The Corporate & Commercial Law Society Blog, HNLU

Author: HNLU CCLS

  • The Mitsui & Co. Challenge: Time to Rethink the Retrospective Tax Amendment?

    The Mitsui & Co. Challenge: Time to Rethink the Retrospective Tax Amendment?

    By Aarushi Srivastava and Ridhi Gupta, second-year students at RGNUL, Patiala

    INTRODUCTION

    After Cairn and Vodafone, the latest instance of a company initiating investment arbitration proceedings against a hefty amount demanded under India’s infamous retrospective taxation regime, is Earlyguard Ltd., a British subsidiary of the Japanese behemoth, Mitsui & Co. The 2,400-Crore tax is being charged over a transaction that took place in 2007, consisting of the sale of Earlyguard’s shares of Finsider International Co., a UK domiciled company which had a 51% stake in Sesa Goa. Earlyguard treated the capital gain properly and in accordance with taxation rules prevalent then, but despite that, the company was served with a tax notice. Thereafter, it initiated arbitration proceedings, before the Permanent Court of Arbitration, under the India-UK Bilateral Investment Treaty.

    Previously, Vodafone, as well as Cairn, have won arbitration cases against retrospective taxation by India and its violation of bilateral investment treaties in international tribunals. However, instead of honouring the arbitration awards of INR 75 Crore and INR 8842 crore respectively, the Indian Government(hereafter Government) has challenged both these awards. In the case of Cairn, the Government stated that it never agreed to arbitrate the dispute, despite it sending a judge to the tribunal. While in Vodafone’s case, the Government has filed an appeal before the Singapore appeals court, stating that it has the sovereign right to taxation and no private individual can decide on it.

    RETROSPECTIVE TAX AMENDMENT

    The origin of the retrospective tax can be traced back to 2007, when Vodafone was taxed by Indian tax authorities. In the case of Vodafone International Holdings B.V. v. Union of India & Anr., the Supreme Court ruled in favour of the telecom company by stating that, “tax laws must be strictly construed and the provision of income tax must not be expanded to impose tax on any exchange that was otherwise untaxable.” It was to override this judgement that the then Government introduced the Finance Bill, 2012 to amend the Income Tax Act, 1961 with retrospective effect, returning the onus of payment to Vodafone.

    1. Fair and Equitable Treatment in Investment Treaties

    Article 1(a) of the Draft Convention on Protection of Foreign Property has influenced various countries to incorporate the principles of fairness in international dealings. The meaning and substance of fair and equitable treatment (“FET”) has been laid down in various arbitral awards such as Biwater Gauff Ltd. v. United Republic of Tanzania and Rumeli Telekom AS v. Republic of Kazakhstan. The following concepts have emerged under the scope of FET :

    • Prohibition of manifest arbitrariness in decision making, that is measures taken purely on the basis of prejudice or bias without a legitimate purpose or rational explanation;
    • Prohibition of denial of justice and disregard to the fundamental principles of due process;
    • Prohibition of targeted discrimination on manifestly wrongful grounds of gender, religion, race or religious belief.;
    • Prohibition of abusive treatment of investors, including coercion, duress and harassment; and
    • Protection of investors’ legitimate expectations arising from a government’s representation and balancing the same with host State’s right to regulate in public interest.

    The introduction of the retrospective tax amendment was a direct violation of the FET under international law. Firstly, the Government had no rational reason to introduce the amendment, other than the motive to reverse the Supreme Court judgment. Secondly, the due process of law was disregarded as all the dealings were based on the India-UK Bilateral Treaty, which is silent on taxation, except in cases where already an international or domestic legislation provides for the tax. Thirdly, the investors, at the time of making the dealings with India in all the cases, Vodafone (2007), Cairn (2006-07) and Mitsui (2007) could not legitimately expect the Government to enforce a tax on these dealings after a period of 5-6 years, as there was no such representation or intention shown by the Government.

    Expropriation means the act of nationalising or taking away money or property, especially for public use without payment to the owner, or through illegal measures. Expropriation could be direct, where an investment is nationalised or directly expropriated, or indirect, through state interference without effect on legal title. Under International law the property or assets of an ‘alien’, i.e., a person from another state must not be expropriated, without adequate compensation. The India- UK Bilateral Treaty states under Article 5(1) that the investments of an investor shall not be expropriated except for a public purpose regulating economic activity on a non-discriminatory basis and equitable compensation. However, in all the aforementioned dealings, the Government enforced the tax regime neither for a public purpose to regulate economic activities nor for the purpose of equitable compensation, and thus, the retrospective tax is a direct violation of the ‘very law’ i.e. the treaty governing all these dealings.

    There have been cases where Tribunals have considered tax measures as indirect expropriation. In the EnCana v. Ecuador, the Tribunal held that, from the perspective of expropriation taxation is in a special category, only if a tax law is punitive, extraordinary or arbitrary, issues of indirect expropriation would be raised. It was held that, in the absence of a specific commitment from the host state, the foreign investor has neither right nor any legitimate expectation that the tax will not change perhaps to its disadvantage, during the period of investment. Further, the Tribunal in Feldman v. Mexico held that a tax measure may amount to expropriation, where the investor had an acquired right with regard to which the tax authorities behaved arbitrarily through a sufficiently restrictive nature.

    The act of the Government of enforcing retrospective taxes on its investors was, thus, not only against the FET but also an act of expropriation. To begin, the amendment was introduced arbitrarily without any consultation with the investors or regard to the India-UK Treaty. Further, the investors had no legitimate expectation that the tax regime would change to their disadvantage and that the tax authorities would function in such a restrictive nature.

    POSSIBLE NEGATIVE OUTCOMES

    When the amendment was introduced in 2012, the then-opposition party, BJP, raised its voice against it and criticized the government. However, years after coming into power, there have  been no attempts from its side to remove the amendment. Instead, tax notices have been sent to companies, their assets have been seized, and the taxation regime has been defended in the arbitration proceedings. This shows the unwillingness of the present Government to discontinue with the tax amendment of 2012.

    However, the Government’s disregard to the arbitral awards will not prevent investors to fight tooth and nail to enforce these awards. Cairn Energy, for instance, is leaving no stone unturned to monetize the award. The company has successfully got the award registered in countries like the US, the UK, France, the Netherlands and Singapore, in order to further the process of enforcing the award against overseas Indian assets. This would mean that Cairn can seize Indian assets in these countries, if India fails to pay the amount. The company can enforce the award in over 160 countries that have signed and ratified the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Cairn has also filed a lawsuit in New York to declare Air India, the national carrier, as an alter ego of the Indian Government. If Cairn does get successful in enforcing the award, this will set precedent for other companies facing the same issue of retrospective taxation. This might lead the country having to lose a significant number of its overseas assets in the future. As a result of which, India’s investment environment can be perceived in a negative light, having a toll over its future investment dealings.

    Since the amendment was introduced, there has been zero revenue collection under it, rather it has resulted in substantial amount of losses in foreign direct investment (FDI) and foreign institutional investors (FII). The FII’s invest huge amounts of money in India that provides a great boost to the economy.  The investors, while investing in a country take close notice of the existing legal framework and then decide on investment. A consistent legal environment is not ‘much’ that the investors expect a country to give, as it is a part of minimum standard of protection of foreign investments under customary international law. However, with all these initiations against India’s retrospective tax regime and yet no reconsideration by the Government, the investors would not legitimately expect a consistent scenario of taxes in India, and they may fear any future amendments that could again impair their rights.

    CONCLUSION

    India was ranked 63rd in the Ease of Doing Business Rankings, 2020 which is indeed a development for India, however, due to the hasty 2012 amendment, the country has been attracting negative attention lately. Not only is the retrospective law against the FET and way of expropriation but also, it can act as a major discouragement for investors globally, who would have otherwise been interested in making investments in India. With two major judgements against the Government, its high time for the Government to look back and revise its arbitrary amendment. It is ironical, that though the present Government has always promoted international trade and business, it has failed to address this major hindrance to international dealings. The retrospective tax amendment should be done away with, in order to regain the trust of the investors and ensure a secure environment for investments in India.

  • ESL v. UEFA: Federation(s) Actions Transgress Principles of Competition?

    ESL v. UEFA: Federation(s) Actions Transgress Principles of Competition?

    By Shubham Gandhi, third-year student and Tanish Gupta, second-year student at Dharmashastra National Law University, Jabalpur

    Introduction

    The furore surrounding the proposed breakaway European Super League (“ESL“) has yet again spurred with the issuing of joint statement canned by the three so-called European giants i.e. Barcelona, Real Madrid, and Juventus bolstered up the ESL keeping the faith of the league alive. This came in the aftermath of a preliminary ruling dictated by the Madrid Commercial Court on 20 April 2021 holding the league to be in violation of EU competition law.

    The idea of Super league, much of its disgrace, has posed a serious question to the world of sport. The author(s) in this manuscript will give readers the premise of the formulation of ESL, how the league is in contempt of the EU Competition law, and also distil the legality of the statement made by the Union of European Football Association President (premier governing body for football in Europe) barring the players’ from participating in the domestic league and world cup. 

    Instaurating European Super League

    The European Super League has been in talks for over the years. As early as 1988, a similar move, a two billion deal was signed to establish a new league of elite, surfaced in the world of football, famously known as  Project Gandalf . The ESL President Mr. Florentina Perez who is also chairman of Real Madrid C.F on Sunday, 18 April 2021 trumpeted to the world the newly formed Super league consisting of 20 teams with a total of 15 clubs as founding members and with 5 spots left for other clubs to earn through promotion. For Mr. Perez the league formation was quintessential in order to revivify the TV rights by recuperating the losing interest of fans towards  football and also to provide indispensable financial assistance to the clubs.

    The founding members (European giants) approached by the ESL, will bring exuberance of watching big star studded matches on every midweek, resurrecting the interest of football fans, making the league popularized. The ESL will also provide the clubs necessitated financial stability, by sanctioning 200 million euros every year.

    UEFA right to forswear

    The presence of Article 49 (3) of UEFA statutes grants the federation to intrude in the formation of the ESL. The statues read as: –

    “International matches, competitions or tournaments which are not organised by UEFA but are played on UEFA’s territory shall require the prior approval of FIFA and/or UEFA and/or the relevant Member Associations in accordance with the FIFA Regulations Governing International Matches and any additional implementing rules adopted by the UEFA Executive Committee.”

