Category Archives: Articles

An Overview of the Labour Welfare Fund Rules in India

NovoJuris Legal through the presentation available at our SlideShare page analyses the various labour welfare fund rules in India. A short background is provided herein:

There are 16 States and Union Territories which have enacted or adopted the Labour Welfare Fund Act and corresponding Rules. These legislations aim to provide for a Board titled “State Labour Welfare Fund Board” with a fund titled “Labour Welfare Fund”. The important duties of this fund are to grant allowance for pension, maternity, marriage, treatment, education, death etc., to labourers in respective States.

The Labour Welfare Fund (LWF) established by the LWF Boards, mandate three methods through which an employer is required to pay the money into the fund as below:

Methods mandated for Employers to pay monies in the LWF Description
1.     Payment of Unpaid Accumulation Any wages or gratuity or bonus (excluding provident fund contributions and compensation due to injured workmen), which is not paid to the employees for a period of three (3) years will be termed as unpaid accumulation. 

Such unpaid accumulation is to be deposited into the respective State LWF within 30 days from the end of every quarter in a calendar year.

(Example: An ex-employee’s statutory bonus in respect of previous financial year)

2.     Payment of Fines realised All fines realized by way of penalty for any violation of code of conduct by employees are also required to be deposited into the respective State LWF within 30 days from the end of every quarter in a calendar year.

(Example: fines realised by way of deduction of salary for late coming).

3.     Payment of contribution (Employer’s share together with deductions from employee’s share Annual/half-yearly contribution is to be deducted from employee’s salary and paid into the LWF

The consequences of non-payment of fines/contribution: Where any penal interest amount is not provided, the employer is liable to be punished with imprisonment of up to three (3) months or with fine of up to INR 500 (In Punjab/Chandigarh, the penalty is up to INR 5,000).

Kindly go through our SlideShare page to have a detailed understanding of the same.

Disclaimer: The compliances mentioned in this article are subject to the amendments promulgated by respective state governments.

Mooting the utility of Representations & Warranties Insurance Policies in exit deals for a PE and VC Investor

M&As and Investment transactions have been growing rapidly in India and there is no doubt that in such transactions allocating the risk of a breach is extremely important. In the recent past, we are witnessing detailed indemnification clauses including the “loss” related clauses covering grossing up of tax and grossing up of shareholding.

In the secondary sale of shares, venture capital investors are reluctant to provide representations beyond their title in the shares that they hold. Traditionally, such investors will be hesitant in providing any indemnity to potential acquirers because the traditional method of indemnification involves the carry forward of payment rule, wherein the VC investor may be required to indemnify the party beyond a certain time frame as well. Moreover, VC investors have a limited fund life and hence prefer not to have indemnity obligations beyond the life of a fund.

The most common way in which a buyer protects itself is by incorporating provisions of indemnity in the contract which requires the seller to indemnify the buyer for any breach of representation or warranty. Traditionally, indemnification is the most common method of safeguarding one’s interest in a transaction but there were many limitations to this approach, like risks for seller wherein he is not able to receive the remainder of the purchase price, risks for buyer wherein the buyer fears that the fund held back would be insufficient to cover all indemnity claims.

Traditionally used methods to secure the promises of indemnification are:

  1. A holdback of purchase price
  2. Escrow account for indemnification
  3. Unconditional bank guarantees
  4. Set-off against future payments

Representations and Warranties Insurance (“RWI”) could be a substitute or augment the traditional indemnification mechanisms.

There are benefits of an RWI policy for both buyers and sellers in a deal/transaction. For sellers, it eliminates any requirement for escrow or holdback that would otherwise reduce the money received by the seller at closing, provide a cleaner exit with fewer contingent liabilities incident to the sale. For the buyers, the bid looks much more attractive as indemnification is protected by a third-party insurer, they can also increase the indemnity amount which otherwise would have been highly-negotiated by the seller. For both parties, the process for negotiation and finalizing of the transaction document is expedited and as the insurance covers all losses, sellers might not be resistant to agreeing to post-closing indemnities in the deal as well.

What are Representations and Warranties?

In case of breach of any representations or warranties in the transaction document, the rise of indemnity claims is almost always provided for. For the uninitiated, a ‘Representation’ is a statement of fact about the current state of the business made by a seller to the buyer or by a buyer to the seller in a purchase agreement[1]. A ‘Warranty’ in simple words, guarantees the accuracy of the representation[2] and ensures compensation in case the representation so made is false. Representations and warranties are negotiated clauses of the transaction and the scope of representations and warranties depends greatly on the nature of transactions.

The terms ‘Representation’ and ‘Warranty’ are not defined in the Indian Contract Act, 1972, however the Madras High Court in the case of All India General Insurance Co. Ltd. and Anr. v. S.P. Maheswari[3] made a distinction between the two terms. The High Court said that those representations which are made the basis of the contract are known as warranties, and otherwise a representation simpliciter is rather something collateral which only has a tendency to induce the other party.

Even after an exhaustive due diligence process, it is difficult for a buyer to know everything relevant to the purchase, so these representations and warranties fill in gaps in the buyer’s knowledge of a company.

RWI Policies for transactions, an Introduction

It is important to know that there are no “one size fits all” RWI policies offered by insurance companies. Typically, parties go for tax insurance or a transaction-based insurance policy, we will concern ourselves with the latter for this discussion.

An RWI is thus an insurance policy used in deals to protest losses arising due to the breach of representations made in the transaction documents. Every transaction is a different transaction and thus, every RWI policy is tailored according to the specific transaction. Each RWI policy is negotiated to match up with the terms and language of each transaction.

What are the types of R&W Insurance available for transactions?

Typically, transaction insurance policies cover either the ‘buy-side’ or ‘sell-side’, however in terms of practice a buy-side policy is more prevalent. The distinct features of them both are discussed below:

  1. Buy-side policy: In this the RWI policy is acquired by the buyer in the transaction. The advantage of this type of policy is that a direct claim can be made against the insurer without pursuing the seller for the same. The purchaser is able to recover its losses while at the same time ensuring a clean exit for the seller. It is important the transaction documents require a recourse-based buy-side insurance policy, wherein the seller is liable to indemnify the counterparty in case the insurer does not make a payment under the claim to the buyer. The buyer under this type of RWI policy gets additional time to detect and report problems and gets an effective indemnity in public deals as well where it will otherwise be difficult to recover such losses.
  2. Sell-side policy: These policies are acquired by the seller in order to limit their losses. A sell-side policy will typically cover the capped indemnity under the agreement along with any additional defense cost for related litigation. A sell-side policy also reduces the liabilities associated with post-closing breaches of representations and warranties such as claw-back liabilities wherein the seller is required to make good the losses if any breach with respect to representation and warranties occurs after the closure of the deal. A seller may also opt for RWI policy if he is a minority investor but bound to indemnify a buyer via a joint or several liability. A sell-side policy is typically preferred by PE and VC funds in order to give a ‘clean exit’ to its investors.

