Reasons For Failure Of Mergers & Acquisitions Deal

Mergers and Acquisitions are vital tools of business strategy to facilitate organizational and economic growth of a business. The terms are often used inter-changeably, however both offer different legal implications. Mergers mean the unification of two players into a single entity, while acquisitions are situations where one player buys out the other to combine the bought entity with itself[1]. Mergers can take place in the form of a purchase in which one business buys another, or they can be a management buyout, in which the business is bought by the management from the owner.

With reference to the legal process of initiating an M&A strategy, the businesses are required to undergo a long drawn and tedious process of sanctioning the initiation of the M&A process by the High Court. At different stages various provisions of the Companies Act, 2013 have to be complied with. Further, the involvement of the central government through the appointment of an Official Liquidator (OL) or the Regional Director of the Ministry of Company Affairs also has to be dealt with. All of the compliances should be carried out to the satisfaction of the Court, resulting in unavoidable delays that may sometimes render the M&A irrelevant or detrimental to the business by the time it is concluded.

However, the serpentine legal process is not the only factor that contributes to an unfavorable M&A. This article aims to analyze the various reasons that add to the failure of M&A deals and enable businesses to mitigate the related risks in the future.

Analysis and Reasons for Failed M&A Deals

Mergers and acquisitions gained significant popularity after 2015. Nearly 3,600 deals worth more than $310 billion were associated with mergers and acquisitions. [2] They are lengthy and complex processes, so a lot can go wrong when negotiating a deal. As per a recent article by Harvard business review, nearly 70% to 90% of the mergers and acquisition deals were deemed to be a failure.[3]

Regulatory issues

Adhering to the legal mandates of the relevant jurisdiction is necessary. There is a chance that the shareholders of an organization may cause legal difficulties by dissenting from the approval of the mergers or by disagreeing with the business’s decision to merge. This would significantly slow down the functioning of the company, forcing it to pay appraisals to the shareholders as a remedy.

Example: HDFC and Max Life Merger Deal:

HDFC Life and Max Life had announced their merger plans in August 2016 through a three-step merger process, under which Max Life would first merge with its parent company Max Financial Services, and subsequently the life insurance business would be demerged from Max Financial and would be merged into HDFC Life. This merger transaction would have led to the automatic listing of HDFC Life through a reverse merger process and would enable HDFC Life to hold a majority stake in the combined entity. The Insurance Regulatory and Development Authority of India (IRDA) denied permission for the proposed merger of Max Life Insurance Co. Ltd and HDFC Standard Life Insurance Co. Ltd (HDFC Life), and observed that the structure of the deal violates Section 35 of the Insurance Act, 1938, which barred the merger of an insurance company with a non-insurance firm.[4]

Mistakes in Negotiation and Overrated Synergies

In various mergers and acquisitions, there are cases of overpayment for the purpose of breach of agreement. Acquiring a company based on money without knowing the working format, procedure, structure of the company and going through the due diligence process will lead to a failed merger.

Mergers and acquisitions are considered significant tools for increasing revenue, reducing net working capital, and improving venture power. Overvalued synergies go hand in hand with transfer overpayment. Overvaluation of exchange synergies is often the initial stage of overpayment. While the prospect of numerous costs remaining largely equivalent between the two combined organizations is attractive, it is also decidedly harder to achieve in practice than most directors admit. Also, energy cooperative income is no less confusing. M&A practitioners would therefore be encouraged to look at the expected cooperation from the exchange through a deeply traditionalist contact point.

Lack of Due Diligence

The importance of due diligence can never be emphasized enough. One of the main problems that arise during the process is that the acquirer depends on the target company to provide information that is not always suitable for their management. This creates obvious problems with agency.

Example: Daimler-Benz and Chrysler Group

In 1998, German automaker Daimler Benz merged with Chrysler Group for $36 billion. This was seen as a win-win situation for both companies as it was essentially a merger between equals. However, after a few years, Chrysler’s value dropped to just $7.4 billion. The merger proved unsuccessful. Many reasons contributed to this, but all experts agree that Daimler Benz never did  proper due diligence before merging with Chrysler. In other words, it overestimated the value of the target company, which led to the failed merger.

Hence, even though an M&A deal may seem lucrative on paper, it is essential for the respective businesses to carry out thorough due diligence and research on predicted profitability trends and projected growth patterns of the proposed merger or acquisition.

Deficiency in Strategic Plan

A good “why” is an essential part of all successful M&A transactions. This means that without a good motive for the transaction, it is doomed from the start.

The academic M&A literature is replete with studies of managers engaged in “empire building” through M&A and research on how hubris is a common trend in M&A.

Difficulty with Integration and Swap Ratio Differences

Integration difficulties that are mostly faced by companies when a new company has to follow or accept a new set of challenges and regulations to position itself in the market. It is very difficult for society to adapt to new conditions. Various plans are created in the form of strategies to help the company adapt to the new environment. This integration sometimes becomes the reason for the failure of the merger due to insufficient effort and imprecise planning.

Example: IDFC Group and Shriram Group deal:

IDFC Group and Shriram Group called off their talks of a merger after failing to agree on a swap ratio. A swap ratio is the ratio at which the acquiring company offers its shares in exchange for the target company’s shares during a merger or acquisition.

The two parties had, on July 8, 2019, entered into a 90-day agreement to evaluate a strategic combination of their relevant financial services. Shriram Employee Trust, Piramal Group and Sanlam Group were set to become the largest shareholders in IDFC and drive the business, but the deal would have hurt the government, which owned a 16.38 per cent stake in IDFC. So due to the difficulty in integration and swap ratio differences this deal was called off. This was the reason for the failure of this deal.[5]

Lack of Involvement of Top Management:

Management involvement is a catch-all answer that also includes many of the abovementioned reasons within its ambit. 

No phase of the M&A process can successfully sustain itself without proper involvement of the management, from the search for a suitable target company to the integration of both companies into a newly created entity.

When managers consider other tasks in their company more important than successful M&A implementation, they should not be surprised when their business is ultimately considered a failure.

Lack of Adequate Communication

Proper communication is one of the most important features of any agreement or contract. If the purpose of closing the deal is unclear, the intent of the buyers and sellers is also unclear, then communication is poor. If there is a lack of synergy and the buyer and seller are unable to articulate the desired results, this is a sign of poor communication. Not only that, but poor communication can also include a lack of communication between key managers and employees. Whenever a company enters into a merger or acquisition, there should be an honest and clear disclosure of the motive and intent. All doubts should be clarified at the initial stage. All levels of society should be given the opportunity to have their say. Messages should be interpreted in a general sense and according to common sense.

Culture Mismatch

Culture mismatch is another significant factor that causes merger failures. If companies have different cultural aspects, then there is a chance of low employee productivity, which leads to lower profits. Culture includes the willingness of employees to collaborate, share, support and team together with a single motive. Company culture is shaped by company founders, but it was also influenced by company managers and employees.

Example: Facebook and WhatsApp

Facebook bought messaging platform “WhatsApp” in 2014 for $22 billion. However, companies quickly realized that the corporate cultures were clashing. There are some memorable articles about table size and toilet stall arguments, but there have been discrepancies in values. WhatsApp famously valued the privacy of its customers and employees (no wonder they had a problem with short toilet boxes), while Facebook had more of an “open door” policy when it came to privacy. Since WhatsApp had committed to using a no ads and no encryption policy for the app its customers, it was clearly not a match that would have succeeded and the founders of WhatsApp eventually left Facebook.

