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Cos Act Ep#1: How Will Life Change?

Published on Sat, Apr 19,2014 | 18:29, Updated at Tue, Jun 03 at 16:34Source : |   Watch Video :

29 chapters, 470 sections, 7 schedules, the rules of the game have changed for each of India’s 9,44,000 companies!

Hello & Welcome to this brand new series – Companies, Act!

Over the next many weeks we will analyze the impact of the new company law on incorporation, capital raising, governance, board management, accounting and audit, M&A, litigation and bankruptcy. On this first episode we start by giving you the big picture view on how life has changed for companies, their management, their boards, auditors and their shareholders. And to that I have with Bharat Vasani, Group General Counsel, Tata Group; Cyril Shroff, Managing Partner, Amarchand Mangaldas;

Jamil Khatri, Deputy Head - Audit & Global Head- Accounting Advisory Services,

KPMG and D Muthukumaran, Head-Group Corporate Finance, Aditya Birla Group


On May 31, 2005 the J J Irani Committee- the original architect of this new law- submitted its report saying our effort has also been aimed at making India globally competitive in attracting investments from abroad by suggesting systems in the Indian corporate environment, which are transparent, simple and globally acceptable. 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.

Does the Companies Act, 2013 meet this criteria?

Shroff: I think we have moved away from a shareholder model to a stakeholder model. I think the Act has been made very compliance oriented –so a reflection of a deep distrust of corporate India. I think the doing business in India difficulty factor has gone up. It has changed a lot of power equations as well; particularly between the majority and the minority. We do make some progress particularly on M&A or capital raising- I think some of those objectives have been achieved.

Tata Group’s General Counsel Bharat Vasani has two key grouses- that the new law attempts to transplant a western model of investor rights in India but more importantly that its implementation has been anything but smooth.

Vasani: The new law was in the offing for the last 10 years. They didn’t give me much time to digest the Rules. There is one fine point which everybody is missing - Section 465 which says that the 1956 Act is repealed has not been even notified as yet. Many of the Rules are completely going beyond the Act and people are now confused whether they should comply with the Act or the Rules. Loans and investments and guarantees by holding company to its wholly owned subsidiary which was completely exempted under 1956 Act was taken away in the 2013 Act. It was taken away by conscious debate, twice it was referred to the parliamentary standing committee; they were very firm. It was based on specific recommendations of a joint parliamentary committee which was investigating Ketan Parekh scam that this layers of subsidiary and diversion of funds of the holding company through the subsidiary should not be allowed. They realized that India Inc had protested but this should have been done through a power to exempt under Section 462. They have just framed the Rule which says that now holding to subsidiary will not be considered. They have invoked three times already - a Section called power to remove difficulties. This is absolutely like a Brahmastra. It is Executive changing the Act of parliament. Internationally, it is called Henry VIII Clause; it is used in rarest of rare cases. Here, within few days of notifying the new Act, we have used it three times and I don’t know how many more times we have to use it.

Aditya Birla Group’s Corporate Finance Head, D Muthukumaran laments the higher burden of compliance.

Muthukumaran: There are a lot of changes on compliance aspect for a company. These are dramatic changes. Bigger theme that seems to be coming out of this this Act is basically around all aspects of corporate governance. There is a concept of reverse merger. There is also a big impact due to definition change of subsidiary. The short way of putting it is there are a lot of probably painful changes in the compliance aspect of it; on the concept aspect of it I have not seen anything which is significantly painful.

KPMG’s Deputy Head of Audit Jamil Khatri is more welcoming of the new law’s focus on better governance.

Khatri: When I talk to my institutional investor clients, they are very happy with what is happening. Right from the basic points on accounting and reporting where remote areas where you could directly hide losses and reserves and not use your P&L to having an internal control framework that is aligned to what we see internationally- I think we are moving in the right direction on that. We have overreached on some of the issues particularly bringing in unlisted companies into the purview of governance.

Doshi: What I would like to do on this show is to look at this from the point of view of different aspects of corporate life and see what has changed for those people. From a CEO, CFO, senior management point of view and hence if I can call it from the company point of view; what has changed in terms of being able to incorporate, being able to grow and innovate, raise funds, merge, acquire- do you see a dramatic shift? What would you identify as some of the two-three big areas for instance private placement and the relaxation of the 50 limit might qualify as one big area?