    The Article accords UEFA and FIFA as the premier body to grant ratification to any new league, planning to engage in football across Europe. Connoting that the ESL were to take prior permission from UEFA for its formulation, perverse to that, the ESL was devised in silence and publicized, as surprise, not to the world but to the players and manager of the clubs as well.

    The riveting point is that many members were part of both the federation this includes Mr. Andrea Agnelli, chairman of Juventus F.C and chairman of European Club Association (“ECA“) who later resigned on the very day when the proposed ESL came into reality. His participation in two opposing federations casted doubt of potential sharing of confidential information for advantage of ESL formation, giving UEFA right of action, based on breach of confidentiality.

    Delving into Competition law

    The European courts have time and again precedented that sports and activities are dictated by competition law. The ECJ in Klaus Hofner and Fritz Elser v. Macrotron GmbH held that the football clubs are termed as “Undertaking” which are capable of affecting competition within Article 101 (1) of Treaty on the Functioning of the European Union (“TFEU”). Also, the ECJ in Meca Medina v. Majcen decreed that competition law does apply to sporting events in relation to economic activities. 

    It renders every restrictive (cartel) agreement as a violation of competition law, but subject to exceptions i.e. if the federation pursues a legitimate objective, are inherent to these objectives, necessary and proportionate.

    The ESL principally infract the principle of equality between the clubs which was endorsed by the courts around Europe. In the Bosman decision of 1995, the court in para 106, summarised the test as “the aims of maintaining a balance between clubs by preserving a certain degree of equality and uncertainty as to results and of encouraging the recruitment and training of young players must be accepted as legitimate”, similar ruling was dictated in the UEFA Champions League decision of 2003. It is safe to say that the ESL being a close league, with 15 members guaranteed spots regardless of their performance, will fail to stand the test of legitimate objective.

    It is to be borne in mind that ESL being a new competition, will gamble upon the existing system and will diminish the financial interest of UEFA, as they are the only federation regulating football in Europe, holding a dominant position.

    The UEFA could be prohibited by virtue of Article 102 i.e. Abuse of Dominant position, from exercising its dominant position by prohibiting other leagues and favouring their  league which is Champions and Europa league. The same be held in Motoe case adjudged by ECJ.

    UEFA’s incongruous statement banning players

    The other wrangle in the brawl between ESL and UEFA is the statement made by UEFA President suspending the players from domestic teams and national teams. The legality of this statement can be posited by Article 102 of TFEU, which declares action taken while holding dominant position as void. The Munich court criticized Fédération Internationale de Basketball (“FIBA“) rule of banning athletes from club and nationals teams, taking part in competition other than the one staged by FIBA. The court while demeaning this rule of FIBA, held them accountable for abusing the dominant position.

    In a much recent case, the EU court in International Skating Union Case 2020 held that International Skating Union (national governing body for the sport of figure skating in the United States)rules regarding blanket ban on players from national teams who are participating in tournaments not accredited by ISU are not proportionate to the legitimate objective as per Article 101(1).

    Moreover, a decision rendered by the regional court of Frankfurt held that, if the federation announces the selection of players for the national team not on the basis of sporting merit, then it will be deemed to be a decision based on abuse of dominant market position.

    Likewise in the German Wrestling League case, the Nuremberg court of appeal while citing the ISU case held though federation are allowed to take measures in order to protect their own economic interest against the competitive organisation but banning players is against the principle of EU and German competition law.

    This in clear terms implies that the announcement threatening to ban all the 12 clubs and players from participating, will not hold a grasp on the courts. The vogue of courts upholding players autonomy is a strong inference that if ESL ever to approach the court, the ruling can be in their favour, same be affirmed by ESL Chairman.

    The banning of players will also stand in violation of the principle of ‘restraint of trade’ as players are free to move, as enshrined in the common law system. The creation of ESL has resulted into a much serious breach of duty on part of the club as the planned league carried out without letting the players know, which is in violation of rules of domestic leagues i.e. to abide by the rules of UEFA and FIFA. This in turn will give the right to players to repudiate the contract on grounds of breach of duty and contractual obligation.

    In the present case all the disputes arising out of ESL, the ban on teams from domestic leagues and the ban of players from playing in the world cup is likely to have breached any law or regulation for the time being in force, will likely be referred to CAS.

    Conclusion

    It will be interesting to watch out how this tale of world football develops in the coming months. The EU courts, while deciding the legality of ESL, also have to set out measures hinting whether TFEU licenses a competitive league ever to be formed finer than ESL or UEFA will continue to hold the dominant positions, concerning all small footballing activities played out in Europe.

    It is safe to say that the decision banning players from all the competition will not hold strong in court and the actions of UEFA will, in turn, violate Antitrust law as insinuated by the court through various precedents.

  • Are Ed-tech Companies Amenable to the Consumer Protection (E-Commerce) Rules, 2020?

    Are Ed-tech Companies Amenable to the Consumer Protection (E-Commerce) Rules, 2020?

    By Aniket A. Panchal and Gauransh Gaur, second-year students at GNLU, Gandhinagar

    Introduction

    Ever since the introduction of the Consumer Protection (E-Commerce) Rules,2020 (hereinafter referred to as ‘Rules‘), the vexing question is whether Ed-tech companies would be subjected to these rules and if they are subjected, whether they would come under the inventory-based e-commerce or marketplace e-commerce model. The applicability of the Rules will differ according to the category to which an Ed-Tech entity belongs. Moreover, if the definition provided under the Consumer Protection Act, 2019 (hereinafter referred to as ‘Act‘) and the Rules is dissected, it can be concluded that the all-embracing definition of ‘e-commerce entities’ could, in fact, capture entities that create and disseminate products or services over digital or online media. However, it is not unequivocally answered in the Rules if they apply to Ed-Tech companies which primarily impart their services through online websites, mobile applications, and similar digital platforms. This article seeks to analyse the newly introduced Rules and their applicability to Ed-tech platforms after a thorough perusal of the diverse judicial opinions regarding the categorization of ‘education’ as a service under the Act. In doing so, the article will also outline how different models of Ed-tech companies are subject to different regulations in light of these Rules.

    Analysis of the Consumer Protection (E-Commerce) Rules, 2020

    As per the Rules, the definition of an e-commerce entity encompasses any Ed-tech platform which provides or facilitates the provision of educational services (online courses, examination preparation, online tutoring, etc.) in return for a fee. There are two models of an e-commerce entity as per the rules, namely: inventory e-commerce entity and marketplace e-commerce entity.

    To contextualise the same, an inventory e-commerce entity would include an “e-commerce entity which owns the inventory of goods or services and sells such good or services directly to the consumers”. This model is used by many Ed-tech platforms wherein they curate their own educational services and provide them to the consumers directly through this platform.

    The other e-commerce model referred to under the rules is the marketplace e-commerce entity. According to the Rules, this e-commerce entity provides “an information technology platform on a digital or electronic network to facilitate transactions between buyers and sellers”. It covers Ed-tech platforms which connect the students to teachers and allow the students to purchase courses offered by various teachers and educational institutions. These platforms could be said to have “facilitated the transactions” between the course offerors and the students.

    Therefore, the determination of compliance requirements by an Ed-tech company regarding inventory-based e-commerce entity or marketplace e-commerce entity would be on a case-to-case basis depending upon their operating procedures among other features.

    Education as a Service? Unravelling The Conundrum

    The question whether education would be considered as a service is a murky one under consumer protection law. Different opinions have emerged on this subject through a myriad of judgements by the Supreme Court, the National Consumer Disputes Redressal Commission (hereinafter referred as ‘National Commission‘) and the State Consumer Disputes Redressal Commission. This part of the article analyses this tumultuous area of consumer protection law, and highlights its implications on the central question- whether Ed-tech companies are covered under the new E-Commerce Rules.

    This question was considered by the Apex court in Bihar School Examination Board v. Suresh Prasad Sinha(hereinafter referred as ‘Bihar School Case‘) Here, the issue for adjudication was whether there was any deficiency in services provided by the Bihar School Examination Board (hereinafter referred as ‘Board‘) when they failed to issue correct roll numbers to the candidates, and subsequently failed to declare the result of one of the candidates. The court held that the Board, in discharging its statutory functions, could not be subject to the consumer protection law. Further, the fees paid by the candidates to the Board to conduct the exams and other related activities could not be equated with ‘consideration’, and hence, the students could not be brought under the definition of ‘consumers’.

    A different stance was taken in Oza Nirav Kanubhai v. Centre Head Apple Industries Ltd,[i] where a student was alleged to have been treated prejudicially by a private college. When the faculty member learned that the student had brought his misbehaviour to the attention of the institution’s head, he insulted him and treated him with bias, even refusing to check the complainant’s homework. He was not even refunded his fees after being rusticated from the college. The National Commission, after observing the misconduct of the faculty, emphasized upon the contractual relationship between the student and the teacher, and thus, brought educational activities under the ambit of ‘services’. The court, through this decision, made a distinction between private and statutory bodies by bringing educational services rendered by a private institution under the consumer protection laws, and exempting the services rendered by a statutory educational institution.

    Following this, a private coaching institute was also brought under the ambit of consumer protection laws in Jai Kumar Mittal v. Brilliant Tutorials, where the coaching institution provided outdated study material to their students.

    However, the Supreme Court has always been reserved in bringing educational institutions under the ambit of consumer protection law. For instance, when the court was confronted with this question in the case of Maharshi Dayanand University v. Surjeet Kaur, it nearly expanded the ratio of Bihar School Case. Nonetheless, it seems to have ‘ostensibly’ settled the debate in P.T. Koshy v. Ellen charitable trust[ii] (hereinafter referred as ‘P.T. Koshy‘), where it ruled that educational institutions do not render any services through their “performance of educational activities”. Consequently, no complaints regarding deficiency in educational services can be entertained against the educational institutions as consumer forums do not have jurisdiction to entertain these complaints.

    Therefore, if the P.T. Koshy decision is taken as the final answer on this quintessentially tumultuous question, the current position of law can be ascertained. It would mean that statutorily and privately established educational institutions providing educational services are not subject to consumer protection laws. Conversely, as a settled law, private coaching institutions are amenable to consumer protection laws as they are recognizably different in nature from private institutions.