Therefore, while considering an M&A it is not only important to ascertain the collective vision and objectives of the businesses, but also to make sure that the culture, policies and values of the businesses stay in alignment going forward.

Human Resource Issues

Human resource issues also pose a threat to the merger. There is insecurity as people tend to leave their jobs due to sudden changes in the course of work or because of cultural or identity issues. There are many human resource related issues even in the pre-combination stage such as the acquisition of key talent etc. as those could be the major concern for the companies for acquisitions. Another critical HR issue is the selection of a leader who will actually manage the new business combination for smooth business operations. These issues may lead to a lack of direction and the postponement of major business decisions. Companies should put their best people in charge of implementing M&A deals, and seek union and community involvement to avoid the risk of deal failure.

Geographic Restrictions

Geographical barriers cannot be overlooked. These play an important role when it comes to cross-border mergers. In general, when a cross-border merger occurs, a two-layer articulation is needed due to the merger of two different companies into different countries with a different set of rules and regulations prevailing in the respective countries.

Other External Factors

External factors may include market position, competition, financing situation, and credit in the company’s lending. If all these things are against the company, there is a chance for the merger to fail.

                                                                          Source: PWC Report[6]

The Way Forward

It is expected that mergers and acquisitions will exceed $105 billion, breaking the record for the largest transactions. [7]  High-rated deals like Reliance Industries’ (RIL) potential $10 billion (Rs 76,000 crore) acquisition of European drug chain Walgreens Boots; the Adani and JSW groups, bidding for Ambuja Cements, and the HDFC twin merger are the leading big mergers and acquisitions (M&A) deals. Consolidation of all the market players has been a major driving force behind the M&A transactions. Tech Mahindra and Infosys focused on exiting entities, while Byju’s acquired Aakash Education, White Hat Junior and Topper Technologies.

According to the 2022 M&A report, despite the ongoing challenge posed by the Covid-19 pandemic and geopolitical tensions in South Asia, the market is showing strong signs of recovery. M&A volumes hit an all-time high in 2021 with more than 80 deals worth more than $75 million. The increase in investment can be partly attributed to Indian government policies such as the productivity-linked incentive program introduced under the Ease of Doing Business initiative. [8]

Thanks to the great interest of foreign buyers, the Indian market for mergers and acquisitions also did well (the US accounted for 35 percent of invested dollars). India’s economy is set for strong growth in 2022 – The IMF has forecast GDP growth of 8.2 percent in 2022, making it the fastest growing major economy and double the expected growth rate of China.

With a total of 174 deals in Q1 2022 (up 28% year-on-year), the stage is set for India’s M&A market to witness strong technology-driven performance. This would make the M&A management process more efficient and powerful. For example, sellers are seeing in real-time how artificial intelligence and machine learning are automating many of the time-consuming parts of M&A—from preparation and marketing to due diligence on both the sell-side and the buy-side. [9]

According to Data site, a leading provider of SaaS technologies to the M&A industry worldwide, deal activity from January to May 2022 shows that companies continue to invest in technology acquisitions as they undertake digital transformations accelerated by Covid-19. Trading on the Datasite platform shows that new global TMT projects rose 18 percent worldwide in the first quarter.

The median time to open and close a new deal or asset sale or merger at Data site increased five percent year-over-year this year, while deal preparation time is also increasing, up 31 percent over the same period. This means that many vendors are “ready” but have not yet launched their projects. [10]

                                                                            Source: VCC Edge[11]

If handled properly, mergers and acquisitions can be a powerful means of propelling a business to greater profitability. Businesses should be cognizant of the abovementioned factors discussed before taking the M&A leap, to ensure sustainable and stable growth projections for their future.

References:

[1] https://www.mca.gov.in/MinistryV2/mergers+and+acquisitions.html

[2]https://tradebrains.in/biggest-mergers-acquisition-india/

[3] https://hbr.org/2020/03/dont-make-this-common-ma-mistake

[4] https://www.livemint.com/Companies/CBGIbJmiwVHYNeSiSQyT8O/Irdai-denies-permission-to-proposed-Max-HDFC-Life-Insurance.html

[5] https://www.thehindubusinessline.com/money-and-banking/idfc-shriram-12-b-merger-called-off-on-differences-over-swap-ratio/article64285553.ece

[6] https://www.pwc.in/assets/pdfs/services/deals/deals-in-india-annual-review-and-outlook-for-2022.pdf

[7] https://www.business-standard.com/article/companies/blockbuster-m-as-keep-india-s-deal-street-buzzing-despite-market-volatility-122042801482_1.html

[8] https://economictimes.indiatimes.com/magazines/panache/with-174-total-deals-in-q1-2022-indian-ma-market-set-to-witness-strong-performance-reveals-datasite/articleshow/92864647.cms

[9] https://economictimes.indiatimes.com/magazines/panache/with-174-total-deals-in-q1-2022-indian-ma-market-set-to-witness-strong-performance-reveals-datasite/articleshow/92864647.cms

[10][10] https://economictimes.indiatimes.com/magazines/panache/with-174-total-deals-in-q1-2022-indian-ma-market-set-to-witness-strong-performance-reveals-datasite/articleshow/92864647.cms

[11] https://www.vccedge.com/

It can be fairly concluded that mergers and acquisitions are powerful means to propel a business to greater profitability, if dealt with properly. Businesses should be cognizant of the abovementioned factors discussed before taking the M&A leap, to ensure a sustainable and stable growth projections for their future.

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Inter-Se Priority Among Secured Creditors in Liquidation - A Judicial Dichotomy  

The Insolvency and Bankruptcy Code, 2016 (“IBC”/”Code”) came into force on 28th May, 2016 with the primary objective of consolidating and amending the laws of reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner to maximise the value of their assets. The Code has been evolving over the last six years, with changing scenarios and adapting to practical circumstances along the way. As a result, the Code has undergone amendments from time to time. The provisions in the Code have also been interpreted and clarified by judicial pronouncements of the Hon’ble NCLTs, the Hon’ble NCLAT and the Hon’ble Supreme Court of India. The law relating to the Code is still emerging and there are a number of issues which are still required to be addressed with unambiguous certainty. One such issue is the distribution of proceeds in liquidation from the sale of assets under Section 53 of the Code to the secured creditors vis-à-vis the validity of inter se priority among secured creditors in respect of their security interests (charges) during liquidation.

What is the meaning of “Charge” and “Inter se Priority”?

Section 3(4) of the Code defines the term “charge” as an interest or lien created on the property or assets of any person or any of its undertakings or both, as the case may be, as security and includes a mortgage.

Several charges can be created in respect of a particular asset. This can be done by way of creating a pari passu charge over the asset where all the charge holders are placed on an equal footing or by way of the creation of a first charge and a subservient charge wherein the first charge holder can satisfy its debts in entirety prior to the subservient charge holders. This principle is embodied in Section 48 of the Transfer of Property Act, 1882. However, under Section 52 of the Code, a secured creditor has two options to realise its debts from secured assets held by it relating to a corporate debtor in liquidation:

Although the Code does not specifically indicate the validity of inter-se-priority of charges at the time of distribution in accordance with the waterfall mechanism provided under Section 53, the issue has been deliberated and decided upon by the Hon’ble NCLTs, Hon’ble NCLAT and Hon’ble Supreme Court of India in recent times, through judicial interpretation.

Pre-IBC Regime: Legal Position under the Companies Act, 1956

Under the earlier Companies Act, 1956, Sections 529 and 529A governed the ranking of creditors’ claims and the distribution of sale proceeds by the Official Liquidator in respect of a corporate debtor in liquidation.

