A technical member of the National Company Law Tribunal and National Company Appellate Tribunal should have expertise in company law.

A constitutional bench of the Supreme Court of India in Union of India vs. R.Gandhi, President, Madras Bar Association, 2010 (5) SCALE 514, upheld the creation of the National Company Law Tribunal and the National Company Appellate Tribunal, and vested in them the powers and jurisdiction exercised by the High Court with regard to company matters that are constitutional in nature. Moreover, the Court held that members of these tribunals should be persons of rank, capacity, and status as nearly equal as possible to the rank, capacity, and status of High Court judges. While deciding this case, the Supreme Court endorsed the view of the Eradi Committee that company law jurisdiction should be transferred from High Courts to tribunals on account of inordinate delay in the disposal of cases by the High Courts. The Companies (Second Amendment) Act, 2002 had provided for appointment of members from the bureaucracy as technical members of the tribunal. The Supreme Court held that merely because a person has served in the cadre of the Indian Company Law Service, he cannot be considered an expert qualified to be appointed as a technical member, unless he has expertise in corporate law.

The Supreme Court emphasized that persons having ability, integrity standing, special knowledge, and professional experience in industrial finance, industrial reconstruction, investment, and accountancy may be considered as persons having expertise and may be appointed as technical members. The Supreme Court further stated that the selection committee should be comprised of the Chief Justice of India or his nominee as its chairperson, a senior judge of the Supreme Court or a Chief Justice of a High Court as member, and a secretary from the Ministry of Finance and Company Affairs, or Ministry of Law and Justice as members. The Supreme Court noted that, to function effectively, tribunals should appoint younger members who have a reasonable period of service rather than persons who have retired. The Supreme Court mandates that every bench shall have a judicial member. The Government of India has agreed before the Supreme Court to implement the order effecting the necessary amendments.

May a member of the public, on the basis of a letter of authorization, appear on behalf of a party before the National Tax Tribunal?

The Supreme Court of India addressed this question in Madras Bar Association vs. Union of India, [2010] 324 ITR 166 (SC). The Madras Bar Association had challenged the constitutional validity of the National Tax Tribunal Act, 2005 (Act) before the Supreme Court of India on the basis that:

(i) Section 13 of the Act permitted “any person” duly authorized to appear before the National Tax Tribunal. The Bar Association claimed that the right to appear should be exclusively restricted to advocates.

(ii) Section 5(5) of the Act provides for the Central Government to transfer a member (the presiding officer of the tribunal) from one bench in one state to another bench in another state. This was challenged on the ground that it would restrict the independence of the tribunal.

(iii) Section 7 of the Act provides for a selection committee comprised of the Chief Justice of India, or a judge of the Supreme Court nominated by him, a Secretary from the Ministry of Law and Justice, and a Secretary from the Ministry of Finance, and that the secretaries forming the majority may override the selection of the Chief Justice or of his nominee.

Initially, this matter had come up before a three judge bench, wherein the Government of India agreed to implement an amendment that would ensure that only lawyers, chartered accountants, and the parties themselves would be permitted to appear before the National Tax Tribunal, and that the opinion of the Chief Justice or his nominee would prevail in the selection of members to the tribunal or the transfer of members from one state to another. However, the case was referred to a constitutional bench, which determined that the matter should be addressed separately because the petitioner also had challenged Article 323B of the Constitution of India.

Art. 323B was added to the Indian Constitution under the Constitution (75th Amendment) Act, 1963. It authorizes the legislature to create and constitute tribunals, and supplements Art. 323A, which empowers the parliament to create tribunals for matters relating to the Union list.

By this case, the court will determine whether the exclusivity granted to advocates to appear before any court prevails over legislation diluting such rights.

May the Central Government seek the removal of managerial personnel of a company who conduct the affairs of the company in a manner prejudicial to the interest of the members, creditors, the company and the general public?

In Union of India vs. Design Auto Systems Ltd., [2010] 156 Comp cas 272 (CLB), the Principal Bench of the Company Law Board ruled that the power of the Board to remove managerial personnel of a company under Sec. 408 of the Companies Act was wide enough to cover present and past acts of mismanagement. In this petition by the Central Government under Sections 388B, 397, 398, along with Sections 401, 406 and 408 against the Company and its managerial personnel, the Company Law Board held that the language “being conducted” in Section 408 of the Act, cannot be interpreted so as to restrict its scope to the present acts of the managerial personnel. Rather the expression is wide enough to cover enquiries related to past conduct whose impact continued or would reasonably be assumed to continue to operate in a manner prejudicial to the interest of the company or the public interest. The Court further observed that the power of the Central Government under Section 408 is preventive in nature, exercised to ensure that the affairs of the Company are conducted in a manner that is not prejudicial to the interests of the company, its members, or to the public interest.

ADDITIONAL CASE NOTES

By Ranjan Jha, Bhasin & Co., Advocates

Arbitration Agreement Not Enforceable By Party Where It Was Not Incorporated At Time Agreement Executed.

