All posts by @SomasekharS

Lawyer. I argue to win you over, not to win over you.

Shun rhetoric, appreciate IBC problem

The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold

The debate over the presidential ordinance amending the Insolvency and Bankruptcy Code, 2016, (IBC) to insert disqualifications of potential participants in the resolution process of an insolvent has become bipolar and divisive. Television channels are going breathless airing alternative views on alternate days. Columns (including in this paper) have attributed motives and sought to call out “canards” — a classic “Hinduho-ke-Musalmaan” type of zeal seen only in “holy wars” claiming righteousness.

 

The very nature of this fight makes it evident that the ordinance is good politics. However, in the process, the sweep of the real problem posed by the ordinance, runs the risk of remaining unaddressed, thereby risking the very effectiveness of the IBC.

 

The disqualifications introduced should first be noticed. The ordinance lists various categories of persons who would stand disqualified from participating in any resolution plan for any insolvent under the IBC.  Any promoter of such disqualified person, and indeed any “connected person” with such disqualified person also stands disqualified. The term “connected person” includes all “related parties” and “associates” of the disqualified person. In other words, once any person is disqualified, the scope and sweep of the disqualification is wide and expansive.

 

Now, three categories of disqualifications in the list, clearly are amenable to the charge of not having been thought through, and will truly have mindless and unintended consequences.

 

First: the disqualification of any borrower that has been classified as a “non-performing asset” and has stayed in that status for over a year. At first blush, this would appear logical — obviously an entity that is unable pay its own debts cannot be involved in resolving the problems for any other insolvent. However, every “connected person” i.e. every “related party” of such entity and every associate too would automatically stand disqualified.

 

The term “related party” under the IBC is wide — for example, any company with common shareholding of just 2 per cent would be a related party. The term “associate” would be even more problematic — but the minute detail is not necessary to make this point in this column. Therefore, if a business goes bust for any reason whatsoever, every promoter of that business, and every related party and associate can never participate in any resolution plan for any other insolvent under the IBC. It is not even the case that only the participation of such related persons in the resolution of that disqualified person would be barred. Every resolution of every other insolvent under the IBC would also be barred.  This is extreme, an unreasonable restriction, and can substantially wipe out the supply of authors of resolution plans.

 

Second: the disqualification of any guarantor of any debt owed by any insolvent under the IBC. This is an inexplicable disqualification. A guarantor of a company’s debt is someone who believed in that debtor and agreed to guarantee that debtor’s promise. When a resolution plan is sought to be made, the guarantor would have skin in the game because it is his neck on the line.  While keeping out such a person from the resolution of the debtor is itself questionable, keeping out such a person and every person connected with him from every other resolution plan for every other insolvent under the IBC is not even intelligible.

 

Third: the disqualification of any person (and indeed, of every connected person, related party and associate of such person) to whom the capital market regulator may have issued directions not to deal in securities or access the securities market. No time frame of the period of prohibition on dealing in securities is set out. The capital market regulator is known to have been trigger-happy in the past, issuing such directions even on an “ex parte” basis (without a hearing). There is no settled science or rationale for the choice of the length of the directions in the law.  Courts disturb or uphold such directions on the basis of the human judgement of nature of the facts in the cases before them. This disqualification would remove from the resolution market for all insolvents, a wide range of persons for no plausible, objective or intelligible rationale.
Worse, the same principles of exclusion from the market, would apply to any affiliate outside India.  This would wipe out from the resolution market almost every single multinational company that has an interest in India.  If any person anywhere in the world has ever become insolvent, or has become a non-performing asset or has been issued any direction not to deal in securities. all affiliates of that person all over the world would be ineligible to participate in a resolution plan in India under the IBC.

 

One can go on to other disqualifications too — for example: the disqualification upon conviction with an imprisonment term for a period of two years, without regard to what the conviction was for. So, if one family member has had an unfortunate tragic criminal conviction, every relative and every “connected person” would be banned from participating in any resolution plan for any insolvent. However, the three examples above would suffice to show how the public debate is wrongly focussed on “good vs. evil” terms — without nuance, and with deployment of blunt weapons rather than sharp instruments.

