Experts Corner Archives

“Stablecoins”: Issues and Possible Approaches on Appropriate Regulatory Response

Cryptocurrencies or crypto assets continue to evoke mixed reactions among the knowledgeable and the lay public.

Do they portend a new world order and which would reshape the entire financial system? Or are they a new form of “tulip mania” or a South Sea Bubble or other mass belief suspending hysteria^[1] and just a financial scam awaiting a damning expose?

In this context, stablecoins — a form of crypto assets — appears to present a halfway house, and deserves a closer review and a deeper understanding.

What are “Stablecoins”?

Stablecoins are a class or type of crypto assets that are backed by a commodity, a currency or an asset. Accordingly, the value of the stablecoins are pegged to, or derived from, the value of such underlying commodity, currency or assets.

Having such an underlying commodity, currency or assets serves to reduce the price volatility of stablecoins (or manages to peg it to the volatility that one observes in the prices of underlying commodity, currency or asset) as compared to other crypto assets. Crypto assets by contrast have shown wild swings in their prices, driven more by speculative forces rather than any practical or real world application (though always spoken as if they do).

Having such an underlying commodity, currency or assets also distinguishes stablecoins from other crypto assets which have no intrinsic worth or value and cannot be redeemed into anything.

Furthermore, any number of stablecoins can be created (subject to availability of the underlying commodity, currency or assets and its acquisition) unlike bitcoins or other crypto assets which are quite so often, by design, limited to a specific number that can be mined and create an artificial scarcity (while projecting the same as an anti-inflation measure).

The (relative) price stability of stablecoins (compared to the volatile prices of other crypto assets) is intended to provide a comfort to investors and merchants in anchoring the prices of goods, services or even other crypto assets.

Stablecoins draw upon the technology and protocols of crypto assets and are backed by or exchangeable into the designated underlying commodity, currency or asset, and hence are considered to represent best of both the worlds: of an important, emergent technology, and of being anchored in real world assets with intrinsic worth that is realisable on demand.

Popular stablecoins and how they describe themselves^[2]

Costs, Income and Risks

Stablecoins are usually expressed in round numbers. Fresh issuance requires the stablecoin issuer to purchase an equivalent value of the commodity, currency or asset that backs such stablecoin.

Given the underpinning of the commodity, currency or asset for stablecoins, one needs to factor in the following costs:

Transaction costs for acquisition or sale of the commodity, currency or asset in form of brokerage, fees, costs, charges and/or stamp duty.
Assayers fees, charges and costs when the commodity or asset is in a physical form for verifying and validating the quality and quantity of the underlying commodity or asset.
Storage, custody and insurance costs when the commodity or asset is in a physical form.
Bank, depository or custodian charges for holding the currency or financial assets.
Auditors fees, charges and costs for verifying and validating the underlying.

Separately, for a holder of stablecoin, there could be costs for purchasing or acquiring stablecoins, storage costs (in a wallet), or transaction costs when making or receiving payments via stablecoins. There are marginal income generation opportunities, for instance by lending the owned stablecoins (with attendant risks).

On the income front, certain underlying assets could generate income for the issuer (akin to but not the same as central banks earning seigniorage^[3]), and help offset its costs. Such income streams can include:

When commodity or physical assets are the underlying: can be lent to earn interest income.
When financial assets are the underlying: these could generate dividend or interest income.
When currency is the underlying asset and has been placed with a bank: interest on deposit.
When the underlying significantly appreciates in value: capital gains.

Such income earning opportunities bring their own commensurate risks.

When the commodity or physical asset has been lent, the risk of borrower failing to return such commodity or asset in a timely manner or failing to service the interest payment obligation or both. Risk of financial assets failing to generate any income. If such financial assets are bonds, debentures or commercial paper of corporations, the risk of such corporations defaulting or failing. When the financial asset is a bank deposit, there is the risk of bank failure^[4]. Price appreciation of an underlying could also mean a later day price correction: if gains have been realised through sale, the issuer may need to purchase the underlying afresh to preserve the equivalence assured for the stablecoin.

Perspectives for a Stablecoin Holder

Acquiring stablecoins closely resembles keeping money as a bank deposit or investing in a liquid mutual fund scheme. The fact that there is an underlying of a commodity, currency or an asset backing the stablecoin and its redeemability inspires enormous confidence.

Apart from the perception of lower transaction costs, stablecoin holders should also evaluate the nature and quality of the income generated from the underlying commodity, currency or asset, even if they are not entitled to the same. This is because any such income brings commensurate risks. Hence, while the income stream may belong to the issuer, when the risks materialise, it could be the stablecoin holders who are left holding the can, and who would have to face the permanently diminished value of the stablecoins.

A further factor to consider is the expectation of quick, simple and ready redemption of stablecoins. Depending on the commodity, currency or asset underlying the stablecoin, unusual high levels of redemption could cause the collapse of the stablecoin. This is akin to how usually high levels of withdrawals of bank deposits can cause a run on such a bank and even lead to its collapse.

Bear in mind that banks have obligations to maintain statutory or cash reserves, are subjected to regulatory supervision and inspection and which is subject to prudential standards for capital adequacy, income recognition and provisioning.

Stablecoins and their issuers have no such obligations or supervisory or regulatory requirements governing them. This can make the issuers of stablecoins susceptible to errors, mistakes or even fraud, which may go undetected for long periods of time. The aspect of underlying commodity, currency or asset if incorrectly valued, not adequately safeguarded or if is uninsured or underinsured may serve to bring operational risks that issuers of stablecoins may not be properly equipped to evaluate and address, but with risks and losses having to be borne by the stablecoin holders.

Given the digital only nature of stablecoins, an investor should be mindful of cyber risks – of hacking, security breaches or compromises of credentials^[5] – that can result in theft or loss of the stablecoins whether at the investor’s end, at any platform where these are traded, at the issuer’s end or at the service providers engaged by the issuer.

Finally, to a large degree, ambiguity over the legal status of crypto assets and of stablecoins should dissuade an investor from putting her hard earned money into such a class of assets. Once there is clarity on the legal status of stablecoins, confidence that one will not run afoul of laws, rules or regulations, and clarity on several aspects mentioned in this paper, is when one could consider making such an investment^[6].

Perspectives for Policymakers, Legislators and Regulators: More Questions than Answers

Stablecoins (or as many a central bank or even Bureau of Indian Standards (BIS) are known to say: “so-called stablecoins” perhaps with a latent fear of endorsing such coins or tokens as indeed being stable) have projected a halfway house between crypto assets and tokens (which display high volatility and price fluctuations) and local currency and payments systems (which are construed as slow or costly or both).

However, a much stronger look at the following aspects is necessary for stablecoins:

Is the issuer “fit and proper”?
Is the underlying duly acquired, and acquired on an arm’s length basis?
Is the underlying duly validated and verified both at the time of its acquisition and at periodic intervals?
Are the costs incurred by the issuer of the stablecoin fair and appropriate for acquisition, storage or custody, insurance or other related costs and charges? Are the arrangements with such service providers arrived at on an arm’s length basis, and are they regulated or inspected and audited at periodic intervals?
Are the underlying assets available in a risk free (or at least, low risk), liquid, easily convertible to cash basis, and can meet redemption requirements?
If the underlying assets are risky, illiquid and difficult to convert to cash when needed, then has there been due disclosure of such risks to the holders of stablecoins?
Can there be avoidance or reduction of the moral hazard of income belonging to the issuer (who, in all fairness it should be said, quite so often also bears some or all of the costs), while the risks are allocated to the stablecoin holders?
Inasmuch as stablecoins resemble bank deposits (or even liquid mutual fund schemes) albeit with features of being digital, transferable and redeemable, should its issuers or its issuance or its holders be regulated? If so, should the regulator be the Reserve Bank of India (if treated akin to bank deposits, with appropriate reserving for the liability and prudential norms for the assets apply) or Securities and Exchange Board of India (SEBI) (if treated akin to liquid mutual fund schemes, with due offer document, disclosure and investments in financial assets, arm’s length and caps on costs) in either situation after the issuer has passed muster with either regulator as “fit and proper”?
Given the projected utility of stablecoins in facilitating payments, should it and its issuers be regulated as a payment and settlements system and its operators respectively?
In case of existing stablecoins issued outside India, what should be the approach? Is such purchase by a holder compliant with foreign exchange remittances limits^[7]? Should the overseas issuer be required to hold or store the underlying in India to the extent Indians hold the stablecoin? Can the underlying be ring fenced? Is localisation and ring fencing desirable, feasible and necessary?
Given the key and material factor of stablecoin requiring or having an underlying commodity, currency or asset, is it collective investment scheme, or a “derivative” and a “securities” in terms of the Indian securities law^[8]? Do its issuers adhere to the securities law on creation of stablecoins? Do stablecoins as a derivative or as securities or both, require being listed and traded only as contemplated in the securities law? Do holders of stablecoins need to hold it only in demat accounts or can they hold it in crypto wallets?

The American View

On 1-11-2021, the President’s Working Group on Financial Markets (PWG), joined by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), released a report on stablecoins^[9].

The press release^[10] notes that: “To address the risks of payment stablecoins, the agencies recommend that Congress act promptly to enact legislation to ensure that payment stablecoins and payment stablecoin arrangements are subject to a federal framework on a consistent and comprehensive basis. Such legislation would complement existing authorities with respect to market integrity, investor protection, and illicit finance, and would address key concerns:

To address risks to stablecoin users and guard against stablecoin runs, legislation should require stablecoin issuers to be insured depository institutions.
To address concerns about payment system risk, in addition to the requirements for stablecoin issuers, legislation should require custodial wallet providers to be subject to appropriate federal oversight. Congress should also provide the federal supervisor of a stablecoin issuer with the authority to require any entity that performs activities that are critical to the functioning of the stablecoin arrangement to meet appropriate risk management standards.
To address additional concerns about systemic risk and concentration of economic power, legislation should require stablecoin issuers to comply with activities restrictions that limit affiliation with commercial entities. Supervisors should have authority to implement standards to promote interoperability among stablecoins. In addition, Congress may wish to consider other standards for custodial wallet providers, such as limits on affiliation with commercial entities or on use of users’ transaction data.”

In short, the recommendations appear to place the issuance of stablecoins with banks, and ensuring banking level of supervision extends to such issuance, wallet providers and requiring arm’s length treatment.

Concluding Remarks

The halfway house approach of stablecoins — in providing low volatility, being speedy and low cost — can bring broader acceptance and adoption, and even provide a playbook or a template for central bank digital currency (CBDC) to follow. These require the questions posed above being satisfactorily addressed.

What also requires being evaluated is that in a country where digital payment tools and technologies such as Unified Payments Interface (UPI) (value across rising volumes of which have crossed USD 100 billion in a single month^[11]), Immediate Payment Service (IMPS), National Electronic Funds Transfer (NEFT), Real Time Gross Settlement (RTGS) being available at a low cost and 24×7 basis and which are within the regulated domain requires stablecoins or crypto assets? These stablecoins or crypto assets could bring risks that are still not fully understood by the lay public, have unaddressed moral hazards, lack of transparency and could be inherently unstable.

Asking that such stablecoins be regulated requires also an understanding and acceptance by the crypto ecosystem that the legal and regulatory framework will bring its scrutiny of fitness and propriety of the players, their dealings and bring additional compliance costs, impose all too necessary fetters (which creators of crypto assets quite so often decry), and perhaps take away the relative cost advantages currently enjoyed over the regulated financial services sector.

For those who already own or hold crypto assets and particularly stablecoins, it is perhaps time to take a closer look at what are the terms of such crypto assets and stablecoins: are these terms fair, appropriate and does the underlying exist, with sufficient assurance that whenever required, redemption will happen. It should not be that in times to come that we discuss and describe these as “so-called stablecoins” or as unstable coins.

† Pramod Rao, Group General Counsel at ICICI Bank. Views are personal.

^[1]Recommended reading: HERE and HERE.

^[2] Source and a recommended read: HERE accessed on 12-11-2021.

^[3] See HERE.

^[4] While the last risk may seem remote, bank failures have been known to happen. Take Northern Rock in the UK, umpteen bank failures in the US where FDIC undertakes an orderly dissolution (which does not necessarily translate to depositors receiving higher than the insured limit in all situations) and closer home where many a cooperative banks have failed (while commercial banks have been by and large rescued by way of forced or voluntary mergers or recapitalisation, and with moratoriums of varying lengths being specified until such rescue took effect).

^[5] There are even incidents of an investor forgetting the password to the wallet resulting in losing access to the crypto asset HERE.

^[6] Read here for views of a SEBI registered investment advisor HERE

^[7] See HERE for RBI posted FAQs on liberalised remittance scheme.

^[8] See definition of “derivatives”, “commodity derivatives” and “securities” in Securities Contracts (Regulation) Act, 1956 (SCRA): Ss. 2(ac), 2(bc), and 2(h); additionally, legality of transactions in derivatives requires such transactions to be in adherence of S. 18-A or of S. 30-A of SCRA.

^[9] See HERE.

^[10] See HERE.

^[11] See HERE.

Experts Corner Tarun Jain (Tax Practitioner)

Judicial Slugfest on Applicability of New Provisions for Reopening of Assessments under Income Tax Law: An Overview

Introduction: Setting the context

Under the fiscal laws assessment has its own unique status and bearing. It implies determination of fiscal consequences under the law concerned, which may result into various implications, such as tax liability (or refund), interest and penal consequences, etc. Accordingly, most fiscal legislations carry specific provisions setting out the powers of the statutory authorities vis-à-vis assessment. These provisions inter alia also provide for “reopening” of assessment i.e. annulling a concluded assessment and redetermining the fiscal consequences.[1] Such provisions are generally applied when there has been non-compliance of the law during the assessment process and the circumstances set out (for the reopening) are complied with.

Different fiscal laws provide for reopening differently. It depends upon the legislative choice as to the process and consequences being stipulated in the fiscal law concerned. It is possible that a particular fiscal law does not stipulate an exhaustive provision for reopening of the entire assessment and only limited aspects of the assessment may be addressed in distinct proceedings, such as “revision”, “rectification”, etc. By contrast, the scheme relating to reopening under the Income Tax Act, 1961 (ITA) is elaborate and specifically sets out the pre-requisite conditions for reopening as also the powers of the assessing officer (AO) who carries out the reopening proceedings.

The reopening related provisions under the ITA have been legislatively revisited recently and a new scheme has been stipulated by the Finance Act, 2021. This new scheme for reopening is substantially different from the earlier scheme of the ITA which had been in vogue for more than two decades and had received extensive judicial enunciation. The temporal application of the new law, besides the admixture of various general orders passed on account of flexibilities required in view of Covid-related protocols, however, have resulted into a quagmire as regards the correct scope and application of the new reopening scheme under the ITA. This has even resulted into conflicting decisions of the High Courts. This article attempts an overview of the changes and the reason for the judicial challenges which are expected to shape the contours of the new scheme for reopening of assessments under the ITA.

The pre-2021 scheme of ITA for reopening of assessment

Chapter XIV of the ITA stipulates the “procedure for assessment”. Within this chapter, Sections 147 to 151 are the substantive provisions which deal with reopening and consequential reassessment of income. These provisions were, prior to the 2021 change, introduced by the Finance Act, 1987 and were operational since 1989. Under this scheme, reopening proceedings could be instituted if the AO had “reason to believe that any income chargeable to tax has escaped assessment”. Even though the ITA specified certain situations wherein it could be considered that income had escaped assessment, the ITA did not exhaustively set out the circumstances in which the AO could have reasons to believe. Accordingly, as is evident, this scheme gave considerable latitude and discretion to the AO as regards reopening of assessment under the ITA.

The 1989 scheme was interjected by the Supreme Court in two leading decisions. In GKN[2] the Supreme Court introduced a substantive entitlement for the taxpayer against whom reopening proceedings had been initiated. In this decision the Supreme Court directed that a taxpayer who was served with a notice for reopening of assessment could inter alia seek “reasons for issuing notice” and the AO was “bound to furnish reasons within a reasonable time”. Thereafter, on receipt of reasons, the taxpayer was entitled “to file objections to issuance of notice” whereupon the AO was “bound to dispose of the same by passing a speaking order”. It was only after such order disposing the objections to reopening that the AO could proceed with the substantive proceedings for the reassessment. Thereafter, in its decision in Kelvinator[3], the Supreme Court again intervened, this time to substantially address the scope of “reason to believe” and the powers of the AO to reopen assessments. The Supreme Court in this case inter alia declared that the power of AO under the 1989 scheme to reopen assessment was not an unlimited power which could be exercised indiscriminately. The “reason to believe”, according to the Supreme Court, could not be a mere “change of opinion” and instead, reopening could take place only if the AO has “tangible material to come to the conclusion that there is escapement of income from assessment” besides the fact that the “reasons must have a live link with the formation of the belief” regarding escapement of income.

There were many other decisions of the Supreme Court and the High Courts which shaped the 1989 scheme relating to reopening of assessment under the ITA. These judicially stipulated standards introduced, thus, the principles of natural justice (inter alia by way an opportunity to defend against reopening of assessment) and substantive entitlements of the taxpayers to guard against unjust reopening of assessments. At the same time, however, these decisions created a parallel remedy to the taxpayer whereby the reopening of assessment could be questioned by way of a judicial challenge through writ petition before the High Court. This, pragmatically, resulted into a number of disputes. The writ jurisdiction of the High Courts was clogged with challenges to reassessment proceedings which often alleged the failure of the AOs to observe the judicially established standards. A flip-flop judicial attitude (such as in Chhabil Dass[4] which was later distinguished[5]), etc., also did not help to settle the controversy. Resultantly the law did not attain tranquility and reopening of assessments under the ITA was an area perpetually mired in controversies.

The 2021 scheme of ITA for reopening of assessment

Driven by the “need to completely reform the system of assessment or reassessment or recomputation of income escaping assessment and the assessment of search related cases”, the Government proposed an overhaul of the scheme for reopening in the ITA through the Finance Bill, 2021.[6] The change was explained as being accentuated by the desire to introduce “a completely new procedure … [which] would result in less litigation and would provide ease of doing business to taxpayers”. This proposal was accepted by the Parliament, whereby the Finance Act, 2021 amended the ITA to introduce the 2021 scheme.

The most striking feature of the 2021 scheme is the removal of the “reason to believe” standard which prevailed under the pre-2021 scheme for reopening of assessments under the ITA. Instead, the AO can initiate the reopening proceedings only if “there is information with the [AO] which suggests that the income chargeable to tax has escaped assessment in the case of the assessee”.[7] Furthermore, it is not that any and every random data qualifies as “information” for the purpose. The ITA specifically provides what qualifies as “information” which enables the AO to initiate reopening proceedings, which is, either[8] (i) information arising from “risk management strategy” formulated by the Central Board of Direct Taxes (CBDT); or (ii) an objection raised by the Comptroller and Auditor General of India (CAG).

Unlike the pre-2021, it is no more a judicial fiat and instead the 2021 scheme now legally obliges the AO to share the information with the taxpayer concerned, provide a hearing opportunity to defend against reopening, and formally dispose the taxpayer’s objections before initiating the reopening proceedings.[9] Furthermore, the limitation period for reopening stands reduced under the 2021 scheme and reopening can ordinarily be ordered only within three years.[10]

Clearly, at least by design, the 2021 scheme appears to be an improvement as it codifies the taxpayers’ right emanating from the decisions under the pre-2021 scheme qua reopening of assessment under the ITA. The discretion of the AO to reopen assessments appears to be regimented with substantive pre-requisites and procedural conditions under the 2021 scheme. It is not out of place, therefore, that taxpayers would to be governed by the 2021 scheme for reopening instead of seeking judicial vindication of their rights under the pre-2021 scheme.

Issues regarding the applicable date and interfacing Covid-induced fiscal extensions

The Finance Act, 2021 provides that the 2021 scheme for reopening of assessments under the ITA shall come into force from 1-4-2021. However, there is no clarity whether the 2021 scheme for reopening of assessment applies for all reopening proceedings after 1-4-2021 or if the 2021 scheme is limited in application to reopening of an assessment which took place after 1-4-2021. In other words, the moot question which arises is that, if an assessment was concluded before 1-4-2021, would its reopening be governed by the 2021 scheme or the pre-2021 scheme would continue to apply for reopening of such assessment. The answer to this question is fraught with consequences because, as observed earlier, there are numerous limitations on the AO’s enablement to reopen under the 2021 and therefore the taxpayer is better off, at least from a substantive entitlement perspective if the 2021 scheme for reopening applies whereas AO has more discretion and powers if the reopening is governed by pre-2021 scheme.

It is also expedient to factor certain aberrations which arose in view of the various legislative extensions granted under the law to address the complexities arising out Covid-induced restrictions. In view of the various lockdowns, the “Taxation and Other Laws (Relaxation of Certain Provisions) Ordinance, 2020” was promulgated in March 2020 to extend the time limit under various fiscal laws. This Ordinance was succeeded by the “Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020”[11] which provided similarly. Various notifications were issued under this Act whereby time limits under various fiscal laws were further extended. These included certain notifications wherein it was provided that the pre-2021 scheme for reopening of assessment was extended (and was to be applied) in respect of concluded assessments.

Current controversy

As evident from above, the introduction of 2021 scheme has resulted into a controversy regarding its contemporaneous application. The AOs have continued to initiate proceedings for reopening assessments of earlier years on the basis of the pre-2021 provisions on the purported premise that the 2021 scheme does not apply to assessments concluded before the assessment of the 2021 scheme. This premise is based partly on account of the 2021 Act and partly on account of the temporary changes introduced in tax laws as relaxation owing to Covid-related restrictions. This premise and actions of the AOs have resulted into a large number of disputes with mixed judicial response.

