CORPORATE LAW E-JOURNAL

ISSUE 4
SEPTEMBER 2014

CENTRE FOR BUSINESS AND COMMERICAL LAW

NATIONAL LAW INSTITUTE UNIVERSITY
BHOPAL, MADHYA PRADESH

TABLE OF CONTENTS

MESSAGE FROM PATRON ................................................................................................. i

MESSAGE FROM CHAIRPERSON .................................................................................. ii

FROM THE EDITORS DESK ........................................................................................... iii

EDITORIAL BOARD ........................................................................................................... iv

EDITORIAL POLICY ........................................................................................................... v

ARTICLES ....................................................................................................................... 1- 83

MESSAGE FROM THE PATRON

It is a matter of great pleasure and pride for me that the Centre for Business and
Commercial Law which was formed in the year 2008, after its three successful releases is
going to unveil its fourth issue of the annual business law journal. The Centre which was
instituted with the aim of facilitating corporate awareness and research has been actively
involved in undertaking various activities such as publishing e-journals, organizing
workshops, panel discussions, paper presentations and weekly corporate news bulletins. The
CBCL e-Journal has been an avenue for promoting research in field of commercial laws. The
journal was conceived with an aim to encourage dissemination of knowledge regarding
intricacies of corporate law. The current issue takes a step further and ensured versatility of
perspective by inviting contributions from students of different universities.
The journal follows a well-defined review procedure to ensure quality of the
publication. The student body is constantly guided by the faculty in charge and alumni
alike. This issue includes articles dealing with various areas of commercial and business law
including securities law, corporate laws as well as emerging areas such as issues of
jurisdiction under competition law, introduction of the Companies Act 2013 and amendments
being made to the Income Tax Act 1961.
I would like to extend my best wishes to the Chairperson of the Centre and my
distinguished colleague, Prof. Surya Prakash and the Editorial Board of the Centre for their
tireless efforts towards this publication. It gives me immense pleasure to unveil this issue for
your reading.

Prof. (Dr.) S.S. Singh

Director
National Law Institute University

MESSAGE FROM THE CHAIRPERSON

The Centre for Business and Commercial Law e-Journal is dedicated to developing
scholarship in the area of business and commercial laws. This fourth edition of the journal
strives to widen the scope of scholarly writing into these areas and deal with pertinent issues
relating to the new Companies Act, recent changes in the tax regime, regulatory approach
towards competition amongst others.
This journal is the result of the efforts of the authors, the Editorial Board and the
University and is an attempt to contribute to the vibrant corporate jurisprudence of our nation.
I wish that the ideas presented in this edition are dwelt upon and constructively criticised to
promote the development of ideas and the jurisprudence.
I extend my warm gratitude to the Director of National Law Institute Unviersity for
constant support and congratulate the Editorial Board headed by Ms. Jomol Joy for realising
the publication of this issue. I hope that the contents of this journal prove to be useful for
academicians and students alike.

Prof. (Dr.) S. Surya Prakash

Chairperson
Centre for Business and Commercial Law

ii

FROM THE EDITORS DESK

It gives me immense pleasure and great honour to present to you the fourth issue of
the Centre for Business and Commercial Law e-Journal. This journal is a double peerreviewed research journal catering specially to the area of business and commercial laws and
publishing articles, case notes and comments. In fact it is one amongst the few e-journals in
the country committed exclusively to corporate law regime in India and abroad. We
understand the needs and challenges of this widening paradigm in the field of law and it is
our attempt to broaden our platform for academicians, professionals and students across the
country to publish their scholarly works on both theoretical and practical issues in the areas
of business, finance, economics and corporate laws. This issue contains works on varied
subjects including the recent amendments to the Companies Act 2013, ponzi schemes and
their regulation in India, a recent amendment to Income Tax Act, 1961 amongst other relevant
issues in the field of corporate law. We are highly indebted to our Advisory Board for their
unwavering and kind support and guidance. I hope this issue would offer our readers
constructive and valuable updates on business and commercial laws.

On Behalf of the Editorial Board,

Jomol Joy
Editor-in-Chief
CBCL e-Journal

iii

EDITORIAL BOARD

Patron:
Prof. (Dr.) S.S. Singh
Director, National Law Institute University
Chairperson:
Prof. (Dr.) S. Surya Prakash
Editor-in-Chief:
Jomol Joy
Supervisory Editors:
Suditi Surana
Gautam Aredath
Neham Tayal
Shantanu Tiwari
Aakanksha Badkur
Technical Editor:
Gautam Aredath

ADVISORY BOARD
Albin Thomas, Associate, Trilegal, Mumbai
Ashish Mukhi, Senior Associate, Juris Corp, Delhi
Deksha Manchanda, Associate, Luthra & Luthra Law Offices, Delhi
Mishita Jethi, Research Fellow, Criterion Economics LLC, Washington DC
Neha Vijayvargiya, Partner, PXV Law Partners, Delhi

iv

EDITORIAL POLICY

We accept Articles, Notes and Comments on a rolling basis throughout the year. The
submissions may be e-mailed (as .doc or .pdf) to cbcl.editorialboard@gmail.com.
1. The title page should include: Title of paper; Full name(s) of author(s) and Institutional
affiliations; Postal address; Phone numbers and e-mail addresses.
2. Co-authorship is allowed to a maximum of two authors.
3. Submissions should be in Times New Roman with font size 12, line spacing 1.5 and
should not exceed 3000 words, and should conform to the Blue Book (19th ed.) mode of
citation.
4. Submissions should be original and should not be simultaneously considered by any other
publication.
5. The journal would possess the copyright in the articles which may be published
elsewhere only after seeking prior written permission from the editors of the journal.

If you have an article or pathfinder for CBCLs Law Journal that you would like to share
with your students, colleagues, or a suggestion for one, please contact:

National Law Institute University, Kerwa Dam

Road, Bhopal, Madhya Pradesh (462044)
Telephone: 0755-6535674
Website: www.nliu.ac.in
e-mail: cbcl.editorialboard@gmail.com

ARTICLES

AN ANALYSIS OF PONZI SCHEMES AND THE STATE OF FINANCIAL REGULATION IN

INDIA ....................................................................................................................................... 1
Shamba Dev, Government Law College, Mumbai
SLUMP SALE THE DEATH OF DISSENT? ....................................................................... 25
Abhijeet Saxena, NALSAR University of Law
COMPETITION LAW ISSUE OF JURISDICTION............................................................. 34
Akansha Mehta, RML National Law University

BLACKLISTING OF COMPANIES BY THE GOVERNMENT OF INDIA IN THE LIGHT OF

ISRAEL MILITARY INDUSTRIES CASE............................................................................. 44
Shivesh Aggarwal, National Law University, Jodhpur
MCA V. SEBI LEGISLATIVE COMMENT ON THE PROVISIONS RELATING TO ROLE
OF INDEPENDENT DIRECTORS IN THE COMPANIES ACT, 2013 AND CLAUSE 49 OF
THE LISTING AGREEMENT.................................................................................................. 53
Shwetha Sriram and Zahra Aziz, Gujarat National Law University
RETROSPECTIVE OR REGRESSIVE? VALIDITY OF AMENDMENT MADE TO IT ACT,
1961 IN 2012........................................................................................................................... 60
Kruthika R. and Aditya Mitra, Christ University
CLASS ACTIONS A NEW FACET OF INVESTOR ACTIVISM IN INDIA........................... 75
Sargam Marwaha, Campus Law Centre, Delhi

AN ANALYSIS OF PONZI SCHEMES AND THE STATE OF FINANCIAL

REGULATION IN INDIA
Shambha Dev
Government Law College, Mumbai

INTRODUCTION
In the broadest sense, fraud means obtaining something of value by deception.
Kautilya, in his famous treatise Arthashastra, referred to fraud or embezzlement in these
words: what is realised earlier is entered later on; what is realised later is entered earlier;
what ought to be realised is not realised; what is hard to realise is shown as realised; what is
collected is shown as not collected; what has not been collected is shown as collected; what is
collected in part is entered as collected in full; what is collected in full is entered as collected
in part; what is collected is of one sort, while what is entered is of another sort.1 Although
written in around 300 BC, these words hold true even today.
Post independence, India had a large low-income rural and semi-urban population
with very limited access to formal banking services and it was only a matter of time for a
complex network of parallel and informal banking and financial entities to start catering to
the needs of consumers, among whom were thousands of unscrupulous financial companies
who actually operated Ponzi schemes 2 in various disguises. Much of the population in India
having previously been dependent on savings schemes run by Indian Postal Service but low
rates of interest in the 1980s and 1990s encouraged the rise of high risk ventures, especially
in the eastern part of the country. As of 2013, 8 out of every 10 multi-level marketing and
finance schemes against which complaints have been received are based in West Bengal. 3 It is
further estimated that these Ponzi funds have in total raised close to Rs. 10 trillion from
depositors in eastern India. 4
1

Kautilya's Arthshastra, B. K. Chaturvedi at p 40.

A Ponzi scheme is a fraudulent investment operation where the operator, an individual or organization, pays
returns to its investors from new capital paid to the operators by new investors, rather than from profit earned by
the operator. Operators of Ponzi schemes usually entice new investors by offering higher returns than other
investments, in the form of short-term returns that are either abnormally high or unusually consistent. The
perpetuation of the high returns requires an ever-increasing flow of money from new investors to sustain the
scheme. The scheme is named after Charles Ponzi, who became notorious for using the technique in 1920.
Sarah Peck, Investment Ethics, (2010) John Wiley and Sons, p. 5; Wests Encyclopedia of American Law:
Ponzi Scheme: a fraudulent investment plan in which the investments of later investors are used to pay earlier
investors, giving the appearance that the investments of the initial participants dramatically increase in value in a
short amount of time.
3
Is Bengal the Ponzi capital of India?, Hindustan Times, 28 April 2013.
4
The fall of Saradha group revives old ghosts of ponzi schemes going bust, The Economic Times, 24 April
2013.
2

In 1980, the first major financial fraud unravelled in West Bengal. The firm
Sanchayita Investments, which had commenced its business in 1975 with capital of Rs.
7,000, accepted loans or deposits from the public over a period of four years and the deposits
were repayable with interest of 12% p.a.5 The terms said that depositors had the right to
withdraw their deposit at any time but in case of premature withdrawal, they would lose
interest at a rate of 1%.6 The firm could also repay the amount plus interest to a depositor any
time before the expiry of the stipulated period, without any reason. 7 In 1978 however,
Parliament passed the Prize Chits and Money Circulation Schemes (Banning) Act 1978. 8
Section 12 of the Act mandated that a 2-year period be given for winding up every kind of
business relating to prize chits and money circulation schemes. On 13th December, 1980 the
Commercial Tax officer lodged a complaint against the firm. The FIR stated that the firm had
been offering interest at 48% p.a., which had been later reduced to 36% whereas the loan
certificate receipts showed that the actual rate of interest was 11% only, clearly evidencing
that the 'Money Circulation Scheme' was being conducted.9 Further it was found that gifts
and cash prizes were awarded to agents, promoters and members. The office of the firm and
residences of the partners were searched by the police, leading to a seizure of large amount of
cash and documents. Certain lists of agents seized showed that they had acquired large
properties at various places. Further investigations revealed that more than 131,000 investors
were duped and by the time Sanchayita imploded, it had raised more than Rs 1.2 billion. 10
Two main partners were arrested while a third partner has been missing. Many investors and
agents committed suicide and a criminal case against the accused is still on.
The seeds of the Sanchayita fraud, however, had been planted well before in the mid1970s when the Reserve Bank of India decided to proceed against Peerless General Finance
and Investment Company, an entity which had been in business since 1932 and later was
nationalised. Peerless had a scheme named Endowment Certificate Scheme, in which a
subscriber was required to pay a fixed annual subscription for a number of years, varying
between 10 years and 30 years. On the expiry of the period, the subscriber would be paid the
5

State of West Bengal v Swapan Kumar Guha, AIR 1982 SC 949.

Id.
7
Id.
8
Section 2(c) of the Act provides:'Money circulation scheme' means any scheme, by whatever name called, for
the making of quick or easy money, or for the receipt of any money or valuable thing as the consideration for a
promise to pay money, on any A event or contingency relative or applicable to the enrolment of members into
the scheme, whether or not such money or thing is derived from the entrance money of the members of such
scheme or periodical subscriptions."
9
Supra note 7.
10
West Bengal in Damage Control After Chit Fund Scam, P Tapadar, Outlook India, 23 March 2013.
6

face value of the certificate. The subscriber was also entitled to be paid a guaranteed fixed
bonus. However, if any instalment was not paid within the stipulated period and grace period,
the certificate lapsed unless it had acquired a surrender value, after the expiry of 3 years from
the date of commencement if the subscriptions for 2 full years have been paid. A certificate
which had not acquired surrender value lapsed on non-payment of instalments and the
amounts paid became forfeit to the company. A lapsed certificate could, however, be revived
at any time before the expiry date of maturity on payment of all dues together with interest at
one paisa per rupee per month. Peerless tapped the small savings of villagers through a
structure of agents, sub-organizers and people chosen from amongst those who had social,
political and official connections. The agents' commission was 30% to 35% of the first year's
subscription and 5% only of subsequent years' subscription. The Supreme Court had rightly
noted that this scheme of commissions offered an incentive to the agents to concentrate on
getting more of fresh business but not to collect subscriptions of subsequent years because
their commission was far less then. 11
Peerless attracted the attention of the Reserve Bank of India (RBI) when the
Miscellaneous Non-Banking Companies (Reserve Bank) Directions, 1977 and the NonBanking Financial Companies (Reserve Bank) Directions came into force on July 1, 1977.
On March 3, 1978 the RBI informed Peerless that it was prohibited from accepting deposits
for more than 36 months and since the deposits were for periods exceeding 36 months, the
RBI wanted to know how the company intended to comply with the requirements. The
company requested that an exemption be granted in public interest. The alternative, it was
said, would be to close the business leading to loss of employment to several thousands of
employees and financial losses to millions of depositors. However, in its letter dated July 23,
1979, the RBI further pointed out that the schemes conducted by the company were covered
by the provisions of the Prize Chits and Money Circulation Schemes (Banning) Act, 1978.
Since Peerless was banned from doing fresh business and was required to wind up, the central
bank did not grant any exemption. Although Peerless appealed and received a favourable
treatment in 1987 from the Supreme Court, most of the field agents of the company founded
or became part of a network of a large number of small and big deposit-taking companies that
have flourished in the two following decades.
In the early 1990s, public investors in West Bengal were struggling to come to terms
with another fraud. The state government alleged that three financial institutions- Overland

11

Reserve Bank Of India v Peerless General Finance, AIR 1987 SC 1023.

Investment, Verona Credit and Commercial Investment and Sanchayini Investment were
carrying on business in violation of the directions of the RBI issued in 1987, and that these
companies were misusing and diverting money of small depositors. In the case of Overland
Investment, the amount deposited as deposit liability was Rs. 253 million as on 1993 against
the actual liability of Rs 578 million. 12 The Directors of Overland belonged to the same
family members and they were drawing huge sums by way of salary and allowances. Further
there were several properties of Overland in which the depositors' money had been invested.
The central bank passed an order prohibiting Overland from receiving any deposit from any
depositor and from dealing with and disposing of any of its assets except for the purpose of
repayment to its depositors. To Verona, the RBI issued a show cause notice along with a
prohibition order restraining the company from accepting any deposits. The court had also
directed the police to inspect the seized records and documents. To Sanchayini, a prohibition
order was passed by the RBI. The one thing that was common in respect of all the three
companies was that none of them were carrying on business strictly in accordance with the
1987 directives of the RBI and were, for several years, and were taking advantage of an
interim order of injunction by the Calcutta High Court, to avoid having to observe the
directives of the central bank. Under these directives, 80% of the deposit had to be kept in the
manner prescribed by the RBI and only 20% of the deposit could be invested by a Company
through a resolution of the Board of Directors.13
Post these frauds, the financial landscape changed. In the years immediately after
liberalization, India witnessed a wave of public investments in equity and instead of raising
deposits from public many companies resorted to raising equity capital from the public.
However, many companies simply vanished after a few years with public money, with the
market regulator unable to act. A Joint Parliamentary Committee Report on Investor
Protection14 stated that 1.5 crore small investors who participated in the stock market between
1992 and 1996 through IPOs15 were defrauded. "At that time Rs. 86,000 core were raised in
four years through public issues and right issues by four thousand odd companies. Most of
these 1.5 crore investors who came in for the first time in the stock market were duped..Till

12

Overland Investment Company v State of West Bengal, AIR 1997 Cal 18.
Id.
14
Para 14. 28 of the Report.
15
An Initial Public Offering (IPO) is the first sale of stock by a private company to the public. IPOs are often
issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately
owned companies looking to become publicly traded. In an IPO, the issuer obtains the assistance of an
underwriting firm, which helps it determine what type of security to issue (common or preferred), the best
offering price and the time to bring it to market.
13

date, 229 companies (only) have been identified by the Government appointed monitoring
committee, as having made public issues and disappeared. No one has been arrested and no
money has been recovered. There has not been even an action plan as to how to recover that
money."16
But with the stock markets performing badly post 1992, and banks cutting back on
interest on deposits, schemes known as plantation schemes became very attractive for
investors impatient for returns and willing to take risks. This lead to the mushrooming of
plantation based schemes but these schemes were to eventually mop off billions in investor
wealth. One such scheme was the infamous Tree Plantation Scheme, run by Chennai-based
Anubhav Group, one of the pioneers of such schemes. After investors started complaining
that their cheques were dishonoured, the Crime Branch, CID, on the strength of the order
passed by the Company Court registered a case in Crime No.1 of 2001, under Sections 467,
468, 471 and 420 of Indian Penal Code, 1860 against the officers of the company. 17 Another
company named Golden Forests India Limited took deposits from investors through nine
schemes, and later admitted that it had 2,465,231 investors who had invested sum of Rs. 9.8
billion as principal excluding returns thereon. 18 In 1998, the Securities and Exchange Board
of India (SEBI) 19 filed a writ petition20 before Bombay High Court seeking, inter-alia, that
Golden Forests India be prevented from conducting its business. In the same year, SEBI
issued caution notices against several hundred companies involved in plantation schemes.21
The regulator noted that 664 entities had collected a total of about Rs. 35.18 billion and out of
these 664 Collective Investment Scheme entities, only 54 entities wound up their schemes
and refunded the money. 22 The Government decided that an appropriate regulatory
framework for regulating entities which issue instruments like Agro Bonds, Plantation Bonds
etc. had to be put in place. A press release was issued by the Government on November 18,
1997, conveying that such schemes should be treated as Collective Investment Schemes
under the SEBI Act, 1992 and to regulate such schemes, both from the point of view of
investor protection as well as promotion of legitimate investment activity, SEBI was asked to

16

Id.
Company Petition No.130 of 1999.
18
National Investor Forum v Golden Forests India Limited, 134 PLR 831.
19
Securities and Exchange Board of India (SEBI) is the regulator for the securities market in India. It was
established in the year 1988 and given statutory powers on 12 April 1992 through the SEBI Act, 1992.
Controller of Capital Issues was the regulatory authority before SEBI came into existence; it derived authority
from the Capital Issues (Control) Act, 1947.
20
W.P No. 344 of 1998 Bom HC.
21
SEBI Public Notice on CIS (http://www.sebi.gov.in/cis/pubnote.html).
22
SEBI Report (http://www.sebi.gov.in/cms/sebi_data/boardmeeting/1326177032722-a.pdf).
17

formulate the draft regulations. However, by that time, most of the money invested in these
schemes had already vanished while as many as 41 cases had been dismissed.

23

During the same time, many over-enthusiastic Non-Banking Financial Companies

were also raising large quantum of deposits from the public at large. These deposit-taking
companies, although had no fraudulent intentions, showed great mismatches in their assets
and liabilities because the deposits were raised on short term basis but used for long-term
purposes. Many went out of business. An extreme case was that of CRB Capital Markets. The
company went public in 1992 but did not apply for registration until 1996, as required by
RBI. While it did apply for registration in 1996, the central bank decided to inspect the
financial position of the company, which was carried out between November 13, 1996 and
November 18, 1996. But while the RBI did put on the hold the in-principle approval it had
granted CRB for setting up a bank, the company went about collecting money from the public
by making false statements in its prospectus that it had promoted its own private sector bank
CRB Global Bank Ltd. During the inspection several illegalities came to light. RBI had also
received complaints from the Tourism Finance Corporation of India Limited regarding nonpayment of deposits. The central bank issued a show cause notice to CRB Capital on 24
February 1997 asking why it should not be prohibited from accepting deposits. Interestingly,
in September 1996, the rating agency CARE had assigned an A rating to CRB's Fixed
Deposits but when RBI stopped CRB from raising fresh Fixed Deposits, CARE immediately
downgraded its rating to C.24 The Outlook reported that SEBI watched silently as CRB's
merchant banking division handled scores of dubious public issues and went around claiming
that it was "the country's No. 1 merchant banker". CRB's auditors would have been blind not
to have read the signs of imminent collapse when they checked the company's accounts."25
The lessons learnt from CRB pushed the RBI to frame new directions in 1998, making it
mandatory for NBFCs to register with it. 26
Like all Ponzi schemes, Sharadha Group, founded in 2006, also promised its investors
mathematically impossible returns.27 Its funds were sold by agents, selected from local rural
and semi-urban areas. As high as 25% to 40% of the deposit was paid to these agents as

23

SEBI Notice, Prosecution Dismissed (http://www.sebi.gov.in/cis/ProsecutionDismissed.pdf).

CARE has been promoted by the IDBI, which in turn had given financial assistance to the group.
25
The Anatomy of Fraud, Shekhar Ghose, Outlook June 11, 1997.
26
RBIs Report on Trends and Progress in Banking in India of 2005-06 pointed out that the RBI received
38,244 applications for grant of certification as an NBFC.
27
The Political Economy of Shadow Finance in West Bengal, S. Chowdhury, Economic and Political Weekly
Volume XLVIII No. 18.
24

commissions and gifts, helping build up a large pyramid of agents. 28 Initially, the group
raised money from the public by issuing debt securities, without issuing prospectus under
Section 67 of the Companies Act 1956, and without approval from the market regulator
SEBI. When SEBI raised objections in 2009, the group changed its methods by opening
many new companies to create more cross-holdings and a complex tiered corporate structure.
However, when SEBI continued its investigations, the group changed its methods of raising
capital again. In West Bengal, Jharkhand, Assam and Chhattisgarh, it ran various collective
investment schemes, such as tourism packages, hotel booking, time shares, real-estate,
infrastructure finance, and motorcycle manufacturing. 29 The investors were not informed
about the true nature of the investments but were only told that they would get high returns
after a fixed period. The investments were also fraudulently sold as a form of chit fund,
although the group or any of its entities were not registered as chit funds. The group also
started to acquire and sell shares of various listed companies and siphoned off the proceeds to
unidentified accounts.30 The Income Tax Department and the Enforcement Directorate
registered a case of suspected money laundering and started investigations. By 2012, SEBI
identified the group's activities as Collective Investment Scheme and in 2013 it demanded
that the group immediately stop operating until it received proper permission from SEBI.