How to negotiate and obtain RWI policy during a transaction?

An RWI policy is typically completed in multiple stages, starting from the pre-indication strategy wherein the buyer or seller reach out to RWI broker for discussing the objective of the policy, then the broker submits important documents to RWI insurer specifying the details of the transaction as discussed in the pre-indication stage. Once the insurer is selected and paid an underwriting fee and provided with all the relevant documents, a diligence call is arranged between the insurer, the parties to the deal, and their legal representatives. A first draft of the insurance policy is soon provided by the insurer after the diligence call. It is important that the language of policy should be in line with the language in the transaction agreement. The final policy is generally negotiated in advance of the closing date of the transaction. The insurer then provides a ‘binder’ to the policyholder that legally obligates the insurer to bind coverage at the time of signing or closing. Once the binder is signed, the policy becomes binding.

Structure of an RWI policy should not be ambiguous and it should clearly mention what is covered and who is covered under the policy. As a general rule, a claim under the RWI policy is triggered only when there is a breach of covered representation and warranty. The RWI policy should also mention whether the insurance is provided on ‘first party’ (providing coverage to the policyholder) basis or ‘third party’ (providing coverage to another party based on policyholder’s liability to another party) basis.

Limitations

Though RWI policies are instrumental in limiting the liabilities of the seller and buyer but there are certain limitations to them, we shall list a few of them below:

  1. Unlike a typical promise of indemnity, RWI policies will always be limited to a cap based on the amount consideration in the deal/transaction, in developed jurisdictions, it is typically 10% of the purchase price.
  2. RWI policies only cover breaches of those representations and warranties that are explicitly mentioned in the agreement. It does not cover breaches that are ancillary to the covered representations and warranties.
  3. RWI policies tend to contain numerous exclusions which are common to many types of insurance policies. These exclusions are generally with respect to corruption, environment, and bribery.
  4. RWI policies exclude claims wherein the insured may have had knowledge prior to the effective date of the policy of certain facts which could give rise to the breach of representations or warranties.
  5. Transactional RWI policies will not provide coverage for tax risks that might result from transfer pricing agreements.
  6. RWI policies can totally exclude certain issues identified in the buyer’s due diligence process.
  7. Unlike indemnity payments, proceeds from an RWI policy may be considered as net taxable income in India.

Relevance of the Indemnity clause in transaction documents is still not diluted

Inclusion of RWI in the transaction agreement would still not cover every liability arising from breach of covered representations and warranties, thus there will be certain aspects where indemnity provision under the transaction document would still hold value.

  1. In determining the loss bearing capacity of parties till the payment retention amount for the RWI policy.
  2. In determining who will bear the loss arising from the items excluded from the coverage under the RWI policy.
  3. Provide for de-minimis amount i.e. the minimum loss to borne before making a claim under the indemnity provision.
  4. In cases where parties commercially agree to include a recourse-based insurance policy, an indemnity provision in the transaction document proves helpful to enable the buyer to enforce a claim against the seller.
  5. RWI policies will always have cap on the recoverable amount and typically have a life of 3-6 years post the closing of the deal. An indemnity provision however, can still cover a higher amount of indemnity or provide a longer time frame than what is provided under the RWI policy.

Conclusion

An RWI policy provides an option to parties involved in M&A/Investment transactions to allocate the risk associated with the transaction to a third-party, and thus proceed with the deal themselves spending less time on negotiating the indemnity clause. It has become an important tool in any restructuring process as it offers greater flexibility when compared to traditional methods for addressing the liabilities (such as holdback, escrows, etc.). As the Indian market matures further, it is important for RWI policies to get tailored as per the need of the Indian market. Inclusion of RWI in the transaction agreements proves instrumental in boosting the confidence of investors seeking to make exits in providing indemnities to potential buyers. However, an RWI policy too has certain limitations and a well-drafted indemnity clause in the transaction document is still needed to bring clarity on those aspects on which the RWI policy falls short.

[1] Marialuisa S. Gallozzi; Eric Phillips, Representations and Warranties Insurance, 14 Envtl. Cl. J. 455

(2002)

[2] Id.

[3] A.I.R.1960 Mad. 484

Opportunities and Challenges for AIFs in India’s first IFSC, GIFT City, Gujarat.

We are pleased to share with you an article that our Founder Sharda Balaji along with our Associate Avaneesh Satyang contributed to the 2nd volume, Issue 2 of the KNOWLEDGEex Magazine released by Indian Association of Alternative Investment Funds (IAAIF). 

Introduction to IFSC and GIFT City

India has been witnessing a high growth in the investment funds domain, ranging from fund-raising activity to active investments by funds, and also an adaptive and dynamic regulatory environment conducive to the witnessed growth. The formation of most of these funds however have been concentrated to the well-known financial hubs such as Hong Kong, Mauritius, Singapore, etc. The success of theses financial hubs is generally attributed to the regulatory, tax and other business-conducive financial service centres. The International Financial Service Centre (IFSC), is India’s attempt to create an avenue into financial globalisation.

An IFSC allows overseas financial institutions and overseas branches/subsidiaries of Indian financial institutions to operate within India and cater to customers outside the jurisdictions of India. This is achieved only when the IFSC provide favourable regulatory regimes and business environment to investors and financial institutions.

Provisions for the setting up and regulations of an IFSC were thus introduced in the Special Economic Zone Act, 2005, and in 2015, Gujarat International Finance Tec-City (GIFT City) came into being to facilitate such financial services within the geographical territory of India, which would otherwise have been carried on abroad or through offshore branches/subsidiaries of Indian financial institutions.

As an IFSC, GIFT City is regulated under specific regulations and guidelines by India’s major financial sector regulators, i.e. the Reserve Bank of India (RBI), the Securities Exchange Board of India (SEBI), and the Insurance Regulatory and Development Authority of India (IRDA). This is because of the major identified thrust areas for IFSCs in India, which would need regulation as follows:

  • Banking and Forex: to be regulated by the RBI
  • Capital Markets: to be regulated by SEBI
  • Insurance: to be regulated by IRDA

Why consider AIFs in GIFT City?

