Wednesday, August 20, 2014

"Make in India" frustrated by regulations "Made in India"

The Delisting Regulations applicable in India have been controversial since inception.  Earlier this year, SEBI published a discussion paper seeking to review them.  This Blog commented on the discussion paper here.

Earlier this week, in my column in Business Standard, I wrote about how tinkering with the Delisting Regulations will not be of help. The Delisting Regulations is a body of law unique to India, and in its interplay with the Takeover Regulations and the law on minimum public shareholding, it adjusts the adjective from "unique" to "peculiar".  The column can be accessed here.


OECD Report on Related Party Transactions in India

The topic of related party transactions (RPTs) has acquired tremendous importance lately and has been the subject matter of intense discussion and debate both on this Blog (here) and elsewhere (here, here and here). The discussions focus on the specifics and the interpretation of the Companies Act and the Rules promulgated by the Ministry of Corporate Affairs (MCA) that deal with RPTs.

In the meanwhile, the OECD has issued a report entitled Improving Corporate Governance in India: Related Party Transactions and Minority Shareholders Protection (h/t: Corporate Law and Governance). The OECD report studies the current state of the law in India regulating RPTs, and makes some suggestions for reform. While the report takes into account the enactment of the Companies Act, 2013 and the reforms introduced thereunder, it does not deal with the nitty-gritties of the issues relating to rule-making and practical implications on companies as contained in the earlier mentioned literature. Nevertheless, it provides a macro-level perspective on the more significant reforms required to rein in RPTs given their prominence in the Indian context due to the presence of corporate groups and concentrated shareholdings.

The macro-level policy matters highlighted in the OECD report may help guide the resolution of some of the more specific issues that have arises in the Companies Act and the MCA Rules on RPTs.


Tuesday, August 19, 2014

Guest Post - Delhi Airport Metro Case: Twilight Zone of the “pro-arbitration” trend

[The following post is contributed by Sujoy Chatterjee who is an Advocate in New Delhi and an alumnus of the National Law University Jodhpur (’13)]

In recent times, there has been a propensity towards characterizing judgments of the Indian judiciary either as “pro-arbitration” or “against the pro-arbitration trend” (for example, see here, here and here). The rationale behind this tendency of binary characterization seems to be that a judgment which, inter alia, upholds the validity of an arbitration agreement, allows arbitration proceedings to commence or continue, etc, is a step in the right direction. However, as pointed out on this Blog (see here), a facially “pro-arbitration” judgment may yet create or propagate principled confusion, giving rise to further litigation in future. This author believes that rather than focusing solely on the outcome of a judgment, it is the contribution the judgment makes towards our arbitration jurisprudence which ought to determine whether the judgment is truly pro-arbitration.

It is in this background that the Delhi High Court’s judgment in Delhi Airport Metro Express Limited v. CAF India & Anr., pronounced on 14 August 2014 is significant. The judgment, which in its outcome allowed an Indian party to proceed with arbitration proceedings in London against another Indian party, ironically arrives at this conclusion by keeping its analysis of arbitration jurisprudence to a minimum. Therefore, while its ultimate ruling is undoubtedly “pro-arbitration”, Delhi Airport Metro’s rationale for this ruling is grounded in contractual provisions and principles of contract law as opposed to the nitty-gritties of arbitration law.

By way of background, Delhi Airport Metro Express Limited had entered into a Maintenance Services Agreement on 30 June 2008 with Construcciones Y Auxiliar De Ferrocarriles, SA (CAF), a company incorporated in Spain. The Maintenance Services Agreement contained an arbitration agreement, which inter alia provided:

(i)         the seat of the arbitration as London, i.e., a place outside India; and

(ii)      the express exclusion of Part I of the Arbitration and Conciliation Act, 1996 (the Act).

(The double layer of protection, i.e., a foreign seat as well as the express exclusion of Part I of the Act, was presumably included in the arbitration agreement to avoid any confusion regarding jurisdiction of Indian Courts, since the Maintenance Services Agreement was executed at a time when Bhatia International v. Bulk Trading held the field in India.)

