SEBI Order on Synchronised Trades

Last week, SEBI issued an order involving synchronised trading in the scrips of Adani Exports Ltd. The case involves a sharp spike in the price of the shares, more than doubling during a one-month period in November-December 2003. SEBI’s investigation revealed possible synchronised reversal of trades by certain individuals and entities that may have contributed to the price movement. While finding a violation of the SEBI Regulations against fraudulent and unfair trading practices, SEBI imposed a 2-year ban on certain persons from accessing the capital markets. SEBI’s reasoning is as follows:

g. The … facts demonstrate that the orders of most of the trades entered by the noticees were punched in with preconceived motive and prior arrangement that the orders would be picked up by a particular client of the group on the opposite side. I note that there is startling proximity in the time of entering of orders at the identical price and quantity resulting into the matching of the trades. This clearly indicates synchronization while entering the orders, even as these were executed on the screen of the exchange. A large number of trades got matched regularly. It is a known fact that persons who are unknown to each other cannot trade continuously by entering orders in such a pattern. It is difficult to accept that several different orders placed on various days always matched with the same entity and were also reversed with them, by mere co-incidence. The execution of synchronized/ reverse trades repeatedly for several days by the noticees reveals a definite nexus amongst them. I note that the orders placed by the noticees had split into multiple trades; however, the volumes generated by such trades have created substantial number of artificial trades in the market. I observe that the noticees had indulged in the trading pattern as discussed above with regularity, which also projected volumes in the scrip in a way that was not market determined, rather with a hidden motive to induce innocent investors to enter the market. Such transactions are clearly not genuine and seen to have been entered by the noticees for creating misleading appearance of trading in the scrip.

h.  … In the present case, the reversal of trades on several days clearly reveals manipulative intent. Additionally, these transactions, apart from creating artificial volume of trading, also influenced the prices, by giving an impression to others that the scrip is being actively traded at prevailing prices.

This is consistent with SEBI’s previous approach on synchronised trades. While synchronised trades per se do not appear to be objectionable, they could trigger the SEBI Regulations against fraudulent and unfair trade practices when they are coupled with manipulative intent and are entered into only with a view to artificially moving the price of the stock. 

Amendments to the Merger Regulations

(The following post has been contributed by Rahul Singh, Assistant Professor of Law, National Law School, Bangalore (on leave) and Senior Associate, Trilegal)

We live in interesting times where the Minister for Corporate Affairs (Indian competition authority’s administrative Ministry) speaks about helping Kingfisher Airlines and slaying the dragon of runaway inflation through the so-called second Big Bang reforms of the National Competition Policy in the same breath! And, while the Minister is presumably busy contemplating how to reconcile the two, within 9 months of enforcement of the Merger Regulations, the Competition Commission of India (CCI) has announced the first set of amendments to the Regulations. The accompanying press release claims that the changes are intended to provide “relief to the corporate entities from making filings which are unlikely to raise adverse competition concerns, reduce their compliance requirements, make filings simpler and to move towards certainty in the application of the Act and the Regulations”. The amendments are based on the CCI’s past experience with merger review.

Following are my comments on the amendments:

• The draft Merger Regulations issued on February 28, 2011 in the run up to the final Merger Regulations announced on May 11, 2011 had undergone a relatively more transparent process of stakeholder consultation. Certain sector-specific regulators, such as the Airports Economic Regulatory Authority of India (AERA), are specifically mandated by the parent legislation to undertake effective consultation with stakeholders. To be sure, unlike AERA, the Competition Act, 2002 (Competition Act) does not contain any specific legislative mandate for the CCI to undertake stakeholder consultation. Nevertheless, in the interest of engendering good governance best practices, the CCI ought to have continued with the precedent of seeking stakeholder comments before the finalization of amendments.

•In the absence of an effective consultation process, the CCI ought to have issued a detailed set of reasons behind the changes undertaken through the amendments. The absence of the regulator’s intent is bound to exacerbate uncertainty.

• Through the amendment to Regulation 5(2), the CCI has done away with the shortest form (erstwhile Form I, Part I) filing in the following instances: (a) conglomerate mergers (i.e. mergers which entailed neither horizontal nor vertical overlaps between parties); (b) where the parties are predominantly engaged in exports; (c) acquisition/acquisition of control by a liquidator, administrator or receiver appointed through court proceedings under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 or the Sick Industrial Companies (Special Provisions) Act, 1985; (d) an acquisition resulting from gift or inheritance; and (e) an acquisition of a trustee company arising from a change of trustees of mutual fund established under the Securities and Exchange Board of India (Mutual Fund) Regulations, 1996. The effect of the amendments is that for the aforementioned instances, Form I (in entirety, as amended) will be required to be filed. Perhaps the reason behind this change is the disingenuous argument of the acquirer in the case of AICA Japan (Combination Registration No. C-2011/09/04 decided on September 30, 2011). In AICA Japan, the acquirer had created an SPV in India for the purpose of acquisition and since the new entity did not engage in any independent business of its own, the acquirer argued that the proposed transaction can seek the benefit of erstwhile Regulation 5(2)(a) i.e. conglomerate mergers and file the shortest form (Form I, Part I). CCI rejected the argument and the acquirer was asked to file Form I (Part I and Part II). The acquirer’s argument was misconceived as the language of erstwhile Regulation 5(2)(a) mirrors that of section 3 (anticompetitive agreements) of the Competition Act and unlike section 4 (abuse of dominant position) and sections 5 & 6 (related to mergers) does not use the phrase “relevant market” to denote horizontal and vertical nature of overlaps between parties. Unfortunately, the CCI, in AICA Japan did not analyze the jurisprudence of ‘market’ in section 3 juxtaposed with ‘relevant market’ in section 4, 5 and 6. It appears that due to the ill-conceived argument of the acquirer in AICA Japan, the CCI has now decided to throw the baby with the bath water! While the CCI’s concerns related to AICA Japan like situations is understandable, its rationale behind doing away with other instances such as predominant exports is unclear.   

