Corporate Law Increased Responsibilities and Safeguards/Protective Measures

CORPORATE LAW — INCREASED RESPONSIBILITIES AND SAFEGUARDS/PROTECTIVE MEASURES

MAHAVIR LUNAWAT*

1.Changing Scenario and Multiplicity of Laws

Limited liability and separation of management from ownership, the two peculiar features of limited liability companies, require special attention for governance of such companies. With the advent of “Global Village”, company form of organisation has undergone considerable changes. Over the last few decades nature and form of a corporate sector has grown complex. Cataclysmic changes have occurred in the composition of the governing boards of the companies. A plethora of statutes have been made applicable to a company. The existing laws are being amended to be made more stringent, at the same time new legislations are being passed quite frequently. Governance processes have been codified and made mandatory.

2. Corporate Governance & Statutory Compliance – Continuous Strengthening

“Strong Corporate Governance is indispensable to a resilient and vibrant corporate market and is an important instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and high quality accounting practices” – Kumar Mangalam Birla Committee Report on Corporate Governance.

To fulfill the societal expectations and provide good governance, statutory compliance by the companies is a pre-requisite. A measure of good Corporate Governance lies in bridging the gap between the precept and practice of multiple statutes by the company effectively and to comply with various statutes and regulations framed thereunder, towards the ultimate aim of protecting the interest of investors’ democracy.

The concept of investors’ democracy in the corporate world denote their supreme authority in the governance of the business and affairs of their respective companies either directly or through their elected representatives. The Act has armed them with very effective and powerful weapons so as to enable them to ensure that the business and affairs of the company are properly managed. Some of the weapons in their armoury are:-

—Section 38 provides that no member shall be bound by an alteration in the Memorandum or Articles of Association of the company if the alteration requires him to take or subscribe more shares or in any way increases his liability.

—Section 167 provides that in the event of default in holding an AGM by the company in accordance with the provision of Section 166, a shareholder may approach the CLB for calling of or directing the calling of the AGM of the company.

—Section 169 makes it obligatory on the board of the directors of a company to proceed forthwith to hold an extra ordinary general meeting of the company on a requisition of the members.

*B.Com.(H), ACS (Gold Medalist), DBF, DEM, Secretarial Officer, ITC Limited.

—Section 171 entitles shareholders to receive a minimum of clear 21 days’ notice in writing for every general meeting of the company. Further, Section 173 makes it obligatory on the part of the company to attach an explanatory statement to the notice of the meeting in respect of all matters of “special business”, setting out all the material facts concerning each item of such business.

—Section 179 enables a member to demand poll before or on declaration of the results of the voting on any resolution by show of hands. Further, Section 183 enables a member entitled to more than one vote to cast their vote differently.

—Section 235 confers upon the shareholder the right to apply the CLB to appoint one or more competent persons as inspectors to investigate the affairs of the company. They may also lodge complaints with CLB under Sections 397 and 398 seeking relief in cases of oppression and mismanagement.

—Section 256 allows a member himself or through some other member to propose candidature of a person other than a retiring director to stand for directorship.

—Section 284 confers upon the shareholders the right to remove directors of a company by way of ordinary resolution.

—Sections 297, 299 and 301 regulate the transactions, contracts, arrangements etc, wherein one or more of the directors are concerned or interested. Applicable requirements like proper disclosures, maintenance of register etc. as required under the said sections should be fulfilled. Approval of Board, Central Government etc., wherever necessary, should also be obtained.

—As a last resort, the shareholders may, in terms of the provisions of Section 439 read with Section 433, file a petition for the winding up of the company, based on the specified ground(s).

The list is an indicative one but not exhaustive.

In India, the process of corporate governance gained momentum with the submission of Report on Corporate Governance by Kumar Mangalam Birla Committee appointed for the purpose. Based on the recommendations of the Committee, the governance processes have been codified and made mandatory by way of incorporating a new Clause, i.e., Clause 49, in the Listing Agreement. Since then, there have been frequent changes in the field of corporate law aiming at better corporate governance. Some of the key changes, introduced recently, in the field of corporate law are -

Companies (Amendment) Act, 2000

—Form of companies : Sections 3, 43A have been amended by virtue of which the concept of deemed public companies has been done away with. Definitions of public and private companies have also been amended.

—Section 55A confers exclusive powers on SEBI to administer the provisions relating to issue and transfer of securities, payment of dividend etc.

