Friday, November 29, 2013

Whether Gold purchase schemes illegal? Bombay HC rejects petition to direct SEBI to take action

Recently, Bombay High Court rejected a PIL seeking action by SEBI in respect of gold purchase schemes (Sandeep Agrawal vs. SEBI [2013] 39 139 (Bom.)). In a brief decision of less than half a page, the Court essentially held that contracts are private commercial contracts and do not require interference by SEBI. The Court observed, “If any shop owner is running such a scheme and the consumers are voluntarily taking part in such a scheme, it is purely a commercial transaction between a businessman and a consumer”.

It is submitted that this decision requires reconsideration. It also appears that the case was not argued well, since the Court had observed, “If the petitioner so desires to bring it in the nature of public ambit the least that is expected is to point out as to under what statutory provisions or the rules framed thereunder the said scheme is prohibited. Nothing is placed on record in that regard.”.

Many of the gold purchase schemes do prima facie appear to be collective investment schemes (CIS). While some recent newspaper reports explain what they are (see here and here), the essentials of some common schemes can be described as under.

The entity that sets up such scheme is often a gold-jewellery shop. Customers are invited to pay a certain sum in equal instalments for a period of time. At the end of the period, a sum, often called “bonus” is added to the amount accumulated. The customer is then given gold ornaments at the ruling market price for such total amount.

The terms may vary. The period may be longer or shorter. The entity may give some flexibility regarding gold price, either in terms of a fixed selling price or an assured appreciation or even some concession in the making charges of the jewellery.

It is difficult to see how most of such schemes are not CISs. Section 11AA of the SEBI Act, which defines CISs widely, seems to be clearly applicable and the conditions specified therein are attracted.

While there are many reputed names involved in such schemes, clearly there is no regulation as of now and SEBI seems to be taking no action against them. Such schemes are ripe for misuse, assuming SEBI takes a view that the provisions relating to CIS do not apply.

An entity other than a gold-jewellery shop may set up such a scheme. The Scheme may be for a long period of, say, three to five years. There is no control over where the amounts raised would be applied – even existing schemes do not provide for assurance that the amounts raised would be used to buy gold which would be earmarked for the customer. The entity may offer a higher “bonus” (which really seems to be disguised interest) to attract customers. It is easy to provide a cash alternative at time of maturity in form of ruling price of gold, which in any case can be assured, apart from “bonus”.

It is arguable that each case would have to be decided on facts and perhaps some of such schemes may not attract the provisions. But regardless of that, the risks of such schemes are too many to be ignored. In the backdrop of recent scams in West Bengal and elsewhere, it is surprising that these schemes have not received closer attention. Ideally, and at the very least, SEBI should have assured the Court that it is looking into the schemes, more so since it was made a party to the petition.

Guest Post: Issue of Capital by Private Companies under the Companies Act, 2013

[The following post is contributed by Yashesh Ashar. Yashesh is a tax and regulatory consultant and the views expressed herein are personal]

The Companies Act, 2013 (‘New Cos Act’) which received the assent of the President on 30 August 2013 seeks to create a major overhaul in the functioning of the corporates in India. A major part of the New Cos Act is to be governed by the Rules proposed to be framed by the Central Government. The Draft Rules under the Companies Act, 2013 (‘Draft Rules’) have already been released by the Central Government for public comments.

The New Cos Act subjects private companies to a greater control and compliances and withdraws most of the exemptions available to private companies under the Companies Act, 1956 (‘Old Cos Act’). One of the aspects which is completely overhauled and widened under the New Cos Act is the conditions relating to issue or offer of securities by private companies. This post seeks to discuss various aspects of the new conditions relating to issue or offer of securities under the New Cos Act and Draft Rules and its impact on private companies.

The Old Cos Act did not refer to the expression ‘private placement’. Instead it provided in the negative that an offer or invitation shall not be treated as public offer, if shares or debentures are available for subscription or purchase only to those receiving offer or invitation and such offer and invitation is restricted to maximum of 49 persons. Further, the Unlisted Public Companies (Preferential Allotment) Rules, 2003 as amended by Unlisted Public Companies (Preferential Allotment) Rules, 2011 issued by the Ministry of Corporate Affairs (together referred to as ‘Preferential Allotment Rules’) prescribed conditions for preferential allotment by unlisted public companies. No such conditions were prescribed for private companies. Further, public companies whose shares are listed on the stock exchange required to comply with the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (‘ICDR Regulations’).