    The Implications of Judicial Pronouncements on Ed-tech companies’ amenability to the rules

    The ratio propounded in P.T. Koshy will not have much effect on the amenability of coaching institutions which are providing educational training through virtual learning platforms, as they are different from the regular schools and colleges. In fact, they would be subject to consumer protection laws for the following reasons: fees charged for their services, profit making objective (the element of ‘commercialization’ in dissemination of courses and training), and the ‘consumer and a service provider’ relationship that is established between a student and a teacher respectively. However, the situation would become tantalizing when any online course would be offered directly by the educational institutions, or through any intermediary acting as a facilitator between the students and the teachers.

    Any statutorily established institution would clearly be exempted the Rules in light of the Apex court’s ruling in Bihar School Examination Board case. Nonetheless, the moot point would be whether private educational institutions would be exempted from the Rules if they provide online courses. If the issue is addressed, considering the decision in P.T. Koshy, they would not be held liable for their educational activities. Therefore, it could be fairly argued that private educational institutions (except coaching centres) would not be subject to the Rules even if their courses go online.

    Ed-tech companies acting as an intermediary between the students and any other education institution, would not be liable under the E-commerce Rules as educational institutions are not amenable to the consumer protection laws. However, the definition of e-commerce entity which includes the marketplace e-commerce model does not exempt Ed-tech companies, which are acting as an intermediary between the students and coaching centres.

    Furthermore, the daunting question is the one concerning the amenability of coaching institutions which operate on a Freemium Model. This model is premised on a combination of free and premium services, where the consumer can avail the basic services free of cost and would be charged only for premium features in case he/she wishes to use them. Thus, a Freemium model operates on two-tiered user acquisition where free users have limited access to the product/services while the premium users get greater access to the product/services. Resultantly, only the premium users can be regarded as true consumers who are receiving education as a service; primarily for the reason that they are paying for availing some extra features/services. Therefore, coaching institutions operating on a freemium model ought to be made liable as far as their services are concerned with respect to the premium users.

    Conclusion

    In light of the foregoing analysis, the authors have arrived at the following conclusion. Firstly, Ed-tech companies operating as private coaching institutes would be subject to consumer protection laws under the Rules. However, when they are operating on a freemium model, they will be amenable to the Rules but only for those aspects which are being provided for a fee. Secondly, these companies would also be required to comply with the Rules when they would be operating in the form of a marketplace e-commerce model by acting as an intermediary between students and private coaching centres. Lastly, educational institutes providing online courses or educational training, or any Ed-tech company providing online courses and training, would not be subject to the Rules owing to the ratio propounded in the P.T. Koshy judgement.

    [i] (1992) 1 CPR 736.

    [ii]P.T. Koshy v. Ellen Charitable Trust, (2012) 3 CPC 615 (SC).

  • Cryptocurrency: A Revolution in the Making

    Cryptocurrency: A Revolution in the Making

    By Aayush Jain and Devansh Parekh, fourth year law students at GLC, Mumbai.

    Introduction

    On 21st April, 2021, for the first time ever, a completely paperless trade transaction between Tata Steel and HSBC India was executed using blockchain technology. The genesis of the technology which enabled this transaction can be traced back to 2008, when a pseudonymous white paper was uploaded online, which envisioned a new way to transfer value over the internet – and thus commenced the era of cryptocurrencies, blockchain and Bitcoin. While they pose significant controversy, fear and caution, cryptocurrencies have attracted immense interest from businesses, consumers, monetary authorities and governments across the world, as they have a promising future to replace the need for the trust in long-standing institutions such as banks.

    The Draft Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019 defines cryptocurrency in a broad manner as, any information, code, number or token, generated through cryptographic means or otherwise, which has a digital representation of value and has utility in a business activity, or acts as a store of value, or a unit of account. A more comprehensive definition has been given by the Financial Action Task Force as a math-based decentralized, convertible virtual currency which is protected by cryptography.

    Potential Uses

    Companies across the globe have begun raising capital through initial coin offerings – where the company sells cryptocurrency either for money or for another cryptocurrency. The time frame and the costs are greatly reduced when compared to a regulated Initial Public Offering. Another important characteristic associated with initial coin offering is that they do not come with voting rights. Today, crypto assets boast a combined market capitalization of over $1.75 trillion.

    Could we have ever imagined a completely paperless transaction? Just as it was hard to guess in the early 1990s how the internet would help sell products across the world, an attempt to precisely understand the use of blockchain technology today is challenging. The advantages and disadvantages vary depending on the nature of the transaction. This nascent technology has several characteristics as discussed below.

    Instant, Low-Cost, Secure Settlement: Crypto-assets, such as Bitcoin, solve the problem of counterparty risks by creating a single, decentralized distributed database, accessible to everyone, but controlled by no single entity. The technology has the potential to bring about safe, real-time trade verification and settlement, through simplification of administrative processes in settlement, which has the ability to handle high volumes at low costs. Since all parties agree on a single database, without the presence of a financial intermediary, transferring money from one account to another is effortless, cost effective and quick as against a banking transaction that would otherwise require confidence that the payment would happen risk-free. The presence of a more secure payment mechanism has the potential to improve access to credit.

    As per a recent report by the innovation fund of Santander Bank, blockchain technology would result in a cost-savings of USD 15 to 20 billion by 2022 as it reduces financial infrastructure costs and time period for the transactions, as compared to traditional transfer of money, which can be done only during banking hours which would take at least a day or two with fees ranging from 1% to 8%.

    Tokenization: Cryptocurrency has a convenient way of tackling the problem of counterfeiting and fraudulent transactions. Tokenization involves maintaining a record of ownership of physical assets in a secure electronic manner. The only way for someone to ‘own’ a digital asset was if a trusted third party recorded the ownership in a database. Because the database is accessible by everyone and controlled by no one [also called permissionless network], crypto assets can provide ownership guarantees that were previously non-existent in the digital world Therefore, the risks arising from a controlling third party are eliminated. For example, blockchain could provide specific financial services without the need of a bank through distributed ledgers. In fact, one could argue that cryptocurrencies have more secure record-keeping capabilities, providing better ownership assurances, than most of the physical ones, while providing an efficient cross-border payment system.

    Smart Contracts: Other potential applications in finance include smart contracts – electronic contracts that are designed to execute automatically upon fulfilment of terms as agreed to by the counter-parties. For example, an options contract could be set up to be exercised automatically if certain defined conditions exist in the market. Such a ledger could potentially replace the paper real estate deeds currently filed at government offices.

    Key Issues and Analysis on India’s Stance towards Cryptocurrencies

    “Why ban when you can regulate?” New possibilities of cryptocurrencies are being discovered as the trading and usage increases day by day. As recent as March 2021, the Finance Ministry made it clear that it has no intentions of banning cryptocurrency in its entirety after witnessing several benefits of fintech and its dependance on blockchain technology. Interestingly, to battle the COVID-19 pandemic, the Government of Maharashtra has been using blockchain technology to store and maintain COVID-19 test results.  .

    In 2018, the Reserve Bank of India (“RBI”) materialized a circular (“RBI circular”) which required all entities within its purview to stop dealing in cryptocurrencies and rendered it illegal to initiate any such dealings or services in cryptocurrencies.

    Amidst concerns of high volatility and risky venture, what perturbed RBI the most was the anonymity of transactions. This raises significant concerns for consumer protection. No Indian regulation specifically targets cryptocurrencies. They have no sovereign guarantee and are of a speculative nature, hence making them very volatile. For instance, Bitcoin lost nearly 80% of its value between December 2017 and November 2018. Interestingly, recently Elon Musk and his tweetshave made some important headlines that led to  fluctuation in rates of certain  cryptocurrencies like  Bitcoin and Doge to the sky and back to the ground. The essence of money has always been to trust in the strength of its worth.

    Another particular concern with cryptocurrencies is that private keys (a ‘key’ which allows access to a user’s cryptocurrency) are stored by cryptocurrency exchanges, which are prone to hacking, malicious activities, human errors or operational problems of exchanges. On 22 April 2021, one of Turkey’s largest cryptocurrency exchanges had to cease operations due to lack of financial strength, leaving hundreds of thousands of investors in panic as their savings worth $2 billion would evaporate.

    Since cryptocurrencies are pseudonymous and decentralized, they could facilitate money laundering and other illicit criminal activities (such as tax evasion), providing a means for criminals to hide their financial dealings from authorities. It also raises the issue whether existing regulations can appropriately guard against this possibility. 

    If cryptocurrency becomes a widely used form of money, it could affect the ability of central banks to implement and transmit monetary policy in the country.

    The RBI circular aims to tackle the above issues by temporarily holding off trading in cryptocurrencies until a suitable legislation is enacted. However, the same was challenged and struck down by the Indian Supreme Court declaring it a violation of fundamental rights vested in Article 19(1)(g) of the Constitution of India. The Court applied the test of proportionality and concluded that RBI failed to consider the availability of least-restrictive alternatives. It must be noted that though the Supreme Court rejected the RBI Circular on the ground of proportionality, it does not rule out the presence of other risks that come along with this order.

    Conclusion

    The entire growth and foundation of Financial technology (“Fintech”) lies upon the initiative of a Sandbox. The United Kingdom and its regulatory body, the Financial Conduct Authority commenced this to reduce time and cost to get ideas to market, enable greater access to funding for innovators and allow more products to be tested and introduced in the market. Arizona was the first state to adapt this in the USA.

    Although growing at an exceptional speed, the fintech industry is still young. This has put some pressure on the regulators to adapt to the inevitable changes time and again. For instance, the USA has a fragmented structure of regulations that govern fintech. The Initial Coin Offering must fulfill the Howey Test in order to be regulated by the SEC. There is not one but several rules and regulations differing from state to state that govern Fintech in the USA. The State Licensing Requirements ensure that there are annual audits, record keeping as well as examination by regulators. Some of the recent initiatives include: In 2015, New York State Department of Financial Services approved the NY BitLicense that issues business licenses for virtual currency activities. In 2017 the Uniform Law Commission released the Uniform Regulation of Virtual Currency Businesses Act that ascribes certain extensive requirements for a virtual business currency to adhere to before it can engage in business activities with the residents of the state. Even though this act has not been enacted by any of the states so far, it is an exhaustive framework that details the transfers, exchange, definitions, licensing and other requirements as well as potential liabilities that can be enacted in the future.

