Many of us have been dissuaded at one time or the other from using the expression “and/or” in legal documentation. Despite inherent ambiguities, its use continues to be quite extensive. I came across this interesting piece containing detailed research on the topic, with the unequivocal conclusion: desist from using it.
Changes to Takeover Regulations
SEBI has approved most of the changes suggested by the Takeover Regulations Advisory Committee (TRAC) last year to the Takeover Regulations. The key changes are summarized in SEBI’s board note:
a) Initial trigger threshold increased to 25 % from the existing 15 %.
b) There shall be no separate provision for non-compete fees and all shareholders shall be given exit at the same price.
c) In cases of competitive offers, the successful bidder can acquire shares of other bidder(s) after the offer period without attracting open offer obligations.
d) Voluntary offers have been introduced subject to certain conditions.
e) A recommendation on the offer by the Board of Target Company has been made mandatory.
In the following areas, SEBI either did not accept, or deviated from, the recommendations of TRAC:
f) Existing definition of control shall be retained as it is.
g) The minimum offer size shall be increased from the existing 20 % of the total issued capital to 26 % of the total issued capital.
The Board did not accept the recommendation of TRAC to provide for delisting pursuant to an offer and proportionate acceptance.
Here are some quick reactions:
2. As for the offer size, SEBI has not accepted the recommendations of TRAC to mandate a 100% offer. Understandably, those recommendations increase the cost of acquisition, especially in a scenario where bank or similar financing is hard to come by (if at all) for Indian acquirers. SEBI has instead adopted an interesting via media of increasing the offer size to 26%. The idea seems to be to provide the acquirer with the ability to obtain de jure control of the company, with an initial 25% acquisition coupled with 26% in the open offer (assuming full acceptance).
3. As far as the definition of “control” is concerned, SEBI’s decision to maintain status quo may perpetuate the existing ambiguity. While the increase in the mandatory offer threshold from 15% to 25% will provide more wiggle room for investors, adequate care must be taken to ensure that they do not get ensnared within the wide definition of “control”, which nevertheless triggers mandatory offer requirements. Although investors have obtained some respite with the favourable ruling in the Subhkam case, the uncertainty may be far from over given that an appeal has been filed in the Supreme Court.
Maiden Order under Merger Control Regulations
Legally India has reported the issuance of the first order by the Competition Commission of India (CCI) under the Combination Regulations that came into force on June 1, 2011.
CCI’s order considers the acquisition by Reliance Industries Limited and Reliance Industrial Infrastructure Limited (the Acquirers) of the 74% stake held by the Bharti Group in each of two joint venture insurance companies, namely Bharti AXA Life Insurance Company Limited and Bharti AXA General Insurance Company Limited. CCI does not seem to have any hesitation in clearing this acquisition proposal. Since the Acquirers do not directly operate in the life insurance or general insurance business and since the target entities do not operate in the Acquirers’ business, there was no question of a horizontal combination. As far as a vertical combination is concerned, a group company of the Acquirers is registered as an insurance broker thereby creating a vertical relationship with the target companies. However, CCI found this to be immaterial given the significant number of other insurance brokers operating in the field. CCI’s views are summarized in its order (which was delivered after surveying the number of players in the industry and the market share):
In light of the above, it is found that the Acquirers and the Acquired Enterprise(s) do not operate in interchangeable or substitutable products. Thus, there is no horizontal overlap in the proposed combination. There is also no significant vertical relationship found in the proposed combination which could pose any competitive constraints in the life and general insurance business. Taking into account the presence of many players in both the life and general insurance sectors and insignificant market share of each of the Acquired Enterprise(s) and having due regard to the factors given in sub-section (4) of Section 20 of the [Competition] Act, the Commission is of the opinion that the proposed combination is not likely to have an appreciable adverse effect on competition.
It appears that the only further information the CCI sought for was the binding acquisition agreement. Since that contemplates an option available to AXA to acquire further shares in the future (when sectoral caps are eased for foreign investment in the sector), the CCI has expressly stated that the present determination does not cover such an acquisition by AXA. Although that is fairly clear (since AXA is not directly a party to the current transaction), the CCI appears to insert such a disclaimer for abundant caution.
The importance of this order is not due to the complexity of its subject-matter, but rather because it is the first of its kind since the Combination Regulations were introduced. By issuing the order within days of being notified by the parties, the CCI has set a positive trend by indicating urgency, which is often crucial in M&A transactions. Readers will recall that possible delays with the CCI were the principal reason why the Combination Regulations were held up for over two years since the first draft was issued in 2009. In that sense, this is a favourable development. However, it is hoped that a similar approach with equal efficiency will be followed even in transactions where the facts are not as straightforward as this maiden case.
UNCTAD’s World Investment Report 2011
There have been several reports in the recent past about the continuing slide in FDI inflows into India. This has been confirmed by UNCTAD’s World Investment Report issued yesterday in which India’s ranking on FDI inflows has slipped to 14th in the world from 8th place last year. The report states the following reasons:
FDI to South Asia declined to $32 billion, reflecting a 31 per cent slide in inflows to India and a 14 per cent drop in Pakistan, the two largest recipients of FDI in the subcontinent. In India, the setback in attracting FDI was partly due to macroeconomic concerns, such as a high current account deficit and inflation, as well as to delays in the approval of large FDI projects; these factors are hindering the Indian Government’s efforts to boost investment, including the planned $1.5 trillion investment in infrastructure between 2007 and 2017.
Analysts also attribute the fall in FDI to other reasons such as extensive powers conferred upon Indian authorities to tax cross-border M&A as witnessed in the Vodafone case. Further, restrictions in significant aspects of the FDI policy, including the unavailability of foreign investment in several sectors, may also have precipitated the fall, although the Government has been constantly relaxing the regime, for example in the latest consolidated FDI Circular. However, the statistics seem to show that more needs to be done.
Supreme Court on Arbitrator's Powers to Grant Interest
A recent decision of the Indian Supreme Court considered the important question of the scope of an arbitrator’s powers to grant interest, and the extent to which this power may be limited by contract. The issue before the Court in Union of India v Krafters Engineers was fairly straightforward- when the arbitration agreement limits the powers of an arbitrator to grant interest, is it an absolute bar, or can any limitations be read into it? Given the thicket of conflicting judicial authority on this apparently simple point, the decision of the Court here is of enormous significance.
On the issue of granting interest pendent lite, relying on the Supreme Court’s decision in Government of Orissa v GC Roy, the Court held that the function of an award of interest is to compensate a party for the deprivation of money to which s/he was entitled, during the pendency of the litigation. Hence, unless the parties have otherwise agreed, an arbitrator, being an alternate forum for dispute resolution, has the power to award interest. It approved the following principle laid down in GC Roy:
Where the agreement between the parties does not prohibit grant of interest and where a party claims interest and that dispute (along with the claim for principal amount or independently) is referred to the arbitrator, he shall have the power to award interest pendente lite. This is for the reason that in such a case it must be presumed that interest was an implied term of the agreement between the parties and therefore when the parties refer all their disputes - or refer the dispute as to interest as such - to the arbitrator, he shall have the power to award interest. This does not mean that in every case the arbitrator should necessarily award interest pendente lite. It is a matter within his discretion to be exercised in the light of all the facts and circumstances of the case, keeping the ends of justice in view.
