Chapter E2
Rule 2 -Seize and Control Initiative
Litigation is like a game of chess where each party is permitted one move in turn. In a game of chess, white moves first. In litigation, either party may decide to move first. The real question is: what do we mean when we say ‘move first’. We have seen that litigation doesn’t begin when either party goes to a court and files something. I have already said in this book that the fate of most litigation is decided before either party reaches the court room. Litigation begins when one party first takes a hostile view of the other party: when it decides that there is a conflict of self-interest. The party that sees this first, and decides to do something about it, is the one who achieves great natural advantage.
Moving first is not necessarily the same as seizing the initiative. Mere movement is not initiative. Let us go back to our illustration on the chessboard. Chess rules specify that white moves first. White may, while making his first move, actually take a defensive position. He may use his first five or more moves merely to become impregnable. On the other hand, black doesn’t have to play defensively only because white got to move first. Black may well choose to leave his flank vulnerable and attack immediately. Each player unfolds his game depending on his perception of the situation, the strategy he has in mind and his judgment of the outcome.
It is the same with litigation. The guy that first spots an insoluble conflict of interest will move first. Whether he moves to attack or defends depends on his perception of his overriding strategy. If he thinks he has more to lose than gain, he may well move defensively. If he believes his best interest lies in attacking, he will attack. His opponent will now make a move. The opponent will move aggressively if it believes he has the upper hand or defensively if he believes his best interest lies in a stalemate. Parties will now jockey for position, occupying the field as best they can, testing weaknesses, waiting for the other guy to make a mistake, feeling each other out so to speak. At some point, one or the other will choose direct attack. The attack may come as litigation, or the attack may come by a decisive movement on the ground which leave the other party no choice but to rush to court. Any which way one looks at it, the party that makes its first move pretty much ‘drives’ what happens next. This in simple terms is initiative.
To be clear, not all moves add up to an initiative. Many parties waste moves, as poor chess players do, making moves that have no visible benefit, or taking an action, then reversing it. So many parties issue pointless lawyer’s notices, thinking that muscle flexing is decisive action in itself. All they get at the end of that effort is a reply from the other side’s lawyer. Clearly, the secret is not merely in moving first, it is in using this first movement to seize the initiative and then to make sure that at all times, this initiative remains with that party.
We need to be crystal clear about this. Initiative as a war tool runs as a central thread through the cases we have studied so far. The Hargear case was good illustration of how Hooda wrested the initiative from Lerion and then pressured Lerion into a settlement. The Weizmann case is illustrative of how Weizmann seized preemptory board control from Gupta and effectively barred him from ever making a comeback. The Metro cable case is excellent illustration of how initiative served to wrest back control of a JV Company that was all but lost to the majority partner on the ground. If you control the initiative, you control the war.
This principle applies to every class of litigation, and not merely wars of corporate control. It applies not only to attack but also to defense. For a change of pace, I will illustrate this principle using a case a little away from the usual corporate battle that has been more my staple fare for some three decades now. This one arises from revenue litigation with the Government, and that itself makes it unique. Revenue laws are so terrifyingly biased in favor of the Government that if you get caught up in one, you usually have no leg to stand on leave alone apply anything like a strategy. Let us look at how the rule of initiative has been applied in a sales tax demand matter.
The Spark Sales Tax case
Spark is a leading manufacturer of white goods with manufacturing facilities in west UP. At the relevant time, state-of-the-art washing machines were their leading products in India. Business was good in the initial years but the late entrants in the market changed the rules of the game. In time, Spark found that its competitors were able to offer washing machine models with the same features at sales points up to 20% cheaper than Spark could. As a general proposition, most white goods manufacturers source the majority of parts from the same pool of local venders. How was this happening?
