The Corporate & Commercial Law Society Blog, HNLU

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  • The Legal Conundrum: Is A New Mandatory Offer Possible During An Existing One? – I

    The Legal Conundrum: Is A New Mandatory Offer Possible During An Existing One? – I

    BY TANMAY DONERIA, FOURTH YEAR STUDENT AT RGNUL, PATIALA

    This article is published in two parts, this is the Part I of the article.

    I. Introduction: Understanding The Context And Conundrum

    The Securities and Exchange Board of India (‘SEBI’) implemented the Substantial Acquisition of Shares and Takeover Regulations, 2011 (‘Takeover Regulations’) with the intent to provide exit options for the shareholders of public-listed companies, regulate the acquisition of direct/indirect control in a company and hostile takeovers. These regulations were implemented on the recommendations of the Takeover Regulations Advisory Committee (‘TRAC’). Before delving into the specifics, we need to understand certain provisions.

    –       Understanding Key Provisions

    Regulation 3(1) of the Takeover Regulations, provides that any acquirer who has breached the threshold of 25% voting rights in a public listed company (also known as the target company) shall make a public announcement for an open offer. This is also known as a “mandatory open offer”. The intent behind this provision is to facilitate/mandate the complete acquisition of the target company or allow the acquirer to gain control of the target company. Furthermore, it also provides an exit option for the shareholders, who are granted an opportunity to sell their shares and exit the target company in case they disagree with the acquirer holding a significant stake in the company. It is to be noted that an acquirer may also announce an open offer even before breaching the requisite threshold or even after completing the mandatory open offer, in order to acquire more shares or voting rights. Such an offer is known as a voluntary open offer in terms of Regulation 6. 

    Pursuant to the public announcement due procedure is followed and an open offer is floated in the market. Thereafter, Regulation 20 provides an opportunity for other interested parties to raise competing open offers within 15 days from the date of publication of the open offer. Regulation 20(3), deems any voluntary open offer made within 15 days from the open offer to be a competing offer. The provision for competing offers is beneficial for the shareholders as well as the target company. From the perspective of the shareholders, this process allows them to get the best prices for their shares, and from the perspective of the target company, this allows them to bring in a friendly investor and resist the hostile takeover, also commonly known as the ‘white-knight defence’. Furthermore, to minimize confusion for the shareholders and prevent overlapping or simultaneous open offers in the target company Regulation 20(5), mandates that after the completion of the aforesaid 15 days, no person is “entitled to” make a public announcement for an open offer or “enter into” any transaction that will attract an obligation to make an open offer till the completion of the offer period.

    Lastly, during this entire process Regulation 26, restricts the target company from entering any material transactions during the offer period outside the ordinary course of business without obtaining the consent of the shareholders through a special resolution. This ensures that no impediment arises during the acquisition process and the same is successfully completed. But there also exist certain exceptions that allow the target company to honour their obligations that were entered prior to the initiation of the acquisition process. The exception relevant to our discussion is found in Regulation 26(2)(c)(i), which permits the target company to issue or allot shares upon conversion of convertible securities issued prior to the announcement of the open offer. Having understood the legal provisions let us take a look at the problem being created by the interplay of these provisions.

    –       Illustration of the Conundrum

    Let us consider a situation, where the acquirer (ABC Ltd.), has breached the threshold of 25% of shares of the target company (TC Ltd.) and consequently, published a mandatory open offer under Regulation 3(1) after following the due procedure on 1.10.2024. Now other interested parties have 15 days i.e., time till 16.10.2024 to raise competing offers.

    A third party (XYZ Ltd.) holds 23% of shares and certain convertible security, that was purchased a long time ago, entitling them to 3% of shares. Hence, upon conversion XYZ Ltd. will hold 26% of shares of TC Ltd. Herein, we shall consider, two situations i.e., firstly, when the conversion occurs during the period of 15 days, let’s say on 12.10.2024 and secondly, when the conversion occurs after the period of 15 days but before the completion of the offer period, let’s say on 18.10.2024 (more on these two situations later). In both situations, XYZ Ltd. holds more than 25% of shares, making them liable to announce a mandatory open offer under Regulation 3(1).

    As noted, earlier Regulation 20 only permits competing offers within the period of 15 days when there is a subsisting open offer. Additionally, Regulation 20(3), only deems voluntary open offers as competing offers i.e., mandatory open offers are not covered within the ambit of this provision. Lastly, Regulation 20(5) specifically prohibits any person from making an open offer after the expiry of the 15 days till the completion of the offer period.

    This gives rise to an absurd situation where XYZ Ltd. who is under a statutory obligation (under Regulation 3(1)) to make an open offer cannot fulfil such obligation as at the same time the regulations (under Regulation 20(5)) are themselves barring them from making an open offer. In other words, XYZ Ltd. is being statutorily barred from fulfilling a statutory obligation. Such a situation gives rise to multiple questions such as- is the third party liable to make an open offer, if it does not make an open offer will there be penalties for non-compliance and what are the possible recourses with the third party in such a situation?

