Companies Bill, 2011...FINALLY!
India first began work on a new Company Law in 2004 with the establishment of the Irani Committee. That was also the year the European Union included 10 new countries in its biggest ever expansion. 11 long years later, the EU is on the brink of collapse and India is only now, finally, on the verge of enacting a new company law. The points Im trying to make is two-fold- the world has changed dramatically in the time this Bill has taken way to get here - which begs the question: has the Companies Bill, 2011 kept up with the fast changing world of global business? To answer that question on the first of our special shows on the Bill, I am joined by Bharat Vasani of the Tata Group and Shobhan Thakore of Talwar Thakore.
Doshi: I am going to start by asking both of you to weigh in on a broader bird’s eye view of what this Bill represents. Mr. Vasani why don’t you go first on what you make of it- the journey it's had over the last several years and what we are faced with today?
Vasani: I have been waiting for the New Company Law of India way back from my student days in 1978 when the Justice Sachar Committee presented the thing. I was deeply involved with the Irani committee recommendations- that are also 6 years old now – 2005. It took almost 56 years to replace 1956 Act. Now this Act will come into force the earliest in 2012 - so which is 56 years exactly if it gets passed by the parliament due to all these issues around. I would call this as a Bill which is a 50% Bill because a very significant chunk of provisions which are there are going to be prescribed by way of rules.
Doshi: So we don’t even know what the rules look like or how the rules may change the game.
Thakore: That’s why it is going to be difficult to give answers to your questions.
Vasani: Also the issue which bothers me is that we had pleaded before the ministry that since almost 50% of the Act is going to be coming by way of rules, the ministry would have a pre-publication of the draft rules for all the stakeholders to comment. Unfortunately, if you see Clause 469 of the Bill, there is no provision for pre-consultation, the rules will be straightaway notified.
Apart from that, I felt that we are revising such an important economic legislation after almost 5 decades, the Bill should not only be contemporary, it should be futuristic and if you ask me, I don’t think this Bill is futuristic, that it will take care of India for the next 50 years. In fact I think the ministry’s vision seems to have colored too much by the immediate episodes of Sahara and the Satyam and they have colored largely to certain amount of additional restrictions on corporates. The function of the Company Law is to create an enabling environment where the companies can raise capital, function smoothly- it should not create an obstacle for the legitimate business activities of the company and when I deal with further discussions, I will find that there are certain obstacles which are created in the legitimate business activities of the company.
Doshi: Mr. Thakore?
Thakore: Just to add what Bharat has said, when you read through the Bill, it gives you the impression that the role of the central government is being diluted significantly compared to the 1956 Act.
Doshi: But that’s a good thing; isn’t it?
Thakore: It's a good thing but my worry is what is going to come in the rules because if the rules are going to bring back if not the whole power, substantially the whole of the process going up to Delhi for everything, then we are back to square one.
Doshi: Fair. What I get from both of you, to begin the show is, it's taken very long, we still have only half of the proposed changes in front of us and on the basis of the half proposed changes that we have in front of us, we are now going to examine whether this Bill passes the test of being a modern futuristic Bill that provides an enabling environment to companies and is equally fair to all other stakeholders.
Lets get down to the specifics then. On today's special show, we’ll discuss the proposed material changes on these broad themes or topics- incorporation, funding raising, inter-corporate loans and investments and of course M&A which legally is known as Compromises, Arrangements and Amalgamations. Let’s start with the first issue and I am broadly clubbing this under incorporation – they have now introduced in this Bill or proposed to limit the number of subsidiary levels to two from what I understand. What do you make of that, is that a good move or bad move, will it constraint companies?
