9911796707
TMI Blog2007 (9) TMI 409X X X X Extracts X X X X X X X X Extracts X X X X ..... K.K. Venugopal, Dr. A.M. Singhvi, Mukul Rohtagi, S. Ganesh, D.J. Kakalia, Syed Naqvi, Ms. Smieeta Inna, Gaurav Bhatia and Rajesh Kumar for the Appellant. Altaf Ahmed, Prashant Chavan, Varun Thakur and A.S. Bhasme for the Respondent. JUDGMENT S.H. Kapadia, J. - State of Maharashtra through Maharashtra State Road Development Corporation Ltd. (for short, 'MSRDC') floated Global Tender for completing Mumbai Trans Harbour Link ('MTHL') between Mumbai and Navi Mumbai on BOT basis. 2. Reliance Energy Limited is a company registered under the Companies Act, 1956. It is engaged in generation, transmission and disbursement of power in Maharashtra, Delhi etc. 3. Hyundai Engineering and Construction Company Ltd. (for short, 'HDEC') is a company incorporated in Korea. It is specialized in construction of bridges. 4. At this stage, it may be noted that the above Project is to be at the cost of Rs. 26,000 million (Rs. 2,600 crores). The bidders were required to submit RFQ Document by 10-1-2005. Under the PQ Document, M/s. Jean Muller, France was appointed as consultant by MSRDC. Under the PQ Document, the bidders were required to submit financial statements of three financial years subject ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Project Company, until completion of construction and thereafter for a period of two years from the date of commencement of operations and meet the financial eligibility criteria of Lead Member as given below. u Those members of the Consortium committing to hold a minimum of 5 per cent of the paid up and subscribed equity capital of the Project Company until completion of construction and thereafter for a period of two years from the date of commencement of operations. The aggregate (taken as the arithmetic sum) of Net Cash Profit and Net Worth (as explained above) of all subsidiary companies in which the respective entities hold a minimum of 51 per cent of total paid up and subscribed equity capital would also taken into consideration. In the case of financials of subsidiary companies being considered as above, the dividend paid by these subsidiary companies to the parent company will be deducted from the Net Profit of the parent company for the purpose of evaluation. The financial evaluation criteria to be satisfied by a Consortium are detailed below. Criteria To be satisfied Amount by Net worth1 (as per Lead Member Rs. 2,000 million the latest audited (Holding a m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... p, court receivership or other similar proceedings that should have been initiated or pending against the Applicant (or any member of Consortium). In addition to the above, information must also be provided of all pending litigations against the Applicant (or any member of Consortium) in which the maximum value of liability that may arise in the event of adverse judgment exceeds Rs. 100 million (or equivalent foreign currency). A consistent history of litigation/arbitration awards against the applicant or any member of the consortium." [Emphasis supplied] 6. Briefly the criteria and conditions were as follows :-- "(a )In a consortium, the entity declared as 'lead member' was required, to hold the minimum of 26 per cent of paid-up and subscribed equity capital in the project company until completion of construction. (b )The aggregate of net cash profit and net worth of the consortium was to be considered for evaluation of financial criteria of the consortium. (c )Two criteria were required to be satisfied by the lead member (REL) as also the total consortium (REL/HDEC), namely, net worth and net cash profit. (d )Net worth is defined as total paid-up share capital + reserves - a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "10th Floor, Star Tower,Tel + 82(2) 21120100 737 Yeoksam-dong,Fax + 82(2) 21120101 Gangnam-gu, Seoul 135-984www.kr.kpmg.com Republic of Korea The Board of Directors and Management Hyundai Engineering & Construction Co., Ltd. 140-2 Kye-dong, Chongro-gu Seoul, 110-793, Korea August 12, 2005 Dear Sir, We have performed the procedures described below, which were agreed by Hyundai Engineering & Construction Co., Ltd. (the 'Company'). The sufficiency of the procedures is solely the responsibility of the Company. Consequently, we make no representation regarding the sufficiency of the procedures described below either for the purpose for which this report has been requested or for any other purpose. The procedures that we performed are as follows : We compared the statements of cash flows for years ended December 31, 2001, 2002, 2003 and 2004 prepared by the Company to the accompanying schedule of net income after adjusting expenses and income not in form of cash transaction which the company prepared according to the Pre-Qualification criteria for Mumbai Trans Harbour Link (MTHL) project in India. The financial statements of the company for years ended December 31, 2001, 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t income after adjusting expenses and income not in form of cash transaction. Description Dec. 31st, Dec. 31st, Dec.31st, Dec .31st, 2001 2002 2003 2004 (1) Net Income (610,507) 15,963 65,546 164,248 (2) Expenses not in form of a cash transaction 686,310 200,753 199,084 285,039 - Provision for retirement and severance benefit 27,009 39,173 32,706 39,541 - Depreciation 49,475 36,221 31,279 27,699 - Stock compensation expense - 89 107 30 - Bad debt expense 183,192 7,357 8,480 - - Other bad debts expense 199,186 - 39,147 171,080 - Interest expense 48,803 23,899 20,683 18,723 - Loss on valuation of foreign currency 107 1,986 3 699 - Loss on disposal of trade note and accounts, receivables 2,770 17,772 10,844 - Loss on valuation of inventories 39,762 20,485 5,364 20,308 - Loss on disposal of Investment securities 42 - 309 43 - Loss on investment securities impairment 61,104 29,900 12,845 2,348 - Loss on disposal of investment in affiliates using equity method - - 1,286 - - Loss on disposal of investment assets 9,120 1,248 - - - Loss on valuation of investment in affiliates using equity method (*) 5,805 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... L/HDEC, HDEC had incurred 'non-cash expenses' amounting to US$ 686.310 million in 2001, US$ 200.753 million in 2002 and US$ 199.084 million in 2003 which did not involve direct cash outflow and, therefore, the said 'non-cash expenses' ought to have been added back to NCP and if so added then the Consortium had NCP of Rs. 2,000 million (Rs. 200 crores) as mentioned in clause 7.2-2. 