Reversal of FDI Policy on Options

Exactly a month ago, the Government announced its updated FDI policy which treated foreign investments in Indian securities as external commercial borrowings (ECB) in case such investments conferred options on the foreign investors. The wide amplitude of the restriction on options gave rise to significant concern among the corporate and investment community, and it has been the subject matter of criticism among practitioners and commentators alike.

However, this concern has been assuaged by a clarification issued by the Department of Industrial Policy and Promotion (DIPP) today which deletes the relevant clause (para 3.3.2.1) of the Consolidated FDI Policy that outlaws options in securities. While this new pronouncement seems unequivocal and the alacrity with which the Government reacted is indeed remarkable, it remains to be seen whether the Reserve Bank of India (RBI) will also now adopt a more liberal approach to options and modify their prevailing position (that the existence of options in securities will convert investments into those under the ECB policy rather than the FDI policy). Moreover, it is certainly not the end of the debate regarding the enforceability of options in securities of Indian companies which continue to encounter issues under companies and securities legislation, namely the Companies Act and Securities Contracts (Regulation) Act respectively.

Limits to the ICS Approach and the Implication of Terms into a Contract

Sir Guenter Treitel has said that Diplock LJ’s judgment in Hongkong Fir Shipping v Kawasaki Kisen “has a fair claim to being the most important judicial contribution to English contract law in the past century.” Perhaps not too far behind is Lord Hoffmann’s speech in Investor Compensation Schemes v West Bromwich Building Society [“ICS”], where the “modern” approach to the construction of contracts was established. ICS is so well-known that the remarkable result in it is sometimes overlooked. In that case, a Board, which had been created to compensate certain investors who had claims in tort against the Building Society, became the assignee of these claims. The assignment clause said that the investors assigned all claims to the Board except “any claim (whether sounding in rescission for undue influence or otherwise)”. The result of a literal interpretation of this clause was “commercial nonsense”, for it meant that the assignee could not sue for damages. Lord Hoffmann set out “five principles” of interpretation the application of which to this clause produced the following result: investors assigned all claims except “any claim sounding in rescission (whether for undue influence or otherwise)”. The essence of Lord Hoffmann’s five principles is that the meaning of a document is not the meaning of its words simpliciter, but the meaning those words would have conveyed to a “reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract”. “Background knowledge”, save in two exceptional cases that we can ignore for the present purpose, does not include pre-contractual negotiations (see ICS, Chartbrook and Oceanbulk).

In parallel to this objective approach to interpretation is the ability of the courts to resort to “implication of terms”. Again, Lord Hoffmann’s speech in AG Belize v Belize contains a masterly exposition of the law, and clarifies that the implication of terms is not an exercise by which the court “adds” terms to the instrument to “improve” it or supply “defects”, which is impermissible, but one which asks whether a “reasonable addressee” of the instrument would understand the instrument “to mean something else” even though is silent as to the consequences of a certain event. In those rare cases, the Court, by “implying” the term, does no more than give effect to what was the intention of the parties, understood objectively. It is notable that both ICS and Belize are founded on the principle that the meaning of an instrument is not the sum of its words, but the meaning those words would convey to a reasonable addressee, even if that meaning in a certain case is not the ordinary meaning of that word in the dictionary.

However, just like Lord Hoffmann’s “assumption of responsibility” approach to damages, it is noticeable that the conventional approach will yield the correct result in a majority of cases. This is not because Lord Hoffman’s test in ICS is deliberately intended to apply to a predefined set of “exceptional” cases, but simply because the “reasonable person” in ICS would in most instances assume that the meaning of an instrument is the dictionary meaning of its words grammatically construed, with no additions, just as the “reasonable addressee” in Belize would normally assume that if a contract is silent as to the happening of a certain event, it was intended that that event has no legal consequences. In other words, neither ICS nor Belize permits a court to rewrite a contract for the parties, even if there is an error in drafting it.

The recent judgment of the Court of Appeal in Estafnous v London and Leeds Business Centres is an interesting case that makes this point.  The London and Leeds Business Centres [“LLBC”] held all the issued share capital of a company called Drillray Properties Ltd [“Drillray”], which was the owner of the leasehold interest in a building known as Regent House Business Centre [“Regent House”]. Drillray held the leasehold in Regent House on trust for LLBC, which was a wholly owned subsidiary of a company that was itself wholly held by a Mr Robert Kidd and two others interested in the business of LLBC.  In early 2001, Mr Estafnous approached Mr Kidd with a proposal to introduce to LLBC a potential buyer for the leasehold in the Regent Street land on the condition that he would be paid £2 million on completion of the sale. Mr Estafnous and LLBC accordingly concluded a contract which provided that “LLBC has agreed to sell...to a party to be introduced by Mr Estafnous” and “in consideration of the introduction of the Intending Buyer to LLBC and upon the Intending Buyer (or any other party related to or associated with the Intending Buyer) completing a purchase of the Property LLBC will forthwith upon such completion pay to Mr Estafnous or as he may direct the sum of 2 million pounds sterling” [emphasis added].

