Stamp Duty on Inter-State Amalgamations

[This post is slightly longer than our usual posts. I would like to thank a reader for drawing attention to a judgment that is the subject matter of this post]
Stamp duty on schemes of amalgamation undertaken through sections 391 to 394 of the Companies Act, 1956 have tended to experience a great deal of controversy, as we have previous discussed on this Blog (here, hereand here). A recent judgment of the Bombay High Court may have stoked it further. While it is now more or less settled that schemes of amalgamation are subject to stamp duty in most states, the question of quantum of stamp duty (especially where companies involved in the amalgamation are incorporated in more than one state) was left open. This judgment seeks to answer that question.
Court’s Decision
In Chief Controlling Revenue Authority v. Reliance Industries Limited,[1] a Full Bench of the Bombay High Court was concerned with the amalgamation of Reliance Petroleum Limited (RPL) into Reliance Industries Limited (RIL), whereby the assets, liabilities and entire undertaking of RPL were to be transferred to and vested in RIL. While RPL was incorporated in the state of Gujarat, RIL was incorporated in Maharashtra. For this reason, the High Courts of both the states were seized of the matter, and passed separate orders sanctioning the scheme after the companies complied with the necessary formalities. While the Bombay High Court passed its order (on a petition by RIL) on June 7, 2002, the Gujarat High Court passed its order (on a petition by RPL) subsequently on September 13, 2002. After both the orders were passed, RIL paid a stamp duty of Rs. 10 crores in the State of Gujarat on the order passed on the Gujarat High Court. Given that the stamp duty of a maximum of Rs. 25 crores was payable in Maharashtra on the amalgamation, RIL took up the contention that it only needed to pay Rs. 15 crores, claiming credit for the Rs. 10 crores that it had already paid in Gujarat. The revenue authorities in Maharashtra refused to accept this position, and instead sought full stamp duty. After a series of appeals, the revenue authorities in Maharashtra preferred a reference to the Bombay High Court to decide on the questions of law.
The Court identified the questions for consideration as follows:
1. Whether a scheme sanctioned between the two companies under Section 391 and 394 of the Companies Act is one and same document chargeable to stamp duty regardless of the fact that order sanctioning the scheme may have been passed by two different High Courts by virtue of the fact that the Registered Offices of the two Companies are situated in two different states?
2. Whether the instrument in respect of amalgamation or compromise or scheme between the two companies is such a scheme, compromise or arrangement and the orders sanctioning the same are incidental as the computation of stamp duty and valuation is solely based on the scheme and scheme alone?
3. Whether in a scheme, compromise or arrangement sanctioned under Section 391 and 394 of the Companies Act where registered office of the two companies are situated in two different States, the Company in state of Maharashtra is entitled for rebate under Section 19 in respect of the stamp duty paid on the said scheme in another State?
4. Whether for the purpose of Section 19 of the Act the scheme/ compromise/ arrangement between the two Companies must be construed as document executed outside the state on which the stamp duty is legally levied, demanded and paid in another State?
The Court decided as follows on these questions.
1.         Scheme or Court Orders? One document or two?
This question is probably the most important one, as the answer to this largely determines the answers to the questions to follow. It is clear that stamp duty is payable on an “instrument” and not a transaction. Consequently, the issue relates to what constitutes an “instrument” in relation to a court-approved amalgamation. The Court noted: “The issue in short is whether the scheme of arrangement between the parties which has been sanctioned by the court is the instrument or the order of the court sanctioning the scheme is the instrument as parties are ad-idem that stamp duty is payable on an instrument.”
In answering this question, the Court referred to the previous line of cases dealing with stamp duty on amalgamations, including Hindustan Lever v. State of Maharashtra, (2004) 9 SCC 438 and Li Taka Pharmaceuticals v. State of Maharashtra, 1996 (2) Mah. L.J. 156. These cases support the proposition that the transfer in case of an amalgamation is effected by an order of the court, which is the instrument for purposes of the Bombay Stamp Act. It found that the scheme of amalgamation itself cannot be an “instrument” as it has no force unless and until it is sanctioned by the court. Accordingly, the Court took the “execution” of an instrument in an amalgamation to be the signature of the High Court on an order sanctioning the amalgamation. Since the Bombay Stamp Act requires that an instrument executed within the State be stamped “before or at the time of execution or immediately thereafter or on the next day following the execution”, the provision was not complied with as required in the present case. The Court took issue with the fact that although the Bombay High Court order preceded that of the Gujarat High Court, the parties proceeded to pay stamp duty in Gujarat before addressing the stamp duty payment in Maharashtra, thereby contravening the chronology of the respective court orders.
