Friday, January 23, 2015

NLS Law and Technology Legislative Analysis Competition 2014-15

[The following announcement is posted on behalf of the Law and Technology Society of the National Law School of India University, Bangalore]

The Law and Technology Society is proud to present the 3rd edition of ‘NLS Law and Technology Legislative Analysis Competition, 2014-15’. This National level competition aims to continue the effort to involve students in research and analysis on pending bills that blur the interface between law and technology. Considering the large number of entries received in our last two editions from law institutions across the country, we hope to expand our outreach even further this year.

The two bills selected for consideration in this edition are:

a) Draft Medical Termination of Pregnancy (Amendment) Bill, 2014

b) 2014 Amendment to Karnataka Prevention of Dangerous Activities of Bootleggers, Drug Offenders, Gamblers, Goondas, Immoral Traffic Offenders and Slum Gamblers Act, 1985 (“The Karnataka Goondas Act”), with a special focus on the extension of the scope of legislations to “copyright violation”, “video or audio pirates” and “digital offenders”.

The deadline for the submission of the paper is 5:00 PM on February 25th, 2015. Those students whose entries are adjudged as best by our panel of judges, would be offered an opportunity to intern with PRS Legislative Research Organization ( and Centre for Internet and Society ( The best submission would also be considered for publication in the Indian Journal of Law and Technology. Furthermore, prize money worth Rs. 5000/- for the best submission on each bill would be awarded.

For further details of the Competition and rules, as well as any queries, please email at . 

For any further clarifications, contact:

Annie Jain: (Ph: +91-7406392695)
Garima Singh: (Ph: +91-9844943787)

Thursday, January 22, 2015

Insider Trading and the Risks of Due Diligence Access

[The following post is contributed by Aparna Ravi, a researcher at the Centre for Law and Policy Research, Bangalore and previously a capital markets lawyer in London. She can be contacted at

She presents an interesting critique of the new SEBI insider trading regulations on matters relating to due diligence set in the backdrop of international experience]

In January 2012, the UK Financial Services Authority (“FSA”) charged a U.S. hedge fund manager, David Einhorn, and his hedge fund, Greenlight Capital Inc., with “trading on the basis of inside information” and imposed upon them civil penalties of about £7.2 million (approximately $11.6 million).[1]  This case attracted a lot of attention in the US and the UK as, in addition to being an example of the FSA’s heightened resolve to aggressively pursue cases of insider trading, it highlighted significant differences between the insider trading regimes in the two countries.  I bring it up here because it involved a case of “inadvertent” wall crossing (explained below), which is worth revisiting in the context of the new SEBI (Prohibition of Insider Trading) Regulations, 2015 (“Insider Trading Regulations”) notified last week, that now explicitly permits the communication of unpublished price sensitive information (“UPSI”) for purposes of due diligence in connection with a potential transaction.

Funds managed by Greenlight owned approximately a 13.2% stake in Punch Tavern plc, a company listed on the London Stock Exchange.  The Board of Directors of Punch was contemplating a private placement transaction and engaged an investment bank to make calls to existing shareholders to assess their interest in the transaction. Shareholders were told that they would need to sign a non-disclosure agreement, which would require them to keep the information confidential and restrict them from trading in Punch’s shares, before they could receive any information, a process termed as being “wall crossed.”  Einhorn declined to sign the non-disclosure agreement, but nevertheless agreed to participate in a conference call where he claimed to have stated that he did not want to receive inside information.  During the course of the conference call, Einhorn learned that Punch was at advanced stages of planning an equity offering and that the proceeds of the offering would be used to repay the company’s convertible debt and to create headroom with respect to certain covenants on Punch’s securitization vehicles.

In the three days following the conference call, Greenlight began selling its shares in Punch and drastically reduced its shareholding to 8.9%.  Punch announced its equity offering six days after the conference call and its share price fell by about 30%, which meant that Greenlight had avoided losses of approximately £5.8 million by selling in advance of the public announcement.  The Einhorn case is an example of an “inadvertent” wall crossing, where the FSA held that Einhorn had received inside information even though he had declined to sign the non-disclosure agreement. The FSA further stated that while none of the individual pieces of information Einhorn had received constituted inside information, the totality of the information met the relevant tests to amount to inside information.

