
its shareholders had considered the option of the rights issue for raising the
equity and for good business reasons and without jeopardising the interest of
the shareholders abandoned this option . . . . Since time was of the essence,
the target company had to choose the quickest way without sacrificing the
interests of its shareholders to raise the necessary funds including the equity
of Rs.50 crores which was a pre-disbursement condition imposed by the banks. We
agree with the learned counsel for the appellants that preferential allotment
was not only the quickest but also the surest method of raising equity. The
option of rights issue if resorted to would have consumed good bit of the 30
months that were available with the target company to start commercial
production. Apart from the delay which that process would have caused, there was
no certainty that the target company would be able to raise Rs.50 crores through
that method. Even in the best case scenario of full subscription in the rights
issue at 1 : 1 ratio, the total money that could be raised would have been Rs.36
crores only leaving a deficit of Rs.14 crores for the project.”

The SAT also pointed out the
risks of uncertainty and costs to the company in a rights issue. It observed, :

“There was also no certainty that all the share-holders would participate in the rights issue. The average market price of the share of the target company during the last six months was around Rs.1.89 and it could at the most offer shares to the shareholders in a rights issue at Rs.1.39 per share, if not lower. It is axiomatic that unless the target company offers the shares at a price lower than the market price, the shareholders would not participate. If the option of rights issue had been adopted, the existing shareholders would have paid at the most at the rate of Rs.1.39 per share, whereas the Promoters to whom preferential allotment has been made have paid Rs.2.25 per share. Has the preferential allotment not added value to the company and in turn enhanced the shareholders’ value. There is yet another reason why the target company did not pursue the rights issue option. This process causes not only uncertainty and delay but also involves extra cost. The appellants pointed out and which fact has not been disputed on behalf of the Board that the total cost of the rights issue would have been close to Rs.56 lakhs and the target company could ill afford at that point of time to spend this amount on this exercise as it had recently wound up its project at Haridwar and was operating at low margins.”

The SAT also held that the prescribed procedure for obtaining approval for the preferential allotment by a postal ballot as prescribed under the Companies Act, 1956, was duly followed in letter and spirit. There was due disclosure of the facts and the relevant and prescribed majority duly approved the resolution. It said that the shareholders were the best judge of their interests and if they have approved something, their judgment cannot be interfered with.

The SAT also rejected the argument of SEBI that an exit route should have been provided to the shareholders through an open offer. The SAT observed :

“We also do not agree with the whole-time member that, in the circumstances of the present case, the shareholders of the target company should have been provided with an exit route by requiring the appellants to make a public of-fer. There has been no change of management or control over the target company consequent upon the preferential allotment as notified to the shareholders. This is also not a case where a rank outsider had acquired a large chunk of shares in the company and was seeking exemption from the takeover code. Such an acquisition or change in management or control over the target company brings with it an element of uncertainty and the takeover code provides that in such an eventuality the existing shareholders be provided with an exit route by requiring the acquirer to make a public offer. In the case before us, there was no element of uncertainty and there was no change of management or control and we are satisfied that the shareholders of the target company did not get affected in any manner by the acquisition.”

At the end, after reversing SEBI’s Order and allowing the exemption, the SAT further observed that in an earlier case on similar facts, SEBI had granted exemption. Thus, SEBI should have granted exemption in the present case too. It observed, “It must be remembered that it is in public interest that a statutory regulator like the Board should be consistent in its approach as that would send the right signals to the capital market and would also insulate the Board from the charge of discrimination.”

While this decision will act as a precedent in future cases and also act as deterrent in arbitrary or inconsistent Orders of SEBI, I respectfully submit that some aspects of this decision of SAT require reconsideration.

Firstly, SAT has, in my opinion, substituted its own judgment in place of the clearly discretionary approval process of SEBI. This is not a case where SEBI has levied, say, a penalty using its discretion whether or not to levy a penalty. It was considering a case of grant of approval which is a concession or benefit given to the Promoters/ other allottees in the present case. SAT also has not found any patent error of fact or law on the face of the record.

Secondly, it may be recollected that till 2002, the Regulations allowed for exemption from open offer to preferential allotment provided certain conditions particularly relating to disclosures were complied with. This exemption has been consciously dropped as a matter of policy. Thus, it could be fair to accept that normal preferential allotment ought not be granted exemption, even if the other formalities in law were duly complied with. With due respect, this decision may indirectly lead to a situation that all allotments through preferential allotments in similar cases of need for fund raising should be exempted. This would make a nullity of the conscious amendment to the law.

Thirdly, the ground that SEBI should be consistent in its Order is of course an advisable and fair ground generally to avoid being seen as arbitrary. However, in cases of grant of discretionary exemption, it is submitted, with respect, that it would mean rigidity and exemptions being taken for granted.

Though not directly on the point, it may be recollected that the Supreme Court (in SEBI v. Saikala Associates Ltd., Civil Appeal No. 3696 of 2005 with Civil Appeal No. 4640 of 2006, decided on April 21, 2009) on the limits and nature of appellate power of the SAT had held that the SAT could not travel beyond the statutory powers in terms of exercising its discretion. The Court observed, “When something is to be done statutorily in a particular way, it can only be done that way. There is no scope for (SAT) taking shelter under a discretionary power”.

To conclude, an appellate window is now open, apparently for the first time, for refusal to grant exemption from open offer by SEBI. However, one trusts that the spirit of discretionary approvals is not defeated by it becoming it mandatory.

Satyam — is pledge of shares insider trading ?

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Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .


(1) Not one more Satyam article, please ! There is certainly
an overdose of reports, articles, blogs, even Twitter messages covering the
latest buzz or views on the Satyam episode. There is serious competition on the
net on how one writer could outdo others in eloquent outrage. However, the fact
remains that at least at the time of writing this article, which is many days
after Mr. Ramalinga Raju’s ‘confession letter’ that, except this very letter,
there are very little other facts brought out. Even the veracity of the contents
of this very letter is being questioned by some. However, as is usually the case
in Trial-by-Media, many parties have been already presumed to be guilty.

(2) However, for the purposes of this column, the Satyam
episode is a dream case study for students of securities laws. If one believes
even some of the reported statements in the press and elsewhere to be true, it
seems that violation of a host of securities laws would be alleged. There would
be question of violations of the SEBI DIP Guidelines while making of
disclosures. There would be allegations of fraud and unfair trade practices in
dealings in securities and making of statements by the Promoters of Satyam and
others. There would be allegations of violation of numerous provisions of
corporate governance requirements. There would be concerns about violations of
the Insider Trading Regulations, since it is reported that shares of Satyam have
been sold by the Promoters over the last many years, either directly or by the
lenders who lent funds against the securities of the shares and then sold the
shares. There could be violation of the Regulations and Code of Conduct for
intermediaries such as merchant bankers, brokers, etc. in their dealings in
relation to Satyam. And so on and on.

(3) However, as stated, it may be worth for us, as students
of this field, to examine one or more of such issues from time to time and then,
in the context of specific ‘facts’ as reported, examine the law and see how it
could apply. This way, we can understand the law in practice.

(4) Let us then, in this context, consider one such
allegation and that is that there has been violation of Insider Trading
Regulations in dealing of shares by the Promoters of Satyam. More specifically,
it is being alleged that the Promoters of Satyam pledged their shares in Satyam
to lenders who, in turn, on default or on margin calls, sold their shares. It is
alleged that this amounts to Insider Trading by the Promoters. It is also
reported that the SEBI Committee examining this issue will also consider whether
the law should be amended, whereby pledge of Promoters’ shares would now be
required to be disclosed. Let us examine here, in the light of the alleged
facts, whether pledge of shares can be held to be Insider Trading under the
existing law. Let us also examine the implications of the recommendation that
the law be amended to require disclosures of pledge of shares by Promoters.

(5) Let us examine the reasoning given in support of the view
that pledge of shares should amount to Insider Trading. The first line of
argument is that pledge of shares is indeed Insider Trading, apparently by
taking an extended meaning of ‘dealing’ in ‘securities’. It is stated that the
word ‘dealing in securities’, the very substance of Insider Trading, is broad
enough to include all transactions relating to securities including, therefore,
even pledge. However, I wonder if the wording of the scheme provides for
coverage of a bona fide pledge. The existing definition of ‘dealing in
securities’ in the SEBI Insider Trading Regulations is quite specific and
exhaustive though a bit clumsy. It says that ‘dealing in securities’ means
‘an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or
deal in any securities by a person either as a principal or an agent’. Pledging
of shares is not subscribing or buying or selling of securities, nor is it
agreeing to do so.

(6) The definition has some clumsiness in terms of being
circumlocutory when it uses the word ‘deal’ again in the latter part of the
definition, but I doubt whether even this would be sufficient to cover bona
fide
pledge of shares.

(7) Consider also the intention of these Regulations
prohibiting Insider Trading. It is obviously to restrict insiders from dealing
ahead of material disclosures, at a time when the price is significantly
different from what it may be if these disclosures were made. In Satyam, it is
being alleged that the Promoters pledged shares when prices were high and thus
obtained monies based on valuations that did not reflect the reality and which
reality was disclosed much later. The lenders allegedly sold shares when market
price started falling and Promoters could not meet margin calls. However, this,
by itself only, cannot make bona fide pledge of shares insider dealing.

(8) When a person pledges shares, he keeps the risks and
rewards in the shares with himself. When the lender sells the shares on default
or margin calls, he sells at a time when the prices may have already fallen, but
then it is the borrower who has to bear such fall. He would be credited
obviously only to the extent of the amount realised by sale. If the borrower
bears the risk of such fall, then this goes against the very concept of Insider
Trading where the dealer profits from a fall in price that may be the result of
adverse information published later.

(9) The second and incidental line of argument is that the
definition of ‘securities’ — Insider Trading involves dealing in ‘securities’ —
under the Securities Contracts (Regulation) Act, 1956 includes ‘rights or
interest in securities’. It is argued, and to that extent rightly so, that
pledge of shares may involve grant of right or interest in securities. However,
from this, a conclusion is apparently being inferred that thereby dealing in
‘securities’ would cover pledge of shares.

10. One possible answer to this is that what is covered under Insider Trading is ‘dealing’ in securities i.e., the process and action itself. It is the word ‘securities’ that has been given an extended meaning under SCRA to cover ‘rights or interest’. The word ‘dealing’ has not so been artificially extended and in fact, as discussed above, is quite specific and exhaustive (except for the quirk, also discussed). If pledge of shares is held to be Insider Trading, then Insider Trading is being interpreted to mean ‘dealing in (dealing in securities)’!
 
11. Interestingly, the Takeover Regulations exempt acquisition of shares by ‘banks and public financial institutions as pledgees’. One may wonder whether, therefore, pledge was thus understood to be acquisition, since otherwise there was no need to specifically give this exemption. However, this conclusion may not be correct since, even here, what is really exempted is ‘acquisition of shares’ as ‘pledgees’ and not the pledge itself. In other words, the pledge has to be an acquisition first – e.g., in the case where the pledgee actually transfers the shares in its name and also does further acts. Also, there are decisions (of SAT,etc., not discussed here) that have held that pledge does not amount to acquisition of shares.

12. The above discussion though applies to bona fide pledge of shares and the moot question of course is whether the pledge of shares in Satyam was bona fide. Obviously, no one knows this yet and it may take a long time before the truth is established. However, clearly, if a pledge is not a bona fide pledge and is actually a sale in disguise, then it would be sale of securities and in that case the Insider Trading Regulations would squarely apply. But this would be by applying the regular and plain inter-pretation of Insider Trading and not by a crisis-driven, extended meaning.

13. If in the heat and pressure of action, to some-how find the Promoters of Satyam guilty of Insider Trading, a stretched interpretation is taken that any pledge of shares should also be deemed to be Insider Trading, it can cause a serious crisis to the whole corporate world generally. Firstly, Promoters of numerous other companies would also be deemed to have committed Insider Trading through pledge. Secondly, this process may bring out the real picture of the status of finances of Promoters in India post-stock market meltdown !

14. It is then that the second suggestion of SEBI can be discussed and that is whether Promoters should be required to disclose the pledge of their shareholdings. I think this is a sensible suggestion and it would be valuable information for shareholders and the markets in general to know to what extent the Promoters are vulnerable and what is their real, net and clear holding and stake. Not that there is anything per se wrong in pledging shares or that it is ‘disclosure’ of Insider Trading. Pledge may be for many reasons – for raising of finance for persons or corporate purposes or even further acquisition of shares, etc. In fact, if funds are raised by Promoters for financing further acquisitions of shares, then this may be even indicative of their own confidence in the Company. Of course, in some cases, this disclosure may help initiating investigation of the bona fide nature of the pledge.

15. However, as stated earlier, making Promoters to disclose, at this juncture, the pledge of their holding would also result in the discovery – probably shocking – of the reality as suggested by the oftquoted statement of Warren Buffet – “You only find out who is swimming naked when the tide goes out”. We may thus find out how many Indian Promoters are swimming dressed very skimpily and how many are swimming stark naked!

Rebirth Of Stock Lending – Opportunities, Confusion and Contradictions

This series of articles introducing securities laws for listed companies to the lay reader continues…

1) A recent and relatively minor amendment suddenly infuses life into the otherwise dead instrument, that is, scheme of stock lending. The amendment provides that now Stock Lending can be for one year, thereby increasing the period from 30 days, which, incidentally initially was, for just seven days. This short lending period was probably the main reason why there was practically no interest in using stock lending, though the scheme has existed since 1997!

2) Let us broadly understand what Stock Lending is and understand some important developments till date. I may add that, as we will see later, numerous other things in securities laws and outside have to be resolved but this latest amendment is, I think, sufficient reason to take Stock Lending seriously now.

3) Stock Lending, as the name suggests, is lending of shares by an owner to a borrower. The borrower pays charges for “using” the shares and is required to return the borrowed stock by the end of the borrowing period. The Borrower normally cannot close the transaction in cash. The arrangement provides that all other benefits of ownership go to the Lender, such as dividends, bonus issue, etc. Hence, if a company makes a 1:1 bonus issue, the Borrower would then have to return double the number of shares he has borrowed. However, all benefits of ownership cannot be protected, such as the ‘right to vote’.

4) The Borrower normally sells the shares in the market, as he is bearish on the scrip and believes that the price of the shares will fall in the ‘borrowing period’. Thus, he will be able to buy shares back at a lower price and return them to the Lender and earn profit.

5) Conceptually, thus, the Lender would have to be a person who is either a long term investor or a promoter who is bullish on the scrip and desires to earn return in the interregnum. Another reason for not selling the shares himself could be that the Promoter may be interested in retaining the shares for the long term for the benefit of control through the shares.