The Court ultimately concluded on this issue that in a scheme of amalgamation involving two companies, there would be two instruments each of which would be liable to stamp duty. It stated:
21        Although the two orders of two different high courts are pertaining to same scheme they are independently different instruments and can not be said to be same document especially when the two orders of different high courts are upon two different petitions by two different companies. When the scheme of the said Act is based on chargeability on instrument and not on transactions, it is immaterial whether it is pertaining to one and the same transaction. The duty is attracted on the instrument and not on transaction.
In other words, what is relevant for purposes of payment of stamp duty is the court order, which represents the “instrument” and not the scheme (which does not have any standing of its own without the court’s order).
2.         Whether the Two Court Orders are Incidental
Since the orders of the two courts relate to a common scheme of amalgamation, the question arose as to whether they are incidental, and whether it was sufficient to stamp the “principal instrument”, being the order of the Gujarat High Court. This argument was not accepted by the Court as section 4 of the Bombay Stamp Act that deals with incidental instruments is specific only to some types of agreements such as development agreement, sale, mortgage or settlement. The Court found that the present case did not fall within any of these categories.
3.         Inter-State Document and Credit for Stamp Duty Paid
Section 19 of the Bombay Stamp Act provides that where a document executed outside a State is subsequently brought into the State, stamp duty would have to be paid on that instrument after giving appropriate credit (i.e. set-off) to duty that has already been paid in another state. Since the Court had already concluded in relation to item (1) above that an amalgamation comprises two court orders, what was relevant for purposes of considering the stamp duty liability in Maharashtra was the order of the Bombay High Court. Since the order of that court was signed in Maharashtra, it was “executed” within the State, due to which the provisions of section 19 would not apply.
For these reasons, the Court concluded as follows (in a nutshell):
1.         A scheme of amalgamation between two companies is not a document chargeable to stamp duty;
2.         An order passed by the court, which effects the transfer, would be a document chargeable to stamp duty;
3.         If there are two High Courts involved, then the High Court “which sanctions the Scheme passed under Section 394 of the Companies Act, will be the instrument chargeable to stamp duty”.
4.         The orders of different courts sanctioning the scheme are not “incidental” orders. Each order is an “instrument”, and that the scheme along cannot be chargeable to stamp duty.
5.         When the orders are passed in different states, section 19 will not apply as the order in respect of a company in a state is passed within that state itself.
Implications
At one level, the decision of the Court is understandable as seeks to address a somewhat controversial issue by engaging in a technical interpretation of the Bombay Stamp Act. While it adheres closely to such an interpretation of individual provisions, and is arguably satisfactory in respect of the same, the end result is counterintuitive, and one wonders whether a more purposive interpretation of the statute would have resulted in a different outcome.
First, let us begin with a rather basic analysis. An instrument is a legal document that conveys property from one person to another. A transfer of property can be effected through a document that is executed between two parties, and there can be no dispute that it must be stamped as one single document. In the alternative structure, the same transfer of property can be achieved through a scheme of arrangement, in which case the transferor and transferee would be companies. A scheme of arrangement is also a consensual arrangement that is initiated by the two companies involved in the transfer, except that in this case the specific process prescribed under sections 391 to 394 of the Companies Act, 1956[2] must be followed, which include obtaining the approval of the relevant classes of shareholder and creditors as well as the sanction of the relevant High Courts. The import of the judgment under discussion is that although a transfer by way of a private contractual arrangement constitutes one “instrument” for purposes of stamp duty, if the same transfer is achieved through a scheme of arrangement under the Companies Act it could constitute two instruments for purpose of stamp duty, neither of which is incidental to the other. If there are more companies involved in a scheme of arrangement, then there would be as many instruments as there are companies. This, to my mind, results in an unintended consequence.
Second, moving further, if one were to consider the disputes involved in the earlier cases discussed above, the question was whether the order of a court in a scheme of arrangement would be a “conveyance” for the purposes of charging stamp duty. While there was some initial hesitation, the position now seems to be a resounding yes, not just from the judiciary but also from the legislature in states such as Maharashtra and Gujarat which have amended their stamp duty legislation to include orders of the court as being “conveyance”. Hence, any doubt regarding the chargeability of stamp duty on a court-based scheme has been removed. What the judgment under discussion does is to extend this principle further to state that not only is the order a “conveyance”, but that each order of a court involved in a scheme of arrangement is chargeable to stamp duty. In other words, it extends the earlier line of judgments that levy stamp duty by enhancing the magnitude of payment of stamp duty. This it does so by means of its textual interpretation of the Bombay Stamp Act.