 

The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold. If the problem sought to be solved was to keep out those responsible for the cause of an insolvency from the resolution of that insolvent, the ordinance as promulgated is not the solution.
The very concept of identifying persons responsible for causing insolvency is very difficult to define in a one-size-fits-all manner.  The ordinance has demonized the occurrence of insolvency instead of recognizing that business failure is a part of life.  Every star investor and global business would have insolvents among their related parties.
This is why the IBC clearly envisages a role for professional resolution professionals and bankruptcy professionals.  It is for these professionals to oversee a resolution plan for insolvent companies. A committee of financial creditors has to approve the resolution plan. It is open to the resolution professional and the financial creditors to weed out misfits from participation. If a resolution professional does not perform well, she is subject to regulatory intervention from the Insolvency and Bankruptcy Board of India, the regulator of these professionals. Instead of studying if this profession performs properly, the ordinance has put the very efficacy of IBC at risk, with an air of misplaced righteousness. It is time to cut out the noise and focus on the gravity of the problem.

 

A substantial part of this piece was published as the Without Contempt column in the Business Standard editions dated November 29, 2017

States challenging Central Law embellishes Federalism

By Somasekhar Sundaresan

A Bench of the Supreme Court is reported to have criticized the Government of West Bengal and its advocate for filing a writ petition challenging the mandatory introduction of Aadhaar.

According to news reports, a judge is reported to have asked the lawyer how a state can challenge law made by Parliament. Taking the cue, it is learnt that West Bengal Chief Minister Mamata Banerjee’s lawyer agreed to get the individual who is the Chief Minister to be the petitioner instead of the state government.

According to this report in Bar and Bench, the judges are reported to have asked:

How can a State challenge a law made by the Parliament? You are challenging the vires of the Act.”

To protect the litigation in substance, finding fault with form, the Court is reported to have suggested,

“Let an individual come, let Mamata Banerjee come. But how can the State come? Tomorrow, what if the Centre challenges a law made by a State?”

This exchange may have been handled expeditiously had petitioner not displeased the Court by countering its observations. The move would have also suited the West Bengal Chief Minister, as it would give her direct political mileage. However, it begs the question if there is indeed any basis for a perception of illegality or impropriety in a state government challenging a law made by Parliament.

Interestingly, the answer, subject to some nuance, is clearly in the negative. There is no bar on a state government challenging law made by Parliament in the Supreme Court. On the contrary, under Article 131, the Supreme Court has exclusive original jurisdiction, to the exclusion of all other courts, over disputes amongst Central government and state governments, as indeed between state governments, where questions determinative of the existence or the extent of legal rights are involved.

In fact, the notion that challenges to law made by Parliament should be circumscribed, came up during the Emergency when Article 131A was inserted to provide that only the Supreme Court could deal with challenges to such legislation. Right after the Emergency, this provision was repealed. That temporary limitation was one of the forum, and not of the eligibility of the party who could litigate.

Then there is the age-old issue of whether a writ petition under Article 32can be pursued by a non-individual, but that does not seem to have been the basis of the change of form of the challenge to Aadhaar by the West Bengal government. The discomfiture appears to have been the seeming impropriety of a state government taking on law made by Parliament. That concern, even from the standpoint of propriety, appears misplaced.

Besides, if public interest litigation filed by individuals can be considered to be “appropriate proceedings” under Article 32, it would stand to reason that a state government (which would be held to a greater standard of propriety in its conduct) too should be able to move court. Of course, a petition without merit can be thrown by the court as it would throw out any petition that is without merit. A state government would be taking serious political risk if the apex court were to stricture it for indulging in frivolous litigation.

In fact, the recent history of the United States is rich with examples of states challenging law made by the Centre. Early this year, US President Donald Trump issued an executive order banning entry of persons from specified Muslim nations into the United States. A total of fifteen state governments – California, Connecticut, Delaware, Illinois, Iowa, Maine, Maryland, Massachusetts, New Mexico, New York, Oregon, Rhode Island, Vermont, Virginia and Washington – chimed in with the state government of Hawaii, to challenge it.