Spark knew that the competition was taking advantage of tax breaks in sales tax havens. Let me take a moment to explain this. Till the introduction of GST in 2017, all States collected sales tax, as did the Central Government. While the Central Government taxed all inter-state sales (meaning sales originating in one state and completing in another), State governments taxed all sales occurring within a state. Since all of them needed to increase their tax collections, they tried to promote industry in ‘backward areas’ by offering tax holidays. For instance, the Central government waived off Central Sales Tax in ‘backward areas’ such as Daman, Silvassa, Pondicherry and so forth. Industries in these areas didn’t pay any Central sales tax at all on inter-state sales or even within these union territories.
Competition being what it was at the time, every white goods brand set up ‘manufacturing’ units in these tax havens and offered their customers tax-free sales from these ‘screw driver’ factories. When Spark finally figured this out, it had no choice but to move to Silvassa. Washing machine components were manufactured in UP, stock transferred to Silvassa, assembled as complete machines in Silvassa and then sold as finished goods from Silvassa to the other States as direct inter-state sales.
If you stop to think about the legal side of it, there were two ways in which tax-free sales could occur. First, it was possible to make ‘local’ sales in Silvassa. To do that, a purchaser could drive to Silvassa and purchase a washing machine across the counter. He could then load it on to the back of his SUV and drive back home. Naturally, any purchaser sitting in (say) Bombay could make a ‘local’ purchase in Silvassa by sending his driver in his car and buying a washing machine. He didn’t actually have to go to Silvassa himself. When dealers figured this out, local Silvassa sales became quite a lucrative scam.
This is how it worked. If you visited a Bombay dealer looking for a washing machine, he would offer to immediately give you a washing machine from stock in Bombay with local taxes paid. Alternatively, if you did not wish to pay local sales tax, he would take your money and give you a tax-free washing machine in 2-3 days sold across the counter in Silvassa. He did this by asking you to sign an authority letter in favor of one of his agents in Silvassa. If you took this route, the Dealer couriered the papers to his Silvassa agent who showed up at the Silvassa shop, purchased the machine and loaded it on a Bombay bound truck. As this practice became more sophisticated, shops gave up on keeping agents in Silvassa: the manufacturers themselves employed ‘shippers and handlers’ who did the job the agents used to. The manufacturer received the couriered paperwork at their Silvassa factory and shipped the machine to the Bombay Dealer with the paperwork showing that it had been delivered across-the-counter to the customer in Silvassa. Incredible India!
Now, you can see the limitation in this little scam. You can make a counter sale in Silvassa to a Bombay purchaser because the two places are only 170 km apart and you can convince the tax department that determined buyers are making the trip to save on the money. From a logistic standpoint, you can make this scheme work because a Bombay buyer would be ready to wait 2-3 days to have his machine delivered after he has paid for it in Bombay. What happens if the buyer is located in Guwahati? Are you able to show that some guy drove from Guwahati to Silvassa to buy a washing machine? Enter Inter State sales!
To save Central Sales Tax, the Guwahati customer would have to place an order directly on the Silvassa factory. Naturally, no one sends a truck from Silvassa to Guwahati to deliver one washing machine. The cost would be prohibitive. If Spark waited for enough orders to come in from Guwahati before shipping the machine, the buyer would have to wait weeks, maybe months. But this is India: there is always a hack! Dealers now took to placing orders directly on Spark Silvassa from fictitious customers. If you showed up at a Spark dealership in Guwahati, they sold you a machine previously ordered directly from Silvassa on someone else’s name! This is how it worked.
If a dealer anywhere in India typically sold ten machines a month, he placed an order for twenty machines using fictitious customer names with fictitious addresses and kicked off his scam. He now had an inventory of ten excess machines with no customer associated with them. He could sell them off-the-shelf to walk-in customers. He told his customers that if they wanted to save tax, they can have the machines delivered against cash but would have to wait to get the paperwork. The sale completed, the dealer now placed an order on Silvassa using the name of this customer. When that machine arrived in a few weeks, he added that one back to his original inventory of ten machines. This way he always had his inventory, yet he supplied machines immediately for spot cash.
