Friday, October 31, 2014

Disclosure of “Encumbrances” on Shares

Recently, the Securities Appellate Tribunal (SAT) had to deal with two separate situations pertaining to the disclosure of pledge or other encumbrance over shares. In an order discussed earlier today, the SAT found that the acquisition of shares by a public financial institution through the invocation of a pledge was required to be disclosed in accordance with SEBI’s Takeover Regulations. Separately, in another order involving Golden Tobacco Limited, the SAT ruled against any disclosure requirement on the company to disclose any “encumbrances” on its shares imposed on promoters through the restraint order of an arbitrator. Both these orders involved the interpretation of disclosure obligations on pledge or encumbrance of shares, albeit under different legal requirements.

In the Golden Tobacco case, SEBI alleged that the company failed under clause 35 of the listing agreement to disclose to the stock exchange that by an arbitration order dated July 23, 2009, nine promoter entities of the company were restrained from selling transferring or creating third party interest in any manner in the shares of the company held by such promoters. Clause 35 requires the company to disclose to the stock exchange the details of “shares pledged or otherwise encumbered”. On account of such failure, SEBI’s adjudicating officer imposed penalties under section 23E of the Securities Contracts (Regulation) Act, 1956 and section 15HA of the Securities and Exchange Board of India Act, 1992. It is against this order that the company preferred an appeal to SAT.

Disclosure of Encumbrances

A peculiar situation arose in this case. Normally, disclosures regarding shareholding (as well as pledge or encumbrance) have to be made by the relevant shareholders to the company, which in turn has to notify that information to the stock exchanges. This is the scheme of regulation, including under SEBI’s Takeovers Regulations as well as Insider Trading Regulations. The channel for the flow of information emanates from the shareholder and passes through the company ultimately to the stock exchange for public consumption. The peculiarity arose here because clause 35 requires the company to provide information to the stock exchanges regarding the encumbrance without a concomitant obligation on the shareholder to notify the company of the same in the first place. In other words, it imposes a unilateral obligation on the company to initiate disclosures without being aided by information from the shareholders. Using this logic, SAT came to the conclusion that it would not be possible to impose such an obligation on the company given that it creates an incongruous position under the listing agreement. On this aspect, SAT observed as follows:

14.       … It is surprising that the format attached to clause 35 of the Listing Agreement casts an obligation on the listed Companies to disclose to the Stock Exchanges details of the shares that are otherwise encumbered by the promoter/promoter group, without making corresponding obligation on the promoter/promoter group to make such disclosures to the listed Company. … If promoter/promoter group are not obliged to give to the listed Company details of shares that are otherwise encumbered under any provision framed by SEBI, then, making it mandatory for listed Companies to disclose to the Stock Exchanges details of shares that are ‘other [sic] encumbered’ by the promoter/promoter group would be wholly unjustified and contrary to the policy decision taken by SEBI which was made public by press release dated January 21, 2009. … Thus, the format annexed to clause 35 of the Listing Agreement goes beyond the scope of clause 35 of the Listing Agreement and contrary to the policy decision of SEBI …

15.       … SEBI has created an anomalous situation, because, promoter/promoter group who have details of shares that are ‘otherwise encumbered’ are not obliged to disclose the same to the listed Company, whereas, listed Companies to whom such details are not furnished by the promoter/promoter group are made to disclose such details to the Stock Exchange. …

This conclusion is entirely reasonable. On matters of shareholding, it would be unduly onerous to impose disclosure obligations on the company without similar obligations on shareholders. The primary disclosure ought to come from the shareholders who are best placed to make these disclosures. Moreover, the expression “or otherwise encumbered” must be read in the context of a pledge (which concept precedes the words in quotes). In other words, the encumbrance must be in the nature of a security interst or something similar over the shares. Viewed in that light, a restraint order of arbitrator (or judicial authority) cannot operate as an encumbrance. Similarly, a negative covenent (sometimes referred to as a negative pledge) or a non-disposal undertaking or a contractual lock-in on the shares would not operate as an encumbrances. In any event, it would be wholly unnecessary to require a disclosure of such matters to the stock exchanges.