On 17 May 2010, CAF executed an Assignment Agreement in favour of CAF India, a wholly owned subsidiary of CAF and an entity incorporated in India, whereby the rights and obligations of CAF under the Maintenance Services Agreement were transferred to CAF India. Thereafter, certain contractual disputes arose between Delhi Airport Metro Express Limited and CAF India with regard to the Maintenance Services Agreement, and on 21 January 2014 CAF India submitted its request for arbitration jointly with CAF as per the arbitration agreement contained in the Maintenance Services Agreement. Delhi Airport Metro Express Limited approached the Delhi High Court challenging the validity and enforceability of the arbitration agreement, thereby questioning the legality of the arbitration proceedings and requesting for a restraint on CAF India from pursuing arbitration proceedings in London.

Delhi Airport Metro Express Limited argued, inter alia, that both it and CAF India were Indian companies and therefore it would go against the public policy of India if the arbitration agreement was given effect to. The rationale behind this argument was that two Indian parties could not, either by choosing a foreign seat or by expressly providing so in their agreement, exclude the applicability of Part I of the Act or attempt to avoid the applicability of the laws of India.

Per contra, CAF India contended, among other things, that Section 5 of the Act mandated minimal judicial intervention and that this principle applied equally to international commercial arbitration as well as domestic arbitration. CAF India also argued that Delhi Airport Metro Express Limited’s suit was barred by Section 14(2) of the Specific Relief Act, 1963 and that the High Court did not have jurisdiction to entertain an anti-arbitration suit.

Manmohan Singh, J. begins his analysis of Delhi Airport Metro by crystallizing the issue as follows:

the question which falls for consideration is as to whether pursuant to the Assignment Agreement dated 17th May, 2010, the rights and obligations of the Defendant No. 2 which is a Spanish Company are completely discharged under the Maintenance Agreement and other agreements between the parties so as to say that it has no role to play in the rights and obligations of the parties under agreement and had exit completely from the agreement. If the answer to the said question is in affirmative, then only the case of the plaintiff and grounds stated therein merits further consideration and on the other hand if the answer is in negative, then the case of the plaintiff is not even required to be further considered as the entire premise of the suit may fail.

(emphasis added by this author)

Framing the issue thus, Manmohan Singh, J. pre-empted an arbitration-centric discussion and proceeded on an astute analysis of the terms of the Assignment Agreement and the Maintenance Services Agreement, as well as Section 62 and Section 43 of the Indian Contract Act, 1872.[1] This analysis culminates with the Court’s conclusion that the obligations of CAF had not been completely discharged under the Maintenance Services Agreement and that CAF continued to have obligations under the Maintenance Services Agreement. On this basis the Court concluded that CAF remained a party to the Maintenance Services Agreement, and therefore the Assignment Agreement did not have the effect of transforming the nature of the arbitration agreement in the Maintenance Services Agreement from an international commercial arbitration to a domestic arbitration.

The only aspects of arbitration law which were briefly touched upon in Delhi Airport Metro were (i) the doctrine of separability, and (ii) the applicability of Section 5 of the Act to the present case. The Court, albeit en passant, opines how an arbitration clause may survive the novation of the main agreement and how section 5 may operate as a hurdle to the maintainability of the suit in the present case. However, even this brief discourse is subjected to a broad rider, i.e., the Court’s finding on these points is independent of the fact that there was no novation to the Maintenance Services Agreement in the present case and that the issue of maintainability did not require adjudication at this stage.

In conclusion, the Court held that since one of the parties to the arbitral proceedings (i.e., CAF) was a party incorporated under the laws of Spain, therefore the proceedings fell within the realm of Section 2(1)(f) of the Act as an international commercial arbitration. The Court ruled that the arbitration agreement as well the arbitral proceedings did not fall foul of Indian public policy by choosing London as the seat of arbitration and by excluding the applicability of Part I of the Act.

Delhi Airport Metro has very subtly highlighted the importance of (i) identifying and addressing the core issues in a dispute, rather than delving into the technicalities of arbitration law merely because the dispute is arbitration-centric; and (ii) reading in-between the lines of a judgment rather than fixating only over the outcome.