    As it stands, there is an urgent need to provide clarity on the status of cryptocurrencies. India is working on its own law to regulate cryptocurrencies. However, the approach taken is severe, even more stringent than China. It would be interesting to see where India takes the project of Digital India from here on. If the draft cryptocurrency bill is passed, India would be first prominent economy to ban any form of engagement with cryptocurrency – including its mining. 

    Like other nations, India should regulate rather than ban cryptocurrencies. The aim should be to develop industry standards, promote transparency, work with regulators to detect fraud and misconduct. Crypto firms in India have experienced a successful phase during the pandemic as the volume of trading on crypto exchanges increased manifold. There is an increased inclination towards accepting cryptocurrencies. Around the world, companies such as Starbucks, Visa and Microsoft now accept certain cryptocurrencies as payment for their products/services. Although the crypto market is highly volatile in nature, regulators can introduce margins, limits, circuit breakers as well tax the transactions to ensure open competition in the market.

    It is well established that the nature of the cryptocurrencies is evolving continuously in the global economy. Due to its increasing acceptance, it should not come as a surprise if India publishes its own set of guidelines or regulations. As to which stand it takes is a question which remains to be answered.

  • Determination of the Status of A Creditor: Artificial Wisdom of the Committee of Creditors

    Determination of the Status of A Creditor: Artificial Wisdom of the Committee of Creditors

    A 4-minute read by Arihant Jain, a fourth-year student of Nirma University

    The National Company Law Appellate Tribunal (‘NCLAT’) on 18.12.20 in the case of Rajnish Jain v. BVN Traders and ors (‘Rajnish Jain’)held that the Committee of Creditors (‘CoC’) constituted under Section 21 of the Insolvency and Bankruptcy IBC, 2016 (‘IBC’) cannot determine the status of a creditor as a financial or an operational creditor. It is a matter of applying insolvency law to the facts of each case. The judgment clarified that only the adjudicating authority has power to adjudicate the status of a creditor as a financial or an operational creditor. The author hereinafter highlights the judiciousness of the Rajnish Jain judgment in the light of the principle of equality of similarly situated creditors, commercial wisdom of the CoC & limited rights of the CoC under the IBC.

    Factual Background

    The National Company Law Tribunal, Allahabad (‘NCLT’) admitted an application under Section 9 of the IBC to initiate Corporate Insolvency Resolution Process (‘CIRP’) against the corporate debtor, Jain Mfg (India) Pvt. Ltd. BVN Traders,the Respondent in this case had extended a loan of Rs. 80,00,000 to the corporate debtor having a secured title deed of the property of corporate debtor against the consideration of 18% per annum. BVN Traders had filed FORM C as financial creditors and the insolvency resolution professional (‘IRP’) admitted the claim of BVN Traders as a financial creditor.

    Rajnish Jain, the promoter, stakeholder and managing director of the corporate debtor, filed an application for removal of BVN Traders from the status of financial creditor. The NCLT directed the resolution professional (‘RP’) of the corporate debtor to seek approval from the CoC to change the status of BVN traders from financial creditor. Pursuant to this, the CoC passed a resolution that BVN Traders is to be treated as financial creditors.  In light of this resolution, the NCLT rejected the claim of the promoter via order dated 23.01.20.

    Subsequently, in the 7th meeting of CoC, the RP again proposed the agenda to determine status of BVN Traders. The CoC passed a resolution with its majority that BVN Traders is not a financial creditor. The CoC also discussed the agenda regarding withdrawal of CIRP under Section 12A of the IBC and for the same, prior approval of 90% majority of voting shares of CoC is required. However, the withdrawal resolution did not attain the 90% majority and the same was not passed. In the 8th meeting of the CoC, withdrawal of CIRP process was again discussed and the same was passed by CoC without including BVN Traders in the CoC. An appeal was filed by Rajnish Jain against the order dated 23.01.20 of the NCLT.

    Decision of the NCLAT:

    The NCLAT observed that the CoC cannot determine the status of creditor. It is a matter of applying the applying the IBC laws to facts. It further held that CoC cannot use its commercial wisdom to determine the status of creditor. The NCLAT observed that despite the order being passed by the NCLT, the CoC proceeded to change its earlier stance and passed a resolution contrary to NCLT order, thereby undermining its authority. The NCLAT also held that the resolution passed in the 8th meeting was bad in law since it was passed after illegally reconstituting the CoC. 

    Current Position of Law 

    Financial creditor and Operational creditor are defined under Sections 5(7) and 5(20) of the IBC. Pertinently, the Supreme Court’s judgment in the case of Swiss Ribbons Pvt. Ltd v.UOI differentiated both the terms by relying on the recommendation of  BLRC Report, 2015:

    “Financial creditors are those whose relationship with the entity is a pure financial contract, such as a loan or a debt security. Operational creditors are those whose liability from the entity comes from a transaction on operations.”

    Further, in Pioneer Urban Land and Infrastructure Ltd and ors v. UOI, the Apex Court observed that financial creditors owe financial debt to meet the working capital or requirement of corporate debtor. On the other hand, operational creditors provide goods and service to the corporate person. In the instant case, the loan extended to corporate debtor is a pure financial contract to meet the working requirement. Therefore, the NCLAT has rightly denied the arbitrary decision of CoC in determining the status of creditor.

    Analysis

    • Principle of Equality – Similarly situated creditors should be treated alike

    Article 14 of Constitution of India provides that equals should be treated equally and unequal should be treated unequally. Further, in CoC of Essar Steel Limited through Authorised Signatory v. Satish Kumar Gupta and ors., the Apex Court observed that similarly situated creditors should be treated equally. Empowering the CoC to determine the status of a creditor will create inequality amongst the same class of creditors as other creditors of the CoC would determine the status of a creditor of the CoC who is in pari passu with them. In the instant case, the NCLT failed to consider the principle of equality by authorizing the CoC to determine the status of BVN Traders.

    • Commercial wisdom of the CoC – Not an absolute power

    Commercial wisdom of the CoC is not an absolute power. The Apex Court in CoC of Essar Steel Limited through Authorised Signatory v. Satish Kumar Gupta and ors has observed that commercial wisdom must be in consonance with the basic aims and objectives of IBC.  Decision of the CoC is subject to checks and balances of the IBC. In Swiss Ribbons Pvt Ltd. v. UOI, the Supreme Court has observed that the primary objective of the IBC is to balance the interests of all stakeholders. Under the IBC, an aggrieved person has the authority to challenge the constitution of CoC or categorization of creditors before the adjudicating authority. In the instant case, reclassifying the status of creditor by CoC is beyond the scope of commercial wisdom since it is in the hands of adjudicating authority to adjudicate the claims of categorization of creditors. Under Section 61(1) of the IBC, aggrieved party may challenge the order passed by NCLT before the NCLAT. However, in the instant case, the CoC sat in the position of NCLAT and gave a resolution contrary to the order passed the NCLT, which is beyond the aims and objectives of the IBC.

    •  The IBC is a complete code in itself

    Section 28(1) of the IBC which enumerates the conditions where prior approval of the CoC is required does not provide for seeking it for the determination of the status of a creditor during CIRP. Moreover, no provision under the IBC empowers the CoC to determine the status of a creditor. It is also pertinent to mention that the IBC is complete in itself. It has unambiguously laid down the powers of the CoC. 

    Further, an aggrieved party dissatisfied with the status of a creditor can submit an application to the NCLT through RP with the approval of 90% voting share of the CoC for the withdrawal of CIRP. However, in the 7th meeting of CoC in the instant case, only 66% of the CoC approved the withdrawal of CIRP. Further, a financial creditor, being a part of the CoC, cannot be excluded from taking part in the voting process of withdrawal of CIRP process. It would be violation of legal right of creditor of CoC mentioned under Section 12A of IBC.  However, in the 8th meeting of the CoC in the instant case, BVN Traders was not allowed to vote for the withdrawal of CIRP. Hence, the legal right of BVN Traders to vote under Section 12A is being defeated. 

    Judgment of Adjudicating Authority: It is a matter of applying law to the facts of each case    

     It is pertinent to mention that it is the statutory duty of court to deliver any judgment based upon the law. For clarifications, the court has the authority to take the opinion of experts. However, the judgment cannot be based solely on the expert opinion. The judgment has to be delivered by applying the law to the facts. In the instant case, the NCLT had delivered its judgment based solely on the decision of the CoC, however, the status of a creditor needs to be determined by the NCLT by applying the IBC to the facts of each case. The NCLAT has rightly clarified that the status of creditor could be determined only by applying the IBC to the facts of each case. 

    Conclusion

    The NCLAT has rightly adjudicated the matter by removing the flaws of NCLT’s decision which   would have led toimbalance by going against the purpose of commercial wisdom of the CoC. CIRP being the collective resolution process seeks parity amongst similarly situated creditors. Preference cannot be given to any similarly situated creditors. The adjudicating authority, by not providing legal reasoning for empowering the CoC to determine the status of creditor failed to consider that legal reasoning is the core of any judgment. The NCLAT has rightly adjudicated that empowering the CoC with such rights would have completely disabled the intent and purpose of the CIRP under the IBC.

  • Recent Trends: Measures taken by SEBI to Regulate the Indian Capital Market

    Recent Trends: Measures taken by SEBI to Regulate the Indian Capital Market

    By Nivedita Rawat, fourth-year student at AMity law school, noida

    Securities Exchange Board of India [“SEBI”] acts as a watchdog for the Indian Capital Market. The Board enacted by The Securities and Exchange Board of India Act, 1992 (“the Act”) has been accorded with comprehensive powers under the Act. The preamble of the Board describes its functions as to “protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto”. In addition to the intent behind the establishment of the Board, Section 11 of the Act lays down the functions of the Board that clearly illustrate “it shall be the duty of the board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit”. This provision exemplify that SEBI has been authorized to take any such measures that in its opinion would protect the interest of the investors and would aid to regulate the market. It’s the reason SEBI keeps on revising and updating by formulating new measures or directions that make securities market conducive, safe and friendly for all kinds of investors that include retail or institutional investors. In the past few months, during and after COVID-19 lockdown times, there have been some key instrumental measures that have been taken by SEBI, such as:

    1. Introduction of UPI and Application through online interface for Public Issue of Debt Securities

    SEBI, in its circular dated November 23, 2020 announced the introduction of Unified Payments Interface [“UPI”] Mechanism and application through online interface for public issue of debt securities. This system has already been in existence for issue of public shares since January, 2019 but is now made available for public debt securities through this circular issued by SEBI under Section 11 of the Act. The said mechanism is in addition to an already existing specified mode under Application Supported by Blocked Amount [“ASBA”]. It would be available for securities opening up for issuance from January 1, 2021 for applications up to a limit of 2 lacs. The concerned entities include National Payments Corporation of India [“NPCI”], UPI and the Sponsor Bank. 