GIFT City as a facilitator of international business has already set a firm initial footing in the above identified thrusts areas with more than 150 units licensed by the financial regulators already operating in GIFT City. The banking units at GIFT City are working well with transactions of more than USD 16 Billion having taken place. In the insurance sectors, the IRDA has licensed entities engaged in insurance business. And for the Capital markets, both National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are operating out of GIFT City, and several SEBI licensed companies are offering IFSC products from GIFT City.

Setting up of Alternative Investment Funds (AIFs) in GIFT City, being the species of private pooled funds recognized in India, becomes another important step in commencing the third stage of proliferation of financial and capital market activities.

It is to be noted that the authorities at GIFT City and the SEBI are fully aware that India has a big market for India-focused offshore feeder funds which are set-up outside India. Keeping in mind the premise offered by IFSC as fully capital account convertible, i.e. providing full exemption from FEMA norms for transactions from and to the IFSC, emerges as an important alternative to offshore feeder funds. For all transactional and regulatory aspects, an AIF operating from GIFT City, is an offshore AIF.

Thus, to assess the viability of setting up AIFs in GIFT City as opposed to an offshore fund will require an analysis on Regulatory (fund formation, registration, tax considerations, etc.) as well as Operational (ease of conducting business, etc.).

Regulatory Regime for AIFs in GIFT City

Soon after the introduction of GIFT City, SEBI promulgated its SEBI (International Financial Services Centres) Guidelines, 2015 (SEBI Guidelines) on March 27, 2015. The SEBI Guidelines permits only ‘recognized entities’ registered with SEBI or registered/recognized with foreign regulators, to set-up units in IFSC, in this regards AIFs operating in IFSCs are treated as recognized financial institutions.

Further operational and regulatory clarifications for stakeholders waiting to set up AIFs in GIFT City, the circular titled ‘Operating Guidelines for Alternative Investment Funds in International Financial Services Centres’ dated 26 November, 2018 (AIFs in IFSC Guidelines) by SEBI, provided much needed clarity on several aspects with respects to setting up and operation of AIFs in GIFT City.

  1. Continued applicability of the SEBI (AIF) Regulations, 2012 – the AIFs in IFSC Guidelines work under the broad ambit of the SEBI (AIF) Regulations, 2012 (the AIF Regulations). Thus, all provisions of the AIF Regulations and the circulars issued thereunder, will also apply to AIFs set-up in GIFT City, and also to the investment managers, sponsors, and investors. This would include periodic reporting, event-based reporting, adherence to disclosure norms to SEBI.
  2. AIFs in IFSC are considered offshore entities – RBI, in its Foreign Exchange Management (International Financial Services Centres) Regulations, 2015 dated 02 March, 2015 has stated that any financial institution or branch of a financial institution set up in the IFSC and permitted/recognised as such by a regulatory authority shall be treated as a person resident outside India. Therefore, under FEMA, the transactions with Indian residents or making investments in Indian securities would require compliance with FEMA norms.
  3. No separate registration process – The conditions as applicable to domestic AIFs for registration with SEBI, will continue to apply to AIFs in GIFT City as well.
  4. Operating Currency – AIFs operating in IFSCs can accept money only in foreign currency.
  5. Eligible Investors – A person resident outside India, NRIs, Indian institutional investor permitted under FEMA invest funds offshore, Indian resident having net worth of at-least USD 1 Million during the preceding financial year (subject to limits under Limited Remittance Scheme of RBI). It would be beneficial if the guidelines clarify, whether investment by Indian residents into the AIF set up in GIFT City, which further invests into Indian companies, is considered as round-tripping.
  6. Investible Securities – AIFs in GIFT City can only invest in securities that are; listed in IFSC; issued by companies incorporated in IFSCs; or issued by companies incorporated in India or companies belonging to a foreign jurisdiction.
  7. Investment Route – Earlier, such AIFs in IFSCs could only invest in India through the FPI route. Now, such AIFs may invest in India through the FDI or Foreign Venture Capital Investor (FVCI) route as well.

Following is an encapsulation of other conditions applicable to AIFs operating in IFSCs:

Minimum Corpus of AIF at least USD 3 Million.
Minimum investment value by any one investor at least USD 150,000 [for employees/directors of AIFs, minimum value of investment is USD 40,000].
Continuing interest of the Manager/Sponsor at least 2.5% of the corpus or USD 750,000, whichever is lower (such interest cannot be through waiver of management fees). For Cat-III AIFs, the continuing interest shall be at-least 5% of the corpus or USD 1.5 Million, whichever is lower.
Sponsor/Manager of an existing AIF in India may act as Sponsor/Manager of AIF operating in IFSC only by setting up a branch in the IFSC or incorporating a company or LLP in the IFSC.
Appointment of Custodian for Securities Sponsor/Manager of Cat-I and II AIFs are required to appoint a custodian registered with SEBI for safekeeping of securities, if the corpus of the AIF is more than USD 70 Million.

Appointment of custodian is mandatory for all Cat-III AIFs operating in IFSCs.

Application and Registration fees
Application Fee : USD 1,500
Registration fee for Cat-I AIF (other than Angel Funds) : USD 7,500
Registration fee for Cat-II AIF : USD 15,000
Registration fee for Cat-III AIF : USD 22,500
Registration fee for Angel Funds : USD 3,000
Scheme Fee for AIFs : USD 1,500

Following are the special conditions as applicable to Angel Funds operating in IFSCs:

Minimum Corpus USD 750,000
Criteria for becoming an ‘angel investor’ (a) Individual investor to have net tangible assets of at least USD 300,000 (excluding value of principle residence).

(b) body corporate to have net worth of at least USD 1.5 Million.

Minimum investment value for ‘angel investor’ Investment from an angel investor should not be less than USD 40,000 (up to a maximum period of 5 years)
Investible entities Angel funds to invest in Venture Capital Undertakings (VCUs) as defined in Reg. 19(F)(1)(a) of the SEBI (AIF) Regulations, 2012. Also;

– Turnover of venture capital undertaking (VCU, is the company which receives the investment by the AIF) must be less than USD 3.75 Million

– VCU must not be promoted/sponsored/related to industrial group with group turnover more than USD 45 Million

Investment caps on Angel Funds Minimum investment by Angel fund in VCU – USD 40,000. Maximum investment – USD 1.5 Million

 

Continuing interest of Manager/Sponsor 2.5% of the corpus of fund or USD 80,000 whichever is lower (such interest cannot be through waiver of management fees)

Key Takeaways from the Regulatory Perspective

Key Opportunities:

  • The regulatory provisions applicable to AIFs in IFSCs do offer a viable alternative to offshore feeder funds, and can act as a feeder fund for an Indian AIF.
  • Other offshore funds investing in India which traditionally operate out of other countries like Mauritius, Singapore, etc. may deliberate on the option.
  • Indian overseas fund managers looking to set up funds for investing outside India, may find it easier to raise capital from overseas investors and Indian investors simultaneously. Indian offshore fund managers can also use AIFs in GIFT City as feeder fund to invest funds offshore.
  • Costs for setting up the fund appear to be much lower in comparison to setting up an offshore fund.
  • As a deemed overseas fund, conditions on overseas investments by AIF prescribed by SEBI in October 2015 such as overall investment limit (USD 750 million), specific SEBI approvals, and other conditions shall not apply.