31

Soon, the group collapsed, causing a loss of Rs 200 to 300 billion to about 1.7 million
investors.32
This titanic collapse triggered the government to conduct search and seizure at offices
of two other companies, MPS Greenery Developers Ltd 33 and Prayag Infotech Hi-Rise Ltd,
for running unregistered collective investment schemes and also arrested directors of two
more companies- ATM Group and Annex Infrastructure Private Limited on charges of
defrauding depositors.34 In addition, the Registrar of Companies has ordered that 42
companies in West Bengal explain their sources of funding. 35 The Assam Government suo

28

In story of Saradha's crores, Bengal's forgotten hundreds, The Indian Express (28 April 2013); Saradha chit
fund scam: State government failed, but so has centre, The Economic Times(26 April 2013); In Bengal's grey
'money market', Saradha is just one, Business Standard, (26 April 2013).
29
After Saradha, next target should be Rose Valley: Sushil Modi, Business Standard, 27 April 2013.
30
How Sudipto Sens strategy stumped SEBI, The Time of India, 30 April 2013.
31
SEBI Order (WTM/RKA/ERO-CIS/19/2013).
32
Saradha raised deposits from 1.7 mn people, probe finds, Live Mint, 20 June 2013.
33
On 11 May 2012, SEBI Issued Prohibition Order on MPS Greenery Developers Ltd., prohibiting the company
from collecting money from investors for Collective Investment Schemes
(http://www.sebi.gov.in/cms/sebi_data/pdffiles/23731_t.pdf).
34
Where there is a will, not bill, there is a way Cops seal two firms' offices, The Telegraph, 2 May 2013.
Director held, The Telegraph (6 May 2013); Bengal-based chit fund owner arrested, Zee News, 25 April 2013.
35
Is Bengal the Ponzi Capital of India?, Hindusthan Times, 28 April, 2013.

motto registered 222 cases against 128 companies.36 In 17 cases, charge sheets were filed
against 42 persons belonging to 15 companies and 303 persons were arrested for laundering
public money; the government also seized nearly Rs 9.4 million in cash from the arrested and
106 bank accounts with total deposit of Rs 240 million. 37 In the aftermath of the Sharadha
crisis, many Micro-finance Institutions stopped lending to high value depositors in multilevel marketing companies, fearing default in payments. The State Government was also
forced under political pressure to raise taxes on tobacco products to assist in the repayment of
investors deposits, which would be a further drain on public savings.
In the recent past, public investors in other states have also been defrauded and lost
valuable life savings. Promoters of a company in Jaipur in Rajasthan named Gold Sukh
promised 27 times return to investors in 18 months and managed to mop up over Rs 2 billion,
leaving close to 200,000 people in the lurch. A multi-level marketing company, Abhinav
Gold, promised to pay investors Rs 172,000 after two years on an investment of Rs 6,000 and
duped 20,000 investors in Gujarat.38 Another company Speak Asia promised Rs 4,000
monthly payout on an investment of Rs 11,000. Speak Asia claimed that it did online surveys
for companies such as ICICI Bank, SBI etc.39 It collected Rs 2,500 crore in less than two
years. 40

In 2012, the Crime Branch (Economic Offences Wing) of Kerala Police had

conducted searches at Amways offices to crackdown its money-chain activities. Amway godowns were closed and goods were seized. In 2013, the Managing Director of Amway was
arrested for an alleged violation of the Prize Chits and Money Circulation Schemes (Banning)
Act, 1978 and charged with Section 420 of Indian Penal Code, 1860.41
The Ministry of Corporate Affairs recently shared details of 20,000-odd companies
which are not registered with the RBI as Non-Banking Financial Companies but are
constituted with objects similar to NBFCs. 42 The Union Minister of Corporate Affairs stated
that unscrupulous companies pose as NBFCs to invest money in MLM schemes with
promises of highly improbable returns on investments, particularly when persons originally
enrolled in a scheme induce others to join the same scheme. Such schemes bring adverse

36

Company Offices Sealed in Assam, The Telegraph, 23 April 2013; Tripura at CBI's door over deposit", The
Telegraph, 9 May 2013; Odisha Police registers second case against Saradha Group, Zee News, 7 May 2013;
Odisha Police registers second case against Saradha Group, DNA, 6 May 2013.
37
Assam Bill Awaits Guv to nod to nip Saradha-like scams in bud, Daily Pioneer, 6 May 2013.
38
Sleight of Hand, Business Today, March 2012.
39
Id.
40
Crime Branch, Delhi Police Report, (http://delhipolice.nic.in/home/backup/26-11-2013.doc).
41
Cr No 129/2010.
42
22,000 firms not registered as NBFCs committing financial frauds, The Hindu, 18 March 2013.

publicity even for the companies that are engaged in bona fide businesses.43 The Ministry
announced that out of the 87 companies that were being investigated for fraudulent activities
against the public through illegal MLM or Ponzi schemes, West Bengal topped the list with
73 firms, followed by Delhi and Tamil Nadu with 5 firms each, Rajasthan with 2 firms and
Karnataka and Uttar Pradesh with 1 firm each. 44
It should be noted that most of these cases are not very different in substance from the
landmark case of the Sahara Group (that had begun as chit fund in 1978). Sahara came under
scrutiny when Sahara Prime City, a real estate venture of the group, filed a Draft Red Herring
Prospectus (DRHP) with SEBI on September 30, 2009.45 This is an initial document that a
company needs to file with SEBI to offer securities to public investors. While going through
this DRHP, SEBI suspected large-scale fund raising practices by two Sahara group
companies- Sahara India Real Estate Corp Ltd (SIRECL) and Sahara Housing Investment
Corp Ltd (SHICL). SEBI also received two complaints alleging illegal means employed by
these two companies to issue bonds in the form of OFCDs (Optionally Fully Convertible
Debentures), to the public throughout the country. The two group companies had floated an
issue of OFCDs and started collecting subscriptions from investors from April 2008 until
April 2011. During this period, the company had a total collection of over Rs 176.56
billion.46 The amount was collected from about 30 million investors in the guise of a "private
placement" without complying with the requirements applicable to the public offerings of
securities. While the matter was being investigated by SEBI, the RBI issued a public notice
warning investors against Sahara, stating that public investors should verify the name of the
company which issues the deposit receipt and whether the said company is authorised by the
RBI to accept deposits from the public. Only three Sahara group entities were registered with
RBI- Sahara India Financial Corp. Ltd (SIFCL), Sahara India Corp Investment Ltd (SICIL)
and Sahara India Infrastructural Development Ltd. (SIIDL); of these three entities, SIFCL, a
residual non-banking company, had been directed by RBI to phase out its deposit-taking
program while SICIL and SIIDL were not authorized to accept public deposits. RBI refused
to guarantee the repayment of deposit by any Sahara group companies. 47

43

Id.
Id.
45
Sebi-Sahara case: How it all began, The Hindustan Times, February 28 2014.
46
SEBI Order, http://www.sebi.gov.in/cms/sebi_data/attachdocs/1360766525407.pdf.
47
Sahara objects to RBI ad on deposits, The Times of India, 22 January 2011; RBI warns investors
against Sahara India Pariwar deposits, The Live Mint, 18 January 2011.
44

SEBI while taking cognizance of the issues pertaining to OFCDs passed an order in
June, 2011 directing the two companies to refund the money so collected to the investors and
also restrained the promoters of the two companies from accessing the securities market till
further orders. Sahara then preferred an appeal before Securities Appellate Tribunal against
the order of SEBI but the Appellate Tribunal confirmed and maintained the order of SEBI by
an order dated 18th October, 2011. Subsequently, Sahara filed an appeal before the Supreme
Court against the order of the Appellate Tribunal. The Supreme Court opined that the SEBI
Act, 1992 is a special legislation bestowing SEBI with special powers to investigate and
adjudicate to protect the interests of the investors. The powers of SEBI are not derogatory to
any other provisions existing in any other law and are analogous to such other law and should
be read harmoniously with such other provisions and there is no conflict of jurisdiction
between the Ministry of Corporate Affairs and SEBI in the matters where interests of the
investors are at stake. To support this view, the Court laid emphasis on the legislative intent
and the statement of objectives for the enactment of SEBI Act and the insertion of Section
55A in the Companies Act 1956 to delegate special powers to SEBI in matters of issue,
allotment and transfer of securities. The Court observed that as per provisions enumerated
under Section 55A of the Companies Act 1956, so far as matters relate to issue and transfer of
securities and non-payment of dividend, SEBI has the power to administer in the case of
listed public companies and in the case of those public companies which intend to get their
securities listed on a recognized stock exchange in India.
Sahara contended that OFCDs were in the nature of hybrid instruments and were
not covered under Section 2(h) of Securities Contract (Regulation) Act, 1956 (SCRA). The
Court held that although the OFCDs are in the nature of "hybrid" instruments, it does not
cease to be a "Security" within the meaning of Companies Act, SEBI and SCRA. The
definition of "Securities" under section 2(h) of SCRA is an inclusive one and covers all
"Marketable securities". Sahara had offered OFCDs to millions of people and therefore there
is no reason to question the marketability of such instrument. And since the name itself
contains the term "Debenture", it is deemed to be a security. The two Sahara companies also
contended that the OFCDs were in the nature of convertible bonds issued on the basis of the
price agreed upon at the time of issue and, therefore, the provisions of SCRA are not
applicable in view of Section 28(1)(b) thereof and consequently SEBI has no jurisdiction in
the matter. The Supreme Court rejected this contention and held that the inapplicability of
SCRA, as contemplated in Section 28(1)(b), is not to the convertible bonds, but to the
entitlement of a person to whom such share, warrant or convertible bond has been issued, to
10

have shares at his option. The Act is, therefore, inapplicable only to the options or rights or
entitlements that are attached to the bond or warrant and not to the bond or warrant itself. The
Court also clarified that Section 28(1)(b) clearly indicates that it is only the convertible bonds
and share or warrant of the type referred to therein that are excluded from the applicability of
the SCRA and not debentures which are separate category of securities in the definition
contained in Section 2(h) of SCRA.
Although the intention of the companies was to make the issue of OFCDs look like a
private placement, it ceased to be so because such securities were offered to more than 50
persons. Section 67(3) of Companies Act 1956 specifically mentions that when any security
is offered to and subscribed by more than 50 persons it will be deemed to be a Public Offer
and SEBI will have jurisdiction in the matter and the issuer will have to comply with the
various provisions of the legal framework for a public issue. Although the Sahara companies
contended that they are exempted under the proviso to Section 67 (3) since the Information
Memorandum specifically mentioned that the OFCDs were issued only to those related to the
Sahara Group and there was no public offer, the Court did not find enough strength in this
argument. Since the companies elicited public demand for the OFCDs through issue of
Information Memorandum under Section 60B of Companies Act 1956, it could only have
been meant for a Public Issue and since introducers were needed for someone to subscribe to
the OFCDs, it is clear that the issue was not meant for persons related or associated with the
Sahara Group. The Supreme Court concluded that the actions and intentions on the part of the
two companies clearly show that they wanted to issue securities to the public in the garb of a
private placement to bypass the various laws and regulations in relation to that. The issue of
securities to more than the threshold statutory limit fixed under proviso to Section 67(3)
therefore violated the listing provisions attracting civil and criminal liability. In addition, the
issue of OFCDs through circulation of Information Memorandum to public attract the
provisions of Section 60B, which require filing of prospectus under Section 60B (9). The two
companies did not come out with a final prospectus on the closing of the offer and failed to
register it with SEBI, therefore there was violation of Sec 60B also. Furthermore, the
companies argued that as per the Unlisted Public Companies (Preferential Allotment) Rules
2003, preferential allotment by unlisted public companies on private placement was provided
for and permitted without any restriction on numbers as per the proviso to Section 67(3) and
without requiring listing of such OFCDs on a recognized stock exchange. They went on to
argue that Section 67(3) was made applicable to Preferential Allotment by unlisted public
companies only in 2011 by amending the 2003 Rules with prospective effect and not with
11

retrospective effect. Hence before the 2011 Rules were framed, they were free to make
preferential allotment to more than 50 persons also. However, the Supreme Court did not
agree and held that the legislative intent was not so, and such a Rule being a delegated piece
of legislation cannot supersede the statutory provisions of Section 67(3) and in the existence
of Section 67(3) it is implied that even the 2003 preferential allotment rules were required to
comply with the requirement of Section 67(3). The Supreme Court observed that even if
armed with a special resolution for any further issue of capital to person other than
shareholders, it can only be subjected to the provisions of Section 67.
The Supreme Court upheld the market regulators decision and ordered refund of
investors money. But in the meanwhile, when Sahara was barred from raising money from
the public, the group moved to a new regulatory domain- the co-operative society- and started
several new investment schemes which raised money under the name of Sahara Credit CoOperative Society.48 The cooperative, being a multi-state one, comes under the purview of the
Central Registrar of Cooperative Societies of the Union Ministry of Agriculture. Needless to
say, the new schemes were simply mirror images of the optionally fully convertible
debentures issued by the two Sahara entities, SIREC ad SHIC, previously. 49 Once again,
SEBI issued a public notice stating that it has been receiving complaints that the Sahara
group, its agents and officials are forcing investors to switch to other schemes in the Sahara
group companies. 50 The Sahara group, like Sharadha, has been switching from one route to
the other to raise public deposits. Although it is difficult to say whether or not the Sahara
Group had been fraudulent in its intentions behind raising deposits, yet the similar nature of
all these multiple frauds makes a valid ground for an enquiry into the underlying reasons for
the systemic failure of financial regulation in the country.

APPROACHES OF REGULATION
In all the Ponzi schemes that have fallen apart in the past, there is always a thirst for
new customers, who come from un-banked sections of the population and operate in areas
where consumers have limited access to equity markets and formal banking channels or
where consumers find it difficult to undergo the lengthy and complicated procedures
followed by banks. Many investors are daily wage earners, small traders, lower-middle class
people and villagers. It is highly unlikely that they would have a fixed amount of savings
48

Sahara takes co-op route to beat Sebi, RBI bans, The Business Standard, 26 April 2011.
Id.
50
SEBI Public Notice (www.sebi.gov.in/cms/sebi_data/attachdocs/1353921926198.pdf).
49

12

every month. In addition, most of them do not even have proper documents to open a bank
account. Putting their money up in a high yield investment is way for their money to grow.
The scheme operators either raise their funds through legitimate channels such as collective
investment schemes, non-convertible debentures and preference shares, or illegitimately
through fictitious instruments such as fictitious ventures in agricultural export, construction,
manufacturing, etc. The operators lure such customers in with promises of absurdly high
returns within a short span of time, than that offered by other schemes and banks. This does
not mean that the schemes offering higher returns are better than low-return schemes; rather
the fact that some schemes are offering mathematically absurd returns might indicate that
they could be fraudulent because there is very little basis in transactional sophistication of
such a scheme. The low-return schemes do not reach the people targeted by the high-return
schemes. At the same time, regulators cannot impose an all-out ban on some or all of these
deposit-taking companies simply because they are promising to offer higher-than-market
returns. Further if the regulators were to do so, it would create a large gap in credit
availability for the needs of the low-income sections of the population.
However, the scheme operators do not invest the customers money as promised.
Instead they pocket it and investors have no way to track their investments. The initial
investors do get some of the fabulous returns, as promised. Naturally the initial fulfilment of
promises lends credibility to the otherwise impossible scheme and induces other investors to
invest. However, returns for the subsequent investors are paid using investors own money, or
money paid in by subsequent investors. This leads to pilling of debt upon a small equity base,
inevitably causing the scheme to collapse, for after all it is next to impossible to deliver the
higher-than-market rates of return by using investors funds while continuing to attract
additional investors and that too at times when economic activity and markets are down.
When it becomes difficult to recruit new investors or when a large number of investors ask to
cash out, the schemes collapse. Further, their collapse have not only affected the schemes
own depositors, but also other consumers across the financial system by leading to increased
costs for all consumers, creating an aversion towards certain products, services and providers,
reducing the level of trust that consumers have in a product or service and resulting in
reputational damage for genuine credit providers. This in turn has spawned more new Ponzis
elsewhere in the system.
In this Part, the article critically analyses the existing structures and approaches of
regulation of financial entities in the country, the nexus between fraudsters and the political
wing, the difficulties in enforcement and delays in justice. The author argues that almost the
13

entire structure and jurisprudence of financial regulation in the country has been evolved
from one fraud after another, but not from first principles. This has left gaps and
inconsistencies and room for regulatory arbitrage. Further the regulations have at best
imposed control over the activities of financial entities through statutory limits, registration,
reporting and disclosure requirements but have failed to look deeper and put checks on
certain types of financial business models, such as pyramidal structures and distributed agent
networks which is where most of the money changes hands and which are unsustainable and
work in opposition to the interests of depositors. Pyramiding enables more Ponzis to multiply
within a Ponzi which happen when agents are running their own schemes and laundering
public money without the company being aware. Adequate evidence also shows that the
effectiveness of the regulations have been further diluted by conflicts of interests due to the
existence of political nexus between the perpetrators and the political wing, delays in
enforcement actions and delivery of justice.
A Fragmented Framework
India is one of the few countries in the world to allow non-banking companies to raise
deposits from public. In most countries of the world, only banks have access to public
deposits. Investment companies that raise deposits from public are incorporated either as
Collective Investment Schemes under Securities and Exchange Board of India (Collective
Investment Schemes) Regulations 1999, or as NBFC, asset finance company or investment
company under regulations of RBI, or as a nidhi company (even though it may offer
financial services) under Ministry of Corporate Affairs or as a chit fund under Chit Funds
Acts of the Centre or States. This division of power between the regulators was not designed
as such but has evolved over several decades, in response to meltdowns and pressure
situations that have risen from time to time. 51 Companies may raise pubic deposits, subject to
provisions of Section 58A of Companies Act 1956,52 which were inserted in 1975 after a
number of cotton mills in the states of Gujarat and Maharashtra laundered public savings.
The regulations allow only deposits to the extent of 25% of net worth of the deposit-taking
company and place restrictions on interest rates, brokerage, etc. Non-banking financial
companies (NBFCs) are allowed to raise deposits upto 10 times of their net worth, but this
relaxation of norms is available only to deposit-taking NBFCs. These regulations have seen
sea changes after the CRB scam leading to the NBFC Directions of 1998. On the other front,
several hundred companies have raised money by private placement of shares because only
51
52

Ministry of Finance, Financial Sector Legislative Reform Commission, Vol. I, p. Xxiv.

Chapter V of Companies Act 2013 read along with Companies (Acceptance of Deposit) Rules 2014.

14

public offers fell under the overview of the securities market regulator. This lead to the
framing of Section 67 of the Companies Act 1956,53 inserted in 2000, whereby any offer of
securities to 50 or more persons was deemed to be a public offer. But this rule does not apply
to NBFCs, and thus several chit funds and financial entities use the NBFC device to issue
instruments such as debentures which are not regulated under public deposit rules. Similarly,
plantation companies with schemes such as money grows on trees have raised public
money without actually selling any trees until the government decided to regulate them.
Recently, SEBI made regulations for Alternative Investment Funds to regulate privately
pooled funds (such as hedge funds and private equity funds). This became effective in 2012
and is the only regulation which is not an example of reactive legislation.
Currently there are 8 regulators of the financial system, more than 60 Acts and
numerous rules and regulations drafted from time to time. Despite this, it is not impossible
for an investment entity to design investment schemes in a manner so as to fall outside the
jurisdictional limits of all the regulators or to exploit areas where regulation is inadequate or
absent. For example, if a money-for-money scheme is structured as one for purchase of goods
or advance for purchase of goods, it comes under neither SEBI nor RBI. Similarly, many
Ponzi schemes operate as multi-level marketing companies. In most cases the entities do not
have the approval to collect deposits from the public but they regularly violate the law. They
market their schemes aggressively, mostly in rural and semi-rural areas, where awareness
levels are low. Their network is so widespread that the authorities have been finding it
difficult to control. Another severe impediment for the regulators is the lack of clarity on
jurisdiction over such multi-level marketing companies. These are regulated under the Prize
Chit and Money Circulation (Banning) Act 1978. Neither SEBI nor the RBI regulates these
schemes and the regulators might be described as mere spectators in case of a fraud. In
other words, the present arrangement has gaps for which no regulator is in charge such as
the diverse kinds of Ponzi schemes that periodically surface in different states, which are not
regulated by any of the existing agencies. There are also several financial entities which are
unregistered with all or some of the financial regulators and are still carrying on the business
of raising deposits from public. It is difficult for regulators to proceed against these entities.
Organizations such as chit-funds which carry out innovative financial activities appear to be
completely out of the purview of any financial sector regulator,54 because they come under
53

Part-I of Chapter III of Companies Act 2013 read along with Companies (prospectus and Allotment of
Securities) Rules 2014.
54
Id at 132.

15

the jurisdiction of individual states. The Indian Chit Funds Act was enacted in 1982 but in
West Bengal, despite its history of financial scams, the state government had never passed a
legislation to regulate chit funds, until the Sharadha scam broke out. 55 Ironically, the
activities of Sharadha did not constitute the business of chit fund, but collective investment
schemes.
The problem with such a fragmented regulatory system is that it ignores on one hand,
the need for coordinated action and information sharing among regulators and on the other
hand the premise that solvency of financial entities needs to be addressed on a group-wide
basis, not at the entity-level. It is a fact that many financial activities spill over from one
entity to another within the same group or within different groups. The fragmented structure
keeps regulators limited by resources, duties and responsibilities, and difficulties in
overseeing private transactions and coming to know of phantom companies spawned by the
group or any of its subsidiaries.
Lack of Consistency
Lack of consistency in financial jurisprudence has also created wide disparities in
treatment of financial institutions by different regulators in the country. For instance, the nonbanking financial companies and housing finance companies that are allowed to take public
deposits do not enjoy the same deposit insurance protection that is available to banks. If the
main rationale for deposit insurance is to protect depositors when a financial institution fails
to refund public deposits, then the same principle should apply to all deposit taking entities.
Deposit insurance is a crucial need for the low-income poor population, who do not have
other means to recover their lost savings. Further deposit insurance puts pressure on the
scheme operators to remain within the regulatory limits and also obligates the central bank to
monitor and act in a timely fashion if the entity oversteps. It was only after the Sharadha
scam that the Ministry of Corporate Affairs tightened the deposit regulations and made
provisions with regard to deposit insurance. Another example of inconsistent law-making by
the Ministry of Corporate Affairs is the recent legislation on Private Placement in Part II of
Chapter III of the Companies Act, 2013, perhaps drafted in an attempt to curb groups like
Sahara from misusing the term private placement and raising deposits. The Companies Bill
of 2009 and 2011 did not have these provisions. The Draft Rules on Public Deposits also
seem to have taken away the exemption available to Optionally Convertible Debentures
(OCDs) from the definition of deposit. OCDs are a mixture of debt and equity and have
55

West Bengal assembly passes bill to regulate chit fund companies, Livemint, 30 April 2013.