Shroff: Just three or four big point because this can be a long discussion. Coming back to some other high level points - ease of doing business has reduced significantly. The difficulty factor has got added; M&A scenario I would sort of give it a five on ten because some things have improved a lot, others are work in progress. For instance wholly owned subsidiary, house merger in a manner of speaking, has become much easier, the level of objection that can be raised in a court in a scheme - that the threshold has been set high enough to eliminating some of that. So both good and bad news.

I think from a structuring point of view because of a number of small changes that have been made, it has led to a lot more difficulties like the restriction on subsidiary or in private placements having a floor valuation - some of these may be unintended consequences of disconnected changes but the level of difficulty in structuring transaction of the M&A or funding or any kind or partnering transactions has gone up. So that is a challenge and I think while another set of provision is yet to come into force, I think the whole class action thing which is looming on the horizon and when it becomes effective is going to be a fundamental change in terms of how corporates look at liability and look at stakes. It is going to be more US style where people become much more cautious not because of regulatory compliance and policing by regulators but what they might have to face in terms of lawsuits which maybe filed. I think that is going to be a huge change when that comes in.

Doshi: What would you all like to add to the list?

Muthukumaran: More than any of the things that you listed whether it is incorporation or it is merger and acquisition and fund raising, the challenge is for a CEO and a CFO now under the new Companies Act is more on actually managing on a day-to-day, year-to-year disclosure, accounting, compliance basis. It is lot more complicated to get the kind of Directors that they are talking about because of the responsibilities. For example there is a definition on the kind of internal control system that needs to be put in place which the CEO and CFO needs to certify. It is really wide and the way I understand it is wider than what is there in the IFRS. IFRS talks about internal control system on financial reporting.

Doshi: I think the Rules somewhere link it to the financial statements but the Act doesn’t do that as yet and that is still a grey area.

Muthukumaran: So the Act overrides the Rules.

Khatri: And the Act is clear that for listed companies, it will be a much wider framework and the Rules address unlisted companies; so any relief is actually an unlisted company relief and not a listed company relief.

Muthukumaran: Yes; so to that extent on a day-to-day management basis of the company, there is going to be lot more complications than what was there in the past. How do you define whether you have appropriate level of internal control systems for non-financial reporting matters? For example it talks about protection of assets, protection of property. There is a proper system on avoidance and detection of fraud. So these are noble unchallengeable intentions. 

Vasani: CEO and CFO and I would like to enlarge it to Directors - there is a perception change that suddenly our liabilities have gone up. In the Board meetings where I go suddenly they say from April 1 they have become more liable. Are we more accountable?

Doshi: Even though the liabilities under the Act have been circumscribed?

Vasani: Liabilities under the Act have not been circumscribed; they have just codified it. In fact everything has got codified which was earlier there as common law.

Doshi: But haven't they said that independent directors …(Interrupted)

Vasani: I don't think so; it is only under the Companies Act so it is very limited, Rs 25000 fine or something. The general liability under all other law is still very much the same.

Doshi: But how can the Companies Act takeaway liability under other laws?

Vasani: Precisely so; the general feeling that now I am immune from any criminal prosecution; that is not correct. The fact remains that certain things like for example the disclosure standards they have gone up to such a high level that I don't know people have really gone through what is required to be disclosed in the Directors report or the annual return or many other filings they have to do it is unbelievable.

For example half of the corporate India even today don't know that from April 1 the disclosures which you have to do as a Director is now required to be filed with the Registrar of Companies. And any changes in the shareholding - which was never the case earlier - has to be filed with the RoC. So many of those things have happened and the number of things which you are required to do at a Board meetings, for example, many of the things which a CEO could do earlier from CEO or CFO’s perspective they are now required to be done mandatorily at the Board meeting.

