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CASE NO.: Appeal (civil)  3526 of 2007

PETITIONER: Reliance Energy Limited & Another

RESPONDENT: Maharashtra State Road Development Corporation Ltd. & Others

DATE OF JUDGMENT: 11/09/2007

BENCH: DR. ARIJIT PASAYAT & S. H. KAPADIA

JUDGMENT: J U D G M E N T CIVIL APPEAL NO.3526 OF 2007

KAPADIA, J.

1.      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. 26000 million (Rs. 2600 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 to the condition that the latest  should not be earlier than the financial year ending  31.12.2002. REL/HDEC formed a consortium. As a  consortium they were required to comply with clause 7.2.2  which stipulated net cash profit at Rs. 200 crores. The said  consortium has been excluded from the second stage of  bidding on the ground that it has not fulfilled the said criteria  mentioned in clause 7.2.2. The consortium had submitted  their RFQ Document on 9.1.2005. The said consortium had  submitted three audited accounts for the financial years  ending 31.12.2001, 31.12.2002 & 31.12.2003. At this stage it  may be noted that the financial year for REL ended on 31st  March whereas the financial year for HDEC, Korea ended on  31st December.

5.      At this stage, we may quote the relevant provisions of the  PQ Document which read as under:

"Section 5.1 in the PQ document - The objective of the Pre-Qualification is to qualify  the applicants that have the necessary experience  and financial and technical capabilities to

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undertake the work for which the Request for  Proposal is to be invited.

Section 5.3.7 of the PQ document inter alia,  provides: No change in, or supplementary information to an  application shall be accepted after its submission.   However, MSRDC reserves a right to seek additional  information from the applicants, if found necessary  during the course of evaluation of the applicants.

Section 7.2.2 For Application by a Consortium In case of a Consortium, the entity declared as the  Lead Member would be required to  

*       hold a minimum of 26% of paid up and  subscribed equity capital in the Project Company  (MSRDC is of the view that a minimum paid up and  subscribed capital of Rs.5000 million may be  required for implementing the project.] 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 detailed below

In case of a Consortium, the following members  taken together shall commit to hold majority  (minimum of 51%) of the total paid up and  subscribed equity capital in the Project Company  until completion of construction and thereafter for a  period of two years from the date of commencement  of operations.

*       Lead Member of the consortium committing to  hold a minimum of 26% 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 and meet the financial eligibility  criteria of Lead Member as given below.

*       Those members of the Consortium committing  to hold a minimum of 5% 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% 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

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by Amount Net worth  (as per  the latest audited  balance sheet \026 not  earlier than the FY  ended December 31,  2002) Lead Member  (Holding a minimum  of 26% equity in the  project company)   Total Consortium (to  be satisfied together  by the Lead member  and those  Consortium members  committing to hold a  minimum of 5%  equity in the project  company) Rs.2,000 million  (or equivalent  foreign currency)   Rs.10,000  million (or  equivalent  foreign currency) AND

Criteria To be satisfied  by Amount Net cash profit   (simple average of  the audited financial  figures over the last  3 financial years of 2  calendar months  each, with the latest  not earlier than the  FY ended December  31, 2002, will be  considered for this  assessment). Lead Member  (Holding a minimum  of 26% equity in the  project company) Total Consortium (to  be satisfied jointly by  the Lead member  and those  Consortium members  committing to hold a  minimum of 5%  equity in the project  company) Rs.500 million  (or equivalent  foreign currency)  

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Rs.2,000 million  (or equivalent  foreign currency)   All figures quoted in a currency other than Indian  National Rupees (INR) would be converted into  Indian National Rupees (INR) at an exchange rate,  which is the Telegraphic Transfer (ASSESSEE- COMPANY) buying rate of State Bank of India as on  the Due Date.  In the event of non-availability of  exchange rate for any currency from the above  source, MSRDC reserves the right to use available  from any other source.

7.4  Basis of Evaluation

The information to be provided by the Applicant  must be in conformation with the following:

?       The information provided by the applicant  should be based on the latest available audited  accounting statements. ?       The latest audited accounting statements  should not be dated earlier than 31st  December, 2002. ?       The Request for Qualification (RFQ) must be  accompanied by the last three audited annual  reports/accounts statements of the applicant  and should include the financial statements of  all subsidiary companies of the Applicant for  the last three financial years.  In case of a  Consortium audited annual reports/account  statements of each member of the Consortium  for the last three financial years should be  provided and should include the financial  statement of all subsidiary companies of the  entities forming the Consortium. ?       The applicant (all members of Consortium)  must submit information on all pending  litigations or proceeding regarding liquidation,  winding up, 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

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(REL/HDEC), namely, net worth and net cash  profit.   (d) Net worth is defined as total paid-up share  capital + reserves \026 accumulated losses,  revaluation of reserves and deferred revenue  expenditure only to the extent of it being not  written-off.  Net worth was to be calculated as per  the latest audited balance sheet not earlier than  F.Y. ending 31st December, 2002.  (e) The leading member (REL) was required to have  a net worth of Rs.200 crores and the total of  Consortium (REL/HDEC) was required to have a  net worth of Rs.1,000 crores.  At this stage, we  may clarify that this last criterion stands satisfied. (f)  As stated above, net cash profit of the lead  member under the PQ document was stipulated at  Rs.50 crores whereas for the Consortium it was  Rs.200 crores. (g)  For the sake of convenience we quote the  definition of NCP given in the PQ document which  reads as follows: "NCP = PAT (profit after tax) + depreciation +  amortization, not in the form of cash transaction"