16

lower cost of debt by way of lower coupon rates. Because of this advantage, they have been
used by many companies in the past. The new provisions however will have the unintended
consequence of eliminating an otherwise useful financial instrument altogether, simply
because of one company misusing it.
Chit funds, which are governed by State governments, also suffer from the problem of
inconsistent treatment. Differences in enforcement levels across States have resulted in some
States becoming more prone to Ponzi schemes. 56 The regulation of collective investment
schemes that come under SEBI's scanner has also left much to be desired. Section 11AA of
the SEBI Act defines "collective investment schemes" in terms of principles to identify such
schemes, but it contains exemptions for institutions such as chit funds, Nidhis and
cooperative societies. Recently in January 2014, SEBI issued a notification amending the
existing Collective Investment Scheme Regulations. The market regulator now mandates that
all deposits be raised only in cheques, drafts or other proper banking channels. While this can
prevent Ponzi companies from raising cash deposits, it also alienates the unbaked sector of
population from legitimate investment opportunities. Prior to that, in July 2013, the Securities
Law (Ordinance) Second Amendment 2013 brought under SEBIs purview all pools
exceeding Rs. 1 billion. However, it is possible for any Ponzi operator to incorporate several
subsidiaries so as not to cross this threshold.
The problem with such piecemeal approach to rule-making is that while it puts
pressures and checks on the companies from time to time, which can nevertheless be flouted
one way or the other, the approach ignores the need to control how financial companies ought
to be run, when they are engaging in risky speculative activities. The regulations therefore
fail to solve the problems associated with business models of certain companies such as
pyramiding and agency problems and by the time a Ponzi scheme comes to light, a huge
agent pyramid has been built or multiple holding and subsidiaries have been spawned and
most of the money is already gone. Thus while regulatory reforms will continue to be
important in preventing Ponzi schemes, it has its practical limitations.
Disregard of Substance over Form
The third major problem with financial regulation in the country is that the rationale
behind regulation has so far relied not on the substance but on the legal form of financial
activity. There are several activities and schemes in the financial system, which are disguised
56

The All India Association of Chit Funds estimates the registered chit fund market at Rs 300 billion and that of
the unregistered chit funds at Rs 30 trillion. Organized multi-level marketing industry is about Rs 65 billion, but
those that operate in the shadows are a multiple of this.

17

to prevent regulatory oversight. It is only a matter of jurisprudence that regulators often need
to lift the veil over the schemes and see beyond the black box of managed investing; they
need to regulate them for what they really are, not what they appear to be on the outside.
Many the deposit-companies have been raising money in the disguise of advances for
unknown projects or even for booking hotel rooms. There are no stated rates of interest, only
promises of double the money after a certain period of time. For example, Sahara Q Shop
Limited launched a scheme a few years ago. A scheme chart provided at the time of the
purchase said that an amount of Rs 1,000 would have a redemption value of Rs 2,354 after 6
years but the "General Terms and Conditions said that this plan was only an advance for
buying goods.57 Certain gold investment schemes accept deposits from public for a period of
12 to 15 months and the scheme operator provides a bonus upon the accumulated amount.
The customers are offered discount on the gold value of the investments in the form of gold
jewellery at the end of the term. In these schemes, there is simply no control over where the
deposits would be applied. The operators often offer higher bonus amounts (which merely
is the interest component in disguise) to attract more customers into the scheme. Although
they appear to be like Collective Investment Schemes, SEBI cannot regulate them because
they are designed as advances for purchase of goods. The Bombay High Court has also failed
in applying the substance over form test. In the matter of jewellery schemes, it said that
we do not find any public interest in the petition. If any shop owner is running such a
scheme and the consumers are voluntarily taking part in such a scheme, it is purely a
commercial transaction between a businessman and a consumer.58 Some entities issue
preference shares to the depositors. A preference share is essentially the capital of the
company, and not a deposit. Some other companies structure their deposit taking scheme as if
the so-called depositor places order for purchase of land by the promoter. Later on, the land
deal is cancelled, and money is returned with interest. But regulators cannot take action
because they view these schemes in their sophisticated legal forms and not in the light of their
economic reality. This was amply exhibited in the case of Sahara group which contended that
its Optionally Fully Convertible Debentures (OFCDs) were not covered by the regulatory
authority of SEBI because OFCDs were a hybrid of debt and equity instruments; the Supreme
Court had to direct SEBI to provide inputs on what OFCDs are: In this matter the questions
as to what is OFCD and the manner in which investments are called for are very important
questions. SEBI, being the custodian of the investor's interest and as an expert body, should
57
58

Allahabad HC issues notice to SEBI, Sahara Q Shop over a scheme, The Economic Times, 9 September 2013.
S B Agarwal v SEBI, Bombay High Court (Nagpur Bench), PIL No. 43/2013.

18

examine these questions apart from other issues. Before we pass further orders, we want
SEBI to decide the application(s) pending before it so that we could obtain the requisite input
for deciding these petitions.59 Similarly, in the case of Sharadha group, a Collective
Investment Scheme had taken the disguise of a chit fund.
In most cases, it is this failure to distinguish between the substance and the form that
has lead to significant delays in containment of Ponzi schemes. It is thus very important to
ensure that simplicity and clarity should inform the content of regulation, leaving no part of
it open to different interpretations by different persons. 60
Conflicts of Interests
To raise a billion units of money from over a million consumers, it is not enough to
exploit loopholes in regulations but scheme operators need to build a network that is fed by
political immunity. For example, in the United States, it has been since that political lobbying
was associated with more risk-taking by the financial sector during the period between 2000
and 2007, resulting in worse outcomes in 2008.61 The US regulators malignly neglected the
importance of extending the regulations to non-banking financial entities, which had
expanded to exceed the size of the depository system. 62 In India too, evidences from court
cases show that the risk of covering up fraudulent activities in return for campaign
contributions, high offices, kickbacks and pecuniary relationship may be quite high. In the
Sanchayita scam, it was observed by the Supreme Court that The materials only indicate that
the firm... also advances monies to political parties.63 In the case of Overland Investments,
the Calcutta High Court had observed that the State knew the affairs of these companies but
we do not find any reason why the State waited for a long time in the matter of bringing to
the notice of the Court inasmuch as long delay might have caused serious prejudice and loss
to the depositors. The State should have come to this Court long back when the State had
come to know all the affairs of the company which according to the State was highly
prejudicial in public interest.64 In the case of Anubhav Group, the Court found that the
Government officials in connivance with real estate promoters fabricated records and a
deliberate attempt was made to grab the Government land and gave specific directions to the

59

Order dated May 12, 2011 in SLP (Civil) No.11023/201.

Report of the Committee for Reforming the Regulatory Environment for Doing Business in India.
61
A Fistful of Dollars: Lobbying and the Financial Crisis, Deniz Igan, Prachi Mishra, Thierry Tressel, NBER
Working Paper No. 17076, Issued in May 2011.
62
The Return of Depression Economics and the Crisis of 2008, Paul Krugman (2009), W. W. Norton Company
Limited.
63
Supra note 7.
64
Overland Investment v State of West Bengal, AIR 1997 Cal 18.
60

19

police to investigate in that line. 65 The Sharadha group scam, which was followed by arrest
and investigations against Members of Parliament and State Legislature, has also
demonstrated that there may be widespread conflict of interests. Further indication of abuse
of executive authority can be inferred from the fact that despite the Ministry of Corporate
Affairs prior warning to the State Government about the activities of the group, no action
was taken by the State Government. On 7 December 2012, RBI Governor had stated that the
West Bengal government should initiate suo moto action against companies that were
indulging in financial malpractice but no action was taken.
The nexus between perpetrators and politicians provides the perpetrators access to a
large army of local authorities and local political outfits within each of its areas of
operations. 66 Many of these people join as agents, sub-agents and so on. They induce
members of the public to participate in the schemes offered by the company, administer the
process of fund collection and distribution of coupons, and may also exercise undue influence
over local enforcement bodies. Thus, by using a mechanism of both trust and fear, these local
people settle disputes of individual consumers, without taking the lid off the entire scheme.
Even legislation has failed to confer enough powers upon regulatory bodies to
independently proceed against the perpetrators. For instance, until the passage of Securities
Law (Ordinance) Second Amendment 2013, in the cases where defaulters failed to pay up the
penalty imposed on them, SEBI had no power beyond just initiating prosecution proceedings.
SEBI also had no power to enforce and was dependent on the government for enforcement.
Under some legislation, both the regulator and State Government have been given concurrent
powers to take action against financial entities. An example of this is Section 45T of Reserve
Bank of India Act 1936, under which both RBI and State Governments have the power to
issue search warrants for contravention of the provisions of section 45S in relation to
acceptance of deposits. However in practice, in order to take action against the offender, the
information should be passed on to the State Police, and thereafter the effectiveness and
authority of regulatory and compliance mechanisms may get diluted by political pressure not
to proceed against a fraudster.

65

The Official Liquidator v R. Vijayakumar, O.S.A.Nos.463, 464/2012 and 61/2013 and M.P.(MD)Nos.1,1/2012
and 1/2013, O.S.A.No.463/2012.
66
Once again a Ponzi lays waste, Economic and Political Weekly, XLVIII (19), 2013 (discussing the
involvement of political power in the rise and fall of Ponzi schemes).

20

Delays in Enforcement and Justice

Civil remedies and criminal actions will continue to be crucial in enabling victims to
pursue recovery when regulators do not act but recovery rates for such schemes through
traditional routes have always been very low, making them particularly harsh for individual
investors. And yet, it is a long and drawn-out process, which can see recoveries mostly
getting diluted by legal costs and miscellaneous expenses. The Sanchayita case has paid back
very little over the last 30 years and a criminal case is still dragging in the court. In the case
of CRB Capital, the case has been dragging for 15 years. In the case of Sharadha group, no
solution has yet come from the court. The Enforcement Directorate and the Kolkata Police,
which is under the control of the state government, has been at loggerheads with each other
over the investigation of Sharadha and the Calcutta High Court noted that the state
government has failed to implement its recommendations and asked for a special court to be
established to bring all types of cases in the scam under one roof. The case of the Sahara
Group is another example of unreasonable delay in enforcement. The three-bench judges of
the Supreme Court remarked: You have no intention of returning the investors money. Your
intention is very shaky. Your every step is shaky. We cant interpret our order according to
your need. You are justifying your conduct, which is not justifiable. 67 Even the Chief Justice
of India remarked: we are more concerned about the common man, who has invested his
money in the companies. If you (SEBI) want me to send them to jail, we would send them. 68
The case has still been dragging in court. One year later in 2013, the Court observed: "You
indulge too much in hide and seek. We cannot trust you any more...There is no escape for
you and the money has to come." 69 But the Sahara group is yet to comply with the order.
Further, regulators and judges are often entangled in long battles in courtrooms over
many legal and factual issues, leading to delays in delivering justice. For example, SEBI had
amended its Act with effect from October 29, 2002, pursuant to which the offences under
SEBI Act became punishable with imprisonment which may extend to 10 years and fine
which may extend to Rs. 250 million or with both. However, in trying fraud cases, the market
regulator has been facing inharmonious treatment from different sections of the judiciary.
Section 26(2) of the SEBI Act provides that no court inferior to the Court of Session shall try
the offences. Prior to the amendment, these offences were punishable with imprisonment
which may extend to one year and fine or with both. The pre-amended Section 26(2)
67

Your Intention is Shaky, Supreme Court Tells Sahara, The Hindu, 3 December 2012.
SC raps Sahara group for not refunding investors money, The Times of India, 3 December 2012.
69
Sahara Cannot Be Trusted Anymore: Supreme Court, The Times Of India, 28 October 2013; The Curious
Case of Indian Businessman Subrata Roy, Forbes, 1 November 2013.
68

21

provided that no court inferior to a Metropolitan Magistrate or a Judicial Magistrate of the

first class shall try these offences. Subsequent to the amendment in 2002, no court inferior to
the Court of Session can try the offences under SEBI Act. However, the jurisdiction of the
Sessions Court for trial of the cases for offences committed prior to the amendment was
challenged by many of the accused, raising the contention that offences prior to 2002 need to
be tried as per the pre-amended provisions. SEBI, on the other hand contented that the
amendment in Section 26 of the Act is procedural in nature and therefore is required to be
applied retrospectively. The High Court of Delhi by order dated September 5, 2006 held that
the offences under SEBI Act are required to be tried by the Court of Session consequent to
the amendment. The same view was upheld by a division bench of the Delhi High Court. As
a result of this order, large numbers of Collective Investment Scheme-related matters were
subsequently tried by the Court of Session and judgments pronounced therein. In contrast, the
Bombay High Court, vide order dated January 16, 2008 held that the offences committed
prior to the amendment are required to be tried by the Magistrate Court. Accordingly the
cases which were committed for trial to the Sessions Court were transferred back to the
Magistrate Court. The judgment passed by the Bombay High Court was challenged by SEBI
by filing Special Leave Petitions before the Supreme Court.
These delays in the criminal justice system and enforcement of orders only add to the
uncertainty over recovery of depositors' money. If matters end up in court for decades, then
the role and authority of regulators and government is further dissolved and it benefits none
but the offenders. In such scenarios, it is seen that the pressures mount on the state
governments to step in and aid the investors who have poured their life savings into what turn
out to be phantom accounts. Although most poor investors may ardently hope that the
government will rescue them, yet, strictly speaking, there is no legal obligation on the
government even if there is a regulatory failure or lack of adequate legislative protection. It is
also unlikely that the state and central government or any of its agencies can be sued for
regulatory negligence. However it is important that regulators and judiciary collectively
maintain the credibility of the financial system in terms of assurance of systemic stability and
consumer protection, particularly for retail customers.

CONCLUSION
Given the practical complexities described in the foregoing section, it is important to
question what kind of financial policy and legislative changes can reduce the menace of
Ponzi schemes from laundering public deposits. To start with, it is essential that financial
22

policy should shift focus from regulating individual products, services and individual entities
to regulating the business models of financial entities and groups. There is a need to put
checks on the proliferation of highly complex and tiered holding-subsidiary and associated
structures in financial businesses as well as on the marketing of financial products to the
public, by curbing subscriptions to schemes that promise absurd returns. Moreover, selling
and distribution of all financial products at the rural and semi-urban level could be organised
under strict governmental supervision or thorough government-established centres or
platforms. Only licensed sellers can participate in these centres. Having these centres could
also mitigate the growth of large and dispersed agent networks and prevent entities from
building pyramids and distribute valuable information, advice and spread awareness among
public depositors and investors. At the same time, policy should be directed to encourage and
provide incentives to legitimate banking and non-banking financial groups to expand their
businesses in rural and semi-urban settings to cater to the needs low-income groups.
Legitimate financial institutions should also be incentivized to disseminate material advice to
all consumers before making investments. In addition to policy changes, legislative and
enforcement actions are also essential. First, legislation is needed to prohibit anyone from
engaging in financial and investment activities in rural areas. Only entities of a certain
prescribed size, experience and class should be allowed to provide services in rural areas.
Second, the legislation should be harmonized between all the regulators and among the
regulators and the enforcement agencies. There must be uniformity in spirit among
regulators. In order to do so, there is a need to establish an umbrella body to deal with matters
which fall beyond the jurisdiction of all regulators. Such an umbrella body should be
established through legislation and should comprise of representatives from all the different
regulators. Matters on which opinions of regulators vary should be referred to the umbrella
regulator and actions will be taken as per the directions of the umbrella regulator. The powers
and authorities of regulators and enforcement agencies also need to be strengthened. Special
enforcement agencies are required to be set up by the regulators and the government to
conduct continuous inspection, surveillance and scrutiny of financial groups and individual
entities engaged in selling, distribution of financial products and other kinds of investment
and deposit-taking activities. Such enforcement agencies should be empowered to demand
disclosures at any time and to make visits and inspections under general search warrant
issued by the government or judiciary. Quick reporting of deviations and information
exchange between enforcement agencies and regulators could enable timely enforcement
actions. It can be hoped that a financial regulatory system based on soundness and
23

consistency in principles, proper coordination and sharing of responsibility, a prompt

judiciary and independent enforcement machinery can go a long way in containing the
menace of Ponzi schemes in the country.

24

SLUMP SALE THE DEATH OF DISSENT?

Abhijeet Saxena
NALSAR University of Law, Hyderabad

INTRODUCTION
Sharing of power has been one of the most troublesome issues in human history. It is
not an issue which is peculiar to corporations; it predates existence of corporations; it is an
issue which is found in all spheres of human interactions such as politics.1 The widely
accepted solution to this issue has been majority rule, in the case of corporations. However
this was not always the case; initially when the concept of corporations was relatively new,
most of the decisions were taken with unanimous consent; this approach gave way to the rule
of majority because of increasingly complex structure of corporations and because of huge
probability of abuse of the unanimous consent method which often resulted in deadlock
situations.2 The subsequent emergence of majority rule does not mean end to the rights of
minority; there are certain fetters on the scope of majority rule. 3
One of the first cases in which majority rule was acknowledged as a cardinal principal
of corporate law was Foss v. Harbottle;4 and subsequently it was also included in various
legislations governing companies. 5 The ratio of Foss v. Harbottle case was essentially that
the court shall not ordinarily intervene in the matters of internal administration and
management of the company as long as the decisions are approved by the majority, and acts
in question are within the powers granted to directors under the articles of the company; in
such a situation minority cannot question such acts. The rule of Foss v. Harbottle does not
grant absolute unsaddled power to the majority and there are certain exceptions to the
applicability of the majority rule such as: a) the rule applies only when the corporate rights of
the members are being infringed and not when the personal rights of the members are being
infringed such as those rights which arise from the contract between the shareholder and the
company and also from the governing law such as right to vote in an annual general meeting
(AGM)6; b) ultra vires and illegal acts i.e. those acts which are not permitted by the

Robert B. Thompson, Exit, Liquidity, and Majority Rule: Appraisal's Role in Corporate Law, Geo. L.J. 1, 1-84
William J. Carney, Fundamental Corporate Changes, Minority Shareholders, and Business Purposes, American
Bar Foundation Research Journal Vol. 5,70 ,69-132 (1980).
3
Id at 90.
4
(1843) 67 ER 189.
5
Ataollah Rahmani, A comparative study of justifications for majority rule in corporations: the case of England
and Iran, I.C.C.L.R. 18(8), 276 , 272-294 (2007).
6
A.K. Majumdar, Company Law and Practice 937-946 (12th ed. 2007).
2

25

memorandum of association (MOA) of the company or are against the law; c) breach of
fiduciary duties, such as directors of a company misappropriating funds of the company or
appropriating for themselves business opportunities which would have been in the normal
course availed by the company; d) fraud or oppression on the minority; a single shareholder
can impeach the action of majority if there has been a fraud or oppression committed on the
minority; and e) inadequate notice of a resolution passed at the meeting of the members; if no
notice is given of a proposed general meeting then any shareholder, who has not attended the
meeting or voted against the resolution, can object to it. 7
The present paper focuses on how the safeguards for minority shareholders are being
circumvented in India by the majority through innovative methods such as slump sale.

MAJORITY RULE EVOLUTION

It is important to understand the theoretical evolution of the majority rule, before
rights of the minority can be analyzed. The theoretical justification of majority rule can be
traced to three theories which are: economic approach, doctrinal approach and political
approach. Each of these has its own shortcomings. 8
a) The economic approach justifies the majority rule over minority rule on the basis of
efficiency; by virtue of majority rule, the people who have a greater investment in a
corporation stand to earn more than those who have a lesser investment in a corporation. By
any other sub majority rule the interest of the majority might not be of the highest priority
and this will lead to lesser efficiency then that of majority rule. 9
b) The doctrinal approach justifies the rule of the majority using certain legal principles such
as principle of indoor management; the business purpose principle etc. All these principles
which are generally meant to benefit corporations and their shareholders, the judiciary and
the society- the principles which all, in one way or another, support the governance of
majority shareholders, seek to encourage financing and risk-taking in corporations which is
necessary for growth of economy, facilitate private ordering in the interest of efficiency etc.
These are worthwhile goals that can be often achieved, but under certain circumstances
during execution of these goals injustice might be dealt to the minority shareholders in
corporations.10

Id at 937-946.
Rahmani, supra note 5, at 279-284.
9
Id at 285.
10
Id.
8

26

c.) The political approach uses political arguments to explain governance of the majority in
corporations which is meant to monitor activities of the corporate management. 11 The use of
political arguments is to mean that the approach relies on personality of corporate members
rather than their capital. Why the majority should rule can be answered the same way as it is
done in the politics. It should rule because allegedly it enjoys greater force, treats members as
equal human beings, allows them to make maximum possible use of their freedom, and offers
them with more benefits and better results. 12 A criticism is that political arguments fail to
work in any human association and group which does not rely on personality of group
members. In addition, as the approach relies on members rather than their capital, it often
provides excessive protection for minorities that can be inefficient for business
corporations.13

MINORITY SAFEGUARDS
There can be no debate about the fact that the majority shareholders enjoy a dominant
position in a corporate hierarchy today, they can virtually appoint all the directors under the
old Companies Act as well as under the new Act 14 and thus can control every decision
making process in the company. The law even grants them a right to buy out the minority in
certain conditions.15
The minority although is on a lower pedestal but is not toothless and has its own
rights16. There are various mechanisms to safeguard the rights of the minority shareholders
which include the following:
I. Operation of Market In a developed market the shareholders dont need to take any legal
recourse as the market mechanism comes to their rescue. The shareholders can choose to sell
their shares if they feel dissatisfied with the running of the company. Such actions result in
drop in the value of shares and require the management to take damage control steps 17. Other
market transactions can also force the majority to treat the minority in a fair manner such as
the possibility of having a hostile takeover18.

11

Id at 283.
Id at 283.
13
Ibid at 283.
14
Section 257of the Companies Act, 1956 read along with section 260 of the Companies Act, 1956, the same
procedure has been substantially reenacted under section 160 of the Companies Act, 2013 read along with
section 161 of the Companies Act, 2013. This provision has been repealed.
15
Section 395 of the Companies Act, 1956.
16
Thompson, supra note 1 at 5.
17
Id at 6.
18
Id at 7.
12

27

II. Contractual Protection The minority can protect their interest by manner of having a
contract with the majority. This approach is easy to implement in closely held corporations
where the minority shareholder has more bargaining power but is very often impractical in
case of large corporations. 19
III. Legal Protection There is statutory protection available to the minority shareholders
under the Companies Act, 1956 (old Act). This protection has been substantially reenacted
in the Companies Act, 2013 (new Act). Doctrines like fiduciary duty, legal provisions
dealing with special majority, mandatory disclosures under Securities and Exchange Board of
India (hereinafter referred to as SEBI) regulations, court evaluation of certain fundamental
corporate changes like that of merger and separate voting for a class of shareholders ensure
that rights of minority are safeguarded.20
The legal provisions for minority protection in India have been discussed in detail
below:
Under Section 235 of the old Act, the central government or company law board
(CLB) can determine whether the company is being run in a fair way or with a intention to
defraud the shareholders21. The central government can take measures on a complaint
received from the Registrar of Companies (ROC) or from the shareholders if they are at
least 200 in number or constitute 10 % of the total shareholding. 22 The new Act also has
substantially reenacted the safeguards which are there in Section 235 of the old Act in form
of Section 210 of the new Act.
The affairs of the company can also be investigated under Section 237 of the old
Act.23 Under this Section, the investigation into the affairs of the company only happens if
there is a) a resolution passed by the company to this effect 24 or b) court orders for
investigation into the affairs of the company. 25 Under Section 235 and Section 237, the
investigation begins broadly with a view to examine the management of the affairs of the
company to find out whether any irregularities have been committed or not. An inspector is
appointed only to investigate the affairs of a company and to make a report.

