The Corporate & Commercial Law Society Blog, HNLU

Author: HNLU CCLS

  • Navigating Uncharted Territories: ICSID Tribunal’s Power to Remove Counsel

    Navigating Uncharted Territories: ICSID Tribunal’s Power to Remove Counsel

    BY AARyA PARIHAR, THIRD-YEAR STUDENT AT RMLNLU, LUCKNOW

    Introduction

    The role of a lawyer is extremely crucial in an arbitration proceeding. The right to effective legal representation of one’s choice is recognized explicitly in various international instruments, like Article 14 of the International Covenant on Civil and Political Rights and Article 6 of the European Convention on Human Rights. Such a right is equally essential in investor-state arbitration proceedings, where it may form part of the due process expectations of the parties to the proceedings with serious transgressions from the principle, even potentially constitute a ground to challenge the award itself. The ICSID Convention, Rules, and Regulations do not expressly address the authority of ICSID Tribunals to permit the withdrawal of legal counsel or to compel their continued participation in the proceedings (against their wishes). This post discusses the authority of ICSID Tribunals to exclude or require the presence of particular counsel in a dispute. The post then discusses the existing arbitral decisions on this issue to examine the contours of ICSID Tribunals’ powers concerning these matters.

    Do ICSID Tribunals Have the Power to Remove/Exclude Counsel?

    ICSID Tribunals are formed to resolve treaty disputes between contracting parties. Every dispute has its own Tribunal with separate procedural rules that disputing parties agree on. Arbitration’s inherent nature of being party-centric, where parties’ autonomy is given primacy, leads to divergent procedural practices. Additionally, the non-binding nature or lack of precedential character of ICSID awards over other ICSID Tribunals leads to differing awards. Thus, it is essential that before moving to ICSID Tribunals, assistance shall be taken from the federal courts of the United States, who have often used their power to decide upon the issue of counsel resignation.

    The U.S. Court in May v. Seibert enquired about the existence of good cause, which depends upon the facts and circumstances of every case. Simply put, there is no straitjacket formula to when a counsel can legally stop their representation. It largely depends upon the peculiar factual matrix of every case and the application of mind by the judge presiding over it.

    In the realm of ICSID, only a few Tribunals were called upon to decide upon the issue of counsel resignation or removal of counsel. Five publicly available awards are from the Hrvatska Tribunal, Rompetrol Tribunal, Edmond Khudyan Tribunal, Fraport Tribunal, and Theodore David Einarsson Tribunal. These five orders from five different Tribunals delve into the removal of counsel. In all these five decisions, the Tribunal found its power to remove counsel under Article 44 of the ICSID Convention, providing residuary power to the Tribunals. It empowers the Tribunals to decide upon any question of procedure which is not explicitly covered under the ICSID Convention, Rules, and Regulations.

    Due to the heavy amount of cross-referencing/quoting done in these decisions, discussing them separately and conjointly is essential. The post attempts to cull out only the important dictum from these decisions, which is required to facilitate analysis in the present article.

    Hrvatska Tribunal

    In the Hrvatska award, the removal of counsel was warranted because of his apparent connection with one of the arbitrators, which might have caused bias. The Tribunal found that the right to effective representation is pitted against the right to effective and unbiased proceedings. After due deliberation, the Tribunal found itself empowered to rule on this issue by virtue of Article 44 of the ICSID Convention.

    Rompetrol Tribunal

    The Respondent in the Rompetrol decision cited the Hrvatska decision as the sole authority to bolster their argument regarding ICSID Tribunals’ authority to exclude counsel from the proceedings. The Tribunal found it has inherent power to exclude counsels under Article 44 of the ICSID Convention but refused to exercise the same in the present dispute. According to this Tribunal, this power should only be used in exceptionally uncommon circumstances where the integrity of the whole proceeding is in question/dispute.

    Edmond and Fraport Tribunals

    In the decision rendered in the Edmond dispute, the Tribunal reiterated that it has the power to exclude the participation of counsel under Article 44 of the ICSID Convention. In this case, both parties agreed to this power of the Tribunal without any disagreements. The Tribunal again emphasized using this power sparingly and only in certain circumstances. It should be used only to protect the proceedings’ integrity and fairness and to ensure the parties’ equality. The Tribunal heavily quoted from the Fraport decision, reaching a similar conclusion. The Fraport Tribunal also imposed the necessary contours of “ensuring fair conduct of the proceedings” while exercising its power under Article 44 of the ICSID Convention.

    Theodore Einarsson Tribunal

    Another crucial decision in this aspect is of the Theodore Einarsson Tribunal, where the Tribunal while deliberating on the removal of a counsel, outlined that the ICSID Tribunals do not have the power to police the compliance of counsels with their deontological or ethical mandates imposed by any local code/rule. These ethical constraints are generally introduced by a local code governing the professional conduct of the lawyer practicing thereof. They include the duty to not discontinue representation without a good cause or the commitment to confidentiality. It reasoned that since the removal of counsel attacks the core of the fairness of proceedings, it is a mandate of the ICSID Tribunal.

    The Contours of the Power of ICSID Tribunals to Control Representation of Counsels

    The Tribunals in all the above-quoted disputes have reasoned that the power to remove counsel is exercised to ensure the fairness and integrity of the proceedings. In both the decisions in Fraport and Theodore, the Tribunals refused to look into the counsel’s deontological or ethical mandate. They found it outside the purview of their authority and a question that is to be decided by local or regional courts.

    It can be understood that the ICSID Tribunals have been reluctant to rule on anything else apart from simply the participation of a counsel. The Author believes that the power to exclude includes the power to retain counsel by overriding the parties’ choice. In simpler words, there are instances where the Client/Party does not want their counsel to continue. The Tribunals have the power to order the continuation of their representation against the party’s wishes. One crucial aspect is the conditions or situations where a counsel can be removed from the ongoing proceedings.

    Ruling on Counsel’s request for removal

    The five above-referenced awards do not concern any situation where the Tribunal was required to address a counsel’s request to resign. Almost all of them had some bias or conflict between the challenged counsel and an arbitrator. There may arise a situation where the counsel wishes to resign, whether voluntarily or per the desire of either party that wants their counsel to discontinue representation. In these scenarios, as already stated, the courts generally use their wisdom to decide based on every case’s peculiar facts and circumstances.

    Generally, counsels decide to withdraw their representation when there is a breakdown of any attorney-client relationship. Simply put, it is when the attorney has lost faith in his client and their case or vice versa. It is broken down to such an extent that the representation would only harm the client’s case. Also, it is essential to note that the withdrawal should not cause undue or unreasonable delay to the proceeding. This also means that there should be no prejudice caused to parties involved by the ‘withdrawal of a counsel’.

    In the Jean-Boscotrial, the International Criminal Tribunal (hereinafter “ICT”) for Rwanda denied withdrawal/replacement of counsel because of the possibility of undue delay in the proceedings that would cause prejudice to the parties. It was highlighted in the Jean-Bosco decision that new counsel needs to acquaint themselves with the facts, documents, and figures of the existing case. Sometimes, this process of getting acquainted with everything also causes an undue delay in the proceedings, and the Courts have rejected the withdrawal for this reason of delay. This similar reasoning was also employed by the ICT for Rwanda in the Jean-Bosco Trial to decide on dismissing the withdrawal/replacement of counsel.

    Suggestions and Conclusion

    There is an apparent dearth of awards and decisions by ICSID Tribunals on the issue of counsel withdrawal/exclusion. The available awards reiterate the similar reasoning applied by the Tribunals in every dispute. There seems to be a well-founded reluctance by ICSID Tribunals to adjudicate over counsel’s withdrawal or exclusion with full vigor. ICSID Tribunals are constituted mainly to resolve the dispute between investors and States. The contours of a Tribunal’s powers are well-defined in the ICSID Convention, Rules, and Regulation. Thus, the Tribunal finds itself in a quagmire or conundrum where the chances of overreach exist. In light of various awards highlighted in this article, it is abundantly clear that the ICSID Tribunals have discovered their inherent power to decide on any question of “procedure” of the dispute flowing from Article 44 of the ICSID Convention. Issues of counsel’s conduct and obligations are not the mandate of ICSID Tribunals. If the Tribunals are given unfettered power to decide upon the issue of counsel’s ethical obligations, it will open a floodgate of fresh proceedings and further cause delay. This would defeat the purpose of arbitration proceedings, where the primary aim is to promote expediency and efficiency.

    If a further step could be taken, the ICSID Convention should insert an explicit provision defining the power of its Tribunals to decide upon the issue of counsel resignation/removal in cases of apparent bias/conflict with the arbitrator or irrevocable breakdown of attorney-client relationship. To develop their contours or limits, the Tribunals may take assistance from decisions of local courts and international tribunals where the issue of counsel resignation has been discussed in length.

  • Arbitral Tribunal’s Powers To Grant Interim Measures Affecting Third Parties: Still At Crossroads?

    Arbitral Tribunal’s Powers To Grant Interim Measures Affecting Third Parties: Still At Crossroads?

    BY PRIYANSHI BHAGERIA, FOURTH-YEAR STUDENT AT RMLNLU, LUCKNOW

    Introduction

    Section 17 of the Arbitration & Conciliation Act 1996 (‘Act’) empowers the Arbitral Tribunal to grant interim measures during the arbitral proceedings. The phraseology of Section 17 is similar to Section 9 of the Act, which grants similar powers to the courts. Both the sections are similar in the sense that they not only deal with the grant of interim measures, although at different stages, but also the orders passed under the respective sections are deemed to be court orders and shall be enforceable in the same manner. 

    One major question that is a subject of repeated discourse is whether the tribunal has the power to grant measures affecting the rights of the third parties since a similar power is often exercised by the courts under Section 9. In this context, it is important to examine if there is a difference in the scope of the powers under both these sections. 

    This article analyses the bare provision and tries to establish that the Tribunal has powers that are at parity with a civil court and are to be governed by the Civil Procedure Code, 1908 (‘CPC’). Further, the effect of the conversion of Section 9 applications to Section 17 applications is dealt with by the author to make a case for the power of the Tribunal to grant interim measures affecting the third parties. Lastly, the article highlights the applicability of the group of companies doctrine and the necessity to grant such a power to the Tribunal. 

    Nature & Scope of Section 17

    A reading of Section 17 suggests that the Tribunal has powers to grant interim measures like interim injunctions, appointment of receivers, appointment of guardians, etc. The powers of the Tribunal are wide and the same can be gauged from Section 17(1)(ii)(e) which empowers the Tribunal to grant any other measures, apart from the ones enumerated in the provision, that it deems just and convenient. Despite the wide ambit of powers, the primary argument against the applicability of Section 17 with respect to third parties is that it is a creation of an express contract between two parties and the tribunal hence cannot pass orders affecting the rights of the third parties. However, this argument cannot be seen in isolation. 

