The Corporate & Commercial Law Society Blog, HNLU

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

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

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

    Introduction

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

     Low Recovery Rates: Discerning the Reasons

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

    A. Does the Judiciary Mitigate the Discontinuity Effect?

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

    Distinct Incentives and Information Asymmetry

    A. Understanding Information Asymmetry Pre-2019

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

    B. Information Asymmetry and Structural Issues

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

    Conclusion

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

     

     

     

     

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

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

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

    Introduction

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

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

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

    Details of the Provision and the Proposed Amendment

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

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

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

    Implications of the Proposed Amendment

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

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

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

    Position of ‘Angel Tax’ In Foreign Jurisdictions

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

    Canada

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

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

    Australia

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

    United Kingdom

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

    USA

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

    China

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

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

    Conclusion

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

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

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

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

    Introduction

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

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

    Issues pervading the taxation of crypto under the ITA

    The Finance Act 2022 inserted four components in the ITA:

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

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

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

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

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

    i.   Tax as Revenue Maximization

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

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

    ii.  Tax as Negative Externality

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

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

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

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

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

    Conclusion

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

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

    [2] ibid.

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

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

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

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

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

    Introduction

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

    Constructing the substructure of arbitration fees

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

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

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

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

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

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

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

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

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

    (B) Civil Proceedings

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

    Forecasting perspectives of ‘Sum in dispute’ as a cumulative

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

    Concluding Perspective

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

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

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

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

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

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

    A.   Introduction

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

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

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

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

    1. Setting up a quantitative criterion for determining materiality 

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

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

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

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

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

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

    2.     Reduction in disclosure making timeframes 

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

    3.     Verification of rumours

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

    C.   Analysis

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

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

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

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

    3.     Potential disclosures of incomplete Unpublished Price Sensitive Information

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

    D.   Conclusion

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

  • Enforcement of Foreign Seated Emergency Arbitration Award in India: Unboxing the Pandora’s Box

    Enforcement of Foreign Seated Emergency Arbitration Award in India: Unboxing the Pandora’s Box

    By Prerna Mayea, fifth-year student at Institute of Law, Nirma University

    I. Introduction

    Emergency arbitration has been a buzzword in the last few years in India since the ruling in Amazon.com NV Investment Holdings LLC v. Future Retail Ltd. The Supreme Court of India held that Emergency Award (‘EA’) in India-seated arbitration can be enforced under Section 17(2) of the Arbitration and Conciliation Act (‘the Act’). This is certainly a big step for creating a pro-arbitration environment in the country. However, this case did not provide authority for the issue that EA in foreign seated arbitration is enforceable in India. This is because Section 17 cannot be relied upon to enforce the EA since Part I of the Act does not apply to foreign seated arbitration.

    II. Judicial Stance On Enforcement Of Foreign Seated EA In India

    The matter regarding enforcement of EA in foreign seated arbitration firstly came before the Delhi High Court in Mr. Ashwani Minda & Anr. V. U-Shin Ltd. & Anr. In this case, the applicant tried to avail the remedy of EA in foreign seated arbitration which was denied to him. Subsequently, the applicant tried to seek interim relief under Section 9 of the Act, which was denied by the court on two premises:

    1. The dispute resolution clause in the agreement excluded the applicability of Section 9.
    2. The applicant had already failed before the emergency arbitrator, and there were no changes in the circumstances.

    The court cited the continuing mandate of the emergency arbitrator to deny the relief under section 9. This suggests that the court considered EA in a foreign seated arbitration as an effective remedy to disallow relief under Section 9.

    In HSBC PI Holdings Ltd. v. Avitel Post Studioz Ltd and Ors., even though the court did not enforce the EA directly, it granted relief under Section 9 of the Act to the party by reproducing the EA verbatim. This suggests an alternate mode of enforcement of the EA by obtaining similar interim reliefs under Section 9. However, this might not be an efficacious remedy since it would require re-adjudication by the court leading to duplication of proceedings and wastage of time.

    In Raffles Design International India Pvt. Ltd. v. Educomp Professional Education Ltd., the court denied enforcement of EA in foreign seated arbitration citing a lack of authority, and insisted on filing a fresh application under Section 9 of the Act. The court however also added that a party cannot be denied interim relief simply because a similar relief has been obtained through EA. Further, the decision to grant the relief will be independent of the interim order in foreign seated arbitration.

    III. Enforcement Of Foreign Seated EA Under The Act

    • Section 44 and 48 – Enforcing as foreign award

    Arbitral award has been defined under Section 2(1)(c) to include an interim award. However, this definition under Part I of the Act cannot be applied in the case of foreign seated arbitration. Section 44 of the Act does not define ‘arbitral award’. However, Section 44(a) applies to arbitral awards arising out of arbitration to which the New York Convention (‘NY Convention’) applies.

    Under the NY Convention, Article 1(2) defines ‘arbitral award’ to “include not only awards made by arbitrators appointed for each case but also those made by permanent arbitral bodies to which the parties have submitted.” This definition is inclusive and wide enough to encompass emergency award made by the arbitrator. It must be noted that emergency arbitrators are appointed by arbitral tribunals and thus such award must be considered to be made by arbitral institutions only and subsequently be included under the definition of an arbitral award. For example, Schedule 1(3) of the SIAC Rules, 2016 states that emergency arbitrator shall be appointed by the president of the institution upon the filing of an application by parties.

