The Indian legislature obviated the need to resort to the difficult exercise of distinguishing between a penalty and liquidated damages by enacting the simple rule in s. 74 of the Contract Act that a court may award “reasonable compensation” not exceeding “the sum named” in the contract as payable in the event of breach, or any other stipulation by way of penalty. As the Constitution Bench put it in Fateh Chand, the Indian legislature dispensed with this “web of presumptions”. I have discussed elsewhere the significance of the 1899 amendment in light of the recent decision of the Supreme Court in BSNL v Reliance. It suffices here to note that, subject to one important qualification, it is unnecessary to distinguish between a penalty and liquidated damages in India. The qualification is that s. 74 allows a court to award such reasonable compensation “whether or not actual damage or loss is proved to have been caused”, and the Supreme Court has held that the sum named in the contract will be taken to represent reasonable compensation in any case where it is unable to assess actual loss (Maula Bax v Union of India AIR 1970 SC 1995). In short, in a significant number of cases, the claimant is entitled to the benefit of a liquidated damages clause without further ado. However, the Court has also held that this benefit is unavailable if the sum is thought to represent a penalty – not, as in English law, because that makes it unenforceable, but because there is then no reason to consider that the sum reflects “reasonable compensation”.

The significance of this distinction has been considered by the Delhi High Court in its recent judgment in Sudhir Gensets v Indian Oil Corporation. The appellant, Sudhir Gensets [“SGL”] had agreed to supply certain equipment to IOC by a specified deadline, and Clause 13 of the contract provided that it would pay liquidated damages of 0.5 % of the value of the goods delayed per week, subject to a maximum of 10 % of the total value. SGL, for a variety of reasons, could not supply in time, and a finding of fact was made that the fault was not that of IOC. Accordingly, IOC deducted (the significance of this is considered at the end) a sum of about Rs. 10 lakh, and SGL challenged it in arbitration proceedings on the ground that IOC had not adduced proof of loss.

Before the High Court, obvious reliance was placed by IOC on the language of s. 74, and the proposition advanced was that it is unnecessary to offer proof of loss. The High Court, after a detailed reference to the decision of the Supreme Court in ONGC v Saw Pipes, accepted this contention, holding that the figure in question represented the value the parties placed on the loss IOC would suffer on account of any delay in delivery. The Court rightly clarified that this result would not follow if the sum named in the contract is found to be a penalty, because there is then no room to assume that it represents a reasonable estimate of losses or “reasonable compensation” for the purpose of awarding damages under s. 74. The following observations are apposite:

28. This is also so provided under Section 74 of the Contract Act. As such, the party claiming breach of contract is entitled to receive reasonable compensation whether or not actual loss is proved to have been caused by such breach. In view of ONGC vs. Saw Pipes, wherever there is a pre-determined amount for the damages, in such a situation the said amount can be deducted by way of liquidated damages by way of specified amount payable by the respondent. Thus, if the compensation is named in the contract by way of penalty, consideration would be different and the party is only entitled to reasonable compensation for the loss suffered. But if the compensation named in the contract for such breach is genuine pre-estimate of loss which the parties knew when they made the contract to be likely to result from the breach of it, there is no question of proving such loss or such party is not required to lead evidence to prove actual loss suffered by him [emphasis added].

A final point must be made. It is interesting to notice in this case that Clause 13 provided that the vendor would pay the said sum as liquidated damages, and not that the purchaser could withhold or deduct that sum. Is there a difference between a claim to damages on the completion of the cause of action, and the crystallised right to enforce the claim once it is part of a decree? In Union of India v Raman Iron Foundry, the Supreme Court held (in a different context) that there is, albeit in a different context, and therefore declined to construe a contractual provision as allowing the deduction of mere claims. That case was overruled in Kamaluddin Ansari v Union of India and it is accepted that a contract can in any event provide for a claim to be appropriated prior to crystallisation – although whether the IOC-SDL contract did so is not clear.

So said a distinguished judge of the Court of Appeal recently in finding a Scout Association liable in negligence for an unfortunate injury that one of its members had suffered. The decision, an important one for many reasons, is reported as Scout Association v Barnes, and is available here.

Mark Barnes, at the time thirteen years old, was by all accounts keenly involved in the activities of the Scout Association, and, in February 2001, participated in a variant of a game known as “Grab”. The game, played by one more boy than the number of “blocks”, required the boys to grab one block each, with each round eliminating the unsuccessful candidate. The variant, called “Objects in the Dark”, was played without illumination in order to, as the scout leader testified in court, add to the “excitement”. Unfortunately, on the day in question, Mr. Barnes collided with a wall and suffered serious, albeit not long-term injury. Subsequently, a claim was brought against the Association for negligence.

It is well known that the law of negligence does not automatically compensate any injury that a claimant sustains, even if there was a significant risk of such injury. Indeed, the presumption, if anything, is to the contrary in such cases, because it is not the function of the law of negligence to eliminate even socially undesirable activities, let alone legitimate ones voluntarily undertaken. Instead, negligence law simply requires compensation from persons who commit acts although it is reasonably foreseeable at the time of commission that such acts are likely to cause damage to a third party to whom those persons owe a duty of care. In short, the fulcrum of negligence law is a combination of knowledge and foreseeability in relation to a defendant and his “neighbour”. In its application to injuries arising out of or in connection with sport, the classic statement of principle expressed by Diplock LJ in 1963 was that even a spectator’s claim fails unless the sportsman’s conduct was “such as to evince a reckless disregard of the spectator’s safety.” Again, the influence of knowledge and risk in the formulation of this test is apparent. On an imperfect analogy with sport, it might follow from this that Mr. Barnes’ claim had to fail. Yet, the trial judge allowed it, and awarded damages of about £7,000. The Scout Association, fearing the consequences of that decision and a possible deluge of claims, appealed.