• The new Regulation 5(3) does not add anything new but restates what was already provided under erstwhile Regulation 5(2)(f) and (g) - the long form (Form II) is required to be filed where the market share is > 15% (in horizontal mergers) and > 25% (in vertical mergers). Interestingly, like the extant Merger Regulations, the amendments continue to treat the long form (Form II) as “punitive” in nature. There are two circumstances where the long form (Form II) is required to be filed by the parties: (a) at the option of the parties; and (b) where parties fail to notify in spite of an obligation to notify. The usage of the word “preferably” in Regulation 5(3) means that parties will continue to be reluctant to file the long form (Form II) as “relevant market” is usually a contested concept in competition law.    

• The new second proviso to Regulation 5(5) means that where the long form (Form II) is filed, the time period of 210 days will restart with the filing of the long form (Form II). This is contrary to what was intended earlier; under the older regulations, the clock would have started with the filing of short form (Form I, Part I and Part II) and the time taken by parties for the filing of long form (Form II), if required, would have been excluded from the timelines. The amendment is likely to increase transaction cost. As mentioned above, the definition of “relevant market” provided by the parties in the forms is likely to become extremely critical.

• The new Regulation 5(9) is related to direct v. indirect acquisitions and mergers/amalgamations. Since there is an exemption based upon the size of the acquired enterprise through a Ministry of Corporate Affairs notification, parties could have (theoretically) escaped Merger Regulations by divesting assets to a newly created entity. The general rule of thumb in law that what you cannot do directly, you cannot do indirectly was earlier contained in Regulation 9(4). Perhaps the new Regulation 5(9) has been added as a matter of abundant caution arising out of the case of acquisition of shares of Navyug Special Steel Private Ltd. (Navyug) by Sanyo Special Steel Co. Ltd. (Sanyo) and Mitsui & Co., Ltd, (Mitsui) [Combination Registration No. C-2011/12/14 decided by the CCI on January 31, 2012]. In this case, Navyug was incorporated on November 8, 2011 as a wholly owned subsidiary of Mahindra Ugine Steel Company Ltd. (Musco). Three days later, on November 11, 2011, Musco transferred its steel and rings division to Navyug  through a business transfer agreement. Simultaneously, on November 11, 2011, Musco, Mitsui, Sanyo and Navyug also executed a shareholders agreement through which Sanyo and Mitsui would, respectively, hold 29% and 20% share capital in Navyug. Under the older regulations, parties could have (theoretically) claimed exemption based upon the size of the acquired enterprise i.e. Navyug. Since the new regulations clarify that what cannot be done directly, cannot be done indirectly, parties will not be able to seek the benefit of such a contrived argument.

•The new Regulation 6(1) mandates that a certified copy of the loan agreement or the investment agreement executed by the public financial institution, foreign institutional investor, bank or venture capital for their acquisition is required to be filed with Form III. The form is required to be filed post facto within 7 days of the acquisition. The requirement of a certified copy of the loan agreement/investment agreement is in conformity with the parent legislation i.e. the Competition Act and was earlier mentioned in item # 5 of Form III. The new Regulation 6(1) is, therefore, clarificatory in nature.

•The new Regulation 6(2) states that the CCI may permit filing of Form III beyond the period of 7 days mentioned in section 6(5) of the Competition Act. This is of doubtful legal validity as regulations cannot override the parent legislation.

• The new Regulations 9(1) and 9(3) permit the Company Secretary, duly authorized by the board of directors, to sign Form I or Form II for acquisitions and mergers/amalgamations. This is expected to ease the burden on the companies as the CCI in certain earlier cases had insisted upon signatures of the Managing Director or a duly authorized Director. (In this context, I must add that personally I have had a better experience with the CCI.)   

• Through Regulation 11(a) and 11(b), the CCI has increased the filing fees by 20 times for Form I (INR 10,00,000) and by 4 times for Form II (INR 40,00,000). This takes the Regulations back to the February 28, 2011 draft version of the Merger Regulations. This is one inflation which the angels of Reserve Bank of India will fear to tread!

•The new Regulation 13 (1A) requires parties to file a summary along with the forms. While Regulation 13(1) mandates merely two copies of the form to be filed, the new Regulation 13(1A) mandates nine copies of the summary to be filed. Nine copies are presumably required for seven members of the CCI. Regulation 13(1A) mandates that the summary shall contains details of (a) the products, services and businesses of the entities; (b) the value of assets/turnover; (c) relevant market; (d) details of agreements or other documents or board resolutions; (d) the nature and purpose of the merger; and (e) likely impact of the transaction on competition. Incidentally, this requirement is not new and earlier parties were filing similar details in section 5.2 of Form I.

• As mentioned by Menaka Doshi earlier (http://www.moneycontrol.com/news/features/cci-does-what-sebi-hasnt_673231.html), through new item # 1, Schedule I, the amendment of 15% to 25% is intended to align Merger Regulations with the Takeover Code. However, it is inaccurate to read the phrase “entitle the acquirer to hold” to mean that convertibles have now been added to be covered. On the contrary, section 2(v) of the Competition Act defines “shares” to mean “shares in the share capital of a company carrying voting rights” and includes “any security which entitles the holder to receive shares with voting rights”. Clearly, the phrase “entitle the acquirer to hold” has been added to align the meaning of the term “shares” with the definition of “shares” in the Competition Act. Therefore, under the Competition Act convertibles were always intended to be covered when they were “compulsorily convertible” and not intended to be covered when they were  merely “optionally convertible”. Of course, the Securities and Exchange Board of India (Sebi) treats convertibles differently as the purpose of the two enactments are different.

• Through the new item # 6, Schedule I exemption the buy back of shares has been added as another category which is “ordinarily not likely to cause an appreciable adverse effect on competition in India”.   

• New Item # 8A (Schedule I) read with amended item #8 (Schedule I) has resulted in an interesting situation. Through the new item #8A (Schedule I), the CCI has sought to clarify that besides the intra-group acquisitions mentioned in item # 8 (Schedule I), intra-group merger/amalgamation of either wholly owned subsidiaries (WOS) of an ultimate parent entity (UPE) inter se or intra-group merger/amalgamation of the WOS into the UPE will be exempt from Merger Regulations. This is unlikely to satisfy the businesses’ demand to amend item # 8 (Schedule I) to include mergers/amalgamations. To add to the confusion, through the new item # 8 (Schedule I), the CCI has done away with the explanation which mandated the CCI to interpret “group” in accordance with Explanation (b) to section 5 of the Competition Act. This leaves little guidance for the interpretation of the term “group”.