The genesis of the requirement to disclose pledge and other encumbrances arose after the Satyam scandal where promoter shares were pledged to financial institutional unbeknownst to the remaining shareholders. The drastic fall of the promoter shares upon invocation of the pledge adversely affected the shareholders. Hence, if a pledge or other encumbrance is likely to result upon invocation in a divestment of promoter share, then that is information worthy of disclosure to the other shareholders. But, in a restraint order or negative covenant, that objective does not even exist. To the contrary, the promoter is unable to sell the shares and exit from the company, which ought to be of additional comfort to shareholders rather than something that shakes the foundations of their trust in the company and its promoters. Although the SAT did not adopt the approach of analyzing these issues and objectives, they are consistent with the ultimate conclusion it arrived at.

While the above constitutes the principal substantive issue that required SAT’s consideration, a few other incidental issues are noteworty, as discussed below.

Amendments to Listing Agreement

While SAT did not have to conclusively rule on the issue, the case raised some issues regarding the legal veracity of the listing agreement as a regulatory instrument, and more particularly the manner in which it can be amended. In amending clause 35 to introduce its current language, it was argued that while SEBI’s circular merely advised the stock exchanges to amend the clause, there was no actual evidence of amendment by the exchanges. However, based on statements provided by the stock excahnges that they have amended the listing agreement, SAT “proceeded on the basis that the amendments have been carried out in accordance with law”.

Although the issue did not emerge to the forefront in this case, the manner of regulating corporate governance and disclosure norms through the listing agreement is bound to raise some consternation. While the listing agreement is essentially contractual in nature between the issuer company and the stock exchange, it derives its legal validity from the Securities Contracts (Regulation) Act. Despite its contractual foundations, it can be amended at SEBI’s instance so as to bind the listed companies without their concurrence. In that sense, it begets unilateral alteration to which issuers are implicitly bound. Matters of procedure regarding the announcement and effectuation of amendments ought to be streamlined further between SEBI and the stock exchanges to obviate such issues.

Consistency in Adjudication

SAT also called for uniformity in the approach of SEBI’s adjudicating officers in similar cases, and also reaffirmed their duty to passed reasoned orders after considering relevant circumstances. The allegation was that the adjudicating officer in this case disregarded a contrary view of another officer in a different case without assigning reasons. SAT observed:

However, the Adjudicating Officer, in the present case, has neither found fault with the order passed in case of Dewan Housing Finance Corporation Ltd. (Supra) nor assigned any reason for taking a view contrary to the view taken therein. Such an attitude on part of the Adjudicating Officer of SEBI deserves to be condemned. View taken by one Adjudicating Officer of SEBI cannot be disregarded by another Adjudication order without assigning any reasons. It is high time that SEBI takes remedial measures and ensure that its Adjudicating Officers respect orders passed by each other. We make it clear, respecting each others order does not mean that even an erroneously order, passed by the Adjudicating Officer must be followed blindly. In such a case, contrary view could be taken by recording reasons for taking such contrary view.

This step would introduce greater consistency in SEBI’s approach in similar cases.

Invocation of pledge by PFI requires disclosure under SEBI regulations

[The following post is contributed by Supreme Waskar, partner at Sterling Associates, Mumbai]

The Securities Appellate Tribunal (SAT) has upheld the order of SEBI against SICOM Ltd. (“SICOM”) imposing penalty of Rs. 5 lakhs for non-disclosure of acquisition pursuant to the invocation of a pledge under regulations 29(1) and 29(2) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SAST 2011”).

SICOM, a Public Financial Institution (“PFI”), had provided financial assistance to Raj Oil Mills (“ROM”) in 2010 by way of bill accounting facility up to a limit of Rs. 15 crore (“Facility”) for which the promoter/director of ROM had pledged equity shares of ROM as security towards the Facility. As ROM failed to repay the amounts due under the Facility, SICOM invoked the pledge on September 28, 2011 aggregating to 6.39% of total share capital and on February 24, 2012 aggregating to 15.35% of the total share capital requiring disclosure under regulation 29(2) of SAST 2011.

The question dealt with by SEBI and SAT related to the interpretation of regulation 29(4) of SAST 2011 and proviso thereto, and specifically whether a scheduled commercial bank (SCB) or a PFI are exempted from disclosure pursuant to invocation of pledge or with the exemption is restricted to the deemed acquisition of shares i.e. creation and release of pledge.