        7.      Therefore, the bidding process for selecting the BOT  Concessionaire was in two stages.  In the first stage MSRDC  had to issue the Pre-Qualification (PQ) document with an  invitation to prospective Applicants to submit their Request for  Qualification (RFQ) for the Project.  The prospective Applicants  were required to submit their RFQ document on or before  10.1.2005.  It was to be evaluated on technical and financial  capability.  Under clause 7.2.2 one of the criteria laid down  was that the Consortium should have net cash profit (NCP) of  Rs.2,000 million (Rs.200 crores).  As per tender condition  7.2.2 the bidders were required to submit financial statement  of three financial years subject to the condition that the latest  should not be earlier than the financial year ending  31.12.2002.  The choice of three years was left to the bidders.   REL/HDEC exercised their option by submitting the financial  statements of HDEC for three years, namely, 2001, 2002 and  2003.   

8.      HDEC had undertaken construction contracts in Iraq.   On account of war in Iraq their annual report for the year  2001 showed negative income.  However, the said Company  achieved net profit of US$ 16 million in 2002, US$ 66 million  in 2003 and US$ 164 million 2004.  These figures have been  taken from the letter of KPMG, Korea, dated 12.8.2005 giving  a schedule of net income after adjusting expenses and income  not in form of cash transaction.  We quote hereinbelow the  entire letter dated 12.8.2005 along with the schedule of net  income which reads as under:  "10th Floor, Star Tower,                                        Tel +82 (2) 21120100 737 Yeoksam-dong,                                               Fax +82(2) 21120101 Gangnam-gu, Seoul 135-984                                       www.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

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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, 2002, 2003 and 2004 were  audited by us and we expressed an opinion that the financial statements of the  Company for years ended December 31, 2001, 2002, 2003 and 2004 were  presented fairly, in all material respects, in conformity with accounting standards  generally accepted in the Republic of Korea.

We audited the statements of cash flows for years ended December 31, 2001,  2002, 2003 and 2004 that under the indirect method of presenting the statements  of cash flows, net income is adjusted to arrive at net cash flows from operating  activities.  The adjustments to net income I performed by removing the effects on  net income of all items that included in net income that do not affect cash receipts  and disbursements. (e.g., those that should be omitted altogether or categorized as  investing or financing activities, such as adding depreciation and amortization).

We found no exceptions as a result of the above agreed-upon procedures.

We were not engaged to, and did not perform an audit, the objective of which  would be the expression of an opinion on the specified elements, accounts, or  items.  Accordingly, we do not express such an opinion.  Had we performed  additional procedures, other matters might have come to our attention that would  have been reported to you.

Accounting principles and auditing standards and their application in practice  vary among countries.  The financial statements are not intended  to present the  financial position, results of operations and cash flows in accordance with  accounting principles and practices generally accepted in countries other than the  Republic of Korea.  In addition, the procedures and practices utilized in the  Republic of Korea to audit such financial statements may differ from those  generally accepted and applied in other countries.  Accordingly, this report and  the accompanying financial statements are for use by those knowledgeable about  Korean accounting procedures and auditing standards and their application in  practice.

This report is intended solely for the use of the Board of Directors and  Management of Hyundai Engineering & Construction Co., Ltd., and should not be  used by those who have not agreed to the procedures and taken responsibility for  the sufficiency of the procedures for their purposes.

Very truly yours

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Sd/- S.H. Goo,. Partner

(Attached: Cash flows from operating activities) (Attached)

Schedule of net income after adjusting expenses and income not in form of cash  transaction.

Description Dec 31st, 2001 Dec 31st, 2002 Dec 31st, 2003 Dec 31st, 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 currence      107 1,986         3

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    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 - - - - Loss on disposal of property, plant and  equipment (*) 7,888 4,121 3,933 1,591 - Loss on impairment of property, plant and  equipment - - 29,584 2,977 - Miscellaneous losses (including other extraordinary loss) - 13,802 2,513 - - Loss on prior year adjustment 42,047 4,700 - - (3) Income not in form of a cash transaction 337,982 76,284

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44,486 55,723 - Interest income         64 2,860 2,117      705 - Gain on valuation of foreign currency -    105       7 1,891 - Gain on disposal of investment assets 2,378 4,349    172 - - Gain on disposal of property, plant and  equipment (*) 27,846 47,589 5,740 7,982 - Gain on disposal of investment securities     498  - - - - Reversal of loss on investment securities  impairment 1,879 - 1,167 2,386 - Gain on valuation of investment in affiliates  using equity method (*) - 2,722 4,941 4,771 - Gain on Debt exemption (*) 305,317 6,987 30,342 18,164 - Gain on redemption of debentures - 1,933 - 95 - Miscellaneous gains    (Including other extraordinary gain) - - - 19,729 - Gain on prior year adjustment - 9,739 - - (4) Net income after adjusting expenses and  income not in form of cash transaction   [(1) + (2) \026 (3) ] (262,179)

