English Courts and Intervention in Arbitration

The allegedly “interventionist” role of Indian Courts in arbitration has been criticized in several fora; though there is something to be said for judicial intervention in arbitration. What is interesting is that a recent English decision highlights that even the Courts in that country are not entirely averse to interfering in arbitration proceedings. The English Arbitration Act in fact allows parties to appeal on a question of law decided by arbitral tribunals, unless otherwise agreed to by the parties. Section 69 reads:

“Unless otherwise agreed by the parties, a party to arbitral proceedings may (upon notice to the other parties and to the tribunal) appeal to the court on a question of law arising out of an award made in the proceedings…”

In this context, the interpretation of the words “unless otherwise agreed by the parties” assumes importance. Given the fact that the judicial role in arbitration is thought to be minimal, one would expect that Courts have given a broad interpretation to these words. Shell Egypt v. Dana Gas is an illustration to show that Court have instead been rather strict. The agreement between the parties stated that the arbitral award was “final, conclusive and binding”; yet the Court held that this did not mean that the right to appeal under Section 69 was excluded. It stated:

In relation to the meaning of the words “final and binding”, in the context of an arbitration agreement, I agree with the conclusion reached by Ramsey J, at paragraph 22 of his judgment in Essex County Council v Premier Recycling Ltd, supra, who, having reviewed certain of the Commonwealth authorities, said:
“However, in summary, I conclude that the use of the words ‘final and binding’, in terms of reference of the arbitration are of themselves insufficient to amount to an exclusion of appeal. Such a phrase is just as appropriate, in my judgment, to mean final and binding subject to the provisions of the Arbitration Act 1996.”


It was then held that the addition of the word “conclusive” could not change this position. Thus, effectively, it appears that in order to exclude the operation of Section 69 of the English Act, express language to that effect must be used.

It has been suggested on the Kluwer Arbitration Blog, “…whilst the outcome in Shell v Dana Gas may seem to overly constrain the autonomy of the arbitration process, the approach taken by the English court does serve to ensure that procedural safeguards are in place to protect those participating in arbitration…” There seems to be no reason to suppose why the same cannot be said of (at least some forms of) intervention by Indian Courts. Indeed, as noted in this post, leading practitioners have strongly defended judicial intervention in arbitration.

Arbitration Clauses and Incorporation by Reference

A recent judgment of the Supreme Court in M.R. Engineers and Contractors v. Som Datt Builders, (2009) 7 SCC 696, has clearly and elaborately discussed the principles relating to incorporation of an arbitration clause into a contract from another document.

The facts were that a contract (the “main contract”) was entered into between the Public Works Department of the Government of Kerala and a contractor for certain infrastructural work. The main contract included an arbitration clause (Clause 67.3). The contractor entrusted part of the work to a sub-contractor under another contract (the “sub-contract”). The sub-contract contained a statement “this sub-contract shall be carried out on the terms and conditions as applicable to main contract unless otherwise mentioned…” The question was: does this clause indicate that the main contract was incorporated in its entirety, so that the arbitration clause in the main contract would also be incorporated in the sub-contract?

Relevant in this regard is Section 7(5) of the Arbitration and Conciliation Act, 1996. Under this clause, an arbitration clause in an independent document will be imported into a contract by reference to the independent document, if the reference is such as to make the arbitration clause in the document a part of the contract. The Supreme Court, speaking through Justice Raveendran, held that the reference must specifically show the intention of the parties to incorporate the arbitration clause into the contract. There must be a conscious acceptance of the arbitration clause. Furthermore:

“A general reference to another contract will not be sufficient to incorporate the arbitration clause from the referred contract into the contract under consideration. There should be a special reference indicating a mutual intention to incorporate the arbitration clause from another document into the contract. The exception to the requirement of special reference is where the referred document is not another contract, but a standard form of terms and conditions of trade associations or regulatory institutions which publish or circulate such standard terms and conditions for the benefit of the members or others who want to adopt the same…”

The distinction drawn by the Court between contracts and standard form terms is particularly important; and this distinction enabled to Court to distinguish its earlier judgments Atlas Export Industries v. Kotak & Co., (1999) 7 SCC 61 and Groupe Chimique Tunisien SA v. Southern Petrochemicals Industries Corporation Ltd., (2006) 5 SCC 275 on a principled basis.

New Search Feature

Thanks to Google, a new feature has been added on the sidebar of this blog – “Search This Blog and Linked Pages”. The search works in the same manner as any Google search; but the results are classified under four heads, accessible under four tabs – “This blog”, “Linked from Here”, “Legal Blogs” and “Useful Links”.

