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Declaring Independence Part 2: Sourcing Work for your Independent Practice

 

Sourcing-Work

Declaring Independence  is a series by Tishampati Sen, an Advocate-on-Record who quit his job at a top-tier law firm to start his own practice. Setting up one’s own practice at a relatively young age is a challenge, albeit one that can have great rewards. Every month, Tishampati will look at an important aspect of going independent and have useful tips and advice for young lawyers who just want to break free! Read the previous post here.

I knew at the time of taking my first steps towards independent practice, that one of the formidable challenges in front of me would be of generating enough work to make a living. One of my greatest apprehensions at the time of making the move was that I might have to sit idle for many months before people would actually entrust with work. From the very beginning, therefore, I associated with and assisted eminent senior counsel and other advocates in their work so as to be ‘in – practice’ even while my independent work gathered momentum

But from very early on, in fact even before I had completely quit the firm that I was a part of, I had started pitching for work and trying to impress upon people the fact that a new hotshot lawyer was soon going to be available to take care of all their legal needs.

DRAWING A BOUNDARY

One of the key questions that people would ask me is “so what kind of work do you do?” and my immediate response would be “Everything”. But invariably the person would continue to look at me expectantly waiting for me to say something more, before finally nodding and uttering a dismissive “good”. But I didn’t know a better answer at the time. I was actually preparing myself to do all sorts of legal work. I had both transactional as well as dispute resolutions experience and intended to do both kinds of work in the future as well. Over a period of time, immediately after my “Everything”, I decided to add, “I do both litigation as well as transactional work” to fill the awkward silence. But to my surprise I was still met with a glazed look.

One of my more experienced colleagues heard my response one day and decided to rescue me. He let me in on a little secret. “Branding is important. People don’t like to believe that ‘everything’ is possible. Give them a boundary and a framework. When you give them your limitations, your capabilities also become believable; and if you haven’t discovered your limitations yet, invent them.”

This is one of the most important and beautiful lessons in human psychology for me. I am not sure if I completely believed it at the time, but the next time some one asked about the kind of work I do, my answer was a little more tempered. I still told them that I do everything but I also added an ‘except…’ and told them one or two things that I don’t do; or what I haven’t done yet – but was willing to do if the opportunity presented itself. Surprisingly, there were many more people now nodding and moving forward with the conversation. In fact, there were even some who would discount my ‘limitation’ and say “Yes, but after all it’s only another branch of law. If you study it, I’m sure you’ll pick it up.” 

FACTORS GOVERNING THE CHOICE OF WORK

There could be a few factors that could govern the kind of matters/work that one may want to source and take up at this stage:

1. Streams: There are some who, like me, enjoy both streams of practice and therefore may actively look to do all sorts of work in both transactional–advisory practice, as well as in litigation. In fact from my experience, the learnings in one could even help your develop your skills in the other. For example, the litigation experience and the understanding of the courts and the processes involved has helped me develop a different perspective on the language used in contracts. I now have an understanding that clauses that may seem air–tight in language may be looked at in a completely different context in court. As such, the advice on the transactional side is now more pragmatic than theoretical. Similarly the experience on the transactional side helps in grasping complex transactions better and may, therefore, allow one to articulate the issues involved much better in court.

However, there are also those who would much rather focus on any one stream (and within that, a sub-stream) to be able to build a brand and expertise in the subject. One cannot deny that in this field where a client’s interest and sometimes life is at stake, how the world perceives you may become relevant. Some time back when a friend needed legal representation for a family member who had unfortunately been tangled up in criminal proceedings, he was very clear that he wanted a ‘pure’ criminal lawyer. Not someone who also practiced criminal law. Similarly in sensitive matters such as divorce etc., parties may be more comfortable with an advocate who shows herself to have expertise in that field.

2. Forum of Practice: This is more relevant for the litigation side of the practice, as often advocates may also target work keeping the forum in mind. There are those who may have a wider network outside the city/state, as such it may make sense to consider appellate forums. The choice of the forum could also be impacted by various other considerations such as the kind of work that one enjoys (trial matters, versus consumer matters, tax etc.), the clientele typically associated with a particular forum, the regularity of proceedings in the forum, or simply what interests you more etc. Here again there could be the debate for specialisation versus exploration. I know of many young advocates who have focused on the practice in a few particular forums. Over a period of time they have developed a better understanding of the processes and the requirements in the registry and are able to better fathom the tendency and mood of the bench. These advocated then become much more in demand in these particular fora. However, on the flip side one may want to practice in various fora and over a much longer period have a much wider presence. In fact some might argue that having matters in various fora and the thrill of appearing before different judges with different opposing counsel is what makes the litigation practice exciting.

3. Realistic Evaluation of Reference of Work: Another perspective to keep in mind, while considering the kind of work that one may want to attract, is what would make sense in terms of being able to develop clientele. For example, as a young advocate it may make sense to spend as much time observing and assisting on trial matters, consumer matters, divorces etc., since the potential to have this nature of matters being referred to you by individual clients is much higher when on your own.

Even on the transaction front, it may make sense to initially focus on the kind of work that could lead to repeat requests and referrals by clients. For example focus could be on the issues facing start–ups that have great need for legal advice but may not have the budget to approach the established and eminent legal practitioners. Focusing on the individuals or smaller business units in the beginning may be a prudent starting point. 

CURB YOUR ENTHUSIASM

A common and popular advice seems to be that a junior advocate must be willing to take whatever work comes his way. Saying no to any work, no matter how tedious or boring it might seem, is almost sacrilegious. It makes sense of course – you must be willing to take the good with the bad, and only when you have had a varied and diverse experience can you even begin to identify your own unique strengths and weaknesses and likes and dislikes. In fact, a bit of a push and pressure may even help develop character and create the mettle to take up challenges. So the general idea is that one should never say no to work, and once accepted one must figure out the capacity and the wherewithal to handle the same.