Mr Estafnous introduced the buyer, a Mr Kapoor. After protracted negotiations between Mr Kapoor and LLBC, it was decided that the sale would be completed not as a sale of the property itself, but through the sale of shares in the company that held the land. This was done to avoid the payment of the stamp duty that would become due on the sale of the property simpliciter. As a result of corporate restructuring carried out for this purpose, a company called IMCO became the ultimate holding company of LLBC, and Mr Kapoor’s company acquired all the issued shares of IMCO. The question that arose was whether this triggered LLBC’s obligation to pay Mr Estafnous the sum of £2 million.

The Court of Appeal held that it did not. It was irrelevant that the parties had all along intended that Mr Estafnous would be paid for introducing a buyer who would gain “control” over Regent House, since the contract, which was not in the least ambiguous, clearly provided that the obligation to pay the sum arose when: (i) the seller is LLBC; and (ii) the property sold is Regent Street. As it happened, this was not the case – the seller was the owner of the shares of IMCO, and the property sold was those shares. Regent House was owned in exactly the same way as before the agreement – legal title with Drillray, held beneficially for LLBC.

The Court of Appeal rejected counsel’s attempt to invoke ICS and Belize, even though it accepted that the purpose of the contract was to pay commission on the acquisition by Mr Estafnous’ party of control over Regent Street. As to ICS, the Court said, rightly, that:

That case is not a licence for the courts to rewrite contracts.  Indeed, as Lord Hoffmann himself said in BCCI v Ali [2002] 1 AC 251 at 269, the primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage.   Interpreted in that way, there can be no doubt, I consider, that the Agreement has the literal meaning identified to which Mr Newman refers.

And as to Belize:

In my judgment, there is no room in the present case for the implication of any term which would have the result for which Mr Newman contends.  This is one of those cases where those involved did not think about what was to happen in certain circumstances, namely if the property sale were restructured as a share sale.  It is not surprising that they did not do so because the individuals concerned – Mr Estafnous for himself and Mr Kidd on behalf of LLBC – made the Agreement against the background of a deal which had already been struck, subject to contract, and it was in relation to that deal or a deal of that sort that commission was to be payable [emphasis added].

This is perhaps a case that is at the very edge: it may be that a “reasonable addressee” would have considered that the £2 million is payable in whatever way control over land is transferred to a party introduced by Mr Estafnous. One may ask whether a claim by Mr Estafnous for breach of contract would have succeeded if, for example, LLBC had sold the land itself to a shell company incorporated for the purpose, and then effected a sale of the land from that company to Mr Kapoor. It was perhaps the fact that the property sold was itself different that was decisive. The case is a good illustration of the true nature of and limits to ICS and Belize.

'Matter which is the subject of an arbitration agreement'

The English High Court, in August this year, has decided an important point on the scope of an arbitration agreement, which, given the similarities in language between section 9 of the English Arbitration Act and section 8 of the Indian Act, is of significance in the Indian context too.

The claimant in Deutsche Bank v Tongkah Harbour had provide a financing arrangement to the Tungkum Limited, which was a gold exploration and mining company based in Thailand. It was a subsidiary of another Thai company, Tongkah, which was the second respondent. Under the financing arrangement, the Bangkok branch of Deutsche Bank entered into a Facility Agreement, by which it lent funds to Tungkum. At the same time, Tungkum entered into an Exports Contract with Deutsche Bank’s London branch, under which it was to sell gold at a price calculated in accordance with a given formula. The net result of this arrangement was that Tungkum would repay the loan given by the Bangkok branch to the London branch. Tungkum’s performance under this arrangement was secured by way of a guarantee provided by Tongkah to Deutsche Bank’s Amsterdam branch. Due to a state of emergency declared subsequently in Thailand, and other difficulties, Tungkum was unable to perform its obligations under the Exports Contract, leading to the London branch granting it a ‘Holiday Period’ in consideration for a revision of the financing agreements. However, taking the stance that these pricing arrangements were unfair, Tongkah and Tungkum refused to revise the agreements, leading to ‘Events of Default’ occurring under the agreements.

The Facility and the Export Contracts entered into between Deutsche Bank and Tungkum granted jurisdiction to English Courts, but in addition, also granted Deutsche Bank the option to pursue their claims in arbitral proceedings. This option was available only to Deutsche Bank and not to Tungkum in either case. The Guarantee Contract did not have any such option for either party. Deuteche Bank began proceedings against Tungkum in relation to the Facility Agreement, and against Tongkah in relation to the Guarantee, in the English Courts. However, it sought arbitral proceedings against Tungkum for the breaches under the Exports Contract. Tungkum and Tongkah challenged the jurisdiction of the English courts on the basis that once Deutsche Bank had begun arbitral proceedings under the Exports Contract, given the strong nexus between the different contracts, and the fact that they performance thresholds in each were calibrated with respect to the others, the ‘matter’ in respect of which the English court proceedings had been brought had been referred to arbitration, leading to a mandatory stay under section 9 of the Arbitration Act.

Section 9(1) of the Act reads-

Stay of legal proceedings.