In Andhra Pradesh Tourism Development Corporation vs Pampa Hotels Ltd., the Supreme Court held that an arbitration agreement executed before a company is formally registered under the Companies Act, 1956 may not be enforced by the company. Andhra Pradesh Tourism Development Corpn. (APTDC) and Pampa Hotels Ltd (Pampa) entered into two agreements, a Lease Agreement and a Development & Management Agreement on 30 March, 2002. Both agreements contained arbitration clauses. Pampa was incorporated under the Companies Act, 1956 on 9 April, 2003. In April 2004, disputes arose between the parties and APTDC terminated the agreement and took possession of the property that formed the subject of the transaction. Pampa filed an application before the Andhra Pradesh High Court under the Arbitration and Conciliation Act, 1996 (“Act”) for appointment of arbitrators. APTDC objected asserting, inter alia, on the ground that there was no contract, and therefore no arbitration agreement, between the parties because Pampa had not come into existence as of the date of the two agreements. The Chief Justice of the Andhra Pradesh High Court appointed an arbitrator to the case, referring all disputes between the parties, including the existence of the agreement, under Section 11 of the Act.

Shortly thereafter, the Supreme Court, in SBP & Co. v. Patel Engineering, held that issues regarding the validity of an arbitration agreement raised in an application for appointment of arbitrator under Section 11 are to be decided by the Chief Justice, or his designee, under Section 11 of the Act. Accordingly, APTDC filed a Special Leave Petition challenging the decision of the appointment of the arbitrator. The main questions before the Supreme Court were whether: (a) an arbitration agreement is enforceable where the party seeking arbitration was a not a company in existence at the time the contract containing the arbitration agreement was executed, and (b) the question of the enforceability of the arbitration agreement must be decided by the Chief Justice or his designee, or by the Arbitrator.

The Supreme Court concluded that if one of the two parties to the arbitration agreement was not in existence when the contract was made, then there was no valid contract. If the agreements had been entered into by the promoters of the company, stating that the agreements were entered into by the promoters on behalf of a company to be incorporated, and that the terms of the incorporation authorized such action, the agreements would have been valid, and the arbitration clause would have been enforceable. On the second issue, the Court held that whether there is an arbitration agreement and whether the party who has applied under section 11 of the Act is a party to such an agreement, is an issue that must be decided by the Chief Justice or his Designate under Section 11 of the Act before appointing an arbitrator. However, because the arbitral tribunal already had been appointed in this case, the Court did not interfere with the appointment of the arbitral tribunal, and left the issue for the arbitrator to decide.

This judgment has a wide range of implications for companies that enter into pre-incorporation contracts – in particular, contracts providing for arbitration. In light of this judgment, a pre-incorporation contract must be entered into by the promoters of a company on behalf of the company proposed to be incorporated and such contract should be specifically provided for in the terms of the company’s incorporation to fall within the ambit of Section 15(h) of Specific Relief Act, 1963. The contract entered into by the promoter must also be duly ratified by the company upon its incorporation to avoid ambiguity and legal scrutiny in the future.

Delhi High Court Comes to the Rescue of Low Priced Books

The Delhi High Court analyzed issues of infringement of copyright and the applicability of the first sale doctrine in John Wiley & Sons Inc. & Ors v. Prabhat Chander & Ors. The court had to decide whether exporting books whose sale and distribution was subject to territorial restrictions could amount to copyright infringement. The Delhi High Court answered in the affirmative, and rejected an application by the defendants to set aside an earlier ex-parte injunction operating in favour of the copyright owner. The court held that India follows the principle of national exhaustion and not international exhaustion.

The plaintiffs, international publishing houses, published special low price editions of text books for school and college students in India. These low price editions (LPEs) were published with the rider that they were meant for sale/re-sale only in the Indian sub-continent and not in any other parts of the world. The plaintiffs contended that they published LPEs so that the same international level books that otherwise are quite costly might be made available to Indian and other Asian students at prices befitting the Asian markets. The defendants, a company and its directors, were engaged in the business of selling books online. The defendants were offering LPEs for sale worldwide in breach of the territorial notice. The plaintiffs filed suit before the Delhi High Court to restrain the defendants from infringing the copyright of the plaintiffs by exporting the books of the plaintiffs to the countries outside of prescribed territories. The plaintiffs also filed an application seeking temporary injunction against the defendants, which came up for hearing with the main suit when the court entered an ex parte order against defendants.

Arguing that the earlier ex-parte injunction was erroneous, the defendants contended that the nature of its activities, i.e., export of the books outside the Indian sub-continent, was not tantamount to infringement of copyright. The defendants invoked the first sale doctrine as a defense, arguing that once the plaintiffs sold a particular copy of the LPE, they could not control its further re-sale. The defendants also submitted that their act of exporting LPE’s was not prohibited by the Indian Copyright Act, 1957 (the Act). They submitted that the Act only prohibited the import of infringing articles into India, the Act was silent about exports, and the court should not add words to the legislation.

The Delhi High Court, examining various provisions of the Act, stated that the Act gives a copyright owner the right to exploit his copyright by assignment and licensing. Such an assignment or license could be limited by way of time period or territory, and could be exclusive or non-exclusive. Therefore, a copyright owner could exhaust its rights in some territories while protecting its right in others. Accordingly, the plaintiffs could prevent the defendants from re-selling and exporting their LPEs to territories where their right of distribution and sale had not been exhausted. The court held that the defendants’ acts were prima facie infringing in nature and the defenses put forth by the defendants to defend their usage were not tenable. Thus, a temporary injunction was warranted until the case was resolved.