Key Challenges:

  • There is lack of clarity with respect to AIFs in IFSCs being able to invest in securities listed on overseas stock exchange.
  • Although, investment under FDI, FVCI or FPI route is allowed for AIFs in IFSCs, it has not been specified whether such AIFs would require separate licenses to invest as FPIs or FVCIs. Ideally, as a recognised AIF, they must be granted FPI/FVCI status as well.
  • New Investment managers of AIF in IFSCs must necessarily be incorporated in the IFSC, this might add to the cost of setting up the fund. Ideally, if the IFSC truly aims to attract global funds, management by offshore managers should also be allowed.
  • With respect to Angel Funds, it appears that angel funds in IFSCs can only invest in Indian entities.

Key Development: Proposed Unified Authority for regulating all financial services in IFSCs in India

Cognizant that the dynamic nature of the business conducted in IFSC requires immense inter-regulatory co-ordination, the Central Government has acted on the need for having a unified financial regulator for IFSCs in India to provide world class regulatory environment to financial market participants. Thus, the International Financial Services Centres Authority Bill, 2019 (the Bill) was introduced in the Rajya Sabha on 12 February 2019 by the Finance Minister providing for the establishment of an authority to develop and regulate the financial services market in the IFSCs. This is an important development, as the presence of a unified and dedicated International Financial Services Centres Authority (the Authority) is proposed to play a significant role towards the IFSCs ultimate goal of ease of doing business.

Under the Bill, all powers relating to regulation of financial products, services, and institutions in IFSCs, which were previously exercised by the respective regulators will be exercised by the Authority. As per the Government’s rationale, the Authority will be responsible for providing world-class regulatory environment to market participants from an ease of doing business perspective.

Tax and Operational Considerations for AIFs in GIFT City

Under Sections 10(23FBA) and 115UB of the Income Tax Act, 1961 (the IT Act), Category I and II AIFs are accorded tax pass-through status with respect to AIF’s income other than business income, thereby tax being chargeable in the hands of the investors. These provisions are extended to AIFs in IFSCs as well, as they continue to be tax residents in India despite being non-residents under FEMA.

There are several beneficial provisions available for IFSC units, however, since they are not AIF specific, which leads to ambiguities regarding the availability of such incentives to AIFs in IFSCs. Nevertheless, the beneficial provisions for IFSC units under the IT Act are as follows:

  1. Tax holiday under Section 80LA – Any unit set-up in an IFSC shall not be taxed in relation to income from business as follows in two blocks. First block of 5 years in which 100% of the income beginning with the year in which the permission or registration was obtained is exempt from income tax, and; Second block of 5 years in which 50% of income is exempt for the next 5 consecutive years.
  2. Lower rates of Minimum Alternate Tax (MAT) and Alternate Minimum Tax (AMT) – MAT and AMT in case of a unit located in an IFSC and deriving its income solely in convertible foreign exchange shall be charged at a lower rate of 9% as opposed to the general 18.5%.
  3. Exemption from Dividend Distribution Tax (DDT) – A unit located in an IFSC and deriving its income solely in convertible foreign exchange, being a company, is exempted from paying DDT at the time of distributing dividend.
  4. Gains from certain securities transferred by non-residents not considered as capital gains – Any transfer of derivatives, global depository receipts, or rupee denominated bonds of Indian companies by a non-resident on a stock-exchange in an IFSC is exempt from tax on capital gains.
  5. Exemption from Securities Transaction Tax (STT) – A transaction undertaken on recognised stock exchange in an IFSC shall be exempt from STT.
  6. Exemption from Goods and Services Tax (GST) – All supplies made to and made by units in SEZs are exempt from GST applicability.

Apart from the tax considerations, units in IFSCs also being subject to the Special Economic Zones Act, 2005 as SEZ Units might face other problems. This argument stems from the fact that the SEZs were originally conceived as special designated zones for manufacture and export-oriented industries, and thus SEZ Units are subject to certain conditions which might prove difficult for non-export-oriented business to satisfy. For example, in the recent Special Economic Zones (2nd Amendment) Rules, 2019 dated 07 March, 2019, Rule 53 of the Special Economic Zones Rules, 2006 was substituted to mandate a positive net foreign exchange earning by SEZ Units calculated cumulatively for a period of five years from the commencement of production. IFSC units specialize in financial services and products, might find it very difficult to meet the net foreign exchange earning criteria set by the government.

Key Opportunities

  • The tax holiday is a big benefit for investment managers established in the IFSC, management fee and other income will be exempt.
  • Other exemptions with respect to MAT and AMT for non-market players, and DDT and STT exemptions make GIFT City an attractive destination.

Key Challenges

  • There is dearth of clarity in taxation of income of AIFs in IFSCs on many fronts, such as will the tax holiday be available to AIFs in IFSCs with no business income, whether investors in AIFs will be required to obtain PAN and file tax returns in India in case of tax pass-through being available, etc.
  • There is a need to harmonize the provisions as applicable to SEZ Units with respect to IFSC Units requiring necessary carve outs and exemptions to be created.
  • Unless a unified regulator is in place, the problem of multiplicity and overlapping of authority will continue to diminish the growth of AIFs in IFSCs as viable alternatives to offshore funds.

Observations:

There certainly are numerous benefits for setting up an AIF in GIFT City. With the proposed unified regulator, ease of doing business, it holds many promises.

However, it is to be noted that many grey areas especially with respect to taxation of AIFs in IFSCs need to be clarified and resolved to understand the true effects of such provisions on AIFs as mentioned above. The determining criteria would be clarity to the tax incentives available for AIFs in IFSCs. How well does GIFT City perform, will determine the success of AIFs in IFSCs, too.

Advisors in Start-ups and Early Stage Companies

India is witnessing a high growth in the number of start-ups in the country and is also amongst the top start-up ecosystems in the world. The government has provided a few benefits to startups as well, through the Startup India Action Plan.