The provision of inside information in the course of granting due diligence access is a common practice across a number of jurisdictions and the new Insider Trading Regulations have now been brought in line with international practice in this regard. SEBI has rightly recognized the practical realities of commercial transactions that prospective investors may often require non-public information about a company in order to assess the merits of a particular transaction.  In these situations, investors look to obtain UPSI not for insider trading but for due diligence on a company’s finances and business, which ultimately benefits all investors by unearthing facts that the company might have otherwise been reluctant to disclose. Taking these factors into account, Regulation 3(3) of the Insider Trading Regulations allows for firms to communicate UPSI in connection with a contemplated transaction subject to certain conditions:

(i)  in situations that would trigger an obligation for the company to make an open offer under the Takeover Regulations, if the board determines the proposed transaction to be in the best interests of the company; and

(ii) in situations that do not trigger an obligation to make an open offer, if the board determines the proposed transaction to be in the best interests of the company and any UPSI provided to potential investors as part of due diligence is made public at least two days prior to the contemplated transaction taking place.

(The disclosure requirement is not specified in the case of open offers because such transactions would in any event require the company to make any information necessary to arrive at an informed decision available to all shareholders.)

The regulations also require the parties receiving UPSI as part of their due diligence to sign confidentiality agreements and agree not to trade in the securities of the listed company while in possession of inside information.

While perhaps a necessity, the provision of due diligence access needs to be closely monitored as it leaves much scope for abuse.  Einhorn is perhaps an extreme example as the broker was trudging into dangerous territory when he offered Einhorn a conference call without being wall-crossed. Yet this case highlights the perils associated with providing due diligence access to investors ahead of a potential transaction and the need for stringent controls over the process.  In this regard, the new regulations as they relate to diligence access leave much unsaid and SEBI will most likely need to issue additional guidance to ensure that these regulations facilitate legitimate transactions while minimizing the possibility for abuse. Some areas that I believe SEBI would need to clarify are:

(1)       Process for providing UPSI: The process employed for selectively communicating UPSI in connection with a contemplated transaction needs to be carefully thought out to ensure that both sides have the same understanding of what constitutes UPSI and the implications of receiving UPSI.  Before being provided with any UPSI, potential investors must be told that they are to be (i) provided with UPSI that they would need to keep confidential and which would restrict them from trading and (ii) given an opportunity to decline to receive the information.  This initial conversation is critical as great care needs to be taken not to inadvertently divulge any information that could constitute UPSI at this stage. Further, there needs to be great clarity on precisely which information constitutes UPSI and how long the trading restrictions would apply. While some of these issues will develop as part of market practice, guidelines from SEBI on best practices, as well as a requirement for compliance officers at the relevant parties to be involved when UPSI is provided, could help ensure discipline in the process.

(2)       Form of Disclosure: The regulations do not prescribe the form in which a company would need to communicate UPSI to the market prior to the transaction taking place, which has been left to the discretion of the company’s directors. It is also interesting to note that only non-public information that is price sensitive (as opposed to all the non-public information that has been shared with investors during the course of due diligence) will need to be communicated to the market. While there is logic to this requirement as companies are not expected or required to communicate very detailed, granular or commercially sensitive information (such as targets or customers) that is not price sensitive to the public, this requirement together with leeway on the form of disclosure leaves much scope for interpretation by a company’s directors. Sifting through the due diligence information provided to potential investors ahead of a transaction to determine the extent of the information that constitutes UPSI may prove to be a challenging task for directors. SEBI will need to monitor how companies interpret this requirement and may need to provide additional guidance to ensure that it achieves the regulation’s objective of providing parity of information to the market.

(3)       Cleansing: Nowhere do the new regulations deal with all too common a situation. What happens if investors are provided with UPSI in connection with a contemplated transaction that does not take place, or, as often happens, is placed on hold for an indefinite period of time?  In such situations, the question of when a recipient of UPSI on an aborted transaction can resume trading on the listed company’s securities assumes great significance. Trading restrictions can only be lifted when investors have been “cleansed” of the UPSI that they received, i.e., when the UPSI in their possession no longer gives them an information advantage over other market participants.