The importance of this decision arises from the fact that the Indian courts have now begun to recognize and protect the right of copyright owners to control the distribution channels of their copyrighted articles in order to obtain maximum royalties. The courts are respecting the divisions of rights along territorial lines by publishers – a form of division which is supported by Sections 19(2), 19(6) and 30A of the Act – and have held that as far as literary works are concerned, the exhaustion of rights occurs on the first legal sale of a copy of a work only within the territory in which the copyright owner intended the work to be sold. Thus, the copyright owner would continue to enjoy the right of resale in all other territories.

ICICI Bank Ordered to Pay Rs. 13 Lakh to NRI in Phishing Scam

Believed to be India’s first legal adjudication of a dispute raised by a victim of a cyber crime in phishing case, the adjudicating officer at Chennai, Govt. of Tamil Nadu (“TN”), in Umashankar Sivasubramanian vs. Branch Manager, ICICI Bank and others, recently directed ICICI Bank to pay Rs 12.85 lakh to an Abu Dhabi-based non-resident Indian (“NRI”) within 60 days for the loss suffered by him due to a phishing fraud. Phishing is a form of internet fraud through which sensitive information such as usernames, passwords, and credit card details are obtained by masquerading as a trustworthy entity.

The ruling was passed under the Cyber Regulations Appellate Tribunal Rules, 2000, with TN IT secretary PWC Davidar acting as the adjudicator under the Information Technology Act, 2000. The application was filed before Adjudication Officer for the State for adjudication under Section 43 read alongwith section 46 of the Information Technology Act, 2000. Sivasubramanian, an NRI employed in Abu Dhabi, maintained a bank account with ICICI Bank, and had Internet banking access for his savings bank account. The Bank sent him periodic statements. In September 2007, Sivasubramanian received an email from “customercare@icicibank.com” asking him to reply with his internet banking username and password or else his account would become non-existent. Assuming it to be a routine mail, he complied with the request. Later, he found that Rs 6.46 lakh were transferred from his account to Uday Enterprises, an account holder in the same bank in Mumbai, which withdrew Rs 4.6 lakh by self cheque from an ICICI branch in Mumbai and retained the balance in its account. When ICICI Bank tried to contact the firm, it found that Uday Enterprises had moved on from the address it had provided two years earlier.

Sivasubramanian contended that the bank had violated the “know your customer” (KYC) norms. When he didn’t get his money back, Sivasubramanian filed a criminal complaint and also appealed to the State Government’s IT Secretary, Mr. P.W.C. Davidar, the Adjudicating Officer under the IT Act. The bank claimed that Sivasubramanian had negligently disclosed his confidential information, such as his password, and as a result became a victim of phishing fraud.

Mr. Davidar stated in his order that a list of instructions the bank had put up on its Web site and which it sends to customers were of a “routine nature” and did not help a customer distinguish between an e-mail from the bank and an e-mail sent by a fraudster. He observed that the bank had not provided additional layers of safeguard such as due diligence, KYC norms, and automatic SMS alerts. He rejected the bank’s effort to take shelter behind routine instructions on phishing and stated that the bank failed to take steps to prevent unauthorized access to its customers’ accounts. Mr. Davidar also observed that the bank’s actions indicated it had “washed its hands” of the customer and that the bank’s branch had been indifferent to the customer’s plight.

The judgment, though likely to be appealed, is significant as it is apparently the first verdict in a case filed under the IT Act awarding damages in a phishing case.

by B.C. Thiruvengadam, Thiru & Thiru, Advocates

In the recent hyperbole surrounding the failure to bring to justice the persons responsible for the Bhopal gas tragedy, scant attention has been paid to the legal requirements to convict corporate executives of criminal conduct. On June 7 of this year, the Magistrate Court in Bhopal imposed suspended sentences of two years jail time and modest monetary penalties to eight former directors of Union Carbide India Limited (“UCIL”). Given the enormity of the tragedy, the sentences were met with widespread national outrage. The court did not rule on the liability of Warren Anderson, the chairman of Union Carbide Corporation (“UCC”) at the time of the incident, and the focal point of public outrage in India. Absent from the discourse is any discussion of the legal doctrines that underlie corporate and individual culpability for the tragic events of that December night twenty six years ago. An appreciation of this is essential for meaningful discussion of the legal reform required to prevent what is perhaps the real tragedy- the failure to adequately compensate the poor and powerless victims of the Bhopal incident.

First, to put things in context, some facts which are not in dispute. The Bhopal plant was owned by UCIL, an Indian company, publicly listed on the Calcutta Stock Exchange. Its shares were held 50.9% by UCC, a New York corporation, another 22% was held by Indian public financial institutions, and the rest by roughly 23,000 small shareholders. At the time of the Bhopal incident, UCIL was celebrating its 50^th anniversary in India. Following the incident, the Government of India (“GOI”) enacted the Bhopal Gas Leak Disaster (Processing of Claims) Act, 1985, appointing itself as the sole representative of the people injured by the gas leak. Two days after the incident Warren Anderson accepted moral responsibility for the Bhopal incident. But the question of his and UCC’s legal (civil and criminal) liability was left open, and to this day has yet to be established by a court of law.