• The rest of the amendments in Schedule II, Form I are consequent to the above referenced changes.                                     

The million dollar question remains: do the above amendments live up to the CCI’s claim that the changes make the process of filings simpler and provide relief to corporate entities?


- Rahul Singh

SAT on Disclosures Regarding “Promoters”

The Securities Appellate Tribunal (SAT) has issued its decision overturning an order of SEBI’s adjudicating officer that had found Enam Securities to have violated securities laws in connection with the IPO of Yes Bank.

One of the key issues in contention was whether Rabobank ought to have been disclosed as a “promoter” of Yes Bank. On facts, while the application to the Reserve Bank of India (RBI) for a banking licence recognised Rabobank as a co-promoter of the issuing bank, the prospectus filed with SEBI pursuant to which securities where issued did not disclose Rabobank as a promoter. After analysing the provisions of the erstwhile SEBI (Disclosure and Investor Protection) Guidelines, 2000, SAT came to the conclusion that the disclosure was indeed appropriate. It noted:

The appellant has been successful in demonstrating as to why Rabobank was shown as a co-promoter in its application for banking license with the RBI.  Simply because Rabobank was shown as a copromoter of Yes Bank for getting a banking license from the RBI will not ipso facto make it a promoter for the purposes of DIP guidelines or other regulations issue by the Board. To bring Rabobank within the promoter category, it must satisfy the definition of promoter as given in the DIP guidelines. There is no general definition of promoter in the DIP guidelines.

Although the SAT’s reasoning largely involves analysis of the erstwhile DIP Guidelines, they are likely to continue to have some impact under the SEBI (ICDR) Regulations that currently govern disclosures.

The fact that SEBI had not raised its concern while reviewing the draft red herring prospectus or other subsequent filings regarding the company seemed to weigh heavily on SAT:

If the Rabobank falls within the promoter category, we fail to understand how such a vital aspect escaped notice of the regulator while clearing the DRHP where Rabobank is not shown as a promoter.  We also fail to understand as to why the regulator continued to accept financial statements, quarter after quarter, year after year, without Rabobank being shown in the promoters’ category and why no action was initiated against Yes bank for making incorrect disclosure in the financial statements. In this background, no fault can be found with the merchant banker of exercising due care and diligence when Rabobank was not shown in the promoter category. 

Such an approach likely places a heavier burden on SEBI to scrutinize draft offer documents more carefully when filed with it.

SAT also did not find a failure on the part of Enam Securities on other aspects of the IPO process involving Yes Bank, including on discretionary allocation of shares in the qualified institutions category and other alleged irregularities in the allotment process.

Arbitrability of an Unfair Prejudice Claim (Part II)

(continued from earlier)

The next argument was that any unfair prejudice claim under s.994 attracts a degree of state intervention and public interest such as to make it inappropriate for disposal by anything other than judicial process, independent of the nature of the claim or the company in this particular case. In response, the Court undertakes a historical analysis of the unfair prejudice claim, observing that since the 1980 Companies Act, the scope of the unfair prejudice claim has consciously been given a life independent of the relief of winding up on just and equitable grounds. Thus, although the two may overlap, the legislature has made a conscious effort to allow the unfair prejudice claim and reliefs under it, for reasons which may not apply to other shareholders in the same class as the claimant, or to creditors. Thus, the unfair prejudice claim is more ‘personalised’ than the winding up of the company on just and equitable grounds. The Court observed that while some of the reliefs sought under an unfair prejudice claim could affect third parties, it was not inherently a class remedy. In cases where it did affect third parties, the Court could impose limitations of the reliefs that could be claimed through arbitration.

This conclusion was apparently at odds with Exeter, which had held relied on an Australian decision in A Best Floor Sanding Party Ltd v Skyer Australia Party Ltd [1999] VSC 170, to hold that the shareholders have an inalienable right to approach a Court for an unfair prejudice claim and had denied a stay. However, as the Court of Appeal here rightly points out, the applicable Australian statute was materially different from its English counterpart. It mere included unfair prejudice as an additional ground for winding-up, and not as an independent head of relief. Further, the reliefs sought there were for winding up and not merely a contractual dispute which formed the basis of an unfair prejudice claim. The Supreme Court of New South Wales in ACD Tridon Inc v Tridon Australia Pty Ltd [2002] NSWSC 896 has also similarly narrowed the scope of the Skyer Australia decision, lending further support to this interpretation. The Court observes that certain company law issues like the rights of members; and the duties of directors, or the consequences of insolvency are not such as may be arbitrated. However, the Court observes that Exeter incorrectly extended the rationale of Skyer Australia beyond these limited cases.

Here, the Patten LJ observes that,

the determination of whether there has been unfair prejudice consisting of the breach of an agreement or some other unconscionable behaviour is plainly capable of being decided by an arbitrator and it is common ground that an arbitral tribunal constituted under the FAPL or the FA Rules would have the power to grant the specific relief sought by Fulham in its s.994 petition. We are not therefore concerned with a case in which the arbitrator is being asked to grant relief of a kind which lies outside his powers or forms part of the exclusive jurisdiction of the court. Nor does the determination of issues of this kind call for some kind of state intervention in the affairs of the company which only a court can sanction. A dispute between members of a company or between shareholders and the board about alleged breaches of the articles of association or a shareholders’ agreement is an essentially contractual dispute which does not necessarily engage the rights of creditors or impinge on any statutory safeguards imposed for the benefit of third parties. The present case is a particularly good example of this where the only issue between the parties is whether Sir David has acted in breach of the FA and FAPL Rules in relation to the transfer of a Premier League player ... The statutory provisions about unfair prejudice contained in s.994 give to a shareholder an optional right to invoke the assistance of the court in cases of unfair prejudice. The court is not concerned with the possible winding-up of the company and there is nothing in the scheme of these provisions which, in my view, makes the resolution of the underlying dispute inherently unsuitable for determination by arbitration on grounds of public policy. The only restriction placed upon the arbitrator is in respect of the kind of relief which can be granted.