(1) A party to an arbitration agreement against whom legal proceedings are brought (whether by way of claim or counterclaim) in respect of a matter which under the agreement is to be referred to arbitration may (upon notice to the other parties to the proceedings) apply to the court in which the proceedings have been brought to stay the proceedings so far as they concern that matter.

Before moving on to the respective contentions and decisions in this case, it is instructive to compare the language with section 8(1) of the Indian Act, which provides-

Power to refer parties to arbitration where there is an arbitration agreement.

A judicial authority before which an action is brought in a matter which is the subject of an arbitration agreement shall, if a party so applies not later than when submitting his first statement on the substance of the dispute, refer the parties to arbitration.

While the language of the clauses is not identical, the concept of a matter ‘which is the subject of an arbitration agreement’, and ‘which under the agreement, is to be referred to arbitration’ is sufficiently similar.

Deutsche Bank argued that although the substance of the claim in the two cases may be similar, the primary issue in the arbitral proceedings was the breach of the Export Contract, which was different from the breach of the Facility Agreement being litigated in the court proceedings. Rejecting the contention, and granting a stay of the judicial proceedings, Blair J held that this reading of section 9 was flawed. Relying on Fiona Trust v Privalov for the presumption in favour of parties wanting only on tribunal to decide all disputes arising out of their relationship, and basing his decision of the substance of the claim rather than its formulation, he held that the parallel proceedings could not be allowed to continue.

What is interesting in this decision is the extent to it was influenced by the fact that the different branches of Deutsche Bank were not separate entities. While section 9 does mention the party against whom the legal proceedings are brought, it does not contain any requirement that the claim be brought by the party who has referred the same matter to arbitration. In most cases, however, the requirement that the ‘matter’ be the same will also mean that the party bringing the claims is the same in both proceedings. However, in the case of inter-connected contacts like the ones here, would the decision have been different if the different branches had in fact been subsidiaries, and hence independent legal entities?

In ¶ 27, dealing with Deutsche Bank’s contention that since different branches of Deutsche Bank brought the different proceedings, Blair J observes that,

It seems to me however that the fact that different divisions of the bank are concerned adds nothing to the legal analysis. Deutsche Bank is a single contracting party. Nor does it matter that different branches of the bank are concerned, this not being a situation analogous (for example) to a bank's liability to repay deposits, where for some purposes its branches are treated as separate entities. In any case, on the facts the point has limited force, because the Export Contract (the province of global commodities) provided the mechanism by which the loans extended under the Facility Agreement (the province of structured commodity trade finance) were to be repaid. It is the connection between the contracts which is at issue.

In this passage, while he does seem to base his decision on the branches not being separate entities, he ends by saying that it is the connection between the contracts (and not the connection between the claimants) that is the issue. However, two observations later in the judgment suggest that had the branches been subsidiaries, the decision may have been different. In ¶ 29, he observes,

What it comes to is that whereas in the Commercial Court action, the bank claims the outstanding loan amount, in the arbitration it claims the early termination amount. It is correct that these are different claims, but they arise out of the same breach of the same contractual arrangements. They are (in my judgment) aspects of the same matter. I fully agree that Deutsche Bank bargained for the right of access to this court, and should not be deprived of it. But it is not being deprived of it. It could have referred the matter to the court, or it could have referred it to arbitration.

This finding that no deprivation of a contractual right had occurred would possibly (though by no means necessarily) have been different, had the branches been independent legal entities. More crucially, in deciding whether the claims against Tongkah under the Guarantee Contract should also be stayed, he observes (¶ 30),

The more substantial point argued by Tongkah is that since its liability under the Guarantee is of a secondary nature, the court should stay the proceedings under its inherent jurisdiction, and/or under its case management powers, pending the arbitration. I reject that submission also. A claim under a guarantee may raise similar or even the same issues as the claim against the principal debtor, but the covenant to pay is given by a different party, here the parent company. Deutsche Bank is entitled to enforce the Guarantee if it can make good its claim, regardless of the claim against the principal debtor. The fact that there may be (as the defendants say) substantial overlap between the claims does not affect this conclusion.

Given the rationale adopted in this passage, it appears that mere overlapping between the contentions is not sufficient to meet the requirements of section 9, unless the party bringing the claim in arbitration is the same as that which also sues in court. However, since Blair J was not explicitly referring to the Arbitration Act, and was rejecting the exercise of the Court’s inherent jurisdiction and its case management powers, this passage is not conclusive of the section 9 question.

Returning again to section 8 of the Indian Act, the difference between ‘which under the agreement is to referred to arbitration’ and ‘which is the subject of an arbitration agreement’ means that this issue arises in the Indian context as well. As discussed here, when dealing with section 9 of the Act, Indian Courts have been undecided on the extent to which third parties to the arbitration can be affected by interim measures granted under section 9. Whether a similar stance is adopted with reference to section 8 is an open question.

[Note: While I am not aware of an Indian case conclusively deciding this issue on the interpretation of section 8, inputs from readers on possible authorities on the point are most welcome].