Bringing Warren Anderson and UCC “to justice” requires an examination of substantive legal doctrines, as well as the requirements of due process of law. Substantive law makes clear that:

• Officers and directors of a corporation may be held criminally liable for offenses by the corporation only in very narrow circumstance, and that any criminal action against Warren Anderson, a U.S. citizen, must be in accordance with international law, including the US India Treaty on Mutual Legal Assistance in Criminal Matters;

• As separate legal entities, UCC may not be held liable for UCIL’s malfeasance unless the court “pierces the corporate veil” or adopts some other theory of enterprise liability to make UCC liable.

In addition, in any future man-made mass disaster it will be essential that the courts and investigative agencies in India function in an expeditious and thorough manner, so that there is no doubt that justice will be served. Doubts had previously been expressed including by none other than the GOI itself, regarding adequacy of the court system in India.

Imposing Criminal Liability on Directors is Not Straightforward

In much of the popular discourse, the criminal liability of Warren Anderson, chairman of UCC at the time of the Bhopal incident, has been taken as a given. Scant attention has been paid to the legal requirements for imposing such liability.

Officers and directors, such as Warren Anderson, are liable for the criminal offenses of a company in very narrow circumstances; certainly not as a matter of course. Their liability rests on the principles of vicarious liability, which itself is based on principles of agency law or imposed by statute. In India, to support a finding of vicarious liability in a criminal matter, there must be a provision in the underlying statute fixing liability on the directors. In the absence of such a provision, criminal liability can be imposed on a director only if he aided and abetted the violation by the corporation through specific conduct or if it is proved that he at the time of the violation was “in charge of” and responsible to the corporation for the conduct of its business. The Supreme Court of India has interpreted these words to require that the accused be in overall control of the day to day business of the entity. This requirement is not met merely by the accused having a right to participate in the business of the entity.

Accordingly, the criminal liability of Warren Anderson as a director of UCC will be founded on painstakingly making a case that he is vicariously liable and proving that he engaged in conduct that establishes beyond a reasonable doubt his culpability for the acts and omissions of that fateful night. This is a monumental prosecutorial challenge.

UCC’s (Parent Company) Liability Cannot Be Taken for Granted

In holding UCC liable, one basic question is whether and to what extent the separate existence of UCIL should be ignored. The separate existence of a corporation is a fundamental assumption that underlies global commercial transactions, and there must be compelling reasons for a court to ignore that assumption. Generally the existence of a corporation is sought to be disregarded when it has no assets. UCIL was a “going concern” with substantial assets, and there is nothing to suggest that it was undercapitalized.

Piercing the Corporate Veil of UCIL

Generally corporate veil piercing is appropriate only when recognition of the separate corporate existence will lead to injustice or an unfair or inequitable result. This is a necessary but not a sufficient condition for imposing liability on shareholders, such as UCC in this case. While piercing is rare, two factors in the present case favor it: (a) liability is sought to be imposed on another corporate entity rather than an individual; and (b) liability arises in the first instance from tort rather than contract.

Many cases in which shareholder liability has been found concern shareholders that are themselves corporations, as is the case here. Often in such cases a parent corporation is being held liable for the debts of the subsidiary. These cases have a somewhat different flavor than cases in which the shareholder defendant is an individual, and there is a general feeling that disregarding the separate corporate existence of the subsidiary may be easier where another corporate entity is held liable.

Beyond that, the general standards applied in determining whether the shareholders (or parent company) of a corporation should be held liable are quite different in contract cases as compared to tort cases. In a contract case, the third party has usually dealt in some way with the subsidiary and is aware that it lacks substance. In a tort case, on the other hand, there is no element of voluntary dealing. The question in these cases is whether it is reasonable for owners of a business to transfer a risk of loss or injury to members of the general public through the device of a corporation which has limited assets.

Generally corporate shareholders, such as UCC, have been held liable for subsidiary obligations in a number of situations:

1. When the subsidiary is being operated in an “unfair manner,” e.g., the terms of transactions between parent and subsidiary are set so that profits accumulate in the parent and losses in the subsidiary;

1. When the subsidiary is consistently represented as being a part of the parent, e.g., as a “division” or “local office” rather than as a subsidiary;

1. When the separate corporate formalities of the subsidiary are not followed;

1. When the subsidiary and parent are operating essentially as parts of the same integrated business, and the subsidiary is undercapitalized; and

1. When there is no consistent clear delineation of which transactions are the parent’s and which are the subsidiary’s.

Enterprise Liability

Besides the doctrine of piercing the veil, the enterprise theory of liability, although not widely accepted, could be a basis for imposing liability on UCC. Enterprise theory views the corporate group as a singular unit, rather than viewing each subsidiary or affiliated corporation as a separate legal entity. Since subsidiaries (especially wholly-owned subsidiaries) at least theoretically act for the benefit of the corporation as a whole, enterprise theory follows the profit and holds the various corporate actors in a given web accountable for the actions of other actors. Enterprise principles thus apply liability according to the patterns of the economic enterprise instead of stopping at the contours of the legal fiction. Adopting this theory would allow claimants of UCIL, one actor in a corporate group, to recover from UCC, another member of the group under ordinary tort circumstances. However, because the Indian courts have not opined on the enterprise theory of liability, this will be new ground.

