[Infographic] The new company law: What should the board of a company look like?

DeekshaSinghWith the notification of the Companies Act, 2013 (“Act”) earlier this year, one of the most notable and much-discussed changes has been the focus on corporate governance. The key tools in this regard are the provisions relating to the composition of the Board of Directors (“Board”) of a company.

The Board of every company must comply with the provisions in Chapter XI of the Act and the Companies (Appointment and Qualification of Directors) Rules, 2014 (“Rules”). Also, the SEBI has the made the provisions of the Act, including those relating to the composition of the Board, applicable to listed companies through amendments to the Equity Listing Agreement. These amendments will come into effect in October 2014.

Let us now take a look at what the Boards of the following kinds of companies would look like if they met the bare minimum requirements in the Act, the Rules, and (where applicable) the Equity Listing Agreement.

One person company

01Board CompositionOnePersonCompanyPrivate company

02Board Compositionprivatecompany


Public unlisted company

03Board CompositionPublicUnlistedCompany


Public listed company

04Board CompositionPublicListedCOmpany

Public listed company, where the Chairman is a non-regular, non-executive director or where the Chairman is a regular, non-executive director who is a promoter, or related to the promoter, or occupies a management position at the Board level in the company

05Board CompositionPublicListedCompany2

Public company with a paid up share capital of Rupees Ten crore or more or with a turnover of Rupees One hundred crore or more

06Board CompositionPublicListedCompany3

Public company with a paid up share capital of Rupees One hundred crore or more OR with a turnover of Rupees Three hundred crore or more

07Board CompositionPublicListedCompany4

Public company with outstanding debt (loans, debentures, and deposits) of Rupees Fifty crore or more

08Board CompositionPublicListedCompany5

Note 1: The charts above show the board having the minimum number of directors permitted for that category. Note that no company can have more than fifteen directors on its Board, unless a special resolution is passed to permit appointment of more directors.

Note 2: Where overlapping roles are shown for a particular director, it does not denote that the same person must necessarily fulfill both requirements (except that independent directors must be non-executive directors).

(Deeksha Singh is part of the faculty on


A brief history of the evolution and purpose of the Board of Directors

CompanyLawMatters_TanikellaRastogi_2Every practitioner of corporate and commercial laws will appreciate the increasingly important role and purpose of the board of directors (“BoD”) of a corporation. In India, as well as globally, the director is no longer a mere agent or nominee of the shareholders of a corporation. With the advent of independent directors, they are in effect, more akin to trustees of shareholder wealth and are answerable to public ownership. A practicing corporate attorney will need to answer several queries about the decisions and deliberations of the BoD and merely applying the law at hand may not always suffice. To make better decisions, it is also important to understand some of the principles and socio-economic factors that have guided the development of the law of business organisation.

The most basic constituent of any economy is the market, which comprises individual participants and the trade of goods and services. As economies grow however, individual participants alone cannot sustain the production of the goods and services needed to meet the growing demand. The capital and the resources employed by individual participants will necessarily be diversified and redeployed to cater to the increased demand. Thus pressed, the entrepreneur will seek out forms of business organisation that will most efficiently enable him to continue providing goods and services at a greater scale.

Separation of ownership and management

Law_of_agency_businessorganisation.jpgA direct consequence of the growth of a market economy is the separation of the actors involved in securing the capital of a business from those who specialise in employing the capital towards the production of goods and services. The simplest (and hence probably earliest) form of such division was the relationship of agency. To regulate this important function, a great deal of care and development went into the establishment of the law of agency.

The agents were responsible for carrying out designated functions (such as the employment of capital) on behalf of the owner (principal). The law in turn recognised the presence of two distinct actors and, to align the interests of the agent and the owner to ensure the efficient running of a business in the overall interests of the market, the law developed to hold owners vicariously liable for the acts of agents in the normal course of business. Over time, to bring greater alignment between the interests of the agent and owner, the economic society recognised the formation of partnerships. In the partnership form, multiple owners could pool in resources, collectively manage the business and share liability for the debt of the business. As the partners are at once owners and agents there is an expectation of greater scale, efficiencies and reduced agency costs.

