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Paper on “Peel-Off” Law Firms in India


Professor Jayanth Krishnanat the Indiana University Maurer School of Law has posted a paper titled Peel-Off Lawyers: Legal Professionals in India's Corporate Law Firm Sector, which studies the phenomenon of lawyers leaving big law firms to set up their own practices. The paper is available on SSRN.
The abstract of the paper is as follows:
This study is about hierarchy within the legal profession – how it presents itself, how it is retained, and how it is combated. The socio-legal literature on this subject is rich, with many roots tracing back to Professor Marc Galanter’s famous early 1970s article on the ‘Haves’ and ‘Have-Nots.’ Galanter’s piece and the work of those influenced by him rightly suggest that resources – institutional, financial, and demographic – contribute to whether lawyers are, and remain as, part of the ‘Haves.’ Yet, while resources of course greatly matter, as this study will argue other forces are significant as well. One set, in particular, relates to what the social-psychology literature has termed mobbing – a phenomenon that contributes to the reinforcing of hierarchy through certain aggressive and passive tactics that those with power use to consolidate their reigns and hinder the upward mobility of the employees beneath them. In a legal professions setting, the result can be an environment where ‘Have-Not’ lawyers within an office are commonly left to feel insecure, powerless, and stuck in the legal employment positions in which they find themselves.

To evaluate how resources and mobbing interact, this study returns to the place from where Galanter’s original inspiration for the ‘Haves’ article came: India. The results of a multi-year ethnography are presented on the Indian corporate bar. Since India liberalized its economy in 1991, numerous Indian corporate law firms have thrived, even post-2008. But often steep professional pyramids exist within these firms – perpetuated by those with power exerting a combination of resource-advantages and mobbing-techniques – that can leave lower-level lawyers feeling excluded from this success. To combat this hierarchical status quo, unhappy lawyers are increasingly peeling-off to start their own new law firm enterprises. Peel-off lawyers are thus seeking to become the new ‘Haves.’ However, the goal for peel-off lawyers is not solely to earn higher incomes but also to create environments that are more democratic, transparent, and humane. As this study argues, such opportunities are now possible because of a more liberal, globalized economy, and given the commitment to greater egalitarian norms, this development is indeed welcome, especially as the next generation of corporate lawyers emerges within India.

Indian Journal of Arbitration Law


[The following announcement is posted on behalf of the Indian Journal of Arbitration Law]
The inaugural edition of the Indian Journal of Arbitration Law (IJAL) (http://www.ijal.in/?q=node/6) had been recently launched by Hon’ble Mr. Justice N.N. Mathur, Vice Chancellor, NLU Jodhpur & Chief Patron, IJAL on Thursday, September 27, 2012.
The IJAL is a biannual peer reviewed student run journal, under the aegis of the Centre for
Advanced Research & Training in Arbitration Law (CARTAL) of National Law University, Jodhpur. The mission of IJAL is to provide timely information, both practical and academic, on developments in the field of arbitration. It emphasises on publishing quality articles rapidly and making them freely available to researchers worldwide.

The Editorial Team of IJAL works under the guidance of an Advisory Board, which includes distinguished scholars like Mr. Fali S. Nariman, Prof. Martin J. Hunter, Mr. S K Dholakia, Mr. Gary B Born, Prof. Loukas Mistelis, Prof. Lakshmi Jambholkar & Mr. Promod Nair.
IJAL Website - http://www.ijal.in
Inaugural Edition Contributions - http://www.ijal.in/?q=node/6
The theme for the next issue will be released soon.

VTB Capital: The Consequences of Lifting the Corporate Veil


The Court of Appeal earlier this year gave judgment on an important issue of corporate law: the consequence of lifting the corporate veil, and, in particular, whether the puppet is deemed to have become a party to contracts entered into in the puppeteer’s name (VTB Capital v Nutritek). The issue is of practical importance because an affirmative answer to this question would allow claims to be framed in contract which would otherwise be framed differently, and of conceptual importance because it reveals the nature of the remedy (ie, what courts mean when they “lift” the corporate veil). As we discuss below, the Bombay High Court and the Court of Appeal have given opposite answers to this question, and the UK Supreme Court is scheduled to hear the appeal against VTB Capital on 12 November.