Absence of Mass Tort Legislation

India has no mass tort legislation that broadens the responsibility for compensation and remediation of harm caused by hazardous activities that may affect the general public and establishes a mechanism to compensate the injured. For example, there is no legislation in India such as the US Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) under which a parent corporation might be liable as an “operator” of the site if it was involved in the operation of the site itself. In the absence of specific legislation, a court will have to rely on common law doctrines to disregard the existence of UCIL (pierce the corporate veil) and hold UCC liable. There is also the separate question of law as to what extent Dow Chemicals, as successor to UCC, could be liable.

Adequacy of Legal Infrastructure in India

It is often said that perception is reality. This is all the more true in this case, where the functioning of the Indian legal system will be critically examined internationally. To be credible, judicial proceedings and criminal investigations in this matter will not only have to meet the highest standards of law, but should also be so perceived by all observers. The GOI itself had serious misgivings on this account at the time of the Bhopal incident. In 1986, the Union of India acting on behalf of the victims of the Bhopal incident is reported to have argued before the federal district court in New York that “the courts of India are not up to the task of conducting the Bhopal litigation . . ., “that the Indian judiciary has yet to reach full maturity due to the restraints placed upon it by British colonial rulers who shaped the Indian legal system to meet their own ends” . . . and “that the Indian justice system has not yet cast off the burden of colonialism to meet the emerging needs of a democratic people.” Dismissing the case on forum non conveniens grounds, federal district judge John F. Keenan wrote:

The Court thus finds itself faced with a paradox. In the Court’s view, to retain the litigation in this forum, as plaintiffs request, would be yet another example of imperialism, another situation in which an established sovereign inflicted its rules, its standards and values on a developing nation. This Court declines to play such a role. The Union of India is a world power in 1986, and its courts have the proven capacity to mete out fair and equal justice. To deprive the Indian judiciary of this opportunity to stand tall before the world and to pass judgment on behalf of its own people would be to revive a history of subservience and subjugation from which India has emerged. India and its people can and must vindicate their claims before the independent and legitimate judiciary created there since the Independence of 1947.

In re Union Carbide Corporation Gas Plant Disaster at Bhopal, India in December, 1984, 634 F. Supp. 842, 867 (S.D.N.Y. 1986). That was then. We do not know if the GOI still holds the same view. Leading members of the Indian bar, including senior advocate N.A. Palkhivala and J.B. Dadachanji, had disagreed and took a contrary view before the court.

Has history disproven Judge Keenan’s determination that the Indian courts are up to the task? We think not. To blame solely the Indian courts for the delay would assume that the parties involved, the GOI and UCC, moved expeditiously in litigating this case. As the parties and not the court alone set the legal “pace” of a trial in India, the saga of this twenty six year old case cannot be entirely attributed to the court alone.

Conclusion

            Justice requires that specific legal criteria be satisfied for the imposition of criminal liability upon the officers and directors of UCC. To impose criminal liability without evaluating whether the facts of Bhopal fall into the limited circumstances under which criminal liability may be imposed would itself be a denial of justice. To prevent what happened in the aftermath of the Bhopal incident, we as lawyers must press the government to pass comprehensive legislation providing for proper compensation to victims of mass torts and for criminal liability if the circumstances allow. The disaster of Bhopal “gnaws at the conscience” of the Indian people according to Prime Minister Manmohan Singh and represents a true human tragedy. There are many legal lessons to be learned in the wake of the Bhopal tragedy. Perhaps the most important is that the law and courts must be better equipped to address any future Bhopal-like mass tragedy.

Anand S. Dayal is a partner with Koura & Company, Advocates and Barrister, based in New Delhi, India. Anand received his J.D. cum laude (1992) from Cornell Law School, and is admitted to the bar both in India and the US (NY and DC). He was previously Of Counsel with White & Case and an associate with Chadbourne & Parke and Pillsbury Madison & Sutro. Anand is chairman of the Anti-Corruption Committee of the American Chamber of Commerce in India. He can be contacted at dayala@vsnl.com or adayal@kouraco.com.

Jonathan Wolff is a second year law student at Washington University in Saint Louis and is currently interning for Koura & Co. His research interests include international corporate law as well as international and United States water law. He can be contacted at jswolff@wulaw.wustl.edu.

by Anand S. Dayal and Jonathan Wolff

On March 18, 2010, President Obama signed into law the Hiring Incentives to Restore Employment Act (the “HIRE Act” or “Act”). The Act incorporated the provisions of the Foreign Account Tax Compliance Act of 2009 (“FATCA”). The FATCA provisions of the Act impose significant reporting and information gathering obligations on individuals and third parties, and will expand the current U.S. withholding regime. The Act will have a substantial impact on foreign investment in the U.S..