SEBI in its order dated May 11, 2014 held that pursuant to the invocation of a pledge on September 28, 2011 of 6.39% of total share capital and 15.35% of total share capital on February 24, 2012 SICOM was required and has failed to make disclosures under regulation 29(1) and 29(2) of SAST 2011 respectively. SEBI also held that the exemption available to the SCB/PFI under the proviso to regulation 29(4) of SAST 2011 is restricted to the deemed acquisition of shares i.e. creation and release of pledge and the said exemption cannot be extended to when shares are actually acquired by them on invocation of pledge. Further, SEBI also held that invocation of pledge being acquisition required disclosure under regulations 13(1) and 13(3) of Securities and Exchange Board India (Prevention of Insider Trading) Regulations,1992 (“PIT Regulations”).

In its appeal before SAT, SICOM submitted that the exemption under the proviso to regulation 29(4) is available to a PFI even when shares are acquired by the PFI on invocation of pledge in the ordinary course of business. SCB/PFI in the ordinary course of business acquire shares on invocation of pledge to recover their loan and not to take over the management/control of the company and hence regulation 10(1)(b)(viii) of SAST 2011 exempts SCB/PFI from making open offer on invocation of pledge and same principle applies for exemption for disclosure under regulation 29(4) of SAST 2011.

Refusing to accept SICOM’s submissions, SAT stated that exemption to SCB/PFI under regulation 10(1)(b)(viii) of SAST 2011 is for making open offer and exemption under regulation 29(4) is specific to the disclosures pursuant to deemed acquisitions i.e. creation and release of pledge and not to actual acquisition of shares pursuant to invocation of pledge.  Regulation 29(4) creates a legal fiction -  to assume existence of a fact which does not exist, by a deeming fiction, the pledgee is treated to have acquired shares and is required to make disclosures. Where the shares are acquired on invocation of pledge, the question of introducing a deeming fiction would not arise because, in such a case, shares are actually acquired on invocation of pledge. Further proviso to regulation 29(4) exempts SCB/PFI from such deemed acquisition since shares are acquired by them in ordinary course of business and not when there is actual acquisition of shares pursuant invocation of pledge.

SAT has reaffirmed SEBI’s view in relation to the disclosure exemption of SCB/PFI from legal fiction of creation of and release from pledge and not from actual acquisition of shares pursuant to invocation of the pledge.

- Supreme Waskar

Wednesday, October 29, 2014

Doing Business Report 2015: A Mixed Bag for India

The World Bank has released its report titled “Doing Business 2015: Going Beyond Efficiency”. It has also published a country report on India for the same year.

At the overall level, India does not emerge in positive light, given that its ranking has fallen to 142 (out of a total of 189 countries) from 140 in last year’s rankings. India does not rank favourably among comparator economies either – Mexico (39), Russian Federation (62), and China (90). The South Asian regional average is above India at 134, with Bangladesh trailing at 173.

This is despite numerous efforts undertaken by the Government both last year (here) as well as this year (here) to improve the environment for business in the country. Since the report is based on data as of June 1, 2014, many of the reforms announced and planned since that date would not have been taken into account for the purpose. It is likely that the more recent reforms would be reflected only in next year’s rankings, which would represent the true test for the country’s performance.

At the same time, all is not bleak, and India performs creditably on an aspect that we pay a lot of attention on this Blog, i.e. investor protection. It ranks at 7 out of the 189 economies. This is perhaps a tribute to the recent reforms in corporate govenance in the form of the Companies Act, 2013 followed by the slew of rules promulgated by the Ministry of Corporate Affairs as well as the revised corporate governance norms prescribed by SEBI.

Tuesday, October 28, 2014

CSR in Government Companies

The concept of corporate social responsibility (CSR) has acquired tremendous prominence in India since the enactment of the Companies Act, 2013 and the Companies (Corporate Social Responsibility Policy) Rules, 2014 (the CSR Rules). They are applicable to large companies, whether or not they are listed on the stock exchange.

Now, the Ministry of Heavy Industries & Public Enterprises of the Government of India has issued the Guidelines on Corporate Social Responsibility and Sustainability for Central Public Sector Enterprises (Guidelines). These apply to central public sector enterprises (CPSEs), which are essentially companies or undertakings owned or controlled by the Central Government. These new Guidelines come into effect from April 1, 2014.

The Guidelines represent an important step in India’s foray into CSR in an unparalleled manner. Some of the unique features of the Guidelines are discussed below.


The Guidelines are applicable to all CPSEs and are in addition to the provisions of the Companies Act and the CSR Rules. In other words, CPSEs are subject to a higher standard of social responsibility than companies in the private sector. Although the operation of CPSEs (or other state-owned enterprises) in India have not been the subject-matter of a detailed study from a corporate governance perspective, this sector encapsulates a larger element of public interest compared to other companies run on largely commercial lines with profit-making being the principal motive.

