Monday, April 30, 2012

Corporate Governance Survey

Despite developments in regulation of corporate entities around the world and India’s own share of scandals in recent years, corporate governance continues to be a matter of “check the box” or a set of compliance requirements, with only limited emphasis on the spirit of governance. This has been underscored in a recent corporate governance survey The India Board Report 2011 prepared jointly by AZB & Partners, Hunt Partners and PWC. The key findings are summarized in the report as follows:
Corporate governance is a subject that attracts a lot of media attention, especially just after a scandal. This usually prompts governments and regulators to appoint committees to review and change laws. After a while, the hype fades and it’s back to business as usual.
Regulation only ensures compliance. Unfortunately, compliance does not equal commitment to corporate governance. This has been one of the key findings of the third edition of our biennial India Board Report - 2011. Clause 49 of SEBI’s listing agreement has been widely praised, in terms of the standards of corporate governance that it sets. However, only 38% of the respondents felt that it significantly contributed to improving governance!
There are other indications as well. More than half the respondents pointed out that their boards did not have a formal process to evaluate their effectiveness. Two-thirds of the independent directors surveyed said that the roles and responsibilities of non-executive directors were not defined clearly. Around 50% of them felt that the time spent by the board in completing the agenda of the meeting was inadequate. 
The findings of the survey are also discussed in a report in the Mint.
Part of the findings may be attributed to the fact that the emphasis of governance norms lately has been to adopt a voluntary approach. In addition to Clause 49 of the listing agreement that lays down the basic norms, the Ministry of Corporate Affairs’ Corporate Governance Voluntary Guidelines of 2009 set out best practices to be adopted by companies on a voluntary basis. However, the proposed approach under the Companies Bill, 2011 is vastly different as it seeks to impose mandatory norms of governance on companies. As and when the Companies Bill is enacted into legislation, it is likely that it would have a significant impact on the manner in which companies approach matters of governance.

Thursday, April 26, 2012


1.         Further Liberalization of ECB Policy
Given the ailments afflicting the civil aviation sector in India, the Reserve Bank of India (RBI) has allowed external commercial borrowings (ECBs) in that sector even where the end-use of funds is for working capital requirements. This is permissible under the approval route, and is subject to several conditions stipulated by the RBI.
Earlier, the RBI also announced relaxations in the ECB regulations governing certain infrastructure sectors such as power and toll roads and highways.
2.         Tax Treaties: Mauritius vs. Singapore
This report in the Economic Times suggests that Singapore is becoming an increasingly attractive option for investment funds focusing on India, and that the importance of Mauritius is likely to wane in the future. India’s tax treaties with both Singapore and Mauritius provide substantially the same benefits as far as taxation with respect to Indian investments are concerned. While the advantage of Singapore is that it is an established financial centre with substantial presence requirements for investors, Mauritius has a first-mover advantage and the availability of treaty benefits has been tried and tested successfully before the Indian courts, including in the form of the Azadi Bachao Andolan case ([2003] 132 Taxman 373 (SC)).
3.         Breakout Nations
In the last decade or so, India has enjoyed the branding of an “emerging market” and has also been an integral part of the "BRIC" nations. However, a new book seeks to demystify some of these notions and challenges the continued relevance of these labels and branding. The book, Breakout Nations: In Pursuit of the Next Economic Miracles by Ruchir Sharma, has been reviewed in the Economist, with the following being some extracts from the review:
“EMERGING markets” is a useful term precisely because it is imprecise. Coined for the convenience of investors looking for somewhere exciting to put their money, it covers a bewildering range of economies with little in common, except that they are not too rich, not too poor and not too closed to foreign capital.
The invention of “emerging markets” as an asset class required the invention of experts to manage those assets; experts who could discourse confidently about places as far apart as South Korea and South Africa. It might seem impossible to say anything coherent about such an eclectic mix of places. But in fact emerging markets have shadowed each other surprisingly closely in recent years, as Ruchir Sharma of Morgan Stanley points out in his new book, “Breakout Nations”.
Mr Sharma argues that emerging-market funds have lost sight of local idiosyncrasies in their fixation with global macroeconomic forces. Because of this “macro mania”, funds make “little or no distinction between Poland and Peru, India and Indonesia”, which he suggests further synchronises these markets. Emerging markets may have little in common except the funds created to invest in them, but that in itself creates a powerful affinity between them. The term “emerging markets” has helped to create the world it named.
The review concludes with the following observations:
Mr Sharma does not believe the shared success of emerging economies can continue. Some countries will break out from the pack, others will disappoint. The very concept of emerging markets may lose its appeal, he writes, as investors discover they need to distinguish between them: “These economies are now too big to be lumped into one marginal class, and are better understood as individual nations.” …