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140,432 220,143 393,564

(*) Gain on Debt exemption, Loss(gain) on valuation of investment affiliates using equity  method.  (Loss(gain) on disposal property, plant and equipment are included for  calculation of net income after adjusting expenses and income not in form of cash  transaction

(Note) We translated Korean Won into U.S. dollars at the basic exchange rates on December 31,  2001, 2002, 2003 and 2004 to US$.  The corresponding rates are as follows:

Dec 31, 2001 Dec 31, 2002 Dec 31, 2003 Dec 31, 2004 W 1,326.1 to US$ 1 W 1,200.4 to US$ 1 W 1,197.8 to US$ 1 W 1,043.8 to US$ 1"                                                                                                              (emphasis supplied)

9.      At this stage, we need to clarify that HDEC had  undertaken construction contracts in Iraq.  That, large  receivables had arisen prior to 1999 on account of war in Iraq.   The Iraq contract receivables had nothing whatsoever to do  with the three accounting years \026 2001, 2002 and 2003,  therefore, there were no Iraq contract receivables nor was  there any write-off as and by way of bad debt in any of the  above three accounting years.  Further, according to  REL/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 requested to extend the validity of their Offer up to  6.10.2005.  By letter dated 24.6.2005, MSRDC requested  REL/HDEC to submit further details and clarifications and  accordingly the Consortium of REL/HDEC was once again

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requested to extend the validity of their Offer till 6.10.2005.   Accordingly, by letter dated 18.7.2005, REL/HDEC extended  the validity of their Offer up to 6.10.2005 (90 days).  By  another letter dated 6.8.2005, MSRDC sought clarifications  from REL/HDEC in respect of certain financial aspects and  the said Consortium was given time up to 19.8.2005 to  furnish such clarifications.  By the said letter, MSRDC stated  that there were no queries in respect of REL, but there were  queries in respect of HDEC.  By the said letter, MSRDC  referred to the break-up of net cash profit submitted by  REL/HDEC and asked for the basis for classifying certain  heads of expenditure under the heading "non-cash  expenditure".  By reply dated 18.8.2005, REL/HDEC  submitted its clarification by pointing out that as on  10.1.2005 when RFQ document was submitted the audited  accounts for FY ending 31.12.2004 were not ready, so far as  HDEC was concerned and, therefore, it had submitted the  audited accounts of HDEC for the years 2001, 2002 and 2003.   By the said letter dated 18.8.2005, the REL/HDEC also  submitted audited accounts of HDEC for FY ending  31.12.2004.  In other words, by 18.8.2005 (i.e. before  6.10.2005 which was date up to which REL/HDEC had kept  its Offer open) the said Consortium had submitted the audited  accounts for the financial years ending 31st December \026 2002,  2003 and 2004.  Therefore, according to REL/HDEC, they had  also complied with the conditions mentioned in the PQ  document by supplying audited account for the reference  years, namely, 2002, 2003 and 2004.   

13.     Since REL/HDEC did not submit audited accounts  concerning HDEC for the financial year ending 31.12.2004 by  10.1.2005, the Consultants of MSRDC took the position that  REL/HDEC were not entitled to bid in the second stage of the  bidding process.  According to the said Consultants, the  audited accounts of HDEC for the FY 31.12.2004 constituted  subsequent information (i.e. information supplied after the  cut-off date of 10.1.2005) and, therefore, REL/HDEC stood  excluded from the second stage of the bidding process.   

14.     On 22.8.2005, a committee by the name "Peer  Committee" was 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 FY ended on  31st March the foreign companies could submit their audited  accounts only up to 31.12.2003 as their FY 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 mean time audited accounting statements  were furnished by HDEC up to 31.12.2004, the same could be  considered for evaluation.  The Peer Committee did not agree  with the opinion expressed by MSRDC’s Consultants that the  loss incurred by HDEC for the financial year ending

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31.12.2001 would have a cash impact in future.  At this stage,  we may reiterate that even according to the Consultants of  MSRDC, provision for bad debt may not involve cash outflow  in the year of incidence but it would have cash impact at a  future date and, therefore, out of abundant caution they  decided to exclude REL/HDEC.  However, the Peer Committee  did not concur with this accounting interpretation.  According  to the Peer Committee the major provision for bad debt was in  the accounts for the year 2001 and it related to receivables  from their contract in Iraq affected by war and since it was  only a provision for bad debt and not a write-off, the  Committee came to the conclusion that there would be no  cash impact in future.  The Committee took the view that even  without taking into account the audited accounts for the year  2004, REL/HDEC fulfilled the financial criteria in clause  7.2.2.  Accordingly, the Peer Committee opined that  REL/HDEC should not be excluded from the second stage of  the bidding process.  At this stage, it may be noted that after  receipt of the said report, made by the Peer Committee dated  1.10.2005, MSRDC placed the report of the Peer Committee  before their Consultants.  Needless to add that the  Consultants of MSRDC retained their original position,  namely, that since the audited accounts for the year ending  31.12.2004 could not have been submitted after 10.1.2005,  the said accounts of HDEC could not have been taken into  account as it would violate the tender conditions and,  therefore, REL/HDEC should be excluded from the second  stage of the bidding process.   

