In risk assessment, effectiveness testing, compliance management, or other areas where qualitative assessment is required, one may be making abstract statements like: we have very effective controls; we have strong risk management practices; we have the best of the practices in compliance management, etc. However, very often, these may be pure abstractions. How do we use a structured approach which may allow us to give a more granular, methodical approach to benchmark ourselves?
Unlike quantitative parameters, there are no set methods or approaches to qualitative assessment. However, every qualitative assessment is also backed by identifying the elements that need to be studied, the ingredients or the check points in each of these elements, the weights of the respective elements in the overall assessment framework, assignment of scores based on the weights and observations for each of the checkpoints, eventually coming to an aggregate score. That is, a purely qualitative assessment may be converted into a score sheet.
One may create one’s own methodology; here is a suggested one. Before proceeding with the methodology, one may submit that the same methodology that may be used for effectiveness assessment may also be used for risk assessment. A good score in effectiveness is a positive indicator; a high score in risk assessment is a threat.
The suggested assessment methodology involves:
Identification of elements: Every assessment can be decomposed into the elements underlie it. Take a very easy example of, say, quality of board minutes prepared in a large company. The quality is purely an abstraction, which can be granularly split into, at the least, the timeliness of minuting, the comprehensiveness, ease of understanding, compliance with the law and standards, etc. Similarly, if one refers to the effectiveness of controls on insider trading, one may decompose the overall control into several elements such as identification of UPSI, sharing of UPSI, management of Designated Persons, codes and policies etc. Note that the more granular the elements are, the better is it for the final result.
Weights of the elements: The next point to understand is whether each of the elements are equally weighted, or do they have differential relevance or importance in the overall matter being assessed. For example, if the subject matter of assessment is “quality of minuting”, compliance with law and standards may be perceived as having a higher weight than, say, comprehensiveness or ease of understanding. The task of assigning weights may, once again, become qualitative – therefore, it is necessary to have a methodical approach towards the weights as well. The weights may be determined based on, in descending order, whether the element may result in penal consequence or reputational loss, whether it may undermine controls or the correctness or reliability of the subject matter, whether it is good to have but not must to have, etc.
Ingredients or check points for each element: The check-points for each element need to be an even more granular list of activities, processes, policies, etc that make up the respective element. For instance, in the context of PIT controls, the check points under DP management may include the manner of categorizing DPs, periodicity of updating the list of DPs, maintenance of DP database etc.
Scores: Once the base work w.r.t. creation of the assessment list is done, actual scores are required to be assigned based on the level of performance of the company on the given check-point. Depending on whether the assessment is a risk assessment, compliance assessment or process review, a scoring parameter may be created, for instance:
Scoring Parameter
Not compliant/ no practice exists for the same
0
Meeting minimum compliance/ practice
1
Good Practices (indicates industry practice)
2
Gold Practices (indicates leadership practices)
3
Weighted score: The scores allotted to each check-point has to be multiplied with the weights assigned to each check point, to arrive at the weighted score of the respective checkpoint. For instance, assume there are five checkpoints in an element, the weighted score can be derived as below:
Check-points
Weights
Scores
Weighted Score
A1
3 (maximum)
1
3
A2
2
0 (minimum)
0
A3
3
3 (maximum)
9
A4
3
2
6
A5
1 (minimum)
2
2
Total
12
20
Maximum score and actual score: The weighted score obtained against each checkpoint of an assessment element sums up to form the actual score of such element. The same is to be compared against the maximum score for such an element, and expressed as a percentage. For instance, in the aforesaid table, the actual score of the element, let’s say ‘A’, that is made up of ‘A1’ to ‘A5’ sums up to 20. The maximum score that can be obtained for the said element ‘A’ is maximum score for a check-point (3) multiplied by the maximum weight (3), i.e., 9 multiplied by the total number of checkpoints (5), i.e. 45. Based on the aforesaid, the percentage score of the element can be calculated as = (Actual score/ Maximum score)*100.
Radar chart: Once the scores are assigned, and the percentage score for each element has been calculated, the same can be expressed in the form of a radar chart. Below is an example of a compliance radar:
In the picture above, (0-25) is the area of non-compliance, depicting lapses in meeting the minimum legal requirements. (26-50) is the area of meeting the minimum compliance with law, (51-75) indicates that the company is moving towards the general industry practices, and a score beyond 75 shows that the company is adopting leadership practices in the respective compliance area.
A risk assessment chart may be similarly formed, wherein, a higher score indicates a higher level of risk. Also see an article on Compliance Risk Assessment.
“I decline to read into any enactment, words which are not to be found there and which would alter its operative effect because of provisions to be found in any proviso.”
– Lord Herschell in West Darby Union vs. Metropolitan Life Assurance Society[1]
Background
Listed entities in India bear significant compliance obligations, including enhanced disclosure requirements and scrutiny by regulators, primarily due to the involvement of public funds and retail investors. To ensure market transparency and investor protection, several measures of ensuring a strong corporate governance (CG) culture have been provided by SEBI. Several of such requirements are enumerated under Regulations 17 to 27 of SEBI (LODR) Regulations, 2015[2] and are applicable on listed entities. However, all listed companies are not required to comply with these CG provisions, as Regulation 15(2)(a) provides certain exemptions for small size entities whose paid up equity capital and net worth do not exceed Rs. 10 Cr. and 25 Cr. respectively.
There are 2 things about the carve out for small listed companies – (a) it is based on monetary limits which were prescribed 9 years ago, and never revised since then, though the official loss of value due to inflation itself would be approx 42.9%[3] (b) Though the Regulation provides a twin-test window for qualifying for the exemption – small capitalisation and small net worth, SEBI was reading these qualifying conditions as being cumulative, with the effect that unless a listed entity was small by both these tests, it will not qualify for the exemption.
While the said Regulation provides for exempting specified classes of listed entities, however, the manner in which the amendment to the said exemption was framed raised two different views on availing the said exemption.