6) In theory, private parties could carry out Stock Lending amongst themselves. The Lender would lend the shares to the Borrower by a private arrangement. The Borrower would sell the shares, buy them back at a later date and return the shares. However, there would be several complexities. The Lender would also have concerns about default in recovery of his shares. Further, the Lender/Borrower would have to search for counter parties and there would not be the benefits of an open market of Stock Lending where parties could find many counter parties. In an open market, the Stock Lending rates would be market determined owing to wider participation.

7) The advantages of a statutory lending scheme are many and in theory, many of the above disadvantages can be overcome. However, SEBI has been struggling, since 1997, to lay down a scheme that retains the aforesaid advantages while ensuring that the terms and conditions do not create problems. However, it has not been successful so far.

8) SEBI had introduced in 1997 a Scheme of Stock Lending. The principal concept was of approved intermediaries, who would act as intermediaries for parties on both sides, i.e., lending and borrowing. Strict approval norms were laid down for approval of intermediaries so that the intermediaries were strong in terms of net worth, which may lend confidence to the Lender. The intermediaries would also be under regulatory control of SEBI. For various reasons, including tax uncertainty (which since 1997 was partly resolved), the Stock Lending Scheme did not take off at all.

9) A decade later, around 2007, SEBI took steps to revive it. A principal change made was that that the stock exchanges themselves would be the intermediaries. It appears that the objective was also of allowing Stock Lending transactions to be effected through the stock exchange. Thus, one could theoretically borrow and lend in a manner similar to buying and selling shares or derivatives. The stock market would also protect the parties for due honour of the terms such as return of the shares and corporate benefits.

10) However, SEBI was unduly cautious. Stock Lending is actually intended to facilitate
short-selling. And short-selling is incorrectly and unfairly seen as a stigmatic act. So much so that the recent recession in the US is blamed on short-sellers. Even in India, a few years earlier, short-sellers were claimed to be behind the huge fall in the stock markets. However, short-selling and speculative buying are two sides of the same coin. If markets are undervalued, a spirited speculator is seen as heroic when he buys, raises the market and then sells the same. The same speculator who feels that the market is overpriced, becomes a villain if he short sells. Speculation is part of the market. But if speculation is indulged in for price manipulation, then, and only then, it should be punished. However, short-selling continues to be stigmatic, at least in perception.

a) Having stated this, Stock Lending is better than naked short-selling in which any quantity of shares could be sold. In Stock Lending, every short sale has to be backed by available shares.

11) Hence, as said earlier, SEBI was unduly cautious. It initially allowed barely 7 days of lending, as if prices would move towards a particular value in such short period. Such a Scheme was bound to fail and it did. It remained a failure when the lending period was increased in 2008 from 7 to 30 days. Now, SEBI has, in one stroke, increased the period to 12 months and there is some excitement in the market. This move has the potential to be the proverbial Tipping Point, when there is a major take-off on account of a small change, though some minor issues in the Scheme and tax and other uncertainties remain.

12) As the revised scheme is now in place, let us note some important features which make the Scheme attractive:-

a) Any person can carry out stock lending and thereby short-selling. The Borrower and the Lender can be any person, individual, corporate, institutional investor, etc.

b) Initially, Stock Lending will be allowed in shares in which futures and options are allowed. SEBI will review this list from time to time.

c) The lending/borrowing period is upto one year.

d) The Lender can request an early termination and the Approved Intermediary can, on a best effort basis, seek to get shares from another lender and give them to the original Lender.

e) The Borrower can also return the shares earlier and the Approved Intermediary can attempt to find another borrower.

f) Timely disclosures will have to be made of the shares that are sold using the Stock Lending mechanism.

g) The clearing corporation/clearing house of the stock exchanges having nationwide terminals will be registered as Approved Intermediaries, through which the Stock Lending would be carried out. The Borrowers and Lenders would approach authorized Clearing Members for their transactions.

h) The Stock Lending would be through the screen-based, order-matching platform. Thus, like derivatives, parties can find out orders available on either side and carry out “trades” of borrowing/lending.

i) There will be a contractual/statutory framework between the parties involved, viz., the Borrowers, Lenders, Approved Intermediaries and the Clearing Members. However, there will not be any direct agreement between the Borrower and the Lender.

j) The contracts would effectively be standardized and thus comparable and capable of being valued uniformly.

k) The Approved Intermediaries will lay down the risk management mechanism so as to ensure that shares lent are recovered or due compensation is otherwise received from the Borrower. This is an important pillar of the Scheme, which would give comfort to the Lender.

l) There are overall limits of shares that can be lent as a percentage of capital. At least in this respect, SEBI has been realistic and has allowed a fairly high percentage of the share capital—10%—though one could argue that even this is arbitrary. There are sub-limits though, at various lower levels.

m) The lending and borrowing would not be deemed to be sale and purchase of shares for various purposes such as for Takeover Regulations. However, one will have to look at actual amendments in the law, if there would be any.

13) Note that while the Stock Lending scheme is approved, steps would have to be taken by stock exchanges and others concerned to lay down the systems and procedures for the same to make it operational.

14) While the Scheme is attractive generally, there are various concerns.

15) The tax law remains uncertain, and though there is a specific but old Section 47(xv) that deals with Stock Lending, some questions worth considering are:-

a) Will lending be deemed to be a sale and borrowing deemed to be a purchase in the revised statutory framework, particularly where there
 

are no direct agreements between Borrower and Lender? Similarly, what will be the treatment of the reverse transactions when shares are returned from the Borrower to the Lender through the Approved Intermediaries?

An incidental question would be how would the period for which the stock is lent be treated? Will it be part of the continuous period for which the shares were held by the Lender?

b) The Borrower would be in a peculiar position. Assuming that he is not deemed to be a purchaser, he would be selling the shares first and then buying them back. How would the surplus/loss be treated? How would he account for his position for tax purposes at the yearend when he has sold shares but he has not yet bought them back? Will he be able to book a provisional loss if the market price is higher than the price at which he sold? How much of such loss will he be able to book?

c) How would the income from Stock Lending be treated? How would the Stock Lending charges paid be treated? How will the treatment differ for those who hold the shares as stock in trade and for those who hold it as capital assets?

d) If there is finally a default in return of the shares and the Lender is compensated in money, what would be its tax treatment? When would the “transfer”/sale be deemed to have taken place?

I must confess that I have only scratched the surface and I am sure readers will think of more issues.

16) Apart from tax, there would be other issues such as:-

a) Can Stock Lending be deemed to be insider trading? In other words, would a Stock Lend-ing by an insider be deemed to be insider trading if he had access to unpublished price sensitive information?

b) How would the lending and borrowing be treated for accounting purposes? How will it differ for shares held as investments and shares held as stock in trade? How will the potential loss on account of rise in price be accounted by the Borrower at the yearend?

c) Will Stock Lending be treated as borrowing for the purposes of Section 58A of the Companies Act, 1956?

d) Will stock lending be deemed to be a financial activity for the purposes of regulations relating to NBFCs?

17) Then there are other aspects. Should an act of a Promoter who lends shares be viewed negatively? Should it show an indication that he is himself bearish on his shares and thus he is protecting himself? By lending, is he not encouraging fall in the share price since there would be selling pressure? Or should a view be taken that the fact that the Promoter is only lending and not selling shows that he is actually confident of his company since he would want his shares back eventually? Whatever the theoretical arguments, on either side, may be, a Promoter who lends his shares may face publicity and, often, publicity relating to such transactions is automatically negative publicity!

18)To conclude, Stock Lending offers a new and attractive instrument but with complex issues that Chartered Accountants, whether in industry or in practice, will have to address.

Can Chartered Accountants be Punished by SEBI ?

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Securities Laws

The issues are:


    (a) Are auditors governed only by ICAI as far as their auditing and certification is concerned?

    (b) Whether SEBI has the right to take action against the auditors, and if so under what circumstances?





These important issues have been recently answered by the
Bombay High Court in Price Waterhouse & Co. v. SEBI, [(2010) 103 SCL 96 (Bom.)].
As we will see later herein, the Court decided against the petitioners. However,
the Court stayed the proceedings for four weeks to allow filing of a special
leave petition to the Supreme Court. As of the date of writing this article, the
status of whether such a SLP has been filed or not is not known.

The issue is whether the work of an auditor should be judged
only by an expert body — that is — ICAI — an institution established under a
statute. It is a matter of serious concern if the same work is also scrutinised
by another authority that may reach a different conclusion and this also results
in multiple actions/
proceedings.

There is also another important reason to be concerned.
Chartered Accountants generally and even as Statutory Auditors are not required
to be ‘registered’ with SEBI. SEBI closely controls registered intermediaries
not only through the process of registration and suspension/cancellation of
registration, but also by closely regulating them through Rules and Regulations.
If SEBI can control and act against unregistered intermediaries, particularly if
they are regulated by another body, it would be a worrisome precedent for not
just chartered accountants, but any person having anything to do with listed
companies or capital markets.

Further, the anxiety is also because the type of action that
the SEBI Act permits is quite wide-ranging and the show-cause notice (‘the SCN’)
that SEBI issued in this matter showed this. The SCN pointed out several actions
that SEBI considered taking, assuming that the allegations were proved. For
example, it said: it would consider banning the auditors from carrying out
statutory audit or other audit/certification of not just listed companies, but
of any other intermediary, etc. registered with SEBI. It would also ban the CA
from ‘accessing the securities markets’ (though it is not clear how a CA may
access it) and certain related actions. It would even initiate prosecution that
may entail a fine of up to Rs.25 crores and imprisonment up to 10 years.

Thus, to summarise, the result would be multiple authorities
judging the auditor, resulting into multiple action and consequences.

It is to be clarified that the SCN was challenged on the
issue of the jurisdiction of SEBI to initiate action. There was no finding of
facts and the Court merely held that it is up to SEBI to investigate the actual
facts and first establish the allegations. But the Court also held that:



  • SEBI does have the power to investigate an auditor with regard to professional
    work done for listed companies and certain other specified persons.



  • Secondly, if the investigation established the allegations as true, then the
    actions of banning, etc. were permissible. In short, the Court held that the
    ICAI did not have exclusive jurisdiction over a CA with regard to the
    professional work done by them for such entities.



  • Thirdly, SEBI and ICAI operated from different angles and thus their
    jurisdictions are simultaneous but not really overlapping.


The issue arose out of the Satyam Computers episode where
several accounting and related frauds have been alleged and are as widely
reported, backed also by an email by Mr. Raju. The issue relating to the role of
the auditors arose as to whether there was any failure/deficiency in the
performance of their professional duties and/or whether there was connivance.

Now let us review the decision in a little more detail.

SEBI issued a show-cause notice to the auditors and certain
other parties. It alleged that in respect of the various alleged accounting
frauds including showing higher revenue, profits, assets, etc., the auditors and
other specified persons did not perform their professional work properly. It
thus asked these parties to explain their stand and said that if the
explanations were not found satisfactory, then it may take actions such as
banning the parties from carrying out audit, etc. of listed companies and
registered intermediaries, accessing capital markets, etc. It even stated that
prosecution may also be considered.

The parties raised a preliminary issue that since they were
Chartered Accountants carrying out professional work and since their
professional work was sought to be judged, they should be judged by the ICAI
only and SEBI had no jurisdiction.

SEBI, however, stated that auditors of listed companies were
entities associated with the capital market and since SEBI’s role was to protect
the integrity of capital markets, it had the right to take action against
persons associated with capital markets. Hence, SEBI has the jurisdiction.

Various issues were raised and it is worth running through
how the Court dealt with them.

The fundamental question is whether SEBI has jurisdiction
over Chartered Accountants or whether the ICAI has exclusive jurisdiction which
SEBI cannot encroach on? The Court raised the issue: (emphasis supplied in all
extracts of the decision in this article):

“However, it is required to be examined as to whether in substance by initiating the proceedings under the SEBI Act, the SEBI is trying to overreach or encroach upon the power conferred under the CA Act.”

“Looking to the provisions of the SEBI Act and the Regulations framed thereunder, in our view, it cannot be said that in a given case if there is material against any Chartered Accountant to the effect that he was instrumental in preparing false and fabricated accounts, SEBI has absolutely no power to take any remedial or preventive measures in such a case. It cannot be said that SEBI cannot give appropriate directions in safe-guarding the interest of investors of a listed company. Whether such directions and orders are required to be issued or not is a matter of inquiry. In our view, the jurisdiction of SEBI would also depend upon the evidence which is available during such inquiry. It is true, as argued by the learned counsel for the petitioners, that SEBI cannot regulate the profession of a Chartered Accountant. This proposition cannot be disputed in any manner. It is required to be noted that by taking remedial and preventive measures in the interest of investors and for regulating the securities market, if any steps are taken by SEBI, it can never be said that it is regulating the profession of the Chartered Accountant. So far as listed companies are concerned, the SEBI has all the powers under the Act and the Regulations to take all remedial and protective measures to safeguard the interest of investors and the securities market. So far as the role of Auditors is concerned, it is a very important role under the Companies Act.”

Further, the Court reviewed the Chartered Accountants Act and the powers therein and did not find any contradiction. Since SEBI was not really seeking to regulate the profession of Chartered Accountants, the Chartered Accountants Act could not prevent SEBI from taking action of the nature proposed in the SCN.

Can SEBI order that an auditor shall be prohibited from auditing the accounts of a listed company? This is what the Court held:
“It is not uncommon nowadays that for financial gains, even small investors are investing money in the share market. Mr. Ravi Kadam has rightly pointed out that there are cases where even retired persons are investing their retiral dues in the purchase of shares and ultimately, if such a person is defrauded, he will be totally ruined and may be put in a situation where his life savings are wiped out. With a view to safeguard the interests of such investors, in our view, it is the duty of the SEBI to see that maximum care is required to be taken to protect the interest of such investors so that they may not be subjected to any fraud or cheating in the matter of their investments in the securities market. Normally, an investor invests his money by considering the financial health of the company and in order to find out the same, one would naturally bank upon the accounts and balance- sheets of the company. If it is unearthed during inquiry before SEBI that a particular Chartered Accountant, in connivance and in collusion with the Officers/ Directors of the company has concocted false accounts, in our view, there is no reason as to why to protect the interests of investors and regulate the securities market, such a person cannot be prevented from dealing with the auditing of such a public listed company. In our view, the SEBI has got inherent powers to take all ancillary steps to safeguard the interest of investors and securities market. The powers conferred under various provisions of the Act are wide enough to cover such an eventuality and it cannot be given any restrictive meaning as suggested by the learned counsel for the petitioners. It is the statutory duty of the SEBI to see that the interests of the investors are protected and remedial and preventive measures are required to be taken in this behalf. It is required to be noted that in the instant case the inquiry is still pending, ultimately the decision is required to be taken by SEBI on the basis of available evidence on record. However, in order to determine the jurisdiction of SEBI, the contents of the show-cause notice which is the first step of initiating proceedings are required to be seen. Reading the contents of the show-cause notices and the relevant statutory provisions, it cannot be said that SEBI has no jurisdiction at all to enquire into the affairs of the petitioners insofar as it relates to Satyam.”