Thus, unlike the Old Cos Act, wherein the conditions relating to private placement were applicable only to public companies, the New Cos Act provides various conditions for private placement of shares and debentures which apply to both private companies and public companies. While some of the conditions in relation to private placements by companies appear as a direct fall-out of the recent cases and also in line with the latest amendments to Preferential Allotment Rules, only a few appear justified for private companies and others appear to have an unwarranted effect in curbing the flexibility available to companies in the fund raising exercise.

Under the New Cos Act, private placement has been defined to mean any offer of securities or invitation to subscribe to securities to a select group of persons by a company through issue of private placement offer letter. Non-compliance of the conditions require compliance with the requirement as regards public offer under the New Cos Act and ICDR Regulations.

Some of the key conditions and their effect are discussed hereunder:

(a) In order to qualify as a private placement, the New Cos Act states that offer of securities or invitation to subscribe to securities cannot be made to persons (excluding QIBs and employees subscribing to shares under an ESOP scheme) exceeding 50 or such higher number as may be prescribed in a financial year. Further, the Draft Rules provide that such offer or invitation shall be made to not more than 200 persons in aggregate in a financial year. On a harmonious reading of the provisions of the New Cos Act and the Draft Rules, it could reasonably be interpreted that though, during a financial year, an offer for private placement can be made to more than 50 but not exceeding 200 persons, aggregate of such offers of private placement during a financial year are to be restricted to 200 persons.

This may lead to availability of larger pool of capital for private companies and therefore, many of the unlisted public companies may consider becoming private. However, tax consequences post conversion of public company into private company may need to be considered on a case to case basis.

(b) A company making an offer or invitation through private placement is required to allot its securities within 60 days from the date of receipt of the application money. This could limit the timelines available to consummate transactions involving subscription of securities by non-residents. In such a case, escrow mechanism as provided for under the FDI Policy could be explored.

(c) The Draft Rules propose to restrict private placement to a maximum of 4 in a financial year with not more than one in a calendar quarter and a minimum gap of 60 days between any two private placement offers. This may create some inflexibility in structured transactions with investments in tranches as well as back to back investments by different investors in different instruments in a way not possible to treat them as single offer of private placement.

(d)            The Draft Rules relating to issue of shares with differential voting rights provide for the following conditions:

- The shares with differential voting rights should not exceed 25% of the post issue paid-up capital of the company.  

- The company (including private companies) is required to maintain a track record of 10% dividends for the preceding three financial years.

- The company shall not convert its existing equity share capital with voting rights into equity shares capital carrying differential voting rights.

These requirements could take away flexibility in organizing the capital as per the agreed commercials amongst the investors, especially, at project level investments which are proposed to be undertaken through newly set-up entities.

(e) The Draft Rules in relation to the issue of preferential issue of optionally convertible securities specify that the price of the resultant equity shares shall be determined beforehand on the basis of a valuation report of a registered valuer. In the Indian context, convertible instruments are widely used by private equity investors for the purpose of developing ratchets to preserve the value of their initial investments as well as participating in any potential upside in valuation after a predetermined period. It requires to be seen whether the conversion ‘price’ for the purpose could be formula based as in the case of FDI Policy.


While some conditions to regulate offer of securities by private companies are warranted considering some of the recent cases, the current set of regulations seem to be too far-fetched, cumbersome and restrictive for private companies.

With adequate regulatory oversight, investors should be provided with adequate flexibility to raise capital in a closely held private company wherein considerations relating to minority investor representation and / or protection are non-existent.

- Yashesh Ashar

Wednesday, November 27, 2013

Guest Post: New Regime of Corporate Governance: Heading Towards “Hung” Companies – Part 2

[The following post is contributed by The following post is contributed by Nivedita Shankar, who is a Senior Associate at Vinod Kothari & Co. She can be reached at

The views expressed herein are solely those of the guest author and cannot be ascribed to the other contributors of this Blog.

This is a continuation from the previous post in this series]

Precedents around the world

United States

Clause 314 of NYSE Listed Company Manual considers the Audit Committee as an appropriate forum to review a related party transaction. The Exchange also reviews proxy statements and other SEC filings, disclosing RPTs and where such situations continue year after year, the Exchange after evaluation also determines whether such RPTs should be permitted to continue.