The first tab displays results from this particular blog. The second tab displays results from all pages which have been linked in a post on this blog. The third and fourth display results from blogs and websites included in the “Legal Blogs” and “Useful Links” lists included on the left sidebar of this blog (see below ‘Labels’). I will shortly be expanding the links in the “Legal Blogs” and “Useful Links” sections.

I hope this will be useful to readers.

Recent Scholarship on evolving Global Corporate Governance standards

Prof. Lucien Bebchuk of the Harvard Law School has co-authored a paper with Prof. Assaf Hamdani, arguing that current models of analyzing corporate governance structures do not recognise the fact that outside of the US and the UK, most public companies are dominated by a “controlling shareholder”. The authors put forward a new model for analyzing the efficacy of governance structures, keeping in mind these divergences in ownership structures. I have described the paper more fully in a post here, and a link for downloading the paper is also available in that post.

Call for Papers: Indian Journal of Law and Technology

The following Call for Papers was received from the Indian Journal of Law and Technology:

The Indian Journal of Law and Technology (IJLT) is an annual law journal published by the Law and Technology Committee of the Student Bar Association, at the National Law School of India University, Bangalore, India. IJLT is the first and only law journal in India specifically devoted to the field of technology law. The previous issues of IJLT have featured articles by distinguished authors such as Yochai Benkler, Donald S. Chisum, Raymond T. Nimmer, John Frow, Jonathan Zittrain, Lawrence Liang and Shamnad Basheer.

The submissions to the Journal are selected for publication on the basis of a peer-review mechanism conducted through an external Article Review Board consisting of academicians and experts in the field of technology law. The Journal is edited by an Editorial Board consisting of students from the National Law School of India University selected on an annual basis through a selection process that tests them on their editing skills and knowledge in the concerned areas of law.

The Journal accepts academic submissions in the form of articles, notes, comments or book reviews on a host of legal issues regarding the interface between law and technology, including e-commerce, cyber crime, biotechnology, bioethics, competition law, outsourcing, intellectual property, related public policy, and law and society issues posed by new technology. The Journal is also oriented towards publishing academic work that considers the aforementioned is sues from a comparative perspective and/or the perspective of the developing world.

The Editorial Board invites submissions for Volume No. 6 of 2010. The Journal follows a rolling submissions policy and the deadline for the forthcoming volume is 15 December 2009. The submissions received after this date shall be considered for the next volume. The submissions must relate to any of the broad themes mentioned above or any other law and technology-related theme. Submissions may be sent to editorialboard@ijlt.in and can also be made on the IJLT website.

TDS and Non-Residents

While the Vodafone decision has been discussed earlier, one aspect which has not been looked at is the application of TDS provisions in the case. In the facts of the case, Hutch had received consideration from Vodafone for the alleged transfer of a capital asset situated in India. The primary liability to pay tax would be that of Hutch (the payee). According to the Revenue, the liability of Vodafone (the payer) would be one to deduct tax at source under Section 195 of the Income Tax Act. With several similar transactions under the scrutiny of the Revenue, and with the Vodafone case itself back before the Assessing Officer to decide on jurisdictional issues, the issue of the applicability of Section 195 has great significance.

The relevant part of Section 195 reads:

Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest on securities) or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salaries" shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force...

One of the important questions in this regard is whether Section 195 operates extraterritorially to cover payments made by non-residents to non-residents outside India. Are the requirements of territorial nexus satisfied in such a case? The Revenue’s argument is clear. For establishing chargeability u/s 9, undoubtedly, nexus is required. According to the Revenue’s argument, once chargeability is established, no further requirements of nexus need to be satisfied for attracting TDS provisions. As such, there is no ground for not giving the words “any person” in Section 195 their natural and ordinary meaning. The Revenue’s stand can be countered by arguing that “any person” can only refer to residents, and the provision must be given a contextual meaning. The case law on the point is not entirely clear. In Satellite TV v. DCIT, (2006) 99 TTJ (Mum) 1025, the Tribunal held that the words used in section 195 were “any person responsible for paying to a non-resident”. On a plain reading, the words “any person” could not be construed to exclude non-residents; nor could it be said that payments made outside India were outside the scope of the Section.