The Court made it clear that SEBI definitely has jurisdiction in such matters by observing, “In our view, it cannot be said that the show -cause notices issued by SEBI are, on the face of it, not sustainable on the ground that SEBI has no jurisdiction to enter into the affairs of the petitioners or that it lacks jurisdiction to go into such questions.”

A critical question that often arises is who are persons associated with the securities markets since that would give jurisdiction to SEBI to inquire and take action. Thus, the question is whether auditors are such persons associated with the securities market. The Court answered in the positive, stating, “even though the petitioners may not have direct association in share market activities, yet the statutory duty regarding auditing the accounts of the company and preparation of balance-sheets may have a direct bearing in connection with interest of the investors and the stability of the securities market. In our view, the petitioners in their capacity as auditors of the company Satyam, which was at one point of time considered to be a blue chip company who had a defining influence on the securities market, can be said to be persons associated with the securities market within the meaning of the provisions of the said Act.”

The Court also held that the power of SEBI is over and above the provisions of S. 227 of the Companies Act, 1956, which provided for removal of an auditor. Thus, it negatived the contention that removal of auditor can only be u/s.227. The Court also compared the powers under SEBI Act with the powers under the Consumer Protection Act and said that neither of this can be said to be encroaching on the powers of ICAI. The Court also rejected the argument that such proposed action by SEBI would amount to infringement of fundamental rights under Article 19(1)(g) of the Constitution of India.

Interestingly, the Court held that the criteria for determining proper performance of duties by the auditors were the very audit norms prescribed by ICAI. The Court, observed, “However, if it is found in a given case that the Chartered Accountant has violated the audit norms prescribed by the Institute under the CA Act, the SEBI can certainly consider the said aspect in order to find out as to whether such a professional person should be allowed to continue to function as an Auditor of a listed company if by continuing such person as an Auditor of a listed company, it may hamper the interest of the investors of such a listed company.”

An interesting aspect is whether SEBI would have jurisdiction only when there is a mala fide intention or connivance by the auditors or whether professional negligence without such an active involvement is also covered. It is not clear from the decision, but the Court did make some interesting observations. An example of such an observation of the Court is:

“In a given case, if ultimately it is found that there was only some omission without any mens rea or connivance with anyone in any manner, naturally on the basis of such evidence the SEBI cannot give any further directions.”

Another thought that comes to the author is: whether the views of ICAI should have been taken here in some manner, since at least indirectly the issue related to the exclusive jurisdiction of ICAI.

Open offer pricing — recent decisions

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Securities Laws

(1) Open offers under the SEBI Takeover Regulations are
perhaps the rare situations in which intelligent investor interest focusses on
the wording and interpretation of securities laws. Whether there will be an open
offer and at what price and to whom are
questions, the answer to which present quick money-making opportunities to them.
In Western countries, professional arbitrageurs used to specialise in this
narrow field and some of them made hundreds of millions of dollars. As many of
these investors resorted to the use of inside information, this rewarding
activity came into disrepute.

(2) Even a simple takeover can create complications for an
intelligent and well-informed investor if he speculates. The issue gets further
complicated if takeover of Company C by B is quickly followed by takeover of B
by A.

(3) A recent decision of the Securities Appellate Tribunal
deals with just some of such complications and should present interesting
reading. The issue essentially related to what offer price should be given to
public shareholders under the mandatory open offer required under the Takeover
Regulations. The interesting aspect was that the company taken over itself
controlled another listed company (that was itself recently taken over). You can
picture the situation that a big fish eats a small fish and before the small
fish is even digested by the big fish, a bigger fish comes and eats the big
fish !

(4) Since the law requires that if a company is taken over
indirectly, then open offer is required for the indirectly acquired company
also. The question was what would be the price that should be offered for such
indirectly acquired company’s public shareholders. The case considers the
complexities that arise in such takeovers and how the law would be
expectedly found to be partially inadequate. The case also offers insights how
the Appellate Authority tries to find a meaningful solution to the issue,
filling in gaps through a ‘purposive’ approach to interpretation of the law. The
issue also is whether the Securities Appellate Tribunal, with due respect, took
an approach that gave benefits to public shareholders, but that was not
justified by the letter and perhaps even the spirit of the law.

(5) Let us go into the facts of this interesting case. The
decision is in the case of Dr. Jayaram Chigurupati v. SEBI and Others,
(Appeal No. 137 of 2009). The 3 companies involved were Zenotech Laboratories
Limited (‘Zenotech’), Ranbaxy Laboratories Limited (‘Ranbaxy’) and Daiichi
Sankyo Company (‘Daiichi’).

(6) Zenotech was the small fish in our analogy and was taken
over by Ranbaxy in the first instance. Ranbaxy made the required open offer to
the shareholders of Zenotech. Thereafter, Zenotech became a subsidiary of
Ranbaxy. Within a few months of the open offer by Ranbaxy — Ranbaxy itself was
taken over by Daiichi and thereafter became a subsidiary of Daiichi. It needs to
be noted that both Zenotech and Ranbaxy are listed companies.

(7) To recap the law, the Takeover Regulations require that
if a listed company is taken over, an open offer is required to be made to the
public shareholders of the listed company. The objective is that when an
acquirer buys shares typically from the Promoters of a Company, he should offer
to buy out at least some of the public shareholders too. The minimum percentage
for which the public offer has to be made is 20% of the equity capital. The
important other relevant factor crucial to the present case is the price at
which such an open offer has to be made. The offer price is determined by a
formula that takes into account the price paid for the initial acquisition, the
average of the prices for the preceding specified period, the price paid by the
acquirer or persons acting in concert with him in the preceding specified period
and so on.

(8) The Takeover Regulations require that if there is an
‘indirect’ takeover, the open offer would be required not only to the public
shareholders of the company taken over, but also of the company indirectly taken
over. The subsidiary company of the company taken over is a classic example of a
company indirectly taken over. In the context of our above example, Ranbaxy was
the company directly taken over by Daiichi and Zenotech was the company
indirectly taken over since Zenotech was a subsidiary of Daiichi.

(9) Thus, Daiichi would have to make an open offer not only
to the shareholders of Ranbaxy, but also to the shareholders of Zenotech. The
open offer to Ranbaxy’s shareholders did not offer any complication and was not
also in dispute here. Complications arose for the open offer of Zenotech and at
what price should the open offer be made to their public shareholders.

(10) A brief digression is required here to explain why the
law in relation to such indirect acquisition is a bit complicated and why it has
certain artificial parameters. Earlier, the differences in reality that may
arise between direct and indirect takeovers were not realised and hence the law
was not much different. However, experience made the lawmakers realise that
indirect takeovers had to be treated differently. It was seen that often
indirect takeovers were proposed but could not be completed because certain
approvals were not eventually received. This was particularly so in case of
cross-border acquisitions and where the parent company abroad was acquired.
Approvals of competition authorities and others made the completion of the
takeover uncertain and at least there was a significant delay involved. If an
open offer is required to be made for a takeover that finally does not happen,
then the shares so acquired would be an undue cost to the acquirer. For these
and other reasons, the law in India was amended and it was provided, in essence,
that in case of indirect takeovers, the open offer would have to be made within
3 months completion and consummation of the takeover of the first company.
However, to be fair to the public shareholders, the price to be offered to them
would be the higher of the prices calculated with reference to the original date
of the takeover of the first company and the date when the open offer is
triggered after the completion of the takeover of the first company.

(a) Thus, the complicated formula would have to be applied
with reference to both such dates.

(11) An interesting parameter provided for in this formula is
that if at any time during the preceding twenty-six weeks, the acquirer or any
person acting in concert with him had acquired shares at a higher price, then
such higher price would have to be offered to the public shareholders. The logic
is not far to see — the law intends to ensure that the highest of the prices
recently paid by the acquirer or persons acting in concert should be paid to the
public shareholders.

12. Now once again let us apply the above law to the facts of the present case and see the interesting twist. To recollect, Daiichi acquired Ranbaxy whose subsidiary was Zenotech. Thus, Daiichi had to make an open offer also to the shareholders of Zenotech within three months of completion of acquisition of Ranbaxy, Daiichi or persons acting in concert with it (except for the interesting twist discussed later) had not acquired any shares of Zenotech in the preceding twenty-six weeks. Thus, Daiichi made an open offer at Rs.114 (rounded off here for simplic-ity), since that was the price determined as per the various parameters.

13. However, the question and interesting twist to the whole issue was this. Ranbaxy had become a subsidiary of Daiichi after the acquisition. At the time when the open offer was being made by Daiichi to shareholders of Zenotech, Ranbaxy was thus a subsidiary of Daiichi. By definition, a subsidiary company is deemed to be a person acting in concert with the holding company unless it is established otherwise. Thus, Ranbaxy was a person acting in concert with Daiichi.

14. Ranbaxy had obviously acquired shares of Zenotech when it took it over and as part of open offer. However, only after such takeover of Zenotech that Ranbaxy was itself taken over by and became subsidiary of Daiichi. Since the preceding twenty-six week period was to be considered, and since Zenotech was taken over by Ranbaxy during this period, obviously Ranbaxy had acquired shares of Zenotech during this period under the first open offer. The question was that whether the price paid by Ranbaxy during this period was to be taken into account.

15. The stakes were large. Ranbaxy had paid a price of Rs.160 and thus instead of the Rs.114 to be paid, Rs.160 would be required to be paid.

16. The aggrieved parties petitioned to SEBI who rejected the claim of increase of the offer price to Rs.160 (interestingly, the erstwhile Promoters of Zenotech holding 26% shares were themselves the primary petitioners). The petitioners went in appeal to the Securities Appellate Tribunal (‘SAT’).

17. The SAT held that since Ranbaxy was a sub-sidiary of Daiichi, it was deemed to be acting in concert with Daiichi. No claims were made to refute this legal presumption. The SAT held that since this was the case, the acquisitions made by Ranbaxy during the prescribed period would also have to be taken into account. Since Ranbaxy had paid Rs. 160 to acquire shares of Zenotech during this period, this higher price would have to be the open offer price. Thus, though the open offer price otherwise determined taking also the current price was Rs.114, the price to be actually offered was held to be Rs.160.

18. Now, one may be tempted to say that if the small and public shareholder is benefitted, it is a good thing. The question, however, is also of justice. Incidentally, it was the erstwhile Promoters of Zenotech who held 26% that would be the major beneficiaries. (A side bar here – normally the Promoters of the target company cannot participate in an open offer and it is restricted to public shareholders only. However, since Zenotech was already taken over, the erstwhile Promoters, though holding 26%, became public shareholders and thus eligible for the open offer). Further, it is possible that eventually Daiichi may also have to pay interest on Rs.160 (for the grace period granted under law, SAT has held though  that no interest  would    be payable).

 19. With great respect, I submit that the decision is not correct in law.

 20. Let us first look at the intention of the law. The intention, as I read the law, is that if an acquirer buys shares that triggers an open offer, the highest recent price’ paid by him should be considered and not merely the price at which the lot of shares that resulted in attraction of the open offer were acquired. For this purpose, since it often happens that many entities of the acquirer group acquire shares, the price paid by such persons acting in concert are also considered. However, it is strange that a person who was never a person acting in concert to start with at the time of the original acquisition, is now deemed to be acting in concert. When Ranbaxy bought shares of Zenotech it had nothing to do with Daiichi. To say that Ranbaxy was acting in concert with Daiichi in view of an event that happened later on and apply this to an earlier date is strange.
 
21. The words used are ‘acting’ in concert and this is in the present tense. Quite apparently, as on the date of original acquisition Ranbaxy was not ‘acting’ in concert with Daiichi.

22. The concept of deemed person acting in concert is an artificial concept and it is a well-settled principle of law that such artificial and deeming provisions should be construed strictly.

23. I do not know whether the SAT deliberately took a view to favour the small shareholders and of course there are no words to that effect though SAT does say that it has taken a ‘purposive’ interpretation of the law. I respectfully submit that on a plain and literal reading as well as reading in terms of the object of the law, the conclusion is, with great respect, not justified in law.

24. As I write this article, there are reports that Daiichi may go in appeal to the Supreme Court and it would be interesting to consider what the Su-preme Court has to say in the matter.

Supreme Court on Takeover Regulations

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Securities Laws

(1) A recent decision of the Supreme Court throws light on
important issues relating to the SEBI Takeover Regulations. Some core concepts
of the Regulations such as ‘persons acting in concert’ and ‘persons deemed to be
acting in concert’ are interpreted. It is important to note the reliance placed
by the Supreme Court on the reports of Expert Committees for interpretation. The
decision is in the case of Daiichi Sankyo Company Limited v. Jayaram
Chigurupati & Others,
C.A. No. 7148 of 2009, dated July 8, 2010.

(2) Of course, the real issue that was in dispute before the
Court, though interesting, has application in rare cases. It concerns a
situation where a listed company was acquired by another listed company and the
latter company, within a short time, got itself acquired by another company. The
question before the Court related to the pricing for the open offer of the
shares of the first company and the interpretation of the legal provisions
applicable to such a situation. Such quick and sequential takeovers do not
happen often and hence that part of the decision may have limited application.
But the other aspects have wider importance.

(3) Let us then broadly understand the facts, the relevant
provision of law and the issue, and then know what the Supreme Court held.

(4) The facts are quite simple. Ranbaxy Laboratories Limited
(‘Ranbaxy’), a listed company, agreed to acquire a significant stake in Zenotech
Laboratories Limited (‘Zenotech’), another listed company paying a price of
Rs.160 per share. As required under the Regulations, it made an open offer @
Rs.160 which was also the price as per the formula under the Regulations.
However, within six months, the Promoters of Ranbaxy agreed to sell more than
15% shares in Ranbaxy to Daiichi @ Rs.114 (rounded off) per share. Eventually,
Daiichi got more than 51% stake in Ranbaxy, thereby making Ranbaxy its
subsidiary. Daiichi thereby acquired indirectly more than 15% stake in Zenotech.
Hence, as required by law, Daiichi made an open offer for shares of Zenotech at
a price Rs.114. Shareholders of Zenotech, including its erstwhile Promoters,
complained to SEBI that the open offer should have been @ Rs.160 and not Rs.114.
As will be seen later on, particularly after considering the decision of the
Securities Appellate Tribunal (‘SAT’), the point at issue was that since the law
deems holding-subsidiary companies to be deemed to be acting in concert with
each other and since the law requires that price paid by a person acting in
concert to be taken into account, the open offer should be Rs.160 as paid by
Ranbaxy.