    It is important to note that there is a reference under this section about the powers of the tribunal being akin to that of a court while granting interim measures. It is significant to highlight that such a mention was specifically made by the Arbitration and Conciliation (Amendment) Act, 2015, highlighting the unambiguous intention of the legislature. Moreover, Section 17(2) states that an order under this section is deemed to be a court order and would be enforceable under CPC. In Pearl Hospitality & Events Pvt. Ltd. v. OYO Hotels and Homes Pvt. Ltd., the Delhi High Court held that the principles governing Order XXXVIII Rule 5 would be applicable, while considering a prayer for furnishing security, under Section 9 or Section 17.  In another case, Navtrip Implementation Society v. IVRCL Ltd., the Delhi High Court observed that the object of Section 17 of the Act is similar to that of Order XXXVIII, Rule 5 of the CPC, and therefore its conditions have to be kept in mind while passing orders under Section 17. This shows that the principles of CPC govern the powers of the Tribunal despite there being resistance regarding the same. Hence, it is absurd to assume that some principles of CPC which grants inherent powers to the courts to grant interim measures affecting the rights of third parties will not be applicable while some mentioned above would still continue to guide the proceedings under Section 17. It is important to clarify that a blind application of all the existing principles of CPC is not desirable. However, unsubstantiated exclusion of these specific principles raises concerns and leads to adverse repercussions for the parties as explained further in the article. 

    Furthermore, Section 28(1)(a) of the Act states that the tribunal shall be bound by the substantive law of India in case of domestic arbitrations. In a number of cases, the Indian courts have enumerated general principles of granting interim measures and the same would apply to the Tribunal by virtue of it being a part of the substantive law of India.

    Therefore, the nature of the power under Section 17 is guided by the principles of CPC and is placed at a similar stature to that of a court. 

    Practice of Converting Section 9 Applications into Section 17 Applications

    Secondly, it is important to highlight a practice of the courts while dealing with an application under Section 9. In a catena of cases, the courts have converted an application under Section 9 to an application under Section 17 once the tribunal has been constituted. If we have a look at the data of the years 2022 and 2023, a significant number of applications filed under Section 9 before were converted into an application under Section 17 by various High Courts. 

    Court YearTotal Number of Applications Filed u/s 9 of the ActNumber of Section 9 Applications converted to Section 17 Applications
    Delhi High Court202240076
    Delhi High Court2023 (till May)18923
    Mumbai High Court202221824
    Mumbai High Court2023 (till May)532

    A bare look at the data might suggest that the number of Section 9 applications converted to Section 17 applications is only a small proportion. However, one must consider that even if the number is not compelling enough, the data indicates a practice which is prevalent. And the repercussions of such a practice are borne by one of the parties who is ultimately rendered remedy less. This also points to the fact that this practice which is supposedly ‘pro-arbitration’ can infact disincentivise arbitration if the Tribunals are not given powers at parity with the courts.

    The prayer under that Section 9 application which is now being converted to a Section 17 application before the Tribunal remains the same. It is impractical to assume that the Tribunal would not have the authority to grant measures at parity with the Court in the same prayer which is now to be dealt with by the Tribunal on the direction of the Court itself. For example, a prayer may pertain to custody or sale of the goods which are subject matter of the arbitration agreement and could include situations where the goods are in the possession of a third party. In such a scenario, the conversion of the Section 9 application to a Section 17 application would cause prejudice to the parties. 

    Moreover, if we were to assume that the powers of the court and the Tribunal are uneven, this conversion would disincentivize the constitution of the Tribunal. The parties would prefer applications under Section 9 or under the allied provision of CPC to an application under Section 17, where the Tribunal’s power is limited. This would create a lacuna and would defeat the purpose of the Act, i.e., to facilitate arbitration.

    Group of Companies Doctrine: Its Effect on Section 17

    Although the final verdict on the applicability of the group of companies doctrine by the Apex Court in Cox and Kings Ltd. v SAP India Pvt. Ltd. is awaited which would give more clarity, it is nonetheless important to analyze the position with regard to the Tribunal’s power under Section 17 affecting the rights of non-signatories. 

    The Supreme Court in cases, such as Chloro Controls (I) Private Limited v. Severn Trent Water Purification Incorporated, Ameet Lalchand Shah v. Rishabh Enterprises, and Mahanagar Telephone Nigam Limited v. Canara Bank, has acknowledged the multi-layered and complex nature of transactions in today’s times and has allowed that in certain exceptional situations, even non-signatories to an arbitration agreement could be referred to a composite arbitration proceeding and could be bound by the award. 

    There is still an absence of consensus with regard Tribunal’s powers under Section 17. This absence of consensus has resulted in courts giving conflicting judgments on the same issue. For example, in Prabhat Steel Traders Pvt. Ltd. v. Excel Metal Processors Pvt. Ltd., the Bombay High Court recognized that the interim orders passed by the Tribunal under Section 17 may affect non-signatory third parties in a direct or indirect manner. However, the same court in Bombay Slum Redevelopment Corporation Limited v. Samir Narain Bhojwani held that a Tribunal passing interim orders against a third party would be overstepping its jurisdiction under Section 17. 

    While ascertaining the Tribunal’s power in this context, the legislative intent must also be considered. Before the 2015 Amendment, Section 8 used the word ‘party’ which was replaced by ‘a party to the arbitration agreement or any person claiming through or under him’. This broadens the definition of party to make space for non-signatories. Hence, the complex nature of today’s transactions must be seen a reason enough for the Tribunal to exercise powers under Section 17 to grant measures that might affect the rights of the third parties.

    Conclusion

    Therefore, it is evident that there is a need to expand the powers of the Tribunal under Section 17 so as to grant interim measures that may affect the rights of the third parties. In order to incentivize arbitration, the Tribunal must be given such power to ensure that the measures granted can be practically executed which is only possible when the Tribunal has the liberty to include third parties. Even if there is no concrete provision establishing this power of the tribunal, the same should be seen in the context of the above arguments and the need of the hour. The courts must formulate guiding principles in this regard and the same must be allowed, even if it is only limited to exceptional circumstances. 

  • Shareholder Intervention in Resolution Proceedings: A Potential Misinterpretation of IBC 2016

    Shareholder Intervention in Resolution Proceedings: A Potential Misinterpretation of IBC 2016

    BY YADU KRISHNA PALLIKKARA, FOURTH-YEAR STUDENT AT SYMBIOSIS LAW SCHOOL, PUNE

    Introduction

    Recently, in Dr. Ravi Shankar Vedan vs. Tiffins Barytes Asbestos (Tiffins), the shareholder of a corporate debtor sought an appeal for two interlocutory orders of the adjudicating authority. First of which was an application seeking a forensic audit of the books of accounts of the corporate debtor and the second regarding approval of resolution application under Section 30 (6) of the Insolvency and Bankruptcy Code (Code). The court dismissed the shareholders’ objections and clarified that shareholders have no locus standi to challenge the resolution plan initiated against the corporate debtor. 

    The post aims to analyse the rationale employed by the court in denying locus standi to the shareholders. It offers a critique of the tribunal’s decision by first, expounding on the concept of shareholders as “persons aggrieved” under Section 61 of the Code . Second, it analyses the interpretation of Section 30(2) of the Code  related to deemed approval and the existing legal position surrounding it. It concludes by advocating for a nuanced approach that protects shareholders’ legitimate concerns while maintaining the effectiveness of the insolvency resolution framework.

    Shareholder as a person aggrieved 

    Herein, the Hon’ble National Company Law Appellate Tribunal (NCLAT) held that the shareholders have no locus standito challenge the resolution plan at any stage, by reasoning that Section 30(2) of the Code provides for deemed approval by shareholders of the corporate debtors, which cannot be taken away by objecting to a resolution plan. 

    Similarly, in Nirej Vadakkedathu Paul & Ors v. Sunstar Hotels and Estates Pvt. Ltd. & Ors  (McDowell Holdings), the NCLAT Chennai denied locus to shareholders who challenged the Corporate Insolvency Resolution Process (CIRP) initiated against the corporate debtor in which they held majority shares.  It forms a part of a catena of judgements, including ICP Investments v. Uppal Housing, Punit Garg vs. Ericsson India Pvt. Ltd., and Anant Kajare vs. Eknath Aher, denying locus standi to shareholders in CIRP proceedings by reasoning that shareholders cannot be aggrieved by initiating CIRP against the corporate debtor, as such interventions in the name of derivative action can render the entire process futile. Accordingly, the contesting parties can only be the financial creditor or the corporate debtor as represented by the Interim Resolution Professional.

    These judgements seemed to altogether overlook the true intention of Section 61 (1) and Section 61 (3) of the Code . While Section 61 (1) provides for “any person aggrieved” by an order of the Adjudicating Authority to prefer an appeal to the NCLAT, Section 61 (3) provides the grounds under which such appeals can be set out, allowing for resolution plan to be challenged for the first time in the appellate stage. While it does specifically identify those who may file an appeal, it sets out that any person aggrieved under Section 61(1) can initiate a proceeding challenging a plan approval order, and shareholders shall come well under this meaning. On a combined reading of both provisions, it is in no way anticipated to exclude shareholders from the meaning of “aggrieved persons,” as that would be a clear injustice and in effect a narrowing of the scope of Section 60 (1).    

    While in McDowell Holdings, the shareholders were denied locus by citing a lack of statutory backing for shareholders ability to challenge a CIRP process and such frequent derivative actions being against the efficiency and purpose of the Code, the court in order to reach its decision had expounded Section 61 (1) of the code. It stated that under Section 61 (1) of the Code, any ‘person aggrieved’ by the order of the Adjudicating Authority may prefer an appeal to the “NCLAT”. The definition of ‘person’ as provided under Section 3(23) of the Code includes ‘individual’, which is a term wide enough to encapsulate ‘shareholders’ within it. This clarifies that while interference from shareholders are generally not preferred, the Code in no manner intends the deprivation of their representative capacity in insolvency proceedings as held in the case of Tiffin’s. 

    In Ashish Gupta v. Delagua Health India Private Limited, the court held that the majority shareholders of a company have the right to challenge the admission of CIRP against the corporate debtor when the admission arose out of collusion among the creditors. It is an example of when courts have considered the specific circumstances demanding intervention by the shareholders and dealt with the same on merits. It proves that shareholder intervention may not always be against the efficiency and purpose of a resolution process under the code and can help in identifying irregularities’ and illegalities in the resolution plan,  aiding in the successful revival of the corporate debtor.

    Also in Tiffins, by interpreting Regulation 2(k) of the Liquidation Regulations 2016, the court held that shareholders who come under the category of ‘stakeholders’ are only recognised in the liquidation process and lack representative capacity in the CIRP. But, according to the same logic, other stakeholders of the corporate debtor such as directors or creditors, can be denied representative capacity by categorizing them as “shareholders” and their consent deemed to be approved, which is totally unwarranted under the code.

    Blurred lines of Deemed Approval and Locus Standi

    Deemed approval of a resolution plan finds no backing in the Code. Under Section 30(2) of the Code, the Resolution Professional (RP) has to ensure that the resolution plan to be submitted meets certain requirements. Under clause (e) of the provision, the RP shall ensure that the plan submitted does not contravene any law in force. The explanation to it provides that the shareholder approval required under the Companies Act, 2013, or other relevant laws for the implementation of the resolution plan is deemed to have been given, provided it is valid and not in contravention of that Act or law. 