Thakore: Just as Bharat said the object of this Bill or Act should be for corporates to continue doing their business as they want to do it for which you don’t need government interference. Now whether I have one subsidiary or 5 subsidiaries - because the object for which I created a subsidiary may be very different from what the Member of Parliament is thinking about. So I don’t see any rational for limiting the number of subsidiaries. I should have or the layers that I should have because these are things which are decisions taken place in the market place as to how I need to do a particular project- whether it's tax efficient, not tax efficient. There are so many other factors that are taken into account. At the same time recognizing that abroad or offshore these transactions are normally done through layers of companies to make it tax efficient…(interrupted)
Doshi: And that is permitted.
Thakore: That is permitted. So I don’t see why the restrictions should be for Indian companies. It just doesn’t seem to make sense.
Vasani: Well I do believe that the number of layers were misused in some cases in the past…(interrupted)
Doshi: So there is some justification for a limit.
Vasani: There is definitely some justification but the issue is that limiting it to two- I don’t know what is the rational behind two or why not three or why not one. The second issue is as far as domestic subsidiaries are concerned, thanks to the Income Tax Law, there is a double whammy that already I paid 2 times so there is a disadvantage in the Income Tax Act itself to create multiple layer of subsidiaries within India and when it comes to outside India, they have specifically carved out that outside India, if the local laws permit, we don’t mind if you have number of layers.
Doshi: In which case, this is a non-effect Clause because in a sense if it didn’t make much tax sense to have more than 2 layers anyways, by limiting it to two layers, they are not really taking away any big advantage though I get the point that you are making saying what's the rational, why take away that flexibility, leave it up to companies?
Doshi: Alright so we are still not sure what the rational is but at least in terms of impact analysis we don’t think, it will have that big an impact. Infrastructure companies may suffer but that again that could be carved out in the rules is a point that you want to make.
Vasani: There are classes of companies for which they can provide for higher number.
Doshi: In the rules and we’ll only know when the rules come.
Doshi: Let me move on to the next point and that is to do with fund raising. This is a very important area for corporate India. I think one of the key issues that come up here is the restrictions on unutilized public issue funds- funds raised by public issue or change in object- so that means if you want to change the objects, you need approval via a special resolution and you need to offer an exit to dissenting shareholders. Painful but livable?
Thakore: Yes but except that again unless some clarification is going to come through the rules because when you say unutilized, unutilized is a very broad word. So, for example, if I have raised Rs 100 crore for a particular project and I spend Rs 90-95 crore out of it and I have got a surplus of Rs 5 crore which obviously makes sense for me to use it in my other business or for some other object in that particular business that I have raised it for and if that is going to entail again seeking approval from shareholders, then again giving an exit to the dissenting shareholders…
Doshi: If it's a related business for which the money had been raised, shareholders will give approval- a special resolution is not that difficult to push through?
Thakore: No, I am not saying that, but then dissenting shareholders has to be given an exit option. So it's just adding something, which I can understand where you have 100 for steel project and you changed that steel into coal project.
Doshi: That has happened.
Vasani: My view is it's an anti-abuse provision and I have come across instances where large industrial houses have misused this.
Doshi: So you are in favour of this new safeguard?
Vasani: I wouldn't object to it. Only thing is the way in which the minorities, dissenting shareholders would be compensated (interrupted…)
Doshi: So that exit price is not clarified?
Vasani: It should not happen that those dissenting shareholders are using it for kind of blackmailing.
Doshi: So if it was to be, let's say, the reverse book building price that they have put in there, then that could amount blackmail?
Vasani: That could amount blackmail.
Doshi: If they were to link the price to let's say a current market price, fair value or something like that, then the chances of it being used as blackmail are lower?
Vasani: I am not against the philosophy of the Section or the Clause, but I am more against likelihood of them, the malpractices, which will emerge in the market because of this.
Doshi: To my untrained eye, there seem to be some change in wording in the way private placement rules or Clauses have also been worded in this new Bill. I have only one simple limited question- we had quite a bit of a ruckus thrown up by Sahara in the last 2 years, a case that seem to exploit gray areas or loopholes in the private placement process and the combined monitoring of both the Centre as well as SEBI on this. Do you believe the changes that have taken place would put that controversy to rest once and for all and does it make it very clear in what cases is an offer a public offer or not?