  • The Religare-Burman Saga: A Wakeup Call To Review Our Takeover Code?

    The Religare-Burman Saga: A Wakeup Call To Review Our Takeover Code?

    BY AAKRITI RIKHI, THIRD YEAR STUDENT AT NATIONAL LAW SCHOOL OF INDIA UNIVERSITY, BENGALURU

    I. Introduction

    On 10th July 2024, the Securities Appellate Tribunal (“SAT”) ordered Religare Enterprises Ltd. (“REL”) to comply with the Securities and Exchange Board of India (“SEBI”) order vis-à-vis the open offer by the Burman Group. This was in light of opposition by the board of directors (“Board”) of REL, the target company, to the proposed acquisition. The interim order by SEBI blocks all attempts by the Board to oppose such a takeover, even as the Board may act in the interests of the stakeholders of the company. [GA1]  The fundamental problem with this order is SEBI’s notion that the Board is accountable to the shareholders only (when a hostile bid is made) and not to all stakeholders of the company. 

    This decision in effect, solidifies the Indian position on hostile takeovers. Hostile takeovers are allowed as long as there is a compliance with the Substantial Acquisition of Shares and Takeovers (“SAST”) Regulations[GA2] , 2011. As per these regulations[GA3] , a limited set of responsibility is upon the Board of the target company, which is owed to the shareholders only. Upon a public announcement of an open offer for acquiring shares of the target company, the Board of the target company cannot act on the offer [R24] without the approval of the shareholders. This, I argue, is extremely constraining. Considering the shift towards the stakeholder model as codified by Section 166 of the Companies Act, 2013[GA5]  (“the Act”), it has become necessary to bestow some scope to act to the Board in the case of a takeover. The current legal framework has not accounted for this shift and as a result, there is a clear imprint of the shareholder-primacy model. 

    This post proposes a re-evaluation of the current legal framework to bring it in line with Section 166 the Act. It does so by firstly, highlighting the problematic assumption of the SEBI order in Religare. Secondly, it rebuts this assumption through a brief analysis of the model followed by India vis-à-vis the duties of directors and finally, using this analysis, it argues for empowering directors with the scope to act during hostile takeovers. 

    II. Analysing the SEBI order: An imprint of the shareholder model

    In the case of REL, prior to the public announcement for acquisition of more shares, the acquirers held 21.54% shares of REL. With the proposed acquisition, the shareholding of the acquirer would have increased beyond 25%, triggering an open offer under Regulation 3(1) and 4 of the SAST Regulations, 2011[GA6] . In relation to this open offer, the Board of REL had constituted a Committee of Independent Directors, which had raised objections to the proposed acquisition, on the ground that the acquirers were not ‘fit and proper’ persons for acquiring shares in the target company. There was no evidence provided in support of these allegations.

    In its interim order, SEBI held that the refusal of the target company to seek statutory approvals from regulators, which would enable the acquirers to discharge their legal obligations and provide an exit option to shareholders in the open offer, defeats the objects of the law and goes against the established canons of corporate governance. As per SEBI, the management of the target company is a representative of the shareholders and cannot act against their rights and interests.

    This ignores the fact that directors owe fiduciary duties to the company and not merely to the shareholders. The fundamental problem with this order is the assumption that shareholders are the only decision-makers of the company. By accounting for only the shareholder’s interests, the order renders the stakeholder model of the present statute otiose and is problematic for the target company. 

    This is symptomatic of our present legal framework for hostile takeovers as the following section will explain.

    III. Duties of Directors during a hostile takeover under the current legal framework

    During an acquisition, the management of a listed company is duty bound to act in the interests of its shareholders under broader corporate governance norms, enshrined in the provisions of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Regulation 4(2) imposes a mandatory duty on the listed company to protect and facilitate the exercise of the rights of shareholders. This is also reflected in the SAST Regulations 2011. As per Regulation 26(2) of SAST Regulations, the Board of the target company cannot take any substantive action without a special resolution of the shareholders. Further, the Board has to constitute a committee of independent directors to provide reasoned recommendations on an open offer. These recommendations have to be provided to the shareholders of the target company. The Board only exercises an advisory role wherein it has no choice but to facilitate the acquirer in the open offer process. This is consistent with the U.K. Takeover Code. This code has enshrined similar provisions on the duty of the Board in case of a takeover. This is termed as the ‘non-frustration rule’. This rule is established to set aside the management when hostile bids are imminent so that the shareholders have the final say on the merits of the bid. 

    In the Indian context, the rationale for this lies in the structure and organisation of companies. Indian companies typically have concentrated shareholding. They have founding families ‘promoters’ with dominant shareholding positions. This, it has been contended[R27] , blocks against a hostile takeover. As a result, there was no contemplation over promoters not holding large stakes while bringing these regulations. Furthermore, there is an assumption implicit in this rationale that the promoters owe a statutory duty to the company as they are endowed with the scope to act in case of a takeover and not the Board. As the next section establishes, it is ultimately the directors who owe a statutory duty to the company and not the promoters. 