Under Regulation S-K of U.S. Securities Law, Item 404 requires public companies to disclose transactions involving amounts of more than USD1,20,000/- in which the related person is or has had direct or indirect material interest.

United Kingdom

Financial Reporting Standard-8 require companies to make adequate disclosures in their financial statements to draw attention to the possibility that the reported financial position and results may have been affected by the existence of    related parties and by material transactions with them. Further, under the Companies Act, 2006, members’ approval is required for any transaction with the director or if the director is connected in such transaction.

Hong Kong

Rule 14A of Listing Rules of the exchange in Hong Kong requires companies to take prior approval of shareholders in case of connected transactions. Any connected person with material interest shall not be permitted to vote at the meeting on the resolution approving the transaction. The manual further requires that the Independent Board Committee of the company should appoint a financial adviser to advise the company’s shareholders about whether the terms of the connected party transactions are fair and reasonable and in the interest of the company and the shareholders as a whole.


The Singapore Exchange Listing Manual requires only disinterested shareholders to vote on any transaction involving interested person. “Interested Person” has been defined to mean a director, CEO or controlling shareholder and an associate of any of these.


The Bursa Malaysia Listing Requirements lay down provisions similar to Hong Kong. Rule 10.08 requires disclosure in case of a related party transaction to the Exchange where the value of the consideration is less than RM 2,50,000 or is a recurrent related party transaction, where the percentage ratio is 0.25% or more. Where any one of the percentage ratios[1] of a related party is 25% or more the company must appoint a Principal Adviser to ensure that such transaction is carried out on fair and reasonable terms and conditions and not to the detriment of the minority shareholders. The stated Requirement debars any interested director from taking part in board deliberations and abstain from voting on such related party transactions. Further, any interested director or major shareholder must ensure that connected persons abstain from voting on such related party resolutions in the general meeting.

Section 188 of Act, 2013 on the same lines as other countries across the world prohibits interested shareholders from voting on related party transactions. The concept of appointing an independent financial adviser for such transactions has not been mandated yet.


What is noticeable is that around the world, including India, RPTs have been given due importance and a lot of thought has gone into preventing such transactions from affecting the business of the company. This thought process has also made the minority or disinterested shareholders an active part of the business of the company. But in the process, the corporate balance has also tilted towards the minority which cannot be good news.

It is similar to a hung parliament where two or three parties which have enough of a  majority to block a particular agenda make not only the ruling party succumb to their pressure, but also bring the parliament to a stand still. In effect this leads to instability in the functioning of the parliament.

A similar situation can be envisaged if the power balance is in the hands of the minority in a company. In this age when the corporates are governed by the corporate laws, provision like section 188 of Act, 2013 have the potential to make every power block to swing making it impossible for companies to function.


- Nivedita Shankar

[1] “Percentage ratios” as per Bursa Malaysia Listing Requirements has been defined in Rule 10.02 and is calculated on the basis of various parameters like value of assets, net profits attributable to the transaction, aggregate value of consideration given or received, equity share capital issued by listed issuer as consideration for an acquisition, total assets forming subject matter of transaction etc, compared with the same parameters as that of the listed issuer.

Tuesday, November 26, 2013

Guest Post: New Regime of Corporate Governance: Heading Towards “Hung” Companies – Part 1

[The following post is contributed by The following post is contributed by Nivedita Shankar, who is a Senior Associate at Vinod Kothari & Co. She can be reached at

The views expressed herein are solely those of the guest author and cannot be ascribed to the other contributors of this Blog]

The OECD in its report titled “Guide on Fighting Abusive Related Party Transactions in Asia” commented: “Abusive related party transactions have increasingly become a challenge to the integrity of Asian capital markets”. In fact, this very report also recommended that the voting system should be such that majority of the disinterested shareholders should approve the related party transactions in general meetings. Such a practice is already followed in Malaysia, Hong Kong and Singapore.

Although such a recommendation is noble, yet the serious repercussions that it may give rise to have been grossly overlooked. The point on independent shareholders voting in general meetings was highlighted by SEBI in its consultative paper under the head "Abusive RPTs" in point 11.25(d). The main reason for proposing this was to ensure that the approval of major Related Party Transactions (“RPTs”) is done only by disinterested shareholders. The Companies Act, 2013 (“Act, 2013”) has incorporated similar provision under section 188 wherein related parties have to abstain from voting on any related party resolution in general meeting. Effectively, this shall mean that only disinterested shareholders shall vote on any resolution. This section is yet to be enforced.