    Further, Article 3 and Article 5(1)(e) of the NY Convention have been interpreted to consider ‘binding effect’ and ‘finality’ as prerequisites for enforcing an award under the NY Convention. This has raised concerns regarding the non-finality of EA as it can be overridden by arbitral tribunal after its constitution. In Yahoo! Inc v. Microsoft Corporation, the US court observed that the emergency arbitrator’s order was final in nature. It reasoned that while deciding to grant a specific interim measure, the emergency arbitrator duly considered all necessary information to resolve the merits of that request. Further, urgent interim reliefs provided in EA have been considered as ‘final’ across several jurisdictions such as Germany and Egypt. Since EA provides a definitive ruling regarding the interim measure, the ‘finality’ requirement under NY Convention must be expansively articulated to include interim measures granted in EA.

    This leads to the conclusion that EA falls within the scope of Section 44 and can be subsequently enforced under Section 48 of the Act.

    • Section 27 (5)- Contempt of Court

    Section 27(5) gives the power to the arbitral tribunal to punish for its contempt. The punishment is alike the offences in suits tried before the court. It is a reprimanding and novel provision that does not trace itself from UNCITRAL Model Law.

    In Alka Chandewar v. Shamshul Ishar Khan, the Supreme Court has ruled that in case any party fails to comply with orders of the arbitral tribunal, this act will be considered to be contempt of court. The aggrieved party can seek relief under Section 27(5) by making representation to the court. The court will be competent to deal with the matter under the provisions of Contempt of Courts Act, 1971, or under Order 39 Rule 2A of the Code of Civil Procedure, 1908.

    After the amendment in 2015, Section 27 is also applicable to Part II of the Act. Thus, Section 27 (5) can be used to ensure the enforcement of EA in foreign seated arbitrations as well. This line of reasoning was raised and rejected in Raffles case. The court reasoned that a person in contempt of interim order passed by tribunal in foreign seated arbitration cannot be punished by Indian courts. This reasoning by the court seems to be flawed to the extent that the party or its assets would be located in India and therefore would be within the jurisdiction of Indian courts, which would have power, even at the instance of a foreign seated arbitral tribunal.

    IV. International Perspective

    Various commercial jurisdictions such as Singapore and Hong Kong have a legislative framework that provide more certainty in enforcement of foreign seated Emergency arbitration award. For instance, in Hong Kong, Section 61 of the Arbitration Ordinance, 2011 requires to obtain the leave of the High Court to enforce interim measures granted by foreign tribunals. The party seeking enforcement needs to substantiate that the order falls within the description of an order or direction that may be made by an arbitral tribunal seated in Hong Kong. This mechanism has also been extended to emergency arbitration under Part 3A of the Arbitration (Amendment) Ordinance, 2013.

    In Singapore, the International Arbitration Act, 1994 (IAA) includes emergency arbitrator within the definition of ‘arbitral tribunal’. Recently, the Singapore High Court in CVG v. CVH has also ruled that ‘foreign awards’ under the IAA would also include foreign interim awards made by an emergency arbitrator, thus allowing for enforcement of foreign seated EA. Further IAA also provides for grounds refusing recognition of EA including breach of rules of natural justice and exceeding the jurisdiction of emergency arbitrator. 

    V. Framework For India

    It is evident that countries are moving towards an arbitration-friendly approach in terms of enforcement of foreign seated EA and interim measures while also providing for safeguards to honor their national public policy. The most effective legislative solution for India is to incorporate in the Act a provision similar to Section 17H of the Model Law, which provides for recognition and enforcement of interim measures by arbitral tribunals irrespective of the country of issuance. Such enforcement must also be paired with appropriate safeguards such as:

    1. Vesting of power to in the court where enforcement is sought, to order for provision of adequate security from requesting party.
    2. Specify grounds for recognition and enforcement of interim measures keeping in mind the public policy of India.

    Such safeguards will help to maintain a balance between party autonomy and public policy of India. It will also make the enforcement of EA faster and easier. Parties must also be cautious while drafting the arbitration clause to ensure that it does not exclude the applicability of Section 9 of the Act. Courts adhere to predetermined procedures when deciding on interim measures. EA, on the other hand, can provide such relief in a more expedient and confidential manner, saving both money and time. Justice Srikrishna Committee Report (2017) and the 246th Law Commission Report have also suggested including emergency arbitrators within the definition of ‘arbitral tribunal’. However, given the existing position of Indian courts refusing to enforce EAs, parties should exercise extreme caution when relying on emergency arbitral awards obtained in a foreign jurisdiction to defend their rights in an emergency

  • Revisiting the ‘Adverse effect’ factor in unilateral commissions: ZOMATO/ SWIGGY CASE

    Revisiting the ‘Adverse effect’ factor in unilateral commissions: ZOMATO/ SWIGGY CASE

    BY PRANAY AGARWAL, THIRD-YEAR STUDENT AT GNLU, GUJARAT

    Introduction

    Unilateral terms of an agreement are seen with suspicion and are often subjected to legal challenge on the grounds that it is arbitrary and unreasonable in nature. The unilateral terms which are abusive and are imposed on others under a‘compelled’      agreement, are also covered within the purview of ‘practice’ encouraging anti-competitive agreements under Section 3(3) of the Competition Act, 2002 (“the Act”). Such a broad interpretation can also be traced to the judgment of BMW Belgium SA v. Commission of European Communities , where the European Court of Justice (“ECJ”) defined the scope and validity of the agreement promoting unilateral conduct of a party. The principle was even adopted for Indian market in Aluminium Phosphide Cartel case to recognise bid rigging as a ‘practice’. However, for the application of the Section, the conduct should have an Appreciable Adverse Effect on Competition (“AAEC”).