The assessee in that case had relied on an earlier decision of a co-ordinate Bench of the Tribunal in Shrikumar Poddar v. DCIT, (1997) 59 TTJ (Mum) 304. The Tribunal in Satellite TV refused to follow Shrikumar Poddar, saying that a decision is authority only for what it decides, and not for everything that may logically follow from it. Poddar had been decided on the ground that the charging provision in that case was not applicable in the facts of that case. Given this fact, the question of deduction of tax in terms of Section 195 did not arise for the consideration of the Tribunal. Therefore, the observations in Poddar (that Section 195 was not applicable as the payment was made outside India) were treated as obiter and not conclusive of the issue. Accordingly, the Tribunal in Satellite TV took a view different from that in Poddar.

Thus, while obiter in Poddar would support the assessee, the ratio of the decision in Satellite TV would go in favour of the Revenue’s arguments. Arguably, the Revenue’s stand is also vindicated by the Supreme Court judgment in CIT v. Eli Lilly, Civil Appeal 5114/2007. The Court suggests that chargeability under Section 9 would constitute sufficient nexus for the purposes of TDS provisions too. Yet, the Supreme Court specifically confined its decision to TDS under Section 192 (TDS in case of salaries); and on the facts of that case, the issue of payments by non-residents did not arise. Given this state of the case law, the question of the extraterritorial application of Section 195 cannot be regarded as settled. On principle, it is at least arguable that Section 195 should not be attracted in a Vodafone-type case. No doubt, the Section uses the words “any person”. However, the rationale behind TDS provisions seems to require a contextual interpretation of “persons” to mean only “residents”. TDS provisions are meant to ensure easier collection of taxes. The logic is that certain sums, though taxable in the hands of the payee, might escape tax because of problems in enforcement machinery in the case of non-resident payees. Hence, those sums should be deducted by the payer, from whom they can be recovered more easily. For this logic to hold true, it is essential that the payer must be in a better position than the payee – it must be easier to collect from the payer than from the payee. This will be true only in cases where the payer is a resident and the payee is a non-resident. In case both parties are non-residents, it will be as easy or as difficult to collect the sums due from the payee as the payer. In that case, the rationale behind application of TDS provisions is not attracted. In order to remain faithful to this rationale, the words “any person” must be read to mean “any residents”. Such an approach is also supported by a decision of the House of Lords in Clark v. Oceanic Contractors, [1983] 2 WLR 94, where their Lordships had to directly consider the question of whether chargeability is ipso facto sufficient nexus to attract TDS provisions. A provision quite similar to Section 195 was not given extraterritorial application, based on principles of statutory interpretation. This judgment has been more recently explained by the Court of Appeal in Andre Agassi v. Robinson (see paragraph 25 onwards). Whether this approach will be followed in India is a matter which remains to be seen.

(This note has also been posted on the Indian Corporate Law blog)

Income Tax: Digest of Cases - August 2009

The ITAT Online digest of recent income tax cases, updated till August 2009, is available on the ITAT Bar Association website. The consolidated digest (January-August 2009) can be downloaded from the same link.

Auditors: To whom is the 'Duty of Care' Owed?

Having looked at some elements of the content of the duty of auditors in respect of the "true and fair" view, the question remains as to who can enforce these duties. To whom does the auditor owe a duty of care? The basic problem in this area of law is to provide a solution to a question posed by Justice Cardozo – if auditors are liable to third parties, how can one avoid the auditors from being placed under a “liability in an indeterminate amount for an indeterminate time to an indeterminate class…”? (Ultramares Corp v. Touche, 1931 174 NE 441).

Claims by third parties

Until the 1960s, common law did not recognize a duty of are to avoid negligent misstatements resulting in economic loss. Such a duty was recognized in Hedley Byrne v. Heller & Partners, 1964 AC 465. The liability of auditors vis-à-vis third parties was founded on the Hedley Byrne principle; and is specifically explained by the House of Lords in Caparo Industries v. Dickman, 1990 2 AC 605. In Caparo, it was alleged that the auditors had been negligent in not detecting irregularities/fraud which led to overvaluations of the company assets in the accounts. The auditors had certified the accounts as representing a true and fair view of the company’s financial position. It was alleged that in doing so, they had not taken reasonable care, and had breached a duty owed to third parties (the plaintiff, which was an investor). The House of Lords held that statutory provisions establish a relationship between those responsible for the accounts (directors)/those responsible for certifying the accounts (auditors) and some other classes of persons. Among these other classes is the company itself, by virtue of its fiduciary relationship with directors and contractual relationship with auditors. However, the Lords held that such a relationship is not established with every person who has a right to be furnished with accounts/right to inspect the accounts. In particular, it was held that the duty which is owed to individual shareholders does not extend to cases where the shareholders decided to buy further shares in the company, even if it is a perusal of the annual accounts which led to that decision. In essence, in Caparo, the idea of “special relationship” was established. According to Lord Bridge, a plaintiff would succeed in showing a special relationship only if he shows that the defendant contemplated that the accounts and reports “would be communicated to the plaintiff either as an individual or as a member of an identifiable class, specifically in connection with a particular transaction or transactions… and that the plaintiff would be very likely to rely on it for the purpose of deciding whether or not to enter upon that transaction or upon a transaction of that kind…”

