Business standard news and legal digest 1-4-2013

LEGAL DIGEST

SC revives 25- year- old suit The Supreme Court has ordered retrial of a suit which started in 1988 in the matter of purchase of five diesel vehicles from Tata Engineering & Locomotive Co Ltd. The apex court said the Bombay High Court applied wrong legal principles and, therefore, the purchaser, Shantilal Gulabchand Mutha, should be allowed to present his case. The Supreme Court also said Mutha was not given a hearing and his application was rejected by the high court without giving adequate reasons. Mutha had given eight bills of exchange through Mercantile Bank Ltd for purchase of the vehicles but the company disputed the interest element and moved the suit. Mutha did not file a statement under the impression that the amounts due had been paid. For that reason, ex parte decree was passed against him. He moved appeals but the high court exercised its discretionary power under the Civil Procedure Code and rejected those on the ground that he had failed to file his statement. In the final appeal, the Supreme Court held the high court was wrong and ordered retrial expeditiously, after providing Mutha the opportunity to file his statement. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Gratuity does not bar pension The Supreme Court has dismissed the appeal of Allahabad Bank and ruled that an officer, who opted for voluntary retirement from service and paid gratuity and provident fund, was also entitled to pension. In this case, Allahabad Bank vs A C Aggarwal, the officer retired and was paid gratuity. Then, he asked for pension. The bank rejected it, saying benefits under the pension scheme was subject to the condition of refund of the amount of gratuity already paid to him and submission of an irrevocable undertaking that he will be getting pension in lieu of gratuity. He challenged the bank’s stand in the Allahabad High Court, arguing that it was against the bank rules and constitutional provisions. He further argued that State Bank of India was paying gratuity to its employees in addition to other retiral benefits and, therefore, there was no justification to discriminate the employees of another public sector bank. The high court accepted the argument and asked the bank to pay pension. It moved the Supreme Court. The apex court rejected the appeal and said the law regarding payment of gratuity has overriding power over other rules and regulations. Moreover, the judgment noted the bank had earlier unsuccessfully tried to get exemption from the gratuity law, but the government had rejected its request. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Cotton seed firms lose case The Delhi High Court has dismissed two writ petitions moved by Maharashtra Hybrid Seeds Ltd and Nuziveedu Seeds Ltd relating to a new cotton seed called ‘ C- 5193’. The first firm filed an application to register its novel variety of cotton, which was published by the Protection of Plant Varieties and Farmers’Rights Authority in the Plant Variety Journal 2008. Another firm opposed the registration on several grounds. But the objection came after the time fixed by the rules. The time was extended by the registrar. This became the main bone of contention between the parties. The high court said “ the legislation in question is in the nature of a beneficial legislation to provide for an effective system for protection of plant varieties and the rights of the farmers and plant breeders”. Therefore, it should be given a liberal interpretation. The registrar can extend the time period for filing the application for opposition. The court also noted the intention of the government, represented by an additional solicitor general, that after a detailed discussion among the relevant ministries, it has been decided to amend Rules 32 ( notice of opposition) to clear the confusion in this respect. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Bar on starting new venture In a dispute between two firms, Jay Ushin Ltd and U- Shin Ltd, the Delhi High Court has restrained the latter from entering into any competing business or to undertake any activity prejudicial to the interest of the former company till such time the arbitrator passes his interim order. Jay Ushin said the opposite firm was in the process of starting competing business in India, despite a joint venture agreement of 1986 was still subsisting between the parties. The technology purchased from U- Shin still vested in the Indian firm. It was further argued that according to the conditions set up by the Government of India as well as the Reserve Bank of India, the terms could not be varied. However, U- Shin has already announced to join hands with M/ s Minda Valeo Security System Ltd in Delhi. The new arrangement is similar to the one which is in existence between the contesting parties and, thereby, is a competing business arrangement. According to the foreign firm, the 1986 agreement has lapsed. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> PSUs penny- wise, pound- foolish The National Consumer Commission has imposed penalty on Oriental Insurance Company for moving five revision petitions three months after the limitation period. The payment will go to the ‘ Consumer Welfare Fund’ set up under the Consumer Protection Act. It followed aSupreme Court judgment which said that “ PSUs (public sector units) spend more money on contesting cases than the amount they might have to pay to the claimant. In addition, precious time, effort and other resources go down the drain in vain. PSUs are possibly an apt example of being penny- wise, pound- foolish.” MJ ANTONY THINKSTOCK