However, there was one person who gave me contrary advice, which also made a lot of sense. This gentleman who has a thriving criminal practice, told me, over a cup of coffee, “it is equally important to curb your enthusiasm.” His point was that at the beginning of one’s independent practice, a junior advocate/lawyer must focus on work as much as self–development. “Eventually you have to start keeping in mind the balance–sheet, and focus on managing your office. Things like the supply of coffee for clients, printer cartridges, wages, etc., also start taking up your time. So value this time in the beginning. Now is the time to develop the lawyer within. Keep the businessman waiting for a while. Appreciate that since for now there is less work, you should read the law for the sake of reading the law. Sooner or later work will find you.”

He also warned me that taking up more than can be handled in the beginning could be more detrimental than not having enough work. If you tell a client frankly that you may not be able to handle his work, you may lose her/him temporarily. But servicing a client badly could lead to the loss of not just that client but many future clients as well. He called it “poisoning the line”, which had a nice dramatic ring to it and so it has stuck with me.

To close off this piece, I would like to remind you of what I had said in the beginning of this series: I am not qualified to give you advice as to your specific way forward. My only aim is to share my experiences and the views that others have selflessly and candidly shared with me. So, choose the viewpoint that suits you and your temperament best. See you next time!

Tishampati Sen

Tishampati Sen is an Advocate–on–Record  of the Supreme Court of India. He worked with one of the premier law firms of the country (in corporate transactions as well as dispute resolution) for many years before deciding to take the plunge of independent practice. He appears primarily before the Hon’ble Supreme Court of India, Delhi High Court and the National Consumer Disputes Redressal Commission.

Written by myLaw

[Video] Share transfer restrictions – Learn the practical stuff, understand the legal debates

A corporate lawyer’s job includes facilitating mergers and investments by and into businesses. Really experienced corporate lawyers become extremely familiar with shareholders’ agreements and joint-venture agreements but young corporate lawyers and law students working at corporate law firm internships are known to look at terms like ROFR, ROFO, tag-along, and drag-along with wonder.

These different types of share transfer restrictions are a massive and complicated topic. To make it easier to understand, we spoke to Arjun Rajgopal (Principal Associate, Khaitan & Co.) and Umakanth V., an Associate Professor at National University Singapore, and among the most respected names in Indian corporate law.

What we have below are two videos which contain a completely lucid, simplified, and practical explanation of shareholder restrictions. In the first part, we discuss their purpose, their different types, and how they work.

In the second part, we look at how Indian laws have treated share transfer restrictions and the massive debate over their enforceability. What did the Companies Act, 1956 say about them and how have things changed with the new Companies Act, 2013?

If you want to be a corporate lawyer, you cannot afford to miss these two videos.

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Written by myLaw

The four types of laws that all private equity lawyers must know

PrivateEquityLawyer_AngiraSinghviTo advise on private equity investments and their structure, lawyers need to be aware of the many laws that affect transactions. Let us look at the four major categories of laws that can regulate a private equity transaction.

1. Foreign investment laws

When investment flows in from countries located outside India for investment in some business activity and not merely stock or trading, the amount is treated as foreign direct investment (“FDI”) and the investment needs to comply with applicable regulations. Many private equity funds are based out of tax havens such as Mauritius and the British Virgin Islands and FDI is routed through such jurisdictions.

Every year, some time in the months of April or May, the Ministry of Commerce and Industry issues an FDI policy, governing areas such as the kind of instruments that may be issued, sectors in which investment may be freely made, and the procedure of issue. The policy is reviewed every year and changed if necessary.

Depending on factors such as the business sector, the nature of the instrument, and the intended percentage of shareholding, FDI can fall under the automatic route or the government route. Under the automatic route, the investor can directly invest into the target company without obtaining any prior approval from the government. Under the “government route” or the “approval route”, prior approval is required from the Foreign Investment Promotion Board. For example, prior government approval is necessary in mining, coal and lignite, and real estate unless some prescribed conditions are complied with.

The Foreign Investment Promotion Board is housed in the Department of Economic Affairs of the Ministry of Finance.

The Foreign Investment Promotion Board is housed in the Department of Economic Affairs of the Ministry of Finance.

Structure of the target: FDI investment into a company or a venture capital fund (not being a trust) is most straightforward because there are fewer restrictions and the investment is permitted through the automatic route. While investors may prefer investing in trusts and LLPs to take advantage of tax and operational benefits, additional structures are required for an FDI investment.

Types of instrument: Indian companies can issue equity shares; fully, compulsorily, and mandatorily convertible debentures; and fully, compulsorily, and mandatorily convertible preference shares under the automatic route subject to the pricing guidelines or the valuation norms prescribed by the regulations under the Foreign Exchange Management Act, 1999 (“FEMA”).

Convertible instruments get converted into equity after a specified period of time. A prescribed conversion formula determines the value of that instrument or the equity shares to be issued. Unless they are compulsorily convertible, they do not fall within the category of permitted instruments under the automatic route.

All other instruments (including optionally convertible instruments) are considered debt and require compliance with the Reserve Bank of India’s guidelines on external commercial borrowing.

The price or conversion formula at the time of conversion of a convertible capital instrument should be determined at the time of its issue according to any internationally accepted pricing methodologies and on arm’s length basis for unlisted companies. For listed companies, a valuation has to be made under the Securities and Exchange Board of India( Issue of Capital and Disclosure Requirements) Regulations.

In order to use the automatic route, the instruments need to be fully paid up and comply with the pricing norms, failing which, the government’s prior approval is required.

Reporting of the investment: The FDI policy requires that any amounts received by the target entity against capital should be reported to the Reserve Bank of India. An amount received against the transfer of existing shares should be reported by filing Form FC-TRS. An amount received against the issue of new shares should be reported by filing Form FC-GPR.

Business sector: FDI policy restricts the level of investment in certain sectors. In such sectors, investment above a certain percentage of the total shareholding requires the prior approval of the government. In some sectors, even indirect shareholding or control is not permitted. For example, in defence production, air transport services, ground handling services, asset reconstruction companies, private sector banking, broadcasting, commodity exchanges, credit information companies, insurance, print media, telecommunications, and satellites, no transfer is permitted that may result in ownership or control by foreign entities.

2. Laws governing listed companies

Acquisition of shares: Ordinarily, shares are freely transferrable in listed companies (unless there are agreements to the contrary). Some provisions of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Regulations”) however, can hinder the acquisition of shares in a company.