Third, the Court in this case was admittedly dealing with an inter-state amalgamation. If one were to apply this principle to intra-state amalgamations, the same issue could arise. For example, let us assume the amalgamation relates to two companies within the same state. Even here, the companies have to file individual petitions, and obtain sanctions of the court independently. It is a different matter that the different petitions may be heard together for the sake of convenience. In such a case too, the question of multiple “instruments” would apply. Do parties have to pay stamp duty on one instrument? If so, which one? If not, applying the present judgments, would they have to pay stamp duty duty as if there are two instruments? This position lacks clarity.
Fourth, the Court’s observations also raise a timing issue. The Court states that the order of the Bombay High Court was issued on June 7, 2002, which itself constituted an instrument that is liable for stamp duty, although the order of the Gujarat High Court only came later. It also notes that RIL ought to have paid with reference to the date of the Bombay High Court order, without having regard to the Gujarat High Court proceedings. This is bound to cause severe practical difficulties. For example, it would require a party (A) to pay stamp duty on an order granted by one of the courts (X) without having any certainty that the scheme would be approved in respect of the other party (B) by the other court (Y). If court Y does not sanction the scheme, there is no transfer while A would have already incurred an obligation to pay stamp duty. This is again an unintended consequence of treating a transfer by way of a scheme of arrangement as two instruments representing the orders of the two High Courts involved.
In all, the decision of the Bombay High Court magnifies the stamp duty on a scheme of amalgamation. Granted that parties should not resort to schemes of arrangement as a means of evading stamp duty that would have otherwise been payable on a transfer through a private contractual arrangement between the parties. The present approach would have the effect of penalizing parties for choosing a scheme of arrangement (which is a more transparent process with greater shareholder and creditor protection) than a private sale (which does not confer those benefits).
It is difficult to argue against the textual interpretation of the Bombay Stamp Act that the Court indulged in. The effect of a scheme of arrangement has been a thorny issue elsewhere too. For example, in The Oriental Insurance Co. Ltd. v. Reliance National Asia Re Pte. Ltd., [2008] SGCA 18, the Singapore Court of Appeal took note of the differing approaches followed by courts regarding schemes of arrangement. While the English approach embodied in the Privy Council decision of Kempe v. Ambassador Insurance Co., [1998] 1 WLR 271 took the view that a scheme of arrangement derived its efficacy purely from statute and operated as a “statutory contract”, the Australian approach stated that the scheme of arrangement derived its efficacy from the order of the court and that it in fact operated as an order of the court. After considering both these approaches, the Singapore courts opted for the Australian one treating the scheme as an order of the court.
In this sense, the Bombay High Court’s view is consistent with the above. But, its application without having regarding to the objects and purpose of chargeability of stamp duty would lead to an incongruous outcome.




[1] Civil Reference No. 1 of 2007, judgment dated March 31, 2016.
[2] The parallel provisions under the Companies Act, 2013 are yet to take effect.

Gender Diversity and Government Companies

It has been more than a year since a provision in the Companies Act, 2013 came into effect that requires all listed companies to have at least one woman director. As we had previously discussed, companies scrambled to comply with the requirement as of April 1, 2015, the effective date. However, a recent news report in the Business Standard indicates that 57 companies listed on the NSE are yet to comply with this requirement. More importantly, at least a third of the violators are public sector companies (PSCs). This represents yet another instance whereby, instead of taking the lead in ensuring compliance with enhanced corporate governance norms, PSCs have been in breach.
Such a situation is not new. A similar one arose a few years ago when several PSCs failed to comply with the requirement of appointing a minimum number of independent directors, and SEBI initiated action against them (discussed hereand here). However, those actions had to be dropped because the PSCs argued that despite their repeated efforts, the appointments of independent directors could not be implemented due to the lack of approval from the President of India for such appointments (as required under the articles of association of such companies). PSCs are staring at a similar bottleneck even regarding the appointment of women directors.
