What to watch under India’s new companies law

Author: Ashley Lee | Published: 9 Aug 2012
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Indian lawyers eagerly await the passage of India’s Companies Bill 2011 to replace the outdated Companies Act 1956. But they are concerned by the new law’s corporate-social responsibility (CSR) requirement and layering restrictions.

Sources agree that the Companies Bill 2011 is an urgent piece of legislation, and the bill is expected to pass during the monsoon session of parliament, which began August 8. The last iteration of the Companies Act was implemented over 50 years ago and does not recognise contemporary concerns.

Moreover, the new law is expected to change corporate governance in India. Key provisions address quotas for female board directors, require unlisted companies with subsidiaries to publish consolidated balance sheets, and grant stronger rights to minority shareholders.

Vijaya Sampath, former group general counsel of Bharti Enteprises and senior partner at Lakshmi Kumaran & Sridharan, told IFLR that the bill is a long-pending, urgent and important piece of legislation, and the sooner it is enacted into law, the better for the corporate sector.

Though India’s regulatory regime has been widely criticised for its lack of certainty and clarity, the text of the Companies Act 2011 is relatively straightforward. Sampath said: “Its current form has been drafted quite well, with many ambiguous provisions now clarified.”

But CSR and layering restrictions have counsel concerned.

CSR requirements

Clause 135(5) of the bill sets out a CSR requirement that applies to every company with a net worth of more than INR 500 crore ($73.3 million), a turnover of INR 1,000 crore or a net profit of 5 crore. It requires the board, in each financial year, to ‘make every endeavor’ to ensure the company spends at least two percent of its net profits made during the three years prior.

However, it’s not clear whether the CSR spending requirement is mandatory or discretionary. Though companies will not be punished for not setting aside the required capital for CSR, they will be required to disclose their reason for non-participation in their annual reports. Sampath also noted that the bill does not define CSR.

Restrictions on investment subsidiaries

Another concern involves restrictions on layering of corporate subsidiaries, forcing companies to become more transparent about their structuring. Clause 186 states that companies will not be permitted to make investments through more than two layers of investment companies.

It is believed the provision was instigated by issues encountered during the so-called Satyam scandal of 2009, when the company’s chair confessed Satyam’s accounts had been falsified.

However the provision also directly targets Mauritius-based companies. According to a Reuters report, 39.5% of India’s total foreign direct investment between April 2000 and February 2012 was routed through Mauritius. This year India considered reviewing its bilateral tax treaty with Mauritius after reports that the country loses $600 million in revenue each year from Mauritius-based companies.

Dr Paritosh Ch Basu, group controller for Essar Group, stated his personal views: “I personally believe that, if structuring is done on a transparent basis in order to add value for shareholders, there is nothing wrong. However, if the layering is to make companies as remote as possible and tracing of transactions becomes difficult, the government needs to issue certain guidelines.”

It is unclear whether the rule will apply retroactively, and if so, what the time frame will be for compliance. However, Sampath said that restrictions on the number of downstream investments should not be a deterrent, though in an ideal world one would have liked more flexibility for structuring.

Though this requirement will undoubtedly irritate foreign investors who are accustomed to structuring as they wish, it will also apply to Indian corporates looking to invest abroad.

Urgency

There are other smaller issues raised by the bill, such as contradictions with other laws governing boards. Sampath said it is important to ensure that laws are in sync with each other, but that some details should be left until after the Companies Act is legislated.

Dr Basu said that, in his personal view, the bill must be passed. “After implementation of the new bill, if difficulties are faced and if genuine amendments are needed, they can be added when necessary,” he said. “But as of now, the bill should be passed as an act, because the first step towards solving problems is to begin with actions.”

Though the bill’s drafting is generally clear, there are fears the lack of clarity on key points may result in litigation and parliamentary gridlock that generates uncertainty long after its passage.