Exodus of Indian HNIs: Risk to Aspirations

India’s economy continues to be on a path of sustained growth. Especially over the last decade and a half or so, several factors have contributed to this growth. These include globalization, a large domestic market, policy reforms, technology-driven disruptions, and much greater levels of entrepreneurial activity than in the past fifty years. On the back of a robust start-up ecosystem and a flow of risk capital, 44 unicorns were created in India during 2021; the first four months of 2022 have seen 14 more Indian ventures get that coveted status. This is truly a remarkable achievement in the face of the large-scale shocks the global economic system has suffered in recent times.

It is estimated that over the next decade, the number of Indian millionaires and billionaires (in terms of US dollars) will rise by over 80%. This represents a significantly higher growth rate than that which will be seen by the US, UK, Germany or France. While this is undoubtedly good news, there is also some sobering news: an estimated 8000 high-net-worth Individuals (HNIs) are likely to relocate from India in 2022 alone. In 2019, an estimated 7000 Indians left India.

At different points in time, different destinations have attracted Indian HNIs. At this time, Singapore, Australia and the UAE are the top destinations, although European nations such as Portugal and Greece are also seeing a rise in the number of Indian HNWIs relocating to their jurisdictions given the benefits of lower costs, the mobility advantages of EU member nations and less stringent physical residency requirements. Just as important are the tax regimes of these countries vis-à-vis what prevails in India. More HNIs staying in India for an adequate number of days in each financial year is helpful in bringing their global income under Indian tax. However, it must also be kept in mind that even when families stay in India for shorter durations to minimise their income tax liabilities here, they will end up paying GST on various goods and services they consume.           

A growing number of Indian business families are taking a considered view of where their members should be based, what citizenship(s) they should hold and where their companies should be registered for regulatory and tax purposes. The travel bans imposed at short notice to curb the pandemic has provided one more reason for many to reconsider where their home bases should be. While reasons will naturally vary with specific individuals and families, this trend of wanting to move out is more evident amongst first-generation entrepreneurs, compared to more-established business houses. It is also more prevalent in new age businesses that are built on new technology paradigms and require clarity and relative stability in the regulatory frameworks. This is not to say that western countries are automatically better in this regard: the EU recently announced that device manufacturers must move to standard mobile charging ports (for phones, tablets, cameras, earbuds, etc.) in the next 2 years – a decision that is expected to significantly impact Apple.

As governments take more action against climate change, to protect data privacy and to regulate AI, 5G, etc., new regulations will come into existence at a faster pace than before. More changes to existing rules and regulations can also be expected. There’s also a greater likelihood of new trade blocs forming and countries becoming members of multiple blocs. There is also likely to be greater harmonisation of tax rates (the first steps have already been taken). In the face of such changes, families need to more carefully think through decisions such as the location of businesses, holding structures, governance and multi-jurisdictional estates in order to ensure smooth inter-generational wealth transfers.

Image Credits:

Photo by Monstera: https://www.pexels.com/photo/anonymous-person-magnifying-view-of-coins-shaped-in-world-map-7412098/

A growing number of Indian business families are taking a considered view of where their members should be based, what citizenship(s) they should hold and where their companies should be registered for regulatory and tax purposes. 

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Voluntary Liquidation Process Under IBC: An Update

The Insolvency and Bankruptcy Code, 2016 read with, the Insolvency and Bankruptcy Board of India (Voluntary Liquidation Process) Regulations, 2020, establish a procedure for the voluntary liquidation of solvent corporate persons.

However, in practice, it can be observed that the majority of voluntary liquidation processes are getting delayed. As per the Discussion Paper released by IBBI, as on December 31st, 2021, 1105 voluntary liquidation processes have been initiated. Of which, the liquidators have submitted final reports to the Adjudicating Authority (AA) in 546 cases only. In other words, more than 50% (i.e., 559 cases) of the voluntary liquidation processes are still ongoing. On closer perusal of the ongoing cases, it is found that 293 cases (around 52%) of them have crossed the one-year time mark. In this background, the Voluntary Liquidation Process (Amendment) Regulations, 2022 have been introduced on April 5th 2022 by the IBBI.

Brief Analysis of the Voluntary Liquidation Process Amendments

The new changes seek to complete the voluntary liquidation process in a quick and efficient manner and ensure that the company does not lose value on its remaining assets since the asset value falls drastically with time. Further, the amendment seeks to clarify the date of the commencement of the liquidation process.  Now, the liquidator shall complete the liquidation process and ensure the submission of final reports within 270 days, 90 days earlier as compared to the statutory time period of 12 months. As per the Discussion Paper released by IBBI, Voluntary Liquidation, being non-adversarial in nature, can be completed in 270 days. Further, the liquidator is directed to distribute the proceeds from realization within 30 days from the receipt of the amount to the stakeholders, as compared to the earlier mandated time period of 6 months.

For the past few years, the government has been promoting several initiatives focusing on “ease of doing business” for corporates. However, it is essential to observe that “ease of doing business” does not only include ensuring a seamless start of a business but also includes a quick and easy structure for the exit.

In this backdrop, in the Union Budget 2022-2023, the Honourable Finance Minister announced that “Now the Centre for Processing Accelerated Corporate Exit (C-PACE) with process re-engineering, will be established to facilitate and speed up the voluntary winding-up of these companies from the currently required 2 years to less than 6 months[1].”

Further, in a Discussion Paper released in February 2022[2], IBBI identified the following problems plaguing the voluntary insolvency process:

  1. It was pointed out that the values of assets fall drastically, and hence a quick and efficient liquidation process is pertinent. However, the Code has failed to stipulate a time limit for such a voluntary liquidation process.
  2. It was also observed that more than 50% of the voluntary liquidation cases had been ongoing as per the data presented to the Board (as of December 31st, 2022). Further, 52% of the ongoing cases had crossed the one-year mark.

The relevant stakeholders also observed that one of the aspects that prolong the voluntary liquidation process is the practise of seeking a ‘No Objection Certificate’ (NOC) or ‘No Dues Certificate’ (NDC) from the Income Tax Department by liquidators during the process, even though the Code and the Voluntary Liquidation Regulations have not mandated the issuance of NOC/NDC. In this regard, the Board issued a Circular in November 2021, clarifying that “an insolvency professional handling a voluntary liquidation process is not required to seek any NOC/NDC from the Income Tax Department as part of compliance in the said process.”[3]

In alignment with the intention of the legislation, the Board has introduced the following amendments to optimize the voluntary insolvency process:

Section 10 (2) (r): Corporate Debtor shall be substituted by Corporate person

The amendment states that the liquidator shall maintain such other registers or books as may be necessary to account for transactions entered by the corporate debtor with the corporate person. This ensures holistic coverage of all financial transactions of the corporate debtor for the purpose of liquidation.

Section 30 (2): timeline for preparation of the list of stakeholders in case where no claims are received is reduced

 

Section 30 (2) requires the liquidator to compile a list of stakeholders within 45 days from the last date for receipt of claims. The amendment inserts the following provision; “Provided that where no claim from creditors has been received till the last date for receipt of claims, the liquidator shall prepare the list of stakeholders within fifteen days from the last date for receipt of claims.”

Previously, no differentiation between the timelines was prescribed in cases where there were no claims from creditors. This timeline was introduced because if no such claims were received till the last date, then it must not take much time for the preparation of a list of stakeholders as the list of shareholders/partners is available with the liquidator at the time of commencement.

Section 35: Timeline for distribution of the proceeds from realization reduced

The amendment reduces the period for distribution of proceeds from realisation to the relevant stakeholders to a period of thirty days from the receipt of the amount, from the earlier mandated six months.

The reason for the reduction of this timeline is that the liquidator remains in close contact with the corporate person and hence should be able to distribute the proceeds quickly.

Further, in cases where there are creditors, since the resolution regarding the commencement of the process is approved by the creditors representing two-thirds of the value of the debt of the corporate person, distribution to the creditors should also take much less time than is currently stipulated.

Section 5(2): Timeline for intimation of appointment as liquidator to the Board enhanced.