Any acquisition of shares or voting rights that will give the acquirer (or persons acting in concert with the acquirer) 25 per cent or more of the voting rights in the target company can only go forward after the acquirer makes a public announcement of an open offer to acquire at least 26 per cent of the voting shares from the public shareholders of the target.

The Takeover Regulations also lay down norms that apply to acquisitions where the acquirer already holds or controls a substantial amount of shareholding in the target company. Further, under Regulation 4 of the Takeover Regulations, irrespective of the acquirer’s shareholding or voting rights in the target company, it shall not acquire control over a target company without making an open offer for acquiring shares.

The term ‘control’ is significant for private equity transactions because investors tend to insist that their active consent should be taken before any main action affecting the company is taken, such as any future financing, entering into any agreement above a certain value, appointment of directors, deciding upon agenda of board and shareholders’ meeting, restrictions on sales and company assets, and sale of shares to third parties. Even when they have a minority stake in the company, they insist upon such rights and often, this list is so wide that it may be interpreted as exercising control over the company.  According to the SEBI, an agreement that incorporates such a condition would give the private equity firm ‘control’ over the company even though its shareholding is not high enough to trigger the Takeover Regulations.

In addition to the requirement of having to make an open offer, the target company and its board of directors become subject to a few other obligations. For instance, during the offer period, no person representing the acquirer (or any person acting in concert with him) can be appointed as a director on the board of directors of the target company.

If the private equity investor decides to acquire the entire public shareholding resulting in the delisting of the company, even more regulations apply in the form of the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009 (“Delisting Regulations”). The company must be listed for a period of at least three years and the delisting cannot result from a buy-back or preferential allotment of shares by the company.

3. Insider trading regulations

It is an offence under the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 to ‘deal in securities’ while in possession of unpublished price-sensitive information, that is, any information that, if published, is likely to affect the price of the securities of a company. The Companies Act, 2013 has also introduced provisions on insider trading. Section 195 of the Act, which applies to unlisted companies also, lays down punishments of imprisionment and hefty fines for their contravention.

4. Other company law aspects

Since private equity investments are usually made in companies, a detailed understanding of the Companies Act, 2013 (“Act”) is necessary before advising on transactions. Some of the important provisions are discussed here.

Layered investment: Investments through more than two layers of investment companies, preffered by private equity investors because of their tax efficiency, are not permitted under the Act.

Restrictions on transfer of shares: Unlike its predecessor, the Act allows shareholders of ‘public’ companies to enforce restrictions on the transfer of securities. Private equity investors therefore, can freely stipulate conditions on the transfer of shares such as drag-along rights, tag-along rights, and right of first refusal (all of which will be explained in detail in a later post on transaction documents). The Act only protects these conditions as if they are a contract between private persons, and so, to bind the company, it may be advisable to incorporate these provisions into the articles of the company.

Differential voting rights: The Act also contains provisions relating to different classes of shares. Barring a few situations, private companies cannot issue preference shares with voting rights.

Representation on the board: In order to safeguard their investment, private equity investors usually nominate one director to the board of the target company. As their legal consultant, you should be able to advise the investors about the consequences of such an appointment. A director who becomes ‘aware’ of any contravention by way of his participation or receipt of information and does not object to such contravention can be subject to prescribed punishments. Such liability extends to non-executive directors as well.

Amendments to a company’s articles: The articles of a company are amended following a private equity investment to reflect the amended understanding amongst shareholders. You should verify whether the current articles of the company contain any provisions that may only be altered after following procedures that are more restrictive than those applicable in the case of a special resolution, and that these procedures are complied with at the time of the closing. Such provisions may also be inserted in the articles to protect the interests of the investor in its capacity as a minority shareholder.

Apart from these major laws that are essential to advice on private equity transactions, some other laws are important at the stage of conducting due diligence over the target. Let us look at those laws in a later post on conducting due diligence.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.

 

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Lock ins, ROFRs, tag alongs, drag alongs – understand the four types of transfer restrictions

Drafting_for_Business_Deepa_Mookerjee.jpgShareholders agreements, we all know, list the rights and obligations of the shareholders in a company and contain clauses that are vital for any M&A transaction. We have already discussed one such clause, the conditions precedent clause. Let us now study another set of clauses – commonly grouped under the term, ‘transfer restrictions’.

Consider the case of a foreign investor who intends to purchase 26 per cent of the shares of a company and has all the know-how and expertise to run the business. This investor’s participation is critical to the business and its Indian partner in the business would prefer that it does not exit the company. Even the foreign investor, mindful of its faith in the Indian partner, would not want the Indian partner to exit the company. The shareholders agreement therefore, would contain clauses that restrict the foreign investor and the Indian partner from transferring their shares to a third party.  A ‘transfer restriction’, simply put, restricts shareholders from transferring their shares in the company.

All doubts about the legality of transfer restrictions under the Companies Act, 1956 has been cleared by the proviso to Section 58(2) in the Companies Act, 2013. It clearly states that “any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract”.

While there is no formal clarification from the Ministry of Corporate Affairs regarding this insertion, it appears that that this provision is an attempt to codify the principles laid down in the judgment of the Bombay High Court in the case of Messer Holdings Limited v. Shyam Madanmohan Ruia and Others, [2010] 104 SCL 293 (Bom). The Court held that it is open to shareholders to enter into consensual agreements in relation to the specific shares held by them, provided such agreements are not in conflict with the articles of association of the company, the Companies Act, 1956, and its rules. Such agreements can be enforced like any other agreement and does not impede the free transferability of shares.

The Companies Act, 2013 has also recognised the position that a share is the property of the shareholder. The shareholder is free to transfer his or her property, provided that it is not in conflict with the articles of the company and other provisions of company law.

Let us now focus on a few common transfer restrictions.

Lock-in period

By a specifying a period during which a party is prohibited from transferring or selling its shares in the company, a shareholder is ‘locked in’ to the company. This restriction can apply to one, some, or all the shareholders of in the company.