Even the equivalent of a “Union Territory” – the District of Columbia (Washington DC, which is like our National Capital Region) – challenged the travel ban. By a sleight of hand, the US President’s team replaced the travel ban under challenge with a new ban, adding a couple of non-Muslim nations to the list of banned sources of travellers and the fight has been reset to the first round again.  Hawaii is leading the fight again, and there is no reason why the other states would not join hands.

A state initiating litigation against the Centre in a court of law, over a constitutional issue, would embellish the robustness of the health of a federal democracy. Likewise, if for example, a State Legislature were to make law that is in the domain of Parliament, it would be a matter of robust federalism that the Central government challenges such law. The Supreme Court would be the right forum for resolving such disputes.

Indeed, there are various types of inappropriate use of judicial time for inter-governmental disputes and propriety would demand that those are not indulged in. For example, the income-tax department often files writ petitions challenging decisions of the Settlement Commission; the Enforcement Directorate is known to have challenged the Reserve Bank of India’s decision to compound offences under exchange controls; a former Union Finance Minister announced to the media that he had advised the capital market regulator and the insurance regulator to approach a court of law to litigate and resolve a turf war over unit-linked insurance schemes that were accused of also being mutual funds.

Last year, the state governments of Bihar and Jharkhand were rebuked by the Supreme Court for a dispute going back to 2004, over sharing of the guest house and state government office between the two states after the separation of Jharkhand from Bihar.

But a challenge to legislation made by Parliament by a state government, or for that matter, a challenge by the Central government to law made by a State Legislature hardly appears inappropriate.

The author is an advocate practising as an independent counsel.

This column was published in the Bar & Bench on November 9, 2017

The problem with ‘tribunalisation’

Shift the oversight of tribunals from the government to the judiciary and reclaim the ground that constitutionally belongs to the latter
By Somasekhar Sundaresan
The has published a report titled “Assessment of Statutory Frameworks of Tribunals in India”. While the report is a response to five specific issues referred to the Commission by the last year, it promises to be a catalyst to a new debate on the legitimacy of the tribunal framework that has come to dominate justice delivery in India.

 

First, while repeated constitutional challenges to the creation of tribunals have met with mixed results, with the institution of tribunals largely being upheld (with tweaks to composition and manner of appointment), one fundamental issue has eluded proper consideration and debate. Under our constitutional framework, separation of powers among the executive (elected government), legislature (and state legislatures) and the judiciary is a vital fundamental feature of checks and balances in running the polity. However, although a large segment of the justice delivery has shifted from courts to tribunals, the latter are run by the (executive) and not the judiciary.

 

The manner of appointment of its members, performance appraisal, career path for tribunal members, remuneration, terms of service are all outside the oversight of the judiciary. This is the foremost problem with tribunalisation. Unless this issue is addressed, one would perpetually be faced with the main litigant before the tribunal being its administrative overseer, presenting an inherent and foundational conflict of interest. A judge, once appointed, can only be removed by through impeachment. That is a constitutional design to provide for judicial independence. That logic is turned on its head when members of the tribunal, including presiding officers who are invariably retired judges, are mere employees without any serious procedure for their removal. The breakdown of the separation of powers is potentially the most unconstitutional feature of the functioning of tribunals.

 

Second, with so many areas of jurisdiction being taken away from the high courts and moved to tribunals, a seriously unmindful long-term damage is being inflicted on the judiciary. The judiciary has been zealous in guarding its independence on appointment of judges but has not been so in guarding what judges get to do after appointment.  Legislation after legislation that confers a tribunal jurisdiction over a body of law contains provisions to oust jurisdiction of civil courts (for example, electricity tribunals or the Securities Appellate Tribunal). Appeals from such tribunals typically lie in the — on the rare occasion with another intermediate appeal in another appellate tribunal (for example, company law) — but clearly taking out the jurisdiction of high courts.

