A 21st century corporate regime

Written by Lalit Kumar | Updated: Dec 27 2012, 06:33am hrs
By dealing with ambiguities & instituting mechanism for whistle-blowers, the recent Companies Bill is a great update for corporate governance

Finally it appears that the new Companies Bill will see the light of the day with the Lok Sabha having recently passed the new Bill. Some very significant provisions have immediately hit the news, such as provisions relating to CSR, additional powers to SFIO in dealing with corporate frauds, appointment and obligations of auditors, payment of 2 years salary to employees prior to secured creditors on companys winding, auditors liability for fraudulent conduct, the mandatory inclusion of a woman director, one person-company, class action, concept of independent directors, setting of NCLT and many more. Although these are the changes that deserve most of the attention, the story of the new Bill does not really end here. There are certain very important provisions that will come into force once the Companies Bill is fully operational.

There is always uncertainty around the status of a private company that is a subsidiary of a public company. Should they be treated as private companies or public companies (since they are controlled or owned by public companies) The problem of uncertainty is multiplied thanks to conflicting judicial decisions. But, the Companies Bill completely removes this ambiguity. Now private companies that are subsidiaries of public companies can retain the basic features of a private company in their articles of association. The most important feature being restrictions placed on the transferability of shares. In effect, such a private company will be treated as a public company for the purposes of the Companies Act but at the same time enjoy the basic features of a private company.

Another important change is that shareholders of a public limited company can contractually agree on restrictions they wish to place on transferability of securities held by them. One of the most important features of a public company is free transferability of its shares. Any kind of restriction on free transferability of its shares is void and unenforceable. However, a Bombay High Court decision has held that shareholders, in a public company, can among themselves contractually agree on restrictions that are to be placed on their shares and, should they do so, such agreements will bind them and be enforceable against them. Failure to honour the agreed restriction could make the defaulting shareholder liable for damages. This specific provision incorporated in the new Bill will give this judgement a statutory backing. Therefore, shareholders will now be permitted to agree on restriction on their shares without violating the concept of free transferability of shares. For instance, restrictions such as right of first offer/ refusal can now be legally contracted by shareholders of public company.

The concept of vigil mechanism has been introduced. It is a kind of a whistle blower mechanism, whereby every listed company will be required to set up a system for its directors and employees, who wish to report genuine concerns about mismanagement and deviant practices followed by the company. This is a very welcome step and will bring Indian law in line with the US practices.

One worrying provision in the Companies Bill is the restriction up to two levels for investment companies. It is believed that such restriction has been introduced to prevent the diversion of funds through many levels of step down subsidiaries. Interestingly, this restriction will not apply in case an Indian company acquires another company outside India and the acquired company has subsidiaries more than two levels. The provision is worrying because it could restrict the companies from creating their own corporate structure. The concern regarding diversion of funds could have been better addressed by enhancing the disclosure requirements, instead of limiting the level of subsidiaries.

A path breaking change that shall promote cross-border merger allows Indian companies to merge with foreign companies. Under the Companies Act, there is a specific prohibition on merging an Indian company with a foreign company while a foreign company can merge with an Indian company. However, a cross border merger or an amalgamation will require prior approval by the RBI. Further, the bill says that any cross border merger can only be with companies incorporated in countries notified by the central government and in accordance with the rules made in consultation with the RBI. This will facilitate and promote the cross border mergers and acquisitions. However, it will be interesting to see which countries are notified by the central government.

Now parties to any dispute will be allowed to voluntarily apply to the central government, NCLT, and Appellate NCLT to refer the dispute to the Mediation and Conciliation Panel. Alternatively, the central government, NCLT, and Appellate NCLT may on its own refer any disputed matter to Mediation and Conciliation Panel. This is a good proposal, which can promote amicable settlement of disputes.

We are very close to see the regime of the new company law. The intent is to bring our old law in line with present-day demands.

The author is a partner with J Sagar Associates. Views are personal