SAT Order in the Sahara Case

(This post has been contributed by Amit Agrawal, a legal practitioner practicing before Rajasthan High Court, Jaipur and an alumnus of the National Law School of India University, Bangalore)

The Securities Appellate Tribunal (SAT) delivered its judgment yesterday in the case involving issue of securities by certain companies within the Sahara group.

The judgment has come after many rounds of legal proceedings before different fora. It may be recalled that Sahara had first challenged the interim order of SEBI passed in November 2010 before the Allahabad High Court. The Allahabad High Court stayed the operation of SEBI’s order in December 2010, which thereby permitted the Sahara entities to continue raising monies from investors. This stay order was challenged before the Supreme Court which however refused to interfere with the interim order of High Court on 4 January 2011 but requested the High Court to expedite the hearing. The matter however could not be disposed in the expected time frame. Subsequently, the Allahabad High Court vacated its previous stay order in April 2011 due to the evasive conduct of Sahara in the matter. Such order vacating the stay was again challenged before the Supreme Court which on 12 May 2011 directed SEBI to complete the inquiry and pass the final order to enable the Supreme Court to pass further orders. SEBI then passed its order in June 2011 confirming its interim order. The Supreme Court thereafter did not examine the merits of the contentions. Through its order dated 15 July 2011 (in Special Leave to Appeal (Civil) No. 11023/2011 with 13204/2011) it directed the parties to appear before SAT. Though the reasons were not expressly recorded for relegating the parties to SAT (where they should in fact have been in the first place) perhaps such an order was passed for the following reasons:

- Any expression of the opinion on the merits of the matter, while hearing an appeal emanating from an interim order (though confirmed in due course), would have prejudicially affected the interests of the parties.

- Adjudication by the Supreme Court on merits would have deprived the parties to appeal to any other forum.

- The Supreme Court, consistent with its view noted in Clariant International AIR 2004 SC 4236 (“….without meaning any disrespect to the judges of the High Court, we think neither the High Court nor the Supreme Court would in reality be appropriate appellate forums in dealing with this type of factual and technical matters”), felt hesitant to decide the matter without having the benefit of opinion of the expert tribunal. For the same reason, it thought that the pending writ petition before the Allahabad High Court should be withdrawn.

The matter was thereafter argued for several days before SAT. In comparison to the lengthy submissions made before SAT, its order is rather concise. The order focuses on the arguments raised rather than attempting to be an encyclopedia of judicial or academic authorities.

Permitting a loss making company with a capital base of Rs. 10 lakhs only to gather approximately Rs. 20,000 crores through use of about 2900 branch offices and ten lakh agents would have been a mockery of the securities law framework – is the thought, not an incorrect one, which underpins the SAT’s order. Important findings of SAT in the matter are:

- A private placement is made to a handful of known persons whose number is less than 50 and therefore an issue to more than such a number is a public issue.

- Optionally fully convertible debentures (OFCDs) are “securities” within the meaning of the Securities Contracts (Regulation) Act, 1956 (SCRA) and consequently SEBI Act, 1992.

- Disclosures made in red herring prospectus (RHP) were not true and fair. Contents of the RHP camouflaged the key issue and concealed more than they disclosed. The fact that millions of investors will be approached was not disclosed.

- Proclamations on paper that the companies did not intend to get listed were not material for ascertaining whether company in fact did not intend to get listed. Their conduct and scheme of operation showed otherwise.

- The companies in fact made a public issue by approaching thirty million investors but by avoiding the rigours of law.

- Untrue statements and misstatements in the RHP can be questioned by SEBI also. This view has also been taken previously by SAT that investor protection is an overlapping concern between the Companies Act and SEBI and is not in the zone of one to the exclusion of another.

- SEBI has jurisdiction over unlisted companies too as long as the same can be said to be ‘persons associated with securities market’. This position has been taken by SAT in its various judgments and also by the Bombay High Court in Price Waterhouse & Co.

- SEBI can change its stand on the questions of law in particular with regard to jurisdiction over unlisted companies.

Whilst the conclusions drawn by SAT on each of the points contended are correct yet the reasoning at times is unclear. The analysis of definition of ‘security’ in particular is arguably open to questioning, in my view. The approach to determining the meaning of an expression for the purposes of SEBI Act, 1992 (which is not defined therein) by looking at the SCRA or Depositories Act only and by refusing to consider the Companies Act, 1956 is highly debatable for corporate laws which are otherwise quite inter-woven. The approach of SEBI as compared to SAT on this point is rather more instructive.

As regards jurisdiction, an issue which the Supreme Court also considered quite central to the controversy, SAT records: “Whether Sebi has the power to deal with such companies or whether they are to be regulated by the Central Government are complicated and important questions of law pertaining to jurisdiction which are to be decided on the interpretation of the provisions of the SEBI Act and the Companies Act”. But its treatment to this particular aspect is quite cursory in nature.

Also, the issue pertaining to the lack of estoppel against the law has not been fleshed out in as much detail. It observed: “There is no principle of administrative law that statutory bodies like SEBI cannot be permitted to alter their interpretation of a provision of a statute particularly when the matter pertains to jurisdiction.” Could a mistake committed once bind one for eternity, was the question it should have answered with greater clarity in the context.