 

Therefore, what a judge gets to work on stands seriously denuded. Apart from civil disputes between parties, matters of serious commercial policy and regulatory implications get dealt with outside the precincts of high courts. The counterpoint would be that writ petitions challenging the constitutional validity of state or regulatory action can indeed be filed in high courts. However, the rare writ petition that gets filed in a high court, and the even rarer one that is actually considered by a in an area of law covered by a tribunal’s jurisdiction, would be the exception that proves the rule. The availability of the alternative efficacious remedy in the tribunal is the first ground that gets fought in such writ petitions, and that alone can take weeks, if not months, on end.

 

When a judge moves up to the and hears an appeal from decisions of these tribunals, she would have barely had a chance to consider these laws in her entire career as a judge. When she retires as a judge and potentially gets appointed as a presiding officer of one of these tribunals, she may have to start from scratch with a specialised area of law, negating the very objective of creating specialised tribunals.

 

In a nutshell, the grand constitutional scheme of conflict by design between the elected political legislature, the unelected bureaucrats in and the judiciary stands demolished. The legislature is happy to let the executive pilot legislation, eroding the space for real and independent justice delivery by bringing a substantial part of the mindshare of the judiciary under the direct oversight and indirect control of the executive government, ousting the jurisdiction of courts.

 

Finally, such an act of pulling of the rug from under the feet of the judiciary is not caused only by creating tribunals. The very creation of regulatory agencies and giving them quasi-judicial powers, again excluding jurisdiction of courts, is where the problem gets seeded. For example, civil courts have no jurisdiction over areas in which the Securities and Exchange Board of India (Sebi) has jurisdiction. The ouster is at two levels in the Act, 1992: Jurisdiction of the and that of the Securities Appellate Tribunal oust the jurisdiction of civil courts. The regulator has to convince no judge in taking action (indeed, a perverse incentive to even take ex parte actions with debilitating consequences) and no judge outside a tribunal can hear an appeal from such an action. After the tribunal, the is directly the forum for the last appeal.

 

Now, the trend is so pernicious that state legislatures have started passing legislation providing for appeals to the as a matter of right — in other words, states seek to task the apex court with judicial work, bypassing the high courts in having jurisdiction over state-level tribunals.

 

All of this points to a fundamental design breakdown. At this juncture, the Law Commission’s report (which is in the nature of recommendations) does provide fodder for contemplation. The recommendations largely and rightly focus on the important aspect of composition of the tribunals and who can man them. The Commission also speaks about a “single nodal agency under the aegis of the Ministry of Law and Justice” to oversee all tribunals.

 

However, the malaise is deeper and needs broader surgical intervention. It can only be corrected by shifting the oversight of tribunals from the executive to the judiciary and reclaiming the ground that constitutionally belongs to the judiciary as an arm of the state.

This post was published as my column titled Without Contempt in the Business Standard’s edition dated November 2, 2017

About justice & conspicuous consumption

When a crime is committed, everyone seems to have a view on who has done wrong, and regardless of judicial outcome through due process of law, theories of how justice was done or not done mushroom
By Somasekhar Sundaresan
The Allahabad High Court has set aside the conviction of the Talwars in the tragic twin of teenager Aarushi Talwar and domestic help in The High Court ruled that the evidence was not adequate to secure conviction of the parents. The trial itself could have well qualified for mistrial in other jurisdictions going by the media coverage fed by the investigators and prosecutors, but that is now par for the course with any trial in India.

 

The same public drama that unfolded during trial has erupted all over again. There are those who have no doubt that the parents are guilty of murdering their child. They have come up with cynical arguments such as: “Therefore, nobody killed Aarushi.” Or, “The court has only said evidence is inadequate. They are of course guilty.” Or, indeed, with statements such as “What a successful peddling of innocence through a book and a movie!”

 

Others, with a contrary disposition, make arguments such as: “How could one even dream of accusing parents of murdering their child to begin with? There was no case here.”

 

In short, society is divided largely between those who believe the Talwars were guilty and those who believe they could never be guilty. Almost everyone has a certainty of belief stronger than what any eyewitness could harbour. Of course, there was none in this case.

