Monday 26 August 2013

Companies Bill, 2012 – Key changes

Companies Bill, 2012 – Key changes


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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