The Court of Appeal dismissed the appeal over a strong dissent by Jackson LJ. Jackson LJ’s dissent, interestingly, did not replicate the knowledge and risk analysis – his Lordship accepted that playing the game without illumination materially increased the risk of injury, but referred to an important principle of the law of negligence that no less an authority than Lord Hoffmann had explained (by way of analogy) in Tomlinson v Congleton. In that case, the claimant had suffered injury by diving into a lake. Reversing an award of damages, Lord Hoffmann had observed that:

the question of what amounts to “such care as in all the circumstances of the case is reasonable” depends upon assessing, as in the case of common law negligence, not only the likelihood that someone may be injured and the seriousness of the injury which may occur, but also the social value of the activity which gives rise to the risk and the cost of preventative measure. These factors have to be balanced against each other [emphasis mine].”

Jackson LJ was of the view that the trial judge had applied the ingredients of negligence without considering the social value of the activity and the cost of preventative measure – an assessment that drew support from the fact that the judge had allowed the claim “with regret”. Jackson LJ held that risk in many fields is accepted, such as cricket, rugby and skiing, “because recreations of this nature have a social value.” This is an interesting basis on which to rest the law’s traditionally hands-off approach to negligence in sport, because the more conventional common law view, highlighted above, is that a claim in those circumstances fails simply as a consequence of the knowledge of the claimant that he, by participating in that game, ran a risk of such injury.

The majority – Smith and Ward LJJ – in fact agreed with much of this substantive analysis. Smith LJ held, however, that the judge had taken into account the principle in Tomlinson, and had concluded that the extent of the social benefit of the activities of the Scout Association was insufficient to offset the particular risk. While this is not apparent from the judgment at first instance, and while it is possible to take a different view on the merits of the application of Tomlinson even if it is apparent, Smith LJ found that an appellate court could not do so, since it is not an error of law. This reasoning is a good example of the deference that English appellate courts give to a finding of fact or an exercise of discretion of a judge at first instance. Indeed, save perverse findings of fact, it is perhaps only when the issue is a question of law – which in Jackson LJ’s view it was – that the Court of Appeal examines the question de novo.  As Smith LJ put it,  “[i]t is trite law that this court will not interfere with an evaluative judgment made by the judge below unless he has taken an irrelevant matter into account, omitted to take a relevant matter into account or has reached a conclusion which is plainly wrong [emphasis mine].” Ward LJ came to almost exactly the same conclusion, and agreed with Jackson LJ’s view of the law, finding, however, that the appellate court was not entitled to substitute its view of the question for the view of the trial judge.

This case is a good reminder that the traditional “neighbourhood” principle articulated in Donoghue v Stevenson, on which the modern law of negligence has been built, is suitable for the vast majority of cases, but does raise some difficult questions in others. The classic examples of that category are economic loss and nervous shock, where one of the premises of the neighbourhood principle – foreseeability of the type and extent of damage – is falsified by the nature of the tortious activity. Equally, it may not be appropriate to apply the strict neighbourhood principle to sport, not only because the claimant typically has taken the risk of injury, but also because it may impair the autonomy of sportsmen. Yet, a third class of activities that are plainly socially desirable but cannot be accommodated in the law on negligence in sport raises further questions about the manner in which the negligence test must apply. While Jackson LJ’s approach hints at “social desirability” as the underlying principle across such categories, the last word has not been said on the extent to which it is a freestanding reason to narrow the test for negligence, especially when it is not clear that the claimant has taken the risk of injury.

Lord Phillips’ judgment, as always,[1] is a remarkably careful and comprehensive analysis of the authorities, and repays close study. For our purposes, it is sufficient to note that the immediate context for the case was uncertainty over the fourth of the five ingredients of the fair comment defence that Lord Nicholls had formulated in Tse Wai Chun Paul v Cheng, [2001] EMLR 777 (“Cheng”). The uncontroversial ingredients were that the comment must be on a matter in the “public interest”, that it must be recognisable as a comment, that it must be based on facts that are either true or privileged, and that the comment must be one that an honest man, no matter how prejudiced or obstinate, could have made. The fourth ingredient was stated to be:

“the comment must explicitly or implicitly indicate, at least in general terms, what are the facts on which the comment is being made.”

In Spiller, the claimant was a member of musical acts that performed across England, and entered into contracts with the defendant whereby the defendant would promote it and arrange performances for a commission on the fee the claimant received. There was some dispute as to whether the claimant breached such a contract in 2005, but the simmering tension between the parties erupted in ugly fashion in 2007, when the defendant discovered that the claimant had agreed to perform a second time for a venue, in breach of a re-engagement clause that any subsequent performances with a venue would be arranged solely by the defendant. The defendant wrote to the claimant terminating the contract, to which the claimant responded in a lengthy email which said, inter alia,

“It appears you do not know the meaning of freelance, that is what all my shows are… You came to me Jason after viewing the quality of our show, your contract is mearly [sic] a formality and holds no water in legal terms.”

The defendant promptly posted on an online forum a message that stated that it had been advised by the claimant that “contracts hold no water in legal terms”. Partly misquoting and partly incompletely quoting the email, the defendant went on to suggest that the claimant would not honour its legal obligations, and warned colleagues that they would be well advised to engage “professional” bands. The post stated that a contract had been breached, but provided no particulars, and did not indicate what contract had been breached. The claimants brought a defamation action, and sought to strike out the defence of fair comment on the basis of the fourth ingredient described above i.e. that the defendant had not indicated the facts on which the comment was made. Since there was substantial uncertainty as to and disagreement over the fourth ingredient, interlocutory proceedings went up all the way to the Supreme Court.