Foreign persons are generally subject to a flat tax rate of 30% on their U.S. source fixed, determinable annual or periodic (FDAP) income. In brief, income is fixed when it is paid in amounts known ahead of time and determinable whenever there is a basis for calculating the amount to be paid. Common examples of FDAP income include compensation for personal services, dividends, interest, pensions, alimony, real property income (such as rents other than gains from the sale of real property), royalties and commissions.

The current 30% withholding regulations, set forth in Chapter 3 of the U.S. Internal Revenue Code, have been in place for many years and impose a withholding requirement on payments to foreign persons of U.S. source FDAP income, unless the FDAP income is effectively connected with a U.S. trade or business, or the withholding is reduced or eliminated by operation of a tax treaty. As a result, taxes on FDAP income to foreign persons must generally be withheld by the U.S. payer (otherwise known as withholding agent) and remitted to the IRS.

The Act creates a new withholding tax, added as Chapter 4 of the U.S. Internal Revenue Code, that expands the current U.S. withholding regime by imposing a 30% withholding tax on any withholdable payments made to foreign financial institutions (regardless of whether such institutions have U.S. account holders), unless the foreign financial institution enters into a reporting agreement with the IRS. A withholdable payment is defined as any U.S. source FDAP income, and gross proceeds from the sale or disposition of any property which produces U.S. source interest or dividends. The Act’s withholding provisions will greatly expand existing law because gross proceeds from the sale of stock or debt instruments are currently not taxable to foreign persons and are not subject to withholding. Furthermore, the Act defines foreign financial institutions (“FFI”) so broadly that it includes virtually every type of foreign bank and foreign investment vehicle, including foreign private equity funds and foreign mutual funds. The reporting agreement requires FFIs to disclose the full details of non-exempt accountholders to the IRS in order to avoid the 30% withholding tax. For these reasons, foreign investors should not be surprised if their local investment bank or brokerage firm soon refuses to invest, directly or indirectly, in U.S. securities in order to avoid a withholding tax on FDAP income or, alternatively, enter into the reporting agreement with the IRS.

Additionally, an FFI that has entered into a reporting agreement with the IRS will be required to deduct and withhold a 30% tax on any pass-through payment made by the institution to an FFI that fails to enter into an agreement with the IRS. For this reason, foreign persons that receive FDAP income may potentially face a “double” withholding. As mentioned above, the current tax regime already requires that U.S. payers withhold 30% of U.S. source FDAP income to foreign recipients. Because of the provisions set forth in the Act, a foreign recipient may be subject to a prohibitive additional withholding on the same payment stream if one or more of its banks has not entered into the proscribed information agreement with the IRS. Although the Act authorizes the Secretary of the Treasury to provide rules to prevent double withholding on the same payment stream, there is no explicit provision within the bill that would limit withholding to one level. This is important because prior versions of the bill contained explicit provisions that would seemingly have prevented a double withholding scenario.

To illustrate, suppose the following set of circumstances: USCO, a U.S. firm, makes a royalty payment for the use of certain intellectual property to IndiaCo, an Indian software firm. Assume that the payment qualifies as U.S. source FDAP which is not effectively connected with IndiaCo’s U.S. trade or business, and therefore subject to a 30% withholding. USCO withholds 30% of the royalty payment and remits the remainder to IndiaCo’s foreign account. However the payment does not travel directly from USCO’s local bank account to IndiaCo’s local Indian bank. Instead, the funds are routed through a network of correspondent and intermediary banks, one of which has failed to enter into a reporting agreement with the IRS as required by the Act. Without additional clarification from the Secretary of the Treasury, it would appear that the royalty payment would be subject to an additional Chapter 4 withholding of 30%. While beneficial owners of withholdable payments will be eligible to claim a refund or credit for any withholding in excess of their tax liabilities, this will require the beneficial owner to file a U.S. tax return.

Significantly, the payment of foreign source FDAP income is not a withholdable payment under Chapter 3 or Chapter 4 of the Internal Revenue Code. The payment of foreign source income to a foreign person is not subject to U.S. withholding or reporting requirements. Except for certain limitations, wages and any other compensation for services performed by a non-resident outside the U.S. are considered to be foreign source income. The place where the services are performed determines the source of the income, regardless of where the contract was formed, the place of payment, or the residence of the payer. Other examples of foreign sourced FDAP payments include: interest payments by a foreign debtor is foreign, royalty payments for property used abroad, and rental payments for property located outside the U.S. Consequently, US firms may continue to make payments to foreign companies for services performed abroad without withholding taxes.

The withholding rules are not just relevant to the foreign recipient but the U.S. payer as well. The IRS has designated the obligation of a U.S. withholding agent to report and withhold on U.S. source FDAP income as a Tier 1 compliance issue. Tier 1 compliance issues are generally considered the highest compliance priorities within the IRS. A withholding agent is defined as any person, U.S. or foreign, that has control, receipt, or custody of, or the ability to dispose or pay, any item of income of a foreign person that is subject to withholding. The withholding agent is required to remit the withheld amount to the IRS, generally, on Form 1042 called, Annual Withholding Tax Return for US Source Income of Foreign Persons, and Form 1042-S, called Foreign Person’s US Source Income Subject to Withholding. The withholding agent is personally liable for any tax required to be withheld. If the withholding agent fails to withhold and the foreign taxpayers fails to pay its tax liability, both the withholding agent and taxpayer will be liable for the tax, interest, and penalty on the outstanding balances due.