As an aside, a question which comes to this author’s mind after reading Delhi Airport Metro is that keeping all the other facts and circumstances of the case constant, if CAF India had initiated arbitration proceedings against Delhi Airport Metro Express Limited by itself and not along with CAF, would the arbitration proceedings still have been valid? A simpliciter “pro-arbitration” finding would probably be inclined towards answering in the affirmative, but a substantive analysis may yield otherwise (see here).

- Sujoy Chatterjee




[1] An analysis of the rationale for Delhi Airport Metro is beyond the scope of this post.

Monday, August 18, 2014

Guest Post - MCA amends RPT rules: Makes provisions stricter

[The following post is contributed by Vinod Kothari and Shampita Das of Vinod Kothari & Company. They can be contacted respectively at vinod@vinodkothari.com and shampita@vinodkothari.com]

The latest setback from the MCA has come by way of the amendments to the Companies (Meetings of Board and its Powers) Rules, 2014 (MBP Rules) vide its notification dated 14th August, 2014, which is yet to be gazette.[1] The key highlight of the amendment was the complete substitution of the Rule 15(3) of the MBP Rules relating to conditions for obtaining approval from members for entering into related party transactions (RPTs).

Lets’ start over!

Section 188 of the Companies Act, 2013 (Act) provides that approval of the Board would be required for entering into certain related party transactions. The first proviso to Section 188 provides that no contract or arrangement shall be entered into by a company having paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, except with the prior approval of the company by a special resolution.

To this effect, Rule 15 (3) of the MPB Rules (prior to the amendment) had laid down dual conditions for passing of special resolution for entering into RPTs. The conditions were:

(a)        Companies having paid up capital of Rs. 10 crores or more; or

(b)       Transaction value exceeds certain prescribed limits.

This meant that fulfillment of either of the conditions (i.e. paid up capital or transaction limits) would have necessitated the approval of the RPT by way of a special resolution. Thus even if my transaction value is Re. 1, if my paid up capital exceeded Rs. 10 crores, I would have had to approach my members for passing the related party contract.

The Amendment

The amendment seeks to substitute this sub-rule (3) to Rule 15 by completely removing the paid up capital criteria of Rs. 10 crore.

Further, the transaction limits of the various related party contracts as listed under Section 188 (1) of the Act has also been reduced. The table below shows the limits of the RPTs before and after the amendment:

­
Before
After
Sale, purchase or supply of any goods or materials, directly or through appointment of agents, as mentioned in Clause (a) and Clause (e), respectively of Section 188 (1)

Exceeding 25% of the annual turnover
Exceeding 10% of the turnover of the company or Rs. 100 crores, whichever is lower.
Selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents as mentioned in Clause (b) and Clause (e), respectively of Section 188 (1)

Exceeding 10% of the net worth of the company
Exceeding 10% of the net worth of the company or Rs. 100 crores, whichever is lower
Leasing of property of any kind as mentioned in clause (c) of Section 188 (1)
Exceeding 10% of the net worth or 10% of turnover of the company
Exceeding 10% of the net worth or 10% of turnover or Rs. 100 crores, whichever is lower.

Availing or rendering of any services directly or through appointment of agents as mentioned in Clause (d) and Clause (e) of Section 188 (1)

Exceeding 10% of the net worth of the company
Exceeding 10% of the turnover of the company or Rs. 50 crores, whichever is lower.

Further, an Explanation has been added after the above sub clauses as follows:
‘It is hereby clarified that the limits specified in sub-clauses (i) to (iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.’

Appointment to any office or place of profit in the company, its subsidiary company or associate company as mentioned in clause (f) of Section 188 (1)

At monthly remuneration exceeding Rs. 2.5 Lakh.
At monthly remuneration exceeding Rs. 2.5 Lakh.
-       No Change
Remuneration for underwriting the subscription of any securities or derivatives thereof of the company as mentioned in clause (g) of Section 188 (1)
Exceeding 1% of the net worth of the company
Exceeding 1% of the net worth of the company.
-       No Change
















































Understanding its Impact

The amendment has changed the entire essence of the earlier Rule. Now, any company – big or small, public or private, irrespective of its paid up capital will be required to pass a special resolution in case the transactions being entered into with related parties come within the amended limits of Rule 15(3) of the MBP Rules.

