Tuesday, June 24, 2014

The curious case of the MCA: A live example that illuminates the Rajan critique of FSLRC

by Pratik Datta.

So deeply entrenched is judicial review in the modern legal system, that at times, the most learned among us tend to take it for granted, overlooking the sheer time and effort it took to reach here. Starting from the fields of Runnymede in 1215, we have come a long way in understanding the importance of judicial review as a fundamental pillar of a liberal democracy.

India has moved substantially in the direction of creating regulators. Parliament has delegated enormous powers to unelected officers to write subordinate legislation, conduct investigations, and impose sanctions for violations of such subordinate legislations. Judicial review of such regulatory actions come in two kinds:
1. Orders written by some regulators can be challenged before a specialised tribunal. For example, SEBI's orders can be challenged before SAT; TRAI's orders can be challenged before TDSAT; CERC's or SERC's orders can be challenged before APTEL; AERA's order can be challenged before AERAAT. The establishment of specialised tribunals is not, as yet, complete. No designated tribunal has been empowered to review decisions passed by some other regulators, like RBI, IRDA, PFRDA. Their decisions can theoretically be challenged in writ jurisdiction of High Courts.
2. A subordinate legislation issued by the regulator can be struck down for being ultra vires its parent statute or the Constitution, meaning that it is beyond the scope of, or contrary to, the provisions of that parent statute or the Constitution. As of today, none of the specialised tribunals have been empowered to review the vires of the subordinate legislations issued by the regulators. Only a High Court or the Supreme Court in writ jurisdiction can look into the vires of subordinate legislation.

A new debate on judicial review

The FSLRC recommended that for the financial sector, there should be a Financial Sector Appellate Tribunal (FSAT). The FSAT will not only have jurisdiction to review all decisions passed by the financial regulators, but can also strike down subordinate legislation (regulations) if they are ultra vires the parent statute. Last week, the RBI Governor Raghuram Rajan expressed grave concerns about this particular power of judicial review of FSAT. He argued about the danger of excessive legal oversight':
So long as the Tribunal only questions administrative decisions such as the size and proportionality of penalties, I do not see a problem. But if it goes beyond, and starts entertaining questions about policy, the functioning of a regulator like the RBI, which has to constantly make judgments intended to minimize systemic risk, will be greatly impaired.
In order to illustrate the questions at stake, a fascinating story is shaping up with circulars issued by the Ministry of Company Affairs. The curious case of the MCA circulars shows us how critical judicial review is, to the working of democracy, and why the judiciary must proactively ensure government agencies operate within the framework of parliamentary law.

Does MCA administer the Companies Act, 2013?

The Companies Act, 1956 was recently replaced by the Companies Act, 2013. Within the Central Government, the administration of the Companies Act, 1956, had been entrusted with the MCA through the Government of India (Allocation of Business) Rules, 1961. Interestingly, these Rules have not yet been updated to include administration of Companies Act, 2013 under the purview of MCA. For the purposes of this post, we will assume that this problem did not exist, and that MCA does have the authority to administer the Companies Act, 2013.

How things worked under the Companies Act, 1956

Under the Companies Act, 1956, there was no provision empowering the MCA to remove difficulties in implementing the Act. Section 642 allowed the MCA to only make rules, but such rules needed to be laid before each House of Parliament.

In jurisdictions with weak rule of law, the executive's tendency to overreach remains unchecked. In the absence of a specific provision empowering MCA to "remove difficulties", the MCA resorted to issuing circulars' for clarificatory purposes. However, since these circulars were beyond the prescribed statutory procedure, MCA did not have to comply with the requirement of laying them before the Parliament. Consequently, the scope of circulars kept on expanding over time and varied in their format. Many circulars have been issued in rem while some are in personam in the nature of a letter. Some of them are signed, some have only a designation but no signature, and some have neither designation nor signature. Moreover, some circulars have been used to issue schemes and guidelines. Therefore, under Companies Act, 1956, without any specific power to issue circulars, the MCA ended up creating a maze of subordinate instruments: circulars, guidelines, schemes. This was going beyond the authority given to the MCA by Parliament.