VTB Capitalwas a dispute that arose out of a loan that was obtained fraudulently. VTB, a company incorporated in England and a subsidiary of a Russian company, was induced to give a loan of about $220 million to Russagroprom LLP [“RAP”] to fund the acquisition of certain dairy companies [“the Dairy Companies”] from Nutritek, a company incorporated in the British Virgin Islands [“Nutritek”]. The loan was made under a Facility Agreement to which the parties were VTB, Nutritek, RAP and RAP’s parent companies as guarantors. The parties to the Share Purchase Agreement (through which RAP bought the Dairy Companies) were RAP, Nutritek and Newblade (the company whose shares were transferred to RAP). The Facility Agreement stipulated that VTB would release funds only after receiving an independent valuation report.

Soon after the loan was made, RAP defaulted, and VTB was left with a considerable shortfall after realising its securities. VTB realised that it had been induced into entering into the Facility Agreement by two fraudulent misrepresentations: (i) that Nutritek and RAP were not under the ultimate control of the same person and (ii) a substantial and deliberate exaggeration of the value of the Dairy Companies, leading to a misleading valuation report. VTB initially brought a claim in contract against VTB, and in tort against Marcap BVI, Marcap Moscow and Mr Malofeev. The allegation was that Marcap BVI, which owned Marcap Moscow, had a substantial stake in Nutritek, and that Mr Malofeev was the controller of all three companies (this was the basis of (i) above). VTB then applied for leave to amend its Particulars of Claim to allege liability in contract against Marcap BVI, Marcap Moscow and Mr Malofeev, on the basis that, once RAP’s veil was pierced, those who controlled it became parties to the Facility Agreement. It is of interest to note that VTB ran this case purely for jurisdictional reasons: a claim in contract would have strengthened its attempt to establish the jurisdiction of the English courts with respect to sue Marcap BVI, Marcap Moscow and Mr Malofeev.

In VTB Capital, Mr Snowden QC argued that the legal consequence of lifting the corporate veil is that the controller is regarded as an additional party to contracts entered into in the name of the company he controls. This, it was argued, was not a matter of “discretion” or a “remedy” devised by the court to do justice, but simply the logical consequence of ignoring the fact that the puppet is a separate legal entity. The outstanding submissions of counsel and the Court’s equally outstanding analysis repay careful study, for these trace the development of the corporate veil as a remedy from the time it was devised to the way in which it is used today, and consider analogies, if any, with the law of undisclosed principals. What follows here is no more than a brief summary of this analysis. Burton, J, in two decisions (Antonio Gramsciand Alliance Bank), had accepted this argument, but Arnold, J, in the judgment under appeal, held that those cases were wrongly decided. Mr Snowden relied on the Court of Appeal’s well-known judgment in Gilford Motor Co v Horne [1933] Ch. 935. In that case, the claimant obtained an injunction restraining Mr Horne and JM Horne & Co from carrying on competing business. Mr Horne had entered into a contract which restrained him from doing this, but JM Horne & Co had not. Mr Snowden’s case in VTB was that no injunction could have been granted against JM Horne & Co except in support of an independent cause of action against it; that cause of action could have only been that JM Horne & Co was deemed, once the corporate veil was lifted, to have become a party to Mr Horne’s contracts. Lloyd LJ rejects this reading of Gilford, and holds that the Court of Appeal granted an injunction against the company only because it was “practically convenient” to do so; an injunction against Mr Horne alone would have sufficed, since there was a finding that he was in breach of the covenant through the company, but it was convenient to grant this remedy against the company as well. Jones v Lipman, Trustor and other cases were similarly explained.

It was also suggested that there is an analogy with the law of undisclosed principals, which allows a third party to sue the undisclosed principal even though he did not know of his existence when he entered into the contract; it was said that a case where a controller deceives a contracting party into thinking that the puppet is not a puppet is identical because it is also a case where the controller acts through another without the knowledge of the other party to the contract. Lloyd LJ rejected this submission because the third party is allowed to sue an undisclosed principal only if the agent entered into the contract within the scope of his actual authority, and, in a corporate veil case, the controller by definition does not authorise the puppet to enter into a contract on his behalf.