While it is impossible to briefly even summarise the result of Lord Phillips’ painstaking analysis of the authorities, from ¶¶32-98, it is useful to notice his observation (and Lord Walker’s) that the defence of fair comment originated in a social context where the principal concern was the scope of permissible criticism of art and literary work in England – naturally, neither an art work nor a literary work can be criticised without being identified. When, however, the defence was extended to individual speech in other contexts, it was still sometimes thought (notably Hunt v Star Newspaper) that the defence of fair comment was available only in relation to facts stated in the comment. The rationale for this requirement was said to be that it allows the reader to judge for himself whether the comment or the inference is warranted by the facts that are set out. It was, in some sense, a belief that a comment that otherwise lowers a man’s reputation may not have that effect if it is clear to the reader that it is unreasonable or unwarranted.  

Faced with this difficulty, the defendants simply argued that the fourth ingredient was formulated incorrectly, because it was contrary to the famous decision of the House of Lords in 1952 in Kemsley v Foot. It was also apparent that the rule in question had never been universally accepted. Readers of Jeffrey Archer’s Fourth Estate may find the facts of Kemsley v Foot familiar – a dispute over a savage attack on Lord Beaverbrook’s newspaper by Michael Foot. The defamation claim was itself confined to the title of the article – “Lower than Kemsley” – and the defendant relied on fair comment. Although there was clearly no express reference to the facts on which the comment was based, the House of Lords allowed the defence, apparently on the basis that a comment as to a public figure was sufficient identification. However, Lord Porter also noted that the defendant need not, in such circumstances, prove as true every fact on which the comment is based, provided he can prove atleast one – and this was taken to be an implicit rejection of the requirement that every fact must be stated in the first place. As Lord Phillips correctly explains in ¶94, that is not the case, for Lord Porter’s speech only states that the defendant need not set out every aspect of the matter on which his comment is based, and that he need not prove every fact subsequently pleaded in defence as true. However, Lord Phillips clarified that in one respect the fourth ingredient formulated was inconsistent with Kemsley – that readers must be in a position to evaluate the fairness of the comment for themselves. This was never more than dicta in some of the cases, and is likely, as Lord Phillips noted, to rob the defence of fair comment of “much of its efficacy” in an era where comment is more widely distributed more easily.

The final aspect of the case concerns law reform. The defendant argued that it was time for the Supreme Court to entirely recast the law on fair comment considering that the principles had been developed at a time when the internet and the pace of modern communication were unknown. While noting that there is a strong case for this view, and especially for abolishing trial by jury, Lord Phillips correctly declined this invitation to reform the law, holding that “in any event, the proposed reforms go beyond changes that could properly be made by this court in the orderly development of common law”. Indeed, it is perhaps this reluctance of judges to decide more than necessary or lightly modify long-standing doctrine – even to cater to changing social conditions – that makes the common law endure as a rational and stable system of private law, and English law among the most widely used systems of law in international commerce.

Another comment on the case is available here.

The focus of this brief comment – company law – has itself been the source of some controversy in 2010. In May, a Constitution Bench gave the Government a Pyrrhic victory in dismissing a challenge to the constitutionality of the National Company Law Tribunal, observing that Parts 1B and 1C of the Companies Act are in their present form unconstitutional. The Court emphasised that while Parliament is undoubtedly competent to create Tribunals, it cannot – in form or substance – exercise that competence in a manner that infringes on the independence of the judiciary. Mihir has discussed the judgment in some detail here, and it is submitted that the decision must be welcomed for it finally clarifies that the “looser” model of separation of powers that the Indian Constitution adopts is not a reason to vest judicial power in bodies that lack the characteristics associated by the Constitution with the exercise of judicial power.

At about the same time, the Court handed down its much-awaited judgment in the dispute between the Reliance brothers, on which I have commented in detail here. Sudershan Reddy J.’s concurring opinion (not dissenting, contrary to media reports) is especially interesting, since it appears in passing to endorse a far wider approach to fiduciary duties of directors than is presently accepted. Krishnaprasad has discussed this matter in more detail on this blog. The majority’s statement that the doctrine of identification is inapplicable to “large” companies may need clarification in the future, especially as to the extent to which Lord Hoffman’s classic exposition in Meridian Global is applicable in India. That is accentuated by the fact that the subsequent judgment in Iridium Motorola on identification and attribution in criminal law does not refer to Meridian either. Mr. Umakanth has commented on Iridium here.

In June, the Court had an opportunity to address one of the most complex and fascinating doctrines in company law – apparent authority and its relationship with the doctrine of indoor management. As the recent Red Jaguar case reveals, this point is not entirely clear even in England. The Supreme Court recognised, and it is submitted correctly, that the doctrine of indoor management cannot be used autonomously, but only to confine the operation of the doctrine of constructive notice – in that sense, both constructive notice (vis a vis apparent authority) and indoor management (vis a vis constructive notice) are negative doctrines, a point that has not always been appreciated.

The SEBI Takeover Code had not until recently been considered in detail by the courts, and the Supreme Court’s opinion in Daiichi, which this blog discussed here, is thus an important development. I have suggested elsewhere that close attention must be paid to two conclusions the Court reached on the scope of Regulation 2(1)(e)(2)(i), and in particular that the observation that it is necessary to establish that a certain acquisition was for the common objective or purpose of substantial acquisition of shares may constitute obiter dicta. Nevertheless, that observation is likely to prove influential especially in the High Courts and it will be interesting to observe what approach the courts take to the deeming provision in Regulation 2(1)(e)(2) when the opportunity next arises.

Perhaps the most significant development in company law this year was the decision of a Division Bench of the Bombay High Court in September in Messer Holdings, where it concluded that s. 111A of the Companies Act does not in fact render invalid restrictions on transfer of shares that are typically found in joint venture agreements. While this decision is enormously helpful for the cause of commercial certainty, it is not clear that it is consistent with the authorities or constitutes good law. The Supreme Court is no doubt likely to be asked to resolve the controversy, since a single judge of the Bombay High Court (overruled in Messer) and the Delhi High Court have reached the opposite conclusion.