The first decision on challenge to 2021 reopening scheme was rendered by the Chhattisgarh High Court in Palak case[12] wherein a Single Judge dismissed the challenge citing practical difficulties in giving strict effect to the 2021 scheme. Sustaining the action of the AO in issuing new reopening notices after 1-4-2021 but under the pre-2021 scheme as necessitated by factual and legal circumstances on account of Covid-related restrictions, the High Court inter alia observed as under:

“The necessity occurred because of the Covid pandemic lockdown in the backdrop of the fact that few of the assessees could not file their return. Likewise since the offices were closed, the Department also could not perform the statutory duty under the Income Tax Act. Considering the complexity, the Parliament thought it proper to delegate the Ministry of Finance, the date of applicability of the amended section. The delegation is not a self-contained and complete Act and was only made in the interest of flexibility and smooth working of the Act, and the delegation therefore was a practical necessity. … The notification is made by the Ministry of Finance, Central Government considering the fact of lockdown all over India, it can be always be assumed that the deferment of the application of Section 148-A was done in a control way.

…

The pandemic and lockdown prevailed all over India. The people could not file their return or comply with the various mandate of Income Tax Act. Considering such situation for the benefit of the assessee and to facilitate the individual to come out of woods, the time limit framed under Income Tax Act was extended. Likewise certain right which was reserved in favour of the Income Tax Department was also preserved and was extended at parity. Consequently the provisions of Section 148 which was prevailing prior to the amendment of Finance Act, 2021 was also extended. Here in this case, the power to issue notice under Section 148 which was prior to the amendment was also saved and the time was extended. In a result, the notice issued on 30-6-2021 (Annexure P-1) would also be saved. Therefore, no interference is required to be made in the said issuance of notice and accordingly the petitions are dismissed.”

The aforesaid reasoning of the Chhattisgarh High Court, however, was not found acceptable by the Allahabad High Court. Its Division Bench in Ashok[13] concluded that the AO was not competent to invoke the pre-2021 scheme for reopening of assessment after 1-4-2021 and therefore all proceedings on that basis lacked legal validity. The Allahabad High Court, in concluding such, opined that the legislative extensions owing to the Covid-related restrictions did not extend the application of the pre-2021 scheme beyond 1-4-2021 inter alia observing as under:

“… in absence of any proceeding of reassessment having been initiated prior to the date 1-4-2021, it is the amended law alone that would apply. We do not see how the delegate i.e. Central Government or the CBDT could have issued the notifications, plainly to overreach the principal legislation. …

Unless specifically enabled under any law and unless that burden had been discharged by the respondents, we are unable to accept the further submission advanced by the learned Additional Solicitor General of India that practicality dictates that the reassessment proceedings be protected. Practicality, if any, may lead to legislation. Once the matter reaches court, it is the legislation and its language, and the interpretation offered to that language as may primarily be decisive to govern the outcome of the proceeding. To read practicality into enacted law is dangerous. Also, it would involve legislation by the court, an idea and exercise we carefully tread away from.

Similarly, the mischief rule has limited application in the present case. Only in case of any doubt existing as to which of the two interpretations may apply or to clear a doubt as to the true interpretation of a provision, the court may look at the mischief rule to find the correct law. However, where plain legislative action exists, as in the present case (whereunder the Parliament has substituted the old provisions regarding reassessment with new provisions w.e.f. 1-4-2021), the mischief rule has no application.

***

Upon the Finance Act, 2021 enforced w.e.f. 1-4-2021 without any saving of the provisions substituted, there is no room to reach a conclusion as to conflict of laws. It was for the assessing authority to act according to the law as existed on and after 1-4-2021. If the rule of limitation permitted, it could initiate, reassessment proceedings in accordance with the new law, after making adequate compliance of the same. That not done, the reassessment proceedings initiated against the petitioners are without jurisdiction.”

Thus, as on date there are conflicting views of the High Courts as regards the relevant date for application of the 2021 scheme. Purportedly seeking a consistent outcome, a transfer petition was filed in the Supreme Court to consolidate all challenges to reopening proceedings. However, that transfer petition also stands dismissed.[14] Thus, more High Court decisions can be expected on this aspect. In fact, various other High Courts are in process of hearing similar challenges.[15] The Delhi High Court alone has over 1300 writ petitions which were heard recently.[16] In any case, given the conflicting views so far, the closure of the issue will indeed require a closer examination by the Supreme Court.

Conclusion

It would be impractical to exhaustively set out the grounds for challenge to the reopening proceedings. These grounds, however, can be summarised to state that the legal challenges to the reopening proceedings present an interesting area of inquiry with an admixture of administrative law, interpretation law, constitutional law and various other dimensions playing out in the arena of fiscal laws. In fact, research would reveal that challenges to reopening of assessment, not just under ITA but also under other fiscal laws, are too frequent and continue to disproportionately claim judicial time. The 2021 scheme is clearly an improvement over the earlier provisions dealing with reopening of assessments under ITA because the 2021 scheme relies upon objectively demonstrable factors as a condition for reopening which arrests the discretion of the AO and thus obviates the scope for errors and abuse of power. Perhaps the recent controversy over the application of the 2021 scheme will also get the attention of the Parliament such that its applicability stands legislatively clarifies instead of relegating them to seek judicial remedies.

† Tarun Jain, Advocate, Supreme Court of India; LLM (Taxation), London School of Economics.

[1] For the substantive implications of reopening and reassessment in the context of income tax law, see Calcutta Discount Co. Ltd. v. ITO, AIR 1961 SC 372 : (1961) 2 SCR 241 : (1961) 41 ITR 191.

[2]GKN Driveshafts (India) Ltd. v. ITO, (2003) 1 SCC 72.

[3]CIT v. Kelvinator of India Ltd., (2010) 2 SCC 723.

[4]CIT v. Chhabil Dass Agarwal, (2014) 1 SCC 603.

[5]See, Jeans Knit (P) Ltd. v. CIT, (2018) 12 SCC 36.

[6]Memorandum explaining the provisions in the Finance Bill, 2021, p. 46.

[7] Proviso to S. 148, ITA (as amended by Finance Act, 2021).

[8] Explanation 1 to S. 148, ITA. Except that in a “search” case, certain additional conditions apply, as detailed in Explanation 2 to S. 148.

[9] S. 148-A, ITA.

[10] The limitation can be extended in certain specific cases

[11] Available at <HERE>.

[12]Palak Khatuja v. Union of India, (2021) 322 CTR 417.

[13]Ashok Kumar Agarwal v. Union of India, Writ Tax No. 524 of 2021 (and connected petitions), decision dated 30-9-2021 (Allahabad High Court).

[14]Rajinder Kumar v. CBDT, Transfer Petition (Civil) No. 1698 of 2021 (and connected petitions), decided on 15-11-2021 (SC).

[15]For illustration, the issue is currently pending before the Bombay High Court in Tata Communications Transformation Services Ltd. v. CIT, Writ Petition No. 1334 of 2021, notice issued vide order dated 5-7-2021.

[16]For illustration, see Mon Mohan Kohli v. CIT, 2021 SCC OnLine Del 4717.

Experts Corner Siddharth R Gupta

Article 14 and Arbitrariness vis-à-vis Legislative Action [Part II]

Part I of this Article dwelt into the origins of the concept of non-arbitrariness through various judgments delivered in the decades of 1950s and 1960s. It discussed the ripening of the said jurisprudence up to the judgment of E.P. Royappa v. State of T.N.^[1] Eventually, whilst referring to various judgments, specifically the judgment of the Supreme Court in K.R. Lakshmanan v. State of T.N.^[2], to deduce that the sword of non-arbitrariness can be swung for invalidating not only the executive action, but also the legislative one. Part I thus, left the remaining discourse to be covered by the present part of this article, which shall be elucidating upon distortion of the applicability of arbitrariness for invalidating legislative action in the judgment of State of A.P. v. McDowell & Co.^[3] How post distortion in McDowell[4], the Supreme Court did a systemic course correction in Shayara Bano v. Union of India^[5] and settled the chequered legal position holding the ground today. The article shall also delve into “time as a testing criteria” for examining the validity or invalidity of the legislation on the altar of Article 14 and the initial view of the Indian judiciary on the same.

Distortion in McDowell and its Resurrection in Shayara Bano

In State of A.P. v. McDowell & Co.^[6], constitutional validity of certain provisions of Andhra Pradesh Liquor Prohibition (Amendment) Act, 1995 were assailed by the manufacturers of intoxicating liquor. The challenge relating to Article 14 and arbitrariness of the amending provisions was mounted essentially on the ground that though there was an absolute prohibition under the enactment, the exempted categories were allowed to consume intoxicated liquor in Andhra Pradesh. Thus the real purpose of imposing a total prohibition within the territories of Andhra Pradesh stood defeated by provisions relating to exemption of specified categories of manufacturers and consumers of liquor, which was pitched to be completely arbitrary. It was argued that roots of Article 14 were traceable to the Federal Constitution of the United States of America, wherein the power of the Parliament/State Legislature to make the laws is delimited by the Bill of Rights. The 3-Judge Bench of the Supreme Court vide para 43^[7] onwards held that only two grounds are available for striking down any legislation/legislative action viz. “lack of legislative competence” or “violation of any fundamental right under Part III of the Constitution of India” or any other constitutional provision, or both. The Court further held that the ground of invalidation must fall within four corners of the wordings of Article 14, then only can it be struck down. In the context of Article 19(1), it was held that parliamentary/State legislation can be struck down only if it is found to be not saved by any of clauses (2) to (6) of Article 19. The Court in clear and categorical terms held that no enactment can be struck down merely on the argument that it is “arbitrary” or “unreasonable”, but there has to be some other tangible constitutional infirmity to be found before the legislation is declared unconstitutional. The Supreme Court vide para 46 held that applicability of arbitrariness as a ground for invalidating any legislation is confined only to legislative actions and no opinion was expressed insofar as its applicability to delegated legislation is concerned. The Court held that any act which is discriminatory can easily be labelled as arbitrary, but the reverse synthesis is not permissible. Accordingly, the Court repelled the challenge to the constitutionality of the A.P. Prohibition Act, on the specific anvil of the arbitrariness under Article 14 of the Constitution of India.

Thus, the judgment of McDowell[8] was essentially a clear distortion from the linear reasoning being adopted prior to it of legislations being invalidated if found “arbitrary” per se. The Supreme Court in McDowell case[9] thus completely shut the doors to entertain any argument of arbitrariness for assailing any legislative enactment.

Pertinently, McDowell case[10] had in its enthusiastic bid to hold or limit the applicability of arbitrariness doctrine to legislative enactments ignored its own binding decisions delivered prior in point of time. The first one being the Constitution Bench judgment in Ajay Hasia v. Khalid Mujib Sehravardi^[11] by a larger Bench and the second one being the Coordinate 3-Judge Bench judgment in K.R. Lakshmanan[12].

Besides the line of reasoning adopted by the three-Judge Bench in McDowell case[13] was that American Courts have discouraged and dissuaded the employment of “substantive due process” for scrutinising and invalidating legislative actions in the US. Therefore the Court should not sit over the wisdom of the legislature and employ “substantive due process” to strike down legislative provisions. This reasoning was completely flawed as by this time, Maneka Gandhi v. Union of India^[14] and its legacy had come to occupy the field with Articles 21, and 14 imbued with the spirit of substantive due process getting interconnected and interlinked with “reasonableness” under Article 19. This was said in so many words by Justice Krishna Iyer in the celebrated judgment of Sunil Batra v. Delhi Admn.^[15], wherein the Court categorically held that Section 21 encompasses substantive due process and fairness also as a ground for testing any executive decision. Vide para 52, the Supreme Court in Sunil Batra[16] speaking through Justice Krishna Iyer held thus:

True, our Constitution has no “due process” clause or the VIII Amendment; but, in this branch of law, after Rustom Cavasjee Cooper v. Union of India[17] and Maneka Gandhi[18], the consequence is the same. For what is punitively outrageous, scandalisingly unusual or cruel and rehabilitatively counterproductive, is unarguably unreasonable and arbitrary and is shot down by Articles 14 and 19 and if inflicted with procedural unfairness, falls foul of Article 21. Part III of the Constitution does not part company with the prisoner at the gates, and judicial oversight protects the prisoner’s shrunken fundamental rights, if flouted, frowned upon or frozen by the prison authority. Is a person under death sentence or undertrial unilaterally dubbed dangerous liable to suffer extra torment too deep for tears? Emphatically no, lest social justice, dignity of the individual, equality before the law, procedure established by law and the seven lamps of freedom (Article 19) become chimerical constitutional claptrap. Judges, even within a prison setting, are the real, though restricted, ombudsmen empowered to proscribe and prescribe, humanise and civilise the lifestyle within the concerns. The operation of Articles 14, 19 and 21 may be pared down for a prisoner but not puffed out altogether. For example, public addresses by prisoners may be put down but talking to fellow prisoners cannot. Vows of silence or taboos on writing poetry or drawing cartoons are violative of Article 19. So also, locomotion may be limited by the needs of imprisonment but binding hand and foot, with hoops of steel, every man or woman sentenced for a term is doing violence to Part III.

McDowell21, which was a 3-Judge Bench pronouncement, was followed by multiple other subsequent judgments of the Supreme Court, as also the High Courts, which are not being spelt out herein, since the discussion has to now get routed to the verdict of Shayara Bano v. Union of India[19] of the Constitution Bench of the Supreme Court of India. Here the practice of instantaneous triple talaq was laid challenge to by Shayara Bano who was a Muslim lady and married to Rizwan Ahmed for 15 years, when in 2016, she was divorced by just being pronounced orally talaq thrice.

She approached the Supreme Court praying for writ declaring the orally declared triple talaq void ab initio on the grounds that it violated her fundamental rights. The question arose about the applicability of Section 2 of the Muslim Personal Law (Shariat) Application Act, 1937, which provided that “notwithstanding any custom or usage to the contrary, all questions relating to marriage, dissolution of marriage, including talaq, ila, zihar, lian, khula, and mubaarat, etc. the rule of decision in cases where the parties are Muslims shall be Muslim Personal Law (Shariat)”. Meaning thereby that in case of Muslims, by virtue of Section 2 of the Application Act of 1937, Muslim personal laws became automatically applicable in disputes appertaining to marriage, dissolution of marriage, including talaq.

The majority opinion led by Justice R.F. Nariman held that the practice of triple talaq is inherently unconstitutional. Referring to the long line of judgments of Sunil Batra[20], Mithu v. State of Punjab^[21], the Court held that a law can always be tested on the allegations of it being arbitrary, oppressive and crossing all the bounds of reasonableness. The Court categorically held that McDowell case[22] had perhaps overlooked and ignored the binding nature and efficacy of multiple Constitution Bench and Coordinate Bench (3 Judges) judgments, which being earlier in point of time were all binding on it. Vide paras 82 to 84 of the Shayara Bano case25, the majority speaking through Justice R.F. Nariman held thus:

It is, therefore, clear from a reading of even the aforesaid two Constitution Bench judgments in Mithu case[23] and Sunil Batra case[24] that Article 14 has been referred to in the context of the constitutional invalidity of statutory law to show that such statutory law will be struck down if it is found to be “arbitrary”.
… A three-Judge Bench in the teeth of this ratio cannot, therefore, be said to be good law. Also, the binding Constitution Bench decision in Sunil Batra^[25] which held arbitrariness as a ground for striking down a legislative provision, is not at all referred to in the three-Judge Bench decision in McDowell^[26].
The second reason given is that a challenge under Article 14 has to be viewed separately from a challenge under Article 19, which is a reiteration of the point of view of A.K. Gopalan v. State of Madras^[27] that fundamental rights must be seen in watertight compartments. We have seen how this view was upset by an eleven-Judge Bench of this Court in Rustom Cavasjee Cooper v. Union of India^[28] and followed in Maneka Gandhi^[29]. Arbitrariness in legislation is very much a facet of unreasonableness in Articles 19(2) to (6), as has been laid down in several judgments of this Court, some of which are referred to in Om Kumar v. Union of India^[30] and, therefore, there is no reason why arbitrariness cannot be used in the aforesaid sense to strike down legislation under Article 14 as well.

Accordingly the Supreme Court expressly overruled the judgment of McDowell[31] and the consequent distortion caused by it. The law eventually resettled by Shayara Bano[32] is that applying the “arbitrariness doctrine”, even the legislative provisions can be struck down if they are found to be discriminatory, with their operation being whimsical, excessive, unreasonable or disproportionate. The Constitution Bench categorically held that this sort of arbitrariness will cut deeply through all kinds of State action, be it legislative or executive and would spare no one. The fine tuning of this doctrine was taken to highest standards in Shayara Bano[33] by holding that Articles 32 and 226 are an integral part of the Constitution and provide remedies for enforcement of fundamental rights as also other rights conferred by the Constitution. Hesitation or refusal on the part of constitutional courts to nullify the provisions of an Act meant to be unconstitutional on the technical grounds of “non-applicability of arbitrariness doctrine” to legislative actions even when such legislative provisions patently infringe constitutional guarantees in the name of judicial humility, would escalate serious erosion of remedies available to the citizens of this country under the Constitution.

The majority opinion of the Supreme Court thus in Shayara Bano[34] ultimately held that triple talaq is gender biased giving uncanalised discretion to a Muslim man/husband to strip off his marital ties with his wife through mere oral recitations. Therefore Section 2 of the Application Act of 1937 was held to be patently unconstitutional being manifestly arbitrary.

Two recent judgments of the Supreme Court in State of T.N. v. K. Shyam Sunder^[35] and A.P. Dairy Development Corpn. Federation v. B. Narasimha Reddy^[36] reiterated the legal position that even legislative provisions can be struck down if found to be arbitrary and resultantly violative of Article 14. Vide paras 52 and 53, the Supreme Court in K. Shyam Sunder[37] observed as follows:

In Bombay Dyeing & Mfg. Co. Ltd. (3) v. Bombay Environmental Action Group^[38], this Court held that:

“205. Arbitrariness on the part of the legislature so as to make the legislation violative of Article 14 of the Constitution should ordinarily be manifest arbitrariness.”

In Bidhannagar (Salt Lake) Welfare Assn. v. Central Valuation Board[39] and Grand Kakatiya Sheraton Hotel and Towers Employees and Workers Union v. Srinivasa Resorts Ltd.^[40], this Court held that a law cannot be declared ultra vires on the ground of hardship but can be done so on the ground of total unreasonableness. The legislation can be questioned as arbitrary and ultra vires under Article 14. However, to declare an Act ultra vires under Article 14, the court must be satisfied in respect of substantive unreasonableness in the statute itself.

In the same vein, the Supreme Court vide para 29 in A.P. Dairy Development Corpn.[41] reiterated the legal proposition as follows:

It is a settled legal proposition that Article 14 of the Constitution strikes at arbitrariness because an action that is arbitrary, must necessarily involve negation of equality. This doctrine of arbitrariness is not restricted only to executive actions, but also applies to the legislature. Thus, a party has to satisfy that the action was reasonable, not done in unreasonable manner or capriciously or at pleasure without adequate determining principle, rational, and has been done according to reason or judgment, and certainly does not depend on the will alone. However, the action of the legislature, violative of Article 14 of the Constitution, should ordinarily be manifestly arbitrary. There must be a case of substantive unreasonableness in the statute itself for declaring the act ultra vires Article 14 of the Constitution.

Completing the whole picture on the issue, it is luminescent that there is no inhibition for the constitutional courts to resort to arbitrariness doctrine for striking down any legislative enactment or provision. I am deliberately avoiding reference to a long line of judgments (more than 10 in number) where the Supreme Court in the last 10 years has struck down statutory provisions of any enactment on being found unreasonable, harsh, oppressive, onerous and resultantly arbitrary. It struck down legislative provisions on being found arbitrary even if not strictly discriminatory.

Article 14 and the Time Machine: Initial Judicial Responses

After an indepth analysis and scrutiny of correlation between “arbitrariness doctrine” and its applicability to legislative action, we shall undertake discussion on the specific topic as to how far passage of time can be a testing criteria for the validity of any legislation or legislative provision. In other words, whether any statutory provision which was constitutional to start with at the time of its enactment can be struck down on the ground of arbitrariness with the efflux of time; what impact “time as a factor” has on the applicability of arbitrariness doctrine to any legislative provision or enactment. Under these subheadings we shall be referring to some of the landmark judgments of the early decades of the 1950s, 60s and the 70s, wherein through various judgments of the Supreme Court, the constitutionality of any legislative provision was anchored on the tide of time as the testing criteria.

The first in the fray is the Constitution Bench judgment of the Supreme Court in Bhaiyalal Shukla v. State of M.P.^[42] In this case the petitioner who was a government contractor challenged the levy of sales tax on the building materials supplied by him for the construction of various buildings, roads and bridges under government contracts. Levy of sales tax on the building materials supplied by him for the construction of various buildings, roads and bridges under government contracts, in District Rewa, which was falling under formerly State of Vindhya Pradesh, specifically after merger of that area in the newly constituted State of Madhya Pradesh formed on 1-11-1956 under the States Reorganisation Act. The sale of building materials in works contract was not subject to any levy of sales tax in another part of (the newly constituted) State of Madhya Pradesh. However the Court rejected the said contention holding that “the laws in different portions of newly constituted State of Madhya Pradesh were enacted by different legislatures and till they are repealed or altered by the newly constituted legislature, they shall continue to operate. Different laws in different parts of Madhya Pradesh, which were earlier part of a different demerged State which was earlier part of another State prior to its merger, would be sustained on the grounds of geographical classification arising out of historical reasons….”^[43]

Thus in Bhaiyalal Shukla[44] the Supreme Court did not directly answer the issue of effect of passage of time over validity of any legislation.