The trust and fairness in a lender-borrower relationship is one of the most fundamental drivers of financial regulation, and ensuring this trust and fairness in lender-borrower relationships is crucial for the growth and stability of the financial sector. NBFCs doing lending business are likely very conversant with the obligations captured in the RBI regulation on fair lending practices that details the general principles on adequate disclosure of the terms and conditions of a loan, and the adoption of non-coercive recovery methods. However, they may be unaware of the rights and obligations under the Consumer Protection Act, 2019 (‘CP Act’) which inter alia deals with “Unfair Contracts”. Interestingly, the CP Act defines a contract to be unfair if such contract significantly undermines consumer rights including clauses that restrict prepayment or contains clauses towards unilateral termination of agreements etc. These terms, which are also covered under the RBI’s Fair Practice Code, highlight a convergence in regulatory and statutory protections for borrowers.
In this article, we explore the rights of a borrower and the obligations of a lender under the CP Act and highlights the extant obligations under the Fair Practices Code, and other RBI regulations, and in doing so also explore the emerging convergence in these regulations concerning consumer protection norms.
Meaning of Unfair Contract and its impact
Section 2(46) of the CP Act, defines an “unfair contract” as follows-
(46) “unfair contract” means a contract between a manufacturer or trader or service provider on one hand, and a consumer on the other, having such terms which cause significant change in the rights of such consumer, including the following, namely:
(i) requiring manifestly excessive security deposits to be given by a consumer for the performance of contractual obligations; or
(ii) imposing any penalty on the consumer, for the breach of contract thereof which is wholly disproportionate to the loss occurred due to such breach to the other party to the contract; or
(iii) refusing to accept early repayment of debts on payment of applicable penalty; or
(iv) entitling a party to the contract to terminate such contract unilaterally, without reasonable cause; or
(v) permitting or has the effect of permitting one party to assign the contract to the detriment of the other party who is a consumer, without his consent; or
(vi) imposing on the consumer any unreasonable charge, obligation or condition which puts such consumer to disadvantage;
Based on the aforesaid definition, from the perspective of lenders, unfair contracts would include any agreement that significantly undermines consumer rights. Examples of unfair terms include:
Preventing early prepayment of debt, even with payment of applicable penalties;
Allowing the lender to unilaterally terminate the agreement without reasonable cause;
Assigning the contract to another party in a manner detrimental to the consumer, without their consent;
Imposing unreasonable charges, obligations, or conditions that disadvantage the consumer.
It is important to note that the aforesaid list is not exhaustive. Beyond these provisions, the RBI Fair Practice Code also identifies practices that can render contracts unfair, including:
Charging excessive interest rates.
Imposing interest during undisbursed loan periods.
Enforcing unreasonable lock-in periods in loan agreements or sanction letters, etc.
The CP Act permits the classification of any contract that results in an unreasonable bargain as unfair, and subject to review by consumer courts such as the State Commission (Section 47(iii)) and the National Commission (Section 58(ii)). Additionally, Sections 49(2) and 59(2) state that if a contract term is deemed unfair by these commissions, it can be declared null and void.
Further, via the principle of the doctrine of restitution, as outlined in Section 65 of the Indian Contract Act, 1872 if any part of a contract is declared void, the benefits received by any party must be returned or compensated to the party from whom they were obtained.
Under the CP Act, an unfair contract exists where there is a manufacturer, trader, or service provider on one side, and a consumer on the other. Therefore, to assess the “unfair contract” aspect in loan contracts, a key consideration will be whether the borrower is a “consumer” as denoted thereunder.
Determination of ‘Consumer’ under the CP Act
Section 2(7)(ii) of the CP Act in respect of loans defines consumer as any person who has availed services for a consideration which has been paid or promised or partly paid by such person and partly promised, however, does not include any person who has availed of such service for any commercial purposes. Hence, in the context of loans, borrowers who have availed of loans for “commercial purposes” would not qualify as consumers under CP Act. As the law currently stands, any person who obtains loans for his personal use would still fall under the definition of the term “consumer”. However, there might be debates on whether a person availing business loans would fall under the ambit of the CP Act. The term “commercial purposes” per se has not been defined under the CP Act and thus, has been subject to judicial interpretation.
We now proceed to analyse the current standing of the law in relation to business loans as well as retail loans and understand what qualifies as a service being taken for “commercial purpose”.
Are retail and commercial borrowers recognized as ‘consumers’
The definition of a “consumer” under S.2(7) of the CP Act includes any person who buys a good or hires a service for consideration paid or under any system of deferred payment.
This would also cover in its ambit borrowers because in the context of Banks, the Supreme Court has held that persons who avail of any banking services is a consumer under the Consumer Protection Act1.
Additionally, as the National Consumer Disputes Redressal Forum, and the State Consumer Disputes Redressal Forum pass reasoned orders on the interests of borrowers obtaining facilities from NBFC, persons obtaining non-banking financial services shall also fall under the definition of “consumer”.
Hence, borrowers of retail loans would be recognized as consumers. However, the definition of a “consumer” under S.2(7) of the CP Act does not cover persons who have obtained goods, or availed services for a commercial purpose.
A commercial purpose includes business-to-business transactions between entities where there is a direct nexus with profit-generating activities. “Commercial” denotes activities pertaining to commerce, and connected with/engaged in commerce having profit as a main aim. Where there is ambiguity, it may be seen whether the dominant intent/purpose of the transaction was to facilitate some kind of profit generation for the purchaser / their beneficiary2. Such activities or contracts would be out of the scope of the Consumer Protection Act3.
As regards loans, where a loan is obtained for a commercial purpose, the person who obtained such a loan does not come under the category of “consumer”4.
A. Overdraft facility
In Shrikant G. Mantri vs Punjab National Bank5, the appellant took an overdraft facility to expand his business profits, and subsequently from time to time the overdraft facility was enhanced so as to further expand his business and increase his profits. The Supreme Court held that the relationship between the appellant and the respondent is purely a “business to business” relationship. As such, the transactions would clearly come within the ambit of ‘commercial purpose’ and accordingly the appellant is not a consumer under the Act.