The legal position vis-à-vis inter-se-priority of charges in the pre-IBC regime was discussed at length by the Hon’ble Supreme Court of India in the case of ICICI Bank vs Sidco Leathers Ltd. [Appeal (Civil) 2332 of 2006, decided on April 28, 2006]. In the said case, the Hon’ble Apex Court, while interpreting Sections 529 and 529A of the Companies Act, 1956, observed that even though workmen’s dues and secured creditors’ debts are treated pari passu, this does not negate inter se priorities between secured creditors. The Hon’ble Court stated that since the Companies Act of 1956 is a special statute which contains no provisions regarding inter se priority among secured creditors, the specific provisions set forth in the Transfer of Property Act, 1882 shall prevail. The Hon’ble Court further held that if Parliament, while amending the provisions of the Companies Act, 1956, intended to take away secured creditors’ entitlement to property, it would have stated so expressly. The Hon’ble Court, while deciding the issue, observed the following:

“Section 529A of the Companies Act does not ex facie contain a provision (on the aspect of priority) amongst the secured creditors and, hence, it would not be proper to read therein to things, which the Parliament did not comprehend. The subject of mortgage, apart from having been dealt with under the common law, is governed by the provisions of the Transfer of Property Act. It is also governed by the terms of the contract.”

“Merely because section 529 does not specifically provide for the rights of priorities over the mortgaged assets, that, in our opinion, would not mean that the provisions of section 48 of the Transfer of Property Act in relation to a company, which has undergone liquidation, shall stand obliterated.”

From the aforesaid, it is evident that the Hon’ble Apex Court upheld the validity of the Transfer of Property Act, 1882, which is a general law, over the provisions of the Companies Act, 1956, which is a special law and which did not recognise the concept of inter-se priority of charges.

 

Post-IBC Regime: Legal Position under the Code and the Report of the Insolvency Law Committee 2018

 

Report of the Insolvency Law Committee dated March 26, 2018

In the Report of the Insolvency Law Committee (ILC) dated March 26, 2018, it was noted that inter-creditor agreements should be respected. The ILC relied on the judgement of the Hon’ble Supreme Court in the case of ICICI Bank vs. Sidco Leathers Ltd. and came to the conclusion that the principles that emerged from the said case are also applicable to the issue under section 53 of the Code. The ILC in its report stated that Section 53(1)(b) of the Code only kept the workmen and secured creditors, on an equal pedestal and no observations were made on the inter-se priority agreements between the secured creditors and the same would therefore remain valid. The Report further clarified that the provision of Section 53(2) would come into effect only in cases where any contractual arrangement interferes with the pari passu arrangement between the workmen and secured creditors which means that contracts entered into between secured creditors would continue to remain valid.

 

Judicial Interpretation in recent times

Section 53 of the Code lays down the waterfall mechanism with respect to payment of debts to the creditors of the corporate debtor. The workmen’s dues and the debts of secured creditors rank pari passu under Section 53. However, the Code does not expressly provide for the preservation of inter-se-priorities between secured creditors at the time of distribution of sale proceeds realised by the liquidator by the sale of assets. The issue is to be understood and interpreted in the light of recent judicial decisions. Some of the recent judgments which have dealt with the issue are:

 

Technology Development Board vs Mr. Anil Goel & Ors. [I.A No. 514 of 2019 in CP(IB) No. 04 of 2017 decided on 27th February, 2020 by the Hon’ble NCLT, Ahmedabad]

In the instant case, the liquidator had distributed proceeds from the sale of assets to the first charge holders, in priority to the applicant who was a second charge holder without considering the claim of the applicant as a secured creditor that such distribution ought to have been made prorate among all secured creditors. It is pertinent to mention here that all the secured creditors had relinquished their security interests in the common pool of the liquidation estate. The Applicant was one of the secured financial creditors of the Corporate Debtor having a 14.54% voting share in the CoC of the Corporate Debtor.

Aggrieved by such distribution which recognised inter-se-priority among secured creditors, the Applicant moved the Hon’ble NCLT, Ahmedabad Bench.

The issue to be determined:

The primary issue that was to be decided by the Hon’ble NCLT was that once a secured creditor has not realised his security under Section 52 of the Code, and has relinquished the security to the liquidation estate, whether there remains no classification inter se i.e., by joining liquidation, all the secured creditors are ranked equal (pari passu), irrespective of the fact that they have inter-se-priority in security charge.

Observations of the Hon’ble NCLT

The Hon’ble NCLT while deciding the aforesaid issue held:

  • It is a settled position that when a charge is created on a property in respect of which there is already a charge, it cannot be said that the creation of the second charge on the property should have been objected to by the first charge holder as an existing and registered charge is deemed to be a public notice.
  • Emphasis was placed on Section 53(2) of the Code, which provides that any contractual arrangements between recipients under sub-section(1) with equal ranking, shall be disregarded by the liquidator if it disrupts the order of priority under that sub-section. In other words, if there are security interests of equal ranking, and the parties have entered into a contract in which one is supposed to be paid in priority to the other, such a contract will not be honoured in liquidation.
  • The whole stance in liquidation proceedings is to ensure parity and proportionality. However, the idea of proportionality is only as far as claims of similar ranking are concerned.

Decision:

The Hon’ble NCLT, relying on the judgement of the Hon’ble Supreme Court of India passed in ICICI Bank vs. Sidco Leathers Ltd., held that inter se priorities among creditors remain valid and prevail in the distribution of assets in liquidation.

 

Technology Development Board vs Mr. Anil Goel & Ors. [Company Appeal (AT) (Insolvency) No.731 of 2020 decided on 5th April, 2021 by the Hon’ble NCLAT, Principal Bench, New Delhi]

The issue to be determined:

Aggrieved by the aforesaid order dated 27th February 2020 passed by the Hon’ble NCLT, Ahmedabad, an appeal was preferred by the Applicant before the Hon’ble NCLAT wherein the issue raised for consideration was whether there could be no sub-classification among the secured creditors in the distribution mechanism adopted in a Resolution Plan of the Corporate Debtor as according to priority to the first charge holder would leave nothing to satisfy the claim of the Appellant who too is a secured creditor.

Observations of the Hon’ble NCLAT

The Hon’ble NCLT while deciding the issue took note of Sections 52 and 53 of the Code and held:

  • Section 52(2) of the Code stipulates that a secured creditor, in the event it chooses to realise its security interest, shall inform the liquidator of such security interest and identify the asset subject to such security interest to be realised. The liquidator’s duty is to verify such security interest and permit the secured creditor to realise only such security interest, the existence of which is proved in the prescribed manner. It is abundantly clear that there is a direct link between the realisation of a security interest and the asset subject to such security interest to be realised.
  • Section 53 deals with distribution of assets by providing that the proceeds from the sale of the liquidation assets shall be distributed in the order of priority laid down in the section. The provision engrafted in Section 53 has an overriding effect over all other laws in force.
  • The essential difference between the two provisions i.e Sections 52 and 53, lies with regard to the realisation of interest. While Section 52 provides an option to the secured creditor to either relinquish its security interest or realise the same, Section 53 is confined to the mode of distribution of proceeds from the sale of the liquidation assets.
  • Whether the secured creditor holds the first charge or the second charge is material only if the secured creditor elects to realise its security interest.
  • A secured creditor who once relinquishes its security interest ranks higher in the waterfall mechanism provided under Section 53 as compared to a secured creditor who enforces its security interest but fails to realise its claim in full and ranks lower in Section 53 for the unpaid part of the claim.
  • Section 52 incorporating the doctrine of election, read in juxtaposition with Section 53 providing for distribution of assets, treats a secured creditor relinquishing its security interest to the liquidation estate differently from a secured creditor who opts to realise its security interest, so far as any amount remains unpaid following enforcement of security interest to a secured creditor is concerned by relegating it to a position low in priority.
  • The non-obstante clause contained in Section 53 makes it clear that the distribution mechanism provided thereunder applies in disregard of any provision to the contrary contained in any Central or State law in force.
  • A first charge holder will have priority in realising its security interest provided it elects to realise and not relinquish the same. However, once a secured creditor opts to relinquish its security interest, the distribution would be in accordance with the Section 53(1)(b)(ii) wherein all secured creditors have relinquished their security interest.