The

19

Id at 8.
Id at 8.
21
Remedies Available To Shareholders For Mismanagement And Fraud Under The Companies Act,
www.majumdarindia.com,(
last
updated
Jan.
20,
2014),
http://www.majmudarindia.com/pdf/Remedies%20available%20to%20shareholders%20for%20fraud%20and%
20mismanagement%20under%20Companies%20Act,%201956.pdf (last updated Jan. 20, 2014).
22
Section 235(2)(a) of the Companies Act, 1956.
23
Supra note 21.
24
Section 237(a)(i) of the Companies Act, 1956.
25
Section 237(a)(ii) of the Companies Act, 1956.
20

28

investigation is no more than the work of a fact finding commission. 26 The new Act also
provides this remedy to the shareholders. 27
Minority shareholders are granted various remedies against any kind of wrong done to
them, but at the same time legislators have also kept in mind that there is a need of certain
kind of minimum threshold to avoid frivolous and malafide litigation. Section 397 of the old
Act provides for approaching the company law board when there is oppression of
shareholders but the minority must at least compromise of 100 shareholders or one tenth of
total shareholding whichever is lesser or any shareholder holding at least one tenth of the
issued share capital of the company. 28 The new Act continues to provide this remedy to the
shareholders.29 The rights of the minority shareholders do not depend only on the common
law doctrines. Their safeguards are expressly provided in the old Act as well as in the new
Act. Minority shareholders with qualified minority may initiate action against decisions of
the majority in a court of law.
Another safeguard in the company law is the requirement that certain major decisions
have to be approved by a special majority of 75% or 90% of the shareholders by value.
Section 189 of the old Act and Section 114 of the new Act ensures that situations where the
rights of shareholders are being affected like a situation where there is going to be reduction
of shares, the standard rule of normal majority will not be applicable and special majority of
75% will be required. 30 Similarly under Section 395 of the old Act and Section 235 of the
new Act imposes a threshold which is much higher than that of the ordinary resolution. .
Section 391 of the old Act which has been substantially reenacted in the new Act 31
provides for safeguarding of minority during mergers and acquisition. In case of a scheme
under Section 391 of the old Act, the Court should be satisfied that the resolutions are passed
by a statutory majority in value and in number, thus, there is a two-fold protection. Also
Section 391 provides for separate meeting of each class of shareholders 32 and sanction of the
scheme of arrangement from the High Court. Under Section 232 the new Act reenacts
substantially all the provisions of Section 391 including the safeguards which are there for
minority shareholders.

26

Supra note 21.

Section 212 of the Companies Act, 2013.
28
Section 399 of the Companies Act, 1956.
29
Section 244 of the Companies Act, 2013.
30
Section 100 of the Companies Act, 1956.
31
Section 232 of the Companies Act, 2013.
32
Section 391(2) of the Companies Act, 1956.
27

29

COMPARATIVE ANALYSIS
It is important to understand the standing of minority shareholders in other
jurisdictions also before framing an opinion on the Indian situation. In USA the minority has
been provided protection in case of fundamental corporate changes. Fundamental corporate
changes (FCG) are those alterations in a corporation where there is need of amending of
the charter of the company and the transaction is affecting the fundamental nature of its
business. 33 Even single shareholders were in a position to take on the majority in the 19th
century34; now minority shareholders have been restricted to appraisal remedy; their squeeze
out is taken as granted by the majority. 35 It is necessary to look at the judicial trend in US in
this regards. Although courts are mostly a passive player but they still intervene in situations
where there is non-compliance with the statutes and when there are elements of self dealing
involved. The court has played a proactive role in those cases where the majority is on both
sides. One such situation is in case of merger where the acquiring corporation already owns
more than 90 % of the shares of the target company. 36 The courts have evolved the business
purpose test37 to evaluate such transactions and they evaluate whether the transaction results
in some greater good for the company or for all the shareholders in the aggregate. This test
has its own shortcomings such as it fails to see whether there is bonafide on the part of the
majority or not.38 This becomes important in case of US because the majority controlling
shareholders own a fiduciary duty to the minority in case of US unlike India.
In Germany squeeze outs are allowed under German Takeover Directive
Implementation Act (bernahmerichtlinie-Umsetzungsgesetz).39 The right of the majority to
squeeze out the minority has been constitutionally challenged in the Moto Meter corporation
case. 40 It was contended that the right to squeeze out is violative of article 14 of the German
constitution which guarantees right to property. 41 The court gave a balancing decision and
decided that majority has a right to squeeze out the minority if there is protection of the
33

William J. Carney, Fundamental Corporate Changes, Minority Shareholders, and Business Purposes, Vol. 5,
No. 1, 69, 69-132 (1980).
34
Id at 79.
35
Id at 71.
36
Id.
37
Id at 97.
38
Id at 131.
39
Anton Babak, Adoption Of Squeeze-Out And Sell-Out Rights Of Shareholders In Ukraine On The Basis Of A
Comparison Of EU, Germany And USA,
http://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CDAQFjAA&url=http%3A%
2F%2Fwww.etd.ceu.hu%2F2012%2Fbabak_anton.pdf&ei=fjNzUa3FEM3QrQfThYDADw&usg=AFQjCNE8T
eFumhdfDolpya0hZ8FfIeZo3w&bvm=bv.45512109,d.bmk, (last updated on 20 Jan., 2014).
40
31 F. 2d 994 (1929).
41
Supra note 40.

30

interest of the minority. These interests are limited to granting fair price share during
squeeze-out.42
Companies Act of 2006 in UK adequately safeguards the rights of the minority
shareholder in case of takeover. There are two levels to the takeover process: at the first stage
there has to be acquisition of 90% or more of the shares of the target company and even then
90% consent is required from the minority which are treated as a separate class. 43 It is
interesting to note that in general the attitude of the judiciary towards minority challenging
compulsory acquisition is generally unsympathetic.44 The judiciary is generally swayed by
the fact that the acquisition is approved by 90% of the shareholding. The burden of proof lies
with the minority shareholders to show that there is existence of exceptional circumstances. 45
It is clear from the analysis of the above mentioned foreign jurisdictions that although in all
these jurisdictions there are adequate safeguards provided to the minority shareholders, the
courts have not been sympathetic to the minority shareholders while interpreting these
safeguards provisions. Even in predicaments such as squeeze out where minority
shareholders have been provided with stern safeguards, they have been interpreted in a
manner which reduced the rights of minority shareholders to a great extent. In case of
squeeze out in takeovers the interest of minority has been more or less limited to the right of
appraisal or compensation.

SLUMP SALE
An ingenious method through which the majority shareholders have circumvented
SEBI Substantial Acqusition of Shares and Takeover Code (Takeover Code) is slump sale.
The traditional way to acquire the business of a corporation has been a takeover, however
recently many companies have opted for an innovative method to acquire business of a
corporation which is through slump sale. In this approach the core business of an entity is
purchased by another corporation which pays a lump sum amount for all the assets and
liabilities, without attributing any specific value to individual assets. There is no sale of
shares. There is only a sale of a particular business of the company which is more often than
not, is the core business of the company. This sale of assets of the company only requires
42

Id.
Hyeok-Joon Rho, New Squeeze-Out Devices As A Part Of Corporate Law Reform In Korea: What Type Of
Device Is Required For A Developing Economy?,
http://www.bu.edu/law/central/jd/organizations/journals/international/volume29n1/documents/Rho_41-78.pdf,
(last updated on 23 December, 2013)
44
Id.
45
Id.
43

31

assent of the 50% of the shareholders 46 which the promoters are easily able to achieve due to
their major shareholding in the company.
Cause
In order to understand why are companies preferring slump sale over traditional
takeover we need to first look at the benefits which are associated with slump sale. There are
various benefits for the company to whom the business is being transferred through slump
sale which include: a) it has the freedom to choose which particular business of a corporation
which is involved in multiple businesses, it wants to purchase. This allows the transferee
company to run its business efficiently without any extra baggage; b) the process of takeover
is a long process where the company has to declare its intention of takeover and inform the
minority shareholders about the exit option. This information should be circulated through a
public notice. Such costs are avoided in case of slump sale; c) the acquirer company is
obligated to provide, under law, an exit option to all dissenting shareholders. This necessity is
not there in case of slump sale; d) since there is no necessity of public notice, the probability
of facing a bid from a competition for the business being transferred is lower in case of slump
sale. All these benefits make slump sale highly popular method of business acquisition in
case of public listed companies.
Position of Minority Shareholder
Some of the prominent slump sale transactions in the recent past include: Smartlink
Network selling its key business to Schneider for rupees 504 crore, Kanoria Chemicals
selling its chemical unit to Aditya Birla Group for rupees 830 crore, JB Chemicals selling its
Russia OTC business to Johnson & Johnson for rupees 1,170 crore, Piramal Healthcare
transferring its formulations business to Abbott for around rupees 18,000 crore, Gwalior
Chemicals cutting a deal with Lanxess for rupees 536 crore.47 If such a sale would have
happened through takeover then the minority shareholders who do not agree with such sale
would have received an exit opportunity under the takeover code.48 In US such transactions
would have been classified as FCG which has been discussed previously, and the dissenting
minority shareholders would have received an option to exit the company in such a
predicament.

46

Section 293 of the Companies Act, 1956.

Apurv Gupta, Companies Sacrifice Minority Interest IN Assets Sale,
The Economic Times,
http://articles.economictimes.indiatimes.com/2012-02-14/news/31059589_1_takeover-code-minorityshareholders-open-offer (last updated on Dec. 24, 2013)
48
Regulation 3 of Securities And Exchange Board Of India (Substantial Acquisition Of Shares And Takeovers)
Regulations, 2011.
47

32

The minority shareholders do not gain anything from such transactions. On the other
hand company loses its crown jewel. Although the company gets consideration for the sale
but the company loses its chief source of revenue and as a result the share value plummets,
the shareholders could have exited a company if the company instead of slump sale had
chosen the takeover route. Slump sale is preferred by promoters as they being in control of
the company are able to control the money coming from the deal; on the other hand a
minority shareholder has to suffer from plummeting share prices and also has to face
uncertainty over future of his investment. Some companies have tried to calm investors with
special dividends but investors complain that such payouts have been a fraction of the
potential open offer price. 49 Stocks of most companies that have sold core divisions have
dipped, with their market capitalization significantly below the amount received from the
slump sale. 50
From the perspective of promoters, the traditional takeover approach is much
cumbersome which involves various safeguards for the minority shareholders under the
takeover code as well as under the companies law.

CONCLUSION
The Companies Act of 2013 has rectified some of the loopholes of the present
corporate legal regime which are being exploited by majority shareholders to oppress
minority shareholders. The new Act introduces a higher threshold for slump sale approval;
now unlike the old Act, there is need of approval from three- fourth majority of shareholders
for sale of assets thus making the process of slump sale much more difficult for promoters.
However it would be relevant to mention here that while such transactions where a major
source of revenue of a company is sold would qualify as FCG in the United States and would
require an exit option to be given to the dissenting shareholders, an exit option is not
available to the dissenting shareholders even under the new Act. In India, in the recent slump
sale transactions companies have invested the money received from the sale for new
endeavors, where the company did not have any kind of presence or expertise before; it
would be fair to give dissenting shareholders an exit option in such predicaments.
It is high time for the Indian corporate jurisprudence to embody concept like FCG in
order to secure the rights of the minority shareholders. Although it was not included in the
new Act, an amendment can cure this oversight.
49
50

Supra note 47.

Id.

33

COMPETITION LAW ISSUE OF JURISDICTION

Akansha Mehta
RML National Law University, Lucknow

INTRODUCTION
Governments may create an uneven playing field in markets where [a Stateowned enterprise (SOE)] competes with private firms, as they have a
vested interest in ensuring that state-owned firms succeed. Accordingly,
despite its role as regulator the government may, in fact, restrict competition
through granting SOEs various benefits not offered to private firms. While in
some areas this preferential treatment will be direct and obvious, there may
also be indirect preferential treatment through other means.1
Competition is an evasive term, and its understanding differs depending on the context.2
This can be assumed to be the reason why the Competition Act, 2002 (the Act) does not
contain the definition of the term competition. 3 Richard Whish defines competition as a
struggle or contention for superiority, and in the commercial world, this means striving for
customers and businesses in the market place. 4 But when the state and its organs enter the
market, it is perceived to be in pursuit of public interest,5 as their aim is not maximisation of
profit but observance of public interest.6 Yet by the virtue of being a commercial body its
conduct somewhere gets intertwined with the factors affecting competition in the market.7
Underlying the same principle the Competition Act, 2002 remains applicable to every
enterprise, person, and group of enterprises and association of persons involved in
commercial activities. This includes both the private players as well as the state run

Asian Law Institute, Application of Competition Laws to Government in Asia: The Singapore Story, Working
Paper Series No. 025. (2011).
2
Department-Related Parliamentary Standing Committee on Home Affairs, Ninety Third Report on the
Competition Bill, 3.0 (2001)
3
Vijay Kumar Singh Competition Law and Policy in India, NUJS Law Review (2011).
4
Richard Whish, Competition Law 3 (2009) (the UK Competition Commission has described competition as
a process of rivalry between firms seeking to win customers business over time.
5
ABA Section of Antitrust Law, Competition as Public Policy, (1st ed. 2010).
6
J.L. Buendia Sierra, Exclusive Rights and State Monopolies under EC Law, Oxford University Press, (1999).
7
Alison Jones & Brenda Sufrin, EC Competition Law: Text Cases and Materials, (4th ed. 2011) (Oxford:
Oxford University Press, 2011).

34

enterprises.8 The rationale behind this is to ensure that the government entities do not get any
competitive advantage over its private competitors.9
Public Sector Units (PSUs)
Public Sector Units or government companies are defined as those companies whose
majority shares are held by the Government. 10 They are engaged in two types of functions
namely - sovereign functions of the state and non-sovereign functions.11 The application of
the Competition Act, 2002 is limited only to the non-sovereign functions of the Public Sector
Units. 12 They include the corporations which are set up by an Act of the Parliament and are
fully owned by the government.13 In India, they contribute 26% to the gross domestic
product and occupy some of the crucial sectors of the economy. 14 There are further two types
of government enterprises - departmental enterprises and non-departmental enterprises. 15 The
former are the ones which are a part of the government financial system with their funds
coming from the general budget, for example, highways, educational and health services,
postal services etc. while the latter are legally separate from Government and maintain
separate accounts under company law. 16 They are set up either under Companies Act or under
a statutory provision.
Competitive Neutrality Theory
The competitive neutrality theory requires that the government entities and the private
enterprises operate on a level playing field while performing its commercial functions and
activities in the market.17 The Organisation for Economic Co-operation and Development
(OECD) defines competitive neutrality as a regulatory framework (i) within which public and
private enterprises face the same set of rules and (ii) where no contact with the state brings
competitive advantage to any market participant.18 However, this notion is restricted only to

The Competition Act of 2002 29(h) (2002).

T. Prosser, The Limits of Competition Law, Oxford University Press, (2005).
10
The Companies Act of 1956 617 (1956).
11
Geeta Gouri., Privatization and Public Sector Enterprises In India: Analysis of an Impact of a
NonpolicyEconomic and political Weekly, (November 30, 1996).
12
The Competition Act of 2002 2(h) (2002).
13
Geeta, Gouri, The Application of Antitrust Law to State Run Enterprises (SOEs) in India, (2003).
14
Geeta Gouri., Privatization and Public Sector Enterprises In India: Analysis of an Impact of a
NonpolicyEconomic and political Weekly, November 30, (1996).
15
Y.Venugopal Reddy, Privatisation Approaches, Processes and Issues, Galgotia Publications, New Delhi,
(1992).
16
Id.
17
OECD, Antonio Capobianco & Hans Christiansen, Competitive Neutrality and State-Owned Enterprises:
Challenges and Policy Options, OECD Corporate Governance Working Papers No. 1, (2011) at 1.
18
OECD Report 2009, State Owned Enterprises and the Principle of Competitive Neutrality, DAF/COMP
(2009) 37.
9

35

the non-sovereign functions of the government entities 19 and has been enshrined under
Section 2(h) of the Competition Act, 2002. The word enterprise has been defined as:
a person or a department of the Government, who or which is, or has been, engaged
in any activity, relating to the production, storage, supply, distribution, acquisition or
control of articles or goods, or the provision of services, of any kind, or in investment,
or in the business of acquiring, holding, underwriting or dealing with shares,
debentures or other securities of any other body corporate, either directly or through
one or more of its units or divisions or subsidiaries, whether such unit or division or
subsidiary is located at the same place where the enterprise is located or at a different
place or at different places, but does not include any activity of the Government
relatable to the sovereign functions of the Government including all activities carried
on by the departments of the Central Government dealing with atomic energy,
currency, defense and space.
Thus, from the definition it can be safely assumed that no exemption is granted to the
government entities which are performing non-sovereign functions.20 However, this provision
explicitly excludes the application of the Act over any sovereign function of the state-like
activities related to currency, defense, space and atomic energy, 21 in order to ensure the
integrity of their delivery. 22 The provision of these types of public services is the prerogative
of the state and affected by the thrust of Competition Law. 23 The intention of the legislature
can unambiguously be inferred that there should be no discrimination between state run
enterprises and the private enterprises and every player in the market should be treated
equally so that they can function independently. 24

SCOPE OF COMPETITIVE NEUTRALITY

The doctrine of competitive neutrality has a limited applicability over the Act as it
does not give a blanket power to the Commission to act against all government entities. 25
Section 54 of the Act gives power to the Central Government to exempt an enterprise
19

Id.
Id.
21
The Competition Act of 2002 2(h) (2002).
22
T. Professor, The limits of Competition Law, Oxford University Press, (2005); also C. Graham, Essential
Facilities and Services of General Interest, (2007).
23
W. Sauter, Services of general economic interest and universal service in EU Law, European Law Review,
(2008).
24
OECD, Antonio Capobianco & Hans Christiansen, Competitive Neutrality and State-Owned Enterprises:
Challenges and Policy Options, OECD Corporate Governance Working Papers No. 1, (2011) at 1.
25
Geeta Gouri., Privatization and Public Sector Enterprises In India: Analysis of an Impact of a Non-policy
(1996).
20

36

performing a sovereign function from the application of the provisions of the Act through a
notification. 26

The Commission needs to be very careful while bringing an action against

government entities as they operate with a non-profit, non-commercial motive in order to

maintain its public service obligations. 27 There are various government entities which do not
strictly fall under the definition of state run enterprises despite its involvement in commercial
activity and its capability of effecting competition in the market to a great extent. These
generally fall under the category of departmental enterprises. Indian Railways is one of the
largest departmental enterprises in India. 28
Upholding the doctrine of competitive neutrality, the High Court of Delhi in the case of
Union of India v. Competition Commission of India29 held the Indian Railways as an
enterprise under section 2(h) of the Competition Act, 2002. The Honble Court also stated the
difference between sovereign and non-sovereign functions of the State.
that the primary, inalienable and non-delegable functions of the Government are
to be considered as sovereign functions of the Government under Section 2(h) of the
Competition Act, 2002. Any welfare, commercial and economic functions are not
sovereign functions and state while discharging such functions is as much amenable to
the jurisdiction of CCI as any other private entity discharging such functions. Running
of railways is a business activity that comes within the purview of Section 2(h) of the
Competition Act, 2002 and hence it is an enterprise.30
The term inalienable functions has been interpreted to mean functions such as
administration of justice, maintenance of order and repression of crime, maintaining foreign
affairs,31 power to acquire and retain territory, the primary and inalienable functions of a
constitutional government like legislative power, the administration of laws, 32 the exercise of
the judicial power.33
The ambiguity resides in the nature and objective of the state run enterprises, whether
these departmental enterprises whose primary objective is to promote welfare and which

26

The Competition Act of 2002 54 (2002).

Capobianco, A. and H. Christiansen (2011), Competitive Neutrality and State-Owned Enterprises:
Challenges and Policy Options, OECD Corporate Governance Working Papers, No. 1, OECD Publishing.
28
Y.Venugopal Reddy, Privatisation Approaches, Processes and Issues, Galgotia Publications, New Delhi,
(1992).
29
AIR 2012 Del 66.
30
Id.
31
Nagendra Rao v. State of Andhra Pradesh, AIR 1994 SC 2663.
32
State of Bombay v. The Hospital Mazdoor Sabha (1960) ILLJ 251SC.
33
Coomber v. Justices of Berks, (1883-84) 9 App. Cas. 61,74 .
27

37

remain a non-profit institution may come under the purview of the Act or not. 34 While
dwelling upon the same it should be noted that such non-profit-making associations which
offer goods or services on a given market may find themselves in competition with one
another.35 The success or economic survival of such associations depends ultimately on their
being able to impose, on the relevant market, their services to the detriment of those offered
by the other operators.36 Also, since these enterprises offer services in exchange for money,
their actions are commercial and trigger potential liability (the exchange of money for
services, even by a non-profit organization, is a quintessential commercial transaction). 37
There are certain entities which are not per se involved in any commercial activity but are
regulatory in nature and are involved in economic activities. 38 While interpreting such entities
as an enterprise, the Commission focuses on the functional aspects of the entity rather than
the institutional aspects.39
Applying the same reasoning in the case of In Re BCCI 40 while deciding the applicability
of the Act over BCCI, the Commission noted:
The scope of the definition on the institutional front has been kept broad enough to
include virtually all the entities as it includes person as well as departments of the
government. The specific exception has been provided only to the activities related to
the sovereign functions of the government. It is in substance the nature of activity that
would decide whether the entity is an enterprise for the purpose of the Act or not. The
aspect of organization brings in activities contributing to the revenues of sports
federations such as grant of media rights, sale of tickets etc. The activities of
organizing events are definitely economic activities as there is a revenue dimension
to the organizational activities of sports federations.41
Similarly, in the case of Dhanraj Pillay & Ors vs Hockey India 42, the issue of
Commissions jurisdiction over Hockey India (HI) and International Hockey Federation
(FIH) was in question. It was stated by the Commission that though HI and FIH were nonprofit organizations, however, the activities carried out by the HI as well as FIH such as grant
34

J.L. Buendia Sierra, Exclusive Rights and State Monopolies under EC Law, Oxford University Press,
(1999).
35
C. Bovis, The Application of Competition Rules to the European Union Transport Sectors, Columbia
Journal of European Law, Volume 11, Issue 5, (2005).
36
Id.
37
Minnesota v. Minnesota., Civil No.10-3884(JRT/JJK).
38
Geeta, Gouri, The Application of Antitrust Law to State Run Enterprises (SOEs) in India, (2003).
39
In Re BCCI Case No. [61/2010].
40
Case No. [61/2010].
41
Id.
42
Case no [73/2011].