    Analysis: The measure taken up by SEBI is extremely upright as it will make the process of subscribing to debt securities simple for the retail investors, will increase the investor base as the investors will have an option to use UPI interface to block their funds for debt securities during an issue through their brokers/intermediaries. Investing into debt instruments would be as similar as subscribing to equity initial public offerings [“IPO”] as it is now less time consuming and more digitalized. Although the initiative is bound to enlarge the responsibilities of the stock exchange, intermediaries and the sponsor bank, but the prevailing times call for such action as a physical process of issue of debt securities is not only a traditional approach but also make the process cumbersome altogether. Moreover, with the availability of UPI mechanism for subscription of debt securities, enhanced participation by the retail investors is anticipated. It is mainly because until now, the debt instruments had usually been subscribed by the high net investors and institutions, but such a measure by SEBI might change up the things and intends to encourage household investors to be a part of debt market as well.

    • Increased Efficiency of E-Voting mechanisms for Meetings 

    The Companies Act, 2013 mandates a company to provide e-voting facility to the shareholders. Section 108 of The Companies Act, 2013 along with Rule 20 of the Companies (Management & Administration) Rules, 2014 provide for such a facility. Additionally, regulation 44 of the SEBI (Listing and Obligatory Disclosure Requirement) Regulations, 2015 also contains provision to this regard.

    On Dec 09, 2020, SEBI released a circular directing the listed entities to provide e-voting facility to its shareholders. The mechanism called for a system wherein the shareholders will have an option to forecast their votes directly through their Dematerialized [“DEMAT”] accounts with the depositories which’ll forward their votes to the E-voting service providers [“ESP”]. The process would take place in two phases. First phase, wherein the shareholders can cast their vote either through the depository’s website or their DEMAT account. After which, the depositories will give the confirmation of the votes to the shareholders once received from ESP’s. In the second phase, the depository will set up an OTP system for login. For this new and much efficient mechanism, SEBI has also asked the Depositories and the ESP’s to provide helpline services to shareholders, whereas ESP’s have been directed to provide links for disclosures by the companies and the report of proxy advisors for investor’s awareness. 

    Analysis: The entire proposed mechanism aims to ease out the task of casting a vote for the shareholders. Elimination of registration with ESP’s and authentication from the point of depository will ensure security and legitimacy of the votes of shareholders. This is unlike the earlier mechanism in which the shareholders had to visit the ESP’s website to cast their votes with distinct usernames and passwords that created the voting procedure tedious and not very simple. The mandatory updating of key details of shareholders regularly by the stock exchange will also help the entities to be in contact with their users for one stop communication. Additionally, the initiative of providing the link for the disclosure by the entities and links to proxy advisor’s website etc.’ would guide the votes of the investors based on sound rationale, and would also enhance the participation in the e-voting process by the non-institutional shareholders or retail shareholders. 

    • Reclassification rules of promoters as public shareholders and disclosure of their shareholding pattern

    Rules for reclassification of promoters have been mentioned in Regulation 31A of SEBI (Listing Obligations and Disclosure Requirements) Regulation, 2015. On 23rd of November, 2020, SEBI released a consultative paper on the same that proposed a few amendments to the existing rules pertaining to promoter reclassification. It composed of the following proposed amendments:

    1. Promoters with shareholding up to 15%, seeking to reclassify should be allowed with shareholding’s status quo maintained.
    2. One-month duration for meeting between board & shareholders and for reclassification request to be put up before exchange.
    3. Promoters seeking reclassification pursuant to an order/direction of government or regulator should be exempted like reclassification pursuant to resolution approved under Insolvency and Bankruptcy Code, 2016. 
    4. Promoters seeking reclassification pursuant to an offer should be exempted from the reclassification procedure where intent for reclassification is mentioned in the offer letter which needs to be in accordance with SEBI Substantial Acquisition of Shares and Takeover [“SAST”] Regulations and Regulation 31A(3)(b) and 31A(3)(c) of SEBI(LODR) Regulations, 2015. 
    5. Pursuant to an offer, where the former promoters aren’t traceable by the listed entity or not cooperative towards it, exemption from reclassification procedures should be given if erstwhile promoters aren’t in control of the company and diligent efforts have been made by the listed company to reach out to them.
    6. Mandatory disclosure of promoters.


    Analysis: SEBI after having acknowledged the shortcomings of the existing process of promoter reclassification, has proposed amendments which seeks to bring orderliness in the procedure of promoter or promoter entity reclassification. There have been instances where a person is tagged as a promoter of a company in spite of having zero shareholding, this not only influences the choices of the investors but also makes the functioning of a company strenuous. The application of one-month deadlines between shareholder and board meetings and for putting up reclassification request by entity in front of exchange has been done with the intent to Fastrack the whole process and not to have any undue delay. The exemptions made for promoters pursuant to an offer have been proposed keeping in mind the procedural formalities which can be set aside in case where the stance of a promoter has already been clear or when it had been impossible to reach out to them. The disclosure of shareholding pattern by a promoter even in case of zero shareholding is a proposed amendment that aims to curb the companies from misusing the law due to existing loopholes. 

    Conclusion

    Additionally, SEBI has been looking forward to revamp the grievance redressal system for the stock exchange, for which the regulator issued directions to the Bombay Stock Exchange regarding the clients of the defaulting trading members. All inclusive, SEBI keeps on making endeavors to structure the capital market in the interest of the investors, listed entities or any stakeholders that form a part of the capital market. The recent measures have been taken keeping into account, the shortcomings of the laid down procedures or regulations of investing in share market. The Indian capital market should essentially avail the benefit of the rise in fintech like any other sectors of the economy. Depository participants such as Zerodha, Angel broking, Motilal Oswal Financial Services etc. have reported massive increase in the newly opened DEMAT accounts. It thus becomes imperative to have stringent securities law in place at the moment, especially when the number of retail investors have leapt up to record high numbers throughout the period of lockdowns in the country.

  • Future Retail v. Amazon: Time to Strike Out Emergency Arbitration in India

    Future Retail v. Amazon: Time to Strike Out Emergency Arbitration in India

    By Swikruti Nayak and Vaishnavi Bansal, third-years students at NLU, Jodhpur

    Introduction

    The single bench decision of Future Retail Ltd. v. Amazon.com Investment LLC passed by the Delhi High Court on 21st December, 2020 has resulted in a lot of turbulence and furore in the legal community for the future of emergency arbitration (“EA”) in India. This judgement sets the tone for increasing the ease of doing business in India and making it more arbitration friendly. The court  upheld the validity of an emergency arbitrator’s order of interim relief in the favour of Amazon. However, this matter is yet to be resolved. On appeal, a division bench of the Delhi High Court passed an interim order against the validity of EA which was upheld in the said judgement. Subsequently, Amazon filed a special leave petition to the Supreme Court, contending that the Delhi High Court neither had the jurisdiction to entertain Future Group’s appeal against Amazon nor can it pass any interim order that acts against the SIAC’s emergency arbitrator order, as the same is valid under Indian law.

    The concept of Emergency Arbitration

    EA, as a process, is based on the importance of obtaining interim relief for the parties which is key to protect and preserve the relationship of parties involved in a dispute, before a final relief is secured. The concept of emergency arbitration finds its origins in the Pre-arbitral Referee Rules of the International Chamber of Commerce (“ICC”) in 1990, however, it was rarely used by the parties.[i] In the Asia-Pacific region, the Singapore International Arbitration Centre (“SIAC”) was the first to introduce provisions regarding EA in 2010, to obtain emergency interim relief before an Arbitral Tribunal is constituted. Essentially, EA enables parties to obtain urgent relief and not spend a considerable amount of time, awaiting the appointment of an arbitral tribunal. This will also enable parties to exercise confidentiality even while seeking interim relief, which is not possible in court system.

    The concept of EA is based on two legal maxims, fumusboniiuris and periculum in mora, which mean that there is a reasonable possibility that the requesting party will succeed on merits and if the measure is not granted immediately, the loss cannot be compensated through damages. The specific details of the procedure may vary in different jurisdictions, but the two common procedures for obtaining a relief in emergency arbitration is, filing of the proof of service of the application to an emergency arbitrator upon opposite parties and payment of the fee decided according to the centre, where the arbitration will be carried out.

    Future Retail v. Amazon: A Shift in the Judicial Trend

    The dispute arose between parties in the present case, Future Retail and Amazon, because of non-compliance with the provision in the Shareholders Agreement, that prohibited Future Retail from selling its assets to some enlisted entities. In the agreement, the parties had chosen the Arbitration Rules of SIAC as the law of the conduct of arbitration making it to be the curial law for their arbitration agreement. Since SIAC rules provide for the appointment of an emergency arbitrator, the parties chose to go for EA. The issue for consideration before the court was whether the emergency arbitrator provision under the SIAC Rules is contrary to the mandatory provisions of the Arbitration and Conciliation Act 1996 (“the Act”), thereby examining the validity of emergency arbitration conducted between the parties.

    The court in its discussion relied heavily on the Supreme Court case NTPC v. Singer which deals with the situation of parties choosing a different curial law and proper law. It came to the conclusion that SIAC rules which is the curial law of arbitration agreement will apply to the extent they are not contrary to the public policy of India or against the mandatory requirement of the Act. Thereafter, the court used the bedrock of the arbitration law i.e. party autonomy to hold that since the rules are chosen by express consent of the parties, the court would not unnecessarily interfere with the award. Rule 30 of the SIAC Rules provide that the parties are also entitled to plead before the judicial authority for the interim relief, thus it is also not taking away the substantive right of the parties to reach the courts for interim relief. Moreover, there is nothing in the Act to invalidate the whole process of EA, merely because it is not strictly falling under the definition of section 2(1)(d). The court also clarified the applicability of section 9 along with section 27, 37(1)(a), 37(2) of the Act in the judgment. It said that applicability of these sections may be derogated with the agreement in International Commercial Arbitration and there is no inconsistency between SIAC Rules and Part 1 of the Act. The court defended it relying on the phrase “even if the place of arbitration is outside India” in proviso section 2(2), making it obvious that the exception is also valid for international commercial arbitrations. Hence, the court upheld the validity of the emergency arbitrator’s order of interim relief.

