Dismissal of Suit Against Satyam Directors

Last week, there was coverage in the financial press about the dismissal of a securities law suit by a New York court against the independent directors of Satyam. Now, a copy of the order dated January 2, 2013 issued by Judge Barbara Jones of the Southern District of New York is available through D&O Diary, which also carries a detailed analysis of the opinion.

The shareholder suits failed on two counts, one procedural and the other substantive. On the procedural count, it was found that on an analysis of the principle laid down by the US Supreme Court in Morrison, the plaintiff shareholders’ claim is to fail because they either bought shares on an Indian stock exchange or exercised employee stock options which was said to have taken place in India. In other words, the New York court was unable to exercise jurisdiction. On the substantive count, it was found that the shareholders’ claim against the independent directors of Satyam was not sustainable because the claims concern an “intricate and well-concealed fraud perpetrated by a very small group of insiders and only reinforce the inference that the [independent directors] were themselves victims of the fraud.”

Although the evidence of successful personal actions against independent directors even in the US is limited, this court ruling would provide some source of comfort to independent directors who are usually concerned about personal liability for actions that are beyond their control. 

Exclusion of Jurisdiction of Civil Courts under the SEBI Act

Legally India has made available certain expert witness statements filed before US Courts in the class action litigation concerning Satyam, which was recently settled. One of the witness statements, by Mr. Sandeep Parekh, makes an interesting point; but I am not entirely sure of the tenability in law of that point. Mr. Parekh’s declaration / statement as an expert witness is available here. I am concerned in this post particularly with the claim made by Mr. Parekh in para 11(a) of his statement: “Private parties have no right to sue to recover damages resulting from the Satyam fraud under Indian statutory or common law because the Indian civil courts have no power to hear disputes where, as in this case, SEBI is empowered to act.” Essentially, this means that a private party cannot maintain a suit in tort in respect of the “Satyam fraud”. Mr. Parekh’s reasoning is effectively based on the bar on jurisdiction in Section 15Y and Section 20A of the SEBI Act. He also places reliance on a Bombay High Court judgment in support of this proposition. With great respect, it is submitted that none of these reasons are strong enough to support Mr. Parekh’s conclusion.

Section 15Y says:

“No civil court shall have jurisdiction to entertain any suit or proceeding in respect of any matter which an adjudicating officer appointed under this Act or a Securities Appellate Tribunal constituted under this Act is empowered by or under this Act to determine and no injunction shall be granted by any court or other authority in respect of any action taken or to be taken in pursuance of any power conferred by or under this Act.”

The key phrases here are, (a) “no court shall have jurisdiction” (b) “to entertain any suit or proceeding” (c) “in respect of any matter which an adjudicating officer appointed under this Act… is empowered by or under this Act to determine.” The issue turns on the scope of (c) above. Are tort claims within the scope of “any matter” which an adjudicating officer or SAT is entitled to determine? In my submission, no. The adjudicating officer is entitled to examine violations of the Act; he has no powers to determine any tortuous liability whatsoever. The same facts which give rise to a statutory violation may very well also constitute a tort claim – this does not mean that the adjudicating officer has jurisdiction to hear and decide the tort claim as well as the statutory violation.

To get over this reasoning, Mr. Parekh relies on the judgment of the Bombay High Court in Kesha Appliances v. Royal Holdings Services Ltd. He relies specifically on this sentence: “The contention of the learned counsel for the plaintiff that there was a pre-existing common law right under section 9 of the CPC and that pre-existing common law right is not taken away by the provisions of sections 15Y and 20A also cannot be accepted.” In Kesha, however, the right in question was a right of rectification. The very next sentence in the judgment says, “It is because the common law right of rectification which is sought to be enforced and exercised by the plaintiff in the present case arises out of the right conferred on the basis of Take Over Regulations and once the provisions of the Take Over Regulations are invoked then the entire jurisdiction by virtue of the provisions of Section 15Y and 20A is exclusively conferred on the SEBI authorities.” 