The order of SAT will perhaps be agitated soon before the Supreme Court. Given that all the contentions pertain to questions of law (with no disputed facts) the entire matter is likely to be re-argued before the Supreme Court.

However, two points which follow from the order of SAT are:

- Is any further action likely to ensue in the wake of finding that disclosures made in the RHP were not true and fair?

- Will an attempt, citing SAT’s observations on jurisdiction (and taking cue from Swedish Match AIR 2004 SC 4219), be made to dodge the penalty proceedings (if any) by requesting the Supreme Court to exercise its extra-ordinary powers under Article 142?

- Amit Agrawal

Hostile Takeovers under the New Code

The new SEBI Takeover Code is set to come into force on October 22, 2011. One of the issues that has received great attention is the ability (or otherwise) of acquirers to carry out a hostile acquisition of an Indian listed company under the new Code. A recent press report has the background.

As far as the Takeover Code of 1997 is concerned, we have previously seen (here and here) that the Code itself does not prohibit hostile takeovers. Moreover, the operation of several corporate and securities laws in India come in the way of establishment of customary takeover defences by Indian companies or their promoters. It is only the high incidence of promoter shareholding in most Indian companies that generally operates to stave off hostile raiders on such companies.

The issue of hostile takeovers acquires importance in the new Code as it specifically prescribes conditions upon which an acquirer can make a “voluntary offer” to acquire shares of an Indian listed company. Regulation 6 sets out the conditions, which can be summarized as follows:

1. A voluntary offer can be made only by a person who holds at least 25% shares in a company, but not more than 75% (taking account of the maximum permissible public shareholding). Hence, a person who does not hold any shares, or holds less than 25% shares, in a company cannot make a voluntary offer without first triggering the mandatory public offer requirement by crossing the 25% threshold.

2. A voluntary offer can be made only by a person who has not acquired any shares in the target company in the preceding 52 weeks prior to the offer. In other words, there is a 52-week moratorium on acquisitions before the acquirer can make a voluntary offer.

3. During the offer period, the acquirer cannot acquire shares other than through the voluntary offer.

4. Once the voluntary offer is completed, the acquirer shall not acquire further shares in the target company for 6 months after completion of the offer. However, this excludes acquisitions by making a competing offer.

All these conditions that operate before, during and after the voluntary offer effectively make a classic hostile takeover almost impossible in the Indian context. It appears that this is a wholly unintended consequence.

In order to ascertain the possible intention of the regulator, it is necessary to examine the source of this rule. This can be traced to the report of the Takeover Regulations Advisory Committee (TRAC), and Regulation 6 is effectively a reproduction of the draft suggested by TRAC. While the acceptance of the TRAC recommendations is understandable, the context in which the conditions were imposed is entirely different. This context appears to have been disregarded while accepting the draft of TRAC in the final Code.

Readers may recollect that TRAC had recommended that an offer under the Takeover Code must be for the entire remaining share capital of the company (i.e. up to 100%). One exception that was made related to voluntary offers, where a 10% limit was allowed. The reason for imposing several conditions for a voluntary offer appears to be to ensure that the acquirer becomes entitled to a lower offer size of 10% only when these conditions are satisfied. The relevant portions of the TRAC report are extracted below:

Voluntary Offers 

Current Provisions:

2.18 Currently, the Takeover Regulations provide for consolidation of shareholding by an acquirer who is desirous of maximizing his shareholding without breaching the minimum public shareholding requirements. The offer size for an open offer under this provision is the lower of 20 % or the maximum permissible acquisition without breaching the minimum public shareholding requirement.

Committee Deliberations:

2.19 The Committee observed that with the proposed increase in the open offer size to 100% of the voting capital of the target company, there is a need to provide for flexibility to acquirers to voluntarily make open offers outside the mandatory public offer requirements. The Committee felt that voluntary offers are an important means for substantial shareholders to consolidate their stake and therefore recognized the need to introduce a specific framework for such open offers. However, to discourage nonserious voluntary offers, the Committee decided to set a minimum offer size of 10 %.

2.20 The Committee also observed that, inasmuch as the voluntary open offer is permitted as an exception to the general rule on the offer size, the ability to voluntarily make an open offer should not be available if in the proximate past, any of such persons have made acquisitions within the creeping acquisition limits permitted under the Regulations. Similarly, such an acquirer should be prohibited from making acquisitions outside the open offer during the offer period, and should also be prohibited from any further acquisitions for six months after the open offer. Also, such an offer should not lead to breach of the maximum permissible non-public shareholding.

Committee Recommendation:

2.21 The Committee therefore recommends that acquirers collectively holding shares entitling them to exercise 25 % or more voting rights in the target company may voluntarily make an open offer to consolidate their shareholding. The Committee has proposed a minimum open offer size of 10 % consistent with the rationale of consolidation option outside the creeping route. Voluntary offers should not, however, be of a size that could lead to breach of the maximum permissible non-public shareholding.

