Author Archives: novojuris

Making Markets Work for Affordable Healthcare – Policy Note

The Competition Commission of India on 28-29 August organized a technical workshop on ‘Competition Issues in the Healthcare and Pharmaceutical sector in India’, as a follow up to this workshop on 24/10/2018 the CCI issued a policy note titled ‘Making Markets Work for Affordable Healthcare’. The primary focus of this policy note is to provide and create a pro-competition market in the healthcare industry.  It has been observed that pharma/healthcare suffer with information asymmetry the note stated.

The press note enumerates various problems related to the pharma/healthcare industry (in four distinct categories) which prohibit the industry from becoming pro-competition.

Below is a summary of the issues and possible solutions discussed by the CCI under the policy note:

Role of intermediaries in drug price build up:

  1. High trade margins and closed and connected distribution channels. Further the self-regulation by trade associations contribute towards high trade margins.
  2. A larger and wider public procurement and distribution system of essential drugs can circumvent the high trading prices. Initiatives like Pradhan Mantri Jan Aushadhi Pari Yojna  are an excellent example of the same.
  3. Using electronic means of trading in drugs with appropriate safeguards would encourage transparency and spur competition in the market among all stakeholders.

Quality perception behind proliferation of branded generics:

  1. The Indian pharmaceutical market is dominated by branded generic drugs which are expensive in nature. The reason being, brand identity and the quality of these branded drugs. The note clearly states in this regards “However, it is also equally possible that the brand proliferation is to introduce artificial product differentiation in the market, offering no therapeutic difference but allowing firms to extract rents”.
  2. The note with regards to the quality of the drugs states that regulatory bodies must ensure consistent application of statutory quality control measures by each drug manufacturer.
  3. It also mentions that the problem of artificial product differentiation may be addressed through ‘a one-company-one drug-one brand name-one price’ policy.

Vertical arrangements in healthcare services:

  1. In-house pharmacies of super speciality hospitals are insulated from competition; generally the inpatients are not allowed to buy drugs or any product from outside pharmacies.
  2. The note also focuses on how all accredited (NABL) pathological labs shall maintain quality standards in terms of infrastructure, equipment, skilled manpower.
  3. Last but not the least the note states that there is no framework that ensures and governs portability of patient’s e-health records. This causes a lock-in situation for all the patients and makes it really hard for them to switch between medical service providers.

Regulation and competition:

Due to presence of various regulatory bodies at centre and state level, regulating the pharmaceutical industry has resulted in multiple standards for the same products. A mechanism under the aegis of CDSCO can be formalized to negate this issue also there should the new drug approval should be time bound.

Further the policy discusses two other issues related to the healthcare industry: (i) shortage of healthcare professionals in the country owing inter alia to high cost of medical education and (ii) inadequacy in health insurance.

Source: https://www.cci.gov.in/sites/default/files/press_release/PressRelease.pdf

 

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Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Fourth Amendment) Regulations, 2018

The Insolvency and Bankruptcy Board of India, vide its notification dated 5 October 2018 amended the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 by notifying the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Fourth Amendment) Regulations, 2018.

The key changes brought through this amendment are as follows:

  • Omitted the meaning of dissenting financial creditors as given in Regulation 2 (1) (f) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016.
  • Removal of the requirement under Regulation 21(3) (b), for the notice of the meeting of committee of creditors to state that the vote of the members of committee should not be taken unless all the members are present at such meeting.

Amendments in the voting process of the committee of creditors

  1. Amendment of Regulation 25 (5) has been brought to provide for the detailed voting procedure by electronic means in case a member is not present for a meeting. The amended regulations now also provide for the circulation of minutes to the authorized representatives in addition to the creditors. The authorized representative is obligated to circulate the minutes of meetings received by it, to the creditors in a class and announce the voting window at least twenty-four hours before the window opens for voting instructions and keep the voting window open for at least twelve hours.
  2. Addition of sub-regulation 1A to Regulation 26 which provides that the authorized representative shall exercise the votes either by electronic means or through electronic voting systems as per voting instructions received by him from the creditors in the class.