Announcement: NLSIR Symposium

(The following is an announcement from the National Law School of India Review)
The National Law School of India Review (NLSIR) - the flagship journal of the National Law School of India University, Bangalore is pleased to announce the V NLSIR Symposium on "Corporate Mergers and Acquisitions in India: Recent Regulatory Changes" scheduled to be held on May 5 and 6, 2012 at the National Law School campus, Bangalore. Confirmed speakers for the symposium include renowned legal luminaries such as Hon’ble Mr. Justice V. Ramasubramanian (Judge, Madras High Court), Mr. Dhanendra Kumar (Former Chairman, Competition Commission of India), Mr. Uday Holla (Senior Counsel, Karnataka High Court), Mr. Nishith Desai (Nishith Desai Associates), Mr. V. Umakanth (Assistant Professor, National University of Singapore), Mr. Sandip Bhagat, Mr. Rajat Sethi (Partners, SNR), Mr. Somasekhar Sundaresan (Partner, J Sagar Associates), Mr. Ajay Vohra (Managing Partner, Vaish Associates), and Mr. K. Swaminathan (Director - Direct Tax and Transfer Pricing Litigation, Delloitte Haskins and Sells), amongst others.

This year, the discussions will be divided into four panels:

Session I: The Competition Regime Governing Transaction of Business in Combinations 
(Forenoon, May 5, 2012, Saturday)

Session II: Takeover Regulation in India: Liberalisation with Caution
(Afternoon, May 5, 2012, Saturday)

Session III: Cross-border Mergers and India’s Taxation Regime
(Forenoon, May 6, 2012, Sunday)

Session IV: Companies Bill, 2011: Indian Company Law at the Cross-roads
(Afternoon, May 6, 2012, Sunday)

Registration fee for the symposium is Rs. 500 for students and Rs. 1500 for others.

For more details including the concept note, program schedule and online registration, please visit:

For regular updates, also see our Facebook page:

For further information, please contact Krishnaprasad K.V. (Chief Editor): +91-9916589670; Ashwita Ambast (Deputy Chief Editor):  +91-9986478265 or email us at

Wednesday, April 25, 2012

Parent's Duty to Employees of its Subsidiary: Chandler v. Cape affirmed

In an earlier post, we had discussed the judgment of the England & Wales High Court in Chandler v. Cape plc, [2011] EWHC 951. In that case, the Court had held that in certain circumstances, a parent company would owe a duty of care to the employees of the subsidiary even in situations where the tests for lifting the corporate veil are not satisfied. This judgment has been affirmed today by the Court of Appeal in Cape v. Chandler, [2012] EWCA Civ 525.

The Court of Appeal “emphatically rejected” the proposition that the case was concerned with principles pertaining to lifting the corporate veil. It was common ground between the parties that the tests for lifting the veil were not satisfied; and the Court (para 70) expressly clarified that the issue was not one of separate legal personality, but of whether the parent company had a direct duty to the employees of the subsidiary.

The Court of Appeal noted that the law of negligence develops incrementally, and also pointed out that an analogous principle was available in the line of authority on the duty of a person to intervene to prevent damage to another. The Court referred to Lord Goff’s statement in Smith v Littlewoods Ltd., [1987] AC 241, that there is in general no duty imposed on a person to prevent third parties causing damage to another. However, Lord Goff had qualified this general rule: there could be a duty to third parties causing harm to each other in situations where there was “a relationship between the parties which gives rise to an imposition or assumption of responsibility”. The Court of Appeal held that this “assumption” of responsibility need not be a voluntary or conscious assumption of responsibility (Customs and Excise Commissioners v Barclays Bank, [2007] 1 AC 181).