Having settled this point, the Court (following ACD Tridon) goes further to say that even in cases where a contractual dispute like the one here was being relied on as the basis of a winding up petition, the right to approach the court continued to be contingent on the underlying dispute being settled by arbitration. “The agreement could not arrogate to the arbitrator the question of whether a winding-up order should be made. That would remain a matter for the court in any subsequent proceedings. But the arbitrator could, I think legitimately, decide whether the complaint of unfair prejudice was made out and whether it would be appropriate for winding-up proceedings to take place or whether the complainant should be limited to some lesser remedy.”

Finally, the Court considered the third and fourth prongs of argument. The third was held as not being supported by the statute, while the fourth was rejected on the basis that while the clause was very broad, inherent limitations would be read in based on the arbitrability of the subject matter of the dispute.

In sum, this is an important decision on the extent to which a company law dispute may be arbitrated. Admittedly, the facts of the case played a crucial role in the conclusion arrived at. However, the analysis of the nature of an unfair prejudice claim, and the concept of arbitrability provides useful guidance for future issues of a similar nature.

(Note: It was helpfully pointed out by a reader that on 22 February, the UK Supreme Court refused Fulham leave to appeal against the UKCA decision.)

Arbitrability of an Unfair Prejudice Claim (Part I)

A recent post considered the relation between arbitration and company law, in the context of the inability of arbitration to develop the body of corporate law jurisprudence. Another fascinating area of substantive overlap, is the arbitrability of company law disputes, which the UKCA in Fulham v David Richards was called on to consider in relation to claims of unfair prejudice.

Given the fact-specific conclusion the Court arrives at, a slightly detailed explanation of the factual backdrop is mandated here. Fulham Football Club had filed an unfair prejudice petition in relation to the Football Association Premier League (which manages and regulates the English Premier League) (“FAPL”). FAPL is organised as a company, with the different football clubs in the English Premier League as its members. The claimant contended that the chairman of the FAPL Board had acted as an unauthorised agent in breach of the FA Football Agents Regulations by brokering the sale of a player owned by Portsmouth Football Club (Peter Crouch, for the benefit of those who follow football) who Fulham were interested in to Tottenham Football Club. Under the FA Rules, any player or club is prohibited from using or seeking to use the services of an unauthorised person to act in the capacity of an agent, representative or adviser to a club, either directly or indirectly, in the negotiations or arrangements of any transaction facilitating or effecting the transfer of the registration of a player from one club to another. When Fulham approached the FA for relief, they were informed that the issue would be put to a shareholders’ meeting. In the alternative, the FA asked Fulham to bring arbitration proceedings under the FA Rules. Fulham instead approached Companies Court, alleging that it was an implied term of the FAPL Rules that members of the board of the FAPL would comply with their fiduciary obligations and not act so as to prefer the interests of one member club over another. By way of relief, Fulham sought an injunction restraining Sir David from acting as an unauthorised agent or from participating in any way in negotiations regarding the transfer of players. In the alternative, it sought an order that Sir David should cease to be the chairman of the FAPL and such other relief as the Court thought fit. On the basis of the arbitration clause in the FA Rules which the clubs were bound by, the FA and Sir David sought a stay of the Court proceedings, under section 9 of the English Arbitration Act, 1996.

Against this factual backdrop, the court was called on to determine the arbitrability of this dispute, and to reconcile two earlier decisions of the High Court in Re Vocam Europe Ltd [1998] BCC 396 and Exeter City Association Football Club Ltd. v. Football Conference Ltd. [2004] 1 WLR 2910, which had arrived at seemingly different conclusions. Although the High Court in this case followed Vocam and granted a stay, Fulham appealed on four principal grounds:

(a) the relief in an unfair prejudice claim would affect third parties and hence was not arbitrable;

(b) the very nature of the unfair prejudice claim was one which involved public interest and could not be resolved by a private contractual arrangement;

(c) the 2006 Act impliedly rendered the right to approach a Court for an unfair prejudice claim an inalienable right; and

(d) the arbitration clause here was too wide to be enforced.

The Court begins by clarifying that neither the Arbitration Act nor the Companies Act had anything which expressly indicated the arbitrability or otherwise of such a dispute. Hence, the decision turned on first principles of arbitrability, and the nature of an unfair prejudice claim, both very interesting and complex issues.

On the first issue, the Court admitted that usually, a decision on an unfair prejudice claim had consequences for several other shareholders who would not be parties. However, the special nature of the FAPL (discussed in paragraphs 47 and 48 of the judgment) meant that the nature of disputes were much more limited than in other private companies. Thus, the Court concluded that the nature of the relief it was seeking in this particular case was not one that would render it unarbitrable.

(to be continued)

Informal Guidance on Preferential Allotment

SEBI has issued an informal guidance to Strides Arcolabs in connection with the company’s eligibility to issue securities to its promoters on a preferential allotment basis. The information guidance essentially pertains to the interpretation of Reg. 72(2) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR), which reads as follows:

The issuer shall not make preferential issue of specified securities to any person who has sold any equity shares of the issuer during the six months preceding the relevant date.

…

Explanation: Where any person belonging to promoter(s) or the promoter group has sold his equity shares in the issuer during the six months preceding the relevant date, the promoter(s) and promoter group shall be ineligible for allotment of specified securities on preferential basis.

On 20-21 October, 2011, there was an inter se transfer of shares among the promoters of Strides. This was effected under the erstwhile Takeover Regulations of 1997 (and prior to the new regulations that came into effect on 22 October 2011), and appropriate reporting requirements were complied with. Strides now wishes to issue securities to certain promoters who were the sellers in that transfer, and sought SEBI’s view on the eligibility to issue securities by way of preferential allotment.