    In a recent letter addressed to Competition Commission of India (“CCI”), the Jubilant FoodWorks, the holding firm of Domino’s have indicated their intention to pull out from the deals with food delivery platforms like Zomato and Swiggy due to high commissions charged by these food delivery giants. The letter is a shockwave of the allegations of National Restaurant Association of India (NRAI) against exorbitant commissions charged by the food delivery platforms which ranges between 10% to 30% and the resultant investigative raids by CCI.

    In the case that ensued, the CCI made the order in favour of the food delivery giants to hold their unilateral conducts not anti-competitive. While normally, the judgment of CCI is in accordance with the principles enshrined in the Indian Contract Act, 1872 (“Contract Act”), the Indian watchdog neglected in taking note of the future outcome of such unilateral terms and the adverse impact it may have on the competition in the market.

    In view of these contemporary developments, this article analyses the status of the unilateral conducts like charging of high commissions, which are however part of the agreement and are therefore valid under the Contract Act, in light of the competition laws and principles of the country. The article then investigates deeper into the facets of AAEC and the importance held by ‘public interest’ in the determination of the case, thus giving a critical analysis of the CCI’s stance. 

    Unfair terms of agreement and unilateral conduct

    Unfair terms of a contract have been a contentious issue in the contract law of every jurisdiction. While some protection has been offered under Section 23 of the Contract Act which considers contracts with objects opposed to public policy     ,reliance is often placed by both the consumers and the courts upon the principles of equity and justice embodied under Article 14 of the      Constitution to escape its pre-conditions. In the recent case of NRAI v. Zomato Ltd. & Anr., one of the major contentions of NRAI was related to the one-sided terms of the contract, particularly      the commission clause. However, from the principle given in the United States v. Parke Davis & Co., the concurrence by even an unwilling party will result into a valid contract.

    This makes it apparent that Section 23 will not be applicable in the present case, even if the Restaurant Partners (“RPs”) did not have any choice but to agree with the unilateral terms. However, the unilateral conduct of the dominant players and unfair trade practices has been a      major issue in the country since the initiation of debates around the Monopolies Restrictive Trade Practices (Amendment) Bill, 1983. The legal void in the contract laws was also recognised in the 103rdReport of the Law Commission of India which recommended the insertion of the provision dealing with unconscionable conducts.

         Given the above legal position, the CCI’s order seems legally justified. However, the order will have dire consequences on the market competition in the future due to its economic and legal value. The problem however could have been avoided if CCI had interpreted Section 3 of the Act from a broader perspective like the ECJ did in BMW Belgium SA case . Although it can be inferred that the provision has been applied in the CCI’s order, the commission made a narrow interpretation of the adverse effect factor by failing to note of the provision, thus showing its ignorance of its prior legal instance and relevant circumstances of the case. This mistake can have a huge impact on not only the market and RPs, but also their customers, thus affecting the economic structure as a whole. 

    Looking from a broader perspective: A Review of the ‘Adverse Effect’ factor

    Section 3(1) of the Act introduces the principle of Appreciable Adverse Effect on Competition       violation of which prohibits the enterprises from entering into anti-competitive agreements. It refers not to a particular list of agreements, but to a particular economic consequence, which may be produced by different sort of agreements in varying time and circumstances. It majorly deals with the acts, contracts, agreements, conducts and combinations which operate to the prejudice of the public interests by unduly restricting competition or unduly obstructing due course of trade.

    However, for the factor to be applicable, reliance has to be placed upon the words ‘appreciable’ and ‘effect on competition’. In the present context, therefore, it is pertinent to       effectively analyse           the food delivery market of India, especially with respect to the separate relevant markets of both Zomato and Swiggy. Moreover, the nature of the restraint and conditions in the respective relevant markets before and after the restraint also has to be judged for giving a proper application to the principle of AAEC.

    The term ‘appreciable’ has been defined by ECJ in Volk v. Vervaeke, where reliance was placed upon the probability ofthe pattern of trade such that it might hinder the very objective of the competition law. Similarly the Commission Notice on Agreement of Minor Importance provides for the circumstances under which actions are not viewed as significantenough to appreciably restrict competition. This further gives a concrete meaning to the term ‘appreciable’.

    Unlike the term ‘appreciable’ which has been given restricted to certain circumstances, the phrase ‘effects on competition’ has to be judged with reference to the market share in the relevant market and thus it becomes an important task to define ‘relevant market’. In the present context, the mammoth task was attempted by both NRAI and Zomato/Swiggy giving narrow and wider interpretations respectively. But in this aspect, it is safe to accept       the position of CCI to simply refer Zomato/Swiggy as online intermediaries for food ordering and delivery.

    Zomato and Swiggy are the biggest food delivery platforms in India, who conjointly holds      90-95% of the Indian food delivery business. Further, as on January 2022, the market valuation of      these giants stood at $5.3 billion and $10.7 billion respectively which shows the dominant position enjoyed by them, which is also prima facie evident by the circumstances of the case.

    Bad news for consumers? Highlighting the significance of ‘Public Interest’

    While the economies of scale can be achieved with the reasonable commissions and the reduced costs will benefit the customers in the form of higher quality and lower prices, exorbitant prices will instead result in the reduction of the profits. The impact of such losses will then be passed down to the ultimate customers, thus having a negative effect on the consumers and RPs. Hence, the unilateral act of charging high commissions without any formal communication to the RPs hurts the interests of the general public and also takes away the ability of RPs to compete independently if they come out of the contract.