There is no specified time period applicable to all transactions. Parties determine the time period for the lock-in depending on commercial considerations such as the nature of the business. Sometimes, the time period may differ among shareholders.

The Indian party in our earlier example may feel that five years is sufficient time to absorb all the foreign investor’s know how and then run the business independently. In such a case, the Indian party would probably be content with a lock-in period of five years applicable to the foreign investor.

Right of first refusal

Sometimes, a shareholder who intends to sell its shares to a third party can only do so after first offering them to the other shareholders and only if they refuse to purchase these shares. The price at which the shares are sold to the third party must be equal to or higher than the price at which they were offered to the other shareholders. This gives the other shareholders in the company a right of first refusal, that is, a right to purchase shares which helps consolidate their own shareholding in the company and also prevent the entry of an undesirable purchaser.

Tag along right

A right is some times granted to a minority shareholder to require the majority shareholder to sell its shares along with those of the majority shareholder, to the same third party. This gives a minority shareholder, the right to exit the company if it does not want to continue in the company with a new majority shareholder.

Drag along right

While a tag along right is granted to a minority shareholder, a drag along right is typically granted to a majority shareholder. A majority shareholder will have the right, while selling its own shares, to require the minority shareholder to sell its shares as well. The majority shareholder can thus drag the minority shareholder along while making a sale.

This right is important from the perspective of a new investor. Consider the case of an investor who is about to purchase 95 per cent of the shares of a company from one party in which another party holds the remaining five per cent shares. Since a new investor would prefer to own all the shares and take full control of the company, the majority shareholder would prefer to exercise a drag along right and force the minority shareholder to sell its five per cent to the same new investor.

The key point to remember while drafting any of these clauses is that your clients (whether a majority or minority shareholder) would like to maximise their investment while exiting the company. Therefore, determining the price at which shares are sold is critical.

Say for instance, your client has a drag along right. While drafting this clause, it may be best to lay down certain principles as to how the share price will be determined to ensure that there is no dispute at a later stage. Generally, the minority shareholder sells his or her shares at the same or higher price than that which is offered by the third party for the shares of the majority shareholder.

Always be very clear while drafting these clauses. You should choose your words and terms carefully and ensure there is no ambiguity while interpreting the nature of the restriction. Remember that these clauses are primarily contractual in nature and will always change depending upon the nature of the transaction. Never cut and paste a clause from another agreement without applying your mind to the facts of your transaction. In short, put in time and effort in understanding the transaction and only then draft a clause to suit the requirements of your client.

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

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After Satyam – how a scandal changed corporate governance law in India

VeraShrivastav

[Learn Corporate Governance and the Fundamentals of Company Law.]

The Satyam scandal of 2009 gave Indian corporate stakeholders a cataclysmic jolt. Ramalinga Raju, who was recently sentenced to seven years in jail, was the chairman of Satyam Computer Services who committed financial fraud to the tune of Rs. 7000 crore. Shockingly, the company’s auditors, PricewaterhouseCoopers, did not notice it. The scale of the scandal and the auditing firm’s neglect brought to light glaring loopholes in the regulatory and legal framework dealing with the directors and the auditors of companies. Eventually, it led to changes in the law.

Before Satyam

Before the scandal, the erstwhile Companies Act, 1956, the primary legislation dealing with the conduct of corporations in India, did not contain any provision for independent directors or impose any stringent obligations on auditors. The report of the Kumar Manglam Birla Committee in 1999 recommended improvements to the function and structure of the board of directors of a company and emphasised disclosures to shareholders. Clause 49 of SEBI’s Listing Agreement (applicable to listed companies only) became a reflection of these recommendations. In 2002, the Naresh Chandra Committee on corporate audit and governance, drawing from the Sarbanes-Oxley Act in the United States, suggested various reforms relating to the appointment of auditors, audit fee, and the certification of accounts. In 2003, the Narayana Murthy committee analysed the role of independent directors, related parties, and financial disclosures. Clause 49 was amended to incorporate its recommendations with respect to the requirement of independent directors on corporate boards and audit committees and the compulsory disclosures that listed companies had to make to its shareholders.
[Learn Corporate Governance and the Fundamentals of Company Law.]

After Satyam

After the scandal, the Confederation of Indian Industries set up a task force to suggest reforms and the National Association of Software and Services Companies established a corporate governance and ethics committee headed by Narayana Murthy. The report of the latter addressed reforms relating to audit committees, shareholder rights, and whistleblower policy. SEBI’s committee on
disclosure and accounting standards issued a discussion paper in 2009 to deliberate on (i) the voluntary adoption of international financial reporting standards; (ii) the appointment of chief financial officers by audit committees based on qualifications, experience, and background; and (iii) the rotation of auditors every five years so that familiarity does not lead to corporate malpractice and mismanagement. In 2010, SEBI amended the Listing Agreement to include the provision dealing with the appointment of a chief financial officer but it did not insist on the compulsory rotation of auditors.

In 2009, the Ministry of Corporate Affairs also released a set of voluntary guidelines for corporate governance, dealing with the independence of directors, the roles and responsibilities of audit committees and the boards of companies, whistleblower policies, the separation of the offices of the chairman and the CEO to ensure independence and a system of checks and balances, and various other provisions relating to directors such as their tenures, remuneration, evaluation, the issuance of a formal letter of appointment, and placing limits on the number of companies in which an individual can be a director.

A new company law – independent directors, accountable auditors, additional disclosures

India’s 2013 company law incorporated many provisions and reforms suggested by the various committees and organisations during the past decade. It clearly established the responsibility and accountability of independent directors and auditors. It provided for the compulsory rotation of auditors and audit firms. In fact, it even prescribed a statutory cooling off period of five years following one term as an auditor.

Under the Companies Act, 2013 (“the Act”), an auditor cannot perform non-audit services for the company and its holding and subsidiary companies. This provision seeks to ensure that there is no conflict of interest, which is likely to arise if an auditor performs several diverse functions for the same company such as accounting and investment consultancy services. Auditors also have the duty to report fraudulent acts noticed by them during the performance of their duties.

