Month: April 2014

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Corporate

A brief history of the evolution and purpose of the Board of Directors

CompanyLawMatters_TanikellaRastogi_2Every practitioner of corporate and commercial laws will appreciate the increasingly important role and purpose of the board of directors (“BoD”) of a corporation. In India, as well as globally, the director is no longer a mere agent or nominee of the shareholders of a corporation. With the advent of independent directors, they are in effect, more akin to trustees of shareholder wealth and are answerable to public ownership. A practicing corporate attorney will need to answer several queries about the decisions and deliberations of the BoD and merely applying the law at hand may not always suffice. To make better decisions, it is also important to understand some of the principles and socio-economic factors that have guided the development of the law of business organisation.

The most basic constituent of any economy is the market, which comprises individual participants and the trade of goods and services. As economies grow however, individual participants alone cannot sustain the production of the goods and services needed to meet the growing demand. The capital and the resources employed by individual participants will necessarily be diversified and redeployed to cater to the increased demand. Thus pressed, the entrepreneur will seek out forms of business organisation that will most efficiently enable him to continue providing goods and services at a greater scale.

Separation of ownership and management

Law_of_agency_businessorganisation.jpgA direct consequence of the growth of a market economy is the separation of the actors involved in securing the capital of a business from those who specialise in employing the capital towards the production of goods and services. The simplest (and hence probably earliest) form of such division was the relationship of agency. To regulate this important function, a great deal of care and development went into the establishment of the law of agency.

The agents were responsible for carrying out designated functions (such as the employment of capital) on behalf of the owner (principal). The law in turn recognised the presence of two distinct actors and, to align the interests of the agent and the owner to ensure the efficient running of a business in the overall interests of the market, the law developed to hold owners vicariously liable for the acts of agents in the normal course of business. Over time, to bring greater alignment between the interests of the agent and owner, the economic society recognised the formation of partnerships. In the partnership form, multiple owners could pool in resources, collectively manage the business and share liability for the debt of the business. As the partners are at once owners and agents there is an expectation of greater scale, efficiencies and reduced agency costs.

The evolution of limited liability

AdvancedProfessionalCertificationinCorporateLawPractice_apcclpNevertheless all of the above forms of business organisation were premised on individual liability for whole of the debts of the concern. Traditionally only specialised community businesses such as guilds shared features akin to limited liability. This led to demand for limited liability partnerships that is, where partners were not responsible for the personal debts of other partners but all the partners were responsible for the debt of the partnership. The relationship between personal debt and partnership debt, that is, questions of which creditors would be preferred while paying back the money if the partner and the partnership both became insolvent, was complex. There was a need for a form of business organisation where the personality of the business was also entirely separate from that of its members and the liability of the members would be limited to the amount contributed by them to the business. With such a model, creditors would be assured of the financial standing of the business before they provide any debt to the business. Moreover, the members would be saved from the unlimited liability to the creditors of the business. The industrial revolution and the increased trade between countries dramatically increased the scales of production and businesses. The increasing exchange of goods and services at a global level required more manpower and a higher commitment of capital. This in turn gave rise to a need for a form of business organisation that permitted hundreds or even thousands of people with varied roles to work together for the production of goods and services and profitability. At this scale, as I have discussed, the legal fictions of a separate legal personality and limited liability were required as in its absence, entrepreneurs were discouraged from scaling up and engaging in international trade. The earliest forms of limited liability corporations were established by the state using an institutional charter to provide legitimacy to a form of business organisation that would be distinct from its ownership in terms of personal liability.

The need to protect shareholder interests

Especially where the ownership had devolved to the public at large to gain greater access to capital, a natural corollary to the separation of functions in a corporation was the need to align the interests of the owners and the management of the business. Thus, a group of experienced persons were designated as nominees of the shareholders and held responsible for the decision-making of the corporation. These representatives of the shareholders of the corporation came to be known as the Board of Directors and provided overall direction and oversight of the corporation’s business. The actual deployment of resources was tasked to managers who were specialist employees.