The next judicial milestone on the subject under discussion is State of M.P. v. Bhopal Sugar Industries Ltd.,^[45] wherein the levy of agricultural income tax in Bhopal, formerly a part of Bhopal State was continued even post merger with the newly constituted State of Madhya Pradesh in 1956. In all other parts of the State, the levy was not being imposed on the identically placed landowners or assessees. The Supreme Court again referring to Section 119 of the States Reorganisation Act, 1956 held that differential treatment arising out of application of the laws pre-existing from the merger of said regions/States in the newly constituted merged State does not invite discrimination or offend equality clause under Article 14. However the Supreme Court acknowledged the impact “efflux of time” would have on the validity of any legislative provision, even though enacted with justifiable cause or reason on the date of its enactment, but later on becoming constitutionally pernicious for perpetuating a treatment not having reasonable cause or rational basis to support it. Vide para 7 (p. 6), the Constitution Bench of the Supreme Court held thus:

… This in the view of the High Court was unlawful because the State had since the enactment of the States Reorganisation Act sufficient time and opportunity to decide whether the continuance of the Bhopal State Agricultural Income Tax Act in the Bhopal region would be consistent with Article 14 of the Constitution. We are unable to agree with the view of the High Court so expressed. It would be impossible to lay down any definite time limit within which the State had to make necessary adjustments so as to effectuate the equality clause of the Constitution. That initially there was a valid geographical classification of regions in the same State justifying unequal laws when the State was formed must be accepted. But whether the continuance of unequal laws by itself sustained the plea of unlawful discrimination in view of changed circumstances could only be ascertained after a full and thorough enquiry into the continuance of the grounds on which the inequality could rationally be founded, and the change of circumstances, if any, which obliterated the compulsion of expediency and necessity existing at the time when the Reorganisation Act was enacted.

(emphasis supplied)

From the above observations it can safely be inferred that the Supreme Court delved upon the inevitable effect time would have on the validity of any legislation, especially in the context of its failure to pass the litmus test of “equal protection of laws” guaranteed under Article 14 of the Constitution of India. As would be detailed below, this jurisprudence has since thereafter been expanded again and again in various dimensions by the Supreme Court.

Another controversy which cropped up before the Constitution Bench of the Supreme Court in Narottam Kishore Deb Varman v. Union of India^[46] was pertaining to the legality of Section 87-B of the Code of Civil Procedure, 1908. The provision under challenge required prior consent of the Central Government as a prerequisite for institution or trial of any suit against the ruler/maharaja of any State/Province, which got merged with the Indian Union. Though the Supreme Court repelled the constitutional challenge to validity of Section 87-B for historical and geographical justifications produced before it including the protection adumbrated under Article 372 of the Constitution of India. However at the same time, after affirming the constitutionality of Section 87-B, the Supreme Court required the Central Government to review and re-examine the extent of period to which the said protection of prior consent of the Central Government to be available as against the said provision being there on the statute book in perpetuity. Vide para 11, the Constitution Bench held thus:

Before we part with this matter, however, we would like to invite the Central Government to consider seriously whether it is necessary to allow Section 87-B to operate prospectively for all time. The agreements made with the rulers of Indian States may, no doubt, have to be accepted and the assurances given to them may have to be observed. But considered broadly in the light of the basic principle of the equality before law, it seems somewhat odd that Section 87-B should continue to operate for all time. For past dealings and transactions, protection may justifiably be given to rulers of former Indian States; but the Central Government may examine the question as to whether for transactions subsequent to 26-1-1950, this protection need or should be continued. If under the Constitution all citizens are equal, it may be desirable to confine the operation of Section 87-B to past transactions and not to perpetuate the anomaly of the distinction between the rest of the citizens and rulers of former Indian States. With the passage of time, the validity of historical considerations on which Section 87-B is founded will wear out and the continuance of the said section in the Code of Civil Procedure may later be open to serious challenge.

Next in the series is the Constitution Bench judgment of the Supreme Court in H.H. Shri Swamiji of Shri Amar Mutt v. Commr., Hindu Religious and Charitable Endowments Department^[47]. As in the earlier cases, the dispute in this case also arose out of the reorganisation of States in various parts of the country in 1956. The South Kanara District, formerly a part of State of Madras was reconstituted to be merged with the State of Mysore (now Karnataka) in 1956, and by reason of Section 119 of the States Reorganisation Act, Madras Hindu Religious and Charitable Endowments Act, 1951 continued to apply to South Kanara District nonetheless when it ceased to be part of erstwhile State of Madras. The challenge to applicability of Endowments Act of 1951 was mounted on the ground that South Kanara District was the only district in the whole State of Mysore (now Karnataka), which continued to be governed by the Madras State enactment, which was thus starkly offensive of Article 14.

The Supreme Court on the point of “time” rendering the purpose of any legislation ineffective or constitutionally offensive referred to celebrated Latin maxim of “cessante ratione legis cessat ipsa lex”, that is, “reason is the soul of the law and when the reason of any particular law ceases, so does the law itself”. It held that an indefinite extension and application of unequal laws for all times to come starts militating against the true character and laudable intent of being a “temporary measure” to serve a “temporary purpose”. Though the challenge to the constitutionality was repelled by the Supreme Court, but the majority speaking through Justice Y.V. Chandrachud reminded the legislature to wake up timely to the altered necessities of time. The majority opinion directing for suitable tailoring of the legislative provisions, lest it would lead to enactment being left vulnerable to constitutional attack observed vide para 31 of H.H. Shri Swamiji case48 thus:

But that is how the matter stands today. Twenty-three years have gone by since the States Reorganisation Act was passed but unhappily, no serious effort has been made by the State Legislature to introduce any legislation – apart from two abortive attempts in 1963 and 1977 – to remove the inequality between the temples and mutts situated in the South Kanara District and those situated in other areas of Karnataka. Inequality is so clearly writ large on the face of the impugned statute in its application to the district of South Kanara only, that it is perilously near the periphery of unconstitutionality. We have restrained ourselves from declaring the law as inapplicable to the district of South Kanara from today but we would like to make it clear that if the Karnataka Legislature does not act promptly and remove the inequality arising out of the application of the Madras Act of 1951 to the district of South Kanara only, the Act will have to suffer a serious and successful challenge in the not distant future. We do hope that the Government of Karnataka will act promptly and move an appropriate legislation, say, within a year or so. A comprehensive legislation which will apply to all temples and mutts in Karnataka, which are equally situated in the context of the levy of fee, may perhaps afford a satisfactory solution to the problem.

From the narrative of the various judgments in the early decades of the 20th century, it can safely be inferred that indefinite extension and application of unequal laws militates against their real character as also the true intent behind their enactment. The strong foundation on which the edifice of any legislation is erected gets weakened with the passage of time if inequality amongst equals continues unabated without sufficient justifications for continuing them. The Supreme Court has always batted for timely reviews and introspections of such categories of legislations, failing which the legislations are bound to become discriminatory and arbitrary attracting the wrath of Article 14.

With this, we are nearing completion of Part II of the three part series article. Part III of the series, which shall also be the concluding part, shall delve into the remaining issues of “obsolescence as a ground for arbitrariness” of any legislation and the extant position of law on the said proposition.

†Advocate practising at Madhya Pradesh High Court and Supreme Court of India. He specialises in Constitutional Law Matters.

†† Final Year Student, B.A.LL.B (Hons.), National Law Institute University (NLIU), Bhopal.

^[1] (1974) 4 SCC 3 : AIR 1974 SC 555.

^[2] (1996) 2 SCC 226 : AIR 1996 SC 1153.

^[3] (1996) 3 SCC 709 : AIR 1996 SC 1627.

[4] (1996) 3 SCC 709 : AIR 1996 SC 1627.

^[5] (2017) 9 SCC 1.

^[6] (1996) 3 SCC 709 : AIR 1996 SC 1627.

^[7] (1996) 3 SCC 709, 737-38 : AIR 1996 SC 1627.

[8] (1996) 3 SCC 709 : AIR 1996 SC 1627.

[9] (1996) 3 SCC 709 : AIR 1996 SC 1627.

[10] (1996) 3 SCC 709 : AIR 1996 SC 1627.

^[11] (1981) 1 SCC 722 : AIR 1981 SC 487.

[12] (1996) 2 SCC 226 : AIR 1996 SC 1153.

[13] (1996) 3 SCC 709 : AIR 1996 SC 1627.

^[14] (1978) 1 SCC 248 : AIR 1978 SC 597.

^[15] (1978) 4 SCC 494 : AIR 1978 SC 1675.

[16] (1978) 4 SCC 494, 518-19 : AIR 1978 SC 1675.

[17] (1970) 1 SCC 248.

[18] (1978) 1 SCC 248 : AIR 1978 SC 597.

21 (1996) 3 SCC 709 : AIR 1996 SC 1627.

[19] (2017) 9 SCC 1.

[20] (1978) 4 SCC 494 : AIR 1978 SC 1675.

^[21] (1983) 2 SCC 277.

[22] (1996) 3 SCC 709 : AIR 1996 SC 1627.

25 (2017) 9 SCC 1, 87 & 88-89.

[23] (1983) 2 SCC 277.

[24] (1978) 4 SCC 494 : AIR 1978 SC 1675.

^[25] (1978) 4 SCC 494 : AIR 1978 SC 1675.

^[26] (1996) 3 SCC 709 : AIR 1996 SC 1627.

^[27] AIR 1950 SC 27 : 1950 SCR 88.

^[28] (1970) 1 SCC 248.

^[29] (1978) 1 SCC 248 : AIR 1978 SC 597.

^[30] (2001) 2 SCC 386.

[31] (1996) 3 SCC 709 : AIR 1996 SC 1627.

[32] (2017) 9 SCC 1.

[33] (2017) 9 SCC 1.

[34] (2017) 9 SCC 1.

^[35] (2011) 8 SCC 737.

^[36] (2011) 9 SCC 286.

[37] (2011) 8 SCC 737, 767.

^[38] (2006) 3 SCC 434 : AIR 2006 SC 1489.

[39] (2007) 6 SCC 668 : AIR 2007 SC 2276.

^[40] (2009) 5 SCC 342 : AIR 2009 SC 2337.

[41] (2011) 9 SCC 286, 303.

^[42] AIR 1962 SC 981 : 1962 Supp (2) SCR 257.

^[43] AIR 1962 SC 981 : 1962 Supp (2) SCR 257, para 18.

[44] AIR 1962 SC 981 : 1962 Supp (2) SCR 257.

^[45] AIR 1964 SC 1179 : (1964) 6 SCR 846.

^[46] AIR 1964 SC 1590 : (1964) 7 SCR 55.

^[47] (1979) 4 SCC 642 : AIR 1980 SC 1.

48 (1979) 4 SCC 642, 659 : AIR 1980 SC 1, 18.

Experts Corner The Dialogue

Why Do We Need Surveillance Reform in India? – Recent Developments

In the 18^th century, one of the social theorists, Jeremy Bentham, developed the concept of panopticon, which brought in an institutional design to establish control. While this shows that surveillance of any form is not a new phenomenon, recent technological developments have completely changed the surveillance architecture. It has paved the way for the development of surveillance tools that are more intrusive and damaging to our democratic safeguards.

In addition to targeted surveillance (which was debated as part of the Pegasus snoopgate controversy 1 , other forms of surveillance such as mass and lateral surveillance are performed in India, which equally curb the right to privacy and freedom of expression.

Surveillance as a craft has a long-standing history, with various social theorists contributing over time; thus, this article will explore recent developments in India regarding various forms of surveillance that call for robust reform.

Mass surveillance

In India, the State and non-State actors have been using various digital panoptican tools such as artificial intelligence, facial recognition, CCTV cameras, integrated database systems, social media analytics, etc., to monitor and surveil.

Recently, India bagged a couple of top ranks in the Forbes list^[2] of most surveilled cities globally, where Delhi stood at rank one. While Delhi CM alluded to Forbes recognition, this would have a chilling effect on privacy and freedom of expression without surveillance reform. In addition, CCTV cameras equipped with other AI-based technology such as facial recognition have been extensively used in India to tackle various social problems despite global criticism on facial recognition malfunctions, accuracy rate and innate discrimination of minorities and women. Besides, it has been reported that drones with cameras are used for monitoring purposes, but it is unclear how video footage will be used later.

On the other hand, the State has made various efforts to integrate databases and analytics tools to monitor people and their actions. For instance, the Central Government has equipped a technology called Advanced Application for Social Media Analytics (AASMA^[3]); this tool will aid both Central and State Governments to monitor social media. But in 2018 Supreme Court of India stopped a similar project of the Central Government titled social media communication hub (SMCH), stating it to be a step to the surveillance State and problematic in the absence of a data protection regime.

Similarly, as citizens use Aadhaar-based authentication systems for any service enrollment or transaction, the information on the authentication process, transaction details, etc., are recorded at a central database. While the Government states that profiling citizens enable better welfare delivery, it has been criticised for its potential to cause exclusion^[4] and surveillance^[5], which is not accounted for. Though Unique Identification Authority of India (UIDAI) has been commissioned as the custodian of Aadhaar data, it is also the regulator of Aadhaar infrastructure, which does not create any meaningful and independent accountability in case of misuse. Besides, in the Aadhaar judgment (2018)^[6], while the Supreme Court provided constitutional validation to the Aadhaar scheme, it has also struck down various provisions on the grounds of proportionality, data security, and privacy. The judgment pushed for the development of a data protection regime and also struck down the provision on data sharing on national security grounds.

Targeted surveillance

Targeted surveillance in the form of interception has a long-standing history predating any of the recent technological developments. Under legal grounds of the Telegraph Act, 1885 [Section 5(2)] and Information Technology Act (Section 69), the Government can intercept, monitor, and decrypt any information for protecting sovereignty, national security, friendly relations with international States, public order, etc.

There are various non-State lawful interception systems^[7] available in the Indian market which are installed into the networks of telecom services and internet services by the Government through the licence agreement. While most of the details on the operations of these systems are confidential, spy files^[8] project by WikiLeaks, which created a revelation, revealed that the capacity of these Indian lawful interception systems is way beyond what is available publicly in terms of surveillance.

However, there are also other not entirely lawful interception mechanisms in the market, like Pegasus. The Pegasus controversy is not a new thing, and it first broke in 2019 when WhatsApp reported^[9] that Pegasus targeted 1400 phone numbers of its users. While the Indian Government asserted to investigate this matter, the recent Expert Committee constituted by the Supreme Court on the Pegasus allegation^[10] will be probing the steps/actions taken by the Government after reports were published.

In addition, like PRISM in the USA, in India, we have a similar system called Central Monitoring System (CMS) and it was implemented in 2015.^[11] While the CMS system still relies on lawful interceptors for interception and monitoring, its operations highlight surveillance capacities as they cut the line of the process to automatically retrieve information from the network of telecom service providers or the internet without approaching them.

Besides, non-State actors like digital platforms perform targeted surveillance to promote business interest and to cater better service to the users without any legal grounds and guidelines for securing user privacy.

Lateral surveillance

While a traditional surveillance set-up involves two actors at different power levels i.e. the State or non-State actor can watch citizens; lateral surveillance^[12] breaks this code by enabling peer-to-peer surveillance.

In response to the pandemic, the Government had resorted to various technological measures to tackle the spread of the virus and for administering the vaccination. One of the most sought out measures globally was the contact tracing app and quarantine monitoring apps. These apps can majorly cause lateral surveillance due to the high chances of data breaches^[13]. In addition, at the aggregate level, these apps encourage “watch over others” culture, where the people from a particular area might watch out for the neighbouring areas, leading towards exclusion and other unintended impacts.

Contact tracing apps are new in the game; apps that stimulate lateral surveillance have been there for some time now. Some of the prominent lateral surveillance apps are HawkEye, C-Plan, RajCop Citizen, etc. Also, to monitor the digital public sphere, the cyber volunteers programme seeks citizens to report unlawful activities on the internet and social media.

Way forward

The Forbes list of most surveilled cities in the world shows that Indian cities have surpassed China in terms of the number of CCTV cameras installed. Being a democratic country, India surpassing/giving tough competition to an authoritarian country like China in terms of surveillance, questions the trajectory that India, as the largest democracy, wants to set for the future. Does India want to subdue its citizens or empower them?

While these monitoring mechanisms are instituted by State and non-State actors for different purposes, in the absence of surveillance reform and data protection, these new technological means subdue citizens by causing unaccountable surveillance, infringing citizens’ freedom of expression and privacy.

The Supreme Court of India delivered its judgment on K.S. Puttaswamy v. Union of India[14], declaring privacy as a fundamental right under Article 21 of the Indian Constitution. Therefore using this judgment as a substratum, comprehensive surveillance reform should be constituted, which gets India into the path of empowered citizenry where the right to privacy is secured from the interference of surveillance.

As the Expert Committee formed by the Supreme Court will recommend enactment/amendment to existing laws^[15] around surveillance to secure privacy, it is important to have a separate/new surveillance legislation that is clearer, purposive, proportionate, and comprehensive (covering all forms of surveillance). The surveillance legislation should bring both State and non-State actors under its purview and demand a robust accountability mechanism that involves both parliamentary and judiciary oversight.

† Senior Research Associate at The Dialogue.

[1]The Pegasus Project (nd). Retrieved from The Guardian: See HERE.

^[2] Delhi, Chennai Among Most Surveilled in the World, Ahead of Chinese Cities (2021). See Forbes India: HERE.

^[3] Ranjini (2020), The Government of India is Monitoring our Social Media. See Logically: HERE.

^[4] Falling through the Cracks: Case Studies in Exclusion from Social Protection (2021). See Dvara Research: HERE.

^[5] Parthasarathy, S. (2018), Aadhaar: Enabling a Form of Super-surveillance. See The Hindu: HERE.

^[6] K.S. Puttaswamy v. Union of India, (2019) 1 SCC 1.

^[7] SFLC (2019), Communications Surveillance in India. See SFLC: HERE.

^[8] WikiLeaks (2011), The Spy Files. See WikiLeaks: HERE.

^[9] Chishti, S. (2019), WhatsApp Confirms: Israeli Spyware was Used to Snoop on Indian Journalists, Activists. See The Indian Express: HERE.

^[10] Ojha, S. (2021), BREAKING: Supreme Court Constitutes Independent Expert Committee to Probe Pegasus Snooping Allegations. See HERE.

^[11] Centre for Internet and Society (2014), India’s Central Monitoring System (CMS): Something to Worry About? HERE.

^[12] Andrejevic, M. (2005, Surveillance & Society), The Work of Watching One Another: Lateral Surveillance, Risk, and Governance. Retrieved from Surveillance & Society: HERE.

^[13] Swaminathan, M. and Saluja, S. (2020), Essay: Watching Corona or Neighbours? Introducing “Lateral Surveillance” during COVID-19. Retrieved from Centre for Internet and Society: HERE.

[14] (2017) 10 SCC 1.

^[15] AK, A. (2021), Pegasus: Members and Terms of Reference of the Committee Appointed by the Supreme Court. See HERE.

'Lex Mercatoria' by Hasit Seth Experts Corner

Exploring the Use of UNCITRAL’s Arbitration Rules and Materials in Indian Ad Hoc Arbitrations

A. Introduction

This article explores the use of United Nations Commission on International Trade Law (UNCITRAL) materials[1] like UNCITRAL Arbitration Rules, Notes on Organising Arbitral Proceedings, Model Law on International Commercial Arbitration, or a new adaptation of these materials for use in ad hoc arbitrations in India. In particular, the article explores the possibilities of mandating or encouraging the use of UNCITRAL arbitration materials in arbitrations or to create a new set of rules based on the existing UNCITRAL arbitration materials for ad hoc arbitrations in India.

Ad hoc arbitrations depend on the parties and the arbitrators to set the procedural norms. Only in some ad hoc arbitrations, parties mutually agree to or the arbitrators set out detailed procedural rules. It is impractical to expect that a similar effort can be done in most ad hoc arbitrations. UNCITRAL Arbitration Rules are a popular solution to the lack of arbitral rules for ad hoc commercial arbitrations, though their popularity is high in investment treaty arbitrations.

The Central Government has not exercised its rule-making power under Section 84 of the Arbitration and Conciliation Act, 1996 (A&C Act, 1996) to prescribe any rules for ad hoc arbitrations. This article also highlights the heavy influence of UNCITRAL Model Law on International Commercial Arbitration and UNCITRAL Arbitration Rules on the A&C Act, 1996 for the procedural aspects of ad hoc arbitrations in India. Hence, this article explores whether rules can be formed under Section 84 of the A&C Act, 1996 to give UNCITRAL materials or their adaptation in the form of new ad hoc arbitration rules an optional or a mandatory status in India. If that may not be done then other possible alternatives are discussed.

