Cos Act Ep#17: Series Finale
In the last 5 months, the over 9 lakh 81 thousand companies in India have all moved to a new law – the Companies Act, 2013. 29 chapters, 470 sections, 7 schedules and dozens of amendments – it’s been a life changing 5 months for India Inc. And today, on this finale episode of Companies, Act we find out if it’s all been worth it? To answer that question I have with me today – Amarchand Mangaldas’ Managing Partner Cyril Ahroff and founder of leading proxy advisory firm IiAS Anil Singhvi.
Doshi: I want to start first by laying out the guiding principles of the JJ Irani committee put down for this new law way back in 2005. The committee advocated that it be a ‘simplified compact law amenable to clear interpretation and that it should enable protection of the interest of the investors and other stakeholders’. I have a two part question, the first one - in the design of this law, how far have we come in being able to achieve any or all of these three guiding principles?
Shroff: On the three criteria, I think we have done reasonably well on the last one in terms of minority protection and perhaps a broader approach towards shareholder and good corporate governance but on the simplicity and clarity, we are probably under achieved.
Doshi: And amenable to clear interpretation?
Shroff: Not at all. I think that is probably where there is much more work to be done and that is - I think- a direct result of good intent but bad implementation in terms of drafting.
Singhvi: I think we have complex laws in India. Look at Income Tax - that is more complicated than Companies Act and we all pay taxes without knowing whether we should be really paying taxes or not if you go by strict interpretations. So I think complexity is very much there in every law; maybe by nature or by genetics we are very complicated people. So we need complex laws. Having said this, I think the needle has moved to some extent as far as protecting the minority shareholder is concerned.
Doshi: It has been 5-6 months since this Act, at least most parts of it, have been notified. What has the experience been, how have companies adapted to it, adopted it and done the best they could?
Shroff: A lot of the ambiguity is in trying to seek interpretation and understanding. So if you leave aside some of those processes, it shows - in substantive terms - it has had a profound impact. So a lot of Boards that I interact with, fortunately many of them are good boards or listed boards, they are now very cognizant of corporate governance as a new benchmark that has been set for broader stakeholder protection, shareholder activism and proxy advisory viewpoints influencing shareholders. So the bar has definitely gone up. Directors, including independent directors, are significantly more careful now in terms of how they formulate a view and they record their views to have shown that they have exercised their duty of care and it is not just ticking a box; many of them are doing it very substantively. There would be a mixed experience but if I compare my own experience in terms of two years ago and now, there is a very big change.
Doshi: Would there be instances of when, let us say just six months ago, they would have designed a transaction or done a deal differently - can you give me an illustration?
Shroff: Lots of them; particularly M&A or group restructurings, which are taking place where there might be a perception that minorities might be affected differently- there is a lot more thought that goes into it in terms of how the minority would be impacted. They may or may not necessarily come out at the perfect spot but two years ago, they wouldn’t even have spent half a minute on it. Now they would spend days on it; that is the big difference.
Singhvi: I think there is a change in thinking. Earlier, there was complete contempt, if I may use the word, towards minority shareholders; now there is at least there is an awareness; may not be respect. So from contempt, we have gone into awareness. I think finally it will get into respect from October 1, 2014. So you have to look at the environment in which you are operating. So it is going to be Companies Act as one leg, SEBI amendment to Clause 49 second and third people like us. Just imagine, Maruti has spent almost last four months going and meeting every investor. Would they have done it otherwise? No.
There are many laudable features of the new company law. The one big area of change is the regulation of related party transactions. More disclosures? Yes. But the law also requires transactions above certain thresholds to get 75 percent shareholder approval and it restricts the related party from voting on the special resolution. The other positive changes include mandatory e-voting, auditor and independent director rotation for higher governance standards and in some provisions dissenting shareholders have been provided an exit. Some of these new measures seem diluted by recent amendments. For instance, the raising of thresholds for related party transactions that need shareholder approval or the clarification on which related party cannot vote.