All in all, it has been an eventful year for Indian private law, and 2011 is likely to continue in the same vein, for it is possible that some of the Companies Bill, the Arbitration Consultation Paper, the Direct Taxes Code and the GST Bill are enacted into law. Whether that happens next year or later, it is clear that Indian private/commercial law is set for a major overhaul. Contract, partnership and agency remain codified by classic statutes, and doctrinal advances in those respects are therefore more likely to be made in the courts than by the legislature.

The case arose out of two agreements that a Thai company and an Indian company had entered into. The first of these, in relation to which no dispute arose, was an agreement signed in 2008 for the purchase by the Indian company of a substantial quantity of aluminum ingots.  This contract was negotiated and signed on behalf of the Indian company by one of its officers – S. Sengupta. However, disputes arose in relation to a second contract the parties (allegedly) entered into, and the Indian company declined to make payment and complete the contract. That contract contained a clause that, although unfortunately worded,[1] indicated that the parties had agreed to resolve disputes through binding arbitration. The contract had been negotiated and signed not by Mr. Sengupta, but by another officer – Sandeep Dabir.

In an arbitration claim for around $350,000 brought by the Thai company, the Indian company denied the existence of the arbitration clause, upon the ground that Mr. Dabir had not possessed any authority to conclude a contract on behalf of the company, although it conceded that he had been authorised to negotiate it. A petition was duly filed under s. 11 of the Arbitration and Conciliation Act, 1996, for the appointment of an arbitrator, and two issues arose – first, whether the designate under s. 11 is required or entitled to consider the existence of the contract, and secondly, if so, the means of adjudicating the claim of lack of authority on the merits.

On the first issue, the designate, Thakur J., correctly held that he was bound by authority to conclude that he is required to consider whether an arbitration clause exists. We have previously charted the course of the law on appointment, and it suffices here to briefly recapitulate it. While Patel Engineering was clear that the appointment power is a substantive and not administrative jurisdiction, doubt arose as to the relative competence of the designate and the Tribunal with regard to certain types of challenges. The most prominent examples are contentions that the claim is no longer live, that the contract has been discharged either by completion or supervening impossibility, that it was procured by undue influence, misrepresentation or fraud, that it was void entirely or that it did not extend to the dispute in question. In Boghara Polyfab, the Court offered guidance by classifying these claims into those the designate is required to consider, those he is entitled to consider, and those as to which he is required to defer to the Tribunal. In keeping with Patel Engineering, the Court found that a majority of the claims listed above fall into either the first or second category, and that continues, despite some doubt arising out of an unreported judgment of the Court, to be good law. As a result, Thakur J. held that the contention that the contract is void for lack of authority was clearly within the scope of the s. 11 jurisdiction.

It is instructive to compare this result with the classic decision in English law (House of Lords, 2007) on the subject of appointment of arbitrators in such circumstances – Fiona Trust v Privalov. Lord Hoffman observed that the approach in construing an arbitration clause must be informed by the principle that the question is essentially whether the “parties intended” a certain type of objection to be resolved by the Tribunal. The speech specifically classified an objection that the agent “entirely lacked” authority to conclude the contract as one that will typically defeat the jurisdiction of the Tribunal, as opposed to one that he “exceeded” authority that he did have. Patel Engineering, of course, makes any such inquiry irrelevant in India.

The second point that arises out of Alva Aluminum is Thakur J.’s treatment of the substantive contention that Mr. Dabir lacked authority. Four reasons emerge from his rejection of this contention – first, that it is clear that the parties were doing more than “just negotiating”; secondly, that the contention that Mr. Dabir’s signature was obtained by misrepresentation or fraud failed for want of materials; thirdly, the claim of lack of actual authority failed because the respondent did not adduce any evidence to demonstrate that it had taken “disciplinary action” against Mr. Dabir for exceeding his authority, which was within its “special knowledge”; and finally that in any event the petitioner had no reason to believe that Mr. Dabir had not been authorised to sign, especially since it was conceded that he had been authorised to negotiate.

While this conclusion is correct in the circumstances of the case, it should be noticed that the first and second reasons are not directly relevant to a claim of absence of actual authority, and that the fourth is relevant only if the court is making a finding of ostensible authority. Thakur J.’s third reason, on the other hand, seems to be a reference, although not expressly, to s. 106 of the Indian Evidence Act, 1872, which provides that the burden of proving a fact within “especially within the knowledge of a person” is on that person. It is submitted that this part of the judgment must be considered to be authority only for the narrow proposition that s. 106 may be invoked to defeat lack of actual authority claims, and not for the wider proposition that such a claim may be defeated only by showing that steps were taken against the errant agent.

The dispute had its roots in a decision by the liquidators of Akai to sell its listing on the Hong Kong Stock Exchange, with the object of realising whatever value they could from the failed company. To do so, however, they were required under local law to enter a scheme of arrangement, which in turn needed the approval of a majority of shareholders, and the sanction of the court. Anticipating that Mr. Ting would not take kindly to the effort to sell, the liquidators obtained an ex parte order allowing them to temporarily disregard his companies’ votes, subject to a court hearing to assess the validity of those votes. At the relevant meeting, attorneys sought to act as proxies for the Ting companies, and were not allowed to do so, on the basis that the letter of authorisation was simply signed by Mr. Ting, without the necessary seal of the companies in question. In the ensuing litigation, it was found, as a matter of fact, that Mr. Ting, when told of this difficulty, had arranged for a board resolution to be typed up and for his signature to be forged. Armed with this “authorisation”, the Ting companies voted against the scheme – those votes were temporarily disregarded in accordance with the ex parte order, and the stage was set for protracted litigation.