(5) The law relating to open offer pricing of such ‘indirect’
acquisitions, i.e., acquisition of shares of a listed company which in
turn controls another listed company, is as follows.

(6) Shredded of irrelevant complexities, it can be said that
when a listed company acquires another listed company indirectly, then it has to
make an open offer for the shares of the company in which such indirect
acquisition has been made. For the purposes of pricing of the open offer, the
law requires that, inter alia, the price paid by the acquirer or any
persons acting in concert with it during the preceding 26 weeks has to be taken
account of and if such price is higher, then such higher price shall be the open
offer price.

(7) In the present case, Daiichi acquired Ranbaxy. However,
it was during the preceding six months to this that Ranbaxy had acquired the
shares of Zenotech @ Rs.160. The law deems a holding and its subsidiary to be
acting in concert with each other. The issue thus was that since Daiichi and
Ranbaxy were deemed to be acting in concert and since Ranbaxy had acquired
shares of Zenotech @ Rs.160 during the preceding six months, whether such higher
price of Rs.160 should be the open offer price by Daiichi ?

(8) SEBI rejected the complaint by the shareholders of
Zenotech that such higher price should have been the open offer price. Such
shareholders appealed to the SAT, who held that the open offer should have been
at Rs.160. It held, in essence, that one has to consider the situation on the
date with reference to which the price formula of preceding 26 weeks was to be
applied. As on this date, Ranbaxy was a subsidiary of Daiichi. Thus, they were
deemed to be acting in concert. Since the law requires that acquisition by
persons acting in concert be taken into account, the SAT held that the higher
price of Rs.160 paid by Ranbaxy should be the open offer price.

(9) The matter reached the Supreme Court. The Supreme Court
considered, inter alia, the history of the provisions and numerous
provisions not just relating to indirect acquisitions, but even related and
incidental provisions.

(10) It held that, firstly, the persons acting in concert
have to actually come together to acquire the shares of a target company. There
has to be an agreement (or understanding, etc.) to acquire shares and such
shares should be of the target company.

(11) Further, the provisions deeming certain connected
persons (such as holding-subsidiary companies in this case) as persons acting in
concert does only that — i.e., it deems that they are acting in concert.
It does not deem that they have been acting in concert for acquiring shares of a
listed company and this would have to be established. Importantly, even the
provision that deems certain related persons as acting in concert has a
clarification that this deeming provision is subject to the contrary being
established.

(12) The Court gave its understanding of the term ‘person
acting in concert’ as follows :

“. . . . the concept of ‘person acting in concert’ under
Regulation 2(e)(1) is based on a target company on the one side, and on the
other side two or more persons coming together with the shared common objective
or purpose of substantial acquisition of shares, etc. of the target company.
Unless there is a target company, substantial acquisition of whose shares, etc.
is the common objective or purpose of two or more persons coming together, there
can be no “persons acting in concert
“. For, de hors the target
company the idea of ‘persons acting in concert’ is as irrelevant as a cheat with
no one as victim of his deception. Two or more persons may join hands together
with the shared common objective or purpose of any kind, but so long as the
common object and purpose is not of substantial acquisition of shares of a
target company, they would not comprise ‘persons acting in concert’.” (emphasis
supplied
)

(13) The other condition it laid down for the term persons
acting in concert to apply in the context of the Regulations is, in the Court’s
words :

“The other limb of the concept requires two or more persons joining together with the shared common objective and purpose of substantial acquisition of shares, etc. of a certain target company. There can be no ‘persons acting in concert’ unless there is a shared common objective or purpose between two or more persons of substantial acquisition of shares, etc. of the target company. For, de hors the element of the shared common objective or purpose, the idea of ‘person acting in concert’ is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of ‘persons acting in concert’ is not about a fortuitous relationship coming into existence by accident or chance. The relationship can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares, etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement or an understanding, formal or informal; the acquisition of shares, etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares, etc. or they may agree to cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of “persons acting in concert” to come into being.”

(14) Thus, it noted that “. . . . mere fact that two companies are in the relationship of a holding company and a subsidiary company, without anything else, is not sufficient to comprise ‘persons acting in concert’. . . . . There may be hundreds of instances of a company having a subsidiary company, but to dub them as ‘persons acting in concert’ would be quite ridiculous unless another company is identified as the target company and either the holding company or the subsidiary make some positive move or show some definite inclination for substantial acquisition of shares, etc. of the target company.”

(15)    In the light of this explanation of the terms ‘persons acting in concert’ and ‘persons deemed to be acting in concert’ that the words ‘unless the contrary is established’ are to be understood.

(16)    The Supreme Court finally reversed the view of the SAT that the deeming fiction could apply retrospectively and thus, if a person was deemed to be acting in concert on a later date, such connection would apply to an earlier date too. It held, “…..the deeming fiction under sub-regulation (2) can only operate prospectively and not retrospectively. That is to say the deeming provision would give rise to the presumption, as explained above, only from the date two or more persons come together in one of the specified relationships and not from any earlier date. Thus, in the case in hand, the deeming provision under sub-regulation (2) would give rise to the presumption that Daiichi and Ranbaxy were ‘persons acting in concert’, provided of course the other conditions as explained above were also satisfied, only from October 20, 2008, the date on which Ranbaxy became a subsidiary of Daiichi and not before that. Hence, the purchase of Zenotech shares by Ranbaxy in January 2008 cannot be said to be by a ‘person acting in concert’ with Daiichi.”

(17)    The Supreme Court thus held that the Daiichi and Ranbaxy were not acting in concert when the shares of Zenotech were acquired by Ranbaxy. The latter development of the holding-subsidiary position cannot alter, factually or in law, the earlier unconnected position. The provision relating to determination of price did not apply retrospectively so as to change the status as on the date of acquisition. Thus, the price paid by Ranbaxy on a date when there was no relation with Daiichi was not to be applied for the open offer by Daiichi of Zenotech.

(18)    Importantly, the Supreme Court relied considerably on the background of these provisions as put forth in the Bhagwati Committee Report to understand the rationale of this provision as well as for its interpretation generally. The Court also recommended that delegated legislations such as the Takeover Regulations should have the ‘objects and purposes’ clause that Acts have.

The following is what the Court said:

“Before parting with the records of the case we would like to say that in arriving at the correct meaning of the provisions of the Takeover Code specially regulation 14(4) and 20(12), we were greatly helped by the reports of the two Committees headed by Justice Bhagwati. We mention the fact especially because as per the legislative practice in this country, unlike an Act, a regulation or any amendments introduced in it are not preceded by the “Object and Purpose” clause. The absence of the object and purpose in the regulation or the later amendments introduced in it only adds to the difficulties of the Court in properly construing the provisions of regulations dealing with complex issues. The Court, so to say, has to work in complete darkness without so much as a glimpse into the mind of the maker of the regulation. In this case, it was quite apparent that the 1997 Takeover Code and the later amendments introduced in it were intended to give effect to the recommendations of the two Committees headed by Justice Bhagwati. We were, thus, in a position to refer to the relevant portions of the two reports that provided us with the raison d’etre for the amendment(s) or the introduction of a new provision and thus helped us in understanding the correct import of certain provisions. But this is not the case with many other regulations framed under different Acts. Regulations are brought in and later subjected to amendments without being preceded by any reports of any expert committees. Now that we have more and more of the regulatory regime where highly important and complex and specialised spheres of human activity are governed by regulatory mechanisms framed under delegated legislation, it is high time to change the old practice and to add at the beginning the ‘object and purpose’ clause to the delegated legislations as in the case of the primary legislations.”

(19)    In conclusion, the decision is welcome as it clarifies and gives the final word on important concepts in Takeover Regulations. The considerable reliance of the Court on the Expert Committee Reports, albeit in the absence of ‘objects and purpose’ clause, increases the value of such reports generally for the student in securities laws. Of course, the irony is that this only increases the complexity of the law for such students. Now, they will have to read and know the recorded history of such law, in addition to the very voluminous bare text of the Act, Regulations, etc.

(20)    P.S.: As this article goes to press, SEBI has released the report on revising the Takeover Regulations and has recommended changes in, inter alia, the subject matter of this article. More on this in the next issue.

Recent relaxation to creeping acquisition limits

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Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .


(1) SEBI, vide Notification dated 30th October 2008 has
amended the Takeover Regulations. The amendment, in essence, permits an
acquirer, and persons acting in concert with him, hereinafter referred to as
promoter group/acquirer, to increase his holding by 5% by acquiring additional
shares or voting rights up to 5% through open market purchases or pursuant to
buyback of shares even if the promoter holding at present is in excess of 55%.

(2) The relaxation seems to be in the background of huge fall
in the stock market. It is apparently felt — rightly or wrongly — that the
present restrictions on promoter group buying shares should be relaxed and hence
this amendment has been made allowing promoter group holding 55% or more to buy
5% more shares from the stock market. Earlier, promoter group could not acquire
even a single share without making an open offer.

(3) The Notification amends Regulation 11(2) by inserting a
2nd proviso hereinafter referred to as the ‘2nd Proviso’ and also makes a
consequential amendment to Regulation 11(2A). There is also another amendment to
11(2). Here are some thoughts and issues.

(4) This new creeping acquisition is not available
annually
and repetitively, unlike the creeping acquisitions up to
55%. Thus, the acquirer will be able to increase his holding by another 5% only.
To give an example, the holding of 58% can be increased up to 63% only. It is
not as if the acquirer can go on increasing 5% every year.

(a) Having said that, there is no time limit for acquiring
this additional 5% and it can be done in stages. One could say that this
facility has been introduced to deal with the low market prices today.
However, there is no restriction of time or stock market indices and one can
acquire this additional 5% even if the market booms again ! Of course, SEBI
could drop this facility at that time ! !


(5) Also, the maximum holding after this additional
acquisition can be only up to 75%. Thus, for example, the promoter group holding
73% can acquire only an additional 2% and not 5%.

(a) The Regulations recognise the fact that there could be
two maximum promoters’ holding — 75% and 90%. However, there is no special
concession in the 2nd Proviso for companies where promoters hold 90%.


(6) Acquisitions are permitted only through normal open
market purchases on the stock exchange or pursuant to buyback of shares by the
Company.

(a) Such acquisitions cannot be through bulk
deals/negotiated deals or preferential allotment.


(7) Can an acquirer buy a single lot of shares through the
open market ?
This is important from many angles and in fact demonstrates
the conflicting objectives of SEBI/small shareholders and the promoters. SEBI
apparently wants that the acquisition should be from retail shareholders or at
least the opportunity should be available to all shareholders equally and
fairly. However, the reality can be that large quantity of shares may be with
shareholders such as FIIs, etc. If the promoters try to buy from the open
market, it is possible that the low liquidity may result in sharp increase in
the price even on purchase of a few shares. Bulk sellers may agree to sell at an
agreed price, though little higher than the market or, in present pathetic
times, even lower ! ! ! — considering that there may not be many buyers other
than the promoter group.

(a) To come back to the issue, can the promoters acquire a
large lot of shares from such sellers through a stock market operation ? While
strictly speaking such a purchase would be an open market purchase on the
stock exchange, we need to remember that the amendment specifically prohibits
bulk deals. SEBI also seems to have a paranoid view of synchronised deals and
even holding them indiscriminately to be manipulative, etc.


(8) Thus, there would be two categories of creeping
acquisitions. One creeping acquisition is for the slab of 15-55% where an
additional 5% is permitted in any manner, whether through open market purchases,
bulk deal, or otherwise including preferential allotment. The second slab is the
newly introduced 5%. Also, remember that up to 55%, one can acquire additional
5% every financial year.

(9) The issue is : How will the amendment affect a promoter
holding between 50-55% and if his acquisition of additional shares crosses 55%?
There is more than one complication here and let me raise some issues. Let me
illustrate by an example of an acquirer holding 53%.


(a) Firstly, can he acquire 2% in any form of purchases under creeping acquisition Regulation 11(1), and secondly, acquire additional shares under the new 2nd proviso only through the restricted route of open market purchases/buybacks ? On balance, he should be able to acquire 2% under 11(1) to reach 55% and purchase additional shares only under the new 2nd proviso to 11(2). However, I must admit that strictly and technically, there is scope for holding the other view, particularly if the purchase is through one lot that increases the holding, for example, increase in holding at one shot by 5% through preferential allotment.

(b) Will such person, after having acquired 2% (or even 5% under another interpretation and circumstances) under Regulation 11(1) be restricted to a further acquisition only 3% (0%) or can he acquire yet another 5% under the new 2nd proviso ? The answer seems to be that he can acquire another 5%. In fact, this would allow a person to acquire about 10% in a single financial year — 5% under 11(1) and another 5% under new proviso to 11(2). Thus, a person holding 50% can increase his holding to 60% in a single financial year.

(10) Now let us consider the amendment made by the 2nd Proviso permitting creeping acquisition also through buyback of shares, Let us first examine what the amendment is, and then consider the earlier controversy surrounding it and what is the change, if any.

(a) The amendment permits an acquirer to ‘acquire additional shares or voting rights’ …. (provided)
….  the acquisition  is :

•  made  through  open  market  ….   or

• the increase in the shareholding or voting rights is pursuant to a buyback of shares. (emphasis supplied).

ii) Thus, if a person holds, say, 55%, his holding, post-buyback can increase up to 60% under the 2nd Proviso.

iii) However, this is not as simple as it may sound because of peculiar mathematics. Let me explain as follows. The holding has to be between 55-75%. The buyback would affect differently, different holdings. To give an example, if a person holds 55%, a mere 8% buyback would result in increase in his holding by 5% (55/92% is 59.78%, i.e., there would be a 4.78% increase). A promoter holding 60% would find his holding increased by 5% at 7% buyback and for one holding 70%, 5% increase happens at just 6% buy-back. This problem would effectively limit the buyback that a company could carry out to 8% only, as compared to the maximum legal 25%. Of course, the simple solution is that the promoters should also sell their shares in a ,lmyback at the appropriate level to ensure that the net increase is only 5%. This may defeat the purpose of really giving retail investors a chance to sell their shares through this amendment. Also, in case of open market buyback, there is the issue of Promoter not being permitted to offer their shares in a ‘buyback’.