RELATED PARTY TRANSACTIONS
- More Disclosures
- RPTs above prescribed thresholds need shareholder approval (75%)
- Related Party cannot vote on special resolution
- Mandatory E-voting
- Higher Governance Standards: Auditor & independent Director Rotation
- Dissenting shareholders to be provided exit
*Example: Change in Objects clause
Amendment: Raised transaction thresholds
Impact: Fewer transactions will need shareholder approval
Amendment: Only the Related Party connected to the transaction cannot vote
Impact: Only some entities of promoter family will abstain
Singhvi: The point is that if we realise that today the most abusive part of running a corporate is related party transactions and we have seen in the last two years of our deep dive into at least 500 companies- the biggest abuse is there in terms of related party transactions- be it royalty, remuneration or appointment or sale and purchase of goods. So if you look at the larger picture from the corporate point of view and where the minority shareholders are, I think related party is one of the major issues. And any dilution in that is really going away from that theme that you really want corporates to be accountable. Why India is different than other parts of the world is largely on account of promoters- whether it is MNCs or Indian companies. I am not even sitting here on judgement of those because according to me MNCs are more abusive of this related party transaction in terms of royalty than the promoters here. Having said this, once they had 188 and then you come with an interpretation of who is related party and whether the related party is related to that particular transaction and then who can vote and who cannot vote. I mean look at JSW.
Doshi: A JSW promoter company owned by the promoter’s wife Sangita Jindal decided to charge group companies a brand royalty. At the JSW Energy shareholder vote, none of the promoter entities participated. Soon after the MCA offered a general clarification that only the related party connected to the transaction needs to abstain. Thereafter at the JSW Steel shareholder vote, only the promoter company- owned by Sangita Jindal - did not participate. Her husband Sajjan Jindal’s promoter companies cast their votes.
RPTs & JSW ROYALTY
Sangita Jindal owned promoter entity owns JSW brand
To charge brand royalty to group companies
JSW Energy Shareholder Resolution
All promoter entities abstained from voting
JSW Steel Shareholder Resolution
Only Sangita Jindal owned company abstained
Singhvi: According to me, all Jindal related promoter companies should have abstained from voting.
Doshi: Let me come to the first issue on this- the dilution in transaction thresholds. I could either take the point that Anil Singhvi is arguing that why are we allowing some transactions to not to be brought to the shareholders for approval or I could take the point that some companies have explained to me saying if you don’t reduce the threshold or don’t dilute them and thereby control the number of transactions going to shareholders, they are going to be overwhelmed by the absolute volume of transactions and they will miss the most important ones in that process.
Shroff: Not only that; I think the whole process of how the audit committees would function in terms of having to pre-approve everything. It will be completely overwhelming for them as well. So there is a right balance to be struck. Whether we have struck the balance so far is debatable but in terms of finding the middle ground I don’t think there is anything wrong with it because you want corporate India also to do business. It is not as if you want to bring them to a standstill.
Singhvi: Why is it that in India we have to have related party transactions for us to run the business? Even if my brother is running a company, I wont buy from him because there will always be an element of some amount of favour granted or received. It is not an ideal case scenario.
Doshi: You cannot wish away RPTs altogether; right?
Singhvi: I am not saying wish it away. I am saying idea should be to reduce it as much as possible as then audit committee, auditors are not really overwhelmed by the number of transactions.
Shroff: We are also seeing it from the corporate side that there is still a very vast array of transactions that are coming to shareholders. It is not as if you have gone from one extreme and back to zero.
Doshi: Let is take the second issue- just the attempt to clarify which related party should vote on a related party transaction and should not vote was required because the proviso is badly worded. It seemed to imply that no related party can vote and yet when it comes to some companies, they have taken a very beneficial interpretation of that to say that the promoter’s wife cannot vote but the promoter can vote.
Shroff: Why do all these clarifications of this type come about? They come about because of originally bad drafting. That goes to my original point of a lot of the ambiguity is because of poor drafting. You could have made it black and white from the beginning. So once you clarify in accordance with what the framework is, if it is legal it is legal. Whether it should be done or not is a separate issue, I am not passing qualitative comments on that.
Doshi: Even before the related party transaction thresholds were raised, one company escapes the net. Cairn India extended a $1.25 billion loan facility to a group company. Now since the amount is within the limits set out in the Section that governs loans by a company, Cairn did not seek shareholder approval. It has also adopted an interpretation that Section 188, that is the related party transaction Section, does not apply.
I am just wondering what is the point of putting this entire related party transaction architecture in place if shareholders are not going to get to decide whether you can extend USD 1 billion or more than that loan to a group company. I find that as a failure of the law especially in places where the law has been accused of having exceeded its brief.
