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What is “immovable property”? The law relating to fixtures to land and buildings: Part II


(The following post has been contributed by Vinod Kothari and Nidhi Ladha of Vinod Kothari & Company. The authors can be contacted at vinod@vinodkothari.com and nidhiladha@vinodkothari.comrespectively.
This is a continuation from a previous post where the authors discuss general principles. Here, they discuss specific cases and conclude)

Interesting recent cases pertaining to immovable property:

However, recently, the question has arisen in some very interesting contexts. That the question should have arisen in sales-tax or excise duty cases is hardly surprising. Cases on whether sales-tax or VAT is applicable on sale of a fixture abound. Recently, interesting cases arose in the context of excise law. However, one very interesting case arose whereby a telecom tower was claimed to be a “building”, liable to municipal taxes. We discuss below some of these cases:

Is Central Excise applicable on making of fixtures?

In Commissioner of Central Excise vs Solid and Correct Enggg Works [http://indiankanoon.org/doc/1068978/] the Supreme Court faced a question on whether asphalt drums/hot mix plants made by the assessee were immovable property, or whether the assessee was engaged in making of components of such plant. Some of the components of such plant were bin feeder, conveyor and dryer unit, embedded in earth on a foundation 1.5 feet deep. It was contended on behalf of the assessee that what was manufactured could not be said to be “goods” especially when the same could not be dismantled and re-assembled without undertaking the necessary civil works.
It was held that the plants were not per se immovable and they become immovable when embedded in the earth. The attachment of the plant with nuts and bolts intended to provide stability and prevent vibration is not covered as attached to earth. The attachment can be easily detachable from the foundation and is not permanent. The plant moved after road construction or repair project is completed. The plants in question are not immovable property and not immune from excise duty. While deciding the applicability of excise duty on the parts and parcels in the instant case, the Apex Court has, very clearly, carved out the difference between movable and immovable machinery. The explanation reads as:
The machines in question were by their very nature intended to be fixed permanently to the structures which were embedded in the earth. The structures were also custom made for the fixing of such machines without which the same could not become functional. The machines thus becoming a part and parcel of the structures in which they were fitted were no longer moveable goods. It was in those peculiar circumstances that the installation and erection of machines at site were held to be by this Court, to be immovable property that ceased to remain moveable or marketable as they were at the time of their purchase. Once such a machine is fixed, embedded or assimilated in a permanent structure, the movable character of the machine becomes extinct.”

Is VAT applicable on transfer of property in fixtures?

If the fixtures are movable in nature, VAT shall be applicable on transfer of such goods. However, if the same is proved to be immovable machinery, the transfer will be treated as a conveyance and hence, requisite stamp duty will have to be paid.

A Telecom Tower: a building?

A building in layman’s vocabulary would mean a structure for protection from forces of nature, habituated by people or, for the purpose of storage of goods.  Recently the question, whether telecom tower is a building arose before the Delhi High Court in Cellular Operators Association ... vs Municipal Corporation Of Delhi on 29 April, 2011, [http://indiankanoon.org/doc/1370737/]. The petitioners, Cellular Operators, argued on the similar lines that a building is a structure habitable and thus a telecom tower is “PLANT & MACHINERY” and is not habitable. However under section 2 (3) the Delhi Municipal Act, under which this case was filed, building includes metal structure. The definition has nothing to do with habitability. Taking into consideration the concept of habitability, once a building is no longer fit to reside will it cease to be a “building”? The answer can be found in an earlier decision delivered by the Full Bench of the Delhi High Court in MCD v. Pradeep Oil Mills P. Ltd [AIR 2010 Delhi 119], where it was held that an underground storage tank also falls within the definition of building, which can by no stretch of imagination be habitable.
The High Court of Delhi was of the view that towers are definitely buildings made of metal or other materials. It also did not accept the contention of senior counsel that that which is not habitable is not a building. Also in the case of United Taxi Operators (Urban) Thrift & Credit Society Ltd. Vs. MCD [2 (1996) DLT 281], the Division Bench of the Delhi High Court negated the opinion that to be a building , it has to be habitable and it was held that putting together sheets of steel to install an underground cellar was a building.
A similar question had arisen before the High Court of Bombay in Bharti Tele-Ventures Limited Vs. State of Maharashtra [(2007) 109 BomLR 585]. The challenge was to the Notification under the Maharashtra Regional and Town Planning Act, 1966 authorizing and/or requiring the various Municipal Corporations in the State to charge retrospectively premium at the rate of land value for the area occupied by the cabin, the tower height premium etc. for granting permission for installation of semi-permanent structures, cabins on top of the buildings for housing Base Station / Telephone Connector to set up Cellular Mobile Telecommunication system in pursuance to the licences granted under the Telegraph Act. The Division Bench held such installation to b a building under the Maharashtra Act (Bombay Provincial Municipal Corporations Act, 1949) which is similar to the Act in Delhi.

