India: A game changer

Author: | Published: 1 Apr 2012
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The proposed Companies Bill (the Bill), 2011 is envisaged to be a game changer in India, replacing the existing Companies Act (the Act), 1956. While the Act has served corporate India in its endeavours over the last 50 years, many believe the time for change has come. The reasons for such change are manifold, but they all lead to the inevitable conclusion that India needs to modernise its corporate law regime, to bring it at par with international laws and developments in the corporate sphere.

While corporate India has remained relatively sheltered by the global financial crisis, it has been buffeted by a number of corruption scams in the corporate world, which has reinforced the need for the new Bill to ensure better transparency and accountability, while making the economic climate more conducive for foreign and domestic investments.

After a long hiatus and various versions, the Bill (in the current form) was introduced in the Lok Sabha (the house of the people or the lower house of Parliament) on December 14 2011. The opposition felt that apart from accepting the changes proposed by the Parliamentary Standing Committee on Finance in relation to the bill introduced in 2009, the government had also introduced other fundamental changes and concepts into the bill, and hence would need to be reviewed again by the Standing Committee. Faced with strong opposition, the government was forced to refer the bill back to the Standing Committee. Reports seem to indicate that the Standing Committee's comments are imminent, but in light of various political setbacks and challenges distracting the government, which is fighting for its very political survival, it remains to be seen whether the Bill will be re-introduced in the 2012 Budget season or if the government will focus on other priorities.

While its introduction may be delayed, the Bill (in whatever form) will eventually introduce many new concepts into Indian law. These include one person/shareholder companies, mandatory corporate social responsibility, codes of conduct for independent directors, rotation of auditors every five years, appointment of woman directors on the board of prescribed companies, restrictions on non cash transactions by directors, categorising insider trading as a criminal offence, restricting layering of subsidiaries beyond a permissible limit and relief in cases of past concluded acts of oppression, among other such changes. Further, the Bill is also trying to consolidate and simplify various aspects of the 1956 Act, replacing more than 650 sections and 15 schedules under the Act, with 470 clauses and seven schedules under the Bill.

One of the main factors contributing towards the development of the Bill was the fallout of the infamous Satyam corruption scandal which shook corporate India a few years ago. The Satyam scandal highlighted the shortcomings of the country's corporate governance regime, and hence the government felt there was an urgent need to address such issues. The scandal raised two pertinent issues: the liability of independent directors, and the accountability of the auditors. These issues are further explored below.

Independent directors


Independent directors are the foundations of good corporate governance, since they bring a fresh and independent perspective on matters, and ensure transparency and accountability in the functioning of the company. They ensure an impartial decision making process, addressing weak management and better oversight over financial accounts.

With a view to addressing the issue of independent directors, the Bill stipulates that one-third of the board of a public listed company needs to be independent, and that such independent directors can only be appointed for a fixed tenure of five years. In order to ensure the independence of the directors, the term "independent director" has been elaborately defined under the Bill to mean a person of integrity and who possesses relevant expertise and experience in the opinion of the board among other qualifications. An additional requirement has been added in Clause 149(6) which requires the director to give a declaration that he meets the criteria of independence as provided in the Bill, whenever there is any change in the circumstances which may affect his status as an independent director.

While there is no substantive concept of independent directors under the Act, the Listing Agreement (a mandatory agreement to be adhered by listed companies with respect to the stock exchanges) mandates the appointment of independent directors on the board of the listed company. Further, as against the Listing Agreement which contains a non-mandatory requirement that the tenure of independent directors may not exceed nine years, the Bill reduces this requirement to five years, following which the further appointment of the director would require a special resolution (75%) of the shareholders, and the disclosure of such appointment in the Annual Report of the board. Further, as per the provisions of the Bill, the tenure cannot exceed more than two consecutives terms. The rationale behind such restrictions upon a director's tenure is to ensure that the independent directors, because of their prolonged relationship with the company, do not become self-interested in the affairs of the company.

Further restrictions include a gap of three years after the conclusion of the second term, and during this gap, the ex-director cannot be appointed or be associated with the company in any direct or indirect capacity. Moreover, a separate schedule in the Bill is devoted to the code of conduct which needs to be followed by such independent directors, which is a very welcome change as it specifically outlines the scope of the duties and role of the independent directors. Therefore, the general outlook is that though the new Bill requires stricter regulatory compliances, the benefits of transparency would accrue in the long term.

Auditors


In the Satyam scandal, the accounts were doctored to the extent that profits for the September 2008 quarter were inflated by 97%. In the Bill, provision has been made to attach the auditor's report to every financial statement and it is expected that the introduction of the mandatory requirement of appointment of an internal auditor (under the Act, the appointment of internal auditor is not mandatory though it provisions for appointment of statutory auditors for every company) will prove to be a milestone in addressing the issue of financial irregularities. The Bill provides for the framing of rules by the central government in this regard, while the Listing Agreement leaves the review and management of internal audit system to the Audit Committee of the company.