However, only a few of these start-ups actually succeed. It is a treacherous path with a lot of unknowns. An advisor or an advisory board in a start-up might help the early stage companies to atleast know some of those unknowns. Financial investors certainly add value, sometimes domain expertise even. The comfort of speaking with an advisor where they bring in the expert views, advice and sheer experience onto the table is very valuable. As the saying goes, ‘Experience is the best teacher’.

Who are these Advisors and what role do they play?

An advisor is a person who brings in his unique skill sets and expert opinion on the business of the company, operational or otherwise. They are the people ‘who have been there and done that’. They can play a major role, especially if the founders and the team are new to the industry and do not have much experience. There are celebrity advisors even, who by being called as an advisor adds value to the startup.

Advisors can play different roles, for example, advisors who bring in their expertise in a particular domain or area; help with their networks and can introduce potential clients, employees or investors; or scaling up teams; expansion to new geo. It is not just having the advisors but also heeding to their advice. Therefore, advisors need to be chosen very wisely, so that their advice can be relied and executed upon.

How to choose the right Advisor?

Hiring an advisor who does not add much value or provides incorrect advice to the company may turn out to be counter-productive or disastrous. The advisors bringing in complementary skills or “deeper” skills which the founding team has a gap would be great. Identify the areas where the founders lack expertise or sufficient industry knowledge, where they face difficulties or have faced difficulties in the past or any area where they would require expert advice. Once there is clarity on where and why advisors are required, do some research and talk to people who can introduce you to some advisors. Discussing the same with the existing investors (if any) might also be a good idea as they might be able to connect the founders with the relevant people. And since the investors have invested in the company, they would ensure that the advisor will be someone who can add value to the company.

Ensure that they are people with the relevant expertise and knowledge, proven track record, good communication skills, networking skills, etc. Advisors should be individuals who would invest their time for the growth of the company and who can provide support to the founders where there is lack of expertise or knowledge.

Engaging with the advisor

An advisor may be compensated in cash, equity etc. Many a time, the advisor is interested in just giving back to the eco-system. One should evaluate if the advisor has time to provide support to the startup, whether the advisor is associated with other companies which the startup may have conflict / competition.  Maintaining a good rapport, having regular discussions and candid conversations, updating the advisor on a regular basis about the business and other relevant aspects of the business can go a long way. The most important factor is to ensure that there is trust between the parties.

Some startups look for a small investment by the advisors into the company, as a test to ensure that the advisor believes in the idea, startup, founders etc.

Compensation for Advisors

Let us now evaluate some of the ways to compensate advisors for the value-add they bring to the company.

Start-ups, more often than not, compensate advisors by giving a percentage of equity in the company since they may not have the finances to give cash compensation (unless well-funded). New shares can be issued to the advisors or shares can be transferred from the founders. Such issuance or transfer should ideally happen at the face value of the shares since it is a compensation for the services rendered by the advisors and the advisors would not want to pay the full price of the shares. As the same is being issued/transferred at face value instead of the fair market value, tax implications need to be evaluated since any issuance/transfer of shares below the fair market value will fall under the ambit of the Income Tax Act, 1961. Also, the percentage holding of the founders needs to be taken into account so that their shareholding percentage does not get diluted to a large extent considering that there will be future investments, where the shareholding will get diluted further. Another aspect to be considered is that, an issuance of shares will dilute the shareholding of all shareholders (including investors if any) whereas the transfer of shares from founders will dilute only the founders’ shareholding.

Another way of compensating the advisors is by issuing shares to them by way of consideration other than cash under section 62 (1) (c) of the Companies Act, 2013 (“Act”) read with rule 13 of Companies (Shares Capital and Debenture) Rules, 2014. The private placement process under section 42 of the Act will have to be followed for this purpose. The advisors have to raise invoice for the services rendered which will be commensurate with the fair market value of the advisory shares. Company will be responsible for TDS which will be a cash out on the Company. Further, the entire amount shall be taxed in the hands of the Investor as income from other sources, at the applicable tax slab.

Yet another option could be granting phantom stock options (“PSOs”) to the advisors. These are options which are settled by way of cash settlement. It a performance-based incentive plan through which the advisors will be entitled to receive cash payments after a specific period of time or upon reaching a specific target. A separate agreement can be entered into for capturing the details. This is directly linked to the value of the company’s share price. For example, the advisors could have promise of ‘x’ number of shares at ‘y’ price at grant. At exercise, the appreciation in the value of the share price, is handed out as cash incentive. Tax will be applicable at the time of payout. However, unlike employee stock options, which is recognized under the Act, PSOs by private limited companies does not fall under the ambit of the Act and therefore, will be in the nature of contractual right. Please see our previous post on  Phantom Stock Options to know more about this.

It has to be noted that advisors are not eligible for employee stock options (ESOPs) as ESOPs can be given only to employees and directors subject to the restrictions under the Act and relevant Rules.

Advisory shares to Non-Residents:

It becomes a little more complex when the advisor is a non-resident since the shares issued/transferred to a non-resident needs 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 non-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, in case of an unlisted company. Considering these rules, granting of advisory shares to a non-resident can be a very tricky situation. PSOs may be a better option in this case.

Formal Agreement with Advisors

The engagement with the advisors should be fruitful for the company and help in its growth. It is advisable to enter into a formal agreement with the advisors which captures all important terms regarding the engagement which will be beneficial for both the company and the advisors. This will help in keeping track of the contribution of the advisors and also if in future, any differences arise between the company/founders and the advisors, it will always help to have a formal agreement. The exact role of the advisor and deliverables, vesting schedule, time commitments, compensation, non-compete, confidentiality, exit related provisions, etc. should be captured in such agreements. Specific milestones may also be included in these agreements. Once the milestones are satisfactorily completed, compensation as agreed can be given.

Once the advisors become shareholders in the company, depending on the shareholders’ agreement (if any), the advisor might need to enter into a deed of adherence, so that the rights of the shares are captured.

Author: Paul Albert

 

Regulatory Display Requirement for an establishment under Labour Laws of India

Indian labour laws require certain notices to be displayed on their notice boards in order to educate its employees as well as visitors to the establishment.  These display requirements are mandated to be in English as well as the local language of the State in which the establishment is situated.  Some States in India have their separate rules, while others follow the rules framed by the Central Government, regarding the display requirements.  Below table provides the name of the legislations mandating the display of notices along with a brief description of the contents of the notice to be displayed.