The resultant imbalance in giving power to minority

Corporate governance is seen as a tool to control any abuse by a related party but in companies in India, the majority control rests with the promoters. Thus, even corporate governance becomes a tool in the hands of majority solely.

Clause 49 of Equity Listing Agreement in its list of recommendations to be included in the annual report of listed companies, requires disclosure of only such materially significant related party transactions that are apprehended to have potential conflict with the interest of the company at large. The discretion has of course been left to the management, which in effect controls the company in most cases. Such a loose approach means that majority shall always have an upper hand in cases of corporate governance also. This seems to have remained the general rule that has governed corporate India for a long time – that of the majority ruling the company. The reactive step in corporate governance to allow only disinterested shareholders to vote has extended the approach to such a precarious situation.

Abusive RPTs

This term is mainly used to signify the tactics adopted by majority shareholders, who in turn are related to each other to divert the funds of the company. Thus, what is rightfully the company’s gets diverted to other fronts owned by the promoters or major shareholders of the company. The term came to the forefront with the string of scams in the last decade. Section 188 of the Act, 2013 prohibits any such related party from voting on any related party transaction.

The phrase “such related party” may give an impression that only the member who is directly related to the resolution being passed shall abstain from voting in the general meeting. Such a belief defies the very basis of any related party transaction. Related party concept is pervasive in nature and transcends across a particular contract. When the very basis is sharing of an economic interest, it can by no means be concluded that only direct interest in the transaction shall be prohibited from voting in general meeting.

Special resolution and non-voting majority – a “hung” company in the making

The section 188 of Act, 2013 deals a double whammy by also prescribing special resolution for according approval for a related party transaction. The very step of allowing only disinterested shareholders to vote in itself is enough to give rise to serious apprehensions regarding passing of any RPT and to add to that, special resolution has also been prescribed.

Effectively this tilts the corporate balance on the side of the minority. So envisage a scenario of 60% shareholding in the hands of majority, which in turn are related. If now the company was to enter into a transaction covered under section 188 of Act, 2013, then the 60% majority are prohibited from voting in the general meeting, which would mean that the remaining 40% disinterested shareholders shall only vote. Since, approvals under section 188 are to be taken by special resolution, then 30% approval of disinterested shareholders would be required. In this way, any shareholder holding 10% or more in the company can create complete havoc and make functioning by companies very difficult. Such errant shareholders can impede any such RPT from being passed, which by no means can be good news for companies. Passing of special resolution itself is deterrent to abuse of majority power. On top of that to also give the power to pass resolutions completely in the hands of disinterested shareholders can result in a “hung” company, similar to a hung parliament. If this was to happen, then how at all will companies function?

Sadly, this does not seem to have been well thought of by the Government and committees which drafted/made recommendations to the law.

At arm’s length price

Proviso to section 188 of Act, 2013 also mentions that where transactions are done at arm’s length price, then nothing contained in section 188(1) of Act, 2013 shall apply. By the term arm’s length, explanation to section 188(1) means such a transaction in which there is no conflict of interest. Such an exemption shall hardly be of any help in case of transactions with subsidiaries. The very concept of “subsidiary company” is exercise of majority control by the holding company and any transaction with subsidiary company by the holding company can never be at arm’s length price.

This makes passing of resolutions involving the holding and subsidiary company difficult in the subsidiary company. The situation becomes even more difficult in case of wholly owned subsidiary company.     

At arm’s length price – issues with secretarial audit

Section 92 of Act, 2013 requires the practicing company secretary to certify that the company has complied with all laws applicable to it. The fact that this is not a well drafted provision has been debated widely.

In the context of RPT, even if we were to consider a scenario of any RPT to have been done at arm’s length price, it may still be difficult to see such transactions through. The presumption in case of transactions with subsidiaries is that the same is not at arm’s length price. Wholly owned subsidiaries mainly thrive on the transactions with their holding companies. Under such circumstances, transactions at arm’s length price can only be a distant possibility. Determination of arm’s length price is subjective and consequently difficult for any auditor to also certify one as such.

Any violation of section 188 can also lead to disqualification for appointment as a director under section 164 of Act, 2013.  

(to be continued)

- Nivedita Shankar