This tax dodge became standard operating procedure across product lines in India. Everyone was happy; except that no machine could be matched to the customer who ordered it. The customer didn’t care. He went to the neighborhood shop, put down the cash, received a washing machine and went home. He wasn’t matching invoices and machine serial numbers and what not. If some sales tax inspector showed up at his door, he would have said “I paid my cash and I took my machine. I received an invoice. What do I know about sales tax?” Who was going to be able to prove what really happened?
In truth, the proof was written on the machine. Every washing machine had a serial number and this number appeared on the invoice. A’s invoice recorded that he was sold a machine no 1 but he received a machine bearing another number from the original feedstock of 10 fictitious customer machines. A’s machine went to B. B’s invoice showed that he had received machine no. 2 but he had received serial number 1, i.e. A’s machine. B’s invoiced machine no. 2 had gone to C but C’s invoice showed that he had machine no. 3, and so on and so forth. Any general survey by which sales tax authorities matched serial numbers appearing on washing machines with serial numbers appearing on their invoices would reveal the truth. If the authorities discovered that locally available machines meant for someone else were delivered to every customer, the entire country wide sale of washing machines would be redesignated as local sales and local taxes would become payable with interest and penalties. Spark was in deep trouble.
The curtain went up on this tax scam when the Sales tax authorities made a random survey of one of Spark’s retail outlet and found a little black book which showed which machine ordered by which customer had been delivered to whom against which order. The sales tax department went into hyper drive. Three days later, they raided all Spark dealers and retail outlets. A month later, they reopened all sales tax assessment of previous years in that state.
Spark’s office in that State was a low-key affair, manned by a lowly employee. His main job seemed to have been to tour the state and provide competitor intelligence to the head office. He was so lowly that he took this notice and send it to Silvassa instead of the Head Office. Silvassa had no idea what this was and ignored it. Since no one took any interest in this notice, on the appointed day, he took it upon himself to visit the sales tax office. This employee later claimed that his meeting with the sales tax officer was a pleasant affair. He said he was asked some questions, served some tea and then told to come back in a month. This went on month on month for some six months. He thought he had done a great PR job!
Meanwhile, Spark’s annual sales tax assessment came up. The Department now responded by disallowing all interstate sales. It slapped a tax claim Rs. 60 million on Spark and issued a Show Cause Notice why Spark should not pay penalties. One day later, the Department issued another notice. This notice claimed that Spark had failed to produce the entire interstate sales records of the last eight years despite demands and it needed to show cause why all interstate sales throughout this eight-year period should not be treated as local sales.
The lowly employee had smartened up by now and did send this notice to the head office. Spark panicked and called in its lawyers. At the initial debriefing, this local employee insisted that all his visits may have included some general discussion on tax issues but were mainly gossip sessions. He acknowledged that the sales tax officer routinely asked him to sign some official looking stationary on his visits to the department. He said he signed these documents to help the sales tax officer show how hard he worked! In this way, unknown to this somewhat naïve employee, all his visits to the sales tax officer were being shown as formal legal hearings.
The lawyers rushed to meet the sales tax officer. At this meeting, they were told that (a) all sales tax assessments had been reopened seven months back, (b) current period assessments had been made disallowing all inter-state sales, (c) Company had failed to produce any evidence to show that inter-state sales for the last eight years were indeed inter-state sales, and (d) the officer had already drafted his order and needed to issue it within three days to meet his performance quota. At the end of the meeting, he told the lawyers he is always happy to meet ‘any party’ at home in a personal capacity over a cup of tea! Spark know it was being hustled.
Still, if you are asked by a departmental official to have a cup of tea with him, you have to go. A middling Spark employee showed up next day. Cut to the bone, the official disclosed Spark faced a liability of Rs. 40 crores. Since Spark would deposit a minimum 25% i.e. Rs. 10 crore to have its case heard in appeal, it would be a good idea for Spark to consider spending a little money to avoid all the trouble. He also added that he was always ready and willing to help everyone and litigation was not a solution.