By imposing higher standards on CPSEs, the Government appears to require them to pave the way for greater social obligations among business enterprises. This is a welcome move. In the past, government companies have been criticized for their lackadaisical attitude towards corporate governance and for adopting and implementing practices that were not only inferior to those in the private sector but also below par judging by the legal requirements (e.g. for board independence). By spearheading the efforts towards CSR, the CPSEs may now have to take the lead in introducing and implementing sustainable and socially responsible business practices.

Sustainability and CSR

One of the criticisms of the Companies Act and the CSR Rules is that they focus on CSR spending (which is essentially corporate philanthropy) and in fact specifically provide that matters carried out by companies in pursuance of their business are not covered within the ambit of CSR. As observed in a previous blog post:

…CSR excludes “activities undertaken in pursuance of the normal course of business of the company”. This appears somewhat paradoxical in that the companies’ normal business conduct will not be taken into account for CSR. This is because the Companies Act’s focus on CSR as a matter of expenditure of funds by companies rather than as a matter of conduct or corporate behaviour. It must be re-emphasized that CSR goes beyond mere spending, and must also promote social responsible and sustainable business practices.

The Guidelines applicable to CPSEs go a step further and lay significant emphasis on sustainability in business practices. They expressly state that CSR and sustainability are complementary in nature and must be dealt with together. Hence, sustainability issues must be ingrained into the business policies and strategies of the CPSEs to the extent possible.

This approach is combining sustainability and CSR is a necessary one. It is important for companies to imbibe sustainability in their regular business practices by taking into account the interests of long-term stakeholders, including shareholders and other affected parties such as creditor, employees, consumers and the community. This is also consistent with the broader duties of the directors in section 166(2) of the Companies Act, 2013. Under the Guidelines, this would be complemented through CSR, which essentially relates to corporate spending (of a share of profits) into specified activities. This approach combines socially responsible business practices as well as spending (as a form of corporate philanthropy). While the Companies Act and the CSR Rules applicable to all companies provide for the spending aspect, they pay short shrift to the sustainability aspect (in that there is nothing in that regime to provide for sustainability or social responsibility in regular business practices). To this extent, the Guidelines for CPSEs score over the Companies Act and the CSR Rules. Perhaps, one might even suggest that the next round of reforms or amendments to company law must consider adopting the CPSE approach for all companies under the broader CSR mandate.

Mandatory Nature

Although it was initially intended to make CSR mandatory under the Companies Act, the provision was subsequently diluted. In its final form, CSR spending represents a compromise which allows companies to adopt a “comply-or-explain” approach. However, for CPSEs the Guidelines adopt a strict mandatory approach. The Guidelines state that it would be “mandatory for all CPSEs which meet the criteria as laid down in Section 135(1) of the Act, to spend at least 2% of the average net profits of the three immediately preceding financial years in pursuance of their CSR activities as stipulated in the Act and the CSR Rules.” They also add that “in case of CPSEs mere reporting and explaining the reasons for not spending this amount in a particular year would not suffice and the unspent CSR amount in a particular year would not lapse. It would instead be carried forward to the next year for utilisation for the purpose for which it was allocated.” Even here, CPSEs are held to a much higher standard of CSR spending than companies in the private sector.

Overall, the Guidelines embrace a more overarching approach towards CSR than the Companies Act and the CSR Rules. It is indeed heartening to note that government companies are leading the way in this regard. As always, much however depends upon the implementation of the Guidelines in determining the success of this approach towards CSR.

Saturday, October 25, 2014

Revisiting penalty clauses in contract

Last year, the English Court of Appeal in Talal El Makdessi v Cavendish Square Holdings [2013] EWCA Civ 1539 considered the enforceability of penalty clauses under English contract law, and was one of the few decisions in recent times to have concluded that the clauses in question were penal and therefore unenforceable. The decision was notable for affirming that the English law rule against the enforceability of penalty clauses applies not only to clauses requiring a payment to be made by a defaulting party, but also to (i) clauses permitting the innocent party to withhold a payment from the defaulting party, and (ii) clauses requiring the transfer of assets from the defaulting party to the innocent party at a reduced price. Both of these propositions are not entirely settled under English law, with no conclusive House of Lords / Supreme Court decision on either point.