Name of the Act/Rules Section/ Rule No. Form number, if any Local Language in addition to English Details of Information to be Displayed
Child And Adolescent Labour (Prohibition And Regulation) Act, 1986 S.12 NA Yes Notice containing an abstract of sections 3A and 14. While 3A prohibits employment of adolescents, Section 14 contains the penalty provision
Contract Labour (Regulation And Abolition) Central Rules, 1971

 

 

 

 

 

R.26(2)(ix) NA No A copy of contractor’s license shall be displayed prominently at the premises where contract work is carried on
R.47 NA No The charges for foodstuffs, beverages and any other items serviced in the canteen shall be conspicuously displayed in the canteen
R.53 NA Yes Notice in language understood by majority of workers to be displayed outside the latrine as “For Men only” or “For Women only”, and shall also bear the figure of a man or a woman, as the case may be.
R.71 NA No Notice showing wage period and the place/time of disbursement of wages
R.79 NA Yes Every contractor shall display an abstract of the Act and Rules
R.81 NA Yes Notices showing the rates of wages, hours of work, wage period, dates of payment of wages, names and addresses of the Inspectors having jurisdiction, and date of payment of unpaid wages, in conspicuous places
Industrial Employment (Standing Orders) Act, 1946 S.9 NA Yes The text of the standing orders as finally certified under this Acton to be posted on special boards to be maintained for the purpose at or near the entrance and in all departments thereof where the workmen are employed
Maternity Benefit Act, 1961 S.19 Form-K Yes An abstract of the provisions of this Act and the rules made there under shall be exhibited in a conspicuous place in every part of the establishment in which women are employed
Minimum Wages (Central) Rules, 1950 R.22 Form-XI Yes 1. Form-XI containing minimum rates of wages fixed together with
2. The abstracts of the Act
3. The abstracts of the rules made there under
4. Name & Address of the Inspector
(These notices are to be displayed at all the offices)
Additionally a notice of period of work including overtime is to be displayed in Madhya Pradesh.
Payment Of Gratuity (Central) Rules, 1972 R.4 NA Yes A Notice specifying name of officer with designation authorised by the employer to receive on his behalf notices under the Act or rules.
  R.20 Form U Yes Display an abstract of the Act and the rules made there under
Karnataka Payment Of Wages Rules,1963 R.7 Form VI Yes Notice specifying the rates of wages payable to different classes of workers to be displayed separately in the main entrance or each of the departments
  R.21 r/w S.25 Form V Yes The abstracts of the Act and of the rules
Rights Of Person With Disabilities Rules, 2017   R.8(2) r/w S.21 No Display equal opportunity policy on either website or at conspicuous place in their premises
Sexual Harassment Of Women At Workplace (Prevention, Prohibition And Redressal) Act, 2013 S.19 NA No 1. Display penal consequences of Sexual Harassment
2. Order constituting the Internal Committee
Karnataka Shops and Commercial Establishments Acts, 1961

 

 

 

S.4(2) NA No Registration certificate to be prominently displayed
S.12(1) r/w R.24(4) Form P No Notice of Weekly Holiday
R.24(5) NA Yes The abstracts of the Act and of the rules
24-A NA Yes The name Board in Kannada version shall be written more predominantly by providing more space than for other languages
Karnataka Tax On Professions, Trades, Calling And Employments Rules, 1976 R.8 NA No Display conspicuously at his places of work the certificate of registration or the certificate of enrolment or a copy thereof

Disclaimer: The Rule name mentioned in the above table is for the State of Karnataka and the respective State Rules will be applicable for establishments in States other than Karnataka.

Author:  NovoJuris Legal

Pharma Giants’ tussle over weight loss medicine: Analysis of EISAI v. Dr. Reddy’s

EISAI Co. Ltd along with the patentee (“Plaintiffs”) have instituted a suit for permanent injunction against Satish Reddy and others (“Defendants”) for restraining the Defendants from manufacturing, selling, distributing, exporting or offering for sale any product that infringes the Plaintiff’s patent no. 215528 including Lorcaserin Hydrocholride (“LH”) or any other pharmaceutically acceptable salts of Lorcaserin such as Lorcaserin Hydochloride Hemihydrate (“LHH”). The Plaintiff had applied for patent in India on 23 September 2004 which was ultimately granted for a period of 20 years i.e. from 11 April 2003 till 10 April 2023. No pre-grant opposition, no post grant oppositions, no counter statements- etc., have been filed against the patent and it has been undisturbed for a period of 10 years.

Plaintiff no.1, a Japanese Pharmaceutical company which is an exclusive licensee of Indian patent no. 215528 and Plaintiff no. 2, is the patentee in respect of the above-mentioned patent. Plaintiff no. 2 claimed that it had invented a man-made molecule named Lorcaserin, around the year 2001 and has spent considerable time and resources to develop and commercialise the molecule. It is to be noted that Plaintiff no. 2 has obtained patents in over 65 jurisdictions and WHO had recognised Lorcaserin to be a new molecule. Further, the Plaintiff has carried out the mandatory requirement as per US FDA and has been granted marketing approvals in six countries. Also the Plaintiffs have already completed the regulatory approval for its drug products in India and expects pre-marketing approval by March 2019.

Issue:

In August 2018, the Plaintiffs found that the Defendants were planning to commercialize Lorcaserin in Indian market. Further, online search revealed that the Defendants had filed a US patent application for LH bearing US patent application No.14/141, 112. The Plaintiffs further found that the Defendants approached the Subject Expert Committee (SEC) for permission to manufacture and market LH in India which was subsequently granted such permission in the SEC meeting of 5 August 2018. The Plaintiffs thus filed a suit for permanent injunction.

Opposition raised by the Plaintiffs:

According to the Plaintiffs, the Defendant’s product LHH infringes the plaintiffs patent No.215528 which covers Lorcaserin and its pharmaceutically acceptable salts, including LHH, which are specifically claimed in Claims 38 and 39. To simplify Plaintiffs’ patent is being infringed as Lorcaserin forms the major portion of LH and LHH, and the Defendants cannot manufacture their product without infringing the Plaintiffs’ patent in the first place.

Further, the Defendants have relied on the data generated by the Plaintiffs who have spent millions of dollars by carrying out more than 18 different studies. As opposed to this, the Defendants have only carried out limited bio-equivalence studies with reference to the Plaintiffs’ drug.

Further, the balance of convenience lies in favour of the Plaintiffs as the Defendants have not “cleared the way” before going ahead with the launch of their product and on the other hand the Defendants have admitted that they got the manufacturing approval only on 22 October 2018 and have not commenced with the manufacturing of the drug. In addition the Plaintiffs would suffer from irreparable loss if the injunction is not granted to them.  The Plaintiffs here have relied on the case of Merck v. Glenmark; 2015 (63) PTC [Del] [Db] where the court observed that “if a defendant is aware that there may be a possible challenge to its product, but still chooses to release the drug without first invoking revocation proceedings or attempting to negotiate, that is surely a relevant factor. The defendant‟s legal right to challenge the patent at any point in time is intact, but that does not mean that this factor cannot determine the interim arrangement”.