There is little doubt that the litigation would have vindicated the position of the liquidators. However, the buyer had the right to withdraw from the scheme unless the Akai shareholders approved it by 31 December, 2002, and the prospect of obtaining a successful order by then, over the opposition of the Ting companies was remote. Indeed, three judges recused themselves from hearing the case after Mr. Ting’s objections, and the liquidators entered negotiations with Mr. Ting to arrive at a settlement, although they now had evidence that his signature had been forged. The liquidators undoubtedly acted in the best interests of the company, for pursuing litigation beyond the 31 December, 2002 deadline would have would brought no more than a pyrrhic victory.

Mr. Ting took full advantage of this opportunity, and entered into an agreement [“Settlement Agreement”] with the liquidators whereby he withdrew his opposition to the scheme, in consideration for their agreeing to “irrevocably covenant” to not sue him or pursue any claim of any nature against him, whether for past, present or future rights etc. The effect of the Settlement Agreement, if valid, was to grant Mr. Ting immunity from virtually any claim that could be brought in a court of law. His opposition was withdrawn, and the scheme went through.

In 2005, the liquidators uncovered evidence suggesting that Mr. Ting may have been guilty of substantial misappropriation of funds. Alleging that the Settlement Agreement was not binding, they commenced proceedings alleging misappropriation of over HK$400 million. Mr. Ting then brought an action to declare that the Settlement Agreement was valid and to restrain the liquidators from proceeding.  The Chief Justice of Bermuda rejected the application, finding Mr. Ting had engaged in “sharp practices”, approached the court with “unclean hands” and that he had committed numerous violations of statutory and fiduciary duties. The Court of Appeal reversed this decision, holding that Mr. Ting owed no duty of disclosure to the liquidators, and that any “sharp practice” or “unclean hands” was covered by the broad terms of the Settlement Agreement. The liquidators appealed to the Privy Council.

In an interesting decision, the Privy Council upheld the claim of the liquidators and denied Mr. Ting immunity. The purpose of this post is not to consider the Board’s analysis of insolvency principles – indeed, those did not directly arise for consideration. The Board instead found that Mr. Ting had opposed the scheme in bad faith and for an improper motive, and noted that had litigation continued at the relevant time, his votes would undoubtedly have been disregarded by the court. Secondly, it held that Mr. Ting had, instead of cooperating with the liquidators as he was bound to do under insolvency law, “opposed the scheme for purely personal and selfish reasons, in the process using forgery and false evidence.” Based on these findings, the Board found that the Settlement Agreement had been entered into “under duress” and consequently not binding.

Two points are noteworthy. First, it settled that the “exercise of a legal right” is not grounds for a finding of duress even if it constitutes enormous hardship to the other party. Exceptions do exist, and while “mala fide” is a test that normally triggers the exception, it does not always do so. Readers will find the relevant principles set out by Mance J. (as he then was) in Huyten v Peter Cramer, [1999] CLC 320.Thus, the question is – was Mr. Ting entitled to oppose a scheme of arrangement, in his capacity as a shareholder, and if he was, did the manner in which he chose to exercise that right attract the exception? The answer to the first part of the question is probably in the affirmative, since shareholders owe no fiduciary duty to the company, subject to legislative provisions to the contrary.

That, then, leads to the second point – it is important to not read the Board’s decision as altering the law on fiduciary duties. The decision instead appears to have upheld the right of the liquidators to avoid the Settlement Agreement for duress because specific duties imposed by insolvency law were not complied with, and/or Mr. Ting’s mala fide acts were sufficient to displace the usual presumption that the exercise of a legal right does not trigger duress. While the Board does not explicitly rest its conclusion on this basis, it is unlikely that it intended to effect so fundamental departure from settled law, especially in a case that did not question the rule. It remains an interesting example of the willingness of English courts to expand the horizons of economic duress in negativing agreements.

Ban on foreign lawyers – another nail in the coffin of India’s international arbitration dreams

The recent decision in Lawyers Collective v Bar Council of India has been discussed widely. Along with discussions on the correctness or otherwise of the decision, several comments have focused on the more normative question of desirability of foreign lawyers being allowed to practice India. Yet no one appears to have paid attention to what is probably the best argument in favour of foreign lawyers, at least in limited circumstances – the impact of keeping foreign lawyers out on India’s recent attempts at becoming an international arbitration destination.

Lawyers collective v  Bar Council of India – A brief overview

As the decision in Lawyers Collective has been widely discussed in the blogosphere, I would like to deal with the case only to the extent necessary for this post. In this case, the legality of permission granted by the Reserve Bank of India under the Foreign Exchange Management Act, 1973 to some foreign law firms to open liason offices in India was assailed. “Practice of law” as per the Advocates Act, 1961, can be carried on in India only by an advocate registered with a Bar Council. The case centered around the question of whether liaison offices which engaged in activities like coordination between foreign firms and their Indian clients, broadly classified as non-litigious practice, were “practicing law” and hence were acting illegally on account of their not being registered as Advocates. The court interpreted the term “practice of law” broadly to include both litigious and non-litigious aspects of practice of law and held that the liaison offices were illegal.

Can a foreign lawyer appear before an arbitral tribunal in India?

The Court, in Lawyers’ Collective took a starting point that all litigious practice was prohibited for anyone but a registered Advocate. In many places in the decision, litigious practice is indicated to include appearing before tribunals. Even if one were to rely on the capital ‘T’ with which tribunal has been spelt by the court and somehow make a fanciful argument that this would be a reference to statutory tribunals and not to private arbitral tribunals, that would, at best, merely take appearances before arbitral tribunals outside the purview of “litigious practice of law”. It would still be “practice of law”, given the wide understanding accorded to the phrase.