This does not at all bode well for corporate governance in India if even the letter of the law cannot be complied with, and where the perpetrators of non-compliance are government-owned companies. As I had observed elsewhere in connection with the earlier episode involving the appointment of independent directors:
This episode may likely have deleterious consequences on corporate governance reforms in India. Compliance or otherwise of corporate governance norms by government companies has an important signaling effect. Strict adherence to these norms by government companies may persuade others to follow as well. But, when government companies violate the norms with impunity, it is bound to trigger negative consequences in the market-place thereby making implementation of corporate governance norms a more arduous task. …

That sentiment would hold good even for the present episode involving women directors. Despite giant strides having been taken in strengthening substantive corporate governance norms in India, much less progress is made with compliance and enforcement.

Second Leg of SARFAESI: All Transactions to be Registered with CERSAI

[The following guest post is contributed by Niddhi Parmar of Vinod Kothari & Company. The author can be contacted at parmar@vinodkothari.com]
Introduction
The Central Government introduced the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Central Registry) Amendment Rules, 2016 (hereinafter referred as ‘Amendment Rules, 2016’) on January 22, 2016 (being the date of publication in the Official Gazette) requiring the particulars of transactions to be registered with Central Registry of Securitisation Asset Reconstruction and Security Interest of India (‘CERSAI’) by banks and financial institutions as the Central Government may notify. The term “financial institutions” has been defined under section 2(m) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act) to mean –
“XX
(iv)    any other institution or non-banking financial company as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934), which the Central Government may, by notification, specify as financial institution for the purposes of this Act.”
Section 45NC of the Reserve Bank of India Act, 1934 grants power to the Reserve Bank of India (RBI) to exempt non-banking institutions from the applicability of the provisions of the RBI Act. Housing Finance Companies (HFCs), being, financial institutions are exempted from complying with the provisions of the RBI Act. However, they are regulated by the National Housing Bank. The Central Government has notified 19 HFCs as on July 25, 2014 to make use of the SARFAESI Act. Subsequently, 41 more HFCs were notified on December 18, 2015.
Non-Banking Financial Companies (‘NBFCs’) irrespective of class or asset size were advised to file and register the records of all equitable mortgages created in their favour on or after March 31, 2011 with the CERSAI as and when equitable mortgages are created in their favour vide its circular no. RBI/2013-14/369 DNBS.(PD).CC.No.360 /03.10.001/2013-14 dated November 12, 2013. Subsequently, NBFCs were advised to register all types of mortgages with CERSAI.
Prior to the Amendment Rules, 2016
Banks and financial institutions were required to register equitable mortgages with CERSAI pursuant to section 23, 24 and 25 of the SARFAESI Act read with rule 4(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Central Registry) Rules, 2011 (hereinafter referred to as ‘Rules, 2011’).
Why only equitable mortgages?
Rule 4(2) of the Rules, 2011 required as follows:
“Particulars of every transaction of securitisation and reconstruction of financial assets and creation, modification or satisfaction of security interest by way of mortgage by deposit of title deeds shall be filed in Form I, Form II, Form III or Form IV, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.”
The most common form of mortgage is mortgage by deposit of title deeds wherein the debtor simply delivers the title deeds to the creditor or its agent. Section 58(f) of the Transfer of Property Act, 1882 defines the term “mortgage by deposit of title-deeds” as follows –
“Where a person in any of the following towns, namely, the towns of Calcutta, Madras, and Bombay, and in any other town which the State Government concerned may, by notification in the Official Gazette, specify in this behalf, delivers to a creditor or his agent documents of title to immovable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title-deeds.”
There exist three important elements for mortgage by deposit of title deeds: debt owed by the mortgagor, deposit of title deeds, and the intent to create security. In India, the expressions “mortgage by deposit of title deeds” and “equitable mortgage” are used interchangeably.
Post Amendment Rules, 2016
Post Amendment Rules, 2016, the institutions are not only required to register the equitable mortgages with CERSAI but also need to register the following:[1]
“2(A). Particulars of creation, modification or satisfaction of security interest in immovable property by mortgage other than mortgage by deposit of title deeds shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.
(2B). Particulars of creation, modification or satisfaction of security interest in hypothecation of plant and machinery, stocks, debt including book debt or receivables, whether existing or future shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.
(2C). Particulars of creation, modification or satisfaction of security interest in intangible assets, being knowhow, patent, copyright, trade mark, licence, franchise or any other business or commercial right of similar nature, shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.
(2D). Particulars of creation, modification or satisfaction of security interest in any under construction residential or commercial building or a part thereof by an agreement or instrument other than by mortgage, shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.”