    IV. Section 166: A codification of the stakeholder model

    Section 166 of the Act lays down the duties of directors. This was the first time that India had codified the duties of directors[R28] . Section 166(2) highlights who these duties are owed to. It has been contended that the wording of this provision indicates a concrete shift from the shareholder primacy model to the stakeholder model. The shareholder primacy model is based on the theory that the Board of directors derives its powers from the shareholders and therefore, the role of directors is to promote the interests of the shareholders. The stakeholder model views the company’s activities as affecting the society in genera[R29] l. It emphasizes that the role of a company’s directors is not limited to maximising shareholder value but also to account for the interests of other stakeholders, without prioritising one over the other. Therefore, to summarise, the shareholder-primacy model prioritises the interests of the shareholder at the expense of others in the company. It only recognises the profit-driven stake of the shareholders while the stakeholder model situates the company in the larger society.

    Historically, India has fluctuated between these models. During the colonial and the post-Independence period, we adhered to the shareholder model. With the 1960s socialist era, the company was beginning to be seen as having a public character so, we shifted towards the stakeholder model. But, with the 1990s liberalisation policies, we reverted back to the shareholder primacy model. As a result, there was a recognition that directors owe a fiduciary duty to the existing shareholders. This was reflected in the Companies Bill, 2009 [R210] wherein clause 147(2) recognised that directors owed duties to carry on the business of the company “for the benefit of its members as a whole” i.e., the shareholders. This was later amended by the Parliamentary Standing Committee, which recommended the inclusion of Section 166(2). 

    The UK on the other hand, followed a different trajectory. Through section 172 of the UK Companies Act, 2006 the enlightened shareholder value model was adopted. This is a variation of the shareholder primacy model where directors are required to have regard to non-shareholder interests as a means of enhancing shareholder value over the long term. So, a hierarchy has been created wherein the shareholder interests are at the top while stakeholder interests remain at the bottom. This interpretation of Section 172 has been upheld recently by the UK Supreme Court as well. 

    Overall, it can be seen that India casts a positive duty on directors to account for other stakeholders whereas UK considers this to be a secondary consideration (if a consideration at all). In light of this duty, it becomes imperative to empower directors to act against a hostile bid. 

    V. Why should directors have scope to act against a hostile bid?

    India’s shift towards the stakeholder model signifies that a body which is accountable to the company and its stakeholders shall exercise the broader decision-making power of the company. When seen in this context, it is apparent that the rationale of allowing the promoters to act does not necessarily hold water. This is because promoters do not owe any statutory duty to the company. The 2013 Act prescribes only two duties of promoters: duty not to make secret profit and duty to disclose to the company any interest in a transaction.[i] This is quite limited when compared with the duties of directors under Section 166. Further, in the case of a promoter being a majority shareholder, there are only two restrictionsprescribed by the Act: limit on the power to alter the MOA and limiting the power from committing fraud on the minority.

    More specifically, in the context of a takeover, there is no mandate imposed on the promoter/shareholder to take into account stakeholder interests. Whereas by reading the duties of directors to include the scope to act in a takeover, there will be a positive duty imposed on them. This becomes significant as a takeover can impact other stakeholders such as employees adversely. For instance, during the Mindtree acquisition by L&T, there was the risk of a cultural mismatch as Mindtree followed an informal culture while L&T followed a command-and-control and top-down management. We can clearly see that by empowering only promoters with control to act in a takeover, there can be severe consequences as they are not bound to account for the interests of other stakeholders. 

    Therefore, India can no longer afford to continue following the non-frustration rule of the UK Takeover Code. The rule still works for the UK because it has adhered to the shareholder primacy model. It no longer works for India as our understanding of a company is that of an entity having a public character. This is evident from the mandatory CSR obligations under Section 135 of the Act. 

    VI. Conclusion

    The purpose of this post is to prompt a review of our takeover-friendly SAST Regulations. Our present law is located at one end of the spectrum as it completely prohibits any action by directors during a hostile takeover. However, we are at a unique position where we can attain a balanced position by providing some scope to directors to act while formulating a standard of review of directors’ actions under Section 166. If we continue with our current framework, we are likely to run into problems as in the case of Religare wherein the directors have no choice but to delay the inevitable through vague mechanisms. 

    [i] Erlanger v. New Sombrero Phosphate Co., (1878) LR 3 App Cas. 1218, 1236, Gluckstein v. Barnes (1900) AC 240. Also note that Sections 34 and 35 of the Companies Act impose liability for untrue statements in prospectus and sections 339 and 447 impose liabilities on promoters for fraudulent trading. 

