VHVK E-Newsletter October 2018
October 2018
Volume II Issue 5
VHVK Law Bulletin
This fifth issue of VHVK Law Bulletin 2018 brings you current developments in business and corporate law. The subjects covered in the issue include (i) strengthening remedies for breach of contract (amendments to Specific Relief Act, 1963) (ii) broadening anticorruption law and checking corporate bribery (amendments to the Prevention of Corruption Act, 1988, (iii) framework introduced for mandatory pre-mediation in commercial disputes (iv) SEBI ruling that issue of share warrants and call options can trigger the open offer requirement under takeover regulations, (v) Supreme Court ends moratorium for sureties under the Insolvency & Bankruptcy Code, 2016, and (vi) Karnataka High Court resolves the issue of payments under the recent Tax Amnesty Scheme (Karasamadhana Scheme, 2017).
Strengthening remedies for breach of contract – amendments to the Specific Relief Act, 1963
In continuing legal reform and strengthening of remedies, the Government of India recently completed the legislative process for the Specific Relief (Amendment) Act, 2018.1 When the new rules come into effect, victims of breach of contract will be in a better position to hold persons who break contracts to better account. In the present regime, monetary damages are the normal remedy for breach. The new rules, on the other hand, facilitate specific performance of contractual obligations by persons in breach and also lay down time limits for completing legal proceedings.
Prevailing law of contracts and specific relief are rather tolerant of breach of contracts. To begin with, monetary damages are considered adequate remedy for breach. Then, under the Indian Contract Act, 1872, strict rules govern the amount of damages that can be awarded to victims of breach. Specific relief, or requiring persons in breach to perform the same obligation is treated as an exceptional remedy. For example, breach of contract for sale of business would not, typically, qualify for specific performance which is mainly restricted to contracts relating to immovable property. And then there are the typical delays with litigation when parties end up in court. Together, these factors can offer perverse incentives and encourage reluctant parties to commit breach of contract.
The new rules under implementation offer specific relief as a powerful alternative remedy, while the option to seek damages continues. Persons affected by breach of contract can now seek specific performance as a matter of course, subject to limited exceptions. Also courts must complete proceedings in 12 months from the service of summons on the defendant with another 6 months permitted in exceptional cases. Redundant technical requirements (for example, plaintiffs’ duty to affirm readiness to perform their part of the contract) are omitted.
To be clear, some exceptions to specific relief continue. Contracts that are minute in detail or depend on the personal qualifications of a party are excluded, because courts cannot supervise/ensure performance as originally intended. The amendment also introduces a list of “infrastructure projects” and prohibits courts injunctions that can delay these projects considered socially valuable.
Overall, the new rules make a signal departure from the longstanding position that was more tolerant of breach of contract and offered a weaker remedy to victims of breach. The new regime can be further strengthened through amendments to the Indian Contract Act, 1872, to enable award of higher damages when justified – for example, wilful breach of contract.
Widening the reach of anticorruption law, promoting corporate ethics
Revisions are made to the Prevention of Corruption Act, 1988, through the Amendment Act, 2018.2 The effort is to bring bribe-givers into the net and new mechanisms are included to strengthen recovery of illicit gains from corruption. Together, the new rules can be effective in combating corruption of government officials and also deter bribe-giving by business enterprises.
The 2018 amendment to the Prevention of Corruption Act makes bribe-giving an offence. This strengthens the anti-corruption effort, making it more comprehensive. Significantly, “commercial organisations” are included in the offence. This reflects the reality of corruption in business transactions. Inducements and facilitation payments are common in a range of transactions – from award of contracts for projects and grant of business licenses (such as mining) to speeding up payment of bills for work done or goods sold and completing tax assessments. The rule against bribe giving can help check the trend and, in doing so, promote corporate ethics and business integrity.
The new rules are adopted from the United Nations Convention against Corruption to which India is a signatory. The UN Convention, adopted way back in 2003, seeks to hold both bribe takers and bribe givers to account. Yet a weakness in the new regime is its neglect of whistleblowers. Protecting whistleblowers against victimization and rewarding them for exposing corruption can greatly strengthen the fight against corruption. Corporate insiders who have information on wrongdoing will be more likely to come forward if (a) they are protected from possible victimization and (b) there is a financial incentive for them to act against corruption. Whistleblower rules have been in place in the US since the turn of the century when the Enron scandal underscored the importance of whistleblowers.
Powerful recovery devices are also included in the 2018 amendments to the Prevention of Corruption Act. For recovering wrongful gains from corruption, an obscure, pre-independence law – the Criminal Law Amendment Ordinance, 1944 – is pressed into service. The Ordinance, introduced by the colonial government during World War II, enables summary proceedings to track gains from corruption and seize the properties of offenders. This is supplemented by recovery under the Prevention of Money Laundering Act, 2002. Together, they can be effective in disgorging wrongful gains from corruption.