10. The aforestated contention advanced by the Consortium was rejected by M/s. Jean Muller Consultant of MSRDC in following words :-- "In case of 'Provision' for bad debts even though they are just 'Provision' but not a 'write-off', the same is treated as cash expense because once a 'Provision' has been made, the 'write-off' does not get routed through the profit and loss account. Moreover, the 'Provision' for bad debt relates to a revenue item that has already been treated as cash inflow on accrual basis." 11. In view of the position taken by MSRDC's Consultants, REL/HDEC stood excluded from the second stage of the bidding process. 12. To complete the chronology of events, by letter dated 22-6-2005, MSRDC informed REL/HDEC that their RFQ document was under, scrutiny and accordingly REL/HDEC were requ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s constituted by MSRDC to review the draft evaluation report submitted by the consultants, M/s. Jean Muller Consortium, relating to pre-qualification of bidders to suggest process of evaluation and to provide recommendations to MSRDC. The said Committee met on 21-9-2005. The consultants M/s. Jean Muller Consortium and M/s. Crisil were both called to give clarifications. The said Committee was headed by Mr. Justice R.J. Kochar, Judge of Bombay High Court (retired), Shri A.K. Banerjee (Technical Member) in NHAI, Mr. R.S. Agarwal, Executive Director of IDBI (retired), Mr. V. Giriraj, Joint Managing Director of MSRDC etc. The Committee noted that pre-qualifications bids were received only from six Applicants, one of them was REL/HDEC. The Committee noted that while Indian companies could submit their audited accounts up to 31-3-2004 as their financial year ended on 31st March the foreign companies could submit their audited accounts only up to 31-12-2003 as their financial year ended on 31st December. The Committee further observed that although the cut-off date was 10-1-2005, clarifications on break-up of non-cash expenses were sought from REL/HDEC up to 22-8-2005 and since in the mea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Ultimately, by letter dated 7-11-2006, MSRDC informed REL/HDEC that they stood disqualified as they had failed to meet the qualification criteria. 16. In the circumstances, REL/HDEC moved the Bombay High Court vide Writ Petition No. 39 of 2007 in which they alleged that a decision to disqualify, taken by MSRDC, was arbitrary, unjustified and contrary to the terms of the tender documents; that REL/HDEC met the financial criteria specified by MSRDC both in terms of the original submission of RFQ document made on 9-1-2005 and further information given to MSRDC; that in the alternative the decision of MSRDC was unjustified and incorrect, particularly when the Consortium had given audited accounts of HDEC for the financial year ending 31-12-2004 and, therefore, on the said basis it was not open to MSRDC to exclude REL/HDEC from the second stage of the bidding process. It was further submitted in the said writ petition that the PQ document did not specify any accounting standard (AS) and in the circumstances it was not open to MSRDC to exclude REL/HDEC by applying AS No. 26; that the accounts of HDEC indicated 'net profits' for the financial year ending December 31, 2002, 2003 and 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d both the reports of Crisil and the Peer Committee, before any independent firm of chartered accountants. Learned counsel submitted that by not doing so the decision-making process itself stood vitiated. In any event, learned counsel urged that Crisil was wrong if one looks at the audited balance sheets of HDEC for the accounting year ending 31-12-2004. Learned counsel urged that even according to Crisil the provisioning for bad debts was 'non-cash expense', however, according to Crisil, such provisioning could have a cash impact in future years. Learned counsel submitted that the conclusion of Crisil, namely, that such provisioning could have a cash impact in future years was unjustified if one takes into account the audited balance sheet for the year ending 31-12-2004. Therefore, according to the learned counsel, the decision of Crisil was arbitrary, since its conclusion was not based on application of proper AS. Learned counsel further submitted that when the entire basis of Crisil's report against HDEC was on the issue of future cash impact, the decision to exclude the audited accounts for the financial year 2004, clearly vitiated the decision-making process. In the alternativ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... financial criteria laid down in clause 7.2-2 was the decision of the consultants and not the decision of MSRDC which had merely acted on the basis of evaluation done by the consultants and, therefore, it cannot be said that the impugned decision taken by MSRDC was arbitrary or unjustified. Learned counsel submitted