The right to maintain an action in deceit or in negligence does not arise out of any provision in the SEBI Act. In Kesha Appliances, the case of the plaintiff was that certain preference share allotments to one defendant by another defendant were violative of Regulation 12 of the Takeover Regulations and hence illegal. Accordingly, the plaintiff sought for rectification. Thus, the actual right which the plaintiff was exercising was a right arising out of statute/regulation – in other words, the statutory violation was an essential basis for challenging the allotment and seeking for rectification. 

The case with a tort situation is in my submission completely different. The Kesha judgment itself clarifies, “Though it is not necessary still I feel it is important to clarify that when the rectification of the share register is dehors the provisions of the Takeover Regulations or any other provisions of the SEBI Act and rules and regulations made thereunder then the court would certainly have jurisdiction to entertain and try such a suit under Section 9 of the CPC. It is because what is barred under section 15Y and 20A is only those acts which falls either under the said Act or under the regulations framed thereunder.” The reason why in Kesha it was ultimately held that there is a bar on jurisdiction is this: “the entire suit is based on the sole ground of violation and/or breach of the Take Over Regulation and no other ground has been invoked for rectification of the Share Register.”

In one of the footnotes to his statement, Mr. Parekh also relies on the decision of the Delhi High Court in M.R. Goyal v. Usha International. In that decision, too, it was found that “on the basis of the averments made in the plaint and the contents of the application, it is apparent that the main thrust of the case of the plaintiffs is that the impugned notice issued by defendant No. 1 is in violation of the guidelines issued by the Sebi Act and the rules and regulations framed thereunder.”

In my view, these decisions are clearly distinguishable from a case where the cause of action is not a statutory/regulatory violation but a tort. If at all, clarificatory observations in Kesha support the proposition that a tort claim can be decided in civil courts notwithstanding the SEBI Act bar on jurisdiction.

Mr. Parekh then highlights the fact that any penalties collected by SEBI would go to the SEBI and not to shareholders of Satyam. This is eminently logical if the shareholders are entitled to a remedy in tort. Thus, the fact that penalties would go to the SEBI would – if at all relevant – tend to support the argument that civil claims are not barred.

It is submitted that, with great respect, a legally untenable result will be reached if one says that the SEBI Act bars a suit in tort in the circumstances. 

Fraud and the amendment of a section 34 application

In an important fallout of the Satyam controversy, the Supreme Court, earlier this month, reiterated the law on the amendment of section 34 applications, and also clarified the kinds of fraud that would justify the setting aside of arbitral awards on grounds of public policy. After the fraud perpetrated Mr. Raju, Venture Global sought to amend its section 34 and bring the facts about the fraudulent conduct on record. Before the AP High Court, Satyam successfully contended that the amendment of the pleadings was hit by the limitation period prescribed under section 34, and could not be allowed. Venture’s appeal against this decision fell for the Supreme Court’s consideration.

Section 34 of the Act, in its relevant part, reads-

34. Application for setting aside arbitral award.

(1) xxx

(2) xxx

(a) xxx

(b) the Court finds that-

(i) the subject-matter of the dispute is not capable of settlement by arbitration under the law for the time being in force, or

(ii) the arbitral award is in conflict with the public policy of India.

Explanation.-Without prejudice to the generality of sub-clause (ii) it is hereby declared, for the avoidance of any doubt, that an award is in conflict with the public policy of India if the making of the award was induced or affected by fraud or corruption or was in violation of section 75 or section 81.

(3) An application for setting aside may not be made after three months have elapsed from the date on which the party making that application had received the arbitral award or, if a request had been made under section 33, from the date on which that request had been disposed of by the arbitral tribunal:

Provided that if the court is satisfied that the applicant was prevented by sufficient cause from making the application within the said period of three months it may entertain the application within a further period of thirty days, but not thereafter. [emphasis supplied]

Based on the language of the provision, there were two arguments available to the Satyam- (a) that the extended period of 30 days, contained in the proviso to clause (3), had expired and it was not open to the Court to allow any further extension; and (b) that the fraud in question had not induced or affected the award, and was not relevant for the purposes of section 34. The first of these arguments had been considered and rejected by the Supreme Court in State of Maharashtra v. Hindustan Construction Company. In this case, the Apex Court had been called on to consider whether the limitation period applied only to fresh applications for setting aside awards, or also to amendments to existing section 34 applications. The Court held that amendments to existing applications, if necessary in the interests of justice, and not amounting to a fresh application, would not be barred by the proviso to section 34(3). (A more detailed discussion of the decision is available here).