Khatri: I think the Board and the audit committee particularly will need to get more involved on transactions which they previously relied on management. For example, internal controls. The audit committee needs to review the internal control certification by the management and in addition to that, related party transactions need to get assessed by the Audit Committee for being at arms length and in the ordinary course of business to make the determination on whether they need to go to the shareholders. Auditor appointment and the non-audit services being provided by the auditors, I think the audit committee would need to step back and really figure out how they are going to implement this. And in my experience this also has an impact on how management deals with the audit committee and some of the dynamics around that. So for example previously management would have presented a lot of information to the audit committee but it turns out to be more for your information kind of a thing while now audit committee because they are responsible would like to get involved into the rationale a lot more. And therefore I think it is about getting used to it.

Vasani: One of the concerns which all audit committees expressed to me is that how to determine whether the transaction is at an arms length basis and Companies Act is not providing any guidance. They may look at Income Tax provisions of transfer pricing but the larger issue which I see now that most of the audit committees would like to play safe. They have been empowered to take independent consultants advice; so I would assume that the accounting firms and lawyers firms would have much more job to do because most of the independent directors would prefer that they have an external certification that the transaction is at arms length. And that would only lead to a frequent external consultation by the audit committee.

And worst part is Sec 177 which deals with the role of the audit committee is much wider than Sec 188 which deals with related party transactions. So it requires prior approval. So in practical terms we were evaluating in our group and we have prepared almost a manual on related party transactions, I find it very difficult that how do you in every case get a prior approval of the audit committee? It means almost every week you have to have a meeting of the audit committee, can it be done by circular resolution, how do you bring audit committees because every transaction which is a related party transaction and the way it has gone so I don't know how are they going to handle it.

Shroff: Eventually when you sit back and ask yourself the question - has it resulted in better governance or not, you may not always get the answer as yes.

Vasani: This certainly has benefitted the accounting community and the lawyer community, and in next couple of years this country is going to be run by legal opinions.

Doshi: The last viewpoint that I wanted to bring on to this table is looking at it from the point of view of promoters and thereby converse minority shareholders and clearly as all of you have said in your opening comments, the shift in balance of powers has taken place there because minority shareholders have been empowered in many instances by this Act to make their voice heard- whether it is the approval of related  party transactions or asking for exits in the case of a change in objects and clauses, etc. How would you look at how that relationship has changed and let me put a question to you that I know you have been putting to many of your clients and associates, is minority the new majority today?

Shroff: On some of the things, yes it is because the decision making authority on certain things has now moved to the minority. However, on a broader note, I see a certain element of legislative and regulatory schizophrenia here. The reason I say this is that on a number of things, you are telling the promoter or the controlling shareholder that particularly when you list and go to the public markets that you are now like every other shareholder. You have no special privileges, you will not take control premium, so, at least as far as your rights are concerned you are like everybody else, you are a citizen with equal rights. However, then when you come into regime like this and you take out this constituency namely the promoter or the controlling shareholders but apart from being equal as far as your rights are concerned, here is a long list of additional roles, responsibilities and liabilities that you have. So, I don’t think that equation is completely fair.

Doshi: What roles, responsibilities, and liabilities?

Shroff: For instance in terms of responsibility say minority exits, options on them or the kind of additional burdens that they will carry has changed the power equation as well it has changed the burden equation. Now, whether that is justified because of the enormous power that promoters have and therefore it is sort of like a compensating regulatory feature; one can have that debate but that is the equation that has changed and that is wherein the mindset of number of promoters who have lived in a very different regime for so long will have to come to terms with this new reality.

Doshi: I have a big smile on my face because the activist in me concedes that some of this may be unviable, difficult to implement and all of that but it clearly pushes us to new era of governance, doesn’t it?

Vasani: This is a fundamental change; this is the biggest piece, there is a paradigm shift. However, there is that angle which I am sure no final word has not been said on - there will be some majority shareholders who say that now you are putting on the obligations on me and my basic right. When I buy 51 percent shares in the company, there is my right to property; that is basically right to receive dividend or right to vote. You are taking away my right to vote and it’s a right which is constitutionally guaranteed.

Doshi: Only in related party transactions, only if the promoter is involved in that transaction, it’s in a very narrow set of cases and those narrow set of cases have been full of abuse in the last so many years; that had to be halted.

Shroff: Just from a purist perspective that fiduciary roles and responsibilities are always attached to Directors and Boards. Shareholder was entitled to act as selfishly as he wanted because of the same theory.

