World Bank’s Doing Business 2013

The World Bank and IFC have published the Doing Business report and country rankings for the year 2013. India still remains at 132 with no signs of overall changes, although its position has improved on some of the parameters, while it has fallen on several others. India’s country report is available here.

As these newspaper reports also suggest (hereand here), India’s ranking is below its neighbours and also other BRICS economies.

Committee for Reforming the Regulatory Environment for Doing Business in India

The Ministry of Corporate Affairs (MCA) has established a 20-member committee to make recommendations to improve the regulatory environment for conducting business in India. Some of the background to this effort is contained in the MCA’s office memorandum:

1. The report of The World Bank and the International Finance Corporation, entitled “Doing Business 2012: Doing business in a very Transparent World”, India has been ranked at a low of 132 amongst a sample of 183 countries. Although, there is a seven – point improvement over 2010 ranking of 139. However, India continues to lag behind even the BRIC and SAARC countries on most of the parameters.

2. Easing of business environment mandates extensive examination of regulations in different areas of root functioning such as financial reforms, governance reforms, liberalized policy framework, process reforms, etc.,. Thus there is a need to conduct an in-depth study into the entire gamut of regulatory framework and come out with a detailed roadmap for improving the climate of business in India in a time bound manner. Such an exercise needs to be undertaken for periodical improvement in the ranking, leading to a situation where India gradually moves towards upward position with almost zero hassles.

The committee is expected to hold consultations and invite opinions, and present a report in six months.

Unsurprisingly, this comes close on the heels of various concerns regarding policy paralysis and retrograde steps that have resulted in India’s image waning as an investment destination. While this is likely to assuage some of the concerns from a perception standpoint, it is not certain if the consultation and recommendations could result in concrete measures given that the terms of reference of the committee are somewhat wide and open-ended.

Guarantees and Performance Bonds

Payment obligations under commercial contracts are often secured by means of guarantees issued by banks, which guarantee the performance of the payment obligation by the buyer. For instance, if A and B enter into a contract whereby A agrees to sell B a ship for the price of $50 million, B's bank may issue to a payment guarantee to A to secure the payment of this amount from B. In the alternative, the contractual arrangements between A, B and the bank may be such that the bank issues a performance bond to A. However, there is a fundamental difference in the nature of the obligation assumed by the bank in the two cases.

If the bank issues a guarantee, the contractual arrangement between the parties is trilateral, whereby the bank undertakes a secondary obligation to guarantee that B will perform its contractual obligations to A. Therefore, any defences available to B are also available to the bank, and A must prove that B has invalidly failed to perform its contractual obligations. In such a case, depending on the nature of the guarantee, A can have recourse against the bank: (a) in damages, for a breach of the bank's obligation to ensure B's performance; or (b) requiring it to step into B's shoes and pay the amount owed by B on the satisfaction of any notice or demand requirements contained in the guarantee.

To the contrary, when the bank issues a performance bond, there are two independent bilateral arrangements in place: one between A and B, and the other between A and the bank. By virtue of the performance bond, the bank is obliged to pay A the secured amount if certain notice/demand conditions are satisfied, irrespective of whether any payment is due from B to A under the primary contractual arrangement.

Therefore, whether a given transaction involves a guarantee or a performance bond depends on the relative bargaining strengths of the parties, and the difference assumes great significance in cases where there is a dispute between A and B as to the existence of the primary payment obligation. It was one such case which was recently considered by the English High Court in Wuhan Guoyu v Emporiki Bank of Greece [2012] EWHC 1715 (Comm).

The facts of the case involved a shipbuilding contract, under which the buyer was to pay the consideration amount in instalments on the completion of certain activities in relation to the ship. The payment of these instalments was secured by means of a 'Payment Guarantee' which was Exhibit B to the primary contract, and was issued by the buyer's financing bank. The seller's bank had also issued a 'Refund Guarantee' to the buyer (Exhibit A), to secure repayment of the consideration amounts if the contract was rescinded or cancelled in accordance with its terms. Both these documents were referred to in the contract as 'irrevocable letters of guarantee'.

The buyer paid the first instalment, following which there was a dispute between the buyer and the seller as to whether the second instalment was due. The seller sought payment of the instalment from the bank notwithstanding this underlying dispute, thus calling upon the High Court to decide whether the 'Payment Guarantee' was a guarantee in the true sense, or in fact a performance a bond.