Post-Caparo, cases have tried to decipher the understanding of “special relationship”. In particular, it has been held that auditors of a subsidiary company owe a duty of care to the parent, since auditors must be aware that the parent will rely on the audit of the subsidiary to produce accounts which provide a true and fair view of the group (Barings plc. v. Cooper, 1997 2 BCLC 427; BCCI v. Price Waterhouse, 1998 BCC 617).

The Caparo approach of requiring a special relationship on facts in cases of claims by third parties has been followed in other commonwealth jurisdictions as well, for instance, in Australia (Essanda Finance v. Peat Marwick, 1997 188 CLR 241) and Canada (Hercules Management v. Ernst and Young, 1997 146 DLR 4d. 577).

Claims by the Company

Insofar as claims by companies are concerned, it is not seriously disputed that the auditor is under a duty of care to the company. The main difficulty in this area of law is: to what extent can the negligence or fraud of the company management be used by the auditor as a defense to a claim against him for negligence? If the company is negligent; contributory negligence applies. But what if an officer of the company has committed fraud? Is that a complete defense for the auditors?

Assume a situation where a certain director is in fact the “directing mind and will” of the company. Further assume that the director fraudulently gives some misinformation. Also assume that the circumstances are such that the auditor should have been suspicious. Later, the management of the company changes; and the new management wishes to sue the auditors. Can the auditor say that he is not liable to the company in such cases because of the application of the maxim ex turpi causa non oriter actio?

In particular, the auditor’s arguments can be that first, under principles of attribution, the state of mind of the ‘directing mind and will’ of the company must be attributed to the company itself (following cases such as Lennard’s Carrying Co v. Asiatic Petroleum., Tesco v. Nattrass, Meridian Global etc.) From this, it follows that the company itself fraudulently conveyed some misinformation to the auditor. Hence (the auditor can argue), allowing the company to now sue the auditor is similar to allowing the company to take advantage of its own wrong. Such a scenario is not allowed by application of the maxim of ex turpi causa non oriter actio. So will such claims be barred?

The company can take several arguments in this regard. It has been held in the leading case on ex turpi causa (Tinsley v. Milligan) that the doctrine would bar all claims without exception, where the plaintiff must set up his own fraud; or where his own fraud is directly material to the issue at hand. The company can argue that in a case pertaining to the auditor’s liability, it will not have to set up its own fraud. Hence, the fact that it is guilty of wrongdoing is immaterial. This argument will turn on individual facts as to whether it must rely on its fraud or not in its plaint.

On law, the company can also argue that the principles of attribution should not apply in such cases. It can argue that it (the company) is a victim and not a vehicle of the fraud of its directing mind and will. In such a situation, under the Hampshire Land principle or under analogous principles (Re Hampshire Land Co., 1896 2 Ch 743), “a company will not have attributed to it knowledge of a fraud when that fraud is being practised on the company itself.” This argument is likely to run into difficulties – the company will find it hard to prove that it was in fact a victim of the fraud of its directing mind and will. It is much more likely that the company was the mode in which the fraud was practised on others. Finally, it might also be possible for the company to argue that the nature of the relationship between the company and its auditors was that the auditors are required to detect the very thing which is sought to be attributed to the company. In other words, the essence of the engagement of auditors is that they can detect frauds which are practiced. Hence, given the particular nature of the company-auditor relationship, the ex turpi causa principle cannot be applied. If it is applied, it will mean that the very thing which the auditors have to do is one which cannot be enforced by the company at all. This argument runs into difficulties as Tinsley v. Milligan, supra states that the ex turpi causa principle applies without exception once it is shown that the company’s fraud has to be relied on. Thus in such a case, it appears that the company cannot bring a claim against the auditors.

The Court of Appeal has held so in a recent case (Moore Stephens v. Stone & Rolls, 2008 EWCA Civ 644); this decision has – in among the last significant verdicts of the House of Lords – been very recently confirmed in a 3-2 verdict. I have posted on the House of Lords decision here.