The Bill introduces mandatory rotation of auditors by listed companies. In case of an individual as an auditor, there are certain restrictions in the appointment and re-appointment of such individual by the company. Similar restrictions as to tenure are also applicable for auditors firms.

To prevent future Satyam-like scandals involving auditors reoccurring in the future, a duty is imposed on the auditors to report to the central government where they have reason to believe that fraud is being committed by the directors or management of the company. The Bill has also increased accountability of auditors by requiring them to adhere to the provisions relating to the contents of the audit report, compliance with Indian auditing standards, among others. When any contravention of such rules is coupled with intent to deceive the shareholders or the company, the Bill imposes a substantial fine and/or imprisonment for one year. In case of an audit firm, when it is proved that the audit partner(s) have committed fraud or abetted/colluded with the directors or officers of the company, they will be held jointly and severally in the manner as provided in the Bill. Through these provisions the government is striving towards achieving a transparent regime by formulating an extensive compliance regime coupled with the deterrent effect of penal and fiscal consequences.

The M&A regime


Presently, Sections 391 to 394 of the Companies Act provide for the framework pursuant to which a company can, among other things, restructure, consolidate, merge and de-merge itself or with respect to other companies. The expression "arrangement" as under the Act includes "a reorganization of the share capital of the company by the consolidation of shares of different classes, or by the division of shares into shares of different classes or, by both those methods". Hence, this definition does not include "mergers" as a defined term; but pursuant to various judicial interpretations, this definition has been interpreted to include a wide range of transactions, such as mergers, de-mergers and other forms of corporate restructuring (including debt restructuring). The Bill codifies the concept of merger and includes both a "merger by absorption" and a "merger by formation of a new company".

Under the Act, the Indian courts have the power to sanction such schemes of arrangements and compromises, which led to time lags due to the time consuming and elaborate procedure. To address which, a specialised body – the National Companies Law Tribunal – was created to deal with such corporate matters, thereby enhancing the possibility of timely disposal of such schemes.

Clause 232 of the Bill deals with mergers and amalgamation of companies. The draft merger/amalgamation scheme is required to be sanctioned by the Tribunal who will in turn give directions for meetings of creditors/members along with notification the Registrar of companies. The Bill requires extensive disclosures, such as valuation reports, potential effects of such compromise on each class of shareholders, key managerial personnel, promoters and non-promoter shareholders laying out in particular the share exchange ratio, specifying any special valuation difficulties among others, accounting statements and clear indication of an effective date on the scheme.

Additionally, the concept of merger of a listed company into an unlisted company, retaining the unlisted nature of the transferee company till it becomes listed has been introduced. Also, the Bill specifically lays down that no compromise or arrangement shall be sanctioned by the Tribunal unless the scheme is in compliance with prescribed accounting standards.

In relation to compromises and arrangements between the company and its members/creditors, there is a notification requirement under the Bill, in regards to the scheme, coupled with extensive disclosures to the central government, income tax authorities, the Reserve Bank of India (RBI), Securities and Exchange Board of India (Sebi), the Registrar, the respective stock exchanges and such other regulators or authorities which are likely to be affected by the compromise or arrangement. This requirement creates overlap and risks of conflict as regulators have independent powers/responsibilities under separate statutes. This extensive disclosure mechanism and the multiple regulators may create transparency in the process, but the increased compliance costs and timelines required to produce such reports are not favoured by the industry, who would prefer a simpler and more streamlined regime to help their expansion plans.

Cross-border M&A


During the last few years, India has seen a spate of cross-border M&A activity. 2011 saw M&A and private equity in India together clocking 1,026 deals contributing $54 billion, as compared to $62 billion in 2010. Further, there was also a notable reverse trend in 2011, with the focus shifting towards inbound M&A as compared to 2010. One example is the BP-Reliance deal in July 2011. To facilitate such cross-border activity, there was a need for the law to adapt to commercial changes and simplify the overall process.

Under the Act, cross-border mergers are permitted only if the transferee is an Indian company but not vice-versa. This implies that an Indian company cannot merge into a foreign company. The expert committee on company law chaired by Tata Sons director J J Irani advocated the idea that "both contract as well as court-based mergers between an Indian company and a foreign company, where the foreign company is the transferee, needs to be recognized in Indian law. The committee recognises that this would require some pioneering work between various jurisdictions in which such mergers and acquisitions are being executed/ created".