5(2) provides that an insolvency professional shall notify the Board about his appointment as liquidator within 3 days of such appointment.  As per the amendment, the regulation has changed the timeline for the intimation from 3 days to 7 days.

Section 37: Timeline to complete the liquidation process reduced.  

The amended provides that if the creditors approve the resolution, the liquidator shall complete the liquidation process and submit the final report to the registrar, board, and adjudicating authority within 270 days from the date of the commencement of the liquidation and within 90 days from the liquidation commencement date in all other cases (where there are no creditors for the company). Previously, the time period for completion of liquidation was one year and no such bifurcation of the time period for completion of liquidation on the basis of the presence or absence of creditors was enumerated. The reason for this reduction in the timeline for completion is that the liquidation estate of the corporate person undergoing the voluntary liquidation process is non-adversarial and also generally straightforward both in terms of the size and heterogeneity of the assets involved. Therefore, the realisation of the assets involved during the voluntary liquidation process takes less time as compared to the liquidation process.

Section 38(3): Final Report and Compliance certificate shall be submitted in Form-H.

Section 38 directs the liquidator to submit the final report to the adjudicating authority along with the application. The amendment has specified Form H for submission of the final report. Such specifications were not provided previously. A compliance certificate provides a summary of actions taken by the liquidator during the voluntary liquidation process. It will assist the Adjudicating Authority in expediting the adjudication of dissolution applications.

Section 39(3): Form H substitutes Form I

As per the amended Rules, Section 39 (3), the stakeholder claiming entitlement to any amount deposited into the Corporate Voluntary Liquidation Account, may apply for an order for withdrawal of the amount to the Board on Form H and not Form I.

Date of Commencement of Liquidation

The amendment clarified that for the corporate person who has creditors representing two-thirds of the debt of the corporate person, the date of liquidation commencement is the date on which such creditors approve the declaration passed for the initiation of the liquidation.

Note: In order to curb delays in liquidation, the Board had recently issued a circular clarifying that an Insolvency Professional handling a voluntary liquidation process is not required to seek any NOC/NDC from the Income Tax Department as part of compliance in the said process.

Conclusion

The amendments effectually fall in line with the Board’s intention to substantiate a streamlined and quick voluntary insolvency procedure, which certainly can be perceived as an initiative in the right direction. The proposed amendments by curtailing the unwarranted time spent on various activities (such as obtaining a No-Objection Certificate from the Income Tax office) may ensure the early completion of the voluntary liquidation process, thereby, providing a quicker exit for the corporate person. Further, the proposed reduction in the time taken for distribution of proceeds would result in an early distribution to the stakeholders and thereby, promote entrepreneurship and the availability of credit. It will assist the Adjudicating Authority in expediting the adjudication of dissolution applications.

The amendments effectually fall in alignment with the Board’s intention to substantiate a streamlined and quick voluntary insolvency procedure, which certainly can be perceived an initiative in the right direction.  The proposed amendments by curtailing the unwarranted time spent on various activities (such as obtaining No-Objection Certificate from the Income Tax office) may ensure early completion of the voluntary liquidation process, thereby, providing a quicker exit for the corporate person.

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Why Businesses Should Focus on ESG?

The world has changed in many fundamental ways especially in the last 25 years. I am not referring to technology-led transformation or geopolitical shifts, this piece is about Environmental, Social and Governance criteria – collectively referred to as “ESG”.

Environmental Criteria

 

Environmental costs, which were for long viewed by economists as “externalities”, are now an important consideration in decision-making by governments and business leaders. Given the devastating effects of widespread environmental degradation and climate change, countries around the world are taking concrete actions to limit further damage; many are setting “net zero” emission targets for individual sectors over the next couple of decades. As a result, new legislations are being enacted that require businesses to act in certain ways and desist from other kinds of actions. Arguably, this is the biggest facet of change globally.

Social Criteria

 

The second area of change is that various forms of social injustice are no longer being tolerated. While there were always rules against such inequities, there is now a greater cost imposed on organizations that violate these rules- not just by governments and regulators, but also by consumers, who choose to shift loyalties towards brands that exhibit greater sensitivity to social causes. By definition, social injustice covers a broad range of issues that includes exploitation of children, women or certain races (e.g., the Uighurs); not providing employees good working conditions (physical environment, denying employees time for bio-breaks and rest, harassment at the workplace etc.); discrimination against people with disabilities, gender, age or marital status; even selling goods that are not safe or bad for health arguably fall under this category.

Governance Criteria

 

The thrust on “governance” is the third major driver of change. It is not as if rules and regulations did not previously exist to prevent breakdowns in governance. Yet, there are a number of examples from around the world that showcase bad governance: from companies in South Korea, Japan, the USA and Europe to the ongoing matters at the NSE and BharatPe in India.

 

Why ESG Adoption is Crucial?

 

In recent years, various members of business ecosystems worldwide, including enterprises, investors, regulators and the general public have become far more aware of the importance of compliance with “ESG” norms and standards. They are much less willing to tolerate breaches in an organization’s “ESG” conduct.

At one level, companies that do not do well on “ESG” parameters are more likely to face explicit financial penalties (e.g., carbon taxes). But just as important are the hidden costs that will increasingly need to be borne by ESG laggards. Perhaps the most important is the reduced access to capital because both banks and PE/VC firms are incorporating ESG criteria into their funding/ portfolio strategies.

On the demand side, many consumers (especially from the younger generations) are more conscious of brands that fare better in terms of their commitment to ESG and this, in turn, shapes their purchase decisions. Brands can quickly lose market share if they do not raise their ESG game.

As shown in the chart below, data over the past decade reveals that companies that have successfully implemented ESG strategies have consistently performed better than other global companies that have not paid as much attention to ESG.

 

Source: Stoxx.com quoted in https://sphera.com/spark/the-importance-of-esg-strategy/

This out-performance can be attributed to a combination of factors, including faster top-line growth, sustained cost reductions, higher employee productivity and reduced employee attrition and of course, fewer instances of fines/penalties for non-compliance. Investment decisions and technology choices that are guided by ESG considerations will drive a more efficient allocation of capital; in turn, this will boost ROCE (Return on Capital Employed).

While it is convenient to look at the three strands of ESG separately, in reality, they are closely intertwined. The sooner business leaders acknowledge that ESG is not a fad or a feel-good factor, but in fact, makes sound business sense, the better it is for the world as a whole.

 

Start Your ESG Journey Right Away

 
Someone quipped that the best time to plant more trees was years ago, but the second-best time is now! It’s not too late for you to begin your ESG transformation. But make sure you do it as a well-structured program, and not merely a hotch-potch of initiatives that have no clear owners, goals or measures and therefore cannot be sustained.

 

To report ESG performance, you can take the help of commonly used frameworks such as the following:

  • UN Sustainable Development Goals (SDGs)
  • Global Reporting Initiative (GRI)
  • Sustainability Accounting Standards Board (SASB)
  • Climate Disclosure Standards Board (CDSB)
  • Task Force on Climate-related Financial Disclosures (TCFD)

Image Credits: Photo by Photo Boards on Unsplash

While it is convenient to look at the three strands of ESG separately, in reality, they are closely intertwined. The sooner business leaders acknowledge that ESG is not a fad or a feel-good factor, but in fact, makes sound business sense, the better it is for the world as a whole.

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Beyond the Pandemic: Are we Recovering with Integrity?

This morning, I came across a news report about an autorickshaw driver in Bangalore who returned Rs10000 that was erroneously transferred to his account. He had just dropped off a passenger, who had paid the fare via UPI. Sometime later, the auto driver received a payment of Rs10000 from the same passenger’s mobile phone. Turns out that soon after getting off the auto, that passenger had received a request from his friend to transfer Rs10000, but by mistake, he had transferred the amount to the auto driver’s account. The honest auto driver called up the passenger and returned the money. The grateful passenger wrote a letter of commendation to the police authorities.

While the above news report gladdened my heart, I have also, in the last few days, read news reports about independent directors of various companies resigning from their respective Boards for various reasons. While honesty and integrity have not altogether disappeared, it is saddening that there seems to be a dearth of these values in the corporate world- where, arguably, they are needed the most. I therefore write this piece with mixed feelings.