The Court concluded (para 80), “… this case demonstrates that in appropriate circumstances the law may impose on a parent company responsibility for the health and safety of its subsidiary's employees. Those circumstances include a situation where, as in the present case, (1) the businesses of the parent and subsidiary are in a relevant respect the same; (2) the parent has, or ought to have, superior knowledge on some relevant aspect of health and safety in the particular industry; (3) the subsidiary's system of work is unsafe as the parent company knew, or ought to have known; and (4) the parent knew or ought to have foreseen that the subsidiary or its employees would rely on its using that superior knowledge for the employees' protection. For the purposes of (4) it is not necessary to show that the parent is in the practice of intervening in the health and safety policies of the subsidiary. The court will look at the relationship between the companies more widely. The court may find that element (4) is established where the evidence shows that the parent has a practice of intervening in the trading operations of the subsidiary, for example production and funding issues…”

One issue which arises is this: is this “incremental development” of the law of negligence confined to “employee health and safety” cases, or would it extend beyond those cases in a more general commercial context? Can a parent have a duty of care to prevent a pure contractual breach by its subsidiary? The tests for liability in a commercial context would perhaps become clearer only after further development of the common law in this regard.

Call for Papers: Indian Journal of Arbitration Law

(The following is an announcement from the Indian Journal of Arbitration Law)
The Indian Journal of Arbitration Law is a biannual, student reviewed e-journal launched by the Centre for Advanced Research and Training in Arbitration Law of National Law University, Jodhpur.
National Law University, Jodhpur, one of the premier national law institutions in India, is taking successful initiatives for the promotion of areas related to the specialized fields of law. To strengthen the promotion of knowledge, research and legal interaction in the subject of arbitration law, it has established the Centre for Advanced Research and Training in Arbitration Law. The Indian Journal of Arbitration Law is the one such initiative of this centre towards the development of this expert legal arena.   
The Journal strives to inculcate the prevalent theories in the field of arbitration with their practical relevance. The editorial board seeks to achieve this feat by including contributions from individuals with varied expertise of practicing arbitration and by focusing on developing trends. In this regard, the board would give due emphasis to the rich thought processes of students of law, who bring to the forefront the innovative academic research currently underway in most law schools all over the world. Inclusion of changing regional trends will play a vital part in understanding the scope and extant of this discipline and would therefore find due importance in the Journal.
The Indian Journal on Arbitration is pleased to announce its inaugural edition, which is to be published in July this year.
The theme for the inaugural edition would be: India's tryst with Arbitration: Are we heading in the right direction?”
The Board of Editors cordially invites original, unpublished submissions for publication in the following categories:
- Articles
- Notes
- Comments
- Book Reviews
For details regarding publishing policy and guidelines please visit
Manuscripts may be submitted via email.
In case of any further queries, please contact the editors at:
Last Date for Submissions: 15 June, 2012.

Tuesday, April 24, 2012

SEBI Reinforces the Sanctity of a Takeover Offer

In a recent order, SEBI refused permission for the withdrawal of a voluntary takeover offer by an acquirer. The details of the case involving an offer by Mr. Pramod Jain and Pranidhi Holdings Private Limited for shares in Golden Tobacco Limited are discussed at the Indian Legal Space Blog, as are reasons for SEBI’s decision.
The following are some of the takeaways from SEBI’s order:
1. SEBI would permit withdrawal of an offer under the Takeover Regulations only in exceptional circumstances. That, in turn, reinforces the sanctity of a takeover offer. Once made, the offer must be taken to fruition by the acquirer. It does not matter whether the offer has been triggered mandatorily due to the acquirer’s acquisitions of stock beyond prescribed thresholds or even if it is merely a voluntary offer. This imposes a significant onus on acquirers to possess the required certainty to be able to complete the offer;
2. SEBI has provided a narrow interpretation to the withdrawal provisions under Reg. 27 of the erstwhile Takeover Regulations of 1997. In other words, although an offer and acceptance thereof are contractual matters, they are a specialized type of contract governed by the provisions of the Takeover Regulations, and cannot be subject to unilateral withdrawal rights of offerors.
3. One of the grounds for withdrawal raised by the acquirer pertained to mismanagement of the target company by its management when the offer was pending, some of which also allegedly violated Reg. 23 of the 1997 Regulations which requires the target not to take certain actions without the approval of its shareholders. This also resulted in a significant drop in value of the target, compared to the time when the offer was launched. However, this ground by itself was found by SEBI to be insufficient to permit a withdrawal of the offer. Instead, SEBI’s approach suggests that these are matters of caution to be exercised by the acquirer by way of deeper due diligence before launching the offer. Such a stance by SEBI seems to impose greater obligation on acquirers to perform more extensive due diligence on the target (which is not always straightforward when the target is uncooperative, such as in a hostile situation), and any dispute regarding the business condition or value of the target cannot give the acquirer a right to walk away from the offer. Nevertheless, SEBI did note the possibility of a breach of the Takeover Regulations on the part of the target and its management, which would require further investigation.
Although SEBI’s order buttresses the position set out previously by the Securities Appellate Tribunal in the Nirma Industries Limited case (2008) which limits the scope of the acquirer’s withdrawal rights, its result goes further in applying the same principles to a voluntary offer as well. As far as possible wrongful conduct of the target is concerned, that is a risk which the acquirer will have to absorb as it is required nevertheless to proceed with the offer so as to protect the interest of the public shareholders.