Procedural rules framed for mandatory mediation for commercial disputes
Under the Commercial Courts Act, 2015, parties to a commercial or business dispute must first attempt mediation before resorting to adversarial litigation in courts (section 12A). At this preliminary stage, courts’ jurisdiction is limited to considering requests for urgent interim relief. Government of India has framed a comprehensive set of rules to streamline the mediation process and improve efficacy.3
Recently established commercial courts are a product of ongoing efforts to facilitate speedy resolution of business disputes. Taking the principle further, the Commercial Courts Act requires parties to first try mediation. Procedural difficulties in mediation and other alternative dispute resolution methods have been known at least since 2004 when the Supreme Court articulated them in Salem Advocate Bar Association v Union of India.4 Standardized procedural rules can greatly improve the efficiency of the mediation device and advance the goal of speedy dispute resolution. With guidance on timeframes and costs, the procedural rules that have been introduced can make the mediation process better manageable and efficient. Salient features include:
Mediator to be appointed by the State Legal Services Authority setup under the Legal Services Authorities Act, 1987
Parties can be represented in mediation by counsel or authorized representative
Confidentiality of proceedings to be maintained, no recording of sittings or proceedings, or related materials can be retained by mediators beyond six months
- Mediation to be completed within 3 months, additional 2 months permitted if parties agree
- Any settlement agreed to by the parties will be on par with arbitral awards under the Arbitration and Conciliation Act, 1996
- Cost schedule for mediation services included in the rules, with slabs varying according to the value of the claim, and to be shared equally by parties
- If mediation fails, mediator must issue report on the status and report to be submitted to court
Well thought-out and comprehensive, the practical value of the rules is clear. Possibly, an avoidable requirement is the need to approach the Legal Services Authority to appoint the mediator. This does not allow the parties to agree on a mediator, which can save considerable time and expense. Legal Services Authorities can be the resort for appointing a mediator when parties fail to make a selection through consensus.
SEBI decides share warrants and call options can trigger open offer requirement
Recently In the matter of NDTV Ltd,5 SEBI interpreted “control” under Takeover Regulations, 1997sup>5 in an overly broad manner. The principle of this ruling, if sustained in appeal, can impact many equity-based financing arrangements. In the NDTV case, interest-free loans were advanced by a lender to the major shareholders in NDTV Ltd and in return, these shareholders gave the lender’s affiliate call options to purchase a large chunk of NDTV shares – 25 percent of the total – at a predetermined price. This was more than 20 percent of voting shares, which is the threshold for launching an open bid to all shareholders. The transaction structure does not suggest that the lender or its affiliates intended to acquire control of NDTV, which is a key principle of takeover regulations.
In essence, takeover regulations check privately negotiated transfer of control of listed companies and payment of so-called “control premiums” to large shareholders in exchange of control. The experience in UK and US with such private arrangements show that large shareholders benefited from selling their controlling interest through a higher price and smaller investors were excluded from this. To counter the trend, takeover rules require persons who wish to acquire 20 percent or more shares in a listed company to make an open offer for the shares and offer the same price to all interested sellers. This enables equitable sharing of the control premium the bidder is willing to pay.
In the NDTV transaction, as stated, there is no indication of any intent to acquire control. In 2009, a large sum (₹ 350 crores) was paid to a company with large shareholding in NDTV as a loan with a 10-year term. Simultaneously, the corporate shareholder gave a call option to the lender to purchase NDTV shares at ₹ 214.65. At this time (July 2009), NDTV shares were selling around ₹ 135 on NSE. The loan agreement did not place the borrower under clear-cut repayment obligations and it is apparent that the intention was to benefit from anticipated increase in the market price of NDTV shares above the strike price for the option (₹ 214.65). Quite possibly, some kind of manipulative transactions occurred in the market soon after the loan/call option agreements were executed in July 2009. In August 2009, there was a nearly 8-fold spurt in the volume of NDTV shares traded on NSE and price crossed ₹ 180. This suggests an effort to boost prices, in the background of call options granted at strike price of ₹ 214.65.
SEBI treated two clauses in the loan agreement as significant. First, the lender got a seat on the board of the borrower/controlling shareholder of NDTV. Second, the borrower was obligated to exercise its voting rights in NDTV to give effect to the terms of its agreements with the lender. The question is whether these clauses had the effect of the lender acquiring control of NDTV. If yes, it would attract the takeover code and the lender must make an open offer for the 25 percent NDTV shares it was interested in. The offer must be at ₹ 214, against the then market price of about ₹ 130.