    In light of the above, the public interest test cannot be ignored while considering the economic consequences the AAEC may cause. Therefore as indicated in Standard Oil Co. v. United States, the factor of AAEC operates on the prejudice of the public interests. Public interest in this sense is the first consideration before the courts while considering the validity of the agreements under Section 3 of the Act. Moreover, Section 19(3) of the Act which provides for factors determining AAEC under Section 3 gives due regard to the accrual of benefits to the customers.

    However, the term ‘public interest’ has to be constructed from a wider perspective with respect to the circumstances of every case. This proposition was made clearer in Haridas Exports v. All India Float Glass Manufacturers Association, where the Apex court clarified that public interest does not necessarily mean interest of the industry but due regard has also to be given to all possible customers in the market for ensuring that the law achieves its objective of fair competition and public justice. 

    Conclusion

    Unilateral fixing of commission rates by the players like Zomato and Swiggy who enjoy a dominant position in the food delivery market in India has been declared by the CCI to be not anti-competitive. However, such narrow application of Section 3 of the competition act influenced by the provisions of contract laws of the country does more harm than good and has the potential to defeat the object of the competition laws. In such scenario, the importance of AAEC factor and test of ‘public interest’ should be relied upon to secure fair competition in the market as well as the interests of both the producers and the customers. While the decision has huge ramifications, one can only hope that the position is rectified in the subsequent decisions.

  • Regulating The Fees Of Insolvency Professional: A Hit Or A Miss?

    Regulating The Fees Of Insolvency Professional: A Hit Or A Miss?

    BY SANYAM GUPTA, FOURTH YEAR AT NLIU, BHOPAL

    Introduction

    Since the advent of the Insolvency and Bankruptcy Code (“the Code”) in 2016, the Code has been evolving through various dictums given by the judiciary and regulations by the Insolvency and Bankruptcy Board of India (“the Board”) to ensure that it works in tandem with the current economic situation of the nation. These regulators ensure that the main spirit of the Code, i.e., value maximization and speedy resolution in a ‘creditor-in-control model’ is upheld and its scope is enhanced. In order to maximize the payment of the debt to the relevant stakeholders, it becomes incumbent to minimize the Insolvency Resolution Process Cost (“IRPC”). The remuneration of the Insolvency Professional (“IP”) forms a relevant portion of the IRPC; therefore, it must be regulated.

    The IP plays a crucial role in the Corporate Insolvency Resolution Process (“CIRP”). He not only acts as the catalyst facilitating resolution but also runs the Corporate Debtor (“CD”) during the CIRP. It is his expertise that ensures the successful and profitable resolution of the CD. In the case of Essar Steel, the CD reported a profit gain of 5% during the CIRP and reported the highest production as well, under the supervision of the Resolution Professional (“RP”), which further lead to most Financial Creditors realizing 100% of their principal outstanding and 90% of their claim. The credit for this can surely be given to the RP running the CD.

    The Adjudicating Authority (“AA”) has on numerous occasions reiterated that there should be some regulations w.r.t. the remuneration of the IPs.  Starting from the case of Madhucon Projects Limited, wherein the fees of the Interim Resolution Professional (“IRP”) were 5 crores by the first meeting of the Committee of Creditors, while the total amount of debt was 4.45 crores; to the case of Variscon Engineering Services Pvt. Ltd. Vs. Pier-One Constructions Pvt. Ltd. wherein the AA specifically pointed out the need for regulations governing fees of the IPs. There are also instances wherein the IP quotes fewer fees in order to get the CIRP assigned to them, following which they add substantial miscellaneous expenses through advisors/support staff to inflate their dues. All this leads to further unnecessary bleeding of the CD. Thus, regulations and guidelines to regulate the remuneration of the IP become quintessential.

    The Board introduced such regulations and guidelines by uploading a discussion paper titled, “Discussion Paper on Remuneration of an Insolvency Professional” which discusses various aspects of how the Board plans on regulating the remunerations of the IPs. The contents of this paper further went on to amend the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“IRP Regulations”), to provide incentives to meet the spirit of the code i.e. timely resolution and value maximization in addition to providing for a base pay for IRPs and IPs. The author of this article has criticized this approach of the Board of setting a base pay, while not regulating the extensive expenses charged by IPs that lead to unnecessary bleeding of the CD. The author further goes on to analyze the ‘ratio of cost of the process to recovery rate’ of insolvency proceedings in India, highlights the problems in the amendment, and provides solutions to improve the same.   

    The Regulation

    The Board, vide notification No. IBBI/2022-23/GN/REG091 published the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2022 (“Amendment”) on September 13, 2022. By this notification, the Board has amended IRP Regulations, in order to facilitate the regulation on the remuneration of IRPs and IPs, appointed on or after 1st October 2022.  The Board has followed a two-pronged structure, wherein a minimum/base pay is set up on the basis of the quantum of claims admitted, followed by incentivizing the fees based on performance towards; i) timely resolution and ii) value maximization. The minimum pay scale will be as follows:

    Quantum of Claims AdmittedMinimum Fee (Rs. Lakh) per month
    (i) <= Rs. 50 crore1.50
    (ii) > Rs.50 crore < = Rs.100 crore2.00
    (iii) > Rs.100 crore < = Rs.500 crore2.50
    (iv) > Rs.500 crore < = Rs.1,000 crore3.00
    (v) > Rs.1,000 crore < = Rs.2,500 crore3.50
    (vi) > Rs.2,500 crore < = Rs.10,000 crore5.00
    (vii) > Rs.10,000 crore7.50

    Since time efficiency and value maximizations are the essence of the Code and the IPs play a major role in its realization, the board has added that apart from the minimum or floor fees, the IPs would be incentivized on the basis of i) resolution of CD in the prescribed timelines as given in the Code, and ii) achieving value maximization of CD. Thus, the Amendment provides a performance-linked fee structure for the timely completion of CIRP, wherein a certain percentage of actual realizable value shall be given to the IP as an incentive based on the time taken to resolve the CD. This ranges from 1% for resolution in less than or equal to 180 days to 0% for resolution after 330 days. Furthermore, a variable fee of 1% of the positive difference between the actual realizable value and fair value will be paid as an incentive to IPs who work towards value maximization. These sums must not exceed Rs. 5 crores and must be approved by the CoC. 