Ramalinga Raju

Ramalinga Raju

The new law also insisted on companies having independent directors, that is, directors who do not have a material or pecuniary relationship with a company. The requirement under Clause 49 of the Listing Agreement, which applied only to listed companies, would thus apply to many more companies. Independent directors have been prohibited from receiving stock options and are not entitled to receive remuneration for their services, except for reimbursement. At least one-third of the board of a company has to consist of independent directors. Even the audit committee has to feature a majority of independent directors. One independent director is required to be a member of the remuneration committee as well.

Additional disclosure norms such as the formal evaluation of the performance of the board of directors, filing returns with the Registrar of Companies with respect to any change in the shareholding positions of promoters and the top ten shareholders, were also mandated. After Satyam, aggrieved Satyam stakeholders in the United States were able to initiate class action suits against the company and its auditors for damages. The same remedy is now available to Indian stakeholders.

(Vera Shrivastav is an Associate at LegaLogic law firm and is a part time researcher and writer.)
We hope you liked this article. You might want to check out our courses on  Corporate Governance and the Fundamentals of Company Law.]

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What does insider trading mean in 2015?

DeekshaSinghThe legal framework for insider trading has recently been overhauled. Provisions relating to insider trading were introduced in the Companies Act, 2013 (“Companies Act”) and the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (“Old Regulations”) were replaced by the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 (“Insider Trading Regulations”).

The prohibitions

Under Regulation 3 of the Insider Trading Regulations, no insider should “communicate, provide, or allow access to any unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders”. However, it specifically excludes communications for legitimate purposes, the performance of duties, or the discharge of legal obligations.

The Insider Trading Regulations also apply to people in general. It prohibits them from procuring unpublished price sensitive information from an insider, or causing an insider to communicate such information. Again, this does not include communications for legitimate purposes, performance of duties, or discharge of legal obligations.

Regulation 4 of the Insider Trading Regulations contains the prohibition on trading in listed securities or securities that are proposed to be listed. This prohibition applies to insiders in possession of unpublished price sensitive information.

Who is an insider?

To understanding these prohibitions, it is fundamental to understand who an insider is. According to Regulation 2(g) of the Insider Trading Regulations, an ‘insider’ means any connected person or a person in possession of or having access to unpublished price sensitive information in respect of the securities of a company.

The term ‘connected person’ refers to any person who is, or has during a period of six months prior to the act of insider trading been, associated with a company, directly or indirectly, in any capacity. This association can be because of frequent communication with the company’s officers or from being in any contractual, fiduciary, or employment relationship with the company.

It can also be as a result of being a director, officer, or an employee of the company or as a result of holding any position including a professional or business relationship between the person and the company (whether temporary or permanent), which allows the person, directly or indirectly, access to unpublished price sensitive information or is reasonably expected to allow such access. Regulation 2(d)(ii) provides a list of persons who are deemed to be ‘connected persons’.

What is unpublished price sensitive information?

first_image_newUnpublished price sensitive information has been defined under Regulation 2(n) of the Insider Trading Regulations to include “any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities…” A similar definition for price sensitive information has also been stated in sub-clause (b) of the Explanation to Section 195 of the Companies Act.

Regulation 2(n) also provides the following illustrative list matters information about which can be considered as unpublished price sensitive information:

– financial results;

– dividends;

– change in capital structure;

– mergers, de-mergers, acquisitions, delistings, disposals, expansions of business, and such other transactions;

– changes in key managerial personnel; and

– material events in accordance with the listing agreement.

In order to be considered price sensitive, the information should be likely to materially affect the price of securities of the company in the market. This requirement is inherent in the concept of price sensitivity.

Exception for due diligence

Rajat Kumar Gupta, an Indian-American businessman and philanthropist, is currently serving a two-year term in a U.S. federal prison for insider trading. Published under a CC BY-SA 2.0 licence.

Rajat Kumar Gupta, an Indian-American businessman and philanthropist, is currently serving a two-year term in a U.S. federal prison for insider trading. Published under a CC BY-SA 2.0 licence.

The Insider Trading Regulations recognise some practical reality of commercial transactions. Prospective investors could often require non-public information about a company in order to assess the merits of a particular transaction. In these situations, investors look to obtain unpublished price sensitive information not for insider trading but for due diligence on a company’s finances and business. Taking these factors into account, Regulation 3(3) of the Insider Trading Regulations allows for firms to communicate unpublished price sensitive information in connection with a contemplated transaction subject to certain conditions:

– for transactions that would entail an obligation to make an open offer under the takeover regulations laid down by the Securities and Exchange Board of India (“SEBI”), only if the board of directors of the company is of the informed opinion that the proposed transaction is in the best interests of the company; or

– for transactions that would not attract the obligation to make an open offer under the takeover regulations, if the board of directors of the company is of the informed opinion that the proposed transaction is in the best interests of the company and the information that constitutes unpublished price sensitive information (and is to be communicated to proposed investors) is made generally available at least two trading days prior to the proposed transaction being effected.

This clause has been included to ensure that in an open offer, all the information necessary to enable an informed divestment or retention decision by public shareholders is made available to all shareholders in the letter of offer under the takeover regulations.

The second point ensures that where the proposed transaction is for the benefit of the company (even though its not a regulatory mandate), the board of directors ensures that there is no information asymmetry in the market.

Defences

Note that insiders can prove their innocence by demonstrating the following circumstances:

– If the insider is an individual: That the transaction is an off-market transfer between promoters who were in possession of the same unpublished price sensitive information without being in breach of Regulation 3 and that both parties had made a conscious and informed trade decision;

– If the insider is not an individual: That-

(1) the individuals in possession of the unpublished price sensitive information were different from the individuals taking trading decisions and that the decision-making individuals were not in possession of the unpublished price sensitive information when they took the decision to trade; and

(2) appropriate and adequate arrangements were in place to ensure that the Insider Trading Regulations are not violated and that no unpublished price sensitive information was communicated by the individuals possessing the information to the individuals taking trading decisions and there is no evidence of such arrangements having been breached.

Note that connected persons bear the onus of proving that they were not in possession of unpublished price sensitive information. In case of all other persons accused of insider trading however, the onus of proving that they possessed the unpublished price sensitive information is on SEBI.