Decision

It was held by the Hon’ble NCLAT that the view taken by the Adjudicating Authority on the basis of the judgement passed by the Hon’ble Apex Court in ICICI Bank vs. Sidco Leathers Ltd. and ignoring the mandate of Section 53, which has an overriding effect and was enacted subsequent to the aforesaid judgment, is erroneous and cannot be supported. The Hon’ble NCLAT therefore held that the order of the Adjudicating Authority holding that the inter-se priorities amongst the secured creditors will remain valid and prevail in the distribution of assets in liquidation cannot be sustained and the liquidator was directed to treat the secured creditors relinquishing the security interest as one class ranking equally for distribution of assets under Section 53(1)(b)(ii) of the Code and distribute the proceeds in accordance therewith.

 

Kotak Mahindra Bank Limited vs Technology Development Board & Ors. [Civil Appeal Diary No(s). 11060/2021]

The aforesaid order passed by the Hon’ble NCLAT has been further challenged before the Hon’ble Supreme Court of India. The appeal is currently pending adjudication, but the Apex Court has stayed the operation of the impugned order dated 5th April passed by the Hon’ble NCLAT, by order dated 29th June, 2021 . The appeal has been last heard on April 29, 2022, wherein an order has been passed to list the matter after eight weeks. It would be interesting to see whether the Apex Court upholds the order of the Hon’ble NCLAT and disregards the inter se priority among creditors at the time of distribution of sale proceeds under Section 53 of the Code or upholds the validity of the same.

 

Oriental Bank of Commerce (now Punjab National Bank) vs Anil Anchalia & Anr. [Comp. App. (AT)(Ins) No. 547 of 2022 decided on 26th May, 2022 by the Hon’ble NCLAT]

  • In the instant case, the appellant, who was the first and exclusive charge holder with respect to the assets of the corporate debtor, had relinquished its security interest in the liquidation estate. The liquidator, however, distributed the sale proceeds on a pro rata basis under Section 53 of the Code. Being aggrieved by the said distribution, the Appellant filed an application [IA (IBC)/101(KB)2022] before the Hon’ble NCLT, Kolkata, which was rejected by an order dated March 4, 2022. Aggrieved by the same, the appellant preferred an appeal before the Hon’ble NCLAT.
  • One of the contentions raised by the Appellant in the instant case was that the order of the Hon’ble NCLAT in the case of Technology Development Board vs. Mr. Anil Goel & Ors. that secured creditors after having relinquished their security interest could not claim any amount realised from secured assets once they elected for relinquishment of security interest, and that they would be governed by the waterfall mechanism under Section 53 has been stayed by the Hon’ble Supreme Court of India and therefore the Appellant is entitled to receive the entire amount realised from its secured assets.
  • The Hon’ble NCLAT rejected the aforesaid contention and observed that in the light of the judgement passed by the Hon’ble Supreme Court in “India Resurgence ARC Private Limited vs. Amit Metaliks Limited and Anr. [2021 SC OnLine SC 409] and “Indian Bank vs. Charu Desai, Erstwhile Resolution Professional & Chairman of Monitoring Committee of GB Global Ltd. & Anr.[CA(AT)No. 644 of 2021] the issue is no more res integra. In the aforesaid two cases, a similar contention was raised by the Appellants that the dissenting financial creditors are entitled to receive payment as per their secured interest, wherein it was decided that “when the extent of value received by the creditors under Section 53 is given which is in the same proportion and percentage as provided to the other Financial Creditors, the challenge is to be repelled”.
  • Since the issue is no more res integra and has been decided in the case of India Resurgence ARC Private Limited vs. Amit Metaliks Limited and Anr. by the Hon’ble Apex Court by its judgment dated 13.05.2021, the instant appeal was also dismissed.

 

Conclusion

 

Section 52 of the Code gives each secured creditor the option of relinquishing their right to the liquidation estate or realising their security interest on its own, subject to the Code’s requirements.

It can be possibly interpreted that once the secured creditor has relinquished its security interest in the liquidation estate, such a secured creditor exercises its option in favour of losing its priority rights over assets charged to it and joins the liquidation pool wherein the secured creditor is paid from the proceeds of the liquidation estate in accordance with Section 53 of the Code. The Code has provided the option to a secured creditor to enforce its first and exclusive charge by taking recourse to Section 52, whereby in the event it is unable to realise its entire dues, it would be ranked lower under Section 53 for realisation of the balance amount. A secured creditor cannot enjoy the fruits of both the provisions under Sections 52 and 53 of the Code at the same time. Once the secured creditor relinquishes its security interest to the common pool of the liquidation estate, it will be treated at par with all other creditors.

It can also be argued that the NCLAT has ignored the legislative intent clarified in the Insolvency Law Committee Report which after considering the decision of the Hon’ble Supreme Court in ICICI Bank vs Sidco Leathers Ltd. applied its principles to the issue under Section 53 of the Code and recommended that inter-se-priority among creditors was not disturbed by Section 53. Section 53 does not deal with inter-se-rights amongst creditors. It merely deals with the distribution of proceeds arising from the sale of assets to various stakeholders. The non-obstante clause in Section 53 would apply to scenarios where the provisions of the section are contrary to any law. Section 53(1)(b) merely mandates that workmen’s dues and debts owed to a secured creditor, in the event such secured creditor has relinquished security in the manner set out in Section 52, shall rank equally and nothing more. The said section does not deal with mortgages or inter-se-priorities amongst creditors/mortgagees. Mortgages are governed by the provisions of the Transfer of Property Act, 1882 and as such inter-se-priorities between mortgagees have been dealt with in that Act. Therefore, there may not be any justification for excluding the applicability of the provisions of the Transfer of Property Act, 1882 relating to mortgages for payment of dues to creditors under Section 53. The absurd result of not providing inter-se-priority to creditors at the time of distribution of sale proceeds under Section 53 would be that every secured creditor holding the first charge on assets would encourage liquidation and realise its dues by selling assets itself by opting to not relinquish the assets to the liquidation pool under Section 52. The chance of selling the corporate debtor as a going concern would then absolutely be eradicated, which would be contrary to the object and spirit of the Code.

It is expected that the Supreme Court will finally rest the issue while deciding the appeal in the case of Kotak Mahindra Bank Limited vs Technology Development Board & Ors. [Civil Appeal Diary No(s). 11060/2021 which is scheduled to appear for a hearing later this month.