The evolution of limited liability

AdvancedProfessionalCertificationinCorporateLawPractice_apcclpNevertheless all of the above forms of business organisation were premised on individual liability for whole of the debts of the concern. Traditionally only specialised community businesses such as guilds shared features akin to limited liability. This led to demand for limited liability partnerships that is, where partners were not responsible for the personal debts of other partners but all the partners were responsible for the debt of the partnership. The relationship between personal debt and partnership debt, that is, questions of which creditors would be preferred while paying back the money if the partner and the partnership both became insolvent, was complex. There was a need for a form of business organisation where the personality of the business was also entirely separate from that of its members and the liability of the members would be limited to the amount contributed by them to the business. With such a model, creditors would be assured of the financial standing of the business before they provide any debt to the business. Moreover, the members would be saved from the unlimited liability to the creditors of the business. The industrial revolution and the increased trade between countries dramatically increased the scales of production and businesses. The increasing exchange of goods and services at a global level required more manpower and a higher commitment of capital. This in turn gave rise to a need for a form of business organisation that permitted hundreds or even thousands of people with varied roles to work together for the production of goods and services and profitability. At this scale, as I have discussed, the legal fictions of a separate legal personality and limited liability were required as in its absence, entrepreneurs were discouraged from scaling up and engaging in international trade. The earliest forms of limited liability corporations were established by the state using an institutional charter to provide legitimacy to a form of business organisation that would be distinct from its ownership in terms of personal liability.

The need to protect shareholder interests

Especially where the ownership had devolved to the public at large to gain greater access to capital, a natural corollary to the separation of functions in a corporation was the need to align the interests of the owners and the management of the business. Thus, a group of experienced persons were designated as nominees of the shareholders and held responsible for the decision-making of the corporation. These representatives of the shareholders of the corporation came to be known as the Board of Directors and provided overall direction and oversight of the corporation’s business. The actual deployment of resources was tasked to managers who were specialist employees.

This arrangement naturally involved a two-stage assessment of any decision — first by the BoD at the stage of making the decision and later, by the managers while implementing it. Since these were entirely different sets of people, the assessments would be without any influence. The relationship of between the directors and the corporation was one of agency and gave rise to fiduciary duties of the directors towards the corporation and the shareholders. Today, the duty to act in good faith, the duty to act in the interests of the shareholders of the corporation, the duty to act with due and reasonable care, skill, and diligence, and the duties regarding conflict of interest and related party transactions are some of the fiduciary duties imposed on the directors by virtue of their position in the corporation.

The modern corporation is a separate entity in the eyes of the law and is governed by its charter documents. The directors act as the agents of a corporation and take decisions on its behalf. The managers execute those decisions. However, as the ownership of the corporation resides with the shareholders and as they are the ultimate beneficiaries of every decision, the centralised management, that is, the BoD chosen by the shareholders, tries to ensure that the interests of the shareholders are protected. Having a BoD eliminates the socio-economic costs imposed by the alternative of shareholders having to meet and approve each decision of the corporation. In turn, the shareholders, by approving the charter documents of a corporation and its by-laws, establish the constitution within which the directors may function. Whenever the directors act on behalf of the corporation and take decisions therefore, they have a duty to not act in violation of the charter documents. These documents set out the structure of the BoD, the manner of appointing directors, the term of the directors, and the committees that need to be appointed to enhance the working of the corporation.

Every decision taken by the directors must consider the interest of all the shareholders – whether they are majority shareholders or minority shareholders. The nature of limited liability corporations however, carries an inherent risk. The directors, since they are agents and lack personal liability, may not act as efficiently as required, leading to erosion of shareholder capital and discouraging further investment and eventually stifling the growth of the business. In this scenario, the executive management serves as the second level of assurance to the shareholders about the efficient functioning of the corporation.

We can now proceed to examine the evolution of the directors from being primarily agents of shareholders to trustees of shareholder wealth and corporate assets. The independent director, in this regard, is a creature of law established in recent times to ensure that the functions of the BoD are not impeded solely by the representation of majority shareholder interests.


llan, Kraakman, Subramanian, Commentaries and Cases on the Law of Business Organization, (Wolters Kluwer, 2009) 3rd ed., at 98.

(Jitender Tanikella is a corporate and tax lawyer with an advanced law degree from Columbia University. Anirudh Rastogi is a general corporate lawyer with an advanced law degree from Harvard University. They are part of Tanikella Rastogi Associates.)