This arrangement naturally involved a two-stage assessment of any decision — first by the BoD at the stage of making the decision and later, by the managers while implementing it. Since these were entirely different sets of people, the assessments would be without any influence. The relationship of between the directors and the corporation was one of agency and gave rise to fiduciary duties of the directors towards the corporation and the shareholders. Today, the duty to act in good faith, the duty to act in the interests of the shareholders of the corporation, the duty to act with due and reasonable care, skill, and diligence, and the duties regarding conflict of interest and related party transactions are some of the fiduciary duties imposed on the directors by virtue of their position in the corporation.

Shareholder_Directors_Management
The modern corporation is a separate entity in the eyes of the law and is governed by its charter documents. The directors act as the agents of a corporation and take decisions on its behalf. The managers execute those decisions. However, as the ownership of the corporation resides with the shareholders and as they are the ultimate beneficiaries of every decision, the centralised management, that is, the BoD chosen by the shareholders, tries to ensure that the interests of the shareholders are protected. Having a BoD eliminates the socio-economic costs imposed by the alternative of shareholders having to meet and approve each decision of the corporation. In turn, the shareholders, by approving the charter documents of a corporation and its by-laws, establish the constitution within which the directors may function. Whenever the directors act on behalf of the corporation and take decisions therefore, they have a duty to not act in violation of the charter documents. These documents set out the structure of the BoD, the manner of appointing directors, the term of the directors, and the committees that need to be appointed to enhance the working of the corporation.

Every decision taken by the directors must consider the interest of all the shareholders – whether they are majority shareholders or minority shareholders. The nature of limited liability corporations however, carries an inherent risk. The directors, since they are agents and lack personal liability, may not act as efficiently as required, leading to erosion of shareholder capital and discouraging further investment and eventually stifling the growth of the business. In this scenario, the executive management serves as the second level of assurance to the shareholders about the efficient functioning of the corporation.

We can now proceed to examine the evolution of the directors from being primarily agents of shareholders to trustees of shareholder wealth and corporate assets. The independent director, in this regard, is a creature of law established in recent times to ensure that the functions of the BoD are not impeded solely by the representation of majority shareholder interests.

References:

llan, Kraakman, Subramanian, Commentaries and Cases on the Law of Business Organization, (Wolters Kluwer, 2009) 3rd ed., at 98.

(Jitender Tanikella is a corporate and tax lawyer with an advanced law degree from Columbia University. Anirudh Rastogi is a general corporate lawyer with an advanced law degree from Harvard University. They are part of Tanikella Rastogi Associates.)

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Are my forests going to be cut?

Kanchi KohliRecently, I received a query from Madhya Pradesh about whether a mining company was allowed to lop off branches and demarcate trees in a forest area. Such queries are common in many parts of the country where forest land is sought for “non-forest use” like industries, dams, roads, mines, and ports.

Confusion reigns, both among community organisers and affected people, about where the buck really stops, especially on what constitutes a “final” diversion of forest land and how the legality of some particular activity on forest land can be questioned. Legal aid practitioners (both formal and voluntary), affected people, and government agencies need to come out of this lack of clarity, illustrated in this case from Madhya Pradesh. The villagers, who had organised themselves into a sangharsh samiti (struggle committee) and had been resisting coal mining operations in the area, had seen the representatives of a mining conglomerate enter the Sal forests typical of this area. When asked by the villagers if they had permission to lop branches off and demarcate trees, these representatives reportedly responded that they had the approval of the Divisional Forest Officer (“DFO”) to enter the forest for such work. They also said that they had recently received permission from the Ministry of Environment and Forests (“MoEF”) to divert the forest land. The villagers should also be aware that it was only a matter of time before the company would be allowed to start mining activity.

On the other hand, local social activists had informed the protesting villagers that the MoEF’s approval was not enough for any mining company to start operations. With this information in hand, the villagers asked the companywallahs whether they had the permission in writing to enter the forest, and they were not able to provide any.