38

of franchisee rights, media rights, television rights, sponsorship rights, and all other rights,
involved generation of revenue and had a commercial component to it.43 Such activities have
to be seen differently from the not for profit nature of certain other activities of HI and FIH. 44
The prime objectives of these activities are to maximize revenues and these activities are
executed through agreements that are commercial. The HI and FIH were hence squarely
covered within the meaning of the inclusive definition of person contained in the Act.
Therefore, the economic activities carried out to organize the game of Hockey by HI and FIH
was interpreted to fall under the definition of an enterprise as contained in the Act.

COMPETITION LAW AND SECTORAL REGULATORS

It is the duty of the Commission to eliminate practices having adverse effect on
competition, promote and sustain competition, protect the interests of consumers and ensure
freedom of trade carried on by other participants, in markets in India. 45 Section 60 of the Act
states the provisions of the Act will have an overriding effect in case of any inconsistency
with the provisions of any other Act. 46 The grey area lies in the jurisdiction of the
Commission over enterprises which are regulated by their respective regulatory bodies. The
major difference between sectoral regulation and competition is that sectoral regulators
address the question of market power directly (for example, restraining the possibility of
pricing a monopoly service below a certain threshold), while competition authorities restrain
indirectly (for example, prohibiting a merger to monopoly, or impeding the monopolization
of a neighbouring market).47 In other words competition regulation explains the participants
in the market what they should not do, while the sector regulation explains them what to do.
Various sector specific regulations provide the regulators with the power to decide on or
regulate the aspect of maintaining or promoting competition in the relevant sector. 48 As a
consequence to this there exists a possibility of overlapping in the jurisdiction of the CCI
with various other sectoral regulators.49 For example, certain functions of the Petroleum and
Natural Gas Regulatory Board (PNGRB) are overlapping with those of the competition
authority. Under Section 11 of the Act, the power to protect the interest of consumers by

43

Id.
Id.
45
The Competition Act of 2002, section 18.
46
The Competition Act of 2002, section 60.
47
OECD, Regulatory Co-ordination for Competition, DAF/COMP/GF (2005) 2.
48
Apurva Sanghi and S.K. Sarkar, Institutional Approach to Regulation and Competition in South Asian
Infrastructure Sector, International Journal of Regulation and Governance.
49
Sampson, Cezley and Faye, Competition and Sectoral Regulation Interface, CUTS Briefing Paper, (2003).
44

39

promoting and sustaining fair trade and competition amongst the entities has been conferred
upon the Board. Relying upon the same the Delhi High Court stayed the CCIs probe into the
alleged cartel formed by the Indian Oil Corp. Ltd (IOC), Bharat Petroleum Corp. Ltd and
Hindustan Petroleum Corp Ltd.50 The PSUs had challenged the Commission's probe stating
that the regulator had no jurisdiction to look into fixing of petrol prices as they are regulated
by the PNGRB.
Similarly, Section 11 of the Telecom Regulatory Authority of India Act, 1997
mandates the Telecom Regulatory Authority of India (TRAI) to facilitate competition and
promote efficiency in the telecom sector. While Section 14 of the same Act excludes the
matter relating to monopolistic, restrictive or unfair trade practices that fall under the
jurisdiction of MRTPC (Monopolistic and Restrictive Trade Practices Commission) from the
purview of TRAI, the MRTPs substitution with Competition Act has not yet been followed
by a parallel amendment in the TRAI Act. The same was questioned in the case of Consumer
Online Foundation v. Tata Sky Ltd. & Other Parties 51 where it was argued that the CCI
cannot claim its jurisdiction over matters which already fell under the purview of TRAI and
TDSAT. Deciding this matter the CCI held that any matter that raises competition concerns
would fall within the purview of the Competition Act enabling CCI to exercise its
jurisdiction.
Section 60 of the Electricity Act, 2003 (EC Act) confers upon the Appropriate
Electricity Commission the power to issue appropriate directions to a licensee or a generating
company which enters into any agreement or abuses its dominant position or enters into a
combination which is likely to cause or causes an adverse effect on competition in electricity
industry. The language of this provision is identical to that used in Sections 3, 4 and 6 of the
Competition Act. This ambiguity created by the anomaly in the language of the Act was
resolved in the case of Shri Neeraj Malhotra, Advocate vs. North Delhi Power Ltd. & Ors.52
where it was argued that only the Delhi Electricity Commission under the EC Act had the
jurisdiction to hear cases relating to anti-competitive behaviour of electricity distributing
companies. It was categorically stated that although all matters pertaining to electricity tariff
have to be decided as per the provision of the EC Act and the DERC Regulations, allegations
of anti-competitive behaviour, including abuse of dominant position by the discoms will fall
within the jurisdiction of the CCI. However, it was reported that the step of CCIs
50

South Asia LPG Company Private Limited v Competition Commission of India, W P (C) 4602/2013 and CM
No. 10571/2013
51
Case No. [ 2/2009].
52
Case No. [06/2009].

40

intervention was not taken well by the DERC, as it believed that such matters fell under their
purview according to the Electricity Act, 2003.
Therefore, it can be concluded that it is the mandate of the Commission to eliminate
practices having adverse effect on competition, promote and sustain competition, protect the
interest of consumers and ensure freedom of trade carried on by other participants, 53 in
markets in India. Sectoral regulators have the necessary technical expertise to determine
access, maintain standard, ensure safety and determine tariff. 54 They set the rules of the game
i.e. entry conditions, technical details, tariff, safety standards and have direct control over the
prices, quantity, quality and focus on the dynamics of specific sectors, whereas the CCI has a
holistic approach and focuses on functioning of the markets through increasing efficiency
through competition. 55 Thus in order to reconcile the issue of jurisdictional conflict all the
issues pertaining to competition should be given exclusively in the hands of the competition
authority and the responsibility of deciding on the technical aspects of the issues is to be left
to the regulators. Their roles are to be complementary to each other as they both share the
same objective of obtaining maximum benefit for consumers. To bring clarity and legal
certainty in achieving the same some Regulatory Acts do explicitly set out the matters
relating to competition to the Commission. For example under the Airports Economic
Regulatory Authority of India Act, 2008 (AERA Act), the jurisdiction of the AERAT is
specifically ousted in matters related to monopolistic trade practices, restrictive trade
practices and unfair trade practices as regulated under the erstwhile MRTP Act, as well as the
matters that fall within the purview of the Competition Act, 2002.56
Another issue to be resolved in respect of sectoral regulation vis--vis competition
laws is the check on exemption provided to certain sectors by the Central government
through Section 54(a) of the Competition Act, 2002. Through a recent notification the Central
Government has exempted banking companies from the application of Section 5 and Section
6 (Combination regulations) of the Competition Act, 2002.57 This power given to the Central
Government under Section 54 is absolute and empowers it to take such decisions unilaterally
which in turn weakens the administration of the Act itself. Therefore, in order to strengthen
the competition law framework it remains highly imperative to bring about such exemptions
with a mandatory consultation with the Commission.
53

Sampson, Cezley and Faye, Competition and Sectoral Regulation Interface, CUTS Briefing Paper, (2003).
Apurva Sanghi and S.K. Sarkar, Institutional Approach to Regulation and Competition in South Asian
Infrastructure Sector, International Journal of Regulation and Governance.
55
Id.
56
Regulatory Authority of India Act, 2008.
57
S.O.93(E) Date of Notification 8th day of January, 2013.
54

41

RECOMMENDATION AND CONCLUSION

Monopoly, whether naturally acquired or state conferred is a position which gives
enough room for the monopolistic enterprise to regulate the market with its conduct. The
conduct of these enterprises not only has an effect over the rival companies but directly
affects the interest of its consumers. Protecting the interest of the consumers by maintaining
free and fair trade in the market is the primary objective of the Competition Act; however the
limited applicability of the doctrine of competitive neutrality makes this objective
infructuous.
Ideally, a government entity functions to deliver its public service obligation, and to
fulfil the same it is given immense amount of discretion and privilege conferred to it by the
statute. It is this unregulated amount of discretion which is abused by the enterprise which
amounts to abuse of its monopoly status. Such enterprises may indulge into anti-competitive
practices in the vertical chain of market which goes unchecked due to the lack of jurisdiction
of the Competition Act over them. There are instances where in there is a state conferred
monopoly of the enterprise which also provides them with special privileges protected by
law. Though monopoly per se is not anticompetitive, competition law is still against creation
of artificial barriers to competition. Therefore, granting of exclusive rights is not in itself an
abuse but when the same exclusive right could not be avoided from being abused or where
the undertaking was induced to abuse it amounts to a contravention of the provisions of the
Act. If the Commission fails to monitor this contravention due to its jurisdictional
incompetence it will defeat the very purpose of the competition law and policy in the country.
Therefore, there is a need for a strict interpretation of Section 2(h) of the Act which defines
enterprise, and every government department engaging in any commercial activity while
performing non-sovereign functions should come under the purview of the Competition Act,
2002 irrespective of it being a departmental enterprise or a non-departmental enterprise.
Another gap in the competition framework in India is the lack of intervention of competition
regulatory body in policy formulation or memorandum passed by the government. The
Commission doesnt have the power to initiate any inquiry against policies drafted by the
government even if they cause an appreciable and adverse effect on competition. Though
Section 49 of the Act states that the Government may while formulating policies make a
reference to the Commission for its opinion over the possible effects of such policies,
however the opinion of the Commission will not be binding upon the government. Also, the
provision states that the Government may make a reference to the Commission for its
opinion over a policy; this means that it is not mandatory for the government to seek the
42

Commissions opinion; it may or may not choose to do so. In such cases, even if the
Commission is of the opinion that the policy might adversely affect competition in the market
it does not have the power to take any action against it. Therefore, this provision should be
replaced with one which is enforceable giving power to the Commission to interfere in such
policy matters.
Addressing the ambiguity created due to overlapping of jurisdiction of the
Competition Commission with other sectoral regulators, such problem has arisen due to lack
of uniform framework. It might be suitable to amend the Competition Act to provide for
coordination between the competition authority and the sectoral regulators, and ultimately for
the competition authority to have an oversight in the regulated sectors on competition issues.
Another option can be to make the competition authority responsible for both sectoral
regulation and enforcement of competition law. This approach may be advantageous as it
would reduce the problem of multiplicity of regulators and accumulates sectoral expertise.
For example, Australia has taken this approach to settle for an economy-wide economic
regulator that integrates technical and competition regulation. In case the issue of concurrent
jurisdiction arises, the work between competition authority and the sectoral regulatory bodies
can be allocated in a number of ways, for example an effective usage of the reference
mechanism mentioned under Section 21 of the Act or having MoUs between the two
authorities. Concurrent jurisdiction may be understood as a situation where in both the
competition authority and the sectoral regulator have the mandate in such matters. In such a
situation the competition authority should carry out investigation into the competition
concerns while the sectoral regulatory body may investigate the technical issues.
Thus, for the competition framework to be robust and successful in India it needs to
address the challenges it faces at the jurisdictional front. For it to remain effective, its scope
should remain large enough to intervene in every aspect which may cause adverse and
appreciable effect over competition in the market. Only then can the competition regulatory
system in India achieve its objectives.

43

BLACKLISTING OF COMPANIES BY THE GOVERNMENT OF INDIA IN

THE LIGHT OF ISRAEL MILITARY INDUSTRIES CASE
Shivesh Aggarwal
National Law University, Jodhpur

INTRODUCTION
Recently, the Honourable Delhi High Court through one of its judgements authored
by Justice Rajiv Shakdher had been in discussion among various eminent lawyers, jurists,
scholars and even business corporations. The pronouncement being talked about above is
Israel Military Industries Ltd. v. Union of India and Anr.1. The aforementioned verdict
clarified the controversial issue related to blacklisting of foreign companies by Government
of India and succinctly answered the query related to availability of Article 14 of Constitution
of India to the petitioner, which is a company incorporated under the laws of State of Israel.
This paper would profusely expound upon the issue related to blacklisting by the Indian
government and will endeavour to delineate upon all the related topics thereto. To elaborate,
the objective would be to discuss the power of the Indian government to blacklist a
corporation and rights available to the latter while being blacklisted. After an elaborate
elucidationon effects of process of blacklisting on corporations, this write-up would
scrutinize the same and suggest any amelioration, if necessary.

ISRAEL MILITARY INDUSTRIES V. UNION OF INDIA AND ANR.

Facts
A writ petition was filed by Israel Military Industries Ltd. (IMI), a company
incorporated under the laws of Israel which was the lowest bidder in the tender to set up a
plant for manufacturing of By-modular Charge Systems in the State of Bihar. By virtue of
this development, it was about to enter into a contract with Ordnance Factory Board (OFB).
But in fact, OFB issued an order debarringIMI from further dealings with itself for a term of
10 years. In other words, OFB blacklisted IMI,in response to which the latter moved the
court with a petition filed under Art.226 of Constitution of India. 2
To elaborate on the instances which led to IMIs blacklisting, while IMI was
preparing itself to execute the project, the Central Bureau of Investigation (CBI) had
1
2

Israel Military Industries v Union of India, 201 (2013) D.L.T. 1 [Hereinafter Israel Military Case].
Id at 1.

44

received intelligence inputs, pursuant to which investigations were commenced against the
then Director General of OFB. Subsequently, an FIR was filed by the former against the
latter. This development forced the Ministry of Defence to put on hold the contracts which
were about to be entered into with foreign companies. In addition to the abovementioned
steps taken, CBI also filed a charge sheet against IMI on grounds payment of illegal
gratification, 3 which resulted in putting IMIs name on the blacklist.
Decision of the Court
The most pertinent ground of challenge by IMI through its writ petition was the noncompliance with the principles of natural justice, the same being vehemently denied by the
government. The main issues which arose before the Court were whether the writ filed under
Art. 226 of Constitution of India was maintainable and whether the principles of natural
justice were followed while blacklisting IMI in the present matter or not. The court after
hearing the contentions of both the parties concluded both the questions in affirmative. To
add, with reference to the first issue, the Court stated that since Article 14 of the Constitution
of India4 is available to all people, irrespective of whether that person is a citizen of India or
not, hence the writ petition filed on the grounds of alleged violation of principles of natural
justice by IMI was maintainable. To address the second issue, the Court after raptly hearing
the arguments of both the parties concluded that principles of natural justice were followed
before IMI was blacklisted, and thus dismissed the petition. While deciding this issue posed
before it, the Court perused through various Supreme Court judgements, which will be
discussed below related to blacklisting and thus, affirmed a well-laid down principle, the
principle being that where a State decides to blacklist an entity, it is duty bound to act fairly
and follow the principles of natural justice. 5 Reiteration of the above principle by taking into
consideration the previous Supreme Court pronouncements, by the High Court makes this
case an important one to be studied in order to elaborate on the aspect of blacklisting of
foreign companies.

CONCEPT OF BLACKLISTING
What is blacklisting?
In order to accomplish the objective of the paper, understanding the concept of
blacklisting is imperative. Blacks Law Dictionary defines blacklisting as a process of putting
3

Id at 10.
Article 14 of Constitution of India reads, The State shall not deny to any person equality before the law or the
equal protection of the laws within the territory of India.
5
Israel Military Case, supra note 2 at 36.
4

45

the name of persons on a list who are to be boycotted or punished. 6 It can also be
characterized as putting a person, group, or a company on a blacklist7which contains names
of one or more individuals or one or more organizations which have been designated for
special discrimination or boycott8or which are under suspicion, disfavour, censure etc.9
Blacklisting in different fields
Blacklisting is a step which is prevalent in different relationships such as in a debtorcreditor relationship, wherein names of delinquent debtors are printed and circulated to other
lenders to indicate that persons whose names are printed are unworthy of credit. 10 It is even
common in employee-employer relationship wherein, the employer disseminates disparaging
information about the employee, thereby precluding the latter from getting employment. 11
Even in the corporate world, blacklisting comes into picture when the government disallows
or debars a company from carrying on its business for a specific term. 12
Effects of blacklisting on companies
Since the endeavour of the paper is only to examine the blacklisting of companies by
Government of India, hence the effort will be to scrutinize the concept of blacklisting
narrowly, thereby focusing only on blacklisting of corporations and various other aspects
related thereto. By its very nature, blacklisting is a purposeful conduct intended to punish the
victim. 13 It is emphasized that blacklisting of companies can have adverse impact on their
growth and development. This is because blacklisting leads to tarnishing of an entitys
image14 and mostly disables the companies from borrowing funds from banks and financial
institutions. 15 Even the Supreme Court has commented on the effects of blacklisting in M/s.
Erusian Equipment & Chemicals Limited v. Union of India and Ors.,16 wherein it stated
that Blacklisting has the effect of preventing a person from the privilege and advantage of

WHARTONS CONCISE LAW DICTIONARY 118 (Dr. Justice A.R. Lakshmanan ed. 15thedn. 2009).
Blacklist, MERRIAM-WEBSTER, available at http://www.merriam-webster.com/dictionary/blacklisting
[Hereinafter BLACKLIST MERRIAM-WEBSTER].
8
Blacklist, THE FREE DICTIONARY, available at http://legal-dictionary.thefreedictionary.com/blacklisting.
9
Blacklist, DICTIONARY.COM, available at http://dictionary.reference.com/browse/blacklist.
10
Masters v Lee, 58 N.W. 222 (1804).
11
Barlow v U.S., 51 Fed.Cl. 380 (2002).
12
Israel Military Case, supra note 2.
13
95AMERICAN LAW REPORTS: ANNOTATIONS AND CASES 660 (2002).
14
M/s. Patel Engineering Ltd. v Union of India and Ors., AIR 2012 SC 2342 [Hereinafter Patel Engineering
Case].
15
MCA blacklists 155, 392 firms for violation of guidelines, INDIACSR, 19 July 2011,
http://www.indiacsr.in/en/?p=1204.
16
M/s. Erusian Equipment & Chemicals Limited v Union of India and others, 1975 SCR (2) 674 [Hereinafter
Erusian Case].
7

46

entering into lawful relationship with the Government for purposes of gains. This wellaccepted principle has been reiterated in a number of cases.17
Due to the negative impact blacklisting has on the companies, by forbidding them
from entering into lucrative contracts; various contentious issues related to powers of
government involved have emanated which will be discussed subsequently in the paper.
Further, since this paper focuses on blacklisting by government, a terse chapter on
government contracts cannot be neglected and thus, emphasis would be laid down on it.

GOVERNMENT CONTRACTS
Article 299 of Constitution of India
A contract succinctly means a legally binding agreement that creates an obligation to
do or not to do something.18 Government contracts are ordinarily awarded after inviting
tenders for a specific purpose.19 In India, Government contracts and the related aspects are
governed by Article 299 of Constitution of India 20 which makes it mandatory for the
government to make a contract in writing 21 and generally forbids implied contracts.22 Further,
a contract in contravention to the said article is void.23
Governments unfettered discretion in awarding contracts
Keeping in mind the aims, requirements and context of the paper, it would be feasible to
stress more upon the chapter of awarding of contracts. It is pertinent to note that before
1979, the Government enjoyed lots of discretion in the matter of awarding contracts to
whomsoever it liked. The courts followed the general principle that the government was free
to enter into a contract with anyone it liked. 24 Hence, when one person was chosen rather than

17

M/s. Kulja Industries Ltd. v Chief General Manager W.T. Proj. BSNL &Ors., 2013 (12) SCALE 423; BMW
Ventures Limited And Another v Export Credit Guarantee Corporation of India Ltd &Ors, Cal HC WP No. 314
of 2010; Sarvesh Security Services Pvt. Ltd. v Delhi Development Authority &Anr., Del HC WP (C) 2546/2013.
18
2 P.RAMANATHAAIYAR, THE MAJOR LAW LEXICON 1478 (4th ed. 2010).
19
Sterling Computers Ltd. v M&N. Publications Ltd., AIR 1996 SC 51.
20
Article 299(1) of Constitution of India reads, All contracts made in the exercise of the executive power of the
Union or of a State shall be expressed to be made by the President, or by the Governor of the State, as the case
may be, and all such contracts and all assurances of property made in the exercise of that power shall be
executed on behalf of the President or the Governor by such persons and in such manner as he may direct or
authorise.
Article 299(2) reads, Neither the President nor the Governor shall be personally liable in respect of any
contract or assurance made or executed for the purposes of this Constitution, or for the purposes of any
enactment relating to the Government of India heretofore in force, nor shall any person making or executing any
such contract or assurance on behalf of any of them be personally liable in respect thereof.
21
MP JAIN, INDIAN CONSTITUTIONAL LAW 1672 (6th ed. 2012) [Hereinafter MP JAIN].
22
K.P. Chowdhry v State of Madhya Prasdesh, AIR 1967 SC 203.
23
State of Uttar Pradesh v MurariLal, AIR 1971 SC 2210.
24
MP JAIN, supra note 22, at 1678.

47

another, the aggrieved party could not claim the protection of Article 14 because the choice
of the person to fulfil a particular contract was left to the government. 25
Power finally limited by Supreme Court judgements
But, the aforementioned view was finally rejected in the subsequent judgements26 and
thus, rights under Article 14 were provided to persons/companies while they were being
awarded contracts. The Supreme Court has laid down that the government is not and should
not be as free as an individual in the matter of entering into contracts. Hence, these cases
finally identified the pre-contractual rights of person/companies who wish to enter into
contract with the Indian government.
Hence, executive power to award contracts is now subject to Article 14 which means
that the government cannot award contracts in an arbitrary or discriminate manner. In F.C.I.
v. Kamdhenu Cattle Feed Industries,27 it was laid down that the State and all its
instrumentalities have to conform to Article 14 of the Constitution of which non-arbitrariness
is a significant facet and this imposes the duty to act fairly, and to adopt a procedure which is
fairplay in action.
The reason why the aforementioned oscillation of views has been discussed is to
highlight the rights available to parties against the government before entering into a contract
with the latter. Since, a pre-contractual right also includes right against blacklisting by
government, wherein the government restrains a person/company from entering into a
contract with itself, the judgments would prove to be helpful in the discussion of the
subsequent topics.