B. Working Capital Loans
In the case of Standard Chartered Bank & Anr. v Mankumar Kundliya6, one Mankumar Kundliya was the sole proprietor of the proprietorship firm M/s Sahil Distributors, who had obtained working capital facility from the bank. The issue before the National Commission was on deciding whether the respondent was a “consumer” under the Act. The court negating the contention held that the working capital loan facility obtained by the respondent “cannot be said to be for earning livelihood of the Respondent, and the same are inherently commercial in nature and the relationship between the parties is purely “Business to Business” in nature. Further, the Appellant also has independent commercial interests. Therefore, the transactions are essentially for ‘Commercial Purpose’ and the case does not fall under the exceptions to the term ‘Commercial Purpose’ carved out in the definition of the term ‘Consumer’ under the statute.”
C. Self Employment
Loans obtained for the purpose of self-employment may be considered business loans from the perspective of the lender, but the CP Act views such borrowers as “consumers”7.
Would retail and commercial borrowers come under the ambit of “unfair contract” as per CP Act
As mentioned above, an unfair contract refers to a contract with a manufacturer, or trader, or service provider on one hand, and a consumer on the other having such terms as which would cause significant change in the rights of the consumer.
Loan contracts are contracts that may be tested against this definition, and the definition of an unfair contract in the CP Act is an “inclusive definition”, i.e. it is not exhaustive. It can cover emerging industry practices not specifically captured in any legislation. The CP Act is to be construed in favour of the “Consumer” as it is a “social benefit oriented legislation”8, and lending entities would be well advised to review their restrictive covenants and terms against this definition, specifically in case of retail borrowers.
Since an unfair contract requires one of the parties of the contract to be a “consumer”, it would not include commercial loan contracts where the parties would not be “consumers” under the Act, save and except in circumstances where such loans have been obtained by the borrower for purposes of self-employment. Consequently, remedies through the State Consumer Commission or the National Consumer Commission under Sections 47 and 58 of the Act respectively are not available. Therefore, recourse to these commissions is not an option for addressing issues related to unfair contracts in this context.
However, if terms of the contract are unfair, businesses can seek remedies through the Commercial Courts Act, 2015. According to Section 2(c)(i) of the Commercial Courts Act, such unfair contracts may form subject matter of a “commercial dispute”. As a result, businesses can still address these issues through the commercial courts, subject to the dispute meeting the quantum of “specified value” as provided under 2(c)(i) of the Commercial Courts Act. Alternatively, the business which has availed business loans will also have other common law remedies, and may file a suit before a court of appropriate jurisdiction to declare the terms of the Contract as unfair and void.
Common/ prevalent terms and covenants that qualify as ‘unfair’
The following terms have specifically been held to be an “unfair contract” or unfair trade practice by the Consumer Disputes Redressal Commissions with regards to lenders regulated by RBI:
Excessive Penal Interest/Charge: Charging of excessive penalty/penal interest (in 2021), holding that incorporating such excessive terms into the loan agreement amounted to an unfair trade practice9.
Ceiling on interest rate: Even where RBI does not prescribe an upper limit for NBFC on rate of interest to be charged, the same can still be considered an unfair contract/unfair trade practice by the consumer courts10.
Enhancement of interest without borrower consent: Enhancing of interest rate without obtaining written consent of the borrower. Additionally, where clauses of the loan agreement are not in conformity with RBI guidelines, the agreement itself becomes voidable being against the law of the land11.
Repossession Clause: Forcible seizure of a vehicle particularly where no prior notice is given before seizing the vehicle, nor any opportunity given to pay dues constitutes an unfair trade practice, and a deficiency in service. The Supreme Court has in this context also held that any action for recovery in these cases may be struck down12.
In addition, the covenants demanding instant repayment of loan facilities by the Lender without the occurrence of any default may also be construed as an unfair contract and draw the remedies/penalties as has been provided below.
Though remedies under the CPA may not be available in case of business loans, however, clauses as has been discussed under consumer loans may also form an unfair contract even in cases of business loans in case the same are present in the terms of the loan agreement with the business entity.
Remedies/ Penalties under the CP Act
The terms of the contract may be declared null and void (by the National Commission and State Commission (S.59 and S.49 of the Act), and the District/State/National Commissions may issue orders to the opposite party directing them to discontinue the unfair practices.
However, penal measures are not present towards business loans considering that persons availing business loans are not included within the ambit of the CP Act.
However, while the ambit of “Unfair Contract” under the CP Act is broader in its coverage, the Fair Practice Code of the RBI generally applies to retail loans as well as business loans, save and except to the circumstances where certain paras in the Fair Practice Code are explicitly made applicable on loans provided to individuals. Accordingly, the persons who have availed retail loans as well as persons who have availed business loans can raise their grievances with the RBI ombudsman in circumstances where the grievances have not been addressed by the lender to the satisfaction of the borrower.
Key Takeaways
Lenders
Borrowers
Consumer Definition: Retail Loans: Borrowers are recognized as consumers under the CP Act.
Business Loans: Borrowers are not considered consumers if the loans are for commercial purposes.
Consumer Protection: Retail Loans: As a consumer, borrowers are protected under the CP Act, which includes rights against unfair contract terms and practices.
Business Loans: Loans obtained for commercial purposes do not fall under the CP Act.
Unfair Contracts: Retail Loans: Lenders must ensure that contract terms do not qualify as unfair under the CP Act to avoid legal challenges.
Business Loans: While the provisions relating to “unfair contract” as provided under the CP Act may not apply, lenders should be aware that such contracts could still be challenged under other legal frameworks.
Unfair Contract Terms: Retail Loans: Borrower can challenge unfair contract terms such as restrictions on prepayment, unreasonable lock-in periods, and excessive interest rates under the CP Act.
Business Loans: Although remedies under the CP Act might not apply, the borrower can seek redress through other legal means if unfair practices are present.
Common Unfair Terms:Lenders should avoid terms that restrict prepayment, impose unreasonable lock-in periods, charge foreclosure fees, or apply excessive interest rates. Even though the CP Act might not apply to business loans, similar terms can affect borrower satisfaction and lead to disputes.