Image Credits: Photo by Dennis Maliepaard on Unsplash

Section 53 does not deal with inter – se – rights amongst creditors. It merely deals with the distribution of proceeds arising out of sale of assets to various stakeholders. The non – obstante clause in Section 53 would apply to scenarios where the provisions of the section are contrary to any law. Section 53(1)(b) merely mandates that workmen’s dues and debts owed to a secured creditor, in the event such secured creditor has relinquished security in the manner set out in Section 52, shall rank equally and nothing more. The said section does not deal with mortgages or inter – se – priorities amongst creditors / mortgagees. Mortgages are governed by the provisions of the Transfer of Property Act, 1882 and as such inter – se – priorities between mortgagees has been dealt with in that Act.

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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.

References: 

[1] https://www.timesnownews.com/business-economy/budget-proposed-c-pace-for-accelerated-corporate-exit-process-article-89283883

[2] https://ibbi.gov.in/webfront/Discussion-Paper-on-Voluntary-Liquidation-process-Jan-2022.pdf

[3] https://www.ibbi.gov.in/uploads/legalframwork/cc881169aad7ee239aea7954505a76ab.pdf

 

Image Credits: Photo by Melinda Gimpel on Unsplash

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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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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Private Equity Investment in Sports: The Off-centre Opportunity

                 “The field of sport is akin to a jigsaw puzzle, where many pieces need to come together to produce a long-term successful athlete. The athlete’s success depends not only on his/her talent but also on the support system s/he receives”

                                                                                                                                                                                        –Sudha Murthy

Earlier this year CVC Capital Partners agreed to a USD 3 billion deal with Spain’s soccer league, La Liga, in return of 10% of all media returns for the next 50 years. Closer to home, in a dramatic turn of events, when the BCCI invited bids for two new Indian Premier League (IPL) teams, a windfall of INR 12,715 crores was definitely unforeseeable – the involvement of the global private equity firm, CVC Capital Partners, to “take over” Ahmedabad added to the mystique.

For the past 13 years, IPL has been the benchmark for exemplifying what private investments can do to a sport and has opened the doors to attracting more corporate investments in other sporting ecosystems. For instance, handball is set to hit India’s television screens next year as the Premier Handball League (PHL) supported by Bluesport entertainment under the patronage of the Handball Federation of India[1].

The Indian Super League (ISL) has also successfully managed to establish itself in terms of viewership and engagement. Furthermore, sports such as hockey, kabaddi, wrestling, badminton and volleyball have managed to garner a significant following and enthusiasm in the country their respective sports league. Owing to stellar performances in the Tokyo Olympics by the likes of Neeraj Chopra, Mirabai Chanu, P.V Sindhu and Ravi Kumar Dahiya, brands are reeling to sign them, driving commercial valuations and impact associated with their respective sports onto a profitable highroad. Hence, India is an ideal ground for significant investments in the field.

Up until a few years back, the involvement of leading conglomerates like JSW, Edelweiss Group, Embassy Group and Infosys had always been purely philanthropic in nature.

However, with the visible shift in trends, the next consideration is whether private equity investment in sports would be a slam dunk!

 

Factors Driving Valuation in Sports Teams and Leagues

Odisha FC, nicknamed the Kalinga Warriors, under the ownership of a global shipping giant, is the most valuable club in the ISL standing at an impressive INR 433.26m. In a more impressive feat, the Pro Kabaddi League, since its inception in 2014, has managed to rank above the ISL and stand in close competition with the IPL in terms of viewership. In 2015, Vivo signed a 300-crore engagement to become the league’s title sponsor. In 2018, over 70 sponsors competed to invest in the league[2]. The previous edition of the event was sponsored by Dream11, while big names like Tata Motors and Honda also retained their sponsorship[3]. Additionally, with the new class of spenders from the Fintech and EdTech industries like CRED, Unacademy and Upstox making their presence felt in the roaring business of cricket, it is evident that private equity investment and sports are definitely a match!

In alignment with the abovementioned dynamics, the following factors seem to be responsible for driving valuations in these sports teams and leagues:

  1. Scarcity and the inherent elite status

Between IPL, ISL and Pro-Kabaddi, there are only 33 teams across the board. Likewise, there are only six significant sporting leagues that show potential for lucrative returns in the country[4]. On the international front, according to the PitchBook data[5] in the United States, there are only 151 teams across the NFL, NBA, MLB, MLS and NHL. Similarly, there are only 98 teams in the Premier League, Serie A, Bundesliga, Ligue 1, and La Liga. Hence, since the supply is limited, the demand remains high, which leads to sky-rocketing prices and bigger returns!

  1. Monopoly

In addition to the limited available options, these leagues rarely expand. Hence, from an investor’s point of view, working in the confines of a marketplace with limited competition and foreseeable projection of factors like market share and revenue is easier.

  1. Illiquidity

Buying shares of a sports team is challenging since most teams are not listed on the stock market. Options like affiliations and exchange-traded funds are currently the only means through which individuals can participate in the functioning of their favourite teams. Therefore, when shares are not traded frequently and the ownership is complex, buyers are keen to pay a premium if and when the opportunity arises.

  1. Fans and emotions

For private equity firms, financial profits and ancillary gains are definitely driving factors. However, when it comes to sports, followership and emotions play a significant role. Andrew Laurino of the PE firm, Dyal, pointed out once that it is more fun to own your favourite sports team than root for a chemical plant.[6]

  1. Money

Considering the financial dynamics and broadcasting revenues involved, sports do offer a fertile ecosystem of astronomical returns. For instance, Sony acquired the media rights for IPL for the first 10 years for approximately 8,000 crores. For the next 5 years, Star India bagged the media rights for 16,000 crores. Media rights for IPL are scheduled to go up for auction in 2023[7] with an expectation of the deal closing in at over 30,000 crores[8]!

 

Key Trends Favouring Private Equity Investments in Sports

The sports industry is expected to grow tremendously in the year 2022, by reaching a valuation of USD 614.1 billion globally. The Asia-Pacific and the Middle East are expected to become the fastest emerging markets in the sports industry, with annual growth rates of 9.04% and 6.2% respectively, in the next few years[9].

The key trends that are expected to drive considerable growth and offer new investment opportunities are:

  1. Because of the pandemic’s rapid integration of technology into all aspects of life, the field of sports is witnessing never-before-seen consumer behaviour. Leveraging a combination of virtual reality, new streaming media and mobile technology, the industry has expanded its experience to a global audience and paved the way for new advertising revenues.
  2. The fitness industry is booming, driven by the new age of health-conscious consumers. The trend has resulted in a growth in participatory sports.
  3. The Indian gambling industry forecasts revenue growth that could hit INR 118.8 billion in 2023[10]. Consequently, the fantasy sports and betting industries are undergoing significant regulatory changes, which are set to streamline the industry and offer more substantial and comprehensive investment opportunities.
  4. Similarly, esports is set to experience a positive movement owing to the development of more sophisticated VR tools.

Since participation in sports will experience growth from traditional and newer channels, investment in associated ancillary industries seems lucrative.  

 

Issues With Private Equity Investments in Sports

Unlike other countries, India lacks a robust, centralized, and comprehensive regulatory framework governing the sport, despite the recent changes (being) introduced over the last decade in this regard. Issues pertaining to competition law, betting, anti-competitive actions, match-fixing, and dispute resolution are dealt with varying legislative frameworks spanning from Torts to criminal law.

Investors are organising collaborations with teams and sporting authorities to access a broader consumer cohort since cemented footholds and sponsorship guarantee greater returns on investment. Often, such sponsorship and advertising campaigns during a sporting event, or associated with any sportsperson, lead to ambush marketing by other competing brands. Moment marketing is another factor that treads upon the intellectual property rights of the players and dents the commercial gains of the investors.