If the transaction does go ahead, the cleansing process is automatic as the new regulations require disclosure of any UPSI to the market at least two days ahead of the transaction.  On the other hand, if the transaction does not occur or is postponed, companies are not in the habit of putting out announcements regarding aborted or postponed transactions. Potential investors who receive UPSI find themselves in the difficult situation of not knowing whether the information they have received still constitutes UPSI or when they can resume trading.  Typically, to cleanse these investors, a company would either need to make a public disclosure of the UPSI provided to select investors or the UPSI must no longer be relevant (for example, the transaction terms of an aborted transaction or if the UPSI has been superseded by subsequent events that have been disclosed).  As potential investors are unlikely to agree to be restricted in the absence of a clearly articulated cleansing strategy if the transaction does not take place, SEBI will need to provide much needed guidance in this complex area.  

While essential for facilitating commercial transactions and capital raising, providing UPSI to potential investors as part of due diligence access is fraught with difficulties. Investors need to be told that they are being provided with UPSI, the expected time period during which they cannot trade, and the cleansing strategy if the transaction does not take place. Great care must also be taken to ensure that potential investors are not provided with any information on the potential transaction unless they agree to the confidentiality obligations and trading restrictions to minimize the risk of inadvertently providing UPSI.  Some of these issues may be clarified in the implementation of the new regulations and will evolve as market practice in this area develops, but SEBI will most likely need to provide further guidance regarding due diligence access that walks the tightrope between facilitating legitimate transactions while ensuring that any information flow of UPSI is tightly regulated.

- Aparna Ravi

[1] FSA’s decision notice, dated January 12, 2012, available at

Supreme Court on Successor Liability

In the past, we have discussed the difficulties of imposing successor liability on the purchaser of a business when such liabilities pertain to those incurred by the seller prior to the sale and purchase transaction. This issue has come up (without satisfactory resolution) in the Bhopal gas tragedy.

Now, it appears that there may be some shift in the approach with a decision of the Supreme Court of India last year in McLeod Russell India Limited v. Regional Provident Fund Commissioner, Jalpaiguri. In this case, the Court imposed a past-period liability on the purchaser of a business even though the contract specifically retained that to be borne by the seller. I refer readers to a detailed analysis of this decision by Harsh Kumar in Singapore Law Review’s Juris Illuminae.

An expansive scope towards successor liability would have to be considered while structuring asset or business acquisition deals. The implications of the decision as pointed out by Harsh are extracted below:

The Supreme Court has clarified that, in the case of a transfer of a business or establishment, in respect of which provident fund dues are pending, the seller and the acquirer will be jointly and severally liable to pay not only the pending provident fund amount but also damages, if any, imposed by the government authorities. It is now imperative for an acquirer to undertake a detailed diligence on the status of provident fund payments by a company or establishment, otherwise it may have to shoulder all pre-closing provident fund liabilities.

From a transactional perspective, acquirers of a business should consider an escrow to appropriately ring-fence their liability for provident fund dues of a company or establishment. If an escrow is not commercially feasible, then acquirers may consider adjusting the valuation for the business, or seeking a specific indemnity from the seller for liabilities not expressly assumed by the acquirers. An insurance cover may also be obtained to appropriately safeguard against pre-closing liabilities. These safeguards and the manner in which parties will bear associated costs for implementing these safeguards should be negotiated with the seller while finalising the business purchase agreement.

Wednesday, January 21, 2015

Bonus Debentures: Features and Implications

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


The reward of being a shareholder is singular: share in profits of the company. A few widely known forms of corporate rewards include cash dividends, bonus shares, preference shares, bonds, debentures, warrants and options, of which cash dividends and bonus shares are most popular.

Just on the lines of bonus shares are another fairly innovative instrument called as bonus debentures.

This post is an attempt to understand the concept, rationale, features, benefits and implications of the issue of bonus debenture.

