VHVK E Newsletter October 2021
Oct 2021
Volume V Issue 5
VHVK Law Bulletin
In this fifth issue of VHVK Law Bulletin for 2021, we are pleased to present the following:
- No tenancy rights created under agreement for sale of business (Supreme Court)
- Approved insolvency resolution plan binding on secured creditor regardless of value of mortgaged property (Supreme Court)
- “Carried interest” payment by Venture Capital Fund trusts to Asset Management Companies (AMC) attract service tax (CESTAT Tribunal)
- Insolvency petition not maintainable against company for non-redemption of preference shares when valuation disputes exist (Supreme Court)
- SEBI consent needed for compounding offences under the SEBI Act (Supreme Court)
- Competition Act investigation against Amazon and Flipkart can continue (Supreme Court)
An agreement for sale of business does not create tenancy rights
Efforts by a buyer of a business to setup tenancy rights against the seller were rejected by the Supreme Court, in Mangala Waman Karandikar v Prakash Damodar Ranad.1 The court ruled the agreement under which the buyer purchased the business did not confer tenancy rights and the seller could evict the buyer.
After the death of a shop owner in the 1960s, his widow entered into an agreement with the respondent under which the respondent would run the shop on payment of monthly “royalty.” The agreement was for a limited term and was extended by the parties for several years until the 1980s. The contract clearly stated there was no rent payment involved, despite the respondent continuing to run the shop at the same place. On these facts, the Supreme Court concluded there was no tenancy in favour of the respondent that entitled him to protection under rent control laws. Accordingly, the court upheld the trial judgment granted to the appellant for the eviction of the respondent.
The decision of the Supreme Court is consistent with the recent trend in legislation as well as courts to relax the rigour of older rent control laws that mostly favour tenants. This checks temptations by tenants to appropriate leasehold properties and squat on them. With the recent development, property owners are less vulnerable.
Secured creditor cannot seek higher recovery based on mortgaged property value
In India Resurgence ARC P Ltd v Amit Metaliks Ltd,2 the Supreme Court rejected the effort of a creditor with very small voting power (under 4 percent) to increase its recovery because the high value of the corporate debtor’s property mortgaged to it. The secured creditor challenged the insolvency resolution plan that had been approved by the corporate debtor’s Committee of Creditors (CoC).
The insolvency resolution plan had been approved by an overwhelming majority of creditors – over 95 percent in value. In dismissing the appeal filed by the lone dissenting secured creditor with less than 4 percent voting power, the Supreme Court held an approved resolution plan cannot be upset by a creditor on the ground it had valuable security interests in the debtor’s assets and use this advantage to improve its recovery.
With appreciation in property values, it often happens creditors with security interests over immovable property are in a strong position to recover their dues from troubled borrowers. However, to address unmanageable debt burden and the risk of business failure, the Insolvency & Bankruptcy Code combines all debt obligations of borrowers to facilitate overall debt reduction. This generally imposes sacrifices on all creditors, including secured creditors. To permit secured creditors in advantaged position to dictate terms can jeopardize the rehabilitation of borrowers and destabilize resolution proceedings.
The decision of the Supreme Court is consistent with the ameliorative principle of the Insolvency & Bankruptcy Code and the intention to help over-extended borrowers regain financial health and continue in business.
Service tax payable on “carried interest” disbursements by Venture Capital Fund
The amount of “carried interest” paid by Venture Capital (VC) funds to their asset management companies and nominees are liable to service tax. Declaring this position in ICICI Econet & Internet Technology Fund v Commissioner of Central Tax,3 the Central Excise and Service Tax Appellate Tribunal (CESTAT) (Bangalore bench) ruled carried interest did not represent mere “return on investment.”
Venture capital funds generally adopt complex structures. Organized as trusts, they issue different classes of “units” to investors. Affiliated asset management companies that manage the investments receive the misleadingly termed Class B/Class C units, while external investors receive Class A units. Class A units, in general, receive the fixed return that has been promised (subject to market risks), but Class B and C units held by affiliates and insiders receive additional share in the surplus earned by the fund. In other words, Class B and C units held by affiliates and insiders are more remunerative than Class A units held by investors.
Tax authorities levied service tax on the consideration received by the VC fund from investors less the return paid to them. The levy was on the amount retained the VC Fund retained after distribution to Class A unitholders (the external investors), including the so-called carried interest payments made to Class B/C unitholders (insiders/affiliates). VC Fund’s challenge to the levy was rejected by CESTAT which affirmed the finding that the retained amount represented “performance fee” collected by the VC Fund and it is liable to service tax.