The other point of interest arising from the case was a reference in Clarke LJ's leading judgment to a significant anomaly at the foundation of the English law on penalties – it doesn't cover clauses which apply when there has been no breach of contract. To borrow the illustration used by Heath J way back in 1801 in Astley v Weldon (1801) 2 Bos. & P. 346, "It is a well-known rule of equity, that if a mortgage covenant be to pay £5 per cent. and if the interest be paid on certain days then to be reduced to £4 per cent. the Court of Chancery will not relieve if the early day be suffered to pass without payment; but if the covenant be to pay £4 per cent. and if the party do not pay at a certain time it shall be raised to £5 there the Court of Chancery will relieve". This anomaly provides latitude for draftsmen to avoid the rule against penalties, and has led to calls from leading academics (including Edwin Peel in the July 2014 issue of the Law Quarterly Review) to call for the abolition of the rule against penalties. It is however interesting to note that a 2012 decision of the Australian High Court (Andrewsv Australia and New Zealand Banking Group Ltd [2012] HCA 30) addressed this anomaly by applying the rule even when there has been no breach of contract and the Indian position has been discussed by Niranjan in a previous post.  

In May this year, the UK Supreme Court granted leave to appeal from the Court of Appeal's decision in Cavendish and the outcome of that appeal will be of great interest (although it is not clear whether the rule against penalties is a subject of the appeal, since the decision also involved findings on two other claims).

However, in the meanwhile, the English High Court last month decided another interesting case in which a liquidated damages provision was held to be penal and unenforceable. Although the facts of Unaoil v Leighton Offshore [2014] EWHC 2965 are rather complicated, the relevant chain of events is easy to summarise. Unaoil, a BVI company which provided a wide range of services across the oil and gas sector, entered into a memorandum of agreement (MOA) with Leighton Offshore in relation to a substantial oil infrastructure project in Iraq. Pursuant to the MOA, Leighton agreed to appoint Unaoil as its sub-contractor in relation to the project, subject to Leighton being appointed by the relevant Iraqi authorities, in consideration for a payment of $70 million. The MOA also contained a liquidated damages clause which provided for the payment of $40 million if Leighton breached the MOA. In particular, the liquidated damages clause stated – "After careful consideration by the Parties, the Parties agree such amount is proportionate in all respects and is a genuine pre-estimate of the loss that Unaoil would incur as a result of Leighton Offshore's failure to honour the terms of the MOA".

Subsequently, there were further discussions as to pricing between Unaoil and Leighton, leading to a supplementary agreement to the MOA pursuant to which the agreed consideration was reduced to $55 million. The liquidated damages clause was left unamended.

Eventually, Leighton was awarded the project but did not appoint Unaoil as its sub-contractor, thereby breaching the MOA as amended. This led to claims by Unaoil on several bases, including a claim for the $40 million payable under the liquidated damages clause. However, the High Court held that the clause was penal and not enforceable. A slightly frustrating aspect of the decision is that the reasoning underlying this conclusion is very brief and leaves a few questions unanswered. It does however lay down an interesting proposition of law, and one for which there was no authority previously.

The rule against penalties does not apply if the amount payable under the contract is a genuine pre-estimate of loss or if it has a commercial justification. However, both these tests are to be applied as on the date of the contract and not on the date of the breach. The question posed in Unaoil however was slightly different, what is the relevant date when the contract has been subsequently amended? The High Court held that- "where, as here, the contract is amended in a relevant respect, the relevant date is, in my judgment, the date of such amended contract … Here, once the original contract price was reduced by Supplementary Agreement No. 2, the figure of US$40 million was, even on Unaoil's own evidence, manifestly one which could no longer be a genuine pre-estimate of likely loss by a very significant margin indeed". Eder J goes on to state- "The reason why the figure of US$40 million was not reduced at the same time as when the contract price was reduced was not explained. Perhaps it was a mistake or an oversight. I do not know. In any event, once the original contract price was reduced, it was, on any objective view, “extravagant and unconscionable with a predominant function of deterrence” without any other commercial justification for the clause".
There are aspects to this decision and the underlying reasoning which are not entirely satisfactory, but contracts draftsmen can draw two important lessons from the passages reproduced above:
  • When key provisions relating to the performance timetable and the consideration payable are amended over the course of long term contracts, it is important to assess the impact of the amendments on the liquidated damages clause, if any. Unfortunately, the phrase "in a relevant respect" does not offer much by way of guidance, but one would think that if the amendment is such that it affects the underlying basis of the "genuine pre-estimate of loss" on which the liquidated damages amount has been arrived at, or affects the commercial justification of the clause, the continued validity of the liquidated damages clause should be considered.
  • If on such consideration, it is decided that the amendment to the substantive terms of the contract does not impact the liquidated damages clause (or indeed, even if it does), it may be helpful to document the basis on which the conclusion was reached – perhaps in the preamble to any amendment agreement. In Unaoil, the absence of a sufficient explanation for why the liquidated damages clause wasn't amended played an important role in the decision. It could be argued that this reliance is difficult to reconcile with Clarke LJ's statement of settled law in Cavendish that "The burden of proving that a clause is penal is on the party making the assertion". However, the point does remain that better drafting of the MOA and the subsequent amendment would have avoided a lot of the controversy – in the words of Eder J, “the disputes which are now the subject of the present proceedings are probably due, in large part, to such bad drafting (of the MOA)". 