E&Y’s Global Integrity Report 2022 reveals that a third of the respondents from India reported that their organizations had suffered a “significant incident of fraud” in the last 18 months. In itself, this is a grave concern but what’s worse is that India ranks second worst in this survey, which polled business executives from 54 countries. The survey’s other findings about Indian executives and companies are cause for worry too. Almost two-thirds of the respondents from India have acknowledged that to benefit their careers, they would be willing to indulge in patently unethical conduct such as falsifying information, paying/receiving bribes or ignoring misconduct in their teams/organizations.[1]

The economic disruption that has occurred in the wake of the pandemic has undoubtedly increased challenges for organizations across industry sectors. Owners, business leaders and employees at all levels have experienced the impact in many ways- cost cutting, job losses, scaling down, longer working hours, greater difficulty in closing deals through virtual channels etc. The magnitude of the impact has been varied but some sectors have bounced back faster than others and depending on the nature of their business, have been able to adapt better to hybrid models of working. But to me, nothing gives anyone the excuse to compromise on one’s integrity and ethics. It is better to work smarter and harder, have honest conversations within the organization and with clients or reach out for help than to succumb to the temptation of short cuts. Once we fall prey, it’s a slippery slope, and there’s almost always no going back.

One of the most important lessons I have learnt from my father and grandfather is to never compromise ethics and integrity no matter what the reasons or potential payoffs. This is one of the core values that our firm holds dear. Every individual who is part of our organization understands the importance of honesty, personal and professional integrity and ethics. To me, leadership is not just about vision, strategy and execution or delivering financial success; it is as much about being able to hold one’s head high and look at anyone in the eye because there is nothing to hide in our conduct or speech. And this is what my colleagues and I strive hard to practise every single day.

 

The economic disruption that has occurred in the wake of the pandemic has undoubtedly increased challenges for organizations across industry sectors. Owners, business leaders and employees at all levels have experienced the impact in many ways- cost-cutting, job losses, scaling down, longer working hours, greater difficulty in closing deals through virtual channels etc.

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Family Businesses Must Think and Act Like the Boy Scouts

A couple of weeks ago, India’s first Chief of Defense Staff, Gen. Rawat, his wife Mrs. Madhulika Rawat and a dozen other army/air force officers and personnel died in a helicopter crash near Coonoor. The loss of any life is sad, but this tragedy was of much greater proportions because Gen. Rawat had only begun the critical task of rearchitecting India’s defense forces in ways that enable greater integration. In a few weeks, our government will assign someone else the responsibility for leading the transformative process that Gen. Rawat had begun; after all, institutions like nations, their armed forces and even corporates are larger than individuals.

But what this tragic incident has painfully reinforced for many of us is the unpredictability of life. And if it hasn’t, it should. There are striking parallels that can be drawn between the outcomes of this helicopter crash and what happens when the head of a family business suddenly dies or becomes incapable of running the company. Both are sudden and cause large voids that can be hard to fill because the next generation family members are young and inexperienced or perhaps not interested in the traditional business.

This is why succession plans must not only cover people in leadership roles but also entire businesses. Maybe a strategic sale should be triggered or perhaps several group companies that already share synergies should be merged and after a few years, the entity could go public. The specific strategy is not the point of this article; rather, the key point I wish to make is that family businesses in particular should be ready with this kind of thinking. Not just a slide deck with the future strategy and trigger events, but at a much more granular level so that implementation becomes easier for those who will become responsible for it.

By the way, the sudden death of founders and leaders is by no means the only uncertainty that family businesses need to be prepared for. Many family businesses have complex holding structures that involve the formation of trusts registered in India and elsewhere. But the world is witnessing a new wave of concerted actions that are aimed at shoring up tax revenues by plugging various loopholes and tax planning avenues that have existed for years. As a result, tax laws can change quite drastically in various jurisdictions. And as geopolitical realignments occur and new regional partnerships are forged, regulatory changes may impact more than just one country. Family businesses that either does not plan for such risks or are not agile enough to respond quickly might find themselves seriously disadvantaged.

Plans are ultimately plans, and any plan can go wrong. Who, for example, could have forecast the Covid pandemic or that it would stretch for 2+ years (and God knows how much longer)? But that does not mean that there is no merit in planning. What is vital is to plan for various scenarios and figure out a solution that works best under a majority of situations. This needs expert advice and more important, perspectives and business savvy. The role of business advisors needs to change; they must acquire and hone their ability to transcend silos or be a part of the right ecosystem so that they are able to orchestrate the best advice for their clients and thereafter, help them execute the strategies and plans.

If you’re still wondering about the reference to the Boy Scouts in the title, I just wanted to tell family businesses to “Be Prepared”.

PS: Being slow to adopt cutting edge technological capabilities and putting them to use to capture insights that help drive strategies is another form of risk – but one that applies to more than just family businesses.

Image Credits:  Photo by Pixabay from Pexels

Many family businesses have complex holding structures that involve the formation of trusts registered in India and elsewhere. But the world is witnessing a new wave of concerted actions that are aimed at shoring up tax revenues by plugging various loopholes and tax planning avenues that have existed for years

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Impact of India's Proposed Central Bank Digital Currency (CBDC)

Numerous signals have been emanating from the government and the RBI in the past several months to indicate the imminent launch of India’s Central Bank Digital Currency (CBDC). This includes the announcement last month that the Cryptocurrency and Official Digital Currency Bill, 2021 will be tabled for discussion in the ongoing session of the Indian parliament.

What is a CBDC?

In simple terms, it is the digital version of legal tender issued by a sovereign central bank. In terms of value, it is the same as the country’s fiat currency and is exchangeable with physical currency on demand. Thus, India’s CBDC will be denominated in Rupees. Like physical currency notes/coins, CBDC can be used by individuals and businesses as a store of value and to make payments for purchasing goods/services.

 

Why does India need a CBDC?

There are many reasons why countries will need their own CBDC systems. In India, interbank transactions and settlements already take place through the reserves individual banks maintain with the RBI, so there may not be much impact in this arena. However, in the retail segment, a bulk of the transactions still rely on physical cash and increasingly, on digital payment solutions. It is important to recognize that payment solutions such as those from Google, Amazon, Apple, or Paytm and Phonepe are all privately-owned and controlled; as such, their growing popularity does pose a risk to the country’s financial system.

For example, it is estimated that 94% of mobile payment transactions in China are processed on transactions owned by Alibaba or Tencent. As the companies behind these apps start to build “ecosystems”, more and more goods and services can be paid for through these apps. Such integration and breadth of usage can easily create a virtual stranglehold that has the potential to place at risk the entire financial system of a country; there could even be regional or global ripples. The launch of a CBDC is thus not just a digital payment system, but also a mechanism towards mitigation of major risks that are associated with an increasingly digital world.

Currently, all payment solutions in India, whether developed and deployed by fintech players, Big Tech or banks, run on the Unified Payments Interface (UPI) infrastructure built and managed by the National Payments Corporation of India (NPCI), which is jointly promoted by the RBI and the Indian Banks’ Association (IBA). That India’s payments backbone has never been in private hands reduces the level of risk to our financial system. Also, it must also be acknowledged that the NPCI has done a fabulous job so far. The month of October 2021 alone saw more than 4.2 billion transactions being processed through NPCI infrastructure. But it is important to keep in mind that the payment apps owned and managed by fintech and Big Tech companies are not under the direct regulatory supervision of the RBI because they are not licensed banks. A CBDC-based ecosystem will make the regulation of such apps and platforms easier and more effective- thus enabling a higher degree of consumer protection. 

There are other reasons too why an Indian CBDC will become a necessity sooner rather than later. Countries like China are already at an advanced stage of launching their versions of CBDC. Given global cross-border trade and investment flows and repatriation of funds by Indian diaspora overseas and tourist travel, it is only a matter of time before Chinese or other CBDC enter the Indian financial system. And as more countries launch their own CBDC, it is imperative that we have our own, so that we can negotiate from a position of experience (and strength) when it comes to agreeing on multilateral CBDC protocols.