  • Rationalizing ‘Connected Persons’: Analyzing SEBI’s Proposed Insider Trading Amendments

    Rationalizing ‘Connected Persons’: Analyzing SEBI’s Proposed Insider Trading Amendments

    BY PRIYA SHARMA AND ARCHISMAN CHATERJEE, Fourth AND third YEAR STUDENTS AT NATIONAL LAW UNIVERSITY, ODISHA

    I. Introduction 

    Securities and Exchange Board of India (‘SEBI’), in the consultation paper dated 29 July 2024 (‘consultation paper’), proposed amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) to rationalize the scope of ‘connected person’. The consultation paper proposes to add additional categories to the current definition of connected persons in the PIT Regulations, and thereby cover more persons who may have access to unpublished price sensitive information (‘UPSI’) by virtue of their relation with an insider.

    While the proposed amendments will help SEBI target additional persons and raise a presumption of possession of UPSI against them, the existing ambiguities in the insider trading legal framework will increase the likelihood of false positives and overregulation in this arena.

    II. Proposed Amendments

    Under the PIT Regulations, an insider is defined as any person who is either a connected person or is in possession of or having access to UPSI. Presently, a ‘connected person’ is defined as a person who is or has, during the six months before the act, been associated with the company, directly or indirectly, in any capacity [Regulation 2(1)(d)]. The relationship with the ‘connected person’ may be contractual, fiduciary or employment-related, and may be temporary or permanent, that allows them access to UPSI or is reasonably expected to allow such access. The PIT Regulations also specify certain categories ‘deemed to be connected persons’, including immediate relatives of the connected person, a holding or associate company or subsidiary company, etc. within its ambit. 

    UPSI is defined as “any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities”. A person who falls under the scope of a ‘connected person’ will be presumed to have access to UPSI, and the person will carry the onus to disprove this presumption. If a person does not fall under the scope of a connected person, the onus to prove access to such information will lie on SEBI.

    The consultation paper notes that certain categories of persons, who have a close and proximate relationship with connected persons, may not be covered under the present definition of ‘connected person’. Therefore, it proposes to replace the term ‘immediate relative’ in section 2(1)(d)(a) with the term ‘relative’. It also proposes the inclusion of additional categories of people who will be deemed to be connected persons, including any person on whose advice, directions or instructions a connected person is accustomed to act, a body corporate whose board of directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a connected person, persons sharing household or residence with a connected person, and persons having material financial relationship with a connected person including for reasons of employment or financial dependency or frequent financial transactions. 

    In order to ensure ease of doing business, the definition of ‘immediate relative’ is proposed to be retained for the purpose of disclosures, and the definition of ‘relative’ is rationalized only for establishing insider trading.

    III. The Good: Targeting a Regulatory Gap

    The changes are proposed with the aim to include persons who may seemingly not occupy any position in the company but are in regular contact with the company and its officers. By virtue of this relationship, such persons may be aware of the company’s operations and get access to UPSI. 

    Under the current regime, the scope of connected persons does not include non-immediate relatives of the person. ‘Immediate relative’ includes the spouse of a person, parent, sibling, and child of such person or of the spouse, any of whom is either financially dependent on this person or consults such a person in making decisions relating to trading in securities. Under the proposed amendments, the term ‘relative’ would include spouse, siblings, siblings of spouse, siblings of parents, any lineal ascendant or descendant of the individual or spouse, or spouse of any of the mentioned persons. Evidently, the new definition will include many more persons.

    Many relevant relations remain uncovered in the present terminology, which requires that either (a) the mentioned person be financially dependent on such a person, or (b) consults such a person in making decisions relating to trading. Such facts are difficult to prove, as they involve the family’s internal affairs, and make it difficult to establish the presumption of insider trading. 

    For illustration, under the current regime, if A is a connected person, B, the father-in-law of A’s sister who lives in another city with her husband’s family, would not be deemed to be an insider unless he fulfills the criteria mentioned in the definition. The proposed amendments would bring B under the ambit of ‘deemed to be connected person’ since he is a lineal ascendant of the sister’s spouse. No other criteria are required to be fulfilled.

    The proposed amendments formulate a comprehensive definition of ‘relative’, much like the Income Tax Act, 1961, and do not limit it to immediate family members. This proposed change promises a stricter, and stronger, regulatory regime.

    IV. The Bad and the Ambiguous: Pre-existing issues

    Section 15G of the SEBI Act specifies that any individual who enters into a trade on the basis of UPSI would be penalized for insider trading. The emphasis here is on the term basis since it showcases the requirement of mens rea for the liability to be attracted. On the other hand, Regulation 4 of the PIT Regulations states that if any individual executes any trade while in possession of UPSI, the liability for insider trading shall be attracted. 

    In this regard, the Supreme Court, in Balram v SEBI, observed that ascertaining the intent of individuals is necessary to affix the liability for insider trading. On similar lines, in Abhijit Rajan v SEBI, the apex court highlighted the need to determine the profit motive of the individuals who are in possession of the UPSI. This showcases a clear conflict between the specific wording of the PIT regulations and the interpretation of the court in terms of the presence of mens rea and increases differences in interpretations. 

