Thursday, December 8, 2016

Is the Doctrine of Ultra Vires Applicable to LLPs?

[The following guest post is contributed by Saumya Kakkar, Associate and Govinda Toshniwal, Senior Associate, both with NovoJuris Legal.  They can be contacted at relationships@novojuris.com]

The objects clause of the Memorandum of Association (“MOA”) of a company enlists and defines the main and the ancillary aims and objects for which the company is incorporated. Any activity or business the company carries out, or intends to do so, should fall under the ambit of this object clause. The company is restricted from performing an activity which is outside the scope of this object clause. The Supreme Court of India recognized this “doctrine of ultra vires” in the case of Laxman Swami Mudaliar v. Life Insurance Corporation of India and stipulated that any act beyond the permitted activities as defined in the objects clause of the MOA of the company is considered void, irrespective of the fact that the shareholders or directors of the company have assented to it.

The MOA of the company clearly defines the objects for which it has been established, thereby permitting the use of funds of the company only for a particular range of activities. This rule was established to protect the interests of the creditors and investors and to keep a check on the manner of utilization of their monies. In order to avoid this rule being attracted, companies started framing a wide objects clause by including all possible business activities ancillary to the main object.

A limited liability partnership (“LLP”) is a relatively new business structure combining the features of a company and a partnership, and was introduced by the Limited Liability Partnership Act, 2008 (“LLP Act”). The liability of partners in an LLP is limited to their agreed contribution to the business. The prospective partners in an LLP enter into an agreement which includes a“business description” stating the business to be carried on by the LLP.

The question that arises is: Whether the doctrine of ultra vires applies to the business description/object stipulated in the LLP Agreement to safeguard the interests of the investors/creditors of the LLP, considering that the liability of the partners of an LLP is limited to their contribution?

Section 67(1) of the LLP Act stipulates that the Central Government may, by notification in the Official Gazette, direct that “any of the provisions of the Companies Act, 1956 (1 of 1956) specified in the notification— (a) shall apply to any limited liability partnership; or (b) shall apply to any limited liability partnership with such exception, modification and adaptation, as may be specified, in the notification.”

Section 366 of the Companies Act, 2013 (the “Companies Act”) defines “company” with reference to the Part 1 of Chapter XXI of the Companies Act dealing with “Companies Authorized to Register under this Act” as any partnership firm, limited liability partnership, cooperative society, society or any other business entity formed under any other law for the time being in force which applies for registration under this Part.

Section 371(2) of the Companies Act states that any instrument that constitutes or regulates an LLP, i.e, the incorporation document or the LLP Agreement is equivalent to a memorandum of association of a company that is incorporated under the Companies Act or under Companies Act, 1956 (corresponding Section 578). Such instrument shall be treated in the same manner, and similar incidents needs to be inserted in a LLP Agreement or an incorporation document of a LLP that are required to be inserted in a memorandum of association of the company. For the purpose of understanding, the “instrument” as per section 371(7) of the Companies Act includes deed of settlement, deed of partnership, or limited liability partnership.

To quote Section 371(2) of the Act–

All provisions contained in any Act of Parliament or any other law for the time being in force, or other instrument constituting or regulating the company, including, in the case of a company registered as a company limited by guarantee, the resolution declaring the amount of the guarantee, shall be deemed to be conditions and regulations of the company, in the same manner and with the same incidents as if so much thereof as would, if the company had been formed under this Act, have been required to be inserted in the memorandum, were contained in a registered memorandum, and the residue thereof were contained in registered articles.”

Hence, by virtue of section 371(2) of the Companies Act read with section 67(1) of the LLP Act, the doctrine of ultra vires shall be applicable on the “business description/Object” in the LLP Agreement/Incorporation Document and hence the LLP cannot perform a business activity that is not included in the scope of the “business description/Object” as provided in the LLP agreement/Incorporation Document. Further, rule 21(1) & (2) of the LLP Rules, 2009 read with sub-section (2) of Section 23 of the LLP Act, provide that any change in the LLP Agreement (in Form 3) shall be filed with the registering authority within 30 days of such change along with the prescribed fee.

Section 11 of the LLP Act mandates the partners to provide the description of the business of the LLP in the LLP Agreement, which forms a part of the incorporation documents, which are to be registered with the registering authority. Further, the LLP Act permits change of nature of business of the LLP in the manner or mode as prescribed in the LLP Agreement and if the partners do not agree on such mode/manner, the change of nature of business will require the consent of all the partners of the LLP, as provided in Schedule 1 of the LLP Act.