15.     By letter dated 28.9.2005, in view of the position taken  by their Consultants, MSRDC requested REL/HDEC to extend  the validity of their Offer for further six months as they wanted  to study the implications arising from the audited accounts  submitted by HDEC for the year ending 31.12.2004.  MSRDC  basically wanted to know as to what would be cash impact of  the provision for bad debts in the accounts of HDEC for the  year 2001.  Accordingly by letter dated 6.10.2005, REL/HDEC  extended the validity of their Offer up to 6.4.2006.     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 FY  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 FY  ending December 31 \026 2002, 2003 and 2004 and on that basis  it had calculated NCP in accordance with internationally  accepted ASs (GAPP) which has been certified by KPMG,  Chartered Accountants in Korea.  According to REL/HDEC, no  particular AS was mentioned in the PQ document and,  therefore, it was implied that the Consortium were free to

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adopt GAAP.  That, in the circumstances, the impugned  decision taken by MSRDC was arbitrary, unjust and wrongful  and contrary to the tender document (PQ document) issued by  MSRDC.

17.     By the impugned judgment dated 4.6.2007, the High  Court ruled that admittedly HDEC had suffered net loss of  approximately US$ 610 million in 2001; that they had earned  net profits in 2002, 2003 and 2004; that audited accounts for  2004 were made available only after 10.1.2005 and, therefore,  could not have been taken into account by the Peer Committee  and, therefore, MSRDC was right in excluding REL/HDEC  from the second stage of the bidding process.  According to the  impugned judgment, the basic debate was about accounting  treatment to be given to "non-cash expenses".  The High Court  was of the view that it had no jurisdiction under Article 226 of  the Constitution to interfere with the decision of MSRDC,  particularly, when there were two different opinions regarding  adjustment to net income.  According to the High Court, the  decision of MSRDC on the future cash impact of "the provision  for bad debts" made by HDEC in its accounts for 2001 cannot  be said to be arbitrary or unreasonable.  For the aforestated  reasons, without going into the question whether provision for  bad debts is or is not a "non-cash expense" liable to be added  back to arrive at net cash profit, the High Court dismissed the  writ petition, hence this civil appeal.   

18.     Mr. K.K. Venugopal, learned senior counsel appearing on  behalf of REL/HDEC (Consortium), submitted that the  decision-making process stood vitiated for the reason that the  report of the Peer Committee, which disagreed with the  Consultants of MSRDC, was not referred to an independent  firm of chartered accountants.  That, Crisil was rating agency  and not chartered accountants.  He submitted, in this  connection, that it was obvious to MSRDC that Crisil had  already taken a position in its first report that REL/HDEC  were disqualified and, therefore, fairness and transparency  which are important aspects of Article 14 of the Constitution  required MSRDC to have placed 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 sheet 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 FY 2004, clearly vitiated  the decision-making process. In the alternative, learned  counsel submitted that in any case where two views are  possible, the view holding that the person/party concerned  should not be disqualified, should be accepted as  disqualification prevents the applicant from participating in  the bidding process, it affects its fundamental rights under  Article 19(1)(g) of the Constitution as also larger public interest  including State finances which ultimately makes MSRDC a

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loser.

19.     Mr. S. Ganesh, learned senior counsel appearing on  behalf of REL/HDEC, submitted that provision for doubtful  debts in the present case has not been written-off till  31.12.2004; that by adding back provision for doubtful debts  made by HDEC in 2001, the Consortium had met the  requirement of NCP for the years 2001, 2002 and 2003; that  the said provision was made only in the accounts of 2001; that  Iraq contract receivables had nothing to do with the years  2001, 2002 and 2003 (reference years); that provision for  doubtful debts is only appropriation of profits and not a  charge on profits and that in fact regarded as "Reserve" for  purpose of "sur-tax" and since it is only appropriation the  amount under it has to be added back to determine the NCP in  terms of the definition in the PQ document.  Learned counsel  further urged that provision for doubtful debts ought to be  included in the net profit; that since NCP is always more than  the net profit it is obvious that the said provision for doubtful  debt has to be included in the NCP.  Learned counsel further  urged that there was no "write-off" during 2001, 2002 and  2003 and, therefore, during those years there was no cash  impact on the cash profit of REL/HDEC or on the net profit of  the said Consortium.                       

20.     Mr. Altaf Ahmed, learned senior counsel appearing on  behalf of the MSRDC submitted that REL/HDEC had failed to  satisfy clause 7.2.2 of the PQ document and, therefore, they  were disqualified rightly.  It was urged that the evaluation of  prequalification criteria was done by reputed international  consultants, namely, M/s. Jean Muller which in turn took  opinion from Crisil.  The entire exercise was carried out by  experts and according to the recommendations of Crisil, duly  accepted by the consultants, the impugned decision was taken  and, therefore, the High Court was right in refusing to  intervene under Article 226 to the Constitution.  Learned  counsel submitted that the failure to satisfy the 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  31st December 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 case of all the six bidders.   Hence, it was not possible to look into the audited balance  sheet for the year 2004 which was placed by the Consortium  only in August 2005.  In other words, learned counsel  submitted that the audited balance sheet for the year 31st  December, 2004 could not have been taken into account after  the cut-off date.  This was the view of the Consultants for  MSRDC and that view has been accepted by MSRDC.  