    The Amendment in the IRP Regulations ensures that all IPs are paid adequately and are incentivized for following the Code to its essence. While the same is beneficial for the creditors, it is detrimental and might lead to unnecessary bleeding of the CD.

    Critique

    The Bankruptcy Law Reforms Committee in its report mentioned the prodigal nature of any constraint to be imposed on the fees of the RP. It further mentions that due to a competitive market for IPs (where the lowest bidder gets the CIRP), the fees to manage the insolvency resolution process will converge to the fair market value for the size of the entity involved.

    Even though the board has ensured that the IPs be paid a minimum (floor) payment for their services based on the quantum of claims, however, as stated earlier, during the process of appointment of the RP, the IPs quote fewer fees in order to get the CIRP assigned to them, following which they add substantial miscellaneous expenses through advisors/support staff to inflate their dues. Regulation 34 of the IRP Regulations provides for the fees and expenses incurred by the RP which shall be fixed by the CoC and shall be a part of IRPC. While fixing this cost, the RP indicates the approximate estimation of the expenses that would be incurred by them during the CIRP. It shall be assumed that since the RP is a professional, he would quote expenses with a reasonable understanding of the general expenses that would be incurred during CIRP. The RP’s exorbitant expenses should thus be regulated to avoid unnecessary bleeding of the CD and wrongful gains to the RP. The board should fix a maximum criterion (like 250% of the approximate cost stated) in order to ensure that the RP does not get illicit benefits. In cases wherein the RP crosses this statutory limit, they should bear these over-the-top expenses on their own, as a penalty.

    The Board has also failed to address the issue of exorbitant fees charged by the IPs during the CIRP. The following is a list of countries along with their recovery rate during insolvency proceedings (cents on every dollar) as well as their cost of process on the basis of the percentage of the estate of the debtor as per data given in the Doing Business Data published by the World Bank in 2019 :

    Name of the CountryRecovery rate (cents on every dollar)Cost of the process (% of estate)
    India26.59%
    United Kingdom85.36%
    United States of America81.810%
    Norway921%
    Sweden789%
    Slovenia88.74%
    Singapore88.84%

    It is quite evident that India has one of the highest costs of the process as well as one of the lowest recovery rates when it comes to insolvency regimes in the world. Thus, it becomes essential for the Board to regulate the IRPC as well as set a maximum limit on the remunerations filed by the RP, similar to the laws in Canada and the USA. The Board may propose different maximum limits on remuneration for different valuations of claims, similarly as it has done for minimum (floor) pay. Further, these limits can be relaxed for a speedy resolution and value maximization, as has been proposed by the Board.

    The Board has also failed in providing a revision mechanism for these minimum (floor) pay scales as well as for the rate of incentivization. For the same purpose, the board may constitute a committee that may meet on an annual or bi-annual basis. The committee should analyze the prevailing market situation and the fair market value of the fees of IPs for various categories of CIRPs based on the quantum of claims, following which the minimum (floor) pay scales as well as the maximum pay scales of the IPs shall be revised by this committee. 

    Conclusion

    The Amendment is merely a start to regulating the fees of IPs and subsequently the IRPC, but it is a long road ahead. While the IP plays a crucial role in the running of CD during the CIRP, they also have to ensure that the CIRP is completed in a timely manner with the aim of value maximization. The Amendment has tried to ensure that the IPs get a minimum pay as well as an incentivization towards the realization of the core values of IBC. This was done in order to reduce the burden of litigation between parties and on the AA. Yet, the Board should consider practical scenarios which lead to the bleeding of CD and hamper the spirit of the code and its core values and ensure rules and regulations such as regulating the maximum fees charged by the IPs, penalty for charging exorbitant expenses after quoting minimal expenses while getting the CIRP assigned to them, ensuring that these minimum (floor) pay rates and maximum rates are revised in a timely manner to be in tandem with the prevailing market rates are put in place to avoid such scenarios.

  • Interplay Between SEBI Regulations and Liability of Financial Influencers (FinFluencers)

    Interplay Between SEBI Regulations and Liability of Financial Influencers (FinFluencers)

    By VARUN MATLANI and Vaibhav Gupta, THIRD-year students at GNLU, GANDHINAGAR

    Introduction

    The massive growth of social media influencers coupled with high internet penetration for a country with the world’s youngest population, particularly in the earning age bracket has given birth to the rise of a new segment of financial influencers or popularly known as ‘FinFluencers’. These FinFluencers claim to advise and teach people about making quick bucks through stock markets. This article examines the legal liability of their advice, to what extent they should be bound by relevant Securities and Exchanges Board of India (‘SEBI’) regulations and what accountability they have for their content to their followers who rely on them and are frequently their source of income from commercials, stock broker affiliate marketing, and the sale of their courses. Further, the article compares the newly evolving jurisprudence internationally especially in Netherlands and Germany by comparing their regulations and guidelines for FinFluencers with that of SEBI in India.

    Are FinFluencers bound by SEBI?