In the course of its careful review of the authorities, the Court of Appeal also made two other important points: first, “lifting the corporate veil” does not ignore the existence of the company, but allows the court to provide a remedy that would otherwise be available only against the company (as opposed to the controller, or vice versa); secondly, there is no requirement that the corporate veil can be lifted only if it is necessary to do so (ie, that there is no other remedy) and Dadourian and Hashem v Shayif, to the extent they suggested there is, are incorrect.

The Bombay High Court, in a case we have discussedon this blog, cited Burton J’s judgment in Gramsci for the proposition that a contract may be enforced against the puppet as well as the puppeteer. Unfortunately, the Court did not consider this issue in detail, or the arguments against Burton J.’s interpretation of Gilford Motor Co. This case is now before the Supreme Court.

There is no doubt that this is a difficult issue as to which there is more than one reasonable view. The strongest argument in favour of the appellants in VTB Capital appears to be the reasoning in Gilford Motor Co v Horne. The strongest argument to the contrary is that (as the Court of Appeal points out) it is difficult to reconcile this proposition with the principle that a contract, construed objectively, creates rights and obligations only between parties (subject to certain exceptions that are irrelevant here). Another difficulty with the argument is that the controller will be deemed to have become a party to the puppet’s contracts even if the fraud he perpetrated was not that the puppet was not controlled by him. In VTB, this issue did not arise because the allegation (assumed to be true) was that Mr Malofeev had fraudulently represented that Nutritek and RAP were controlled by different entities.

The Supreme Court’s decision in VTB Capital is keenly awaited.

Erroneous Legal Opinions and Criminal Liability


The Supreme Court has recently decided on the nature and extent of criminal liability that may be imposed on a lawyer who issues a legal opinion that is found to be erroneous. In what might be a matter of some relief to the legal fraternity, the court has set very high standards to be satisfied by the prosecution to charge a lawyer for the crime of conspiracy in defrauding a bank.
In Central Bureau of Investigation,Hyderabad v. K. Narayana Rao, the lawyer concerned, being a panel advocate representing a bank, delivered a series of legal opinions relating to the title to several properties. The bank lent monies on the strength of the legal opinions, which were found to be erroneous. The lending transaction was found to be part of a larger scheme by several persons to defraud the bank by inducing it to lend monies that caused wrongful loss to the bank. The Central Bureau of Investigation (CBI), after investigation, filed charges against the lawyer. These charges were quashed by the Andhra Pradesh High Court, against which the CBI appealed to the Supreme Court.
In its judgment, the Supreme Court considered the legal position on two counts. First, it determined whether the High Court has the requisite powers to quash charges under section 482 of the Criminal Procedure Code, a matter that falls squarely within the domain of criminal law and procedure. Second, the court also considered the role of a lawyer issuing a title opinion on behalf of the bank, and the responsibility of such lawyer, particularly under criminal law. It is with the second aspect that we are concerned.
In the present case, the lawyer issued a customary title opinion after considering all the documents provided by the parties. The opinion provided conclusions on whether the owner possessed the necessary title to the property to be able to convey the same to the purchaser. It was specifically found that a substantial part of the opinion was based on photocopies of documents, and few originals were provided. After considering the available evidence, the court concluded that there was insufficient material to conclude that the lawyer was acting as a conspirator so as to be charged for the offence to defraud the bank.
The Supreme Court sought to lay down the standards of lawyers in such circumstances:
22. ... In the banking sector in particular, rendering of legal opinion for granting of loans has become an important component of an advocate’s work. In the law of negligence, professionals such as lawyers, doctors, architects and others are included in the category of persons professing some special skills.
23. ... The only assurance which such a professional can give or can be given by implication is that he is possessed of the requisite skill in that branch of professional which he is practising and while undertaking the performance of the task entrusted to him, he would be exercising his skill with reasonable competence. This is what the person approaching the professional can expect. Judged by this standard, a professional may be held liable for negligence on one of the two findings, viz., either he was not possessed of the requisite skill which he professed to have possessed, or, he did not exercise, with reasonable competence in the given case, the skill which he did possess.
...
25. ... Mere negligence unaccompanied by any moral delinquency on the part of a legal practitioner in the exercise of his profession does not amount to professional misconduct.
26. Therefore, the liability against an opining advocate arises only when the lawyer was an active participant in a plan to defraud the Bank. In the given case, there is no evidence to prove that [the lawyer] was abetting or aiding the original conspirators.
27. However, it is beyond doubt that a lawyer owes an “unremitting loyalty” to the interests of the client and it is the lawyer’s responsibility to act in a manner that would best advance the interest of the client. Merely because his opinion may not be acceptable, he cannot be mulcted with the criminal prosecution, particularly, in the absence of tangible evidence that he associated with other conspirators. At the most,  he may be liable for gross negligence or professional misconduct if it is established by acceptable evidence ...
While this may seem to exonerate lawyers from criminal liability for erroneous opinions, the ruling must be read in its specific context. What was in question in that case was the charge of criminal conspiracy, which now seems to be difficult to establish against erring lawyers. To that extent, it may stated that the risk to lawyers is somewhat contained. However, this decision does not deal with the specific issue of liability for gross negligence or professional misconduct, on which the court has left the door open. Moreover, this decision is specifically in the context of criminal liability for conspiracy to defraud, and does not touch upon the issues if civil liability for professional negligence or misconduct, which might continue to operate if circumstances so justify.
Although not directly addressed by the court, the context of this decision also underscores the difficulties in the real estate sector in India where the determination of title to property with any level of certainty is a daunting task. 