In SEBI’s view, the interpretation of Reg. 72(2) and its explanation would not permit Strides to make a preferential allotment of securities to the promoters who earlier sold shares in the inter se transfer among promoters. SEBI’s reasoning is as follows:

The said regulation and its explanation do not differentiate between inter-se transfers made to entities within promoter group and sales made to others. Hence, the term “any person who has sold any equity shares of the issuer” shall also include any person who has made inter-se transfers within the Promoter group. Thus, as per the extant Regulations, if there is any inter-se transfer among the promoter group entities in the prece[]ding six months, then all the persons/entities forming part of “promoter(s) and promoter group” shall become ineligible for allotment of specified securities on preferential basis.

Arguably, this represents a technical approach, and a more purposive interpretation could lead to different results. For instance:

1. The objective of the set of regulations that prescribe specific holding periods for preferential allottees is to prevent short-termism whereby certain investors can take advantage of price movements to sell shares and then obtain them through preferential allotment at more beneficial price. This particularly applies to promoters as they are in a position to control the allotments through their substantial shareholding. Such an objective does not appear to have a place in the context of inter se transfer among promoters because it is just a rearrangement of shareholding among the promoter group without a sale to persons outside the group. While a literal interpretation would lead such a transfer to be a “sale”, a purposive interpretation would not bring it within the mischief that the rule seeks to prevent.

2. The above broad objective of the regulations is also evident from the scheme of Reg. 72(2) and its explanation. For example, the explanation suggests that when there is a sale by any person belonging to the promoter group, then the promoter group itself is disqualified from obtaining shares through preferential allotment for a period of six month. The disqualification appears to operate not just to the individual or entity that sold shares, but to the entire promoter group. In other words, the attribution of an individual seller’s action extends to the entire group, thereby fortifying the position that the promoter group must be treated as a whole. In that case, transfers within the group should be of no consequence, and should not be treated as a sale at all.

3. This approach is not unique to the ICDR Regulations, but also to regulatory frameworks such as the Takeover Regulations that provide specific exemptions from mandatory open offers in case of inter se transfers among promoters so long as specified conditions have been complied with. Such compliances were adhered to even in the Strides case, but that seems to have held no water with SEBI while interpreting Reg. 72(2).

Calcutta High Court: Stamp Duty on Mergers/Demergers

We have earlier discussed the peculiar issues that have arisen on whether schemes of arrangement in the form of mergers and demergers are liable to stamp duty in states where the Indian Stamp Act applies or where there is no specific entry for levying stamp duty on such transactions. In relation to several states such as Delhi, Tamil Nadu and Uttar Pradesh, the relevant High Courts have held that schemes would be liable to stamp duty as a “conveyance” despite the lack of a specific entry. These courts seem to have drawn principles from the Supreme Court’s judgment in Hindustan Lever v. State of Maharashtra (2004) 9 SCC 438.

The state of West Bengal was, however, an outlier as the law there developed in a different direction. In our earlier post (link above), we had summarized as follows:

The development of case law in West Bengal has been somewhat mixed. A single judge of the Calcutta High Court held in Gemini Silk Limited v. Gemini Overseas Limited, 2003 53 CLA 328, that an order sanctioning a scheme of amalgamation under section 394 is covered by the definition of “conveyance” under the Indian Stamp Act and therefore liable to stamp duty. That was the case even though “conveyance” was not defined to expressly include an order of amalgamation. Subsequently though, a Division Bench of the Calcutta High Court adopted a contrary view in Madhu Intra Limited v. Registrar of Companies, (2006) 130 Comp. Cas. 510, where it was held that an order of amalgamation was not subject to stamp duty, because it did not fall within the definition of a “conveyance”; moreover even if such an order were to be taken as a “conveyance” or an “instrument” the transfer of assets and liabilities effected thereby is purely by operation of law. The Division Bench even went to the extent of expressly setting aside the order and judgment of the single judge in the Gemini Silk case.

In an interesting development, a single judge of the High Court at Calcutta has last week decided in Re Emami Biotech and Others that stamp duty is payable on schemes of arrangement involving transfers even in the state of West Bengal. This is despite the holding of the division bench in Madhu Intra to the contrary. The reasons are elaborated in the judgment:

It must be respectfully observed in the context that in the light of the judgment in Hindustan Lever, the view expressed in Madhu Intra does not hold good. The judgement in Madhu Intra did not notice the Supreme Court pronouncement in Hindustan Lever. If the Division Bench of this court had noticed Hindustan Lever and had still rendered the opinion in Madhu Intra, it would have been binding on the company Judge of this court. But in Madhu Intra not noticing Hindustan Lever and it being apparent that the question has been answered otherwise by the Supreme Court, it is the Supreme Court view that has to be followed.

The single judge in the Emami Biotech case expresses the background rationale for the ruling as follows in the first paragraph of the judgment:

Considering the stage of the proceedings, the primary issue which has arisen at the behest of the court may be premature; yet the matter is of some importance and it is necessary that an unsavoury practice is immediately arrested. The issue does not appear to be res integra, yet the petitioners insist that there is much to say in support of the continuing practice in this State for veritable sales and transfers of immovable properties to be concluded without offering any stamp duty to the State. Equally, this apparently cash-starved State is to blame for not being alive to its interest and insisting on the payment of stamp duty on the transfer of properties pursuant to the sanction of any scheme of amalgamation or demerger under the Companies Act, 1956. There can be no suspense as to how the question should be answered and the more conventional form needs to be eschewed to pronounce, at the outset, that stamp duty would be payable on transfers effected pursuant to any scheme of amalgamation or demerger under the Companies Act since that is the law of the land as recognised by the Supreme Court in the year 2003.

This judgment appears to create some uncertainty regarding the law in West Bengal on whether stamp duty is payable on transfer of properties through an order of court sanctioning a scheme of arrangement. Although this judgment quite clearly lays down the legal position, the existence of a division bench ruling in Madhu Intra to the contrary will continue to cause anxiety to litigants in the state. Ultimately, it boils down to whether the transfer occurs by operation of law or through contract (as a transfer inter vivos); the prevailing wisdom suggests that it is the latter.

At a broader level, such jurisprudential debates are not confined to India or to stamp duty. There continues to be inconsistencies among courts in different jurisdictions as to whether a scheme derives its efficacy from an order of court (a view adopted by courts in Australia and Singapore) or from the statute (a view adopted by the English courts). A discussion of this issue can be found in: Anil Hargovan, “The source of efficacy for creditors’ schemes of arrangements in England, Australia and Singapore” 31 The Company Lawyer 199 (2010).