As mentioned earlier, the Plaintiffs have stated that non-grant of injunction would result in serious irreparable loss and they relied on the above-mentioned case of Merck v. Glenmark, wherein the court observed “where an infringer is allowed to operate in the interim during the trial, it may result in a reduction in price by that infringer since it has no research and development expenses to recoup – most revenue becomes profit. The patentee however can only do so at its peril. Importantly, prices may not recover after the patentee ultimately prevails, even if it is able to survive the financial setback (or “hit”) during the interim, which may take some time. The victory for the patentee therefore should not be pyrrhic but real”.

Defences taken by the Defendants

The Defendants have relied on three main defences. The Defendants claim that:

  1. they have not infringed the suit patent as the patent does not cover LHH, for which they are obtained the approval for;
  2. the Plaintiffs have not worked out the suit patent in India; and
  3. the suit patent is invalid.
  4. The first contention of the Defendants is that the suit patent of the Plaintiffs does not contain LHH. According to the Plaintiffs the contention taken by the Defendant ignores the well-established concept of basic and improvement patents. The Plaintiffs have relied on the case of G. Farbenindutrie A.G.’S Patents: (1930) 47 RPC 289, where the court observed that that chemical patents can be divided to two classes. The first class of patent is based on what is described as an originating invention that is the discovery of a new compound or new reaction. And the second class comprises of patents based on a selection of related compounds such as the homologous and substitution derivatives of the original compounds, which presumably have been described in original patent.

The Court observed that the suit patent was in the nature of an originating/genus patent and the numerous patent applications were for its improvement/selection inventions. Thus, merely because Plaintiffs applied for a patent separately for specific species of genus i.e. Lorcaserin, it does not mean that the species patent i.e. LHH would not fall within the ambit of genus patent.

As regards to the second contention placed by the Defendants, the same stands to be false. The remedy provided in case of non- working of a suit patent is provided in Sections 83 and 84 of the Patents Act, 1970 which calls for the Defendants to seek for a compulsory license. However, the Defendants have not applied for either a compulsory or voluntary license and on its own violation decided to seek the marketing approval by relying on Plaintiff’s data. Further, it is to be noted that the Plaintiffs have taken steps to commercialise the LHH product in India and are expected to receive the final regulatory approval by March 2019. Thus the question of non-working is completely irrelevant.

The Defendants here also relied on the case of Franz Xaver Huemer v. New Yash Engineers; AIR 1997 Del 79, for nonworking of a patent, where the defendants related to a special kind of loom which was vital for textile industry in the country and which would affect the economy of the country by seriously affecting the market. The Court in this case accepted that the plea of injunction as the market would be seriously affected as a mechanical device invented in abroad or in India would be kept unused for the benefit of the public, and industry.

However, in the present case as stated earlier the Plaintiffs have applied for marketing which will be granted within a period of next two-three months and therefore the above mentioned case’s facts are distinguishable from the present case.

The contention made by the Defendants that the suit patent is invalid in view of Section 3(d) of the Patents Act was found to be erroneous. The suit patent is novel and that an inventive compound and does not fall under Section 3(d) of the Indian Patents Act. For Section 3(d) to apply two conditions need to be satisfied: (a) the claimed invention is a new form of a known substance or a derivative of a known substance; and (b) the known substance should have known efficacy.

In the present case, the compounds of the present invention are structurally different from the compounds disclosed by the Defendants and the compounds in the present invention are not a salt, ester, ether, polymorph or derivative of any known compound that has known efficacy.

Further, the court also discussed on the issue of granting an injunction in relation to a product that is not taught, motivated, suggested, disclosed, or covered by a patent. Relying on Novartis AG v. Union of India [2013 (6) SCC 1] the court stated that the disclosures made in a patent application should enable a Person of Ordinary Skill in the Art(POSA) to “make” the invention. If such disclosures are lacking then such invention would not be covered by the patent. The Plaintiff maintained that L/LHH were covered and disclosed in the suit patent (even though the Plaintiff had taken a contradictory stand before the Indian Patent Office) and the Court concluded that the suit patent specifically claimed Lorcaserin and all its pharmaceutically acceptable salts and hydrates.

Judgement of the court

After considering the submissions of the Plaintiffs and the Defendant, the Delhi High Court found the balance of convenience in the favour of the Plaintiffs and thus allowed their application for injunction by restraining the Defendants from making, using, selling or in any other manner dealing in any product that infringed the Plaintiffs’ patent.

Authors: Mr. Anuj Maharana and Mr. Asis Panda

Analysis of Section 396 of the Companies Act, 1956 in the light of NSEL merger order.

Section 396 of the Companies Act 1956 (‘the Erstwhile Act’) (i.e. Section 237 of the Companies Act 2013) gives power to the Central Government to order “forced amalgamation” of two companies if it is satisfied that it is essential in the “public interest”. This was invoked for the first time by the Ministry of Corporate Affairs (‘MCA’) in 2014. The order came in order to revive the National Spot Exchange Limited (‘NSEL’) from the major financial crisis in the year 2013 and in the setting, the Forward Market Commission (‘FMC’) had proposed a merger between NSEL and its holding company FTIL (now 63 moons) in ‘public interest’ so that dues amounting to Rs. 5,600 crores could be paid to investors and traders of NSEL. It was an unprecedented order made by the MCA and led to a lot of speculations on how the said provision can be invoked to revive a private limited company. Before analyzing the given provision under law, it would be relevant to discuss the background of the case.

Background

In 2013, NSEL, a spot exchange for trading commodities was trading in commodities which were not backed by the stocks in the warehouse. This resulted in a crisis with NSEL owing more than INR 5500 crores to its investors. Thereafter, the Government suspended all the forward trading operations by NSEL and made it subject to resolution plan of 33 weeks so as to revive it. The plans failed and NSEL could not be restored to its normal or even near-normal functional capabilities. To revive the subsidiary and to protect all its shareholders, FMC recommended its merger with its holding company (i.e. 63 moons). This step appeared to be in contradiction to the “limited liability” state of private companies and was criticized by many. Subsequently, in order to revive NSEL, MCA passed a merger order and marked it as a precedent for all similar future scenarios. This order was eventually contested in the Bombay High Court, where the bench upheld the merger order. It was further appealed by 63 moons in the apex court which rejected the order by analyzing the principle behind Section 396 of the Erstwhile Act.