RIGHTS AVAILABLE TO CORPORATIONS BEFORE BEING BLACKLISTED

Reasons behind blacklisting
It is known that every government and organisation has a blacklist of companies and
people whom it would rather avoid or with whom it does not wish to contract. Also, it is a
well-settled fact that the government can debar a company or person if there is a strong
justification for it, such as that person was guilty of malpractices like bribery, corruption and
fraud. Additionally, though the authority is duty-bound to give "fair consideration" to the
representations made in that regard, it is not bound to disclose the details of information in its

25

C.K. Achutan v State of Kerala, AIR 1959 SC 490; G.E. & E. Co. v Chief Engineer, AIR 1974 (Ker.) 23.
KasturiLal v State of Jammu & Kashmir, AIR 1980 SC 1992; Jespar I. Slong v State of Meghalaya, AIR 2004
SC 3533.
27
F.C.I. v Kamdhenu Cattle Feed Industries, AIR 1993 SC 1601.
26

48

possession.28

Additionally,

even

Central

Vigilance

Commission

which

favours

blacklisting29empowers the government to debar and blacklist those firms which follow
unethical practices. 30
No persons right to insist government to enter into contract
Recently it was held by the apex court, while considering the authority of State to
blacklist companies that Union of India and States have the authority to make contracts for
any purpose and to carry on any trade or business 31 by virtue of Article 298 of Constitution of
India.32 The Court also asserted that the right to make a contract includes the right not to
make a contract.33In other words, the State is at liberty to decide as to whether or not it
wishes to enter into a contract, like any other private entity and no person has any
fundamental right to insist that the Government must enter into a contract with it. 34
Equal treatment to everyone
But the aforementioned right is not unfettered. Supreme Court in a recent decision,35
while considering the possibility of arbitrariness due to the wide powers given to the
Government with regards to entering into the contract, laid down that, Such a right either to
enter or not to enter into a contract with any person is subject to a constitutional obligation to
obey the command of Article 14. Though nobody has any right to compel State to enter into a
contract, everybody has a right to be treated equally when State seeks to establish contractual
relationships.36 Hence, it can be concluded that right given to an executive is not unlimited
and is subject to some guidelines in order to avoid arbitrariness and unfairness.
Limitations to power of blacklisting
Having said so, even the power to blacklist a company is subject to some limitations,
which is the very theme of this paper. As already stated, the objective is to ascertain the
limitations imposed on the government when they exercise the power of blacklisting a
company. This will be accomplished after review of slew of cases, thereby concluding with a
28

M.J. Antony, Blacklisting companies? What the government must do, REDIFF.COM, 19 June 2013, 11:50 PM)
,http://www.rediff.com/money/column/blacklisting-companies-what-the-govt-must-do/20130619.htm.
29
CVC to Finalise anti-corruption strategy by Jan end, OUTLOOKINDIA.COM 8 January 2012, (12:46 PM),
http://news.outlookindia.com/items.aspx?artid=746934.
30
MONTHLY NEWSLETTER OF CENTRAL VIGILANCE COMMISSION, August 2011, available at
http://cvc.nic.in/nl01092011.pdf.
31
Jagdish Mandal v State of Orissa and Ors., (2007) 14 SCC 517 [Hereinafter JagdishMandal Case].
32
Article 298 reads, The executive power of the Union and of each State shall extend to the carrying on of any
trade or business and to the acquisition, holding and disposal of property and the making of contracts for any
purpose subject to the laws made by the Parliament and the State Legislature.
33
Jagdish Mandal Case, supra note 32.
34
Assn. of Registration Places v Union of India, AIR 2005 SC 469.
35
Patel Engineering Case, supra note 15.
36
Patel Engineering Case, supra note 15, at 11.

49

common principle emanating from the cases. Lastly, the concluded principle will be analysed
so as to ascertain any limitations, if identified.
The most important decision with regard to the fetters imposed on the government is
M/s Patel Engineering Ltd. v. Union of India and Ors. 37 In the aforementioned judgement, it
was emphasized that, State can decline to enter into a contractual relationship with a
person or a class of persons for a legitimate purpose. The authority of State to blacklist a
person is a necessary concomitant to the executive power of the State to carry on the trade or
the business and making of contracts for any purpose, etc. There need not be any statutory
grant of such power. The only legal limitation upon the exercise of such an authority is that
State is to act fairly and rationally without in any way being arbitrary. 38
Prior to the aforesaid judgement, Supreme Court in M/s. Erusian Equipment &
Chemicals Limited v. Union of India and others,39 also stressed on the right of a company by
averring that the order of blacklisting has the effect of depriving a person of equality of
opportunity in the matter of public interest and hence government cannot choose to exclude
without discrimination. Also due to blacklisting, a person is deprived of entering into
advantageous relations with the Government.40 Hence, it was concluded that the company
which is being blacklisted should be given the right under Article 14 of Constitution of India
and thus, a fair and non-discriminatory procedure should be adopted by the Government.
Furthermore, it has been held that duty to act fairly would entail that a person should be given
notice, and a right or an opportunity to represent his case before he is blacklisted. 41 To cite an
example, in Raghunath Thakur v. State of Bihar,42 petitioner was declared successful in an
auctionbut was subsequently blacklisted by the State. The appellant was not given any notice
prior to it being blacklisted. The apex court reversed the decision of the State by asserting
that, it was an implied principle of the rule of law that any order having civil consequence
should be passed only after following the principles of natural justice.
In a nutshell
A few indispensable rights have emerged from the various judgements discussed
above, the most important right being right to be heard when the companies are threatened of
being blacklisting. In other words, principles of natural justice need to be followed and
37

Id.
Id at 12.
39
Erusian Case, supra note 17.
40
Id at 677.
41
Israel Military Case, supra note 2.
42
Raghunath Thakur v State of Bihar, (1989) 1 SCC 229; Southern Painters v Fertilizers and Chemicals
Travancore Ltd. and Anr., AIR1994 SC 1277.
38

50

cannot be tampered with. Second is the right against discrimination and unfairness. Lastly,
right to trade with reasonable restrictions can also be considered to be bestowed to the
companies by the court.
Analysis of right against blacklisting
It is argued that by giving a right to the companies under Article 14 of the
Constitution of India, the Supreme Court has not only limited the powers of the government,
but also enhanced the powers of the companies to question the governments exercise of
power. Further, by according the companies with the rights, a new aspect has been attached to
the field of commercial law. This is because, as discussed earlier blacklisting disables
someone to enter into a contract for a certain period of time, and by giving a right to question
blacklisting by government, the court has invigorated the right to enter into a contract. As per
the analysis, a question may be raised about the sufficiency of the rights gifted and the
necessity of any further improvements.
Recommendations
In view of the above question put forth, it is submitted that notwithstanding the
governments duty to conform to the principles of natural justice, further steps can bring
more fairness and accountability.
1. Stating reasons for blacklisting should be made compulsory: For instance, giving
proper reasons for blacklisting a company should be made mandatory. This process
will not only bring more transparency and satisfaction, but will also make the
governance system more efficacious. Moreover, it will make companies cognizant
about themistakes committed, thereby giving them an opportunity to improve upon
themselves and to avoid the recurrence of similar errors again.
2. Blacklisting should only be used sparingly: Further, it is emphatically suggested that
since blacklisting adversely affects the expansion and reputation of the company, the
government should only undertake this adverse step as a last resort. In other words
government should blacklist only if it has strong and cogent evidence against the
company and not on the basis of allegations or suspicions because blacklisting
prohibits a company from entering into agreements with other parties, and thus
blatantly attacks its contractual ability.
3. Adopting guidelines from other countries: Another way in which the process of
blacklisting can be made more transparent, just and non-arbitrary is by taking
recourse to the blacklisting guidelines of the other countries and incorporating the
same in the Indian laws subject to due consensus. For instance, India can seek help
51

from comprehensive blacklisting guidelines

laid down by the Philippine

government.43 This process will ameliorate the laws, rules and guidelines related to
blacklisting.
In view of the aforementioned, it is submitted that the decision of blacklisting should
only be taken after a comprehensive analysis of the circumstances involved, defiance of
which may imperil Indias trade and investment relations with other countries, thereby
proving to be detrimental to the entire nation in the long run.

CONCLUSION
In light of various concepts such as blacklisting, government contracts and Israel
Military case discussed, it is concluded that there are a number of rights available to the
companies against blacklisting, notwithstanding the fact that the company involved is
incorporated in a foreign country. Hence, as already mentioned in the above study,
Government needs to act transparently and in a trustworthy manner. Also, an opportunity of
fair hearing should be accorded to the companies before undertaking the adverse step of
putting the name on the blacklist.
It is also observed, after going through a number of judgments, that the Indian courts
have played a pivotal role in enhancing the rights of companies by giving them the right of
fair hearing and right against discrimination, thereby limiting the unquestionable powers of
the government. It is finally submitted that a few improvements are still necessary in order to
make the process of blacklisting more honest, fair and expeditious, and thus to uphold the
celebrated principles of justice and equity.

43

Uniform guidelines for blacklisting of manufacturers, suppliers, distributors, contractors and consultants,
DEPARTMENT OF PUBLIC WORKS AND HIGHWAYS, available at http://www.dpwh.gov.ph/pdf/blacklisting.pdf.

52

MCA V. SEBI LEGISLATIVE COMMENT ON THE PROVISIONS

RELATING TO ROLE OF INDEPENDENT DIRECTORS IN THE
COMPANIES ACT, 2013 AND CLAUSE 49 OF THE LISTING AGREEMENT
Shwetha Sriram and Zahra Aziz
Gujarat National Law University, Gandhinagar

INTRODUCTION
The success of any organization lingers on its ability to mobilize and utilize all kinds
of resources to meet the objectives clearly set as part of the planning process. Managing well
depends on internal and external factors; the latter include availability, cost effectiveness and
technological advancement. Increasingly, revelations of deterioration in quality and
transparency, have called for adoption of internationally accepted best practices. The
acceptance of the concept gave rise to corporate governance. Corporate governance
encompasses commitment to values and to ethical business conduct to maximize shareholder
values on a sustainable basis, while ensuring fairness to all stakeholders including customers,
employees, and investors, vendors, government and society at large. SEBI defines corporate
governance as:
Acceptance by management of the inalienable rights of shareholders as the true
owners of the corporation and of their own role as trustees on behalf of the
shareholders. It is about commitment to values, about ethical business conduct
and about making a distinction between personal & corporate funds in the
management of a company.1
Corporate governance is about ethical conduct in business. Ethics is concerned with the
code of values and principles that enables a person to choose between right and wrong, and
therefore, select from alternative courses of action. Further, ethical dilemmas arise from
conflicting interests of the parties involved. In this regard, managers make decisions based on
a set of principles influenced by the values, context and culture of the organization. Ethical
leadership is good for business as the organization is seen to conduct its business in line with
the expectations of all stakeholders. 2
1

Narayana Murthy, Report of the SEBI Committee on Corporate Governance, 2003, (June 28, 2014),
http://www.sebi.gov.in/commreport/corpgov.pdf.
2
SEBI, Consultative Paper on Review of Corporate Governance Norms in India, January 04, 2013, (June 28,
2014), http://www.sebi.gov.in/cms/sebi_data/attachdocs/1357290354602.pdf.

53

COMPANIES ACT, 2013 AND CLAUSE 49 OF THE LISTING AGREEMENT

The Companies Bill, 2012 passed in both the Houses of Parliament received the
Presidents assent on 29th August, 2013 and was published in the Official Gazette on
30th August, 2013, and finally became the Companies Act, 2013. The Companies Act, 2013
(Act) is enacted to gradually replace the old Act of 1956, with the objective to bring more
accountability and good corporate governance. The Ministry of Corporate Affairs has notified
one hundred and eight-three sections of the Act which have come into effect from April 01 st,
2014. The Act appears to place a higher degree of responsibility on the Board members for
good corporate compliance.
Now, the primary role of corporate governance is always to ensure the independence
of the board of directors (BOD) in a company. Independent directors (ID) on the board
predominantly enhance the monitoring and supervising of the management and the promoters
of a company. This in turn immensely helps in protecting and safeguarding the interests of
the public shareholders. The Act, on one hand, bestows independent directors with greater
say in corporate governance and, on the other hand, places a greater demand from them.
Now, the relevant provisions concerning IDs in the Act are Sections 149, 150 and Schedule
IV.
The definition of an independent director under the Act has been amply broadened
and tightened.3 For example, if a director is a chief executive of a non-governmental
organisation that receives funding from the company to a certain extent, the person would not
qualify as an ID. Also, the Act has added some positive attributes of independence i.e. the
candidate must be a person of integrity and possess the relevant expertise and experience in
the opinion of the board.4 This definition of independent director was missing in Clause 49 of
the listing agreement. Further, the central government is also vested with the power to
prescribe qualifications for independent directors.5 Also, every ID is also required to declare
that he or she meets the criteria of independence. 6
One of the most predominant and major criticism pertaining to the current
appointment of independent directors in the board is that they are appointed like any other
director. This in turn gives promoters wide influence and clout in determining the identity of
the independent directors. The Act mandates the formation of nomination and remuneration
committee. The concerned committee is required to consider candidates for appointment as
3

The Companies Act 2013, section 2(47) read with section 149(5).
The Companies Act 2013, section 149(6).
5
The Companies Act 2013, section 150(4).
6
The Companies Act 2013, section 149(7).
4

54

independent directors and to recommend to the board. This would bring in greater fairness
and objectivity in the appointment of independent directors. However, the Act does not
provide for greater participation of minority shareholders in the appointment of ID through
methods such as cumulative voting or proportionate representation. Thus, this is only an
optional method and the Act does not make it mandatory for the companies to allow the
participation of minority shareholders in the appointment of independent directors.
Furthermore, the Act also contemplates the establishment of a data bank of IDs, from which
persons may be chosen by companies. 7
In order to ensure that IDs maintain their independence and do not become too
familiar with the management and promoters, minimum tenure requirements have been
prescribed. The initial term shall be 5 years, following which further appointment of the
director would require a special resolution of the shareholders. However, the total tenure shall
not exceed two consecutive terms.8
Under the Act, independent directors are entitled only to fees for attending the
meetings of the board. They are being expressly disallowed from obtaining any stock options
in the company. Further, IDs are also entitled for fees pertaining to reimbursement of
expenses for participation in the board and other meetings and profit-related commission as
may be approved by the members of the company. But, owing to these onerous requirements,
the present provisions provide little room for companies to attract required talent by
remunerating directors for the services they provide.
The role of an ID is broadly set out in the Schedule IV of the Companies Act, 2013.
The concerned schedule contains a code that sets out the role, functions and duties of IDs and
incidental provisions relating to their appointment, resignation and evaluation. The code lays
down certain broad guidelines like upholding ethical standards of integrity, acting objectively
and most importantly devoting sufficient time and attention for informed and balanced
decision making. There are certain critical functions entrusted to them to scrutinise the
performance of management and to satisfy themselves on the integrity of financial
information and robustness of financial controls and risk management. The role of audit
committee has been enhanced thereby placing greater responsibilities on independent
directors. The audit committee will now have to examine financials (currently review) and
approve related party transactions (currently they are reviewed).

7
8

The Companies Act, 2013, section 150(1).

The Companies Act 2013, section 149.

55

Thus, by defining responsibilities and duties in a mandatory code of conduct, onus has
been placed on independent directors thereby reducing their chance of getting the benefit of
doubt in case of non-compliances. This predominantly casts an important fiduciary
responsibility on independent directors towards investor community and other stakeholders
concerned. Discharging this responsibility, would require orientation, knowledge and
involvement. The downside of these onerous requirements is that many potential IDs would
be hesitant in taking up the new role.
The Act has sought to balance the wide nature of the obligations, functions and duties
imposed on IDs. The Act only seeks to restrict and limit the liability of IDs to matters which
are directly relatable to them. Section 149(12) limits the liability of an ID only in respect of
acts of omission or commission by a company which had occurred with his knowledge,
attributable through board processes, and with his consent or connivance or where he had not
acted diligently. Nominee directors, despite not being considered as independent under the
new definition, would nevertheless be eligible for immunity, as long as they are nonexecutive.
The concept of independent meetings of IDs has been put in the Act. The Act now
requires all the IDs to meet at-least once in a year. The meeting must be convened without the
presence of the non-independent directors and members of the management. IDs would also
evaluate the performance of the chairperson of the company. Also, the act requires the IDs to
review the performance of the non-independent directors and the board as a whole of the
company. These measures would immensely aid in ensuring the smooth and proper
functioning of the BOD of a company. The concept of independent board meeting of IDs is
already prevalent in US and UK.
These are the major changes in the provisions of the independent director in the
Companies Act, 2013. The Clause 49 of the Listing Agreement contains provisions on
corporate governance for listed companies and its revised from time to time to align it with
the Companies Act.
Clause 49 of the Equity Listing Agreement consists of mandatory as well as
non-mandatory provisions. Those which are absolutely essential for corporate governance
can be defined with precision and those which can be enforced without any legislative
amendments are classified as mandatory. Others, which are either desirable or which may
require change of laws are classified as non-mandatory. The non-mandatory requirements
may be implemented at the discretion of the company. However, the disclosures of the
compliance with mandatory requirements and adoption (and compliance) / non-adoption of
56

the non-mandatory requirements shall be made in the section on corporate governance of the
Annual Report.
As per Clause 49 of the Listing Agreement, there should be a separate section
on corporate governance in the Annual Reports of listed companies, with a detailed
compliance report on corporate governance. The companies should also submit a
quarterly compliance report to the stock exchanges within 15 days from the close of
quarter as per the prescribed format. The report shall be signed either by the Compliance
Officer or the Chief Executive Officer of the company. 9
On February 13th, 2014 SEBI made amendments to the Clause 49 Listing Agreement
to align it with the Companies Act, 2013. This part will highlight those amendments made by
SEBI to the Listing Agreement which narrow down the scope of the provisions of the
Companies Act, discuss SEBIs competence to override the Companies Act and its impact on
listed companies.
Two major amendments made by SEBI which are narrower in scope than the Companies
Act are:
1. Number of boards in which a person can be a director
2. Tenure of an Independent Director
Section 165 of the Act provides that a person can be a director of a maximum of 20
companies and in the case of public companies the number should not exceed 10. However,
SEBIs recommendation on this is more stringent. It provides that a person cannot be an
independent director of more than 7 companies and a whole-time director of more than 3
companies.
The second major amendment is with respect to the tenure of an independent director.
Section 149 of the Act provides for two consecutive terms of 5 years each for an ID after
which there needs to be a compulsory 3 year cooling off period before that person is
reappointed as an independent director through a special resolution. Further, an explanation
to this Section also provides that any tenure of an independent director on the date of the
commencement of this Act shall not be counted as a term for the purpose of this Section.
However, the change proposed by SEBI takes into consideration the previous terms ( if a
person has served as independent director on a board for 5 years or more, starting October 1 st
he shall be eligible to only one term of 5 years). When the Act specifically chose to apply this
Section prospectively, SEBI has decided to apply it retrospectively for listed companies. With
9

SEBI, Consultative Paper on Review of Corporate Governance Norms in India, January 04, 2013, (June 28,
2014), http://www.sebi.gov.in/cms/sebi_data/attachdocs/1357290354602.pdf.

57

regard to both these amendments to the Listing Agreement the recommendations made by
SEBI are more stringent and they practically override the provisions of the Act.

CONCLUSION
Both the provisions of the Companies Act, 2013 and the Listing Agreement have
made significant changes with regard to corporate governance norms and role of independent
directors. With a view to promote and raise the standards of corporate governance, SEBI by
exercising its power conferred by Section 11(1) of the Securities Exchange Board of India
Act, 1992 read with Section 10 of the Securities Contracts (Regulation) Act, 1956, revised
the existing Clause 49 of the Listing Agreement to align it with the Companies Act, 2013 on
February 13th, 2014.10 The amendments made by SEBI though its board meeting to the
Listing Agreement not only aligned the provisions of the Listing Agreement with those of the
Act but also narrowed down certain provisions. The Listing Agreement is applicable to all
listed companies and these new changes made by SEBI require higher level of compliance
from those companies than what is required of them from the Act.
The question arises whether SEBI can go above and beyond the Companies Act and
narrow down the provisions laid down in the Companies Act. SEBI is entitled to impose
more stringent conditions than the Act for listed companies alone, as only they come under
the purview of SEBI. To look at this holistically we must look at the legality of the provision,
the desirability and its practical applicability.
On the legality of the provision, SEBI has the power to frame stricter provisions for
listed companies. The intention behind doing so is to prevent cronyism from creeping in and
it is certainly a desirable step. On the practical applicability aspect, the question that needs to
be considered is whether the pool of independent directors is sufficiently large to keep
generating good qualified competent independent directors and that might pose a problem.
India Inc. might be forced to come up with an expanded list of potential independent
directors.
On the legal aspect, as far as SEBI is concerned, it has imposed this provision qua
listed companies over which it has jurisdiction. This provision under the Act relates to all the
companies and not merely to listed companies. To that extent SEBI has carved out more
stringent provisions relating to listed companies as a condition of the Listing Agreement.
Since the legislature has not made it mandatory by inserting a non-obstante clause stating
10

SEBI Board Meeting, PR 12/2014, (February 18, 2014),

http://www.sebi.gov.in/cms/sebi_data/docfiles/27383_t1.html.

58

notwithstanding any rules or regulations, on face of it seems that SEBI has not encroached
upon the dictate of the legislature.
However, looking at this from the perspective of implementation, this imposes a lot of
difficulties for listed companies as they have to comply with varying standards and there is
no uniformity. The amendments made by SEBI in its board meeting on February 13 th, 2014 to
the Listing Agreement become effective only from October 1st, 2014. Hence the
repercussions of the same will be felt only after that. SEBI has decided to step up and come
out with stringent rules that bring about effective corporate governance practices in
companies in India.

59

RETROSPECTIVE OR REGRESSIVE? VALIDITY OF AMENDMENT

MADE TO IT ACT, 1961 IN 2012
Kruthika R. and Aditya Mitra
School of Law, Christ University

CONSTITUTIONALITY OF FINANCE ACT, 2010 WITH RESPECT TO ARTICLE 14

The fundamental rights guaranteed in our constitution are indubitably the greatest
protection given to the people against injustice. The positivity of law is certainly not the only
qualification to establish its lawfulness. This proposition is enumerated in Article 13(2)(a)
which requires the court to deem any law unconstitutional if it violates any of the
fundamental rights.1 This section deliberates upon how the Finance Act, 2012 repulses the
principles of reasonableness and embraces arbitrariness, thereby violating Article 14 of the
Indian Constitution.
The last paragraph of Section 9(1)(i) reads through the transfer of capital asset
situated in India. Explanation 4, inserted by the Finance Act, 2012, gives the meaning of the
word through as in consequence of. The implication of this is that transfer of shares
outside India would have resulted in transfer of the underlying assets in India and thereby
attracting capital gains. 2
The effect of Explanation 5 to Section 9(1)(i) brought about by the Finance Act, 2012
is that if a share derives its value substantially from assets located in India, whether directly
or indirectly, it shall be deemed to have been situated in India. 3 The implication of bringing
this type of a transaction within the ambit of Section 9 of the Income Tax Act is highly
absurd and injurious. If the subsidiaries of a foreign company are in several countries,
including India, but the company derives substantially from the assets located in India, then
the shares will be considered to be situated in India. 4 This proposition depicts absurdity. As a
result of this, for example, if a Japanese companys shares are listed on the Tokyo Stock
Exchange and the value of these shares are substantially derived from the assets situated in
India, the shares will be considered to be situated in India from 1962 onwards. Accordingly if
Japanese citizens transfer the shares in Tokyo, as a result of this transfer if any income
accrues or arises then it will be deemed to have been accrued or arisen in India. The tax has to
1

Art. 13, cl. 2 (a), Constitution of India, 1950.