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21.     Learned counsel submitted that Mumbai Trans Harbour  Link (MTHL) Project is based on BOT, therefore, global tenders  were invited.  It is an important project which is required to be  given to the bidder who qualifies and goes successfully  through both the stages of the bidding process; that REL had  entered into an agreement with HDEC; that it was a  consortium; that the said Consortium did not fulfill the  financial criteria of Rs.200 crores (NCP); that according to the  annual accounts of HDEC there was a loss of US$ 610 million  in the year 2001; that in Form F-S submitted by the  appellant’s Consortium, non-cash expenses for financial years  ending December 31 - 2001, 2002 and 2003 in respect of  HDEC were US$ 686 million, US$ 201 million and US$ 199  million respectively which cannot be added back to net  profit/loss.  Learned counsel further contended that according  to the Consultants of MSRDC "adding back" was not  permissible and even if it is held to be permissible it is not  advisable as it would result in future cash impact on the net  profits of HDEC.  Learned counsel submitted that provision for  bad debts were examined by the consultants and upon  examination of bad debts expenses, the consultants opined  that the said expenses may not involve a direct cash outflow in  the year of incidence but they may have a cash impact at a  future date and hence they cannot be treated as non-cash  expenses.  Learned counsel submitted that there is a  difference between "cash expense" and "non-cash expense".   The distinction lies in the answer to the question as to  whether there is a cash impact in the current year or future  years and if it has cash impact at a future date then it would  constitute an item of cash expense, even though in the year of  incidence the item may be non-cash expense.  Therefore, the  impugned decision, namely, that REL/HDEC did not satisfy  the financial criteria under clause 7.2.2, was right.  Learned  counsel lastly submitted that bad debt expenses 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 in the case  of I.R. Coelho vs. State of Tamil Nadu \026 (2007) 2 SCC 1,   Article 21/14 is the heart of the chapter on fundamental  rights.  It covers various aspects of life.  "Level playing field" is  an important concept while construing Article 19(1)(g) of the  Constitution. It is this doctrine which is invoked by  REL/HDEC in the present case. When Article 19(1)(g) confers  fundamental right to carry on business to a company, it is  entitled to invoke the said doctrine of "level playing field".   We

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may clarify that this doctrine is, however, subject to public  interest.  In the world of globalization, competition is an  important factor to be kept in mind.  The doctrine of "level  playing field" is an important doctrine which is embodied in  Article 19(1)(g) of the Constitution.  This is because the said  doctrine provides space within which equally-placed  competitors are allowed to bid so as to subserve the larger  public interest.  "Globalization", in essence, is  liberalization of  trade.  Today India has dismantled licence-raj.  The economic  reforms introduced after 1992 have brought in the concept of  "globalization".  Decisions or acts which results in unequal  and discriminatory treatment, would violate the doctrine of  "level playing field" embodied in Article 19(1)(g).  Time has  come, therefore, to say that Article 14 which refers to the  principle of "equality" should not be read as a stand alone item  but it should be read in conjunction with Article 21 which  embodies several aspects of life.  There is one more aspect  which needs to be mentioned in the matter of implementation  of the aforestated doctrine of "level playing field".  According to  Lord Goldsmith - commitment to "rule of law" is the heart of  parliamentary democracy. One of the important elements of  the "rule of law" is legal certainty.  Article 14 applies to  government policies and if the policy or act of the government,  even in contractual matters, fails to satisfy the test of  "reasonableness", then such an act or decision would be  unconstitutional.   

23.     In the case of Union of India and another vs.  International Trading Co. and another - (2003) 5 SCC 437,  the Division Bench of this Court speaking through Pasayat, J.  had held :   "14.    It is trite law that Article 14 of the Constitution  applies also to matters of governmental policy and if  the policy or any action of the Government, even in  contractual matters, fails to satisfy the test of  reasonableness, 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  there is any discernible principle emerging from the  impugned action and if so, does it really satisfy the  test of reasonableness."

24.     When tenders are invited, the terms and conditions must  indicate with legal certainty, norms and benchmarks.  This

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"legal certainty" is an important aspect of the rule of law.  If  there is vagueness or subjectivity in the said norms it may  result in unequal and discriminatory treatment.  It may violate  doctrine of "level playing field".   