(See Regulation 6 of the Proposed Takeover Regulations)

The TRAC report (especially the underlined portions above) clearly indicate that the reason why all these conditions were introduced is because a voluntary offer (with a size of only 10%) was considered as an exception (with greater leniency to the acquirer) compared to the general offer size of all the remaining shares of the company (i.e. up to 100%). While the final form in which the new Takeover Code was accepted makes significant deviations from the overall offer size requirements by limiting it to 26%, there was no attempt to address the consequential conditions for voluntary offer that were based on the general offer size being 100%. Although the purpose for the introduction of these conditions loses relevance with the non-acceptance of the 100% offer size requirement imposed by TRAC, they have nevertheless found their way into the new Code leading to possible difficulties in effecting hostile takeovers.

Another possible interpretation is that given the genesis of these conditions as discussed in the TRAC report, they must become applicable only when a voluntary offer seeks to avail of the lower offer size of 10%, but not otherwise. In that sense, the voluntary offer mechanism in the Code is only an option that can be availed of by acquirers, but nothing prevents them from making a full offer for all of the remaining shares of the company (or even the general offer size of 26% that has been now prescribed) without complying with these conditions. However, these matters are open to interpretation, and clarity from regulators would help create the certainty required of the legal environment on this essential aspect of takeovers under Indian law.

Power of Arbitrator to Punish for Contempt

(In the following post, Ms Renu Gupta, Advocate, considers the law on the power of an arbitral Tribunal to enforce its orders and punish for contempt)

The more popular legal understanding is that the orders of an arbitrator are toothless since the arbitrator has no power to enforce them. Accordingly, intervention of a Court to obtain enforceable orders, even in a pending arbitration, becomes inevitable.

This article is aimed at disproving this proposition by elaborating that an arbitrator is vested with the power of contempt (just like the Court), under the [Indian] Arbitration and Conciliation Act, 1996 (hereinafter, the “Arbitration and Conciliation Act”), and has full powers of enforcing its own orders without intervention of any Court.

Arbitrator not a “Court”

An arbitrator under the Arbitration and Conciliation Act exercises various powers similar to that of the Court, for instance, the power to grant interim relief under Section 17. Even though an arbitrator is an adjudicating authority under the Arbitration and Conciliation Act and has to conduct itself judicially, an arbitrator is not a Court.

Premised on the same rationale, under Section 17 of the Arbitration and Conciliation Act, an arbitrator is not bound by the principles of the Code of Civil Procedure, 1908 and the Indian Evidence Act, 1872 (hereinafter, the “Evidence Act”). Even the definition of “Court” under Section 2 of the Evidence Act expressly excludes an arbitrator. Hence, it is evident that an arbitrator is not a “Court”.

Since an arbitral tribunal is not a “Court” and is a creature of a contract between the parties, it has no power to punish a disobedient party for contempt of its orders, either under the Constitution of India or under the [Indian] Contempt of Courts Act, 1971.

Supreme Court of India on arbitrator’s power to enforce its orders

The Supreme Court of India, in the case titled MD, Army Welfare Housing Organisation v, Sumangal Services (P) Ltd. at paragraph 59, while dealing with the provisions of the old Arbitration Act, 1940, made certain observations (which at best could constitute obiter dicta), regarding the power of an arbitrator to enforce its orders under Section 17 of the Arbitration and Conciliation Act, which vests a power in the arbitral tribunal to grant interim relief to the parties, during the pendency of the arbitration proceedings. The Court observed that even under Section 17, no power is conferred upon the arbitral tribunal to enforce its order nor does it provide for any judicial enforcement.

Even in a case titled Sundaram Finance Ltd. v. NEPC India Ltd., the Supreme Court of India has held that although Section 17 gives the arbitral tribunal the power to grant interim relief, such orders cannot be enforced as orders of a Court. Accordingly, Section 9 gives a concurrent power to the Court to pass interim orders even during the arbitration proceedings.

Section 27 (5) of the Arbitration and Conciliation Act

In the author’s view, the decisions of the Supreme Court fail to take notice of Section 27 (5) of the Arbitration and Conciliation Act, which expressly confers the power on the arbitral tribunal to punish for its contempt.

Section 27 (5) specifies that “[P]ersons failing to attend in accordance with such process, or making any other fault, or refusing to give their evidence, or guilty of any contempt to the arbitral tribunal during the conduct of arbitral proceedings, shall be subject to the like disadvantages, penalties and punishments by order of the Court on the representation of the arbitral tribunal as they would incur for the like offences is suits tried before the Court”.

Delhi High Court on interpretation of Section 27 (5) of Arbitration and Conciliation Act

In a case titled Sri Krishan v. Anand, reported at (2009) 3 ArbLR 447 (Del): MANU/DE/1828/2009 (a search at the Delhi High Court website did not disclose any appeal having been filed against the judgment), the Delhi High Court was seized of the question whether a whether a petition under Section 9 of the Arbitration and Conciliation Act would lie for the same interim measure which has already been granted by the arbitral tribunal under Section 17.

The petitioner had sought to justify the petition under Section 9 on the ground that orders passed by an arbitral tribunal are toothless and unenforceable.