    However, this was not the first instance where the courts were faced with the question of enforceability of the EA in India. In 2016, Raffles Design International India Pvt. Ltd. &Anr. v. Educomp Professional Education Ltd. and Ors.was decided by the Delhi HC wherein the court upheld the maintainability of application for interim measures under section 9 after an emergency award was obtained from a foreign seated arbitral tribunal. The court held that section 9 cannot be used to enforce emergency awards but can be used by the parties to file interim relief. This judgment, however, fails to take note of the Bombay HC judgment of HSBC PI Holdings (Mauritius) Ltd. v. Avitel Post Studioz Ltd. &Ors. which was the first case to recognise the concept of EA in India. In this case, the emergency arbitrator in SIAC had passed two interim awards and the court had also granted interim relief to the party. The judgement of the HC was affirmed by the SC in 2020.

    Ashwani Minda and Anr v. U-Shin Ltd. and Anr, a Delhi HC judgement of 2019, laid the foundation to enable the bold stance of the court in Future Retail. The court recognised the concept of EA, however, dismissed the application for interim relief as the emergency arbitrator had declined the same.  The Japan Commercial Arbitration Association (“JCAA”) Rules governing the conduct of the arbitration, which provides for emergency arbitration to obtain relief before an arbitral tribunal is constituted. The arbitration agreement did not contain a provision for obtaining relief from domestic courts. The enforceability of emergency awards was not clearly discussed, however, the court held that once EA is invoked, interim relief cannot be sought from domestic courts. According to the court, the emergency arbitrator passed a very detailed and reasoned order and hence it did not interfere with it.

    Hurdles Lying Ahead

    It is quite evident that the judicial trend in India is gradually changing from circumventing discussions on the status of EA to discussing relevant issues related to the validity of EA. However, the concept of EA is far more complex, involving separate and specific procedures that need to be answered before India adopts an authoritative status of EA. As under section 2(1)(d) of the Act, an emergency arbitrator has not been recognised as an ‘arbitral tribunal’- his position and statutory benefits are not clear. Concurrent jurisdiction also presents a major issue since for obtaining interim relief, parties will be free to approach both the courts as well as the emergency arbitrator. The status of EA proceedings needs to be clarified, for instance, whether under section 8 which provides a judicial authority with the power to refer the parties to arbitration in the presence of an arbitration agreement, is applicable to an EA agreement or not. The scope of interference by court under EA as in full arbitral proceedings under section 34 also needs to be laid down. Moreover, an arbitral tribunal may continue proceedings ex-parte under section 25(3) of the Act and grant an award on the basis of the evidence before it, however, the same is not clear in case of an emergency arbitrator. Emergency arbitral awards apart from above are also susceptible to various enforcement issues in different jurisdictions as it is  more of a voluntary practice between parties. Moreover, it is mostly agreed upon, because of the consequences of refusing an EA order on the full arbitral tribunal process. There is no mention of the procedures like EA in Model law on which India’s arbitration law is based, which further strikes on its enforceability and acceptance in India.

    Conclusion

    The concept of EA holds a promising future worldwide as, besides Singapore, countries such as Hong Kong, Netherlands and Bolivia have amended their rules to include provisions regarding an emergency arbitrator. The Stockholm Chamber of Commerce (SCC), the London Court of International Arbitration(LCIA), the International Centre for Dispute Resolution of the American Arbitration Association(ICDR/AAA) and the International Chamber of Commerce(ICC) have also inserted provisions specifically dealing with emergency arbitration. In the USA, there is no specific provision regarding an emergency arbitrator, but national courts have generally tended to favour their validity.

    The decision of the Delhi HC in Future Retail v. Amazon revived a much-needed discussion on the status of EA in India. In the light of the principle of party autonomy, parties are free to choose the curial law of arbitration which can have specific provisions for approaching an emergency arbitrator to obtain interim relief. The same does not restrict a party to approach the domestic courts under section 9 of the Act. There is nothing contained in the Act which invalidates the whole process of EA and makes the emergency arbitrator’s order unenforceable. Although, the decision paves the way for facilitating a more business-friendly economy in India and reaffirms the true essence of arbitration i.e. party autonomy, it left the door wide open for interpreting what exact position an emergency arbitrator holds and the technicalities of EA.

    [i] Suraj Sajnani, ‘Emergency Arbitration in Asia: Threshold for Grant and Enforcement of Emergency Relief’ in Arbitration: The International Journal of Arbitration, Mediation and Dispute Management (Brekoulakis ed., 2020).

  • Jurisdictional Defect Beleaguering the Assessment Proceedings under Income Tax Act, 1961

    Jurisdictional Defect Beleaguering the Assessment Proceedings under Income Tax Act, 1961

    By harshita agarwal and raj aryan, third-year and fourth-year students at ms ramaiah college of law, bangalore and llyod law college, respectively

    It is well-settled under Section 232(9)(c) of the Companies Act, 2013, that after a merger between two or more entities, all the legal proceedings in the name of blending entities pending or arising before the effective date of the deal will be enforced against the name of the blended entity. Any legal proceedings initiated against the blending entities individually would be considered void ab-initio. Surprisingly, Income Tax Appellate Tribunal, New Delhi (“Delhi ITAT”) recently in the case of Boeing India Pvt. Ltd (Successor v. Acit Circle- 5(1), New Delhi on 17 August 2020 (“Boeing India case”) came across the same issue wherein the Assessing Officer (“AO”) as per above law erred in taking into consideration that after a merger no legal proceedings can be initiated against the name of blending company which have lost its existence after the merger.                                                                          

    In this blog, the authors critically analyse the issue of whether the jurisdictional defects in the later stages of the proceedings can be remedied under the law in the light of the Boeing India case. Further, the authors analyse whether proceedings under Section 144C of the Income Tax Act, 1961 (“the Act”) can be initiated on the ambivalence of jurisdictional validity of the assessment order.

    Factual Matrix of the Case

    Boeing India Pvt. Ltd.(“BIPL/Appellant”) notified its merger with Boeing International Corporation India Private Limited (“BICIPL”) to the Regional Director. The effective date of this scheme was 15.02.2018. On 10.04.2018 the Appellant apprised the AO that the BICIPL was dissolved and all the legal proceedings after the merger will be initiated or transferred in the name of the BIPL. Further, on 19.10.2018 the Transfer Pricing Officer (“TPO”) under Section 92 CA(3) of the Act drafted an order determining the arm’s length price of the international transaction of BICIPL with its Associated Enterprise in the name of the Appellant. But later the AO issued the draft assessment order in the name of a non-existent company i.e., BICIPL. On appeal to the Dispute Resolution Panel (“DRP”), it turned the deaf ear to the Appellant’s appeal. Aggrieved by the DRP order, the Appellant approached the ITAT Delhi claiming that there exists a jurisdictional defect in the draft assessment order. In this case, the Tribunal strived to discuss whether the jurisdictional defects can be remedied under assessment proceedings of Section 144C of the Act . 

     Understanding the legal anatomy of Section 144C assessment proceedings 

    Firstly, while referring to any issue before DRP, the procedure embodied under Section 144C of the Act needs to comply. Under Section 144C(1) of the Act, the AO needs to frame the draft assessment order in the name of the ‘eligible assessee’. The draft assessment order constitutes the foundational structure before inbounding into further procedural aspects under the Act. For better clarity, it is pertinent to note the definition of the eligible assessee. The definition is under Section 144C(15)(b) in accordance to which an ‘eligible assessee’ is any person whose variation of income or expenses arises as a consequence of the TPO’s order passed under Section 92CA(3). As per the definition outlined above, the eligible assessee before the merger was BICIPL. However, after the merger, it is BIPL. In the instant case, the AO defaulted in addressing the concerned person, thereby causing a jurisdictional defect.

    The DRP obviated that the defect can be remedied in the further proceedings under the Act. However, the DRP’s order under Section 144C(5)  lacked legal standing as firstly, Section 144C(3) specifies that the final assessment order needs to be drafted based on the draft assessment order. Secondly, Section 144C(2) narrows down the order of DRP as according to this sub-section, once the draft assessment order has been framed then the immunity to accept or change it lies in the hands of the assessee only. In other words, the AO’s power to make further changes in the draft assessment order is inhibited. While drawing reference to the above contention, reliance can be placed in the case of Turner International Pvt. Ltd v. DCIT wherein the Hon’ble High Court ruled that failure in complying with Section 144C(1) will make the whole final assessment proceedings void. The act of the AO outbroke the foundational structure of Section 144C, thereby making the entire proceedings null and void.

    Remedying the jurisdictional defect under Section 144C

    In the second contention of remedying the jurisdictional defect under Section 144C of the Act, it is pertinent to ponder over the question of whether all the procedural mistakes can be remedied under the Act. For this, it is necessary to first understand the comparative analysis of jurisdictional defects between the initial stages and later stages of the proceedings. 

    To understand the comparative analysis of the jurisdictional defect between the initial stages and later stages of the proceedings under the Act, it is pertinent to canvass the ruling of Sky Light Hospitality LLP v. Acit (“Sky Light Hospitality LLP case”) to distinguish the procedural matter in the beginning and later stages of the proceedings. In this case, the AO committed a mistake by issuing notice under Section 148 of the Act, under the name of the non-existent company. Based on the above facts, the Delhi High Court ruled that the procedural mistakes at the beginning of the proceedings can be cured under Section 292B, as it does not form the root of the matter. The Delhi ITAT in Boeing India case construed that the Sky Light Hospitality LLP case was distinguishable to the instant case as in the above case the procedural defect happened at the initial stages of the proceedings, thereby not affecting the root of the proceeding. However, where the defect occurs at the later stages of the proceedings, the mandatory requirement to complete the assessment proceedings under Section 144C of the Act is contravened, thus vitiating the final proceedings in-toto.