    Through Tiffin’s judgement, court has interpreted this explanation of clause (e) as a mechanism of ‘deemed approval’, allowing actions under the resolution plan requiring shareholder approval to have been automatically approved, and more importantly, holding that shareholders have no locus to challenge or object to it. Similar subscription to the deemed approval doctrine can be seen in cases including Jaypee Kensington Boulevard Apartments Welfare Association. vs. NBCC (India) Ltd., DMI Finance Pvt. Ltd. v. Abloom Infotech Pvt. Ltd., Airro Holdings v. Abhilash Lal,  Mr. Keshav Agrawal  Vs. Abhijit Guhathakurta where the courts have rooted their reasoning to the explanation of Section 30 (2) (e) of the Code.

    The courts have overlooked the fact that the explanation was intended solely to facilitate actions that typically need shareholder approval under laws like the Companies Act, such as capital reductions or director appointments, without requiring specific approval for each. It wasn’t meant to cover the entire resolution plan but only those actions needing shareholder consent, and it cannot be used to oust the shareholder’s locus on all matters concerning the CIRP. The MCA notification of 2017 also clarified that the approval mechanism applies only to specific actions required for the implementation of a resolution plan as required under the Companies Act 2013 or any other law in force.

    Shareholders should be allowed to voice concerns about other aspects of the plan, such as illegality, procedural irregularity, or actions harming the company or the public interest, which do not require shareholder approval. [AM7] The same has been clearly set out under Section 60 (5) (c) and Section 61 (3) of the Code, the former of which provides that the Adjudicating authority is empowered to hear any question of law or facts arising in relation to the insolvency resolution of the corporate debtor. The latter provides that any person aggrieved may appeal against an order of the Adjudicating Authority approving a resolution plan, in the circumstance it contravenes the provision of law or if there is material irregularity in the powers exercised by the resolution professional. The provisions can be seen to have been deployed by shareholders to resolve their concerns in various cases including Synergy Technologies vs Parthiv Parikh and Dr. Periasamy Palani Gounder vs Mr. Radhakrishnan Dharmarajan. 

    Conclusion

    In the landmark case of Swiss Ribbons v UOI, the Supreme Court had held that the Code is a beneficial legislation that is aimed at putting the company back on its feet rather than being mere recovery legislation for the creditors. Such an effort to recoup the company requires adequately tending to all the stakeholders involved, including the shareholders of the corporate debtor. While sources such as the Bankruptcy Law Reform Committee Report of 2015 hints that the Code aims at a complete reduction of share capital and the shifting of control to creditors, the mechanism of ‘deemed approval’ of the shareholders and depriving them of representative capacity is not envisaged under the code.

    There is no contention as to the fact that the resolution plan is generally binding on the shareholders post-approval under Section 30(6) and that those shareholders challenging the plan for malicious and vindictive reasons shall not stand strict judicial scrutiny under Section 61(3) of the Code. However, there is no reasonable explanation to prohibit them from challenging the plan for bona fide reasons. 

    Such a blanket decision denying locus to shareholders on all and any matters of Code is unwarranted and can bring in uncertainty considering the concerns that the shareholders can face during a CIRP, including procedural irregularity or illegality in the resolution plan as seen in DHFL’s case  or unfair treatment of shares of the company in the resolution plan as seen in Sintex Industries Case . SEBI had issued a consultation paper in November 2022 proposing protection to minority shareholders of companies undergoing resolution. If the position as laid out in the case of Tiffin’s is maintained, such protections shall be rendered redundant, putting shareholders in a vulnerable position. Given these circumstances, it is imperative that the code does not restrain shareholders from raising their grievances, and the courts may hear the instances and decide on the merits of the case and the degree and reason for such intervention. This will aid in balancing the interests of relevant stakeholders and help in an effective and successful revival of the company. 

  • Unlocking Competition Law For Public Sector: Challenges & Prospects

    Unlocking Competition Law For Public Sector: Challenges & Prospects

    BY ANOUSHKA ANAND AND MD. HASHIR KHAN, FOURTH-YEAR STUDENTS AT NLU, JODHPUR

    Introduction

    India’s journey towards industrialization began in the mid-20th century, shortly after gaining independence from British colonial rule. The country sought to reduce poverty, promote self-sufficiency, and enhance economic growth. The establishment of Public Sector Undertakings (PSUs), thus, became a cornerstone of India’s planned development strategy, which aimed to harness and channel resources effectively for national development. Since then, PSUs have been instrumental in the development of strategic sectors such as defense, energy, telecommunications, and transportation. These sectors are crucial for national security, self-sufficiency, and infrastructure development. Examples include Bharat Heavy Electricals Limited in the power sector and Bharat Electronics Limited (BEL) in defense electronics. PSUs have also aided in regional development – Oil and Natural Gas Corporation is a prime example of a PSU that has contributed to the development of several regions in India through its oil exploration and production activities.

    After the enactment of the Competition Act 2002, which aimed to prevent anti-competitive practices and maintain a level playing field in the market, anti-trust scrutiny was made applicable to PSUs and private entities alike. However, under Section 54, the act provided for an exemption for activities related to sovereign function and allowed the central government to exempt the act, by notification, for enterprises performing a sovereign function or if such exemption is necessary for the public interest. Despite this, the application of the act to PSUs has not been smooth, with various concerns regarding the definition and demarcation of ‘sovereign function’ and ‘non-sovereign function’. The recent Supreme Court ruling in Coal India, however, settles the dust to an extent, when it comes to implementation of the act to PSUs.

    The Supreme Court Ruling

    The case arose when the Competition Commission of India (CCI) fined Coal India Limited (CIL) ₹591.01 crore for imposing unjust and discriminatory terms in fuel supply agreements (FSAs) with power producers for non-coking coal. In essence, CIL was found to provide lower-quality essential resources at inflated prices, along with unclear conditions in the contract regarding supply standards and quality. The regulator argued that Coal India and its subsidiaries operated without market competition and held a dominant position in the Indian non-coking coal production and supply sector. CIL contended that it bases its operations on the ideas of advancing the common good and making sure that coal, a crucial natural resource, is distributed fairly. Further, it argued that it uses differential pricing to encourage the production of captive coal with the aim of preserving the greater functioning ecosystem and pursuing welfare goals. The court, however, took a two-tier approach to reject the contentions of the appellants in this case. Firstly, it delved into Section 2(h) of the Competition Act to investigate if CIL fell within the definition of “enterprise” which is defined as a “person or a Department of the Government who or which is, or has been, engaged in any activity, relating to the production, storage, supply, distribution, acquisition or control of articles or goods, or the provision of services, of any kind”. The court held that CIL would fall into the category of a person since the term includes a company or a corporation under Section 2(i). Further, under Section 2(i) the term goods includes products manufactured, processed, or mined, thus the court concluded that there is no doubt that the appellant is a person, who is engaged in activity relating to production, storage, supply, distribution, and control of goods. Secondly, the court analyzed Section 2(h) to see if CIL fit within the exception carved out under the provision– the same being an activity of the government related to sovereign function. It went on so far as to say that what is excluded from the act is a government department performing sovereign functions and not a government company. Following this, the court concluded that carrying on business in mining, cannot, by any stretch of imagination, be described as a sovereign function.

    Implications

    The judgment’s pivotal advantage lies in its recognition of the paramount importance of competition in driving efficiency and fostering performance improvements within state monopolies and Public Sector Undertakings. By subjecting these entities to the purview of competition law, the market environment is revitalized, thereby cultivating a culture of innovation, cost optimization, and enhanced service delivery for consumers. This measure not only instills healthy competition but also stimulates these entities to evolve and adapt to changing market demands, ultimately benefitting the broader economy. Further, the endorsement of divestment and privatization by the court is a welcome move since if PSUs are subjected to market-driven pressures, they are compelled to streamline their operations, reduce inefficiencies, and elevate the quality of goods and services provided to consumers.

    However, at the same time, the judgment’s accentuation of competition and efficiency may have inadvertent ramifications on general welfare schemes provided by PSUs. As these entities grapple with the imperatives of competition and profit optimization, there is a prospect of diverting focus from welfare objectives to revenue maximization. For example, a government-owned telecom service provider offering reduced tariffs for rural areas to ensure connectivity for all citizens might start to focus on more lucrative urban markets, potentially neglecting the expansion and maintenance of services in remote or less profitable regions, impacting connectivity and communication access for marginalized communities. The complexity further deepens when considering turnover calculation, a fundamental aspect in assessing the applicability of enforcement mechanisms. Unlike private enterprises, PSUs often operate in sectors with complex interdependencies and cross-subsidization, making the calculation of turnover more intricate. When it comes to sanctions, traditional mechanisms might not be as effective for PSUs. Turnover-based fines, a common approach in competition enforcement, might prove cumbersome to compute given the intertwined roles of PSUs in both economic and social spheres. Additionally, monetary penalties might not effectively deter anti-competitive behavior if the financial burden is borne by taxpayers, diverting from the intended purpose of competition enforcement.

    Unsettled Concerns

    While the debate has been settled to an extent, it is still unclear as to what other activities would be qualified as “sovereign functions” other than those dealing with atomic energy, currency, defense and space. Additionally, Section 54 gives the Central Government powers to exempt an enterprise in the name of public interest – however, there is a lack of specific guidelines as to what comprises “public interest” and to what extent can these enterprises be exempted. In the absence of specific guidelines, the act bestows a wide discretion to the government which could be easily misused and exposed to subjective interpretations. Furthermore, exceptions must be defined to encompass a wide range of essential services, such as government-delegated water supply to economically disadvantaged or remote regions.

    A Way Forward

    There needs to be legislative changes to address the aforementioned concerns and to clear ambiguity regarding the extent and scope of competition law on PSUs. A solution could be the introduction of a public interest assessment mechanism that allows competition authorities to consider the broader public welfare implications when evaluating the competitive conduct of PSUs. This assessment should involve weighing the benefits of competition against the potential adverse effects on public services, national objectives, or other social and economic factors. An example of balancing the applicability of competition law on PSUs or State Owned Enterprise (SOEs) and public interest can be taken from the Italian Competition Authority’s (ICA) decision on breaches of competition rules by Ferrovie dello Stato (FS), the Italian incumbent railway undertaking. While the authority qualified the conduct of FS as a serious competition breach, it levied on it a competition fine of a negligible amount, relying on a special provision that allows the authority to impose the fine of a symbolic amount in certain circumstances. In this case, the authority considered the economic efficiencies and public welfare due to the long-awaited electrification of the Bulleno link as a strong factor for the minimal fine imposed.

    Further, it is time to consider a strict demarcation between the social and commercial functions of Public Sector Undertakings. In essence, this proposition advocates for a deliberate separation of roles that PSUs undertake in the realms of social welfare and commercial enterprise. While PSUs historically embraced multifaceted responsibilities, the interplay of competition law and changing economic landscapes necessitates a refined approach. By delineating their functions, much like the distinct poles of a compass, PSUs can navigate the course more effectively, shedding the inefficiencies that stem from blurred roles and curbing the rampant issue of free-riding. A cardinal benefit of demarcation is the enhanced accountability it ushers in. With delineation, PSUs are better equipped to define their objectives and allocate resources accordingly. This crystallization of purpose not only simplifies governance but also paves the way for enhanced transparency, making it easier to track performance against set goals. Additionally, the separation of roles allows for a more precise evaluation of how PSUs interact with markets and whether their actions may have adverse consequences on competition. For instance, when the social and commercial functions are distinct, it becomes easier to scrutinize whether a particular PSU is using its dominant position in one sector to gain an unfair advantage in another, potentially anti-competitive manner.