Resolution Plan

  1. Substitution of sub-regulation (1) of Regulation 38 which now provides that the mandatory content of the resolution plan shall provide that the amount due to operational creditors under a resolution plan must be given priority in payment over financial creditors. Earlier the provision provided for specifying the insolvency resolution process costs providing that the insolvency resolution process costs will be paid in priority to any other creditors;
  2. Omission of Regulation 39 (1) (b), the requirement of providing an undertaking by the prospective resolution applicant that he shall provide additional funds to the extent required is no longer required.
  3. Omission of sub-regulation (3A) of Regulation 39, the committee is no longer required to specify the amounts payable from resources in the contents of the resolution plan, while approving the same.
  4. Addition of regulation 39A, which provides for preservation of records. It states that the Interim Resolution Professional or the Resolution Professional shall preserve physical and electronic copy of the records relating to corporate insolvency process of the corporate debtor as per the record retention schedule that the Insolvency and Bankruptcy Board may communicate in consultation with the Insolvency Professional Agencies.

Sources

  1. https://ibbi.gov.in/webadmin/pdf/whatsnew/2018/Oct/CIRP%20Amendment-5.10.2018_2018-10-05%2023:21:24.pdf
  2. https://ibbi.gov.in/webadmin/pdf/legalframwork/2018/Aug/Insolvency%20and%20Bankrutpcy%20Code,%202016%20(31%20of%202016)%20upto%20date%20amendment%2017.08.2018_2018-08-19%2013:27:42.pdf.
  3. https://ibbi.gov.in/webadmin/pdf/legalframwork/2017/Oct/CIRP%20Regulations%20-%20after%202nd%20Amendment_2017-10-24%2017:32:27.pdf.

Enhanced disclosure requirements for Credit Rating Agencies

SEBI vide its circular dated 13 November 2018 has tightened the norms for Credit Rating Agencies (CRAs) by enhancing the levels of disclosures required to be made by the CRAs under the SEBI (Credit Rating Agencies) Regulations, 1999 (CRA Regulations). As per the recent circular, the following changes have been brought about:

  1. Under an earlier circular dated 1 November 2016, SEBI had prescribed the standard format for press releases put out by CRAs regarding rating action. Now, specific disclosures must be made in the press release;
    • with respect to rating factors where support from a parent/group/government entity is expected, the name of such entities and the rationale for such expectation to be mentioned.
    • when subsidiaries or group companies are consolidated to arrive at a rating, the names of all such companies, along with the extent of consolidation and rationale for the same to be disclosed.
  2. The above-mentioned press release must also contain a specific section on ‘Liquidity’ with parameters like liquid investments or cash balances, access to unutilised credit lines, liquidity coverage ratio, adequacy of cash flows for servicing maturing debt obligation, etc.
  3. Disclosure of any linkage to external-support for meeting near term maturing obligations must also be made by CRAs.
  4. CRAs may review their rating criteria with regard to assessment of holding companies and subsidiaries in terms of their inter-linkages, holding company’s liquidity, financial flexibility and support to the subsidiaries, etc.
  5. In monitoring of repayment schedules, CRAs to analyse the deterioration in the liquidity conditions of the issuer and also take into account any asset-liability mismatch.
  6. CRAs may treat sharp deviations in bond spreads of debt instruments vis-à-vis relevant benchmark yield as a material event.
  7. CRAs to publish their average one-year rating transition rate over a 5-year period, on their respective websites, calculated as the weighted average of transitions for each rating category, across all static pools in the 5-year period. This shall be adhered during the half-yearly internal audit of the CRAs under the CRA Regulations.
  8. CRAs to furnish data on sharp rating actions in investment grade rating category to Stock Exchanges and Depositories for disclosure on website on half-yearly basis, within 15 days from the end of the half-year (31st March/ 30th September).