This was reiterated by the Supreme Court in NC Budharaj, where a “specific stipulation or prohibition in the contract” was required to displace this power to grant interest. The complication in this fairly straightforward area arose as a result of the decision in Engineers-De-Space-Age, where the Court held that even an express contractual prohibition did not curtail the powers of an arbitrator to grant interest pendent lite. The Court drew a distinction between interest for the period between the cause of action and the reference, and between the reference and the award. The contractual prohibition was held to apply only to the former and not to the latter. However, the Constitution Bench in Sayeed Ahmed doubted the validity of these observations. It went further and held that even if Engineers-De-Space-Age was good law under the 1940 Act, since there was a specific provision in s 31(7) of the 1996 Act, which subjected the power of the arbitrator to the agreement between the parties, the position under the 1996 Act would be different. This was markedly different from s 29 of the 1940 Act, dealing with the grant of interest on awards, which does not contain the phrase ‘unless otherwise agreed by the parties’. Again, in Madnani Construction, considering the 1940 Act, the Court held that the contractual bar did not affect the arbitrator’s powers to grant interest pendent lite. Interestingly, Sayeed Ahmed was not cited in Madnani, which only considered the conflict between Engineers-De-Space-Age and Saraswat Trading Agency, which could be reconciled on the language of the arbitral clause. This issue was finally considered by the Court in Kamatchi Amman Constructions, which affirmed Sayeed Ahmed, and the distinction drawn there between the language of the 1940 and the 1996 Acts. However, on facts there, the issue did not arise, since the arbitrator had exercised his discretion and refused to award interest.
Thus, the Court in Krafters Engineers was called on to decide an issue on which there is much conflicting authority, which had not been conclusively decided. After discussing this conflicting authority, the Court concludes,
Reliance based on the ratio in Board of Trustees for the Port of Calcutta (supra) is unacceptable since the said view has been overruled in Sayeed Ahmed and Company (supra) and insofar as the ratio in Madnani Construction Corporation Private Limited (supra) which is also unacceptable for the reasons mentioned in the earlier paras, we reject the stand taken by the counsel for the Respondent. On the other hand, we fully accept the stand of the Union of India as rightly projected by Mr. A.S. Chandhiok, learned ASG. We reiterate that where the parties had agreed that no interest shall be payable, the arbitrator cannot award interest for the amounts payable to the contractor under the contract. Where the agreement between the parties does not prohibit grant of interest and where a party claims interest and the said dispute is referred to the arbitrator, he shall have the power to award interest pendent elite. As observed by the Constitution Bench in G.C. Roy's case (supra), in such a case, it must be presumed that interest was an implied term of the agreement between the parties. However, this does not mean that in every case, the arbitrator should necessarily award interest pendente lite. In the subsequent decision of the Constitution Bench, i.e., N.C. Budharaj's case (supra), it has been reiterated that in the absence of any specific stipulation or prohibition in the contract to claim or grant any such interest, the arbitrator is free to award interest.
Thus, given a provision in the arbitration agreement that ‘No interest will be payable upon the Earnest Money or the Security Deposit or amounts payable to the Contractor under the Contract’, the Court applied s 31(7) of the 1996 Act to hold that the arbitrator did not have the power to grant interest. Another argument that is conclusively rejected is one which turned on the language of the arbitration agreement. In Engineers-De-Space-Age, it was held that a bar on one party claiming or paying interest was not necessarily a bar on the arbitrator awarding interest. This was considered “outlandish” in Sayeed Ahmed, approved in Kamatchi, and now stands affirmed in Krafters.
In sum, the position now is that under the 1996 Act, if the arbitration agreement curtails the arbitrator’s powers to grant interest, this limitation cannot be bypassed by drawing the distinction drawn in Engineers-De-Space-Age. Whether this distinction, approved in Madnani, continues to apply under the 1940 Act is still not conclusively decided, although serious doubts have been cast.
Gender Diversity on Corporate Boards
We have been examining the “mandatory vs. voluntary” debate with respect to corporate social responsibility (CSR). A similar debate has arisen with participation of women on corporate boards. Some countries (particularly in Europe) are adopting mandatory quota requirements. Others are adopting a voluntary approach, for example in the UK where executive search firms have published a voluntary code of conduct.
Quotas are too blunt a tool for such a tangled problem. The women companies are compelled to put on boards are unlikely to be as useful as those they place there voluntarily. Quotas force firms either to pad their boards with token non-executive directors, or to allocate real power on the basis of sex rather than merit. Neither is good for corporate governance. Norway started enforcing quotas for women in 2006. A study by the University of Michigan found that this led to large numbers of inexperienced women being appointed to boards, and that this has seriously damaged those firms’ performance.
Available statistics through a McKinsey report discussed by the Economist place India at the bottom of surveyed countries when it comes to women board-members as a percentage of the total. It ranks below the other BRIC countries of Brazil, Russia and China. There is certainly a case for increasing diversity on Indian boards through women participation, although that must indeed be through voluntary measures and not mandated by law (such as by quota).
Further Steps in Allowing FDI in Retail
Last week, the policy making machinery within the Government took the farthest steps so far towards permitting FDI in multi-brand retail. Reports indicate (here, here and here) that majority foreign ownership (up to 51%) will be allowed, although this is likely to be accompanied by a number of conditions including minimum foreign investment (said to be $100 million). Although further procedures (including assent from the Cabinet) are required before this can become law, it represents clarity in regulatory thought following the discussion paper issued by the DIPP last year.
Good Faith in English Contract Law
Over the past few years, the traditional distinction between the common law and civilian notions of good faith in the law of contract has been blurred. However, instead of incorporating a general obligation of good faith in contract, English law has adopted a piece-meal approach, by accepting the obligation of good faith in insurance contracts, when fiduciary relationships are involved, when expressly provided (Berkeley Community Villages v Pullen), or statutorily through legislations like the Unfair Contract Terms Act 1977. A recent decision of the High Court in Astrazeneca v Albemarle appears to be another incidence of this approach, where Flaux J incorporates good faith into the interpretation of ‘right of first refusal’ clauses in contracts.