Saturday, April 21, 2012

Substance vs. Form Conflict in True Sale | Hong Kong Court Goes by the Language Used by the Parties

(The following post is contributed by Soma Bagaria, who is a Legal Advisor at Vinod Kothari & Company in Kolkata. She can be reached at

In every assignment transaction, there has been a constant conflict of whether the substance or form shall dominate while determining the nature of a transaction. There are two schools of thought on this: one which gives dominance to substance over form and the other which prefers the dominance of intention that is expressed rather than that not expressed, i.e. prefers the form over substance.

Generally speaking, when the nature of a transaction goes for determination, while respecting the intention of the parties set out in the documents, it shall be preferable to probe into the substance of the transaction rather than the plain label and language used so as to decipher what actually the transaction is all about. As has been said by many, language as an indicator is good but cannot be a determinant.

Recently, the Hong Kong High Court in the case of Hallmark Cards Incorporated v. Yun Choy Limited and the Standard Chartered Bank (Hong Kong) Limited[1] (an insolvency law matter), where the document in question was the Receivables Purchase Agreement (“RPA”), has given supremacy to the form over substance and held a transaction as a sale even though, as discussed hereunder, the elements of a sale were absent.

1. Arguments of the Liquidator of the Company (Yun Choy Limited)

1.1. The liquidators of the Company argued that (a) the transaction amounted to a lending secured by a charge on the book debts of the Company; (b) since the charge is not registered, the same is invalid; (c) the transaction amounted to a general assignment of book debts and hence void by reason of non-registration under the applicable bankruptcy laws of Hong Kong.

1.2 The liquidators harped on the substance of the RPA arguing that even though the transaction was expressed as a sale and purchase of the debts due from the Company’s customers, in substance it was an assignment by way of security creating a fixed charge over the book debts.

1.3 The Company retained the risk of non-repayment of debt by a customer. Hence, in absence of transfer of risk, being an essential ingredient of sale, the transaction cannot be a sale.

1.4  In the transaction:

(a) In a termination event, the Bank could require the Company to purchase all the outstanding debts and sum of the funds in use;

(b) The Bank had to account to the Company who could recover full value of its book debts, i.e., if the payment by the Company’s customers to the Bank exceeds the sums debited in the factoring account, the credit balance would be payable to the Company;

(c) In case of a shortfall, the Bank could recover the balance from the Company;

(d) There was no fixed price for the purchase of a debt.

1.5. It was, therefore, argued that the elements set out in the case of In re George Inglefield Ltd.[2], were satisfied in the transaction, and hence, the same would not amount to a sale but a mortgage. George Inglefield case has set out clear differences between a true sale and a mortgage:

True Sale

No recourse
Seller is not entitled to get back the asset sold by returning the money to the purchaser.
Mortgagor is entitled, until foreclosed, to get back the asset by returning the money to the mortgagee.

Account of profit
Purchaser does not have to account the seller of any profit realized by sale of the asset purchased from the seller.
Any amount realized in excess of the amount sufficient to repay the mortgagee shall be accounted back to the mortgagor.