    While the concept of clear delineation holds promise, its execution is not without challenges. Identifying the line that separates social and commercial functions demands meticulous analysis, considering factors such as public interest, economic impact, and market dynamics. Striking the right balance between social welfare and business viability requires deliberate calibration. Nonetheless, navigating the delicate balance between PSUs and the Competition Act underscores the need for a nuanced approach that fosters both public welfare and fair market dynamics.

  • Obsolescing Bargain: Do Ex-Ante Provisions Curb Opportunism In Public-Private Partnerships?

    Obsolescing Bargain: Do Ex-Ante Provisions Curb Opportunism In Public-Private Partnerships?

    BY SATCHITH SUBRAMANYAM, A FOURTH-YEAR STUDENT AT GNLU, GANDHINAGAR

    Introduction

    The primary objective of procurement is to source goods or services, at the right quality and price, at the right time. While ‘public procurement’ refers to broader exercise, public-private partnerships (‘PPP’) projects are a means to public procurement. The Government of India views this exercise as entering into a procurement function, as opposed to perceiving it as a mere partnership. This is apparent from the definition of PPP under the Public Procurement Bill, 2012. India is one of the leading markets for PPP projects. Nevertheless, data suggests that out of 1500 projects, that commenced two decades ago, only 48% of them are operational. Even those projects which are operational have left private developers in disdain, due to the lack of adequate financial returns resulting in reduced participation.

    The legal framework for such projects has been streamlined by the Department of Economic Affairs in the form of appraisal and approval mechanisms, which consist of separate guidelines to be followed. The responsibility to oversee such compliance is with the Public-Private Partnership Appraisal Committee (‘PPPAC’). Further, Concession Agreements (‘CA’) are sector-specific and define all the aspects related to the partnership, such as ownership, responsibilities, risk allocation, and contract management. It is essentially a standardized form of the concession agreement between a Government Contracting Authority (‘GCA’) and a private entity (‘Concessionaire’), wherein the GCA awards certain rights to the concessionaire for the implementation and execution of public services. For instance, an agreement is entered into between the National Highway Authority of India and a private operator. In the said agreement certain rights are granted and vested in the private entity for undertaking the operation, maintenance & management of a project highway.

    PPP contracts are intrinsically subject to reassessment, which may be attributed to the long duration of such contracts, spanning years. Decision-makers cannot foresee all the risks. Hence, a critical feature of a PPP transaction is the transfer of specified risks from the GCA to the concessionaire. From the standpoint of the government, this is one of the key methods for obtaining value for money in a PPP transaction by having the private sector take on some risks that would often be borne by the government in a conventional public works project. On the other hand, from the perspective of the private sector, the concessionaire is willing to accept various risks and earn profits by managing them efficiently.

    The downside of incompleteness in concession contracts is that it promotes opportunistic behavior on the part of the contracting parties who seek to interpret this vagueness to their advantage. It ensues in conflicting interpretations, with each party promoting its own agenda. The typical solution to this issue is renegotiation of the contract. It refers to the process of making modifications to the original contract, in order to address unforeseen events, which often entails significant changes to the core concession clauses. Almost 40% of the PPP projects in India are renegotiated. Nevertheless, there is no established legal or institutional framework which governs such renegotiation.

    One central issue associated with the renegotiation of concession contracts is that it can lead to retrospective distortion of the competitive tender procedure. The key attribute of awarding contracts through competitive tenders is that it provides the potential concessionaires with a fair chance to compete for the contract. Moreover, it also ensures that the GCA selects the most qualified concessionaire based on a competitive price while maintaining high standards of performance.

    Post renegotiation, it is doubtful whether the concessionaire chosen for the project delivers the best cost-effective option. This is due to the fact that the projects that were originally tendered and those that were renegotiated are literally two separate projects. Further, the GCA has to be cautious of opportunistic renegotiation initiated by the concessionaire. In the same vein, opportunistic renegotiation on the part of the GCA will not just jeopardize its relationship with the concessionaire but will also serve to be detrimental to the long-term interest of the private sector.

    Obsolescing Bargaining Theory-

    Obsolescing Bargain refers to a private player’s gradual loss in power of negotiation in PPP contracts. This phenomenon results in government opportunism, giving the government an upper hand over the concessionaire. The theory posits that the negotiating leverage shifts during the course of the project. At first, the government offers enticing terms because it needs private investors. Once the project is up and running, the investors need a long amortization period to realize their promised return while the government has already acquired the necessary resources, making the initial agreement no longer relevant. 

    Private entities see a lot of commercial & regulatory risks in infrastructure investment. As compensation for bearing these risks, they expect high returns, which the government is willing to concede ex-ante. Nevertheless, once investors sunk their capital, created jobs, utilized technology, and produced output, their bargaining power was reduced, and the private returns that the government thought were reasonable ex-ante, seemed excessive and superfluous ex-post. Projects like the GMR Ambala Chandigarh Expressway and L&T Halol Shamlaji Tollway, are quintessential to this aspect. In these projects, the issue was attributed to the unrealistic traffic projections before the agreement was entered into. During the operation stage there was lower-than-expected traffic growth which resulted in reduced toll fee collection and, hence lower returns.  

    Indian Contract Law-

    The contractual concept of undue influence, economic duress and the judicial dicta on renegotiation of contracts in general, are against the government engaging in such behavior. In, Atlas Express Ltd. v. Kafco ltd, the Queen’s bench held that, where a party to a contract was under economic pressure to the extent that he was compelled by the other party to renegotiate the terms of the contract to his detriment, his apparent acquiescence to the new terms was vitiated by economic duress. Further, in Mahavir Singh v. State of Haryana, there was a disparity in the bargaining power of the petitioner and the GCA. The court underscored that in such circumstances the private entities are expected to sign on dotted lines, which amounted to renegotiation vitiated by economic duress.

    In tune to these judicial pronouncements, a committee was constituted to formulate a policy on efficiently regulating renegotiation. 

    The Kelkar Committee-

    To curb phenomena such as obsolescing bargaining among others, the government formed the Kelkar committee. The committee report gave many recommendations to revitalize the PPP model in India. Among these, the committee recommendations on obsolescing bargaining was one based on incorporating safeguards in favor of the concessionaire in the CA. The key recommendation was the inclusion of ex-ante provisions in the renegotiation framework. The committee made a case for the ab initio inclusion of such contractual safeguards to ensure a certain level of bargaining power during the renegotiation of issues and prevent jeopardizing the sanctity of the bid award long after the project is finished. Further, the report posits the ex-ante establishment of critical assumptions, and only if the actuals deviate significantly from these assumptions can the renegotiation of the terms of the original contract be allowed.

    One critical prerequisite for the implementation of these recommendations is identifying the possible contingencies while drafting the CA. This usually involves front-end transaction costs which are the costs incurred on identifying possible future events and the efficient allocation of obligations, which are usually high. Concessionaires may protect themselves from these risks through such ex-ante contractual designs. Nevertheless, a major fallout of such measures is that they fail to redress the fundamental incentive for the government to renege. Additionally, a government that is motivated to renege may concoct justifications or look for legal loopholes to do so. Moreover, the government may renege even in cases where a scenario transpires that was anticipated in the original CA. For instance, the government reneges when the country witnesses a macroeconomic shock. Indeed, in such situations, the government indulges in “wholesale reneging” (across several agreements).

    It is understandable that ex-ante provisions in the context of renegotiation attempt to incorporate the flexibility required to promote efficiency. Nevertheless, the likelihood of renegotiation may jeopardize ex-ante efficiency. Consider a scenario where the parties to a CA renegotiate it to ensure effective performance. To do this, they must come to a new understanding of how to divide the surplus brought about by their trade. This surplus is inclusive of the gains from any particular investments, and the concessionaire who makes the investment will already have incurred the associated costs. Therefore non-investors (GCA) will benefit from a larger amount of the gains of investment, but will not incur a larger portion of the investment’s sunk costs (incurred on the investment which cannot be recovered) by participating in the redistribution of the surplus. Hence ex-ante efficiency is compromised since the initial investment is discouraged by the possibility of being “held-up” during renegotiation.

    Therefore, contract design can go some distance in safeguarding the concessionaire from the phenomenon of obsolescing bargaining, but only to a certain extent. At best they serve as an inception for renegotiation in cases where the GCA reneges. Therefore a more effective protection is to be found.

    Conclusion

    The issue of obsolescing bargaining yields a very peculiar state of affairs. While precluding government reneging by means of contract design has failed to hold up well in practice, it suggests that concessionaires can be safeguarded by building a business strategy that ensures equity in bargaining relations. The concessionaire must deliver the project benefits gradually over time. For instance, the concessionaires may intend to develop a project in stages, despite compromising on the economies of scale. The phased transfer of investment and technology will maintain the bargaining power with the GCA. Such a measure will not just protect the concessionaire from unforeseen changes beyond his control, but will also make sure that the recourse to renegotiation is not misused.

  • Financial Creditors As The Super Actors Of CIRP: A Psycho-Analytical Account Of Low Recovery Rates 

    Financial Creditors As The Super Actors Of CIRP: A Psycho-Analytical Account Of Low Recovery Rates 

    BY ROHIT DALAI, A FORTH-YEAR STUDENT AT NLSIU, BANGALORE

    Introduction

    This article argues that the low recovery rates from the Corporate Insolvency Resolution Process (‘CIRP’) under the Insolvency and Bankruptcy Code, 2016 (‘Code’) is a consequence of the vesting of extensive powers with the financial creditors (‘FCs’). This vesting of near plenary control of the CIRPs under the Code provides the FCs with the incentive to make self-interested decisions. The making of the self-interested decision by the FCs is evident in two contexts. First, the interaction of FCs with other actors upon the commencement of CIRP. Second, the decision-making by the FCs as the drivers of CIRP. To this end, the article is divided into three parts. The first part analyses the reasons behind low recovery rates under the Code. In doing so the article uses the social-psychological concept of the ‘discontinuity effect’ to scrutinise the interaction of distinct actors upon the commencement of CIRP. The second part builds on the ‘discontinuity effect’ to study the incentive of the actors and the effect of information asymmetry in a CIRP. In the third part, the article concludes by arguing that the combined effect of the ‘discontinuity effect’, distinct incentives and information asymmetry in the CIRP is the reason for low recovery rates.