    The majority of FinFluencers operate outside of SEBI’s purview and prima facie do not adhere to its regulations, operating in a grey space or on a thin line of difference of definition as research analysts. SEBI, staying committed to its tagline “strength of every investor” has voluminous regulations binding those giving investment advices in order to protect the gullible and first-time investors from falling into dubious schemes. The author contends that these FinFluencers would fall within the ambit of definition of ‘Research Analyst’ under Regulation 2(u) of SEBI (Research Analysts) Regulation, 2014 making them accountable for their content as per the relevant regulations.

    The definition holds a person to be considered as Research Analyst if they prepare or publish content of research report or provide research report or offer an opinion with regards to a public offer or give price targets also.     These regulations also require them to be technically qualified and pass National Institute of Securities Market (‘NISM’) exams, providing a safety net for investors and fulfilling the fundamental purpose of  SEBI.

    Interestingly, the word ‘Research Report’ under Regulation 2(w) includes any kind of electronic communications and generally exempts opinion on overall market trends or generalised opinions. Therefore, the videos and posts of these FinFluencers does not escape the definition of report.

    In light of these regulations, one may scrutinize the “top FinFluencers” (in terms of their follower base on social media platforms), and can broadly ascertain a pattern of content that is posted by them, i.e., giving analysis on IPOs, fundamental analysis of stocks, recommending stocks for long term or short term. A major problem that arises here is that till the time the end user watches the video, the information can be converted into misinformation due to time variation gaps (for instance, an Instagram reel being uploaded today and end user considering it relevant when it reaches him/her, but the substantial time has elapsed for the user to act correctly) and information asymmetry causing heavy losses to the viewers. SEBI Regulations provide for regulation(s) for publication of report public media whereby the said regulations are directly applicable in literal manner. Electronic communication which is perceived through various social media with a massive reach to the audience may also be categorised similar to appearance before public media whereby too, as per Regulation 21, there exists a requirement for disclosure and assurance of reasonableness and fairness in creation of such report.

    Liability if FinFluencers are made to register as Research Analyst

    Many of the “top FinFluencers” would not qualify under technical requirements (for example, possessing the 5-year experience, professional qualification, or postgraduate degree) for education under the regulation. Further, NISM exam mandate would ensure not anyone with access to the internet can start giving opinions on the internet.

    Once considered as Research Analyst, Regulations 16 and 18 shall restrict these FinFluencers from trading into scrips.

    The contents of the research report would need more precision in terms of rating and time horizon benchmarking (i.e., the validity of such advice) along with a disclaimer and persuasive liability on publishers to ensure reliable facts and information forming part of their research as per Regulation 20.

    Regulation 24 makes research analysts responsible for maintaining an arms-length distance from taking up promotional activities and ensuring that the members involved in publishing of such content are complying with Regulation 7 (with regards to technical qualifications).

    Regulation 25 would require keeping a record of all their research along with the rationale of providing so, thereby preventing any escape by any deletion of such reports and also subjecting these records for inspection.    

    International Comparative Analysis of Existing Regulatory Frameworks for Social Media Influencers Pertaining to Financial Information

    In this segment, the regulatory frameworks of Germany’s German Federal Financial Supervisory Authority (also known as BaFin) and Netherland’s Authority for Financial Markets (Autoriteit Financiële Markten – AFM) – the SEBI’s counterparts of their respective countries, are analysed with respect to their regulations and evolving legal framework with administrative actions for FinFluencers.

    • Netherlands

    The Dutch authority, AFM, conducted exploratory study to understand the legal landscape of FinFluencers and has even adopted the term FinFluencers for referring to those giving financial advice on social media platforms. The study found that FinFluencers lack neutrality and transparency, promoting risky products, and thereby keeping their own interests first. AFM also flagged the risk of non-compliance of regulations in Dutch that require influencers/finfluencers/third-party advertisers for license (s)/registration with AFM which can be drawn parallel to SEBI’s regulations in India.

    There is a Dutch ban on third-party inducements, which further prohibits FinFluencers from charging referral fees or advertisement fees. It was also noted that merely posting a disclaimer does not allow an escape route from regulations if they provide such services de facto. In the recent case of Grinta Invest, AFM issued notices to the company as well as FinFluencers for not holding appropriate licenses and promoting highly risky instruments such as foreign exchange and CFDs.

    • Germany

    The German authority ‘BaFin’ too requires FinFluencers to comply with the ‘Unfair Competition Act’ in terms of advertising products within the ambit of competition law and secondly, to comply with Market Abuse Regulation along with specific requirements from Delegated Regulations on the Market Abuse Regulations which directs any person recommending investment or investment strategy and presents himself as financial experts to comply with transparency, disclosures, fairness and other relevant provisions of Market Abuse Regulations.     Non-compliance with these regulations can lead to fine and other punishment within the ambit of German Securities      Trading Act. Unfair practices with regards to these regulations can also make the financial companies directing FinFluencers liable.

    Evolving Jurisprudence in India

    SEBI has taken note of the the impact of social media influence on stock markets, price discovery, and losses of the gullible new investors falling for “tips” or recommendations. Lately Telegram groups, which were the biggest direct contributor to these factors have been cracked down upon. In Re: Stock Recommendations using Social Media Channel (Telegram) (SEBI) it was held that those running the channel were not registered as Research Analysts or Investment Advisors and had unfairly charged fees. The number of members and quantum of tips/recommendations did have an impact though for a short time since there was a spike in trading of a particular scrip which also involved Prevention of Unfair Trade Practices regulations. This has been a leading step against social media influence on Indian traders and stock markets. But, deliberation on indirect harm to the new/gullible investor community by FinFluencers needs to be done at the earliest.