(b) I had written an article in the August 2008 issue of the BCAJ as to whether increase in percentage holding arising solely out of buyback of shares would amount to acquisition under the Takeover Regulations and thereby trigger an open offer or be counted as part of creeping acquisitions, etc. My view was that, on balance, even considering the fact that buybacks are initiated by the promoter, the ‘buy-back’ does not result in triggering ‘open offer’. This may be an anomaly and even an unfair loophole, but I had suggested that to remove this, the law needs to be specifically amended.

(c)To recollect further, in essence, the argument is that Regulations 10, 11 and others require a specific acquisition of shares or voting rights. If there is no acquisition, these Regulations  do not get attracted.  A buyback  of shares results in an increase in percentage  holding  without  any acquisition. While the promoters  cannot shrug off the  issue  by  saying  that  the  increase  is on account  of the company’s  decision when  they are in control of the company,  the fact remains that the express provisions of law do not cover ‘buyback’. SEBI,however, apparently required or permitted a practice by companies to seek an exemption for such increase and then wors-ened it by assuming in the recent amendment that this is also the law without amending 10, 11 and other Regulations. So where does this new amendment leave the view that increase in holding through buyback should not be counted for Regulations 10, 11, etc. ?

(d) Let us consider  here the exact wording  of the 2nd  proviso.   It  permits   an  acquirer   to “acquire additional shares or voting rights (provided) …. the  acquisition is made through  open market …. or the increase in the shareholding or voting rights of the acquirer is pursuant to a buyback of shares by the target company” (emphasis provided). Clearly, even this amendment is self-contradictory when it permits an acquirer to acquire additional shares and then clarifies that increase through buyback is also covered. Further, a strict view can be that even if increase through buyback is to be covered, it would be solely for the purposes of this clause only. One cannot, thus, require a person holding 14.99% shares, whose holding increases to, say, 15% on account of buyback to make an open offer. Again can law force a person holding 25% and whose holding increases to 30.1% on account of buyback, to make an open offer.

e) However, while we could debate endlessly, the reality is that companies/promoters have already been making applications for seeking exemption for increase on account of buyback. SEBI has also been expressly and publicly granting such exemptions on a case-to-case basis discussing the merits. SEBI has issued a Press Release indirectly stating that it considers increase through buyback as ‘creeping acquisition’. The recent amendment further supports this view. Consider also this in the background that in reality it is the promoter who pushes the buyback and it is the promoter who does not participate-in the buyback which results in the increase in promoter’s holding. All of this still cannot change the express provision of law. But, surely, a Judge interpreting this law, which requires a purposive interpretation, would want to inquire of the promoter how he can ignore the fact that his (promoter’s) holding has increased and hold that the amendment is effectively redundant?

11) SEBI has also made what seems to be a consequential amendment to 11(2A). Consistent with Regulation 11(2),Regulation 11(2A)provided that if a person holding between 55-75/90% seeks to acquire, he can do so only through an open offer. Now, the word ‘only’ has been dropped, apparently to suggest that one can acquire up to 5% under the 2nd Proviso but one could also go through the open offer route. This seems to be the intention, though the wording could have been better.

12) There is yet another interesting amendment to Regulation 11(2). Regulation 11(2) prohibits acquisition of ‘additional shares’. These words are amended and now read’ additional shares entitling him to exercise voting rights’. I confess I do not understand this amendment and its intent. The Take-over Regulations define shares as shares carrying voting rights including securities that entitle the holder to receive shares with voting rights, but excluding preference shares. The amendment now says that the additional shares should be such that should entitle the acquirer to exercise voting rights. Numerous questions arise of which I do not have answer and seek readers’ views:

a) Does this mean that, for acquisitions under 11(2), only shares presently carrying voting rights are covered? Does this mean, therefore, that, for example, fully convertible debentures can be acquired? But then, what would happen at the time of ‘conversion’ ?

b) The 2nd Proviso obviously is intended to be an exception to 11(2) and in such case, how can it have broader scope than 11(2) itself? Of course, under the 2nd Proviso one has to acquire ‘shares or voting rights’ through open market operations on the stock exchange and hence this issue may be academic.

c) Why has 11(1)not been so amended? Does this mean that creeping acquisition up to 55% may be of any type of ‘shares’ but thereafter, only by acquisitions of additional shares with such voting rights?

(13) To conclude, it is likely that this is just one of the many tweaking amendments that have been made to Regulations to try to revive stock markets. The law of course gets only more complex in the process! But who bothers.

Is levy of penalty mandatory for violation of securities laws ?

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Securities Laws

(1) Is levy of penalty for violation of securities laws
mandatory ? Is there no discretion to the Adjudicating Officer on whether or not
to levy penalty ? Are adjudication proceedings a mere formality ? Is intention
to commit the violation a totally irrelevant factor in determining penalty ?
And, finally, are all the preceding questions answered in the affirmative
by the Supreme Court ?

(2) In the past couple of years, SEBI has repeatedly levied
stiff penalties citing certain sentences mainly from a decision of the Supreme
Court. It is claimed that the Supreme Court has held that if one does not comply
with securities laws, levy of penalty is mandatory. Good intentions and other
mitigating factors are irrelevant. And that the Supreme Court had mandated SEBI
only to find whether a particular provision is violated or not and their job
ends there. They are then left with the only choice of levying a penalty —
usually a stiff one.

(3) One of the following sentences from two Supreme Court
decisions is invariably cited :

“The Board does not have any discretion in the matter and,
thus, the adjudication proceeding is a mere formality. Imposition of penalty
upon the appellant would, thus, be a foregone conclusion.”

And, from another decision, :

“Once the violation of statutory regulations is
established, imposition of penalty becomes sine qua non of violation
and the intention of parties committing such violation becomes totally
irrelevant. Once the contravention is established, then the penalty is to
follow.”

(4) Amongst the numerous SEBI orders levying penalty citing
the above and, very often, doing nothing more, are Platinum Finvest Private
Limited – AO No. SD/AO/-46/2009, dated April 20, 2009 in which a penalty of
Rs.10 lakhs was levied for non-filing of certain reports regarding their
holdings, the order in Jayesh Waghela’s case dated June 23, 2009 where a penalty
of Rs.15 lakhs was levied and the order in Santosh Narvekar’s case levying a
penalty of Rs.25 lakhs.

(5) These Supreme Court decisions are also cited in ongoing
penalty proceedings and parties are sought to be persuaded that their
intentions, whether good or bad, are now irrelevant and adjudication proceedings
are a mere formality now. Penalty is a foregone conclusion. Considering that
typically SEBI has power to levy penalty of Rs.25 crores or even more and Rs.1
lakh per day of delay, parties find settling through consent orders a better
option rather than fight a battle that is lost to begin with since it amounts to
payment of penalty where otherwise penalty may not be warranted. Of course,
settling through consent order means that one is forced to accept a stiff
penalty.

(6) However, is it true that the above mentioned statements
are really what the Supreme Court has decided ? What was the
context in which it has said that ? What are the qualifications to such
statements ? What are the related observations ? What were the facts of these
decisions that led the Supreme Court to make these statements ? And, thus,
finally, what conclusions should one draw regarding the state of law on levy of
penalty for violation of securities laws ?

(7) To begin with, the Supreme Court has said exactly what
the SEBI orders say and what has been cited above. The Supreme Court has made
the above statements in Swedish Match AB v. SEBI, (122 Comp. Cas. 83 (SC)
(2004)) and SEBI v. Shriram Mutual Fund, [68 SCL 216 (SC)], respectively
(let us refer these decisions as Swedish Match & Shriram).

(8) It is worth reviewing these decisions briefly. However,
before we do that, let us consider the background of the issue.

(9) Violations under securities laws could be broadly and
loosely bifurcated between what are non-compliances of civil obligations and
what amounts to criminal violations. The former would typically involve civil
proceedings to levy penalty, etc., while the latter may result in prosecution.
Secu-rities Laws have numerous provisions that amount to civil obligations such
as requirements of filing of information and documents. When faced with penalty
proceedings for such non-filings, parties often argue that levy of penalty
requires that SEBI should prove that there was mens reai.e.,
guilty mind or intention. In other words, the argument was that a guilty state
of mind has to be proved and, further, the onus to prove it was on SEBI. If SEBI
could not establish mens rea, no penalty could be levied. As we will see
further, the decisions of Shriram and Swedish Match have settled the law by
holding that establishing of mens rea by SEBI is not a pre-condition for
levy of penalty.

(10) However, this is what the Supreme Court has said and
nothing further, if one reads the decisions as a whole, reads the same into
context and reads the qualifying and incidental statements.

(11) Since Shriram is the decision consistently cited, let us
review this decision. In that case, Shriram Mutual Fund was alleged (all
statements made in this article are allegations of SEBI and not necessarily
established to be true) to have repeatedly exceeded the trading limits placed on
mutual funds for dealings through associated brokers. Penalties were levied on
the mutual fund and the matter went finally to the Supreme Court. The Supreme
Court observed (incidentally the decision was ex parte) that this
violation was conclusively established. The question then was, when such
violation is conclusively established, does “imposition of penalty becomes a
sine qua non
of the violation” ?

(12) The Supreme Court described the scheme of the Act and
particularly the framework for levy of penalty. It pointed out that various
factors were specifically laid down as relevant for consideration for
determination of the quantum of penalty, and that “The Legislature in its wisdom
had not included mens rea or deliberate or wilful nature of default as a
factor to be considered by the Adjudicating Officer in determining the quantum
of liability to be imposed on the defaulter”.

(13) It also pointed out that the provisions relating to
penalty contained in S. 15A to S. 15H, etc. provide that the violator ‘shall be
liable’ to penalty and therefore, it held that penalty is mandatory.
Incidentally, it was not brought before the Court that S. 15I which provides for
levy of penalty by the Adjudicating Officer specifically uses the words ‘he
may
impose such penalty’ as he deems fit.

14) It further held that the provisions relating to penalty under the aforesaid Sections were ‘neither criminal nor quasi-criminal’ and were actually breaches of civil obligations. Thus, it held that “Therefore, there is no question of proof of intention or any mens rea by the appellants and it is not essential element for imposing penalty under SEBI Act and the Regulations.” This issue is thus well settled now.

15) The issue, however, is not whether mens rea has to be proved by SEBI or not. The issue is whether mens rea is wholly irrelevant as SEBI claims. Or that even absence of mens rea is irrelevant. Or that mens rea does not appear into the picture at all.

16) I repeat and submit that the only thing the Supreme Court has laid down is that there is no onus on SEBI to prove mens rea as a pre-condition to levy penalty. Violation is by itself sufficient to attract penalty. However, mens rea is certainly a factor to determine the quantum of penalty, when the penalty provided is within a range of amount. Further, I would even submit that absence of mens rea and presence of other mitigating factors should actually mean that SEBI should use its discretion not to levy any penalty at all. As one reads the decision further, this is actually what the Supreme Court has laid down.

17) One should also note the peculiar facts of the case which the Supreme Court specifically listed. Firstly, the offender was a mutual fund which is expected to know the law. Secondly, the facts showed that the mutual fund had repeatedly violated the law – as many as 12 times. The nature of the violation that was violated is also of interest. The mutual violated the restriction on not dealing through associated brokers beyond 5% – the intention of the restriction is obvious – the mutual fund should not farm out business of brokerage to group concerns beyond a specified limit. In fact, the mutual fund farmed out business even to the extent of 91% and 52% in a couple of cases.

18) It was also felt that when a knowledgeable mutual fund violates the limit, then ex facie, the violation    was intentional.

19) Importantly, the Supreme Court emphasised that the discretion of the Adjudicating Officer in levy of penalty and held that “the quantum of penalty is discretionary”.

20) It also held that “the respondents have wil-fully violated statutory provisions with impunity and hence the imposition of penalty was fully justified”. In other words, far from holding that intention or mens rea is irrelevant, it has actually given weight to the fact that the violation was wilful, made with impunity and this factor made the levy of penalty justified.

21) The Supreme Court further observed, “it has been established by the Adjudicating Officer as well as admitted by the respondents that there has been a conscious disregard of the obligation inas-much as the respondents were aware that they were acting in violation of the provisions of Regulations.”. In other words, while, to begin with, there was no onus on SEBI to establish mens rea as a pre-condition to levy penalty, the Court itself gave full weight to the fact that the violation was a conscious one, that the mutual fund was aware that they were acting in violation and, finally, the mutual fund itself admitted that they were so conscious and aware. Thus, mens rea was given its full and due weight as regards the quantum of the penalty and also as regards whether the discretion to waive penalty should be exercised or not. In the face of such words, it does not at all lie on SEBI to contend that mens rea is irrelevant.

22) I submit that discretion to levy penalty is actually discretion not to levy any penalty and the Supreme Court made observations confirming this position of law. The Supreme Court observed,” The facts and circumstances of the present case in no way indicate the existence of special circumstances so as to waive the penalty imposed by the Adjudicating Officer.” In other words, it, firstly, recognized that penalty can be waived, and that under special circumstances, it, should be waived. It then proceeded to discuss the various factors in that case that, on one hand justified a lesser penalty and on the other hand justified a higher penalty. An important adverse factor was whether the violation was made for benefit by the mutual fund.

23) The summary and essence of the decision – which strangely none of the SEBI decisions ever cite is beautifully and succinctly laid down in the following observation – “On particular facts and circumstances of the case, proper exercise or judicial discretion is a must, but not on a foundation that mens rea is an essential to impose penalty in each and every breach of provisions of the SEBI Act.”

24) It is in the above light, then, the words of the Supreme Court cited at the start of this article need to be reread. To repeat, the Supreme Court observed, “In our considered opinion, penalty is attracted as soon as the contravention of the statutory obligation as contemplated by the Act and the Regulation is established and hence the intention of the parties committing such violation becomes wholly irrelevant.” Thus, it is only for deciding the question whether penalty is to be levied or not that the intention is wholly irrelevant. However, for determining the quantum of penalty – from zero to Rs.25 crores – indeed for even waiving the penalty intention and mens rea are very much relevant. Indeed, the Supreme Court itself, in this very decision, repeatedly relied on the intention and mens rea.

25) Then let us consider the apparently even more drastic words of the Supreme Court that in Swedish Match’s case that, “The Board does not have any discretion in the matter and, thus, the adjudication proceeding is a mere formality. Imposition of penalty upon the appellant would, thus, be a forgone conclusion.”

26) Let us first consider the facts of this second case. To summarise them very briefly, in this case, the appellant was held to have violated the requirements of open offer and thus was required to make an open offer and also pay interest for the period of delay. The appellant, however, expressed concern that SEBI may levy penalty on them. The Supreme Court noted that the appellant was by the decision required to comply with all its obligations and, in fact, taking into account also the interest, the appellant was being made to pay a large amount. The Supreme Court had already decided the dispute of law before it as to whether the open offer was required to be made or not. The issue of penalty was not at all a matter of appeal. There was no order or even Notice of SEBI relating to penalty.