 

hile this is a physical criminal case involving murder, in the corporate-business-financial sector, such an approach of society is consistently universal. In every single case, everyone in society has a clear view on who has done wrong, in what manner, and regardless of the judicial outcome through due process of law, theories of how was done or was not done mushroom.

 

In most financial sector laws, the enforcement folks do not even have to convince a court of of their story — they themselves can pass orders indicting an accused. In appeal, it is the defence that is on trial — the appellant has to convince the relevant tribunal that the order is not sustainable. Justice, in such circumstances, has become a matter of conspicuous consumption. It is easy to assail a victorious appellant as someone who got away for want of proper evidence — an alias for saying society will treat an accused as guilty even if courts do not believe her to be guilty.

 

Add to the mix, the practice of passing ex parte orders (orders passed without even a hearing) with clear and firm conclusions even before investigations are completed. A regulator can take a public position, however wrong investigations may subsequently prove them to be, and pass orders imposing restraints on the suspect. Having done so, the process of a “post-decisional hearing” and the suspect’s efforts at getting the restraints removed necessarily entails the defence being put on trial. The regulator gets a lot of mileage by attacking the credibility of the defence, without caring to first demonstrate the basis and validity of the unilateral ex parte order in the first place. In the eyes of society, that the state machinery has found fault with someone and believes that she has done wrong, is enough to make the suspect a convict.

 

Little wonder then that colourful use of language often seeks to make up for absence of articulated reasons in such orders. Indeed, even in the Aarushi case, the trial judge who wrote the order buying into the prosecution story, is reported to have taken pride in an interview with Avirook Sen (author: Aarushi; the interview is set out in Sen’s book on the case) in how he flew down his son, whose command over English was put to use to write a good quality order.

 

No one can really predict what will eventually happen to the Talwars in the judicial process. A further appeal is likely to follow — it may or may not succeed. The Supreme Court will eventually rule. That court is necessarily right because it is final. It is not final because it is right. Regardless of judicial outcome, sections of society have very clear and firm views on their guilt or on their innocence.

 

Worldwide, even after final rulings by supreme courts, convicts have been pulled out of prison or even out of death row because of relentless efforts by journalists and television documentaries, whose intrigue about a case refuses to let them accept what meets the eye and what is dished out to selective ears. That a book even got written on this case in India, with an independent resolve to probe facts rather than re-hash the versions given by prosecutors, is the Indian media’s saving grace.

 

That a movie-maker even took interest in a story of this nature to risk a commercial film on it is also not common. For a movie like Talvar, that is accused of influencing the outcome in the appeal, there has also been a movie such as No One Killed Jessica, which spoke about accused being wrongfully absolved (unwittingly, the name has laid down a popular expectation that when there is a crime, if the accused has not done it, the crime never took place). That movie too followed meticulous journalistic work proving how witnesses had lied during trial.

 

Somehow, the sight of a specific person going to prison for a crime seems to warm many an Indian heart as compared with the sight of seeing the evidence stacked up against an accused just not withstanding judicial scrutiny. There is a nice coinage that has been developed for this concept: “collective conscience”.The concept was, for example, relied on to confirm the death sentence for an accused in the case involving the attack on Parliament, even while acknowledging that the evidence and the quality of trial was weak.

 

In other words, if a case shakes up society well enough to have its attention rivetted, the standard of would practically vary. Therefore, the incentive for prosecutors and regulators is perversely weighed in favour of scandalising a case strongly enough for society’s attention to stay rivetted to the lurid details dished out, leaving it open to ignore facts and evidentiary standards. Of course, whether someone going to jail or someone being let off is more acceptable for a society’s collective conscience is a pointer to what kind of society we are as a collective.

 

This column was published under the title Without Contempt in the Business Standard editions dated October 19, 2017

Between what’s said and left unsaid

If at the end of reading this piece, you feel it is an “impractical” and “theoretical” approach to “Indian realities”, you may not be alone. Yet, the following has to be said: Our policymakers just demonstrated doublespeak in relation to market integrity. They have flinched in making truth available to financial markets, a vital element for informed market decisions.