that according to the opinion expressed by the consultants, the financial position of HDEC for the year ending 31-12-2001 was poor and the provisioning made by HDEC for the years 1999, 2000 and 2001 would have future cash impact. This was the view of the experts which MSRDC accepted. That, the entire process was transparent and every aspect was considered. There were detailed discussions during the decision-making process. Queries were raised from time to time. Explanations and clarifications were sought from time to time. Full opportunity was given to the Consortium to put forth their case. In the circumstances, learned counsel submitted it cannot be said that the decision-making process was faulty, arbitrary, unjust or wrongful. Learned counsel next contended that the cut-off date was 10-1-2005. That cut-off date, according to the learned counsel, was applicable in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... did not qualify as "amortization" and, therefore, such provision cannot be added back to net profits of HDEC. Learned counsel lastly submitted that in the present case that Consultants of MSRDC had rightly relied on AS 26 under which the terms 'amortization' and 'write-off' are interchangeable and, therefore, provisioning for doubtful debts did not constitute 'amortization' and, therefore, it could not have been added back to the net profits, particularly when the definition of NCP in the tender document defined NCP to mean 'PAT + depreciation + amortization, not in the form of cash transaction'. 22. We find merit in this civil appeal. Standards applied by courts in judicial review must be justified by constitutional principles which govern the proper exercise of public power in a democracy. Article 14 of the Constitution embodies the principle of 'non-discrimination'. However, it is not a free-standing provision. It has to be read in conjunction with rights conferred by other articles like Article 21 of the Constitution. The said Article 21 refers to 'right to life'. In includes 'opportunity'. In our view, as held in the latest judgment of the Constitution Bench of nine-Judges i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess, it would be unconstitutional. 15. While the discretion to change the policy in exercise of the executive power, when not trammelled by any statute or rule is wide enough, what is imperative and implicit in terms of Article 14 is that a change in policy must be made fairly and should not give impression that it was so done arbitrarily or by any ulterior criteria. The wide sweep of Article 14 and the requirement of every State action qualifying for its validity on this touchstone irrespective of the field of activity of the State is an accepted tenet. The basic requirement of Article 14 is fairness in action by the State, and non-arbitrariness in essence and substance is the heart beat of fair play. Actions are amenable, in the panorama of judicial review only to the extent that the State must act validly for a discernible reasons, not whimsically for any ulterior purpose. The meaning and true import and concept of arbitrariness is more easily visualized than precisely defined. A question whether the impugned action is arbitrary or not is to be ultimately answered on the facts and circumstances of a given case. A basic and obvious test to apply in such cases is to see whether t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng of marks had different stages. Objectivity was thus provided. 26. One of the points which arise for determination in this case is whether the criteria of objectivity stand satisfied in the present case. 'Profit/net income' and 'cash' are concepts. However, there is a difference. 'Profit' is based on 'value judgment' whereas 'cash' is 'fact-specific'. In the PQ document, 'net cash profit' has been defined to mean - 'PAT + depreciation+ amortization, not arising from cash transaction'. The last five words which have underlined are descriptive. They merely indicate the meaning of 'amortization'. It is not in dispute that depreciation and amortization are 'non-cash expenses'. 27. In the present case, REL/HDEC claims adding back of the non-cash expenses of US$ 686,310 million for the year 2001, of US$ 200,753 million for the year 2002 and of US$ 199,084 million in the year 2003, to the net loss of US$ 610,507 million; net profit of US$ 15,963 million and US$ 65,545 million during the years 2001, 2002 and 2003. However, according to the Consultants of MSRDC, such 'add back' was not possible because even though provisions are not 'write-offs' the former should be treated as cash exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53, this Court has brought out succinctly difference between 'provision' and 'reserve' as follows :-- "The next question is whether the amount so provided is a provision or a reserve. The distinction between a provision and a reserve is in commercial accountancy fairly well-known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit & loss account and the balance sheet. On the other hand reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest (see Spicer and Pegler's Book-keeping and Accounts, 15th edition, page 42). An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iabilities is not dependent on the actual timing of cash spent on capital expenditure and cash inflow on account of capital receipt. Thus the financial statements prepared on accrual basis do not reflect the timing of the cash flow and amount of cash flow. The object of the cash flow statement is to assess the company's ability to generate the cash flow in future and to assess reasons for difference between 'net profit' and 'net cash flow' from operations. 33. 