     Low Recovery Rates: Discerning the Reasons

    To better appreciate the reasons behind the low recovery rates, it is imperative to delve into the objective of the Code. According to the Preamble, the Code provides for “reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner”. Notably, the Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016 identifies reorganization as the “sole object of the Code” . In the context of the Code’s objective, reorganization rather than liquidation ought to be the mode of closure of the CIRPs. The reorganisation would necessarily entail the  restructuring of the assets and debts thereby ensuring that the business continues with its operations. It is through this objective of keeping the enterprise continuing its operation for the foreseeable future does the Code purport to ensure better returns for ‘creditors of all classes’. In the recent Supreme Court decision in K.N Rajakumar v. Nagaraj and Ors., Justice Gavai through a common judgement and order propounded that under the scheme of the Code, every attempt was to be “first made to revive the concern and make it a going concern, liquidation being the last resort”.[1] Interestingly, empirical evidence points to the fact that creditors of all classes generally get better returns in instances of reorganization vis-à-vis liquidation.[2] However, a scrutiny of the Code in effect evinces the fact that the predominant mode for closure of the CIRPs has been the commencement of liquidation. A perusal of the Quarterly Newsletters released by the Insolvency and Bankruptcy Board of India (‘IBBI’) from 2018-2022 reveals that on average 48% of the CIRPs that were closed, ended up in liquidation. This underlying cause of the mismatch between the purpose and the outcome of the Code can be attributed to the ‘discontinuity effect’. The term ‘discontinuity effect’ is used to refer to the typical phenomenon wherein “groups act more competitively and more selfishly when interacting with other groups than when individuals interact with individuals”. As a corollary to acting selfishly, groups end up engaging in a mode of thinking known as ‘groupthink’.[3] Groupthink is essentially the dominance of intragroup concurrence-seeking and the overriding of “realistic appraisal of alternative course of action”.[4] In the context of CIRP, discontinuity effect and groupthink are evident in the context of the decision making and control over the CIRP by the FCs. It has been observed that the vesting of “near-plenary control of CIRP” in the form of restriction of the voting membership in the Committee of Creditors (‘CoC’) to the FCs, in turn, leads to the FCs to seek a speedy return for themselves. This seeking of speedy returns by the FCs is at the same time a manifestation of the discontinuity effect and groupthink. This manifestation is evident from the frequent prioritisation by the FCs of their monetary payoff over alternative concerns,  “such as fairness or reciprocity” towards other players such as the Operational Creditors (‘OCs’) and the corporate debtor. Moreover, the manifestation is also apparent in opting for liquidation over reorganization even when the recovery rates tend to be low.

    A. Does the Judiciary Mitigate the Discontinuity Effect?

    Pertinently, the Supreme Court (‘SC’) in Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India and Ors.  did charge the FCs who “drive the entire decision making on the CoC” to not ignore the claims of OCs.6 This essentially meant that all creditors were to be equitably treated, even if they have little say in the CIRP. However, a scrutiny of the subsequent judicial pronouncements points towards the adoption of an ‘extreme deferential standard’. Notably, the ruling in Karad Urban Cooperative Bank Ltd. v. Swwapnil Bhingardevay and Ors. and Kalpraj Dharamshi and Anr. v. Kotak Investment Advisors Ltd. and Anr. evinces this extreme deferential standard taken by the SC. The aforementioned cases pertained to allegations of breach of confidentiality while CIRP was underway. The SC in both cases exhibit deference to the commercial wisdom of the CoC. Interestingly, in both aforementioned cases, the SC did not necessarily refer back to the Code while exhibiting deference. This non-reference to the Code points to the fact that the SC failed to take a nuanced view of when the commercial wisdom of the CoC can be deferred to. A nuanced understanding suggests that the CoC’s decision in assessing the feasibility and viability of the Resolution Plan ought to be deferred. In instances where the commercial wisdom of the CoC is deemed to be paramount without the Code being necessarily referred to, the ‘discontinuity effect’ becomes pronounced. This is because in absence of substantial oversight, the FCs as the members of the CoC have ‘unconstrained interaction’ with other actors in the CIRP such as the OCs.7 This unconstrained interactiondoes lead to intergroup competitiveness as groups seek to maximise their benefits.8 In short-run, intergroup competitiveness to maximise outcomes results in a deadlock.9 However, when one of the groups such as the FCs has wider powers and informational asymmetry in its favour, a resultant deadlock is not the consequence. It is this informational asymmetry that further explains the greater liquidation and lower recovery rates.

    Distinct Incentives and Information Asymmetry

    A. Understanding Information Asymmetry Pre-2019

    As has been depicted through the discontinuity effect and groupthink above, distinct actors in CIRP have distinct incentives. It needs to be emphasised that the FCs are driven by the incentive of seeking debt recovery through liquidation. One of the aspects that significantly strengthens the incentive to go for liquidation is the asymmetry of information in CIRP. Pre-2019 the information asymmetry subsisted in the context of taking over of the control and management by the Resolution Professional (‘RP’) and the suspension of the board of directors (‘BoD’) of the company on the commencement of CIRP. Notably, upon suspension, the corporate debtors’ BoD were not allowed access to the resolution plan even though they are given participatory rights -“to be present when required or called for”– in the CoC meeting. This secrecy in the form of non-accessibility of resolution plans produced informational asymmetry. This secrecy with regards to the resolution plan was uncalled for as it was “contrary to the scope, intent and purpose of the Code”. The fact that the erstwhile BoD would know the intangible and tangible value of the assets in addition to them being interested in the value maximisation of the assets of the corporate debtor warranted the supplying of a copy of the resolution plan. Notably, the 2019 decision of the SC in Vijay Kumar Jain v. Standard Chartered Bank held that the erstwhile BoD was to be furnished with the copy of the resolution plan as part of the documents that have to be given in addition to the notices of CoC meetings. While the judgement addresses the problem of information asymmetry to some extent, the problem subsists nonetheless. 

    B. Information Asymmetry and Structural Issues

    The subsisting problem of information asymmetry is also structural when seen in the context of CIRP. While the CoC is entrusted with the task of evaluating the feasibility and viability of the resolution plan in addition to balancing the interest of all stakeholders, it does not necessarily have to deliberate with other stakeholders. For instance, the CoC can benefit from deliberations with OCs to whom the corporate debtor owes more than 10% of the value of its debt. However, the scope for deliberations is foreclosed by the fact that instances, where a single OC is owed such a sum, is likely to be relatively rare. In such circumstances, the CoC does not have to provide the OCs with a forum to put forth their concerns. This non-involvement of the stakeholders such as OCs by the design of the CIRP pronounces the information asymmetry. However, this information asymmetry is distinct in the sense that it works to the detriment of the FCs. Notwithstanding the discontinuity effect and the concomitant self-serving decision-making by the FCs, the free flow of information would allow the FCs to choose reorganisation over liquidation. The fact that FCs go for liquidation even when the probable consequence is low recovery points towards irrationality in decision-making. Put simply, when incomplete information is admitted while making decisions, the decision maker takes decisions that may turn out to be irrational post hoc. Since the CIRP is a “collective process” that intends to bind the corporate debtor’s stakeholders, it is imperative to make provision for effective participation of non-FCs, “whether by giving them an opportunity to vote on the resolution plan, or otherwise”.

    Conclusion

    The low recovery rates under the Code are a combination of two factors. First, the greater control of the FCs over the CIRP. Second, information asymmetry in the process of CIRP. An interplay of the two factors results in liquidation and the concomitant low recovery rates. While the Code seeks to emphasize restructuring, it is the actions of the FCs as the members of CoC that results in the purpose of the Code being defeated. It is only when the loopholes are plugged would the objectives of the Code be realized.

     

     

     

     

  • Extension Of ‘Angel Tax’ Provisions To Non-Residents: Is the Proposed Change Angelic Enough?

    Extension Of ‘Angel Tax’ Provisions To Non-Residents: Is the Proposed Change Angelic Enough?

    BY PURAVA RATHI, A SECOND-YEAR STUDENT AT NLIU, BHOPAL

    Introduction

    The Union Budget 2023, presented by Finance Minister Nirmala Sitharaman, proposed an amendment via the Finance Bill 2023 to Section 56(2)(vii-b) of the Income Tax, 1961. The amendment extends the applicability of the ‘Angel Tax’ to the funding received by privately held, unlisted companies from ‘non-residents’. This tax was previously levied only on the funding received from affluent ‘residents’ or high-net-worth individuals of the country. The provision was introduced in 2012 to mainly combat money laundering, corruption, and tax evasion. The imposition of such a tax is intended to increase transparency.

    However, due to its extension to non-residents, the proposed amendment is set to adversely impact the financing of start-ups, which has been showing a trend since 2022. Funding received by Indian startups has been showing a downward trend since 2022 and has plunged nearly 33% when compared to the previous year.

    This article intends to study the details of the proposed amendment and its impact on the start-up culture of the country. The apparent conflict pertaining to the calculation of the Fair Market Value (‘FMV’), between the Foreign Exchange Management Act, (1999) (‘FEMA’) and the Income Tax Act 1961 (‘IT Act’) has been highlighted. Moreover, the status of such a tax under different jurisdictions and initiatives taken by foreign governments to promote the start-up industry has also been put forth.  

    Details of the Provision and the Proposed Amendment

    Angel investors generally invest in firms where they see growth prospects. A corollary of the same is that they usually opt for convertible debt or ownership equity due to the unpredictability and volatility of the markets. This tax is imposed on the amount that startups receive while selling shares at a premium. When the shares of a company are sold at a higher share price than their FMV, the government taxes the excess income accordingly under the head of ‘Income from other sources’. This provision was introduced in 2012 because, then, the common practice was that of converting black money to white money by investing in shell companies. Therefore, its purpose was to mainly combat money laundering, corruption, and tax evasion.

    The introduction of such a provision was certainly a welcome move. However, there exists no mechanism to assess the genuineness of a transaction. As a result, due to the indistinguishability between bonafide and mala-fide transactions, these ventures suffer.  Therefore, the imposition of the same on finances raised from ‘non-residents’ might be detrimental to the growth of startups in India given that the government is majorly focussing on foreign direct investment, investment facilitation, and the ease of doing business in the Indian economy. 

    In this context, it is also pertinent to discuss certain exemptions from the applicability of the angel tax provided via the exemption notification of 2019. It stated that only ‘start-ups’ recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) and whose total paid-up share capital and share premium after the issuance or intended issuance of shares, if any, do not exceed Rupees 25 Crores are eligible for the exemption. This is limited by the requirement that start-ups must not have invested in or would not invest in the class of assets that includes immovable properties, loans and advances, capital contributions to other entities, shares and securities, motor vehicles, or any other mode of transportation, jewelry, or any other asset class. Funds from non-resident investors shall not be included in computing the aforesaid threshold. However, it is expected that the exempted categories would also be amended soon to align them with the proposed amendment. 

    Implications of the Proposed Amendment

    Interestingly, the proposed amendment presents a dilemma for startup companies. This is because of the induced compulsion to raise shares at FMV. FEMA disallows the issuance of shares below the FMV and the IT Act taxes the amount raised in excess of the FMV. Therefore, startups are constrained to issue shares at the FMV.