FDI Reforms Take Effect


We had earlier discussed the key aspects of the FDI reforms proposed by the Government. Unlike the previous occasion where the Government had to keep the FDI reforms in the retail sector in suspended animation, this time it was quick to notify the reforms that have now taken legal effect, as follows:
Press Note No. 4 (2012 series): FDI in single-brand product retail trading;
Press Note No. 5 (2012 series): FDI in multi-brand retail trading;
Press Note No. 6 (2012 series): FDI in the civil aviation sector;
Press Note No. 7 (2012 series): FDI in the broadcasting sector; and
Press Note No. 8 (2012 series): FDI in power exchanges.
These changes have taken into effect from September 20, 2012.

A Comment on the New FDI Reforms


The Government has attempted to stem the trend of economic policy paralysis by announcing a slew of measures yesterday with a view to enhancing foreign direct investment (FDI), including in some sensitive sectors which had witnessed political deadlock over the last year or so. The new measures relate to multi-brand retail, single-brand retail, civil aviation, power trading exchanges and broadcasting.
Multi-brand Retail
The most prominent (and even emotive) sector relates to multi-brand retail. After the Government had to call of its proposed opening of the sector to FDI last November, it has sought to resuscitate its policies, this time with some modifications in an apparent effort to cushion its impact and to enhance its acceptability to various stakeholders. However, given this is a political hot-potato, the extent to which it receives acceptances remains to be seen.
The Government’s new proposal is contained in its press release. First, the Government’s balancing act is evident from that fact the states are provided significant powers. Multi-brand FDI can be carried out in specific states only if that is permitted by the relevant state governments. This is driven by both legal and political compulsions. The legal compulsion, which is expressly stated by the Government, is that the retail sector is regulated under the Shop & Establishments Act, which is essentially within the domain of the states. This legislation touches upon governing the working conditions of personnel employed within the sector. From a political standpoint, this involves some tight-rope walking so as to initiate FDI in states which are amenable to this policy, without confronting those that are against. While some states have taken a liberal view on the issues, several states continue to oppose FDI in the sector. The Times of India lists out the approaches adopted by some of the key states on the issue.
Second, the retail outlets must be set up in urban agglomerations with a population of more than 10 lakhs. In states with no such cities, specific dispensations have been made. This is to ensure that the impact of the proposal can be contained to urban areas, without any impact on the rural areas.
Third, a minimum of 50% of the FDI is to be utilised in “backend infrastructure”, which includes “capital expenditure on all activities, excluding that on front-end units; for instance, back-end infrastructure will include investment made towards processing, manufacturing, distribution, design improvement, quality control, packaging, logistics, storage, ware-house, agriculture market produce infrastructure etc.” This is a significant condition as it generally well-accepted that there is a dire need for funding to develop such backend infrastructure in India. The arguments in favour of liberalisation of FDI in the multi-brand sector have been premised on the need for such funding. Specifically, the press release also states that land cost and rentals will not be counted towards that purpose.
In all, while this move is expected to please the markets and demonstrate the Government’s aim to create a more conducive investment environment, a lot will depend on the acceptability of such a policy to the states. To that extent, while the Government’s policy is merely enabling, the ball now lies in the individual states’ court.
Single-brand Retail
The Government’s approach on single-brand retail has been bolder. The effort has been unequivocal in terms of reducing the burden on foreign players in being able to meet with investment conditions. When the Government allowed 100% FDI in single-brand retail earlier this year, it imposed several conditions, including the requirement for local sourcing from micro, small and medium enterprises (MSME). However, this was considered to be restrictive, and many single-brand retailers including Ikea made representations to the Government to ease the process. The Government, in its new proposal, agreed to relax two significant conditions.