Link to source:

https://www.sebi.gov.in/legal/circulars/nov-2018/guidelines-for-enhanced-disclosures-by-credit-rating-agencies-cras-_40988.html

Ecommerce: Intermediary’s liabilities and duties

The Delhi High Court in the case of Christian Louboutin SAS v. Nakul Bajaj and Ors.[i], (hereinafter Louboutin case) has dealt in detail the circumstances where an E-commerce platform could be considered as an intermediary and when it loses the safe harbour  under the Information Technology Act, 2000 (“Act”).

The facts of the case are as follows. The defendant has been operating a website named www.darveys.com (“Website”) offering for sale, various luxury products including the plaintiff’s brand of luxury shoes under the brand “Christian Louboutin”. The plaintiff (Christian Louboutin SAS), claims that the Website gives an impression that it is in some manner affiliated, sponsored or has been approved by the plaintiff for selling the plaintiff’s luxury products. The plaintiff therefore claimed that the display of plaintiff’s product on the Website results in the infringement of trade mark rights of the plaintiff and dissolution of the luxury status enjoyed by its products and brands.

The defendant’s claimed that the Website is an intermediary, as it not selling the products, but is merely enabling booking of such products through its online platform and that it is only booking orders on behalf of the sellers whose products are being displayed on their platform.

E-commerce platform and their role as intermediaries

In an e-commerce marketplace platform, it usually displays the name of the sellers and assists the customers by providing reviews of the various sellers who are listed on the platform. It also provides for other services such as online payment, maintaining warehouses, delivery and the like. The question that arises is at what point can the platform can say it is only an intermediary.

Section 2(w) of the Information Technology Act defines an intermediary as an “intermediary, with respect to any particular electronic records, means any person who on behalf of another person receives, stores, or transmits that record or provides any service with respect to that record or provides any service with respect to that record and includes telecom service providers, network service providers, internet service providers, web-hosting service providers, search engines, online payment sites online auction sites, online- market places, and cyber cafes.”

In Google France SARL, Google Inc. v. Louis Vuitton Malletier SA & Ors. (hereinafter, ‘Google France’), one of the point noted it that “it is necessary to examine whether the role played by that service provider is neutral, in the sense that its conduct is merely technical, automatic and passive, pointing to a lack of knowledge or control of the data which it stores.”

The Google France case has laid out certain principles on the liability of intermediaries and the Louboutin case makes a reference to it. Below are some useful excerpts from the judgement:

  1. Exemptions from liability of intermediaries are limited to the technical process of operating and giving access to a communication network. Such an exemption is needed for the purposes of making the transmission more efficient.
  2. The activity of the intermediary is merely technical, automatic and passive – meaning thereby that the intermediary does not have any knowledge or control over the information which is transmitted or stored.
  3. The intermediary gets the benefit of the exemption for being a “mere conduit” and for “caching”, when it is not involved in the information which is transmitted/translated.
  4. If any service provider deliberately collaborates with the recipient of a service, the exemption no longer applies.
  5. In order for the service provider to continue to enjoy the exemption, upon obtaining knowledge of any illegal activity, the service provider has to remove or disable access to the information.
  6. In order to constitute a mere conduit, the service provider should not initiate the transmission, select the receiver of the transmission, or select or modify the information contained in the transmission.
  7. The storage of the information has to be automatic, intermediate and transient.
  8. The provider should not obtain any data based on the use of the information.
  9. For claiming exemption from damages, the service provider should not have any knowledge of the illegal activity, and upon acquiring knowledge, should expeditiously remove or disable the information.
  10. Service providers do not have a general obligation to monitor the information which is transmitted or stored.

In the case of  L’Oreal SA & Ors. v. eBay International AG & Ors.[ii], the Court of Justice of European Union held that an operator which provides assistance “which entails, in particular, optimizes the presentation of the offers for sale in question, or promotes them”, even if the operator has not played active role and he provides the above service, the operator can claim protection as an intermediary. However, the said intermediary, if upon becoming aware of the facts which lead to an inference that the offers made on the website were unlawful, failed to act expeditiously, then the exemption ceases.