Right to receive the shortfall
Purchaser cannot recover from seller any amount which upon resale of the purchased property was insufficient to recoup the money paid to seller.
A mortgagee is entitled to recover from the mortgagee the difference between the amount from sale of asset and the amount due from mortgagor, if the amount from the sale of asset is insufficient to meet such amount due.

Looking at the clauses in the RPA, it could be validly argued that the principles of a true sale transaction (as discussed below) were missing, and looking at the substance it may not appear as a true sale.

2. Arguments of the Bank (i.e. the Standard Chartered Bank)

2.1  The Bank argued that:

(a) The Company’s entitlement to be paid the credit balance in the factoring account did not amount to an equity of redemption.

(b) There is nothing wrong in a sale of debt for the purchase price to be fixed by the amount to be collected by the purchaser later.

(c) A sale with recourse is still a sale.

2.2 In support, the Bank relied on two famous cases of Welsh Development Agency v. Export Finance Co Ltd[3] and Orion Finance Ltd v. Crown Financial Management Ltd[4].

(a) In Welsh Development case, the Court had held a transaction to be sale even though the same apparently looked like a financing transaction but was documented as a sale, setting out the following principles of determination:

(i) The agreement shall be looked at as a whole and its substantial effect shall be seen.

(ii) It is only by a study of the whole of the language that a substance can be ascertained.

(iii) The plain meaning of any term in the agreement cannot be discarded unless there can be found within the agreement other language and stipulations which necessarily deprive such term of its primary significance.

(iv) Factoring amounts to a sale of book debts, rather than a charge, even though under the purchaser of the debts is given recourse against the vendor in the event of default in payment of the debt by the debtor.

(v) There may be a sale of book debts, and not a charge, even though the purchaser can recover the shortfall if the debtor fails to pay the debt in full.

(b) Further in the Orion Finance case, the Court had said that unless the documents taken as a whole compel a different conclusion, the transaction which they embody should be categorized in conformity with the intention which the parties have expressed in them.

3. Verdict of the Hong Kong High Court

The transaction was held to be a sale.

4. Analysis of the decision

The Hong Kong Court did not give any basis for its decision and neither did it discuss the parameters of a sale transaction. This case is a clear case of a form over substance ruling.

However, looking at some of the factors of a sale, it cannot be said that the transaction was a sale

4.1 Going the US way – substance over form approach

In the United States, the Courts have normally refused to go by the label of the contract rather than looking into the nature of the agreement. One important aspect to be seen, which was elaborated in the case of Major’s Furniture Mart v. Castle Credit Corp[5], is whether the risks have been retained by the seller. In this case the Court had said that it shall be seen whether the nature of recourse is such that the legal rights and economic consequences of the agreement bear a greater similarity to a financing or a sale transaction.

Therefore, primarily, the US Courts have preferred a substance over form approach, which is different from the form over substance which the UK Courts have preferred.

4.2 Revocable Transaction

If the transaction is revocable, i.e. presence of a repurchase agreement has the effect of being treated as a secured borrowing.

4.3  Failure of the transaction to satisfy the determinants for a true sale transaction

(a) No recourse against the seller

The risks and rewards shall be transferred by the seller to the buyer, thereby eliminating a possibility of any recourse against the seller. This is primarily a negative attribute and may not in itself be a determinant factor as recourse is like a warranty given by the seller on the quality of the assets sold.

The transaction for determination before the Hong Kong Court gave the Bank a recourse against the Company, in spite of which the transaction was upheld as a sale. The Hong Kong High Court accepted the Bank’s contention that even though there may be recourse against the seller, a transaction could be sale.

(b) Retention of residual interest by the seller

In a sale transaction, the seller cannot have control on profits of the buyer that arise after the sale. This was also clearly highlighted in the George Inglefield case by the liquidator of the Company. As has been stated, the rewards shall also stand transferred along with the risk in a sale transaction.

(c) Uncertain sale consideration

Where the amount of sale consideration is not ascertained or fixed, it cannot be said to be a sale transaction. This factor makes the transaction move closer to a financing transaction.

5. Conclusion

The tendency of the UK Courts and those following the UK principles to accept the language of the contract as the primary indicator of substance continues. The ruling does not help resolving the substance v. form conflict, which still continues as an unresolved debate.