Friday, October 24, 2014

SEBI’s Order in the DLF Case: A Summary

[The following post is contributed by Supreme Waskar, partner at Sterling Associates, Mumbai]

In its order dated October 10, 2014, the Securities and Exchange Board of India (“SEBI”) has restrained DLF Limited (“DLF”), its 5 directors and CFO (“Noticees”) from accessing the securities market and prohibited them from dealing in securities for the period of 3 years on the ground of active and deliberate suppression of material information in its red herring prospectus (“RHP”)/ Prospectus so as to mislead and defraud the investors in the securities market in connection with the issue of shares of DLF in its IPO, thereby violating the provisions of the SEBI Act, the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“PFUTP Regulations”), the SEBI (Disclosure and Investor Protection) Guidelines, 2000 ("DIP Guidelines") and the SEBI (Issuance of Capital and Disclosure Requirements) Regulations, 2009 ("ICDR Regulations").


DLF had filed a draft RHP (“DRHP”) with SEBI in January 2007 for raising Rs. 9187.5 crore through an IPO. Thereafter, DLF issued the RHP on May 25, 2007and the Prospectus was filed with the Registrar of Companies (“ROC”) on June 18, 2007. One Mr. Kimsuk Sinha ("Mr. Sinha") had filed complaints with SEBI on June 4, 2007 alleging the Sudipti Estates Private Limited ("Sudipti") and certain other persons had defrauded him of 34 crore in relation to a transaction between them for purchase of land (“Complaint”) and also registered a first information report (“FIR”) dated April 26, 2007 alleging that two of DLF’s wholly owned subsidiaries (“WOS”) were the only shareholders of the Sudipti and requesting to disallow the listing of DLF pursuant to the IPO and for immediate action. Subsequently the allegations in Complaint were denied by DLF.

SEBI’s investigation pursuant to Delhi High Court’s order

Pursuant to the inaction of SEBI in relation to Complaint against DLF, Mr. Sinha filed a Writ Petition before the Delhi High Court (“DHC”) and the DHC vide order dated April 9, 2010 (“Order”) issued directions to SEBI to undertake an investigation into the aforementioned Complaints. Accordingly SEBI, vide an order dated October 20, 2011 ordered an investigation into the allegations levied by Mr. Sinha in his complaints to ascertain the violations, if any, of the provisions of the DIP Guidelines read with corresponding provisions of ICDR Regulations and the relevant provisions of the Companies Act, 1956 ("Companies Act") and issued a Show Cause Notice (“SCN”) to the Noticees.

Charges levied by SEBI

1.   Non disclosure of material information in relation to alleged subsidiaries by DLF in RHP/Prospectus

At the relevant time, 3 WOS of DLF held entire equity shares in Sudipti, Shalika Estate Developers Private Limited ("Shalika") and Felicite Builders & Construction Pvt. Ltd. ("Felicite"). On November 29, 2006, the entire shareholding in Felicite held by WOS of DLF was sold to 3 who were wives of key managerial personnel (“KMPs”) of DLF. On November 30, 2006, WOS of DLF sold their entire shareholding in Shalika to Felicite. On the same date, the 3 WOS of DLF sold their entire shareholding in Sudipti to Shalika. The said three “Housewives” were shareholders of Felicite until their respective husbands were KMPs of DLF and when they ceased to be KMPs, shares were transferred to other KMPs' 'Housewives'. Further payments even in respect of those transfers were made by the respective husbands of the purchasers. Hence SEBI alleged that DLF never lost control of Sudipti, Shalika and Felicite (“Alleged Subsidiaries”) and they were and are subsidiaries of DLF. In terms of the provisions of DIP Guidelines and AS-23, certain disclosures with respect to its subsidiaries should have been disclosed in the RHP/Prospectus of DLF and was not disclosed. Therefore, it was held that DLF has violated provisions of clause of the DIP Guidelines.