The Bill, in furtherance of this idea, introduced provisions dealing with cross-border mergers where the transferee company can be a foreign company. Clause 234 of the Bill deals with such schemes of mergers and amalgamations which are entered into between companies registered under the proposed Bill and companies incorporated in the jurisdictions of such countries as may be notified by the central government (in other words, foreign companies).

It envisages prior approval from the RBI in the situation wherein a foreign company is to be merged into a company registered in India or vice versa. The central government may make rules, in consultation with the RBI, in connection with mergers and amalgamations provided under this clause. Unfortunately, these rules have not yet been notified or made available to the public. This can potentially extend the stipulated timeline as such approvals generally are time taking and require extensive compliances and disclosures.

The introduction of the concept of outbound cross-border mergers is significant in many ways. For instance, in case of a merger between two foreign companies with one company having a subsidiary in India, the new provision will allow the acquirer to merge the Indian operations with itself and may also realise maximum tax benefits by offsetting losses of the subsidiary against its profits. Also, this gives flexibility to Indian companies to restructure their deals maximising their benefits by such outbound mergers.

Further, the payment of consideration to the shareholders of the merging company can be in cash, or in Depository Receipts, or in both in accordance with the scheme to be drawn up for the purpose. (The expression "foreign company" for the purposes of this clause, means any company or body corporate incorporated outside India whether having a place of business in India or not.)

Fast-track mergers


In the present Act, there is no such provision for so-called fast-track mergers, and all mergers are subjected to the same statutory and compliance regime, which is expensive and time consuming. The Bill, on the other hand, introduces a welcome concept of a simplified fast-track merger, to facilitate mergers between two or more small companies or between a holding company and a wholly owned subsidiary or such companies as may be prescribed under the Bill. A small company has been defined as a company which has a paid up share capital of less than Rs50 lakh (approximately $100,000) or a company which has a turnover of less than Rs2 Crore ($400,000). These provisions with respect to criteria of paid-up capital and turnover do not extend to a holding company or a subsidiary.

The Bill requires that a notice should be issued by the transferor company or companies and the transferee company inviting objections or suggestions from the Registrar and Official Liquidators where registered office of the respective companies are situated or persons affected by the scheme, within 30 days. It is further required that objections and suggestions received by the companies are considered in their general meeting and a declaration of solvency is filed with the Registrar.

Also, another welcome step is in the form of dispensing with the prior approval of the Tribunal in case the rules prescribed are adhered. However, the Bill provides that the central government can intervene whenever a transaction is against public interest or against the interests of the creditors and file the application with the Tribunal stating the reasons. The companies, which come under the ambit of these fast-track provisions nevertheless, on account of the non-obstante clause in Clause 233, can resort to the provisions applicable to general mergers and amalgamations

To ensure that the interests of the minority shareholders are protected, however, the disclosure norms have been made stringent and are required at various levels such as filing the scheme with the central government, Companies' Registrar, and so on, ensuring that the minority shareholders are well informed. For example, the scheme is to be approved by majority representing nine-tenths in value of the creditors or class of creditors of respective companies indicated in a meeting convened by the company.

Minority protection rights and dissenting shareholders


Under the Act, there was no specific provision for acquisition of minority shareholders by majority shareholders. The interest of the minority during a merger/arrangement was protected by the courts when such scheme came for the court's sanction, by analysing its bona fides. On the other hand, the Bill introduces provisions for exit options for minority shareholders on payment of a price arrived on the basis of valuations by the registered valuer and certain other rules under the Bill. Further, this right to purchase minority shares is given to an acquirer or person acting in concert with the acquirer when it becomes holder of 90% or more of the issued capital of the company, either directly or by virtue of any amalgamation, share exchange, conversion of securities or any other reason. The Sebi (Substantial Acquisition of Shares and Takeover) Regulations, 2011 defines an acquirer as any person who, directly or indirectly, acquires or agrees to acquire whether by himself, or through, or with persons acting in concert with him, shares or voting rights in, or control over a listed target company.

Section 394 of the Act gives power to the court to make provision for any persons who, within such time and in such manner as the court directs, dissent from the compromise or arrangement. However, Clause 235 of the proposed Bill states that the company can acquire the shares of the dissenting shareholder on the expiry of one month from the date on which it gives a notice to such shareholders or, if an application to the Tribunal by the dissenting shareholder is then pending, after that application has been disposed off.

The introduction of CSR


The concept of corporate social responsibility (CSR) has been introduced in the Bill to provide an equitable angle to the responsibility of the corporate world. The Bill categorically specifies the class of the companies on whom the obligation of forming CSR committees lies; this includes every company having net worth of Rs 500 Crore ($100 million) or more. The board's CSR committee is required to consist of at least three directors, out of which at least one director is required to be an independent director. Further, the responsibility of the CSR committee include to formulate and recommend a CSR policy for the company; recommend the expenditure on the activities referred in the policy and monitor the policy at regular intervals. The policy will enunciate such activities to be undertaken by the company, an indicative list of which is already provided in the Bill.