Minority Shareholder Protection in M&A

The Economic Times examines a recent trend whereby companies have preferred asset sales or business sales (also known as “slump sales”, an expression that bears uniqueness to India, as I am yet to come across that expression elsewhere) over takeovers thereby shortchanging minority shareholders of the seller companies. The argument goes: by structuring the deal as a business sale, all that is required is an ordinary resolution of the shareholders, which is not difficult to muster where promoter shareholding is significant; moreover, minority shareholders are deprived of the exit option otherwise available under the takeover regulations. While that is certainly understandable, and I am myself fairly sympathetic to that line of argument, this is a function of the manner in which M&A transactions are subject to regulation.

While teaching M&A, one of the aspects I stress is that parties are usually able to structure transactions in different ways to achieve similar commercial goals (or end-games). However, it is often the case that regulations are structured to address the means rather than the end. That provides sufficient leeway to parties and their advisors to structure deals in a manner that is least susceptible to shareholder veto or that provides minimal protection to minority shareholders (in that it does not enable them to participate in the benefits of the deal on par with promoters or management).

To illustrate, a typical M&A deal involving a public listed company can structured either as a sale of business or slump sale (regulated principally by contract), a scheme of arrangement (governed by sections 391-394 of the Companies Act, 1956) or a takeover (regulated by SEBI through the takeover regulations). Although it is not possible to use any scientific metric or parameter that indicates whether one type of structure is optimal to minority shareholders as opposed to others, some qualitative assessments can certainly be attempted, as follows:

1. A business sale is perhaps least effective for minority shareholders, as a simple majority of shareholders can approve the transaction. Since the voting requirement is a majority of “those present and voting”, it is not even necessary that the controlling shareholders hold more than 50% shares, or sometimes even anywhere close to that, in the company to exercise effective control.

2. A scheme of arrangement provides greater protection to minority shareholders. For example, there is a requirement for approval by “classes of shareholders”, which makes the classification exercise quite crucial. The required threshold for shareholder approval is also higher: majority in number holding 3/4^th in value of shares. More importantly, the scheme and the process are subjected to close scrutiny by courts. Nevertheless, one downside of the scheme from the minority perspective is that, once approved, it is binding even on dissentient shareholders. There is no exit route, as Indian corporate law does not provide for automatic appraisal rights (in the form of buyout of dissenting shareholders) as does exist in jurisdictions such as the US (Delaware) and New Zealand. In theory, an Indian court can order a buyout of dissenting shareholders under section 394(1)(v) of the Companies Act, but I am not aware of such discretion having been exercised in practice, at least not in any of the high-profile schemes of arrangement.

3. The most significant right that a takeover provides is the option to minority shareholders to exit on same terms as controlling shareholders or promoters. In the Indian context, however, this right may be somewhat diluted because the acquirer only needs to accept a minimum of 26% shares from public shareholders. In any event, the takeover regulations are structured primarily with a view to protecting the interest of minority shareholder through the exit and other rights.

Given the current state of regulation, the choice of structure is left to the companies, their management and promoters. Courts and regulators usually tend not to disturb the choice, except in extreme circumstances. This concern also appears to be somewhat universal. For example, even in the US context, there has been a history of companies using business sales and asset sales in order to achieve the same result as a statutory merger (or amalgamation as we understand) without providing shareholders either approval rights or appraisal rights or both. More often than not, courts have accepted the structures and denied the arguments of minority shareholders to treat the transactions as de facto mergers (that would have provided minority shareholders the same rights as in a statutory merger). The other example is the use of statutory merger or amalgamation structures to squeeze out minority shareholders, where the US (Delaware) courts have been more sympathetic to the concerns of minority shareholders than courts in the Commonwealth (in countries such as India, UK and Singapore). We have had occasion to discuss the squeeze outs issue in the past.

Coincidentally, I just read an extremely insightful paper that compares minority shareholder rights under a scheme of arrangement and a takeover: Jennifer Payne, “Schemes of Arrangement, Takeovers and Minority Shareholder Protection”, 11 Journal of Corporate Law Studies 67 (2011) (an earlier version of the paper is available on SSRN). The paper seeks to address issues of the kind discussed in this post, although the author concludes that the different levels of protection available to minority shareholders are justified because the purpose of minority protection is different under the two structures.

Corporate Law and Arbitration

The virtues of arbitration as a method of resolving commercial disputes are well-known. The primary benefits of arbitration over the conventional court system are the reduction in costs and delays. However, during a recent conversation with a senior corporate counsel, I was given to understand one drawback in using arbitration as a method of resolving disputes in corporate law. And, that is its inability to develop the body of corporate jurisprudence through judge-made law and interpretation. Given that one of the key features of arbitration is the confidentiality of proceedings, the arbitral awards and the reasoning of arbitrators neither operate as precedents (even if they are not binding in subsequent cases on the lines of stare decisis) nor are they even available for consideration subsequently by courts or other arbitrators.

An apt example of this limitation is the arbitral award in the Sterlite-Balco case, which was on a vexed issue of law concerning restrictions on transfer of shares. Although there has been some amount of debate on that arbitration due to its high-profile nature, much of it is based on secondary sources with no public access available to the terms of the award and its reasoning. For instance, one question that remains unanswered is why the arbitrators disregarded restrictions on transfer of shares in contractual arrangements despite a clear ruling to the contrary by a division bench of the Bombay High Court in the Messer Holdings case. For these reasons, the corporate counsel I spoke with suggested an interesting via media, which is to develop a system whereby the principles of law developed in arbitral awards are documented on a no-names basis without reference to specific cases or their facts. That would at least preserve the reasoning for subsequent consideration, reliance and use.