    If the proposed changes are implemented, many more individuals would be deemed to be connected persons, and the presumption of access to UPSI will be raised against them, even if the access is factual or not, or any mala fide intent to act upon it is present or not. For instance, B, being the father-in-law of A’s sister, who may be deemed to be a connected person by virtue of being a relative if the proposed amendments are made, is able to overhear certain UPSI at a family function, and despite the same, he sells his shareholding as he intended to do so even before possessing the UPSI. In such a scenario, B could still be liable for insider trading under PIT Regulations even though there was a lack of intent and profit motive. 

    Therefore, the present regulatory framework showcases the lack of uniformity and clarity about the threshold for attracting liability for insider trading, and the issue will be exacerbated if the definition of ‘deemed to be connected persons’ is widened. Additionally, such a low threshold (no mens rea required, according to the PIT Regulations) to hold a person liable might lead to false positives, which in turn may overburden SEBI as well as the accused persons. In fact, it was advised by the N. K. Sodhi Committee, which was formed to review PIT Regulations of 1992, that a defense should be incorporated into the provisions which would allow the insider to prove that the alleged illegal trade has an effect which is opposite to what the UPSI requires for one to draw an unfair advantage.

    To address this, we suggest implementing a higher threshold for those connected persons who are very remotely connected to the primary insider and a lower threshold for those who are directly connected. The current framework treats all immediate persons on the same footing. For instance, an individual who came into accidental possession of UPSI might get prosecuted for the offence of insider trading. 

     The incorporation of a threshold on the basis of a higher burden of proof or requirement of mens rea (possession or usage) could increase the efficiency of the framework. To elucidate, for proving insider trading in the case of relatives by birth, the mere possession of UPSI should be enough to hold them guilty, and the opposite can apply in case of relatives by marriage. Similarly, the burden of proof required to prove their innocence should be lesser for relatives by marriage and the contrary for those related by blood. Such a framework is more effective than the proposed changes, as it does not automatically deem ‘immediate relatives’ as connected persons (as is the case in the present scenario), and instead, creates comprehensive criteria for the regulator to implicate relatives in actions against insider trading. Moreover, SEBI should not overlook profit motive as mens rea and refine the insider trading provisions in the PIT Regulations, bringing it more in line with the Act. Lastly, the addition of more defenses in Regulation 4, such as those recommended by the Sodhi Committee, may help dilute the adverse impacts of the proposed amendments. 

    V. Conclusion

    While the proposed amendments aim to broaden the scope of ‘connected persons’ to encompass those in close proximity to insiders, thereby strengthening regulatory oversight, they also introduce challenges. The potential for increased false positives and ambiguities surrounding the intent requirement highlight ongoing concerns within the insider trading legal framework. To mitigate these issues, SEBI must strike a balance by refining definitions, clarifying thresholds for liability, and incorporating defenses against inadvertent breaches. Such measures are essential to uphold both the integrity of the securities market and the rights of individuals ensnared in the regulatory net.

  • CCI Needs to Reconsider its Approach-Balancing Patent Rights and Public Welfare

    CCI Needs to Reconsider its Approach-Balancing Patent Rights and Public Welfare

    RAVNEET KAUR, THIRD-YEAR STUDENT AT RGNUL, PUNJAB

    Introduction

    Section 4 of the Competition Act, 2002 (‘Competition Act’) lays down the practices, which if undertaken by a dominant enterprise, would amount to abuse of dominant position. One of such practices is ‘unfair’ or ‘discriminatory’ pricing. Generally, unfair pricing of a commodity can have two connotations. It can either be unreasonably high or unreasonably low compared to the expenses incurred in its production.  

    While predatory pricing, dealing with the latter scenario, has been specifically included within the ambit of unfair pricing under section 4(2)(a) of the Competition Act, excessive pricing has neither been mentioned nor defined. Does that imply that an enterprise possessing a dominant position could conveniently impose unreasonably high prices on people, prices that have no rational nexus with the costs incurred? This is certainly not the case. In the Indian context, excessive price forms a subset of unfair price.

    However, this inclusion has not been able to yield any outcome so far. In reality, excessive pricing is rarely considered as an abuse of dominant position. This policy of non-intervention in case of excessive pricing stems from two reasons. Firstly, regulation of prices might cut incentives for new players; secondly, the self-regulatory mechanism is assumed to operate in the market. However, this approach tends to get problematic when applied in the pharmaceutical industry where the commodity in question is an on-patent drug, resulting in the failure of a self-regulatory mechanism.

    Approach Towards Pharmaceutical Industry

    This policy of non-intervention in case of excessive pricing has been time and again applied in the pharmaceutical industry as well. The Competition Commission of India (‘CCI’) has been rather reluctant in making a prima facie case of abuse of dominance against an enterprise where it is accused of charging excessive prices.

