The much delayed
sanction to the Companies Bill, 2012 (the “Bill”) by the upper house of the
parliament was granted on August 8, 2013. The Bill brings about significant
changes to the existing corporate law and procedures. It has taken almost a
decade for the Bill to reach this stage after several rounds of consultations
with various stakeholders.
The Bill is an attempt
to modernize and overhaul the framework of corporate law presently governed by
the Companies Act, 1956 which is a 5 decade old law. As such, the Bill contains
several key changes on various aspects ranging from company formation to
governance to corporate social responsibilities and in this edition of the BMR
Edge on the Bill (please click
here to view the previous alerts) we have focused on some key
themes and trends emerging from the Bill.
Overhaul of corporate
governance provisions
The lead up to the
formulation of the Bill has been a general environment of high profile corporate
frauds, accounting scandals and the likes. A holistic reading of the
discussions preceding the Bill and the provisions thereof seem to make it clear
that a significant portion of the legislators mind share was directed at a
complete overhaul and relook at the existing systems of governance. Significant
changes have been brought in to bring about a sense of accountability and
responsibility in the mindsets of corporate, especially in case of listed
companies.
Independent
Directors
The Bill has sought to
codify within the company law framework, the requirements for listed companies
to have one third of its Board members as Independent Directors (“ID”).
Furthermore, extensive provisions have been incorporated to make the directors
truly independent by prohibiting individuals connected with the management,
promoters or individuals who have been employees, auditors, company
secretaries, legal advisors, etc for donning the role of an ID. The Bill also
prescribes a minimum term of 5 years for an ID and caps the appointment to a
maximum of 2 terms (implying a maximum tenure of 10 years). IDs are further
prohibited from being associated with the company in any capacity for a period
of 3 years from the expiry of their term.
The provisions of the
Bill in relation to the IDs are indeed welcome, but the cap on the number of
directorships (20 overall and 10 in case of public companies) may act as a
constraint, especially considering the extremely exhaustive list of restrictions
which among other things excludes any person (and in some cases relatives of
such persons) having any pecuniary interest with the
company.
The Bill provides
detailed guidance on the code of conduct to be followed by the IDs. The manner
in which the code of conduct defines the roles, functions and duties of the said
directors is extremely onerous. Also, while the liabilities of the ID have been
sought to be limited to an extent by making an ID liable only in respect of acts
of omission or commission by the company with the knowledge of the director or
attributable to a board process, etc, given the onerous responsibility put on
the directors in the Bill, this is likely to be a significant concern for
IDs.
Role of directors in
general
In another hotly
debated topic, the Bill has also attempted to codify the specific duties of
directors and a contravention of these duties would attract penal consequences.
Some of the ‘duties’ specified are somewhat prescriptive in nature, such as
requirement for directors to act in good faith in order to promote the interests
of the company for the benefit of its members, employees, shareholders, etc.
The said duties also bar a director from being involved in any situation which
may result in a direct or indirect interest that conflict, with the interest of
the company. Similarly, a director would now be liable to the company for any
undue gains made by him, his relatives or associates from dealings with the
company. On principles, the point to be debated is, since the Bill has specific
provisions dealing with issues such as related party transactions, whether there
was indeed a need to have overarching principles attempting to define the duties
of the directors and even if this were the case, should these principles have
been more in terms of general guidelines as against the present provisions where
the non-compliance attracts penal consequences.
Related party
transactions
The Bill proposes a
significant enhancement in the scope of Related Party Transactions (“RPT”) as
compared to present law. Broadly, the changes can be summarized as
follows:
·
The
definition of the term related party itself has been significantly expanded,
inter alia, to include key managerial personnel (CEO, CFO, company secretary,
etc) or their relatives, holding and subsidiary companies, persons in advisory
capacity on whose advise a director is normally accustomed to act, companies
where directors of a company have a prescribed shareholding, etc;
and
·
The list
of transactions to which the RPT provisions would be attracted has also been
expanded to include selling or buying or leasing of properties, appointment of
agents, etc.
The primary aim of the
changes is to ensure a greater degree of fairness and transparency in dealings
with related parties. Such transactions would now require shareholder’s
approval for companies with prescribed paid-up share capital as against Central
Government approval – signaling a shift towards shareholder centric governance.
All RPT would need to be reported in the Directors Report along with
justifications for entering into such a transaction. Transactions at arms’
length in the normal course of business are, however exempt from the rigors of
the said provisions.