25.     In the case of Reliance Airport Developers (P) Ltd. v.  Airports Authority of India and others -(2006) 10 SCC 1,  the Division Bench of this Court has held that in matters of  judicial review the basic test is to see whether there is any  infirmity in the decision-making process and not in the  decision itself. This means that the decision-maker must  understand correctly the law that regulates his decision- making power and he must give effect to it otherwise it may  result in illegality.  The principle of "judicial review" cannot be  denied even in contractual matters or matters in which the  Government exercises its contractual powers, but judicial  review is intended to prevent arbitrariness and it must be  exercised in larger public interest.  Expression of different  views and opinions in exercise of contractual powers may be  there, however, such difference of opinion must be based on  specified norms. Those norms may be legal norms or  accounting norms.  As long as the norms are clear and  properly understood by the decision-maker and the bidders  and other stakeholders, uncertainty and thereby breach of  rule of law will not arise.  The grounds upon which  administrative action is subjected to control by judicial review  are classifiable broadly under three heads, namely, illegality,  irrationality and procedural impropriety.  In the said judgment  it has been held that all errors of law are jurisdictional errors.   One of the important principles laid down in the aforesaid  judgment is that whenever a norm/benchmark is prescribed  in the tender process in order to provide certainty that  norm/standard should be clear. As stated above "certainty" is  an important aspect of rule of law.  In the case of Reliance  Airport Developers (supra), the scoring system formed part of  the evaluation process. The object of that system was to  provide identification of factors, allocation of marks of each of  the said factors and giving 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 expense  because once a provision is made, the "write-off" does not get  routed through the P&L account and that in any event if such  add back is allowed then it would result in "cash impact" in  future.

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28.     To answer the first point we need to know what is  "provision" and how it is made.   

29.     "Provisioning" is a matter of estimation.  ASs are policy  documents.  Accounting interpretation depends on application  of several ASs simultaneously.  The concept of "amortization"  is not restricted only to AS 26.  Similarly,  the concept of "cash  flow analysis" is not restricted to AS 3.  Therefore, different  methods are prescribed for estimating net profits and/or net  cash profits.  There are no two views on this point.   Provisioning for doubtful debts cannot be equated to "write- off".  In the case of provisioning there is no "cash outflow".   This proposition is undisputed.  What is being argued is that  once there is "provisioning", the "write-off" does not get routed  through the P&L account and, therefore, there will be cash  impact in future.  This argument amounts to begging the  question.  If this argument is to be accepted then we are  obliterating the difference between "provisioning" and "write- offs".  The question of "cash impact" in future is a separate  question.  It has to be answered in terms of "cash flow  reporting" which falls in AS 3 which has been invoked by the  chartered accountants of REL/HDEC.  In the case of  Commissioner of Income-tax and Excess Profits Tax,  Central, Bombay  v.  Jwala Prasad Tiwari \026 1953 (24) ITR  537, the Division Bench of the Bombay High Court speaking  through Chagla, C.J. has held as follows: "’Writing Off’ is a technical term used by  financiers and auditors.  There are two methods of  dealing with a debt which has been written off in  the books of account, (1) by giving the  corresponding credit to the debtor’s account, and (2)  by giving the corresponding credit to the bad and  doubtful debts account.  The first method is only  employed where it is desired to close the account of  the debtor.  The second method is employed where  there are some chances of recovery, howsoever  remote they may be.

When we talk of ’writing off’ we are not  concerned with the credit to be given to an account.   ’Writing off’ means the raising of a debit entry.  This  can only be to the debit of the profit and loss  account.  This is the only debit which can possibly  be raised as a result of writing off a bad debt."

30.     In the case of Metal Box Company of India Ltd. v.  Their Workmen \026 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 P. & L.  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

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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 reserve  but an amount set aside out of profits and other  surpluses to provide for any known liability of which  the amount cannot be determined with substantial  accuracy is a provision: (see William Pickles  Accountancy, second edition, p. 192 ; Part III,  clause 7, Schedule VI to the Companies Act, 1956,  which defines provision and reserve)."

31.     Applying the tests laid down in the aforesaid two  judgments [Jwala Prasad (supra) and Metal Box (supra)] it is  clear that the concept of "provision for doubtful debts" is  different from the concept of "write-off".  The effect of the two  is quite different.  Provisions made against anticipated losses  are charges against profits and, therefore, to be taken into  account against gross receipts in the P&L account and the  balance-sheet.  "Provisions" are usually shown in the balance- sheet by way of deduction from the assets whereas "reserves"  are shown as part of the interest of the proprietor.  In the  present case, there is no dispute regarding the aforestated  concepts.  However, according to the consultants for MSRDC  though provision for doubtful debt is a non-cash expense it  has to be treated as a cash expense because once a provision  has been made, the write-offs cannot be routed through P&L  account and, therefore, what is conceptually a non-cash  expense is being treated as a cash expense.  As stated above,  this is begging the question.  If the aforestated argument is to  be accepted it would obliterate the conceptual difference  between "provision" and "write-off".  The above reasoning  shows that the only reason for excluding REL/HDEC is the  future cash impact of the provision made in the accounts of  HDEC for the FY 2001.  This aspect has been discussed by us  in the following paragraphs.  