A terse one-line press release, appropriately drafted in passive voice, was issued by the (Sebi) on September 29, 2017. It read: “It has been decided to defer implementation of Sebi circular no CIR/CFD/CMD/93/2017 dated August 4, 2017, until further notice.”

The press release is significant for what it did not say rather than for what it did. What the circular being deferred was about, when it was meant to take effect, what weighed with the regulator in introducing it and what weighed with the regulator to indefinitely defer its introduction, what transpired in the time between the two events were all left unsaid.

This column is not another iteration of lawlessness in the process of law-making. Indeed, pre-legislative consultations are to be expected only for measures that the regulators are reluctant to introduce or repeal. On measures that could beget bouquets or brickbats, it is normal not to expect any pre-consultations.

Back to the circular that has been put off. On August 4, 2017, Sebi issued a circular to provide that effective October 1, every listed company would have had to disclose within one day, the occurrence of any default in payment of interest or principal on the due date. A simple measure that would have brought cleanliness and transparency to financial markets, it would also have spurred the solvent but indolent to buck up and ensure they did not inadvertently err in servicing financial obligations.

The measure was vital for integrating the with the rest of the financial market system. That a company is unable to meet its obligations when due could be material information that would inform investors’ decision on what to pay for or what to expect for the securities of that company. The disclosure obligation was introduced on this premise. However, the known inability to pay would make it clear to the market for banking and financial services that a company, which is unable to pay its debts when due, is borrowing from the system. This would enable a clearer profiling of the risk in dealing with such a borrower.

When the circular was issued, a retiring whole-time member of Sebi spoke about its virtues at length in public interviews. Sebi was happy to take credit for being the harbinger of a game-changing measure. The withdrawal, on the other hand, has been made in a whimper.

However, it seems these are not good times for dissemination of bad news.  Perhaps it was felt that a spate of disclosures of defaults would follow, lending credence to the gnawing belief that the economy is in a spiral, headed for a hard landing. Inexplicably, without any articulation of the cause for change of heart, the regulator has given credence to that assumption.

“India is not ready for it” is an argument one usually hears in relation to any inconvenient policy reform measure — for example, making an open offer to acquire all the residual shares during a takeover of a listed company; and getting every listed company to publish a prospectus-type document to bring material information about the state of affairs into the public domain even without a securities offering being involved.

This circular had also imposed a statutory obligation on listed companies to inform credit rating agencies about such defaults. Virtually every credit rating agency of relevance is facing proceedings with Sebi for not having downgraded a certain listed company’s debt-servicing capacity. When this company’s inability to service debt was discovered, the effect was so severe that a certain mutual fund with exposure to that debt had to shut the gate for redemption of units. If the regulator now believes that full and clear transparency to rating agencies is not in public interest, surely it should stop making fall guys out of them.

Sebi is quick and prone to lashing out with premature actions against alleged insider trading. Even bank accounts get impounded for periods longer than the law permits in the garb of securing proceeds of insider trading. The introduction of an obligation to make timely disclosures would have served the regulatory war against insider trading. It would have prevented wrongdoing and obviated punishment — the quicker the dissemination of material information, the lesser the scope for those in possession of it, thereby reducing the ability to trade ahead of the rest of the market, without fear of also violating the law mandating dissemination.

The leadership at Sebi has been actively involved in a policy game changer in the financial system — the introduction of the Insolvency and Bankruptcy Code, a legislation that has so far largely received a resounding endorsement from the higher judiciary. World markets were looking at this circular as a game changer in aiding the effectiveness of this new law. Now, it is not to be.

If media reports are to be believed, the circular was considered to be utopian enough to make many in the banking system chicken out. If we send a signal that bringing out the full truth would be unpalatable not only for listed companies but also for banks that have exposure to such listed companies, it would mean that we are happy to let the truth — not just about borrowing listed companies but also listed banking companies — be shoved under the carpet.