Therefore, to perform any business activity beyond the scope of the “business description” of the LLP Agreement/Incorporation Document, the LLP needs to amend its “business description” stated in Form 2 while registering the LLP by filing Form 3 within 30 days of such change with the registering authority.  

Considering a penalty is imposed on providing false information in the incorporation documents, with a punishment of imprisonment for a term which may extend to two years and with fine which shall not be less than ten thousand rupees but which may extend to five lakh rupees, the business description and objects of the LLP provided in the incorporation document, shall be in sync with the business activity of the LLP. Also, if the partners of the LLP do not file any form, document, return, statement or do not comply with the provisions of the LLP Act, the LLP and its every partner shall be punishable with a fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees.

To quote section 11 of the LLP Act -

“(1) For a limited liability partnership to be incorporated—

(a) two or more persons associated for carrying on a lawful business with a view to profit shall subscribe their names to an incorporation document;

(b) the incorporation document shall be filed in such manner and with such fees, as may be prescribed with the Registrar of the State in which the registered office of the limited liability partnership is to be situated; and

(c) there shall be filed along with the incorporation document, a statement in the prescribed form, made by either an advocate, or a Company Secretary or a Chartered Accountant or a Cost Accountant, who is engaged in the formation of the limited liability partnership and by any one who subscribed his name to the incorporation document, that all the requirements of this Act and the rules made thereunder have been complied with, in respect of incorporation and matters precedent and incidental thereto.

(2) The incorporation document shall—

(a) be in a form as may be prescribed;

(b) state the name of the limited liability partnership;

(c) state the proposed business of the limited liability partnership;

(d) state the address of the registered office of the limited liability partnership;

(e) state the name and address of each of the persons who are to be partners of the limited liability partnership on incorporation;

(f) state the name and address of the persons who are to be designated partners of the limited liability partnership on incorporation;

(g) contain such other information concerning the proposed limited liability partnership as may be prescribed.

(3) If a person makes a statement under clause (c) of sub-section (1) which he—

(a) knows to be false; or

(b) does not believe to be true,

shall be punishable with imprisonment for a term which may extend to two years and with fine which shall not be less than ten thousand rupees but which may extend to five lakh rupees.”

In light of the above, we argue that the doctrine of ultra vires applies to the “business description/object clause” included in the LLP Agreement and hence, this business description should be drafted in such a manner that it does not attract the rule. It would be interesting to hear a counter view on this.

- Saumya Kakkar & Govinda Toshniwal


Wednesday, December 7, 2016

US Supreme Court Clarifies Tippee Liability in Insider Trading

The law on insider trading has received considerable attention in the United States (US) in recent years. At the same time, the law in the US is quite narrow compared to most other jurisdictions because liability for insider trading arises only if the person trading owes a fiduciary duty to the company and its shareholders, which has subsequently been extended to a duty owed to the source of the information. This becomes especially important in the case of persons who receive information, known as “tippees”, who then trade while in possession of that information. A tippee who receives such information with the knowledge that its disclosure breached the tipper’s duty acquires that duty and may be liable for securities fraud for any undisclosed trading on that information.

Tippee liability was enunciated by the US Supreme Court in 1983 in Dirks v. SEC, 463 US 646, wherein the Court held that “there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”

In the present case, Salman was indicted for trading on inside information he received from a friend and relative-by-marriage, Michael Kara, who in turn received information from his brother Maher Kara, who was a former investment banker with Citigroup. Salman was convicted, and the Ninth Circuit held that Dirks allowed the jury to infer that the tipper breached a duty because he made “a gift of confidential information to a trading relative.” On the other hand, the Second Circuit held in United States v. Newman, 773 F. 3d 438, that a mere gift of confidential information to friend or relative is insufficient and that there must be “proof of a meaningfully close personal relationship” between the tipper and the tippee “that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature”. It was these different approaches adopted by the Second and Ninth Circuits that the Supreme Court was called upon to resolve.

In a unanimous judgment delivered yesterday by Justice Alito in Salman v. United States, the US Supreme Court affirmed the Ninth Circuit’s decision that was on appeal before it, and rejected the position adopted by the Second Circuit in Newman. In doing so, it simply adhered very closely to its earlier decision in Dirks, “which easily resolves the narrow issue presented here”. The decision noted: “Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to “a trading relative,” and that rule is sufficient to resolve the case at hand”. Accordingly, when a tipper provides information to a relative or friend, there is a consequential inference that the tipper meant to provide the equivalent of a cash gift. To the extent that the Second Circuit in Newman required something of a “pecuniary or similarly valuable nature” in exchange, the Supreme Court disagreed with that requirement.