—Sections 117A to 117C dealing with debenture issue have been inserted.

—Section 192A provides for passing of resolution by the shareholders by way of postal ballots. Voting at the doorstep helps to expand the concept of shareholders democracy, which would go a long way to protect the shareholders interest, by enabling all the shareholders to participate, sitting at their own places.

This will, perhaps have larger shareholder participation protecting their own rights in their desired ways. To enable companies to implement the voting by postal ballots the Central Government has framed Rules in this regard. The Institute of Company Secretaries of India has also come out with a Guidance Note on Postal Ballot describing very minutely the nitty-gritty to enable companies to handle the issue effectively in the sake of protection of investor interest.

—To strengthen the governance processes, several provisions relating to corporate management, like Sections 217, 274, 275, 292A etc. have been amended/inserted. It has been made mandatory for directors to give responsibility statement in the Directors’ Report. Additional grounds of disqualification, restriction on maximum number of directorship etc. are some of the further changes introduced to strengthen governance processes. Provisions relating to Audit Committee have been incorporated in the Act.

—Section 252 has been amended in terms of which a Public Company having paid up capital of Rs. 5 crore or more and one thousand or more small shareholders (i.e., shareholders holding shares of nominal value of Rs 20000 or less) may have at least one director elected by such small shareholders in the manner as may be prescribed. Consequently, Companies (Appointment of Directors by small shareholders) Rules have been notified detailing the procedural aspects in this regard.

—Sections 58AA & 58AAA cast an obligation on the company, which accepts deposits from a small depositor (a depositor who has invested in a financial year a sum not exceeding Rs. 20,000/-) and later defaults in its repayment or any interest thereupon to furnish all details to the CLB on monthly basis. On receipt of such intimation the CLB shall pass an appropriate order within a period of thirty days.

The Companies (Amendment) Act, 2002

Conversion of Co-operative Societies into Companies : A new Part IXA is being inserted in the Companies Act. The new provisions deal with various aspects of functioning of Co-operative Societies which choose to incorporate themselves as limited liability companies (in the form of private companies only) under the Act, to be thereafter known as ‘producer companies’. All the provisions of this Act, other than those specifically provided under this Part, shall apply to such a company, as if it is a private limited company.

The Companies (Second Amendment) Act, 2002

—Imposition of Annual Cess on all Companies : There has been introduced a Rehabilitation Fund for revival of sick companies in which every company will be required to contribute, annually, by way of cess at a rate not less than 0.005 percent and not more than 0.1 percent on the value of its annual turnover or its annual gross receipt, whichever is more, as the Central Government may specify. Non payment of such contribution may invite a penalty not exceeding 10 times of the amount in arrears.

—Setting up of NCLT : A National Company Law Tribunal (NCLT), is being set up, with all powers that were earlier entrusted with CLB/ Central Government / High Court under the Companies Act. The decisions of the NCLT can be appealed at the Appellate tribunal, called National Company Law Appellate Tribunal, whose decision, in turn, can only be challenged in the Supreme Court.

—Provisions relating to Winding-up : Based on the recommendations of Iradi Committee, the provisions relating to winding up have also been amended.

—Revival and Rehabilitation of Sick companies : A new Part VI A on ‘Revival and rehabilitation of sick industrial company’ is being inserted in the Companies Act. The provisions of this Part are in replacement of the provisions of Sick Industrial Companies (Special Provisions) Act, 1985, which will cease to be in force from the date of notification of this Bill.

Other Significant Changes in the Companies Act and Rules thereunder :

—Managerial Remuneration– Amendment to Schedule XIII : The limits on managerial remuneration for companies, not having adequate profits or with no profits, have been revised with additional conditions, including approval of Remuneration Committee. Payment of remuneration, as stated above, shall also be subject to the other conditions specified in the Notification. Further, if a company having negative effective capital intends to pay any managerial remuneration, it shall also require Central Government approval. [GSR No. 36(E) dt. 16/01/2002]

—Disqualification under Section 274(1)(g) and Nominee Directors : Nominee Directors (appointed by the Central or State Government/ Banking companies/ Public Financial Institutions and companies established under the Acts of Parliament having overriding effect over the Companies Act), have been exempted from the purview of disqualification under Section 274(1)(g). [Circular No: 8/2002 dt. 22/3/2002]