All subsisting transactions under sub-rules (2A) to (2D) need to be registered with CERSAI by the secured creditor on or before such date as may be specified by the Central Government wherein no fee shall be payable on such filing. However, in case of failure to register within the prescribed time limit, the same shall be subject to applicable fees specified in table below.
The term subsisting transaction has been defined under the explanation to proviso to mean those transactions which existed before the Amendment Rules, 2016 coming into force.
Fees for creation and modification of security interest:
Particulars
Form No.
Amount of fee payable (in Rs.)
Post Amendment Rules, 2016[2]
Prior to the Amendment Rules, 2016
Creation or modification of security interest by way of mortgage by deposit of title deeds:
1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh
Form I
50
100
250
500
Creation or modification of security interest by way of mortgage of immovable property other than by deposit of title deeds
Form I
NIL
NA
Creation or modification of security interest in hypothecation of plant and machinery, stocks, debt including book debt or receivables, whether existing or future:
1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh
Form I
50
100
NA
Creation or modification of security interest in intangible assets, being know- how, patent, copyright, trade mark, licence, franchise or any other business or commercial right of similar nature:
1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh
Form I
50
100
NA
Creation or modification of security interest in any under construction residential or commercial building or a part thereof by an agreement or instrument other than by mortgage:
1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh
Form I
50
100
NA
Satisfaction of charge for security interest filed under subrule (2) and (2A) to (2D) of rule 4
Form II
NIL
250
(only for subrule 2)
Securitisation or reconstruction of financial assets
Form III
500
1000
satisfaction of securitisation or reconstruction transactions
Form IV
50
50
Any application for information recorded/ maintained in the Register by any person
10
Any application for condonation of delay upto 30 days
Not exceeding 10 times of the basic fee , as applicable
Not exceeding 2500 in case of creation of security interest for loan upto 5 lakh and not exceeding 5000 in all other cases
An additional fee[3]is payable on delay in filing the records from January 22, 2016 as below:
– From 31 days to 40 days – twice the amount of applicable fees;
– From 41 days to 50 days – five times the amount of applicable fees;
– From 51 days to 60 days – ten times the amount of applicable fees.
Conclusion
Post Amendment Rules, 2016, the banks and financial institutions are required to register all transactions referred in rule 4(2) to (2D) with CERSAI within a period of 30 days from the date of such transactions. Further, the gazetted copy of the Amendment Rules, 2016 states that the fees payable in case of security interest being created under sub-rule (2A) of rule 4 shall be NIL. However, a notification issued by CERSAI dated February 1, 2016[4]states that no fees shall be payable in case of security interest being created under sub-rule (2A) of rule 4 to sub-rule (2D) of rule 4.
– Niddhi Parmar




[1] Sub-rules have been inserted in rule 4 of the Rules, 2011.
[2] As per the Gazetted Amendment Rules, 2016.
[3] CERSAI Notification No. CERSAI/CMD/2016-1232 dated March 4, 2016 – site last visited on April 30, 2016.
[4] CERSAI Notification No. CERSAI/IT/1178/2016 – site last visited on April 30, 2016.

Interim Dividends – Is the Confusion Clearing?

[The following guest post is contributed by Siddharth Rajaand Neeraj Vyas, who are Founding Partner and Associate respectively of Samvad Partners. Views are personal, and comments are welcome]
The concept of ‘interim dividend’ was only introduced into the Indian companies statute in 2000 — that was legislative recognition of a move that had started to develop and gain acceptance within Indian corporates, especially in the 1990s.  A move that essentially postulated freedom to a Board of Directors (in contrast to the shareholders in general meeting) to declare a dividend in the interregnum between two ‘regular’ (so to speak, although the word is not used in the statute) dividend declarations which typically take place at annual general meetings of shareholders, year-on-year. 
The Companies (Amendment) Act of 2000, amending the Companies Act, 1956 (the “1956 Act“), made it clear that the Board of an Indian company may declare an ‘interim dividend’, which had to then be segregated into a separate bank account for the only purpose of making the payment of such ‘interim dividend’ — importantly, the terms under which such an ‘interim dividend’ could be declared and paid was the same as applicable to dividends itself.  As a result, one of the key conditions governing both ‘interim dividend’ and ‘dividend’ under the 1956 Act was the need to declare and pay the same only out of profits.