Thakore: Unfortunately, as the Bill reads today, all those things are still yet to be prescribed. So till that is prescribed one can't answer yes or no.
Doshi: How many investors make a public offer?
Thakore: How many investors in value, yes.
Doshi: So till now it was 50, but we don't know if it's going to 50 anymore?
Vasani: What is the quantum of money you are going to collect is also to be mattered and I think the way this section and clause - other clauses have been worded that - they are definitely trying to plug all the loopholes, which are there in Section -67- I think to a very large extent.
Doshi: Have they succeeded?
Vasani: To a large extent. Now private placement will be a private placement and public issue will be a public issue; yes.
Doshi: So that's been clarified and once the number comes in, we will know that number will make it clear; whether it's 50 or 500?
Vasani: It's a very well drafted (interrupted…)
Doshi: And amount has been a new addition to this?
Vasani: Yes, absolutely a new addition.
Doshi: This that they do not exit (interrupted…)
Thakore: Which makes sense now because earlier if it was less than 49 and if you were raising some Rs 10,000 crore, it just seem too odd to be a private placement.
Doshi: The other good development that's come in and this is going to settle years of litigation or maybe not the ongoing litigation, but atleast prevent the next decade of litigation is that ROFRs, call and put options and any such contractual agreements have been explicitly permitted in these companies. Have I have understood that correctly?
Vasani: No, I don't think they have explicitly permitted it. I wish they had done it that way. The way the Clause is worded- it only says, clearly, that while there is a general free transferability of shares, shareholders can enter into agreements relating to transferability of shares. I would have been happier if they had said very categorically that shareholders can enter into voluntarily consensual agreements, which limits the free transfer.
Doshi: That's what they said 'Any contract or arrangement between 2 or more persons in respect of transfer of securities shall be enforceable as a contract?
Vasani: Transfer of securities, but not agreeing to restriction on transfer of securities, the word agreeing to a restriction on transfer of security would have made it abundantly clear and also it could have been little happily worded - that's what I am trying to say.
Thakore: In a sense it takes care of it.
Vasani: It also to a large extent will atleast read with the amendment with Clause 5 with regards to restriction with the Articles. Perhaps you may not have to reproduce the entire shareholders agreements into article based on that Rangarajan's judgment of the Supreme Court. My view is that now the old controversy surrounding the free transferability due to Bombay High Court's single judge judgment last year to a large extent will get resolved.
Thakore: As far as two shareholders are concerned, yes, it is very clear (interrupted…)
Doshi: The private company, public company bit that was going on, that all gone?
Thakore: All gone and the position, which was there before Rangarajan's judgment where you need to have these agreements into the articles, now has disappeared. So you go back to what was there in the 50-60s where you had shareholders agreements, which were considered as enforceable in any court of law.
Doshi: Can you confidently now put rights of first refusal and call and put options in your agreement?
Vasani: If the Bill is passed by the parliament.
Doshi: What about the Securities Contracts Regulation Act (SCRA) when it comes to call and put options because that was also a big problem?
Vasani: I don't think that put and call option issue is addressed by this amendment; that's a separate issue.
Doshi: ROFRs is?
Vasani: ROFRs is and the lock-in provisions and any other restrictions on transfer.
Doshi: Let me come to the other big issue that we want to discuss and this is equally important to corporate India- inter-corporate loans and investments. Mr. Vasani, I am told, that there are several new limits that have been imposed that restrict the ability of one group company funding the other as well as several instances of having to go back to shareholders for approval. Explain what the changes are?
Vasani: First of all, let me clarify, that limits of 60% of networth or 100% of free reserves which is there in current Section 372 (A) of the Companies Act has not changed. Those limits have been retained. What they have brought about a change which is a very significant one and it could have a profound impact is the issue that currently any investment made by a holding company into its wholly owned subsidiary was completely exempt and… (Interrupted…)
Doshi: From shareholder approvals?