It is essential to determine whether the service provider played an active role or not, and whether it has the knowledge or control over the data which is stored by it. Further, if the service provider has no knowledge, then upon obtaining knowledge of the unlawful activity, it should expeditiously remove the data or disable access, failing which the service provider may become liable.

In Inwood Laboratories, Inc. v. Ives Laboratories, Inc.[iii], the question of contributory negligence with regard to infringement of trademark by the online service provider and the manufacturer (famously known as ‘Inwood Test’) observed that “if a manufacturer or distributor intentionally induces another to infringe a trademark, or if it continues to supply its product to one, whom it knows or has reasons to know is engaging in trademark infringement, the manufacturer or the distributor is contributorially responsible for any harm done as a result of the deceit”.

In the Louboutin case, the Honourable High Court of Delhi, observed that the defendant had a membership fee to place an order for goods on the Website, guaranteed authenticity that the products procured and sold were from the international boutiques and luxury stores, shipping to customers would be only after quality checking.

The Court opined that the safe harbour provisions for intermediaries under section 79 of the Act is not absolute. An active participation by the intermediaries is to be examined and if there is an active participation then the ring of protection or exemption granted to the intermediaries would not apply.

With regards to trademark infringement, section 101 of the Trade Marks Act states “that a person shall be deemed to apply a trade mark when (a) the mark is placed, enclosed or annexed to any good which are sold or are exposed for sale, (b) when the mark is used in relation to the goods or services in any sign, advertisement, invoice, catalogue, business paper price list”. Further, section 102 states that “a person shall be deemed to falsely apply to goods or services a trade mark, who without the assent of the proprietor of the trade mark (a) applies such mark or a deceptively similar mark to goods or services or any package containing goods; (b) uses any package bearing a mark which is identical with or deceptively similar to the trade mark of such proprietor, for the purpose of packaging filling or wrapping therein any goods other than the genuine goods of the proprietor of the trade mark”. Therefore, when an ecommerce website actively participates and allows storing of counterfeit goods, it would be aiding in the infringement of the trademark.

In the Louboutin case, the Delhi HighCourt held that the defendant had not sold the plantiff’s products on its Website, though the Website did advertise and promote the plaintiff’s brand and products. The Court did not order for damages/ rendition of accounts.

The Court did give the following directions to the defendant on the activities of running the Website as an intermediary so as to (i) disclose the complete details of all its sellers, their addresses and contact details on its website (ii) obtain a certificate from its sellers that the goods are genuine (iii) If the sellers are not located in India, prior to uploading a product bearing the Plaintiff’s marks, it shall notify the plaintiff and obtain concurrence before offering the said products for sale on its platform (iv) If the sellers are located in India, it shall enter into a proper agreement, under which it shall obtain guarantee as to authenticity and genuinity of the products as also provide for consequences of violation of the same (v) Upon being notified by the Plaintiff of any counterfeit product being sold on its platform, it shall notify the seller and if the seller is unable to provide any evidence that the product is genuine, it shall take down the said listing and notify the plaintiff of the same, as per the Intermediary Guidelines 2011 (vi) It shall also seek a guarantee from the sellers that the product has not been impaired in any manner and that all the warranties and guarantees of the Plaintiff are applicable and shall be honoured by the Seller. Products of any sellers who are unable to provide such a guarantee would not be, shall not be offered on the Defendant’s platform (vii) All meta-tags consisting of the Plaintiff’s marks shall be removed with immediate effect.

It is certainly interesting to note the thought process of the Court and the direction that it took, in this judgment.

