SEBI Clarifies on Schemes of Arrangement

Following SEBI’s circular of February 4, 2013 imposing stringent requirements for oversight of schemes of arrangement, there were certain issues that required clarification (discussed here and here).

Now, by way of another circular dated May 21, 2013, SEBI has clarified some of the outstanding issues and also made some modifications to the previous circular. In this post, we discuss some of the key items:

1. Applicability of the Circular

SEBI has now clarified that the February 4 circular is applicable to all types of schemes of arrangement including amalgamation, reconstruction and reduction of capital. It is not limited to reverse listings or other schemes that may require an exemption under Rule 19(7) of the Securities Contracts (Regulation) Rules, 1957.

The wide applicability of the circular would mean that all schemes of arrangement will now be closely scrutinized and will require review by the stock exchanges and SEBI.

2. Majority Requirements for Voting

The February 4 circular provided that proposal for a scheme will pass muster only “if the votes cast by public shareholders in favor of the proposal amount to at least two times the number of votes cast by public shareholders against it.” In other words, in addition to the usual majority the scheme must also receive the approval of 2/3rds of the public shareholders. This requirement has now been done away with.

A more stringent majority requirement as well as voting through postal ballot and e-voting and greater disclosure measures are now limited to schemes of arrangement that are undertaken where promoters are a party or are affected by it. Examples of this are where promoters are allotted further shares under the scheme, or where a group company is a party to the transaction. In such cases, there must be a majority of public shareholders voting in favour of the scheme, in addition to the normal majority required by the Companies Act. The stringent majority requirements therefore apply only to related party transactions undertaken through schemes of arrangement and not to all transactions (which are carried out at arm’s length).

It appears that the earlier circular treated all transactions with the same level of circumspection and imposed high burden on companies that would have made obtaining the requisite majority cumbersome, but now that is limited only to related party transactions that require greater protection for minority shareholders.

3.         Others

Under the revised circular, while valuation reports are required to be submitted in all types of schemes, they are required to be obtained from an independent chartered accountant only if there is a change in the shareholding of the listed company / resultant company. What amounts to change in shareholding pattern is defined with specificity along with illustrations.

The revised circular achieves two results. On the one hand, it clarifies the scope of applicability of the previous circular. On the other hand, it lessens the stringency of the previous circular by making some of the onerous requirements applicable to specific types of schemes where minority interests are likely to vulnerable rather than to all types of schemes.

Public Shareholding Norms: Consequences of Non-Compliance

The June 2013 deadline for compliance by listed companies with the minimum public shareholding of 25% is looming closer. The deadline for compliance by public sector (government) listed companies to comply with the 10% minimum public shareholding will follow in August.

Over the last few months, several companies have already reduced their promoter shareholding to meet with these norms. This has been accomplished through various facilities provided by the Government and SEBI to achieve the minimum public shareholding norms. SEBI has also provided specific exemptions and dispensations in certain cases. The latest episode of The Firm has a comprehensive discussion on the manner in which companies have gone about reducing their promoter holdings and the various issues that have arisen in the process.

Despite a rush to achieve these norms, there will certainly be a significant number of companies that are unable to comply with them by the June deadline. SEBI has been steadfast in its stance that it will not extend the time period for compliance.

In these circumstances, a lawyer friend recently raised the issue of the possible consequences of non-compliance by listed companies. In order to consider this, we must note that the minimum public shareholding norms are embodied in Rule 19A of the Securities Contracts (Regulation) Rules, 1957 (SCRR) that was introduced by way of amendment in 2010. In addition, the listing agreement in clause 40A requires companies to comply with Rules 19(2) and 19A of the SCRR.

The first consequence of non-compliance would be a delisting of securities on account a breach of the listing agreement. As we have repeatedly argued before, this would be a paradoxical tool to ensure compliance with listing norms. In case of a delisting, it is the public shareholders who would suffer due to a loss of liquidity and exit opportunity in the markets. Public shareholders would be penalized by failure of the company and promoters to comply with norms that are intended to benefit them. While this regulatory response exists on paper, it must be exercised cautiously after considering the extensive impact it may have.

The second consequence would be penalties levied on the non-compliant companies. Section 23E of the Securities Contracts (Regulation) Act, 1956 (SCRA) provides that in case of failure to comply with the listing conditions, SEBI could impose a penalty not exceeding Rs. 25 crores (rupees 250 million). SEBI could potentially invoke this power in case the public shareholding norms are not met by the deadline.

While these measures exist on the statute books, it is a different matter as to how they might be exercised by SEBI in practice. The past track record indicates certain difficulties in the implementation of corporate and securities laws. For example, when stringent measures of corporate governance were to be introduced by amendments to clause 49 of the listing agreement in 2004, the implementation was delayed several times and they came into effect only on January 1, 2006. These include a tighter definition of board independence and the like. Even thereafter, when SEBI tried to enforce the board independence requirements against several listed companies, primarily in the public (government) sector, it had to drop them subsequently.