A well-designed CBDC system reduces the threat of counterfeit currency- something that our adversaries have used over many decades to weaken our economy. Arguably, CBDC can also play an important role in the nation’s fight against corruption and black money- although much will depend on how it evolves and the operational rules and regulatory framework governing it.

 

CBDC: The Road Ahead

At this time, it is unclear when and how the government will choose to launch India’s CBDC. But it is fair to say that an entirely new digital currency ecosystem will be needed. It is likely that the RBI itself will cause to design, develop and run the CBDC infrastructure. There are also speculations that they would be regulated as financial assets by the Securities & Exchange Board of India (SEBI). Big Tech, fintech and banks will need to link their apps to this new infrastructure as well- assuming that over time, individuals will retain the option to pay via physical currency-backed UPI platforms or their CBDC cousins.

Since no regulator can compete with those it is tasked with regulating, the RBI may have to let financial intermediaries continue to take responsibility for the distribution of digital currency via e-wallets or other pre-paid digital instruments and similar solutions. This also means that fintech players, BigTech and retail banks will need to evolve their platforms and come up with innovative offerings to ride this new wave of opportunity. The road ahead will have its own challenges at both the policy and operational levels. The success of CBDC will also depend on how quickly internet access expands across the country and how resistant to hacking and breaches the underlying systems are.

Fasten your seatbelts and prepare for an interesting ride at the end of which, digital currency could be the crowned king. 

 

Image Credits:  Photo by Alesia Kozik from Pexels

At this time, it is unclear when and how the RBI will choose to launch India’s CBDC. But it is fair to say that an entirely new digital currency ecosystem will be needed. It is likely that the RBI itself will cause to design, develop and run the CBDC infrastructure

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Tools for Effective Succession Planning for Family Businesses

The pandemic has hurt many families. There is no solace or succor for the lost loved ones. Yet as harsh as it may sound, life has to go on, for the rest of the family. This feeling of vulnerability has to be channelized to ensure that every entrepreneur, business owner, and head of business family think of securing themselves legally to ensure succession & estate planning.

It is way past the days when parampara (tradition) and prathistha (prestige) and prashasan (administration) were sufficient for a family to run its business. Since change is the only constant, the pandemic has forced many family businesses to re-consider and re-structure their succession and legacy planning as it has drastically increased the probability of unforeseeable deaths and long-term health complications of the family members. Demise of the family’s patriarch in the absence of a legitimate will, post-covid health complications rendering everyday functions and business operations redundant are some of the scenarios which are impairing the families resulting in stress, loss of business liquidity, and business opportunities.

Despite the abovementioned challenges and economic uncertainty statistics reveal a strong resilience for recovery. In the current financial year. 51% of family businesses are eyeing opportunities for growth in the domestic market, 22% shall be focusing on diversification, while 10% are contemplating entering the international markets[1]. However, it has also paved the way for drastic changes in the ways a family business shall operate.

Two areas that will be witnessing restructuring in the family business operations are; legacy planning and digitization. According to PWC’s 10th Global Family Business Survey, 2021[2] over 87% of family-run businesses have identified digital innovation and technology as the focal point of priority over the next two years. Succession planning is one of the most sensitive issues in family-run businesses. However, Covid 19 appears to have concentrated minds in this area. The survey confirmed that 20% of business families have incorporated a formal succession plan, while 7% of such families have revised their legacy plans in light of the pandemic.  

This piece intends to explore various tactics, legal resources, and preventive measures that are currently available at the disposal of family businesses to adopt a viable succession plan and lay down a comprehensive list of suggestions and actions that can be immediately incorporated and undertaken by such entities to this effect.

Dos and Don’ts of Succession Planning

 

While undertaking measures to establish a legacy plan, family harmony and communication are the two keys, which are imperative to be kept at the forefront. It is pertinent to ensure that succession planning does not prove to be detrimental to a family’s peace and unity.

The following two approaches should be incorporated while formulating a succession plan for a family business, in favor of the family’s interest:  

  • Family Harmony Comes First: Successful family business owners have believed that selflessly putting the family first is key to the survival of their business. Decisions that keep the family together should be given priority even if they could potentially cause short-term losses. Dynasties crumble due to family feuds and individual egos overpowering affection and mutual respect.
  • Communication is the Key: There needs to be clarity amongst all the family members, especially the next generation about their future roles. The older generation needs to have an open discussion with the young beneficiaries, about their exit and the subsequent taking over of the business after them. Similarly, the younger generation needs to communicate their plans for the future and expectations in advance so that a succession plan can be tailored in line with their mutual terms of agreements and prospects. It is advisable to engage an external facilitator who can assist the concerned parties to convert their aspirations, interests, and competencies and formulate a plan in the larger interest of the business. If the younger generation wants no part in the family business, then their decision should be respected otherwise a forced responsibility in the family business either through a Will or otherwise will only lead to resentment and strife in the family; and be violative of industry’s regulatory clauses depending upon the nature of business.
 
 

Planning for Protection of Assets in the Event of Succession

 

Most Indian family-owned businesses managed their assets and wealth themselves. Therefore, succession was either governed by will or personal laws. However, since succession and property laws are unique to every religion, the process became complex.

The indifference and ignorance of senior members of the family towards these issues is the primary cause for extensive litigation cases, mainly pertaining to title disputes. The following succession planning tools are recommended to sidestep from such scenarios:

  1. Will: Leaving behind a validly executed Will is the most uncomplicated mode through which a property can be passed down to the next owner. There is no fixed format for a Will under the law. The only requirements for a valid Will according to the Indian Succession Act, 1925 are; it should be made by a sound adult, signed by them, and attested by two witnesses. It is recommended that an Executor be appointed in the Will to reduce hassles. It is not compulsory to register a Will. Probate is also required only if the Will is made in Bengal, Bihar, Orissa, and Assam and within the local limits of the ordinary original civil jurisdiction of the High Courts of Madras and Bombay or where the property of the deceased is situated in these areas.

There are two scenarios that are to be considered while determining the ownership of a share in the family business after the death of a person:

  • In case a person dies leaving a Will: A person can make a bequest of his share in the family business by a Will according to the constitution of the family business:
    1. Corporate Structure: Large family businesses often operate through a private company structure in which the shares are issued to family members and the management positions are held by family members. Shares held by an individual family member can be willed by that person. A family company continues to operate after one’s death as it is a separate legal entity. The assets in the company belong to the Company alone and cannot form part of the estate and therefore cannot be transferred by a Will.
    2. Partnerships: Most small-scale family businesses in India work through the partnership model. The Partnership Deed between the family members as partners should ideally have a clause that provides for the procedure to be followed on the death of a partner. A family business owner can make a bequest of his share in the partnership in the Will, but the beneficiary does not become a partner to the firm unless all the partners of the firm consent to it.
    3. HUF: Many traditional family businesses do not have a formal document in place but may operate through a Hindu Undivided Family (HUF). According to Section 30 of the Hindu Succession Act, 1956, a person can make a testamentary disposition of his share in a co-parcenary property i.e he may dispose of his share in the assets of the family business (HUF) through a Will.
  • In case a person dies without leaving a Will: The ownership of the stake in the family business will be determined by intestate succession i.e succession according to the personal law of the deceased individual. The heirs will be determined in accordance with the religion of the intestate for example Hindus, Buddhists, Sikhs, and Jains will be governed by the Hindu Succession Act, 1956, Muslims will be governed by the Mohammedan Law and all others will be determined by the Indian Succession Act, 1925.
  1. Trusts: The Indian Trusts Act, 1882 governs the creation of a Private Trust. A trust may be created during the lifetime of a person, referred to as the author / s It may be created with a written legal document through which the assets of the settlor are placed into a trust and trustees are appointed therein who manage these assets for the benefit of the settlor and the beneficiaries named in the Trust Deed. The biggest advantage of Trust is that it operates both during and after a person’s life.
    • A written Trust Deed is signed by the Settlor, requires a minimum of two trustees and two witnesses. The trust may or not be registered; registration is required only if an immovable property is transferred to the trust.
    • Family wealth can be secured with the help of trusts. The manner of conducting business, areas of responsibility, and pre-empting scenarios can also form part of the trust constitution.
    • Another benefit of Trust as a planning option is its dependability during a crisis. It helps in ringfencing the assets from any action taken by creditors or banks in the event of a financial crisis.
    • When a settlor dies, the trustee pays the debts, files the tax returns, and distributes the assets of a deceased. Trusts are an effective estate-planning tool if one wants to avoid the costs and hassles involved in obtaining probate. It is a quick and quiet procedure, preserving one’s privacy and done without any court interference.
  1. Family Constitution/ Charter/ Framework: Business assets such as securities can be accounted for in a Will or a Trust, however, it is also necessary for a family business to plan for succession of management of the business. These are often covered in Family Constitutions or any other business manifests. It clearly lays out the interaction between the family and the business. It is a document that can be used for governing the administration of the family business. Apart from detailing the values and ethos of the family business, it may also specify rules like the incoming generation would need to get a master’s degree and, work outside to ensure they are well equipped when they join the business. It may also make provisions for events like death, marriage and divorce in the family. However, for any family members to succeed onto the Board of Directors or any other Key Managerial Position, resolutions by the existing Board of Directors and/or shareholders would be required. It is recommended that the younger generation (if adults) should be made aware of the Family Charter, allowed to participate and their opinions should be given due consideration so that the document is in line with the thoughts of the incoming members of the business. This helps in maintaining a balance between the old and the new.
  1. Family Arrangements: Family arrangement resolves present or possible future disputes among family members ensuring equitable distribution of property among the family members. In a Family arrangement, a member gives up all claims in respect of all the properties in dispute other than the ones falling to their share. The rights of all the others are recognized. Therefore, under a Family arrangement, members of a family may decide amongst themselves about the distribution of the property of the deceased. A Family arrangement would have to be appropriately stamped and registered. However, even oral arrangements are valid in the eyes of law.
  1. Clear Retirement Policies: While making a succession plan, there should be a provision for a clear retirement policy that includes defining the benefits and shareholding of the outgoing generation post-retirement.
  1. Guardianship: Where minor children are involved, it is very important to make provisions either in a Will or by Trust, for appointing a guardian for minor children in the event of a parent’s death. If one parent dies, then the other living parent likely becomes the guardian subject to personal laws. If both parents die, then it is needed to mention who will be accorded guardianship. Failure to do so will involve the intervention of courts and various applicable laws given India’s pluralistic society. The need for an appropriate guardian is not only to provide for personal needs but to also ensure that the share of minors in family businesses are protected during the period of minority.
  1. Conflict Resolution Forums: Family disputes are often dragged to courts and fought in public. Creating conflict resolution forums in the family constitution is recommended where family members can discuss their differences and resolve disputes amicably. These forums may consist of trusted family members or outsiders like family friends who can fairly resolve the dispute. In case the dispute continues, family members may resort to mediation or arbitration. Litigation should be used only as a last resort. To maintain peace in the family, a well-drawn-out conflict resolution forum is necessary. Resorting to legal recourse at the first opportunity creates hostility and breaks down family relations.
  1. Setting up of Family Offices: Keeping track of investments and family wealth as it grows can become an extremely cumbersome task. Family Offices rescue family businesses and high net worth individuals from such burdens along with managing the administrative issues that crop up daily. Family Offices handle investment portfolios, taxes, provide legal support, maintain documentation, and manage shared assets of the family businesses.
  1. Choosing a Successor: The family business will flourish only if a family member has the passion to take on the responsibilities to run the day-to-day business. It is, therefore, important to identify a successor who not only has the skill sets to be the leader but also has the drive and excitement to take the business forward. Forcing the responsibility of running the family business onto uninterested family members would be detrimental to the business as the stakes are high for all stakeholders. When deciding between family and non-family members to run the business, the family should objectively identify and evaluate a variety of candidates early on. Whether family or non-family, they should be given the requisite training and opportunities to grow, and the best candidate often emerges over time. If no family member is qualified and/or willing to take the position, then the current leader must make the tough decision to appoint an external candidate or professional for the role.
  1. Mentoring the Next Generation: An important factor for successful business transfer is mentoring of the next generation of leaders before and after they take over the family business. It would be fruitful to train and groom them so that they learn and understand the culture and values on which the business was built. Often, business owners are afraid to give up their central roles in the system and hand over the reins of the business to newcomers even if they are family members. Successful family business leaders have kept aside their egos and objectively help build the mindset of the prospective leaders. One way to groom the next generation is to give them challenging tasks and the autonomy to make their own decisions. The current generation can also create a management training program for the next generation joining the business, in consultation with key senior personnel. This gives them a flavour of various aspects and functions of the business.
  1. Tackling Issues of Nepotism: One of the biggest challenges in any family business is tackling nepotism allegations, especially by the younger generation. Nepotism is inevitably a part of the package deal that cannot be avoided. If an undeserving family member is given a senior position in the business, it may result in low morale amongst the employees. What can be done is, minimalize its effect on the non-family employees. A good way to tackle nepotism is to set out clear employment policies. What qualifications would be required for a certain position in the business and what is expected from a family member if they do take up that role? Giving them compensation based on their performance instead of their relationship within the family, preparing them thoroughly for a position, and giving them jobs that fit their skill sets are some of the best practices which can be adopted by family-run businesses.

Since change is the only constant, the pandemic has forced many family businesses to re-consider and re-structure their succession and legacy planning, as it has drastically increased the probability of unforeseeable deaths and long-term health complications. Demise of the family’s patriarch in the absence of a legitimate will, post-covid health complications rendering everyday functions and business operations redundant are some of the scenarios which are impairing the families resulting in stress, loss of business liquidity, and business opportunities. 

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The Other Face of Digitalization: Changes to Tax Laws and More

Very often, speeches and articles begin by alluding to an environment of significant change, that brings in its wake, opportunities as well as higher levels of uncertainty. The wave of digitalization triggered by the emergence of various technologies is often cited as a prime example of this change. Digitalization has undoubtedly proved its worth in the past 18 months. Enabling remote working for millions of employees in various industries, enhancing the convenience of online banking, creation of new mobile payment options, virtual video/audio conferences are all examples of how digitalization has transformed the global society.

But there is a flip side to this too. Big Tech companies are growing rapidly, not just in terms of influence but also their financial muscle. To put it in perspective, the combined market capitalization of the top five Big Tech companies- i.e., Apple, Microsoft, Alphabet (Google’s parent), Amazon and Facebook was around US$9 Trillion as of 1 October 2021[1]. By comparison, the market cap of India’s top five companies was around US$750 Billion.

Tax laws need to keep up with the “digital economy”

The pandemic has severely dented government revenues worldwide, while expenses have ballooned. This has led to spiraling fiscal deficits, that have their own consequences. Given that most corporate tax regimes worldwide evolved keeping conventional businesses in mind, and that digital economy businesses are very different in nature, a new corporate tax playbook is clearly needed.

Given its large number of digitally-savvy consumers, a country like India is often one of the top three markets for digital economy companies such as Amazon, Facebook, Netflix, etc. But the nature of their business is such that they can carry out business in India (or any other jurisdiction) without having a significant place of business in that jurisdiction. So while countries like India contributed to revenues, low local operating costs meant higher profits. But this did not translate into higher taxes for India because MNCs registered companies in countries with lower tax rates and assigned IPR to these companies. The subsidiary operating in India would then pay a royalty to this overseas company. This is not illegal under the letter of existing tax laws, but it does lead to low tax revenues.

The Tax Justice Network estimates that India loses US$10.1 Billion annually due to abuse of tax laws; the US is believed to lose five times that amount (US$49.2 Billion). It is interesting that the same study identifies the Netherlands, the Cayman Islands, China, Hong Kong and the UK as the largest enablers of tax abuse. (source: “How global Tax Rules may reshape India”, The Mint, 23 September 2021).  