- Soma Bagaria

[1]  [2012] 1 HKLRD 396
[2] [1933] Ch 1
[3] [1992] BCLC 148
[4] [1996] 2 BCLC 78
[5] 602 F.2d 538 (3d Cir. 1979). This is one of the most cited cases when determining a sale v. financing question.

Friday, April 20, 2012

Securities Regulation Redux

Over the last decade, there has been a continuous tightening of securities regulation and corporate governance norms in the US following the various corporate governance scandals (Enron, WorldCom, etc.) and the global financial crisis. This has appeared in the form of legislation such as the Sarbanes-Oxley Act and the Dodd-Frank Act. More recently, however, there has been a relaxation on some counts with a view to enable companies to raise finances without being adversely affected by stifling regulation (following criticism that tighter regulation increases the cost of raising capital and of doing business).
The new Jumpstart Our Business Startups Act (known as the JOBS Act) seeks to ease the process of raising capital through IPOs for “emerging growth companies”, which are companies with total annual gross revenues of less than $1 billion for the past fiscal year. It also facilitates the process of crowd funding (previously discussed here). The JOBS Act is summarized at the Harvard Corporate Governance Blog, and the US SEC has also issued a set of FAQs.
While this legislation is intended to ensure competitiveness in the US markets, it has already attracted severe criticism on the ground that it offers inadequate investor protection. Examples are available here and here. It appears that the nature of regulation is being governed by economic compulsions rather than the long-standing goal of securities law, which is investor protection.

Takeover Regulations: Pledge of Shares to Trustee Company

The SEBI Takeover Regulations (both the erstwhile regulations of 1997 and the present ones of 2011) carve out specific exemptions from disclosure and open offer requirements in case of pledge of shares in favour of banks or (public) financial institutions even if such pledge were to exceed the prescribed threshold shareholding percentages. Given the limited nature of these exceptions, one of the questions that were raised with SEBI through an application for informal guidance was whether a pledge of shares in favour of a trustee company (in the nature of a debenture or securities trustee) would be subject to disclosure or open offer requirements.
In its application, the IL&FS Trust Company Limited (ITCL) made the argument the pledge or even any shares or voting rights acquired by it were not for its own benefit but on behalf of several banks or financial institutions that are otherwise exempt from disclosure or open offer requirements. In other words, although not expressed in these terms, the argument was that if the pledge of shares directly in favour of banks or public financial institutions was exempt, there was no reason the same treatment should not be made available if the pledge was in favour of an intermediary such as a trustee who would hold it on same terms. ITCL went on to state that even where the pledge was made to ITCL for the benefit of another type of entity (such as a non-banking finance company) that was not exempt under the Takeover Regulations, no disclosure or open offer obligation must be imposed since ITCL as a trustee was not entitled to exercise voting rights directly, and hence cannot be said to have acquired any control over those shares.
However, in its guidance, SEBI refused to accept either of these arguments of ITCL. Instead, SEBI observed:
… ITCL is a Debenture Trustee and there is no express provision in either the erstwhile or present Takeover Regulations providing exemption to ‘Debenture Trustees’ acting as custodian/agent for the pledged shares on behalf of the lenders. Therefore, in the absence of such provisions, you may be required to be governed by the relevant provisions of the Takeover Regulations, 1997 and Takeover Regulations, 2011, as the case may be.
SEBI appears to have adopted a literal interpretation in that in the absence of an express exemption for debenture trustees, all provisions of the Takeover Regulations will apply to such transactions. It has sought not to go behind the transaction and examine its substance where the debenture trustee may indeed be only an intermediary performing an administrative function of holding the pledge on behalf of commercial banks or public financial institutions who may otherwise be eligible to the exemption under the Takeover Regulations. Perhaps that is understandable because such an interpretation would require an examination in each case as to who is the ultimate beneficiary of the pledge, which might not always be clear, especially if a large portion of the pledge is held on behalf of other entities such as non-banking finance companies that are ineligible for the exemption, as this news report suggests.