The Court was called on to interpret a right of first refusal which was contractually granted by Astrazeneca to Albemarle. The former was a pharmaceutical company, which sold an anaesthetic named ‘Diprivan’. One of the ingredients of this anaesthetic is propofol, which Astrazeneca manufactured itself, by distilling another ingredient DIP, which was supplied to it by Albemarle. However, the supply contract between Astrazeneca and Albermarle provided that if even Astrazeneca decided to cease distillation, and procure propofol directly, Albemarle would be granted the right of first refusal to supply the propofol. The relevant clause in the contract was:
H– Switch to Propofol
In the event that at any time BUYER reformulates or otherwise changes its Diprivan brand to substitute propofol for the PRODUCT, BUYER will so notify SELLER and will give SELLER the first opportunity and right of first refusal to supply propofol to BUYER under mutually acceptable terms and conditions.
Subsequently, Astrazeneca decided to go ahead with procuring propofol from a third company, Sochinaz, which led to litigation between the parties. While the judgment of the Court is lengthy and deals with several issues, the relevant portions for the purposes of this discussion is only from ¶¶ 1-65. There were three issues before Flaux J:
What is the meaning of ‘first opportunity and right of first refusal’?
What degree of flexibility does ‘under mutually acceptable terms and conditions’ allow Astrazeneca?
At what time can such a right of first refusal be said to have been breached?
Flaux J, based on a review of prior precedent, which constituted only four previous decisions of the English High Court, concluded that such a clause could not be said to be void on grounds of uncertainty, and conferred a clear right on Albamerle. Also, the right of first refusal meant that the grantor of the right was under an obligation, when desirous of entering into a contract with a third party, to make an offer to the grantee on terms which the grantor would be willing to accept. This meant that the essence of the ‘deal’ which the grantor was willing to enter into with the third party should be communicated to the grantee, and the grantee should be provided the opportunity to negotiate on the basis of the same ‘deal’. Further, once these negotiations commenced, the grantor had an obligation to carry on these negotiations in good faith. Thus, Flaux J provided for good faith to operate at two stages, albeit having a bit of an overlap, are nevertheless distinct. First, the grantor must convey the deal it was willing to accept to the grantee. The terms of the deal need not be spelled out, especially in cases like the present, where the relevant clause expressly provided for ‘mutually acceptable terms and conditions’ to be arrived at subsequently. However, once this deal was communicated, the grantor also has an obligation to continue the negotiations in good faith. As to the third issue outlined above, on facts, due to procedural and regulatory reasons, there would be a lapse of between eighteen months and three years between the deal with a third party, and the final conclusion of a contract after the procurement of the necessary licenses. In such a case, Flaux J held that the obligation to make an offer to Albamerle (or to provide them an opportunity to make an acceptable offer, as was the case here) arose when the deal with Sochinaz was agreed in principle, and not when the final contract was concluded.
What is most important about this decision, which appears eminently reasonable and not particularly remarkable, is that Flaux J bases Albamerle contractual rights entirely on the meaning of ‘the right of first refusal’ in English common law, starting from the decision of Brightman J in Smith v Morgan, and ending with Park J’s supplemental judgment in QR Sciences v BTG International. This is a clear indication that the very right of first refusal has a stand-alone meaning at common law, which presumably would apply to every contract, unless otherwise expressed by the parties. What Flaux J’s review of precedent also makes clear is that there is no general principle of good faith negotiation in English contract law, with the cases relied on dealing only with rights of first refusal. Thus, this is another instance of the incremental approach which English law has adopted to good faith in the law of contract.
Enforceability of “Side Letters”
Background
It is customary for parties to enter into “side letters” in corporate and commercial transactions. Side letters are documents which are ancillary to the principal transaction documentation. There are a number of reasons why parties could potentially enter into side letters, rather than include their subject matter in the principal documentation. Side letters are useful when parties wish to complete the transaction without finalizing the terms of certain aspects of the deal, the broad contours of which may be included in a side letter for formalization post-closing. They are used to set out private inter-se arrangements between some (but not all) of the parties to the principal documentation. It may not altogether be unreasonable for parties to omit certain terms from the principal documentation and include them in side letters instead if those terms contain sensitive information that cannot be put out in the public domain (for example those that may confidential in nature or those that could be subject to misuse by competitors).
Despite the seeming usefulness of side letters, they generate uneasy legal issues on their enforceability. For example, is a side letter a legally binding contractual arrangement that is enforceable in a court of law? Does a side letter vary or amend the terms of the principal documentation (in case parties are the same)? While there are no straightforward answers to these questions, courts in different jurisdictions have had the opportunity to consider some of them, and here we discuss one recent judgment of an English court in Barbudev v. Eurocom Cable Management Bulgaria [2011] EWHC 1560 (QBD, Comm) that decided upon the enforceability of a side letter.
Facts and Decision
Barbudev brought an action before the court seeking to enforce the terms of the side letter against ECMB. The court in this case ruled in favour of ECMB and refused to enforce the side letter.
On the issue of whether the side letter constituted a legally enforceable contract, the court examined “three questions – whether the Side Letter was intended to create legal relations, whether it was an agreement to agree, and whether it was a sufficiently complete and certain contractual agreement”. Each of these questions was dealt with separately:
1. Intention to create legal relations
The court examined the language of the side letter as a matter of construction and found that the Side Letter was not intended to be legally binding. The fact that it made a reference to an Investment Agreement (to be entered into between the parties) showed that only such a concluded agreement was intended to be binding. Moreover, an agreement can be intended to create legal relations only if it is legally enforceable (based on the conclusions to the other two questions below).
2. Agreement to agree
The court held that in order for an agreement to be enforceable, it must be sufficiently complete and certain on all essential terms. In other words, it must be a self-effectuating document. If it does not contain matters that are essential to its implementation, then it would be invalid as it is too incomplete or uncertain to enforce.
For the reasons set forth, the court refuse to enforce the side letter in this case.
Analysis
This case involves an intricate area of the law where there are judicial decisions both ways. In the Barbudev case, the court has sought to emphasise some of the issues to be considered while determining the enforceability of side letters. In doing so, it has followed another recent English case in Dhanani v. Crasnianski [2011] EWHC 926 (Comm.) which also held that an agreement to agree and negotiate further is not legally binding.
The principles enumerated above provide some indications in terms of the nature of drafting that goes into side letters. This discussion would also equally extend to other types of documents which do not fully set forth the terms of a transaction – these customarily include documents such as letter of intent, memorandum of understanding, term sheet, comfort letter, and the like. In essence, courts would construe the nature of these documents and the intention of the parties from a construction of the document itself. Hence, it pays to include as much clarity as possible into such documents as regards the intention of the parties, i.e. whether they intend it to be enforceable or not. If the intention of the parties is to have the document bind the parties, then it is prudent not only to expressly state so but also to include all the essential terms that are required to perform the terms of the agreement. On the other hand, if parties do not intend it to be binding, the simplest solution to avoid subsequent disputes is to expressly state that the document will not be legally binding. It is silence (of the nature we see in the Barbudev side letter) that creates ambiguity as to whether it is enforceable or not, although it is entirely possible that parties may sometimes find it in their interests to prefer ambiguity over certainty and clarity and therefore to remain silent (which must nevertheless be a conscious choice).