The Companies Act, 2013 (the “2013 Act“) had further refined the construct of ‘interim dividend’, but the wording of the provisions has left a lot to be desired — something the Report of the Companies Law Committee of February 2016 notes as ‘disharmony’, while suggesting ameliorative measures that are certainly welcome.  But, some of the suggested changes or comments on clarifications to be made, especially in the Companies (Declaration and Payment of Dividend) Rules, 2014 (the “Dividend Rules“), are yet to see the light of day, currently, whether in draft or final form.
Dividends:    Section 123 of the 2013 Act (earlier — although entirely the same as — Section 205 of the 1956 Act) deals with the declaration of dividends.  Section 123(1) inter alia provides that dividend can only be declared or paid by a company for any financial year out of profits for that year, or out of the profits of any previous financial year(s), arrived at after providing for depreciation.  
Furthermore, no dividend can be declared or paid by a company out of its reserves other than free reserves (emphasis added), but, subject in those cases, to the fulfilment of certain conditions.  In other words, the Further Proviso to Section 123(1) provides that, in cases of losses (or, what the provision calls, ‘absence of profits’) or the inadequacy of profits in any financial year, the company in question may only declare a dividend out of the accumulated profits earned by it in previous year(s) and transferred by it to the reserves, subject to the procedure and conditions laid down in the rules prescribed by the Central Government in this regard (namely, Rule 3 of the Dividend Rules).
Interim Dividends: The concept of ‘interim dividend’, as contrasted with that of a ‘dividend’ dealt with above, is provided for in Section 123(3) of the 2013 Act — the Board of a company may declare an ‘interim dividend’ during any financial year out of the surplus in the profit and loss account and out of profits of the financial year in which such interim dividend is sought to be declared.  
The only restriction statutorily provided on interim dividends (in the Proviso to this Section 123(3)) is a ceiling on the maximum rate of any such interim dividend in case the company in question has incurred a loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of such interim dividend — the ceiling in that case, is a rate no higher than the average dividends declared by the company during the immediately preceding three financial years.
Scope of Application ofthe Dividend Rules; whether applicable toSection 123(3):
Based on a combined and harmonious reading of the provisions of the main statute itself and the Dividend Rules properly constructed, the view, we think, is inescapable that Rule 3 of the Dividend Rules does not apply to the concept of an ‘interim dividend’ as in Section 123(3) of the 2013 Act.
The Dividend Rules, by its very terms, have been promulgated in exercise of powers conferred on the Central Government under Section 123(1) of the 2013 Act — its applicability is, therefore, confined to that Section 123(1) relating to ‘dividends’ and, cannot and, indeed, does not extend in its application to Section 123(3) of the 2013 Act dealing with ‘interim dividends’. 
This position is further borne out by the express provisions of the Further Proviso to Section 123(1) of the 2013 Act that clearly references and provides for the Dividend Rules having effect in the case of declarations of ‘dividends’ (as opposed to, and not as regards, ‘interim dividends’), proposed to be paid out of accumulated profits earned in previous years and transferred to reserves, but where there is inadequacy or absence of such profits in the financial year of such proposed dividend (note, not ‘interim dividend’) declaration.  
Moreover, Rule 3 of the Dividend Rules provides for the procedures and conditions to be followed when dividends are to be paid out of the free reserves (emphasis added), whereas Section 123(3) of the 2013 Act (unlike the Dividend Rules, as delegated legislation, which is subject to the principal statute) deals with the declaration of interim dividend (emphasis added) from out of the surplus in the profit and loss account, as well as the profits of the company for that particular financial year in which such interim dividend is sought to be declared.
Circumstances under whichinterim dividendcan be declared and paid:
Now, unfortunately, Section 123(3) of the 2013 Act is not happily worded as regards the use of the word ‘and’ in the phrase ‘….declare interim dividend during any financial year out of the surplus in the profit and loss account AND out of profits of the financial year in which such interim dividend is sought to be declared’.
The Parliamentary Standing Committee on Finance (2009-10; headed by Mr. Yashwant Sinha), in its 21st Report of August 2010 on the then Companies Bill, 2009 suggested the inclusion of what eventually became Section 123(3) of the 2013 Act — with one important drafting clarification relevant for our current purposes, which, unfortunately, was garbled in the 2013 Act itself as brought into force: the two criteria for the declaration of an interim dividend, namely, (i) from out of the surplus in the profit and loss account, and (ii) from out of profits of the financial year in which such interim dividend is sought to be declared, the Standing Committee suggested should be separate, i.e., by the use of the words ‘as well as’, which is not the same as ‘and’ in these circumstances.