'Operating cash profit' can be derived by either 'Direct Method' in which cash items of cash inflow are listed like cash received from customers, payment of interest etc. as against cash outflows like payment to supplier, payment for taxes etc., or by 'Indirect Method' which is also known as 'Reconciliation Method' in which the 'operating cash profit' is derived by adding to the net profit non-cash items like provision for taxes, provision for doubtful debts, loss on sale of fixed assets and investments, depreciation, amortization of intangibles etc., because these items do not affect cash. Similarly, profit on the sale of fixed assets and investments are deducted from the net income figure as these items also do not affect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as prepared under the direct method are also relevant under the indirect method." [Emphasis supplied] (2) 'Fundamentals of Corporate Accounting' by J.R. Monga, 11 Edition 2005-06, pages 12.15, 12.16, 12.17, 12.20, which read as under :-- "12.15 Cash flows from operating activities [Cash provided by (or used in) operating activities] - One of the major items of information in the cash flow statement is the net cash flow provided by (or used in) operating activities. In fact it is the regular source of cash in any enterprise that determines whether or not an enterprise will continue to exist in the long run. The logic for determining the net cash flow from operating activities is to understand why net profit (loss) as reported in the profit and loss account must be converted. As we know that financial statements are generally prepared on accrual basis of accounting which requires that revenues be recorded when earned and the expenses be recorded when incurred. Earned revenues more often include credit sales that have not been collected in cash and expenses incurred that may not have been paid in cash during the accounting period. Thus under accrual basis of accounting net income w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rovided (or used) by operating activities. 12.16 - 12.17. The indirect method provides less information because it does not disclose the individual cash inflows and cash outflows from the operating activities. Instead under this method we start with net profit (or loss) and adjusts this figure to obtain net cash flows from operating activities. The indirect method is also known as 'Reconciliation Method' because it involves reconciliation between net profit (or loss) as given in the profit and loss account and the net cash flow from operating activities as calculated on the cash flow statement. Direct v. Indirect methods Direct Method Cash Flows from operating Activities (A)Cash receipts from customers. (B)Cash paid to suppliers and employees. (A-B)Cash generated from operations. Less: Interest and tax. (C)Cash before extraordinary items. Adjust for extraordinary items to get :-- (1)Net cash from operations. (2)Net cash from (used on) investing activities. (3)Net cash from (used on) financing activities. (D)Net increase (decrease) in cash and cash equivalents (1+2+3) Opening balance of cash and cash equivalents. Closing balance of cash and cash equivalents. Indirect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount would be closed be transfer to Profit and Loss Account. The net affect would be : Either Profit and Loss AccountDr. To Provision for Depreciation Account Or Profit and Loss AccountDr. To Fixed Asset Account It is clear that cash is not affected in the above journal entries. The depreciation does not require any expenditure in cash. Thus, the amount of depreciation charge must be added to be reported net income in order to arrive at the total increase in cash provided from the operations. Amortization of intangibles - goodwill, patents, etc.: The amortization of (i.e., writing off) goodwill, trademarks, patents copyrights, etc., has the same effect as the depreciation expense. The amount of amortization reduces the profit but does not involve any flow of cash as is evident from the following entry :-- Profit and Loss AccountDr. To Goodwill etc. Account There is no change in cash. Thus amount of intangibles so written off must also be added back to the reported net profit (income)'. 12.20 Stage-2 : Adjustments in respect of current assets and current liabilities: The adjustments made in the net profit (income) figure as per profit and loss account as outlined in Stag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffer only in presentation of the data contained in the cash flows from operational activities. No reason has been given by the Consultants of MSRDC for rejecting the indirect method invoked by KPMG, Chartered Accountants of REL/HDEC in their letter dated 12-8-2005. The said method is known as 'reconciliation method'. In this case, as stated above, the only reason given by the Consultants of MSRDC to exclude REL/HDEC was the negative impact on the future cash flows on account of the provisioning for doubtful debts in the accounts of HDEC for the financial year 2001. If future cash impact was the basis to exclude REL/HDEC, then the Consultants for MSRDC should have considered cash flow reporting methods, which includes Reconciliation Method. There is no question of difference of opinion or different views as far as the application of cash flow reporting, which also falls in AS 3. There is nothing to show whether indirect method has at all been considered by Crisil, particularly when KPMG had invoked that method. There is no reason given for rejecting it. Lastly, in the PQ document, the referral years were three years. The criteria was that there should be NCP of not less than Rs. 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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