    The reluctance of the CCI in this regard could be attributed to two factors-

    1. Research and Development Costs

    In the pharmaceutical industry, particularly, enormous and unwarranted margins between manufacturing cost and market price often go unchecked. This is because there is a general perception that the manufacturing of drugs is preceded by years of research and expenditure that comes with it. Therefore, it is argued that using conventional benchmarks (such as price-cost comparison) could reduce the incentive for further research and development (‘R&D’). It is primarily because if firms expect price regulation to capture a sizable share of a market, their incentives for innovation and entry into new markets will be diminished, damaging consumer welfare in the long run. In the case of Biocon Ltd. v. F. Hoffmann-La Roche AG, the complaint against the ‘excessive pricing’ of the anti-cancer medicine Trastuzumab was dismissed. The grounds cited were that the original drug price increase was justified by the enormous expenditures invested in R&D and innovation.

    • Interface of Patent Rights and Maintenance of Competitive Environment

    The prime argument that is offered to pitch for non-intervention in case of excessive prices is that it is an exercise of lawful monopoly. In the Indian context, the Patents Act, 1970 (‘Patents Act’) guarantees a statutory and time-exclusive right to the patentee to decide upon the commercial exploitation of the patented drug. This right includes the determination of prices. Touching upon the aspect of excessive pricing, it is argued that monopoly prices are an accolade that enterprises get for making uncertain and risky investments. The US Supreme Court, in the context of monopoly pricing, observed that “mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free market system”. A situation like this generates a collision between two statutes. While the Competition Act seeks to maintain competitive conditions in the market, the Patents Act safeguards the rights of a patentee.

    Analysing the Problematic Approach

    Regarding the clash between the Competition Act and the Patents Act, it is worth pointing out that while section 3 of the Competition Act provides some sort of exemption under section 3(5) to the actions arising out of rights vested under the Patents Act, no such exemption has been granted under section 4. In simpler words, if a certain action attracts applicability under section 3 of the Competition Act but has arisen out of the rights guaranteed under the Patents Act, it would be exempted from the rigours of the Competition Act. However, an action which results in the abuse of a dominant position would not be exempted even if it stems from the rights guaranteed under the Patents Act. The intention of the legislature is unambiguously clear in not permitting the rights of a patentee to get in the way of a competitive environment. With particular reference to the pharmaceutical industry, this distinction indicates that if the prices imposed by an enterprise qualify as ‘unfair’ within the meaning of section 4, it would amount to an abuse of the dominant position irrespective of the fact that the enterprise has a statutory right to decide upon the determination of prices of an on-patent drug.

    Further, the opinion on non-interference in the cases of excessive pricing is mostly premised on the principle of self-regulation. In the absence of market failures, excessive prices motivate potential competitors to enter the market and are, therefore, self-correcting. However, the application of this principle presupposes the availability of alternatives for the commodity in question and the absence of entry barriers for new players to enter the market. As for the pharmaceutical industry, primary and secondary manufacturing are the two fundamental steps in the production of drugs. Producing a drug’s active pharmaceutical ingredient is known as primary manufacturing. The process of incorporating the active ingredient into a delivery system is called secondary manufacturing. Therefore, it is this Active Pharmaceutical Ingredient (‘API’) that has therapeutic qualities.

    When a new drug is invented, the manufacturing enterprise gets the API patented. Now, in order to manufacture the drug of the same efficiency, the API used in the formerly manufactured drug is a pre-requisite. By patenting the API, the enterprise successfully eliminates the possibility of a new player entering the market and selling the drug at a lower price. The problem aggravates when the drug in question does not have any comparable or reasonable substitutes. In the pharmaceutical industry, ‘therapeutic substitutability’ is a mandatory requirement for some other drug to have the potential to cause competitive constraints over the drug in question.

    This essentially questions if consumers, faced with a price increase, could easily switch to other alternatives without the therapeutic efficiency being compromised. In the case of critical diseases like cancer, the availability of therapeutically substitutable drugs is unlikely. Seeking to reap the benefits of a situation like this, in the absence of competitors or reasonable substitutes, enterprises hike the prices of their drugs manifold. Consequently, the self-regulatory mechanism escapes applicability in a case like such, with heavy entry barriers and no substitutes. A consumer, faced with this adversity of unreasonable prices, is made to choose between life or death. If he chooses life, the financial burden continues to grow heavier until it becomes impossible to endure and if he refuses to pay the exorbitant prices, his life is on the line. Top of FormBottom of Form This clearly flies in the face of the idea behind the recognition of providing access to essential medicines at affordable prices as a core obligation under the right to life in the constitutional context.