Change is already in the air

India was, in fact, a pioneer of sorts, when it introduced the equalization levy (a sort of digital service tax) in 2016 to bring some of the revenues of these digital companies into the tax net. Many other countries followed suit. Not surprisingly, there are now more concerted efforts to plug loopholes that Big Tech in particular is able to exploit to avoid tax in jurisdictions with higher tax rates. A major step to address this situation was announced in July 2021 by the OECD and G20. The move envisions a minimum corporate tax rate of 15% worldwide as well as a new framework for allocating more rights to tax digital economy companies to countries housing digital consumers- i.e., ensure fairer taxation of businesses in those jurisdictions where they earn profits.

Stop press!

Talk about timing! Just as I thought I had finished writing this blog, I saw the news that the OECD has finalized the framework for this major international tax reform. A new global minimum corporate tax rate of 15% has been set and will apply to companies whose revenues exceed 750 million Euros. Additionally, MNCs with global sales above 20 billion Euros and profitability above 10% will also be covered by the new rules. Model rules are expected to be formulated in 2022 and the new regime is to take effect in 2023.[2]

Including India 136 countries (that together account for 90% of global GDP) have backed this framework. Once such a regime comes into effect, individual countries will be required to withdraw any digital taxes they levy- e.g., India’s equalization levy.

While this kind of thinking will have a far-reaching impact on digital businesses and the global economy, new tax laws are not the only drivers of major change. If the recent testimony to the US Senate by whistleblower Ms. Frances Haugen is any indication, Facebook and other companies may soon face tougher laws around advertising and targeting specific segments of users. And given Google’s dominant position in the search business, competition laws too will inevitably get tougher. And as seen by India’s tough stand on Mastercard, data localization requirements too will become increasingly stringent. And finally, of course, data privacy laws too will evolve. The popular saying “May you live in interesting times” (incidentally, there’s no credible evidence that this was indeed a Chinese curse, as is often claimed) seems to have had the current period in mind. Even if it didn’t, we do live in interesting times- that’s for sure.

I wish you all a Happy Navratri/Durga Puja.

  1. https://www.statista.com/statistics/1181188/sandp500-largest-companies-market-cap/
  2. https://economictimes.indiatimes.com/news/economy/policy/oecd-deal-mncs-will-be-subject-to-a-minimum-tax-of-15-from-2023/articleshow/86876192.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Photo by fabio on Unsplash

The pandemic has severely dented government revenues worldwide, while expenses have ballooned. This has led to spiraling fiscal deficits, that have their own consequences. Given that most corporate tax regimes worldwide evolved keeping conventional businesses in mind, and that digital economy businesses are very different in nature, a new corporate tax playbook is clearly needed.

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Bad Bank in India: A Concept Note

The Indian banking system has been grappling with the ballooning Non-Performing Assets (NPAs) crisis on its balance sheets for decades now. The pandemic marked a further downward spiral for the Indian economy; proving specifically detrimental to individual borrowers and large corporates across sectors, who were adversely affected by the cash flow in businesses which led to defaults in outstanding obligations. The consequential increase in the NPAs revived the discussions for institutionalizing an independent entity that would exclusively deal with the bad loans and help in cleaning up the NPAs off the balance sheets. As of March 2021, the total NPAs in the banking system amounted to Rs 8.35 lakh crore (approx). According to the Reserve Bank of India’s (RBI) financial stability report, the gross NPAs ratio for the banking sector could rise to 9.8% by March 2022.

Following India’s first-ever Bad Bank announcement in the 2021-22 Union Budget by the Finance Minister; India, Debt Resolution Company Ltd (“IDRCL”), an Asset Management Company (“AMC”) has been set up that shall work in tandem with the National Asset Reconstruction Company Ltd (“NARCL”) to streamline and square away bad loans as per the documents and data available with the Registrar of Companies (“RoC”).

Proposed Mechanism of Bad Bank in India

  • The Government of India (“GOI”) has primarily set up two entities to acquire stressed assets from banks and then sell them in the market.
  • The NARCL has been incorporated under the Companies Act, 2013. NARCL will buy stressed assets worth INR 2 lakh crore from banks in phases and sell them to buyers of distressed debt. NARCL shall also be responsible for the valuation of bad loans to determine the price at which they will be sold. Public Sector Banks (PSBs) will jointly own 51% in NARCL.
  • The IDRCL will be an operational entity wherein 51% ownership will be of private-sector lenders / commercial banks, while the PSBs shall own a maximum of 49%.

NARCL will purchase bad loans from banks and shall pay 15% of the agreed price in cash, and the remaining 85% in the form of Security Receipts. If the bad loans remain unsold, the government guarantee shall be invoked; a provision worth INR 30,600 crore has been structured for the same.

Benefits of Bad Bank in India

Since non-performing assets have majorly impacted Public Sector Banks, the institutionalization of a Bad Bank shall equip PSBs in selling / transferring the NPAs, while simultaneously improving and promoting credit quality, strategically minimizing efforts in loan recovery and enhancing the macroeconomy.

Additionally, the profits of the banks were mostly utilized to cut losses. With the NPAs off their balance sheets, the banks will have more capital to lend to retail borrowers and large corporates.

The issues faced by Asset Reconstruction Companies (ARCs) relating to the governance, acceptance of deep discount on loans, and valuation may not concern the Bad Bank, owing to the government’s initiative and support that engages appropriate expertise.

 

Challenges of Bad Bank

As per the operational structure, bad banks shall buy bad loans, that have been recorded in the books of the PSB’s or private lenders. If the institution fails to secure buyers and record appropriate prices for the assets, the entire exercise shall prove to be futile.

In India, 75% of the bad loans are defaulted corporate loans, including a consortium of banks that had loaned corporations to finance major infrastructure and industrial projects. Countries such as Mexico, Greece, South Korea, Argentina, and Italy have portrayed that bad banks rarely yield positive outcomes in settings dominated by industrial, corporate, and conglomerate-level bad loans. Hence, structural and governance issues at various levels with state governments, judiciary, and political interests shall have to be streamlined and implemented efficiently to steer away from making them a repository of bad loans and for cleaning up the books of the PSBs.

Bad Bank: A One-Time Exercise?

The Government of India will have to undertake appropriate reforms/lending norms to reduce the number of NPAs. Setting up Bad Bank is most likely to tackle only the existing NPAs problem and should be a one-time exercise.

The concept of Bad Bank has been a success in certain European countries and the United States of America, however, it is pertinent to understand that they were structured to tackle home loans and toxic mortgages, unlike in India. Hence, in-depth analysis of the experiences of these countries should be utilized and intricately be revamped in alignment with key differences to ascertain the role of Bad Bank in the near future in the country.

Banks will get a huge financial boost with the transfer of the NPAs off their books and help in credit growth in the country. The success of Bad Bank is also crucial in restoring the faith of the taxpayer in the banking system. With the existence of the Insolvency and Bankruptcy Code, 2016 and Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, it remains to be seen how a Bad Bank will be a complement in the resolution of the bad loans.

 

Image Credits: Photo by Visual Stories || Micheile on Unsplash

The concept of Bad Bank has been a success in certain European countries and the United States of America, however, it is pertinent to understand that they were structured to tackle home loans and toxic mortgages, unlike in India. Hence, in-depth analysis of the experiences of these countries should be utilized and intricately be revamped in alignment with key differences to ascertain the role of Bad Bank in near future in the country.

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Force Majeure: Evolution of Jurisprudence in India Post COVID-19

The extraordinary outbreak of the Covid19 pandemic has had staggering effects on the economy, health and commerce of about 110 nations across the globe. Even after almost a year, the situation is far from normal. In addition to the massive pressure on the health and medical segments, several other unprecedented factors played crucial part in the whole system, economy, commerce, or business. Given the present situation of disruption of supply chaindisruption of assured manpower, uncertainty of future planning, inadequacy of security as well as the forced restraints in free commercial activities, numerous commercial contracts have either been interrupted, delayed or cancelled. The present situation has thrown light on several important questions with respect to the jurisprudence of the force majeure clause in various commercial contracts or frustration of contracts 

 

Force Majeure Typically in Law

 

The term force majeure which seems to have been borrowed from the Code Napoleon had received interpretation in several decisions of the English Courts in earlier years. In Matsoukis v. Priestman and Co.[i] . Justice Bailhache opined that force majeure would include strikes and break-down of machinery but not bad weather, or football matches, or a funeral. In Lebeeaupin v. Crispin[ii] Justice McCardie had observed: “A force majeure clause should be construed in each case with a close attention to the words which precede or follow it, and with due regard to the nature and general terms of the contract. The effect of the clause may vary with each instrument.”