While these issues require some thought, two separate episodes occurring in the US have raised further questions about the use of arbitration in corporate disputes. First, the Delaware legislature has adopted a provision in its corporate law that permits resolution of corporate disputes through a confidential arbitration process. This has attracted a lot of attention because the arbitrators would effectively be judges of the court that adjudicates corporate disputes. As the Race to the Bottom blog notes:

What made the provision unique was the identity of the arbitrator.  The provision provided that the Court of Chancery had "the power to arbitrate business disputes when the parties request a member of the Court of Chancery, or such other person as may be authorized under rules of the Court, to arbitrate a dispute."  10 Del. C. § 349. In effect, therefore, parties would get the benefit of one of the Chancellors/Vice Chancellors at the Delaware Chancery Court (or one of the court masters).

It further notes that a constitutional challenge has been mounted to that provision on the ground that it restricts access to free trial.

Second, in its IPO offering document, Carlyle recently inserted an arbitration provision to resolve shareholder claims that effectively barred securities class action litigation. The Deal Professor studies its impact:

The thing that pushes Carlyle’s corporate governance structure over the edge is the arbitration requirements. Carlyle is requiring that public shareholders arbitrate all claims against the company. The arbitration must be confidential, meaning no one would ever even know about it unless it was required to be disclosed by another law. Class-action lawsuits are specifically barred.

The effect of these three provisions is to essentially eliminate any ability of shareholders to sue the board for even the most egregious acts. This includes federal securities law claims as well as any state law claims, though to be honest any grounds for state law claims have largely been eliminated anyway. The costs to most shareholders of bringing this type of litigation are prohibitive unless a class action is available.

However, due to stiff resistance from the Securities and Exchange Commission (SEC), Carlyle was forced to drop the arbitration clause in its offering document. While this seems entirely reasonable, some commentators (here and here) believe that the clause should have been retained since investors have the final choice in whether to invest in the stock or not, and whether to discount its value due to the presence of limitations on class action remedies.

SAT on Scope of Insider Trading

In the past, the SEBI regulations against insider trading were attracted only if the insider traded “on the basis of” unpublished price sensitive information (UPSI). Since it became unduly onerous on SEBI to prove that the trading was “on the basis of UPSI”, regulation 3 was amended to provide that an insider trading offence would be committed if the trading was carried out merely “when in possession of” UPSI. Surprisingly though, while the SEBI regulations were amended to make it seeming beneficial for SEBI to initiate enforcement of insider trading violations, section 15G of the SEBI Act that provides for the penalty for insider trading continues to carry the words “on the basis of” thereby creating some level of incongruence between the two sets of legal provisions.

In the light of a recent judgment of the Securities Appellate Tribunal in Chandrakala v. SEBI, the requirement that the insider trade “on the basis of” UPSI is read into even regulation 3 of the SEBI regulations, at least partially in the sense of creating a presumption, which is rebuttable by alleged insider. Relevant parts of SAT’s ruling (at para. 7) are extracted below:

The prohibition contained in regulation 3 of the regulations apply only when an insider trades or deals in securities on the basis of any unpublished price sensitive information and not otherwise. It means that the trades executed should be motivated by the information in the possession of the insider. If an insider trades or deals in securities of a listed company, it may be presumed that he / she traded on the basis of unpublished price sensitive information in his / her possession unless contrary to the same is established. The burden of proving a situation contrary to the presumption mentioned above lies on the insider. If an insider shows that he / she did not trade on the basis of unpublished price sensitive information and that he / she traded on some other basis, he / she cannot be said to have violated the provisions of regulation 3 of the regulations.

By requiring an examination of the insider’s motives for trading, this interpretation effectively nullifies the expansion that SEBI sought to bring about by amending the regulations such that mere possession of UPSI is sufficient. While SEBI’s intention in the regulations appears to be driven by the need to introduce some sort of strict liability, the interpretation of the regulation has reintroduced the requirement of a mental element.

In its judgment, SAT also provides further guidance on the manner in which one can consider whether the insider traded “on the basis of” UPSI (at para 7):

… where an entity is privy to unpublished price sensitive information it will tend to purchase shares and not sell the shares prior to the unpublished price sensitive information becoming public if the information is positive. In this case declaration of financial results, dividend and bonus were positive information but the appellant not only bought but also sold the shares not only during the period when the price sensitive information was unpublished but also prior to and after the information becoming public. A person who is in possession of unpublished price sensitive information which, on becoming public is likely to cause a positive impact on the price of the scrip, would only buy shares and would not sell the shares before the unpublished price sensitive information becomes public and would immediately offload the shares post the information becoming public. This is not so in the case under consideration. The trading pattern of the appellant … does not lead to the conclusion that the appellant’s trades were induced by the unpublished price sensitive information.

In arriving at its conclusion, SAT sought to distinguish its earlier decision in Ranjana R. Kothari v. SEBI.

SAT’s observations in the Chandrakala case could potentially have some implications on two other orders of SEBI on insider trading passed last month in the cases involving Manoj Gaur (in respect of shares of Jaiprakash Associates) and V.K. Kaul (in respect of shares of Orchid Chemicals), if those were to be heard on appeal before SAT. A discussion of SEBI’s orders in those cases is available at Moneycontrol – The Firm.

STOCK Act 

On a related note, legislative efforts are being made in the United States to impose curbs on members of Congress from trading based on nonpublic information they may have received in their congressional capacity.

Facebook’s Capital Structure and Governance

In the wake of Facebook’s mega-IPO, the Deal Professor examines the capital structure of the company, whereby it has decided to follow suit from the earlier high-profile Internet IPO of Google and go with a dual-class share structure. He notes:

… an investment in Facebook is really an investment in Mr. Zuckerberg: Facebook’s offering documents show he will retain control over Facebook even when it becomes one of America’s largest publicly traded companies.

Mr. Zuckerberg’s control is based on the structure of Facebook’s shares. Facebook is proposing to go public with a dual-class share structure. Public shareholders will purchase Class A shares that have one vote apiece. Mr. Zuckerberg, Facebook employees and current Facebook investors will hold Class B shares, which have 10 votes apiece. This is a deviation from the one share one vote norm followed by most publicly traded companies.

Although this seems to provide too much control to the founder, there is nothing unusual in this except for the fact that in this case the control rests with a single individual rather than a group of persons. As noted on the Deal Professor column:

Mr. Zuckerberg is not alone in using this type of structure to maintain ownership of a prominent technology company. The founders of Google, Larry Page and Sergey Brin, set up a similar structure and retain voting control over Google.