The first relaxation pertains to the condition that the foreign investor must be the owner of the brand. It was felt that this does not recognise group holding structures whereby for reasons of commercial exigency the entity that makes the investments into the Indian company may be different from the entity that holds the brand. Therefore, the new condition simply provides that any non-resident entity, “whether owner of the brand or otherwise”, may make the investment. A protective measure, however, has been introduced to state that only one investment will be permitted for a specific brand. This change is understandable, and can at best be said to be procedural rather than any substantial overhaul.
The second relates to the domestic sourcing condition, which was found to be onerous. The previous condition stipulated that where the FDI were to be in excess of 51%, then a mandatory domestic sourcing was required to the extent of 30% of the value of products sold, and such sourcing was to be from small industries (which were defined as industries where investment in plant and machinery did not exceed US$ 1 million). Representations were made to the Government that this was not practicable for high value goods, and that even where industries may have satisfied the requirement as the commencement of supply to the single-brand retailer, they would soon outgrow their “small” industry status. The Government has favourably addressed these concerns by removing the mandatory nature of the local sourcing norms. The new requirement states that single brand retailers may source their needs locally, and “preferably” from MSMEs, village and cottage industries, craftsmen and artisans “where it is feasible”. The only mandatory part relates to geographical element, i.e. the fact that 30% of the sourcing must be done locally, from India. The rest of the requirement seems to be merely a “good faith” effort on the part of the retailers, and there appears to be no immediate attempt to enforce this so as to invite legal consequences upon retailers who may not source from MSMEs or the village or cottage sectors.
Aviation
The liberalisation of FDI in the aviation sector, although not unexpected, is interesting for different reasons. In case of the retail sector, there has been significant pressure from the multinational players to open up the sector. However, in the aviation sector, the trigger appears to have emerged from within, due to the domestic circumstances. Foreign airlines have been seeking a share of the domestic aviation pie for over a decade now. But, the Government has been steadfast in its resolve not to open up the sector for foreign strategic players. However, the recent economic fractures in the domestic aviation industry have necessitated a change in approach. With the domestic industry being competitive, and with several players facing dire financial circumstances, the new FDI measures appear to be a way of preventing further downturn in the domestic sector in the hope that foreign airlines would be interested in infusing the much needed funds into the domestic aviation sector.
Under the new dispensation, foreign airlines will be permitted to invest in “scheduled and non-scheduled air transport services” that were hitherto out of bounds for them. The investment will be allowed under the Government (approval) route up to a maximum of 49%. The investment cap and other related measures are to ensure that control of the domestic company remains in Indian hands. The proposal also addresses some of the security concerns involved in the industry.
Others
In the broadcasting sector, changes have been made to bring the key services within the scope of FDI to the extent of 74%, so as to confer similar treatment as the telecom sector. Separate regimes continue for cable networks and news (and current affairs) broadcasting services. A limit of 49% has been set for FDI in power trading exchanges.
In a related move, the Cabinet has also announced disinvestments in some key public sector undertaking, which may in turn boost the capital markets.

To conclude, these proposals appear to be an attempt to boost the economy and address the concerns of policy paralysis that have afflicted the country more recently. While it will certainly have the effect of altering the perceptions among investors in the markets, it might be too early to determine the impact of these reforms on the ground. The FDI in multi-brand retail is left to be determined by the states, many of whom continue to reject the idea. Moreover, there could also be a political backlash from the opposition and other regional parties to the idea of liberalisation in that sector, the effect of which will be known only in the coming days and weeks. From a technical standpoint, the current decisions have been taken by the Cabinet, but there appears to be no formalisation in terms of changes to the FDI Policy, which might soon follow nevertheless. But, until these formal legal changes are effected, concrete steps towards investment may have to wait. That would be a prudent approach considering the previous experience where the proposal to open up the multi-brand retail sector last November generated great enthusiasm, only to be soon followed by the proverbial “slip between the cup and the lip”. 