27) However, the concern arose on whether, after the appellant makes the open offer, SEBI may initiate penalty proceedings and even levy a penalty of Rs.25 crores. The appellant argued that SEBI cannot initiate such proceedings. SEBI rightly pointed out that this matter was not at all the subject matter of proceedings before the Supreme Court and therefore should not be discussed or decided.

28) It is in this light that the Supreme Court raised the concern that since the appellant is complying with its obligations and also even paying interest, should it also face penalty the levy of which is a matter of course. It also apparently referred to a peculiar wording of the law where the penalty leviable is exactly Rs.25 crores and not upto Rs.25 crores. It observed that in such a case, levy of penalty of Rs.25 crores would be ‘a foregone conclusion’ and the adjudication proceedings being reduced to a mere formality.

29) The Supreme Court thus directed that SEBI should not initiate penalty proceedings. It gave this direction by exercising its jurisdiction under Article 142 of the Constitution of India. In fact, it even stated specifically that “This may not, however, be treated to be a precedent”.

30) I submit that the issue as to whether levy of maximum penalty is automatic or not, and whether adjudication proceedings are required or not were not matters for consideration before the Supreme Court. Hence, at best, these were mere obiter dicta and not a considered decision on issues raised. With great respect, I would also state that the view that adjudication proceedings are now a mere formality is not correct. In any case, this decision was followed by Shriram which in fact laid down the objective factors for levy of penalty.

32) To conclude, unfortunately for SEBI, the Supreme Court has not made its job easy so that it needs only to establish the default to levy the maximum penalty. Adjudication proceedings are not a formality – at least not in the manner which SEBI would like us to believe. Far from ignoring the intentions of parties, SEBI will have to consider them. If it wants to levy very high penalties, it may even have to establish mens rea. It will have to consider other factors such as disproportionate gain, loss caused to investors and repetitive nature of the default. It will have to consider mitigating factors. Of course, all these will have to be put forth by the party – obviously SEBI may not go out of its way to help the party. And, in the right and special facts, SEBI will even have to exercise its judicious discretion to waive the penalty.
 
32) In other words, the presumption that has been invalidated is ‘no mens rea, no penalty’. But, there is no new rule that ‘mere violation = maximum penalty’.

Registration, restrictions, reprimands and retributions of intermediaries — the new all-in-one regulations for intermediaries

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Securities Laws

1. It was a long-standing vision of SEBI that there should be
common regulations relating to all intermediaries not only as regards procedures
for registration but also for continuing matters such as restrictions and
punishment. That dream is finally achieved, though partly (and perhaps
anomalously) by the Notification of the SEBI (Intermediaries) Regulations, 2008,
on 26th May 2008.

2. SEBI had issued a consultative paper in July 2007 giving
the Draft Regulations for discussion. These Draft Regulations have now been
given the status of law.

3. To recap, we see today a multitude of regulations
providing for matters relating to registration, regulation and finally
reprimands and retributions. We have separate regulations for stockbrokers,
merchant bankers, bankers, registrars, etc. Each of these regulations provide
for substantially similar requirements. Such a multitude of regulations does not
merely make the law complex, but also results in conflicting provisions. Later,
amendments or innovations are often not updated at all places. Further, because
of separate regulations for each type of intermediary there also arises a need
for having common regulations for dealing with some aspects or provisions that
apply to all intermediaries. A good example of this is ‘enquiry and punishment’
for violations of law. A separate set of regulations for this purpose applicable
to all intermediaries was required. Yet another example is of certain
eligibility requirements for registration that are common to all intermediaries.
These too were required to be put into yet another set of regulations (the ‘Fit
and Proper’ regulations) since otherwise these provisions would have had to be
inserted in regulations for each category of intermediaries. Thus, the existing
multiple regulations became more complex and voluminous.

4. There was a need for having a common set of regulations
which deal with all common matters relating to all
categories of intermediaries. The common regulations would deal with :


à
registration of all intermediaries.


à
monitoring


à
in case of wrongdoing, they should deal with enquiry, action for violation and
penalisation.



The recently notified regulations do just that. In effect,
these regulations do not provide for anything new except for consolidation and
reduction of complexity and volume. However, the process goes beyond the effort
of mere compilation, as attempt has been made to remove inconsistency as well as
provide for common approach.

5. It is also worth reviewing the background of these
regulations in terms of what SEBI stated in its Consultative Paper in July 2007
as to the intention of the regulations :

“2. In the past 15 years SEBI has notified more than a
dozen regulations, each with the objective of regulating a different category
of intermediary/entity. As each of these regulations was drafted in order to
provide a framework which would enable SEBI to better regulate and monitor
intermediaries/entities, the broad framework of such regulations is very
similar to one another.

3. It has been observed that every regulation seeking to
regulate an intermediary incorporates some basic provisions regarding
registration, general obligations, inspection and investigation, default, etc.
In addition to the above, the general requirements of the Code of Conduct
provided in almost all the regulations are also similar in nature. Except for
the clauses relating to the specific requirements of, and particular concerns
in, each category, the content of all the regulations is common either in
language or in spirit, if not in both.

4. Given the overlap in content and the fact that many
requirements and obligations of most intermediaries are common, SEBI now
proposes to consolidate the common requirements under these regulations and
put in place a comprehensive regulation which will apply to all intermediaries
and prescribe the obligations, procedure, limitations, etc. insofar as the
common requirements are concerned.”

6. Having said that, one must quickly dispel an illusion that
we would now have ‘Master Regulations’ dealing with all aspects of all
intermediaries. It needs to be noted that the intention is to have only ‘common’
provisions relating to intermediaries to be placed in these regulations. Thus,
though a little anomalous, there would exist separate set of regulations for
each category of intermediaries in addition to the common regulations.

7. It would be thus worth reviewing these new regulations
from at least two angles. Firstly, an overview of the scheme of the regulations
is worth since it will refresh our memory of the manner in which intermediaries
have been always regulated in some aspects and in any case would now be
regulated. Secondly, it is worth seeing how the new regulations have common and
uniform provisions applicable to all intermediaries in place of differently
drafted, if not inconsistent, regulations applicable to different
intermediaries.

8. It is important to note here that the new regulations are only partially applicable with immediate effect. As of now, only the provisions relating to enquiry and taking of action for violation contained in these new regulations have been brought into effect. Other provisions, for example, those relating to application and registration common to all intenmediaries, are not yet effective. Thus, the provisions in the existing regulations for each category continue to be in force. The regulations provide that SEBI will notify from time to time the categories of intermediaries to whom these regulations will apply. The intention appears to be that the regulations will be notified for one or more categories at a time, with the corresponding existing regulations relating to those intermediaries being repealed. However, since the provisions relating to enquiry and taking of action for violation have been brought into effect immediately, the corresponding common regulations of 2002 have been repealed. Further, the provisions relating to ‘fit and proper’ requirements for intermediaries have been also brought into effect – though they are a slimmer version of the separate regulations – and such separate regulations have also been repealed.

9. Let us now consider some special features of these regulations.

10. A common application form for registration as an intermediary has been prescribed. Thus, all intermediaries would have to use this form when they seek registration. However, this common form will not be enough as the intermediary would also ha e to provide information that is required by the applicable specific regulations. In other words, for example, if the applicant is a stockbroker, he will have to provide the additional information sought by the ‘Regulations’ applicable to the stockbrokers.

11.1 It may appear that this requirement applies only to new applicants seeking registration for the first time. However, there is a strange requirement which will result in all intermediaries having to register themselves all over again and that too by a specified deadline. It has been provided that every intermediary will have to make a fresh application within 21 months (actually 24 months less 3 months advance period specified) of the commensment of the regulations for that intermediary. If the intermediary does not apply, it will have to stop continuing its activities. If the term for which the intermediary has been granted registration expires earlier than the specified date for making fresh application, the expiry date would be relevant for seeking registration in the ‘common form’. For those intermediaries who have been given ‘permanent’ registrations, the corresponding deadline is 24 months.

11.2 To repeat, as this requirement is not yet made effective, the existing provisions will continue to apply.

12. ‘Fit and  Proper’ criteria:

Readers may recollect that the intermediaries have to pass the so-called ‘fit and proper’ criteria for registration. These have been contained in a separate set of regulations. The existing regulations have been repealed and the, simplified requirements have been incorporated in these ‘Common Regulations’.

13. Change  of status  or constitution:

Change of status or the constitution of the intermediary would require prior approval of SEBI. What is change of status or constitution has been very broadly defined in the ‘Common Regulations’ and hence before carrying out any form of such change, the intermediary needs to carefully study the ‘definition’.

14. Registration to be permanent:

The registration under these new regulations will be permanent subject of course to continuing compliance of the conditions of registration. However, the intermediary will have to provide a certificate from its Compliance Officer annually that these regulations as well as the eligibility criteria continue to be complied with.

Q. : Has any form for compliance certificate been prescribed? If so please mention the fact.

15. Code  of Conduct    :

A comprehensive Code of Conduct has been provided for in the ‘Common Regulations’ to be complied with by the intermediaries. However, though this Code seems to be elaborate, it appears that the Code of Conduct under the respective Regulations applicable to each category of intermediaries will also apply. Possibly, SEBI may from time to time, remove the common requirements that have been inserted in these regulations. Until this happens, the intermediaries would have to look at and comply with two Codes of Conduct.

16. Enquiry and punishment:

16.1 A separate Chapter has been brought into force with immediate effect, which provides for enquiry with regard to violations and punishment in the form of suspension or cancellation of the certificate of registration, or other action.

16.2 The structure and procedure remains quite similar to the existing procedures. Having said that, if one goes in detail, there are important differences with regard to the type of punishment, with regard to procedural aspects of hearing, etc.

16.3 Appeal to the Securities Appellate Tribunal can be made against orders under this Chapter.

16.4 In a future article, I may analyse the changes in the procedure and punishment.

17. Conclusion:

Clearly, the ‘Common Regulations’ are a step that has been taken towards simplification of the law, though it is equally clear that it is only a partial step. The expectation of having a common and exhaustive set of regulations dealing with all aspects relating all categories of intermediaries has not been realised. In fact, it can be seen that while the volume may decrease, the complexity remains and has even increased, since instead of repealing multiple regulations, yet another set of regulations has been created.

Pre-Emptive Rights Held Void — Trouble in Joint Venture Paradise

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Securities Laws

The Bombay High Court has
recently held (in Western Maharashtra Development Corpn. Ltd. vs. Bajaj Auto
Ltd.
— unreported, Arbitration Petition No. 174 of 2006, order dated
February 15, 2010) that an agreement between two shareholder groups that one
will not sell its shares, without offering them at the proposed sale terms to
the other, shall be void. This decision would effectively make other similar
agreements such as ‘tag-along rights’ (explained later) also void. Fears have
been expressed, exaggerated I think, that the decision is so unequivocal that
even statutory restrictions such as those under SEBI Guidelines and Regulations
such as those for lock-in period would also be affected.

This decision would apply
not just to listed companies but also to other public companies. However, its
significance and wide implications made it a worthy topic for this column.
Shareholders of surely thousands of companies have entered into such agreements
and clearly all these will suddenly find their arrangements disturbed.

The implication is that not
only the company cannot honour such agreements — not even if the terms of this
agreement are incorporated in its articles — but the agreement is void even
between the shareholders themselves.

The decision affects not
merely promoters who often have such agreements amongst themselves but also to
the large number of companies having private equity/strategic investors who are
relatively passive but still hold significant quantity of shares.

Let us make a quick review
of why and how such agreements are entered into. Typically, when two shareholder
groups join together in a company and invest in it, they would like to ensure
that the other group does not exit leaving the former halfway. This is
particularly so in case of investments by private equity and similar investors
who invest on the faith of the main and working promoters continuing with their
stake. There is also usually a certain level of faith on the skills and other
personal qualities of such promoters that prompt them to invest. Such investors
thus insist on certain terms. For example, they require that if the main
promoter seeks to sell his shares, he shall offer those shares to such other
group first at the same price and other terms offered by the outsider (‘right of
pre-emption’). The other group may alternatively ask that his shares be
‘tagged-along’ with the proposed sale and also sold at the same terms offered by
the outsider.

Depending upon the needs and
often the bargaining strengths of the parties, other terms are also agreed upon.

Often the company is also
made a party to such agreements and is required to effectively honour such
agreements, particularly by not allowing transfer of shares that are in
violation of such agreements. This raises the protection, practically and also
legally, since this is consistent with what the Supreme Court held in V. B.
Rangaraj v. V. B. Gopalakrishnan
[(1992) 1 SCC 160]. The Supreme Court had
held that for such restrictions to be binding on the company, such terms should
be incorporated in the articles of association of such company.

In a sense, then, it
appeared to be well-settled law, in the light of the aforesaid decision of the
Supreme Court and several other decisions that some of such restrictions are
valid inter-se the shareholders and also binding on the company if they are
incorporated in the Articles. The recent Bombay High Court decision now
overturns this state of affairs.

The facts of the case are
complicated and actually involved appeal against a ruling of an arbitrator on
several issues, but essentially, the issue for discussion here is whether such a
right of pre-emption was valid under law.

The Court considered the
Supreme Court’s decision in Rangaraj and also another Supreme Court’s decision,
i.e., M. S. Madhusoodhanan v. Kerala Kaumudi [(2003) 117 Com. Cases 19].

The Court then analysed the
provisions of S. 111A of the Companies Act, 1956, the relevant Ss.(2) of which
reads as under :

“Subject to the provisions
of this Section, the shares and debentures and any interest therein of a company
shall be freely transferable”. (emphasis supplied)

The aforesaid provision is
applicable to public companies, as compared to the provisions of S. 111 that is
applicable to private companies.

The Court then applied the
provisions of S. 9 of the Act, which says that any provisions in the Memorandum
and Articles, in any agreement entered into by the company or in resolutions,
etc. that is repugnant to the provisions of the Act would be to that extent
void.

The Court also analysed the
meaning of the term ‘freely transferable’ referring to dictionaries and
decisions and also the implications of such restrictive clauses being
incorporated in the Articles of Association of the company.

The Court held that in case
of private companies, the Articles are required by law to provide for
restrictions on transfer of shares. However, the position for public companies
is different. It observed, “situation involving the restriction on the
transferability of shares in a private company has to be contrasted with cases
involving public companies where the law provides for free transferability. Free
transferability of shares is the norm in the case of shares in a public
company”.