Doshi: So, how is this putting a fiduciary responsibility?

Shroff: It does; how do you disenfranchise somebody from voting because of a conflict of interest? Why do you say that the majority will not vote implicitly because of a conflict of interest?

Doshi: If a Director is the interested party in the Board meeting, the Director cannot vote. If the promoter is an interested party in a general meeting then promoter cannot vote. You are looking at conflict of interest here and wherever you are conflicted you are not allowed to be part of the decision making.

Vasani: I am not opposed to this view but I would say fundamentally, from a purist perspective as Cyril pointed out, there is enough of literature in international legal circles which suggests that shareholders owe no fiduciary duty.

Doshi: But why must you say this is a fiduciary duty, this is a removal of conflict.

Vasani: The Board is prevented from voting because Board is acting at a fiduciary capacity for somebody else. Shareholder is supposed to act in his best interest.

Doshi: So, he should be allowed to cast a vote in his favor?

Vasani: In his favor with proper disclosures. They tried it in England in 1985 in Companies Act but they didn’t succeed; so they brought it back in 2006 that the majority can vote.

Shroff: Again, this is behind us, so let’s not debate it as good or bad but this is what from an impact perspective is going to be the single biggest implication for controlling shareholders.

Khatri: The way I see this is, if you already have a provision which says if something is on an arms length and in the ordinary course of business as determined by the audit committee, you don’t have to go to the shareholders. Therefore, this is seeking to as an anti-abuse provision; if something is not arms length and not in the ordinary course of business; legal points have been well made but what this will do in my mind is make sure that transaction with related parties go through the arms length and the ordinary course of business assessment which is with the audit committee and I don’t think that’s necessarily a bad thing.

Shroff: One negative fallout could be greenmail by small shareholders; that is going to happen.

Vasani: No proxy advisory firms. 

Shroff: I think it sort of goes with the package.   

Muthukumaran: I find it hard to challenge this provision. Conceptually, to say that somebody who is actually conflicted should not vote in a resolution is a right provision. What I find hard is the point that you last mentioned which is actually is there going to be a greenmailing issue? I will give you an example- delisting provision in India is through reverse book building. I would argue it has been reasonably misused by the minority shareholders against many international companies.

Doshi: There was a time when single shareholder could hold up a scheme for months. Now, they have gone the other extreme and said look if you don’t own 10 percent, you cant make an objection at all in the scheme.

Vasani: That’s only one single provision which has gone against the minority shareholders. The 10 percent threshold is pretty high, very high.

Doshi: Who has 10 percent, even the mutual fund or institutional investor would find it difficult then to object to the scheme.

Muthukumaran: I don’t know how the Tribunal will deal with it. In the past we have seen the experiences…(Interrupted)

Doshi: We are pretty much at the end of our time though there are several other issues to talk about. CSR is a whole new concept in this Act; we will probably touch upon it in future episodes. Mr Vasani has already touched upon the Rules and the overreach so to speak.

The impact on private companies, that’s the subject matter of another half hour discussion because they have been brought into this Act and some of you have already referred to that in some way. Jurisprudence- the old Act, all the case law that you have, what happens to the concepts in new Act, how do you work through that?

Vasani: There is some guidance available. If you see the preamble of the Act, it’s a consolidating and amending Act. There are Supreme Court judgments that suggest that when it is consolidating and amending Act, unless the provisions are identical, the old jurisprudence does not hold valid. The problem I have is some of the landmark judgments of the Supreme Court whether it was on Miheer Mafatlal versus Mafatlal Industries that in a merger scheme the court is only having supervisory jurisdiction and not an appellate jurisdiction whether it will hold valid for National Company Law Tribunal (NCLT)- the provisions are not similar; they are significantly different. So, that is the worry. This Companies Act, one area where they could have done it that some of the important principles of law which Supreme Court laid down in some of the landmark judgments have not been qualified. Whenever you are revising a statute, normally you do that; that has not been done. Needle Industries judgment on Section 81 rights issue not qualified. So, many of these things will come haunt us. Only time will tell how courts will interpret it but the old judgments- unless they are absolutely identical provisions- will not be helpful to us.


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