Since its recent passage, the Act has generated a great deal of commentary within the legal and financial communities. The withholding provisions set forth in the Act are scheduled to apply to payments made after December 31, 2012. However, many observers believe that this date will be pushed back to account for the significant issues involved with the Act’s implementation, and for the Treasury to provide sufficient guidance to financial institutions to properly implement the new reporting procedures.

In conclusion, U.S. payers of FDAP income to foreign recipients should keep in mind the IRS’s increased scrutiny of FDAP reporting and withholding requirements. While payments to foreign persons for services performed abroad (and other payments of foreign source FDAP income) should not be affected by the new law, we recommend that U.S. payers nonetheless keep a watchful eye on the changing landscape of the U.S. withholding regime and maintain careful records of their transactions. Likewise, foreign recipients should note that their payments will soon be subject to an expanded withholding tax, which may make potential future investments in U.S. securities markets less attractive.Timothy D. Richards is the managing partner and founder of The Richards Group, in Miami, Florida. He specializes in domestic and international tax, estate planning and corporate law. He may be contacted by email at trichards@richards-law.com

Alonso Sanchez is an associate in The Richards Group’s tax department. He may be contacted by email at asanchez@richards-law.com

by Timothy D. Richards and Alonso E. Sanchez

Modern biotechnology, involving the use of recombinant DNA (“rDNA”) technologies, has emerged as a powerful tool with applications in healthcare and agriculture. New plant varieties developed using rDNA techniques, commonly referred to as genetically engineered (“GE”), genetically modified (“GM”) or transgenic plants, have and are being developed to enhance productivity, reduce dependence on agricultural chemicals, modify the inherent properties of crops, and enhance the nutritional value of foods and livestock feeds.

Genetically modified food crops are key to increasing agricultural production and enhancing food security in India. Such crops are not new to India. Genetically modified cotton is commercially cultivated in India, and according to currently available information, twelve crops (of which eleven are food crops) are under various stages of development. While genetically modified crops have been successfully used in India — accounting for about 85% of the cotton grown — their use for food crops is controversial. This article describes the governmental approval requirements in India for the introduction of genetically modified food crops; how the process is expected to unfold in practice, based on experiences in other recent cases; and suggests strategic steps that an applicant should consider in applying for regulatory approval.

Regulatory Requirements and Approval Process

Several governmental authorities regulate the manufacture, import, use, research, and release of genetically modified organisms (“GMOs”) in India. These authorities operate at the central (federal), state, and local (district) level. The approvals required from these authorities often are interdependent and one approval may be a pre-requisite for others.

The apex authority is the Genetic Engineering Approval Committee (“GEAC”), a multi-ministerial body located in the Ministry of Environment and Forests (“MOEF”). The GEAC has the authority to permit the use of GMOs and its byproducts for commercial application, including their large-scale production and release into the environment. GEAC approval is based in part on the clearance given by the Review Committee on Genetic Manipulation (“RCGM”) in the Department of Bio-Technology (“DBT”). In addition, a new regulatory body, the Food Safety and Standards Authority of India (“FSSAI”), has been empowered to regulate the safety aspects and approval process for GM foods and is in the process of framing rules for this purpose.

The regulatory requirements for cultivation of GM crops are set forth in the Rules for the Manufacture, Use, Import, Export and Storage of Hazardous Micro-Organisms, Genetically Engineered Organisms or Cells, notified on December 5, 1989 (“1989 Rules”). The 1989 Rules define the competent authorities (and their composition) charged with administering the 1989 Rules.

Besides the 1989 Rules, the regulatory framework is supplemented by guidelines and notifications issued by the other governmental authorities having jurisdiction over activities addressed under the 1989 Rules. These effectively add another layer of regulation. The steps in the regulatory approval process are as follows:

• Import of GMOs and/or GM seeds
• Testing and research in contained conditions, depending on the following risk categories:
• Category-I Risk (routine rDNA laboratory experiments in a contained environment)
• Category-II Risk (laboratory and green house or net house experiments in a contained environment)
• Category-III Risk (green house or net house and limited field trials in open field conditions)
• Confined field trials (controlled introduction) at bio-safety research level-I (BRL-I) and BRL-II, as defined in bio-safety guidelines for field trials issued by the RCGM
• Food safety assessment
• Commercial cultivation of GM crops
• Production and sale of GMOs

Regulatory Process in Practice

Despite the guidelines provided in the 1989 Rules and related regulations, in practice, there is significant risk and uncertainty. Key risk areas are outlined below. These are based largely on the challenges faced since 2000 for the introduction of a genetically modified egg plant called Bt Brinjal.

Proceedings continue in the Supreme Court in the Public Interest Litigation (“PIL”) filed in early 2005 seeking to establish a comprehensive, stringent, scientifically rigorous, and transparent bio-safety protocol in the public domain for GMOs, and for every GMO before it is released into the environment. Aruna Rodrigues v. Union of India, Writ Petition (Civil) No. 260 of 2005 (“Bt Brinjal Case”). So far the Court has issued six orders addressing the role and function of the GEAC. The PIL is yet to be ultimately determined, with the most recent order of January 19, 2010 requiring the government to respond in four weeks to the question of what steps the government has taken to protect traditional crops. Details of the government’s reply are not available as of this writing.