Spark was an ethical multinational Company. They knew about the rules of the desi game. They were not about to play by those rules. They gave their lawyers carte blanche to defeat the claim, whatever the cost.
It was a big ask. Tax claims usually go only one way. To begin with, Spark had to beat the three-day deadline. Spark’s middling employee visited the sales tax officer at home again. To cut through the sleaze and to the chase, the Officer informally gave Spark an extra week to come up with a ‘solution’!
Spark now had one week to comb through its record and get to grips with this case. A team of lawyers fanned out to Silvassa and put the record together in three days. They came up with mixed findings. Although sale paperwork generally followed procedures, records did not show that each washing machine had been delivered to the customer whose name appeared on the invoice. Worse, a lot of machines had been delivered to the same generic name like “Babu Lal” and “Ram Kumar”. Each of these Babu Lals and Ram Kumars also seemed to receive washing machine every other day on behalf of a variety of invoiced customers located in different towns. Worst of all the entire state seemed to use only about three ball point pens! Spark could not produce these records before the sales tax authorities.
Spark lawyers decided to seize the initiative and fight off the front foot. To begin with, this meant creating ‘legal hurdles’ in the department’s path. It prepared a long submission for the department to consider as follows:
(a) Spark argued that by law, an assessment already made could not be reopened unless the officer had a ‘reason to believe’ that the payment of sales tax had been evaded. Spark argued that there was no material on the record to show that any departmental officer acting reasonably could have such a ‘reason to believe’.
(b) Next, Spark argued that the rules of natural justice had been violated. How could the Company defend itself when it did not know what it was accused of? This point had a bit of a history to it. The original notice reopening old assessments was based on some internal 40-page departmental document called the ‘Scrutiny Report’. From the material that Spark could get hold of, it appears this report analyzed the method by which tax was evaded in detail. It was therefore the foundation the case against Spark. A Spark employee informally got hold of a copy of this report and it showed the amazing muddle headedness of the case. Its author was just making stuff up as he went along, drawing conclusion unjustified by the facts, making leaps of faith and otherwise dancing amidst logical absurdities.
The Company didn’t have to get into any of this of course. If the Department could not show that it had handed over this Scrutiny Report to the Company, the previous seven months proceedings against the Company would be illegal since in all this time, the Company could not have known what case it was defending.
(c) Third, and as you would expect, the Company argued that all inter-state sales were truly inter-state sales. At best, the evidence only showed that a bunch of customers, dealers, traders, middle men, and other street-smart sales guys had played games with deliveries but it could not be shown that the Company had done anything wrong. The Department could prosecute these guys but how could the Company be held accountable?
(d) Finally, Spark argued that the notice was conjectural and fanciful. The notice did not cite any specific evidence to show that the Company avoided payment of tax.
It was now time for the hearing. There was touch-and-go tension in the air, but as the hearing unfolded, it became clear that the government should have earned some entertainment tax on it! Spark trooped into the sales tax office with 16 large cartons of papers and some 40 books on the law. The lawyers filed its written submissions and then started to argue the case. Soon, they were quoting case after case, reading each case in great detail. In two hours, the Officer was fighting to keep awake. He tried to end his pain by telling the lawyers not to read each case: if they left copies, he would read them later. The lawyers were not to be discouraged. The lawyers then started opening the cartons and cross referring to the Company’s paperwork. By then, the officer was utterly exhausted. He asked the lawyers to hand over the paperwork to his subordinate and make their main arguments.
The lawyers agreed. The 16 cartons were moved to the next room and the review of the documents started in parallel. Spark was delighted to find that this subordinate had a greater passion for gossip than he did for grunt work. It would be weeks before he would run through 16 cartons of this stuff!