That then left only the question of whether the fraud perpetrated by Mr. Raju could be said to have induced or affected the impugned award. Mr. Salve contended for Satyam that the phrase ‘making of the award’ had to be read narrowly, and that events subsequent to the award had no bearing on a section 34 application. Mr. Venugopal, for Venture Global, contended that since the facts were not revealed by Mr. Raju until after the award, there was no way they could have been made part of the original section 34 application. Also, since the concealment had materially affected the passing of an award in Satyam’s favour, it was material for the purposes of setting aside the award. Accepting the Respondent’s contentions, the Supreme Court overturned the decision of High Court and allowed the amendment of the application. The Court observed that the phrase ‘making of the award’ could not be read narrowly, especially since the scope of the provision was widened by the phrase ‘induced or affected’. Further, the Court went on to elucidate on its conception of public policy in the following words-

The concept of public policy in ABC, 1996 as given in the explanation has virtually adopted the aforesaid international standard, namely if anything is found in excess of jurisdiction and depicts a lack of due process, it will be opposed to public policy of India. When an award is induced or affected by fraud or corruption, the same will fall within the aforesaid grounds of excess of jurisdiction and a lack of due process. Therefore, if we may say so, the explanation to Section 34 of ABC is like `a stable man in the saddle' on the unruly horse of public policy. [emphasis supplied]

Thus, the Court concluded that the amendment of the section 34 application could not be barred by limitation in the interests of justice, and that the fraud alleged was such as to fall within the scope of fraud which had ‘induced or affected the making of the award’. On this basis, the decision of the High Court was overturned. (Another exhaustive discussion of the decision is available here).

On a concluding note, one issue discussed earlier seems to be interesting in the context of the discussion above. In Moore Stephens, the House of Lords had held that fraud by the ‘directing mind and will’ of a company will be attributable to the company is all cases, except when the company itself is a victim (as opposed to a vehicle) of the fraud. In the case of Satyam, whether the company was a vehicle or a victim of the fraud is open to argument. Hence, in a case like this, it may be possible to argue that the fraud perpetrated by Mr. Raju is not attributable to Satyam. However, on the text of section 34, there is no requirement that the fraud which ‘induced or affected the making of the award’ be attributable to a party to the arbitration proceedings. It is probably for this reason that the question of attribution was not argued before or considered by the Court. It is instructive to contrast the Indian language with that of the English Arbitration Act, 1996, which talks of an award ‘being obtained by fraud’. The use of the word obtained (as opposed to influenced or affected) can be taken to signify that under English law, the fraud in question should be attributable to a party.

On this reading of the provision, it seems that the question of attributability of the fraud is not relevant for the purposes of section 34(3). However, on a closer examination of the decision of the Supreme Court, there are a couple of observations which can be taken to be assumptions by the Court that fraud under section 34 is fraud attributable to a party. First, the Court cites and approves the provision in the English Arbitration Act, which, as seen above, can be interpreted as containing the requirement of attribution. Secondly, there is the observation of the Court that “If the argument advanced by the learned counsel for the respondents is accepted, then a party, who has suffered an award against another party who has concealed facts and obtained an award, cannot rely on facts which have surfaced subsequently even if those facts have a bearing on the facts constituting the award ... Such a construction would defeat the principle of due process and would be opposed to the concept of public policy incorporated in the explanation” [emphasis supplied]. Admittedly, neither of these instances are authority for the proposition that attribution of the fraud to a party has been read into section 34 by the Court. This is especially so given broad observations like “if the concealed facts, disclosed after the passing of the award, have a causative link with the facts constituting or inducing the award, such facts are relevant in a setting aside proceeding and award may be set aside as affected or induced by fraud”. However, since the Court only decided that the application may be amended to make fraud a ground, and did not dispose of the question of whether the award may be set aside on grounds of fraud (which being a question on merits, is still to be decided by the lower courts), there is always the possibility that this question comes up for consideration in future.