B. A Summary of UNCITRAL Arbitration Rules

UNCITRAL Arbitration Rules, originally endorsed by the United Nations General Assembly in 1976, have multiple versions. But the present rules (last modified in 2013 with expedited arbitration rules coming into force in 2021) mandate that parties to an “arbitration agreement concluded after 15-8-2010 shall be presumed to have referred to the 2013 Rules”[2]. This article’s discussion is based on the UNCITRAL Arbitration Rules as revised in 2013. The UNCITRAL Arbitration Rules are structured in four sections:

Section 1: Introductory rules (Articles 1-6)

Section 2: Composition of the Arbitral Tribunal (Articles 7-16)

Section 3: Arbitral proceedings (Articles 17-32)

Section 4: The award (Articles 33-43).

UNCITRAL’s website in its “frequently asked questions” section explains the difference between the UNCITRAL Model Law on International Commercial Arbitration and UNCITRAL Arbitration Rules as being their intended users and uses. The UNCITRAL Model Law on International Commercial Arbitration provides guidance to States enacting an arbitration law, while parties to an ad hoc arbitration can choose UNCITRAL Arbitration Rules to regulate ad hoc, arbitral proceedings. UNCITRAL itself explains the difference as:

“The UNCITRAL Model Law provides a pattern that lawmakers in National Governments can adopt as part of their domestic legislation on arbitration. The UNCITRAL Arbitration Rules, on the other hand, are selected by parties either as part of their contract or after a dispute arises, to govern the conduct of an arbitration intended to resolve a dispute or disputes between themselves. Put simply, the Model Law is directed at States, while the Arbitration Rules are directed at potential (or actual) parties to a dispute.”[3]

UNCITRAL Arbitration Rules provide a rule-based procedural framework, yet they are flexible enough to support party autonomy in arbitration. They allow parties to override the rules by an agreement[4]. UNCITRAL Arbitration Rules preserve party autonomy by allowing modification of the rules for specific needs of the parties.

Very recently, UNCITRAL Expedited Arbitration Rules have come into force. Expedited Arbitration Rules that were adopted by the UNCITRAL on 21-7-2021 entered into force on 19-9-2021[5]. These expedited rules apply as a voluntary choice of parties. As A&C Act, 1996 has its own “fast track procedure” in Section 29-B that pre-dates the UNCITRAL Expedited Arbitration Rules coming into force, a detailed comparison is not undertaken in this article’s scope.

C. India’s Arbitration and Conciliation Act, 1996 and the UNCITRAL Arbitration Rules

The Law Commission in its 246^th Report recognised the key source of India’s A&C Act, 1996’s text being the UNCITRAL Model Law on International Commercial Arbitration. The Law Commission’s 246^th Report notes, “The 1996 Act is based on the UNCITRAL Model Law on International Commercial Arbitration, 1985 and the UNCITRAL Conciliation Rules, 1980.”[6] As the UNCITRAL Model Law on International Commercial Arbitration and the UNCITRAL Arbitration Rules have a functional overlap, the A&C Act, 1996 also has deep linkages with the UNCITRAL Arbitration Rules. Further in this article the deep relationship of the A&C Act, 1996’s procedural provisions and the UNCITRAL Arbitration Rules are discussed in detail. At adoption of A&C Act, 1996, its provisions were rooted in the UNCITRAL Model Law on International Commercial Arbitration.

D. UNCITRAL Notes on Organising Arbitral Proceedings

A relatively lesser known UNCITRAL document is titled, UNCITRAL Notes on Organising Arbitral Proceedings (UNOAP). While the UNCITRAL Arbitration Rules are a definitive, rule-based framework for ad hoc arbitrations, UNCITRAL noted a further need existed to assist Arbitral Tribunals with practical guidance to organise arbitral proceedings. This led to the adoption of UNOAP in 1996[7]. The UNOAP are structured as discussions that the Arbitral Tribunal and parties can have to structure, operate and smoothen the international commercial arbitration process. But the ideas underlying UNOAP are equally suitable for ad hoc Indian arbitrations due to the linkages of UNOAP with UNCITRAL Arbitration Rules, which in turn have a functional linkage to the A&C Act, 1996.

E. Need for Rules in Indian Ad hoc Arbitrations

The Government and the arbitration community in India would like to see a growth in institutional arbitration. In a vast country like India, there is ample space for both ad hoc and institutional arbitration to grow. The stark reality is that ad hoc arbitrations will continue to dominate the count in arbitrations for some years to come. This situation will remain so until institutional arbitration expands across India. Hence, there is a clear and present need to think about rules for ad hoc arbitrations in India.

A major handicap in conducting ad hoc arbitrations in the author’s experience, whether as a counsel or as an arbitrator, is the absence of any procedural guidance apart from provisions in the A&C Act, 1996. For example, there are no norms for admission and denial of documents. Whatever local norms prevail for admission and denial of documents in court trials are followed in ad hoc arbitrations. The other challenge is that Section 19 (determination of rules of procedure) is vague. It neither rules out nor specifies in what way Civil Procedure Code, 1908 or Evidence Act, 1872 will apply in arbitrations. Section 19 merely says, “The Arbitral Tribunal shall not be bound … [CPC, 1908 and Evidence Act, 1872].” Different arbitrators apply this “shall not be bound…” mandate as chancellor’s foot – sometimes CPC and evidence law is followed too strictly and sometimes too loosely. This is not to argue that CPC or any evidence law should be made applicable to arbitrations. But some definite guidance as rules for ad hoc arbitrations for evidentiary procedure would be very useful. This article proposes a solution to this problem based on UNOAP’s guidance.

F. Comparing UNCITRAL Arbitration Rules and Arbitration and Conciliation Act, 1996’s Procedural Provisions

UNCITRAL Arbitration Rules provide basic mechanics of conducting arbitration by giving simple, clear procedural rules that can be applied in an arbitration. Several provisions of UNCITRAL Arbitration Rules are already present in pari materia form in the A&C Act, 1996. For example, Article 19 of UNCITRAL Arbitration Rules enables the arbitrator to determine language of the arbitration, subject to the choice of the parties. Article 19 of the UNCITRAL Arbitration Rules is effectively mirrored in Article 22 of the UNCITRAL Model Law on International Commercial Arbitration and hence also in Section 22 of the A&C Act, 1996. But not all the rules in the UNCITRAL Arbitration Rules have same or similar linkages to the provisions of the A&C Act, 1996 as discussed next.

In ad hoc arbitrations in India, the A&C Act, 1996 provides minimal guidance regarding how statement of claim (SOC) and statement of defence (SOD) can be structured. Section 23 of the A&C Act, 1996 prescribes requirements for SOC and SOD. The details required by Section 23 of the A&C Act, 1996 for SOC and SOD are: “… the claimant shall state the facts supporting his claim, the points at issue and the relief or remedy sought, and the respondent shall state his defence in respect of these particulars, unless the parties have otherwise agreed as to the required elements of those statements….” A&C Act, 1996’s Section 23’s cryptic guidance is rooted in Article 23 of the UNCITRAL Model Law on International Commercial Arbitration, which merely prescribes that the claimant in its SOC shall state “… facts supporting his claim, the points at issue and the relief or remedy sought”.

In contrast to Section 23 of the A&C Act’s limited guidance regarding contents of SOC, Article 20 of the UNCITRAL Arbitration Rules provides very specific guidance to parties in arbitration. Article 20(2) specifies that SOC shall include the following particulars:

(a) the names and contact details of the parties;

(b) a statement of the facts supporting the claim;

(d) the relief or remedy sought; and

(e) the legal grounds or arguments supporting the claim.

As can be seen, the A&C Act, 1996 in Section 23 adopts UNCITRAL Arbitration Rules’ Article 20(2)’s clauses (b), (c), (d) but somehow omits clauses (a) and (e), which are critical in any arbitration. This is so because Article 23 of the UNCITRAL Model Law on International Commercial Arbitration also does not include UNCITRAL Arbitration Rules’ clauses (a) and (e), hence the omission of those same clauses can be seen in Section 23 of the A&C Act, 1996. Further, Section 23 of the A&C Act, 1996 and Article 23 of the UNCITRAL Model Law on International Commercial Arbitration make elements of SOC subject to parties’ agreement, but UNCITRAL Arbitration Rules’ Article 20 does not do so by stating that SOC “shall include” the specified elements. Hence, for specific issues UNCITRAL Arbitration Rules provide more definitive procedural guidance than UNCITRAL Model Law on International Commercial Arbitration or even its adaptations in the A&C Act, 1996’s provisions.

UNCITRAL Arbitration Rules’ Article 20(3) also requires that a copy of the contract or legal instrument out of which the arbitration arises along with the arbitration agreement shall be annexed to SOC. Section 23 of the A&C Act, 1996 has no such requirement, although this would be a basic need in any arbitration. Article 20(4)’s requirement is that SOC should, as far as possible, be accompanied by all documents or references to those documents that are relied upon by the claimant, while Section 23 of the A&C Act, 1996 states that parties “may” submit with their statements all documents or references to documents with their statements.

UNCITRAL Arbitration Rules’ Article 20 specifies requirements for SOC and Article 21 specifies SOD’s requirements. In contrast, A&C Act, 1996’s Section 23 merges requirements for SOC and SOD into one single rule. Article 21(2) specifically requires replies to Article 20’s SOC elements viz. statement of the facts supporting the claim and legal grounds, points at issue, relief or remedy sought and arguments supporting the claim, while Section 23 has no such specificity of response in the SOD. Both Section 23 and Article 21 provide for set-off and counterclaim.

One unique aspect of UNCITRAL Arbitral Rules’ Articles 20 and 21 is that they allow adoption of notice of arbitration or its reply as party’s pleadings provided they comply with the specified requirements of contents of SOC and SOD. A&C Act, 1996 does not contain such a provision. A&C Act, 1996’s Section 23(3) permits SOD and SOC to be supplemented or amended, similarly Article 22 allows the same. Section 23(3) enables the Arbitral Tribunal to reject the amendment or supplement having regard to delay. While Article 22 has a similar provision as Section 23(3), it goes further by not allowing amendments that extend claim or defence beyond the jurisdiction of the Arbitral Tribunal.

As regarding challenge to the Arbitral Tribunal jurisdiction and the Tribunal’s power to determine the same is in Article 23 and has also been enacted in Section 16 of the A&C Act, 1996. Both provisions are substantially similar in terminology and scope.

Article 24 has a specific provision for further written statements at the discretion of the Arbitral Tribunal, but A&C Act, 1996 has no such provision, particularly in Section 23 that provides for statements of claim and defence.

Article 25 specifies periods of time for the communication of written statements that should not exceed 45 days unless the Arbitral Tribunal extends the time period. A&C Act, 1996 does not specify time for filing SOD or SOC but specifies by Section 23(4) an outer limit of six months for completing pleadings from the date notice of arbitration has been received by the arbitrator(s).

A&C Act, 1996’s scheme for interim relief is different from Article 26. A&C Act, 1996 seeks to grant the Tribunal with powers that are pari materia to a civil court’s interim relief powers while trying a civil suit. Article 26 is generally worded to balance equities in granting interim relief.

For evidence, A&C Act, 1996’s Section 19(4) provides guidance similar to UNCITRAL Arbitration Rules’ Article 27(4) that the Tribunal shall determine admissibility, relevance, materiality and weight of any evidence. Further, Section 19(1) provides cryptic guidance that in an arbitration under the A&C Act, 1996, the Arbitral Tribunal shall not be bound by the Code of Civil Procedure, 1908 (5 of 1908) or the Evidence Act, 1872 (1 of 1872). Does “not be bound by” civil procedure or evidence law, mean that they have to be followed but can be ignored at will or a tribunal can be totally free to decide rules of civil procedure and evidence? Article 27 puts burden of proof on the parties asserting facts that support claim or defence, but A&C Act, 1996 has not such counterpart regarding burden of proof. Article 27 allows witnesses including experts who are related to the party or the arbitration to testify and also give their evidence through a signed written statement.

A&C Act, 1996’s Section 26 has a provision for a tribunal appointed expert but there is no mention of a bar on being an expert witness being a related party similar to Article 27. The process for appointment of an expert is consultative under Article 29, while in Section 26 the power to appoint an expert is with the Arbitral Tribunal but subject to an agreement by the parties.

Article 27(3) enables the Arbitral Tribunal to order document production by the parties within a time frame, but A&C Act, 1996 grants no such specific time-bound document production powers to the Arbitral Tribunal.

Equal treatment of the parties is mandated both by Article 17(1) and Section 18, A&C Act, 1996.

Joinder of parties is possible under Article 17(5) provided that the party to be joined was a signatory to the arbitration agreement. In Section 2(1)(h), “party” is defined as a party to the arbitration agreement. But in A&C Act, 1996 there is no specific provision for the powers of Arbitral Tribunal to join parties.

By recent amendment, A&C Act, 1996 has included a specific provision of Section 42-A for maintenance of confidentiality in arbitration by the arbitrator, the arbitral institution and the parties, only exception being disclosure of the award for implementation and enforcement purpose. The UNCITRAL Arbitration Rules have no specific provision for confidentiality of the arbitration proceedings, but Article 28(3) states that hearings will be in camera unless parties agree otherwise.

Article 28 requires adequate notice of hearings to the parties, a requirement also mirrored in Section 24(2). Under the UNCITRAL Arbitration Rules, only the hearings are to be held in camera as mandated by Article 28(3) unless the parties agree otherwise. Under Article 34(5), an award may be made public either by the consent of all the parties, under a legal duty or to pursue proceedings before courts or authorities. There is no general duty of confidentiality under the UNCITRAL Arbitration Rules. On the contrary, under the related UNCITRAL Rules on Transparency in Treaty-Based Investor-State Arbitration, there are transparency provisions subject to a few exceptions.

Under Article 16, the parties waive all their claims against arbitrators, appointing authority and anyone appointed by the Arbitral Tribunal except for intentional wrongdoing. Recently, the A&C Act, 1996 has added Section 42-B for protection of actions taken by an arbitrator in good faith by barring any suit or legal proceedings against the arbitrator.

The form and effect of award is quite similar under both the A&C Act, 1996 and the UNCITRAL Arbitration Rules. As per Article 34(2), the award is final and binding between the parties. Similarly, under Section 35 the award is final and binding on the parties and anyone claiming under them. There is further similarity in laws and rules applicable to the substance of the dispute in Article 35 and Section 28. For ad hoc arbitrations in India, the A&C Act, 1996’s Section 28(1)(a) specifically applies Indian law as substantive law. For international commercial arbitrations seated in India, Section 28(1)(b) mirrors the provisions of Articles 35(1) and (2) where substantive law is one designated by parties and in the alternative it is to be decided by the Arbitral Tribunal to be appropriate.

Interestingly, A&C Act, 1996 only by an amendment in 2019 included in Section 28(3) Article 35(3)’s requirement that the Arbitral Tribunal shall decide the dispute in accordance with the terms of the contract, if any, and shall take into account any usage of trade applicable to the transaction. This indicates that the Central Government and the Parliament are constantly referring to UNCITRAL Arbitration Rules to improve the A&C Act, 1996. This is being done by including some aspects, e.g., Article 28(3) that mirrors Article 35(3) of the UNCITRAL Arbitration Rules into the A&C Act, 1996 that were not earlier included.

Provisions for default under Article 30 are present similarly in Section 25. Under Article 30, upon a claimant’s default in communicating its statement of claim, the Arbitral Tribunal shall terminate the arbitral proceedings unless any other matter needs to be determined. Section 25(a) also mandates the same effect of termination of arbitral proceedings. On respondent’s default in communicating its statement of defence, both Section 25(b) and and Article 30(1)(b) provide for continuation of proceedings without considering such default as an admission of the claimant’s claim.

Curiously, Section 25(b) does not include a similar effect for claimant’s failure to file a defence to respondent’s counterclaim, while in contrast Article 25(b) has a specific provision for the same. This omission can perhaps be explained as A&C Act, 1996 included provision to file a counterclaim as an amendment to Section 23. This amendment in the form of Section 23(2-A) came on the statute by the 2016 amendment (with effect from 23-10-2015). Hence, perhaps the effect of not filing a defence to counterclaim is not yet considered by the statutory draftsperson. Both Section 25(c) and Article [30(2) and (3) read together] provide that if a party that fails to appear at hearings, the Arbitral Tribunal may continue the proceedings and make the award with the evidence before it.

Provisions for awards, interim awards, correction of awards, finality, termination, settlements and substantive law are broadly similar in UNCITRAL Arbitration Rules. For example, Articles 33 (decisions), 34 (form and effect of the award), 35 (applicable law, amiable compositeur), 36 (settlement or other grounds for termination), 37 (interpretation of award), 38 (correction of the award) and 39 (additional award). These articles of UNCITRAL Arbitration Rules are pari materia with A&C Act, 1996’s Sections 28 (rules applicable to substance of disputes), 29 (decision making by panel of arbitrators), 30 (settlement), 31 (form and contents of arbitral awards), 32 (termination of proceedings) and 33 (correction and interpretation of awards; additional award).

A&C Act, 1996’s costs and related provisions are in Section 31(8), which links to Sections 31-A (regime for costs), 38 (deposits) and 39 (lien on arbitral award and deposit as to costs). In comparison, UNCITRAL’s cost provisions are in Articles 40 (definition of costs), 41 (fees and expenses of arbitrators), 42 (allocation of costs) and 43 (deposit of costs). The heads of cost claims are broadly similar in Article 40 and Section 31-A(1). While Arbitral Tribunal’s fees are components of costs under both the UNCITRAL Arbitration Rules and A&C Act, 1996, both contain different approaches for determining the quantum of Arbitral Tribunal fees.

G. Application to Indian Ad hoc Arbitrations

There is a common thread of UNCITRAL Model Law on International Commercial Arbitration underlying both the UNCITRAL Arbitration Rules and the A&C Act. Hence, the differences and similarities between UNCITRAL Arbitration Rules and the A&C Act, 1996 are but natural to occur. UNCITRAL Arbitration Rules are not the best choice as a suggested new set of rules for ad hoc arbitrations in India. The reason for UNCITRAL Arbitration Rules not being the best option for ad hoc arbitrations in India is that the A&C Act, 1996 text has several overlaps and omissions compared to the text of UNCITRAL Arbitration Rules. Therefore, if the UNCITRAL Arbitration Rules are recommended as the rules in ad hoc arbitrations in India, there will be endless debates during the challenge to the award arising from the differences or similarities between the UNCITRAL Arbitration Rules and the A&C Act, 1996. Hence, there is a need to carry the improved provisions in the UNCITRAL Arbitration Rules into any arbitration rules for ad hoc arbitrations in India.

The author does not support any mandatory set of rules being enacted for ad hoc arbitrations under Section 84, A&C Act, 1996’s rule-making power or otherwise. But given the benefits of a set of rules in ad hoc arbitrations, there are two possible options:

(1) Parties can choose from a set of one or more rules that can be enacted or recognised under Section 84 as a non-binding recommendation; or

(2) design a voluntary code with simple but defined rules that are championed by users of arbitrations to cover most beneficial aspects of the UNCITRAL Arbitration Rules, UNOAP and any other ideas from institutional rules that can be used in ad hoc arbitrations.

Either of the above options can be beneficial for ad hoc arbitrations, because they retain the procedural flexibility and party autonomy while providing definite procedural guidance. With non-statutory nature of a voluntary set of rules for ad hoc arbitrations, they can be amended easily. The State and Central Governments can recommend adoption of such a set of rules in their own arbitrations to make them popular.

H. Features of Any Future Rules for Ad Hoc Arbitrations

A few concepts to include in any set of rules for ad hoc arbitrations are described next. A major issue to consider in any proposed rules for ad hoc arbitration is the evidentiary procedure. Arbitral Tribunals in India fall back on procedure of providing proof of contents of documents as per the Evidence Act, 1872. The A&C Act, 1996’s Section 19 provides vague guidance that neither fully applies nor completely exempts application of the Evidence Act, 1872. Further, Section 1 of the Evidence Act, 1872 makes that law inapplicable to proceedings before arbitrator. Yet, invariably, the same procedure used in trials is used to “mark” documents as admitted in evidence. Proof of contents of each document needs to be proved with primary evidence i.e. the original document itself or by alternate methods applicable to secondary evidence. Further, electronic evidence has to be admitted via a certificate method (Section 65-B of the Evidence Act, 1872). The highly adversarial process of proving contents of documents as practised in trials is not suitable for arbitrations, which are supposed to be more efficient than trials. In some in arbitration in India, the arbitrators with the consent of the parties now mark everything in evidence unless specific objections are taken. But there is no uniform guidance or practice available to arbitrators and parties to admit documentary evidence in arbitrations.

Next there are challenges of document production or discovery. While Civil Procedure Code, 1908 has provisions for discovery under Order 11, the process is strongly judge-centric and time consuming. Any future rules for ad hoc arbitrations should widen the scope of discovery inter se between the parties.

One solution for evidentiary issues in ad hoc arbitrations would be to adopt the guidance of UNOAP for evidence in any future rules for ad hoc arbitrations. Item 13 of UNOAP provides guidance for documentary evidence.

Document production guidance in UNOAP is under Note 77 on the lines of popular, “Redfern Schedule”:

“77. Requests for disclosure of documents may be made in various ways but are typically recorded in a schedule that is provided to the other party and sets out not only the documents requested, but also the reasons for the request and often, as well, a statement as to why the requested documents are believed to be in the possession of the other party and are not otherwise available to the requesting party. The other party may then state in the schedule whether it agrees with the request and if not, the reasons. Usually, the parties first exchange the disclosed documents only among themselves and then they determine which of the disclosed documents to submit as evidence.”