Impact of Ban on foreign lawyers on international arbitration

In an international commercial arbitration several legal systems come into contact. For instance, let us assume a contract between an Indian party and a Swiss party which is governed by French law and which provides for arbitration in India according to LCIA India Rules. Upon a dispute arising between the parties, the Swiss party seeks arbitration. The Indian party, contests the validity of the arbitration clause on the ground that the Swiss party was incompetent to contract, a question usually to be settled under the law of domicile of the party concerned, in this case Swiss law. Also, if the dispute was to reach the merits stage, the claims of the parties are to be decided in accordance with the substantive law of the contract, in this case French law. Thus, the dispute here is going to be adjudicated under laws of two civil law countries, entirely different from the common law tradition in which Indian lawyers are trained. Indian law may come in handy if one of the parties wants to move court for interim relief or for appointment or removal of an arbitrator. But, apart from these limited functions, Indian law has nothing to do with the dispute.

In this situation, given a choice who would a party prefer – an Indian lawyer or a continental lawyer? Choice of a lawyer trained in civil law is bound to be the logically sound option. Yet, India’s closed door policy on foreign lawyers forces Indian lawyers to argue out the case despite their lack of competence in the subject area.

India has recently been attempting to make itself an “arbitration friendly” jurisdiction or an arbitration destination. Yet, will any foreign party agree to arbitration in India in a contract governed by a non-Indian substantive law when he knows that his choice of lawyers in case of a dispute is limited to Indian lawyers? One may say that a foreign party may still agree to have India as the legal seat of arbitration and merely hold hearings outside India with foreign lawyers of his choice. But that hardly makes India an “arbitration destination”. Also, I cannot see what could be so attractive about Indian arbitration law that lures a party who does not intend to hold a single sitting in India into designating India as the legal seat of arbitration.

What is the solution?

A general permission for foreign lawyers to practice law in India seems to be distant. A more pragmatic solution will be to bring this issue within the purview of arbitration reforms that India is pursuing and make a special exception (probably through a non-obstante clause in the Arbitration and Conciliation Act, 1996) allowing persons of any nationality, whether or not registered as Advocates in India, to appear before arbitral tribunals seated in India where the arbitration in question is an international commercial arbitration.

In very simple terms, tax deducted at source [“TDS”] represents an alternative and more efficient collection mechanism for the Government. Conceptually, TDS is not a separate charge, nor is it a levy additional to the income tax charged under the Act. In other words (conceptually), TDS pertains not to whether tax is payable, but to who pays it, and when it must be paid. This conceptual understanding of TDS was thrown into some doubt last year by the well-known decision of the Karnataka High Court in CIT v. Samsung Electronics. The High Court held in that case that the obligation to deduct tax under the Income Tax Act arises regardless of the chargeability under the Act of the principal sum. Theoretically, this led to results that it is difficult to believe the legislature intended – for example, if chargeability is irrelevant, a payment made by an American company to a Belgian company for a transaction entirely outside India could attract the requirement. As a result, there was doubt as whether the Karnataka High Court reached the correct conclusion, and in GE Electronics, the Supreme Court has confirmed that it did not.

Before discussing the decision of the Supreme Court, it is worth noting that this question is governed by the provisions of s. 195 of the Income Tax Act. S. 195(1) provides that

Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries” shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income tax thereon at the rates in force …  [emphasis supplied]

S. 195 is placed in Chapter 27 of the Act, which is titled “Collection and Recovery of Tax”. S. 190, defining the scope of the chapter, provides that “notwithstanding” regular assessment in respect of “any income…” the tax on “such income shall be payable by deduction or collection at source or advance payment…” All of this seems to reiterate the conceptual understanding that the question of TDS does not arise unless it is clear that the principal sum is liable to tax. What led the Karnataka High Court to hold as it did was a decision of the Supreme Court in Transmission Corporation.

Thus, two issues arose before the Supreme Court in GE Electronics – first, whether the issue was concluded by the decision Transmission, and, if not, whether there is warrant to read s. 195 in the manner suggested by the Karnataka High Court. On the first issue, the Supreme Court held that Transmission Corporation does not conclude the matter, because it was decided on a different point of the scope of s. 195(2) in the case of a “composite” payment made by a resident to a non-resident. The Court carefully examined its opinion in Transmission, and cited certain passages from it to demonstrate that the case did not lay down any general proposition on the applicability of s. 195(1).

Having so found, it was free to consider whether the language of s. 195 points to this result. It began by noting that the expression “chargeable to tax” clearly indicates the intention of the legislature to activate TDS only when the principal sum is itself chargeable, and further contrasted this with other provisions in Chapter 27 that significantly omit the expression “chargeable under” and simply provide that TDS is applicable to any “sum paid” to a non-resident. Finally, the Court also pointed to an absurd consequence that would follow from accepting the Revenue’s position – the payer would have no avenue to appeal against the payment of TDS on a sum even patently outside the ambit of the Indian Act (since, in law, TDS is not paid to discharge the tax liability of the payer), in addition to the fact that only the payee can seek a refund. One of the Department’s main contentions was that a blanket rule requiring deduction promotes tax compliance and prevents “seepage of revenue”. The Supreme Court rejected this contention, correctly noting that it is open to the Department in such cases to disallow the expenditure claimed by the payer on the principal sum paid to the non-resident.

Two points are clear. First, as several High Courts and Tribunals across the country pointed out, the approach of the Karnataka High Court in Samsung is, with respect, incorrect. Secondly, the Supreme Court was right to affirm the primacy of the “text” of s. 195 of the Income Tax Act, 1961 in answering this question – in an era where the text of a provision is often subordinated to various other considerations, it is perhaps welcome that the Supreme Court stifled the Department’s attempt to effectively rewrite s. 195 of the Act in a bid to promote revenue-collection.

______________________________________________________________

The latest review of companies’ legislation in India has already witnessed a span of more than 5 years. Although there was a glimmer of hope that the process will fructify with the enactment of a new legislation, the recent report of the Parliamentary Standing Committee on Finance on the Companies Bill, 2009 suggests that the process is only likely to be elongated further. This is because several recommendations of the Standing Committee run counter to proposals contained in the Bill, thereby requiring a fundamental debate on some of the issues. One such issue pertains to the question of whether Indian companies can issue shares with differential rights, a matter this post will focus on.