Grievance Redressal: Retail Loans: Utilise the mechanisms for redressal, including filing complaints with the National or State Consumer Disputes Redressal Forums.
Business Loans: Address grievances through the Commercial Courts Act, 2015, or common law remedies if contract terms are deemed unfair.
Remedies and Compliance: Retail loans: Lenders should be prepared to modify or eliminate unfair terms to comply with the requirements of the CP Act and avoid regulatory as well as statutory action.
Business loans: Lenders should understand that while remedies under the CP Act might not be available, there are still other legal avenues for addressing unfair practices.
Fair Practice Code:Both retail and business loan borrowers can escalate unresolved grievances to the RBI ombudsman under the Fair Practice Code.
Fair Practice Code:Ensure compliance with the RBI’s Fair Practice Code for both retail and business loans. Complaints can be escalated to the RBI ombudsman if unresolved satisfactorily.
Conclusion
In navigating the complex landscape of borrower rights and lender obligations under a financial transaction, the CP Act, and the RBI’s Fair Practices Code play pivotal roles. The CP Act safeguards borrowers by addressing “unfair contracts,” including terms that restrict prepayment or impose excessive penalties. While these robust protections are available for retail loans, they do not extend to business loans intended for commercial purposes. However, borrowers of business loans are still covered under the Fair Practices Code, which ensures fair treatment and provides a grievance redressal mechanism through the RBI ombudsman.
We recommend that Lenders be vigilant in crafting fair contract terms to avoid legal disputes, and ensure compliance with both regulatory and statutory frameworks. For retail loan borrowers, avenues for challenging unfair practices are clear and accessible. For business loan borrowers, while direct remedies under the CP Act may not apply, alternative legal channels are available. Ultimately, understanding and adhering to these regulations is crucial for maintaining trust and fairness in lender-borrower relationships which constitutes the bedrock of the financial services sector.
Citicorp.Maruti Finance Ltd vs S.Vijayalaxmi on 14 November, 2011 AIR 2012 Supreme Court 509 ↩︎
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2024-09-18 10:39:572024-09-18 10:58:27Navigating Unfair Contracts: Understanding Borrower Rights and Lender Obligations under the Consumer Protection Act
The year 2024 will witness one of the first and biggest board transitions when it comes to Independent Directors (“IDs”) serving for a decade in the Indian public companies, either listed or unlisted. This is because the applicability of Section 149 of the Companies Act, 2013 (“Act”) became applicable from the 1st of April, 2014 wherein IDs were allowed to hold office for a maximum tenure of upto 5 consecutive years and be associated as such for not more than 2 such terms. The tenure of IDs held before the applicability of the Act was grandfathered.
Following the conclusion of the two terms on March 31, 2024 (or, if the appointment was effective till the 2024 AGM, then the AGM date), more than 130 IDs across nearly 75 companies have ceased their roles[1]. As of March 31, 2023, there were 198 companies within the NIFTY 500 that had 375 IDs whose tenure exceeded 10 years. Notably, 14 of these directors had served on their respective boards for 30 years or more.[2] As the maximum tenure for IDs is two consecutive terms of five years each, followed by a cooling-off period of 3 years, an extremely pertinent question comes up on the continued association of these outgoing IDs with such companies.
Role of IDs
If corporate governance is all about rising above the interests of limited stakeholders, IDs as an institution form the very lynchpin of corporate governance. IDs perform a number of critical functions, including but not limited to bringing independence,, expertise and objectivity to Board discussions, balancing stakeholder interests, and offering unbiased opinions during board discussions on issues such as risk management, related party transactions and board performance. Appointment and participation of IDs in decision-making proceedings have been kept at a higher pedestal as compared to other categories of directors when it comes to board independence and ensuring a proper mix of independent and non-independent directors.
Several requirements are linked with appointment and presence of IDs under the Act as well as the SEBI Listing Regulations, including the following:
The presence of IDs is a must to constitute a quorum for the meetings of the Board of Directors of top 2000 listed entities.
The composition of the Audit Committee, Nomination and Remuneration Committee (“NRC”), Stakeholders Relationship Committee, and Risk Management Committee of listed entities must include IDs.
Only IDs have the power to approve Related Party Transactions (RPTs) of listed entities in Audit Committee meetings.
IDs of listed entities are required to be appointed to the Boards of their material subsidiaries[3].
IDs are also responsible for reviewing the performance of non-IDs and the Board as a whole.
Whistleblowers have direct access to the Chairman of Audit Committee, who is responsible for addressing their concerns/ grievances, including potential fraud allegations.
The committee of IDs is required to provide a report, which is to be filed with the stock exchange, recommending the draft scheme of arrangement, ensuring that the scheme is not detrimental to the shareholders of the listed entity and has compensated the eligible shareholders for fractional entitlement.[4]
Appointment and Tenure
The appointment of IDs on the Board of an unlisted public company requires an ordinary resolution to be passed by the shareholders and a special resolution in case of re-appointment, based on the recommendation of NRC and the approval of the Board.
In case of listed entities, the appointment and re-appointment of an ID on the Board will require the approval of shareholders by way of a special resolution. However, if the resolution for the appointment of an ID fails to be passed by a special resolution, it may still be considered passed if the following dual conditions are satisfied:
There is an ordinary majority of all the shareholders, including the promoters and promoter group;
There is an ordinary majority of the public shareholders, that is, disregarding the voting of the promoters and promoter group.
Cooling Off Period
The cooling-off period for IDs is prescribed under the Act as well as Listing Regulations. It can be categorized as: (a) Pre-appointment cooling-off period and (b) Post -appointment cooling-off period.
Pre-appointment cooling-off period for an ID:
The Act prohibits IDs from having any pecuniary relationship with the company, its group, their promoters or directors, during the present or past two preceding financial years preceding the appointment. However, remuneration as a director or any other transaction not exceeding 10% of IDs total income is permitted.
The Listing Regulations are more stringent and require IDs to have no material pecuniary relationship with the company, its group, their promoters, or directors, during the present or past three financial years preceding the appointment, apart from remuneration.