Vasani: Not only shareholders approval, two important things – it was not even included in counting 60% limit. Now what has happened, for example, take any Tata Group company- we would invest in subsidiaries overseas and the quantum of investment which we would have made in acquiring all these cross border transactions, we would have included the investment made in wholly-owned subsidiaries for the purpose of counting the limit of 60%. Now suddenly one fine day when the new Bill is enacted into a law, the companies would realize that they have already exhausted the limit and every time then you need to make a fresh investment or give a fresh inter-corporate loan or issue a fresh guarantee, you require to go back to shareholders and take a special resolution, unanimous consent of all Directors present at the meeting. So one director can block it and the problem I have is that issuance of corporate guarantee by a parent to a subsidiary is a very normal commercial transaction and if I am required to go back to shareholders every time I have to… (Interrupted…)
Doshi: Because even the issue of corporate guarantee will now require shareholder approval
Vasani: So to that extent… (Interrupted)
Doshi: Is it a special resolution that you require to pass all of this?
Vasani: Yes absolutely and for listed companies, it is also to be done by postal ballet and now they are also contemplating that other Clause 108 that they would provide electronic voting and I believe CDSL itself is working in that direction. So while I am not opposed to electronic voting, all I am trying to say is that the requirement of corporates approaching the shareholders far too frequently and the result and costs… (Interrupted)
Doshi: More importantly it takes away the advantage of speed from companies?
Vasani: Speed from companies.
Doshi: Which will be the most important thing, you want to be able to raise money… (Interrupted)
Thakore: That it basically detracts from the principle. The subsidiary is your own. It's not an outside company which you are investing in. So it's really for convenience that you put up a subsidiary- may be to execute a particular project or whatever it is.
Doshi: What if the wholly owned subsidiary was in some completely different business? Shareholders have no idea why the parent company is investing in this completely different business. Not that they had the opportunity to voice their opinion or an approval for it, now at least they will have the opportunity to voice their opinion or approval considering that it will be a special resolution and yet in companies where promoters have controlling stake, they will be able to push it through.
Thakore: But that is provided only if it is going to exceed that 60% limit otherwise there is no reason.
Doshi: But you are investing a large amount of your money from the parent company into a wholly owned subsidiary that has invested in some third business altogether, shouldn’t the shareholder have a right to say yes?
Thakore: I don’t dispute- all I am asking is that if I have lent up to Rs 100, for an additional Rs 20- up to 100, he has got no say- for that Rs 20 he has a say.
Doshi: Yes; if Rs 120 makes up 60% of your capital.
Vasani: If you see the history of this Section on inter-corporate loans and investment, it's certainly not a glorious chapter in the history of India's Company Law. Originally, it was holding company into subsidiary. Amendment came later in 1988 or rather it came in I think 1998-2000 that the holding to subsidiary was changed to holding to wholly owned subsidiary. And now they said even that is removed. There is one more removal done that entire 372 discipline of inter-corporate loans and investment was not applicable to private companies and in Ketan Parekh case which was investigated by Joint Parliamentary committee (JPC), they found out that this route was abused and I think I can directly see the impact of the JPC report on the amendments which are now proposed.
Doshi: So it's a sensible safeguard except that it will take away the advantage of speed and may impose additional cost.
Vasani: Yes and the flexibility given to private companies which were completely outside the discipline of this Section has been brought. Now exemption to private company is also taken away.
Doshi: So you are arguing in favor of the safeguard that they have made but in full acknowledgement of the fact that this will mean higher costs and more time taken which takes away some flexibility.
Vasani: Yes takes away some flexibility available to the companies.
Doshi: Alright. So now that brings us to the last broad issue that we want to tackle in this special show and that is Compromises, Arrangements and Amalgamations or M&A. It seems to me there has been a practice that schemes of Section 391 to 394 or 395 as you called it was this all forgiving umbrella set of sections that allowed for a lot of restructuring, M&A type of activity. Has that advantage been taken away in this case?