Meanwhile, Spark lawyers turned to the purely legal issues, arguing that in the absence of the Scrutiny Report, the Company could not possibly defend itself. What were they defending? The officer didn’t like that. He said he had made a copy available months ago. He looked for proof in his file and failed to find it. Pushed to a corner, he fished out another copy and handed it over to the lawyers. That was a fatal mistake because in that moment, he wiped out seven months of proceedings he had shown on paper the department’s record. Spark was at a new beginning.
It was now near 4.00 PM. The Officer wanted to go home. He said it was time to wind up. Spark seemed shocked. It had just received the Scrutiny Report, it needed a week to study it, two weeks to make a defense and further time to argue the case before the same officer. The Officer protested that he was on a March 31st deadline, and it was April 10th already. He also he had no reason to see all the papers. The whole case depended on proof of delivery to the end customer. Why did Spark need so much time? Spark now appeared to reluctantly agree to this but asked for time to compile the ‘proof of delivery’. This started a long round of haggling over the time it was to get. Ultimately, the Officer gave the Company three further days to bring all proofs of delivery.
To conclude on the story so far, the Company had successfully gained time by wresting the initiative but three days was a short respite to earn. The Officer was back on neutral ground. The Company could not prove delivery. It needed to pull a new rabbit out of its hat. All it could do was stonewall. How to do that?
At the next hearing, Spark filed another application. It said it had read the Scrutiny Report but this report was impossible to understand because it referred to some 200 documents. The report said these were company documents but Spark didn’t know anything about these documents. Unless it could review this paperwork, it couldn’t understand what case it was to defend. Could the department please give copies of these documents to it?
The Officer was besides himself with frustration. He needed to close the case by March 31st, but it was April 14th already. It didn’t seem like the hearing was anywhere near conclusion. He had just wanted to shake down the Company: it was now becoming apparent that he was getting sucked into complicated legalese. He threatened the Company. It should withdraw the application or ‘face the consequences’ with heavy penalties. The Company responded with a charm offensive. The lawyers were doing a job: what else could they do? Another haggling session began. By when would these 200 documents be supplied? How much time would Spark then have to study these documents and explain them to the department? Ultimately, they all agreed that they would meet in two weeks.
Remarkably, at the next hearing, the Officer had changed his mind. He refused to deliver the 200 documents. Instead, he read out an order stating that the Company demanded a complete disclosure of all documents because it wanted to customs tailor a defense. He ordered the Company to first file all documents proving delivery to the end customer and only then would the department hand over copies of these 200 documents. From Spark’s point of view, it was the perfect response.
The law was and remains pretty clear on this point. If anyone wants you to defend yourself in any court of law, you have to know what you are to defend. Spark had a legal right to have these documents. Making an allegation that the Company could fabricate documents doesn’t take away this right. Spark now had a case to take to court!
Spark was in court within a week and it took less than 5 minutes for the court to issue notice of the writ to the Department. In the meantime, it stopped the Department from proceeding further. The Department was quite unprepared for this. It put its case very simply and it made perfect sense. An inter-state sale is an inter-state sale if the Silvassa factory sells directly to a customer in another state. All the Company had to do was show that these machines had been delivered to the end customer. Instead of doing that, the Company was avoiding the issue and adopting delaying tactics. It could not prove deliver of the machines and needed to manufacture evidence. The quality of the evidence it would manufacture depended on what the Department had against it. For this reason, it demanded that the Department disclose its case so that it could start manufacturing records to explain the case against. If Spark would only show delivery, the problem would be solved.