To make a comparison, during October and November 2008, SEBI passed a series of orders involving the lack of appointment of the requisite number of independent directors to several government companies, viz. NTPC Limited (Oct. 8), GAIL (India) Limited (Oct. 27), Indian Oil Corporation Limited (Oct. 31) and Oil and Natural Gas Corporation Limited (Nov. 3). The principal ground for dropping the action was that in the case of the government companies involved the articles of association provide for the appointment of directors by the President of India (as the controlling shareholder), acting through the relevant administrative Ministry. SEBI found that despite continuous follow up by the government companies, the appointments did not take effect due to the need to follow the requisite process and hence the failure by those companies to comply with Clause 49 was not deliberate or intentional.

Returning to the public shareholding norms, a lot would depend upon the stance adopted by SEBI for enforcing them after the deadline has expired. While some of it may be known post-June 2013 when the deadline for private sector companies expires, but the real enforcement test may lie if there are violators among the public sector companies, which will be clear subsequently.

Madras High Court on SEBI Circular for Scheme of Arrangement

A few months ago, I had discussed SEBI’s circular of February 4, 2013, which imposes more stringent oversight by SEBI and the stock exchanges on different types of schemes of arrangement.

Shortly thereafter, our guest contributor Yogesh Chande has pointed to issues relating to the scope of the SEBI circular, and specifically whether the circular applies only to such schemes that require exemption from Rule 19(7) of the Securities Contracts (Regulation) Rules, 1957 (SCRR), which principally relates to reverse listings, or whether it applies more widely to all types of arrangements. This ambiguity is caused because although the SEBI circular applies generally to all types of schemes, including schemes among listed companies and even capital reductions under section 100 of the Companies Act, the genesis for the circular can be related to a 2009 circular which is confined to reverse listings and was also repealed by the February 2013 circular.

In an unreported judgment dated April 1, 2013, the Madras High Court holds that SEBI’s circular is applicable only where an exemption is being sought from Rule 19 of the SCRR and not for other schemes. That case involved a merger of two companies both of which were listed on the stock exchanges. The companies made an application to the court for convening meetings under section 391 of the Companies Act. Since this was not a reverse listing, the court clarified in response that the SEBI circular is not applicable. The relevant portion containing the discussion on the point of law on the issue is extracted below:

5. The learned counsel for the applicant contended that the conditions laid down by the Securities and Exchange Board of India vide circular CIR/CFD/DIL/5/2013 dated 04.02.2013 are not applicable to the case of the applicant, as the applicant is not seeking exemption under Rule 19(7) of the Securities Contracts (Regulation) Rules, 1957, as the transferor company listed its shares in the recognised Stock Exchange after complying with the conditions laid down under the Securities Contracts (Regulation) Rules, 1957.

6. On consideration, I find force in this contention. Rule 19 of the Securities Contracts (Regulation) Rules, 1957 stipulates that a public company as defined under the Companies Act, 1956, desirous of getting securities listed with the recognised Stock Exchange are required to apply for the purpose to the Stock Exchange along with its application, document contained under the Rule.

7. A submitted by the learned counsel for the applicant, this already stood complied with, when the stock was listed with the recognised Stock Exchange.

8. The learned counsel for the applicant is also right that Rule 19(7) gives right to the Securities Exchange Board to waive or relax strict enforcement of any of the rules. In the present case, it is not a case where the applicant is to get the stock listed. In the case in hand, what is being done is that the stock which is already listed is being regulated without seeking any exemption, therefore, for the purpose of amalgamation of the companies, the provisions of Rule 19(7) would not be applicable, as no exemption under the rules is being sought therefore, the circular issued in exercise of power under Rule 19(7) will not be applicable to the applicant.

The court has adopted a narrow view of the circular. While it is understandable that the circular refers to Rule 19(7), that does not explain the wider objective of SEBI that is evident in the circular and also in the fact that it covers other schemes of the arrangement such as capital reduction that does not involve any listing of securities without following the usual disclosure process.

As Yogesh mentions in his post, there is some ambiguity regarding the scope of the circular, and this decision also underscores the type of issues that could arise in practice. Given this ambiguity, it is recommended that SEBI expressly state its intention regarding the scope of the circular. By issuing a clarification or a set of FAQs, possible uncertainties regarding the schemes of arrangement, which are a popular form of a transaction in India, can be avoided.

Update - May 22, 2013: SEBI has since clarified that the circular is applicable to all types of schemes of arrangement and not only those that require an exemption under Rule 19(7).