Kanga And Palkhivala, The Law And Practice Of Income Tax 347 (Arvind P Darar , Lexis Nexis 10th ed.
Volume 1, 2014).
3
Id.
4
Id.
2

60

be deducted by the Japanese transferor at source. According to some commentators5 it may

be difficult to find a more absurd provision than that is contained in Explanation 5.
The Explanation 5 to Section 9(1)(i) brings the foreign shares of foreign companies,
of which any income is accrued from India, under the ambit of Income Tax Act, 2012. By
doing this the Parliament has brought in this class of shares to the shares whose situs is in
India and owned by Indian companies. This act of classification is not only arbitrary but also
unreasonable. An act which is arbitrary involves negation of equality. 6
The Supreme Court in State of Bombay v. Balsara 7 stated that in order to establish the
reasonableness of the classification the following two tests must be decisively proved:

the classification must be founded on an intelligible differentia which distinguishes

the persons or things that are grouped together from other left out of the group

the differentia must have a rational nexus to the object sought to be achieved by the
act
The primary goal behind the principle of reasonable classification is that upon

classification into groups, such groups may be differently treated. However such a
classification must succeed in the test of reasonable basis for such distinction. 8 The tenet of
classification is certainly not natural but a logical corollary to the rule of classification. It is
imperative to attach the connotation to equality as parity of treatment under parity of
conditions9.
The ramification of this act of the Parliament is nothing but palpable inequality. This
is because the amendment has placed both the foreign shares of foreign companies, if any
income is accrued in India and the class of shares whose situs is in India and owned by Indian
companies in the same category. This results in the former being operated by the same law as
the latter thus resulting in flagrant inequality because both these groups are placed in different
conditions. Thus similar treatment of both these groups who are prima facie situated in
distinctive conditions by the same law is a testimony of the Parliaments failure to determine
the inherent differences between them.
Another rule in determining the validity of the classification is that the differentiations
must be based on substantial grounds and they must certainly not reflect illusion. 10 It is rather
5

Kanga And Palkhivala, supra note 2.

Dr. Durga Das Basu, Commentary on the Constitution Of India 1703(Honble Mr.Justice C.K Thakker et. Al.
eds, Lexis Nexis, 8th ed. Volume 2, 2011).
7
State of Bombay v. Balsara , AIR 1951 SC 318.
8
Supra note 6.
9
Id.
10
Basu, supra note 10 at 1402.
6

61

unfortunate that the reasons for such a classification sought by the amendment to Explanation
5 do not in any way insinuate substantiality. On the other it suggests unreasonableness and
absurdity.
Applying the above doctrines to the classification made by the Explanation 5 to
Section 9(1)(i) it is irrefutably apparent that the classification made by the Parliament
certainly fails in fulfilling the requirements for a valid classification. In this manner it is
against the principles enumerated under Article 14 of the Indian Constitution.

ANALYSIS OF RETROACTIVE AMENDMENT

The amendment made to the Finance Act, 2012 was made with retrospective effect
from 1st April, 1962.11 It is indispensible to understand the meaning of the word
retrospective. The meaning that retrospective law and retroactive law delivers cannot
be distinguished. 12 Blacks Law Dictionary defines retroactive law as follows: A legislative
act that looks backward or contemplates the past, affecting acts or facts that existed before
the act came into effect.13 Therefore the Finance Act, 2012 operates from 1962 affecting the
transactions and nature of obligations of the stakeholders from 1962. This section
contemplates the judicial position on amendments which negate the efficacy of a judicial
pronouncement and the analysis of the legislative power to enact retrospective tax
amendments.
a) Judicial Position on amendments which remove the effects of a judicial decision
The judiciary, without ambiguity, has positioned its views against any act of
Legislature which encroaches upon the independence of the judiciary. However the
significant question that needs to be answered is whether the act of Legislature of rendering a
judicial decision invalid by passing a law amounts to transgression of the cardinal principle of
separation of power. To this the Supreme Court has in more than one instance answered
negatively.
The undisputed principle in determining the validity of a law is that the Legislature
has twin powers to enact law on the basis of the Chapter I of Part XI of the three lists attached
to Schedule VII of the Constitution and the subsidiary or ancillary powers to validate a law
which has been deemed to be unconstitutional by the court.14 The act of the latter nature is

11

Kanga And Palkhivala, supra note 5 at 347.

BLACKS LAW DICTIONARY 4106 (Bryan A Garner, West Publishing Co., 8 th ed. 2004).
13
Id.
14
Supra note 10.
12

62

called validating acts.

In Union of India v. Association for Democratic Reforms15 the

Supreme Court gave certain mandates which require the candidates to disclose their criminal
antecedents and also to disclose the assets that each candidate held. However to remove the
efficacy of this judgment the Parliament amended Representation of Peoples Act, 1951 by
inserting Section 33B. The Supreme Court opined that the power of the Legislature can only
be exercised to an extent which results in removal of defects on the basis of which law has
been involved. The Legislature most certainly has no power to direct state instrumentalities to
disregard or not obey the decision of the Supreme Court.
The Court also observed the following: A declaration that an order made by the
Court of law, is void is normally a part of judicial function and is not a part of legislative
function. Although there is in the Constitution no rigid separation of powers, by and large,
the spheres of judicial function and legislative function have been demarcated and it is not
permissible for the Legislature to encroach upon the judicial sphere. A Legislature while it is
entitled to change, with retrospective effect, the law which formed the basis of the judicial
decision, it is not permissible to the Legislature to declare the basis of judicial decision, it is
not permissible to the Legislature to declare the judgment of the Court void or not binding.
Therefore accordingly the legislative act must be a validating one which primarily
needs to remedy a defect in law. However if it touches upon judicial functions like declaring
a judicial pronouncement void then it results in Legislature stepping into judicial sphere
resulting in violation of separation of power.
In I.N.Saksena v. State of Madhya Pradesh 16 the Supreme Court has asserted the
position that while understanding the distinction between the legislative and judicial function,
the Legislature certainly cannot overrule a judicial decision via a bare declaration. However,
the Court affirmed that the Legislature can most certainly pass a law nullifying the effect of a
judicial decision as long as the Legislature acts within the plenary power granted to it by the
virtue of Article 245 and Article 246 of the Indian Constitution. In Indira Nehru Gandhi v.
Raj Narain17 the Supreme Court held that the rendering a judicial pronouncement ineffective
by a legislative enactment does not give rise to encroachment on judicial power.
Therefore the Supreme Court has recognized the act of Legislature in these occasions
to be within the plenary power conferred upon it by the constitution and consequently has
deemed such acts to be not violative of judicial independence.
15

Union of India v. Association for Democratic Reforms, AIR 2002 SC 2112.

I.N.Saksena v. State of Madhya Pradesh , AIR 1967 SC 1264.
17
Indira Nehru Gandhi v. Raj Narain , AIR 1975 SC 865.
16

63

b) Analysis of the power of the legislature to enact retrospective tax amendments

The basis of presumption while interpreting a statute is that it operates from the date
specified in the Act or from the date it receives the assent, in case if such assent is
necessary. 18 The established rule is that all laws affecting the substantive rights are presumed
with prospective operation. However, if anything in the statute is contrary to this then the
presumptions withers away. 19 There also lies a presumption against retrospectivity if the
vested rights and obligations are affected.20
There exists a presumption of prospective application of laws but this presumption
can be refuted if the law expressly or impliedly requires for retrospective application of the
law.21 This rule of presumption can be applied only in those cases where statute specifically
aims to affect the vested rights or to impose new burdens or to impair existing obligations.
The only requirement is to provide sufficient evidence from the statute exhibiting either
express or implied intention of the Legislature to apply the law retrospectively. 22
In the present case the general presumption of prospective application of the law is
rebutted since the Finance Act, 2012 expressly states that the amendments to the Income Tax
Act, 1961 shall be applied with retrospective effect from 1st April 1962.23
The connotation that a retrospective tax statute delivers is that it affects a period of
time which is prior to the date of enactment. 24 Another crucial point is that there is no
limitation imposed upon the legislative power to amend tax law retrospectively. However
such an enactment must have the qualification of representing the legislative intent clearly
and without ambiguity. 25
It is inarguably certain that a statute carries with itself the presumption of
constitutionality. 26 The underlying principle for such a presumption is that it is Legislature,
being the true representation of the people, is the most appropriate authority to formulate
laws. In Amalgamated Tea Estate Co. Ltd. v. State of Kerala 27 the Supreme Court averred
that Legislatures are the ultimate guardian of liberties and welfare of the people in quite as
great a degree as a court. But it has been established that such a presumption is indeed a

18

N S Bindra, Interpretation Of Statutes 1463( M N Rao et al. eds., Lexis Nexis, 10th ed. 2007).
Supra note 10.
20
Punjab Tin Company v. Central Government, AIR 1984 SC 87.
21
Keshava Madhava Menon v. State of Bombay, AIR 1951 SC 128.
22
Mithilesh Kumari v. Prem Bahadur Khare, AIR 1951 SC 1247.
23
Supra note 2.
24
Supra note 18.
25
Id.
26
Musliar v. Potti, AIR 1956 SC 246.
27
Amalgamated Tea Estate Co. Ltd. v. State of Kerala , AIR 1974 SC 849.
19

64

rebuttable one. 28 If it is conclusively proved that the legislation delivers nothing but obvious
arbitrariness it will be deemed to be invalid and unconstitutional. 29
In Tikamdas Nadimal v. State of Madhya Pradesh 30 the High Court of Madhya
Pradesh held that while interpreting a statute to which retrospective operation has been given,
the rule of strict interpretation must be adhered to. However the deviation to this rule can be
permitted only if the language of the statute provides for such a departure.
It is incontestable that Legislature has authority to ably exercise its power to enact a
tax statute prospectively or retrospectively. Nevertheless it is indispensible to take into
consideration whether such retrospective taxation qualifies the test of reasonableness or not. 31
It is a resolved proposition that legislative acts which are remedial in nature are
considered to have retrospective operation as long as it endeavors to strengthen effort to
correct abuses, suppress the mischief and advance the remedy. Nonetheless it is imperative
that such laws do not impair contracts or disturb vested rights. 32
Therefore it is amply clear that the Legislature without any doubt has power to make laws
with prospective or retrospective effect. However in the present case the law made by the
Parliament, as discussed earlier, does not successfully clear the tests of reasonableness and
equality.

SUMMARY OF THE VODAFONE CASE

The Hutchison group entered the telecom sector in India in 1992. Through multiple
and varied acquisitions, the company evolved and eventually became Hutchison Essar Ltd.
(HEL). In the course of its business ventures in India, HEL acquired various companies and
gradually acquired interest in over 23 telecom circles in India. Now HELs shareholding
structure involved a 52% direct or indirect holding by the Hong Kong Hutchison group and
33% was held by the Indian Essar group and the remaining 15% was held by small
shareholders. In 2006, the Hutchinson group decided to exit and invited open offers for sale
of its 52% holding and an additional 15% holding which was of course contingent. Vodafone
was the successful bidder and eventually purchased one share of a Cayman Island company
that was owned by Hutchinson group for USD 11 billion. Thus HEL became Vodafone Essar
Ltd. (VEL). The law on transfer of shares between two non-resident companies outside
28

State of Bihar v. Bihar Distillery Ltd., AIR 1997 SC 1511.

supra note 32.
30
Tikamdas Nadimal v. State of Madhya Pradesh ,AIR 1965 MP 271.
31
Jawaharmal v. State of Rajasthan , AIR 1966 SC 764.
32
Levy v. Brin Schien, 240 NW 140.
29

65

India was clear and there was no imposable liability to pay capital gains tax. This supposition
arose from a basic premise of taxation law i.e. transfer of shares did not amount to transfer of
underlying assets in India. The only restriction involved was the permission required by the
Reserve Bank of India prior transfer of any interest under Section 26(4) of the Foreign
Exchange and Regulation of Act.
The governments case for imposing tax liability on VEL was based on the premise
that VEL was the representative assesse of Vodafone International. The question of
liability for payment of capital gains tax was based on the transfer of shares. This was based
on certain key propositions made by the government.
1. The government made the assertion that the sale did not involve a simple transfer of
shares to the Cayman Island Group (CGP) but the transfer of various rights and
entitlements;
2. It was contended that business, industrial licences, goodwill, controlling interest, noncompete agreements and shares are capital assets under Section 2(14) of the Income
Tax Act;
3. The government contended that it was Hutchinson and not Vodafone International
who was the transferee;
4. The shares transferred constitute capital asset situtated in India;
5. The income is chargeable to tax under Section 9(1) (i) read with Section 45 of the
Income Tax Act.
6. The transfer of shares results in extinguishment of rights and transfer of underlying
capital assets.
7. Section 195 of the Income Tax Act applies extra territorially and regardless of the
chargeability.
The Bombay High Court stated that the transaction was neither a sham nor an attempt
to evade tax but it did state that the transfer of shares also resulted in transfer of other diverse
rights and entitlements thus leading to part income being liable for tax.
The case then went on appeal to the Supreme Court. There too the primary argument
made was that the transfer of shares outside India had resulted in extinguishing its property
rights in the Indian subsidiaries and consequently, the said transfer would attract capital gains
tax. The secondary argument made was that irrespective of the first contention the income
from the sale of one share in the Cayman Island company would nonetheless fall under
Section 9.

66

This was based on the interpretation of the word through in section in Section
9(1)(i), inter alia, means in consequence of a transfer of share abroad, hence such income
would be taxable in India. The Supreme Court introspected the meaning of the look at and
look through provisions, tax avoidance and tax evasion, situs shares and whether the
purchase of one share was a sham or a legitimate transaction. The essential factors involved
in such a case were the existence of asset, transfer of asset and situation of such asset in India.
The court taking all these factors into consideration made the following observations:
1. Section 9 is based on the look at provision and not the look through provision;
2. Unless the place of accrual of income is within India, a non-resident cannot be
subjected to tax;
3. Income must accrue or arise to a non-resident only on account of transfer of a capital
asset situated in India;
4. Section 9(1)(i) applies to capita assets and not to underlying assets;
5. The words directly and indirectly in Section 9(1) go with income and not with the
transfer of capital assets.33
The judgment while clearly controversial was deemed by many legal scholars as one
that was legally sound. This however led to the Legislature making an even more
controversial decision.
In the aftermath of the decision several amendments were made to nullify the
judgment with retrospective effect from April 1, 1962. These amendments were inserted by
the Finance Act 2012. The following amendments were thus made:
1. The last paragraph of Section 9(1)(i) reads through the transfer of a capital asset
situate in India. The government via the newly inserted Explanation 4 stated that the
word through would have always meant in consequence of essentially what this
meant was that the Supreme Courts ruling on through being a provision of the
look at and not the look through doctrine was nullified;34
2. The insertion of Explanation 5 to Section 9(1)(i) was also to get over the observation
of the Supreme Court that the situs of shares is where the registered office is located.
The argument the government had made was that since the value of the share
transferred in Cayman Island derived its value substantially from assets located in
India, whether directly or indirectly, it shall be deemed to have been situated in India.

33
34

Kanga and Palkhivala, supra note 5 at 346.

Kanga and Palkhivala, supra note 5 at 347.

67

Therefore if a foreign company has subsidiaries in India then the shares shall be
deemed to be situated in India;
3. Interpreting Section 2(14) defining a capital asset, the Bombay High Court and the
Supreme Court held that controlling interest is not a capital asset. In clause (14), at
the end, the Explanation inserted clarifies that the word property is inclusive of the
rights of management or control or any other rights whatsoever;
4. In clause (47), the Explanation clarified that transfer includes disposing of or
parting with an asset or any interest therein, or creating any interest in any asset in any
manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or
involuntarily, by way of an agreement whether entered into in India or outside India
or otherwise.

ASSET SALE V. SHARE SALE

There is an essential component that needs to be noticed when it comes to
understanding the difference between an asset sale and a share sale. When the shares of a
corporation are sold, it indicates a shift in overall ownership and equity. It is more than mere
assets; it encompasses all the rights which entail everything from the company name to the
liabilities that are transferred including assets and the employees.35 When shares are sold the
entire liability of the company is diverted. The 2012 amendment to the Income tax Act, 1961
puts both assets and shares in the same class. This is fundamentally problematic to say the
least. The sale of an asset is always associated with a capital gain and asset categorization by
companies in many situations leads to prioritization of assets over another class of assets.
Simply said; assets are capable of generating profits notwithstanding the fact that they can be
liquidated in order to compensate for the company in certain matters. Shares on the other
hand do not simply mean certain rights that control specific functions of the company but are
also seen as indications of both a companys health and value. It is accepted that shares and
assets both come under the category of ones propriety right when we analyze with respect to
an individual person. However, corporate jurisprudence gives it a different meaning with
respect to a corporation. A corporation itself possesses a separate entity as a legal person in
the eyes of the law. This fictional person has a personality that is; while distinct from the
members of the organization, is somewhat derived from their common will. Yet it is an

35

Commissioner Of Income Tax v. M/S. Motor And General Stores, AIR 1968 SC 200.

68

established principle in law that this personality is different from the shareholders and that the
shareholders do not form part of the corporate entity. Under the current scenario by equating
shares to assets what the legislation essentially does is it makes shareholders a part of the
corporate entity and consequently it not only goes against a century of legal theory but
against logic as well. Another essential difference between shares and assets is that unlike
assets shares cannot be liquidated. The company can merely dilute its shares to attract
investment, and shares are indisputably representations of a companys value. Transfer of
shares is merely a transfer of that value from one person to another and taxation of that
transfer leads to issues of double taxation where in the company ends up paying both on
behalf of its assets and its shares. If the two are mutually inclusive then common sense
dictates that these share values and benefits are derived only after the assets are taxed. The
reason why only assets are taxed and not shares is because the shares are investments whose
actual value manifests in the assets which the company obtains and this is the reason for its
taxation. As per the current legislation the taxation system is applicable in a bilateral manner.
The assets are taxable based on the fact that profit is derived from them while the transfer
shares are taxable because they contribute to the value of the asset. This invariably defies
both logic and is a link that needs to be both corrected and clarified in the amendment
considering the repercussions it has on the existing legal, economic and the accounting
system.

ECONOMIC OUTCOMES
The financial year 2011 12 saw a massive influx of FDI to India and the amount
was around USD 35.12 billion. In the following year, this amount saw a massive drop of
close to 38% aggregating only USD 22 billion. 36 A lot of factors were attributed to this
tumultuous slow down. This decline in FDI is detrimental to India due to a lot of factors.
India needs inflows to drive investment in infrastructure and to expand capacity and
technology in multiple sectors. This fall in FDI is also detrimental to the monetary policy as
well as it keeps the balance of payments under pressure and will continue to undermine the
value of the rupee which is already on a severe decline. The increase in the deficit coupled
with the inflation prevalent in the market could lead to excessive tightness in market
liquidity. Considering this scenario and the economy which is delicately poised at this stage,
36

FDI dips by 38% to $22.4 billion in 2012-13 dated Jun 2, 2013 (Feb 19,
http://timesofindia.indiatimes.com/business/india-business/FDI-dips-by-38-to-22-4-billion-in-201213/articleshow/20392486.cms,

2014),

69

the amendment to the Income Tax Act will lead to multinational companies being hesitant to
make investments in India. While it is possible for companies to deal with the possible
taxation of share transfers it is relatively impossible for them to fix any previous form of
action that has already been undertaken in past instances. The Supreme Court may say that
the rarest of rare doctrine may be applied to the cases involving retrospective taxation under
Section 9(1)(i) of the Income Tax Act, yet the grounds for determining that amount itself is
flawed. If the doctrine of rarest of rare case would apply, then in those cases involving
income tax it would have to be ascertained based on the quantum of damages involved in the
case. Essentially the amount referred to in this case is the tax evasion amount. This raises
serious constraints that have already been referred to with regards to ascertaining of value in
a retrospective manner. The reasoning that the Supreme Court would apply the rarest of rare37
doctrine is not enough to calm the nerves for any of the large foreign multinational
businesses.
While it may be unfair to say that the retrospective amendment to the Income Tax
Act, 1961 is the main reason why FDI inflow to India has dried up, it is not a total
exaggeration to say that the act played a role in incepting the seeds of doubt in the minds of
the investors. It tells the everyday entrepreneur that they are vulnerable to income tax suits at
any point in time. The vulnerability of companies towards initiation of suits that are likely to
involve heavy litigation costs would be a huge factor to deter companies from investing in
India. What the Legislature has clearly shown in its acts is a poor and irrational understanding
of the financial system and intent to extract short term benefits yet remain oblivious to the
long term harms to the economy owing the dearth of investments.

IMPLEMENTATION OF RETROSPECTIVE LAWS

In its 77-page report for reforming the regulatory environment for doing business in
India, an expert panel headed by former SEBI Chairman M. Damodaran said that death and
taxes are equally undesirable aspects of human life, but even death is never retrospective.
The Parthasarathi Shome panel, looking into the controversial retrospective tax issue as well
as the final roadmap on the General Anti-Avoidance Rules (GAAR), has said that
retrospective tax should apply to the rarest of rare cases. The panel noted that the following
recommendations should apply irrespective of prospective or retrospective application:
37

Draft Report on Retrospective Amendments Relating to Indirect Transfer, Expert Committee (2012),
http://www.incometaxindia.gov.in/archive/DraftReport_10102012.pdf.

70

There has to be a direct participation in ownership, capital, control or management;

Intermediaries between the foreign company and assets in India may be ignored to
arrive at the valuation of shares of a foreign company;

Taxation of capital gains on indirect transfer should be restricted only to capital gains
attributable to assets in India;

Provisions relating to taxation on indirect transfer of assets are not clarificatory in

nature and they should be applied prospectively. 38
This leads us to one of the most important features of the amendment i.e. the scope of

the amendment with respect to past cases. Despite the rarest of rare 39 doctrine applying, it is
essential to note that the monetary and financial parameters have undergone significant
change from 1962. In the event that cases are re-opened against companies in prior years
what metric is the government going to use to determine the loss suffered due to the instance
of tax evasion? Economic circumstances have changed across the period of 50 years and it
will be extremely difficult for the government to gauge losses that they have suffered since
incessant inflation has led to a drastic change in prices. The other alternative which may be
considered is equally ludicrous. If a company indulged in tax evasion back in 1970, do we
determine the amount to be demanded based on the value established at that time? The
change in value of the rupee is sure to create various other computational problems for the
government in order to implement them. It is extremely difficult to ascertain these rates
because stock values keep changing and share value similarly keeps changing. In that respect
the government drawing a close association with share value and asset value will find it
exceptionally difficult to align the share value with the existing, pre-existing and prospective
market prices.

JURISPRUDENCE OF RETROSPECTIVE ACTION

Historically jurisprudence has always looked down at the entire concept of
retrospective action. One of the greatest critiques of retrospective action Lon Fuller describes
retrospective legislation as one of eight ways not to make law. Fuller is particularly harsh on
this aspect of law making. In his very own words the abuse of retrospective legislation,
which cannot by itself guide action but under cuts the integrity of rules of prospective in

38

Final Report on General Anti Avoidance Rules (GAAR) in Income-tax Act, 1961, Expert Committee Report
(2012), http://finmin.nic.in/reports/report_gaar_itact1961.pdf.
39
supra note 39.