In the Indian context, the Supreme Court has considered, interpreted and decided the events of force majeure in various judicial precedents, inter-alia from Satyabrata Ghosh vs Mugneeram Bangur[iii] to Energy watchdog vs CERC[iv] The Court has maintained a strict yet flexible approach towards the concept of force majeure and frustration of contracts. In the case of Alopi Prashad and Sons vs. UOI[v] the Supreme court had observed that commercial hardship shall not be a just and reasonable ground to support frustration of contract and excuse performance.

As we find in the commercial world, contracting parties have generally been incorporating the force majeure clause in their contracts since ages, to absolve themselves of any liability arising out of events beyond their reasonable control. However, in this discussion we would focus the force majeure arising out of Covid-19 pandemic.

 

COVID 19 and Application of Force Majeure

 

There was a difference of opinions and questions were raised over the fact that some contracts though having a force majeure clause, do not stress on the word ‘pandemic’, ‘epidemic’, ‘disease’ etc. , while majority of the contracting parties rely on the general phrase ‘any other unforeseeable event, not under the control of either of the parties.’

 
Executive Interpretation:
 

Alike the private sector, the Government contracts and the Public Sector transactions also started suffering on account of the pandemic and declaration of lockdown throughout the country. To address the situation fairly, the Ministry of Home Affairs came out with Notification No. F. 18/4/2020 PPD dated 19-02-2020 with respect to Manual for Procurement of Goods, 2017 declaring that the interruptions in supply chain due to Covid 19 from China or any other country shall be covered under the ambit of force majeure, and that force majeure shall be invoked whenever considered appropriate following the due process of law.

While the power of the Ministry to bring certain events within the ambit of force majeure under clause 9.7.7 of the Manual for Procurement of Goods, 2017 by a simple notification, may be a different issue, but as it appears, by this notification the Corona Pandemic was brought within the meaning of force majeure as defined in the Manual for Procurement of Goods, 2017 and tacitly, this event certainly becomes applicable in respect of all government and/or public sector contracts irrespective of application of the Manual for Procurement of Goods, 2017.  It may be noted that this Memorandum of 19th February 2020 was issued prior to Covid-19 affecting operations in India, recognizing the difficulty faced by the contracting parties regarding import of materials from other countries which were impacted by the pandemic.

Similarly, on account of various representations and submissions made by various Renewable Energy (RE) Developers and RE Associations, and considering the prevailing situation, the Ministry of New and Renewable Energy vide Office Memorandum No. 283/18/2020-GRID SOLAR dated March 20, 2020 declared Covid-19 as a force majeure event. The Ministry vide the said order granted time extensions in scheduled commissioning date of RE projects, in light of disruption of supply chain due to the pandemic.

The Ministry of Roads Transport and Highways also in its Circular dated 18.05.2020 inter-alia classified the pandemic as a force majeure event. In addition, the Ministry of Home Affairs by its Order no. 40-3/2020(D) dated 24 March 2020 expressed that the country was threatened with the spread of Covid 19 virus and therefore has considered to take effective measures to prevent its spread across the country and therefore in exercise of powers under section 10(2)(I) of the Disasters Management Act 2005 issued various guidelines for immediate implementation. Subsequently, by Office Memorandum dated 13 May 2020 the Ministry of Finance, Department of Expenditure referred to its earlier memorandum dated 19 February 2020 and also referred to the Manual of Procurement and recognized inter-alia that in view of the prevailing restrictions, it may not be possible for the parties to the contract to fulfill contractual obligations. Therefore, after fulfilling due procedure and wherever applicable, parties to the contract could invoke force majeure clause for all construction / works contracts, goods and services contracts, and PPP contracts with Government Agencies up to a certain period and subject to certain conditions. Therefore, officially the Government of India recognized Covid-19 Pandemic as an event of force majeure applicable in relation to contracts with Government Agencies, in effect resulting inclusion of Public Sector Undertakings also.

While the specific acceptance of force majeure in relation to Government sector contracts may not have any binding effect on the contracts outside the scope of the explicit instances or in relation to purely private contracts between two private parties, they probably offered an explanatory value to bring Covid 19 and the forced restraints imposed on account of lockdowns, within the ambit of force majeure.  

 
Judicial Interpretation:
 

In the Indian judicial scenario the court would rely on the terms of force majeure clause in the contracts or on principles of frustration under section 56 of the Contract Act. This means, unless there is compelling evidence for non-performance of contract the courts do not favor parties resorting to frustration or termination of contract. On account of the enormous devastative effects the Pandemic created on the commercial and economic environment in the country, different Courts had to come forward and grant relief to different contracting parties who were severely affected by the Pandemic.

The Delhi High Court considered the matter in June 2020 in the case of MEP Infrastructure Developers Ltd vs. South Delhi Municipal Corporation and Ors[vi]. The court essentially relied on the Ministry of Roads Transport and Highways (MORTH) circular and observed that:

27(i) The respondent Corporation itself referred to Circular dated 19.02.2020 which notified that the COVID-19 pandemic was a force majeure occurrence. In effect, the force majeure clause under the agreement immediately becomes applicable and the notice for the same would not be necessary. That being the position, a strict timeline under the agreement would be put in abeyance as the ground realities had substantially altered and performance of the contract would not be feasible till restoration of the pre-force majeure conditions.” 

The court also expounded on the continuous nature of the force majeure event and held that the subsequent lockdown relaxations given by the central government and the state government shall not amount to abatement of the force majeure event, at least in respect to major contracts such as road construction projects. The court also identified the distinct effects of the lockdown, independent of the effects of the pandemic and its implications on various contracts which many be affected by the force majeure conditions.  

In the case of Standard Retail vs G.S Global Corp Pvt. Ltd[vii] steel importers had approached the Bombay High Court seeking restraint on encashment of letters of credit provided to Korean exporters in view of the COVID-19 pandemic and the lockdown declared by the Central/State Government citing that the contracts between the parties were unenforceable on account of frustration, impossibility, and impracticability. The Bombay High court by its order dated 8 April 2020 rejected the plea inter-alia on the grounds: 

  1. The Letters of Credit are an independent transaction with the Bank and the Bank is not concerned with underlying disputes between the buyers and the sellers.
  2. The Force Majeure clause in the present contracts is applicable only to one respondent and cannot come to the aid of the Petitioners.
  3. The contract terms are on Cost and Freight basis (CFR) and the respondent had complied with its obligations and performed its part of the contracts and the goods had already been shipped from South Korea. The fact that the Petitioners would not be able to perform its obligations so far as its own purchasers are concerned and/or it would suffer damages, is not a factor which can be considered and held against the Respondent.

The court also observed that:  

“The Notifications/Advisories relied upon by the respondent suggested that the distribution of steel has been declared as an essential service. There are no restrictions on its movement and all ports and port related activities including the movement of vehicles and manpower, operations of Container Freight Station and warehouses and offices of Custom Houses Agents have also been declared as essential services. The Notification of the Director General of Shipping, Mumbai, states that there would be no container detention charges on import and export shipments during the lockdown period.

In any event, the lockdown would be for a limited period and the lockdown cannot come to the rescue of the Petitioners so as to resile from its contractual obligations with the Respondent No. 1 of making payments”.

Therefore, even if the event is a force majeure, contracts may not be avoided if the event does not affect performance of the entire contract or affect every aspects of any contract. The event has to be specific to the failure.

In the Halliburton case[viii] , decided on May 29, 2020, the Delhi High court was of an unequivocal opinion that:

“62. The question as to whether COVID-19 would justify non-performance or breach of a contract has to be examined on the facts and circumstances of each case. Every breach or non-performance cannot be justified or excused merely on the invocation of COVID-19 as a Force Majeure condition. The Court would have to assess the conduct of the parties prior to the outbreak, the deadlines that were imposed in the contract, the steps that were to be taken, the various compliances that were required to be made and only then assess as to whether, genuinely, a party was prevented or is able to justify its non- performance due to the epidemic/pandemic”.