IICA’s Legal Compliance Manual


I just came across a Legal Compliance Manual put together by the Indian Institute of Corporate Affairs (IICA). It contains a list of compliances required to be carried out on the part of businesses that arise under various central and state legislation. Areas addressed include corporate law, environmental law, labour law, tax law and other general laws.
It is indeed a useful tool for practitioners and businesses given the plethora of legal compliance required on their part while operating in India.

Some highlights of Supreme Court's decision in Sahara Companies' matter


As has been widely reported, the Supreme Court rejected all the contentions of the two Sahara companies (“Saharas”) against the order of SAT which in turn was against the order of SEBI. The matter of course is far more complex than being a linear sequence of orders and appeals and has several detours to Allahabad and other courts but, in essence, it is sufficient to consider this series of Orders only. The decision of the Supreme Court covers many important issues and, to clarify at the outset, this is only to highlight some important aspects of the decision. The decision covers many important areas – of powers of SEBI, of what constitutes an issue to the public, of the sanctity of Guidelines of SEBI and so on. There are concerns about the dubious role that the Registrar of Companies performed. The Supreme Court also appears to have endorsed the possibility of criminal action against the Saharas. These and other issues may need separate legal analysis as to its scope and implications. Further, the progress of implementation of the order of the Supreme Court in terms of payment of refund monies into the designated bank, identification of the OFCDs holders, etc. will have to be seen. There are reports that the Saharas may pursue further litigation and hence this matter may develop even further.     

The essential facts are summarized in a simplified manner below. However, one preliminary thought comes to mind. The facts are quite glaring and extreme. The Saharas offeredtheir Optionally Fully Convertible Debentures (“OFCDs”) to croresof people, hiring lakhs of agents through thousands of branches and raised tens of thousands of crores of rupees. And then they claimed, clearly on technical grounds, that there was no issue of securities to the public that would result in need for compliance of SEBI Regulations and other laws for disclosure, investor protection, etc. Further, they refused to provide information to SEBI and adopted delaying tactics. In face of such facts, one wonders whether the decision – which rejects every contention of the Saharas and even removing several creases and gaps in law in the process – could be interpreted to some extent as restricted to the facts of the case.

To come to the facts, the Saharas, as the Supreme Court records, sought to raise funds through Optionally Fully Convertible Debentures (OFCDs”). They filed/circulated an information memorandum/ Red Herring Prospectus with the Registrar of Companies but no documents with SEBI. It took a view that issue of shares to a group of people – described in an extremely broad manner – did not amount to an issue to the public requiring compliance with the provisions of the Companies Act, 1956, the SEBI Act and Regulations, etc. that dealt with public issues. The Saharas, however, appointed about 10,00,000 agents, opened 2900 branches and offered the OFCDs to crores of people, and issued the OFCDs to some 66 lakhs people (it appears actual figures may be even higher). Contrast this with the maximum limit of 49 offerees permitted under Section 67(3) of the Companies Act, 1956, beyond which the offer would become a public offer.

When the Sahara Group filed an offer document through merchant banker for a public issue of shares of another group company, SEBI, having come to know through this offer document of the earlier issues of OFCDs, made preliminary inquiries with the merchant banker. The merchant banker essentially replied, relying on legal opinions, that the earlier issues of OFCDs were in compliance of law but did not provide more details. When SEBI pursued the matter further with the Saharas, they insisted that SEBI had no jurisdiction and that they had complied with the law and would respond only to the Registrar of Companies. In what was seen to be further delaying tactics, they claimed that the issue as to whether they are liable to provide information to SEBI was pending determination before the Law Ministry and SEBI should wait till the matter was resolved. This resulted in gathering of information by SEBI from ROC documents and passing of certain orders by SEBI, petitions before High Court, etc. and finally, the Order by SEBI which, alongwith the Order on appeal by SAT was upheld by the Supreme Court.

Several issues were raised before the Supreme Court. The rulings of the Supreme Court and their implications would need far more detailed analysis and at this stage, some important of these issues and rulings are highlighted below.