New challenges for audit committee Dominant shareholder manages most Indian companies. In those companies, independent directors are de- facto appointed by the management. Similarly, it decides the remuneration of the top management personnel. As a result, the nomination and remuneration committees are non- starters. But the audit committee has established itself as an important institution within the board even in those companies. Is it a contradiction that the management, which does not want interference with the appointment of independent directors and in deciding the top management compensation, wants a watchdog to check earnings management and to protect independence of auditors? There is a contradiction if we assume that the board’s primary responsibility is to monitor the executive management and to protect minority shareholders’ interest. But there is no contradiction if we appreciate that the board in those companies plays more of an advisory role than the monitoring one. The audit committee’s approach is also consistent with the overall approach of the board. The management values the audit committee’s role in strengthening internal audit, internal control and risk management, which aim at protecting assets level. It values the committee’s management, if any. It seldom takes up strategy audit to ensure that shareholders’ money is not wasted in pursuing empire- building strategies or due to inappropriate strategies. An example is the downfall of Subhiksha. The audit committee hardly protects the independence of auditors. Both the internal auditor and the statutory auditor hold office at the pleasure of the management. The audit committee hardly gets involved in the process of selecting the auditors. It approves proposals placed before it by the management. The statutory auditor’s independence is protected only through regulations. This is the reason why the Companies Bill 2012 has introduced few new regulations to protect the audit independence. In spite of the above shortcomings, we must accept that the audit committee is doing a good job. It holds independent views on various issues to which it pays attention, although it avoids traversing the terrain that might be murky. The good job done by the audit committee has raised stakeholders’ expectations, including those of regulators. Increased expectations have widened the gap between what the audit committee can do and what stakeholders’ expect it to do. The Companies Bill 2012 mandates that the audit committee shall approve and modify, if required, related party transactions ( RPT) except those that are entered in the ordinary course of business on arm’s length basis. It shall obtain professional advice from external sources, if required. RPT is a two- way sword — some benefit the company, others hurt minority shareholders’ interest. There is a general belief that companies that are managed by the dominant shareholder abuse RPTs to tunnel minority shareholders’ wealth. Therefore, there is concern over abusive RPTs across the globe. Presumably, this concern has prompted the government to include the modified provision in the Bill. In order to determine whether a RPT requires its approval, the audit committee, has to either examine every RPT or establish criteria to test whether a transaction is on arm’s length basis. Unfortunately, it is difficult to establish straightforward criteria. Moreover, the committee has to form a judgement on whether a particular RPT is abusive. This situation challenges the independence of the audit committee. If, at a later date, aRPT approved by the committee is found to be abusive or the Income Tax Department considers that the transfer price was not on arm’s length basis, quite likely, the committee will join the management to defend the decision. This has the potential to impair the independence of the committee. The Bill also provides that the board report shall disclose where the board had not accepted any recommendation of the audit committee and the reasons therefore. Both the board and the committee will avoid such a situation. Therefore, in certain situations the audit committee might have to compromise with its independent views. A well- intended provision might have dysfunctional effects. The new provisions might strengthen the motivation of the management to appoint independent directors who are not independent. Those who can hold independence in an adverse situation might not join the audit committee because they will be required to spend more time than before to diligently carry out new responsibilities. They may also expect, and rightly so, higher compensation than that of other independent directors in the board. Higher compensation to members might impair the independence of the audit committee. Time will tell whether we have killed agolden goose due to over expectation from it. Affiliation: Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; Advisor ( Advanced Studies), Indian Institute of Cost Accountants; Chairman, Riverside Management Academy Private Limited Email: asish. bhattacharyya@ gmail. com ACCOUNTANCY ASISH K BHATTACHARYYA Overreach on buybacks AKILA AGRAWAL AND ANJALI PURI The Securities and Exchange Board of India ( Sebi) released adiscussion paper on proposed modifications to the framework for open- market buyback offers. The modifications appear irrational, bordering on excessive. It appears that the fundamental theme of the proposed amendments relates to “ manipulation of share prices through buyback offers launched with wrongful intent”. The only proposal that appears reasonable is the one on increasing the minimum buy quantity to 50 per cent of the offer size. The current Sebi regulations require the company to disclose the minimum number of securities that it proposes to buy back. However, the regulations do not fix a minimum buy quantity. In 2008, the Securities Appellate Tribunal had directed the minimum buy quantity to be one per cent of the offer size. In recent buyback offers, Sebi has, in practice, insisted on a minimum buy quantity of 25 per cent. This appears to be agreeable to most companies. The fact that most companies actually buy back more than 25 per cent of the offer size may be one reason for their acceptance of this directive. In this context, increasing the minimum buy quantity to 50 per cent seems a fair proposal given the objectives of increasing the actual number of shares bought back and discouraging the use of buyback offers to manipulate