Such litigation is primarily brought by non-governmental organizations. Often they are brought ex parte, as a matter of urgency and without notifying the other concerned parties. The obvious immediate consequence of such litigation is delay and uncertainty. Typically, the court initially issues an interim order to maintain the status quo while the parties can be heard. For example, in the Bt Brinjal Case, the Supreme Court initially ordered that the GEAC “withhold approvals until further instructions to be issued by this court on hearing of all concerned.” Bt Brinjal Case, Order dated 22 September 2006. This order had the effect of suspending the grant by GEAC of approvals on all applications pending before it, not just the Bt Brinjal application. The Order was subsequently modified by the court (on an application filed by the government) to allow the continuation of field trials subject to conditions stipulated by the court. Bt Brinjal Case, Order dated 8 May 2007.

The other consequence of such litigation could be the imposition by the court of additional conditions on confined trials in response to concerns expressed by the petitioner and other concerned parties. These additional conditions could adversely affect the overall economics of the GM crop and the timing for its introduction.

Although the GEAC is the designated permitting authority, its decision can be suspended or held in abeyance by the government. Given the past controversy surrounding GM crops, the GEAC is expected as a matter of practice to refer its recommendation to the government (Ministry of Environment and Forests) for a final decision. The outcome of this may be to confirm, suspend or modify the GEAC approval. See MOEF, Report of Minister Shri Jairam Ramesh, 9 February 2010 (“Report of Environment Minister”) (declaring an indefinite moratorium on the release of Bt Brinjal). In view of the public nature of the controversy, the government’s stand in this matter is likely to be dictated by politics as much as scientific considerations.

The regulatory framework for GM crops is evolving. Recent developments are expected to alter existing regulatory requirements. These will most certainly apply to pending applications, but may also affect existing approvals.

• First, the GEAC has been directed by the MOEF to draft a new protocol for the specific tests that will be conducted on GMOs in order to generate public confidence in GM food crops. The Environment Minister has directed that “under no circumstances should there be any hurry or rush” to complete the aforesaid. Report of Environment Minister, paragraph 30. Therefore until such new protocols are issued, there is substantial uncertainty as to the regulatory requirements.

• Second, the Food Safety and Standards Authority of India, a regulatory body constituted under the Food Safety and Standards Act, 2006 will hence forth regulate the safety assessment and approval process for GM foods. The FSSAI will regulate “food stuff, ingredients in food stuffs and additives including processing aids derived from living modified organisms where the end product is not a living modified organism.” MOEF, Notification No. S.O. 1519(E) dated 23 August 2007. The FSSAI has released for public comment draft rules on “Operationalizing the Regulation of Genetically Modified Foods in India.” The comment period ended on July 14, 2010. The draft clarifies that the research and development, environmental release, and commercialization of GMOs will continue to be governed by the 1989 Rules, and thus will continue to be regulated by the GEAC at MOEF and RCGM in the DBT.

Suggested Strategic Approach

Given the risks described above, an applicant should consider including the following elements in its strategic approach to complying with the regulatory requirements in India. First, due to the uncertainty in the regulatory process and questions as to finality of the GEAC approval, it would be prudent to enter into an “implementation agreement” with the MOEF. Because the financial investment and effort required to commercialize GM crops is substantial, an up-front understanding with the government will help reduce the degree of arbitrariness involved in the application of the regulatory requirements. Implementation agreements are the norm in sectors where a long gestation period is involved and where successful implementation depends on governmental actions and support, such as hydropower projects.

Second, the applicant should consider applying for “in-principle” approval from the GEAC as early in the process as possible. Such approval, although not final or binding, would typically set forth the conditions to be met by the applicant for grant of final approval. MOEF approvals for infrastructure projects are structured in the foregoing manner.

Third, because most public interest litigation is filed by non-governmental organizations (“NGO”), it is prudent for the applicant to be pro-active and manage its relationships with the concerned NGOs.

Navigating the regulatory process for commercialization of GM food crops in India is not for the faint hearted. The road to commercialization has had, and will likely continue to have, many twists and turns. While the government has decided to embrace food produced through bio-technology to feed its citizens, the regulatory decision making process is often influenced more by political pressure from these opposed to bio-technology than by critical and balanced scientific and technological judgment. To help mitigate the resulting delay and uncertainty, it is helpful for businesses entering this sector to approach the government early on and develop a high-level road map for tackling the approval process.

Anand S. Dayal is a partner with Koura & Company, Advocates and Barrister, based in New Delhi, India. Anand received his J.D. cum laude (1992) from Cornell Law School, and is admitted to the bar both in India and the US (NY and DC). He was previously Of Counsel with White & Case and an associate with Chadbourne & Parke and Pillsbury Madison & Sutro. Anand is chairman of the Anti-Corruption Committee of the American Chamber of Commerce in India. He can be contacted at dayala@vsnl.com or adayal@kouraco.com.

by Anand S. Dayal