It is therefore prudent to formulate a competent legal framework to curb doping, betting, match-fixing, ambush marketing, sports-related arbitration, and mediation and dispute resolution. There is a pressing need for cohesive and specific legislation comprehensively covering sports in India to be implemented.

Further, at a time when private investment activity in sports is moving away from CSR and philanthropic objectives and short-term collaboration and involvement, it is pertinent to ensure that the regulatory framework aligns with the commercial interests of investors while upholding the integrity of sports. The absence of the same can and will dissuade significant private party involvement in the area.

While there are still obstacles to be overcome, the prospects for sports are evident, and successful case studies have already begun to support the investment thesis. Investors and sporting organisations must be aware of possible hazards, but under the proper circumstances, the partnership has the potential to produce radical change and growth in the sector.

References: 

[1] https://www.thehindubusinessline.com/news/national/i-day-special-sports-gets-a-corporate-push/article35915385.ece

[2] https://newsable.asianetnews.com/sports/pro-kabaddi-league-and-ipl-a-tale-of-the-two-most-successful-sporting-leagues-in-india-ayh-qpp9ow

[3] https://thebridge.in/kabaddi/how-pro-kabaddi-change-face-sport-india-25937

[4] https://www.financialexpress.com/sports/from-ipl-to-isl-sports-leagues-in-india-to-watch-out-for/2337628/

[5] https://pitchbook.com/news/articles/private-equity-sports-investing-deals-strategy

[6] https://www.institutionalinvestor.com/article/b1tckcs3y46zw4/Private-Equity-Has-Definitively-Entered-the-World-of-Professional-Sports-Here-s-What-Comes-Next

[7] https://www.indiatoday.in/sports/cricket/story/bcci-could-earn-up-to-5-billion-from-ipl-broadcasting-rights-1867693-2021-10-21

[8] https://www.exchange4media.com/ipl-news/next-five-year-ipl-media-rights-to-cost-rs-24000-crore-rs-40000-crore-115794.html

[9] https://www.torrens.edu.au/blog/why-sports-industry-is-booming-in-2020-which-key-players-driving-growth#.YZyRHNBBxPZ

[10] https://www.helplinelaw.com/business-law/LSOFSI/legal-status-of-online-fantasy-sports-in-india.html

 

 

 

 

 

Image Credits:  Image by Pexels from Pixabay 

At a time when private investment activity in sports is moving away from CSR and philanthropic objectives and short-term collaboration and involvement, it is pertinent to ensure that the regulatory framework aligns with the commercial interests of investors while upholding the integrity of sports.

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Blockchain Arbitration: The Future of Dispute Resolution

The current buzzword- Blockchain has advanced from being a theoretical concept to reaching the sphere of technology where it is shaping today’s society and the legal profession. The field of legal technology has not only streamlined knowledge management requirements and operational aspects of a legal office, but also transformed the way lawyers practice law!

Smart contracts and blockchains have the potential to alter the way documentation and dispute resolution are approached. Hence the concepts need integration, implementation and recognition with arbitration for a more efficient, cost-effective and automated structure.

Smart Contracts, Blockchain and Arbitration

 

These self-executing, new generation contracts are geared towards the realization of predetermined conditions. With the help of smart contracts, Blockchain Arbitration can facilitate storing and verification of rules and automated execution (upon a particular event constituting a breach of the agreement) by invoking the arbitration clause incorporated in the smart contract.

In case of a dispute, the smart contract will notify the Arbitrator via a blockchain-based dispute resolution interface. A party can digitize the terms of an agreement, lock the funds into a smart contract, and condition the intelligent contract so that the task at hand is fulfilled and the funds will pass through. Upon completion of the process, the self-executable nature of the smart contract will automatically enforce the award and transfer the prescribed fee to the Arbitrator.

However, it is yet to be seen how smart contracts shall interact with data protection and privacy laws, intricacies of dispute resolution, and obligations and rights of the parties involved.

Blockchain Technology: An aid to Arbitration?

 

Arbitration aims to be a time-bound and specialized decision-making process. In this backdrop, Blockchain Arbitration theoretically promises to be an ideal structure for the trial process in the following ways:

  • Briefs, Transcriptions & Document Management: The tool in the blockchain system can quickly and efficiently provide synopsis and briefs of the record which would be beneficial not only to the Tribunal but to the parties.
  • Elimination of intermediaries and cost-effectiveness: There shall be no mechanism requiring approval and control at every stage, and the intermediary institutions are not included in the process. For instance, Banks, involved as intermediary institutions in legal and financial transactions, incur costs at every stage of the transaction and are time-intensive in nature.
  • Automation: A blockchain-based dispute resolution platform would exclude oral hearings and the Arbitrator’s decision and automate other aspects of filing of pleadings, filing of documentary evidence, correspondence with the Arbitral Tribunal.
  • Ease in making the Arbitral Award:  Blockchain tools can assist the Tribunals in preparing awards. The tools ensure that all necessary ingredients to make the arbitral award reasoned and enforceable have been taken care of.  The blockchain will continue to prepare the award from the beginning as the arbitration progresses.
  • Confidentiality / Security of Data: Blockchain is the safest way of storing information. Each block will be authenticated by the Arbitral Tribunal and the party to the proceedings. There is no provision for changing, altering or deleting the data unilaterally. It can only be done when it is authenticated by the Arbitral Tribunal and the party to the proceedings. Since third parties are entirely absent from the proceedings, the possibility of breach of data and information is negligible. Disputes arising out of smart contracts can be made confidential which will limit the exposure of the nature of dispute between the parties. Blockchain has a decentralized structure and the security of the system is protected by cryptography.
  • Removal of human error: The reliability and validity of a transaction depend upon the accuracy of the algorithm underlying the transaction. Since, each transaction is based on algorithms, which are mathematical models, it is free from human influence and intervention and, consequently, human error. 

Security and privacy of data are primary concerns in the conventional Arbitral process. In fact, as a specific case representing the flaws of the present model of international arbitration, in July 2015, the website of the Permanent Court of Arbitration was hacked during an essential hearing of maritime border arbitration between China and the Philippines, in the international arbitration of the “Republic of Philippines v. People’s Republic of China.”[1]  

As far as the credibility of blockchain technology in resolving such issues is concerned, the World Economic Forum, in its 2015 survey recognized that by 2025-27, about 10% of the global GDP would be stored in blockchains, owing to its efficient attributes of data security management. By 2025, even taxes are strongly probable to be collected by employing blockchain technology. Moreover,  in its research published in 2018, World Trade Organisation described at length the opportunities that lie ahead in the future, owing to the efficacy associated with the safeguard mechanisms of blockchains. 

Legal Recognition of Blockchain Arbitration and procedure to be adopted

The UNCITRAL Electronic Model Law on Electronic Commerce (1996 Convention) and the ‘UNCITRAL Convention on Electronic Communications in International Contracts (2007 Convention)’ are the primary legal instruments facilitating blockchain contracts.[3]

Articles 6 and 18 of the 2007 Convention assert the validity of on-chain arbitration by allowing for electronic data records and electronic transactions in the arbitration process, thereby providing legal recognition to on-chain arbitrations.

  1. Appointment of an Arbitrator

 Once the notice of arbitration has been sent, the appointment of an arbitrator can be done through blockchain. Thus, the exchange of documents, e-mails, and messages, etc. are all recorded automatically and replicated at all stakeholder’s computers without the involvement of any third party. The case management conference can be done online using a video conferencing facility of blockchain which is recorded and filed in the computers of all stakeholders in original and thereby removing manipulation.

