Tuesday, November 25, 2014

SEBI Reforms – Part 3: From Listing Agreement to Listing Regulations

In most jurisdictions, several aspects of corporate governance and disclosures for listed companies are regulated through stock exchange listing requirements. These apply only to listed companies, and they are enforced by the stock exchanges. Operating as conditions to continuous listing, one of the enforcement mechanisms used is the threat (sometimes carried out) of delisting the securities. While this operates as a disincentive against companies as well as their directors and managers from flouting the listing requirements, the consequences are faced by the minority shareholders who are deprived of the liquidity in the stock. Although it operates as a blunt tool of enforcement, it has been used effectively in several jurisdictions.

India has had a chequered history in terms of using listing requirements as measures of governance, disclosures and other conditions of continued listing. Listing requirements have been enshrined in the listing agreement that is entered into between the issuer company and the stock exchanges on which the issuer’s securities are listed. In that sense, the basic framework of listing requirements is contractual in nature, although the genesis for such a contract is found in the Securities Contracts (Regulation) Act, 1956 (SCRA) and the Securities Contracts (Regulation) Rules, 1957 (SCRR). Given the somewhat contractual nature of the requirement in India, the enforcement of the listing agreement has always been fraught with difficulty. In the past, the consequences of flouting the requirements were woefully unclear, with several companies utilising the legal loophole to breach the requirements with impunity.

It was only in 2004 that Section 23E was introduced into the SCRA that imposed large penalties of Rs. 25 crores (Rs. 250 million) for non-compliance with the listing agreement. Under this framework, while the listing agreement itself is contractual in nature, any breach thereof would result in penal consequences. Empirical evidence suggests that the market was positive about the more stringent consequences of the breach of the listing agreement. Despite the regulatory sanctions accompanying the listing agreement, the actual experience regarding its use as a measure for enforcement is not entirely satisfactory. While SEBI has indeed initiated several cases for ensuring compliance with the listing agreement, its success has been mixed.

In order to obviate any confusion regarding the enforceability of the listing requirements, and also to streamline the disclosures and corporate governance norms, SEBI has decided to convert the listing agreement into the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2014 – or the LODR Regulations, to introduce a new regulatory acronym. The LODR Regulations are intended “to consolidate and streamline the provisions of existing listing agreements thereby ensuring better enforceability”. The LODR Regulations apply to all types of securities, including shares, convertibles, Indian depository receipts, mutual fund units, securitised debt instruments, and the like.

The LODR Regulations provide much emphasis on disclosure and transparency. For instance, companies are subject to a mandatory filing requirement on the stock exchanges through the electronic platform. Other information mechanisms such as annual information memorandum are addressed. There is also a great deal of emphasis on investor redressal. The LODR Regulations also incorporate several other procedural matters that have hitherto been addressed in the listing agreement.

One of the key components of the listing agreement is clause 49 thereof, which encapsulates the corporate governance norms for listing agreement. It has also been substantially modified in the wake of the Companies Act, 2013, with the new version taking effect on October 1, 2013. The SEBI press release is, however, silent as to the treatment for clause 49, although logically that too should find a place in the new LODR Regulations to be announced.

While this is a useful reform in consolidating and streamlining the listing requirements and in clarifying their legal nature so as to obviate any issues as to their enforceability, there does not appear to be any substantial changes to the approach or to the substantive legal provisions. In that sense, this effort is largely procedural in nature – in other words, a regulatory “clean-up” exercise.

Tighter Restrictions on Offshore Derivative Instruments

The issue of offshore derivative instruments (ODIs) such as participatory notes (PNs) have been the subject matter of regulatory controversy for some time now. These are instruments issued by foreign institutional investors (FIIs) (now foreign portfolio investors (FPIs)) to investors overseas that mimic the risks and rewards on underlying securities held by the FIIs/FPIs in Indian companies. These instruments have caused difficulties from a regulatory standpoint as they have been issued overseas within limitations on the long-arm jurisdictions of SEBI. These issues have been discussed in a previous paper.