No insolvency proceedings when preference share redemption is in dispute
Rejecting the efforts of Kotak India Venture Fund to initiate insolvency proceedings for non-redemption of convertible preference shares issued by Indus Biotech P Ltd, the Supreme Court affirmed disputed liabilities cannot be a ground for action under the Insolvency & Bankruptcy Code (IBC). Delivering the ruling in Indus Biotech P Ltd v Kotak India Venture Fund,4 the court appointed arbitrators to inquire into the dispute, as sought by Indus Biotech.
The preference shares Indus Biotech had issued to Kotak were convertible into equity shares. Prior to a Qualified Initial Public Offering (QIPO) of equity shares Indus Biotech planned, Kotak made efforts to convert its preference shares into equity shares and demanded 30 percent equity stake in Indus Biotech at conversion. Indus Biotech disputed the valuation for conversion and the resulting exchange ratio. In apparent retaliation, Kotak demanded redemption of the preference shares and initiated insolvency proceedings against Indus on the ground the company failed to redeem its preference shares.
Indus Biotech, adopting a different method, made efforts to initiate arbitration under its shareholders agreement with Kotak, to resolve the dispute on the conversion ratio for the preference shares. Upholding Indus’ submission that a dispute existed, the Supreme Court ruled there was no crystallized liability that could justify an insolvency proceeding against Indus Biotech. An important question the court did not consider was about the character of preference shares – as risk capital or loan – and whether non-redemption of preference shares can even be a ground to initiate insolvency proceedings against a company.
Compounding of SEBI Act offences not possible without SEBI concurrence
In Prakash Gupta v SEBI,5 the Supreme Court ruled compounding of offences under the Securities & Exchange Board of India Act (SEBI Act) requires consent of the prosecuting agency – namely, Securities & Exchange Board of India (SEBI). On this principle, the court rejected the criminal appeal filed by an individual charged with manipulating share prices in violation of regulations framed the SEBI Act.
Investigating into a complaint about illegal practices in the shares of Ideal Hotels & Industries Ltd, SEBI found the appellant violated several regulations – Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market Regulations, 1995, Substantial Acquisition of Shares and Takeovers Regulations, 1994, and Substantial Acquisition of Shares and Takeovers Regulations, 1997. SEBI filed a criminal complaint against the appellant for offences under the SEBI Act.
The appellant approached SEBI with an application to compound the criminal offences. Suffering rejection of the compounding application, the appellant sought relief from courts. In dismissing the appellant’s plea to compound, the Supreme Court referred to the effect of the applicable provision in the SEBI Act (section 24A), which overrode the Criminal Procedure Code, 1973. As such, composition of offences under the SEBI Act can only be made with SEBI’s consent.
Amazon and Flipkart cannot object to investigation under the Competition Act
Refusing to interfere with the investigation initiated by the Competition Commission of India against Amazon and Flipkart, the Supreme Court granted the companies additional time to file replies to the notices received by them. In Flipkart Internet P Ltd v Competition Commission of India,6 the court affirmed similar rulings by the Karnataka High Court in the Writ Petitions earlier filed by the companies. Supreme Court’s decision facilitates continuation of Competition Commission’s investigation launched on a complaint about anti-competitive practices adopted by the global e-commerce companies, received from an association of retail merchants, the Delhi Vyapar Mahasangh.
Supreme Court’s order in the Flipkart/Amazon case is consistent with the longstanding position that courts will not interfere with investigations by regulatory agencies, in the absence of compelling reasons – for example, evident lack of jurisdiction. Persons and companies under investigation must participate and explain their position, so the investigating agency can make appropriate orders. These orders can be agitated in accord with the appeal procedure that is normally provided. Courts in exercise of their extraordinary writ jurisdiction would not, in general, interfere in regulatory investigations.
The Competition Act investigation against Amazon/Flipkart is significant for its international dimensions. Concerted action against the Big Tech companies and strengthening competition law enforcement are, presently, under active consideration by US and European regulators that are keen to rein in corporate and check Big Tech’s market dominance. Potentially, the proceeding in India and its outcome can have reverberations overseas and they can influence the regulatory trends against Big Tech and in competition law enforcement.
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VHVK Law Partners
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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.