Author: Mr. Anuj Maharana

 

[i] Christian Louboutin SAS v. Nakul Bajaj and Ors., CS (COMM) 344/2018

[ii] L’Oreal SA & Ors. v. eBay International AG & Ors., Case C-324/09

[iii] Inwood Laboratories, Inc. v Ives Laboratories, Inc.,456 U.S. 844

Basic Cyber Security Framework for Primary (Urban) Cooperative Banks (UCBs)

The Reserve Bank of India (RBI) on October 19, 2018 issued a set of guidelines for Basic Cyber Security Framework for Primary (Urban) Cooperative Banks (UCBs). Such a framework was issued by the RBI as a measure to enhance security of the UCBs in light of the increasing number and impact of cyber security attacks on the financial sector including banks. [1]

  1. Board Approved Cyber Security Policy
  • All UCBs need to immediately put in place a Cyber Security policy, duly approved by their Board/Administrator, giving a framework and the strategy containing a suitable approach to check cyber threats depending on the level of complexity of business and acceptable levels of risk.
  • On completion of the process, confirmation of same within 3 months must be sent to the Department of Co-operative Bank Supervision.
  • The Cyber Security Policy should inter alia encapsulate the following concerns:
  • Preventing access of unauthorised software.
  • Network Management and Security.
  • Secure Configuration.
  • Anti-virus and Patch Management.
  • Secure mail and messaging systems.
  • The IT framework/framework must be reviewed periodically by the Board or its IT subcommittee in order to identify vulnerable areas and put in place a suitable cyber security system to address the issues after assessment.
  1. Cyber Crisis Management Plan
  • The Cyber Crisis Management plan, prepared by CERT-In (Computer Emergency Response Team – India maybe referred to by the UCBs for guidance.
  • UCBs should promptly detect any cyber intrusions (unauthorised entries) so as to respond/recover/contain impact of cyber-attacks, especially those offering services such as internet and mobile banking, RTGS/NEFT/SWIFT, credit and debit cards etc.
  1. Organizational Arrangements
  • UCBs should review the organisational arrangements so that the security concerns are brought to the notice of suitable/concerned officials to enable quick action.
  • UCBs should actively promote among their customers, vendors, service providers and other concerned parties an understanding of its cyber security objectives.
  • UCBs, as owners of customer sensitive data, should take appropriate steps in preserving the Confidentiality, Integrity and Availability of the same, irrespective of whether the data is stored/in transit within themselves or with the third party vendors; the confidentiality of such custodial information should not be compromised in any situation.
  • UCBs to put in place suitable systems and processes across the data/information lifecycle. UCBs may educate and create awareness among customers with regard to cyber security risks.
  1. Supervisory reporting framework
  • UCBs should report immediately all unusual cyber security incidents (whether they were successful or mere attempts) to Department of Co-operative Bank Supervision giving full details of the incident.
  • UCBs are advised to implement basic Cyber Security Controls and report the same to respective Regional Offices of Department of Co-operative Bank Supervision on or before March 31, 2019.

Source: http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11397&Mode=0

https://rbidocs.rbi.org.in/rdocs/content/pdfs/63NT19102018_A1.pdf

[1] http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11397&Mode=0.

Competition Act: Amendment to the Combination Regulations Seeks to Simplify the Procedures Relating to Combinations

The Competition Commission of India (“Commission”), with the main objective of simplifying the procedures relating to combinations provided under the Competition Act, 2002 (“Competition Act”), has recently amended the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 (“Combination Regulations”). The Combination Regulations, which was first introduced on May 11, 2011 has been amended multiple times and the latest amendment to the same is the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Amendment Regulations, 2018 (“Amendment Regulations”) which was notified on 9 October, 2018.