UNOAP Note 78 gives guidance when document production is contested:

“78. Where requests for disclosure of documents are contested, the requesting party may decide to submit the contested requests to the Arbitral Tribunal for its determination whether to order either or both parties to disclose documents. The Arbitral Tribunal will often add to the schedule a record of its decision whether to order disclosure on any contested requests.”

Further guidance is provided in Notes 80 and 81 when authenticity of a document is questioned:

“(d) Assertions about the provenance and authenticity of documentary evidence

1. At an early stage of the arbitral proceedings, the Arbitral Tribunal will often specify that unless a party raises objections to any of the following conclusions within a specified period of time, it will be understood that: (a) documentary evidence is accepted as having originated from the source indicated in it; (b) a dispatched communication is accepted without further proof that it has been received by the addressee; and (c) a copy is accepted as a faithful reproduction of the original. A statement by the Arbitral Tribunal to this effect can simplify the introduction of evidence and discourage unfounded and dilatory objections.
2. If there are issues regarding the provenance, authenticity or completeness of documentary evidence, the Arbitral Tribunal may require verification thereof; it may further require that the evidence in its original form remain accessible to the parties and the Arbitral Tribunal.”

More guidance for presenting documentary evidence to avoid duplication is given in Notes 82, 83, 84, 7 and 10. In a gist, these UNOAP notes provide for the following issues: (i) avoiding duplicate production of a document by making it sufficient if one side produces it; (ii) preparing a joint set of common documents; (iii) preparing a set of core or working document (called “convenience compilations” in India at times); (iv) expert summaries; (v) flow of communications; and (vi) practical methods of handling the document sets.

As can be seen almost none of the above-discussed documentary evidence handling practices are commonly used in India (exceptions apply) in trials or arbitrations. The UNOAP guidance has substantial due process safeguards built into the process without diluting the arbitration system’s famed procedural flexibilities and party autonomy intact. Hence, any future set of rules for ad hoc arbitrations can incorporate the guidance in UNOAP for evidentiary issues as a practical utility.

Guidance in the form of suggestions, hints, notes, recommendations, etc. depend on parties mutually agreeing to follow them. Then it is left to the arbitrator to form effective procedural norms in an arbitration with no real power of sanctions for violation of even mutually agreed procedural norms. There is a need in Indian ad hoc arbitrations for a set of clear, simple rules on the lines of UNCITRAL Arbitration Rules for evidentiary and other procedures. Any such rules for ad hoc arbitrations need to give more sanctioning powers to the Arbitral Tribunal on lines of A&C Act, 1996’s Section 24(1)’s second proviso that enables the Arbitral Tribunal to impose even exemplary costs for seeking adjournments without any sufficient cause. The arbitrator in an ad hoc arbitration can then enforce such rules, which the parties choose in their arbitration agreement or later.

I. Conclusion

To make ad hoc arbitrations more effective in India, a need exists for a set of simple, easy to implement and well-thought-out procedural rules. Such rules should include present best practices in international commercial arbitrations for handling documentary evidence rather than relying on Evidence Act, 1872 or Civil Procedure Code, 1908. The provisions of such ad hoc arbitration rules should enable arbitrators to better control the arbitration proceedings with more effective provisions for costs and sanctions. Such ad hoc arbitration rules, mutually chosen by the parties in arbitration agreements or later, should be available as a non-binding option through a recommendation via enacted list of one or more optional rules under Section 84.

† Hasit B. Seth practices as a counsel in the Bombay High Court, India and in arbitrations.

[1]All UNCITRAL materials referred in this article are freely available at <www.uncitral.un.org>, hence their sources are not referred repeatedly.

[2]Art. 1(2), UNCITRAL Arbitration Rules (2013 Revision).

[3]Frequently Asked Questions – Arbitration, UNCITRAL (25-10-2021, 6.42 p.m.), <HERE>.

[4]Art. 1(1), UNCITRAL Arbitration Rules (2013 Revision).

[5]UNCITRAL Press Release dated 16-9-2021, UNIS (26-10-2021, 12.09 p.m.) <HERE>.

[6]Law Commission Report No. 246, p. 3.

[7]UNCITRAL Notes on Organising Arbitral Proceedings, preface, p. iii.

Experts Corner Pramod Rao

Harnessing ODR by Startups and Commercial Enterprises

As many of the discerning readers of the SCC Blog may be aware, your columnist is a big believer and evangelist of Online Dispute Resolution (‘ODR’).

Check this out here for a brief on what ODR is and where it is currently at.

ODR represents a singular opportunity to reimagine dispute resolution at scale for consumers, citizenry, enterprises and ecosystems.

Rather than making individuals or organisations go to a designated location i.e. the courtroom (itself inaccessible at times due to distances, costs and time), ODR is accessible anywhere (and at times, anytime) that the individual desires. Cost and time savings accrue to both the sets of disputing parties when the medium is online: be it voice, video, chat, document (or combination of all of them) as the medium. ODR serves to level the field for the disputing parties.

ODR institutions build and operate the platform which connect the disputing parties and the neutral/s, and provide the online medium required for dispute resolution. Due safeguards for managing conflicts, ensuring confidentiality and data privacy, onboarding neutrals as well as assistance to those unfamiliar with the platform are some of the roles played by ODR institutions.

Harnessing neutrals – arbitrators, mediators or conciliators – brings independent, experienced individuals committed to furthering the rule of law, and helping resolve disputes amicably (mediation or conciliation) or decisively (arbitration) all in a short span of time.

Automated dispute resolution takes this one step further: where the dispute revolves around information, data or records, the system searches the records, assesses the claim or grievance against the same, and provides the verdict. It is at once free of bias, is objective and provides an auditable trail for the verdict it renders.

In this paper, your columnist will articulate the use cases for ODR by startups and commercial enterprises.

Why does an entrepreneur or an established enterprise need to harness ODR?

Almost every economic activity brings together two or more parties who undertake a transaction or a series of transactions with one another.

For a vast majority, the transactions are concluded smoothly and without a hitch. In a way, this is also the biggest hurdle or mental block for startups or established enterprises to embrace a well-designed dispute resolution mechanism.

To them, to design something which addresses a very small set of transactions or parties is regarded as unnecessary or wasteful. However, such exceptions can contribute disproportionately to the costs, time and bandwidth that is spent dealing with the exceptions.

Furthermore, disgruntled consumers may:

refrain from engaging in further transactions (an opportunity cost);
engage in badmouthing the enterprise or the counterparties that adversely impacts the reputation of the enterprise; or
file complaints or claims with the regulatory authorities, or law enforcement agencies or in the courts.

So if one has to think for the long haul – cost, time and bandwidth being saved, retention of consumers (probably acquired after a huge cost and/or effort), maintain goodwill and good repute in the market (important for attracting and acquiring future potential customers), and to avoid situations compelling interventions by authorities, agencies or courts would be the biggest reasons to embrace ODR.

Harnessing ODR for almost everything: Nothing too small – Nothing too large

You have embraced the entrepreneurial journey and established a startup.

Among the first few things you would probably do is: find the right set of individuals who will join your startup. They might be few in number, but as the startup scales and goes through various rounds of funding or growth or both, their numbers will rise. Whether they be co-founders or employees or such other designation that is conferred, anticipating situations of conflict, differences or disputes is something you should consider. By incorporating the dispute resolution process (of the ODR variety) in the employment letter, employment agreement or founders agreement, you will be able to ensure that there are amicable, confidential, closed-door resolution of issues, conflicts, differences and disputes which arise.

As again, maybe none ever arises, and you make the list of best workplaces and best employers – congratulations and well done. Keep in mind that embedding the ODR clause did not hinder nor detract that.

While Covid-19 may have encouraged work from home, if you have an office in a space that is taken on lease or leave and licence, ensuring any differences or disputes with the landlord are resolved satisfactorily to both of you is something ODR can do.

You have now moved from ideation to MVP – minimum viable product, and started the client acquisition process. You have chosen the direct model – perhaps it is a mobile app or on the website that your potential clients, customers or consumers experience the product. They want to sign up and avail of the product or service.

If what is promised by you is exactly what is understood by the consumer, and the product or service does what it has been said and understood, you are home free and have succeeded. Congratulations and keep at it.

Pause to consider the alternatives. What if what you promised:

Is miscommunicated or misunderstood (amounts to misselling).
Is well communicated and well understood, but the product or service does not perform in the manner it was communicated and understood (becomes product or service deficiency or defect).

You get the picture.

Any of these will lead to conflict, disputes and differences. How you propose to deal with these situations is important for the reasons already outlined above: of time, cost and bandwidth savings, of customer retention, of keeping goodwill and good repute and of avoiding intervention by authorities, agencies or courts. That it should be ODR would be clear by now.

Moving forward: you have added distribution heft for customer acquisition. These distributors are well-regarded establishments and have well-trained, experienced staff. Once you have explained the product or service construct, they become your startup’s representatives to potential clients, customers or consumers. They will communicate what you promise such that it is exactly what is understood by the consumer, and the product or service does what it has been said and understood. You are home free and have succeeded once more. Congratulations.

Pause to consider the alternatives.

Could the distributor or its staff foul up the communication to potential consumers? Could the consumers have misunderstood what has been shared with them? Could the commission you pay the distributor be incentivising making a sale at any cost? Could the distributor despite commitments to you be deploying inexperienced, poorly trained staff, and/or be departing from well-thought-out sales practices?

How do you deal with such distributors? Can you just disassociate and pick up the pieces? Can you instead hold them accountable and help you fix the mess they may have created? As again, ODR can come to aid and help enforce the commitments you were given or being compensated for lack of adherence to them.

Then again: perhaps your startup is the vendor or supplier to an established enterprise. If you are an MSME, and end up facing delay in payment (life-threatening to your startup), ODR being harnessed can help in providing swift, timely and enforceable outcomes.

In every direction that you had consider: vendors and suppliers, or other intermediaries (warehouses or wholesalers), service providers or partner organisations, if you can have conflicts, differences or disputes, then choosing ODR will make sense again and again and again.

As far as established enterprises go, it is much the same. However, admittedly they come with their own baggage.

You can almost hear them say: this is the way we have always done things around here. Why fix something which is not broken? We would be upsetting the apple cart of how we deal with these things today? It really baked into our pricing and costing and it does not matter.

What may not be said out loud: we are at the receiving end of many grievances and disputes – this will make it far easier for the consumer to hold us accountable.

The fact is that it does matter. Those having the grievance start to treat it as a grudge. The as-yet unaffected consumers start to become anxious and require constant reassurances. The social media powered word of mouth makes potential customers and consumers apprehensive of availing of the product or service. The stakeholders become far more watchful of what you do and do not, and swoop in when the situation is precarious.

In the meantime, your competitor is already embarked on the journey or is seriously considering doing so. Guess what the marketplace will think of its embracing ODR and your lack of embracing ODR.

Across all areas and across the lifecycle

ODR is capable of being embraced across all the areas that a commercial enterprise has, does or needs, and across all of the lifecycle of the enterprise, be it a startup or an established enterprise. More and more enterprises and ecosystems are embracing ODR.

Choose wisely and choose immediately. Embrace the emerging dispute resolution solutions and systems, and the future.

ODR also represents a greenfield opportunity for law students and lawyers among others to consider pursuing as a career. In fact with the right training and skills being imparted, almost anyone can consider becoming a neutral – helping resolve conflicts and disputes and bridging the differences.

† Group General Counsel at ICICI Bank. Views are personal. His Linkedin profile can be accessed HERE

This column is inspired a brief status of ODR outlined, Here.

Here are further reading materials for those interested:

See HERE
The ODR Handbook HERE
Example of an ecosystem/digital platform harnessing ODR HERE

Bharat Chugh Experts Corner

Voice Samples in Criminal Investigations and Legal/Constitutional Issues that Remain

It is now well settled that compelling the taking of voice samples from an accused for the purpose of an investigation does not amount to a violation of Article 20(3) of the Constitution. In other words, seeking voice samples from an accused does not amount to compelling an accused to be a witness against herself

But the question that still remains is: which statute or legal provision provides the power to compel the accused to provide a voice sample? In the last decade, 5 Judges of the Supreme Court (over three different opinions) have attempted to locate this power within the law. And, well, none of them have succeeded.

Justice Ranjana Prakash Desai in Ritesh Sinha v. State of U.P.[1], acknowledged that there is no specific legal provision under which the Magistrate can authorise the investigating agency to take voice samples. Justice Desai then proceeded to painstakingly identify provisions that could be purposively interpreted in order to empower the Magistrate to authorise the collection of voice samples.

For this purpose, the Court began the quest to find such authority in the Identification of Prisoners Act, 1920 — a legislation aimed at securing the identification of an accused person.

Previously (and before the matter landed before the Supreme Court in 2013 in Ritesh Sinha[2] case), in this context, the Bombay High Court in CBI v. Abdul Karim Ladsab Telgi[3] (Telgi), has held that measuring the frequency or intensity of speech sound waves can be considered to be “measurement” as defined under the Identification of Prisoners Act. Therefore, the Magistrate who is empowered under Section 5 of the Act to order a person to be “measured”, may compel the accused to provide their voice sample.

However, the Delhi High Court in Rakesh Bisht v. CBI[4], disagreed with the Bombay High Court and ruled that the purpose of Section 5 of the Act was only to identify the accused person after the investigation was complete.

Though the Delhi High Court’s logic in Rakesh Bisht[5] appears to be more sound, Justice Desai followed the reasoning of Telgi[6], without providing any reason to disagree with Rakesh Bisht[7].

In his dissent in the same judgment, Justice Aftab Alam recognises that even if – by some interpretive gymnastics — a voice sample can be considered “measurement” under the Act, that would lead to the unseen consequence that even the police (without magisterial authorisation) may be empowered to compel the accused persons to provide the voice sample. This is because Sections 3 and 4 of the Act empower the police to take measurement of convicted and non-convicted persons.

Apart from the Identification of Prisoners Act, Justice Desai also examined various provisions of the Evidence Act, 1872 and the Criminal Procedure Code, 1973 (CrPC). Section 73 of the Evidence Act, which deals with “comparison of signature, writing or seal with others admitted or proved”, only enables the court to compare these writing/signature specimens. It does not empower the court to direct the accused to provide such samples to the investigating agency for the purpose of investigation. While, Parliament attempted to correct this anomaly by the inserting Section 311-A CrPC, the problem still remains. This is because Section 311-A of the Code deals only with specimen signatures and handwriting and does not empower the Magistrate to authorise the taking of voice samples.

Having ruled out these provisions, the Court then examined Sections 53 and 54-A CrPC. Section 54-A provides that where a person is arrested on a charge of committing an offence and his identification by any other person or persons is considered necessary for the purpose of investigation of such offence, the court having jurisdiction, may, on the request of the officer in charge of a police station, direct the person so arrested to subject himself to identification by any person or persons in such manner as the court may deem fit. Surprisingly, the Court has consistently overlooked Section 54-A without providing any justification. In our opinion, a possible reason for this could be that Section 54-A relates to only arrested persons and not all accused persons.

Having examined the various provisions, Justice Desai eventually located the power of the Magistrate under Section 53 CrPC. Section 53 CrPC deals with “examination of accused by medical practitioner at the request of police officer”. According to the Explanation to this provision:

“examination” shall include the examination of blood, bloodstains, semen, swabs in case of sexual offences, sputum and sweat, hair samples and fingernail clippings by the use of modern and scientific techniques including DNA profiling and such other tests which the registered medical practitioner thinks necessary in a particular case.

A bare perusal of this section and its genealogy would reveal that it was never meant to apply to voice samples.

Position elsewhere in the world

Elsewhere in the world, a similar question came up before the Supreme Court of Appeal of South Africa, in Levack v. Regional Magistrate, Wynberg[8]. Even though the power to obtain voice samples was not explicitly mentioned in South Africa’s Criminal Procedure Act (51 of 1977), the Court provided a purposive interpretation to Section 37 of the South African legislation and held that the police was empowered to obtain voice samples as under this section they retained the power to take steps as they might deem necessary to ascertain the characteristic or distinguishing features of the accused.

Adopting a similar approach, Justice Desai applied the rule of ejusdem generis to the Explanation to Section 53 CrPC and held that voice samples were covered under “such other tests”. However, Justice Alam disagreed with this conclusion, as according to him, “such other tests” is to be decided by the medical practitioner and not the police.

More importantly, Justice Alam disagreed with the judicial exercise to purposively interpret statutes in order to locate the Magistrate’s power to authorise the collection of voice samples. According to him, such power must be explicitly granted by Parliament. The 87th Law Commission Report had made recommendations to provide statutory power to collect voice samples. Parliament’s non-implementation of the Report and other similar suggestions only add weight to Justice Alam’s reasoning, that the court should not legislate, when the Parliament is itself apprehensive about making law. Thus, unable to reach a consensus, the quest to discover the power of the Magistrate to compel the production of voice samples was now passed on to a three-Judge Bench of the Supreme Court.

Making law, instead of finding it

The problem that 2 Judges could not solve was – strikingly – now totally avoided by 3 Judges in Ritesh Sinha v. State of U.P.[9] (Ritesh Sinha 2). In the interregnum, before the matter was heard by the 3-Judge Bench, in a well-reasoned judgment, the Gujarat High Court painstakingly examined various provisions of the Code but also failed to locate the statutory powers of the Magistrate to compel the accused to submit to a voice spectrograph test.

The 3-Judge Bench of the Supreme Court, instead of considering the applicability of various provisions including Section 54-A of the Code, appears to have decided that it would rather make the law, than find it. The Court observed that:

… we unhesitatingly take the view that until explicit provisions are engrafted in the Code of Criminal Procedure by Parliament, a Judicial Magistrate must be conceded the power to order a person to give a sample of his voice for the purpose of investigation of a crime. Such power has to be conferred on a Magistrate by a process of judicial interpretation and in exercise of jurisdiction vested in this Court under Article 142 of the Constitution of India.[10]

The judgment of the Court was premised on the principle that “procedure is the handmaid, not the mistress, of justice and cannot be permitted to thwart the fact-finding course in litigation”. Therefore, instead of dealing with this procedural thorn in the State’s right to investigate, the Court invoked its extraordinary powers under Article 142 of the Constitution and gave a carte blanche to the investigators without laying down any safeguards against the abuse of this power, or laying down the modalities of exercise of this right.

Privacy concerns

In our humble opinion, this is deeply problematic. The Court ought not to use its discretion under Article 142 in a manner that may infringe and violate the inalienable fundamental rights of the citizens. While the issue of Article 20(3) is no longer res integra, it is pertinent to note that compelling voice samples from an accused may also raise right to privacy concerns. The Court acknowledged this concern but dismissed it without any analysis by stating that:

… the fundamental right to privacy cannot be construed as absolute and but must bow down to compelling public interest. We refrain from any further discussion and consider it appropriate not to record any further observation on an issue not specifically raised before us.[11]

The Court may have dodged the bullet but the silence has only compounded the problems. For instance, the Punjab and Haryana High Court, has placed reliance on the abovementioned observation of the Supreme Court to dismiss any and all privacy concerns vis-à-vis the collection of voice samples. Apart from the issue of privacy, many other crucial questions remain unanswered.

What is most problematic is that while the 3-Judge Bench has allowed the Magistrate to authorise the collection of voice samples, the Court has provided absolutely no guidelines or procedure by which the Magistrate must exercise these powers. While, the power has finally been identified/granted, the dilemma on implementation or exercise of the power remains:

How should the voice samples be collected?
Should the Magistrate direct and oversee the collection of voice samples?
Can the legal representative of the accused person oversee and supervise the collection of the samples?
How long should the sample be?
Can the Magistrate direct the investigating agency to use the voice samples only for a specific purpose?
Can any and all police officers be authorised to collect samples?
Who decides the transcript of the voice sample?
What, if at all, is the quality control and how can false positives be avoided.

Procedural issues/issues of implementation

Some of these questions have already reached courts. For instance, in Sudhir Chaudhary v. State (NCT of Delhi)[12] the accused person consented to providing a voice sample, but raised an issue with the transcript that was provided by the investigating agency. It was argued that the transcript contained serious inculpatory statements. This was problematic, since a sample of the inculpatory statements would be similar to a testimonial confession. Compelling a voice sample does not violate Article 20(3) because the sample is to be matched with the evidence. But the sample itself cannot be a confession or a testimony. On the other hand, science demands that the transcript must incorporate the language of the recorded evidence, to ensure best results. Such cases drive home the point that issues of science and policy, which require specialised training and understanding, cannot be comprehensively resolved by a court of law on a case-by-case basis or an ad hoc decisional basis and need a more nuanced response. In this case, the Supreme Court while balancing the right of the accused under Article 20(3) and the interest of the State to prosecute, directed that the proposed passage which the accused person shall be required to read out for the purpose of giving their voice samples shall use words, but not the sentences from the inculpatory text.

While, this safeguard is laudable (particularly since the judgment has been followed by a few High Courts[13]) it is crucial that the Court acknowledges that the numerous unanswered questions reflect a dire need to provide more such protections to the accused persons. Doing complete justice, would not only be to recognise or grant powers to the courts/investigators but also provide an instruction manual on how such power must be exercised, for the process to be just, fair and reasonable.

† Bharat Chugh is a former Judge and independent counsel.

† † Siddharth Shivakumar is an advocate and a counsel at the Chambers of Bharat Chugh. They can be reached at contact@bharatchugh.in.

[1] (2013) 2 SCC 357 : AIR 2013 SC 1132.

[2] (2013) 2 SCC 357 : AIR 2013 SC 1132.

[3] 2004 SCC OnLine Bom 1187 : 2005 Cri LJ 2868.