    To date, the Indian authorities do not have a developed jurisprudence pertaining to excessive pricing. Owing to this, the authorities tend to seek aid from the jurisprudence developed in foreign countries. United Brands Company and United Brands Continental BV v Commission of the European Communities Brands case, for instance, is the most cited precedent in this regard which has its shortcomings, one of them being the determination of benchmark price. CCI’s indifferent approach towards this lacuna is highly problematic. The only apparent and discernible solution to this problem is establishing an authority to fill the void of undeveloped jurisprudence. CCI should formulate guidelines to govern cases about excessive pricing with special reference to pharmaceutical industries. These guidelines must ensure that public welfare and patent rights co-exist harmoniously.

    Conclusion

    The challenge here is to strike a balance between the rights of a patentee and the obligation towards the public. Allowing the prices of life-saving drugs to go unregulated would mean denying people the right guaranteed to them by the makers of the constitution under Article 21. The enterprises, undoubtedly, enter the market with a vision to gain maximum profits but these profits should not be permitted to come in the way of larger public interest. Going by business wisdom, it is needless to say that the market price of a drug has to exceed the expenses incurred and that there has to be a margin between the cost of production and the market price but this margin should not go unchecked. It is for the CCI to ensure that this margin is reasonable and caters to the interests of both the enterprise and the general public. The regulatory guidelines are the need of the hour to inhibit big players from benefitting from the masses’ helplessness.

  • Bharati Airtel & Anr v. V.V. Iyer – Unraveling the Set-Off Saga in Insolvency

    Bharati Airtel & Anr v. V.V. Iyer – Unraveling the Set-Off Saga in Insolvency

    by Pratishtha Agarwal and Prabhav Tripathi, students of third-year at the Institute of Law, Nirma University

    Introduction

    While the Insolvency and Bankruptcy Code, 2016 (“IBC”) serves as a complete code, many a time, the exclusive nature of the Act presents a legal lacuna in the procedure and calls for determining the application of other general laws in such absence of relevant provisions. On a similar note, in the recent case of Bharati Airtel Limited and Anr. v Vijaykumar V. Iyer and Anr., the Supreme Court decided upon the question of the right to claim set-off in the Corporate Insolvency Resolution Process (“CIRP”). In set-off, it is a debtor’s right to settle the smaller claim owed to him against the larger claim payable to his creditor. As there is no statutory provision on setting off the balance amount once the CIRP has been initiated, the Bench comprising Justice Sanjiv Khanna and Justice S.V.N. Bhatti observed the appeal.

    It was held that insolvency set-off and statutory set-off do not apply to CIRP. Though the right to claim of set-off is generally granted under Order VIII Rule 6  of the Civil Procedure Code, 1908 (“CPC”), it is not permitted in the CIRP when the Resolution Professional proceeds to take control and custody of Corporate Debtor’s assets under Section 25(2)(a) of IBC.

    This blog aims to understand the rationale behind the judgement and the exceptions it carved, discuss the arguments presented from both sides and analyse the dissenting stances of foreign jurisdictions on claim of set-off in insolvency proceedings.  

    Facts of the Case 

    In April 2016, eight spectrum trading agreements were executed between Bharti Airtel Limited, Bharti Hexacom Limited, Aircel Limited, and Dishnet Wireless Limited to acquire the usage rights of the spectrum allocated to the latter. Since the agreement was contingent on the approval of the Department of Telecommunications, Government of India, (“DoT”) it had demanded that the Aircel entities submit bank guarantees for Rs 457.73 crores owing to certain licenses and spectrum dues.

    After the Aircel entities filed a challenge with the Telecom Disputes Settlement and Appellate Tribunal (“TDSAT”)regarding DoT’s directive, they were ordered by TDSAT to provide bank guarantees for which they approached the Airtelentities. On the Aircel entities replacing the bank guarantees furnished by the Airtel entities and Airtel entities receiving them from the DoT, Rs. 411.22 crores were payable by the Airtel entities to the Aircel entities.

    Pertinently, the bone of contention arose on 10th January 2019 when the Airtel entities made a payment of Rs 341.80 crores due to Aircel entities after setting-off a balance amount of Rs 145.20 crores on the ground that Aircel entities owed that amount to them. This set-off was contested before the Adjudicating Authority (“AA”) in Mumbai by Airtel wherein an order in favour of the Airtel entities held that they had a right to set off Rs. 112.87 crores from the payment. The Resolution Professional contested the Adjudicating Authority’s order before NCLAT which held ‘set-off to be antithetical to the objective of the IBC.’ 

    Provisions And Principles: No Right To Claim Set-Off In The CIRP

    Relying upon the opening part of the enactment, the Supreme Court judgement addresses IBC as a complete code to consolidate the laws relating to insolvency resolution and reorganization. The intentional omission of statutory set-off or insolvency set-off provisions during CIRP reflects a legislative decision to preclude the assertion of such rights in insolvency proceedings. Additionally, Regulation 29 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”) which addresses setoff and mutual credits, is confined to Chapter III Part II, specifically about the liquidation process. This posits that if there were a conflicting legislative intent, the law would have encompassed Chapter II Part II of the IBC to allow the application of set-off claims during CIRP.