Thakore: I don’t think so. I think much will depend upon how the Tribunal at the end of the day, which is now going to be in charge of the legislation and not the High Court, is going to look at it because as far as High Courts are concerned, till date, they have had the view that a scheme can be any scheme. So long as it is approved by the requisite… (Interrupted)
Doshi: I am going to underline that ‘any scheme’ because you quite literally saying ‘any scheme’ used 391-394?
Vasani: And especially this scheme became like a Ganga Bath for the companies because the Supreme Court judgment in Mafatlal Industries versus Mihir Mafatlal case where they said that the High Courts are not exercising any Appellate jurisdiction, it's only a supervisory jurisdiction. So as long as the court is convinced that this is approved by requisite majority, they would not interfere with the terms of the scheme. Now they have articulated so many new restrictions in the scheme - Section 230 to 240- 391 to 395 has become 230-240 and there are lot of new restrictions which they have proposed which would certainly - for example they are saying that the buy back is categorically provided that if the scheme involves a buy back we have to go through the discipline of the section dealing with buyback.
Doshi: And not use the scheme to gloss over that aspect.
Vasani: Gloss over that aspect and there are many such carve outs that they have done to categorically provide that if there is some other Section of the Companies Act dealing with it, you have to get the approval under that Section and not under the Scheme.
Doshi: You would admit that ‘any schemes’ used to get through and the courts used to hardly ever object to the kind of schemes that came in?
Thakore: As he rightly said that the courts function is not to sit and give judgment, the court was only supposed to see two things – whether the statutory approvals have been granted and whether it's again public interest. Now public interest is a very wide phrase but nobody really argued public interest. The only argument you had in court were that the valuations are not correct and the value should be X and not Y. That’s about all that the courts used to go into. Now much will depend on how the Tribunal is going to approach it.
Doshi: So in an attempt to safeguard, has this gone to any extreme whereby it blocks the effective use of these sections or clauses as we are calling them now?
Vasani: No, I don't think so.
Doshi: Sensible safeguard?
Vasani: No absolutely; no problem at all. Only thing I tell you is that the right to object, which was either available to everybody and now this has been restricted to only person holding 10% and in my opinion, 10% is a significantly high number.
Doshi: Very few institutional shareholders even own 10%?
Vasani: So the ability and I suspect the minority shareholders will be up in arms because their ability to object to the scheme of mergers and demerger would be now significantly reduced.
Doshi: Dissenting shareholders to a scheme again have been provided some of exit clause in this.
Doshi: This is the second one we are discussing, but if you go through the Bill, in several places dissenting shareholders have to be provided an exit by the promoter or the controlling shareholder- not by the company, by the promoter or the controlling shareholder; that's important?
Vasani: There are 3 safeguards they have brought about for the dissenting minority shareholders. One is that they have said that any scheme approved under this particular Clause has to be in conformity with the accounting standards prescribed. Number two is that they have given a complete exit to minority shareholders. So let me point out- it's not only in India, in England also when they amended the Company's Act in 2006 when they brought Section 900 of the English Companies Act, it also provided that the minority shareholders can be given an exit by the High Court.
Doshi: We don't know what that exit is. So how that exit is structured, we don't know that?
Vasani: That will be prescribed by the way of rules.
Doshi: Does SEBI have a say on how that happens?
Vasani: If it's a listed company, SEBI will have a say.
Doshi: Explain this to me, you can only object or if I can use the word interchangeably dissent, if you own 10% and yet dissenting shareholders get an exit. How does these two reconcile? So does that mean only somebody who has 10% or more can dissent and therefore only those kinds of shareholders will get an opportunity to dissent?
Thakore: It depends on how you use the word dissent and objection. Objection is maybe I object on a particular ground and if assuming that is rectified in the scheme, which is fine, then it's acceptable to me- so then I may not even exit from here. In that sense, I am not a dissenting shareholder. Dissenting shareholder is the one who is totally opposed to the scheme, irrespective of any safeguards - then he says I just don't accept (interrupted…)
Doshi: So you are drawing that difference between the two words, is it clear in the Bill itself?