Auditors: "True and Fair" View

Recent events have highlighted the role and responsibilities of auditors. This post will look at the content of the auditor’s duty; and a subsequent post will look at who the duties are owed to. Typically, auditors have a duty certify whether or not the accounts of a company give a “true and fair” view of the financial state of a company. What exactly this true and fair view constitutes is a matter of some controversy.

“True and fair view”

Initially, an auditor was stated to have been given a broad discretion to rely on information provided by the management – an auditor is a watchdog and not a bloodhound (Re Kingston Cotton Mills No. 2, 1896 2 Ch. 279). However, the auditor cannot simply rely on information provided by the management when suspicious circumstances have arisen. According to Lord Denning, an auditor “must come to (his task) with an inquiring mind – not suspicious of dishonesty, I agree – but suspecting that someone may have made a mistake somewhere and that a check must be made to ensure that there has been none…” (Formento v. Seldson Fountain Pen Co., [1958] 1 WLR 45). For instance, where it was discovered that certain invoices had been altered, it was held that the fact of alteration should have caused the auditors to carry out their own check on the stock, without relying merely on invoices (Re Thomas Gerrard, 1967 2 All ER 535).

A true and fair view of accounts is one which is such that directors or other persons in control are not deprived of knowledge which might have afforded them the opportunity to take remedial action or which might afford them the chance to incur liabilities to third parties on the basis of inaccurate accounts (according to Professor Gower).

It has been held, in observations relied on by the Supreme Court of India, “The auditor must exercise such reasonable care as would satisfy a man that the accounts are genuine, assuming that there is nothing to arouse his suspicion and if he does that he fulfils his duty; if his suspicion is aroused, his duty is to 'probe the thing to the bottom'…” (see ICAI v. P.K. Mukherji, AIR 1968 SC 1104). In general, it can be stated that the accounts will present a “true and fair view” if the accounting standards prescribed by the concerned accounting body are followed. (Gower).

It might be argued that as long as the accounting standards are not breached, the auditor can adopt any interpretation which will best serve his clients’ need or which he thinks fit. Thus, once the AS are complied with, nothing more needs to be done to ensure that the “true and fair view” standard has been adopted. But are they conclusive in the sense that they can never be departed from? In this context, it has been held in England, “they are very strong evidence as to what is the proper standard which should be adopted and unless there is some justification, a departure from this will be regarded as constituting a breach of duty…” (Lloyd Cheyham v. Littlejohn, 1987 BCLC 303). Thus, if the AS are deviated from and yet the auditors certify the accounts as giving a true and fair view, that will in general be regarded as a breach of the duty of care. Only in exceptional situations can a deviation be justified.

In India, the Supreme Court has held that the Accounting Standards are mandatory (JK Industries). The Court stated, “…reference can be made to Section 211(3A), (3B) and (3C). Before introduction of Sub-sections (3A), (3B) and (3C) …these Standards were not mandatory. Therefore, the companies were then free to prepare their annual financial statements, as per the specific requirements of Section 211 read with Schedule VI. However, with the insertion of Sub-sections (3A), (3B) and (3C) in Section 211, the P&L a/c and the balance-sheet have to comply with the Accounting Standards… Thus, the Accounting Standards prescribed by the Central Government are now mandatory qua the companies and non-compliance with these Standards would lead to violation of Section 211 inasmuch as the annual accounts may then not be regarded as showing a "true and fair view".”

Thus, the exception which is permissible in English law does not seem to find a place in Indian law, at least after JK Industries. Compliance with the Accounting Standards is a necessary condition for saying that the accounts reflect a true and fair view. But is it a sufficient condition? Can it be argued that despite complying with the AS, a true and fair view is not satisfied?

On this issue, a recent British decision in Macquarie Internationale Investments. v. Glencore offers some help. As noted by Shantanu Naravane in a post on Indian Corporate Law, “the Court accepted that accounts created in accordance with the FSR need not necessarily be ‘true and fair’. However, the concept “must be understood and given effect in light of generally accepted accounting practices”. Only in exceptional circumstances would the Court conclude that FSR-compliant accounts do not give a ‘true and fair’ picture of the accounts of an entity…” Shantanu’s post is available here. Another post is available here. An opinion in this connection prepared by Martin Moore Q.C. is available here.

Can Courts Restrain a Party from Encashing a Bank Guarantee?

I have recently posted on Indian Corporate Law a note dealing with the law surrounding the invocation of bank guarantees; and the role of the 'fraud' exception to the general rule of non-interference of Courts in that regard. The note is available here.