In sum, this decision keeps alive a comparatively expanded scope of liability for trading by tippees. The Newman decision had caused some controversy by arguably limiting the scope of liability, but the situation appears to have been corrected by the Supreme Court by staying true to the spirit of its earlier decision in Dirks. To that extent, it emboldens prosecutorial efforts in insider trading cases.

At the same time, it may be noted that the jurisprudence developed in the US, while quite often cited by the Indian regulator and appellate authorities, must be adopted with caution because the regulatory approach towards insider trading in the US (based on fiduciary duties) is vastly different from the rule-based approach in India (based on parity of information).


Monday, December 5, 2016

Corporate Insolvency Resolution Process under the Bankruptcy Code: Relevant Provisions Notified

[The following guest post is contributed by Shikha Bansal, under the aegis of Vinod Kothari & Company. She can be contacted at Shikhabansal2610@gmail.com]

The Ministry of Corporate Affairs, by way of Notification no. S.O. 3594(E) dated 30 November 2016, has notified 1 December 2016 as the date for commencement and enforcement of certain core sections of the Insolvency and Bankruptcy Code, 2016 (“the Code”), as listed below –

(i)   clause (a) to clause (d) of section 2 (except with regard to voluntary liquidation or bankruptcy);

(ii)  section 4 to section 32 [both inclusive];

(iii) section 60 to section 77 [both inclusive];

(iv) section 198;

(v)  section 231;

(vi) section 236 to section 238 [both inclusive]; and

(vii) clause (a) to clause (f) of sub-section (2) of section 239.

The provisions pertain to the corporate insolvency resolution process envisaged under the Code.
It may be noted that a few days ago the Central Government, by way of Notifications S.O. 3568(E) and S.O. 3569(E), both dated November 25, 2016, notified 1st December, 2016 as the date on which the SICA Repeal Act, 2003 shall come into force. On and from this date, any reference or inquiry pending before the Board of Industrial and Financial Reconstruction (“BIFR”) and any appeal pending before the Appellate Authority for Industrial and Financial Reconstruction (“AAIFR”) shall stand abated, and companies may make reference to the National Company Law Tribunal (“NCLT”) under the Code within 180 days from the commencement of the Code in accordance with the provisions of the Code.[1]

The present notification opens the gate for such companies too to proceed for resolution under the Code.

Enforcement Status of the Code Till Date

It may be noted that the proviso to section 1(2) of the Code allows for a piecemeal enforcement of the Code. The Central Government, so far, has issued give notifications. The present notification is fifth in the series, with the earlier ones being –

(1)        Notification S.O. 2618 [E] dated 5 August 2016[2] notifying 7 sections of the Code. Sections 188 to 194 (both inclusive) were enforced.[3]

(2)        Notification S.O. 2746 [E] dated 19 August 2016[4] , notifying 17 sections of the Code under Chapter VII of Part IV and sections under Part V of the Code.[5]

(3)        Notification SO 3355 [E] dated 1 November 2016[6] providing for commencement of Sections under Chapter II, Chapter VII of Part IV and sections under Part V.[7]

(4)        Notification S.O. 3453(E) dated 15 November 2016[8] providing for commencement of Sections under Chapter III, Chapter IV, Chapter VI of Part IV and sections under Part V.[9]

 

Provisions Notified in the Present Notification

1.         Section 2(a) to 2(d) (except with regard to voluntary liquidation or bankruptcy) – Applicability of the Code

Section 2 deals with the applicability of the Code. It reads as follows:

“2. The provisions of this Code shall apply to—

(a) any company incorporated under the Companies Act, 2013 or under any previous company law;

(b) any other company governed by any special Act for the time being in force, except in so far as the said provisions are inconsistent with the provisions of such special Act;

(c) any Limited Liability Partnership incorporated under the Limited Liability Partnership Act, 2008;

(d) such other body incorporated under any law for the time being in force, as the Central Government may, by notification, specify in this behalf; and

(e) partnership firms and individuals,

in relation to their insolvency, liquidation, voluntary liquidation or bankruptcy, as the case may be.”

Note that only clauses (a) to (d) of section 2 have been notified. The provisions relating to insolvency resolution and bankruptcy of individuals and partnership firms have not been notified. Further, provisions relating to liquidation and voluntary liquidation of the persons covered under clauses (a) to (d) are due for enforcement. In essence, the notification seeks to enforce provisions relating only to insolvency resolution process of corporate persons.