—Appointment of Wholetime Secretary under Section 383A - Revision of ceiling : Now, a company having a paid-up share capital of Rs.2 crores or more (earlier limit – Rs. 50 lakhs) shall be required to have a wholetime Company Secretary. [GSR 419(E), dated 11-06-2002]

—Debenture Redemption Reserve (DRR) : Section 117C requires every company to create a DRR to which ‘adequate amounts’ shall be credited out of its ‘profits’ every year until such debentures are redeemed. DCA has issued a clarification stipulating creation of DRR on the basis of value of debentures, pending redemption. [Circular No. 9/2002, Dated 18-04-2002, issued by DCA]

—Amendments in Schedules

—Alteration in Schedule VI

—Substitution of ‘Unclaimed Dividends' by the ‘Investor Education and Protection Fund’ (with its sources) under the category of ‘Current Liabilities and Provisions’. [GSR 762(E), dt. 13-11-2002]

—Introduction of different slabs of turnover for rounding off of the figures in Balance Sheet. (earlier the figures were permitted to be rounded off to ’000 or ’00, irrespective of turnover) [GSR 545(E), dt. 1-8-2002 ]

—Disclosure of the name(s) of small scale industrial undertaking(s) to whom the company owes any sum (as against earlier limit of a sum exceeding Rs.1 lakh) together with interest outstanding for more than 30 days. [GSR 376(E), dt. 22-05-02]

—Schedule V : Substitution of ‘General Revenue Account of the Central Government’ by ‘Investor Education and Protection Fund’ [G.S.R. 751(E) – dt. 02-11-2002]

—Schedule II : Directors, in every Prospectus to be issued by a company, to give a declaration of compliance with relevant provisions of the SEBI Act, 1992 and guidelines issued thereunder, in addition to, what was required earlier – the Companies Act and guidelines issued by the Government. [G. S. R. 650(E) – dt. 17-09-2002]

—Director’s Relatives (Office Or Place Of Profit) Rules, 2003 : Central Government vide Notification No. G. S. R. 89(E), dated 5-2-2003, in exercise of the powers conferred under Section 642(1)(b), read with sub-section (1B) of Section 314 of the Act, has notified Director’s Relatives (Office or Place of Profit) Rules, 2003.

Any appointment, which carries a monthly remuneration exceeding Rs. 50,000 p.m., of (a) Partner or relative of a Director or Manager; or (b) Firm in which such Director or Manager, or relative of either is a partner; or (c) Private company of which such Director or Manager or relative of either is a Director or Member, shall have to be approved by the Central Government.

The said Rules require inter alia selection of a relative of Director, for holding place of profit in case of a public company, to be approved by a Selection Committee, the majority of which shall consist of Independent Directors and an expert in the respective field from outside the company. Further, following undertakings shall also have to be given -

—An undertaking from the appointee that he/she will be in the exclusive employment of the company and will not hold a place of profit in any other company.

—In case of the appointment of a relative, an undertaking from the Director/Company Secretary of the company, that the similarly placed employees are getting comparable salary, shall also be enclosed along with the application.

—Companies (Auditor’s Report) Order, 2003 : The Manufacturing and Other Companies (Auditor’s Report) Order (MAOCARO) has been replaced by the Companies (Auditor’s Report) Order, 2003 (CARO) with effect from July 1st, 2003. CARO has introduced some additional items for coverage by the Auditors in their Audit Report.

—Increase in Maximum Amount of Sitting Fee : DCA, by Notification G.S.R. 580(E), effective from 24th July, 2003, has increased the amount of maximum sitting fees that can be paid to the Directors. Accordingly, companies having Paid-up share capital and free reserves of Rs.10 crore and above or Turnover of Rs.50 crore and above, can pay sitting fees upto Rs. 20,000/- and other companies upto Rs. 10,000/-.

3. Global movement for better governance – impact in India

A.Companies Act

The global movement for better corporate governance progressed subsequent to the Enron debacle of 2001, followed by other scandals involving large US companies such as WorldCom, Qwest etc. In June 2002, less than a year from the date when Enron filed for bankruptcy, the US Congress introduced the Sarbanes-Oxley (SOX) Bill, which was assented to by the US President on 30 July 2002. SOX Act brought with it fundamental changes in virtually every area of corporate governance.