It is customary for parties to enter into “side letters” in corporate and commercial transactions. Side letters are documents which are ancillary to the principal transaction documentation. There are a number of reasons why parties could potentially enter into side letters, rather than include their subject matter in the principal documentation. Side letters are useful when parties wish to complete the transaction without finalizing the terms of certain aspects of the deal, the broad contours of which may be included in a side letter for formalization post-closing. They are used to set out private inter-se arrangements between some (but not all) of the parties to the principal documentation. It may not altogether be unreasonable for parties to omit certain terms from the principal documentation and include them in side letters instead if those terms contain sensitive information that cannot be put out in the public domain (for example those that may confidential in nature or those that could be subject to misuse by competitors).
Despite the seeming usefulness of side letters, they generate uneasy legal issues on their enforceability. For example, is a side letter a legally binding contractual arrangement that is enforceable in a court of law? Does a side letter vary or amend the terms of the principal documentation (in case parties are the same)? While there are no straightforward answers to these questions, courts in different jurisdictions have had the opportunity to consider some of them, and here we discuss one recent judgment of an English court in Barbudev v. Eurocom Cable Management Bulgaria [2011] EWHC 1560 (QBD, Comm) that decided upon the enforceability of a side letter.
Facts and Decision
Barbudev had been the CEO and 40% shareholder of a Bulgarian cable television and internet company (target company). The target company was acquired by ECMB, which was a part of the Warburg Pincus group. During the negotiations for the acquisition, Barbudev expressed his keenness on taking a stake in the purchaser company. However, the parties were unable to agree upon the terms of Barbudev’s investment in the purchaser before the acquisition for the target company was complete. Hence, the parties agreed to enter into a side letter, the principal terms of which were as follows:
Investment AgreementIn consideration for you agreeing to enter into the Proposed Transaction and to sign the Transaction Documents, the Purchaser hereby agrees that, as soon as reasonably practicable after the signing of the Agreement by all Parties, we shall offer you the opportunity to invest in the Purchaser on the terms to be agreed between us which shall be set out in the Investment Agreement and we agree to negotiate the Investment Agreement in good faith with you. Such terms shall include, without limitation the following:1. you shall invest an aggregate amount of not less than Euro 1,650,000 in consideration for a combination of shareholder debt and registered shares which shall represent ten (10) per cent. of the registered share capital of the Purchaser on the date of the Investment Agreement;
…3. tag along and drag along provisions which are customary for a transaction of this nature shall be included in the Investment Agreement. [Emphasis supplied]
Subsequent to the acquisition of the target company, certain other issues arose due to which the parties were unable to negotiate and finalise an Investment Agreement as contemplated in the side letter. In the meanwhile, ECMB even sold its investment in the target company.
Barbudev brought an action before the court seeking to enforce the terms of the side letter against ECMB. The court in this case ruled in favour of ECMB and refused to enforce the side letter.
On the issue of whether the side letter constituted a legally enforceable contract, the court examined “three questions – whether the Side Letter was intended to create legal relations, whether it was an agreement to agree, and whether it was a sufficiently complete and certain contractual agreement”. Each of these questions was dealt with separately:
1. Intention to create legal relations
The court examined the language of the side letter as a matter of construction and found that the Side Letter was not intended to be legally binding. The fact that it made a reference to an Investment Agreement (to be entered into between the parties) showed that only such a concluded agreement was intended to be binding. Moreover, an agreement can be intended to create legal relations only if it is legally enforceable (based on the conclusions to the other two questions below).
2. Agreement to agree
The court reiterated the principle under English law that “an agreement to agree is legally unenforceable”. [Note that the Indian position would be similar by virtue of section 29 of the Contract Act, 1872 which treats certain agreements as void for uncertainty.] Even though the broad terms of the investment were set out in the side letter (as extracted above), the court was not convinced of its certainty and sufficiency. It observed (at para. 103):
As a matter of construction of the document, I consider that the agreement to negotiate in good faith extends not merely to the proposed Investment Agreement, but to the price to be paid by Mr. Barbudev and the percentage to be acquired as well. The reason is that the terms of the letter (“not less than”) allowed for negotiation of an amount of more than Euro 1.65 million, and did not settle how the combination of shareholder debt and shares representing 10% of the share capital was to be made up. Even on those key terms, therefore, although the parties had agreed in principle, there was no finality. … [T]he terms of the document as well as surrounding circumstances make it clear that they had not actually reached agreement.
3. Certainty of terms
The court held that in order for an agreement to be enforceable, it must be sufficiently complete and certain on all essential terms. In other words, it must be a self-effectuating document. If it does not contain matters that are essential to its implementation, then it would be invalid as it is too incomplete or uncertain to enforce.
For the reasons set forth, the court refuse to enforce the side letter in this case.
Analysis
This case involves an intricate area of the law where there are judicial decisions both ways. In the Barbudev case, the court has sought to emphasise some of the issues to be considered while determining the enforceability of side letters. In doing so, it has followed another recent English case in Dhanani v. Crasnianski [2011] EWHC 926 (Comm.) which also held that an agreement to agree and negotiate further is not legally binding.
The principles enumerated above provide some indications in terms of the nature of drafting that goes into side letters. This discussion would also equally extend to other types of documents which do not fully set forth the terms of a transaction – these customarily include documents such as letter of intent, memorandum of understanding, term sheet, comfort letter, and the like. In essence, courts would construe the nature of these documents and the intention of the parties from a construction of the document itself. Hence, it pays to include as much clarity as possible into such documents as regards the intention of the parties, i.e. whether they intend it to be enforceable or not. If the intention of the parties is to have the document bind the parties, then it is prudent not only to expressly state so but also to include all the essential terms that are required to perform the terms of the agreement. On the other hand, if parties do not intend it to be binding, the simplest solution to avoid subsequent disputes is to expressly state that the document will not be legally binding. It is silence (of the nature we see in the Barbudev side letter) that creates ambiguity as to whether it is enforceable or not, although it is entirely possible that parties may sometimes find it in their interests to prefer ambiguity over certainty and clarity and therefore to remain silent (which must nevertheless be a conscious choice).
Announcements: Calls for Papers
(The following announcements may be of interest to our readers although they do not directly relate to the subject-matter of this Blog)
A. Socio-Legal Review
Socio-Legal Review welcomes contributions for its eighth volume to be released in 2012.
The Socio-Legal Review (SLR) is a student-edited, peer-reviewed interdisciplinary journal published annually by the Law and Society Committee of the National Law School of India University, Bangalore. The Journal aims to be a forum that involves, promotes and engages students and scholars to express and share their ideas and opinions on themes and methodologies relating to the interface of law and society. SLR thus features guest articles by eminent scholars as well as student essays, providing an interface for the two communities to interact.
