Column : Lost in translation

Updated: Jan 8 2013, 06:35am hrs
Many of the well-meaning changes, such as on loans to directors, have been rendered useless due to clumsy drafting

KS Mehta

Companies Bill 2012 is a watershed for greater corporate governance in the area of loans, investments, deposits and capital raising. Exemptions to private companies for loans to subsidiaries have been withdrawn; loans to all persons and not just to companies are now covered within the stipulated limits. Similarly, deposit raising from public for non-NBFC companies must be secured and credit rated. Some critical provisions need amendments to be in line with what the law makers intended.

Loans by private companies to directors, their relatives, partners or companies where they control 25% or more voting power including loans to subsidiary companies now require approval (Bill clause 184). However, it does not provide for the process for such approval. The only exemption is if it is the normal business of the company and interest is at bank rate or above, or it is to working directors. Related party transactions approval process (clause 188) covers only transactions in goods, property, services, agency appointments or appointment to a place of profit but not the granting of loans or providing guarantee or security for loans. It is therefore necessary to expand the scope to cover related party loans, guarantees and securities; otherwise, even loans to 100% subsidiary cannot be given. A unique feature of this approval process (clause 188) is that any member who is a related party cannot vote on any special resolution regarding such contracts even at the general meeting. This strengthens public shareholder power in companies of notified classes but will block normal working even of private companies having 100% promoter and associate ownership. Who will vote on such interested party contracts at the general meetings of such companies A process has to be built in.

Regulation of inter-company loans and investments have been a major feature of the law since 1956. The Bill expands it considerably to cover loans to all persons, and not merely to companies; and the exemption to private companies and to transactions with subsidiary companies has been withdrawn. Exemption to investment company, banks, insurance, NBFC, HFC companies continues; but the law needs an amendment to clarify exemption to companies engaged in providing finance to infrastructure facility providers as was perhaps the intent but not the meaning of the current proposed clause [clause 186 (11)(a)]. The central government is to make rules for operationalising the law on loans, securities etc. But can such rules or any clarification go beyond the law Loans at below bank rates have to be given to weak companies or companies under CDR schemes if so stipulated by banks for group companies, and if approved by shareholders, it should be permitted under both clause 184 and 186.

Indian companies are becoming multinational and have to give loans to subsidiaries abroad in some cases. These rates are much below the bank rate as applicable to domestic transactions. Provision should be made for them.

Investments cannot be made beyond two steps of investment subsidiary companies. Law should have required an annual disclosure of the health of the companies where funds have been lent or invested above, say, 5% of the lenders net worth together with strategic plans of revival if the investee is not doing well.

Restrictions have been placed on any company registered under section 12 of the Sebi Act from taking loans or deposits exceeding Sebi prescribed limits. Shareholders have no power to go beyond this limit. Directors and interested parties can vote on special resolution for loans beyond limits etc at the general meeting (clause 186) unlike in other related party contracts for goods and services (clause 188) where they cannot vote.

Disclosure in annual report has to be made for short-term loans and advances to related parties; investment in (a) subsidiary, (b) associates, (c) joint venture and (d) controlled special entities has to be made giving volume and extent of the investments. The audit committee is mandated to review the financial health of these investments.

A sea change has been introduced in deposit taking by non-NBFC companies. They can take unsecured deposits only from members; and only secured deposits, after credit relating, from the public. If they have defaulted in repayment of past deposits or in interest and dues on term loans, they cannot raise deposits until the aberration is corrected. Rules have to be complied with.

Differential voting rights shares, which were proposed to be dropped, have been continued. Preference shares for infrastructure companies that have a life exceeding 20 years have been introduced. No shares can be issued at a discount unless they are sweat equity shares. A retrograde amendment is that share premium account now cannot be used to write off old losses as is now permitted with court approval. For a private company making issue of shares through private placement a process has now been laid down. This includes that the directors must consider a valuation report from an approved valuer before deciding the share issue price. As per its present drafting, this will apply even to a rights issue of shares to existing shareholders. This is unnecessary and needs to be deleted. For example right shares can be issued at any price so long as they are issued to all shareholders proportionately. Time periods at every stage of the issue process for all securities has been shorteneda very welcome move.

Share buyback has been put into a straitjacket. Even under a scheme of arrangement, it has to now comply with buyback rules. Under these rules, the share purchase has to be offered (a) proportionately from all shareholders, or (b) from open market. Courts had held that last-in first-out is also a justifiable principle but the new law will not permit it. Many times, collaborations or a part of the promoters have to be bought out. This should be permissible with shareholders resolution.

uthor is managing partner, SS Kothari Mehta & Co.