Thakore: No, it's not clear.
Doshi: To me, it seems a little confusing. So does it say that if I have 10 shares, I can dissent and I am gracefully allowed to exit from that company, which I could have done by selling the shares in the market place itself, so now my only play is to get more money than the current market price? So therefore now what will be important is how they structure that exit or if I am seriously objecting to this scheme itself and yet want to stay invested, I need to have 10% of the company- have I understood this correctly?
Thakore: I suspect that the rules probably will provide for a valuation as by the registered valuer- I can't see any other new formula coming into place. Having introduced a concept of a registered valuer into this Bill, I think the only function he is going to perform is that; what else is he going to do.
Doshi: Let me come to other point, I want to bring up under M&A and that is the typically amalgamations is to result in the creation of treasury stock, which in itself was not allowed in the existing Act but companies founding genius ways of being able to hold that treasury stock through independent trusts etc, we have seen that happen over a last decade or so. From the wording in this Bil,l it seems treasury stock is well and good dead, have I understood that correctly?
Vasani: There are two conflicting provisions in the Bill itself, but I would like to believe that the subsequent and more specific provision categorically provides that you have to extinguish those shares. When a subsidiary merges into a holding company, this situation is bound to come that the holding company, which was holding the shares in the subsidiary, those stocks it cannot hold on its own account. Now it cannot create a trust (interrupted…)
Doshi: Any such device? (interrupted…)
Vasani: Yes, so the treasury stock and the trust stock is gone in my opinion.
Doshi: Gone from where? Now that’s the operational question I have- what happens to treasury stock that’s been created in the last decade and it's being held by trust. Will that have to find a way?
Thakore: This can only be a prospective because if the subsidiary is already holding the stock, you can't say now from today you (interrupted…)
Vasani: Therefore, perhaps, they may give a transit time that in 2 years, you will dispose off the shares.
Thakore: I wonder; but I doubt very much.
Vasani: As of today nothing is spelt out.
Doshi: In the interest of time, I want to move to the next topic under the broad theme of M&A and that has to do with dual mergers. The existing Act permits only foreign companies to merge into an Indian company. The Bill now allows for the reverse to happen as well that is Indian companies to merge into foreign companies, but we don't have full information because there is a country list that is yet to be notified- is that correct and what is the impact of this going to be?
Vasani: I suspect that all these tax havens like Mauritius and Cyprus and all that thing will be out and that would lead to large number of mergers, which where happening today under the scheme was through the Mauritius companies merging into Indian companies. So in all probability that route is plugged now.
Doshi: So they will notify a list of countries and only with companies in those countries can an Indian company merge into or vice versa?
Vasani: Very importantly what they have done is that RBI is going to play a key role.
Doshi: In devising the list?
Vasani: Currently the mergers are under the Foreign Exchange Management Act (FEMA), under automatic route. Now they say, there is no automatic route. You have to take an RBI approval. Even the rules - Government of India is going to prescribe the rules for this cross-boarder mergers- RBI will play a critical role in prescribing those rules. Also if you read the scheme of the new provisions- so first of all, RBI approval is mandated while under the FEMA currently exempts if you meet with certain conditions, they are under automatic route. Now they have compulsorily brought in approval route, by amending not the FEMA, but the Company's Act and also importantly that it's plugged very significantly because most of these mergers happened when the companies were in tax havens.
Thakore: It has a very limited impact. According to me, it's not very game changing or something like that (interrupted)
Vasani: There are mergers of Mauritius companies …(interrupted)
Doshi: So again another safeguard?
Vasani: Another safeguard and they have tried to kind of - the significant part is that role, which was either to be played by High Court, Company Law Board is going to be played by the Tribunal now and how the tribunal is going to function- if they are going to convert the existing Company Law Board (CLB) benches into tribunals, then you had it
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