Traditionally, public companies in India have been permitted to issue only two classes of shares, viz. preference shares and equity shares, while private companies possess the flexibility to issue different classes of shares. All equity shares in public companies are generally required to carry same rights without any discrimination among equity shareholders.

However, this changed nearly a decade ago with an amendment to the Companies Act, 1956 (specifically to Section 86) and with the promulgation of the Companies (Issue of Share Capital and Differential Voting Rights) Rules, 2001. The regulatory changes permitted public companies to issue equity shares with differential rights as to voting or dividend.

The logic behind such an enabling regime was to provide companies with an option to raise finances from investors by decoupling economic rights (e.g., dividend) from control rights (e.g. voting). For example, companies could issue shares with higher dividend and lower voting rights to outside shareholders primarily keen on greater returns, while they could issue shares with lower dividend and higher voting rights to insiders (such as promoters) primarily keen on reinforcing their control over the companies. However, under the relevant rules, only companies that comply with certain stringent conditions are eligible to issue such shares; the conditions include a 3-year profitability track-record, no failure to repay debts or pay dividend and no default in meeting investors’ grievances. The shares with such differential rights cannot exceed 25% of the total share capital issued.

Due to the onerous nature of these conditions, it has not been received favourably by the Indian industry. In fact, until 2008 no leading Indian company had undertaken an issuance of shares with differential rights when Tata Motors came up with a rights offering to finance its acquisition of Jaguar-Land Rover from Ford, a deal which was announced earlier that year. The company issued a new class of equity shares named ‘A’ Ordinary Shares, which carried dividend rights at 5 percentage points greater than other equity shares while it carried only 1/10^th voting rights compared to other equity shares.

On the one hand, shares with differential rights constitute an effective tool for companies to raise finances on favourable terms, and are therefore popular with the corporate sector. Several high profile companies in other economies too have put this tool to effective use, with Google and New York Times being prime examples. On the other hand, the idea of shares with differential rights is not without its critics. They argue that coupling of economic rights and control rights is essential to strengthen the corporate governance framework, and also that a decoupling will enable promoters to amass excessive control without concomitant economic interest so as to stifle minority interests. It is no wonder, they say, that the instrument of shares with differential rights is on its decline in certain jurisdictions as Europe which are moving towards a stringent one-share-one-vote rule.

Given the dichotomy of views differential shares generate, they have been subject to close regulatory scrutiny in India. The judiciary, when confronted with the issue (albeit in a single instance thus far), has adopted a somewhat liberal attitude. In Anand Pershad Jaiswal v. Jagatjit Industries Limited, MANU/CL/0002/2009, the Company Law Board (CLB) seemed favourable to the issue of shares to insiders that enhanced their control rights without the same economic rights. Unfortunately, the CLB did not have the opportunity to delve into the details of the issues raised in that matter or interpret the legal provisions because it was settled through a consent order.

The Securities and Exchange Board of India (SEBI) has, on the other hand, adopted a more stringent approach in protecting the interests of minority investors. In July 2009, SEBI amended the listing agreement to introduce a new condition whereby listed companies are now prohibited from issuing “superior rights as to voting or dividend vis-à-vis the rights on equity shares that are already listed”. SEBI’s effort adds a qualitative element to the analysis. Apart from a determination of whether shares have a “differential” element from other equity shares, there is a need for a determination of whether the new shares are “superior” to existing shares. If superior, the issue of new shares will not be permitted. On its face, while SEBI’s amendment appears to strike at the root of possible abuse of the differential shares mechanism by ensuring that promoters of companies do not confer greater control rights on themselves, it creates unnecessary obstacles to genuine transactions involving issue of shares with differential rights to outsiders. This confusion prompted Tata Motors, that continues to be one of few companies accessing the mechanism, to approach SEBI for a ruling on whether their existing issue of Ordinary ‘A’ shares is protected within the new dispensation under the listing agreement. Although SEBI’s response to Tata Motors was favourable, several questions remain unanswered, as discussed here.

Matters appeared to be heading towards a dead-end and it was almost as if the above debate is only of academic value because the Companies Bill, 2009 proposes to eliminate the concept of shares with differential rights. It seeks to revert to the pre-2001 position where all equity shares ought to carry similar rights, in a sense following the trend adopted by countries in Europe. More recently though, the relevance of this debate has been resuscitated because the Standing Committee has suggested that the Government must re-examine the Bill due to the overwhelming suggestions received to permit the issue of differential shares. It is therefore clear that the issue is back on the anvil and will need to be considered further.

While the substantive part of this post seeks to outline the various twists and turns in the legal position (existing and proposed), it is reflective of another phenomenon. We find that in a span of a decade, the law has undergone a significant number of changes resulting in some uncertainty as to the precise legal position. Despite the fervour generated by the issue, very few companies have in fact adopted the route of issuing differential shares, a fact that hardly comes as a surprise.

Interestingly, it is often the most ubiquitous commercial commodity that poses the greatest difficult to the law. In many cases, this is because it is difficult to “classify” the commodity in question under existing legal pigeonholes, and yet necessary to do so in the interests of applying a coherent regulatory framework to it. Thus it is with software. Without attempting to be exhaustive, this post discusses developments primarily in Indian law over the past few years on various aspects of classifying software transactions.

Such an account must begin with the decision of a Constitution Bench of the Supreme Court in Tata Consultancy Services v. State of Andhra Pradesh. The decision is an extremely influential one, and arose out of a sales tax dispute concerning the taxability of software sold to customers of TCS in connection with services that the company rendered. Frequently, these products were “off-the-shelf” or “branded” software, manufactured on a large scale without a significant degree of customization. Such companies also “sell” software that is heavily customised to the needs of a particular consumer – referred to commonly as “bespoke” software. In both cases, consumers are usually asked to enter into an “End User Licence Agreement” [“EULA”] as a precondition for using the software. However, the Supreme Court in TCS was concerned with the former but not with the latter – a point that has significance for the scope of its observations in the case.