Yesterday, SEBI issued a circular that imposes significant restrictions on the issue of ODIs by FPIs. In a measure intended to align the applicable eligibility and investment norms between the FPI regime and the ODI route, SEBI has prescribed that an FPI can issue ODIs only to subscribers that meet the eligibility requirements under the SEBI (Foreign Portfolio Investor) Regulations, 2014. These eligibility criteria include that fact that the applicant is resident in a country whose securities markets comply with IOSCO requirements, or a bank falls within the framework of BIS. It excludes investors from countries that have been shortlisted for failing to comply with transparency requirements. Furthermore, FPIs are not allowed to issue ODIs to subscribers that have opaque structures as defined in the FPI Regulations.

The above circular effectively curbs a fairly significant market for ODIs. Investors find reason to invest in ODIs only if they otherwise do not wish to register themselves as FPIs and invest directly into the Indian markets. One of the reasons why ODIs are attractive is because of the relative opacity it offers. The risk accompanying ODIs is that it may be misused for money-laundering and for round-tripping by Indian investors. SEBI’s circular effectively curbs such activity and makes the ODI process more transparent as only investors that qualify to register as FPIs would be entitled to take up ODIs. In other words, SEBI has in one fell swoop eliminated the regulatory arbitrage that was available to foreign investors who wish to remain opaque. This is indeed a welcome move from the perspective of transparency. It also puts a significant onus on FPIs to ensure they issue ODIs only to qualifying investors, which might mean tightening of the KYC norms.

There has been some tightening on other incidental aspects as well. For instance, ODIs will be counted (in terms of beneficial ownership) for determining the maximum limits for investment by FPIs in Indian companies. It would not be possible to circumvent the investment limits through indirect routes such as participation in ODIs.

This measure might likely result in a significant reduction in the use of the ODI structure. This is relevant given the substantial increase in ODI activity in recent times. While this may affect investment flows in the short run, SEBI’s approach is necessary and timely from a regulatory perspective.

Sunday, November 23, 2014

Revival of Sick Units Takes Precedence Over Loan Recovery

[The following post is contributed by Prachi Narayan of Vinod Kothari & Company. She can be contacted at prachi@vinodkothari.com]

The Supreme Court in its judgment in the case of KSL Industries Ltd vs. Arihant Threads Ltd on October 27, 2014 finally settled the position of law over the vexed issue of precedence of two special enactments, the Sick Industrial Companies (Special Provisions) Act, 1985 (“SICA”) and the Recovery of Debt Due to Banks & Financial Institutions Act, 1993 (“RDDBFI”).

Since both the enactments are special laws, there have been diverse views from the courts with regard to precedence of one over the other. The lurking issue is finally resolved with the unanimous judgement of the three judge bench of the Supreme Court which upheld that the provisions of SICA shall prevail over the provisions of RDDBFI.

The Case

The facts of the case are that Arihant Threads Ltd (Respondent) had availed a loan from IDBI Bank for its export-oriented spinning unit set up in Amritsar, Punjab. The Respondent defaulted in payment of loan installments and IDBI moved the Debt Recovery Tribunal (DRT), Chandigarh and obtained an ex-parte order in its favour in July 2003 to dispose off the Respondent’s assets. The Respondent stayed away from the DRT proceedings despite having been given a chance to explain its position.

In September 2004, the movable and immovable properties of the Respondent were valued accordingly and put for auction wherein KSL Industries Ltd (Appellant) was declared the highest bidder.

The Respondent moved an application in DRT, Delhi for settling the ex-parte order of DRT, Chandigarh in December 2004. DRT Delhi set aside the auction sale holding that the properties of the Respondent were not valued properly.

Subsequently, both the Respondent and the Appellant moved the Debt Recovery Appellate Tribunal (“DRAT”), Delhi. DRAT Delhi stayed the ex-parte order of DRT Chandigarh. Meanwhile, the Respondent invoked the provisions of SICA by making the reference to Board of Industrial Finance & Reconstruction (BIFR). The DRAT Delhi confirmed the sale in favor of Appellant.

However, before the sale formalities could be completed, the Respondent filed two Writ Petitions in the Delhi High Court on the ground that the debt recovery procedure cannot be carried out because of the prohibition in Section 22 of the SICA. The Delhi High Court allowed the writ petitions setting aside the order of DRAT, Delhi. The Appellant preferred an appeal in the Supreme Court where, the two-judge bench had a difference of opinion. Therefore, the matter was referred to the three-judge bench that ruled that the debt recovery procedure is barred under section 22 of the SICA, which shall prevail over Section 34 of the RDDBFI.