Was the offer of OFCDs by the Saharas a “private placement” or an issue to the public?
It was noted that the offer was made to “friends, associates, group companies, workers/ employees and other individuals associated/affiliated or connected in any manner with Sahara India Group of Companies”. These persons in reality turned out to be nearly 3 crores in number. When finally details of the allottees were provided, the Supreme Court was dissatisfied with the details and noted that the front page was enough to cast doubt on the genuineness of the persons. An allottee was named merely “Kalavati” and the person introducing her was named “Haridwar”. No details were provided how the allottees even formed part of the group described above.
It was held that in view of the first proviso to Section 67(3), offer to more than 49 persons would be deemed to be an offer to the public. The fact that the offer was clearly made to more than 49 persons attracted this provision. Apart from the offer to more than 49 conditions, another preceding that the offer should have been made as a matter of domestic concern between the persons making and receiving the offer was also not satisfied in view of the extremely broad description of the offerees. Further, since the OFCDs were transferable, yet another preceding condition – that the offer should not be calculated to be received by persons other than the offerees – was also not satisfied.
Thus, the offer was clearly a offer to the public under Section 67(3) of the Companies Act, 1956.
Whether there was violation of rules of natural justice in the Order of SEBI (FTM) as held by SAT?
This issue was not pursued before the Supreme Court though held against SEBI by SAT. However, the Supreme Court still felt it appropriate to consider this issue.
SEBI, on basis of certain investor data made available, had approached randomly four of the investors. It found that two of the “investors” were not traceable. The other two stated that they had invested because agents approached them. SEBI held that thus this showed that the offer was made to the public and not even to the broadly described group. SAT held that relying on such findings without providing them to the Saharas and giving them an opportunity to rebut them amounted to violation of the rules of natural justice.
The Supreme Court held that this was not correct. The rules of natural justice were “available only to a party which has itself been fair, and therefore, deserves to be treated fairly”. The Saharas had not at all cooperated with SEBI in providing the data despite having been provided with several opportunities. Further, instead of countering the findings of SEBI with correct data, it merely contested this issue on the basis that the rules of natural justice were violated.
Thus, it was held that the Order of the SAT on this aspect could not be sustained.
Whether the OFCDs which admittedly were “hybrids”, were securities and hence amenable to jurisdiction of SEBI?
The Saharas contrasted the definition of securities under the SEBI Act/SCRA and the Companies Act, 1956 to submit that the term securities under the SEBI Act/SCRA did not cover hybrids while that under the Companies Act, 1956, covered it. Reliance was placed on the definition under the Companies Act, 1956, which reads:-
“2(45AA) “securities” means securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956), and includes hybrids;” (emphasis supplied)
Thus, it was argued by Saharas that since hybrids were specifically included as an addition, it showed that the basic definition of securities under SCRA could not have included hybrids. Thus, in short, the OFCDs, being hybrids were governed only by the Companies Act, 1956, and SEBI – who obtained jurisdiction under the SEBI Act/SCRA, could not govern issue of securities.
The Supreme Court first held that since under Section 55A, SEBI had powers to administer various specified provisions of the Companies Act, 1956, in matters of issue of securities and since securities specifically included hybrids, SEBI did have jurisdiction to that extent.
Then, the Supreme Court examined the definition of hybrid under the Companies Act, 1956, and noted that it covered any security that had the character of more than one type of security including their derivatives. The definition under SCRA defines securities inclusively and not exhaustively. Since, by definition, a hybrid is a “security”, it is covered by definition of “securities” under SCRA. Further, securities under SCRA included “other marketable securities of a like nature” and thus hybrids would be once again be covered. It was particularly noted that the OFCDs were transferable, i.e., “marketable” as understood in this context.
Thus, hybrids were held to be securities under SCRA too and hence SEBI was held to have jurisdiction over them.
It is submitted that this does not fully explain why the definition under the Companies Act, 1956, specifically included hybrids.
Whether the listing of OFCDs on stock exchanges was optional or mandatory?
The Saharas argued that under Section 60B, there was clear demarcation of listed and unlisted companies and unlisted companies were required to file the RHP only with the Registrar of Companies. The Saharas were neither listed nor intended to be listed. SEBI countered that Section 73 clearly requires that a company seeking to offer securities to the public has to apply for listing to the stock exchanges.