Further, the Act and Listing Regulations prohibit the appointment of a person as an ID if he/she is or has been a KMP or employee of the company or group entities during the past three financial years. However, relatives of employees other than KMPs are permitted to become IDs.
The proposed IDs in the last three FYs should not be an employee, proprietor, or partner of :
Any legal or consulting firm that has had transactions with the company or group entities amounting to ten percent or more of the gross turnover of such firm.
A firm of auditors, company secretaries in practice, or cost auditors of the company or group entities.
In respect of relatives of IDs:
They should not be indebted to the Company, its group, their promoters or directors beyond a specified amount, nor should they have given a guarantee or provided any security in connection with the indebtedness of any third person to these entities or individuals in the current or past three financial years.
The pecuniary transaction or holding of securities by relatives in the listed entity or its group should not exceed 50 lakh rupees or two percent of the paid-up capital during the current or past three financial years, nor should they have any other pecuniary transaction or relationship with these entities amounting to two percent or more of their gross turnover or total income.
Post-appointment cooling-off period for an ID:
Unlike the pre-appointment cooling-off period which is evaluated and examined almost every year irrespective of whether there is a new appointment or not, the post-appointment cooling-off period has assumed a never-before noteworthiness. The obvious reason is as mentioned above, i.e. due to the first mega ID transitions on the board of a significant number of IDs in public companies. The relevant extract of Section 149(11) of Act which lays down the requirement is reproduced below:
“(11) Notwithstanding anything contained in sub-section (10), no independent director shall hold office for more than two consecutive terms, but such independent director shall be eligible for appointment after the expiration of three years of ceasing to become an independent director:
Provided that an independent director shall not, during the said period of three years, be appointed in or be associated with the company in any other capacity, either directly or indirectly.”
Going by the language of the law, it seems an ID who has completed two consecutive terms of 5 years cannot be associated with the company in any manner during the cooling-off period. Further, it is understood that the provisions start with a generic reference by saying “no director” but then become specific to say “such independent director”. However, in the proviso, the reference again becomes generic. Also the phrase “any other capacity” is broad, barring any possible positions such as a consultant or an adviser. These positions cannot be occupied indirectly too, the term “indirectly” seems to include the appointment of any company or firm where the ID has a substantial stake. The possible intent of these provisions is that the IDs should not exploit their past relationship with the company (during the time of being an ID) to gain an advantage after their term, as this may create a conflict of interest with their duties as an ID.
This is one possible view, and obviously, a conservative one. This view is premised on the principle that the association of the ID in any form is likely to get his some pecuniary interest, and this continuing pecuniary interest during the cooling off is alien to the whole principle of cooling off. Hence, the cooling off is like sampoorna vairagya.
There is another view, however. This view seeks to connect the cooling off with the “come back director”. That is, the ID who intends to come back after the 3 years’ cooling off and occupy the position as an ID should maintain abstinence during the cooling off. However, for the one who is content at not coming back, there should be no objection to the ID occupying a position other than as an ID.
This interpretation is based on the interpretation of the language of the proviso to Section 149(11). Since, the language of the proviso – it does not say “such independent director shall not”; instead, it says “an independent director shall not”. Therefore, the bar in the proviso is an independent bar, and not a mere qualification of the cooling off period itself.[5]
There are merits in both the views. The first view is grounded on the principle that indispensability is fatal to independence. If the ID during his term creates a continuing necessity of his services, his independence is bound to be questioned. The ID serves limited stint, during which he serves the company with objectivity and independence, and once his twin terms are over, he should allow the inevitable – a change. After all, what could be the justification for the company to lean on him to the extent of needing his services even during cooling-off?
The other view is based on the possibility of the ID having developed an understanding of the company’s business model and its functioning to the extent that losing his association after 10 years will be adverse to the company’s interest. After all, he does not intend to come back as an ID even after 3 years.
A question comes – can the ID offer one-off consulting services or professional advice to the company during the cooling off? Offering of professional advisory services, without any fixed relationship or commitment, is allowed pre, during and post retirement. As the safe harbour provision under the Act and Listing Regulations allows IDs to have a pecuniary relationship with the company and its group entities upto 10% of their total income, in addition to their remuneration.
Since the word in the proviso is “associate himself with the company in any other capacity”, a person offering one-off professional services does not have an “association”.
The real issue is not professional services. Quite often, these IDs are actually transitioned to other roles in the companies. For example, the erstwhile ID is appointed as NED, or, in some cases, ED. As regards the change of role into an ED, Listing Regulations mandate a cooling-off period of one year for the transition of IDs who have resigned from the Board and then joined as an executive director or WTD in the same company, holding, subsidiary, associate company or any company belonging to the promoter group. SEBI in its Board Meeting[6] noted that there could be valid reasons for an ID to transition to an ED or WTD, such instances where an ID knows that he/she may move to a larger role in the company in the near future, may practically lead to a compromise in their independence.
Cooling-off period in foreign jurisdictions
As far as the cooling-off restrictions in foreign jurisdictions are concerned, one can only notice the pre-appointment cooling-off period and not vice-versa. Some of these have been discussed below:
The UK Corporate Governance Code, 2018[7] provides the cooling-off condition for the appointment of a non-executive director. The director should not have been an employee of the company or group in last five years; have no material business relationship with the company, either directly or indirectly in last three years; and has not served on the board for more than nine years from the date of their first appointment. However, provisions are required to be followed on a ‘comply or explain’ basis.
The NASDAQ [8]and NYSE[9] Listing Standards restrict a person from being appointed as an ID, if they have been an employee of the listed company or had a material relationship with the listed company in the past three years.
The Luxembourg Stock Exchange Principles[10] sets out the criteria to be considered by companies for appointment of ID which requires the director to not be an executive or MD of the company or an associated company in the last five years; should not be an employee in last three years; and has not served on the board for more than twelve years as non-executive or supervisory director.
The SGX Code of Corporate Governance 2018[11] requires that an ID must not have served as a director or employed in the same company or related corporations for the past three financial years.