Laws applicable to diversion of forest land for non-forest use

The Indian Forest Act, 1927 (“IFA”), its corresponding state laws, and the Forest Conservation Act, 1980 (“FCA”) apply to the issue of diversion of forest land for non-forest use. In the Indian constitutional scheme, both the Union government and the state governments can make law on the subject of forests.

Anyone who wants to use the forest, whether it is a government department, or a private agency, or an individual, needs the permission of the relevant forest department, and the DFO in particular, to divert the forest land. The DFOs needs to inspect the site, prepare a report based on a series of criteria, and forward their recommendation on whether the forest should be given away for non-forest use. Based on the DFO’s recommendation, the Principal Chief Conservator of Forests (“PCCF”) should forward the proposal to the MoEF. This practice of taking prior approval from the MoEF by the state government was institutionalised through the FCA in 1980, when the Union government felt that the country’s uncontrolled and unprecedented rates of deforestation required central regulation.

At the MoEF, for cases like this, a Forest Advisory Committee (“FAC”) reviews the proposal and gives its recommendations. During this process of review, the FAC can call upon experts, take additional site visits, and seek any amount of additional information. In this case, the FAC had (as documented here) already reviewed the proposal thrice and had refused permission on the grounds that diversion would cause the loss of forests of a very good quality and that the coal from mining coal in the area would only last for fourteen years.

PanchmarhiValleyMadhyaPradesh_DhanbadCoalMine
The Panchmarhi valley (left) in Madhya Pradesh and a coal mine in Dhanbad in Jharkhand.
Both images are from Wikimedia Commons. CC BY-SA 3.0 and CC BY 2.0 respectively.

After extensive political and bureaucratic lobbying however, this company received approval in two stages — first in October 2012 and then in February 2014. In accordance with the MoEF’s practice, they received the first (in-principle) approval with a wide list of conditions including the recognition of the rights of tribal and forest dwelling communities under another critical national law, ensuring land is made available for compensatory afforestation, and carrying out a whole range of studies related to the cumulative impact of the mines on water and other resources. The approval at the second stage came amidst even more controversy.

Through this period, the affected community and local activists protested against the fact that the due procedures of law had not been followed, especially those related to forest rights under the Scheduled Tribes and Other Traditional Forest Dwellers (Recognition of Forest Rights) Act, 2006 (“FRA”). Before the final diversion takes place, the process under the FRA, including taking the necessary permission from the Gram Sabha (village assembly), needs to be complete.

The villagers, now armed with the relevant legal provisions with some help from local and national activists and legal empowerment practitioners, complained to the District Collector and the Minister of Tribal Affairs. Tools such as the Right to Information Act, 2005 were important for them to be able to procure panchayat records and verify the signature of the villagers. The company had and government had claimed that the process under FRA was complete as villagers had signed on their claims at a gram sabha meeting. Information accessed using the RTI Act revealed that many of the signatures were forged. What the company had hoped would be behind them, is now an issue that remains unresolved and open to a formal enquiry.

With the final approval from the MoEF, the coal mining company had entered the area to initiate the lopping and demarcation work. They still did not have the approval of the state government. They had applied to the State Forest Department for diversion, but without the permission required from the state government under Section 2 of the FCA and the corresponding provisions of the IFA, they cannot move ahead, especially if the forest is a “Reserved Forest”. At the time of writing this article, there is no information in the public domain that the state government has given its approval. The state government is waiting for the release of compensatory afforestation land in Sagar district of Madhya Pradesh before giving its permission. At the same time, the District Collector, based on the complaints of the villagers, has set up an enquiry on the process under the FRA and has been quoted in the media saying that his enquiry will only be completed after the national elections of 2014.

Now, the villagers have also filed a complaint with the MoEF and the state forest department. In their letter, they have said that the activity carried out by the company’s representatives was in contravention of the law and that action should be taken. While they are yet to receive any formal reply, the complaint has deterred the company from carrying out any further activity.