The Journal subscribes to an expansive view on the interpretation of “law and society” thereby keeping its basic criteria for contributions simply that of high academic merit, as long as there is a perceivable link. This would include not just writing about the role played by law in social change, or the role played by social dynamics in the formulation and implementation of law, but also writing that simply takes cognizance of legal institutions/ institutions of governance/administration, power structures in social commentary and so on. Through this effort, the journal also hopes to fill the lacunae relating to academic debate on socio-legal matters among law students.
SLR has been listed in the Directory of Open Access Journals and has been uploaded on Westlaw and Heinonline. It was supported by the Modern Law Review for three years and entered into an agreement with SAGE in 2010, to sponsor the Annual SLR-Sage Essay Writing Competition.
Contributions should be mailed only in a soft copy to slr@nls.ac.in.
B. 3rd NUS-AsianSIL Young Scholars Workshop 2012
The National University of Singapore (NUS) and the Asian Society of International Law (AsianSIL) are pleased to invite applications to attend the 3rd NUS-AsianSIL Young Scholars Workshop 2012 – Asian Approaches to International Law. The Workshop will be held at NUS in Singapore from Thursday, 23 February to Friday, 24 February 2012.
The workshop builds on the success of the first and second NUS-AsianSIL Young Scholars Workshops in 2008 and 2010 and is intended to cultivate the next generation of international legal scholars. Younger academics, doctoral students, young legal professionals with an interest in scholarship are encouraged to apply. Exceptional Master’s students are also welcome to submit their abstracts. Paper-givers who are selected through a competitive process will have their reasonable expenses covered.
Theme for the 2012 Workshop
Asia has long been an outlier both in terms of its international institutions and its embrace of international law. Asia has not chosen to construct regional institutions comparable to those in Europe, Africa, and the Americas, preferring to adopt an approach of variable geometry and pragmatic alliances. The region’s commitment to what some call the “Asian way” has sometimes privileged consultation and consensus over clear and binding obligations. The 3rd NUS-AsianSIL Young Scholars Workshop 2012 seeks to explore, from the perspective of younger scholars from Asia, how international law in the region has developed and what its prospects are in the decades to come.
The Workshop is intended to provide a platform for younger academics from the region to discuss ongoing research in international law with one another and more senior commentators. It also fosters the presence of “Asian voices” in international law through the post-Workshop publication of cutting edge research in the Asian Journal of International Law. (Please note that while all paper submissions shall be considered for publication, the Asian Journal of International Law’s offer to publish is subject to peer-review and editorial discretion.)
Proposals from young scholars and professionals across the region are encouraged on any topic linked to international law, but particularly focusing on Asian Approaches to International Law. Subject areas might include (a) History and Theory of International Law, (b) Law of Armed Conflict (IHL), (c) International Organizations, (d) Dispute Settlement, (e) Law of the Sea, (f) Law of Environment, (g) Human Rights, (h) International Criminal Law, (i) Law of Development, (j) International Economic Law, (k) Private International Law (Conflict of Laws).
To submit a proposal, please complete the Online Abstract Submission Form by Friday, 16 September 2011.
Details on the workshop can be found at http://asiansil.org/conference/YSW2012/
Those selected to participate in the workshop will be notified by Friday, 7 October 2011. Participation will be contingent on producing a draft of the paper (in the order of 8,000 words) by Friday, 30 December 2011.
Companies Bill Rekindled
The recent change at the helm of affairs of the Ministry of Corporate Affairs (MCA) has rekindled the discussion on the Companies Bill. Newspaper reports indicate that the new Bill is expected to be introduced in Parliament during the monsoon session that begins August 1. The reports also highlight some key areas recently at the forefront.
It has been suggested that SEBI will be conferred powers to regulate all companies (whether listed or unlisted) that raise public funds. This seems to come at the heels of the Sahara controversy where the companies have challenged SEBI’s powers. Of course, we do not yet know the details of the changes proposed, but if the change is intended to be clarificatory in nature such that it covers all “public” offering of securities (even by unlisted companies) that is understandable. However, if the proposal is to provide greater authority to SEBI to investigate all share issuances by SEBI (whether they relate to 50 offerees or less), that would be a case of overregulation. Unlisted companies must be given the flexibility of carrying on financing their businesses through issuance of shares when it is within the domain of private placements – in such a case no public interest is involved. In its pursuit of dealing with exceptional situations such as those in the Sahara case, the Companies Bill should not come in the way of genuine private fund raising by unlisted companies. The problems of excessively applying securities regulations to unlisted companies are only too well-known because the Securities Contracts (Regulation) Act (SCRA) is sought to be applied by courts and regulators to such companies as well thereby inhibiting transactions such as forward contracts and options in securities.
Another suggestion is that corporate social responsibility (CSR) will be made mandatory in the Bill. This represents a flip-flop on the issue as the last known stance of the MCA was that the CSR requirement would be introduced in the nature of a disclosure obligation (by way of “comply-or-explain) rather than a mandatory requirement.
Miscellaneous
The following developments and readings may be of interest:
1. Sahara: Public Offering vs. Private Placement
We have been following the Sahara case as it involves the crucial question of what differentiates a public offering from a private placement of securities under Indian company law and securities regulation. Newspaper reports (here, here and here) indicate that the Supreme Court has now asked the company to approach the Securities Appellate Tribunal (SAT) for a determination rather than the High Court of Allahabad (as it has done in the past).
The Supreme Court is said to have underscored the importance of the issue:
2. SEBI Actions
Mobis Phillipose has an interesting analysis on the tough stance adopted by SEBI in the Sahara case as well as in the public offering process involving another company, Vaswani Industries Ltd.
In terms of due process, SEBI has begun the practice of permitting alleged offenders to cross-examine witnesses.
3. SEC’s Actions Against Outside Directors
The Harvard Law School Forum on Corporate Governance and Financial Regulation has a detailed post on recent actions initiated by the US SEC against outside (independent) directors of public corporations. Although the discussion largely pertains to relevant US securities regulation, there are some general ideas regarding possible mitigating steps directors may undertake at the time of joining public company boards and during their tenure.
4. Infrastructure Finance
A number of new ideas are being floated for filling the current gap in financing infrastructure development. One that is fructifying is the infrastructure development fund, although that is subject to shortcomings. Some have even lamented the conversion of developmental financial institutions (DFIs) (that earlier performed this role) into banks.
5. FDI in Retail
The discussions to allow foreign direct investment (FDI) in multibrand retail seem to be advancing at a rapid pace, with expectation of some kind of policy pronouncement from the Government in the near future. This post in the Critical Twenties Blog contains a recent analysis.
1. Sahara: Public Offering vs. Private Placement
We have been following the Sahara case as it involves the crucial question of what differentiates a public offering from a private placement of securities under Indian company law and securities regulation. Newspaper reports (here, here and here) indicate that the Supreme Court has now asked the company to approach the Securities Appellate Tribunal (SAT) for a determination rather than the High Court of Allahabad (as it has done in the past).