[4] 2007 SCC OnLine Del 13 : 2007 Cri LJ 1530.

[5] 2007 SCC OnLine Del 13 : 2007 Cri LJ 1530.

[6] 2004 SCC OnLine Bom 1187 : 2005 Cri LJ 2868.

[7] 2007 SCC OnLine Del 13 : 2007 Cri LJ 1530.

[8] (2003)1 All SA 22 (SCA).

[9] (2019) 8 SCC 1 : AIR 2019 SC 3592.

[10] Ritesh Sinha (2) case, (2019) 8 SCC 1, 12 : AIR 2019 SC 3592.

[11] Ritesh Sinha (2) case, (2019) 8 SCC 1, 12 : AIR 2019 SC 3592.

[12] (2016) 8 SCC 307.

[13] Kumar v. State, 2021 SCC OnLine Mad 5486 : (2021) 1 LW (Cri) 147; Manish Mourya v. State of M.P., Misc. Crl. Case No. 35470 of 2019, decided on 28-8-2019 (MP).

Experts Corner Siddharth R Gupta

Article 14 and Arbitrariness vis-à-vis Legislative Action

“So diverse and adverse are the decisions of different High Courts, and of the same High Court, that in examining cases, as precedents by which to try a suit, the lawyer encounters a perpetual change of cloud and sunshine, and occasionally a real thunderstorm, succeeded by a burning sun. What was law at one time, is not law now – what is law in one place, is not in another – locality, individuality, prejudice, and perpetual change, characterise the decisions of Judges learned in the law.”

Levi Carroll Judson

(American Jurist)

Laws and institutions are constantly tending to gravitate. Like clocks, they must be occasionally cleansed, and wound up, and set to true time.

Henry Ward Beecher

(American Congregationalist Clergyman, Social Reformer and Speaker)

The 3-part series of this article attempts to dive deep into “arbitrariness as a testing criteria” for examining the validity and constitutionality of any legislative enactment. In other words, how far “arbitrariness as an independent ground” can be a reason for the constitutional courts to strike down any law having become a havoc for Article 14 of the Constitution of India. A priori, we would have a peep into how the concept of arbitrariness has been expanded to be made applicable to parliamentary/State enacted legislations for nullifying them through the sword of Article 14. The article which shall be split in 3 parts, shall be compartmentalised into the following sub-sections:

Jurisprudence of Arbitrariness: Origins and Growth up to Royappa.
Unconstitutionality of Legislative Provisions vis-à-vis
Distortion in McDowell and its Resurrection in Shayara Bano.
Article 14 and the Time Machine: Initial Judicial Responses.
Obsolescence as a Ground for Arbitrariness and Unconstitutionality.
Outdated Legislations in the Context of K.S. Puttaswamy.
Scrutiny of Certain Legislations as Being Obsolete and Resultantly Unconstitutional.

Jurisprudence of Arbitrariness in India: Origins and Growth up to Royappa

Most of us understand the roots of “concept of arbitrariness” to be originating from the celebrated judgment of E.P. Royappa v. State of T.N.^[1] and its intertwining with other pillars of Part III viz. Articles 19, 21 and 32 of the Constitution of India. However very few of us are actually aware that E.P. Royappa[2] had merely enamoured the content of Article 14 with “concept of arbitrariness” in a well-articulated expression, in a way never done before. The Supreme Court in E.P. Royappa[3] in fact did not actually discover “arbitrariness” in Article 14 for the first time, but had elegantly woven the same thing said before, but on different occasions and in different judgments. We will explain how.

Article 14 has its reflection in the Preamble to our Constitution, the relevant portion of which reads “Equality of Status and of Opportunity”. It is a hybrid amalgam of two different species of equality viz:

(a) Equality before law – (concept borrowed from the UK Constitution).

(b) Equal protection of law – (concept borrowed from 14th Amendment to the US Constitution).

The theory of classification adopted by American Courts was a corollary to the concept underlying equality clause, namely, that a law must operate alike on all persons under like circumstances. In fact, the latter component of Article 14 was the reason for the evolution of the concept of “classification”.

The celebrated dissent of Justice Subba Rao in State of U.P. v. Deoman Upadhyaya^[4] stated that Article 14 comprises both “positive content” as well as “negative content”. Whereas, equality before the law is a negative content, equal protection of the laws exhibits a positive content of Article 14. In this case, the accused Deoman was convicted for offence of murder by the Sessions Court, Gyanpur. The challenge to the conviction arose on the inherent anomaly in Section 27 of the Evidence Act, 1872 making inadmissible the statements of persons under the presence of a police officer, but not actually in police custody. The statement by Deoman purportedly was made in the presence of the police officer and therefore benefit of Section 27 was being pleaded by the accused. The Constitution Bench affirmed the classification of accused persons separately between those actually in police custody and those with police personnel present around them as reasonable. The Court though accepted that the statements may be confessional in nature, however separate treatment of both the categories of accused was found to be justified. Justice Subba Rao, however in his historic dissent accorded a different dimension and colour to Article 14, vide para 24, he has thus:

… This subject has been so frequently and recently before this Court as not to require an extensive consideration. The doctrine of equality may be briefly stated as follows: All persons are equal before the law is fundamental of every civilised constitution. Equality before law is a negative concept; equal protection of laws is a positive one. The former declares that everyone is equal before law, that no one can claim special privileges and that all classes are equally subjected to the ordinary law of the land; the latter postulates an equal protection of all alike in the same situation and under like circumstances. … So, a reasonable classification is not only permitted but is necessary if society should progress. But such a classification cannot be arbitrary but must be based upon differences pertinent to the subject in respect of and the purpose for which it is made.

In yet another landmark dissent in Lachhman Dass v. State of Punjab^[5], Justice Subba Rao cautioned on imperceptible deprivation of Article 14 of its glorious content and shining aura, whilst emphasising too much on the doctrine of classification. The appellants in this case, were a joint Hindu family firm which has been carrying on business since 1911 in grains, dal, cereals, cotton ginning and pressing, oil manufacture and the like, in the erstwhile State of Patiala. The firm had an account called the cash credit account and used to borrow money in this account by pledging its stocks. In 1951-1952 there was a heavy slump in the prices of the commodities with the result that the amounts advanced by the bank on the security of the goods were very much in excess of the market prices thereof. To cover this shortfall the firm entered into an arrangement with the bank and it is this that formed the source of the litigation in this case. The bank sanctioned a loan on “demand loan account”. The amount payable under the demand loan account not having been paid by the appellants, the bank took steps to realise the same in accordance with the provisions of the Patiala Recovery of State Dues Act, 2002. The vires and constitutionality of this enactment was challenged before the Supreme Court on the ground that the Act and the Rules made thereunder became void on the coming into force of the Constitution as being repugnant to Articles 14 and 19(1)(f) and (g), and the proceedings taken under those provisions being illegal. Vide para 47, the dissenting opinion lent importance to the “positive content” under Article 14. Justice Subba Rao while discussing the scope of Article 14 in the aforementioned para, stated that:

47. … It shall also be remembered that a citizen is entitled to a fundamental right of equality before the law and that the doctrine of classification is only a subsidiary rule evolved by courts to give a practical content to the said doctrine. Overemphasis on the doctrine of classification or an anxious and sustained attempt to discover some basis for classification may gradually and imperceptibly deprive the article of its glorious content. That process would inevitably end in substituting the doctrine of classification for the doctrine of equality: the fundamental right to equality before the law and equal protection of the laws may be replaced by the doctrine of classification.

Perhaps the first landmark judgment which actually spotted the virtue of non-arbitrariness in Article 14 was S.G. Jaisinghani v. Union of India^[6] . The Court, for the first time held “absence of arbitrary power” as sine qua non to rule of law with confined and defined discretion, both of which are essential facets of Article 14. Quoting the celebrated saying of Douglas, J., in United States v. Wunderlich^[7] :

… when it has freed man from the unlimited discretion of some ruler…. Where discretion is absolute, man has always suffered.

It is in this sense that the rule of law may be said to be the sworn enemy of caprice. Discretion as Lord Mansfield stated it in classic terms in John Wilkes^[8], Burr at p. 2539:

“… means sound discretion guided by law. It must be governed by rule, not by humour: it must not be arbitrary, vague, and fanciful….”

In Jaisinghani[9], the constitutional validity of seniority rule in regard to Income Tax Officers was challenged along with the improper implementation of the “quota” recruitment as infringing the guarantee of Articles 14 and 16(1) of the Constitution. Justice Subba Rao (this time majority opinion) elaborating on the wide expanse of Article 14 , vide para 14 held thus:

In this context it is important to emphasise that the absence of arbitrary power is the first essential of the rule of law upon which our whole constitutional system is based. In a system governed by rule of law, discretion, when conferred upon executive authorities, must be confined within clearly defined limits. The rule of law from this point of view means that decisions should be made by the application of known principles and rules and, in general, such decisions should be predictable and the citizen should know where he is. If a decision is taken without any principle or without any rule it is unpredictable and such a decision is the antithesis of a decision taken in accordance with the rule of law.

Another milestone in the development of the concept of arbitrariness in State of Mysore v. S.R. Jayaram^[10] wherein the constitutional validity of Rule 9(2) of the Mysore Recruitment of Gazetted Probationers Rules, 1959 was challenged. Under the first part of the said Rule 9(2), the candidates were provided preferential claim to appointment as per their place on the merit list subject to certain reservations for SC/STs and OBCs. The latter part however vested upon the Government the right of making appointment of any candidate to any particular cadre as it deemed suitable at its discretion. This part of the rule was assailed as arbitrary as can be gleaned from the submissions of the counsels appearing from the petitioner therein. The Constitution Bench of the Supreme Court examining the challenge to Rule 9(2) resorted to the principle of “conferment of arbitrary powers”. Arbitrariness was construed in the judgment of S.R. Jayaram[11] as vesting of uncanalised and unguided discretion of the executive and thus opposed to positive content imbibed in Article 14 r/w Article 16.

Thereafter, in the celebrated judgment of Indira Nehru Gandhi v. Raj Narain^[12], whilst dealing with the challenge to newly inserted clauses (4) and (5) to Article 329-A , the Constitution Bench of Supreme Court imported the concept of “inherent arbitrariness” in the amending Act to strike down the said clause (4). Whilst declaring clause (4) unconstitutional, the Court held that the amendment to the Constitution created a situation of vacuum with no law to be applied for deciding the dispute of election. The explicit opinion of Justice Chandrachud held that newly inserted clauses (4) and (5) to be arbitrary with the potential to altogether destroy the rule of law. Vide para 681, Justice Chandrachud in his concurring judgment employed the “rationale of arbitrariness” to declare clauses (4) and (5) to be violative of Article 14. His observations ran thus:

681. It follows that clauses (4) and (5) of Article 329-A are arbitrary and are calculated to damage or destroy the rule of law. Imperfections of language hinder a precise definition of the rule of law as of the definition of “law” itself.[13]

From the above expositions, one would conveniently comprehend that the foundation stone as also the basic groundwork for embodiment of “concept of arbitrariness” as an essential attribute of Article 14 was laid much before the judgment of E.P. Royappa[14]. It would therefore be prevaricating to state that concept of non-arbitrariness was expounded for the first time in the judgment of E.P. Royappa[15]. As would be detailed below, the Supreme Court in E.P. Royappa[16] just beautifully joined the dots together to meticulously articulate the negative correlation between arbitrariness and Article 14. E.P. Royappa had challenged the validity of his transfer from the post of Chief Secretary, first to the post of Deputy Chairman, State Planning Commission and thereafter as Officer on Special Duty as violative of his Articles 14 and 16 rights. The assail rested on mala fide exercise of power by the State with an inferior officer being appointed to the position of Chief Secretary, overlooking the seniority of petitioner Royappa therein.

The stage was thus set in the peculiar constitutional facts for the constitutional prodigy Justice P.N. Bhagwati who despised any attempt to “crib, cabin or confine” the unlimited reach of Article 14. Vide para 85, speaking for the majority, Justice Bhagwati held[17]:

85. … Now, what is the content and reach of this great equalising principle? It is a founding faith, to use the words of Bose, J., “a way of life”, and it must not be subjected to a narrow pedantic or lexicographic approach. We cannot countenance any attempt to truncate its all-embracing scope and meaning, for to do so would be to violate its activist magnitude. Equality is a dynamic concept with many aspects and dimensions and it cannot be “cribbed, cabined and confined” within traditional and doctrinaire limits. From a positivistic point of view, equality is antithetic to arbitrariness. In fact equality and arbitrariness are sworn enemies; one belongs to the rule of law in a republic while the other, to the whim and caprice of an absolute monarch. Where an act is arbitrary, it is implicit in it that it is unequal both according to political logic and constitutional law and is therefore violative of Article 14, and if it affects any matter relating to public employment, it is also violative of Article 16. Articles 14 and 16 strike at arbitrariness in State action and ensure fairness and equality of treatment. They require that State action must be based on valid relevant principles applicable alike to all similarly situate and it must not be guided by any extraneous or irrelevant considerations because that would be denial of equality. Where the operative reason for State action, as distinguished from motive inducing from the antechamber of the mind, is not legitimate and relevant but is extraneous and outside the area of permissible considerations, it would amount to mala fide exercise of power and that is hit by Articles 14 and 16. Mala fide exercise of power and arbitrariness are different lethal radiations emanating from the same vice: in fact the latter comprehends the former. Both are inhibited by Articles 14 and 16.

Thus in E.P. Royappa[18], the concept of arbitrariness came to be formally embedded as a ground for striking down any legislative or executive action being antithetical to Article 14.

Unconstitutionality of Legislative Provisions vis-à-vis Arbitrariness

Post the verdict of E.P. Royappa[19], the Supreme Court found itself armed with a dynamic tool for testing the constitutionality of any legislative or executive action on the touchstone of arbitrariness. The substantive right of “equal protection of law” came to be acknowledged as synonymous to a substantive right and protection against “arbitrariness per se”. Though Seervai in his treatise on Constitutional Law of India^[20] has argued that the new doctrine of arbitrariness “hangs in the air” as it is propounded without reference to the terms in which the right to “equal protection of laws” is conferred. Courts have misunderstood the relation between “arbitrariness” and “discrimination”. From the Supreme Court’s reasoning, it appears that “arbitrarness” involves a voluntary action of a person on whom the arbitrary power has been conferred. However, according to Seervai, one cannot attribute will or intention to a legislature. Whatever violates equality is not necessarily arbitrary, though arbitrary actions are ordinarily violative of equality.

Equality vis-à-vis arbitrariness was further polished and fleshed out in the celebrated judgment of Maneka Gandhi v. Union of India^[21], where the Supreme Court held that the trinity of three articles i.e. Articles 14, 19 and 21 fertilise and cultivate each other mutually. The Court correlated the principle of reasonableness under Article 19 with non-arbitrariness under Article 14 with substantive due procedure under Article 21.

The Supreme Court thereafter in A.L. Kalra v. Project and Equipment Corpn. of India Ltd.^[22] and D.S. Nakara v. Union of India^[23] accorded new dimension to Article 14 by holding that arbitrariness does not always require a comparative/relative evaluation between two persons for recording a finding of discriminatory treatment. The Court held in absolute terms that an action per se arbitrary, (even in the absence of any correlation with any other similarly circumstanced person) shall be violative of second part of Article 14. Kalra[24] thus impliedly extended the applicability of non-arbitrariness to legislative action as well.

Thereafter, in Ajay Hasia v. Khalid Mujib Sehravardi^[25], the Constitutional Bench of the Supreme Court (five Judges) in no uncertain terms, held the concept of reasonableness and non-arbitrariness to be applicable even to legislative actions. Vide para 16, the Court speaking through Bhagwati, J. held thus:

… Wherever therefore there is arbitrariness in State action whether it be of the legislature or of the executive or of an “authority” under Article 12, Article 14 immediately springs into action and strikes down such State action. In fact, the concept of reasonableness and non-arbitrariness pervades the entire constitutional scheme and is a golden thread which runs through the whole of the fabric of the Constitution.

Thus, the collateral nurturing of the doctrine of non-arbitrariness and reasonableness throughout for both legislative as well as executive actions, cannot be said to be confined only to the latter. It would therefore, be a constitutional fallacy to state that arbitrariness applies only to executive actions and not to legislative actions. This is evident from the analysis of the Madras Race Club (Acquisition and Transfer of Undertaking) Act, 1986 in K.R. Lakshmanan v. State of T.N.^[26] on the touchstones of arbitrariness and unreasonability. The Madras Race Club, a limited liability company registered under the Companies Act, 1956, was formed in the year 1896 by taking over the assets and liabilities of the erstwhile unincorporated club known as Madras Race Club. Race meetings were held in the club’s own race course for which bets were made inside the race course premises. The Tamil Nadu Legislature enacted law by bringing horse racing under the ambit of the definition of “gaming”. The said law was challenged by the club on the grounds that “chance” is a controlling factor in gaming which does not include games of skill like horse racing and thus the said enactment was unconstitutional. The Tamil Nadu Legislature during the pendency of the appeal however, enacted the Madras Race Club (Acquisition and Transfer of Undertaking) Act, 1986 (the 1986 Act) which provided for acquisition and transfer of the undertaking of the Madras Race Club on the basis of “public purpose and public good”. The said Act was challenged as violative of Articles 14 and 19(1)(g) of the Constitution of India being irrational and arbitrary. The Court struck down the legislative enactment for being arbitrary and discriminatory. The Supreme Court in Lakshmanan[27] thus established beyond any cavil of doubt that a legislative enactment could be assailed as being arbitrary. This proposition however, stood distorted later owing to an erroneous interpretation of Article 14 subsequently by a lesser Judge Bench (3 Judges) in State of A.P. v. McDowell & Co.^[28]

The remaining discourse on the subject shall continue in Part II of this article to follow after a short while.

† Siddharth R. Gupta is an Advocate practising at Madhya Pradesh High Court and Supreme Court of India. He specialises in constitutional law matters.

†† Final year student, BA LLB (Hons.), National University of Study and Research in Law (NUSRL), Ranchi.

^[1] (1974) 4 SCC 3 : AIR 1974 SC 555.

[2] (1974) 4 SCC 3 : AIR 1974 SC 555.

[3] (1974) 4 SCC 3 : AIR 1974 SC 555.

^[4] (1961) 1 SCR 14 : AIR 1960 SC 1125.

^[5] (1963) 2 SCR 353 : AIR 1963 SC 222.

^[6] (1967) 2 SCR 703 : AIR 1967 SC 1427.

^[7]1951 SCC OnLine US SC 93 : 96 L Ed 113 : 342 US 98 (1951).

^[8]R. v. Wilkes, (1770) 4 Burr 2527 : 98 ER 327.

[9] (1967) 2 SCR 703 : AIR 1967 SC 1427.

^[10] (1968) 1 SCR 349 : AIR 1968 SC 346.

[11] (1968) 1 SCR 349 : AIR 1968 SC 346.

^[12] (1975) 2 SCC 159.

[13] Indira Nehru Gandhi v. Raj Narain, 1975 Supp SCC 1, 258.

[14] (1974) 4 SCC 3 : AIR 1974 SC 555.

[15] (1974) 4 SCC 3 : AIR 1974 SC 555.

[16] (1974) 4 SCC 3 : AIR 1974 SC 555.

[17] E.P. Royappa case, (1974) 4 SCC 3, 38 : AIR 1974 SC 555.

[18] (1974) 4 SCC 3 : AIR 1974 SC 555.

[19] (1974) 4 SCC 3 : AIR 1974 SC 555.

^[20] H.M. Seervai, Constitutional Law of India, 438 (paras 9.6 and 9.7 ), 4th Silver Jubilee Edition, 1991.

^[21] (1978) 1 SCC 248 : AIR 1978 SC 597.

^[22] (1984) 3 SCC 316 : AIR 1984 SC 1361.

^[23](1983) 1 SCC 305 : AIR 1983 SC 130.

[24] (1984) 3 SCC 316 : AIR 1984 SC 1361.

^[25] (1981) 1 SCC 722, 741 : AIR 1981 SC 487.

^[26] (1996) 2 SCC 226 : AIR 1996 SC 1153.

[27] (1996) 2 SCC 226 : AIR 1996 SC 1153.

^[28] (1996) 3 SCC 709 : AIR 1996 SC 1627.

Experts Corner Tarun Jain (Tax Practitioner)

Supreme Court emphasises on Simplification of Tax Law

Introduction

It was under the shadow of a war that India introduced two major fiscal legislations; the Income Tax Act, 1961 and the Customs Act, 1962, paving way for tax policy of independent India. Both legislations have witnessed umpteen amendments to accommodate the shifting priorities of the incumbent Governments and are now well past their sell-by date. In respect of customs, no fundamental alteration is required as the law is mostly aligned to the international framework[1] which ensures that it stays abreast with the changing times. However, the framework of the income tax law – notwithstanding the tide of significant policy changes and amendments to reverse the judicial pronouncements – continues to wheel the Indian economy like a patchy retreated tyre.

Earnest attempts to bring about holistic changes have not yielded fruit despite the Direct Taxes Code of 2009,[2] the Direct Taxes Code Bill, 2010,[3] followed with a 2013 Bill,[4] all of which lapsed. Thereafter, another fresh attempt in recent past by an Expert Committee in 2019[5] seems to have met the same fate. This is so despite the fact that substantial changes have been made in the income tax policy and law. To enumerate certain landmark changes, the 2016 black money legislation[6]; 15% corporate tax rate for new manufacturing entities announced in 2019;[7] India’s digital services tax i.e. the 2020 Equalisation Levy;[8] Taxpayers’ Charter;[9] scheme for faceless assessments, appeals, penalties;[10] the new scheme for reopening of assessments unveiled in 2021;[11] etc. are some of the path-defining measures. However, their fullest potential cannot be realised given the limitations inherited under the old framework. It is not a surprise, therefore, that the Supreme Court recently implored the Parliament, particularly the draftsmen, to frame simpler tax laws which do not scuttle the taxpayers’ ability to carry out their affairs.