It is only a matter of time before the land required for compensatory afforestation is found and the collector’s report is finalised. The legal action might then move from the administrative and regulatory arena to the wisdom of the judiciary. All the build up till now, will then be the evidence, which is critical in any such situation to prove and illegality. In some of the future articles in these series, we will delve upon the nature of evidence in environmental law and challenges in being able to collect it and present it before a regulatory agency or judicial forum.

Many similar cases involving the issue of diversion of forest land for non-forest use may be developing across the country. Understanding the law and practice of forest diversion and recording illegalities will be critical for all concerned. Each case will be peculiar and as practitioners, we will need to delve deeper and work with the affected community to build evidence around it. Even when it comes to the environment, the law is best invoked when backed up with proof.

Kanchi Kohli (kanchikohli@gmail.com) is an independent researcher and writer.

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Drafting a Memorandum of Understanding

Drafting_for_Business_Deepa_Mookerjee.jpgLet’s say you are the CEO of ABC Limited, a multinational company. You have had oral discussions with the CEO of Apples Pte, a non-resident company that, in a highly lucrative deal, wants to invest in your company. While you do not want binding documents to be signed at this stage, you would like some kind of documentary proof that this deal is being negotiated. What would you do?

Ideally, both parties would sign a Memorandum of Understanding (“MoU”). In all commercial transactions, initial discussions between parties are usually followed by the execution of a document that lays out the preliminary intention of the parties to enter into a deal. This document is termed a MoU, a term sheet, or a letter of intent — terms are often used interchangeably in commercial transactions.

At first glance, a MoU looks like a simple document. Drafting the MoU however, is one of the most important steps in the transaction. This is because it serves as the basis for more detailed legal documents. It thus lays the groundwork for a transaction and ensures that the parties agree on all major issues, thereby reducing the possibility of a misunderstanding.

Signing_an_MoUWhile drafting a MoU, always ensure that you specify the correct name and description of the parties. If this is not done, it is a clear loophole that may allow either party to wriggle out of the deal, as the MoU does not place any obligations on them. Similarly, include a clear description of the deal. Never use vague or unclear language as it creates confusion.

Let’s understand some other key points to keep in mind while drafting a MoU.

Binding or non-binding?

A MoU can be drafted to be either legally binding on the parties to the MoU or serve as a document that is not binding and only captures the intent of the parties. A legally binding MoU is useful when parties have already agreed on major aspects of the deal and do not want this understanding to change under any circumstances. It also ensures that the parties do not back out of a deal without facing any consequences.

Assume that Apples Pte. has agreed on the amount of consideration, the nature of indemnification, and all the representations and warranties to be provided under the deal. All of these are key points that make or break a deal, and so you may want to enter into a binding MoU to ensure that Apples Pte. is tied to the deal. On the other hand, if the negotiations are still at a very preliminary stage, you could consider a non-binding MoU. It gives you the comfort of some documentary proof of the discussions, without restraining you from backing out of the deal at a later stage.

Often parties opt for a non-binding MoU as they wait to complete a due diligence exercise. This is a detailed investigation of a company and its results typically affect the terms of the deal materially. Parties therefore, do not want to enter into any binding documentation before the investigations are complete.

Exclusive or non-exclusive MoU

Non-ExclusiveMoU_MemorandumofUnderstanding.jpgA MoU can be exclusive or non-exclusive. For an exclusive MoU, parties are restrained from entering into similar MoUs with any other entity during the term of that MoU. On the other hand, the document can be drafted on a non-exclusive basis, in which case, the parties are free to enter into discussions with other entities dealing with the same subject.

If you are apprehensive that your competitors may also approach Apples Pte, start negotiations with them, and thus harm your deal, you can enter into a MoU on an exclusive basis. This would mean that during the term of the MoU, Apples Pte is barred from negotiating with any other party.