Auditors more accountable, need to be more independent under new company law

DeepaMookerjee_CompaniesBillSeeking greater transparency and corporate responsibility, the Companies Act, 2013 (“New Companies Act”) has changed the role of auditors in companies.

Discussions about the role of auditors took center stage in the United States after a number of corporate scandals — the best documented of them being the Enron scandal, which sounded the death knell for its auditor, Arthur Andersen. Reacting to this scandal, the United States passed the Sarbanes Oxley Act, 2002 (“Sarbanes Act”).

Arthur Andersen (1885-1947) was one of the founders of the firm that came to be known as Arthur Andersen & Co. in 1918.
Arthur Andersen (1885-1947) was one of the founders of the firm that came to be known as Arthur Andersen & Co. in 1918.

This law established a separate body for the independent oversight of public company audits. This ended more than hundred years of self-regulation of the public company audit profession. The Sarbanes Act also prescribed that all audit committees (in listed companies) be independent of the management. This independent audit committee, rather than the management, would be directly responsible for the oversight of the external auditor. Additionally, audit firms were prohibited from providing certain non-audit services to the companies they audit.

All these provisions — ensuring that auditors are independent, free from all external influences, and solely responsible for doing their job efficiently — stem from the basic motive of increasing their accountability. Since its notification, the Sarbanes Act has been both critiqued and applauded.

In India, the Satyam scandal brought to the fore the inadequacies in the regulatory scrutiny of accounting. It is shocking that B. Ramalinga Raju could stand before the company’s board and admit that he had falsified accounts for “several years” to stave off a takeover, when a reputed accounting firm such as Price Waterhouse India (“PWC”) had been auditing their accounts for several years. While PWC claimed that they had received adequate evidence from Satyam and had carried out audits in accordance with applicable Indian auditing standards, the scandal begged the question whether it could have been averted if there had been stricter regulatory scrutiny of auditors. The following questions were also asked: Should a company be forced to rotate its auditors? Should there be a greater liability on auditors to deter such scandals? Let us now see whether the New Companies Act provides any answers.

Auditor’s term                                                          

Advanced Commercial ContractsUnder the Companies Act, 1956 (“1956 Act”), an auditor was appointed at the annual general meeting, for a term of one year. Under Section 139 of the New Companies Act, an auditor will be appointed at the first annual general meeting and will hold office till the end of the sixth annual general meeting, though its appointment will be ratified at every AGM.

Mandatory rotation

The New Companies Act (Section 139(2)) read with the draft rules provide for the mandatory rotation of auditors. Individual auditors will be compulsorily rotated every five years and the audit firm will be rotated every ten years in all companies except one-person companies and small companies. This step was inserted to ensure that auditors do not increase their familiarity and reduce their independence by continuing to audit a company for an unlimited period of time. One questions however, whether such stringent requirements are needed in private companies.

A more basic question is whether the rotation of auditors really results in independence? The Standing Committee on Finance reviewing the Companies Bill was sure that rotation does in fact lead to independence. On the other hand, some feel that companies do not have much choice in relation to auditors, and that such rotation may lead to cartelisation among large audit firms. Another argument is that the rotation policy discourages small and medium-size audit firms from investing in technology and training because of the uncertainty of securing another client of the same size operating in the same industry, given that there are only a few large players operating in a particular industry. Arguments from both the sides appear to have some strength.

Cooling period

A cooling period of five years is also prescribed (Proviso to Section 139(2)) before the reappointment of auditors who complete one term. The same company cannot reappoint such auditors or audit firms for the next five years after completion of one term.

Non-audit services

Similar to the Sarbanes Act, the New Companies Act in Section 144 lists a few services that a company’s auditor cannot provide, directly or indirectly, to the company and its holding and subsidiary companies. The intent is to ensure that the auditor avoids any conflict of interest arising from the provision of other services such as accounting and book keeping, internal audit, management, and actuarial and, investment advisory services.

Tribunal’s power to remove auditors

While no separate regulatory body has been set up to regulate auditors, the National Company Law Tribunal (“Tribunal”) has (in addition to the company itself) the power to order the removal of auditors. The Tribunal under Section 140(5) can order a company to remove its auditor, if it believes the auditor has acted in a fraudulent manner, or abetted or colluded in any fraud.

