Tag: Deepa on Companies Bill 2012

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Corporate

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 myLaw.net.)

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Corporate

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 myLaw.net.)

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Corporate

Hold your horses, we don’t have a new company law just yet

DeepaMookerjee_CompaniesBillThe Companies Bill, 2013 finally received Presidential assent on August 29, 2013. It has also been published in the Official Gazette, as the Companies Act, 2013 (the “Act”). Even so, this law has not yet come into force totally. All the substantive provisions have not yet been notified. This is clear from Section 1(3).

“This section shall come into force at once and the remaining provisions of this Act shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint and different dates may be appointed for different provisions of this Act and any reference in any provision to the commencement of the Act shall be construed as a reference to the coming into force of that provision.”

The substantive provisions of the Act therefore, will be effective only once notified by the Central Government in the Official Gazette. No such notification has been made. Until then, we can assume that the Companies Act, 1956 continues in operation.

Given that the Act proposes sweeping changes in the way business is carried out, it is expected that the Act will be implemented in phases, giving companies enough room to comply with the new provisions.

The Corporate Affairs Ministry is also drafting new rules for implementing the Act. The draft rules will soon be published on the website of the Ministry of Company Affairs and all interested parties, including the general public would have the opportunity to provide comments and suggestions within a prescribed period.

Mergers-and-Acquisitions-LawWhile there is no schedule or timeline for the Act to come into force, companies should consider setting their house in order, to ensure they are in a position to be compliant with the new provisions.

(Deepa Mookerjee is part of the faculty on myLaw.net.)

 

Categories
Corporate

Companies Bill brings in changes to mergers and amalgamations regime

DeepaMookerjee_CompaniesBillThe Companies Bill, 2012 (“Companies Bill”) proposes a number of key changes to the manner of implementing mergers and amalgamations in India. Let us have a look at Clauses 230 to 240, the provisions that impact the mergers and amalgamations regime as a whole.

Recognition of the forms of business restructuring

In the explanation to Clause 232(8), the Companies Bill has recognised, for the first time, the various forms of business restructuring used in the market.

A merger by absorption: The undertaking, property, and liabilities of one or more companies, including the company in respect of which the compromise or arrangement is proposed, are to be transferred to another existing company.

A merger by formation of new company: The undertaking, property, and liabilities of two or more companies, including the company in respect of which the compromise or arrangement is proposed, are to be transferred to a new company.

A scheme: The undertaking, property, and liabilities of the company in respect of which the compromise or arrangement is proposed, are to be divided among and transferred to two or more — existing or new — companies.

Regulatory approval for mergers and de-merger schemes

The Companies Bill has also proposed replacing the High Court with the National Company Law Tribunal (“NCLT”). All merger and de-merger schemes would now have to be filed before the NCLT for approval. While the creation of a single forum for approving mergers and amalgamations is welcome, it is still to be seen when the NCLT will be established. After all, even the Companies Act, 1956 (“Companies Act”) had provided for its establishment. Till the NCLT is formed, the power to approve schemes will continue to lie with the High Courts.

Currently mergers between listed companies need prior approval from the securities regulator, the Securities and Exchange Board of India (“SEBI”) (Feb 4, 2013 SEBI circular), and certain combinations need approval from the competition regulator, the Competition Commission of India (“CCI”). Clause 230 (5) of the Companies Bill, makes it mandatory that a notice for a merger or de-merger to be sent to the:

  • Central Government,
  • Income tax authorities,
  • Reserve Bank of India (“RBI”),
  • SEBI,
  • Registrar,
  • Stock exchanges,
  • CCI,
  • official liquidator, and
  • any other sectoral regulator.

These notices need be sent only if the particular regulator has jurisdiction over the deal. For instance, a merger between two unlisted companies need not be notified to the stock exchanges or the SEBI. However, depending on the market share in question, it may need to be notified to the CCI. Each regulator has also been given a time period of thirty days to file any representations or objections it may have. Once the thirty-day period expires, it is deemed that the regulator has no objections.

It will be interesting to see how these provisions tie in with the current notification requirements under the Competition Act, 2002 and the SEBI regulations. The Companies Bill does not remove the requirement for notification under the other laws. Notification requirements under the Companies Bill therefore, may amount to an additional procedural step. It is however a step in the right direction because an attempt has been made to consolidate different requirements under one main law.

NCLT can dispose of a creditors meeting

Another interesting proposal is to empower the NCLT to dispense with creditors meetings. Under the Companies Act, all schemes must be approved at a shareholders and creditors meeting, by a majority in number, representing three-fourths of the value, of those present and voting. While this requirement has been retained, given the serious nature of a merger or de-merger, the NCLT can now dispense with calling of a meeting of creditors or a class of creditors where those creditors or class of creditors, having at least ninety per cent value, agree and confirm, by way of affidavit, to the scheme of compromise or arrangement (Clause 230(9), Companies Bill).

This should go a long way in simplifying the process for a merger or de-merger, while at the same time ensuring that a majority of the creditors agree to such a fundamental change in the company.

Fast-track amalgamations

The new Companies Bill seeks to simplify the merger process for a certain types of companies. In a “fast-track approval”, companies need not file schemes with the NCLT. The Central Government has the power to approve the scheme. Once approved, the scheme may be filed with the Registrar of Companies within thirty days. On registration, the scheme will be effective.

Clause 233 of the Companies Bill permits fast-track mergers or de-mergers, between:

  • Two or more small companies;
  • A holding company and a wholly-owned subsidiary company; and
  • Such other classes of companies as may be prescribed.