When persons form a public
company or buy shares of a public company, they should be conscious that the
shares are, by law, freely transferable and they cannot enter into agreements
that restrict such free transfer. The Court observed :

“The provision contained in the law for the free transferability of shares in a public company is founded on the principle that members of the public must have the freedom to purchase and, every share-holder, the freedom to transfer. The incorporation of a company in the public, as distinguished from the private, realm leads to specific consequences and the imposition of obligations envisaged in law. Those who promote and manage public companies assume those obligations. Corresponding to those obligations are rights, which the law recognises as inhering in the members of the public who subscribe to shares.

The principle of free transferability must be given a broad dimension in order to fulfil the object of the law. Imposing restrictions on the principle of free transferability, is a legislative function, simply because the postulate of free transferability was enunciated as a matter of legislative policy when the Parliament introduced S. 111A into the Companies’ Act, 1956. That is a binding precept which governs the discourse on transferability of shares. The word ‘transferable’ is of the widest possible import and the Parliament by using the expression ‘freely transferable’, has reinforced the legislative intent of allowing transfers of shares of public companies in a free and efficient domain.”

The Court particularly relied on a decision of the Delhi High Court in Smt. Pushpa Katoch v. Manu Maharani Hotels Ltd., [121 (2005) DLT 333] where too the grievance was that some shareholders, in violation of the agreement between the shareholders, transferred their shares without offering to others. The Court held that no provision was made in the articles of association recognising such restriction. Morever, even if such a restriction was contained, such restriction would have been void since the provisions of Act override the Articles and make contrary provisions void u/s.9. This part is as important as it is controversial, since it now holds that even a specific provision in the Articles of the company will not help — in fact, even this provision would be void.

The Court specifically rejected the argument that private agreements could still be made for such restrictions. The Court rejected the argument that the provisions of S. 111A were intended to curb the directors from refusing the transfer of shares.

To reiterate, the decisions would have far-reaching implications both for existing and new arrangements. Numerous companies, listed and unlisted, have entered into some form of such agreements to provide for rights for preemption and similar other restrictions. If the decision reflects the correct state of law, all these agreements would be deemed to be void.

It is submitted that, with great respect, this decision requires reconsideration on several grounds.

Firstly, the decision incorrectly relies on S. 9 which holds that provisions contained in articles, agreements, etc. that are contrary to the provisions of the Act are void. S. 9 clearly refers to such provisions in the “articles of a company, or in any agreement executed by it.”. Thus, S. 9 applies only where the company is a party and I also submit that it makes even such agreement void only as far as the company is concerned. While in the early part of the decision, the Court refers to the exact wording of this Section, in the concluding part, the Court observes that “A provision contained in the Memorandum, Articles, Agreement or Resolution is to the extent to which it is repugnant to the provisions of the Act, regarded as void.”. I submit respectfully that the Court has cast the net unjustifiably wider and has held even agreements to which the compa-ny is not a party to be void on account of S. 9 when that Section covers only agreements to which the company is a party.

Even the provisions of S. 111A are read out of context and particularly out of the mischief that provision was designed to cure. If one reads the heading of S. 111A, it reads ‘Rectification of register of transfer’. Even its originating S. 111 has the heading ‘Power to refuse registration and appeal against refusal’. If one traces the history and purpose of this Section, they were meant to cover the circumstances under which the Board of Directors of a company can refuse transfer of shares. Indeed, simultaneous with the introduction of S. 111A, the counterpart provision in the Securities Contracts (Regulation) Act, 1956, S. 22A, was omitted and this S. 22A dealt with the circumstances under which transfer of shares of a listed company could be refused.

S. 111A was also introduced in the context of demate-rialisation of shares and dealing of transfer of shares by a depository. In case of dematerialised shares, the transfer takes place electronically and there is no formal process of approval by the Board. In fact, for this reason itself, S. 111A was introduced to provide for ‘rectification’ post-transfer and a fairly wide power is given for raising objections against transfers taken place and reverse them.

However, having said that, it has to be conceded that the intention was also to emphasise free transferability of shares. The technical argument also could be that when the words itself are clear and unambiguous, one cannot refer to headings, history, etc.

Nevertheless, the scheme of provisions does point to the role of the company and its Board in inter-fering with transfer of shares. In fact, even for the Board, specific power has been given to interfere when there are specified factors present, such as violation of laws, etc. or even generally if there is ‘sufficient cause’.

Having stated the above, it is also apparent that many of these defensive arguments were actually raised before the Court and the Court did consider and rule on them. Thus, it may be tough to argue that the decision should have restricted application.

While one hopes that there is an early re-consideration of this decision at a higher appellate level, companies and promoters will have to be careful as regards their existing agreements and also new ones.

SEBI amends lock-in and other requirements

 This series of articles introducing securities laws for listed companies to the lay reader continues . . .

(1) SEBI has amended the DIP Guidelines vide Circular dated 24th February 2009 (available on http://www.sebi.gov.in/circulars/2009/ dip342009.pdf). It may be recollected that the SEBI DIP Guidelines provide for various requirements in connection with issue of shares and other securities by listed companies and for other matters. Some of the recent amendments are minor or consequential to other amendments while some have far-reaching impact. The amendments have been made to tighten up the schedule relating to IPOs and incidental matters. Some important amendments are highlighted here but two of them — those relating to Share Warrants and those relating to lock-in — are discussed in detail.

(2) Listing of equity shares with differential rights as to dividends, voting or otherwise :

    (a) Equity shares with differential rights as to dividends, voting, etc. are emerging instruments being tested in India. These are available globally. As they tend to protect and favour the Promoters/Founders, they are also criticised. However, many investors are happy with diluted voting rights if there are other sweeteners involved and hence such shares are often accepted as investments. The alternative is issuing shares with higher voting rights (but with lesser other rights) to the Promoters. It is also found in the West that even such a situation is acceptable. In India, amendments to the law permitting issue of such shares were made a decade back, but because of procedural hurdles and other reasons, these shares were not common in listed companies though recently some companies did experiment with such issues. SEBI has now made an amendment in the Guidelines to clarify some issues.

           (b) By an amendment, conditions for listing of such equity shares that are issued otherwise than by making an IPO have been laid down. Important substantive conditions are that such shares should be issued by way of rights/bonus to all existing shareholders and the Company should be compliant of minimum public shareholding norms for its equity shares already listed and also for the fresh issue.

(3) Listing of warrants offered along with NCDs under Chapter XIII-A (Qualified Institutions Placements) :

(a) Such warrants can now be considered for listing if there is a combined issue of NCDs/warrants and Chapter XIII-A is fully complied with for such issue.

 (b) There would be a minimum trading lot of such NCDs/warrants of Rs.1 lakh.

(c) The application for listing of the equity shares with differential rights and warrants/NCDs shall be made through the designated stock exchange which will forward the application to SEBI with its recommendations.

(4) Increase of minimum deposit on Share Warrants from 10% to 25% :

    (a) Share Warrants can be issued on a preferential basis to selective investors. One of the conditions for such issue is that the investor should pay a minimum deposit of 10% of the issue price which has to be forfeited if the Share Warrants are not exercised. It was increasingly felt that (as discussed in more detail in latter paragraphs) that this 10% deposit is too low. Finally, now, the minimum amount payable with application for Share Warrants in case of preferential issues has been raised from 10% to 25% of the issue price.

         
    (b) Considering the ongoing debate on such low deposit amount since a long time now, this amendment was the least unexpected. In my opinion, the amendment has come too late, because Share Warrants have already been heavily misused and abused. The amendment is also made at a time when Promoters are least likely to subscribe to Share Warrants. In fact, there appears to be literally a flood of cases of Promoters allowing the 10% deposit on existing Share Warrants to be forfeited.

(c)    It is also worth  considering  the very rationale – in idealistic theory and in actual practice – of Share Warrants.

(d)    Let us first quickly highlight some aspects of Share Warrants to place the recent amendment in context. Share Warrants are instruments that give a right and option to the holder to acquire shares within a specified time at a specified price. They are thus similar to ESOPs and also to options traded in markets, though the latter represent private contracts where the listed company is not involved.

(e)    Share Warrants have several advantages. You don’t need to pay the full share price up front. You can exercise the Share Warrants anytime. You even have the option to back out and let the deposit be forfeited.

(f)    For the Company, they were often useful as, for example, acting as sweeteners to otherwise unattractive unsecured, non-convertible bonds. They also had the weak justification, in the early years of globalisation, of allowing Promoters to increase their stake to prevent hostile takeovers. However, they quickly degenerated to being used almost exclusively to enrich Promoters, at the cost of the Company and other shareholders.

(g)    Consider, from the point of view of the Promoters, the undue advantage Share Warrants offer them.

(i)    They get Share Warrants (earlier for free) by paying just 10% deposit. Even if this deposit is forfeited, they still get to share it to the extent of their holding (e.g., a Promoter holding 50% of the Company thus shares 50% of the for-feited deposit).

(ii)    Even this deposit of 10% was an absurdly low amount – it barely covered the interest on the balance 90% for 18 months. But interest is obviously not the only factor. Often the bigger advantage is of the option. Even if you do simple valuation of such Share Warrants, applying even the basic Black-Scholes or similar formula, it will be seen that particularly in times of higher volatility, even the increased 25% deposit would be too low.

(iii)    Further, in case of market-traded options, the option premium is an additional cost and not part-payment of the purchase price. Thus, even if one decides to actually purchase the shares, one pays the full purchase price in addition to this premium. In case of Share Warrants, the deposit paid is adjusted  against the issue price.

(iv)    Till a recent prohibition, Share Warrants also represented simple arbitrage. Sell today and buy Share Warrants by paying 10% deposit. This also meant that the surplus cash could be used to acquire higher shares and raise the balance amount later.

(v)    It was also quickly realised by Promoters that Share Warrants could help avoid the creeping acquisition limits. Well planned, the Promoters could increase their holding by 15% over 18 months without violating the 5% creeping acquisition limits. All this by paying just 10% today and that too at today’s prices! Needless to say, this technique was widely used.

(h)    How sound was the deal from the point of view of the Company? Almost certainly a loss-making one since if the same deal was offered to a third party, he would have paid a far higher amount. The public shareholders also lost.

(i)    SEBI of course has been chipping away slowly at the anomalies. The early amendments included reducing the conversion period to 18 months. There is a ban on preferential allotment to those who have sold shares in the last six months. The lock-in period has been effectively increased, as discussed separately here.

(j)    Consider from a different perspective, these amendments over a period of time are mainly in-tended to protect Share Warrants from misuse by Promoters. How these amendments will impact Share Warrants as a financial instrument?

How sound a financial proposition  they appear to third  party  –  non-Promoter  investors?

How attractive would Share Warrants sound, if one has to :

  • pay 25% up front, if one converts them within 18 months, suffer double lock-in period,

  • and if the conversion price has to be a minimum one related to recent prices?

(k)    The latest amendment comes not only too late, but also at a time when Promoters are least in the mood to acquire ‘Share Warrants’, simply because the six-monthly average prices are typically higher than the current market price.

(1)    Share Warrants thus, the way they are generally issued now, result in profits to the Promoters at the cost of the Company and other shareholders. I would even go to the extent of recommending that they be simply prohibited.

(m)    Alternatively, major changes are required if they are to be continued. Linking their pricing and deposit for Share Warrants to past average prices is absurd. Share Warrants are equivalent to options and should be valued as ‘options’. Even a rudimentary version of the Black-Scholes formula would give a fairer price. Remember, this technique is already being used, albeit as an alternative, for valuing and accounting for ESOPs.

(n)    And, at the very least, it is this price that should be paid. The amount should be paid as a premium for being granted the Share Warrants and not as a deposit that is adjustable towards the issue price! At the risk of sounding petty, I would even suggest that if the amount paid by Promoters is forfeited, it should be distributed as a special dividend/bonus to non-promoter shareholders!

(o)    There should also be a commercial justification for issuance of Share Warrants, especially from the point of view of the Company. The Company puts itself in a peculiar position when it issues Share Warrants. Other potential investors are wary of the potential dilution and thus investment in the Company becomes slightly unattractive. The uncertainties involved are:

  • the Company may not receive the balance amount.

  • the balance price is to be received at any time the Promoters deem fit, though there is a time limit.

The question is :

‘Is it a commercially sound proposition for the Company to issue Share Warrants on such terms ?’

Unless the answer to the above issues is a clear yes, the Share Warrants should not be issued. I would suggest that there should be a ban on issuance of Share Warrants to only Promoters, just as ESOPs are banned.

(5)    Amendments clarifying lock-in of Share Warrants and shares arising out of exercise of Share Warrants:

(a) Readers  may recollect that in August  2008, the lock-in period relating to warrants, etc. were amended. There was controversy arising out of such amendment. SEBI has attempted to simplify the wording and make it internally consistent.

(b)    Let us again consider the background and con-text of this amendment. Securities issued on a preferential basis are typically locked in for 1 year from the date of allotment (Promoters face a lock-in for 3 years to some extent, but this aspect is not discussed here). Some of the securities such as Share Warrants, FCDs, etc. are convertible into equity shares. The requirement was that all securities so allotted should be locked in for one year and if convertible securities are converted into equity shares during such lock-in period, the shares so allotted would be locked in for the remaining period out of such one year. In other words, the shares allotted did not face a fresh lock-in period of one year but the period for which the convertible securities already suffered lock-in was netted of and the equity shares suffered lock-in for the balance period.

(c)    It was felt that Share Warrants were different from equity shares, FCDs, etc. since in case of Share Warrants, only a part of the amount was paid up front, there were other differences also. SEBI had amended the Guidelines in August 2008 whereby it intended to provide that the aforesaid rule of netting off shall not apply in case of Share Warrants. Thus, in case of Share Warrants, the shares allotted on exercise of Share Warrants will face a fresh lock-in period. However, the amendments were ambiguously worded – at least as opined by some experts
and so the latest amendments seek to make clarificatory amendments.

(d)    This has been done by. bifurcating the ambiguous clause relating to lock-in period of instruments/ shares into two parts.

(e)    The first part talks of lock-in period of instruments allotted to Promoter/Promoter Group and shares allotted to them on exercise of Warrants. Both shall be locked in for 1 year. These lock-in periods are obviously in addition to the 3-year period otherwise applicable for allotments to such persons, read with of course the 20% limit for the 3-year lock-in.

(f)    The second part is almost identically worded, except that it refers to instruments/shares allotted to persons other than such Promoters.

(g)    In clause (d), which refers to set-off of lock-in suffered by instruments, it is now provided that such instruments shall not include warrants.