Enforceability of Put and Call Options: Reality Soon?

Although put and call options are quite common in investment agreements, its enforceability under Indian law has been in serious doubt due to age-old provisions in securities laws which have not been updated to meet with the requirement of the times. I have discussed the issue in detail in this paper and also called “for a reconsideration of the legal regime so that physically settled options that are customary in investment agreements may be treated as valid and legally enforceable”.

Although this issue has been on the anvil for a long time, now there seems to be some tangible movement towards resolution. News reports indicate that the Law Ministry has, based on a proposal from the Finance Ministry, decided to permit options in investment agreements.

It is not clear how the revisions will be effected. It could be done simply by way of a notification by SEBI amending/repealing its earlier notification of March 1, 2000, which put paid to these options. The other alternative would be to amend the Securities Contracts (Regulation) Act, 1956 (SCRA), which is perhaps both unnecessary and more cumbersome given that the intervention of Parliament will be required.

It is too early to be euphoric because the devil is always in the detail!

Papers published on BALCO

Ironically, the judgment of the Constitution Bench in BALCO may turn out to be as significant for domestic arbitration as it is for finally shattering the misconception that the omission of the word “only” in section 2(2) of the Arbitration and Conciliation Act 1996 was designed to expand the jurisdiction of the Indian courts in relation to foreign arbitration. Some of these questions have been explored in three articles recently published in the Supreme Court Cases journal, of which the following is a brief summary.

Shantanu and I wrote a paper titled “Three Errors in BALCO” ((2012) 9 SCC J-26) in which we argued that while the Court was entirely right in overruling Bhatia International on the applicability of Part I of the Act to foreign arbitrations, it nevertheless made-as the title of the article suggests-three significant errors on other points. To briefly summarise:

       (1)   The conclusion in paragraph 96 that section 2(1)(e) of the Act refers to two courts, the court of the seat and the court of the cause of action is, with respect, clearly incorrect. Section 2(1)(e) confers jurisdiction on the court which would have had jurisdiction to entertain a suit forming the subject matter of the arbitration. As the Delhi High Court rightly pointed out in GE Countrywide, this means that a court in which an application under the 1996 Act is instituted must imagine that the arbitration clause does not exist and ascertain whether it would have had jurisdiction to entertain a suit relating to that dispute. So, if two parties from Mumbai and Delhi respectively choose Calcutta as the seat of arbitration, the Calcutta High Court would not have jurisdiction to entertain an application under the 1996 Act unless it was shown that some part of the cause of action arose in Calcutta. Unfortunately, the Supreme Court assumed in paragraph 96 of its judgment that section 2(1)(e) is a reference to two courts (the court of the seat and the court of the cause of action) and has therefore overruled by implication, a consistent view that has prevailed for over seventy years.

   (2) The Court, with respect, misunderstood the decision of the House of Lords in the Siskina and consequently proceeded on the erroneous premise that an action instituted solely to obtain interim relief in aid of foreign arbitration is alien to the common law. Had the Court appreciated that the common law does recognise such an action, it would then have had the opportunity to consider whether such an action is recognised by Indian law. We suggested that such an inquiry would likely have led the Court to conclude that such an action may be brought under section 151 CPC, addressing one of the major concerns raised by practitioners about the consequences of BALCO.

   (3)   There was no case whatsoever for overruling Bhatia International prospectively, considering that the dispute related to a point of statutory construction, and in particular a jurisdictional statute. As the House of Lords emphasised in Re Spectrum, the power should be exercised only in wholly exceptional cases, and with particular caution if the point the court is asked to overrule prospectively is one of statutory construction rather than the common law (Lord Scott of Foscote in his dissenting speech thought the power should never be exercised in relation to statutory construction).

A response to this article titled "Not Three but Half an Error in  BALCO" ((2013) 1 SCC J-81) was published by Mr SK Dholakia, Senior Advocate and Ms Aarthi Rajan, Advocate  in which they sought to support the judgment of the Court. In summary, their contention on section 2(1)(e) was that the “overarching seat theory” was the basis of which BALCO was decided, and led to the conclusion that the territorial court for domestic arbitration is solely the court of the seat, regardless of where the cause of action arises. According to them, in the Mumbai/Calcutta example above, the Calcutta High Court would have exclusive jurisdiction by virtue of being the supervisory court, that is, the court exercising territorial jurisdiction over the chosen seat of arbitration. They make the powerful argument that if two foreign parties choose Chennai as the seat of arbitration, and the cause of action arises entirely outside India, neither the Madras High Court nor any other Indian court would have jurisdiction under section 2(1)(e) even though Part I of the Act applies (by virtue of section 2(2)), which they contend is an anomaly that impedes the growth of arbitration where India is a neutral forum. In relation to our argument on the maintainability of an action for interim relief in aid of foreign arbitrations, they relied on the well-known judgments of the English courts in Castanho and Siskina, and the recent judgment of the High Court in Royal Westminster, to suggest that there can be no “suit” purely for interim relief. They also suggest that section 151 CPC cannot be invoked for this purpose because Order 39 Rule 1 is exhaustive. In relation to prospective overruling, they agree that using arbitration agreements (as opposed to pending petitions or applications, for instance) entered into after 06.09.2012 as the yardstick was erroneous, but support the use of prospective overruling in principle, relying on Patel Engineering.