Spark wasn’t willing to accept this as a reasonable view. For so long as the Department was investigation tax evasion, it could ask the Company to produce any record it wanted to see. That stage had passed. We were in ‘adjudication’ (the process of judging the case). Besides it was not a case of first assessment. A done deal was reopened and was now being reassessed. It was like a criminal case. If it lost, the Company faced penalties and censure. How could the Department switch its hat backwards and forward, treating the adjudication as an adjudication on one day and as an investigation on the next. At this stage, the Company had no duty to disclose anything except as its defense. When it was given a complete case to defend, it would meet that case but not before. Besides, can the Government ever rough ride over a basic legal right on the ground that a citizen may misuse it? By that token, why should we be allowed out of our bedrooms? Who knows, we may steal something or burn something or rape somebody.
The High Court took the correct legal view. The Department could not ‘trade’ in documents during adjudication proceedings. It ordered that the Company be given copies of all documents in a month. To secure that the company did not then indulge in wholesale fabrication of ‘proof of delivery’, it also gave the Company a short period of two weeks to then file its own documents.
This was a great result for the company but from a purely tactical viewpoint, it wasn’t nearly enough. The Company still had the initiative for the moment, but it would go up in flames as soon as the Department shared the 200 documents with it. The Company needed to find another way to keep the momentum of its attack.
It took more than two months for the department to find, compile, photocopy and deliver all 200 documents. What showed up eventually came as no surprise. Some of these documents were copies of internal records taken from shop owners. They showed that shop owners had diverted washing machines working in tandem with the trucking industry. They did not show that the company had anything to do with it. But then again, did all this really happen because it says so on pieces of paper maintained by a third party? Perhaps it was only a bored shop owner entertaining himself by writing pulp fiction in his little black book!
The rest of the documents seemed more damning. Most of them were third and fourth carbon copies of Spark shipping documents – Lorry Receipts, copies of invoices, copies of customer orders, and consignment delivery receipts. The Babu Lals and Ram Kumars had received most of these machines. Spark’s lawyers scratched their heads about it, and decided that ultimately, it wasn’t Spark’s problem because they hadn’t participated in any of this alleged skullduggery. Quite the opposite actually. The Company’s contract with its transporters specified that goods could only be delivered to the invoiced customer. If transporters violated their contracts with the company, how could you hang the company for it?
That didn’t make everything okay. The court had ordered the company to file its own ‘proof of delivery’ documentation. If it did, it would be damned for it. If it didn’t file the documents, the Department would use these third-party documents to hang Spark. Either way, the Company would face a sales tax demand. Spark chose to wrest the initiative by another means.
Lawyers brainstormed the issue and decided that Spark’s best option was to argue that it did not need to prove delivery of the machines to customers. Since large trucking companies transported washing machines from Silvassa to customers, the Company need only prove that it had delivered the washing machines to the transport company with the correct delivery instructions. Spark now filed thousands of transporter lorry receipts. It also filed a comprehensive letter setting out its position. The movement of goods in an interstate sale occurred through a transporter. As far as the Company was concerned, the washing machines went out of its hands the moment it placed the goods into the custody of the transporter. Clearly, handing over possession of the machine to the transporter was the primary ‘proof of delivery’. It was now for the trucker to show that it had done what Spark had asked it to.
Spark didn’t stop there. It said that the Tax Department had the power to call for the transporter’s records. In truth, it should have already done so because that was the proof of the pudding. Instead, it wanted the company to do the Department’s job and voluntarily hang itself.
Fate now intervened. The Officer who had spearheaded this campaign against Spark had come to the end of his tenure. His successor did not have the same incentives, nor did he understand the case in quite such depth. The Department lost its momentum. Its true that the case dragged on for some time and Spark had to file another writ petition but the wind had basically gone out of the Department’s sail. As months turned to years, the case went into limbo, then disappeared from the public view, forever.
The Spark case is a good illustration of the importance of seizing and retaining initiative in all circumstances. Spark entered battle in a difficult situation, when it was already on the back foot, one hand tied behind its back. It used proactive bold moves to get back the lost ground. It was then able to pressure the Department back through continues attack, retaining at all times, the initiative, the pace, and the control of the war. Ultimately, through this relentless pressure, it was able to beat the Department into inactivity.