    At a time when the startup industry is growing rapidly, with the most significant number of unicorns in India after the USA and China, this government initiative seeks to dampen the enthusiasm and growth prospects. The reason is that foreign investors are the major source of funding for start-ups in the country. India also provides for various schemes to promote and enhance the growth of startups. These initiatives include the Startup India Seed Fund Scheme, the Startup India initiative, and Startup Accelerators of MeitY Product Innovation and Growth (SAMRIDH). However, a provision like an angel tax may have an adverse effect on the advantages of these schemes. The growth of startups, as a result, may be impeded. An obvious outcome could also be apprehension amongst foreign investors due to the increased risk of litigation about the subjective valuation of the company, which is often challenged by tax officials. Due to the application of angel tax, these startups come under the close scrutiny of tax officials, since the excess amount is to be accounted for. The income tax provisions provide for a valuation mechanism for unquoted equity shares which permits the usage of net asset value (formula-based) or discounted cash flow approach as determined by a merchant banker. This creates subjectivity. A higher valuation is likely to be questioned by tax officials, and angel tax would be levied on the excess amount raised.

    Further, with the ambit of the ‘angel tax’ extended, startups would want to shift or establish their base in foreign countries where such tax restrictions are not applied. Such a move may also lead to ‘externalization’ which is the transfer of ownership to a holding company that is based in a conducive business environment in a foreign jurisdiction. This would further impact employment generation and the ease of doing business in the country. Therefore, it is hoped that the government will reconsider this proposed amendment given the complex consequences that are to ensue. 

    Position of ‘Angel Tax’ In Foreign Jurisdictions

    It is pertinent to note that angel tax is not a widely recognized concept in foreign jurisdictions. It is not surprising that such a tax, which disincentivizes funding for startups and the overall growth of the startup culture in the country, has not been adopted by other countries. 

    Canada

    In Canada, there is no specific angel tax provision, but there exist tax credits and incentives for investors who invest in certain types of companies, including startups. For example, the Canadian government offers the Scientific Research and Experimental Development (‘SR&ED’) tax credit to encourage investment in research and development. 

    Canada offers low business taxes for companies and a very good business climate. Total business tax costs here are by far the weakest among the G7 countries.
    Companies investing in Canada can benefit from a range of incentives and tax credit programs including the Global Skill Strategy, Accelerated Investment Incentive, and Innovation Superclusters initiative.

    Australia

    The Australian government, under its National Innovation and Science Agenda (NISA), provides for a ten-year exemption on capital gains tax for investments held as shares for more than 12 months. The scheme also provides for a 20 percent non‑refundable carry-forward tax offset on amounts invested in qualifying early-stage innovation companies (ESICs). Moreover, the country also provides capital gains tax exemptions to eligible foreign investors on their share of capital or revenue gains made under Venture Capital Limited Partnerships (VCLPs).  Such measures as providing tax offsets at the funding stage contribute to developing a healthy startup culture in the country.

    United Kingdom

    In the United Kingdom, the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) provide tax relief for investors. The UK has tried to maintain a congenial environment for attracting foreign direct investment. The country also imposes foreign equity ownership restrictions in a limited number of sectors. However, the UK’s decision to implement the improved National Security and Investment Act unfavorably affects the startup ecosystem in the country. The Act aims to investigate hostile foreign direct investment that threatens UK’s national security.  

    USA

    The USA does not have a central law for angel investments. However, it passed the Protecting Americans from Tax Hikes (PATH) Act of 2015 by amending Section 1202 of the Internal Revenue Code. This has made permanent a 100 percent exclusion from capital gains tax for any gains on long-term investments in qualified small businesses, up to 10 million dollars or ten times the original investment, whichever is greater.

    China

    China provides tax incentives to venture capitalists that invest at the seed capital stage. 70 percent of the investment amount can be offset against the taxable income of the venture capital enterprise for Corporate Income Tax (‘CIT’) purposes. Small businesses (whose annual income does not exceed RMB three million) have enjoyed a low CIT rate (2.5%) since 2020, up to a revenue of RMB one million. Small and Low-Profit Enterprises (‘SLPE’) are subject to a 20 percent CIT rate on 25 percent of their taxable income amount after the adjustment.  Therefore, the effective CIT rate for SLPEs is currently 5 percent. Because the SLPE evaluation is carried out at the entity level (instead of at the group level), small subsidiaries of foreign multinational enterprises (MNEs) in China can also benefit from these CIT cuts.

    Therefore, there do not exist any specific angel tax provisions in prominent foreign jurisdictions. These countries may serve as the perfect opportunity to escape the application of the angel tax provision, thereby leading to externalization, as discussed above. They function as tax havens, incentivizing the funding process for non-residents and subsequently benefiting the company.

    Conclusion

    In light of the above discussion, certain further amendments or notifications on the part of the government are expected to clarify the apparent conflict between the two laws. It is also imperative to consider that there already are various acts that govern and control these transactions in India, including the IT Act and FEMA. This raises pertinent questions as to the need for such a provision in the Indian context. Moreover, startups find it burdensome to bear the levy of this tax, as most of the funding received from non-residents goes into paying it. Since there are more unfavorable effects of the proposed amendment than favorable ones, it is imperative that the government reconsider the amendment before its implementation.

  • Cryptocurrency Taxation: Pigouvian Taxation Does Not Solve The Problem Of Tax Evasion

    Cryptocurrency Taxation: Pigouvian Taxation Does Not Solve The Problem Of Tax Evasion

    By Manas Agarwal, a fourth-year student at NLSIU Bangalore

    Introduction

    Cryptocurrency (‘crypto’) is an ideal example of the intersection between finance and technology. This is because technology makes crypto decentralized and unregulated, which gives rise to finance-related concerns. One such concern is taxation, and this is precisely the backdrop against which this article is set. The focal point of this article is the taxation of crypto that was put forth in the Union Budget of 2022-2023 (para 131). Consequently, the Finance Act, 2022 amended the Income Tax Act, 1961 (‘ITA’), with effect from April 1, 2022.

    Structurally, the article is divided into two parts. First, the author will critique the scheme of taxation of crypto prescribed under the ITA. Further, the author will flag some definitional issues in the present scheme of taxation. Second, the author will employ the law and economics framework of analysis to argue that the true purpose behind the present scheme of taxation is deterrence through negative externalities. Consequently, the author proposes to argue that the present scheme of taxation for cryptocurrencies is not sound either from a revenue maximization perspective or from the standpoint of addressing a negative externality.

    Issues pervading the taxation of crypto under the ITA

    The Finance Act 2022 inserted four components in the ITA:

    • The definition of Virtual Digital Assets (‘VDAs’) under Section 2(47A) of the ITA.
    • An explanation clarifying that VDA shall come under the definition of ‘property’ – section 56(2)(x) of the ITA.
    • Imposition of 30% tax rate on transfer of VDAs – Section 115BBH of the ITA.
    • Tax will be deducted at source for payment of consideration for the transfer of VDAs – Section 194S of the ITA.

    All these provisions pose policy challenges, including an increase in compliance costs. Compliance costs cover all costs that a taxpayer, as well as a third party, has to bear to comply with the tax law and other requirements of the tax authorities. Section 115BBH imposes a flat rate of 30 percent on the transfer of VDAs. This leads to an increase in compliance costs as; firstly, a flat tax rate obliterates the distinction between income from capital gains and business income. Under the ITA, the former is charged at a lower rate. However, in the new tax regime, a person will not be able to seek the benefit of a lower tax rate. Secondly, Section 115BBH does not allow setting off the loss from the transfer of VDAs against any other income.

    Additionally, Section 194S mandates every person (except those exempted) paying consideration in exchange for crypto to withhold tax at 1%. First, ‘Specified persons’ is one category that has been given certain exemptions from the section. Though the criteria to identify a specified user are elaborated on in the explanation, further information is required to assess who meets those criteria. This will increase compliance costs and also result in a decline in trading volume since users will stop dealing in crypto due to anonymity concerns. Second, the compliance costs will be significant in crypto-to-crypto transactions. This is because, a plain reading of the section suggests that firstly, both parties will have to deduct tax at the source, and secondly, the fair market value of the crypto will have to be ascertained to deduct the tax at the source.

    The real purpose behind the taxation of crypto is that of establishing control over virtual digital assets

    In this segment, the author, using different theories of taxation, argues that the government wishes to disincentivize crypto trading and crypto investment.

    i.   Tax as Revenue Maximization

    The first view reflects the traditional theory of taxation, which advocates that the purpose of taxation is revenue maximization so that public funding activities can be financed.[1] Hence, this view will advocate that due to the large trading volume of crypto, it can serve as a good source of revenue. However, if revenue maximization is the purpose, then the existing scheme of taxation of crypto is not optimal. This can be understood through Adam Smith’s canons of taxation. The second and third canons, the canons of certainty and simplicity, state that the levying of taxes should be certain, non-arbitrary, and convenient for the taxpayer (pages 36-37). Moreover, the fourth canon states that the difference between the amount in the public treasury and the amount recovered as tax should be minimal (pages 36-37). In other words, costs such as the salary of tax officers, the costs of legislation, etc. must be minimal. Net revenue equals administrative costs and compliance costs subtracted from gross tax revenue.[2]

    As mentioned above, the prohibition on setting off losses from crypto (Section 115BBH) and the onerous Tax Deducted at Source (‘TDS’) requirements (Section 194S) increase the compliance cost. Furthermore, vagueness in the definition of VDAs and a lack of a coherent mechanism for the valuation of fair market value will increase the administrative costs of litigation, appeals, and explainers. Hence, the goal of revenue maximization will remain unachieved because of the high compliance costs.

    ii.  Tax as Negative Externality

    The central argument of Modern Monetary Theory is that sovereign governments face resource constraints, not financial constraints. Hence, the theory advocates that the traditional mechanism of first imposing taxation and then spending on public financing is outdated and works only in times of commodity-based money. With the introduction of fiat money, there is now a mechanism in which the government spends first and imposes taxation later.[3] This is because, unlike non-state actors which use the currency, the state issues it. Hence, revenue maximization is not the sole purpose of taxation.

    One such purpose is Pigouvian taxation. Pigouvian taxation is used to minimize the deadweight loss in cases where the society faces a deadweight loss due to the private cost being less than the external cost. For instance, pollution imposes external costs on society that are not borne by the private actor, the polluter. Hence, a tax is imposed on the polluter to ensure that, while deciding how much to pollute, the polluter internalizes the external costs (for example, carbon tax, plastic tax)[4]. The author argues that the present system of crypto taxation is an example of Pigouvian taxation.

    The Indian regulatory landscape has been hostile towards crypto. For instance, Section 8 of the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 states that direct/indirect mining, generating, holding, selling, dealing in, disposing, and issuing are declared offenses and can have penal consequences. Furthermore, all these offenses are non-bailable and cognizable in nature (sections 8(1) and 12(1). However, this staunch opposition does not extend to Central Bank Digital Currency (‘CBDC’), which is a digital token recognized as a legal tender (para 111). The exclusion of ‘Indian currency’ from the ambit of section 2(47A) of the ITA saves CBDC from falling within the definition; otherwise, it would have also been treated as a VDA under the ITA. This is because even private digital currencies fulfill the three roles of money (store of value, medium of exchange, and unit of value). Hence, the elephant in the room is not the ‘digital’ nature of private crypto but the lack of government control over it. This happens because; first, unlike CBDCs, private crypto is not easily traceable, and hence monitoring, reporting, and surveillance is difficult, and; second, unlike CBDCs, crypto operates independently of financial intermediaries such as banks, as crypto is only dependent on the demand and supply in the market (pages 38, 42). Hence, the central bank loses control in addressing concerns such as inflation because crypto is independent of the monetary measure of interest rates.