This judgment surely puts to rest the conundrum with regard to the precedence of one special enactment over other special act and is also quintessential to the rules of interpretation. The larger bench ruled that while addressing the precedence of SICA and RDDBFI, in view of the non obstante clause contained in both, one of the important tests is to carefully examine the purpose of the two enactments, so as to recognize and ensure that the purpose of both enactments is, as far as possible, fulfilled.

The General Rules of Interpretation

It is a settled principle of interpretation that a subsequent enactment has precedence over the previous enactment Further, the doctrine of “generalia specialibus non derogant” (general provisions will not abrogate special provisions) is also well settled.

In the instant case, both the principles became equally applicable and thus the confusion cropped up as to which principle of interpretation would apply.

However, in cases where such confusions spring up, the widely accepted rule of construction is that if one construction leads to a conflict, whereas on another construction the two enactments can be harmoniously construed, then the latter must be adopted.

The meaning of “Special”

Special in layman terms would mean “something otherwise than usual” or something designed for a particular purpose or occasion. It would not be a daunting task to ascertain when the base for comparison is “generic or general”. It becomes complicated when the task is to distinguish “the special” or “especial” between two specials.

The Apex Court has carefully and at breadth examined the issue of “especial” and addressed the same accordingly, laying down the determining factor to be the purpose of the enactment and the subject matter it deals with.

In the case of LIC vs. DJ Bahadur,[1] the Apex Court held that “In determining whether a statute is a special or a general one, the focus must be on the principal subject-matter plus the particular perspective. For certain purposes, an Act may be general and for certain other purposes it may be special and we cannot blur distinctions when dealing with finer points of law.”

The purpose of SICA is to provide ameliorative measures for reconstruction of sick companies, and the purpose of RDDBFI is to provide for speedy recovery of debts of banks and financial institutions. Indeed both are special laws. With the purpose of reconstruction and matters incidental thereto, SICA must be considered as special law, though it may be a general law in relation to recovery of debts. Whereas RDDBFI is a special law, in relation to recovery of debts and SICA may be considered as general law.

In the above context, the approach is to carefully examine the purpose, intention and objectives the enactment aims so as to construe what is actually special and what becomes general.

Further, in order to ascertain the real purpose of both the enactments and also to address the ambiguity over why in this case the subsequent act would not prevail over the previous act, a deeper look into the Statement of Objects and Reasons of both enactments becomes imperative.

Statement of objects and reasons of SICA

The introduction to SICA states: “An Act to make, in the public interest, special provisions with a view to securing the timely detection of sick and potentially sick companies owning industrial undertakings, the speedy determination by a Board of experts of the preventive, ameliorative, remedial and other measures which need to be taken with respect to such companies and the expeditious enforcement of the measures so determined and for matters connected therewith or incidental thereto.”

It is fairly clear from the above that SICA was enacted in 1985 to provide for timely determination of a body of experts for providing preventive and remedial measures that would need to be adopted to sick companies so as to address the ill effects of sickness in industrial companies such as loss of production, loss of employment, loss of revenue to the governments and locking up of investible funds of banks and financial institutions. In order to fully utilize the productive industrial assets, afford maximum protection of employment and optimize the use of funds of the banks and financial institutions, it was found imperative to revive and rehabilitate the potentially liable sick industrial companies. Further the Act not only aims to revive and rehabilitate all sick companies but those in the schedule to the Industries (Development and Regulation) Act, 1951 (IDRA), that are presumably vital to the economy of the nation.

In order to achieve the purpose for revival and rehabilitation, protection of sick companies from its creditors and the multitude of remedies which they may avail of against the sick company and its properties, it was vital and imperative for the BIFR to draw up a scheme best suited for the sick company. In this backdrop, section 22 of SICA was enacted dealing with suspension of legal proceedings, contracts, etc. during the continuation of BIFR proceedings.