“Being practical” is in itself a dangerous phrase. Many a social problem today ranging from domestic violence to female foeticide has been compounded by living in denial and enforced silence. Perhaps, we just got the financial markets version. If inadvertent payment defaults by solvent companies sending avoidable panic signals to the markets was what the Sebi was worried about, it could have tweaked the timing of the mandatory disclosure to the date on which the cure period for the default expires without the default getting cured.

 

This column was published as Without Contempt in Business Standard editions dated October 5, 2017

 

Sebi on the right path over control of companies

Its decision to desist from amending the Takeover Regulations is acknowledgement of the fact that one size doesn’t fit all

The (Sebi) has announced that it would refrain from amending the Takeover Regulations to specify situations in which it would rule that there is no change of control over a listed company. This is a right step for a variety of reasons.

When one acquires control over the management and policy decisions of a listed company, an offer to buy shares from other is mandatory.   Likewise, acquisition of shares with voting rights of 25 per cent or more mandatorily triggers an open offer. Typically, acquisition of control occurs along with acquisition of shares. However, the regulations contain a provision that makes it an obligation to make an open offer when acquiring control regardless of the quantum of shares acquired.

This is an important regime. One can acquire control without crossing the 25 per cent voting rights that would trigger an open offer. This could take shapes and forms that cannot be predicted in advance — through contractual rights and arrangements embedded in documents to which the listed company is bound. Now, when investors execute investment agreements with listed companies and desire a degree of say in decisions that could alter the very foundation of the company they invested in, the question often arises whether they have taken over control.

For example, if a company that manufactures paper seeks to change its activity to manufacturing steel, and an investor secures a contractual right to stop it, that would not represent the capacity to control the day-to-day management of the company. It would only be a right to insist that a company stays its course truthfully. On the other hand, if an investor were to have a right to approve every contract above a threshold value, it would point to control over how to manage the company.

Life is never led in either extreme, but there is a lot of truth in between the two extremes. For example, an investor may secure a right to object to a transaction that is a substantial component of the value of the net worth of the company — in other words, the right to scuttle a risky proposition.  What the size of the net worth is and how much percentage of it is the threshold, what nature of transaction is sought to be covered — these are all factors that would answer the question of whether such a right constitutes control over management and policy decisions. For example, the right to approve the room tariff policy of a hotel owned by a listed company could be control over the company if the only business of the company was to run that one hotel. Such a right over one hotel, which does not constitute a major source of revenue for a company that owns multiple hotels, would not constitute control.

Now it would be impossible to stipulate by legislation what constitutes control in a manner that wold cover all possible factual situations. Therefore, beyond stating that rights, which merely constitute some influence over material and fundamental changes to the ordinary course of conduct would not necessarily constitute control, it would not be possible to stipulate more. Such guidance could emerge from rulings and case law rather than by legislation that would lay down hard rules, which may not fit every situation. That even undertook a public exercise of considering these issues points to its acknowledgement that a one-size-fits-all approach of alleging control would be wrong — just as it would be impossible to provide immunity that certain types of rights would never constitute control.

In recent orders, has adopted a mature stance of acknowledging this position. Other legislation, too, have references to “control” and pretty much sail in the same boat. To legislate that unless 25 per cent is owned there would be no control would be a lazy option and can have a deleterious effect, with an incentive to fly just under the radar and actually wield control. To legislate that certain types of rights can never ever constitute control or that they would always and necessarily constitute control would also be fundamentally flawed. This is why the Achuthan Committee, whose draft is the basis of the current version of the Takeover Regulations (Disclosure: The author was a member), consciously left this to case law to evolve on the facts of each case.

Indeed, can issue guidance notes explaining the principles that it would apply in its approach to enforcement in this regard. Beyond that, whether or not any person has acquired control will necessarily be left to a “question of fact” to be answered from the facts and circumstances of each case. It may well sound like a fallback on the Justice Potter Stewart’s famous ruling in a case involving a charge of “hard-core pornography” against a movie. He ruled: “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description, and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.”