TCS challenged the levy of sales tax on the theory that the transfer of off-the-shelf software does not constitute a “sale”. There are two arguable points to support this contention in any case: first, that software “inherently” does not constitute “goods” for it predominantly represents intellectual property; and secondly, that even if it does, its transfer does not constitute a “sale”, because the rights accorded to the end-user are so severely limited as to militate against such a characterization. In TCS, the judgment reveals that the petitioner argued the first point, but not the second.

Consequently, the Constitution Bench’s analysis is mainly directed towards ascertaining whether software is inherently goods. The dominant view in several jurisdictions is that it does, for any entity represents underlying intellectual input manifested in a suitable physical form. This test, of course, is not very helpful when software is transferred without a physical medium. However, the Constitution Bench found that Indian law on the meaning of “goods” does not attach importance to the medium of transfer, adopting as it does the functional test of whether the entity in question is capable of “abstraction, consumption, transmission, transfer etc.” These software is undoubtedly capable of – and thus the question was answered against the petitioner. Paragraph 29 of the majority opinion is of vital significance, for the court notes that although there is “no distinction between branded and unbranded software”, it does not follow necessarily that the transfer of unbranded software is a sale because “other questions like situs of contract of sale and/or whether the contract is a service contract may arise”. As the Court was not required to classify unbranded software, it left this question open, and paragraph 29 continues to be a source of some ambiguity. Since the petitioner did not argue the second point we discussed above, no opinion was expressed on that at all.

I have argued elsewhere that the Supreme Court, with respect, may need to reconsider this issue because its first conclusion that software constitutes goods, although correct, does not conclude the matter. The reason, quite simply, is that the typical EULA transfers to the end-user very limited rights of use – many concede that it is not symptomatic of a typical sale contract. However, there is opposition to this view as well, and an analysis of the decisions of courts in England and America shows that the question is a close one. Intriguingly, courts and tribunals in India appear to have recognised in other contexts that the typical software transfer agreement may only constitute a limited licence.

To better understand the importance of this point, it is useful to refer back to the famous decision in State of Madras v. Gannon Dunkerley, and to the opinion of the legendary Justice Venkatarama Iyer. At issue was whether the State Government could charge the “sale” of cement to sales tax, when it occurred in the course of an architect building a house for a client. Clearly, neither the architect nor the client viewed the contract as “the sale of cement to be employed for the purpose of constructing a building” but as “a service contract for the construction of a house”. The Supreme Court held therefore that it is not open to tax authorities to “vivisect” or “dissect” a “composite” contract unless it is shown that the parties themselves intended to enter into two separate contracts. It further laid down three ingredients that any transaction must fulfill to qualify as a sale – the existence of “goods”, an intention to transfer “title” to those goods, and the consequent or actual transfer of title. A line of decisions applying Gannon Dunkerley made the principle a firm part of Indian jurisprudence, and parties began to use it as a means of tax avoidance (not evasion). For example, a petitioner who entered into a “99 year lease” successfully argued that the transaction was not a sale, relying on Gannon Dunkerley.

The decision was criticised by the Law Commission, and the 46^th Constitutional Amendment was passed to partially modify it. It inserted Art. 366(29A) into the Constitution, which provides that “tax on goods” include six specific transactions listed in sub-clauses (a)-(f). Each clause nullified a particular decision of the Supreme Court applying Gannon Dunkerley – for example, it is now possible to levy sales tax on the “sale” of food served at a restaurant. While the constitutional validity of the amendment was upheld in Builders Association, the Supreme Court (per Ruma Pal J.) noted in paragraph 29 of BSNL v. Union of India that Gannon Dunkerley is good law in every situation save the ones specifically enumerated in Art. 366(29A) [emphasis mine].  In the case of software, we must turn to Art. 366(29A)(d), which provides for sales tax on “the transfer of rights to use goods”. This appears to meet any objection based on the limited nature of a EULA. Or does it?

In a further twist, Parliament added s. 65(105)(zzzze) to the Finance Act in 2008, proposing to levy service tax on “any service provided or to be provided … in relation to information technology software…” The “development” of such software was specifically listed in the Act. Writ petitions were filed in several High Courts challenging the constitutional validity of this provision. Ironically, these petitions relied on TCS to argue that since the typical software transaction has been held to be a “sale”, it is within the exclusive legislative competence of State Legislatures, and therefore outside the purview of service tax. On 24 August, 2010, the Madras High Court rejected this challenge (hat tip: Shantanu Naravane), and I have posted a detailed account of the decision here.

The Union of India argued before the Madras High Court that a typical software transaction need not constitute a sale because the terms of the EULA that accompanies the software is characteristic of a licence – in short, the argument the petitioner in TCS could have advanced to take software beyond the purview of sales tax. The petitioner relied on Art. 366(29A)(d) in response. The High Court rejected the petitioner’s contention with a somewhat ambiguous conclusion in paragraph 31 that Art. 366(29A)(d) may not apply because the owner of software does not intend to transfer copyright, but ultimately found that it could not strike down a statutory provision that would turn on the circumstances of an individual transaction.

What are we to make of this? In my submission, the Supreme Court, with respect, reached the wrong conclusion in Tata Consultancy Services in holding that the transfer of off-the-shelf software constitutes a “sale”, although this undoubtedly had a lot to do with the fact that the petitioner in that case did not press the point. However, that is the law as it stands today, and while the Madras High Court’s opinion is not inconsistent with it, a clear conceptual articulation of the legal classification of software is absent. Perhaps the way forward is for the Court to revisit its opinion in TCS and attach greater importance to the circumstances of the particular transaction.