Recent decision of Supreme Court

September 9 decision of the Supreme Court in South Indian Bank[12] is a quintessential illustration on why the founding premise of the tax law needs to be revisited. The decision has been rendered in the context of Section 14-A of the Income Tax Act which disallows claim for expenses which are incurred for earning tax free income.[13] This single provision, which was inserted in 2001, has seen more than its fair share of litigation. Notwithstanding the correctness of the underlying premise,[14] stretched interpretation of the law and an indiscriminate and patchy implementation has resulted into multiple and tiresome controversies. In its two decades of existence, it has engaged the Supreme Court more than 25 times and cluttered the dockets of the tax tribunals and High Courts.

This part of law illustrates that an over-empowered tax administration results into ad hoc stances. It is routinely invoked by tax officers who insist that a proportional disallowance to the ratio of average investments to average assets is mandatory.[15] The application of this provision and the accompanying subordinate legislation[16] warrants a closer look at the minutest of facts of a business enterprise during the assessment stage, which have to be subsequently revaluated at multiple appellate levels in the tax litigation system. In most cases, the disallowance is pressed upon to require businesses to justify whether the expenditure is not just directly related to exempt income but also to rule out its indirect linkage.[17]

The practice of ad hoc disallowance may appear to be trivial but it indicates a discomforting scenario. It not only obliges business to incur more compliance costs, but also disproportionately influences business choices, making them perennially sceptical of Tax Department’s outlook, and perpetuates a penny wise pound foolish quandary.

The Supreme Court decision, echoing Adam Smith’s canon of certainty in tax law, seeks to impress upon the Government that “it is the responsibility of the regime to design a tax system for which a subject can budget and plan”. The Supreme Court has unhesitatingly implored upon the Government to ensure a fair balance of taxpayers’ entitlements such that “unnecessary litigation can be avoided without compromising on generation of revenue”. The observations of the Court, therefore, could not have come at a more appropriate instance. The Government must, however, go beyond. It must reinstitute the tax system such that it scuttles the tax officials’ urge to assume the role of the corporate managers and review their decisions from a tax expediency perspective. In other words, the Department should not be permitted to put itself in the shoes of the taxpayer to assess how a prudent businessman should operate.[18]

Aspirational cravings

The ambitious outlines of the Government, to make India a 5 trillion dollar economy[19] and an economic powerhouse, cannot be achieved with an outdated tax system. The recent withdrawal of 2012 retrospective amendment[20] reveals that the Government is not shy of undertaking bold course correction measures. Having undone all legacy issues, it is time for reforming the administration and functioning of officials. All bets now rest on the faceless assessment scheme, which has had a rough start, given the clutch of writs issued by some High Courts on denial of natural justice and quashing of notices for fallacious reopening of past cases by application of old archaic provisions despite simplification brought into the statute.[21] One cannot over-emphasise the urgency for a new tax system which synergises (and not digests) the aspirations and energies of this reinventing nation, a tax system which facilitates business activity and does not scare away business or drive out investments with humongous compliances and energy sapping inspector-like approach of tax officers.

The Government of India must attempt a GST-like[22] rewriting of entire direct tax landscape which should be based on deep stakeholder consultations such that the progressive advancement of tax system is not replete with thorny issues. The basis premise of the law must be simple; business should focus on doing business without managing tax consequences and Tax Department should collect tax without sitting in judgment over how business should do business. The correct tax lawmaking process, which is usually centred around budget day, is too secretive and gives overwhelming powers to the tax bureaucracy and requires businesses to immediate react to the changes because, many of which are overnight. India can do well to take inspiration from advanced countries wherein lawmaking is a continuous process of stakeholder discussion and duly factors economic metrices and impact analysis before deploying the tax measure. Such system avoids a trial and error approach and obviates the need for frequent course correction measures which become inevitable when the measure has not been thought through. In short, the tax law must reduce avenues for friction.

† Tarun Jain, Advocate, Supreme Court of India; LLM (Taxation), London School of Economics.

[1]The Indian Customs policy and law is aligned to India’s participation and multilateral agreements inter alia under the aegis of (a) World Trade Organisation; (b) World Customs Organisation; and (c) Harmonised Commodity Description and Coding System (or Harmonised System).

[2] This was draft for public consultation. Available HERE.

[3] Introduced in the Lok Sabha on 28-8-2010. Available HERE.

[4] Available at HERE.

[5] The Task Force on Direct Tax Code submitted its Report to FM Nirmala Sitharaman on 19-8-2019. For details, see HERE.

[6]The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

[7] For details, see, corporate tax rates slashed to 22% for domestic companies and 15% for new domestic manufacturing companies and other fiscal reliefs, (PIB 20-9-2019), available HERE.

[8]Vide Chapter VI (Part VI) of the Finance Act, 2020 (amending provisions of Finance Act, 2016).

[9]Unveiled in year 2020. For details, see HERE.

[10]For details, see <HERE>.

[11]In terms of Ss. 40-45 of Finance Act, 2021 (amending Ss. 147-151 of Income Tax Act, 1961).

[12]South Indian Bank Ltd. v. CIT, 2021 SCC OnLine SC 692.

[13]“14-A. Expenditure incurred in relation to income not includible in total income.— (1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.”

[14]In a detailed decision in Maxopp Investment Ltd. v. CIT, (2018) 15 SCC 523, the Supreme Court upheld the underlying premise of S. 14-A.

[15]For illustration, see CIT v. Jagson International Ltd., 2018 SCC OnLine Del 12874 opining that the mandatory conditionalities under the Income Tax Rules need to be satisfied before S. 14-A disallowance can be triggered and rejecting the stand of the tax authorities of automatically applying the provision.

[16]I.e. R. 8-D, Income Tax Rules, 1962.

[17]For illustration, see CIT v. Sociedade De Fomento Industrial (P) Ltd., 2020 SCC OnLine Bom 1896 : (2020) 429 ITR 207.

[18]For illustration, see recent decision of the Supreme Court in Shiv Raj Gupta v. CIT, 2020 SCC OnLine SC 589 where the “doctrine of commercial expediency” has been affirmed. In this case the Supreme Court inter alia observed that “a catena of judgments has held that commercial expediency has to be adjudged from the point of view of the assessee and that the Income Tax Department cannot enter into the thicket of reasonableness of amounts paid by the assessee”.

[19] For details, see Vision of a USD 5 Trillion Indian Economy, (PIB 11-10-2018), available HERE.

[20]Vide Taxation Laws (Amendment) Act, 2021 (Act 34 of 2021), assented by the President on 13-8-2021.

[21]For illustration, see Pooja Singla Builders and Engineers (P) Ltd. v. National Faceless Assessment Centre, 2021 SCC OnLine Del 4294, holding that even if principles of natural justice have been complied with, still the proceedings cannot be sustained if an order was passed without issuing a show-cause notice which is a mandatory statutory condition.

[22]See generally, Tarun Jain, One Year of “Goods and Services Tax” in India, available at HERE.

Experts Corner Pramod Rao

Nomination Facilities and Joint Ownership of Financial Assets in the Indian Financial Sector

The advent of Covid-19 brought home the fragility of life in a way that none in living memory had considered. Both the first wave and the second wave, and the impending third wave, make it all too clear that taking safeguards (masks, frequent hand wash or use of sanitisers) and precautions (taking both the doses of the vaccine) are all too necessary lest life or health will be in severe jeopardy.

It is also a time that compels contemplating taking “precautions” to reduce the impact of what the survivors, successors and legal heirs may face after the death of an individual in relation to personal finances and financial assets of such individuals. Nominations have long been considered the panacea both for the individuals and their survivors/successors, and for the institutions that provide nomination facilities. Another initiative often considered is opting for the joint ownership of financial assets, so that the surviving joint owners can access financial assets notwithstanding untimely demise.

Both these approaches serve to bypass the daunting and time-consuming process of obtaining succession certificate or court orders (in case of intestate succession) or probate or letters of administration [in case of the testamentary instrument (will) being available], and to reduce, remove or eliminate submission of cumbersome paperwork for enabling access.

Your columnist examines the legal and regulatory regime governing nominations and joint ownership of three popular financial assets and their nuances.

(a) Current accounts, savings accounts and fixed deposits with banks.

(b) Safe custody and safety lockers with banks.

(d) Mutual funds holdings.

Nomination facility in current accounts, savings accounts and fixed deposits with banks

The aggregate of balances in current and savings accounts, as well as fixed deposits in India stands at Rs 153.1 trillion as of 31-3-2021, and represents a sizable amount of money saved or in transit (to be saved or spent). It also represents the most safe savings instrument (barring rare exceptions) in the country.

Nomination facility is encoded in a statutory provision viz. Section 45-ZA of the Banking Regulation Act, 1949, added in 1985 to ease the release of deposits to the nominee specified by the depositor upon death of the depositor. The section governs credit balances in savings accounts and current accounts, and to fixed deposits with banks. The norms for access to articles kept in safe custody with banks[1] and safety lockers^[2] also follow principles and norms applicable for deposits (unless otherwise noted).

Individuals who jointly own and operate bank accounts or deposits are also permitted to make nominations. Nominations can only be made when the deposits are held in an individual capacity, and not in a representative capacity (including as a holder of an office or otherwise).

The forms as prescribed are part of the Banking Companies (Nomination) Rules, 1985.^[3]

If the nominee is a minor, the depositor can choose while making the nomination to appoint another individual (who is a major), to receive the amounts on behalf of the nominee (during the minority of the nominee) in the event of the death of the depositor.

A depositor can vary or cancel the nomination during the tenure of the deposit. Banks are required to provide acknowledgment of nominations to the depositor, and register the nomination, cancellation or variation in its records.

The key benefit that nominations provide to banks is that they receive a full discharge of the liability in respect of the deposit on making payment of the monies to the nominee^[4].

It is important to note that while the nominee is legally entitled to receive the money from the bank, the nominee does not constitute the successor or inheritor of such sums. The successors or legal heirs (either in terms of the will executed by the depositor, or as per the personal laws of succession governing the depositor who dies intestate) are entitled to claim their rightful share from the nominee^[5].

Many a time one sees claimants (claiming to be legal heirs or successors of a deceased depositor) serve notice of their claim or interest to the bank. As such^[6], a bank is not bound to receive such notice nor is bound by such notice even when it has been expressly delivered to it. Only and only if a decree, order, certificate or other authority from a court of competent jurisdiction relating to such deposit is notified or served on the bank, is the bank required to take due note of such decree, order, certificate or other authority^[7].

Table 1: Current and savings accounts, fixed deposits, safe custody and safety lockers

In the event of:	Transmission in favour of:
In the event of:	Nomination provided	Nomination not provided
Death of single holder	Nominee	Legal heirs (as per succession certificate/probate/letters of administration)
Death of one of the joint holders	Surviving joint holder(s)	Surviving joint holder(s)
Death of all the joint holders	Nominee	Legal heirs (as per succession certificate/probate/letters of administration)

A further element which bears consideration is that in terms of the current law, the nomination by a bank depositor is limited to a single individual^[8]. This is in contrast to several other financial assets which permit multiple nominees and/or even specification of allocation (in percentages) among such multiple nominees.

Hence, it appears that almost by design the bank or the nominee, or both could be placed in a situation of having to deal with the legal heirs, successors and claimants, and which could also lead to litigious situations.

It is your columnist’s view that Section 45-ZA of the Banking Regulation Act (and consequently the Rules thereunder) should be amended to facilitate depositors being able to specify multiple nominees (together with percentage allocation of the money among them). This would help bank deposits keep pace with the approach adopted for other financial assets. Such a change would allow the depositors to specify, as far as possible, their legal heirs as nominees together with the percentage allocation among them. It would help reduce or remove possible friction and burden that the nominee carries in having to deal with the legal heirs, successors and claimants.

A separate thought is for banks to facilitate nominations being done on their internet banking sites or mobile banking apps. There has been a (mis)apprehension on account of the prescribed forms requiring signatures (construed as wet or physical signatures): this has led to banks hesitating in digitalisation of the nomination process.

In fact, the provisions of the Information Technology Act of 2000 and the various mechanisms specified therein for concluding contracts, can extend to the nomination forms being completed and submitted through authenticated means (such as internet banking or mobile banking apps) and will be legal, valid and effective (just as the transactions conducted over such internet banking sites or mobile banking apps). Adoption of such means – Aadhaar-based eSign, or OTP-based confirmation or simply undertaking the nomination after authentication of credentials of the internet banking site or mobile banking app – would also mean that requirement of witness if any can be dispensed with.

In respect of articles kept in safe custody or kept in the safety lockers, one item worthy to call out as a difference (from treatment of deposits) is that the bank, before returning any articles to the nominee or prior to removal of contents of the safety locker by the nominee, is required to prepare an inventory of such articles. The nominee is required to sign a copy of such inventory, and is entitled to receive a copy of the inventory.

Joint ownership and operation of current and savings accounts, fixed deposits, articles in safe custody and safety locker

Almost all financial assets are capable of joint ownership. One critical aspect, especially relevant for ease of access to financial assets, is the treatment of joint ownership and of joint operation of such financial assets on the death of one of the joint owners.

One key benefit is the rule of survivorship, which specifies that the surviving joint owners get the legal title to the asset. It would of course beg the question then why is nomination permitted and encouraged for jointly owned accounts: it is for the remote contingency of all the joint holders perishing simultaneously or together, that nomination becomes relevant.

In terms of practicality, in case of current or savings accounts, it is the mode of operation which also determines the ease.

For instance, specifying “either or survivor” or “anyone or survivor” enables any one of the account holders jointly owning an account to access the account even upon death of any of the account holder/s. Specifying “former or survivor” allows the first account holder to operate the account during her lifetime and upon her death, the survivor to operate the account. “Latter or survivor” works in pretty much similar way, where the second account holder operates the account in her lifetime and upon her death, the first account holder can operate the account.

If however, the mode of operation has been specified as joint, then it requires all account holders during their lifetime to jointly provide the instructions or sign cheques. Upon death of one of the account holders, the right to operate such a joint account will stand revoked or suspended. Such surviving account holders would need to establish a separate account to receive the proceeds from the joint account.

Accordingly, the choice of mode of operation is highly important, and certain choices, as above, can provide ease of access to the survivors and allow the continuing operation of an account upon death of one of the account holders.

In terms of the rule of survivorship, the surviving account holders (under all modes of operation) get a legal title to the balance in the account, and the bank gets a good discharge from such surviving account holders.^[9] Nomination, if any made, for such joint accounts has no relevance, unless all the joint account holders are no more.

It is all too necessary to call out that just as in the case of nominees, while the surviving account holder/s are legally entitled to receive the money from the bank, the survivors may not constitute the successors or inheritors of such sums. The successors or legal heirs (either in terms of the will executed by the deceased account holder, or as per the personal laws of succession governing the deceased who dies intestate and subject to the arrangements among the joint holders) are entitled to claim their rightful share from the survivors^[10].

It is your columnist’s view that the choices in the mode of operation that bank accounts provide is worthy of emulation across other financial assets. Several of the financial assets straitjacket the joint ownership, and hinder the ease of access to joint owners and survivors.

Summary of reforms recommended for current accounts, savings accounts, fixed deposits, articles in safe custody and safety lockers


	Permit multiple nominees (doing away with current limitation of one nominee).
	Permit specification of allocation of percentage of among multiple nominees.
	Facilitate e-nominations (over internet banking or mobile banking apps).
	Placing a deadline for all holders of current accounts/savings accounts/fixed deposits that are presently without nominations to provide nominations.

Nomination facility in depository or demat accounts

With a growing number of investors in the equity markets, or those holding bonds and debentures or even sovereign gold bonds, having a depository account (more popularly referred to as “demat account”) with a depository participant (which in turn are linked to either of the two securities depositories^[11] licensed by the Securities and Exchange Board of India – SEBI) is a given. The total count of demat accounts stood at 55 million plus as of 31-3-2021^[12], with Rs 518.83 trillion constituting the total value of securities held in such demat accounts.

Nomination is possible for demat accounts. There is flexibility to specify up to three nominees, and in case of multiple nominees, the demat account holder/s can specify the percentage of share of each nominee. In the event percentage allocation is not specified, the presumption of equal division among the nominees applies.

Individuals who jointly own demat accounts are also permitted to make nominations. Nominations can be made only by individuals, and only individuals/natural persons can be specified as nominees^[13].

A minor can be a nominee, subject to the name and address of the guardian being provided.

The prescribed forms require photographs of the nominee and other details to help identify and give effect to the nomination. Additionally, the form requires a witness for nomination.

Nominations can be varied or cancelled and fresh nominations made.

The key benefit that nominations provide to depositories and depository participants is that they receive a full discharge of the liability upon the transmission of the securities balances in the demat account to the nominee.

It is important to note that while the nominee is legally entitled to receive the transmission of the securities balance in the demat account, the nominee does not constitute the successor or inheritor of such securities. The successors or legal heirs (either in terms of the will executed by the demat account holder, or as per the personal laws of succession governing the demat account holder who dies intestate) are entitled to claim their rightful share from the nominee^[14].

Table 2: Depository or demat accounts

*In the event of:*	*Transmission in favour of:*
*In the event of:*	*Nomination provided*	*Nomination not provided*
Death of single holder	Nominee(s)	Legal heirs (as per succession certificate/probate/letters of administration)
Death of one of the joint holders	Surviving joint holder(s)	Surviving joint holder(s)
Death of all the joint holders	Nominee(s)	Legal heirs (as per succession certificate/probate/letters of administration)

As can be noted, the demat accounts permit more than one nominee (though imposes a limit of three nominees). It permits percentage allocation among the nominees for all the securities held in demat account (in the aggregate and not individually).

One reform to consider would be to do away with the limitation of three nominees. It would facilitate demat account holders being able to specify multiple nominees without limitation (while continuing with the percentage allocation of the money among them). Such a change would allow the demat account holders to specify, as far as possible, their legal heirs as nominees together with the percentage allocation among them. It would help reduce or remove possible friction and burden that the nominees carry in having to deal with the legal heirs, successors and claimants. Nonetheless, flexibility of having up to three nominees is certainly better than one.

Another limitation is the manner in which nominations along with the percentage allocations takes effect: such nominations and allocations apply across the securities balances held in the demat account, and securities-wise nominations or allocation are not currently possible. Hence, if there are multiple sets of shares and securities held, the nomination and percentage allocation uniformly cuts across all the shares and securities. A potential reform to consider is facilitating nominations and percentage allocation at the level of each security held in the demat account. Such a possibility, it must be noted, exists for physical shares and securities.

A few recent changes^[15] that have been made by SEBI which regulates depositories and depository participants that provide demat accounts, in respect of nomination, are important to consider:

On and from 1-10-2021, investors opening new demat accounts have a choice of providing nomination or opting out of making a nomination. Due formats have been prescribed for either course, and for changes to or cancellation of nominations made.

Indeed, while the regulator has provided a choice of making nomination or opting out of making a nomination, it is your columnist’s view that it would be particularly foolish and indeed downright mean for demat account holders to not use the nomination facility. It would leave the survivors and successors facing a needless, time-consuming and daunting process of obtaining a succession certificate or court orders (in case of intestate succession) or probate or letters of administration, with attendant costs and efforts. Having chosen to invest and open a demat account, it would be prudent and practical to utilise the nomination facility.

All existing eligible demat account holders are required to make a choice of providing nomination or opting out of making a nomination on or before 31-3-2022, failing which no debits can be made to the demat account, effectively freezing trading of securities held therein.

Such a missive is a much-needed measure. Lack of nomination impacts both the survivors, successors and inheritors as well as the depositories and depository participants. Both bear the burden of having to arrange for (and receive) duly notarised copy of succession certificate or an order of a court of competent jurisdiction (when the demat account holder has not left a will) or duly notarised copy of probate or letter of administration (when the demat account holder did execute a will). Either course is a daunting court process, which the survivors, successors or inheritors face. For the depositories and depository participants, when there is no nomination, then good discharge can be achieved only by receiving such documents.

A key change has been dispensing with the witnessing of the nomination form in the following circumstances:

(a) Nomination form signed under wet signature of the demat account holders.

(b) Online nomination form signed using e-Sign facility.

Witness signature is however required when the demat account holders affix thumb impression (in lieu of signatures).

It is your columnist’s view that such a measure is quite laudatory and appreciable: it removes the friction of the depository participant or the investor having to arrange for an independent witness, and provides due privacy to investors affixing wet signatures or using e-Sign facility. In respect of investors affixing thumb impressions, perhaps if could be nudged instead to use e-Sign facility (which also relies on biometric identification), would also have the same benefit. Notably, most other financial assets also do not require witnessing of the nomination form and this measure brings demat accounts in line with the same.

Joint ownership and operation of demat accounts

Individuals can jointly own demat accounts, subject to a limit of three joint owners. A minor cannot be one of the joint owners^[16].

In keeping with the recommendation of lifting the limit of number of nominees, it would be appropriate to also recommend lifting the limit of number of joint owners of a demat account.