2.         Section 4 to section 32 [both inclusive] – Corporate Insolvency Resolution Process

Sections 4 to 32 (both inclusive) are comprised in Chapters I and II of Part II of the Code. Chapter I of Part II (sections 4 & 5) contains preliminary provisions while Chapter II of Part II (sections 6 to 32) provides for corporate insolvency resolution process. Such sections do not cover fast track corporate insolvency resolution process.

Section 4 limits the applicability of the Code to cases where the amount of default is a minimum of Rs. 1 lakh. The Central Government may, by way of notification, raise such minimum limit up to a maximum of Rs. 1 crore. Section 5 contains definitions of the words and expressions used in Part II of the Code (i.e. in context of the corporate insolvency resolution process).

The corporate insolvency resolution process as contained in sections 6 to 32 has been briefly stated as follows:

- There must be a debt, in respect of which the corporate debtor must have committed a default. The amount of default should be Rs. 1 lakh or more.

- A financial creditor (solely or jointly), an operational creditor, or a corporate applicant may file an application for initiation of corporate insolvency resolution process in respect of the corporate debtor to the adjudicating authority. In case of operational creditor, a pre-requirement is delivery of demand notice.

- The adjudicating authority admits or rejects the application.

- On admission of the application, the corporate insolvency resolution process commences.

- Moratorium commences, interim resolution professional is appointed, and public announcement is made.

- Committee of creditors is constituted by the interim resolution professional

- Resolution professional is appointed by the committee of creditors in its first meeting.

- Resolution professional prepares information memorandum.

- Resolution applicant prepares resolution plan on the basis of the information memorandum.

- The resolution plan is examined by the resolution professional, and approved by the committee of creditors.

- The resolution plan is approved by the adjudicating authority.

The corporate insolvency resolution process has to be complete within the default maximum period of 180 days, extendable by a further period of 90 days only once.

3.         Section 60 to section 77 [both inclusive] – Adjudicating Authority for Corporate Persons and Offences & Penalties

Sections 60 to 67 cover provisions relating to adjudicating authority for corporate persons, while sections 68 to 77 list out offences in relation to the processes of resolution and liquidation and penalties therefor. These constitute another set of necessary provisions to facilitate corporate insolvency resolution process.

4.   Section 198 – Condonation of Delay

The section deals with condonation of delays made by the Insolvency and Bankruptcy Board. The section is a non-obstante clause and provides that where the Board does not perform any act within the period specified under this Code, the relevant Adjudicating Authority may, for reasons to be recorded in writing, condone the delay.

5.   Section 231 – Bar of Jurisdiction

Section 231 bars the jurisdiction of any court in respect of any matter in which the adjudicating authority is empowered by, or under, this Code to pass any order. No injunction shall be granted by any court or other authority in respect of any action taken or to be taken in pursuance of any order passed by such adjudicating authority under this Code.

6.   Section 236 to section 238 [both inclusive] – Trial of Offences by Special Court, Appeal and Revision, and Overriding Effect of the Code

Section 236 provides for trial of offences under the Code by the Special Court established under Chapter XXVIII of the Companies Act, 2013. According to section 237, the High Court may exercise, so far as may be applicable, all the powers conferred by Chapters XXIX and XXX of the Code of Criminal Procedure, 1973 on a High Court, as if a Special Court within the local limits of the jurisdiction of the High Court were a Court of Session trying cases within the local limits of the jurisdiction of the High Court.

Section 238 emphasises on the overriding effect of the Code -- The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

7.   Clause (a) to clause (f) of sub-section (2) of section 239 – Power of Central Government to frame Rules under the Code

Section 239 (2) empowers the Central Government to frame rules in regard to the following (only notified part reproduced) –

(a) any other instrument which shall be a financial product under clause (15) of section 3;

(b) other accounting standards which shall be a financial debt under clause (d) of sub-section (8) of section 5;

(c) the form, the manner and the fee for making application before the Adjudicating Authority for initiating corporate insolvency resolution process by financial creditor under sub-section (2) of section 7;

(d) the form and manner in which demand notice may be made and the manner of delivery thereof to the corporate debtor under sub-section (1) of section 8;

(e) the form, the manner and the fee for making application before the Adjudicating Authority for initiating corporate insolvency resolution process by operational creditor under sub-section (2) of section 9;

(f) the form, the manner and the fee for making application before the Adjudicating Authority for initiating corporate insolvency resolution process by corporate applicant under sub-section (2) of section 10;”

Note that the Central Government has also issued the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 by way of Notification no. G.S.R. 1108(E) dated 30 November, 2016.