Also, most of the contract limits have been reduced to bring more RPTs within the scanner of the members and the government. This includes putting an upper cap for transactions worth Rs. 100 crores or Rs. 50 crores to necessarily require special resolution, notwithstanding its percentage value to the networth or turnover of the company.

Further, the Explanation that has been added to the amended Rule provides that the contract limits shall apply to both individual transactions, and transactions taken together in a financial year with a related party. The question here arises is whether the same needs to be assessed for ‘all contracts with one related party’ or ‘all contracts with each related party’.

That is, suppose a company has A, B and C as related parties and it enters into sale of goods agreement with each of them. The aggregate value of the contract with A comes to Rs. 70 crore, with B to Rs. 102 crores and with C to Rs. 25 crores, in a financial year. The aggregate value of such contracts with each related party comes to Rs. 197 crores. However the threshold (i.e. Rs. 100 crores) of all contracts with one related party is breached only for B.

Here, the special resolution will be required for entering into transactions with only B, i.e. all contracts with one related party needs to be seen. This is because the Section 188 (1) uses the phrase ‘….no company shall enter into any contract or arrangement with a related party with respect to -’. Hence the merit of transactions with individual related parties needs to be seen and not the aggregate of the all such transactions.

Further, the MCA has clarified in its Circular No. 30/2014 dated 17 July 2014[2] that only the related party to such contract or arrangement will refrain from voting on the special resolution.

A Critical Take on the Amendment

With the amendment in Rules, Section 188 has become completely futile. There was absolutely no case for dropping the "large company" criteria - in fact, there was a very strong case to make the "large company" and "large contract" criteria cumulative, rather than alternative. However, the section as it now stands is counterproductive - as it will be tougher for small companies to comply with, than for large companies.

We are surprised as to how the amendment is a case of dilution of the provisions of law. The change in the Rules has exactly gone opposite to the essential philosophy of control over RPTs. It has made section 188 lighter for larger companies and harder for small companies. If you see the discussions before the Parliamentary Committee, MCA has represented there that section 188 is meant for larger companies. Now, as the situation prevails, small contracts by large companies do not need sanction; however for small companies, smaller contracts need sanction (as the limit reduced from 25% to 10%). Dichotomy between listing norms and the Act continues - as SEBI's rules still continue to define "material RPTs" differently. The implication of Section 188 as it now stands defies all logic - smaller companies, for whom every small contract will be relatively large, as they themselves have small aggregate turnover and networth, will have to run to get general meeting resolutions every now and then. Proposed exemption notification for private companies was also diluted before going to Parliament to deny complete exemption to private companies. Hence, private companies will also need to run to their general bodies to approve contracts with related parties. Worst hit will be smaller public companies, which do not have any exemption from the Rule that requires a related party to refrain from voting.

Also, as the change of Rules happened mid way during the financial year, what about those contracts which have already been signed/approved during the financial year, before the Gazette notification?

How could larger companies and smaller companies, particularly those with no public stakes at all, be painted with the same brush? Is there clarity as to the direction in which the Companies Act is moving?

This is the biggest concern that had been mentioned in Mr. Vinod Kothari’s article titled "Ten monsters of the Companies Act, 2013[3]". He had mentioned that as lawmaking moves from the domain of the Parliament to the domain of the MCA, the executive arm of the government starts doing what the Parliament of the country is supposed to do. How could such massive changes take place, completely without any deliberation or public discussion? Had it been the time-tested, globally followed Parliamentary process, this change would have required a Bill, debate in Parliament, and so on. Now, since rule making is absolutely in the clutches of the MCA, all that it needed was one simple notification, and there is such a substantive swing in substantive rights and liberties of businesses.

- Vinod Kothari & Shampita Das