Executive discretion under the Companies Act, 2013

Like its predecessor, the Companies Act, 2013, gives MCA the power to make rules (s. 469) but does not specifically empower MCA to issue circulars. But unlike its predecessor, it has a new feature. It empowers MCA to issue "orders" (s. 470) to remove difficulties in implementing the Act. Such orders can be made only for the first five years after the commencement of the Act. Moreover, like the rules, these orders also need to be laid before each House of the Paliament.

During the drafting phase of the Companies Act, 2013, various suggestions were made to modify certain provisions in the Companies Bill, 2011. In many instances, the MCA argued that clarificatory issues can be addressed by draft clause 470 (removal of difficulty clause) which appeared in the Bill. The details can be found in the Standing Committee Report (2011-12). Therefore, it can be safely assumed that the MCA knows that it should issue clarifications to the Companies Act, 2013 through orders under section 470 of the Act and not through clarificatory circulars.

So how is MCA issuing clarifications?

The MCA website categorises four types of legal instruments under the Companies Act, 2013 in the following sequence:

• Rules
• Circulars
• Orders

So how are these instruments being used? As of today, 5 orders under section 470 have been published in the official gazette and are available on the MCA website (here, here, here, here and here) . These have been issued by officers of the rank of Joint Secretary.

MCA has also issued 20 circulars (as on the date of this post) under the Companies Act, 2013, as available on the MCA website. 8 of these claim to clarify provisions of the Companies Act, 2013 (for example, see here and here). These have been issued by officers of Deputy Director or Assistant Director ranks.

Doing indirectly, what cannot be done directly

Through circulars issued by subordinate officers, MCA has tried to achieve what should have been done only through orders under section 470 by senior officers. The Supreme Court has time and again held that what cannot be done directly, cannot be done indirectly. The MCA cannot directly notify an order. Such an order must be laid before the Parliament. But a circular, being beyond the scope of the Act, is not bound by any such constraints. And so, continuing with its earlier behaviour under the Companies Act, 1956, the MCA has been interpreting provisions of the Companies Act, 2013, through circulars instead of issuing orders under section 470 of the Act. This is clearly an indirect way of achieving what MCA could not otherwise achieve directly - giving its own interpretation to provisions of a Parliamentary legislation (the Companies Act, 2013) without putting it through Parliamentary scrutiny.

Note that this act on the part of MCA is not an administrative decision' in personam. It is a legislative act in rem. Rajan believes that such acts should not be reviewed by a Tribunal. Let's think about the consequences that would flow from this.

On a related note, see Difficulties with special guidance and general guidance in the IFC by Burman et. al., Ajay Shah's blog, 11 February 2014.

What if we did as Rajan says

NCLT is the proposed tribunal under Companies Act, 2013. Let us assume that NCLT has become operational and that it has limited power of judicial review as proposed by Rajan - it cannot strike down subordinate legislations passed by MCA as ultra vires the Companies Act, 2013 ("the Rajan proposal"). Let us further assume that a case pending before the NCLT hinges on interpretation of a particular provision of the Companies Act, 2013. One party is relying upon the interpretation of that provision by a MCA circular. The other party points out that such circulars cannot be passed by MCA under the Companies Act, 2013 (as argued above) and therefore such an interpretation is not binding on NCLT. Going by the Rajan proposal, NCLT cannot question the legal capacity of MCA to pass such a circular. Therefore, NCLT will be bound by the interpretation given by MCA even though under Companies Act, 2013, MCA is not even allowed to interpret the Act by such a circular. This will be a travesty of justice. The Rajan proposal will only perpetuate an illegality.