A violation of these
provisions by any director(s) or any employee(s) could attract fine and, in case
of listed companies, the erring director(s)/ employee(s) could also be subject
to imprisonment for up to a maximum of one year. Additionally, the Bill also
restricts a person who has been convicted of an offence dealing with RPT at any
time during the last 5 years, from being appointed as a director of any
company.
The intent once again
seems to be good, however on a practical level, requiring shareholders’ approval
for all RPT, with limited exemptions, could considerably slow down the decision
making process. Interestingly, in a shareholder meeting, the interested
shareholder is precluded from voting and this could lead to peculiar situations
for instance in transactions between a holding company and its subsidiary (which
would be covered within the expanded definition of the term related
parties).
Constitution of
National Financial Reporting Authority
The Central Government
has been empowered to constitute an independent authority to be called as the
National Financial Reporting Authority (“NFRA”) to formulate accounting and
auditing standards, ensure compliance with such standards, oversee the quality
of service of relevant professions and perform such other matters as may be
prescribed. NFRA has been vested with quasi-judicial powers to investigate into
matters of professional or other misconduct by chartered accountants or
chartered accountant firms, either on its own or on a reference made by the
Central Government, for such class of bodies corporate or persons, as may be
prescribed. NRFA has also been empowered to impose penalties on erring
professionals including debarring the professional from
practice.
Presentation of
financial statements
The changes in
relation to presentation of financial statements have been summarized as
under:
·
A uniform
financial year i.e. period ending March 31, has been prescribed for all
companies except for companies having foreign holding companies/ subsidiaries
which are required to follow a different period under the foreign laws for
consolidation of accounts;
·
Holding
company is required to include consolidated financial statements as part of its
financials;
·
Annual
return of every company (except ‘a one person company’, ‘small company’ or
‘dormant company’) is required to have a cash flow
statement.
These changes have
been made with a view to streamline the presentation of annual financial
statements and to provide more relevant information to the readers of financial
statements.
Checks on
Auditors
The Bill prescribes
mandatory rotation of auditors for listed companies and other classes of
companies (to be prescribed). An individual auditor cannot hold office for more
than one term of 5 consecutive years and an audit firm cannot hold office for
more than two terms of 5 consecutive years. The Bill also restricts an auditor
from rendering services such as accounting, book keeping, investment banking,
internal audit, etc ‘directly or indirectly’ to the company or its holding/
subsidiary. These measures act as a check on the impairment of the auditor’s
independence.
Auditors are to be
subjected to penal consequences for contravention of the provisions of law. The
penalties are substantially higher in cases of wilful default or where the
default is done with an intention to defraud the company/ shareholders/
creditors/ tax authorities even leading to liability to refund the
remuneration.
Corporate loans and
guarantees
The Bill prohibits
grant of loans/ issue of guarantees by companies to its directors/ persons in
whom directors are interested, without shareholders nod. The need for prior
approvals from the Central Government has been dispensed
with.
The limits and
conditions applicable on grant of loans/ guarantees are sought to be made
applicable to private companies also and for loans/ advances to persons other
than body corporates. The exemption on application of restrictions/ conditions
on loans/ guarantees/ investments between holding companies and its wholly owned
subsidiaries have been withdrawn.
Stringent
punishments
Again, in an attempt
to deal with corporate frauds in a stringent manner, the Bill, inter
alia, provides for imprisonment of any person guilty of a fraud and the Bill
contains provisions for recovery and disgorgement to provide relief to the
victims.
The term ‘fraud’ has
been defined in a broad manner to include any act or omission or abuse of
position with an intent to deceive or obtain undue gain or to injure the
interests of the company, its shareholders or its
creditors.
The Serious Fraud
Investigation Office (“SFIO”) in existence since 2003 as a body of the Ministry
of Corporate Affairs has been granted statutory recognition, thereby making it a
nodal agency for investigations of corporate delinquencies. The problems of
lack of powers with the SFIO has been addressed by allowing it to initiate
prosecution, demand production of books of accounts and other documents,
summoning and enforcing of attendance of persons.
Investor protection
measures
In line with the
objective of providing better protection to the investors, several changes have
been introduced to the existing provisions. Some of the changes are
specifically intended to support minority shareholders. The changes which are
noteworthy in this regard are discussed below.