    Section 238 IBC provides an overriding power wherein notwithstanding anything inconsistent present in any other law for the time being in force, the laws laid down are in effect. This legal position also disarms Regulation 29 from subsuming the CIRP under its scope of insolvency set-off. Further, Order VIII Rule 6 of CPC creates a legal or statutory set-off wherein the defendant has a right to claim set-off against the plaintiff’s demand for an ascertained sum of money that is legally recoverable and is not beyond the pecuniary limits of the court’s jurisdiction. However, this set-off too, is overridden by Section 238 and rendered inapplicable from being exercised during insolvency proceedings, thus maintaining the rigidity and exclusivity of the Code.

    It was further argued that the concept of insolvency set-off, in its entirety, goes against the principle of pari passu. Section 53 of the IBC lays down the priority order of creditors for the distribution of sale proceeds of liquidation assets under the “waterfall mechanism”. Here, set-off offers an overriding effect and primacy to the creditor entitled to claim set-off against the demanded credits of the Corporate Debtor. In the process of dealing with these cross demands by set-off, the assets are depleted in favour of that single creditor with set-off entitlement that was initially available to be settled amongst the general body of creditors. As a consequence, with a decrease in the dividend payable, the same class of creditors are not treated equally and the liquidation hierarchy is also compromised. Thus, if such a claim is permitted in the CIRP, it is bound to go against the waterfall mechanism by keeping the entitled creditor on a higher footing and the other creditors at a disadvantageous position.

    Contradictory Viewpoint on the Applicability of Set-Off to CIRP

    The SC judgment attempts to clear the air on the applicability of set-off to CIRP however it raises pertinent questions on whether the Apex Court has taken an erroneous stance. The judgment moots the contention that Regulation 29 of the Liquidation Regulationsmandates the mutual set-off however the instant regulation only corresponds to liquidation.

    Pertinently, as noted earlier, the judgment of the SC in the case of Swiss Ribbons v. Union of India held that set-off can be considered during CIRP subject to the challenge before the AA. Interestingly, the judgment takes note of the mandatory nature of insolvency set-offs in the United Kingdom as highlighted by the judgment in the case of National Westminster Bank Ltd. v. Halesowen Presswork & Assemblies Ltd.. Therefore, it is vital to highlight that set-off is a widely accepted and practised principle of insolvency law internationally. Notably, Section 553  of the U.S. Code provides for the right of a creditor to offset a mutual debt that arose before the commencement of the case i.e. pre-petition debt. However, per the ratio of In re Shopper’s Paradise,  it was highlighted that a creditor can never offset a post-petition debt against a pre-petition debt. This in line with the distinction drawed upon in the instant judgment in relation to set-off pre and post the initiation of the CIRP. 

    Further, in the matter of Pramod Kumar Sharma Uniworld Sugars Pvt. Ltd. v. ED&F Man Sugar Ltd., NCLT Chandigarh had held that set-off was permissible during CIRP in view of ‘the treatment reflected in the book of accounts of the Corporate Debtor while determining the liability of the parties with regard to the purchase and sale of sugar.’ A case has been made out in detail below for allowing set-off in the context of CIRP. 

    Justifications for Permitting Set-off in the Context of CIRP

    1. Litigation Minimization: Permitting setoffs can aid in the reduction of litigation throughout the CIRP. The presence of set-off may potentially mitigate disputes concerning the validity and magnitude of claims, as it incentivizes the involved parties to negotiate settlements rather than engage in protracted legal disputes.

    2. Encourages Credit Flow: An effectively operating set-off mechanism has the potential to encourage credit flow. If creditors are certain that the quantities owed by the debtor can be offset against their exposure, they may be more inclined to grant credit to financially distressed companies. This would subsequently increase the availability of credit in the market.

    3. Promoting Creditor Engagement: Permitting set-off enables creditors to be more motivated to actively participate in the CIRP. To encourage greater participation in negotiations, contribution to the resolution plan, and support for the company’s revival, creditors might be more inclined to offset their claims against the liabilities of the debtor.

    Conclusion

    However, the Apex Court has carved out two exceptional conditions in Paragraphs 30 and 32 of the judgement, wherein the set-offs are permitted in CIRP in two circumstances. Firstly, a contractual set-off is allowed if its entitlement is effective before or on the date of CIRP initiation.  As the same cannot be precluded, the terms of the contract remain binding besides the moratorium period. Secondly, equitable set-off, wherein the claim and counter-claim are linked by transactions that can be treated as one, was also made an exception by the Bench. Herein, the set-off needs to be “quantifiable, genuine, and established on fact and in law.” Through this judgement, the Supreme Court reiterated the sanctity and exclusivity of IBC and settled the position of law on the applicability of the right to claim set off in the CIRP. In the context of insolvency law, the ratio decidendi is a right step in the way to establish a proper demarcation of claims in CIRP and other laws.

  • 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.

  • 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.