Confidentiality

During negotiations of this nature, to understand the nature of each other’s businesses and the general condition of the company, parties exchange a lot of information, much of which is proprietary in nature. Obviously, no party will invest without having complete information about the investee company. In order to ensure that this information is not leaked to your competitors or the public in general, one very important clause that must be included in every MoU is a comprehensive confidentiality clause. Always insist on a clause that states that all information exchanged between the parties is to be treated as confidential and must never be disclosed to the public.

These are just few of the important clauses that you will see in every MoU. Remember always, that there is no set format for a MoU. It could be a one-page document or it could run into several pages. Ultimately, at the end of the day, the nature, contents, and form of the MoU will depend upon the nature of the deal and what your clients want.

(Deepa Mookerjee is part of the faculty on myLaw.net.)

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Does India have a balanced legal framework for clinical trials?

JSaiDeepakpicRecently, it was reported in the media that 254 Indian women — all participants in a 15-year clinical trial for a treatment for cervical cancer, had died during the course of the trial. The facts are not very clear and any conclusion would be premature but yet again, the episode calls for increased awareness of the law governing the conduct of clinical trials and an examination of the framework.

In response to the Supreme Court’s stinging observations in the course of a pending PIL filed by the Indore-based Swasthya Adhikar Manch (Writ Petition (Civil) No. 33 of 2012), the Union Government made a few changes to the Drugs and Cosmetics Rules, 1945. Rule 122-DAC which was notified in February last year, requires every clinical trial to be mandatorily registered with the Clinical Trial Registry of India.

A “clinical trial” is defined in Rule 122-DAA of the Drugs and Cosmetics Rules, 1945 as follows:

“Definition of Clinical trial.– For the purpose of this Part, “Clinical trial” means a systematic study of new drug(s) in human subject(s) to generate data for discovering and/or verifying the clinical, pharmacological (including pharmacodynamic and pharmacokinetic) and/or adverse effects with the objective of determining safety and / or efficacy of the new drug.”

For the benefit of the general public, in December 2012, the Central Drugs Standard Control Organization (“CDSCO”) issued an order informing the public of the requirements that apply to the conduct of clinical trials, which are spelt out in the amended Schedule Y of the Drugs and Cosmetics Rules, 1945. Schedule Y requires the sponsor of the trial or the investigator to obtain prior permission from the Drug Controller General of India (“DCGI”) and also the independent “Ethics Committee” of the institution where the trial is sought to be conducted.

IPEthics Committees need to be registered with the DCGI under Rule 122-DD, which was notified on February 8, 2013. The role of these committees is to ensure the safety of the trial subjects and their approval is mandatory prior to the initiation of a clinical trial. In fact, the Informed Consent Form that the trial investigator is required to obtain from each participant of the trial, for which a template has been prescribed in Appendix V to Schedule Y, must be approved by the Ethics Committee and submitted to the DCGI.

New guidelines on compensation

Apart from  Schedule Y, the generation of data and the documentation of clinical trials must be in accordance with the guidelines on Good Clinical Practices (“GCP guidelines”) issued by the CDSCO under the Drugs and Cosmetics Act, 1940. Importantly, the GCP guidelines also deal with issues relating to compensation for participants in clinical trials in the event of a trial-related injury or death. The compensation awarded to participants for disability or death caused by a clinical trial is distinct from the compensation provided to the participant for participation in the trial.

Until January 2013, the compensation in the case of injury or death during clinical trial was governed by a notification of the Ministry of Health and Family Welfare dated November 18, 2011. Draft guidelines were then issued in August 2012 with a view to improve on the 2011 notification and finally, on January 30, 2013, new guidelines were notified. Currently, these guidelines govern the compensation to be awarded to a subject in case of death or injury during a clinical trial. This has been inserted as Rule 122DAB of Drugs and Cosmetics Rules, 1945 and appears to be giving sleepless nights to Clinical Research Organizations (“CROs”).