A small company has been defined to mean a ‘private company’ that has paid-up capital that does not exceed Rupees Fifty lakh (or higher amount as may be prescribed but not be more than Rupees Five crore), or turnover (as per its last profit and loss account) that does not exceed Rupees Two crore (or higher amount as may be prescribed but not more than Rupees Twenty crore) (Clause 2(85), Companies Bill).

This definition is important because the Companies Bill does not provide this exemption to small companies that are public companies. Only small private companies that are merging with each other are entitled to this relaxation.

Cross-border mergers

Clause 234 of the Companies Bill permits mergers and amalgamations between Indian and foreign companies subject to rules prescribed by the Central Government in consultation with the RBI. A foreign company can, subject to the prior approval of the RBI, merge, or amalgamate into an Indian company or vice-versa. The Companies Act on the other hand, only permitted a merger of a foreign company with an Indian company.

Mergers-and-Acquisitions-LawThese are just a few of the broad changes proposed in relation to mergers and amalgamations. In the next post, we will explore the law in relation to the acquisition of minority interests in mergers and amalgamation schemes, and how these changes affect other aspects of M&A law.

(Deepa Mookerjee is a member of the faculty at myLaw.net.)

Categories
Corporate

A new company law for a new economic environment

DeepaMookerjee_CompaniesBillAfter a long wait, the Rajya Sabha finally approved the Companies Bill, 2012 on August 8, 2013. The Lok Sabha had, after detailed deliberations, approved the Companies Bill in December 2012. It is now on the cusp of becoming an act, and only requires presidential assent and notification in the Gazette of India.

Once effective, it will replace a fifty-year-old legislation, the Companies Act, 1956 (“Companies Act”), the primary legislation for the incorporation, operation, and governance of corporate bodies in India. The bill promises to create a more effective, efficient, and simplified corporate law framework in India.

A good indication of the simplified structure is the overall framework of the Companies Bill. While the Companies Act consisted of 658 sections, the Companies Bill appears to be much cleaner, and takes only 470 clauses (divided into twenty-three chapters) and seven schedules to deliver the message. Through a series of posts here, I will explore and analyse the wide breadth of amendments proposed. To begin with, I will provide an overview of the major proposals.

One-person company

ACC-BlogAdIn line with global norms, the Companies Bill introduces the concept of “one person company”, a special type of private company. Defined in Clause 2(62) of the Companies Bill, the term simply means a company in which only one person is a member. These companies have been provided the flexibility of having only one director and enjoy exemptions in relation to filings and the holding of meetings. For instance, if there is only one director, Clause 122(4) of the Companies Bill proposes that a board resolution that needs to be passed can simply be entered in the minute books of the company, without holding a physical board meeting.

Private companies

Life may get tougher for private companies under the new regime. They stand to lose many of the exemptions they were entitled to under the Companies Act. A good example would be Clause 62 of the Companies Bill, which makes a special resolution a mandatory prerequisite for a preferential allotment in a private company. Under Section 81(1A) of the Companies Act, the requirement for a special resolution was applicable only to public companies.

Corporate Social Responsibility

Detailed provisions on corporate social responsibility (“CSR”) are also part of the Companies Bill. CSR activities have been made mandatory for the first time in India. Companies will have to spend on such activities in one financial year, at least two per cent of the average net profits of the three preceding financial years. This requirement is restricted, according to Clause 135 of the Companies Bill, to every company with: (a) a net worth of Rupees five hundred crore or more, or (b) a turnover of Rupees one thousand crore or more; or (c) a net profit of Rupees five crore or more, during any financial year. Such companies must constitute a corporate social responsibility board committee consisting of three or more directors, out of which at least one director will be an independent director.

M&A

Changes have been proposed in the procedure for mergers and amalgamations to make the process simpler and more efficient. The provision for fast-track mergers, where the approval of the National Company Law Tribunal is not required, if it is a merger between two small companies, between a holding and subsidiary company, or between any other companies as may be prescribed, appears to be a welcome change. Cross-border mergers have also been specifically permitted under the Companies Bill.

Corporate governance

RamalingaRaju
The Satyam scandal has influenced the direction of Indian company law. Source: WIkimedia Commons.

In the wake of the Satyam scandal, the Companies Bill has sought to prescribe stringent standards of corporate governance. The term “independent director” has been defined, and the standards and qualifications necessary for appointment have been prescribed. Further, independent directors should make up at least two-thirds of the board of directors of every listed company. Interestingly, independent directors have been insulated from any liability in case of a fraudulent act (unless of course it has been done with their knowledge). It is expected that such a provision will go a long way in attracting the right kind of talent to these posts as they can now be assured that they will not be subject to any liability unless they have willfully taken part in it.

 

Class action suits

Clause 245 of the Companies Bill introduces the concept of class action suits. Simply put, a class action suit is one where a number of persons with the same claims and legal grounds can sue a corporate body. The Enron situation, where class actions suits were filed in the U.S. against Enron claiming millions in damages, is a well known example.

Under the Companies Bill, a class action suit can be filed against a company, its auditors, directors, or other concerned experts by a prescribed number of members or depositors if they are of the view that the affairs of the company are being carried out in a manner that is prejudicial to their interest. It will indeed be interesting to see how this provision plays out in the corporate sector.
These amendments are just a few of the many changes proposed in the new Companies Bill. This proposed law looks to alter the way businesses are run today to make them more efficient and profitable, but also socially conscious and accountable to their stakeholders.

Even though it is difficult to predict how all the proposed changes will interact with each other, the corporate world will finally see some changes to Indian company law to bring it in line with the changing economic environment.

(Deepa Mookerjee is a member of the faculty at myLaw.net.)