In case of death of any one joint owner, the rule of survivorship will be applicable. To briefly recap, this means that the surviving joint owners get the legal title to the balances in the demat account. It is noted that while the surviving account holder/s are legally entitled to receive the securities balances in the demat account, the survivors may not constitute the successors or inheritors of such securities. The successors or legal heirs (either in terms of the will executed by the deceased demat account holder, or as per the personal laws of succession governing the deceased who dies intestate and subject to the arrangements among the joint holders) are entitled to claim their rightful share from the survivors^[17].

When the surviving demat account holders provide a notarised death certificate of the deceased account holder, the depository participant would proceed to freeze the demat account, and transmit the balances to the demat account of the surviving demat account holders.

This presumably preserves the record of holdings, transactions and of the demat account holders (including the deceased account holder) in the records of the depository, and fresh records are created for the surviving demat account holders and their transactions.

This perhaps is a key difference between joint bank accounts and joint demat accounts: the former is a running account, capable of being operated (subject to the mode of operation) even upon the demise of one of the joint holders, while the demat account is closed upon death of one of the joint holders. A reform worthy of consideration is treating the demat account as a running account, the way bank accounts are: so demise of a joint owner should not mean closure of the demat account (with attendant transmission of the balances to the demat account of the surviving demat account holders). Rather, the surviving demat account holders should be allowed to continue operations in the same demat account.

Jointly owned demat accounts also have a very limited scope on mode of operation: the depositories require that all joint holders authorise the transactions.

Practically, the first holder or main holder could be conducting the transactions, especially in case of online transactions. Additionally, reliance is possibly placed on a letter of authority or power of attorney given by all the joint owners of the demat account holders.

As mentioned earlier, the multiple choices in the mode of operations that bank accounts provide is worthy of emulation for demat accounts. Limiting the mode of operation to only jointly by all the demat account holders, and allowing practices to develop wherein parties rely upon a letter of authority or a power of attorney from all the demat account holders can be thought of as an inefficient and poor workaround. Rather, just as banks facilitate different types of modes of operations, the two depositories could upgrade their systems to provide the same or similar facility.

Summary of reforms recommended for depository or demat accounts


	Permit multiple nominees (doing away with current limitation of three nominees).
	Permit ability to specify nominations and percentage allocation at the level of each security held in the demat account (from current account level nomination and allocation being feasible).
	Removal of choice of opting out from making nomination.
	Permit multiple joint owners (doing away with current limitation of three joint owners).
	Permitting jointly held demat accounts to become a running account by surviving demat account holders after the death of one of the joint holders (doing away with closure of demat account and transfer of balances to demat account held by surviving holders).
	Permitting multiple modes of operation for jointly held demat accounts (either or survivor, anyone or survivor, former or survivor, latter or survivor, joint).

Nomination facility in mutual funds

Investments in mutual fund schemes have grown by leaps and bounds, and particularly post demonetisation. The current corpus under management of mutual funds is at Rs 31.4 trillion as on 31-3-2021.

Nomination is possible for mutual fund holdings. Nomination made by a mutual fund investor is applicable for units held in all the schemes under the respective folio/account and gets rescinded on redemption of such units or its transfer.

There is flexibility to specify up to three nominees, and in case of multiple nominees, the mutual fund investor can specify the percentage of share of each nominee with such allocation/share being required to be in whole numbers without any decimal. In the event percentage allocation is not specified, the presumption of equal division among the nominees applies.

Individuals who are joint investors in mutual fund (irrespective of the mode of operation) are also permitted to make nominations, being required to do so jointly.

Nominations can be made only by individuals. Non-individuals including a society, trust, body corporate, partnership firm, karta of Hindu Undivided Family, a power-of-attorney holder and/or guardian of minor mutual fund investor cannot nominate.

Nominations can be in favour of individuals/natural persons, and also the Central Government, State Government, a local authority, any person designated by virtue of his/her office or a religious or charitable trust can be specified as nominees. This is an expanded set of eligible nominees (distinct from nominations permitted for bank accounts or demat accounts).

A minor can be a nominee, subject to the name and address of the guardian being provided.

Nominations can be varied or cancelled, and fresh nominations made.

Uniquely, there is a specification of consequences in case of death of a nominee. In the event of the nominee(s) predeceasing the mutual fund investor(s), the nomination is automatically cancelled. In case of multiple nominations, if any of the nominee is deceased at the time of claim settlement, that nominee’s share would be distributed equally amongst the surviving nominees.

Transmission of units in favour of the nominee(s) constitutes valid discharge of the asset management company, the trustee company and the mutual fund. It is important to note that while the nominee is legally entitled to receive the units, the nominee does not constitute the successor or inheritor of such units. The successors or legal heirs (either in terms of the will executed by the mutual fund investor, or as per the personal laws of succession governing the mutual fund investor who dies intestate) are entitled to claim their rightful share from the nominee^[18].

To claim the units after the death of a unit holder, the nominee has to complete the necessary formalities, such as completion of KYC process, along with proof of death of the unit holder, signature of the nominee duly attested, furnishing of proof of guardianship in case the nominee is a minor, and such other document as may be required for transmitting the units in favour of the nominee(s)^[19]. One key element, which appears to be excessive or contributing to avoidable friction is requirement of attestation of nominee’s signatures. When the transmission amount is up to Rs 2 lakhs, the attestation by a Bank Manager is required in a prescribed form, and when the transmission amount is more than Rs 2 lakhs, the attestation by a notary public or a Judicial Magistrate, First Class (JMFC) is required. Attestation requirements also extend to various documents including bank passbook/bank statement, death certificate and so on, all of which appear excessive and could be dispensed with.

It is also important to note that when units in mutual fund schemes are held in a depository or a demat account, the nomination details provided to the depository/depository participants will be applicable to such units and govern the transmission.

Table 3: Mutual fund folios/accounts

In the event of:	Transmission in favour of:
In the event of:	Nomination provided	Nomination not provided
Death of single holder	Nominee(s)	Legal heirs (as per succession certificate/probate/letters of administration)
Death of one of the joint holders	Surviving joint holder(s)	Surviving joint holder(s)
Death of all the joint holders	Nominee(s)	Legal heirs (as per succession certificate/probate/letters of administration)

As can be noted, the mutual funds permit more than one nominee (though imposes a limit of three nominees). It permits percentage allocation among the nominees for the units held in the folio/account (in the aggregate and not individually).

One reform to consider would be to do away with the limitation of three nominees. It would facilitate mutual fund investors being able to specify multiple nominees without limitation (while continuing with the percentage allocation of the money among them). Such a change would allow the mutual fund investors to specify, as far as possible, their legal heirs as nominees together with the percentage allocation among them. It would help reduce or remove possible friction and burden that the nominees carry in having to deal with the legal heirs, successors and claimants. Nonetheless, flexibility of having up to three nominees is certainly better than one.

One further reform to consider is doing away with a choice not to furnish a nomination. As previously noted, it is your columnist’s view that it would be particularly foolish and indeed downright mean for mutual fund investors to not use the nomination facility. It would leave the survivors and successors facing a needless, time-consuming and daunting process of obtaining a succession certificate or court orders (in case of intestate succession) or probate or letters of administration, with attendant costs and efforts. Having chosen to invest and create assets in form of units of mutual fund schemes, it would be prudent and practical to utilise the nomination facility.

Finally, enabling e-nomination facilities could greatly boost specifying nominee(s). Either the mutual fund industry and AMFI – the Association of Mutual Funds in India – could harness the provisions of the Information Technology Act of 2000 and the various mechanisms specified therein for concluding contracts, for completion of the nomination forms and submission through authenticated means and will be legal, valid and effective. Adoption of such means – Aadhaar-based eSign, or OTP-based confirmation or simply undertaking the nomination after authentication of credentials of the internet site or mobile app of the AMC – would also mean that requirement of witness if any can be dispensed with. Alternatively, SEBI could specify e-nomination norms for mutual funds akin to the norms specified for demat accounts.

Joint ownership and operation of mutual fund investments

Individuals can jointly own units in mutual fund schemes, subject to a limit of three joint owners.

In keeping with the recommendation of lifting the limit of number of nominees, it would be appropriate to also recommend lifting the limit of number of joint owners of units in mutual fund schemes.

In case of death of any one joint owner, the rule of survivorship will be applicable. To briefly recap, this means that the surviving joint owners get the legal title to the units of the mutual fund scheme. While the surviving joint holders are legally entitled to the units of the mutual fund scheme, the survivors may not constitute the successors or inheritors of such units. The successors or legal heirs (either in terms of the will executed by the deceased joint holder, or as per the personal laws of succession governing the deceased who dies intestate and subject to the arrangements among the joint holders) are entitled to claim their rightful share from the survivors^[20].

Akin to bank accounts, the folios/accounts and the units held in such folios/accounts continue to operate without any issue, and only the details of the holders – nominees in case of sole mutual fund investor, or the surviving joint holder/s – get updated.

Mutual funds permit “either or survivor” mode of operation when investments are jointly held, thereby providing flexibility for the investors in transacting. The exception is making nominations, which have to be jointly made.

Summary of reforms recommended for mutual fund investments


	Permit multiple nominees (doing away with current limitation of three nominees).
	Removal of choice of opting out from making nomination.
	Permit multiple joint owners (doing away with current limitation of three joint owners).
	Removal of attestation requirement for signatures of nominees or of documents submitted by nominees regardless of amounts that are to be transmitted.

Concluding remarks

As would be appreciated, there are very many similarities (and the differences are less apparent) in the nomination facilities, and joint holdings of financial products. These similarities and differences can have significance for orderly claim by nominee or survivors, and due discharge of the financial institutions. In many senses, the system may be efficacious, but quite tedious, time consuming, and also containing many pain points, friction and overall stressful to the nominees and claimants navigating the process. The financial institutions which have to process such claims also are hidebound to adhere to rules framed in a different era and time, running the risk of not securing due discharge and/or regulatory reprimands or penalties if deviate from such rules.

For anyone who has lost a loved one and is coping with an unfamiliar and difficult process, aggravated by the circumstances Covid-19 has brought, if financial sector regulators and financial institutions can consider reforms for further easing the pain, the friction and the efforts that survivors make in accessing the financial assets of the deceased, it would be highly commended and appreciated.

Adopting the best features regarding nominations or joint holdings as outlined above for each type of financial product would appear the easiest way forward.

Additionally, a few of the limitations – number of joint owners or number of nominees – most likely come from a technology system design perspective, where the record-keeping capability or capacity perhaps acted as the reason for the limits. In case of bank accounts, it is in fact coded into the statute. In real life and for assets such as real estate or physically held securities, such limits do not apply. The technology and systems should accordingly adapt and be upgraded to enable individuals and families to deal with financial assets in the mode, manner and extent that they desire.

It is time for society to be fair-minded to its financial consumers and their nominees, successors and survivors at the time they most need solace and support.

† Group General Counsel at ICICI Bank. His Linkedin profile can be accessed HERE

Disclaimer: Views in this article are his personal views.

*Vanaj Vidyan, student of RMLNLU has assisted in the research of the article.

[1] Governed by S. 45-ZE of the Banking Regulation Act, 1949.

^[2] Governed by S. 45-ZE of the Banking Regulation Act, 1949.

^[3] See <HERE>; Vide Noti. No. S.O. 264(E), dated March 29, 1985, published in the Gazette of India, Extra., Part II, S. 3(ii), dated 29th March, 1985, pp. 10-18.

^[4] S. 45-ZA(4) of the Banking Regulation Act, 1949.

^[5] Proviso to S. 45-ZA(4) of the Banking Regulation Act, 1949; also specification in the will that the nominee is the beneficiary can obviate challenges or issues from arising.

^[6] S. 45-ZB of the Banking Regulation Act, 1949.

^[7] Proviso to S. 45-ZB of the Banking Regulation Act, 1949.

^[8] In case of jointly operated lockers i.e. by two or more individuals jointly, such hirers may nominate one or more persons to whom, in the event of the death of such joint hirer or hirers, the bank may give, jointly with the surviving joint hirer or joint hirers, access to the locker and liberty to remove the contents of such locker.

^[9] Banks as such do not take notice of any rival claimants to the monies even if notified though would take note of a decree, order, certificate or other authority from a court of competent jurisdiction relating to such money if is duly notified or served on the bank.

^[10] Specification in the will that the joint owners or surviving joint holders are the beneficiaries can obviate challenges or issues from arising.

^[11] NSDL: National Securities Depository Ltd., and CDSL: Central Depository Services (India) Ltd.

^[12] 55,127,436 as of 31-3-2021 for the detail oriented.

^[13] Akin to nominations for bank accounts excluding non-individuals.

^[14] Specification in the will that the nominee/s is the beneficiary/ies can obviate challenges or issues from arising.

^[15] See <HERE>.

^[16] On account of minors incapacity to enter into contracts.

^[17] Specification in the will that the joint owners or surviving joint holders are the beneficiaries can obviate challenges or issues from arising; one other potential challenge that should be considered is how the surviving joint holders get along (or do not), and hence segregating securities into distinct demat accounts with one joint holder each could be a better approach (unless securities level nomination is permitted).

^[18] Specification in the will that the nominee/s is the beneficiary/ies can obviate challenges or issues from arising.

^[19] See Here

^[20] Specification in the will that the joint owners or surviving joint holders are the beneficiaries can obviate challenges or issues from arising; one other potential challenge that should be considered is how the surviving joint holders get along (or do not), and hence segregating the mutual fund holdings into distinct folios with one joint holder each could be a better approach.

Akaant Mittal Experts Corner

Interplay of IB Code with Law on Limitation – The Consistent “Inconsistency” – Part III

Recapitulation

The present column post will conclude the 3-part series on the law of limitation and its interplay with the Insolvency and Bankruptcy Code, 2016 (IB Code).

In the first part of the column, we had discussed the initial issues in the interplay of IB Code with the law on limitation and how they were resolved by the insertion of Section 238-A to the IB Code and the Supreme Court rulings in B.K. Educational Services^[1] and Vashdeo R. Bhojwani v. Abhyudaya Cooperative Bank Ltd.^[2] We also discussed the recent ruling of the Supreme Court in Sesh Nath Singh v. Baidyabati Sheoraphuli Cooperative Bank Ltd.[3] which provided some respite as far as Section 14 of the Limitation Act is concerned and how a creditor can use that provision to seek extension of limitation period.

In the second part of the column, we discussed the applicability of Section 18 of the Limitation Act to the applications seeking initiation of resolution process under the IB Code. The missed opportunities of Babulal Vardharji[4] now stand settled conclusively by the rulings in Laxmi Pat[5]. Similarly, the limitation issues concerning the acknowledgment of debt for the purposes of Section 18 of the Limitation Act by virtue of entries in balance sheets of a company was settled by the Supreme Court in Asset Reconstruction Co.[6] ruling.

In this third part, we will discuss the issue of the effect of Section 19 of the Limitation Act, 1963 which stipulates the “effect of payment on account of debt or of interest on legacy” on an application seeking initiation of resolution process under the IB Code.

Brief on Section 19 of the Limitation Act, 1963

Effect of payment on account of debt or of interest on legacy.—Where payment on account of a debt or of interest on a legacy is made before the expiration of the prescribed period by the person liable to pay the debt or legacy or by his agent duly authorised in this behalf, a fresh period of limitation shall be computed from the time when the payment was made:

Provided that, save in the case of payment of interest made before the 1st day of January, 1928, an acknowledgment of the payment appears in the handwriting of, or in a writing signed by, the person making the payment.

To attract the application of Section 19, two conditions are essential (i) the payment must be made within the prescribed period of limitation; and (ii) it must be acknowledged by some form of writing, either in the handwriting of the payee himself or signed by him.

Applicability of Section 19 of the Limitation Act, 1963 to IB Code

The National Company Law Appellate Tribunal (NCLAT) has been confronted on several occasions where partial payment of the debt or payment of interest has been made by the debtor on account of the debt.

For instance in Neha Himatsingka v. Himatsingka Resorts (P) Ltd.^[7] the argument that the debt in question was time barred was rejected. The NCLAT noted that as per the record the corporate debtor had paid interest even after the year 2016-2017 and also issued cheques in the year 2018; therefore, the argument that the claim is time barred was rejected.

Similarly in T. Johnson^[8], the creditor relied upon (1) the revival letter dated 20-2-2016; (2) balance confirmation letter dated 22-2-2016 by the corporate debtor; and (3) the factum of last payment having been made on 14-11-2017 to establish that its claim is not time barred.

The NCLAT noting that apart from the above, there is an admission on the part of the corporate debtor on the basis of the written submissions of the appellant before the National Company Law Tribunal (NCLT) and the fact that the appellant debtor is merely disputing the correctness of the quantum of balance claimed by the financial creditor rejected the argument that the claim is time barred.^[9]

As we have seen in the previous columns, in the rulings of Laxmi Pat[10], Sesh Nath[11] and Asset Reconstruction Co.[12] the Supreme Court has settled that the phrase “the provisions of Limitation Act have been made applicable to the proceedings under the Code, as far as may be applicable” in Section 238-A of the IB Code means that all the relevant provisions of the Limitation Act can be invoked while filing an application under the IB Code. The same in those cases meant that Sections 5, 14 and 18 of the Limitation Act were invoked to extend limitation period.

Now the recent ruling of the NCLAT ruling in Rajendra Narottamdas Sheth v. Chandra Prakash Jain,[13] provides us with a more useful reference point to understand the interplay between Section 19 of the Limitation Act, 1963 with the IB Code.

In Rajendra Narottamdas[14], the account of the debtor was declared as a non-performing asset (NPA) on 30-9-2014 and the financial creditor filed an application seeking initiation of corporate insolvency resolution process (CIRP) against the debtor on 25-4-2019.[15] The debtor claimed that the application is time barred as it was beyond the three-year limitation period that commenced on the date of the NPA.[16] The financial creditor argued that the limitation period got extended on account of Section 18 of the Limitation Act by relying on the documents showing acknowledgments of debt by the corporate debtor in writing. The creditor also placed reliance on the statements of accounts showing various instalments paid on account of debt and interest, even after the declaration of NPA to invoke the application of Section 19 of the Limitation Act.[17]

The NCLAT referred to the following undisputed facts where: (a) the corporate debtor had issued balance confirmation letter dated 7-4-2016 and acknowledged the debt; (b) the account statements showed regular credit entries after 7-4-2016 till May 2018; and (c) the corporate debtor issued a letter dated 17-11-2018 giving details of amounts repaid till 30-9-2018 and acknowledging amount outstanding in respective accounts as on that date.

On the basis of these facts, the NCLAT held that the benefit of Sections 18 and 19 were attracted and the application by the creditor was not time barred.[18]

Conclusion

If the reasoning in Sesh Nath[19], Laxmi Pat[20] and Asset Reconstruction Co.[21] is to be accepted that the “provisions of Limitation Act have been made applicable to the proceedings under the Code, as far as may be applicable”[22], then clearly Section 19 of the Limitation Act can be used to extend limitation period. To that effect, the ruling of the NCLAT in Rajendra Narottamdas[23] shows the way ahead for the application of Section 19 of the Limitation Act to the IB Code.

± Akaant Kumar Mittal is an advocate at the Constitutional Courts, and National Company Law Tribunal, Delhi and Chandigarh. He is also a visiting lecturer at the NUJS, Kolkata and the author of the commentary Insolvency and Bankruptcy Code – Law and Practice.

The author gratefully acknowledges the research and assistance of Sh. Abhishek Jain, 3^rd Year, B.A.LLB. (Hons.), Student at National University of Juridical Sciences, Kolkata, in writing this article.

^[1] B.K. Educational Services (P) Ltd. v. Parag Gupta and Associates, (2019) 11 SCC 633 : (2018) 5 SCC (Civ) 528.

^[2] (2019) 9 SCC 158 : (2019) 4 SCC (Civ) 308.

[3] 2021 SCC OnLine SC 244.

[4]Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries (P) Ltd., (2020) 15 SCC 1 : 2020 SCC OnLine SC 647.

[5] Laxmi Pat Surana v. Union Bank of India, 2021 SCC OnLine SC 267.

[6] Asset Reconstruction Co. (India) Ltd. v. Bishal Jaiswal, 2021 SCC OnLine SC 321.

^[7] 2018 SCC OnLine NCLAT 784.

^[8] T. Johnson v. Phoenix ARC (P) Ltd., 2019 SCC OnLine NCLAT 244.

^[9] Id., para 6.

[10] 2021 SCC OnLine SC 267.

[11] 2021 SCC OnLine SC 244.

[12] 2021 SCC OnLine SC 321.

[13] 2020 SCC OnLine NCLAT 827.

[14] Id.

[15] Id, para 3.

[16] Id, para 4.

[17] Id, para 8.

[18] Id, paras 24-27.

[19] 2021 SCC OnLine SC 244.

[20] 2021 SCC OnLine SC 267.

[21] 2021 SCC OnLine SC 321.

[22] Laxmi Pat Surana, 2021 SCC OnLine SC 267, para 41.

[23] 2020 SCC OnLine NCLAT 827.

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Concluding Remarks

† Pramod Rao, Group General Counsel at ICICI Bank. Views are personal.

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†† Final Year Student, B.A.LL.B (Hons.), National Law Institute University (NLIU), Bhopal.

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F. Comparing UNCITRAL Arbitration Rules and Arbitration and Conciliation Act, 1996’s Procedural Provisions

G. Application to Indian Ad hoc Arbitrations

H. Features of Any Future Rules for Ad Hoc Arbitrations

I. Conclusion

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