  1. Pleadings

The pleadings including a statement of claim, statement of defense, counterclaims, and reply to counterclaims and further submissions can be submitted online and are automatically served to the parties & the Tribunal along with automated acknowledgment. This ensures timely submissions and helps in maintaining uniformity in the pleadings thus circulated. Any delay will also be penalized in terms of the penalty prescribed by the Tribunal or as agreed by the parties. The fear of ex-parte communication will also be mitigated when the procedural orders and communication by the Tribunal will be auto-delivered to both parties. 

  1. Interim Measures

Interim measures that are sought from courts can be executed on the blockchain if the judicial system of a particular jurisdiction allows for a seamless digital interface with the parties’ computers. In the case of an automated interface with the judicial system, the execution of court orders can also happen immediately provided the jurisdiction’s administrative machinery is using blockchain. 

  1. Recording of Evidence & Preparation of Award

 The efficiency of blockchain can be seen in evidence-taking and award preparation. Witness conferencing, cross-examination, and taking of oral evidence can be easily done using video conferencing suites, or even if hearings are done physically, they can still be transferred on blockchain and stacked for procedural integrity. Statements of expert witnesses, oral submission by experts, and expert communications can be recorded on the blockchain. 

  1. Security of Data

Blockchain is a secure way of storing information because each block is replicated and authenticated by all stakeholders. The provision to alter or delete any data does not exist until authenticated by all stakeholders. In the absence of intervention of a third party, there is no network administrator or supervisor making the possibility of data breach negligible. 

Globally, blockchain technology is being readily resorted to as an effective means of data storage, management, distribution, and transfer. Blockchain technology has immense potential to enhance the efficacy of Arbitral proceedings, especially owing to its mechanism of encryption, which helps secure data.

Contemporary issues in Blockchain Arbitration

The functioning of blockchain arbitration highlights various concerns. Firstly, in an on-chain arbitration, there would be no requirement for oral hearings which are integral to the current justice system and stand at a juxtaposition with the principles of natural justice.

Secondly, an essential principle of arbitration is the underlying idea of confidentiality. Despite the strong protection afforded by blockchain, data privacy can pose a significant concern when an independent third party gets involved as an oracle in dispute resolution. The General Data Protection Regulation (GDPR) provisions are not currently empowered enough to regulate the intricacies in the decentralized functioning of blockchain, which makes it difficult to impose liability on data controllers. Furthermore, the traceable feature of blockchain is again in conflict with the GDPR’s requirement of the “right to be forgotten“.

Thirdly, The New York Convention on the Enforcement of Foreign Arbitral Awards of 1958 (hereinafter referred to as “the New York Convention”) is the most prominent code on enforcing international arbitral awards with 166 contracting states to the Convention. According to Article II of the New York Convention, an arbitration agreement must be in “writing” and requires the parties’ signature. However, in a virtually operative blockchain arbitration, there is no scope for written agreements or signatures.[4]

Challenges in the enforceability of the Blockchain arbitration award in India

 

Lack of enforceability of the agreement itself under the New York Convention

One problem identified with the enforceability of blockchain arbitration awards is the lack of enforceability of the agreement itself under the New York Convention which requires such agreements to be in writing or through an exchange of telegrams/telefaxes.

Section 7 of the Arbitration and Conciliation Act, 1996 requires that a valid arbitration agreement should be in “writing”. However, unlike Article II of the New York Convention, Section 7 of the Arbitration and Conciliation Act, 1996 clarifies that an agreement would be considered as having been made in writing if it has been communicated through “electronic means”. The allowance for “electronic means” was introduced through the Arbitration and Conciliation (Amendment) Act, 2015, yet remains undefined.

Theoretically, it can be asserted that an award generated in a blockchain arbitration may fall within the ambit of the definition of an ‘electronic record’ under the Information Technology Act, 2000.

Difficulty in determining Awarding Country in a Blockchain Arbitration

India although is a signatory to the New York Convention, only foreign awards made in only certain Contracting States of the Convention (gazetted by the Central Government) can be enforced in view of India’s reciprocity reservation. India has gazetted less than 1/3rdof all of the Contracting States to the New York Convention.[5] 

In the working of a blockchain arbitration, Arbitrators are appointed by a blockchain-based dispute resolution platform. The award is generated on a blockchain and circulated to the parties before the Arbitrator. The parties may be in different countries and the origin/awarding country may be difficult to trace out. In the absence of details of an awarding country, the enforceability of such an award in India becomes a daunting task.

 

Enforcement of Arbitral Award

As per the Arbitration and Conciliation Act, 1996, an application for enforcement of an arbitral award shall be accompanied by an original arbitral award. In a blockchain arbitration, the award is circulated as an electronic record in the blockchain to the parties directly. The concept of a hard copy/original award is alien in blockchain arbitration.

 

Conclusion and Suggestion

A conspectus of the aforesaid facets of the blockchain system shows that the same needs multi-fold reforms before being set to use by the legal fraternity. Even though the blockchain assures, to a great extent, protection of data, but it cannot be forgotten that the hackers also keep updating their own skills and no technology is flawless. The blockchain system has to be made dynamic enough so as to keep abreast with the challenges of new advents in unethical hacking.

Secondly, it is also required that a proper training module is formulated for lawyers of the participating countries which shall ensure unimpeded use of the technology.

Lastly, the author strongly recommends that the use of blockchain should be limited only to procedural aspects in such cases where the dispute involves issues of interpretation of the clauses and or statutes including common law. This may be achieved by adopting a hybrid model of dispute resolution with embedded human intervention modules.

References: 

[1]Gargi Sahasrabudhe, Blockchain technology and arbitration, VIA Mediation & Arbitration Centre, (Nov. 3, 2021, 5:00pm), https://viamediationcentre.org/readnews/ODE1/Blockchain-technology-and-Arbitration

[2]Athul aravind, Blockchain arbitration: the future?, Law and Dispute resolution blog, (Nov. 3, 2021, 5:00pm), https://www.mappingadr.in/post/blockchain-arbitration-the-future

[3] Dena Givari, How does arbitration intersect with the blockchain technology that underlies cryptocurrencies, Kluwer Arbitration Blog, Wolters Kluwer, (Nov. 6, 2021, 8:00pm), http://arbitrationblog.kluwerarbitration.com/2018/05/05/scheduled-blockchain-arbitration-april-17-2018/

[4] Idil Gncosmanoglu, Blockchain-smart contract and arbitration, Mondaq, (Nov. 5, 2021, 5:00pm), https://www.mondaq.com/turkey/fin-tech/967452/blockchain-smart-contracts-and-arbitration.

[5] Ritika Bansal, Enforceability of awards from blockchain arbitrations in India, Kluwer arbitration Blog, http://arbitrationblog.kluwerarbitration.com/2019/08/21/enforceability-of-awards-from-blockchain-arbitrations-in-india/, (2019)

 

 

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Photo by Launchpresso on Unsplash

The use of blockchain should be limited only to procedural aspects in such cases where the dispute involves issues of interpretation of the clauses and or statutes including common law. This may be achieved by adopting a hybrid model of dispute resolution with embedded human intervention modules.

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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.