    In this case, the draft assessment order has not been treated as a mere irregularity but as incurable illegality . The reference to the above can be drawn from the case of The Asst. Commissioner Of Income v. Vijay Television Private Ltd. wherein the court held: “Section 292B of the Act cannot be read to confer jurisdiction where none exists.” Further, the Circular No.179 dated 30 September, 1975 has limited the scope of Section 292B of the Act to rectify the mistakes of notices, the return of income, assessment, summons, or other proceedings only if they are in substance form and do not deviate from the intent or purpose of the Act. The jurisdictional defect is outside the intent of the Income Tax Act, 1961, thereby excluding such defect from Section 292B of the Act.

    In other words, the basis of refusal to remedy the jurisdictional defect lies in the context that Section 292B can be invoked only when there subsists technical irregularity in the order but not in the stance where there exists wrong jurisdiction. Thus, this made it clear that the jurisdictional defect cannot be cured under Section 292B of the Act. 

    Conclusion

    The enforceability of law demands the requisite of valid jurisdiction. To invoke the provisions of any law in India, a person is required to satisfy all the jurisdictional requirements set down by the laws in India. The failure of valid jurisdiction will allow the courts or tribunals to repudiate the validity of any order, plea, petition, or any case. The Delhi ITAT’s stern response to the jurisdictional defect under Section 144C (1) of the Act envisaged that jurisdictional defect cannot be sustained by any court in India. This even implies to all the authorities and regulatory bodies in India. This case had further drawn light on the procedural mistakes in the assessment proceedings that can be cured under Section 292B of the Act and the procedural mistakes in the assessment proceedings that cannot be cured under Section 292B of the Act by differentiating them as procedural mistakes at the initial and later stages of the assessment proceedings.

    The second loophole that subsists in this case was the lack of independence of DRP. The DRP, in this case, intentionally supported the Department Representative in the procedural mistake under Section 144C (1) of the Act even after being acquiescent to the fact that there was a jurisdictional defect in the draft assessment order. This connotes that the DRP overlook the procedural irregularities of the case, which can affect the tax adjudication in India. It is a need of an hour that even DRP should look into technical intricacies of the case before adjudicating any dispute.

  • Sanctity Of Legal Process Vis-À-Vis Maximisation Of Value Under The IBC: A Watertight Case?

    Sanctity Of Legal Process Vis-À-Vis Maximisation Of Value Under The IBC: A Watertight Case?

    BY DEVASH GARG, THIRD-YEAR STUDENT AT VIVEKANAND INSITUTE OF PROFESSIONAL STUDIES, NEW DELHI

    The Insolvency and Bankruptcy Code, 2016 (hereinafter the “Code”) since its enactment has become a routine subject of exchange in the legal community due to its dynamic character. It has proved to be a milestone of the Indian legislature inasmuch as it has successfully improved the Indian insolvency and bankruptcy laws by simplifying and bringing them under one umbrella.

    The Code mandates the creation of a Committee of Creditors (hereinafter “COC”) for managing the transactions of the corporate debtor during Corporate Insolvency Resolution Process (hereinafter “CIRP”). Be it as it may, the Code places its complete faith in the commercial wisdom of the COC for protecting the commercial interest of the stakeholders and as well as for reviewing and selecting the resolution plans (hereinafter R-Plan) submitted by the rival Resolution Applicants (hereinafter “RA”). Even the Insolvency Law Committee reinstated in its report that one of the primary objectives of the Code is to respect the ‘commercial wisdom’ of the COC. However, it has been observed that under the guise of commercial wisdom, ofttimes COC misuse its wide discretionary powers thereby, abusing the due process laid down by law.

    Therefore recently, on 5th August 2020, the Hon’ble NCLAT passed an elaborate order in the case of Kotak Investment Advisors Ltd. v. Krishna Chamadia, where it observed that, while the COC is indeed fully authorised to exercise its discretionary powers in pursuance of its commercial wisdom, however it doesn’t mean that COC has unfettered powers under the guise of its commercial wisdom to instruct the Resolution Professional (hereinafter “RP”) to adopt an arbitrary or an ab-initio illegal procedure or a procedure which violates the principles of natural justice in the conduct of CIRP. The author attempts to analyse the decision of NCLAT along with its implications in the article.

    I. Constitution of COC- steering body of the CIRP

    Though, unlike Part III (insolvency and bankruptcy for individuals and partnership firms), Part II of the Code doesn’t define the COC for Corporate Persons, but harmonious reading of Code’s provisions would give a fair idea about the purpose, constitution, functions, and powers of the COC. Once all the claims of corporate debtor are collated, under s.21(1) of the Code, the Interim Resolution Professional is required to appoint the COC under s.18(c) of the Code. As a general rule laid down under s.21(2), the COC primarily consists only of financial creditors however, if a corporate debtor doesn’t has any financial creditor, then as per Regulation 16 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (hereinafter the “CIRP Regulations”), the COC will consist of, 1) operational creditors, and 2) one representative each, elected by workmen and employees.

    The Code helms the COC as one of the steering bodies of the CIRP. As a result, various provisions of the Code acknowledge the significance accorded to the COC at the different stages of the CIRP.

    The RP is obliged to carry out every act in conducting business of the corporate debtor with COC’s prior approval. More specifically, s.28 of the Code lays down certain decisions which can’t be taken without prior clearance from the COC, like raising interim finance or changing capital structure of corporate debtor etc.  

    The COC remains in the saddle even at the very end of the CIRP. According to s.30(4) of the Code, for a valid approval, the R-Plan must be approved by at least 66% members of the COC. Regulation 39(3) of the CIRP Regulations, while further relying upon COC’s commercial wisdom, provides that the approved plan must have been strictly scrutinised and measured by the COC. And, once the COC approves the R-Plan, the RP becomes bound under s.31 of the Code to place it for review before the NCLT.

    Most importantly, the Code doesn’t subject the COC’s decision of approving the R-Plan to per se judicial review as the NCLT i.e. Adjudicating Authority (hereinafter “AA”) is obliged under s.31 of the Code to approve the R-Plan submitted to it by the RP. It may not grant such approval only on the basis of the limited grounds mentioned under s.30(2) of the Code. Similarly, NCLAT can examine appeals from such challenge only on the grounds mentioned under s.61(3) of the Code. On similar lines, the Supreme Court in the case of Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta and Ors., laid down the doctrine of commercial wisdom and crystallised the law on this point by observing that COC exercises its “commercial wisdom” while accepting, rejecting or abstaining the R-Plans submitted by the RAs to it.

    In this manner, the Code has conferred exclusive access to negotiations and the final hand in taking commercial decisions, to the COC.

    II. Commercial wisdom- “Non reviewable”

    Accruing to this statutory backdrop, Courts have adopted a deterrent approach in interfering with the commercial decisions taken by the COC.

    The Supreme Court in Swiss Ribbons Pvt. Ltd. v. Union of India, while interpreting the Code’s preamble held that; as the fundamental aim of the Code is to revive and run the corporate debtor as a going concern, to balance the interests of all stakeholders, and to maximise the value of its assets, thus, CIRP can’t be at odds with the interests of the corporate debtor. And thus, paramount importance must be given during the CIRP to protect corporate debtor’s interests. In this context, the Court upheld the BLRC report which pegged the financial creditors (who constitute the COC) of the corporate debtor as the most qualified persons to manage and revive the said corporate debtor.

    It is pertinent to mention that the Supreme Court in another case, i.e. in K. Shashidhar v. IOB and Ors., observed certain intrinsic assumptions with regards to COC to explain the Code’s rationale for conferring it wide discretionary powers. The Court said that COC possess requisite expertise to analyse and assess the commercial viability of the R-Plans submitted to revive the corporate debtor and that its decisions are outcome of a thorough commercial analysis of the proposed resolutions based upon assessment, deliberations and voting and thus, judicial intervention in commercial decisions of the COC is barred to ensure completion of the CIRP within the timelines prescribed by the Code.

    In a comparatively recent case of Karad Urban Cooperative Bank Ltd. v Swwapnil Bhingardevay, the Apex Court, while saluting the commercial wisdom of the COC, observed that the decisions taken by the COC under its commercial wisdom are non-justiciable. The Court even remarked that as compared to COC, the NCLT has merely a “hand’s-off” role during the entire CIRP.   

    However, above decisions didn’t involve the issue of sanctity of process of law. These decisions are merely binding on the issue of exercise of “commercial wisdom” of the COC, and not whether the COC has the power to go beyond the process envisaged under the Code and mould it according to its whims and fancies under the guise of its “commercial wisdom”.  

    III. NCLAT’s decision in the instant case

    In the present case, the RP invited expressions of interest (EOI) from the interested RAs after initiation of the CIRP of corporate debtor, i.e. Ricoh India Ltd. After receiving EOIs, the RP issued process memorandum with the express approval of the COC to mandate the last date for submission of R-Plans. Two plans were submitted under the said deadline. Both the plans were opened by COC and discussions started within the COC in respect of these plans. However, after initiation of discussion and lapse of considerable time, the RP accepted two R-Plans which were submitted well beyond the last date of submission without issuing a fresh notice calling for EOIs. Most interestingly, one of these two plans, was approved by the COC as a successful plan and the RP moved an application under s.30(6) of the Code for the approval of AA. At this juncture, the unsuccessful RA (who submitted the R-Plan under the prescribed timeframe), filed miscellaneous application with the NCLT challenging the approval of the said plan.

    The AA clubbed both the matters and rejected the miscellaneous application filed by unsuccessful RA thereby, accepting the application filed by RP for approval of the R-Plan. The AA placed its reliance on K. Shashidar (supra), and held that “the commercial decision of the COC for approval of R-Plan is non-justiciable and hence, is required to be sanctioned by the adjudicating authority.” This decision was challenged by the unsuccessful RA before NCLAT in the instant case.

    The main issues before the NCLAT were 1) whether the RP with the approval of COC, was authorized to accept the R-Plans after the expiry of the deadline for submission of the Bid, without extending the timeline for submission of EOI? and 2) whether grant of approval by the COC to the RP, in accepting the R-Plan after the expiry of the deadline was under the commercial wisdom of the COC?

    In consonance with the jurisdictional bounds laid down in Essar Steel (supra), the NCLAT, while answering both of the issues in negative, described the RP’s act of accepting the R-Plan which was submitted beyond the mandated cut-off date, though, with due approval of COC, as “material irregularity” under s.61(3)(ii) of the Code. The NCLAT held that:

    “The act of the Resolution Professional to accept the R-Plan after opening the other bids, which were all submitted within the deadline for submission of R-Plan cannot be justified by any means and is a blatant misuse of the authority invested in the Resolution Professional to conduct CIRP.”