Extended $1.25 bn loan facility to group company
Within Section 186 limits
If loans by a company exceed prescribed thresholds
- Shareholder approval via special resolution required
Singhvi: Completely in agreement with you. I found it very bizarre that such a large transaction is escaping and we are going to sit on some small transactions which is goods purchased or other things which has been done. But if you have this kind of leeway provided in the Act, this is bad.
Shroff: I am not going to comment on this one but I take a general point that goods and services is a limited thing and should there be a discussion in related party transaction to any kind of related party transaction- I think that conversation needs to be had.
Doshi: Let me put it to you non-company specific. If it is a transaction that gets covered under 185 or 186 - which is a loan to a Director or a loan or advance otherwise inter group - then should related party transaction provisions apply to that transaction or not because if they don’t and you are giving money intra-group or otherwise and you are not giving your shareholders the chance to vote on this.
Shroff: Leaving the facts of particular cases aside, there has always been and there will always be a need for greater flexibility to move funds around in the group. In a conglomerate, particularly you need to have that flexibility, because parents need to support their subsidiaries, sibling companies need to support their sibling companies and that is how conglomerates work- that is the reality- provided that there are adequate disclosures. Here situation that is emerging, it is emerging because of the fact that related party transactions in the context of 188 has been defined specifically for goods and services. Should there be a broader discussion in terms of any kind of related party arrangements or not, as I said, that is a conversation that needs to be had and it will cut both ways.
Singhvi: But 188 should be superimposing and powerful than 185 and 186.
Shroff: You have to amend the law for that.
Singhvi: Absolutely. So, the law as you rightly pointed out in case of Cairn, it really requires that kind of amendment to come in or a clarification to come in that a transaction of this nature should be covered by 188; not going by 185 and 186.
Doshi: Why would you need to amend the law if I may ask you that? The ministry said that 188 does not apply to schemes through a circular; thereby clarifying the situation. It did not say it does not apply to schemes and it does not apply to transactions under 185 and 186.
Shroff: The logic over there is that because in a scheme of arrangement there is a court which looks at it. So schemes is a separate category.
Doshi: But there is no court that looks at 185 and 186. The MCA itself withheld any clarification on that. One could draw the assumption that since it did not say it does not apply to 185 and 186, it should apply to 185 and 186. I am saying why do you need an amendment? It is a matter of interpretation; if the MCA made it clear saying 188 will apply to 185 and 186.
Shroff: Let them say that. The law as it stands today, it is not the case.
Doshi: If both of you are making the point that this law has served the purpose of better governance… (Interrupted)
Shroff: It is not perfect. I think it has moved a needle.
This problem of good intent but confusing outcomes plagued even the E-voting measure. Meant to enhance shareholding participation, E-voting has instead been postponed to next year because the provision is drafted to mean that voting at a meeting via a show of hands is not valid but if offers no prescription for a replacement implying that shareholders present at a meeting cannot vote. Eventually this AGM season some companies conducted paper ballots, some relied on a Bombay High Court judgement to offer E-polling and others resorted to assent, dissent notes and the like.
Every listed company with not less than 1000 shareholders
To provide e-voting facilities
Outcome: Deferred upto December 31st, 2014
Section 107 makes voting by show of hands invalid
But provides no specific replacement
Implying that shareholders present at a meeting cannot vote!
Outcome: Polls, E-polls, Assent/Dissent notes…
Shroff: This sort of legislation has to be drafted in consultation with people who practice and live it everyday. That was not done. You have to sort of know how a meeting runs when you can frame these provisions.
Singhvi: E-voting is very good. We have moved away from how our normal election polls were conducted in Bihar where you had the booth capturing and the results were declared before even vote was casted. So similar situations were there in the corporate world- it was a huge amount of booth capturing in a different form and a different shape and size. Today a shareholder can comfortably sit in his house and cast a vote which is a phenomenal thing. You have seen in many companies in at least last two or three months the percentage of people’s participation in voting has gone up and gone up substantially. You look at Tata Motors; Tata Motors won’t have lost the resolution, not that I am saying it was a bad resolution to have lost by Tata Motors, but they do not do the work. In fact I am coming back to Cyril’s point, do companies really explain to the shareholders why this resolution is so much needed for the company.