Indeed, the Report of the Companies Law Committee of February 2016 appointed to further review and examine and suggest changes to the 2013 Act notes that the use of this word ‘and’ is at “disharmony with the provisions of sub-section 1(a), which provides for the declaration of dividend out of the profits of the company for that financial year, OR [our emphasis] the profits of the company from any previous financial year(s) (subject to deduction of depreciation and other conditions), OR BOTH THE AMOUNTS [our emphasis].”
The Committee’s recommendation in this regard has been accepted in full — such that the 2016 Amendment Bill to the 2013 Act that is currently pending in Parliament, expressly provides an amendment in Sub-section 3 to Section 123 of the 2013 Act as follows (all emphasis supplied):
“The Board of Directors of a company may declare interim dividend during any financial year or at any time during the period from closure of financial year till the holding of the annual general meeting out of surplus in the profit and loss account or out of profits of the financial year for which such interim dividend is sought to be declared or out of profits generated in the financial year till the quarter preceding the date of declaration of the interim dividend.”
The suggested elimination of the word “AND”, and its substitution by “OR”, is welcome, as is the construct to declare interim dividends out of profits in the ongoing financial year until the quarter preceding the date of declaration of such interim dividend.
The Committee further “…felt that once Rule 3 is aligned with the provisions of the Act, it would be clear that in case a company declares dividend out of surplus i.e. accumulated credit balances of Profit and Loss Account which has not been transferred to reserves, the provisions of the [2013] Act and Rule 3 would not be applicable (our emphasis).  The Committee recommended harmonization of Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014 and Section 123 of the [2013] Act to provide clarity on the issue”.
Clarity continues to be elusive on this aspect; but hopefully we may see a change in the Dividend Rules soon.
In effect, therefore and until the 2013 Act and the related Rules are modified as above, the current Section 123(3) (read with its Proviso) is, in our view, to be interpreted as follows:
1)    In order to be able to declare an interim dividend it is not necessary that BOTH criteria for the declaration of such an interim dividend in Section 123(3) of the 2013 Act be present — in other words, a company can validly declare an ‘interim dividend’ in terms of Section 123(3) if it has a surplus in its profit and loss account; it can also (or in the words of the Parliamentary Standing Committee on Finance, “as well as”) declare validly such an ‘interim dividend’ out of the profits of the financial year in which such interim dividend is sought to be declared.
2)    The only stipulation then on the declaration of such an interim dividend is as regards the rate of such interim dividend — that rate cannot be higher than the average dividends declared during the immediately previous three financial years, if the company has incurred a loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of such interim dividend.  The Proviso is so drafted as to cover the situation when interim dividends are declared during the financial year in question; the only caveat being that that rate of interim dividend cannot exceed a certain stipulated threshold if there are losses up to the previous quarter, thereby implying the ability of a company to declare such interim dividends during any quarter.
This leads to two probable situations: 
Firstly, situations wherein the company has surplus in its profit and loss account and also has profits in the said financial year.  In such cases, the Proviso does not apply and the board of directors can declare any interim dividend.  The only issue that remains to be touched upon here is the quantum of any such dividend — the statute by the use of the words “out of” or “from” profits or free reserves (as the case may be) clearly prevents any excessive dividends of either type that are not matched by the amounts of such profits or free reserves.
Secondly, situations wherein the company has incurred losses during the current financial year up to the end of the quarter immediately preceding the date of declaration of the interim dividend (or even for the full year), but has had a surplus in the profit and loss account during the quarter in question.  In such cases, as per the Proviso, the rate at which dividend is declared cannot be higher than the average dividends declared by the company during the preceding three financial years.  But, that position does not invalidate the interim dividend declaration. 

Siddharth Raja & Neeraj Vyas

RBI Permits Deferment of Consideration and Escrow Mechanism Under Automatic Route

[The following post is contributed by Abhishek Dubey who is a Managing Associate with BMR Legal, Delhi. The views expressed here are personal.]
In continuation of its policy to rationalize the existing regime under the Foreign Exchange Management Act and to promote the ease of doing business, the Reserve Bank of India (RBI) has amended the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 to permit, under the automatic route, deferment of purchase consideration and escrow mechanism in share purchase transactions involving foreign investment. Under the earlier regime, deferment of purchase consideration was not permitted and escrow mechanism was permitted (with several restrictions) under the automatic route for a maximum period of only six months. The amendment regulations have been notified in the official gazette and are effective from May 20, 2016. The amendment regulations can be accessed here.