71

effect, since it puts them under the threat of retrospective change.40 There are many other
theorists like Dworkin who also deem retrospective legislation as both regressive and
abhorrent to the integrity of law itself. In Dworkins analysis when a retrospective legislation
is enacted it essentially leads to the pre-existence of a new set of rights and duties that predate
a particular line of action. So it raises two valid points in the eyes of the law. Did the
individual manipulate a loophole in the legislation with a mala fide intention to trick or
demean the power of the sovereign and is it a practice which if followed denigrates the
benefits that accrue to society?
In reference to the given case intention cannot be unascertained in which case it is
probably believable that the transaction in a tax haven like the Cayman Island indicates clear
intention to manipulate loophole existing in law. However the second point needs to be
evaluated more intricately. The question that needs answering is whether the transaction of a
deal in the Cayman Islands is unfair in that it cause certain intangible or tangible harms to the
society from which the benefit is derived. Subsequently a distinction must be drawn between
what the Government or the legislators are trying to achieve and what they might achieve as
this is a matter of economics. In purely business terminology many corporate sector
representatives have identified the amendment to Section 9 of the Act by the Finance Act,
2012 as problematic. The economic consequences and absurdity of the amendment apart one
needs to understand that from a business perspective retrospective subjection to laws which
are in fact punitive in nature is a nightmarish prospect. Unless this legislation is given a
restricted interpretation in terms of scope and extent every company whose share value is
majorly derived from India is subject to this law for business transactions conducted in the
previous 50 odd years. The only advocate of such action in jurisprudence would be John
Austin, an individual who believed in the supremacy of the sovereign and its ability to enact
legislation and enforce them. In the Austinian theory if a state had the power to enact law in
where it did not exist, then it has full authority to enact the law even if it is retrospective in
nature.41 In the case of business laws however Austin does concede to the utilitarian
conception of evaluating the feasibility of retrospective laws. While no jurist has ever
advocated the use of retrospective laws in cases where criminal sanctions are involved, the
stance on business laws is slightly softer. In the case of business laws one must revert to the
utilitarian conception of determining what is feasible or more specifically what is more
desirable. This requires a cost benefit analysis of the situation. If we go by the concept of rule
40
41

Lloyd, Introduction to Jurisprudence 119 ( M.D.A Freeman, Sweet and Maxwell 8th ed.( 2008).
John Austin, The Province of Jurisprudence Determined 114 (Universal Law Publishing 2012).

72

utilitarianism that was conceived by John Stuart Mills then one needs to see the validity of an
act if applied as a general rule and its net benefits and harms in the long run. 42 In the current
scenario if one evaluates the repercussions of the action undertaken at Parliament then in the
long run it risks leading to a dearth of foreign investment in India, a trend which is
increasingly becoming clearer. The harms it causes are a stagnation of industrial and tertiary
sector growth which is regressive for the economy and society. The attempt made by the
government to make a gain by taxing Vodafone is a short term prospect and in the long term
is clearly dissuading investors from coming to India. It is easy to see why enforcing
legislations that are retrospective in nature is a non-issue especially when one makes the
utilitarian decision that the law is for the benefit of the business because the cost benefit
analysis favors it in such a situation. This brings back the initial argument to justify
retrospective action where general societal harms and benefits need to be considered to judge
the authenticity of an act. Another perspective that needs to be understood is the motive to
analyze this amendment which is in fact ex post facto. Thus the question arises as to whether
the government enacted this legislation purely to undo the courts verdict in the case. This
raises a serious question as to how laws are framed. If laws are framed in a manner that they
are created to neutralize certain decisions or enacted in a manner that their application is
exclusively intended for a particular set of facts and circumstances then the extent to which
they can be misused or misconstrued is beyond measure. The reason for the enactment of the
amendment to Section 9(1)(i) is as clear as daylight, it was simply sour grapes on part of the
government who chose to play spoil sport in order to neutralize the judiciary for the purpose
of attaining a short term financial benefit with no regards to the far reaching consequences
that it may have in the future. It would be fair to say that any legal scholar would find the
logic behind such retrospective amendment both flawed and repulsive in that it has no
consideration with the financial repercussions which exist in a close nexus to the issue.
Jurisprudence has always been majorly unanimous on its verdict on retrospective law since
the Nuremburg trials of 1945. If retrospective laws are enacted it violates the most
fundamental concept of natural law a person is guilty for what is wrong as per the laws of
the time of the perpetration of the act itself. In truth we can never know of the mental
intention of a person more so a corporation and it becomes illogical to create laws that punish
past acts which were never wrong or more so never intended to be wrong to begin with.

42

Wayne Morrison, Jurisprudence: From The Greeks To Poest-Modernism 203 (Lawman India Private Limited
1997).

73

CONCLUSION
The Supreme Court in the Vodafone case certainly espoused the correct legal
proposition. Nevertheless the Legislature, with its enormous power overturned the judicial
pronouncement via an amendment to the Income Tax Act, 1961 by Finance Act, 2012. As a
consequence of this the judgment given in the Vodafone case is ineffective and otiose. It is
undisputed that the Legislature has such kind of plenary power. But it is even more certain
that such an act must be reasonable and must not in any way violate the fundamental rights.
This qualification is not met with the present situation. The Explanation 5 to Section 9(1)(i)
inserted via the amendment results in adverse implications on the legal, jurisprudential and
economic spheres of India. The amendment definitely has deteriorated the foreign direct
investment in India, apart from causing other economic problems.
The most unfortunate part is that the level of absurdity that this law tries to achieve is
beyond imagination. The Parliament undoubtedly will not make an effort to remedy this
colossal mistake. Nevertheless this amendment has been challenged in two High Courts.
SABMiller, a British Beer company has challenged the constitutional validity of the
amendments introduced by the Finance Act, 2012 in Bombay High Court and McLeod
Russell, the largest tea conglomerate has done the same in the Calcutta High Court. 43
Therefore the academic discussion of determining the constitutional validity of the
Finance Act, 2012 and the relevance of the same will reach its finality once these matters
reach the Supreme Court of India. Till then the position of law in this aspect will strive to
deliver injustice.

43

Ashwin Mohan, SABMiller Files Petition Against Retrospective Taxation in High Court; Challenges The
Constitutional Validity dated Aug 23, 2012 (Feb 20, 2014), http://articles.economictimes.indiatimes.com/201208-23/news/33342182_1_retrospective-amendments-tax-laws-sabmiller.

74

CLASS ACTIONS A NEW FACET OF INVESTOR ACTIVISM IN INDIA

Sargam Marwaha
Campus Law Centre, Delhi

INTRODUCTION
A class action suit, in common parlance, means a suit in which a large group of
people, who have suffered a legal injury, bring a claim collectively through a representative.
Its main purpose is to redress the grievances of people with a common cause of action in an
effective and inexpensive manner in order to give them better access to justice. This concept
originated in the United States of America and is still used there. Deliberations over the need
to introduce class action lawsuits are taking place in a lot of countries. For example, Italy has
a class action legislation now, while countries like France are also mulling over the issue.

CLASS ACTION LITIGATION UNDER US LAW

The concept of class action litigation is provided in Rule 23 of the Federal Rules of Civil
Procedure1, which states that: One or more members of a class may sue or be sued as
representative parties on behalf of all members only if:
i.

the class is so numerous that joinder of all members is impracticable;

ii.

there are questions of law or fact common to the class;

iii.

the claims or defences of the representative parties are typical of the claims or
defences of the class; and

iv.

the representative parties will fairly and adequately protect the interests of the class.
In order to check abuses of the class action concept by some state courts with reputations

for hostility towards business defendants, the Congress enacted Class Action Fairness Act,
2005, which expanded the federal jurisdiction to encompass substantial interstate class
actions by removing them from the state courts.
The procedure for filing a class action in the USA is to file a suit by one or several
representatives on behalf of a class of people who have suffered a common legal injury.
Then, such representative(s) has to file a motion called class certification to determine
whether the suit is fit to be brought as a class action suit. The court hears both plaintiffs and
defendants in order to determine whether it should certify the class action. At this stage, the

Fed. R. Civ. P. 23, available at http://www.federalrulesofcivilprocedure.com/rules/rule-23-class-actions/.

75

court does not go into the merits of the case. If the certification is granted, a notice is given to
the class members giving them an opportunity to opt-out of the suit. Once all the members
who wish to be a part of the suit are finalised, the court proceeds to taking evidence and
delving into the merits of the case. Eventually the class action lawsuit is either settled out of
court or tried. If the case is decided in favour of the plaintiffs, the defendant may appeal to a
higher court and if the case is settled, the parties present the proposed settlement to the court
which, after conducting a fairness hearing, approves the settlement as well as the fees and
expenses of the class attorneys.2
A recent example of class action suits in the USA is the one filed against the worlds
largest social media company, Facebook, Inc., for intercepting private messages and sharing
the data with marketers for profit. 3 A class action suit was also filed against the maker of
Nutella, Ferrero USA in 2012 for false advertising and $3.5 million were awarded as
damages. As a result of this, anybody who had bought Nutella between the period Aug. 1,
2009 and Jan. 23, 2012 in California could file a claim. 4

EVOLUTION IN INDIA
In India, the basis of class actions can be found in Order I Rule 8, Code of Civil
Procedure, 1908 (CPC) which provides that one person may sue on behalf of all in the same
interest with the permission of the court. However, these suits have so far been filed in the
guise of Public Interest Litigations (PILs). Class action suits and PILs both involve a
collective suit on behalf of a large number of plaintiffs having the same cause of action.
However, they cannot be used synonymously because PILs can be filed only against the State
or other public authorities, in which a private party may be joined. This means that in case of
corporate/securities matters, a PIL can be filed against the Ministry of Corporate Affairs
(MCA) or the Securities Exchange Board of India (SEBI), but not against the company alone.
Also, in case of PILs, the plaintiff may not have a locus standi, which is necessary in case of
class action litigation. Thus, PIL is basically a tool for enforcement of basic human rights in
cases where a public injury is caused by the wrongful act/omission of the State or other
public authorities, whereas a class action suit is a form of mass tort claim, where the main

Janet Cooper Alexander, An Introduction To Class Action Procedure In The United States, available at
http://law.duke.edu/grouplit/papers/classactionalexander.pdf (last visited on February 15, 2014).
3
Matthew Campbell and Michael Hurley vs. Facebook Inc., filed on December 12, 2013, available at
http://digitalcommons.law.scu.edu/cgi/viewcontent.cgi?article=1611&context=historical.
4
Nutella: Consumer Class Action Settlement, abc News, August 29, 2012, available at
http://abcnews.go.com/blogs/business/2012/04/nutella-consumer-class-action-settlement/.

76

purpose is to compensate for the damage caused to every individual and deter future
wrongdoing by companies, auditors etc.
In Sand Carriers Owners Union vs. Board of Trustees for the Port of Calcutta 5, the
Calcutta High Court ruled that representative action or class action may be initiated by any
member of the class affected by any order or action or inaction on the part of the government
after obtaining leave of the Court and in such a case, the principle laid down in O.1 R. 8
(CPC) is followed by which after the notice pursuant to the order of the court is issued, any
member of the class who is affected by such order may join in such writ application as a
petitioner and that if the Court grants such leave, the members of that class are bound by such
decision.
The concept of class actions has been well developed in the industrial jurisprudence
as under the Industrial Disputes Act, 1947, it is open to the union to come to the rescue and
espouse the cause of workers collectively against the mighty employers.
In 1993, in order to enable consumers to take on large companies against
unfair/illegal trade practices, the Consumer Protection Act, 1986 was also amended to include
a provision to allow complaints to be filed with the District Forum by one or more consumers
having the same interest on behalf of or for the benefit of all the consumers so interested.6
This was a major step towards consumers activism.
In Re: Grasim Industries Ltd. and Samruddhi Swastik Trading and Investments Ltd.
vs. Securities and Exchange Board of India7, the applicants, Investors Grievances Forum
(IGF) and Ghatkopar Investors Welfare Association (GIWA) sought permission of the
Securities Appellate Tribunal (SAT) to intervene in the appeal on behalf of defrauded
investors. They argued on the need to encourage class actions and to permit investor
associations to take up the cause of investors in litigations. However, their application was
dismissed by SAT and it was held that if IGF and GIWA wanted to provide assistance, they
should have gone to SEBI as witnesses; however they could not be impleaded as interveners.

Sand Carriers Owners Union vs. Board of Trustees for the Port of Calcutta, AIR 1990 Cal. 176.
Consumer Protection Act, 1986, Section 12(1)(c).
7
Samruddhi Swastik Trading and Investments Ltd. vs. Securities and Exchange Board of India ,(2003) 2
CompLJ 365 (SAT).
6

77

The J.J. Irani Committee on Company Law 8 in 2005 had pointed out that while
principles relating to class/derivative actions have been upheld by courts on various occasions
but the same need to be expressly laid down in the law.
The need for a statutory provision relating to class actions was strongly felt in India in
2009 when around 3 lakh shareholders sued M/s Satyam Computers Services Limited for
defrauding them of around INR 5000 crores by manipulating the companys accounts.
However, the Indian shareholders could not take any legal recourse against the management,
while their US counterparts were able to claim a large amount as damages. This was
primarily because of absence of any concrete provision relating to class actions in India at
that time, and also because Indian legal practice rules (Bar Council of India Rules on Ethics
and Professional Conduct and the Advocates Act, 1961) do not allow contingency fee
arrangements. In contingency fee model, the traditional pre-determined fee is not paid to the
lawyers. Only if the suit is successful, the lawyers get a fixed portion of the compensation
awarded. This model, prevalent in the USA, encourages lawyers to initiate prosecution on
behalf of clients who cannot pay upfront.
With lessons learnt from the Satyam scam, SEBI introduced Investor Protection &
Education Fund Regulations, 20099 read with Aid for Legal Proceedings Guidelines, 200910
which gave it the power to financially aid investor associations recognised by it to undertake
legal proceedings in the interests of the investors in securities that are listed or proposed to be
listed. However, this aid would not be provided in cases where SEBI itself is made a party,
which is a major drawback because if there is fraud/mismanagement in a listed company,
SEBI is most likely to be made a party.

CLASS ACTIONS UNDER COMPANIES ACT, 2013

SEBIs initiatives and a lot of deliberations over the issue gave way to a concrete
provision in the Companies Act, 2013 (2013 Act) introducing the concept of class actions in
India.
For class actions relating to securities, Section 37 11 of the 2013 Act provides that if
there are any misleading statements in the prospectus of a company, or if any person tries to
fraudulently induce people to invest money, a suit can be filed by any person, group of
8

J.J.
Irani
committees
report
on
company
law,
http://www.mca.gov.in/Ministry/reportofexpertcommittee.html.
9
Available at http://www.sebi.gov.in/cms/sebi_data/commondocs/Investorpro2009_p.pdf.
10
Available at http://www.sebi.gov.in/acts/legalaid.pdf.
11
Section 37 has been notified by MCA.

available

at

78

persons or any association of persons affected. No minimum number of persons required to

file the suit is prescribed in the Act. However, a SEBI recognised investor association, in
order to obtain aid for legal proceedings from SEBI, is required to show that at least a
thousand investors are affected or are likely to be affected by such an act. SEBI, if satisfied,
can reimburse up to 75% of the legal expenses 12 actually incurred by such associations.
Under Section 24513 of the 2013 Act, a prescribed number (stated below) of members
or depositors can file an application with the National Company Law Tribunal (NCLT), if
they are of the opinion that the management or conduct of the company are being conducted
in a manner prejudicial to the interests of the company or the members/depositors.
Earlier it was proposed that creditors should also be allowed to institute class actions.
However, on the recommendation of the Standing Committee on Finance on Companies Bill,
2011, it was removed as it was felt that since creditors can enforce their claims through
contracts/ agreements with borrower companies, they should not be given statutory right for
class action.
The number of members required to file an application are: 14
i.

For a company having a share capital

Not less than 100 members, or 10% of the total members, whichever is less, or
Any member(s) holding singly/jointly not less than 10% of the issued share capital,
provided they have paid all the calls or other sums due on their shares.

ii.

For a company not having a share capital

Not less than one-fifth (1/5th) of the total members.
The number of depositors required to file the application are:
Not less than 100 depositors, or 10% of the total depositors, whichever is less, or
Any depositor(s) holding singly/jointly not less than 10% of the total value of
outstanding deposits of the company.
Such an application can be filed against the company, its directors, an auditor/audit firm,

or any expert/advisor/consultant or any other person, on any of the following grounds: 15

12

SEBI (Aid for Legal Proceedings) Guidelines, 2009: 3(1)(a), Expenses are the expenses incurred with
respect to any or all of the following in connection with a legal proceeding:- i. Court fees, process fees and other
fees/charges payable in the courts as per law; ii. The bills of solicitors, advocates and senior advocates for
professional services rendered by them ; iii. The clerkage and other miscellaneous expenses charged by the
counsels, senior counsels and solicitors, as applicable.
13
Yet to be notified by Ministry of Corporate Affairs.
14
Companies Act, 2013, Section 245(3) read with the Draft Companies Rules, 2013 issued by Ministry of
Corporate Affairs.

79

i.

to restrain the company from committing an act which is ultra vires the articles or
memorandum;

ii.

to restrain the company from committing breach of any provision of the memorandum
or articles;

iii.

to declare a resolution altering the memorandum or articles as void if the resolution

was passed by suppression of material facts or obtained by mis-statement to the
members or depositors;

iv.

to restrain the company and its directors from acting on such resolution;

v.

to restrain the company from doing an act which is contrary to the provisions of the
2013 Act or any other law for the time being in force;

vi.

to restrain the company from taking action contrary to any resolution passed by the
members;

vii.

to claim damages or compensation or demand any other suitable action from or

against- the company or its directors for any fraudulent, unlawful or wrongful act,
omission or conduct or any likely act or omission or conduct on its or their part; the
auditor including audit firm of the company for any improper or misleading statement
of particulars made in his audit report or for any fraudulent, unlawful or wrongful act
or conduct; or any expert or advisor or consultant or any other person for any
incorrect or misleading statement made to the company or for any fraudulent,
unlawful or wrongful act or conduct or any likely act or conduct on his part;

viii.

to seek any other remedy as the Tribunal may deem fit.

The NCLT has to take into account various factors before admitting an application, viz.

whether the cause of action is one where a class action is not required, whether the applicants
are acting in good faith, or whether there is evidence as to involvement of anyone other than
directors or officers of the company, etc.16
If such an application is admitted, public notice is required to be served on such
members/depositors and the cost or expenses connected with the application of the class
action are to be defrayed by the company or any other person responsible for such oppressive

15
16

Companies Act, 2013, Section 245(1).

Companies Act, 2013, Section 245(4).

80

act.17 The legal expenses incurred in pursuing class actions are to be reimbursed out of the
Investor Education Protection Fund established by the Central Government. 18
In order to keep a balance between the need for investor protection as well as companies
rights, if an application filed before NCLT is found to be frivolous, the NCLT shall order the
applicant to pay to the opposite party such cost, not exceeding INR 1 lakh. 19 This is provided
in order to avoid misuse of this provision by unscrupulous minority shareholders to hamper
the functioning of the company.
The NCLTs order is binding on the company and all its members, depositors,
auditors, advisors etc.20 Non-compliance shall attract a fine between INR 5 lakhs and 25
lakhs for the company, in addition to imprisonment (up to 3 years) and fine (between INR
25000 and 1 lakh) for the officer in default.
Banking companies are kept outside the purview of class actions as Banking
Ombudsman Scheme introduced by RBI under Banking Regulation Act, 1949 serves well to
redress customers grievances in an expeditious and inexpensive manner. The RBI has
proactively started issuing general directions called class actions to all banks so as to
protect the bank customers against banks' act of commissions and omissions. Such directions
are issued by it in cases that could benefit not only the applicant but all those customers
similarly placed without their having to approach their respective banks/ the Reserve Bank.
Another feature of this provision is that after having joined a class action,
members/depositors cannot resort to individual litigations as when an application is admitted,
all similar applications prevalent in any jurisdiction have to be clubbed together into a single
application. So, whatever may be the outcome of the litigation, an individual cannot appeal
on his own with a grievance that he did not get compensation commensurate with the loss he
personally suffered. This is a welcome step in a country like India, as allowing individual
applications would only add up to the increasing backlog of cases pending before
courts/tribunals, thereby destroying the purpose of class actions.

ADVANTAGES
The intention of inserting Section 245 is not only to safeguard the interests of the
members of the company, but also the depositors, unlike Sections 241 to 244 of the 2013 Act
17

Companies Act, 2013, Section 245(5).

Companies Act, 2013, Section 125(3)(d).
19
Companies Act, 2013, Section 245(8).
20
Companies Act, 2013, Section 245(6).
18

81

which provide protection only to the members against oppression and mismanagement. Also,
under Section 245, an application can be filed even against the auditors/ advisors/ consultants
etc. whereas as application for oppression and mismanagement can only be filed against the
company and its statutory appointees. So, if a case like that of Satyam surfaces now, the
shareholders can also sue the auditors for fraud. This will ensure that experts, advisors and
auditors of the company act carefully and diligently before advising a company and its
management.
The biggest benefit that class action suits carry in a country like India is that it
provides small investors, who otherwise cannot afford to institute individual suits against
well-financed corporate opponents, a medium to fight a case as one unit and claim damages.
This ensures that the damages claimed are spread equally amongst all the claimants. This also
gives them the funds to engage superior legal talent for fighting their case.
Class action suits also reduce multiplicity of suits by clubbing all similar applications,
thereby saving courts time by avoiding individual trials in different courts. By instilling a
fear of litigation in the companys management, it makes them more responsible and
accountable as any class action suit will have an adverse impact on the brand equity of the
company.

CONCLUSION
Class actions, being so successful in nations like the USA, leave no doubt that they
will change the casual way with which some companies function in India and will definitely
increase investor confidence. The fear of class actions will keep the managements as well as
the auditors/experts/consultants on their toes. This would mean fair disclosures to the general
public and thus, strengthening the reputation of Indian companies.
As Barack Obama has rightly put it, A good piece of legislation, is like a good
sentence; or a good piece of music. Everybody can recognize it21, the enthusiasm and
awareness to file class action suits can already be seen by a representative suit similar to a
class action suit filed on January 15, 2014 under Order I Rule 8, CPC (as Section 245 has not
been notified by the MCA as yet) by Modern India along with 3 other investors against
Financial Technologies (India) Limited (FTIL) and 37 other entities, including defunct

21

William Finnegan, The Candidate, The New Yorker,

http://www.newyorker.com/archive/2004/05/31/040531fa_fact1.

May

31,

2004,

available

at

82

National Spot Exchange Ltd (NSEL), which is facing a payment settlement crisis, to stop
them from selling their assets till the case is resolved in court.22
The need of the hour is to make the investors aware of their rights and encourage
them to form investor associations23. Also, Indian practice rules should introduce contingency
fee arrangements in class action suits so that more and more lawyers are encouraged to help
these small investors. The major challenge that lies before India now is how well it can
enforce a mechanism like class actions, considering there is a huge difference in the
implementation of laws between India and other developed countries where this concept is
used

robustly.

22

Khushboo Narayan, Modern India files class action suit in NSEL case, Live Mint, January 15, 2014,
http://www.livemint.com/Companies/dBYpED1LWXWA9Vp4F1qX9O/Modern-India-files-class-action-suitin-NSEL-case.html.
23
There are just 26 SEBI registered investor associations as on February, 2014.

83

CORPORATE LAW E-JOURNAL

ISSUE 4, SEPTEMBER 2014
CENTRE FOR BUSINESS AND COMMERCIAL LAW
NATIONAL LAW INSTITUTE UNIVERSITY