Further, while discussing the scope of the force majeure clause in contracts it was observed by the court that:

“Para 63. It is the settled position in law that a Force Majeure clause is to be interpreted narrowly and not broadly. Parties ought to be compelled to adhere to contractual terms and conditions and excusing non-performance would be only in exceptional situations. As observed in Energy Watchdog it is not in the domain of Courts to absolve parties from performing their part of the contract. It is also not the duty of Courts to provide a shelter for justifying non- performance. There has to be a ‘real reason’ and a ‘real justification’ which the Court would consider in order to invoke a Force Majeure clause”.

The Madras High Court in the case of Tuticorin Stevedores’ Association vs The Government of India[ix], dated 14 September 2020, observed that the question as to whether on account of the pandemic outbreak of Covid-19, the parties can invoke the principle of force majeure need not detain us. The calamitous impact and disruption caused by Covid-19 on the economic front has been recognized by the Government itself.

In Confederation for Concessionaire Welfare & Ors. vs Airports Authority of India & Anr[x] the Hon’ble Delhi High Court observed on 17 February 2021 inter-alia that the court has perused the clauses relating to Force Majeure. There can be no doubt that the pandemic is a force majeure event. Since the Petitioners wish to terminate/exit from their respective agreements, while directing completion of pleadings and while the issues are under examination by this Court, there is a need to reduce the risk to both parties as simply postponing the exit by the Petitioners would also make it impossible for the AAI to re-allot the spaces to willing concessionaires and the outstanding against the Petitioners would continue to mount. Accordingly, as an interim measure the Hon’ble Court directed certain processes to be followed.

In another case of Ramanand vs. Dr. Girish Soni RC.[xi], an application came under consideration of the Delhi High Court which raised various issues relating to suspension of payment of rent by tenants owing to the COVID-19 lockdown crisis and the legal questions surrounding the same. By order dated 21-5-2020 the Delhi High court while determining whether lease agreements are covered under the ambit of section 32 and section 56 of the Act and even though it was held that suspension of rent on the grounds of force majeure is not permissible under the circumstances, the court allowed relaxation in the schedule of payment of the outstanding rent owing to the lockdown.

The Hon’ble Supreme Court in the case of Parvasi Legal Cell and Ors. Vs Union of India and Ors., observed that the pandemic was an ‘unusual’ situation, that had impacted the economy globally. This case revolved around the liability of the airlines to compensate passengers who faced cancellation of flights due to government-imposed lockdowns and restrictions on inter-state and international travels. The court relied on the office memorandum issued by the Ministry of Civil Aviation dated 16th April 2020 to dispose of the petition.

In the case of Transcon Iconia Pvt. Ltd v ICICI Bank[xii], the Bombay High Court while determining whether moratorium period would be excluded for NPA classification observed inter alia as under:

‘38… the period of the moratorium during which there is a lockdown will not be reckoned by ICICI Bank for the purposes of computation of the 90-day NPA declaration period. As currently advised, therefore, the period of 1st March 2020 until 31st May 2020 during which there is a lockdown will stand excluded from the 90-day NPA declaration computation until — and this is the condition — the lockdown is lifted’.

Yet, in another judgment passed in R. Narayan v. State of Tamil Nadu & Ors.[xiii] the Madras High Court directed the Municipal Corporation to waive the license fee for running a shop at a bus stand, and observed that:

“…this Court would be justified in treating the “lock down” as a force majeure event which will relieve the licensee from performing his obligation to the corresponding extent.” The Court also observed that … “The respondents (The Government of Tamil Nadu & Ors.) themselves have chosen to treat the lock down restrictions as a force majeure event. But they have relieved the licensees from the obligation to pay the fees only for two months. The reason for granting waiver for the months of April and May would equally hold good for the entire “total lockdown” period.”

Therefore, as it appears, most of the High Courts relied on the government orders that classified pandemic as force majeure, although the relief granted in each case has been subjected to restraint based on the accompanying facts and circumstances. The common observation however remained that the Covid-19 pandemic is a force majeure event.

 

Key Takeaways

 

Hence, it can be summarized that, commercial hardship shall not be a just and reasonable ground to support frustration of contract and excuse performance. The Courts have no general inclination to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events. Parties are at an obligation to complete their part of the contract against all odds, within a reasonable and practical limit. However, where the contract itself either impliedly or expressly contains a term according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself and such cases would be dealt with under Section 32 of the Act. If, however, frustration is to take place de hors the contract, it will be governed by Section 56.

The following preliminary conditions are emerging to be sine quo non to invoke covid-19 as a valid defense for non-performance:

  1. The contract is rendered impossible to perform: To establish pandemic as a force majeure occurrence de hors the contract the parties must demonstrate how the pandemic has disturbed the fundamental basis on which the obligations and agreements of the parties rested [Naihati Jute Mills Ltd. Vs Khayaliram Jagannath[xiv]]. This principle was also adequately elaborated upon by the Bombay High Court in Standard Retail vs G.S Global Corp Pvt. Ltd. A mere invocation of the force majeure clause in light of the pandemic does not absolve the parties from discharging their contractual obligations. A prima facie case has to be built justifying the reason for inability and seeking such an exemption.
  1. Prior conduct of the parties: While pleading the defense of force majeure, it is highly pertinent for the concerned party to ensure that, prior to the outbreak of the pandemic, the party was discharging its functions in a bona fide manner within the stipulated conditions of the contract. Additionally, as enumerated in the Halliburton case by the Delhi High Court, the concerned party should have demonstrated a bona fide attempt at undertaking all reasonable measures to execute its obligations in light of the situation and was genuinely prevented to act upon the same due to the collateral effects of the pandemic.
  1. Collection of documents capable of corroborating the claim of force majeure: It is crucial for the party invoking the force majeure clause to corroborate their claims with valid documents applicable to the specific instance, given the unusual and unprecedented situation. In the present scenario, these documents can include the abovementioned government circulars and guidelines, local medical reports, news reports, announcements etc. It needs to be kept in mind that generic documents howsoever crucial they may be, might not be enough in any specific case. While citing such documents, the affected party also has a duty to carry out a due diligence to ensure such exemptions and relaxations are strictly applicable to their case as observed in Standard Retail vs G.S Global Corp Pvt. Ltd.

 

No Straitjacket Formula                     

 

As can be summarized, different Courts in India have upheld the defense of frustration of contract and the defense of force majeure sparingly in every case. Even though the Covid 19 pandemic and its consequent lockdown can be generally covered under the ambit of force majeure, but there can’t be any straitjacket formula and its invocation strictly and solely shall depend upon the facts of each case, previous conduct of the parties and the prevailing circumstances in the specific scenario. If there are alternate modes of performing contractual obligations, the liable party shall not have the luxury to hide behind the comfort of doctrine of frustration or the doctrine of force majeure and absolve themselves of their duties. Accordingly, it would need a very careful examination of the whole situation before any ground is taken for avoidance of obligations under a concluded contract.

References:

[i] (1915) 1 K.B. 681

[ii] (1920) 2 K.B. 714

[iii] [1954 SCR 310]

[iv] [(2017)14 SCC 18].

[v] [1960 (2) SCR 793]

[vi] W.P.(C) 2241/2020

[vii] Commercial Arbitration Petition (l) no. 404 of 2020

[viii] Halliburton Offshore Services Inc. v. Vedanta Ltd. O.M.P (I) (COMM.) No. 88/2020 & I.As. 3696-3697/2020

[ix] WP(MD)No.6818 of 2020 and WMP(MD)No.6217 of 2020

[x] W.P.(C) 2204/2021 & CM APPL.6421-22/202

[xi] REV447/2017

[xii] 2020 SCC OnLine Bom 626

[xiii] Case No.19596 of 2020 and W.M.P.(MD)Nos.16318 & 16320 of 2020

[xiv] AIR 1968 SC 552

Image Credits: Photo by Medienstürmer on Unsplash

The Courts have no general inclination to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events. Parties are at an obligation to complete their part of the contract against all odds, within a reasonable and practical limit.

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