Conclusion
The provisions around the pre-appointment cooling-off period are pretty clear in terms of being interpreted and examined, however, that does not seem to be the case for the post-appointment cooling-off period where the letters of law suggest a complete exile for the outgoing ID as far as the concerned public company is concerned. However, the practice by the corporates tends to suggest otherwise. Several companies can be found to have allowed the continued association of their ex-IDs in some sort of other positions so as to avail some sort of services whether in consulting or anything like. Eventually, there is also a conscience call for the ID – can he be said to have compromised his independence, if he nurtures an interest in the company after he demits his office.
[3] “material subsidiary” shall mean a subsidiary, whose income or net worth exceeds twenty percent of the consolidated income or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2024-06-05 12:11:242024-06-19 12:07:54The Detachment Dilemma: Cooling-off period for 2 term Independent Directors
Given the significance of the amendments, we are organizing an online workshop on Verification of Market Rumours by listed entities and other related amendments on Monday, 27th May, 2024. Details of workshop can be accessed here Register here
Regulatory instruments and standards on rumour response:
Reg 30 (11) & (11A) of Listing Regulations dealing with rumour verification. There was a work in progress at SEBI on making the regulation more certain and easier-to-implement. Changes were made in Re. 30 (11) requiring top 100/top 250 companies to mandatorily respond to market rumours, but there were several issues in implementation. SEBI Consultation Paper w.r.t. Verification of Market Rumours (‘CP’) based on the recommendations of the Industry Standards Forum (ISF) and subsequently, SEBI Board decision taken in the meeting held on March 15, 2024 resulted into these changes.
Original implementation dates were October 1, 2023 and thereafter, extended twice to February 1, 2024/ August 1, 2024 and thereafter to June 1, 2024/ December 1, 2024 for top 100/ top 250 companies1. It is now confirmed that the implementation dates remain the same.
Further, SEBI vide Circular dated May 21, 2024 has given recognition to the Industry Standards Forum (‘ISF’)2 that released the Industry Standards Note (ISN) on rumour verification in order to facilitate uniform approach and set out an SOP for compliance with rumour verification requirement. The compliance with Industry Standards are mandatory for the listed entities [SEBI Circular dated 21 May, 2024]. The ISN inter alia covers following aspects:
Delineation of “mainstream media” (as requirement to respond will only be applicable to rumours reported in specific media sources (see below) ;
Guidance on rumour responses through illustrative scenarios pertaining to potential M&A transactions, ;
Guiding principles through some illustrative non M&A transaction scenarios, such as whistleblower complaints, internal investigations, potential change in KMPs, ill health of MD/ CEO etc.
Top 100/top 250 companies based on market capitalisation.
Presently as per March 31, 2024
Effective from December 31, 2024 based on the average market capitalisation from July 1 to December 31 of that calendar year
Top 100 companies – 1st June 2024
Top 250 companies – 1st Dec 2024
For the rest of the companies, the framework is still voluntary, but logically, the reference point being “material price movement” may be extended to these companies too.
What will affected companies be required to do?
If:
There is a material price movement (MPM)
There is a rumour in mainstream media
About some definitive event or information
Which is “impending”, that is, about to happen or waiting to be disclosed by the Company.
The company shall respond:
Either confirm that rumour
Or deny it
Or make a statement that the rumoured event has not become disclosable at the present time
Or remain silent, if the rumour does not qualify for a response in terms of the ISN
And for either confirmation or denial, if the company needs further information from a promoter, director, KMP, or SMP (that is, the rumoured information pertains to them), the company shall promptly seek the same, and the counterparty shall promptly, accurately and adequately respond to the same.
The company shall do the confirmation or denial or provide a clarification within 24 hours from the trigger of the MPM
The company need not respond:
If the rumoured event or information is not “specific”, or does not otherwise qualify for a response
If the rumoured event/information pertains to the pre-intimated items in a notice of Board meeting u/r 29 (1) of Listing Regulations .
Appropriate disclosure to be made after conclusion of the Board meeting.
However, if the rumour goes beyond the information in the pre-intimation, and otherwise qualifies for response, the company will respond.
Basic attributes of a rumour requiring response:
Should be relating to the Company and not generally about sector, industry, geography, etc
Should be specific, that is, should give some facts/information likely to influence the decision of investors, or should have quoted a source which can be relied for the information in question
Should be relating to an event/development which is impending, that is, imminent, at a stage of development
Should not be an elaboration of something that has already been disclosed by the Company, unless new material facts or information not disclosed by the company are contained
Should be contained in “mainstream media”
Should have caused an MPM
There should be a reasonable nexus between the rumour and the MPM, so as to lead to a conclusion that the MPM has been triggered by the rumour
What is the trigger point of the MPM (MPM Trigger)?
Since MPM (see discussion below) is based on price movements during a day, the trigger point may happen at any time during trading hours.
Cut off percentages [that is, 5, 4 or 3%, +/- relevant index variation in the same direction as the MPM – see below] for price variation, or the price band being hit ;
Relevant index changes: Nifty 50 in case of NSE listed entity/ Sensex in case of BSE listed entity/ both in case listed on both, to be seen at the start of the trading day i.e. at 9.30 a.m. That is, change in the index is frozen at the start of the trading day.
ISN intends to classify rumoured news into “positive news” or “negative news”, and correlate the price change with the same (that is, require response only where prices have gone up with a positive news and gone down with a negative news). However, for many news pieces, the ascertainment of whether the news is positive or negative will not be possible. Therefore, the only basis for determination of the direction of the news is the direction of the prices. For instance, disposal of a division may be negative news, if the sustainable income from the same will be lost, but may be taken as positive if the rate of return from the outgoing division was suboptimal.
However, the reflection of the movement in the Index (provided is equal to or more than 1%) needs to be done on the MPM cut off percentages only if the Index movement is in the same direction as the MPM.
As for the stock, the price movements are taken at any time during the trading day..
Percentage variation in share price and the benchmark index movement will be calculated wrt the closing price of the immediately preceding trading day.