Economic rationale

Bonus debentures are issued out of distributable profits and reserves to the shareholders for free. Like any other debenture, bonus debentures also carry a face value, an interest and a maturity period. In essence, this instrument has some features similar to bonus shares, some resembling debentures and some distinct ones of its own. But before delving into the nuances of this instrument, it would be appropriate to reflect upon the rationale behind issuing such instruments.

A company usually employs two methods to share its divisible profits with its investors: cash dividends and bonus shares. While cash dividends involve immediate payment of cash by the company, bonus shares involve issuance of additional shares to the equity investor. Cash dividends involve huge outflows from the company immediately, which could have been retained by the company for business purposes for a little longer.

Bonus shares being the other alternative, do work well but then it leads to dilution in equity, as there is an expansion in the equity base of the company that eventually reduces the earnings per share as well as dividend pay-out.

A bonus debenture is thus unique as it perfectly subsumes within itself the benefits of cash distribution and capitalisation of profits (erstwhile bonus shares) thereby limiting the outgo of huge cash from the company and making it a staggered outflow (at least until redemption). This ensures availability of funds to meet business and operational needs of the company.

How is the issue done?

A company may declare bonus debentures out of its free reserves, i.e. profits available for distribution to shareholders. Instead of paying dividends in cash, shareholders receive debentures equivalent to the amount of dividend. In layman terms, the company issues a paper acknowledging the dividend, having a face value, coupon rate and a redemption period.

For example, take a shareholder who owns 100 shares in company. The company declares a dividend of Rs. 5 per share. Total dividend share receivable by the shareholder is Rs. 500. The company issues 100 bonus debentures with face value of Rs. 5 each carrying a coupon rate of 10%, redeemable at the end of 3 years.

Such bonus debentures may be secured or unsecured. Secured bonus debentures shall be secured in manner provided in rule 18 of the Companies (Shares and Debentures) Rules, 2014. Further, secured bonus debentures may be listed with stock exchanges to provide better liquidity to the shareholders.

Benefits of Bonus Debentures

This instrument caters to the needs of the investor as well as the company. From a company’s perspective the instrument helps the company improve its return on equity as there is an increase in the debt capital of the company, which in turn brings the advantages of leverage. These instruments are issued from the accumulated profits and thus do not impact reported profits of a company. There is no immediate cash outflow and the company is able to utilize its excess cash over a period of time, at least until maturity of the instruments. Further, it is one of the most efficient ways of offering “bonus” without expanding the equity capital base and without diluting the earnings per share. Bonus debentures do not dilute the share value unlike bonus shares. Further, the interest payments made to investors are tax deductible. Hence, the company can save on the tax outgo to the extent of interest payment made in a given period.

From a shareholder’s perspective, bonus debentures are additional rewards that shareholders receive from company. Issue of bonus debentures entitle them to yearly interest until such debentures mature or are redeemed.  In addition, it is a tax-free receipt of redemption amount. The amount of bonus debentures is not taxable in the hands of debenture holders as the dividend distribution tax is paid by the company. Listed bonus debentures further provide a shareholder with better liquidity options, as shareholders can easily sell them in the secondary market if they desire.

Provisions of law

Bonus debentures are not expressly covered under provisions of Companies Act, 1956 or Companies Act, 2013. Further, section 123 (5) of the Companies Act, 2013 provides that a dividend shall be paid to shareholders in cash or shall be utilized to issue fully paid up bonus shares or shall be used for payments of  such amounts that are unpaid on the shares held by the members. Except for these, any other form of dividend paid to the shareholder is not explicitly allowed by the Act.  Further, provisions relating to bonus shares under section 63 of Companies Act, 2013 are not attracted as they specifically deal with the issue of shares only.

In absence of any explicit provision of law governing issue of bonus shares, it is obvious that one would wonder as to what would be the procedure of issuing such instruments. Bonus debentures are issued pursuant to a scheme of arrangement under sections 391-394 of Companies Act, 1956, that involves approval of shareholders and the High Court and Reserve Bank of India (in case issued to non-resident shareholders). It is pertinent to note here that since a scheme is approved by the members, the requirement for an express provision in the articles of association of the company is also not required.