    Conclusive Analysis with Indian Regulations

    In light of international regulatory framework, the authors opine that SEBI must draw inspiration from international bodies in terms of conducting research and identifying the impact of these FinFluencers on Indian markets and the stakeholders. The SEBI regulations already in place are an example of an effective and well thought rule of law, but its implementation intertwined with the rapidly growing social media needs to be closely examined. It must be also noted that SEBI, to a great extent, has been successful in introducing changes with regards to telegram tips and trades, but cognisance of these FinFluencers and their growing popularity must be taken.

    Interestingly, in the Telegram case, SEBI took note of how a huge subscriber base can lead to manipulation of stock prices and has been actively taking steps (like imposing a ban on Telegram channels, issuing show-cause notices to offenders, etc. to prevent practices promoting unhealthy and unfair trade practices.      In contrast, the US markets have lately faced a lot of such manipulations which went uncontrolled by the Securities Exchange Commission (SEC) in cases such as Reddit’s WallStreetBets’ pump and dump of particular scrips, which is an appreciative comparison of the effective management of SEBI to keep up with the objective of securing Indian investors.

    Further, though cryptocurrency hasn’t been a domain of SEBI, the dark reality of FinFluencers can be quantitatively examined. For example approximately Rs. 5 Lakhs almost all the famous Indian Finfluencers promoted Crypto-FD, a highly risky product of Vauld, which lately stopped all withdrawal activities, a close look into the functioning would have made it evident, that the product they promote has fundamental flaws, especially in uncertain crypto markets.

    More often than not their target audience is the first-time investor, who can lose faith in markets forever with one such instance, and these are usually those who themselves have a little safety net of earnings. This example must be boldly noted to examine the ill impact that FinFluencers have the power to bring about.

  • Robinhood: A Case Study against Mandatory Consumer Dispute Arbitration

    Robinhood: A Case Study against Mandatory Consumer Dispute Arbitration

    BY PRATEEK, GRADUATE FROM ARMY INSTITUTE OF LAW, MOHALI

    Introduction

    Arbitration has seen a meteoric rise in adoption in the United States of America (“The USA”). This can primarily be attributed to the arbitration friendly approach taken by the courts while interpreting statutes like the Federal Arbitration Act, 1925. A manifestation of this became the arbitration friendly approach taken towards arbitrability of disputes. Consumer dispute arbitrability is a glaring example of this. While Indian courts have taken a cautious approach towards consumer dispute arbitrability, ruling against the mandatory enforcement of pre-dispute arbitration agreements, courts in the USA have allowed mandatory enforcement of pre-dispute arbitration agreements. This case study of arbitral proceedings against Robinhood provides an analysis into the problematic aspects of mandatory consumer dispute arbitration.

    Background

    Robinhood Market is a trading platform founded in the USA in the year 2013. The platform is primarily populated by day traders and retail investors consisting of primarily small portfolios of shares and options trading.

    Retail investors identified that stocks like AMC and GameStop were being betted against by some Wall Street Hedge Funds. Against such backdrop, the community aimed at pumping the stock to sky-rocket its price till they achieve a short-squeeze through buying and holding shares. This caused a frenzy of online memes, sounding calls for retail investors to cause a short-squeeze, and earned these stocks the designation of “meme stocks”. Robinhood saw massive trading volumes since the retail investors were primarily driving this surge. This allegedly caused a major liquidity crisis for the platform creating an inability for Robinhood to meet collateral requirements for trades with National Securities Clearing Corporation (‘NSCC’), their clearing house. Due to this, Robinhood restricted trading on these “meme stocks”, causing substantial losses to customers.

    The FINRA Way of Arbitration

    Alleging damages due to missed-opportunity for making profits through trading said “meme stocks”, caused by Robinhood’s trading restrictions, a few users decided to raise their claims against the platform. Claims were raised through disputes governed by Section 38 of the Robinhood Consumer Agreement , which contains a pre-dispute arbitration clause whereby all disputes between parties to the agreement are to be mandatorily submitted for arbitration before Financial Industry Regulatory Authority (‘FINRA‘) Dispute Resolution in the State of California.

    In January 2022, Jose Batista, a retail investor aggrieved by Robinhood’s actions, was awarded approximately $30,000 through the FINRA Dispute Resolution Mechanism. While this award is seen as a victory for the average retail investors, the mechanism through with the award was won creates a barrier that systematically isolates the approach to remedy for every consumer. Robinhood’s actions caused losses to multiple customers but due to arbitration being the mandate, the dispute cannot be resolved through any form of class action. This barrier is further solidified through the FINRA Code of Arbitration Procedure for Consumer Disputes, under which Rule 12204 posits that class action claims cannot be arbitrated under the code.

    American Position on Consumer Dispute Arbitration

    In the USA, arbitration is primarily governed at the federal level by the Federal Arbitration Act, 1925 (“The FAA”). Under this statute, once the mandatory arbitration clause is established, the court is required to refer the dispute to arbitration. This mechanism has been radically interpreted by the Supreme Court in Moses H. Cone Memorial Hospital v Mercury Construction Corp., where the court mandated a presumption in favour of arbitration when faced by an arbitration agreement. The doctrine of unconscionability does provide respite to parties in cases where the contract is clearly tarnished by unfair terms, and deficient or imbalanced bargaining powers between parties. But this test has been held in Zapatha v Dairy Mart Inc., to be applicable only on a case-to-case basis since the court posited that no all-purpose definition of unconscionability was possible. Further, the already limited grounds for escaping mandatory arbitration, restricted to prima facie unconscionability, fraud, misrepresentation, coercion, incompetence, and illegality of consideration being established through a bare reading of the agreement, were held to be subject to the doctrine of separability in the case of Prima Paint Corp. v. Flood & Conklin Mfg. Co.. Application of the doctrine of separability meant that tainted sections of an arbitration agreement could be excluded, to allow a consistent and legally binding reading of the mandatory arbitration agreement, as long as the agreement was not entirely vitiated or defeated by such exclusions. Consequently, all claims of fraud and unconscionability are also to be adjudicated upon by the arbitral tribunal. 