References: 

[1] https://timesofindia.indiatimes.com/business/india-business/most-family-owned-companies-remain-bullish-on-fy22/articleshow/83103426.cms

[2] https://www.pwc.in/assets/pdfs/services/entrepreneurial-and-private-business/pwc-family-business-survey-2021.pdf

Image Credits: 

Photo by João Jesus from Pexels

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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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 Covid–19 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 chain, disruption 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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Intensifying Social Accountability of Corporates in India

In a bid to make companies progressively accountable in the social panorama, the government has been modifying the provisions of Corporate Social Responsibility (“CSR”) ever since its introduction. Amendments have been made in section 135 of the Companies Act, 2013 (“the Act”), The Companies (Corporate Social Responsibility) Rules (“the Rules”) and Schedule VII (“Schedule”) of the Act by the Ministry of Corporate Affairs (“MCA”), from time to time.

While the earlier amendments to section 135 of the Act and the Rules were mostly clarificatory in nature or were relating to the inclusion of certain activities relating to COVID – 19 as the contribution made towards  CSR, the amendments to section 135 of the Act inserted by the Companies (Amendment) Act, 2019 and the Companies (Amendment) Act, 2020 and notification of The Companies (Corporate Social Responsibility) Amendment Rules, 2021 (“the Amended Rules”), both effective from January 22, 2021, has brought about a radical change in the treatment of unspent CSR amount, among other amendments, which is dealt with in this write-up.

  1. CSR applicability extended to newly incorporated companies as well:

Sub-section (5) of section 135 provides that every company crossing the threshold limits prescribed in section 135(1) has to necessarily spend at least 2% (two percent) of the average net profits of the company made during the immediately preceding three financial years. By way of inclusion to section 135 (5), newly incorporated companies that cross the threshold limits prescribed under section 135(1) of the Act have also been brought within the ambit of compliance with CSR provisions.

  1. Compliance in respect of unspent CSR amount:

A brief outline of the amendments relating to the treatment of unspent amount is provided below:

 

  1. Penalty for non-compliance of sub-sections (5) or (6) of section 135 of the Act:

The newly-inserted sub-section (7) of section 135 of the Act deals with a penalty for non-compliance of provisions of sub-section (5) or (6). It is pertinent to note that the provisions of Companies (Amendment) Act, 2019 had prescribed for imprisonment for a term extending to three years, apart from a fine that may be imposed, on the failure of a company to comply with the provisions of sub-sections (5) or (6) which relates to transfer of unspent amount other than ongoing project and transfer of amount towards ongoing project respectively.

Understandably, there were apprehensions over the proposed implementation of penal provision with imprisonment for CSR activity, and after deliberations, the provision was replaced with a provision in the Companies (Amendment) Act, 2020 which provides only for penalty without imprisonment for non-compliance of sub-section (5) or (6) of section 135 of the Act.

Penalty for the company – twice the amount required to be transferred by the company to the Fund specified in Schedule VII / unspent CSR account (or)

INR 1,00,00,000/- (Indian Rupees One Crore only), whichever is less.

Penalty for every officer of the company who is in default –

one-tenth of the amount required to be transferred by the company to such Fund specified in Schedule VII / unspent CSR account (or) INR 2,00,000/- (Indian Rupees Two Lakhs only), whichever is less.

  1. Power to give general or special directions:

As per sub-section (8) which has been inserted, the Central Government may give general or specific directions to a company or a class of companies, as necessary, which are required to be followed by such company/class of companies.

  1. Constitution of CSR Committee:

CSR committee is not required to be constituted by a company, where the amount it has to spend towards CSR activities is not more than INR 50,00,000/- (Indian Rupees Fifty Lakhs only) and the functions of the CSR committee shall be discharged by the Board of Directors of the company.

  1. Other notable changes in Amended Rules:
  • Registration under sections 12A and 80G of the Income Tax Act, 1961 has been made mandatory for CSR implementation entities (Rule 4(1) of the Amended Rules).
  • Every CSR implementation entity has to file Form CSR – 1 and obtain CSR registration number compulsorily from April 01, 2021 (Rule 4(2) of the Amended Rules).
  • Chief Financial Officer or any person responsible for financial management shall certify that the funds disbursed have been utilized for the purposes and manner as approved by the Board (Rule 4(5) of the Amended Rules).
  • In case of ongoing project(s), the Board shall monitor its implementation and shall make necessary modifications, as required (Rule 4(6) of the Amended Rules).
  • The CSR Committee shall formulate and recommend an annual action plan in pursuance of its CSR policy to the Board comprising the particulars as specified in Rule 5(2) of the Amended Rules, which may be altered at any time during the financial year, based on a reasonable justification.
  • Surplus earned from CSR activities shall be ploughed back into the same project or transferred to the “unspent CSR account” and spent as per the CSR policy and annual action plan or shall be transferred to the Fund specified in Schedule VII of the Act but shall not form part of the business profit of a company (Rule 7(2) of the Amended Rules).
  • The CSR amount may be spent by a company for the creation or acquisition of a capital asset, which shall be held by a CSR implementation entity specified in Rule 4, which has CSR registration number, or beneficiaries of the CSR project or a public authority (Rule 7(4) of the Amended Rules).
  • Annual report on CSR to be in the format specified in Annexure-II of the Rules, in respect of board’s report for the financial year commencing on or after April 01, 2020 (Rule 8 (1) of the Amended Rules).
  • Companies having an average CSR obligation of INR 10,00,00,000/- (Indian Rupees Ten Crores only) or more in the three immediately preceding financial years has to undertake an impact assessment of CSR projects, having an expenditure of INR 1,00,00,000/- (Indian Rupees One Crore only) or more and which have been completed not less than one year before undertaking the impact study, through an independent agency (Rule 8(3) of the Amended Rules).

Ambiguities in the recent amendments:

  1. Whether unspent amounts of previous years have to be transferred?

Although, it has been specifically provided in some of the Amended Rules (viz., implementation of CSR provisions through specified entities, reporting of CSR as provided in Annexure provided in the Amended Rules) that the said amendments are applicable on or after April 01, 2021, the time period from which the provisions relating to the transfer of unspent CSR amount to “unspent CSR account” / Fund is applicable, i.e. whether the unspent CSR amounts relating to the past financial years (from the date of applicability of the CSR provisions to the company) are required to be transferred to the “unspent CSR account” / Fund or only the CSR amount remaining unspent as on March 31, 2021, has to be transferred, has not been explicitly provided in the Act or the Amended Rules.

  1. Whether the outstanding amount of provision created for the unspent amount must be transferred?

The amended provisions do not stipulate whether unspent CSR amounts of the previous financial years have to be transferred to the designated account / Fund in case a company has created a provision in the books of accounts for such unspent amount for the relevant financial years.

The foregoing matters require suitable redressal by the MCA in the form of clarifications or FAQs or amendments to the existing provisions, which will offer a much-needed clarity on these matters.

Conclusion:

With the recent amendments, the CSR provisions have undergone a paradigm shift from “Comply or Explain” to “Comply or Pay” regime as they provide for penalties on failure to transfer unspent CSR amount to the specified account / Fund, whereas earlier, providing reasons for not spending CSR amount was considered adequate compliance. Hence, the said amendments have placed additional responsibilities on corporates.  Having introduced the concept of penalty, it is only appropriate that the MCA addresses the obscurities arising from the amendments at the earliest so that corporates are not caught off-guard in complying with the CSR provisions.

Image Credits: Photo by Tim Marshall on Unsplash

the CSR provisions have undergone a paradigm shift from “Comply or Explain” to “Comply or Pay” regime as they provide for penalties on failure to transfer unspent CSR amount to the specified account / Fund, whereas earlier, providing reasons for not spending CSR amount was considered adequate compliance.

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