32.     On the second question of future cash impact it may be  reiterated that KPMG, the chartered accountants for  REL/HDEC has invoked the principle of "cash flow reporting"  which also finds place in AS 3.  According to the said principle  of  "cash flow reporting", when  P&L accounts and balance- sheets are prepared on accrual basis, revenues and expenses  are recognized on accrual basis, i.e., when the transaction or  event occurs. However, timing of cash flow is not reckoned in  such system of accounting.  Similarly, in cases where  accounts are based on accrual system of accounting,  recognition of assets and liabilities 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

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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 cash.  Similarly,  adjustments in respect of current assets and liabilities are also  required to make to net income (loss) figure to arrive at cash  profits.  Both the methods give the same results in respect of  the final total.  

34.     We quote hereinbelow some of the illustrations of  "Indirect Method" which shows that provision for bad debts  can be added back to "net profit" in order to arrive at "net  cash" from operating activities:  

       (1) "Advance Accounts" by Shukla, Grewal and Gupta,  Vol.II, Edition 2008, pages 23.20 - 23.21, which read as  under:  

       ""(ii)  Indirect Method: Zed Ltd. Cash Flow Statement for the year ended 31st March, 2001

Rs. Rs. Cash Flows from Operating  Activities Net profit before income tax and extra- ordinary item: Adjustments for:     Depreciation     Provision for bad debts     Underwriting commission amortised     Profit on sale of investments     Income from investments     Interest on debentures Operating profit before working capital  changes Adjustments for:     Increase in inventory     Increase in trade debtors     Increase in trade creditors     Increase in outstanding expenses Cash inflow from operations Income tax paid

Cash flow from extraordinary item:     Compensation recd. in lawsuit Net cash from operating activities Cash Flows from Investing Activities Purchase of fixed assets Sale proceeds of investments Interest recd. on investments* Net cash used in investing activities Cash Flows from Financing  Activities Redemption of debentures at par* Interest on debentures paid Dividends and corporate dividend tax  paid Net cash used in financing activities Net increase in cash and cash  equivalents

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Cash and cash equivalents as on 31st March,2000 (Opening Balance) Cash and cash equivalents as on 31st March,2001(Closing Balance)

7,77,000

1,80,000 1,000 1,200 (7,500) (21,000) _____66,000

9,96,700

(93,800) (20,000) 19,200 ______5,600 9,07,700 ___(4,16,000) 4,91,700

_____55,000

(2,00,000) 1,57,500 _____21,000

(1,00,000) (66,000)

___(3,30,000)

5,46,700

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(21,500)

____(4,96,000)

29,200

_____1,64,200 _____1,93,400 *Alternatively, interest received on investments and interest paid on  debentures may be treated as flows from operating activities.

Working Notes:

(i) Net profit before income-tax and extraordinary item:                    Rs.     Net profit before income tax                                        8,32,000     Less: Compensation received in lawsuit                                      55,000                                                                         7,77,000 Working notes (iii), (iv) and (v) 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 PERATING 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 will not indicate the net cash provided by operating  activities or net loss will not indicate the net cash used in operating  activities.  In order to calculate the net cash provided by (or used in)  operating activities, it is necessary to replace revenues and expenses  on accrual basis with actual receipts and actual payments in cash.   This is done by eliminating the non-cash revenues and non-cash expenses  from the given earned revenues and incurred expenses in the profit and  loss account.  In addition to regular non-cash revenue and non-cash  expense items, the profit and loss account is also debited and credited with  purely non-cash items which reduce and increase the profits respectively  but do not affect the cash at al e.g. depreciation, loss (or profit) on the  sale of fixed assets, amortization of intangible assets like goodwill, patents  trademarks etc. deferred revenue expenditures like preliminary expenses,  discount on the issue of shares and debentures and so on.  Since cash  provided by operations is to be calculated, certain non-operating items  like rent income, interest income, dividend income, refund of tax etc.

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should also be adjusted although these items may have been recorded on  cash basis.  Such items are analysed separately in the cash flow  statement as operating, investing and investing activities.

ATTENTION  PLEASE

The term ’operating activities’ means business transactions pertaining  to regular business activities, e.g., purchase and sale of goods and  services.

DIRECT VS. INDIRECT METHOD There are two method of preparing the Cash Flow Statement.  Both  methods give the identical or same results in respect of the final total as  well as the sub-totals of the three sections \026 operating, investing and the  financing.  They differ only in the manner the data or information is  presented in Cash Flows from Operating Activities section.

The direct method lists separately each significant cash inflows and  outflows from operating activities, e.g.,

Cash inflows : (i)     Cash received from customers (ii)    Receipts of interest payments (iii)   Receipts of cash dividends on investment in the shares of other  companies

Cash outflows : (i)     Payments to suppliers for goods purchased (ii)    Payments for operating expenses (iii)   Payments for interest (iv)    Payments for taxes

The outflows (payments) are subtracted forms the inflows (receipts) to  determine the net cash provided (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 VS. 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)

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Opening balance of cash and cash equivalents. Closing balance of cash and cash equivalents.

Indirect Method

Net Profit as per Profit and Loss Account Adjusted for: Provision for tax Provision for doubtful debts. Profit (Loss) on sale of fixed assets. Depreciation Profit (loss) on sale of investments. Interest expenses. Exchange rate effect Dividend income. Interest income. Leave salary provision (earlier year) Operating profit before working capital change. Adjusted for: Trade and other receivable. Inventories and other current assets. Trade payables and other current liabilities. Cash generated from operations. Income tax paid (Net of refunds) The above provides: Cash flow before extraordinary items. Adjust for extraordinary items to get. Net cash from operating Activities.