The text of the newly introduced Regulation 10A is reproduced below:
“10A. In case of transfer of shares between a resident buyer and a non-resident seller or vice-versa, not more than twenty five per cent of the total consideration can be paid by the buyer on a deferred basis within a period not exceeding eighteen months from the date of the transfer agreement. For this purpose, if so agreed between the buyer and the seller, an escrow arrangement may be made between the buyer and the seller for an amount not more than twenty five per cent of the total consideration for a period not exceeding eighteen months from the date of the transfer agreement or if the total consideration is paid by the buyer to the seller, the seller may furnish an indemnity for an amount not more than twenty five per cent of the total consideration for a period not exceeding eighteen months from the date of the payment of the full consideration:
Provided the total consideration finally paid for the shares must be compliant with the applicable pricing guidelines.”
The amendment regulations seek to introduce the following:
(i)   Deferment of Purchase Consideration: The amendment regulations permit deferment of purchase consideration in share purchase transactions involving foreign investment (both inbound and outbound) for a maximum period of 18 months from the date of the definitive agreements. The amount of the consideration that is sought to be deferred under the share purchase agreement shall not be more than 25% of the total consideration.
(ii)  Escrow Arrangement: The buyer and the seller can enter into an escrow agreement and open an escrow account in India for depositing the deferred consideration. The escrow amount shall not exceed 25% of the total consideration and the duration of the escrow account shall not be more than 18 months from the date of the share purchase agreement.
The flexibility conferred by the RBI of having an escrow account will provide significant comfort to the buyer in securing its indemnity rights and having an effective remedy against the seller for breach of warranties. Further, hold-back of consideration by the buyer in the escrow may give impetus to a trend of ‘post-closing purchase price adjustment’ in the Indian M&A space.
It is to be noted that the reference date for commencement of the 18 month period for escrow arrangement as well as for deferred consideration mechanism is the date of the share purchase agreement. The date of the share purchase agreement is referred to as the “execution” date which is different from the date of “closing” when the seller transfers the shares to the buyer and buyer transfers the consideration to the seller. The time gap between execution date and closing date may range from 60 days to 180 days and even more in large transactions requiring approvals from regulators (CCI / FIPB / DGCA). Therefore, the effective life span of the escrow account or effective period of deferment consideration would depend on the time gap between execution of the share purchase agreement and closing of the transaction – it can be full 18 months only in transactions that sign and close simultaneously. 
(iii) Seller Indemnity: The amendment regulation provides that if the seller has received full consideration from the buyer, the seller may provide an indemnity to the buyer for a maximum period of 18 months from the date of payment of full purchase consideration. The indemnity could be of a maximum amount of 25% of the total purchase consideration.
The introduction of restrictions on subsets of indemnity is a potential cause of ambiguity because in the regime existing prior to this amendment there were no limits prescribed for indemnification time period or indemnification amount. The indemnification period is usually contractually agreed between the parties based on various factors such as the time period prescribed by the statute of limitation, the lookback period under taxation laws and practical considerations such as the time required by the buyer in discovering non-compliances after taking over the target or time probability of a claim arising. Similarly, the liability cap under the indemnification provisions is usually a fraction of or in certain transactions a factor of the total purchase consideration. Given that the objective of the amendment regulations is to rationalize the existing FEMA regime, the interpretation of this insertion needs to be seen.
It is to be noted that while the reference date for commencement of the 18-month period in case of deferred consideration and escrow account is the execution date of the share purchase agreement, that in case of seller indemnity is the date of closing of the transaction, i.e., the date when the seller receives the purchase consideration and transfers shares to the buyer. Therefore, the effective protection offered to the buyer by the amendment regulations is more in the case of seller indemnity in comparison with deferred consideration or escrow arrangement.
Conclusion
Deferred consideration mechanism and indemnity escrows are recognized features of M&A transactions worldwide. However, Indian definitive documents for cross-border transactions carried ambiguity in respect of these globally accepted risk allocation mechanisms until now. With the introduction of the flexibility of having deferred purchase consideration mechanism or an indemnity escrow account in Indian cross-border transactions, the RBI has taken a significant step not only towards buyer protection but also towards aligning the Indian M&A landscape with the regime prevalent in acquirer / investor states.  

– Abhishek Dubey