What is Missing?

The present notification misses out on one of the most crucial aspects in the corporate insolvency resolution process – avoidance of transactions. Sections 43 to 51 of the Code empower both the liquidator and the resolution professional to file applications to the adjudicating authority for avoidance of certain transactions, viz.

(i)   preferential transactions,

(ii)  undervalued transactions, and

(iii) extortionate credit transactions,

The resolution process may not be effectively carried out in the absence of these provisions.

The way ahead

In furtherance of the power conferred under section 240, the Board has issued the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 by way of Notification no. IBBI/2016-17/GN/REG004 dated 30 November, 2016.

Seeing the trend, it is evident that the Central Government is keen on implementing the Code in fast track mode and it is expected that the sections relating to avoidance of transactions will be notified soon.

- Shikha Bansal




[1] Read more: http://www.india-financing.com/images/Articles/SICA_bids_adieu.pdf
[2] http://www.mca.gov.in/Ministry/pdf/Notificationdated05.08.2016.pdf
[3] Read more: http://www.india-financing.com/images/Articles/7_sections_notified.pdf
[4] http://www.mca.gov.in/Ministry/pdf/Notification_22092016_1.pdf
[6] http://www.mca.gov.in/Ministry/pdf/Notification_01112016.pdf
[7] Read more: http://www.india-financing.com/images/Articles/Sections_notified_under_the_Bankruptcy_Code.pdf
[8] http://www.mca.gov.in/Ministry/pdf/Notification_17112016.pdf
[9] Read more: http://www.india-financing.com/images/Articles/Sections_notified_under_the_Code_4th_Tranche.pdf

Comparative Paper on Corporate Purpose

Professor Afra Afsharipour has posted on SSRN a paper titled “Redefining Corporate Purpose: An International Perspective”, the abstract of which is as follows:

Over the past decade, corporate law in India has begun a reform journey with important implications for not only corporate governance, but also for deeper questions about the purpose of the corporation and beneficiaries of the corporate form. Following years of debate and attempts at reforms that began in the late 1990s, the reform efforts culminated in the 2013 Companies Act. In designing India’s new corporate law, policymakers grappled with the subject of corporate purpose and determining which institutional structure is in the best place to further the purpose of the corporation. When viewed holistically, the Companies Act is a radical experiment with corporate purpose. The Companies Act does not specifically detail the concept of corporate purpose, other than stating that a company may be formed for any “lawful purpose.” Nevertheless, the Act’s various provisions regarding board fiduciary duties and responsibilities make clear that shareholder wealth maximization should no longer be the primary lens for decision-making by Indian boards. One of the most essential provisions of the Act declares that corporate directors “shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.” Moreover, the Act’s code for independent directors requires them to “safeguard the interests of all stakeholders” and to “balance the conflicting interest of the stakeholders.” These duty-focused provisions are then bolstered by several other important provisions including those relating to CSR spending and disclosure and, in some cases, stakeholder access to board members. The substantive reforms of the Companies Act are overlaid with an extensive disclosure regime that envisions a vast increase in corporate transparency.

India’s new corporate law in many ways both mirrors and moves beyond debates in other parts of the world to redefine the purpose of the corporation. Given the large extent to which corporate law in India looks at comparative examples from other common law jurisdictions, this Article primarily focuses on comparative developments in the U.K. and U.S. In the U.K., for example, the concept of “enlightened shareholder value” was introduced through statute with passage of the U.K. Companies Act 2006. Similarly, while India was undergoing its debates regarding corporate purpose, the U.S. was debating the purpose of the corporation and experimenting with different forms of business entities, such as benefit corporations, aimed at moving away from the claim that the law requires shareholder wealth maximization as the primary purpose of the corporation.

Overall, India's reforms suggest that India intends to transform corporate purpose beyond the ESV model adopted in the U.K. Moreover, unlike the U.S. move to allow for benefit corporations, India’s transformation of corporate purpose does not apply to a mere subset of entities, but instead contemplates an overhaul of corporate vision in Indian firms. Nevertheless, there is reason to doubt that the specific legal provisions provided by the Companies Act will in fact lead to substantive structural change given the various forces and institutions that may stand in the way of redefining the purpose of the Indian firm.