    The government will justify control through taxation because decentralization and (pseudo) anonymity present in the crypto transaction make crypto a tax haven. Furthermore, there have been numerous instances of crypto being used to finance terrorist activities and in money laundering. Therefore, people who illegally deal in crypto impose external costs on society (if there is an increase in criminal activities and the focus of the State is on preventing such activities, then there might be a resource crunch due to which the welfare activities of the State are compromised). Hence, a high tax rate will act as a deterrent, and the external costs due to crime will be internalized. Therefore, crypto taxation represents a Pigouvian tax.

    However, characterizing crypto taxation as a Pigouvian tax by itself is insufficient. This is because a cardinal principle of taxation is neutrality. It means that taxation should not be used to distort consumer choices, and consumers should be allowed to make a decision based on welfare and/or economic reasons. However, one might argue that Pigouvian acts as an exception to neutrality since it establishes an equilibrium between private costs and social costs. Though this is true, the exception is not being drawn in the present case. This is because the issues concerning tax evasion, illicit activities, etc., and the imposition of a Pigouvian tax as a solution to these issues do not have a direct correlation. Under the ITA, the prominent mode of filing returns is based on self-assessment (sections 139, 140A) where taxpayers must assess their tax liability themselves based on factors such as (i) income, (ii) taxable income, (iii) head of income, (iv) concessions, (v) exemptions, and (vi) TDS. Self-assessment helps to address the case of crypto taxation because of the anonymity coupled with high compliance costs. Furthermore, techniques of summary assessment, (section 143(1)) regular assessment (section 143(2)), and re-assessment (section 144) are not adequate to receive taxation on crypto because crypto acts independently of banks and financial institutions and posits a cloud of anonymity. Moreover, it can be said that the probability of self-assessment and third-party reporting is indirectly proportional to the compliance costs and directly proportional to the probability of detection of tax evasion. As stated before, compliance costs are high and the probability of detection is low in a crypto transaction, thus, a model of Pigouvian taxation for crypto by itself is not the optimal solution.

    Conclusion

    The present scheme of crypto taxation suffers from various policy concerns. This is because Sections 115BBH and 194S of the Indian Tax Act raise compliance costs, and hence cryptocurrency taxation is not optimal for revenue maximization. Furthermore, using crypto taxation as Pigouvian taxation is not helpful, because the issue of tax evasion, illicit activities, and the solution of levying a Pigouvian tax, do not have a direct correlation. This is further aggravated by the low probability of detection because of self-reporting. Hence, (a) the present taxation of crypto under the ITA does not solve the fintech issue of tax evasion due to anonymity inherent in the technology used in crypto and (b) the taxation of crypto does not achieve the goal of either revenue maximization or Pigouvian taxation.

    [1]Beverly I. Moran, ‘Taxation’ in Mark Tushnet, and Peter Cane (eds), The Oxford Handbook of Legal Studies (OUP 2012) 377.

    [2] ibid.

    [3] L. Randall Wray, Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems (2nd ed, Palgrave Macmillan 2015).

    [4] ‘Environmental Taxation’ in James Mirrlees (ed), Tax By Design (OUP 2010)231.

  • Disintegrating ‘Sum in dispute’ in Fourth Schedule for Arbitration Fees

    Disintegrating ‘Sum in dispute’ in Fourth Schedule for Arbitration Fees

    by Mohammad Atik Saiyed and Shukla Pooja Sunilkumar, Third year students at GNLU, Gujarat

    Introduction

    We are living in a global village with transforming commercial realities and with such radical evolutions – the corporate entities are driving forces of economic value additions. In correspondence to the novel societal structure, interdependent and entangled utility alternatives, new perspectives, disagreements, questions, and jurisprudential mechanisms have also evolved. Arbitration has developed as the core effective means for alternative dispute resolution and the exponential increase in its practice unveils a question of how much fees are to be paid for the arbitration, which was recently revisited by the Apex Court in the case of Oil and Natural Gas Corporation Ltd. v. Afcons Gunanusa JV.

    Constructing the substructure of arbitration fees

    Constructing the sub-structural root of the legal question, Section 31(8) of the Arbitration and Conciliation Act, 1996 (the “Act”) empowers the arbitral tribunal with the authority to ascertain the costs in accordance with Section 31A. Section 31A accredits the ‘discretion’ of the tribunal to determine three aspects revolving around the regime of costs – Firstly, whether costs are payable by one party to another; secondly, the amount of costs and thirdly, the time of payment of costs. Within the horizon of the present analogy, the explanation to Section 31(8)(a) and Section 31A(1) provides that the term ‘costs’ symbolizes “reasonable costs relating to the fees and expenses of the arbitrators and witnesses”, among other things. Moving further in the prism, Section 38(1) of the Act encompasses the authority of the tribunal to fix the amount of deposits, separately for claims and counter-claims, as an advance for the arbitration fees which is an integral part of ‘costs’ in Section 31(8). 

    The tribunal holds the power to determine costs and deposits as enshrined in the sections highlighted but the tribunal cannot be granted unbridled authority to unilaterally determine its own fees. This unveils the central question of how much fees are to be paid for the arbitration. Comprehensively dealing with ad hoc arbitrations, the Fourth Schedule (the “Schedule”) of the Act advances a model framework for the determination of arbitration fees. Rooting out the parliamentary purpose, the Schedule was introduced by the 2015 amendment on the recommendation of the 246th LCI report, which addressed the issue of arbitrators charging exorbitant fees in ad hoc arbitrations. The Fourth Schedule sets out ‘Sum in dispute’ as a standard for ascertaining the fees of arbitrators based on the model prescribed. Ergo, for the determination of fees, the undefined terminology gives rise to a substantial legal dilemma regarding the interpretation of ‘Sum in dispute’ in the fourth schedule as to whether the sum for the determination of fees has to be accounted for claims and counter-claims, cumulatively or separately? Settling the two competing interpretations holds core importance, as the applicability of the ceiling enshrined in the Schedule will be resolved on that premise. 

    Cumulatively or separately? – Weighing ‘Sum in dispute’ on both ends

    Navigating the two arguments based on the interpretation conundrum, firstly, if ‘Sum in dispute’ is regarded as the cumulative total of claim and counter-claim, on acceptance, there will be a common fee for adjudicating both the proceedings and the fee ceiling within the Schedule will apply to the cumulative total, whereas, secondly, if ‘Sum in dispute’ is considered separately for claim and counter-claim, with adoption, there will be different fees for claim and counter-claim proceedings and the fee ceiling within the Schedule will be administered separately to each proceeding. For instance, the sixth entry in the Schedule provides that if the ‘Sum in dispute’ is above Rs.20 Crore then the model fees would be “Rs. 19,87,500 plus ‘0.5 percent’ of the claim amount over and above Rs.20 Crores with a ceiling of Rs.30 Crores.” Consider a situation wherein, the claim is INR 20 Crores and the counter-claim is INR 20 Crores, ergo, with an interpretation of ‘Sum in dispute’ as cumulative of claim and counter-claim, then the fee ceiling will be INR 30 Lakhs, whereas, understanding ‘Sum in dispute’ separately for claim as well as counter-claim, then the fee ceiling stands at INR 39,75,000/-. 

    Comprehensive analysis and interpretation of ‘Claim’ and ‘Counter-claim’

    Importantly, the terms, ‘Claim’ and ‘Counter-claim’ are not defined within the Act, and since the issue revolves around the two terminologies, to settle the question, it is foremost to comprehensively understand ‘Claim’ and ‘Counter-claim’ along with their nature in the proceedings. Understanding the nature of ‘Claim’ and ‘Counter-claim’ proceedings is important since the amount of deposits can be ascertained on that basis by the tribunal, wherein, if both proceedings are distinct and independent of each other, then separate deposits for claims and counter-claims would be required. As highlighted earlier, arbitration fee is an integral part of deposits and consequently, separate deposits imply that separate fees would be charged for ‘Claim’ and ‘Counter-claim’, and subsequently, the model in ‘Fourth Schedule’ will apply independently. Whereas, if a contrary interpretation is considered then ‘Claim’ and ‘Counter-claim’ will constitute the same proceeding, ergo, a combined deposit for both proceedings would be required. 

    To serve the interpretation question of whether the ‘Claim’ and ‘Counter-claim’ are independent proceedings or not, reference is made to diversified sources of legal jurisprudence on two dimensions – arbitration proceedings and civil proceedings.

    ‘Claim’ and ‘Counter-claim’ in Arbitration Proceedings

    • Within the statutory frame of the Arbitration Act, Section 2(9) highlights that if under the Arbitration part of the Act, there is any reference to claim & defense to claim, it must also apply to counter-claim and defense to counter-claim respectively. Thereby, the act treats both proceedings separately. Furthermore, Section 23(2A)  obligates the tribunal to adjudicate upon a counter-claim or set-off, if the subject is covered within the ambit of the arbitration agreement directing ‘independence’. On the same lines, attributing Section 38(2) relating to deposits, the tribunal has the discretion to terminate the proceedings ‘separately’ for the claim, counter-claim, or both with failure to provide appropriate deposits. Ergo, the act principally provides that both are different proceedings drawing inference for separate deposits. 
    • Unfolding extensive analysis of ‘Claim’ and ‘Counter-claim’ by investigating academic opinions and references, it can be derived from Justice Bachawat’s seminal treatise on Law of Arbitration and Conciliation[i] that the tribunal has the jurisdiction and the obligation to adjudge both claims and counter-claims ‘autonomously’, and CR Dutta’s treatise[ii] reinforces the inference that the Arbitration Act perceives and handles claim and counter-claim as two separate and independent proceedings. Citing Gary Born on arbitration, it can be extracted that counter-claims are not restricted to claims wherein the subject of the counter-claim can be absolutely unlinked, provided that it falls within the ambit of the agreement. To dissolve, the Procedure and Evidence in International Arbitration, by noting that the counter-claim is not a defense to the claim and stands completely independent, corroborates the autonomy of claims and counter-claims.
    • Progressing to the dimension of judicial behavior even before the introduction of Section 23(2A) in 2015, there existed various pronouncements including IOCL v. Amritsar Gas Service, whose position was supplemented in State of Goa v. Praveen Enterprises, that unanimously substantiate the obligation of the tribunal to ‘independently’ adjudicate counter-claims and provide that the rationale for recourse to the same arbitration is to eliminate the multiplicity of proceedings, Additionally, from Voltas Ltd. v. Rolta India Ltd., the independent nature of the claim, and counter-claim proceedings can be noted.