Penalty for violation

We should note that the Insider Trading Regulations do not specify a specific penalty for violation of the prohibition contained therein. However, Regulation 10 gives the SEBI the power to deal with any violation in accordance with the Securities and Exchange Board of India Act, 1992 (“SEBI Act”).

Section 15G of the SEBI Act prescribes a penalty of not less than Rupees Ten lakh, extending up to Rupees Twenty-five crore or three times the profit made from the insider trading activity, whichever is higher.

Deeksha Singh is part of the faculty on myLaw.net.

Written by myLaw

4 essential documents that you will come across during M&A transactions

Drafting_for_Business_Deepa_Mookerjee.jpgLet us now learn to draft transactional documentation. All M&A transactions are not identical. Sometimes the drafting of definitive documentation begins before negotiations. Parties exchange the first draft of documents and then negotiate to resolve major outstanding issues. In other cases, parties begin to negotiate major issues even before the first draft is complete. They may either negotiate while the agreement is being drafted or commence drafting only after the major issues have been resolved. Irrespective of the approach, a lawyer’s job is to draft the best possible agreement to suit the clients’ needs.

Before starting to draft, it is important, especially as a junior lawyer, to understand the different documents that are typically used in various transactions. Once you are part of a corporate law firm, you will realise that the more senior lawyers will ask you to draft documents quickly and may not be able to spare the time to explain the nature of the document. You must be quick on your feet and read up as much as possible.

I will now discuss a few agreements that you will find most commonly in M&A transactions. Remember that since M&A transactions are of various types, this is not an exhaustive list.

1. Share purchase agreement

Dee Limited has two shareholders, A and B. A intends to sell its shares in Dee Limited to Karl Limited for a specified monetary consideration. This understanding between the parties will be recorded in a share purchase agreement (“SPA”), a legally binding agreement. This agreement is important as it contains all the terms and conditions relevant to the sale such as:

(a) the exact description of the sale (including the number of shares, the names of the seller and the purchaser, and the consideration for the sale);

(b) the conditions that must be satisfied before the sale takes place;

(c) the date on which the sale will be completed;

(d) the manner in which the transfer will be made;

(e) any indemnities or protections available to the parties;

(f) the representations and warranties made by either party; and

(g) the conditions upon which the agreement will terminate.

The parties to a SPA are typically the seller, the purchaser, and the company whose shares are being sold. Often shareholders who may not be selling their shares may be also be a party to the agreement if specific consents are required from them for the transfer to take place.

2. Share subscription agreement

A new investor C wishes to invest in Dee Limited, the company in the example above. However, instead of purchasing shares held by A and B, Dee Limited will issue fresh shares to C. In other words, C will subscribe to fresh shares in Dee Limited. This understanding is typically recorded in a share subscription agreement (“SSA”). A SSA is similar in nature to a SPA. The only difference is the subject matter of the agreement. A SPA is executed when there is a transfer of shares from a shareholder to an investor while a company executes a SSA in case of a fresh issue of shares.

Watson_Free coursesThe parties to a SSA are typically the new investor and the company that is issuing fresh shares. The shareholders of that company are also parties to the SSA if certain consents are required from them before the transaction can be completed.

 

3. Shareholders agreement

A shareholders’ agreement is a contract that contains the rights and obligations of the shareholders in a company. Typically, this agreement supplements a SPA or a SSA. However, a shareholders agreement is not necessary in all cases. Lets understand this better with the help of certain examples:

Assume Dee Limited is purchasing 100% of the shares of Ceka Limited. Ceka Limited’s existing shareholders are transferring all their shares to Dee Limited. After the share transfer, Dee Limited will be the sole shareholder of Ceka Limited. In this case there is no need for a shareholders agreement. This is because there will be only one shareholder after the transfer and that shareholder has full control over the company.

Look at a slightly different scenario. Assume Ceka Limited has two shareholders P and Q. P is selling all his shares to Dee Limited. After the share transfer, Dee Limited and Q will be the two shareholders in the company. In such a case, a shareholders agreement is typically entered into to regulate the relationship between the shareholders.

In other words, a shareholders agreement is usually entered into when a company has more than one shareholder. The parties to a shareholders agreement are typically the shareholders of the company and the company itself. This agreement contains the rights and obligations of each shareholder on various matters such as:

(a) the manner in which shareholders can exit the company;

(b) the procedure for transfer of shares (whether in whole or part);

(c) the manner in which to wind up the company (in case of insolvency);

(d) the manner in which to resolve a disagreement between the shareholders;

(e) the manner in which the company will operate on a day-to-day basis and the rights of each shareholder regarding such operations; and

(f) the composition of the board of directors.

The SPA (or the SSA) and the shareholders agreement are often combined into one document that contains all the details of thjoie transaction and the manner of operation of the company after a transaction has been completed.

4. Joint venture agreement

A joint venture agreement (“JVA”) is similar to a combined shareholders agreement and SPA or SSA. It is essentially an agreement that parties enter into when they wish to run the company as partners. JVAs are executed between parties who intend to set up a new joint venture company or invest in an existing company. More often than not, if the company in which the investment is being made already exists, that company is also a party to this agreement. This is done to ensure that the provisions of the agreement are binding on the company.

The provisions of JVA are similar to that of a shareholders agreement and SPA or SSA.

We have learnt about four agreements that you will typically find in an M&A transaction. Other agreements are also generally drafted in such transactions and you can learn about them in our Programme on Advanced Commercial Contracts. In my next blog post, we will discuss the contents of these agreements in greater detail.

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

Written by myLaw

With new proposals on related party transactions, India will turn back on corporate governance reform

DeekshaSinghThe Companies Act, 2013 (“Act”), the statute that transformed India’s six-decade-old company law and containing provisions geared towards a stronger corporate governance regime, was almost unanimously welcomed. Most of its provisions were notified last year. Earlier this month however, even before all the provisions of the Act could be notified, the Union Cabinet, announced through a press release, its approval for the introduction of amendments to this Act. Some of the proposals in the Companies (Amendment) Bill, 2014 (“Amendment Bill”), if they end up becoming law, will dilute the impact of India’s corporate governance reforms.