Section 22 (1) provides that “Where in respect of an industrial company, an inquiry under section 16 is pending or any scheme referred to under section 17 is under preparation or consideration or a sanctioned scheme is under implementation or where an appeal under section 25 relating to an industrial company is pending, then, notwithstanding, anything contained in the Companies Act, 1956 (1 of 1956) or any other law or the memorandum and articles of association of the industrial company or any other instrument having effect under the said Act or other law, no proceedings for the winding up of the industrial company or for execution, distress or the like against any of the properties of the industrial company or for the appointment of a receiver in respect thereof and no suit for the recovery of money or for the enforcement of any security against the industrial company or of any guarantee in respect of any loans or advance granted to the industrial company shall lie or be proceeded with further, except with the consent of the Board or, as the case may be, the Appellate Authority.”

The Appellants had put forth that section 22 provides for stay on proceedings of winding up or execution and distress and does not provide for any stay on the recovery of debt process. The bench carefully examined the provision and ruled that the time when SICA when enacted in 1985, recovery under RDDBFI was neither in existence nor was such a mode contemplated. The section further was amended in 1994 include stay on suits for recovery of money or enforcement of security against the sick company. These words appear to have been inserted to expressly provide, rather clarify that no suits for the recovery of money, etc. would lie or be proceeded with against such a company. Further, the bench concluded that the even though “proceedings” under RDDBFI are not covered expressly but any proceeding resulting in the execution and distress against the property of such company would be construed as proceedings within the meaning of section 22.

Statement of objects and reasons of RDDBFI

The introduction to RDDBFI as provided in the text of the Act sets forth: “An Act to provide for the establishment of Tribunals for expeditious adjudication and recovery of debts due to banks and financial institutions and for matters connected therewith or incidental thereto”

RDDBFI was enacted in 1993 by the Parliament to effectively address the issue of recovery of debts due to banks and locking of investible public funds that prevented proper utilization and recycling of funds for development of country. The urgent need to work out a suitable mechanism, through which the debts of banks and financial institutions could be realized without delay, was in the form of Special Tribunals, which would follow a summary procedure for adjudication. These Tribunals eventually came to be known as Debt Recovery Tribunals, which precisely was the intent behind enactment of RDDBFI. 

However, in view of multiple remedies under various other laws for recovery of money and order to protect the sanctity of proceedings and uphold the objectives for speedy recovery of debts, exclusive protections in form of section 18 and 34 were cautiously inserted by the Parliament.

Section 34 of RDDBFI provides “ (1) Save as provided under sub-section (2), the provisions of this Act shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force or in any instrument having effect by virtue of any law other than this Act.

(2) The provisions of this Act or the rules made thereunder shall be in addition to, and not in derogation of, the Industrial Finance Corporation Act, 1948 (15 of 1948), the State Financial Corporations Act, 1951 (63 of 1951), the Unit Trust of India Act, 1963 (52 of 1963), the Industrial Reconstruction Bank of India Act, 1984 (62 of 1984), the Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986) and the Small Industries
Development Bank of India Act, 1989 (39 of 1989).”

Sub-section 1 as stated above is a saving as well as a non-obstante clause conferring an overriding effect of the provisions of the RDDB over other laws for the time being in force, while sub-section 2 is in addition to and not in derogation of the special statues as provided for. Further, it is pertinent to note here that reference to SICA and the Small Industries Development Bank of India Act, 1989 (39 of 1989), was inserted with effect from 17.01.2000 by Act No. 1 of 2000 of the Parliament.

Sub-section 1 starting with “save as provided in sub-section 2 ”, is a saving clause. According to Black’s Law Dictionary[2]A saving clause in a statute is an exception of a special thing out of the general things mentioned in the statute; it is ordinarily a restriction in a repealing act, which is intended to save rights, pending proceedings, penalties, etc., from the annihilation which would result from an. unrestricted repeal”

The meaning as set forth above clearly carves an exception for sub-section 2, thereby preserving the contents and interpretations as stated therein.

Further, upon cursory and plain reading of language of sub-section 2, it is fairly clear that when an Act provides that its provisions shall be in addition to and not in derogation of another law or laws, it means that the legislature intends that such an enactment shall co-exist along with the other Acts. Further, the act of the legislature to further amend and include SICA within the purview was also to be construed as per principles of co-existence. It is clearly not the intention of the legislature, in such a case, to annul or detract from the provisions of other laws.