    Exceptionalism of arbitration forms the centrepiece of judicial jurisprudence on the subject in America. This overriding prioritization is manifested through the sections under the FAA, and with the case of Southland Corp. v. Keating, the Supreme Court ruled that the FAA pre-empts all state laws on the subject. Consequently, statutes like the Mont. Code Ann. § 27-5-114 (1993) providing safeguards to protect consumer interests, were struck down by the court while holding the law restrictive of arbitration. This exceptionalism is especially mind-boggling as the prohibitively expensive nature of arbitration and its deterrent effect on a consumer’s ability to bring disputes to court has been noted by courts. While exorbitant and incapacitating cost of arbitration was acknowledged as grounds for escaping arbitration, in Green Tree Financial Corp.-Ala. .v Randolph, the Supreme Court held that the burden to prove the prohibitive nature of costs was on the consumer who is seeking to escape mandatory arbitration. 

    With respect to class action arbitration, in cases where the agreement is silent on the issue, the Supreme Court in Green Tree Financial Corp. v. Bazzle delegated the task of determining the issue to arbitral tribunals. Through subsequent decisions, this power was significantly curtailed. In the case of AT&T Mobility L.L.C. v. Concepcion, the Supreme Court held that the FAA pre-empts the use of unconscionability as means to allow class action consumer arbitration. The court further expressed displeasure against the concept of class action arbitration itself. 

    Shortcomings of Consumer Dispute Arbitration Praxis from an Indian Perspective

    The Robinhood case study can provide interesting insights from an Indian standpoint into the following possible ramifications of a liberal approach towards consumer dispute arbitrability:

    A. Lack of Precedent Value:

    Some arbitration agreements, like in the Robinhood case, may not require a reasoned order. In any case, even if a reasoned order made, this cannot be used as precedent in arbitral proceedings by other aggrieved consumers under the same issue. This is primarily due to mandatory confidentiality requirements and further lack of precedential value of awards. This may create deterrence for smaller claims being raised. Since facts are usually similar in consumer disputes arising out of unfair business practices, creation of precedence defeats the impediment created by class action waivers. This is due to the creation of certainty in outcome.

    B. Prohibitive Cost:

    The public policy argument against arbitration is premised on the comparative inferiority of arbitration in comparison to court adjudication. On this subject, in Vidya Drolia v Durga Trading Corp. The Supreme Court of India reiterated the observation made in Union of India v. Singh Builders Syndicate, stating that arbitration is expensive for parties in comparison to judicial adjudication.

    This prohibitive cost creates a virtual barrier against consumer arbitration. Consumer disputes largely involve smaller claims, and recognition of this fact is evident from the regime of costs under the Consumer Protection Act, 2019. This issue is magnified under consumer disputes where the claimant is usually an individual consumer who may not anticipate the grant of compensation to extents that would justify the risk of undertaking expensive arbitration proceedings. 

    C. Unequal Bargaining Powers in Standard Form B2C Agreements:

    Indian courts have observed limited acceptance of the doctrine of unconscionability as grounds for nullifying agreements under public policy. In these cases, the doctrine of unconscionability was based on unequal bargaining power. Similar inequality is observed in standard form B2C contracts, especially in a country like India. This inequality is exasperated by widespread digital illiteracy and a lack of legal awareness. Thus, there is scope for applying the principles of unconscionability in India under public policy for denying enforcement of mandatory arbitration agreements. 

    D. Express and Implied Class Action Waivers:

    Since arbitration attains legitimacy through party autonomy, any breach in privity of contract would compromise such autonomy and consequently, the whole process of arbitration. This structural barrier can be avoided if Business to consumer agreement (‘B2C‘) agreements allow for class action lawsuits, but businesses lack the incentive to allow such provisions. Due to the inequality in bargaining power regarding standard form B2C agreements, class action waivers become a part and parcel to protect business interests.

    Class action becomes an essential tool for vulnerable parties to attain equality in bargaining power while seeking redressal of disputes. While in cases of victories, the overall compensation may not be as high as individual claims due to their division amongst a large class, the risk value being low rationalises the trade-off. This is because raising disputes is itself expensive, and class-actions allow division of costs. Such metrics are particularly relevant for arbitration, while is an uncertain and expensive process. 

    The Way Forward

    While class-actions may provide some respite to consumers from above-mentioned issues, business incentive to include class-action waivers in standard form contracts is very high. Further, lack of precedent on legality of these waivers in India makes this argument moot for now.

    Interestingly, the pro tem solution to this issue is possible through elimination of the incentives that businesses have for undertaking consumer arbitration. In Manchester City Football Club Ltd v Football Association Premier League Ltd., an English court published a confidential arbitral award in the name of public policy. Such publication of awards impacting a larger class of people under the direction of courts may be useful for arbitral tribunals engaged in similar disputes against the same unfair business practice. While arbitral awards are not binding precedents, persuasive value can surely be derived. This is especially true since the award in such cases is granted higher legitimacy due to recognition of public interest by the court. Eliminating reduced publicity of claims is a disincentive for businesses to promote expensive arbitration with consumers since the biggest ace up their sleeves is rendered useless.