2.   Non-disclosure of related party transactions by DLF in RHP/Prospectus

There was no change in the members of board of Alleged Subsidiaries, who were also the employees of DLF and continued to be the directors of these companies even after the aforesaid sale of shareholding. Also there was no change in any of the authorized signatories of the bank accounts, registered office and statutory auditors of Alleged Subsidiaries even after the date of claimed dissociation. Hence, it was inferred by the SEBI that DLF was in a position to control the boards and through its employees was involved in day-to-day operations and associated with Alleged Subsidiaries even after the date of claimed dissociation. Therefore, the Alleged Subsidiaries were related parties of DLF in terms of AS-18. Hence, SEBI held that DLF has failed to disclose its related party transactions.

3.   Non-disclosure of outstanding litigation relating to Alleged Subsidiaries by DLF in

Further, the DIP Guidelines required DLF to disclose outstanding litigation in respect of its subsidiaries or any other litigations whose outcome could have a materially adverse effect on the financial position of DLF. However, the RHP/Prospectus of DLF did not provide any information of the FIR.

4.   Violations of DIP guidelines by five directors and CFO of DLF

Since the directors and CFO of DLF had authorised the RHP/Prospectus and signed the declarations certifying the compliance of DIP Guidelines, SEBI held that they have failed to ensure disclosures to be true and correct thereby violating provisions of DIP guidelines read with ICDR regulations.

5.   Deliberate and active suppression of material information amounting to Fraud in terms of PFUTP

In compilation of all the aforesaid facts, SEBI held that the entire share transfer process in the Alleged Subsidiaries was executed through sham transactions by DLF and its associates/subsidiaries by camouflaging the association of Sudipti with DLF as dissociation thereby failing to ensure disclosures of Alleged Subsidiaries.

DLF’s arguments before SEBI

1.      SEBI has transgressed its authority by not limiting its investigation to Complaint as directed in Order and extended its authority to invocation of DIP Guidelines, PFUTP Regulations, etc. without jurisdiction;

2.       SEBI has violated the principles of natural justice by denying request for inspection of documents;

3.       At the relevant point of time, Mr. Sinha was neither an investor nor a subscriber to the shares of DLF or related to the securities market and therefore had no legitimate cause to take recourse to the jurisdiction vested in SEBI;

4.       The RHP/Prospectus also fairly disclosed the developmental rights in the land owned by Sudipti and the risk relating to the said development rights;

5.       SEBI has exercised its regulatory powers at distant point of time, which would only be   counterproductive to the interests of the securities market and millions of investors who have invested in shares of DLF;

6.         SEBI had reviewed and issued comments/observations on DRHP;

7.         SEBI did not allege any motive behind the alleged acts;

8.        DLF acted in good faith on the basis of expert advice of Merchant Bankers and legal advisors and no mala fide intent can be imputed on them;

9.      SEBI has applied incorrect to test for determining Alleged Subsidiaries as “related party” or “subsidiary”;

10.       There was no dealing in securities, hence no fraud under PFUTP Regulations;

11.      No shareholding/voting rights in or control over Alleged Subsidiaries for the purpose of holding-subsidiary relationship;

12.   SEBI has adopted an incorrect yardstick to deduce control by relying upon the definition of “control” under AS-23 and the SAST Regulations;

13.     FIR is neither a litigation nor one which could affect the operations and finances of DLF, as required to be disclosed of DIP Guidelines.

Key Conclusions in SEBI’s order

SEBI concluded that non-disclosure/omission of material information in RHP/Prospectus makes the Issuer, its directors and CFO liable for violation of DIP guidelines/ICDR regulations. Active and deliberate suppression of material information in RHP/Prospectus amounts to fraud in terms PFUTP Regulations and consequently restraining access and prohibiting dealing by Issuer, its directors and CFO in securities market.

However, DLF has filed an appeal before the Securities Appellate Tribunal (“SAT”) against the order of SEBI which is pending.

- Supreme Waskar