(h)    The amended clauses are certainly worded better, if one compares only to the earlier wording, which was felt to be a little convoluted, being the result of redrafting exercises over time. However, despite such amendments and consistency in wording, certain basic ambiguities remain. Actually, the lock-in requirements are intended to be quite simple and the whole clause could have been redrafted, instead of focussing on the recent changes.

(6) The  Sat yam  amendments:

Several relaxations to pricing, disclosures, etc. are now provided for where SEBI has already granted exemption under the new Regulation 29A to the Takeover Regulations. Considering that Regulation 29A itself had, I think, effective applicability of one single case, the amendments will have similar shelf life. However, they will remain as part of Regulations and the DIP Guidelines till they are dropped.
 
(7)  Bonus shares:

These shall now be issued within 15 days of Board approval, where shareholder approval for such issue is not required. And the Board cannot change such decision. Where approval of shareholders is required as per the Company’s Articles of Association, the issue shall be made within 2 months of the Board meeting where such issue was announced.

(8)    The amendments made by these Guidelines are generally prospective but with two interesting exceptions.

(a)    The amendment increasing the minimum amount payable for issue of Share Warrants from 10% to 25% applies if the shareholders’ approval is obtained before 24th February 2009. This would affect all those cases (I presently do not know how many or if any) where notices are already issued and the general meeting is convened on 25th February 2009 or later.

(b)    It would be interesting to examine how the amendments relating to lock-in apply to issues made since the last amendment in August.

SAT speaks — a few recent and interesting decisions of SAT

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Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .


(1) The Securities Appellate Tribunal (‘the SAT’) is a vital
appellate authority. It hears appeals from decisions of SEBI. For most small and
medium entities and persons, it is for all practical purposes, the last
appellate authority, since appeals against decisions of SAT are to be made
directly to the Supreme Court.

(2) Another interesting feature of the Hon’ble SAT is that
its Bench consists of a mix of Members with legal and commercial backgrounds.
SAT, like SEBI, examines issues that are not purely legal and are often
commercial issues where an in-depth knowledge of the current dynamics of the
securities markets is required. Even the procedural rules help the Hon’ble SAT
to ignore at times the highly technical and legal niceties.

(3) Yet another interesting aspect is that SAT is an
all-India appellate body, in the sense that there is a single Bench for the
whole of India. Contrast this with, e.g., the Income-tax Appellate
Tribunal which has state-wise Benches. One advantage of this is that one does
not face the confusion of differing decisions from Benches of the Tribunal.
Undoubtedly, while the SAT may, in its wisdom, reverse its earlier decisions if
it deems fit, generally speaking, SAT follows its earlier precedents. This, once
again, establishes the importance of a person dealing with the securities market
to keep abreast of the decisions of SAT.

(4) Finally, it is necessary for a Chartered Accountant to be
aware of the SAT decisions, because as an auditor he should be able to advise
the auditee of recent developments and he can also appear before SAT.

(6) Mefcom Securities Limited v. SEBI,


(2008) 82 SCL 193 :

(a) SEBI’s framework also requires regular checking of the
compliance of ‘intermediaries’ by auditors. Auditors during the conduct of audit
may come across irregularities which may be both mundane — that is —
non-compliances in documentation and involving serious violation of law. Often,
SEBI itself censures the broker or levies nominal penalties. The logic behind
the requirements are often thought to be procedural — more so when the
irregularities are not in the nature of manipulations or fraud. Of course, some
requirements lie between being merely procedural on the one hand and being a
blatant manipulation/fraud on the other hand. In this background, SEBI’s
decision to levy a hefty penalty of Rs.10 lakhs on a broker and the Hon’ble
SAT’s upholding of the same with reasons make this decision of SAT worthy of
note.

(b) In this decision, the audit resulted in many findings,
such as failure to maintain separate books of account for transactions,
non-maintenance of client agreements, failure to separate clients’ funds from
own funds, dealing with unregistered sub-brokers, etc. SEBI deemed it fit to
levy a penalty of Rs.10 lakhs.

(c) In appeal, the appellant made, inter alia, an
important submission that 83% of its trades were proprietary in nature. Further,
of the remaining 17%, 14% did not result in deliveries and only 3% resulted in
deliveries. Often, it is seen that brokers shun clients and do exclusively or
predominantly own trading, since having even a few clients would need compliance
with several requirements. The appellant also submitted that there was no
complaint made by any client.

(d) However, the SAT upheld the penalty on several grounds.
It did not accept that the defaults were merely technical ones. It explained the
logic of some requirements and the consequences that may result if these are not
complied with. It upheld the whole of such penalty. Consider some extracts from
the decision of SAT :

“The proportion of the trade of the appellant on account of
clients vis-à-vis his proprietary trade has little to do with the
extent of care and skill to be exercised by him in adhering to the regulatory
requirements that are meant to protect the interest of investors. The size of
the clientele is not relevant in this respect, nor is the fact whether there
are complaints from the clients. We also do not agree that the violations of
regulations found during inspection were merely technical in nature. In any
case, the appellant had no reason whatsoever to allow its banker the authority
to transfer funds from and to the accounts of the clients, since this was a
gross violation of a statutory regulation. While some of the infractions are
of procedural nature, others could be quite serious in their consequences. For
example, segregation of every client’s account from the broker’s account as
well as use of unique client code leads to greater transparency in the
business operations of the brokers and thereby enhances the integrity and
quality of the securities markets. It is far from correct to hold that such
requirements are ‘merely’ technical in nature. Similarly, absence of
broker-client agreement would lead to difficulties or even failure in
retrieval of information by regulators during any check or investigation and
this would seriously affect the efficacy of the regulation process. The lapses
on the part of the appellant clearly reflect a lack of exercise of due care,
skill and diligence required of a broker and deserve to be viewed seriously.”


(e) Thus, in one stroke many of the standard defenses pleaded
by brokers have been categorically rejected. One hopes that this decision
removes the complacency often found in ‘intermediaries’ with regard to
compliance with procedural requirements.

(7) Deep Kumar Trivedi v. SEBI, (2008) 82 SCL 209 :

a) The issue in this decision is actually more on facts than of law. SEBI alleged that it had served a summons on the appellant, seeking that he appear before it. When the appellant did not appear, SEBI levied penalty of Rs.10 lakhs on the appellant for such non-appearance. In appeal, the appellant denied that he was served with the summons. The Hon’ble SAT went into the documents and contentions relating to the service of notice. On review of the facts, SAT finally held that it was not conclusively brought out that the summons was indeed served. The SAT also made an important observation that the appellant was not informed at any stage in the related proceedings that a summons was served and that the appellant had not complied with it. The order of penalty was thus set aside.

b) One reason for highlighting this decision is that several such proceedings have been required to be dropped on similar grounds. In several cases, at the level of the Adjudicating Officer itself, the )-proceedings are formally dropped on the ground that no adequate proof existed for summons/notice having been served.

c) Further, often, the distinction between summons for ‘Information’ and summons for ‘Presence’ is forgotten. A summons for information (as the wording of the summons itself clearly brings it out) seeks information that is to be filed with SEBI.The summons does not state at any place that the person served with such summons should appear before the SEBI Officer. Indeed, no date and time is given and, in fact, a last date is usually given for filing of the information. However, though the person concerned files the information, later on, it is alleged that the person should have appeared personally also. Usually, these proceedings are dropped, but the party has to undergo the suffering of the proceedings.

8) HFCL Infotel  Ltd. v. SEBI, 82 SCL 199 (2008) :

a) Often, a difficulty is faced by parties who have proceedings initiated against them under one or more provisions of securities laws. While these proceedings are pending, the party may need to – approach SEBI for one or more clearances, registrations, etc. SEBI is naturally in a dilemma. If it does not give such clearances, etc., and if it is ultimately found that the party has not violated securities laws as alleged, then there would be injustice. However, in the reverse situation, if the party was indeed guilty, by allowing it further access to securities markets, SEBI would have effectively allowed it perhaps to commit more irregularities.

b) As the decision cited above shows, it is not uncommon that such a party may find that its proposals before SEBI may be held up indefinitely. In fact, the party may have to suffer because SEBI itself may take quite a long time to complete the proceedings. Having said that, it is also interesting to note that SEBI has framed guidelines on how to expeditiously dispose such matters. So let us consider this case to know what SAT spoke on these issues.

c) The facts of the case were that the appellant company was the result of a merger between an unlisted company and a listed company. The unlisted company was of far greater size than the listed company. Without going into more details, it may be stated here that a requirement was placed on the appellant to make an offer of a certain number of shares to the public. The appellant initiated the process for this and filed an offer document in 2003. The offer document was held up by SEBI, because SEBIhad initiated proceedings against the company and other parties in relation to alleged violations of the SEBI FUTP Regulations. Till the offer was not made, the shares of the appellant that were issued pursuant to the merger could not be listed. The appellant appealed to SAT against the holding up of such clearance.

d) The Hon’ble SAT noted the fact that there was an undue delay. A huge quantity of shares got held up for listing on account of a small quantity of shares that were required to be offered to the public. The Hon’ble SAT also pointed out that SEBI itself has framed Guidelines for its guidance in such matters and the delay in the present case was against these very Guidelines.

e) The following were some extracts from the Guidelines:

“2. Treatment where show-cause notice has been issued. – Where a show-cause notice has been issued to the entities, observations on draft offer document(s) filed by the issuer with the Board shall be kept in abeyance for a period of 90 days from the date of show-cause notice or filing of draft offer document with the Board, whichever is later. The appropriate authority shall, in a fit case, within the period of 90 days, pass an appropriate interim or final order after hearing the person affected;

Provided that where there is any pending show-cause notice as on the date of issuance of this General Order, the period of 90 days shall begin from the date of issuance of this General Order:

Provided further that any time taken by such entities/notice(s) shall be excluded while computing the 90 days period.

Where no such interim or final order is passed within the period of 90 days, the Board may process the draft offer document for the purpose of issuance of observations subject to relevant disclosures in the offer document about receipt of the show-cause notice and the possible adverse impact of the order on the entities.”

9. Allowing the appeal and directing SEBIto dispose of the application within six weeks, the SAT observed as follows :

“The Board itself observes in this order that no person is presumed to be guilty unless proved to be so and, therefore, it would be in the interest of the investors and the securities market that their application for the consideration of offer documents be considered and disposed of within a reasonable period even when proceedings against such entities are contemplated or have been initiated. The guidelines framed by the Board provide that the offer documents are to be disposed of within a period of 21 days, but in the case of entities against whom proceedings are either contemplated or have been initiated, the same shall be disposed of within a period of 90 days. This period has long expired and no action has been taken. There is logic in what the Board has said in the general order. In the case of offer documents presented by entities against whom any regulatory action is contemplated or to whom show-cause notices have been issued, the Board insists that they ‘should make all relevant disclosures in the offer document including the receipt of show-cause notice and the possible adverse impact it could have, so that the investing public is adequately informed. The purpose of these disclosures is to enable the investing public to make informed investment decisions. It follows and the Board is aware that in the case of such entities, the consideration of the offer document is not to be withheld till the disposal of the proceedings against them, but relevant disclosures are to be insisted upon. In the case in hand, the Board should and, we have no doubt that it shall, insist for such disclosures and leave it to the public to invest or not. Whoever then invests shall do so with eyes open and will have no cause to complain later. The guidelines also provide for such disclosures. This is in accordance with the scheme of the Act, different regulations and guidelines framed thereunder. The Board as a regulator has a duty to protect the interest of the investors and to promote the development of and to regulate the securities market by such measures as it thinks fit. It thought fit in its wisdom to issue the general order, which in our opinion, is in the interest of investors and the securities market and there is a recital to this effect in that order. In view of the general order passed by the Board, it should have itself disposed of the letter of offer as per the procedure stated therein.”

a) In conclusion, I may add that parties do not merely face the problem of delay of clearances, etc. but often, a more serious issue arises, viz., if, during pendency of such proceedings, the party has to make an application for renewal of registration or they propose to make an application for registration as another form of intermediary, the entity faces the possibility of its application being rejected on the ground that it is not a ‘fit and proper’ person (see the column in this series for September 2007 issue of BCAJfor several such examples). ‘Justice delayed is justice denied’ may sound to be a cliche, but the impact of this denial of justice is really experienced only by persons whose proposals are indefinitely put on hold or, worse, rejected, on account of such pending proceedings.

Hence, speedy disposal of such issues is advocated and this is what SAT suggests in this decision.

Foreign investment in India by SEBI registered Long term investors in Government dated Securities

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Presently, SEBI registered Foreign Institutional Investors (FII), Qualified Foreign Investors (QFI) and long term investors can purchase, on repatriation basis, Government securities up to US $ 25 billion and non-convertible debentures (NCD)/onds issued by an Indian company up to US $ 51 billion.
This circular has increased the limit for investment in Government securities by US $ 5 billion from US $ 25 billion to US $ 30 billion. This additional limit of US $ 5 billion is available to long term investors registered with SEBI viz. Sovereign Wealth Funds (SWFs), Multilateral Agencies, Pension/ Insurance/ Endowment Funds, Foreign Central Banks.
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A. P. (DIR Series) Circular No. 110 dated June 12, 2013

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Foreign Direct Investment – Reporting of issue/ transfer of Shares to/by a FVCI

Presently, transfer of equity shares/fully and mandatorily convertible debentures/fully and mandatorily convertible preference shares (hereinafter referred to as ‘shares’) of an Indian company, from a nonresident to a person resident in India (resident) or vice versa, has to be reported to RBI, through the bank, within 60 days of the transaction. Also, receipt of consideration for issue of shares of an Indian company, to a non-resident has to be reported to RBI, through a bank, within 30 days from the date of receipt.

This circular has amended Form FC-GPR & Form FC-TRS by inserting the following remarks in para 3(4) and 5(a)(4) of form FC-GPR and para 4(4) and para 5(4) of form FC-TRS: –

‘The investment/s made by SEBI registered FVCI is /are under FDI Scheme, in terms of Schedule 1 to Notification No. FEMA 20 dated 3rd May, 2000.’ This circular also clarifies that whenever a SEBI registered FVCI acquires shares of an Indian company under FDI Scheme in terms of Schedule 1 of Notification No. FEMA 20/2000-RB dated 3rd May, 2000 such investments have to be reported in form FC-GPR/ FC-TRS only. When investment is made in terms of Schedule 6 of the Notification No. FEMA 20/2000-RB dated May 3, 2000 no FC-GPR/FC-TRS needs to be filed. Such transactions have to be reported by the custodian bank in the monthly reporting format as prescribed by RBI from time to time.

Annexed to this circular are the revised forms FCGPR and FC-TRS.

A. P. (DIR Series) Circular No. 111 dated June 12, 2013

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