Under such circumstances, the only option left before the aggrieved party will be to file a parallel writ proceeding before a High Court challenging the vires of the particular circular. Therefore, now for the same cause of action, there will be two parallel proceedings: one in NCLT and one in the High Court. Other than multiplying litigations and costs, it will also generate coordination problems between the two judicial bodies. If the High Court stays the proceedings before NCLT till it disposes off the writ petition, the disposal of the matter by NCLT will also be delayed. This will adversely affect the pendency statistic of NCLT as well as the High Court.

NCLT is likely to accumulate knowledge and organisational capital in the field, as the Securities Appellate Tribunal has in the field of securities. It is likely to do better in thinking about the substance of a regulation when compared with the High Court. The fear of judicial review that Rajan expresses is ironically asking that the matter be heard at a court less capable of understanding the merits of the case.

FSLRC gets it right

Now, in our hypothetical example, let us substitute the Rajan proposal with the FSLRC proposal of giving the tribunal the power to strike down subordinate legislations as ultra vires the parent statute. In this case, instead of filing a fresh writ petition in a High Court, the aggrieved party can move an application in the same matter before NCLT praying for quashing of the circular. Now, the NCLT can strike down the MCA circular as ultra vires the Companies Act, 2013. This will save time and costs for the High Court, the NCLT as well as the litigants. No coordination problem will crop up between the High Court and NCLT. NCLT will be able to dispose off the case faster without having to wait for the High Court's decision. This will cause the least judicial delay.

The Financial Sector Appellate Tribunal (FSAT), envisioned by FSLRC, will be a specialised court working in the field of finance. It will build up organisational capital and knowledge of the field. This will help produce better decisions.

More generally, the precision of drafting of the Indian Financial Code (IFC) is quite different from the Companies Act of 1956 or 2013. The behaviour of MCA, documented above, would not be possible under the IFC.

Conclusion

After extensive deliberations with experts from the field of finance, economics and law, the FSLRC noted that as per the constitutional scheme, the Supreme Court and the High Courts enjoy the power of judicial review. But to cut down on delay and to ease the pressure on the High Courts, it is essential that the judicial entity (the FSAT) which has the primary duty to pass judicial orders based on subordinate legislations should also have the power to strike down subordinate legislations ultra vires the parent statute. This is not in derogation to the powers of judicial review of the Supreme Court or High Courts and is compliant with the constitutional scheme. Accordingly, it was recommended that FSAT should have power of judicial review of subordinate legislations passed by the financial regulators. Such a review, although not limited to administrative actions', does not amount to reviewing the policy.

Rajan uses the word policy' but under the rule of law, there is no place for the word policy'. All we must focus upon is the objectives and powers established by Parliament for every public body, and live within these. To allay the misapprehensions in the mind of the RBI Governor, Lord Justice Lawton's observations in Laker Airways case ([1977] Q.B. 643) would be instructive:

Judges have nothing to do with either policy making or the carrying out of policy. Their function is to decide whether a minister has acted within the powers given him by statute or the common law. If he is declared by a court, after due process of law, to have acted outside his powers, he must stop doing what he has done until such time as Parliament gives him the powers he wants. In a case such as this I regard myself as a referee. I can blow my judicial whistle when the ball goes out of play; but when the game restarts I must neither take part in it nor tell the players how to play.

In a few odd matches, the striker may end up hitting the referee and missing the goal. But that is no reason to remove the referee from the game altogether. Similarly, the fear that some day some judge might somehow affect a policy decision should not lead us today to opt for a system where for every cause of action multiple proceedings are filed resulting in higher case pendency and further judicial delay.

Greed for more power is an inborn urge. The executive always has a temptation to grab more power than is conferred by Parliament. Wisdom in public administration lies in being aware of these urges and controlling them. The way forward for Indian democracy lies in writing precise laws, which define specific objectives and narrow powers for every public body. Once this is done, a potent system of tribunals and courts is required, to ensure that the legislative intent is not transgressed by the executive. We must respect the wisdom of FSLRC, and spurn this and other attempts to achieve unrestricted executive discretion.