Rule 122-DAB is extracted below:

Compensation_InjuryOrDeath_ClinicalTrials_Rule122DAB_DrugsAndCosmeticsRules.jpg

An initial reading of Sub-rules 1 and 2 of Rule 122-DAB seems to suggest that the scope of Sub-rule 1 is wider than that of Sub-rule 2. The former appears to cover any injury suffered by the trial subject, even if such injury is not related to the clinical trial and the latter is restricted to injuries which are related to the trial. This could mean that under Sub-rule 1, if the trial subject meets with a road accident, the sponsor of the clinical trial is expected to bear the expenses for life-long medical management of the subject to treat such an extraneous injury.

A purposive reading of the very object of these Rules however, informs us that they are meant to secure the interests of a trial subject with respect to trial-related injuries. They are not meant to provide the subject with a carte blanche for extraneous injuries that have no connection with the clinical trial. Such blanket compensation is not envisaged even in the GCP guidelines. Therefore, this particular apprehension of CROs may not be completely justified.

Penalising the failure of the trial

What is certainly a cause of concern however, is Sub-rule 5 of Rule 122-DAB. Sub-rule 5 exhaustively lists the specific instances or causes that shall be considered to have caused clinical trial-related injury or death. They are:

a. The adverse effect of investigational product(s);

b. A violation of the approved protocol, scientific misconduct, or negligence by the sponsor or his representative or the investigator;

c. The failure of the investigational product to provide intended therapeutic effect;

d. The use of placebo in a placebo-controlled trial;

e. The adverse effects due to concomitant medication excluding standard care, necessitated as part of approved protocol;

f. Injury to child in-utero because of participation of the parent in the clinical trial, and

g. Any clinical trial procedures involved in the study.

Four_colors_of_pillsSituation C, which envisages the payment of compensation in the event of injury or death due to “failure of investigational product to provide for intended therapeutic effect”, in my opinion, is unreasonable. It expects every clinical trial to succeed. The very purpose of the trial is to evaluate the efficacy of the investigational product. Therefore, to saddle the sponsor with liability for its failure beats common sense, rendering the Sub-rule vulnerable to challenge in a writ petition.

The inclusion of Situation C in Rule 122DAB is probably reflective of the establishment’s need to shore up its reputation in the eyes of the Supreme Court. In the process, it could have the effect of deterring sponsors from undertaking clinical trials in India and thus adversely affecting the fortunes of CROs in India, which already face stiff competition from China. While it is certainly the duty of the government to protect the interests of its citizens who participate in clinical trials, it cannot be the government’s case that the only way to achieve this object is to deter the very conduct of clinical trials in India. It is time to re-examine this privision and bring in a sense of balance.

(J. Sai Deepak, an engineer-turned-litigator, is a Senior Associate in the litigation team of Saikrishna & Associates and the legal member in the Ethics Committee of the All India Heart Foundation. He is the founder of “The Demanding Mistress” blawg. All opinions expressed here are academic and personal.) 

Categories
Human Rights

How digital activists got the European Parliament to vote their way on net neutrality

joemcnameeRecently, the European Parliament voted to stop internet service providers from charging for preferential access to their networks, something known as a “net-neutrality” law. The legislative proposal is also notable because of the five-year long campaign that preceded it. We spoke with Joe McNamee, the Executive Director of European Digital Rights, a Brussels-based advocacy group, about this campaign. He said that main reason behind the success of the campaign was the co-ordination between professional Brussels-based activists and the people around Europe who were mobilised and empowered to speak to their parliamentarians.

“It is very difficult be successful as a civil society organisation if you rely exclusively on professional activism in the capital because you need the weight of the populace behind you and  you will never get anywhere if you just rely on public outcries because the compromises that are made between politicians will not necessarily reflect the key nuances of what you’re trying to deliver. You really need to have both professional activists and a wider campaign across society.”

IPHe added that digital activists needed to develop a more sophisticated response to the public relations machinery of the telecom companies. “There is a need to engage the press in a far more efficient way because the big lobbies have their press lobbies already in place. There is a risk that if a misleading version of events is going through the press, that you’re not going to have as much of a public outcry.”