This column was published as Without Contempt in editions of Business Standard dated September 21, 2017

A tale of two jurisdictions

By Somasekhar Sundaresan
The standard for treating as illegal, by those tipped off with price-sensitive information by insiders, underwent yet another yo-yo in the last week. The constant change in standard on what constitutes illegal insider is a hallmark of insider law in that country.

 

An appellate court has ruled that it would not be necessary to show that the person, who receives a tip-off from an insider, has to have a “meaningfully close personal relationship” with the latter. The same court had ruled in December 2014 that such a relationship would be vital to hold that insider took place. In that case, two men, who had traded in securities, were held to have had only vague and casual acquaintance with the source of the inside information. In the absence of any meaningfully close personal relationship, it was held that they could not be said to have been gifted or sold the tip by the insider for the to be violative. In short, no benefits could be inferred for those giving them the information.

 

Two years later, in December 2016, the ruled in a case that involved by a person, based on information received from a sibling who was the insider, that there would be no need to look for a benefit or gain to provide the tip. Applying that rationale, the appeals court has now ruled that there is no real need for any “meaningful close personal relationship” to exist to render the illegal. The court has gone on to say that if an insider were to give a tip to a doorman instead of a tip in the form of money, he would still be achieving his objective of providing gratification and, therefore, the by the person receiving the tip would be illegal.

 

Cut to India. Virtually every man on the street here would believe that the US has a far greater regime for punishing insider and that India is lax on the matter. The truth is far more nuanced. First, under Indian law, by definition, any person receiving unpublished price-sensitive information becomes an “insider”. Therefore, by the recipient of any price-sensitive inside information would become violative “insider trading”. Second, the very act of communicating unpublished price-sensitive information has been rendered illegal by law in India — unless, of course, a legitimate purpose for such communication can be shown, for example, providing an auditor with draft accounts.

 

In practice, how this is enforced makes in securities quite dangerous in India. It is now becoming routine for any trade by any person to be rendered vulnerable to attack as being illegal if a link between the person who traded and an insider, however tenuous, is found. It is this extreme that the is zealously wary of — an exposure of innocent traders to the charge of insider leads that system to err on the side of caution in favour of presuming bona fides by those  The Indian regulator has chosen to err on the side of caution in favour of presuming mala fides by those trading: So long as some form of link is found, it would be presumed to be illegal motivated by inside information, regardless of whether information was actually communicated.

 

Surprisingly, despite the law having been amended to empower the regulator to demand and get call data records from telecom companies to demonstrate circumstantially the communication links between the insider and the person who has traded, the regulator never uses this power. Usage of such power would bring with it the necessity of having to prove the intensity of the link. Worse, informal guidance has been issued to say that without even going into evidence of communication between a discretionary portfolio manager and his client who may be an insider, trades on behalf of an insider by the portfolio manager, even if made without reference to his insider client, would be illegal (not “could be illegal if the client indeed exercised his own discretion in the decisions”).

 

The legal status of a person, who has actually received unpublished price-sensitive information from an insider, as an “insider” is easy to understand if evidence (circumstantial evidence) reasonably shows that the person who traded indeed received such information. However, for those who are actually insiders themselves, the treatment becomes even more dangerous. A “connected person” is one who is reasonably likely to have access to inside information. Whether such a person indeed had access and who would need to show that she had such access are questions that are routinely given the go-by, hoping that courts would give enforcement a long rope.

 

This is the kind of outcome that a dissenting judge in the appeal judgment has warned against. According to her, prosecutors would “seize on this vagueness and subjectivity”, which, to her mind, “radically alters insider law for the worse”.

 

There is one material distinction that makes the problem exponentially worse in India. US enforcement agencies have to satisfy a neutral judge of the strength of their charges, with cogent evidence. This leads to the finely nuanced and, at times, abstruse judicial analysis of the standards necessary to bring home a charge. In India, the regulator has to convince no one for declaring a person to be guilty of insider  How well it has to explain itself depends on the quality of the challenge mounted in an appeal that can only be filed after the event of being held guilty.

 

Twitter: @SomasekharS

This column was published under the head Without Contempt in the Business Standard editions dated September 7, 2017