Price range of the listed equity shares
Percentage variation in share price which shall be treated as material price
Benchmark index movement (+/-) is less than 1% at 9.30 am
Benchmark index movement (+/-) is greater than 1% at 9.30 am, and MPM is in the same direction as the Index change
In cases not covered by column on LHS
Rs. 0 to 99.99
≥ 5%
≥ 5% + % change in Benchmark index at 9:30 am) or Band hit
≥ 5%
Rs. 100 to 199.99
≥ 4%
≥4% + % change in Benchmark index at 9:30 am) or Band hit
≥ 4%
Rs. 200 and above
≥ 3%
≥3% + % change in Benchmark index at 9:30 am) or Band hit
≥ 3%
Assuming there is an MPM in my scrip at 12.30, which subsides later in the day, shall we still say the MPM has occurred? Answer seems to be yes. In case of intraday price movement (i.e. after 9:30 am), only the price range-based price variation in the scrip to be considered, irrespective of the Index movement.
While there may be price movement due to a combination of various factors such as rumour, announcements or other events (other than the rumoured event), then MPM is deemed attributed \to the rumour.
Where should one look for rumour?
ISN has restricted the scope of “mainstream media” to the following:
English national dailies satisfying the following conditions:
Top English dailies with a circulation of 1 lakh or more copies as per RNI data; currently 14 newspapers along with the editions have been listed by ISN.
Business/ Financial News Dailies: Economic Times, Business Standard, Live Mint, Financial Express and Hindu Business Line.
Regional Dailies: the top 2 (two) regional dailies having the highest circulation, for each of the 22 (twenty two) official languages of India, subject to meeting the RNI Circulation Threshold, as per the list of regional dailies given in ISN.
Digital versions of the newspapers covered above
Digital/ online news sources: specified news sources meeting the following Business News Parameters:
Specified sources are – Bloomberg, BQ Prime, Money Control, Business Today, Business World, Reuters, Reuters India, and Press Trust India.
International media :
Top business/ finance dailies (from top 5 jurisdictions from where foreign portfolio investments are concentrated) comprise –
Wall Street Journal and Financial Times for USA;
Business Times and Financial Times for Singapore; and
Financial Times for UK;
For other jurisdictions where the Company has “material operations” (in our view, the Policy may define what is “material” operation), the Board is required to identify list of English business/ financial news sources from such jurisdictions. List to be published in the materiality policy.
Business News Channels: satisfying the following conditions:
English news channels – CNBC TV-18, ET Now and NDTV Profit
Other Business news channels – CNBC Awaaz, ET Swadesh, Zee Business and CNBC Bazaar
Exclusions: News aggregators (for e.g. google news, inshorts, daily hunt etc.) and social media platforms (for e.g. whatsapp, twitter, facebook, instagram etc.) will not get covered under mainstream media.
Inclusions: Social media handles of news sources identified above, will be included. However, quotes/ re-tweets/ re-posts made from such social media handles will not be included.
What are the actionable for companies w.r.t. Mainstream media?
Companies to put in place appropriate technology solutions, engage external media agencies;
For identifying and tracking the digital news sources set out above.
Implement internal systems for prompt reporting, coordination and communication between investor relations, corporate communications and compliance teams.
Companies are required to respond only once and not when the same or similar rumour is published in another news source.
Question – are companies expected to track all that is written about the company, in all the “mainstream media”, at all times? Answer should be No. However, the company may have to keep sources/media agencies on the standby, that is, to trigger them into action when there is MPM.
What is the guidance for action?
Companies have to be alert on MPM. MPM is assessed on a daily basis – therefore, companies may have appropriate technology tools to give a signal if there is an MPM.
If there is an MPM, the company will have to search for “rumour” in “mainstream media”.
Here, while companies may be required to keep appropriate technology/ arrangements with external media agencies in place, the same should not be taken to mean that the company is required to track rumour on a daily basis, irrespective of the MPM trigger.
The tracking has to be done for a reasonable period of time backwards. Ideally speaking, the impact of a rumour on price will be reflected within 24-48 hours itself, however, companies may consider keeping a window of 5-10 trading days or any other specific period as part of their internal SOP for the tracking back of rumour in case of an MPM trigger.
What does the rumour relate to? Is it about some “definitive” event or information, or generic in nature (say performance, prospects, etc)? Is it about the company or relates to the company specifically, and not generic (for example, sector, country, economy, etc)? If the answer to these questions are yes, see below.
If the answer is yes, does the rumour relate to an “impending” event or information? That is, there is some event or information within the company which is developing, but the rumour has leaked the same. If yes, confirm it. If no, then deny.
Do all of this within 24 hours of the MPM Trigger.
[Note – Where a prior intimation of Board meeting of the company has been given under Reg 29 of LODR for such “impending” event or information, the company need not respond to the rumour till the conclusion of the Board meeting.]
In the Table below, we take few situations to understand the applicability of verification of market rumour:
MPM
Impending specific event under reg. 30
Rumour in mainstream media
Verification of rumour by company required?
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes, as the existence of MPM by itself satisfies the condition for rumour verification
Yes
Yes
No
No, there is no rumour to be verified. The company may disclose based on the information/event reaching the appropriate stage.
Yes
No
No
There is no rumour to be verified.
No
Yes
Yes
Rumour verification is not required, but the general principles of disclosure of events or information at an appropriate stage will be followed.
What happens if the rumour is confirmed?
Any reported event or information on which below mentioned pricing norms apply, the effect on the price of the equity shares of the listed entity due to MPM and confirmation of the reported event or information to be excluded for calculation of the unaffected price for that transaction.
Chapter V (preferential issue) of the ICDR Regulations (refer amendment including as part of a scheme of arrangement; or
Chapter VI (QIP) of the ICDR Regulations (refer amendment);
Regulation 8 (17) (offer price) or Regulation 9 (6) (listed securities offered as consideration) of the SAST Regulations (refer amendment);
Regulation 19 (price in case of open market buy-back) or Regulation 22B (vi) (computation of lower end of price range in case of buy-back through book building) of the Buy-back regulations (refer amendment).
scheme of arrangement involving a listed company (irrespective of whether the scheme involves a preferential issue or not), undertaken in compliance with the requirements of the SEBI Master Circular on Schemes of Arrangement, dated June 20, 2023; or
any other transaction where the pricing is regulatorily required to be linked to the traded price of the scrip, including but not limited to cross border transactions involving the equity instruments (as defined in FEMA NDI Rules) of a listed company (i.e. purchase, sale, issuance of such equity instruments).