share prices. Of course, the company is not forced to buy back any shares if the shares trade at a price higher than the maximum price announced by the company. On the other hand, the proposal to limit the maximum period of buyback to three months is devoid of logic. Both the Companies Act and the Companies Bill, 2011 state that the shares should be bought back within 12 months from the date of the shareholder/ board resolution. Sebi’s proposal to reduce the time period is contrary to the flexibility provided in the Companies Act. If Sebi intends to impose a minimum buy quantity, it is only fair that companies be provided adequate time to comply with it. Reducing the buyback period neither serves the interests of the investing public nor the companies that make such offers. Then again, Sebi has proposed that 25 per cent of the maximum buyback amount be placed in escrow. Currently, open market buyback offers do not entail an escrow mechanism. Sebi’s proposal, intended to ensure that only “serious” companies launch buyback offers, appears arbitrary, given that such offers are executed through a registered stockbroker after complying with the requisite norms on margin money and so on. Given that other capital market transactions of this nature ( such as an offer for sale on the stock exchange and block deals that are conducted on the floor of the exchange) do not entail depositing funds into escrow, Sebi should continue to dispense with an escrow requirement for open market buyback offers, too. Sebi’s proposal prohibiting a further issue of shares for two years after a buyback issue closes also seems unreasonable. Both the Companies Act and the Companies Bill, 2011 prescribe a six- month cooling- off period. Given that the legislature has, in its wisdom, reduced the period from two years to six months in 2001, Sebi’s current proposal merely on the ground that “ companies should have a long- term view on utilisation of funds when launching a buyback” appears excessive. This is especially so after having imposed a minimum buy quantity of 50 per cent to ensure that the offer is not frivolous or manipulative. Currently, the cooling- off period of one year between two buyback offers is limited to offers made solely following a board resolution. No cooling- off period is prescribed in the Companies Act if the offer is made after a shareholder resolution. Sebi has proposed that a oneyear cooling- off period for all buybacks be imposed in case the company has failed to exhaust the maximum offer size in its first buyback. It is interesting to note that the Companies Bill, 2011 also prescribes aone- year cooling- off period between two buybacks ( irrespective of whether they are launched following a board or shareholder resolution). Therefore, an increase in the time period in order to align with the Companies Bill, 2011 seems rational — but an increase in the time period as a form of penalty seems extremely unreasonable and onerous. Further, Sebi is of the view that abuyback of 15 per cent or more of paid- up capital and free reserves must be only by way of a tender offer. Sebi thinks buyback offers through the tender offer process are more favourable to investors since they are generally at a premium to the market price. Openmarket buyback offers are normally done closer to the market price (and, naturally, between a willing buyer and seller). Sebi’s proposal to limit open- market buyback offers to 15 per cent will only result in future buyback offers being made with an offer size of 14.9 per cent of paid- up capital and free reserves. It will not result in any benefit to shareholders — since it is fairly clear that companies prefer the open- market purchase method over the tender offer process. Given the scope and ambit of the Sebi ( Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, which adequately cover offences of manipulation of share prices and fraudulent or unfair trade practices, the market regulator should utilise them to address any mischief, rather than make wholesale changes to the existing buybackrelated rules. Sebi should also reconsider proposed amendments that are in contradiction to the provisions of the Companies Act. Agrawal is a partner and Puri is an associate in the corporate transactions team of Amarchand Mangaldas. These views are their own Sebi’s proposed changes to these regulations appear irrational ‘Take corporate governance seriously’ BS REPORTER Mumbai, 31 March It is important for companies to focus on the details of ways to improve corporate governance, stresses Mazars India in asurvey on the subject. Mazars is an international organisation, specialising in audit, accounting, tax and advisory services. Its report says companies vigilantly monitoring their strengths and weaknesses would go far in improving their processes. This includes having a whistleblower framework to report unethical behaviour, actual or suspected fraud or violation of the company’s code of conduct and ethics policy. “For any whistle- blowing policy to be successful, attentiveness and strong leadership is required by the board and senior levels of management to create aculture that is open, honest and encourages people to speak out, without fear of retribution,” said Sunil Sangar, chief internal auditor, Tech Mahindra. About 85 per cent of firms with a whistle- blower mechanism stated they provided complete anonymity and protection to anyone who reported amatter. Two- thirds of survey respondents ( it covered 500 companies from a diverse array of sectors) stated an Ombudsman directly reported to the audit committee. A little over half of the respondents said members of the audit committee, including directors, had called independent external for an objective assessment of aspects in their management reports. “Companies are facing strong demands for transparency and accountability. It is, therefore, important for directors to have independent perspectives, particularly when making difficult decisions,” said Arvind Chopra, group president, group assurance and cost control, Essar Group.