Justice R.S Endlaw of the Delhi High Court while rejecting the contention of the petitioner held that the legislative intent of enacting Section 17 of the Arbitration and Conciliation Act is to make the arbitral tribunal a complete forum not only for finally adjudicating the disputes between the parties but to also order interim measures. The Court further held that no purpose would be served in approaching the arbitral tribunal under Section 17, if for enforcing orders under Section 17, a separate petition under Section 9 has to be filed subsequently.

The Court held that under Section 27 (5) of the Arbitration and Conciliation Act, any person failing to comply with the order of the arbitral tribunal would be deemed to be “making any other default” or “guilty of any contempt to the arbitral tribunal during the conduct of the proceedings”.

Accordingly, the remedy of aggrieved party in a case of disobedience of the order of the arbitral tribunal is to apply to the tribunal for making a representation to the Court to meet out such punishment to the disobedient party, as would have been warranted for contempt of Court. The arbitral tribunal should make such a representation to the Court only upon being satisfied that the defaulter is in default or in contempt.

Once such a representation is received by the Court from the arbitral tribunal, the Court is competent to deal with such disobedient party as if in contempt of order of the Court. This could be either under the provisions of the Contempt of Courts Act or under the provisions of Order 39 Rule 2A of the Code of Civil Procedure, 1908, which provides for consequences of disobedience or breach of injunction.

This position of law has been upheld by a subsequent judgment of the Delhi High Court in the case of India Bulls Financial Services Limited v. Jubilee Plots and Housing Private Limited, reported at MANU/DE/1829/2009.

Relying upon the afore-mentioned judgments of the Supreme Court of India, all the courts in the country have held that the arbitral tribunals have no power to enforce their own orders. This author has only been able to find two dissenting judgments by the same judge.

Conclusion

When parties are required to take recourse to Courts for assistance despite having agreed to arbitration, the benefits and attractiveness of arbitration gets significantly diminished.

Giving due meaning to Section 27 (5) of the Arbitration and Conciliation Act by the Courts would act as a deterrent to litigants for filing separate proceedings for the same relief under Section 9 and Section 17 of the Arbitration and Conciliation Act, and would also be consistent with the objectives of the Arbitration and Conciliation Act, in reducing interference of Courts in arbitration proceedings.

Owing to Article 141 of the Constitution of India, the decisions of the Supreme Court of India, continue to be the “law of the land” and are binding on all other Courts in the country. However, in light of Section 27 (5) of the Arbitration and Conciliation Act and the decisions of the Delhi High Court, the law on this subject needs to be revisited.

The Role of the Seat of Arbitration in Implied Exclusion

It is becoming increasingly difficult to state with confidence the prevailing position of law in India on a question that should, in principle, have a straightforward answer: in what circumstances will the Indian courts decline to exercise jurisdiction under the Arbitration and Conciliation Act, 1996 [“A and C Act”] and what must a contracting party which wishes to achieve this result insert in its agreement? The Supreme Court's judgment last month in Yograj Infrastructure v Ssang Yong Engineering has added to the difficulty.

Before attempting an account of the effect of this decision on the law, it may be helpful to briefly recapitulate. As we have previously discussed, this controversy revolves around what suffices to trigger the “implied exclusion” of Part I of the A and C Act which the Supreme Court accepted in paragraph 32 of Bhatia International. So far, five possibilities have been put to the Supreme Court: (i) the designation of a foreign proper law but no designation of a seat of arbitration; (ii) the designation of a foreign proper law and a foreign seat of arbitration, with or without the further designation of a foreign lex arbitri; (iii) the designation of a foreign seat of arbitration, Indian proper law and a foreign lex arbitri (iv) the same as case (iii) but with a foreign law governing the arbitration agreement, as opposed to the arbitration itself; and (v) the designation of foreign seat of arbitration simpliciter. The Supreme Court has held that Part I of the Indian Act is excluded in cases (ii), (iii) (Dosco v Doozan; Hardy Oil) and (perhaps) (iv) (Videocon v Union of India); and that it is not excluded in case (i) (Indtel Technical Services; Citation Infowares v Equinox). The contention that the lex arbitri is “presumed” to follow the designation of a foreign proper law was rejected in the decisions cited for case (i).

In Ssang Yong,* the respondent (Ssang Yong) was awarded a contract by the NHAI which it sub-contracted to Yograj [“the Agreement”]. The Agreement provided in clause 28 that it would be governed by the laws of India, and clause 27, the arbitration clause, read as follows:

27.1 All disputes, differences arising out of or in connection with the Agreement shall be referred to arbitration. The arbitration proceedings shall be conducted in English in Singapore in accordance with the Singapore International Arbitration Centre (SIAC) Rules as in force at the time of signing of this Agreement. The arbitration shall be final and binding.

27.2 The arbitration shall take place in Singapore and be conducted in English language.

27.3 None of the Party shall be entitled to suspend the performance of the Agreement merely by reason of a dispute and/or a dispute referred to arbitration.  