It is herein important to construe the meaning of the phrase “not in derogation of”. Black’s Law Dictionary[3] defines derogation as “The partial repeal or abolishing of a law, as by a subsequent act which limits its scope or impairs its utility and force. Distinguished from abrogation, which means the entire repeal and annulment of a law”

In view of the above, it is undoubtedly clear that the subsequent Act cannot be in nature of limiting the scope of relief as provided under the previous act. It necessarily has to provide an impetus to the objectives of the previous act and not vitiate the same. The express inclusion of the phrase “not in derogation of” in sub-section 2 of section 34 of RDDBFI undoubtedly establishes that the legislature never intended to undermine the force and utility of SICA by enacting RDDBFI but rather intended to preserve the powers of the authorities under the SICA and save the proceedings from being overridden by the subsequent enactment i.e. the RDDBFI.


Even though the judgment settles the issue of precedence of SICA over RDDBFI, the implications are far-reaching and wide. Any defaulter could possibly apply to BIFR for reconstruction thus delaying debt recovery process and with courts frequently staying the recovery proceedings it would adversely affect the recovery climate in the country. Further, it would also largely affect the value of the collateral and its enforceability, as litigation as all know is a time consuming affair in the country. This clearly indicates that banks and financial institution would now have to bear the brunt of more bad loans.

It is further disheartening to see that legislation dating back as early as 1980 and 1990s are found contradicting three decades after. It surely indicates that drafting was ill-considered leaving it to the interpretation of the courts each time leading to severe inefficiencies in the implementation of the legislation.

- Prachi Narayan

[1] (1981) 1 SCC 315
[2] http://thelawdictionary.org/saving-clause/
[3] http://thelawdictionary.org/derogation/

Friday, November 21, 2014

SEBI Reforms – Part 2: Delisting

Delisting of securities tends to be somewhat controversial given that it represents the tension between the interests of the controlling shareholder who want to delist the company and the interests of minority shareholders who are caught between the options of exiting the company at the offered value or remaining in the company without the liquidity and protections that a stock exchange listing provides. These controversies have played out in the Indian markets as well thereby necessitating a review of the SEBI (Delisting of Equity Shares) Regulations, 2009.

The review commenced with SEBI’s discussion paper on the topic earlier this year. Somasekhar Sundaresan and I have separately analysed SEBI’s discussion paper (here and here, respectively). SEBI’s approach has been to address two broad concerns. First, the constraints and complexities in the delisting regime make it difficult for controllers to successfully delist. Second, public shareholders holding a significant stake can dictate terms as to the determination of the delisting price and thereby hold the other shareholders to ransom.

In the recently announced reforms, SEBI appears to have considered responses to the discussion paper. In tweaking the regime, SEBI has addressed one of the above issues, but not the other. The reforms continue to protect the interest of minority shareholders against both the controllers as well as significant public shareholders. On the other hand, it has arguably made it more difficult for controllers to delist their companies (rather than ease the process as it initially set out to do). An analysis of a few of the reforms would demonstrate this point further.

SEBI has reinforced the importance of the reverse book-building (RBB) process for delisting. While the RBB has arguably operated in favour of public shareholders, its rigidity has paid put to controllers’ delisting plans. It appeared from the discussion paper that SEBI may be willing to reconsider the utility of RBB in delisting, but in the end decided to stay with the option. Hence, it is unlikely that the new regime would make a significant difference to controllers’ delisting efforts. Although some of us had suggested alternatives to the RBB method that might facilitate value-generating delisting that might nevertheless protect the minority shareholders, that option does not appear to have found favour with SEBI.

Furthermore, the thresholds for delisting continue to be quite daunting. A successful delisting requires the satisfaction of two conditions: (i) the shareholding of the acquirer together with the shares tendered by public shareholders must constitute 90% of the total share capital of the company, and (ii) at least 25% of the number of public shareholders must tender in the RBB process.

As for the offer price, it would be determined through RBB and shall be the price at which the shareholding of the promoter, including the shareholding of the public shareholders who have tendered their shares, reaches the threshold limit of 90%.