Legal Provision

MCA passed the merger order by the powers it had under Section 396 of the Erstwhile Act (i.e. Section 237 of the Companies Act, 2013)[1]. Section 396(1) reads:

“(1) Where the Central Government is satisfied that it is essential in the public interest that two or more companies should amalgamate, then, notwithstanding anything contained in sections 394 and 395 but subject to the provisions of this section, the Central Government may, by order notified in the Official Gazette, provide for the amalgamation of those companies into a single company with such constitution ; with such property, powers, rights, interests, authorities and privileges ; and with such liabilities, duties, and obligations; as may be specified in the order.”

Further, Section 396(3) of the Erstwhile Act reads:

“(3) Every member or creditor (including a debenture holder) of each of the companies before the amalgamation shall have, as nearly as may be, the same interest in or rights against the company resulting from the amalgamation as he had in the company of which he was originally a member or creditor; and to the extent to which the interest or rights of such member or creditor in or against the company resulting from the amalgamation are less than his interest in or rights against the original company, he shall be entitled to compensation which shall be assessed by such authority as may be prescribed and every such assessment shall be published in the Official Gazette..”

The underlined words suggest that the powers held by the Central Government may be exercised only when an amalgamation is “essential in public interest”. Also, it is to be noted that the stakeholders would continue to enjoy the same rights and interests in the new company post amalgamation as they were entitled earlier. Therefore, any order made invoking the said provision has to satisfy these basic criteria as pre-requisites.

Judgment

MCA propounded while giving the merger order that it was of the “considered opinion that to leverage combined assets, capital and reserves for efficient administration and satisfactory settlement of rights and liabilities of stakeholders and creditors of NSEL, it would be in essential public interest to amalgamate NSEL with FTIL“. MCA further contended that NSEL seemed incapable of recovering any of its dues from its defaulting members and given the amount in question it intended to protect the interests of the creditors by merging the defaulting holding company with its parent company, considering that NSEL does not have the wherewithal to make payment of Rs. 5,600 crore.

The apex court’s bench consisting of Justice R. F. Nariman and Justice Vineet Saran heard contentions of both sides and held that the amalgamation order was ultra-vires Section 396 and violative of Article 14 of the Constitution of India and struck it down.

The court discussed the meaning and application of term “public interest” at length. To quote from the judgement authored by Justice Nariman:

In the context of compulsory amalgamation of two or more companies, the expression “public interest” would mean the welfare of the public or the interest of society as a whole, as contrasted with the “selfish” interest of a group of private individuals. Thus, “public interest” may have regard to the interest of production of goods or services essential to the nation so that they may contribute to the nation’s welfare and progress, and in so doing, may also provide much needed employment. “Public interest” in this context would, therefore, mean the combining of resources of two or more companies so as to impact production and consumption of goods and services and employment of persons relatable thereto for the general benefit of the community. Conversely, any action that impedes promotion of industry or obstructs growth which is in national or public interest would run counter to public interest as mentioned in this Section.

Further Justice Nariman concluded that on a holistic reading of the amalgamation order, the leveraging of combined assets, capital, and reserves of the companies was primarily intended to settle liabilities of certain stakeholders and creditors who had allegedly been duped and hence no “public interest” was served through the amalgamation order.

Explaining the scope of Section 396 of the Erstwhile Act, the court explained that, “essential to public interest” is the first and foremost criteria which should be satisfied whenever an order is invoked under this section. The expression “essential” has been defined in P. Ramanathiyer’s Law Lexicon (4thEdn.) as follows:

Essential. Indispensably necessary; important in the highest degree: requisite that which is required for the continued existence of a thing.

In this instance, the sole objective of the amalgamation is to satisfy the dues of the creditors and this being a private interest cannot be translated into an essential public interest. Therefore, an amalgamation order should not only be in public interest but it should also satisfy the litmus test of being essential.

The Hon’ble Supreme Court also settled the issue with respect to immunity of the Central Government’s amalgamation order under Section 396 of the Erstwhile Act from being challenged under Article 14 or Article 19 by virtue of Article 31 A of the Constitution of India. Article 31A(c) of the Constitution saves certain laws from being challenged under Article 14 or Article 19 if the law provides for the amalgamation of two or more corporations either in the public interest or for the proper management of any corporation. It was opined by the apex court that Article 31A has to be construed in light of Article 13 (3) of the Indian Constitution, which defines ‘law’. It states ‘law’ could be any ordinance, order, by-law, rule, regulation, notification, custom or usage in India having the force of law.

However, the ‘order’ should be legislative in nature and not administrative. The Hon’ble Supreme Court relied on number of judgements to set out the difference between a legislative order and an administrative order. It has laid down that legislation is a rule making process wherein a general rule of conduct is formulated without referring to any particular case. It is indicative of the future course of action. Whereas administration is the process of applying the general rule of conduct to particular cases by performing particular acts or issuing orders. It is determinative of past and present facts and the rights and liabilities. While the former is general, the latter is particular.

The argument that the amalgamation orders passed under Section 396 of the Constitution of India is immune from being challenged under Article 14 or Article 19 by virtue of Article 31A was not accepted by the Apex Court. It was held that the above-mentioned amalgamation order was not a legislative order but an administrative order because it directly impacted the rights and liabilities of the company, its shareholders and creditors. Such orders do not generally apply to all the companies but to particular companies which are to be amalgamated. There is an absence of general rule of conduct in the Central Government’s amalgamation order as it a specific direction with respect to two specific companies. Relying on the K.I. Shephard judgment[2], the bench concluded that even if Section 396 (5) mandates the Central Government order to be laid before the Houses of Parliament, it does not detract from the fact that the order is administrative in nature and not legislative. Therefore, it cannot be construed as ‘law’ within the meaning of Article 13 and the Central Government order cannot claim immunity under Article 31A.

Conclusion

In the context of the exceptional order of the Central Government, the court analysed the power of the Central Government in relation to the amalgamation of companies in public interest. For a Section 396 merger, no order of amalgamation can be made unless an order of compensation is first made under sub-section (3) of Section 396, and an appeal therefrom has either not been filed or has been disposed of. Also, keeping the corporate identity of a holding-subsidiary company intact, a merger under the said section should be ordered only when all other possible routes of reviving a company have failed.

Authors: Unnita Bhattacharya and Asis Panda

References:

[1]http://www.mca.gov.in/Ministry/pdf/Notice_NSEL_FTIL.pdf [Last Accessed on May 15 2019 at 4pm]

[2] K.I. Shephard&Ors. v Union Of India, 1988 AIR 686