The transactions between the lender and the controlling shareholders of NDTV, described above, appear murky. In any case, financing done on the expectation of share price increase is not presently illegal. And it is an entirely different question whether the transactions amounted a takeover or change of control. It is doubtful if the lender had any interest in acquiring control of NDTV. Obviously, the lender was willing to pay a significant premium over the market price for the right to buy NDTV shares through call options and as a part of this deal, “lent” ₹ 350 crores to the company’s controlling shareholder without placing it under a clear duty to repay.
Considering the object of takeover regulations, SEBI’s reasoning in applying them to the NDTV transaction is questionable. It is doubtful if the order will survive in appeal, if preferred by the lender who must now make an open offer. Another interesting feature is the lender was reportedly an associate of Reliance Industries Ltd in the past.
Supreme Court rules: no interim moratorium for personal guarantors
In State Bank of India v Ramakrishnan,7 the Supreme Court of India ruled that interim moratorium under the Insolvency & Bankruptcy Code, 2016 (IBC) (section 14) cannot cover sureties of corporate debtors. This reverses the decision of the National Company Law Appellate Tribunal that sureties are also protected when insolvency resolution proceedings are in progress. Supreme Court was perhaps logical in reaching this conclusion, yet the decision will likely compel sureties to start multiple proceedings that can potentially undermine the efficiency of the insolvency resolution process.
In conception, IBC aims to be comprehensive. While finding solutions to the problems of debt, default, and recovery by creditors, it also encourages rehabilitation of affected borrowers. To achieve these broad and challenging goals, the rules included in IBC cover not only corporate borrowers but also their sureties – usually directors and/or major shareholders. When corporate borrowers file for insolvency resolution, they qualify for moratorium on their debt obligations when the resolution process is pending (section 14). The question is whether the moratorium can also extend to sureties of corporate borrowers. IBC is not explicit on this.3
In Part III, IBC has a separate set of rules on bankruptcy proceedings of individuals including sureties. They enable interim moratorium for individual debtors (sections 96 and 101). A problem is these rules are not yet brought into force. In this situation, sureties have tried to rely on the general moratorium provision that governs corporate debtors (section 14).
Pointing out that IBC rules on moratorium for sureties is not yet in force, the Supreme Court ruled that sureties would not be eligible for the protection available to corporate debtors under section 14. In a technical sense, the reasoning appears valid. However, the results can be more complicated. It is unclear when the government will notify the Part III rules applicable to individuals and sureties, and enable them to seek/obtain moratorium. Until this happens, sureties might be forced to approach the civil courts to resist enforcement measures by creditors against them personally, when insolvency resolution process for the corporate debtor is pending.
Payments under Tax Amnesty Scheme to be adjusted first against tax, Karnataka High Court rules
In resolving an issue in the implementation of the Karnataka Tax Amnesty Scheme 2017,8 Karnataka High Court ruled in favour of taxpayers that the sums paid by them under the scheme must first be adjusted against tax arrears. In State of Karnataka v WS Retail Services,9 the court quashed the action of the government in appropriating the payments against interest and penalty.
Government of Karnataka introduced the Tax Amnesty Scheme (Karamasamadhana Scheme, 2017) in its 2017 budget. The scheme was meant to facilitate closure of pending tax disputes, thus clearing the backlog of cases and enabling dealers to “turn a new leaf.” Per Clause 2 of the Scheme, dealers who paid full tax arrears by 31 May 2017 would qualify for waiver of 90 percent of any penalty and interest that might be applicable. Relying on this, several dealers submitted applications under the Amnesty Scheme and paid sizable amounts.
In implementing the Amnesty Scheme, tax officials purported to first adjust the payments towards interest and penalty leaving the dealers saddled with significant arrears of tax. In doing so, the officials relied on the Karnataka Value Added Tax Act, 2003 (section 42) and similar provisions in other tax laws under which payments by dealers had to be first applied towards penalty and interest, and then any balance would go towards outstanding tax amounts. The action had the effect of nullifying the benefit of the Tax Amnesty Scheme and the promise to waive penalty and interest. Faced with this, the dealers approached the High Court.
The High Court agreed with the submission of the dealers that the terms of the Tax Amnesty Scheme would prevail. In the circumstances, the tax law rule that payment would first go towards penalty and interest would not apply. The ruling ensures outcomes consistent with the Tax Amnesty Scheme, which offered waiver of substantial penalty and interest upon payment of disputed tax arrears.
VHVK Law Bulletin is issued for information purposes only and does not constitute legal advice. For more information on any of the material covered here and/or their implications for your situation, please obtain competent legal advice.