There are two stages for achieving the net cash flows from operating  activities: Stage-1: Calculation of operating (cash) profit before working capital  changes, by adding to net profit as reported in the profit and loss account,  non-cash charges: depreciation, amortization of intangible assets, loss on  the sale of fixed assets and long term investments, provision for tax and  dividends and the like because these items do not affect cash.  Similarly  profit on the sale of fixed assets and long term investments are deducted  from the net income figure as these items also do not affect cash.  In fact,  it is a partial conversion of accrual basis profit to cash basis profit.  Such  adjustments are made by analyzing individual non cash items in journal to  find out the absence of cash in these items.  Moreover, non-operating  items (also known as extraordinary items) like rental income, interest  income, dividend income are deducted from the reported net income  figure because these items are disclosed separately on the cash flow  statement.  The net result of these adjustments is operating (cash) profit  before working capital changes.

Some of the significant non-cash items are explained in the following  paragraphs followed by adjustment of current operating assets and  liabilities. (See Stage II). Depreciation: This item of expense reduces the profit since it is a charge  made against revenue for the use of tangible fixed assets.  The likely  journal entry to record the depreciation expense is:

(i)     Depreciation Account                           Dr.             To Provision for Depreciation Account                 (or Accumulated Depreciation) Alternatively         Depreciation Account                                    Dr.            To Fixed Asset Account  

In either case the depreciation account would be closed be transfer to  Profit and Loss Account.  The net affect would be:

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                  Either           Profit and Loss Account                                       Dr.                 To Provision for Depreciation Account                     Or           Profit and Loss Account                               Dr.                 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, trade marks, 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 Account                                 Dr.                 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 Stage-I above, gives As Operating  Profit before Working Capital Changes.  Several other adjustments  are made in respect of current (Operating) assets (e.g., debtors, bills  receivable, inventories, prepayments etc.) and current (Operating)  liabilities (e.g., creditors bills payable, outstanding liabilities etc.) to  obtain the final net cash from operating activities.  There is an intimate  relationship between the revenue and expense items of income  statement and current assets and current liabilities items of the  balance sheet.  Since the income statement is prepared on the accrual  basis, the resultant net income figure is affected by cash and non-cash  items.  But the net income on a cash basis considers only cash receipts as  revenue and subtracts from cash receipts only cash spent for purchase of  goods or raw materials) and expenses.

The following general rules, as an aid to analysis of current assets and  current liabilities affecting cash, may be noted :

(i)     An increase in an item of current asset causes a  decrease in cash inflow because cash is blocked in  current assets.

(ii)    A decrease in an item of current asset causes an  increase in cash inflow because cash is released from the  sale or recovery from current asset.

(iii)   An increase in an item of current liability causes a  decrease in cash outflow because cash is saved.

(iv)    A decrease in an item of current liability causes  increases in cash outflow because of payment of  liability.

Some of the adjustments are discussed below :

(i)     Debtors and Bills Receivable (Credit Sales) : It needs no  explanation that the major source of cash from operations is

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cash sales.  But it is not uncommon to find a significant  amount of credit sales in the form of debtors and bills  receivable representing current assets.  This indicates that  the sales were made both for cash and credit.  Consequently  the net income (or profit) figure does not disclose the cash  from operations.  The following adjustment, however,  enables to overcome this difficulty : Cash from Operations = Operating Profit before Working Capital  Changes + Net Decrease in Debtors and Bills Receivable." (emphasis supplied)          

35.     Taking into account the above principles, it is clear that  there are two methods of "cash flow reporting" i.e. direct and  indirect.  Both give identical results in the matter of the final  total.  They differ only in presentation of the data.  They differ  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 FY 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  crores.  However, the opinion of the Consultants proceeds on  the basis that if "add back"  is allowed it may have future cash  impact.  In the evaluation process, the Consultants were  entitled to take into account future cash impact but in order to  do so they had to say why the indirect method of "cash flow  reporting" should not be accepted and if at all the impact of  the provisioning was to be seen then there was no reason for  not examining the audited accounts of 2004.  There is a mix- up of two concepts here.  The concept of non-compliance of  financial criteria and the impact in future years on cash flow.    As stated above, the very purpose of "cash flow reporting" is to  find out the ability of HDEC to generate cash flow in future  and if an important method of cash flow reporting is kept out,  without any reason, then the decision to exclude REL/HDEC,  is arbitrary, whimsical and unreasonable. In our view, for non- consideration of the Reconciliation Method, under cash flow  reporting system, the impugned decision-making process  stood vitiated.    

36.     In the result, we set aside the impugned judgment of the  High Court; we hold that REL/HDEC (Consortium) was  erroneously excluded from the second stage of bidding  process.  Accordingly, we allow this civil appeal with no order  as to costs.

37.     Since we have allowed this civil appeal, we extend the

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period for presenting financial bids by REL/HDEC up to  15.12.2007.