We have now published a response to this article titled “Three Errors Revisited” ((2013) 4 SCC J-1), explaining our original argument and responding to some of the points raised by Mr Dholakia and Ms Rajan. We point out that the jurisdiction of the Indian courts to supervise arbitration is statutory, not inherent, supporting the view taken by the Delhi High Court in GE Countrywide, and therefore that it is not permissible for an Court to assume jurisdiction not provided by section 2(1)(e) on the basis of the "overarching seat theory". This cause-of-action based system of organising jurisdiction has, for better or worse, been part of Indian law for over seventy years. Whether that should be discarded in favour of a consent-based system of jurisdiction is, we suggest, a decision for Parliament, not the Supreme Court. On the maintainability of an action for interim relief in aid of foreign arbitrations, we demonstrate that the transition from the 1882 CPC to the 1908 CPC contains indications that what is now Order 39 Rule 1 is not exhaustive (indeed, the Calcutta High Court so held in the early 1900s), and that section 151 CPC is a possible basis on which such interim relief may be granted. We also revisit the discussion of the common law and establish that it contains no bar to such an action. Finally, we reiterate that it was not appropriate to overrule Bhatia International prospectively, because the appellants had not established that this was, to quote Lord Nicholls in Re Spectrum, “the wholly exceptional case” in which parties had relied on Bhatia International in organising their affairs. More generally, we suggest that prospective overruling should not be used on a case-by-case analysis of the “justice” of the competing claims but should proceed on the basis of clearly established legal principle, which should distinguish between overruling a point of common law and overruling a point of statutory construction.

Call for Papers – Journal on Governance

[The following announcement is posted on behalf of the Center for Governance, National Law University, Jodhpur]

Center for Governance, National Law University, Jodhpur, proposes the VII issue of “Journal on Governance,” its annual publication.  Journal on Governance offers a forum for critical research on interplay of contemporary corporate governance issues with other disciplines, including, inter alia, law, management and societal studies.  Aside to highlighting the problems and the challenges, the Journal attempts to explore and offer workable solutions, which may be helpful in regulatory and policy decisions.

A few of the Center’s such endeavours include comments on the consultative paper on the SEBI’s suggested Clause 49 reforms, followed by a panel discussion involving eminent stalwarts like Padmabhushan Shri D.R. Mehta (Founder Chairman, SEBI), and Ms. Usha Narayanan (Former Executive Director, SEBI, and currently partner, Amarchand & Mangaldas & Suresh A Shroff & Co.).

Previous issues of the Journal boast of scholarly discourses from eminent legal practitioners, academicians, research scholars and students.  The articles for publication are selected through a meticulous and intense process of review, edit and refinement. The Journal has received acclaim and appreciation from all contours of the industry and academia.  For the forthcoming issue, the Center invites Articles on the following sub-themes under the broad theme of "Governance- the contemporary challenges":

1.         Governance in Microfinance Industry

2.         SEBI’s Jurisdiction on Corporate Governance- a critical assessment

3.         Governance in PPP Model of Infrastructure Projects

4.         Corruption and Corporate Citizenship

5.         Conflict of Governance and Related Party Transaction

Please note that the submissions must conform to the following requirements:

- The acceptable length of Articles is 5000 words, and of notes and comments is 3000 words, including footnotes.

- All submissions must include an abstract of not more than 300 words, explaining the main idea, objective of the article and the conclusions drawn from it.

- The Article should be on A4 sized paper, in Times New Roman Font Type, font size 12, 1.5 line Spacing and 1 inch margins on each side. Authors should follow Harvard Blue Book Footnoting style. Footnotes should be in font size 10 and with single line spacing.

- Authors should provide their contact details, designation and institutional affiliation in the covering letter for the submission.

- The submission must be the original work of the authors. Any form of plagiarism will lead to direct rejection. The relevant sources should be duly acknowledged as footnotes. The decision of the reviewers in this regard shall be final.

- Authors are requested to send an electronic version of their manuscripts (.doc or .docx format) to journal.governance@gmail.com with the subject as “Submission”. All queries may be addressed to the Editors on the aforementioned email address.

- Submission deadline for the Article, Notes and Comments is on the 31 July 2013.