The point is that we have gone into the E-voting but we have really not taken into consideration how we should be informing shareholders to seek his vote.
Doshi: I am saying beautifully intended provisions and yet you can already see within the first five months that there are loopholes available or extreme confusion going on?
Singhvi: The point which Cyril is making and I agree with him that considering the fact that until this Act came in, the situation in India on all these rated party and other transactions and all that, from there to where we are and more importantly as we move forward to amended Clause 49 from October 1st 2014 for the listed company and today at least our discussion is largely for listed companies, I think the bar has already been raised by SEBI; even more than MCA.
Doshi: I agree that this law intended to help and support public shareholders or empower them further but we just discussed instances where public shareholders have not got the coverage of the law that they hoped for. Let me give you one more instance- when it comes to objecting to a scheme till April 1st, actually even now because the scheme Section has not been notified, anybody can go to a court even if they own just two shares in that company and object to the scheme, that was one extreme. The other extreme is in this new Act, which is only if you have 10 percent. Now I can understand if you have just two shares, you cannot hold up a scheme of demerger or whatever for one year or six months or whatever it takes but it can’t be that you have to own 10 percent- even LIC will fall short of that threshold in many cases. That means they won’t have a voice in this scheme?
Singhvi: This is a point which we also saw and we felt very bad about it that 10 percent is too large.
Shroff: There is a huge schizophrenia in India. This was the point I have been making on previous shows as well that there is a lot of confusion in terms of whether it is pro-minority protection or not and those are very different outcomes.
Confusion notwithstanding, the Companies Act does go some distance in empowering minority shareholders, but now the majority is questioning this loss of voting rights. Is majority the new minority?
Shroff: Look at it because that goes in this sort of whole route of what is corporate democracy, let everyone vote. When there is a conflict I can still see the perception of whether disclosure was the answer or there should have been some guidelines in terms of what kind of transactions can be put through. So I am not going to debate that too much but we have gone the other extreme in terms of making the majority the new minority.
Singhvi: I beg to differ with Cyril. At the end of the day all shareholders should have a voice and are same and the people who run the businesses in India and particularly India specific situations- so you can’t draw any parallel on that. If they have a resolution in which they are interested or perceive to have some interest in that, minority should have a say completely on this that either we are agreeing or we are not agreeing. I will cite Maruti again. For them to agree that Suzuki can set up 100 percent subsidy to produce the same kind of thing what they are doing here and it is not a subject matter of majority of minority then we have lost the battle because I asked Mr Bhargava this question that are you really talking as a Chairman of Maruti or a representative of Suzuki and he didn’t have an answer to this.
Doshi: Companies have been complaining and going through a very difficult period of adjustment for the last six months, but if the benefits of the law and what it does for the standard of corporate governance in this country overwhelm that period of adjustment then it has been well worth it or the benefits of the law don’t make up for all this adjustment pain that has been experienced by everybody. That is what I am asking you- has it been worth it, will it change governance standards in India Inc?
Shroff: It already has.
Singhvi: There are two-three things. One Act itself cannot change the whole corporate governance.
Doshi: My question is simple- has the pain been worth it, is it worth all of this transition?
Shroff: No, he is questioning whether there has been any pain at all.
Doshi: I know you don’t get it but there is pain. Like for instance; do you have to reappoint your independent directors or not, all of that.
Shroff: That is transitional pain. I don’t think this is perpetual.
Singhvi: But there is no pain in this. What is the pain in that; then even a person getting married is also a pain. They have to find a girl or find a boy, it is a pain.
Doshi: Finding a woman director on board for many companies - they claim it has been tough.
Singhvi: Yes; but again the point is they have not said a woman has to be independent. So as it is I often say that most boardrooms in India are like bedrooms and this one Clause will make it complete.
Shroff: Almost every problem that we have discussed today arises out of bad drafting. Every single issue we have discussed on the table is a bad drafting issue; except perhaps for whether the majority should vote or not which is more of a philosophical issue and it is not a drafting problem; everything else has been a drafting issue.
Doshi: So you would say this Act has been game changing.
Shroff: I think so. If I look at it also as the trigger to the SEBI change, if you look at it cumulatively but the primary trigger being the Companies Act - it has been a game changer.
Doshi: Would you say this is game changing.
Singhvi: Not yet.