The press release lists the proposed amendments along with a rationale and they are categorised below.

Proposals that will increase the ease of doing business

1. Omitting the requirement for minimum paid up share capital and consequential changes.

2. Making a common seal optional and consequential changes for the authorisation for the execution of documents.

3. Empowering the Audit Committee to give omnibus approvals for related party transactions on an annual basis. (This amendment was made to align the provision with SEBI policy and to increase the ease of doing business.)

Proposals to meet corporate demand

1. Prohibiting public inspection of Board resolutions filed in the Registry.

2. Rectifying the requirement of transferAPCCLP_CompanyLaw-Bannerring equity shares for which unclaimed or unpaid dividend has been transferred to the IEPF even though subsequent dividend(s) has been claimed.

3. Replacing ‘special resolution’ with ‘ordinary resolution’ for the approval of related party transactions by non-related shareholders. (The specific rationale provided here is that this amendment is to meet the problems faced by large stakeholders who are related parties.)

4. Exempt related party transactions between holding companies and wholly owned subsidiaries from the requirement of approval of non-related shareholders.

Proposals to address errors

1. Prescribing specific punishment for deposits accepted under the new Act.

2. Including provision for writing off past losses or depreciation before declaring dividend for the year.

3. Exemption under Section 185 (Loans to Directors) provided for loans to wholly owned subsidiaries and guarantees or securities on loans taken from banks by subsidiaries.

4. Winding up cases to be heard by a two-member bench instead of a three-member Bench.

Other proposals

1. Enabling provisions to prescribe thresholds beyond which fraud shall be reported to the Central Government (below the threshold, it will be reported to the Audit Committee). Disclosures for the latter category are also to be made in the Board’s Report. (This amendment is being introduced as a result of demand from auditors.)

2. Bail restrictions to apply only for offence relating to fraud under Section 447.

3. Special Courts to try only offences carrying imprisonment of two years or more. (This amendment is being made to allow magistrates to try minor violations.)

It appears that the BJP government is demonstrating its adherence with its ‘development’ manifesto. The amendments ostensibly made “for ease of doing business” and “to meet corporate demand” are probably a response to the lobbying that the corporate sector commenced shortly after the Act was notified.

Proposals dilute regime governing related party transactions

Some of the proposals however, may have the effect of reversing the positive steps towards sound corporate governance that the Act had introduced. One such proposal is that of diluting the requirement for a special resolution of disinterested shareholders for the approval of material related party transactions (“RPTs”). The amendment proposes to change this to only an ordinary resolution. A second proposal in relation to RPTs proposes to exclude RPTs between holding companies and wholly owned subsidiaries from the requirement of disinterested shareholder approval.

The provisions relating to the regulation of RPTs were key corporate governance reforms introduced by the Act. If these proposals become law, they will dilute the impact of these reforms.

The Amendment Bill is an opportunity for the government to address some errors and essential requirements. While evaluating these proposals, it is crucial that the interests of all stakeholders, large and small, and indeed, the principles of sound corporate governance are given as much importance by our legislators as “corporate demand” and “ease of doing business”.

Deeksha Singh is part of the faculty on myLaw.net.

Written by myLaw

Five tips to help you negotiate an M&A transaction like a boss

Drafting_for_Business_Deepa_Mookerjee.jpgThinking about negotiations, we may picture lawyers from opposite sides meeting in a conference room. Negotiations however, can take place over the phone or even through email. While most ‘big-ticket’ M&A transactions will comprise at least one meeting where the parties and lawyers are physically present to discuss all the major issues, minor issues can always be discussed through email or over a phone call. Remember, after having studied how to conduct an effective due diligence exercise and draft a comprehensive report, we are now moving ahead in the timeline of an M&A transaction. Actually, as you will see below, it often happens at the same time as the due-diligence.

Consider this scenario. Care Insurance Limited, a foreign insurance company, is investing in 26% of the equity share capital of Happy Life Insurance Limited, an Indian insurance company, and both companies have entered into a memorandum of understanding (a preliminary document about which we have already learnt), quite a few issues remain open. Care Insurance has two options. It can (a) wait to see the results of the due diligence exercise and then commence negotiations; or (b) if it is reasonably sure about its intention to invest, it can commence negotiations while the due diligence exercise is going on and then decide on any issues that may arise from the due diligence. More often that not, parties chose the second option unless they expect to see major red flags after the due diligence.

M&A negotiations can start in one of two ways — either one of the parties will circulate a first draft of the definitive documentation that can then be negotiated at a meeting or the parties will circulate a list of major negotiation points, which once decided, will then be inserted into definitive documentation. The choice of process is entirely up to the parties.

NegotiationInProgressRemember that a negotiation process is very sensitive and delicate as parties (sometimes with completely opposing positions), need to arrive at a mutually acceptable solution. Your job as a lawyer is to facilitate the closing of a deal. Here are five points you should keep in mind while preparing for a negotiation. Some of these may seem pretty obvious but after several negotiations, you will realise that even the smallest issue can make a difference.

1. Think about what to negotiate

Always sit with your clients to prepare a comprehensive list of issues that you would like to negotiate, before any meeting with the opposing counsel. Unless your clients would like to keep their position confidential till time the negotiation commences, it is best to set out their positions on these issues and circulate it to the other side. At times, the opposing counsel will also set out their responses to the issues you have circulated. The result is that before the negotiation commences, you will have a document that lists the major negotiating points and the views of both sides on each. This will help structure the discussion as the parties will be focused on the issues at hand. It will also give each side some time to consider the other party’s position before the negotiation commences, often aiding in a smoother negotiating process.

2. Be on the same page as your client

It is best to have a few meetings with your client (whether over the phone or in person) before your meeting with the opposing counsel. You should know how your client would like to see each individual issue resolved. Make sure that you have discussed possible outcomes with your clients and that you have taken them through both the best and the worst-case scenarios. Think about how the issues might relate to each other—for instance, is there some issue your client might be willing to concede in order to succeed in another aspect of the case? Finally, and importantly, make sure that you have determined—in consultation with your client—your ‘bottom line’, that is the point beyond which you cannot concede in a negotiation. If for example, Happy Life believes that Care Insurance must at least invest Rupees One Hundred crore for purchasing 26% shares in the company, then Rupees One Hundred crore is the bottom line. You cannot go below this number in your negotiations.