Wednesday, April 18, 2012

OECD Report on Related-Party Transactions

One area that is yet to receive significant attention in terms of regulatory reforms pertains to related-party transactions (RPTs). This is despite the enormous potential for RPTs in India given the concentrated ownership structures of public listed companies. All of these provide less protection to minority shareholders. In the past, although several suggestions for reform have been made (see for example, the AGCA White Paper on Corporate Governance), they have not been taken up in earnest by the regulators.
A recent report by the OECD titled “Related Party Transactions and Minority Shareholder Rights” embarks on a comparative study of regulations relating to RPTs. India is included among the 5 countries that are studied in-depth in the report (with the other countries being Belgium, France, Israel and Italy).
A summary of OECD’s findings are set out below:
In approving RPTs, great emphasis has been placed on boards’ approval, the tendency being for this task to be given to a committee of independent board members. There are often continuing questions about how to ensure effective independence of board members from controlling shareholders. Three approaches have been taken which represent evolving good practice when there are controlling shareholders. First, in a few jurisdictions shareholders have been given a say in approving certain transactions, with interested shareholders excluded. Second, in several jurisdictions minority shareholders are able to vote directly for a board member of their choosing. Third, in some cases a controlling shareholder has a fiduciary duty to other shareholders and the company. An abusive RPT would be against the interest of non-controlling shareholders and thus represent a breach of duty.
The current emphasis on board’s role in tackling RPTs is true in India as well, although the role of the board is largely to ensure proper disclosure of the RPTs rather than to pre-approve them. However, as far as the three aspects of good practice that are being evolved in jurisdictions, none of them has been adopted in India.
Regulation of RPTs continues to lag behind other areas of reform in corporate governance in India and require greater attention.