Yet they are two people who counterbalance each other, not a single individual.

Three other prominent company founders, Andrew Mason at Groupon, Mark Pincus at Zynga and Reid Hoffman at LinkedIn, have also adopted similar dual-class voting structures at their companies. At the time of those public offerings last year, Mr. Mason controlled 19.7 percent of the votes at Groupon, Mr. Pincus controlled 37.4 percent of the votes at Zynga and Mr. Hoffman controlled 21.7 percent of the votes at LinkedIn.

These companies, however, are much smaller than Facebook. And while their stakes are sizable, they do not entitle any of the three founders to remove and replace directors at will.

It appears therefore that deviations from the one-share-one-vote rule are becoming much more common than one would ordinarily imagine.

In the Indian context, after much back and forth regarding the desirability of permitting shares with differential voting rights, the Companies Bill recognizes the need for flexibility to companies and their founders to structure their shareholding along similar lines. However, SEBI continues to deny the issue of shares with “superior voting rights”.

As far as the governance structure of Facebook is concerned, one aspect that is highlighted in the Deal Professor column deserves attention:

Unlike most public companies, Facebook will not have a nominating committee for its directors comprising the independent directors on Facebook’s board. Instead, all of the directors will be selected by the board itself, a group that will be appointed by Mr. Zuckerberg. He can also remove and replace any director at any time.

The company has sought to take advantage of an exemption under the relevant listing requirements to steer clear of some of the conventional corporate governance norms such as board independence and independent nomination of directors that act as a monitoring mechanism on the managers and controlling shareholders. Facbeook's registration statement filed the SEC states:

We have elected to take advantage of the “controlled company” exemption to the corporate governance rules for publicly-listed companies.

Because we qualify as a “controlled company” under the corporate governance rules for publicly-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In light of our status as a controlled company, our board of directors has determined not to have an independent nominating function and has chosen to have the full board of directors be directly responsible for nominating members of our board, and in the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee. Our status as a controlled company could cause our Class A common stock to look less attractive to certain investors or otherwise harm our trading price.

Given the high-profile nature of the company, its founder and the offering, it is not clear if such concerns regarding the governance of the company will either turn away investors, or force a discount on the valuation of the shares.

Fourth Week of Arguments: Constitution Bench on Bhatia International

Arguments continued this week before the Constitution Bench comprising the Chief Justice, and Justices Jain, Nijjar, Khehar and Desai. Mr Salve began his arguments this week by pointing out that the choice of the seat of arbitration is of great importance in international arbitration because parties often wish to resolve their disputes in a neutral forum. It is partly for this reason that London, both as an arbitration centre and for its commercial court, is among the most popular dispute resolution venues in the world. Counsel submitted that accepting any theory of “concurrent” jurisdiction undermines this choice and the sanctity of the seat. To the question whether it is possible to challenge in court the validity of an arbitration agreement (especially when it is governed by Indian law) in an arbitration with a foreign seat, counsel’s submission was that the Indian court may consider the issue only if there is a specific provision to that effect (for example, if a suit is brought here and an application under section 45 is filed to refer the parties to arbitration), and that there is no “freestanding” jurisdiction to consider the validity of the agreement or the award simply because the law governing the substance of the dispute is Indian. Similarly, as far as the validity of the award is concerned, counsel’s submission was that if an award is passed by an arbitration with a foreign seat that is contrary to Indian public policy, it is likely that the award will in any event be set aside in the court of the seat, and in support of this submission, reference was made to the decision of the Court of Appeal in Regazzoni v Sethia [1958] AC 301. Counsel argued that there is in any event no remedy if the arbitrators abroad simply “misconstrue” an Indian statute but do not contravene Indian public policy.

Counsel then developed his submission that Indian Arbitration Act, by adopting the UNCITRAL Model Law, firmly committed himself to a territorial approach to jurisdiction. He pointed out that the contesting views before the Model Law, so far as jurisdiction is concerned, were either in favour of the seat of arbitration (the English view), or in favour of what is known as “delocalisation” (principally the French view), and there was never at any point support for the proposition that the court of the country whose law governs the substance of the dispute is entitled to set aside an award. Counsel’s submission was that the drafters of the Model Law, keenly aware of these opposing views, consciously chose the territorial approach based on the seat of arbitration, and that Parliament did likewise in enacting section 2(2). Counsel dealt at some length with the travaux préparatoires to the Model Law, and pointed out that the omission of the word “only”, on which Bhatia International and the Appellants had placed considerable reliance, was in reality irrelevant, because even the UNCITRAL Model Law originally did not contain that word. Counsel placed extracts from the travaux (particularly a statement by the Italian delegate and the Chairman’s response) demonstrating that word “only” was added to article 1(2) of the Model Law because of an apprehension that the exception clause (“except articles 8, 9, 35 and 36”) may otherwise be construed to not apply unless the seat of arbitration is abroad (which was never the intention), and that Parliament did not need to add the word because that exception was itself omitted from section 2(2).

As far as section 34 is concerned, counsel submitted that the words “under the law of which” in section 48(1)(e) do not confer any jurisdiction on the country whose law governs the substance of the dispute, because it is at best only a reference to the lex arbitri. Counsel argued that the judgment of the Supreme Court in NTPC v Singer, on which we have commented, may have been wrongly decided because it misconstrued section 9(b) of the Foreign Awards (Recognition and Enforcement) Act, 1961. As far as section 9 is concerned, counsel’s submission was that Bhatia International was wrongly decided insofar as it relied on the omission of the word “only” for the travaux demonstrated that the inference the Court drew in Bhatia as to this omission was unfounded; and that the only possible remedy a foreign claimant who wishes to preserve Indian assets before or during arbitration has is to obtain a Mareva injunction from an Indian court by way of a suit. Counsel argued that an application under section 45 in such a suit, even if allowed, does not prevent the Court from granting interim relief, and stressed that in any case the lack of such a remedy is in any event no reason to “rewrite” section 9. 

Arguments continue on Tuesday.