Some of the Key Amendments are:

The Amendment Regulations Provides Clarity on the Time Period of 210 Days for a Combination to come into Effect:

As per the Act, every combination shall come into effect only after 210 days have passed from the date when the notice regarding the combination has been given to the Commission or the Commission has passed an order in relation to the same, whichever is earlier[1]. The Combination Regulations provides for getting additional information, clarifications, rectification of defects, etc. if required. However, there was no clarity in relation to whether the time taken to get these details would be covered within the 210 days period. Now, as per the Amendment Regulations, it is clear that the time period for getting additional information, clarifications, rectifications of defects, etc. is not included in the 210 days period. This essentially means that the time taken for a combination to come into effect will now be longer even for deemed approval due to the additional time that may be taken for getting additional information, clarifications, rectifications, etc.

Withdrawal and Re-Filing of Notice

As per the Amendment Regulations, a new regulation 16A has been inserted which states that, any time prior to issuance of notice by the Commission to the parties to a combination under Section 29 (1) of the Act[2], the Commission, may on the request of the parties to the combination allow withdrawal and refiling of the notice. Also, in case of withdrawal and refiling, the fee already paid in respect of such notice will be adjusted against the fee payable in respect of the new notice, provided the new notice is given within 3 months from the date of withdrawal.

Modifications to the Combination

As per the Amendment Regulations, before the Commission forms an opinion under Section 29 (1) of the Act, the parties to the combination may offer modifications to the combination and the Commission may approve the proposed combination basis such modifications. The position before the amendment was that, only if the Commission considered it necessary, it may require the parties to file additional information or accept modification.

Modifications in response to the Notice issued by the Commission

As per regulation 25 (1) of the Combination Regulations, the Commission can propose appropriate modifications to a combination if it is of the opinion that such combination is likely to have adverse effect on competition but such adverse effect can be eliminated by suitable modifications. Now, a new regulation 25 (1A) is inserted whereby, along with the response to the notice issued by the Commission under Section 29 (1) of the Act, the parties to the combination also can offer modifications to address the concerns of the Commission. The Commission may approve the combination basis such modifications. In such a case, the additional time required to evaluate the modification shall be excluded from the period provided under sections 6 (2A), 29 (2) and 31 (11) of the Act.

Source:https://www.cci.gov.in/sites/default/files/whats_newdocument/Comb.%20Amend%20Regl.2018.pdf

[1] Section 6 (2A) of the Act

[2] As per Section 29 (1), where the Commission is of the prima facie opinion that a combination is likely to cause, or has caused an appreciable adverse effect on competition, it shall issue a notice to show cause to the parties to combination calling upon them to respond within 30 days of the receipt of the notice, as to why investigation in respect of such combination should not be conducted.

Anti-dilution protection in shareholders agreement – Implementation under Indian laws

Anti-dilution protection is one term which is present in almost every investment transaction. From the perspective of the founders, especially in case of a start-up or an early stage company, it is very important to understand the implications of having such a provision in the shareholders agreement (SHA). Founders generally tend to agree to so-called “standard” terms in the SHA, when in dire need of the investment. An anti-dilution provision has to be reviewed closely in order to ensure it is not too harsh on the founders and also since the transaction documents set precedents for the subsequent round of investments. This article discusses some of the main methods of anti-dilution protection usually seen in transactions in India and some of the difficulties associated with actual implementation of such anti-dilution provisions.

What is Anti-Dilution Protection?

Before moving to anti-dilution, we need to understand the concept of dilution. Dilution is the decrease in the shareholding percentage of a shareholder in a company due to increase in the number of outstanding shares. For example, when a company receives subsequent round of investment, the shareholding percentage of the existing investors gets diluted. It is good to have the value of a company increase in subsequent rounds of funding. However, there might be situations when a company may not perform or grow as expected due to which the value of the share decreases. In such a scenario, anti-dilution protection is triggered by the existing investors to maintain their shareholding percentage in the company to a certain extent (which is explained below).

Essentially, anti-dilution protection is such protection given to the existing investors of the company when new shares are issued in a subsequent round at a price per share which is lower than the price paid by the existing investors. It is pertinent to note that anti-dilution protection is applicable only when shares are issued at a price per share which is lower than the price paid by the existing investors and not for every subsequent issue of shares. The reason being that, if shares are being offered to subsequent investors at a price per share which is higher than the price per share paid by the existing investors, even though their percentage shareholding in the company reduces, the value of the shares held by them increases.