What happens if the rumor is not verified?
Unverified event or information cannot be considered as generally available information for the purpose of PIT Regulations. The definition has been amended to exclude unverified event or information reported in print or electronic media (refer amendment). That is to say, merely because the event/information is rumoured, but not confirmed by the company, it cannot be said to be generally available information.
No “unaffected price” computation; that is, all price movements will be taken into consideration for the purpose of corporate actions
Are any changes in materiality policy required?
Amendments in law will override. The timeline for responding may be aligned from 24 hours from the reporting of the event or information to 24 hours from the trigger of MPM. The obligation cast on the promoter, director, KMP or SMP may also be inserted in the policy.
Specific amendments to be made in line with the ISN as indicated below:
In addition to the specified international news sources for top 100 listed entities, all listed entities covered by mandatory rumour verification requirement are required to identify the foreign jurisdictions where the company has material business operations, along with a list of English business/ financial news sources from such foreign jurisdictions to be tracked. List of such news sources and parameters applied for determining what would constitute ‘material business operation’ to be published in the materiality policy.
SOP may be framed additionally to add the responsibility centers, timelines and other operational aspects.
This may also cover the time frame upto which rumours will be tracked in mainstream media, in the event of an MPM trigger.
Who will be responsible to ensure compliance?
Companies will have to define responsibility. Generally speaking, the compliance officer remains responsible to ensure compliance with LODR Regulations [Reg. 6(2)(a)], but internally, for rumours and responses, companies may define the ownership/responsibility centre.
The Industry Standards refer to “officers” u/s 2(59) of Companies Act. The definition therein is a very broad and inclusive definition. For the purpose of compliance with these regulations, the company may specify the meaning of “officers” to refer to the KMPs and SMPs of the company.
If the information has been sought by the company from the promoter, director, KMP, SMP, then the respective promoter, director, KMP, SMP is responsible to give adequate, accurate and timely response to queries raised or explanation sought.
The stock exchanges shall independently continue to seek clarification from the listed entities on news/rumours pertaining to the listed entity as part of their existing surveillance measures.
What are the Industry Standards w.r.t. M&A Transaction Specific Aspects?
Scope of M&A Transactions
transactions concerning purchase, sale, buyback, delisting of securities of listed company;
Preferential issue or any other fund-raising;
Scheme of arrangement involving listed entity or any of its subsidiaries
Acquisition / sale of undertaking or shareholding of another company;
Proposed joint venture between listed entity and another entity.
Exclusions – transactions undertaken in the ordinary course of business
An on-market bulk/ block deal transaction, in respect of listed entity’s securities.
An on-market treasury transaction or non-strategic transaction (pursuant to treasury management policies/ objectives – for e.g. investing surplus funds to acquire 0.5% equity stake undertaken by a listed entity in respect of another listed company)
Treasury transaction/ non-strategic transaction would generally have the following features –
pertains to the treasury function, i.e., investment of surplus funds of the company,
indicates the regular investments made by the company in the stock market,
is not intended to fulfil any strategic expectations of the company,
the size of such investments are similar to other frequent investments,
the company has not raised funds specifically for making such investments, and
decisions with respect to such investments are generally taken by a delegated authority under section 179 of the Companies Act, 2013.
Transaction stages –
Preparatory stage (where the name of the target/ counterparty is not disclosable); and
Signing of NDA, non-binding term sheet, letter of intent, commencement of DD, engagement of professionals for DD, evaluating overall viability of the deal (including for internal management) or engaging registered valuers;
Constitution of sub-committee of Board to evaluate material terms/ assess viability, Committee granting an in-principle approval subject to further evaluation.
Illustrative language of disclosure provided for each of the two sub-stages discussed above.
Advanced stages (where the name of the target/ counterparty is disclosable)
Multi-party bid process is ongoing and sole/ exclusive bidder is pending to be identified/ confirmed or has been confirmed,
parties have entered into binding term-sheet w.r.t. listed target,
where all material commercial terms have been agreed and final approval of Board or delegated board committee is being sought,
Illustrative language of disclosure provided for listed bidder(s) and for listed target.
Unaffected price to be considered only in case of advanced stages.
Where company is not a party to the deal/ does not have ‘knowledge of the deal’3
no specific confirmation/ denial would be required.
What are the Industry Standards w.r.t. Non M&A Transaction Specific Aspects?
Illustration of Non-M&A Transactions
Whistle-blower complaint received by the Company;
Internal Review or Investigation i.r.o. operational / financial aspects of the Company;
Potential change in KMPs4 (including resignation and/ or removal of KMPs);
Situation where MD/CEO is indisposed or unavailable to carry out the role in a regular manner for more than 45 days in any rolling period of 90 days on account of ill health.
Guiding Principles for rumour verification of non-M&A Transactions
The market rumour should provide specific identifiable details:
details of the matter/ event; or
Should provide quotes or be attributed to sources who are reasonably expected to be knowledgeable about the matter,
Excludes market rumours that are vague or general in nature.
The market rumour should be i.r.o impending event i.e imminent event, close at hand or about to happen,
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Corplawhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Corplaw2024-05-18 19:16:252024-05-23 18:04:29Top companies forced to respond to rumours on big price spikes: Changes in Listing Regulations relate rumour responses to “material price movement”
We, here at Vinod Kothari and Company, have curated all our materials and FAQs relating to fraud monitoring and reporting under Companies Act, 2013, SEBI Regulations and RBI Regulations to provide a single point access to our various resources. This page is intended to be a one stop solution to all your queries regarding the same. Hope that the readers find it useful.
Date
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July 17, 2024
Revamped Fraud Risk Management Directions: Governance structure, natural justice, early warning system as key requirements