Reporting fraud

The New Companies Act also enhances the accountability of auditors. It does so by placing on auditors, the onus of reporting fraud noticed by them, during the performance of their duties (Please see the draft rules).

(Deepa Mookerjee is part of the faculty on


Put and call options: New legitimacy but doubts remain

DeepaMookerjee.jpgIn what is being termed as an “investor friendly” move, the Securities and Exchange Board of India (“SEBI”), permitted put and call options in shareholders agreements through a notification dated October 3, 2013. It appears that it will help clear up some of the ambiguity regarding the validity of these options under Indian law.

Simply, a “call option” is a right but not an obligation to purchase shares at a specified price, on the happening of a specified event. Assume that there are two investors — A and B — in a joint venture company. A has a call option over twenty-six per cent shares held by B, which he can exercise once the foreign direct investment (“FDI”) cap is raised. This means that once the FDI cap is raised, A has a right to purchase twenty-six per cent shares from B. If A exercises this right, B cannot decline to sell the shares to A.

A “put option” on the other hand, is a right but not an obligation to sell shares upon the occurrence of a specified event at a specified price. Here, assume that A has a put option over twenty-six per cent of his own shares in the company. A can exercise this option once the company is insolvent. If the company declares insolvency, A can sell his shares to B. Once A exercises his put option, B cannot decline to purchase A’s shares.

Historically, put and call options, along with other rights such as pre-emption rights and right of first refusal have been the subject of much controversy in India.

Prohibition under company law

Section 111A of the Companies Act, 1956 stated that shares of all public companies were freely transferable. Hence, any restriction on the transfer of shares (including options in shares) would be illegal. Since, put options and call options restricted a person’s right to transfer shares, such options were illegal. Based on this, some market players took the view that even though these options were prohibited in a public company, private companies were free to incorporate such conditions.

This issue has been put to rest in the Companies Act, 2013, which states in the proviso to Section 58(2) that any contract or arrangement between two or more persons in respect of the transfer of shares will be enforceable. Though there has been no formal explanation for its insertion, one could argue that the proviso recognises shareholders’ competence to contract. It appears therefore, that this proviso lends legal sanctity to put and call options, which are essentially agreements for the transfer of shares between shareholders.

Prohibition under securities law

The Securities Contracts (Regulation) Act, 1956 (“SCRA”) and the Securities and Exchange Board of India (“SEBI”) are the next set of roadblocks to these options. This is because, the SEBI had issued a notification in 2000, which provided that no person can enter into any contract for the sale or purchase of securities other than spot delivery contracts (Section 18, SCRA) or permissible contracts in derivatives. A “spot delivery” contract is one where the delivery and payment of shares takes place on the same or following day. (For a more detailed understanding of the development of the law, please look at Investment Agreements in India: Is there an “Option?”)

Through a number of decisions (the Cairn Vedanta case and the Vulcan case), the SEBI reiterated its view that call and put options were prohibited because:

  • they were not valid derivative contracts that can only be traded on a stock exchange (Section 18A, SCRA); and
  • put or call options give parties the right to trade on shares at a future date which makes it an invalid “spot-delivery” contract under Section 2 (i) of the SCRA.

Contingent contracts and the Bombay High Court

Securities-LawMoreover, the Bombay High Court in Niskalp Investments held that a clause permitting the buy back of shares if certain conditions were not met would be hit by the restriction in relation to spot delivery contracts. Contingent contracts were also therefore, hit by prohibitions on spot delivery contracts. One can argue that call and put options are contingent contracts that come into effect once they are exercised. Once exercised, the delivery of shares and payment can take place simultaneously. These clauses therefore, are not invalid spot-delivery contracts. This position gained legal backing in MCX Exchange, where it was held that options come into existence only once the option is exercised. Till such exercise, the option is not fructified and therefore not hit by the prohibition. From all this, it was clear that there was much judicial debate on this issue. No clear answer was emerging.

In its recent notification, the SEBI has permitted options in shares and rescinded its 2000 notification. Put and call options are now permitted provided the seller owned the “underlying securities” for at least one year from the date of the contract, the transfer is priced according to existing laws, and the underlying securities are delivered. This puts the controversy to rest as far as SEBI is concerned, to a certain extent.