1. A brilliant post indeed!

I hope the govt pays heed and does in fact give the tribunals the power to adjudicate upon the vires of all the delegted legislations that the regulators come up with. In the mean time, I hope the issuance of circulars by the MCA when the new act does not allow them to do so is challeneged before the HCs or SC.

2. Dear Sir
There are two aspects to any financial regulation. The first relates to prudential issues and the second refers to conduct. Prudential part of the regulation is specifically afflicted by 'incomplete contracting', i.e. issues , which are not completely covered under any existing contract. In such issues second guessing of regulatory judgments can render the existing regulators 'paper tiger'.
2. I do not know enough about MCA's activities to comment on the same. But, it is interesting that illustration author chooses refer to MCA which per-se, cannot be deemed a financial regulator since no financial intermediary falls under its ambit. I can think of no overseas G-7 countries which allows regulatory pronouncements on prudential aspects to be second guessed by an appellate tribunal.
Regards
Neel

3. Dear Neel,

I fully agree with you that the job of the Tribunal should not be to second guess the regulatory wisdom. And that is why a judge must not go into policy questions. This is a very well settled principle in law. That is why I cited the 1977 Lakers decision in the first place.

My argument is that reviewing of a subordinate legislation does not require a judge to question the policy (and this is where I differ from Dr. Rajan's speech and give the MCA circulars example). All a judge needs to do is to check that in issuing the subordinate legislation the regulator has not gone beyond the powers given to it under the law by the Parliament (as MCA has done).

Note that in the blog post I did not even go into the substance of any MCA circular. And still I managed to argue why MCA's circulars are illegal. Therefore, it is possible to legally challenge a subordinate legislation without even going into the substance (policy) of it. This is exactly what Justice Lawton meant when he compared a judge with a referee. Just as the referee does not substitute a player and start passing the ball himself, a judge also need not substitute the regulator in framing the policy.

For this limited purpose, it is immaterial whether the law under review is a prudential regulation or a MCA circular. The concept of judicial review applies on MCA circulars as much as it would apply on any other subordinate legislative instrument of your choice.

Hope this clarifies my stand.

1. Mr. Dutta
Thanks for the clarification. But the objection to such overview stem for the fact that, by construct, any legislation will be incomplete since it cannot possibly foresee every nuance arising in the future. Therein the role of regulator in interpreting it comes into being. Now some of these interpretations will take into account the fall out with regards to macro prudential norms, regulatory treatment parity with overseas or domestic regulators etc. i.e. they may occasionally go beyond what is possibly implied in the legislation. Every regulator resorts to such creative interpretations of their power from time to time [look at Fed during the crisis which almost reached the limit of its so called emergency powers with regards to acceptance of 'quality' collateral during the crisis. ] . A lot of RBI actions actually stem from so called prudential concerns which prima facie may seem to be going against specific banks business models.My concern is second guessing of such actions by an Appellate tribunal with very little experience.
Regards and again thanks for your response.
Neel

4. The aspect of bringing upon appellate tribunals to sit on judgement over subordinate legislation inclusive policy circulars would be retrogade and against principles of prudence and proactive risk assessment and management which needs to displayed by regulators, particularly in the present context of huge worry over the delays in the judicial and quasi judicial processes. Can you think of any developed country having such tribunals? There are other avenues of addressing the issues. While the concept theoretically appear okay, but I worry over the practicalities.
Rajesh Sharma

5. Sir

You have hit the nail on its head. MCA has been blatantly misusing its powers since long. I have a fear that NCLT would also do the same. Because NCLT has some executive powers also. It will refrain itself from taking a judicial review and confronting the MCA or sitting on judgement on its own actions.

What is required is a Law Review and Reform Commission which should be able to review the vires of any delegated legislation sue-moto or an application by a citizen. It should also review the relevance of a Law after certain years of its existence.

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