A machine fixed with bolts and nuts: movable or immovable?

A decision of Allahabad High Court in Official Liquidator v. Sri Krishna Deo and Ors. [AIR 1959 All. 247], wherein, the Court held that a machinery fixed to their bases with bolts and nuts although easily removable are not movable property when they have been set up with definite object of running an oil mill and not with intention of being removed after a temporary use.

Installation of lifts: chargeable to sales tax

In State Of Andhra Pradesh vs M/S Kone Elevators (India) Ltd [http://indiankanoon.org/doc/994291/], the Apex Court, while deciding the nature of the contract for installing a lift, held that the major component of the end- product is the material consumed in producing the lift to be delivered and the skill and labour employed for converting the main components into the end-product was only incidentally used and, therefore, the delivery of the end-product by the assessee to the customer constituted a "sale". 
The Supreme Court also differentiated a works contract and a sale contract. In a "contract of sale", the main object is the transfer of property and delivery of possession of the property, whereas the main object in a "contract for work" is not the transfer of the property but it is one for work and labour. Another test often to be applied to is: when and how the property of the dealer in such a transaction passes to the customer: is it by transfer at the time of delivery of the finished article as a chattel or by accession during the procession of work on fusion to the movable property of the customer? If it is the former, it is a "sale"; if it is the latter, it is a "works- contract". Therefore, in judging whether the contract is for a "sale" or for "work and labour", the essence of the contract or the reality of the transaction as a whole has to be taken into consideration.

Paper making machines: movable asset

While considering the leviability of excise duty on paper-making machines in Sirpur Paper Mills Ltd. v. Collector of Central Excise, Hyderabad(1998 1 SCC 400), based on the facts of that case, the Supreme Court came to the conclusion that the machineries involved in that case did not constitute immovable property. The Tribunal, in this case, had pointed out that it was for the operational efficiency of the machine that it was attached to earth. If the appellant wanted to sell the paper-making machine it could always remove it from its base and sell it. Agreed with the views of the Tribunal, the Apex Court decided that the paper printing machine, in the given case, was a movable asset.

Others

The grinding room made up of metallic enclosures are embedded in the Earth along with civil work and while removing the same, it becomes a scrap. It was held in Axialo Industries v CCE [2008 (223) ELT 454 (Tri)] that the erection of grinding room/enclosure done piece by piece and along with civil work and brings into existence immovable property.  Duty of excise is not leviable thereon.

A machine whether movable or immovable-depends on volume and weight

In T.T.G. Industries Ltd. V. CCE, Raipur [2004 (167) ELT 501 (SC)], the machinery was erected at the site by the assessee on a specially made concrete platform at a level of 25 ft. height. Considering the weight and volume of the machine and the processes involved in its erection and installation, this Court held that the same was immovable property which could not be shifted without dismantling the same.

Conclusion:

English law attaches greater importance to the object of annexation which is determined by the circumstances of each case. One of the important considerations is founded on the interest in the land wherein the person who causes the annexation possesses articles that may be removed without structural damage and even articles merely resting on their own weight are fixtures only if they are attached with the intention of permanently improving the premises. In Wake V. Halt (1883) 8 App Cas 195 Lord Blackburn speaking for the Court of Appeal observed:
“The degree and nature of annexation is an important element for consideration; for where a chattel is so annexed that it cannot be removed without great damage to the land, it affords a strong ground for thinking that it was intended to be annexed in perpetuity to the land.”
Indian law has been developed on similar lines and the mode of annexation and hence, object of annexation may be applied as relevant test in this country also. However, in the absence of express provisions in the extant laws, the confusion as to whether a subject matter of a particular contract is “goods” or “immovable property” has serious questions of determination of applicable law. Not that tax payers are trying to evade or avoid taxes – the uncertainty can be purely factual or decisional. The proposed subsuming of different taxes into a common GST may go a long way in removing uncertainties in this regard, but pending that, a General Clauses Act amendment at least creating clear provisions on trade fixtures is most important.
- Vinod Kothari & Nidhi Ladha

What is “immovable property”? The law relating to fixtures to land and buildings: Part I


(The following post, which deals with a continuingly vexed question of law, has been contributed by Vinod Kothari and Nidhi Ladha of Vinod Kothari & Company. The authors can be contacted at vinod@vinodkothari.comand nidhiladha@vinodkothari.comrespectively)
At first glimpse, the question –what is an immovable property – sounds too basic to warrant any attention. Land and buildings are immovable properties.  But that is not where the question is significant. The question becomes complicated when we extend the meaning of immovable property to include things which are embedded or fastened to earth, commonly known as “fixtures”. Fixtures may be done to civic structures - for example, doors or windows to buildings; fixtures may also arise in case of variety of plant, machinery, equipment, installations, such as furnaces, boilers, towers, and so on. To distinguish the latter from the former, we will call the latter “trade fixtures”. So, the question is, are trade fixtures immovable properties?