The Supreme Court is said to have underscored the importance of the issue:
We are asking for an early hearing because this is a very important matter. It [is] a fundamental question of law.This development at least indicates that the dispute is likely to be resolved in a more focused manner. Since SAT is the appropriate authority to examine appeals from SEBI, the matter should perhaps never have been taken to the High Courts in the first place from SEBI’s initial order (although that may have been due to the company’s challenge of SEBI’s jurisdiction).
2. SEBI Actions
Mobis Phillipose has an interesting analysis on the tough stance adopted by SEBI in the Sahara case as well as in the public offering process involving another company, Vaswani Industries Ltd.
In terms of due process, SEBI has begun the practice of permitting alleged offenders to cross-examine witnesses.
3. SEC’s Actions Against Outside Directors
The Harvard Law School Forum on Corporate Governance and Financial Regulation has a detailed post on recent actions initiated by the US SEC against outside (independent) directors of public corporations. Although the discussion largely pertains to relevant US securities regulation, there are some general ideas regarding possible mitigating steps directors may undertake at the time of joining public company boards and during their tenure.
4. Infrastructure Finance
A number of new ideas are being floated for filling the current gap in financing infrastructure development. One that is fructifying is the infrastructure development fund, although that is subject to shortcomings. Some have even lamented the conversion of developmental financial institutions (DFIs) (that earlier performed this role) into banks.
5. FDI in Retail
The discussions to allow foreign direct investment (FDI) in multibrand retail seem to be advancing at a rapid pace, with expectation of some kind of policy pronouncement from the Government in the near future. This post in the Critical Twenties Blog contains a recent analysis.
Voluntary Guidelines on Environmental Social Governance
The Ministry of Corporate Affairs (MCA) this week issued the National Voluntary Guidelines on Social, Environmental & Economic Responsibilities of Business (ESG Guidelines), which represents a significant and substantial effort in enhancing the protection of stakeholder interests in the corporate sector.
The concepts of stakeholder interests and corporate social responsibility (CSR) have gained importance in the Indian context more recently. The first formal initiative from the Government came in the form of the Corporate Social Responsibility Voluntary Guidelines, 2009. However, a reading of those Guidelines would suggest that they were overly broad in nature with insufficient detail to enable concrete action by companies. In the meanwhile, the debate over the Companies Bill, 2009 also raised questions of whether CSR should be made mandatory, although the current thinking seems to be to retain it as a voluntary effort.
In this context, the new ESG Guidelines do well to establish concrete measures that may be voluntarily adopted by companies to address interests of various stakeholders such as employees, customers and the environment. They suprecede the Guidelines of 2009 and revolve around 9 core principles, which are:
1. Businesses should conduct and govern themselves with Ethics, Transparency and Accountability;
2. Businesses should provide goods and services that are safe and contribute to sustainability throughout their life cycle;
3. Businesses should promote the wellbeing of all employees;
4. Businesses should respect the interests of, and be responsive towards all stakeholders, especially those who are disadvantaged, vulnerable and marginalised;
5. Businesses should respect and promote human rights;
6. Business should respect, protect, and make efforts to restore the environment;
7. Businesses, when engaged in influencing public and regulatory policy, should do so in a responsible manner;
8. Businesses should support inclusive growth and equitable development; and
9. Businesses should engage with and provide value to their customers and consumers in a responsible manner.
Each of these core principles receives further elaboration in the ESG Guidelines. Emphasis has also been placed on the importance of corporate governance and disclosures in achieving overall stakeholder protection, a matter that some of us have called for in the past.
While the ESG Guidelines set the right tone, much would depend on the nature and extent of adoption by companies, and the manner in which they are implemented in practice. The ideals are nevertheless lofty, as this statement from the preface to the Guidelines indicate:
The Guidelines emphasize that businesses have to endeavour to become responsible actors in society, so that their every action leads to sustainable growth and economic development. Accordingly, the Guidelines use the terms 'Responsible Business' instead of Corporate Social Responsibility (CSR) as the term 'Responsible Business' encompasses the limited scope and understanding of the term CSR.
The Guidelines take into account the learnings from various international and national good practices, norms and frameworks, and provide a distinctively 'Indian' approach, which will enable businesses to balance and work through the many unique requirements of our land. By virtue of these Guidelines being derived out of the unique challenges of the Indian economy and the Indian nation, they take cognizance of the fact that all agencies need to collaborate together, to ensure that businesses flourish, even as they contribute to the wholesome and inclusive development of the country. The Guidelines emphasize that responsible businesses alone will be able to help India meet its ambitious goal of inclusive and sustainable all round development, while becoming a powerful global economy by 2020.
Hat tip: Richa Naujoks
The New Microfinance Institutions Bill
Over the last year or so, there has been a serious debate about the nature of regulation governing the microfinance sector. In view of the debacle in Andhra Pradesh, the Reserve Bank of India (RBI) had appointed a committee under the chairmanship of Mr. Malegam to review issues pertaining to the sector. The committee submitted its report in January this year.
In view of these events, the Government decided to relook at the Microfinance Bill previously presented in Parliament in 2007. Consequently, the Ministry of Finance has drafted the Micro Finance Institutions (Development and Regulation) Bill, 2011, which is published on its website for comments which are due August 7, 2011.
Under the new Bill, the RBI is designated as the umbrella authority that will regulate microfinance institutions. The Bill details the powers exercisable by RBI over the various types of institutions currently carrying on microfinance activity (which include non-banking finance companies and cooperatives). More importantly, the draft legislation seeks to do away with the fragmentation that currently exists in regulating the sector. For example, RBI’s role is expected to supersede regulatory powers exercised by various state governments, such as Andhra Pradesh that swiftly promulgated an ordinance last year that significant curtailed the ability of microfinance institutions to carry out their activities in that state. However, states can be expected to challenge the possible usurpation of powers by Parliament (and there are already signs of that occurring), which in turn lead to interesting constitutional questions involving the division of legislative powers between the centre and the states.
As for regulation of the sector itself, the scope of the Bill largely covers the role of RBI in overseeing the sector in terms of its supervisory powers over various institutions carrying on microfinance activity. All institutions will be required to register with the RBI. In that sense, it does not cover the whole gamut of issues considered by the Malegam committee. Moreover, as noted in this critique, the Bill’s predominant focus on organizational aspects of microfinance institutions overshadows the required regulation on the relationship between the institutions and their customers, who are represented by the needy sections of society. The Bill perhaps lacks in its silence on the latter aspect.
Although the Bill is an important step in generating greater discourse on the topic, it is bound to generate issues or objections from various interest groups, with the likelihood that its passage in any form or its implementation could be met with delays.