The Supreme Court read Section 60B and Section 73 harmoniously and held that it was concluded by it earlier that the offer was indeed an offer to the public. In view of this, there was no option left in manner of applying for listing. Listing was an inevitable consequence of such an offer and thus not optional but mandatory. Requirement of listing automatically brings in the jurisdiction of the SEBI, as it transforms a “public company” into a “listed public company” and thus covered by Section 60B too.
Whether Section 55A gave powers to SEBI to administer specific provisions on unlisted companies that did not intend to get their securities listed?
Section 55A gives powers to SEBI to administer certain provisions in case of listed companies and unlisted companies that intended to get their securities listed on recognized stock exchanges. The Saharas were neither listed nor, they claimed, they intended to get listed. This was even clearly specified in various documents.
The Supreme Court held that intention could not be grasped and determined out of context of the actions of the Saharas. The Saharas did make an issue to the public. Such a public issue necessarily resulted in their being mandatorily required to get such securities listed. Thus, there is a deemed intention since they could not carry out acts which require listing and then claim that they do not intend to list their securities.
Even otherwise, the Supreme Court held, Section 11 of the SEBI Act was wide enough to give powers to SEBI to protect the interest of investors in securities and to regulate the securities markets by such measures as it thinks fit. This is wide enough to give powers to SEBI under the present facts. Later provisions of the Act do state that SEBI has certain powers over “other persons associated with the securities markets” and public companies which intend to get their securities listed on recognized stock exchanges. Even if these are taken to be restrictions for those sections and purposes, they do not apply to the former provisions. Thus, SEBI has adequate powers to govern the unlisted Saharas.
Furthermore, Section 11A is even more specific in matters of issue of prospectus, etc. Section 11B/11C reinforce this conclusion that SEBI has powers to govern listed and unlisted companies. Being a stand alone statute, the SEBI Act cannot be limited even by the provisions of the Companies Act, 1956.
Thus SEBI had jurisdiction to regulate and administer the unlisted Saharas.
Whether the SEBI DIP Guidelines had statutory force or were mere “departmental instructions”?
The Supreme Court held that the DIP Guidelines did have “statutory force” and that the OFCDs were issued in contravetion of the DIP Guidelines as also of the SEBI ICDR Regulations that succeeded them.
Whether there was a pre-planned attempt by the Saharas to by pass the regulatory and administrative authority of SEBI in respect of issue of OFCDs?
It was pointed out by SEBI that the Saharas had modified the explicit format of declaration required to be given in the prescribed format. The prescribed format required the companies issuing a prospectus to state, inter alia, that the guidelines of SEBI have been complied with and no statement is made contrary to the provisions of the SEBI Act or rules made thereunder or guidelines issued thereunder. The Saharas omitted these declarations. There was further attempt to misguide by stating that the offer was by way of private placement when the invitation was extended to approximately 3 crores persons. The Supreme Court said that it certainly seemed so that there was a pre-planned intention to bypass the regulatory and administrative authority of SEBI.
The manner of issuing the information memorandum/RHP showed that the procedure adopted was “obviously topsy-turvy and contrary to the recognized norms in company affairs”. All this made, the Supreme Court said, the entire approach of the Saharas “calculated and crafty”.
Their repeated refusals to share information and their non-cooperation, the unrealistic and possibly fictitious information provided and other similar factors made the Supreme Court to also state that the whole affair was “doubtful, dubious and questionable”.
Accordingly, the Supreme Court upheld the proceedings initiated by SEBI and the Orders of SEBI and SAT. It upheld the Order of SAT for refund of the amounts collected by issue of OFCDs alongwith interest @ 15% per annum. Mechanism was laid down to ensure this including deposit of the amounts with a nationalized bank, appointment of a retired Judge of the Supreme Court to oversee the process and several other directions for safeguarding various interests.


List of abbreviations:-
OFCDs – Optionally Fully Convertible Debentures
ROC - Registrar of Companies
Saharas – the two Sahara Companies – (i) Sahara India Real Estate Corporation Limited and (ii) Sahara Housing Investment Corporation Limited.
SAT – Securities Appellate Tribunal
SCRA – Securities Contracts (Regulations) Act, 1956
SEBI – Securities and Exchange Board of India
SEBI (FTM) – SEBI (Full Time Member) or SEBI (Whole-time Member)
SEBI ICDR Regulations – Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements), 2009
SEBI DIP Guidelines – Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines 2000