Recognition of
inter-se shareholders’ arrangements on transferability
The debate as to
whether any restrictions can be imposed on transferability of shares in a public
company has been laid to rest by the Bill by explicitly upholding the
enforceability of such contracts. It would now be possible to contractually
agree on terms such as right of first refusal, right of first offer, tag along,
call option, put option, etc in the shareholder agreements/ investment
agreements, in the case of a public company as well. These terms would now be
binding on the investors. This change would be extremely welcome particularly
by the investment community.
Entrenchment
provisions
The Bill recognizes an
interesting concept of entrenchment. Essentially, the provisions allow for
certain clauses in the articles to be amended upon satisfaction of certain
conditions or restrictions (such as obtaining a 100% consent) greater than those
prescribed under the Bill. This provision would once again be a welcome
protection to the minority shareholders and would be of specific interest to the
investment community.
Class action
suits
The Bill, as a part of
the ‘oppression and mismanagement’ related provisions has introduced principles
of class action suit, a concept borrowed from developed economies. The Bill
essentially lays down an operational framework whereby shareholders could
directly approach the National Company Law Tribunal (the “Tribunal”) to seek
relief on various types of issues and, inter alia, seek damages against
the company, its directors, auditors or advisors, who have knowingly assisted in
wrongdoings. The Tribunal has been given wide powers to deal with such class
action suits and the orders of the Tribunal would be binding, with stringent
penalties and imprisonment for non-compliance with
directions.
The statutory
recognition to this concept coupled with stringent penal mechanisms should act
as a deterrent from perpetration of frauds. In order to prevent frivolous
litigations against the company/ its personnel several safeguards have been
built into the law.
Acquisition of
minority stake
The Bill contains
providing minority shareholders with a compulsory option to exit in case of a
merger of a listed company with an unlisted company. The Bill also provides
that where a person or group of persons become shareholders with 90% or more
stake in a target company (listed or unlisted), then such person/ group shall
compulsorily notify the target company of their intention to acquire the balance
stake held by the minority shareholders. The price mechanism for such deal is
yet to be formalized; however the same needs to be carried out by a registered
valuer.
Corporate Social
Responsibility
In perhaps one of the
most widely debated and controversial provisions, the Bill makes it mandatory
for all companies (public and private) having net-worth of 5,000 million or more
or turnover of 10,000 million or more or net profit of 50 million or more in a
financial year to constitute a Corporate Social Responsibility (“CSR”) Committee
with 3 or more directors. Based on the CSR policy formulated by the CSR
Committee, the qualifying company would need to spend at least 2 percent of its
average net profits in the last three years towards various permitted social
causes. The stated rationale for this move is to impart a CSR culture amongst
big corporates.
As mentioned earlier,
this has been a very widely debated topic and the general view in the corporate
world has been that the mandatory CSR is a proxy to additional taxes. A failure
to meet CSR obligations require the Board to give justifications in its report
for such a failure, which is expected to act as a sufficient check on
non-compliance. It appears that an attempt has been made to make these
provisions more acceptable to the corporates, by making CSR mandatory, on one
hand and by merely prescribing a reporting requirement for failure to comply, on
the other. Therefore, at this stage it is a ‘comply or report’ regime without
any penal provisions for non-compliance with the CSR
requirements.
“New”
concepts
While several
provisions of the Bill seems to be more onerous compared to the existing law at
first glance, the Bill has introduced a few new categories of corporate entities
with lower compliance levels which has been discussed
below:
One-person
company
Currently, private
companies need to have at least 2 members and 2 directors. The Bill has
introduced new concepts in the form of ‘one-person company’. Like in most
developed countries, a private company in India can now be formed with a single
person and one director, paving the way for individuals to be organized as a
‘corporate’. Initial reading of the provision seems to suggest that this form
of business entity would be available only to a natural person. However, it
would be interesting to watch the development on this front to see if this form
of business entity is opened up for corporates which would be of immense
interest, for instance, to various subsidiaries of foreign companies operating
in India.
Small
company
A ‘small company’
concept has been introduced to mean a private company having paid-up share
capital between five million and fifty million or turnover between twenty
million and two hundred million, as may be prescribed. Some relaxations are
specifically made available to one person companies/ small companies with
respect to holding Board meetings, presentation of cash flow statements, etc
which would ease their compliance burden.
Dormant
company
Companies formed for
future projects or to hold assets/ intellectual property rights having no
significant business transactions or inactive companies can apply to the
Registrar for availing the status of a ‘dormant company’. Dormant companies
would be allowed to remain in existence with very minimal compliance
requirements.
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