Fuerst Day Lawson: S. 50 Arbitration Act, and "consolidating legislation"
On Friday, a two-judge Bench of the Supreme Court (Alam and Lodha JJ.) gave judgment in Fuerst Day Lawson v Jindal Exports [hereinafter “FDL”]. The judgment contains a careful and comprehensive examination of a long line of authorities, and an authoritative analysis of two very important issues in arbitration law and civil procedure—whether a Letters Patent Appeal [“LPA”] is maintainable in circumstances in which an appeal does not lie under either s. 37 or s. 50 of the Arbitration and Conciliation Act, 1996 [“the 1996 Act”], and more generally, what it means to say (correctly) that the 1996 Act is a consolidating legislation. This post provides a detailed account of the reasons the Court gave (omitting a preliminary objection), with paragraph numbers to facilitate easy reference; a second post will discuss some of those reasons in more detail.
The case arose out of a batch of appeals from the Delhi and Calcutta High Courts in which an order of a single judge on an application to enforce a foreign award had been challenged before a Division Bench, under Letters Patent Rules. The Delhi High Court had held that such appeals are not maintainable; the Calcutta High Court had taken the contrary view. The Supreme Court’s conclusion that an LPA is not maintainable in these circumstances was based on its analysis of three broad sets of issues, of which the second and the third are the most important.
First, the Court examined cases in which it had been argued that an order passed by a single judge under various special legislation is immune from challenge under the Letters Patent Rules. These cases did not fall into any pattern. For example, the Supreme Court had held that an LPA is maintainable against a judgment given by a single judge under: (a) s. 76(1) of the Trademarks Act, 1940 (National Sewing Thread Co v James Chadwick—a three-judge Bench); (b) s. 6 of the Specific Relief Act, 1963 (Vinita Khanolkar v Pai—a two-judge Bench); (c) s. 54 of the Land Acquisition Act, 1894 (Sharda Devi v State of Bihar—a three-judge Bench); (d) s. 299 of the Indian Succession Act, 1925 (Subal Paul v Malina Paul—a three-judge Bench) and (e) order 21 of the Civil Procedure Code [“CPC”], for example in an application to set aside a sale (PS Sathappan v Andhra Bank—a Constitution Bench). Several reasons were given in these cases—that exclusion of jurisdiction cannot be readily inferred (Subal Paul); the general principle that an appeal, once it is before a court, must be regulated in accordance with the rules of practice of that court, including Letters Patent (James Chadwick) and that Letters Patent jurisdiction must be excluded expressly, because it was preserved by the Government of India Act and the Constitution of India (Sharda Devi; Vinita Khanolkar). On the other hand, the Court had held, for example, that an LPA is not maintainable against a judgment given by a single judge under s. 39(1) of the Arbitration Act, 1940 (Union of India v Mohindra Supply and other cases), principally because the provision indicated that the legislature intended to create a self-contained code of adjudication. In FDL, the Supreme Court demonstrated (¶29) that these cases do not really conflict, and noted that Subal and PS Sathappan expressly recognised that a self-contained code can have the effect of excluding any general rule of civil procedure, including LPA. In other words, the question had to be resolved by simply asking on which side of the line the legislature intended s. 50 of the Arbitration Act to fall, and not by resort to any general principle that LPA can, or cannot, be easily excluded.
Secondly, this led the Court to examine the relationship between three arbitration legislations—s. 39 of the Arbitration Act, 1940 [“the 1940 Act”], s. 6 of the Foreign Awards (Recognition and Enforcement) Act, 1961 [“the 1961 Act”] and ss. 37, 49 and 50 of the 1996 Act. S. 39 of the 1940 Act corresponds to s. 37 of the 1996 Act, which provides, in Part I of the Act, that an appeal “shall lie from the following orders (and from no others)”, and proceeds to list those orders. S. 50 of the 1996 Act provides, in Part II of the Act, that “an appeal shall lie from the order” refusing to refer the parties to arbitration under s. 45 or enforce a foreign award under s. 48. It does not contain the expression “and from no others”. Senior counsel for FDL therefore conceded that Mohindra Supply would apply pro tanto to an appeal against a judgment under s. 37, but argued that s. 50 is different because of the omission of the crucial expression “and from no others”. The Supreme Court held that even if ss. 37 and 50 are to be treated differently (¶51), it is not because of the expression “and from no others”. For one, it is possible that it was merely clarificatory, since it was used in “brackets” by the legislature (¶¶ 36, 37), and more importantly, a close analysis of the 1961 Act, the predecessor to s. 50, demonstrated that there was a powerful reason to construe s. 50 narrowly. Under s. 6(1) of the 1961 Act, a foreign award was enforced in India by a court pronouncing judgment “according to the award”. In other words, it was the decree of an Indian court embodying a foreign award that was enforced, and s. 6(2) provided that no appeal would lie from that decree except where the decree is “in excess of or not in accordance with the award”. The 1996 Act makes a fundamental change to this scheme, because s. 49 provides that a foreign award that a court is satisfied is enforceable “shall be deemed to be a decree of that Court.” The result, as the Supreme Court observes in FDL (¶58), is not only to eliminate the intervening procedural step of giving judgment embodying the foreign award, but also to “completely remove” the possibility of an appeal even on the limited ground that s. 6(2) previously provided. The inference from this is best expressed in the words of the Supreme Court (¶59): “[i]t would be futile, therefore, to contend that though the present Act even removes the limited basis on which the appeal was earlier maintainable, yet a Letters Patent Appeal would lie notwithstanding the limitations imposed by Section 50 of the Act.” An important question, of course, is whether an LPA was excluded under s. 6(1) of the 1961 Act, notwithstanding s. 6(2), and will be discussed in more detail subsequently.
The third reason the Supreme Court gave for its conclusion is of even wider significance—it held that an LPA must be taken to have been excluded by the legislature because the 1996 Act is a consolidating legislation. In support of this proposition, the Court referred to the Statement of Objects and Reasons and the Bill that preceded the Act, and in particular to the limited “supervisory” jurisdiction envisaged for the courts, in line with the goals of the UNCITRAL Model Law. In addition, the Court noticed that the 1940 Act, which was itself the successor legislation to the Arbitration Act, 1899, had raised similar questions, and that the courts had almost uniformly taken the view that there was no room to bring an ordinary civil suit to enforce an arbitration agreement “outside” the definition of that term in the 1940 Act (Meredith J., Gauri Singh v Ramlochan Singh and Chagla C.J., Natverlal Bhalakia)—this was a close analogy to the question whether an appeal under “ordinary civil law” is maintainable notwithstanding a specific appeal mechanism under the 1996 Act (¶60). Furthermore, the very question before the Supreme Court—whether an LPA is maintainable—had been answered in the negative in Mohindra Supply in the context of the 1940 Act. The conclusion the Supreme Court drew from this (¶72) was as follows:
72. It is, thus, to be seen that Arbitration Act 1940, from its inception and right through 2004 (in P.S. Sathappan) was held to be a self-contained code. Now, if Arbitration Act, 1940 was held to be a self-contained code, on matters pertaining to arbitration the Arbitration and Conciliation Act, 1996, which consolidates, amends and designs the law relating to arbitration to bring it, as much as possible, in harmony with the UNCITRAL Model must be held only to be more so. Once it is held that the Arbitration Act is a self-contained code and exhaustive, then it must also be held, using the lucid expression of Tulzapurkar, J., that it carries with it "a negative import that only such acts as are mentioned in the Act are permissible to be done and acts or things not mentioned therein are not permissible to be done" (emphasis mine).