    It also observed that COC in exercise of its commercial wisdom doesn’t possess the power to authorise RP to “adopt a procedure in the conduct of CIRP which is, ab-initio illegal, arbitrary and against the Principles of Natural Justice.”

    The tribunal went on to remark that the RP with the prior approval of COC is fully authorised to call for fresh invitations of EOIs of R-Plans even after the expiry of last date of submission, provided that such timeline for submission of R-Plan can only be extended by publishing a fresh notice in Form ‘G’ under Regulation 36A of the CIRP Regulations. Lastly, NCLAT clarified that COC can’t accept R-Plans from those RAs who haven’t submitted EOI within the prescribed deadline. The NCLAT finally held that COC, under exercise of its commercial wisdom can’t adopt any special procedure for accepting R-Plan after expiration of the deadline otherwise it would tantamount to vitiation of CIRP.

    IV. Conclusion

    The NCLAT grabbed the opportunity with both hands and indisputably flagged the objectives in the preamble to the Code, which reads as “the objective of the IBC is resolution, in a time-bound manner, for maximization of assets”, and successfully established that the objective of maximisation of value doesn’t supersede the sanctity of the process under CIRP. The objective of maximisation of value of assets of the corporate debtor is intrinsically weaved with the sanctity of process and objective of speedy resolution and hence, must not be put upon a higher pedestal.  This submission gains certitude from the decision of the Supreme Court in the case of ArcelorMittal India Private Limited v. Satish Kumar Gupta, wherein R.F. Nariman, J. said that “it is of utmost importance for all authorities concerned to follow…model timelines as closely as possible”. The decision of NCLAT in the instant case was commendable, for it dealt forensically with the meat of the matter, i.e. collision between maximisation of value and sanctity of law. However, it’s submitted that the Courts must further balance the conflict between maximisation of value and sanctity of process to build a water-tight case in near future by declaring the law on the basis of the objectives and provisions of the Code, the regulations and the BLRC report.

  • Proxy Advisors: A Look at the Growing Intermediary & Increasing Regulations

    Proxy Advisors: A Look at the Growing Intermediary & Increasing Regulations

    BY ABHIRAJ DAS, FOURTH YEAR STUDENT AT GNLU, GANDHINAGAR

    In the past few years, there have been some striking recommendations and red-flags being given by “proxy advisors” regarding corporate-governance of some of the leading incorporates of India. A few instances can be red-flagging the 35-years-long tenure of RIL’s auditors, or recommendation in the Tata-Mistry skirmishes. Very recently, in Crompton-Greeves Power, a huge value depreciation for minority shareholders owing to the issues of corporate governance & conflict of interest of independent director was highlighted.

    What are Proxy advisory firms? 

    Proxy advisory firms are independent analyst offering analysis and voting recommendations to the institutional shareholders and investors. Securities and Exchange Board of India (SEBI) defines proxy advisors as “a person who provides advice in relation to the rights of the shareholders and investors including recommendations on public offer or voting on agenda items.” The term “proxy-advisory” originates from the concept of “proxy voting” where shareholders authorizes other person to vote on his/her behalf, and offer services related to proxy-voting by aggregating-and-standardizing information.

    Roles/impact

    It is a gospel truth that shareholders do not pay much attention to the voting in the AGMs or EGMs. In large public listed companies, public shareholders have relatively small stakes and there remains a collective-action problem and “shareholder-apathy” which lead them to vote as per the vox populi, and institutional investors like mutual funds, banks, DFIs, insurance companies, etc. cannot possibly make an well informed decisions in such voting owing to the huge-number of stocks they handle. Proxy advisory firms (PAF) undertake heavy-data researches and analyse the major agendas which are subjected to voting, providing detailed reports on voting to strengthen the corporate governance within the company.

    The recommendations by these independent and expert firms have tendencies of de-stabilising (or re-stabilising) management and raise corporate governance standard as these advisories may be related to voting against re-appointment of independent directors, auditor’s appointment, M&A and corporate structuring where there seem possibilities that public shareholding might erode, and thus, have become important corporate intermediaries. While proxy advisories in India are still at nascent stage, the American ISS deal with around 44,000 meetings in 115 markets yearly to execute more than 10.2 million ballots representing 4.2 trillion shares. A recent study has shown that around 83% of ‘vote against’ recommendations include mainly “reappointment of non-executive directors” and “remuneration of statutory auditors”.

    Issues concerning the PAF

    In addition to the potentially huge impacts these firms have, there are several downsides as well. Sometimes, simultaneously these firms also offer voting advices to the shareholders of the same companies to whom they provide corporate governance recommendations which leads to conflict of interest. There are conflicts also when the key managerial persons of proxy firms hold important positions in the subject companies. Another major concern is that these advisory firms are not subjected to fiduciary duty to show that their recommendations are in the best interest of shareholders and the corporations. Independent study has shown that ratings used by these firms do not accurately foretell subject’s performance. Further, there have been diametrically opposite opinions on the same issue. Concerns are also there that they sometimes provide distorted recommendations to further their own interests. Another issue is that even when any error is highlighted they have not always been rectified.

    Recent Regulatory Developments in the US

    The Concept-Release of 2010 by the US Securities and Exchange Commission had raised concerns inter alia regarding the influence proxy advisors had over their clients “without appropriate oversight” or “an actual economic stake in the issuer”. Amendments have been adopted by SEC allows investors utilising proxy voting advice to receive “more transparent, accurate, and complete information on which to make their voting decisions.”

    In July 2020, Exchange Act Rule 14a-1(l) has been amended to include if a person (includes entity) offers proxy advises, it shall constitute as “solicitation” under s. 14a and that such persons shall be generally required to file and furnish information regarding definitive proxy statements. Further, paragraph ‘A’ is inserted to Rule 14a-1(I)(1)(iii) clarifying that the terms “solicit” and “solicitation” include any proxy voting advice.

    Addressing the issue of conflict-of-interest, amendment has been made to Rule 14a-2(b) which now obligates that proxy-voting recommendations includes the conflicts-of-interest disclosure specified in new Rule 14a2(b)(9)(i). Further facilitating informed decision-making by the clients of such advisors, a new Rule 14a-2(b)(9)(ii) has been adopted which requires that “proxy voting advice business” adopt and publicly disclose written policies and procedures. This new term provides flexibility to cover future business models which may engage in type of advice the rules aims to address, and does not merely base upon the businesses which presently provide such services. It has also been provisioned that the registrants i.e. the subject companies shall also be provided with the report of the voting-recommendations under Rule 14a-2(b)(9)(ii)(B). Para ‘E’ has been inserted to Rule 14a-9 to define the scope of ‘misleading’ which means “the failure to disclose material information regarding proxy-voting-advice, such as the business’s methodology, sources of information, or conflicts-of-interest.” Adoptions of these amendments addresses the different concerns with the proxy firms.

    Recent Regulatory Developments in India

    SEBI brought SEBI (Research Analyst) Regulations, 2014 within a few years of the advent of the industry in India. The Regulation requires such entities to register with SEBI and lays down internal policy, and also imposes a fiduciary duty to offer detailed disclosures if required. Further, firms must proffer unbiased advice based on reliable information. Under regulation 23, they are also required to disclose the reasoning to the public. An eight-point Code-of-Conduct for firms and their employees has been adduced which broadly covers honesty & good faith, diligence, conflict of interest, insider-trading or front-running, confidentiality, professional standards, compliance, and responsibility of senior management. Recently, SEBI has introduced Procedural Guidelines for Proxy Advisors and Grievance Resolution between listed entities and proxy advisors. These circulars are the result of SEBI Working Group which recommended improvements through disclosures of conflict-of-interests, voluntary best practises, setting up code-of-conduct which are to be followed by proxy advisors on “comply or explain” basis. One of the remarkable procedures required is that the firms must also share the recommendation to the subject company as well and to include company’s response thereto as addendum. This will allow subjects to clarify on any aspect which it considers have not been completely regarded while extending the proxy recommendations.

    It is very much evident that the circulars issued by SEBI are similar to the US SEC issued Rule Amendment for Proxy Voting Advice 2020 in various terms such as affording subject companies a copy of the recommendation, client access to company response, conflict of interest disclosure norms, etc. However, given the fact that Indian industry for proxy advisors is still at nascent stage, and the US market is relatively aged, it was prudent only on the part of the regulator to consider the US model. The advisory firms are required to disclose the recommendations on their website and are mandated to devise policies for voting advices including the situations when voting-recommendations are not to be offered. These policies are required to be reviewed at least once a year.

    It is pertinent to note that there is no specific mention about foreign proxy-advisory-firms in either of the circulars, thus it will be interesting to observe how the code-of-conduct, as was recommended by the Working Group, are applied to them. Another interesting aspect is that compulsory disclosures of revenue models, key income-sources, clientele have not been provisioned. Since there is a possibility of conflict-of-interest in situations where the firms may retaliate against the incorporates who didn’t avail their services by way of aggressive advices to their clients, though proxy advisors are required to disclose and mitigate any “potential” conflicts, the disclosures of the clientele could have offered reassurance against such recommendations. However, in case of any grievance the listed entities are at liberty to approach SEBI which shall investigate the matter considering non-compliance with regulation 24(2), which provides for Code-of-Conduct, r/w regulation 23(1) of SEBI (Research Analyst) Regulations, 2014 or the procedural guidelines circular recently issued. If any contravention is established, it can lead to inter alia suspension/cancellation of the registration under SEBI (Intermediaries) Regulations, 2008.

    Conclusion

    Shareholder’s votes have the potential of wide consequences on corporate decisions and governance of a company which in turn affects the market and economy ultimately. Therefore, there lies a fiduciary responsibility upon the institutional investors, who represent large number of shareholders, to vote in the best interest, and attributes a huge relevance to the recommendations made by the proxy-voting advisors. The extensive impact such recommendations may have and the possible conflict-of-interest which may arise are the major reasons for regulating these proxy-advisors.

    Having higher standards of transparency and oversight will certainly enhance the quality and credibility of this intermediary. These various aspects would require that investors take the ultimate decision based on the proxy advices and the company’s responses thereto, which would lead to more-informed exercise of voting rights and at the same time ensure that proxy advisors do not ‘control’ the voting. This sector needs nurturing at the hands of regulators & this could prove to be a major step. But time will only tell how these rules perform.