3. Know the transaction

APCCLP_CompanyLaw-BannerKnow the contours of the transaction and the several issues that can arise. Be aware of the law and the manner in which it relates to the transaction. This will ensure that you never agree to anything that is illegal (due to your ignorance of the law) which you will have to go back on later. For instance, you should be aware that the maximum permissible limit of foreign investment in any insurance company is 26%. Also, be aware of the manner in which the Foreign Investment Promotion Board allows a company to make this investment. Is investment allowed by way of preference shares or only equity shares? How can a foreign partner exit the company? Is there any guidance on the number of directors that can be appointed by a foreign partner? You should have answers to all these questions before you start negotiations.

4. Keep copies of all supporting documents ready

Make sure that you have enough copies of all supporting documentation (emails, preliminary documents, term sheet, reports and the like) that you might need before you enter into a negotiation. Keep additional copies in case anyone needs it. It is always best to have more copies so the negotiation does not need to be halted for something as trivial as taking printouts or photocopies. Also, make sure you have enough stationery – pens, papers, and notepads — for all participants in the negotiation.

5. Plan the conference

Make sure you have a comfortable environment for the negotiation. It should take place in a private room, such as a conference or meeting room. If possible, you can provide a smaller, private room for the other side to go to if they need to discuss anything in private during the course of the negotiation. This is typically called a break out room.

Ensure that facilities such as printers and photocopying machines are available through the duration of the conference. Finally, keep in mind that refreshments such as water, juice, lunch, and dinner should be provided to all the parties with minimal fuss so that they can be focused on the discussion rather than deal with ancillary issues.

Remember planning the meeting is as important as your conduct in negotiations. Good planning leads to an effective negotiation while incomplete planning will result in a bumpy negotiation process.

In my next post, I will discuss the manner in which you should conduct yourself at negotiations and the steps you should take to conclude your negotiation successfully.

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

Written by myLaw

Learn to structure and communicate a good due diligence report

Drafting_for_Business_Deepa_Mookerjee.jpgIn my last post here, I listed out some points that are important for a due diligence exercise. Completing the investigation (or the due diligence) however is just half the job. The latter half – often more confusing – is to organise all the information you have collected in a structured manner and communicate it effectively to your client.

Before starting to draft, determine the type of due diligence report your client wants. Typically, though there is no formal classification, there are two types of due diligence reports.

A comprehensive due diligence report

You will come across this type more frequently. Many pages long, often going into hundreds of pages, it will contain all the information that you have found from your investigations about the company. It is usually divided into many chapters, each containing information about a specific part of the company.

Generally the chapters include:

Corporate information: This chapter contains details about all corporate matters related to the target company, including its date of incorporation, number of directors, provisions in the articles of association, corporate compliances, and key decisions of the board and the shareholders.

– Litigation: This chapter lays out the details of all the litigation pending against, and filed by, the target company and their impact on the transaction, if such litigation is decided against the target company.

– Material agreements: Here, all the material agreements that a company has with its suppliers, consumers, and retailers, are reviewed to understand the important terms of such agreements, and determine whether there are any particular clauses that will hinder the transaction.

– Human resources: Here, a broad overview is provided of the employee structure, the key employees, their terms of employment, and conditions of their contracts.

– Financial information or indebtedness: In this chapter, all information about loans or financial indebtedness of the company is reviewed, and key issues such as requirement of consents from lenders, and restrictions on transfer of shares or assets, are highlighted.

– Compliances: In this chapter, there is a detailed investigation into the registration and licenses required under law to carry on the business of the company. Information regarding all statutory compliances is found in this chapter.

– Property: Information about all property (movable and immovable), whether owned or leased by the company, and their terms and conditions, is reviewed and outlined in this chapter.

– Intellectual property law issues: This is important if the target company has registered trademarks, copyrights, or patents. All documents in relation to their registration, ownership, or assignment are analysed, to examine any restrictions present on such intellectual property rights.

– Environmental law issues: If the target company is a manufacturing, construction, or engineering company, acquirers ensure that the company is in compliance with all environmental statutes in India and does not violate any pollution standards that have been prescribed.

– Insurance law issues: This chapter outlines the insurance policies taken by the target company, to provide the acquirer with a general idea of the protection available to the target company.

Since such a report runs into many pages, a client often asks for a separate document listing key issues to accompany this report. The list of key issues is a three-or-four-page document (maybe more depending on the transaction) which only lists out the problem areas of the company and provides concrete suggestions on how to solve these problems. Remember that the client will always want a solution to the problems. It is not enough to only identify the problems in the company. As a lawyer it is your duty to provide a solution. Therefore, while drafting, take some time out to think clearly about the manner in which a particular problem can be solved, and then specify that.

An “exceptions only” due diligence reportAPCCLP_CompanyLaw-Banner

Here, a lawyer is only supposed to list out the problem areas or issues with the company. The due diligence report will have language to the effect that “everything is in order with the company except the following…”. This is a report where the client assumes that all the items are in order except those listed in the report. The only problems with the company or its operations are those identified in the report. In other words, while drafting, you will only list out the problems with the company that you have investigated. You will not spend your time stating facts about the company that are in order.

In a comprehensive due diligence report, you will provide the client with all the facts (whether they are in order or not). You will obviously identify problem areas specifically but provide a complete picture as well. In an “exceptions only” report, the client will assume everything is in order except those issues that you have mentioned. Reports like this are becoming common and clients often ask for such reports as they are more concise and much easier to plough through.

Obviously the manner in which you will draft will depend upon the type of report that your client asking for. However, there are some basic drafting points to keep in mind for any report. See the image below.

DraftingaDueDiligenceReport_DosAndDon'tsKeep these points in mind while drafting your report. While some of these seem very simple and obvious, browsing through it before starting to draft will always help refresh your memory and hold you in good stead in your career as a commercial lawyer.

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

Written by myLaw