In summary, this important judgment of the Supreme Court clarifies that (a) s. 50 of the 1996 Act is even narrower than its predecessor, s. 6 of the 1961 Act; (b) more generally, that implied exclusion of ordinary civil jurisdiction depends on a close analysis of the structure of the special legislation as evidence of the likely intention of the legislature; and (b) that a consolidating legislation is more likely to have so intended than other special legislation. A subsequent post will discuss these reasons in more detail, and the implications for other areas of the Arbitration Act of the use the Court made of the fact that it is a consolidating legislation.
Patni Computer Systems: Transfer Pricing and "International Transaction"
The Pune Bench of the Income Tax Appellate Tribunal recently clarified several aspects of the law in relation to transfer pricing, as well as some issues in relation to the position in relation to Section 10A of the Income Tax Act, 1961. The elaborate decision, Patni Computer Systems v. DCIT, is available here.
Insofar as the issues in relation to Section 10A are concerned, the principle issue was whether the losses of 10A-eligible units could be set off against the normal business income of the assessee. In the context of Section 10B of the Act, the Bombay High Court has held in Hindustan Unilever v. DCIT, 38 DTR 91 (Bom) that losses of 10B units can be set off against normal business income. The Court had observed:
“Prior to the substitution of the provision, the earlier provision stipulated that any profits and gains derived by an assessee from a 100 per cent Export Oriented Undertaking, to which the section applies "shall not be included in the total income of the assessee". The provision, therefore, as it earlier stood was in the nature of an exemption. After the substitution of Section 10B by the Finance Act of 2000, the provision as it now stands provides for a deduction of such profits and gains as are derived by a 100 per cent Export Oriented Undertaking from the export of articles or things or computer software for ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce. Consequently, it is evident that the basis on which the assessment has sought to be re-opened is belied by a plain reading of the provision. The Assessing Officer was plainly in error in proceeding on the basis that because the income is exempted, the loss was not allowable. All the four units of the assessee were eligible under Section 10B. Three units had returned a profit during the course of the assessment year, while the Crab Stick unit had returned a loss. The assessee was entitled to a deduction in respect of the profits of the three eligible units while the loss sustained by the fourth unit could be set off against the normal business income. In these circumstances, the basis on which the assessment is sought to be re-opened is contrary to the plain language of Section 10B.”
In Patni, following the assessee’s own case for a previous assessment year, the same principle was extended to Section 10A as well. As will be seen from the extract above, the logic behind the decision in Unilever was that Section 10B as it currently stands (post the amendment brought in by the Finance Act 2000 w.e.f. 1/4/2001) is a deduction provision and not an exemption provision. The position in relation to Section 10A is the same. (The decision in the assessee’s own case for the previous year has been affirmed on appeal by the Bombay High Court in CIT v. Patni Computer Systems, ITXA/2177/2010, decided on 1/7/2011: it is thus safe to say that the law on the point is fairly settled, at least so far as that High Court is concerned: losses of 10A/10B units can be set off against normal business income).
Besides the grounds pertaining to Section 10A, the Tribunal in Patni also had to decide two interesting issues related to transfer pricing provisions. We shall discuss the first of these in this post, while the second issue will be discussed in a subsequent post.
The first of these issues pertained to the addition of notional interest under transfer pricing provisions. The assessee had entered into certain transactions with associated enterprises in relation to software development and consultancy services. The Transfer Pricing Officer made adjustments on account of notional interest. The argument of the Department was that “considering the significant cost incurred by the assessee, the extension of the credit to the Associated Enterprises beyond the period of credit contracted for, could not be regarded as an action at arm’s length… a sum of Rs 3.99 Crores was to be construed as the arm’s length compensation receivable by the assessee on account of interest chargeable on the amounts due from the Associated Enterprises, beyond the stipulated period of credit.” The assessee on the other hand placed reliance on the decision of a co-ordinate (Mumbai) Bench in Nimbus Communications v. ACIT, ITA No. 6597/Mum/09, and contended that any “interest” element would be relevant only in the context of indebtedness created out of a loan transaction. It was contended that such an arrangement with associated enterprises did not fall within the scope of “international transaction”, and transfer pricing provisions could not be invoked. In Nimbus, the Mumbai Bench had observed:
“A continuing debit balance, in our humble understanding, is not an international transaction per se, but is a result of international transaction. In plain words, a continuing debit balance only reflects that the payment, even though due, has not been made by the debtor. It is not, however, necessary that a payment is to be made as soon as it becomes due. Many factors, including terms of payment and normal business practices, influence the fact of payment in independent transaction which can be viewed on standalone basis. What can be examined on the touchstone of arm’s length principles is the commercial transaction itself, as a result of which the debit balance has come into existence, and the terms and conditions, including terms of payment, on which the said commercial transaction has been entered into. The payment terms are an integral part of any commercial transaction, and the transaction value takes into account the terms of payment, such as permissible credit period, as well. The residuary clause in the definition of ‘international transaction’ i.e. any other transaction having a bearing on the profits, incomes, losses or assets of such enterprises, does not apply to a continuing debit balance, on the given facts of the case, for the elementary reason that there is nothing on record to show that as a result of not realizing the debts from associated enterprises, there has been any impact on profits, incomes, losses or assets of the assessee. In view of these discussions, in our considered view, a continuing debit balance per se, in the account of the associated enterprises, does not amount to an international transaction under section 92B in respect of which ALP adjustments can be made…”
Following this, in Patni, the Tribunal held, “the extension of credit to the Associated Enterprises beyond the stipulated credit period cannot be construed as an “international transaction” for the purposes of section 92B(1) of the Act so as to require adjustment for ascertaining the ALP…”
The other transfer pricing issue pertained to whether adjustments can be made in a case where associated enterprises had received “specific and identifiable benefits” due to certain actions by the assessee, even though there was no specific “mutual agreement or arrangement” between the assessee and the AEs in this regard. The assessee had paid a certain sum to McKinsey & Co. “for undertaking a study for the purpose of restructuring the assessee’s organizational structure.” As per the Revenue, the proposals/recommendations in the study conducted by McKinsey also gave specific benefits to the AEs; and hence, an arms length allocation of cost of consultancy expenses paid to McKinsey was required to be made. This contention of the Revenue was also rejected. I will look at this issue in detail in a subsequent post.
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