    (B) Civil Proceedings

    Parallelly, understanding whether civil proceedings treat ‘Claim’ and ‘Counter-claim’ as independent and separate proceedings or not is also important for an extensive analysis. Advancing the statutory structure of the Code of Civil Procedure, 1908 (“CPC”) and explicitly concentrating on Order VIII of the CPC associated with written statements, set-offs, and counter-claims, the distinction between set-offs and counter-claims can be constructed, as set-offs are covered within Rule 6, and Rule 6-A deals ‘explicitly’ with the counter-claims by the defendant. Emphasis has to be placed on Rule 6-D of Order VIII, which provides that “even if the suit which has been instituted by the plaintiff is stayed, discontinued, or dismissed, it will not affect the defendant‘s counter-claim”, concludes that counter-claims are not simply set-offs but stand distinct and independent as a separate proceeding. Moreover, investigation of academic convictions such as Mulla’s, Sarkar’s, and Zuckerman’s treatise on the Code of Civil Procedure consonantly points that counter-claim is an ‘independent action’ and they also crystalize Rule 6-D acknowledging that counter-claims remain unaffected by the dismissal of claims. Correspondingly, Halsbury’s Laws of India (Civil Procedure) describes a counter-claim as “a claim, independent of and separable from the plaintiff’s claim, which can be enforced by a cross-action.” Moreover, examining judicial precedents, Jag Mohan Chawla v. Dera Radha Swami Satsang and Rajni Rani v. Khairati Lal, among others, unanimously establish the aspect that counter-claims can arise out of the unconnected cause of actions and are ‘absolutely independent.’ 

    Forecasting perspectives of ‘Sum in dispute’ as a cumulative

    Advancing a different viewpoint, if we consider ‘Sum in dispute’ as a cumulative of claim and counter-claim, extensive repercussions on procedural fairness can be forecasted, such as, firstly, equitable division of fees between parties while accounting for individual deposits within Section 38(1), secondly, intermediate revision of arbitration fees in case of dismissal under Section 38(2) and thirdly, combined fees unproportionate to separate efforts for unique subject matters raised in same proceedings as empowered by Section 23(2-A). Taking note of the purposive interpretation of the insertion of the Fourth Schedule emphasized by the 246th LCI Report, which highlighted the problem of exorbitant fees being charged by arbitrators in ad hoc arbitration; however, the lucid legislative meaning in the statute would have an overriding effect and if the contrary is required, there exists parliamentary wisdom for the amendment. 

    Concluding Perspective

    In line with the stark contrasts and reasonable conflicts in the comprehensive legal and logical analogy of the multidimensional prism of “Sum in dispute,” the distinction and independence of proceedings of claim and counter-claim can be lucidly outlined and accordingly, both are capable of being raised in individual proceedings, but the primary rationale for consideration to same arbitration is to eliminate the multiplicity of proceedings. Conclusively, a counter-claim is not a rebuttal to the claim, besides, the dismissal or result of the claim will have no bearing on the counter-claim proceedings. Wherefore, it is reflected that in an arbitration case, deposits in respect of arbitration costs, including arbitrator fees, have to be filed separately for both. Dissolving the color of the same horizon to the interrelated prism of Section 31(8), Section 31A, Section 38(1), as well as the Fourth Schedule of the Arbitration Act, it can be outlined that the standard of “Sum in dispute” in the Fourth Schedule for ascertaining arbitrator fees has to be considered distinctively and independently for ‘Claims’ and ‘Counter-claims,’ thereby, the fee ceiling will be applicable autonomously and differently for claims and counter-claims, that will further enhance income for arbitrators. 

    [i] Justice R S Bachawat, Law of Arbitration and Conciliation (Volume I & II, 6th Edition, LexisNexis, 2017)

    [ii] C R Datta, Law of Arbitration and Conciliation (Including Commercial Arbitration) (LexisNexis, 2008)

  • SEBI’s Plan to Amend Material Disclosure Mandates: Needless Escalation of Compliance Burden?

    SEBI’s Plan to Amend Material Disclosure Mandates: Needless Escalation of Compliance Burden?

    BY HARSHIT SINGH AND AKSHATA MODI, THIRD-YEAR STUDENTS AT GNLU, GUJARAT

    A.   Introduction

    A robust and continuous disclosure mechanism for listed entities is quintessential to ensure transparency and timely dissemination of material information and events. Such a mechanism is necessary to maintain the efficiency of capital markets. A strong disclosure regime also helps to reduce any information asymmetry among market participants and enables them to be levelled at the same footing. Regulation 30 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 [“SEBI LODR Regulations” or “Regulations”] governs the disclosure of material events and information by listed entities to stock exchanges. Disclosures under this regulation are classified into compulsory disclosures and discretionary disclosures. 

    Under Regulation 30(2) of the SEBI LODR Regulations, events specified in paragraph A of Part A of Schedule III are deemed to be material events and are mandatorily required to be disclosed by listed entities. Such events include matters related to mergers and acquisitions, insolvency, capital structuring and outcomes of the board of directors’ meetings, among others. At the same time, disclosure of events listed in paragraph B of Part A of Schedule III is discretionary and is determined by the materiality policy of the companies. 

    To review and strengthen the disclosure requirements of listed entities, the Securities & Exchange Board of India [“SEBI”] has recently issued a consultation paper [“Consultation Paper”], proposing drastic changes to Regulation 30 of the SEBI LODR Regulations. The Consultation Paper comes against the backdrop of several complaints received by SEBI in the past about delayed, inaccurate and misleading disclosures being done by the listed entities. Through this article, the authors aim to discuss the key changes proposed by the consultation paper and analyse their probable impact on the compliance burden of listed entities. 

    B.    Key changes proposed in Regulation 30 of the SEBI LODR Regulations

    1. Setting up a quantitative criterion for determining materiality 

    The Regulations currently prescribe for events and information falling under paragraph A of Part A of Schedule III to be classified as material events, and for their disclosure to be mandatory. However, disclosure of events falling under paragraph B is discretionary and would be determined based on the ‘materiality policy’ of the entity, as provided under Regulation 30(4).  Presently, the regulation stipulates for a listed entity to consider the following criteria while determining the materiality of events:

    1. the omission of an event will or is likely to result in alteration or discontinuity of information already publicly available, or
    2. the omission of an event is likely to cause a significant market reaction if such omission comes to light later.

    As per the current norm, events or information falling into either of the categories shall be deemed to be material. 

    Regulation 30(4)(c) confers upon the board of directors wide discretionary powers for determination and disclosure of material events. Through the Consultation Paper, SEBI proposes to move towards an objective, quantitative and non-discretionary threshold for determining the materiality of events and information. The proposed changes aim to bring uniformity to the materiality policy across all listed entities and limit the discretion conferred upon the board for disclosure of events specified under para B. SEBI has suggested the three below-mentioned minimum thresholds for determination, upon fulfilment of any one of which, an event or information would be considered material [“Materiality Test”]. 

    1. Two per cent of turnover as per the last audited financial statements;
    2. Two per cent of net worth as per the last audited financial statements;
    3. Five per cent of the average profit or loss of the past three years. 

    The Consultation Paper proposes to add these thresholds to Regulation 30(4)(i) and accordingly, make it mandatory for the materiality policy of all listed entities to provide for these triggers. Furthermore, dilution of these thresholds by the entities would be prohibited, and strict adherence would be prescribed for the determination of materiality. 

    2.     Reduction in disclosure making timeframes 

    Regulation 30(6) presently mandates all listed entities to disclose events or information falling under Part A of Schedule III to stock exchanges no later than twenty-four hours from the occurrence of such event or information. However, SEBI has recorded several instances in the past whereby the entity made the disclosure at the last hour after such information had already been publicly circulated through media. To address this delay in disclosure, the Consultation Paper has proposed to reduce the twenty-four-hour disclosure time limit to twelve hours. Further, it has also been recommended that the disclosure of events or information emanating from the board of directors’ meetings should be made within thirty minutes from the end of such meeting. 

    3.     Verification of rumours

    Presently, Regulation 30(11) provides that a listed entity on its own, may refute or confirm any rumour or reported market information; however, the same is not obligatory. SEBI believes it to be essential to verify rumours in order to avoid any false market sentiment leading to widespread speculation and price manipulation. As a result, through the Consultation Paper, SEBI has proposed to make it mandatory for the top 250 listed entities (by market capitalisation) to verify “any market rumour, or reported event or information which may have a material effect on such entity”.

    C.   Analysis

    1.     Rigidity in the quantitative disclosure criteria and potential overflow of information

    Setting up quantitative criteria for determining the materiality of events significantly reduces the discretion of listed entities for the disclosure of events and information. It creates a more objective disclosure regime, resulting in better clarity for investors and for the listed entities. However, establishing the Materiality Test may lead to the disclosure of wide-ranging events and information to the public. Such disclosures may be redundant and may not be having any significant or material impact on the entity’s operations or business. An overflow of information about a listed entity could lead to a greater degree of speculation in the market, thus, sharply affecting the stock prices of such an entity. Additionally, the proposed materiality threshold is too low and might result in a company disseminating a large volume of superfluous information through its disclosures. Most of all, it gives rise to a greater probability of crucial disclosures being bypassed by investors amidst an overflow of information to the public, which potentially makes the disclosures counter-productive.

    2.     Verification of market rumours could lead to premature disclosure of sensitive information 

    Verifying any information or event reported in print or digital media may be challenging for companies. Such challenges arise because while conforming or refuting any rumour, the listed entity will have to take a stance on a matter, whichcould be premature and might not have crystallised into a disclosure requirement otherwise. Verifying all rumours reported by media could be particularly challenging for companies undergoing mergers and acquisitions [“M&A”]. In public M&A transactions, price certainty and success of a deal are contingent on the deal’s confidentiality. This is because these transactions must take place above the floor price prescribed by SEBI, and this floor price largely depends on the historical price movement of the stock. As per the proposed changes, if there is any rumour in the media about the M&A transaction, the company would be compelled to confirm such speculation and be forced to divulge details of a half-baked deal. Such disclosure would drive the stock prices too high and jeopardise the deal’s commercial viability. 

    3.     Potential disclosures of incomplete Unpublished Price Sensitive Information

    Another concern is the premature disclosure of Unpublished Price Sensitive Information [“UPSI”], which could prove to be counter-productive to the public interest. SEBI (Prohibition of Insider Trading) Regulations, 2015 mandates for UPSI to be disclosed upon becoming concrete and credible. Disclosure of UPSI at the correct time is essential to ensure information symmetry in the market and to minimise price speculation. However, the Consultation Paper proposes to make it mandatory for a company to disclose and confirm information regarding any market rumours, even on deals which are currently in progress and are not yet confirmed. There will be sharp reactions in the market to any such disclosures, and the shareholders consequentially might lose if the deal falls through. Furthermore, by verifying market rumours, the company might disclose an incomplete UPSI, which would not be in the best interest of the investors.  

    D.   Conclusion

    The proposed changes by SEBI would substantially increase the compliance burden of listed entities. It could lead to a tsunami of disclosures and overburden investors with needless information which may not carry any material impact on the entity’s operations. The consultation paper further proposes for the top 250 listed companies to corroborate market rumours. This would make disclosures considerably onerous and would require companies to beef up their existing capacities to track and reply to all media reports. On implementation, the proposed amendments could cause companies to reconsider their listing plans. It could also potentially inhibit the growth of capital markets. Therefore, it is the view of the authors that SEBI should reconsider the changes proposed in the Consultation Paper and attempt to strike a balance between protecting investors’ interests and the compliance burden of listed entities.