Further, a company may additionally choose to list its bonus debentures to provide better liquidity to its shareholders. In such a scenario, compliance with provisions of debt listing agreement, 100% asset cover for the listed bonus debentures- in line with rule of 18 of Companies (Share Capital and Debentures) Rules, 2014 and provisions of debt listing agreement, appointment of debenture trustees and creation of debenture redemption reserve in line with 71(4) of Companies Act, 2013, rule 18(7)(c) of Companies (Share Capital and Debentures) Rules, 2014 and rule 7 of Companies (Share Capital and Debentures) Rules, 2014 would be required. Further, provisions of private placement under section 42 of the Companies Act, 2013 will mutatis mutandis apply to bonus debentures.

Scheme of arrangement

Bonus debentures are issued as a scheme of arrangement under sections 391-394 of Companies Act, 1956, as express provisions on such instruments are absent.  Any scheme under section 391-394 is essentially an arrangement either between the company and its shareholders or the company and its creditors, as the case may be. Further, a scheme of arrangement between the company and its members may be for any arrangement that the company and its members may enter into, not necessarily pertaining to reconstruction only. In this case, the scheme is drawn for distribution of dividends other than cash. The scheme would thus have to be in full compliance with provisions of sections 391-394 of the Companies Act, 1956 as corresponding provisions under Companies Act, 2013 are yet not enforced.

The provisions as they stand today require the scheme to be approved by the High Court and by majority of shareholders of the company. In case of bonus debentures, it is worthy to note here that a separate meeting of creditors may not be required at all unlike a scheme of reconstruction or merger/demerger. In a scheme of reconstruction or merger approval of creditors is required as the interests of creditors are likely to get affected by such a scheme. A scheme purely between the company and its members for distribution of dividend in no way affects the interests of the creditors as the creditors anyways have no right/share in the divisible profits of the company.

Further, Reserve Bank of India vide Notification No.FEMA.291/2013-RB dated October 4, 2013 has amended its guidelines so as to grant a general permission to Indian companies to issue debentures to non-resident shareholders, including the depositories that act as trustees for the ADR/GDR holders, by way of distribution as bonus from its general reserves under a scheme of arrangement approved by a court in India and subject to no-objection from the income tax authorities.

Taxation of Bonus Debentures

Section 2(22)(b) of the Income Tax Act, 1961 provides that dividend includes a distribution by a company to its shareholders of debentures by way of bonus to the extent of accumulated profits of the company. Thus, it is evidently clear that the allotment of bonus debentures is treated as dividend and company shall pay dividend distribution tax (DDT) on the amount of bonus debentures issued. Since such dividend is exempt in the hands of the shareholder, there would be no tax payable by the shareholder. In subsequent years, when the debentures are either sold or redeemed, only the difference between the sale price or redemption amount would be subjected to capital gains tax.

Further, the yearly interests paid by the company to its shareholders until redemption qualify as admissible deduction under the provisions of Income Tax Act, 1961.

Precedents in India

The concept of bonus debentures is still nascent and is yet to gain ground among Indian companies. In India, the bonus debentures were first issued by Hindustan Unilever Ltd in 2001. Post that Britannia Industries Limited came with its issue of bonus debentures in 2009, followed by Dr. Reddy’s Laboratories Ltd in 2010. Coromandel International Ltd. made its first attempt of bonus debentures in the year of its golden jubilee in 2011. In recent times, Blue Dart Express Ltd and National Thermal Power Corporation (NTPC) have rewarded their shareholders with fully paid up bonus debentures.

Even though bonus debentures may seem to be truly rewarding for both the shareholders as well as the company, the presence of the instruments in the market is less. This may primarily be due to the fact that legal procedures involved for approval of the scheme from various authorities is lengthy and time consuming.  Some simplification of the lengthy procedures may provide the necessary impetus to companies to come out with bonus debentures, as successful implementation of the scheme has been very positive for the companies opting for it.

- Prachi Narayan