In accordance with the Agreement, Yograj furnished a Performance Bank Guarantee in 2006, and commenced work. However, on account of disputes that subsequently arose, Ssang terminated the Agreement on 22 September, 2009. Both Yograj and Ssang filed applications for interim relief before the District Judge in Madhya Pradesh, and subsequently, the dispute was referred to SIAC arbitration. Once again, Yograj and Ssang filed applications for interim relief, and the arbitrator’s order directed Yograj to inter alia release plant, machinery and equipment for Ssang’s use. Yograj challenged this order before the District Judge in Madhya Pradesh purportedly under section 37(2)(b) of the A and C Act, and the question arose whether such an application is maintainable.

The Supreme Court held that Part I of the Act is impliedly excluded. In short, the Court gave two reasons: first, that the designation of Indian proper law is, in principle, sufficient to permit the inference that Indian law of arbitration (ie the A and C Act) applies, but secondly, that the designation of SIAC Rules as the “curial law” excludes Part I of the A and C Act because Rule 32 of the SIAC Rules provides that the law of arbitration for an arbitration under the SIAC Rules shall be the Singapore International Arbitration Act, 2002.

In discussing the first issue, the Court began by noting that the question it had to answer was “what would be the law on the basis of which arbitral proceedings would be conducted”, and relied on Clause 28 above to hold that the governing law of the arbitration agreement is the A and C Act. The observations the Court made immediately after this finding are of crucial importance, and therefore set out in full:

The learned Counsel for the parties have quite correctly spelt out the distinction between the "proper law" of the contract and the "curial law" to determine the law which is to govern the arbitration itself. While the proper law is the law which governs the agreement itself, in the absence of any other stipulation in the arbitration clause as to which law would apply in respect of the arbitral proceedings, it is now well-settled that it is the law governing the contract which would also be the law applicable to the Arbitral Tribunal itself [emphasis added].   

Two points may be made. First, it appears that this observation, whether correct in principle or not, is not entirely consistent with cases involving a foreign proper law. In these cases, the Supreme Court has (despite NTPC v Singer) consistently rejected the suggestion that the designation of foreign proper law implies that foreign law governs the arbitration agreement or the conduct of arbitral proceedings as well. For example, as we discussed, the Court held in Citation Infowares that the designation of American law as the proper law of the contract does not warrant the inference that American law applies to the arbitration. 

Secondly, this case raised an issue the Court did not need to resolve in Doosan and Videocon – is the designation of a foreign seat of arbitration in and of itself sufficient to impliedly exclude Part I? The Court’s reasoning in Doosan suggests that it is (see paragraph 15), while the emphasis in Videocon on the designation of a foreign lex arbitri suggests that it is not. Indeed, the decision in Bhatia International itself may indicate that a foreign seat is not sufficient, because there the seat of arbitration was Paris, but an added complication is that there is a view that section 9 may have to be treated differently from other agreements. The Court’s answer in Yograj – that Rule 32 resulted in implied exclusion – strongly suggests that the A and C Act would have applied in the absence of Rule 32, even though Singapore was the seat of arbitration. In short, while this may be the result dictated by authority, the seat of arbitration in Indian law has perhaps a more marginal role than it deserves in determining whether Part I has been impliedly excluded.

Another analysis of the case is available here.

*Readers may wish to note that there are a few typographical errors in the judgment of the Supreme Court that may cause confusion: (i) it is stated in paragraph 3 that the parties had agreed that the law governing the arbitration was the A and C Act, 1996 – clause 27 actually provides that the law of India shall govern the agreement, not the arbitration; (ii) in paragraph 36, it is stated that the question in Bhatia International was whether the A and C Act applies when the seat of arbitration is in India – the question was in fact whether the Act applies when the seat is outside India. Readers may also wish to note that the Respondent in the SLP was Ssang, but that the Respondent before the single arbitrator was Yograj, and references to “Respondent” in the judgment should be read accordingly. 

Revised FDI Policy: Options Outlawed

In the comments section to my previous post on the new FDI policy, reader Menaka highlights another important clarificatory change regarding the policy stance of the Government that now clearly outlaws options in securities held by foreign investors in Indian companies. The relevant clause in Circular No 2 of 2011 is as follows:

3.3.2.1 Only equity shares, fully, compulsorily and mandatorily convertible debentures and fully, compulsorily and mandatorily convertible preference shares, with no in-built options of any type, would qualify as eligible instruments for FDI. Equity instruments issued/transferred to non- residents having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the extant ECB guidelines. [emphasis supplied]

Although the Reserve Bank of India has been adopting this stance lately (as discussed here), it is now well-etched in the policy of the Government of India as a formal matter, and not just in the form of interpretation of the regulations. This suggests that the Government has taken strong exception to the use of put options in equity investments as a method of guaranteeing returns to foreign investors and providing financial protection against their investments. It is bound to curtail investments in certain sectors and by specific types of investors (e.g. financial investors such as private equity funds) who tend to rely upon put options in securities as an essential component of the transaction structure.

Another aspect to consider is that even though the concern of the foreign investment regulators arises in the context of a “put” option as that may provide the investment with the character of an external commercial borrowing (ECB), a plain reading of the clause in the new FDI policy quoted above is wide enough to extend it to “call” options as well. This would lead to the result that foreign investors holding call options will also fall within the proscription contained in the new policy, although it does not carry the same reasoning for a ban as that of put options.