Thursday, April 12, 2012

The Implied Authority of a Managing Director

Does a managing director have implied authority to suspend the Chairman of the board of directors? This is a question the Court of Appeal considered in its recent judgment in James Butler v John Smith. The leading judgment was given by Arden LJ. The case is significant because it dealt not with the ostensible authority of an MD in relation to a third party (on which there is a plethora of authority), but with his actual (implied) authority.
Mr James was the MD and Mr Smith the Chairman of Contact Holdings Ltd, holding, respectively, 31.2 % and 68.8 % of its issued shares. They were therefore its only shareholders and any meeting in the absence of either one of them would have been inquorate. On 1 July 2011, Mr James, without a prior board resolution authorising him to do so, informed Mr Smith that he was suspended with immediate effect and denied him entry into the company’s premises. Mr James said that he did this because he discovered that Mr Smith had diverted the company’s funds to pay his own credit card expenses and had committed financial fraud in other ways. His explanation for his failure to seek a board resolution was that this would have allowed Mr Smith to intimidate employees and destroy or tamper with evidence before the resolution could be effectively implemented. As Arden LJ notes in her judgment, however, protecting the company was not the only reason for Mr James’ intervention – Mr Smith had in the past threatened to appoint a CEO over Mr James’ protests that this would constitute constructive dismissal and the two had disagreed on other important issues. Mr Smith then issued a notice demanding an extraordinary general meeting to consider the removal of Mr James, but Mr James intimated that he would not attend this meeting, thereby rendering it inquorate.
Mr Smith then brought an action for a declaration that his removal as Chairman was beyond Mr James’ powers as MD, and for an order under section 306 of the Companies Act, 2006, convening a general meeting with only one member (Mr Smith himself), to consider the removal of Mr James as MD. The Company and Mr James resisted these applications but the order was made at first instance.
In the Court of Appeal, it was argued for Mr Smith that an MD does not possess the power to suspend a Chairman, in the absence of a special provision in the articles of association authorising him to take this step, or a specific delegation of power from the board of directors. For this proposition, reliance was placed on a first instance decision, Mitchell & Hobbs v Mill [1966] 2 BCLC 102, where Mr Machin QC had held that an individual director, as a general rule, lacks the power to commence proceedings in the name of the company. For Mr James, it was submitted that this case in fact supported him, because the judge was said to have also held that a director who is in breach of duty cannot set up lack of authority as a defence in proceedings to remedy that defect.
In her judgment, Arden LJ explains that the starting point of the analysis must be the articles of association of the company and the contract of employment between the company and the MD. This is because the MD is a director but also an employee of the company. In this case, nothing in the contract shed light on his power to suspend the Chairman, and the company had adopted Table A as its articles of association. Regulation 72 of Table A provided that the board could appoint a managing director and delegate to him such powers as it deems fit, and deprive itself of those powers. Since no specific delegation had been made, it was necessary to determine what powers it was intended the MD should have. Arden LJ held that the default rule is that an MD’s “powers extend to carrying out those functions on which he did not need to obtain the specific directions of the board.” The obvious question is what those functions are. Arden LJ’s answer is that this depends on applying to the contract of employment (and presumably to the articles of association) the process of interpretation that Lord Hoffmann explained in AG Belize v Belize Telecom to ascertain what powers a reasonable man would have understood the MD to have been given by the board.
Applying this test, Arden LJ said this:
On this basis, as might be expected, the test of what is within the implied actual authority of a managing director coincides with the test of what is within the ostensible authority of a managing director: see Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 176.
This accords with the view expressed in the masterly work on the law of agency, Bowstead and Reynolds, where the editors explain that “actual authority” consists not only of authority conferred expressly on the agent (such as through a power of attorney) but also of: (a) incidental authority (which consists of those acts which are necessary to execute express authority); (b) usual authority (which is the authority an agent in such a position normally has) and (c) customary authority (which is the authority that is found in the general business practices of the particular segment). Readers will notice that “ostensible authority”, as the editors point out, will normally coincide with usual (and therefore implied actual) authority. This may seem somewhat anomalous at first sight since ostensible authority is premised on a lack of actual authority, but the explanation simply is that implied actual authority is relevant as between the agent and the principal, whereas ostensible authority is relevant as between the principal and the third party (thus a private instruction to an agent limiting his authority affects implied actual, but not ostensible authority, constructive notice apart). Of course, it should be noted that there is controversy over whether the classification of usual authority as a part of implied actual authority is correct, or whether it is more appropriate to consider it a species of apparent authority, or perhaps a distinct head of authority altogether.
This led Arden LJ to the conclusion that it could never have been intended by the board of directors that the MD have the power to suspend its chairman without its prior authorisation. But the importance of the analysis is that, contrary to the view expressed in Mitchell & Hobbs v Mill, an MD does have implied authority, including the authority to commence proceedings in the name of the company.* It is simply that this implied authority does not extend to suspending the chairman.
The Court of Appeal also affirmed the order made under section 306 ordering a meeting with a single member, since Mr James’ actions had clearly made it “impracticable” to order a meeting on the ordinary terms. In addition, the judge had ordered Mr James to pay the costs incurred by the company in resisting Mr Smith’s actions, and Arden LJ affirmed this on the principle that one who litigates in the name of the company without authority is liable to pay its costs.
* Readers may wish to note that Rimer LJ, although concurring with Arden LJ on the result, preferred to reserve his opinion on the implied authority of the MD to commence proceedings. But Mr Justice Ryder concurred with Arden LJ in the entirety of her judgment and that therefore is the judgment of the Court.

Tuesday, April 10, 2012

Revised FDI Policy

The Department of Industrial Policy and Promotion (DIPP) has issued the new Consolidated FDI Policy Circular 1 of 2012 that is effective from today. An accompanying press release lists the key changes.
Some of the key changes relate to sectoral issues:
- relaxation for foreign investment in commodity exchanges whereby FII investment may be brought in through the automatic route; and
- clarification regarding the scope of ‘leasing’ for investment in non-banking finance companies (NBFCs).
Others relate to the imposition of additional restrictions on foreign direct investment (FDI):
- unavailability of share issuance option for purchase of second hand machinery from foreign suppliers; and
- the need to make prior intimation to the Reserve Bank of India (RBI) while increasing the limit of 24% foreign institutional investments (FIIs) in a single company.
The remaining changes formalize previous announcements that were already made by the Government:
- investments by foreign venture capital investors (FVCI) through private arrangements and purchase on stock exchange (discussed here);
- investments by qualified financial investors (QFI) (discussed here);
- liberalization of policy on transfer of shares in the financial services sector; and
- changes to sectoral policy in pharmaceuticals and single-brand retail trading.
In terms the periodicity of changes to the FDI policy, a decision has been taken to review the policy annually rather than to follow the current practice of bi-annual changes. In the interim, changes will be effected by way of press notes.
Although these are only the highlights of the policy, other issues might likely arise based on a detailed reading of the new policy, especially on matters of interpretation.