The Court began by clarifying that the question is one of construing the contract, and while previous cases could provide guidance as to the relevance of several factors, the identity of each document depended on its particular language and context. Based on a very useful survey of authorities (contained in paragraphs 32-54 of the report), the Court culled out the following principles which are relevant to determining the identity of a particular document:

• The labelling of the document as a 'guarantee' is not determinative, and neither is an elaboration of the commercial purpose of the document (e.g. 'to indemnify …')
• An undertaking to pay the on 'first written demand' and a provision that such demand is the only condition for payment indicates that the document is a performance bond
• The reasoning must start with the wording of the contract and the Court must not bring any pre-conceived notions to interpreting the document
• A key question is whether the condition for payment is the presentation of documents which assert certain facts, or the actual existence of the facts asserted
• A clause stating that the presentation of certain documents shall be 'conclusive evidence' indicates that the document may be a performance bond
• The issuance of the document in a banking context is material. In non-banking contexts, there is a strong presumption against it being a performance bond
• If the transaction is cross-jurisdictional, it may suggest that the parties would prefer to avoid a detailed proving of the merits of the underlying claim (and hence provide a performance bond)

On a detailed consideration of these factors, the Court concluded that the document in question was a guarantee and not a performance bond. While a detailed discussion of the conclusions would be out of place here, some interesting points emerging from the reasoning are:

• The fact that both the Payment Guarantee and the Refund Guarantee were referred to as 'irrevocable letters of guarantee' suggested that they had the same legal effect. The Refund Guarantee was undoubtedly a guarantee in legal terms (the contrary view would be commercially unreasonable), and therefore the Payment Guarantee was also likely a guarantee.
• The reference to the bank as the 'primary obligor' was not conclusive, since it begged the question of what the bank's primary obligation was. If the effect of the document was to create an obligation to guarantee and not to pay, then the reference to 'primary obligor' was not material.
• The bank's obligation arose if the buyer breached its obligations and then the seller issued a demand, which suggested that the breach a necessary precondition to payment. Although there is authority indicating that the use of such language ('if … when'; 'then') was not conclusive, when read in the context, the language here suggested that payment was condition on more than just the presentation of a demand notice.
• The fact that the bank was financing the buyer provided some commercial context to the bank's likely obligations. It was not a pure banking relationship, and the bank, in its capacity as the buyer's financer, was also likely to have an interest in the performance of the primary contract. While this was not a "particularly sure guide to the correct interpretation", it nevertheless refuted the seller's argument that the bank had no interest in the merits of the underlying transaction.

In sum, the decision provides a useful summary of the applicable principles in distinguishing between guarantees and performance bonds, and also is an example of their application to an interesting but not unusual set of facts.

Two Global Indicators: Measuring India’s Performance

Doing Business

Doing Business 2011, a co-publication of the World Bank and the International Finance Corporation, was released earlier this week. As far as India’s position is concerned, nothing significant has altered compared to its ranking in last year’s report. Of a total of 183 countries covered in the report, India ranks 134 (one place above its ranking of 135 in the 2010 report). Even within individual sub-categories against which countries are measured, there has been no significant improvement in India’s performance.

The report indicates two specific areas where reforms in India have been implemented recently:

Starting a business India eased business start-up by establishing an online VAT registration system and replacing the physical stamp previously required with an online version.

Paying taxes India reduced the administrative burden of paying taxes by abolishing the fringe benefit tax and improving electronic payment.

On the other hand, India’s ranking continues to be low when it comes to enforcing contracts, where it is 182 (second from the bottom). This reflects upon the efficiency of the dispute resolution system, which is plagued by delays and costs.

While one may always quarrel with the veracity or even the necessity or relevance of such a report carrying a cross-country analysis, the fact of the matter is that the results do not bode well for India’s continued rise as a leading economic power, as this report suggests.

Human Development

Economic indicators tell us only part of the story. How does increase in business activity and economic progress impact livelihood of people inhabiting a country and affect human development? Coincidentally, this week also witnessed the release of the Human Development Report 2010 by UNDP. Indian ranks 117 out of a total of 169 countries based on human development indicators. On a positive note, India ranks high among countries who have witnessed improvements in HDI over the 1970-2010 period as measured by annual percentage growth rate in per capita GDP. However, this leaves unanswered questions when it comes to non-economic indicators. As the report notes:

India’s deregulation since the early 1990s. India has a long tradition of entrepreneurial activity, with well established business families and networks. Many business families supported the independence movement and were politically aligned with post-independence governments. The extensive regulations during the first few decades after independence restricted corporate activities but did not threaten domestic business interests. The 1990s liberalization removed restrictions on corporate activity and steadily opened the economy to foreign competition—in effect, reducing regulatory burdens in return for greater efficiency. The evidence on business development in new sectors and on entrepreneurs emerging from different socioeconomic groups suggests a new dynamism. But there is intense debate about rising inequality, the need for complementary social actions, and problems with specific aspects of corporate governance and state-business relations.