The RBI’s view

The Reserve Bank of India (“RBI”) had also expressed doubts on put and call options. It felt that granting put options to non-resident investors was akin to a debt investment made by such an investor. This is because an investment backed by a put option meant that the non-resident was guaranteed a specific rate of return. Such a transaction would therefore need to comply with the External Commercial Borrowing (“ECB”) Regulations. In fact, the Consolidated FDI Policy of October 1, 2011 contained a provision that stated that equity instruments issued or transferred to non-residents having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the extant ECB guidelines.

Interestingly however, this statement was later deleted from the policy by a notification issued by the Foreign Investment Promotion Board. This led to further confusion. Did the withdrawal mean that the RBI had implicitly permitted these transactions or that it was simply a withdrawal due to public pressure? The RBI has not clarified matters and this confusion still exists. Therefore, even though listed companies may get the go ahead from the SEBI, the RBI may still be a roadblock.

The Bombay High Court, the RBI, the SEBI, and the Ministry of Corporate Affairs have all made their views on put and call options heard.
The Bombay High Court, the RBI, the SEBI, and the Ministry of Corporate Affairs have all made their views on put and call options heard.

To conclude therefore, the SEBI Notification has not put the controversy to rest. Since the SEBI Circular is only prospective, it only protects investments from October 3, 2013. Clarity is still required on the treatment of those arrangements entered into prior to October 3, 2013. Will those clauses be void?

Till these final issues are put to rest, the question mark still remains over the validity of put and call options.

(Deepa Mookerjee is part of the faculty on



Independent directors are now a crucial part of Indian company law

DeepaMookerjee_CompaniesBillContinuing with our series of posts on the Companies Act, 2013 (“2013 Act”), let us now turn our attention to the role of independent directors in a company, an issue that has become increasingly important after the Enron and the Satyam scandals. As I will discuss below, India’s new company law has recognised independent directors as a vital facet in the operation of a company.

Independent directors are considered the watchdogs of a company. Appointed to the board of directors of a company to oversee its business, they should be free of all external influences. To ensure their complete autonomy, an independent director should not have any material or pecuniary relationship with the company.

IndependentDirector_CorporateGovernanceWatchdogInterestingly, the Companies Act, 1956 did not contain any reference to independent directors. Further, the reference found in Clause 49 of the listing agreement is only applicable to listed companies.

Definition: The 2013 Act, for the first time, defines an “independent director”. Interestingly, the definition in Section 2(47) is similar to the one provided in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, a regulation applicable only to listed companies. The principle of impartiality is embedded in this definition. An independent director can only be a person:

– who is not a managing director, whole-time director, or a nominee director;

– who is not or was not a promoter of the company or its holding, subsidiary, or associate company;

– who is not related to the promoters or the directors of the company, its holding, subsidiary, or associate company; and

– who has or had no pecuniary relationship with the company, its holding, subsidiary, or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year.

Keeping in mind that an independent director must be free from all influence, the 2013 Act also places limits on the amount of shares that can be held in the company by a relative of such a director. Independent directors are also not entitled to any remuneration in the form of stock options.

ACC-BlogAdNumber of independent directors:
Under Section 149 of the 2013 Act, there is a specific obligation on every listed public company that at least one-third of the board of directors should comprise of independent directors. This mirrors the requirement in Clause 49 of the listing agreement, and marks the first time that corporate governance norms have been recognised in company law in India. Additionally, Section 177(3) states that the majority of the members of an audit committee (in a listed company) must be comprised of independent directors.

In fact, Section 173(2) of the 2013 Act states that any board meeting held at shorter notice (to transact urgent business) requires the presence of at least one independent director. If such a director is not present, the matter discussed at the board will be considered approved only once an independent director ratifies it.

Protection from liability: Finally, in order to encourage a healthy environment where learned and well-respected individuals become independent directors in a company, the 2013 Act has, to a certain extent, protected independent directors from liability. Section 149 states that independent directors are liable only if any fraudulent act has been committed with the consent of such a director or where such director has not acted diligently and if such an act is attributable to the board process.

These are all welcome changes, and indeed, they will help improve the manner in which business is run in India by instilling strong corporate governance norms in a company.

(Deepa Mookerjee is part of the faculty on