Goods and Properties:

Note the immense significance of the question, in light of the age-old distinction between “goods” (dealt with by Sale of Goods Act, 1930) and “properties” (dealt with by Transfer of Property Act, 1882). But more important than the branches of law that deal with them, there are immense tax implications of an asset being taken as a movable or immovable property. If the asset in question is “goods”, it is covered by Sales-tax/ value added tax (VAT) laws. If the asset manufactured is goods, there is a Central Excise implication. If the asset being sold is an immovable property, the question of sales-tax/VAT does not arise – however, there may be stamp duty applicable to the conveyance of immovable property. Transactions transferring interest in immovable property also require mandatory registration under Registration Act, 1908. Lease, mortgage or charges on immovable property may also bring in the implication of the Transfer of Property Act, conveyancing and registration requirements. Questions involving substantial sums of money continue to arise due to the fragmented nature of taxation laws in India, and the regime of control on immovable properties by civic authorities.
Immovable property is defined by Section 3(26) of the General Clauses Act, 1897 as including land, benefits arising out of land and things attached to the earth, or permanently fastened to anything attached to the earth. “Attached to earth” is defined in section 3 of the Transfer of Property Act as meaning (a) rooted in the earth, as in the case of trees and shrubs; (b) imbedded in the earth, as in the case of walls or buildings; or (c) attached to what is so imbedded for the permanent beneficial enjoyment of that to which it is attached.
In case of trade fixtures, the rule is permanent attachment, that is, such attachment, whereby, removing the item in question will require demolition.

Intent and extent of annexation:

To ascertain whether the item is permanently attached to earth, English and Indian courts have consistently used two-fold tests – (i) the extent of annexation and (ii) the object of annexation. The extent of annexation means annexing the fixture or object ceases to be detachable. It would need to be demolished if one were to remove it. In considering whether the article is permanently annexed, the question is not the loss value – the question is – economically, is the asset what it was even after removal? That is, does it retain its commercial character, or the same gets lost in the process of removal?
The intent or object of annexation test may sound more intricate. The test lays down that where a movable property gets annexed with an immovable property, if the intent of annexation is of permanent beneficial enjoyment of the immovable property, then the fixture becomes an immovable property. If the intent of annexation is the beneficial enjoyment of the movable property, then the property still remains movable. The test may sound quite subjective: however, note that here also, the precondition is “permanent beneficial enjoyment”. There are two implications of the intent test – first, the annexation must only be such as is required for beneficial enjoyment of the movable property. For example, a machine is cemented to earth because that is the best way to use the machine. But if a storage tank is made of bricks and cement is built, one cannot say that the object of annexation is to use the storage tank. The tank has become such permanent part of the land that it is land which is being used by putting storage tank on it. The second implication, of course, goes back to the extent test – if something is permanently attached so as to make it permanent fixture on land or another immovable property, one cannot contend that the intent of so doing is to enjoy the fixture.
Thus, the determination of whether the property is movable or immovable becomes a facts-and-circumstances question. Needless to say, the question is as old law of properties – dating back to centuries.
Specific cases dealing with this question are discussed in a subsequent post.
- Vinod Kothari & Nidhi Ladha

Corporate Governance Survey


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

Miscellaneous


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

Announcement: NLSIR Symposium


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

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

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

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

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

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

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

For more details including the concept note, program schedule and online registration, please visit:  http://www.nlsir.in/symposium.html.

For regular updates, also see our Facebook page: http://www.facebook.com/NationalLawSchoolOfIndiaReviewSymposium2012?ref=ts.

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

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


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

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

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

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

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

Call for Papers: Indian Journal of Arbitration Law


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

SEBI Reinforces the Sanctity of a Takeover Offer


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

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


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

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

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

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

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

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

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

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

1.4  In the transaction:

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

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

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

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

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

Basis
True Sale
Mortgage

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

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

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


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

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

2.1  The Bank argued that:

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

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

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

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

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

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

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

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

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

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

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

3. Verdict of the Hong Kong High Court

The transaction was held to be a sale.

4. Analysis of the decision

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

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

4.1 Going the US way – substance over form approach

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

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

4.2 Revocable Transaction

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

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

(a) No recourse against the seller

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

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

(b) Retention of residual interest by the seller

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

(c) Uncertain sale consideration

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

5. Conclusion

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

- Soma Bagaria


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