Anti-Dilution Protection and its Variants

In India, the two commonly used forms of anti-dilution protection are: (a) Full Ratchet and (b) Broad Based Weighted Average.

Full Ratchet: Under this method, if shares are issued at a subsequent round of investment at a price per share that is lower than the price per share paid by the existing investors of the company, then the price of the shares/ conversion price of the existing investors will be revised to the price at which the new shares being issued. In such scenario, either additional shares will be issued to the existing investors for the surplus consideration after such price adjustment without the existing investors making any further payments or conversion price would be revised to the price of such shares being issued. Thus, the full-ratchet method does not consider the number of shares held by the existing investors or the number of shares being issued in the subsequent investment round, but only considers the price at which the new shares are being issued and the new price will be applied to all the shares held by the existing shareholders. Thus, the full ratchet method of anti-dilution protection is very harsh on the Company and the Founders as compared to the broad based weighted average method. Also, the shareholding percentage of the founders may get diluted to a very large extent if a full ratchet provision is implemented.

Broad Based Weighted Average: As compared to full ratchet mechanism, broad based weighted average method uses a formula which considers the number of shares issued in a subsequent round of investment and the number of shares held by the existing investors. Therefore, the broad based weighted average method is fair to the founders as well as to the investors and is adopted more frequently in investment transactions. The weighted average formula used in the transaction documents describe how the weighted average price is determined by taking into the consideration the existing price or the conversion price of the shares, number of outstanding shares prior to the new issuance, the number of shares to be issued and the purchase consideration to be received by the company with respect to such issuance.

Implications of Anti-Dilution Provision 

Pricing Guidelines under Indian Laws:

Any further issuance of shares by a Company registered in India shall adhere to various provisions of the Companies Act, 2013 (the “Act”), Foreign Exchange Management Act, 1999 including rules and regulations notified thereunder, regulations prescribed by Securities Exchange Board of India (“SEBI”) (if applicable) and Income Tax Act, 1961 (the “IT Act”).

In India, implementation of anti-dilution protection is complex considering the existing laws. For instance, shares issued to foreign investors need to be in compliance with the pricing guidelines as provided in Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (“FDI Regulations”). As per the pricing guidelines, capital instruments which are issued or transferred to a foreign resident has to be priced as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a chartered accountant or a SEBI registered merchant banker or a practicing cost accountant in case of an unlisted company.

Convertible Instruments: Additionally, in case of convertible instruments, the price/ conversion formula of the instrument should be determined upfront at the time of issue of the instrument and the price at the time of conversion should not in any case be lower than the fair value worked out, at the time of issuance of such instruments, in accordance with the FDI Regulations. Therefore, even adjusting the conversion ratio of a convertible instrument can pose complexities.

Considering aforementioned guidelines, enforcement of anti-dilution provisions and issue of shares pursuant to the same, especially to non-residents will be very difficult. Also, implementation of anti-dilution which results in issuance of new shares for no consideration, would not be allowed under the Act (which is applicable for both resident and non-resident investors).

Tax: Further, there is a complication which has to be examined under tax laws. As per section 56 (2) (x) (c) of the IT Act, when any person receives shares for a consideration which is less than the aggregate fair market value (FMV) by an amount exceeding fifty thousand rupees, the aggregate FMV of such property as exceeds such consideration is taxable as ‘income from other sources’ in the hands of the person receiving such shares.

Our thoughts:

Considering the nuances associated with the issuance of shares at a price below FMV or for no consideration, the actual implementation of anti-dilution provisions poses a lot of difficulties. Unless certain exceptions are brought in the existing laws, actual implementation could be a challenge in India, especially with respect to foreign investors.

Authors:  Mr. Paul Albert and Mr. Ashwin Bhat