At the same time, SEBI has undertaken some efforts relax some aspects of the process. For instance, the timelines for delisting have been reduced from approximately 117 working days to 76 working days. Public shareholders will benefit from taxation benefits accompany the proposal to use the stock exchange platform for delisting (which have also been extended to buyback and takeovers). Finally, exemptions have been carved out for small and medium-sized companies who are spared the strict norms for delisting.

A surprise inclusion in the reforms (that was conspicuously absent in SEBI’s discussion paper) is the streamlining of SEBI’s takeover regulations with the delisting regulations. It would now be possible for an acquirer who has made an offer under the takeover regulations to delist directly without increasing the public shareholding. This would ease the process for acquirers who wish to make an offer to the target’s shareholders and simultaneously delist the target if the offer is successful. It creates the badly needed symmetry between the regimes relating to takeovers and delisting. This recommendation made by the Takeover Regulations Advisory Committee (TRAC), which was ignored in the SEBI Takeover Regulations of 2011 and also in SEBI’s discussion paper on delisting, has finally seen the light of day.

In all, the reforms relating to delisting represent a mixed bag. The changes are incremental in nature, which do not affect the overall philosophy or address the broader concerns and tensions in delisting. Given this scenario, it is not clear if we will witness significant changes in the manner in which delisting is carried out in India or the type of problems faced. Again, we will have to await the text of the amendments to the regulations before making more detailed prognoses.

Thursday, November 20, 2014

SEBI Reforms – Part 1: Insider Trading

Yesterday, SEBI’s board unleashed a series of capital market reforms. These relate to insider trading, delisting, enforceability of the listing agreement and several other matters. In this post, I briefly examine the implications of the reforms on regulations pertaining to insider trading.

The SEBI board has approved a new set of regulations dealing with insider trading. While the text of the regulations are awaited, here I discuss some of the broad reforms announced. The impetus for reforms in this area came from the report of the SEBI appointed committee that was issued in December 2013 (as previously discussed here). In the current reforms, SEBI has broadly adopted the recommendations of the committee on several aspects, but it has either not adopted others or made significant changes.

First, the crucial definition of “insider” has been widened to include “persons connected on the basis of being in any contractual, fiduciary or employment relationship that allows such person access to unpublished price sensitive information (UPSI).”  It expands the nature of connections a person may have with the company so as to fall within the scope of an insider. Also, any person who is in possession of or has access to UPSI would also be an insider. At the same time, some proposals of the committee in this behalf have not been accepted, such as the inclusion of a public servant with access to UPSI as a connected person.

Second, immediate relatives would be presumed to be connected persons, with the burden shifted on to them to show that they were not in possession of UPSI. The evidentiary aspects of insider trading have been given great importance given the difficulties SEBI has faced in the past to establish that a person was in possession of UPSI. While the use of circumstantial evidence has worked in some cases, in others it has failed. This burden shifting effort may end up being somewhat crucial in SEBI’s efforts to curb insider trading.

Third, as regards communication of UPSI, certain allowance has been made for “legitimate purposes, performance of duties or discharge of legal obligations”. These has been a substantial discussion about the need for communication of UPSI in genuine commercial or investment transactions, such as due diligence for a private equity investments, which fell within the scope of the prohibition under the existing regime. The new regime makes some leeway for such genuine transactions (with some conditions) that may benefit the company and its investors more generally.

Fourth, where communication of UPSI is permitted, such as in the case of due diligence discussed above, the UPSI must be disclosed to the markets at least 2 days prior to the trading in the securities. This is necessitated so that information symmetry is created in the market such that no investor has any undue advantage.

Fifth, the scope of UPSI and “publication” have been clarified. For example, for information to be generally available (so as to fall outside the scope of UPSI), such information must be accessible to the public on a non-discriminatory platform which would ordinarily be the stock exchange platform. In other words, dissemination through the stock exchange is considered the preferred channel of publication. Furthermore, the definition of UPSI has been aligned with the information and disclosure requirements under the listing agreement.

Overall, some of the changes are indeed significant, given the mixed success of the present insider trading regime. However, as is usually the case, a lot will lie in the wording of the regulations and their interpretation.