Playing a pro-active role, the Department of Company Affairs, on 21 August 2002, appointed Naresh Chandra Committee to examine various corporate governance issues. Among others, this Committee has been entrusted to analyse and recommend changes, if necessary, in diverse areas such as:

—the statutory auditor-company relationship, so as to further strengthen the professional nature of this interface;

—the need, if any, for rotation of statutory audit firms or partners;

—the procedure for appointment of auditors and determination of audit fees;

—restrictions, if necessary, on non-audit fees;

—independence of auditing functions;

—measures required to ensure that the management and companies actually present ‘true and fair’ statement of the financial affairs of companies;

—the need to consider measures such as certification of accounts and financial statements by the management and directors;

—the necessity of having a transparent system of random scrutiny of audited accounts;

—adequacy of regulation of chartered accountants, company secretaries, and cost accountants, and other similar statutory oversight functionaries;

—advantages, if any, of setting up an independent regulator similar to the Public Company Accounting Oversight Board in the SOX Act, and if so, its constitution; and

—the role of independent directors, and how their independence and effectiveness can be ensured.

As reported by the Naresh Chandra Committee, “When in doubt, disclose” is probably the simplest and best yardstick for evaluating good corporate governance.

The Committee presented its Report to the DCA in December, 2002 culminating finally into the Companies (Amendment) Bill, 2003, presented before the Rajya Sabha on 7th May, 2003.

Companies Amendment Bill, 2003

Based on the reports of the above Committee and Joshi Committee, the Companies Amendment Bill, 2003 has been presented before Rajya Sabha on 7th May, 2003. Some of the broad amendments sought to be carried out by the Bill are :-

—Electronic maintenance/filing of documents, Board-meeting by tele-conferencing etc.

—Mandatory requirement of having Independent Directors and Women Directors on the Board

—Training of Independent Directors

—Additional disqualification of directors, retirement age, additional disclosure in Directors’ Report etc.

—Consolidated Financial Statements

—Only one tier of holding-subsidiary companies

—Well-defined duties of company secretaries

—Pre-certification of statutory documents by secretaries in wholetime practice

—Mandatory appointment of Chief Accounts Officer

—Additional disqualifications of auditors, prohibition on providing non-audit services by statutory auditors etc.

—One investment arm only

—Notice and Agenda for Board-meetings, ratification of resolution by circulation etc.

Valuation Committee Report

The Central Government (DCA) had constituted an Expert Group under the chairmanship of Shri Shardul Shroff to suggest guidelines on valuation of corporate assets and shares in connection with amalgamation, merger, demerger, acquisitions, buy-back, etc. of shares and / or restructuring of capital of companies.

On 31st January, 2003, the Committee presented, to DCA, its Report containing several recommendations in the context of valuation. This report does not seek to limit the management’s prerogative of taking decisions as long as they are reasoned, logical or justifiable in the interest of the company.

The recommendations made are in addition to the valuation or pricing requirements which may be contained in SEBI Laws or Regulations, foreign exchange or other laws and regulations and these recommendations are supplementary and not in derogation of existing laws. Transactions for which independent valuation by the Registered Valuer(s) has been recommended to be mandatory, inter alia include all schemes of Compromise and Arrangement under Sections 391 to 394 of the Companies Act.

—Major Factors influencing the Valuation : The valuer should mention the key factors which have a material impact on the valuation. All valuations carried out in compliance with the requirements set out in the Report are to be carried out in sufficient details to comply with the “duty of care”.

—Rejection/Modification of Valuation Report : If an independent valuer renders a valuation report, then it shall not be open to a company or its management to summarily disregard or reject such a Report and appoint another valuer, without disclosing the valuation and its findings to the Board of Directors and the Shareholders. Board can disregard / modify the valuation and can enter into a transaction at a valuation price or exchange ratio, which is in variance with what is assessed by the valuer(s), with sufficient justification being presented at the meeting of the Board of Directors and disclosure to that effect is made in the Explanatory Statement of shareholders notice, if any.

—Role of Chairman of the Audit Committee

—The Chairman of the Audit Committee shall be entrusted with the duty to appoint the valuer and shall also be the signing authority for such appointment and the mandate letter.

—The Chairman of the Audit Committee shall have the duty to verify the independence of the valuer for the purposes of an independent valuation.

—The disclosure principle and the appointment norms for valuers enunciated above will apply to all companies whether listed or unlisted, where an Audit Committee is appointed for purposes of good governance.