The role of the board after approving the policy and publishing the same on the website of the company is to implement such Policy optimally and further "endeavor" to ensure that they spend a minimum amount of 2% of the average net profits for preceding three years on activities pursuant to their CSR policy and "give reasons" where they are not able to. This creates issues in relation to the interpretation of such requirements, as it involves subjective interpretations.

It can be said that the Bill tries to undertake a restricted approach by earmarking a lower limit of expenditure on CSR and by having a formulated policy in place; however, it leaves the issue unresolved by only directing the board to endeavour in absence of any specific reason as to what will govern such expenditure. A strict and formulaic approach may shift the focus from the social and economic need of such charitable concepts towards evasive acts which can be adopted by the companies to circumvent such CSR obligations. Incentive measures and tax benefits on the other hand, may have ensured better compliance.

Conclusion


The Bill is a welcome change and aims to refurbish the entire corporate regime with introduction of several fundamental concepts such as cross-border mergers, stringent accountability and transparency provisions, exit options to minorities, and CSR, among various others. Though the red tape approach taken by the government is hindering the introduction of the Bill, its eventual introduction in the not too distant future may help revitalise India's complicated and cumbersome merger and amalgamation process.

Cyril Shroff
  Cyril Shroff is managing partner of Amarchand Mangaldas, India’s largest and foremost law firm with approximately 500 lawyers and offices at Mumbai, New Delhi, Bangalore, Kolkata and Hyderabad. With more than 25 years’ experience in a range of areas, including corporate laws, securities markets, banking, infrastructure and others, he is regarded and has been consistently rated as India’s top corporate, banking and project finance lawyer by several international surveys including those conducted by International Financial Law Review, Euromoney, Chambers Global, Asia Legal 500 and Asialaw. He has authored several publications on legal topics.

He is a visiting lecturer of securities law at the Government Law College. He is a member of the Advisory Board of the Centre for Study of the Legal Profession established by the Harvard Law School, and a member of the Advisory Board of the National Institute of Securities Markets. He is a member of the Executive Council – Legal Practice Division of the IBA and the Advisory Board of the Asia-Pacific Forum of the IBA. He is a member of the Media Legal Defence Initiative International Advisory Board, and a member of the Primary Markets Advisory Committee of the Securities and Exchange Board of India.

He is also part of various committees of the Confederation of Indian Industry and has been a member of several governmental and other regulatory committees on law reform concerning the corporate and securities market, bankruptcy laws, and commercialisation of infrastructure.

Shroff was admitted to the Bar in 1982 after receiving his BA and LLB degrees from the Government Law College in Mumbai. He has been a Solicitor of the High Court of Bombay since 1983.

Amarchand Mangaldas
Peninsula Chambers
Peninsula Corporate Park
Ganpatrao Kadam Marg
Lower Parel
Mumbai 400 013
India

T: +91 22 2496 4455, 6660 4455
F: +91 22 2496 3666, 6662 8466
am.mumbai@amarchand.com

Alice George
  Alice George is a partner in the Mumbai office of Amarchand Mangaldas. She is part of the general corporate team in the firm and has significant experience in the areas of projects, outbound acquisitions and equity investments in the infrastructure space. She has represented private sector developers and private equity investors in various transactions and projects across sectors such as roads, ports and telecom. As the lead transaction counsel her responsibilities have ranged from drafting, structuring, reviewing and negotiating acquisition documents such as share purchase and share subscription agreements for equity investments/acquisitions. George joined the firm in 2006 and became a partner in 2011. Her clients have included Goldman Sachs, Essar Global, AB Volvo and JSW Steel.

Amarchand Mangaldas
Peninsula Chambers
Peninsula Corporate Park
Ganpatrao Kadam Marg
Lower Parel
Mumbai 400 013
India

T: +91 22 2496 4455, 6660 4455
F: +91 22 2496 3666, 6662 8466
am.mumbai@amarchand.com

Rishabh Shroff
  Rishabh Shroff is a senior associate in the Mumbai Office of Amarchand Mangaldas. After completing his LLB at the London School of Economics, he joined the firm in 2007. He was admitted as an advocate in the Bar Council of Maharashtra & Goa in the year 2007. He is also a Solicitor of the Supreme Court of England and Wales. Shroff is part of the corporate team, specialising in foreign investment into India, private mergers and acquisitions and joint ventures transactions. He also is a member of the private client practice team and the Japan desk. He has also worked in the projects and projects finance practice. He worked for three months at Homburger (Zurich) in 2008 as part of a secondment programme between Amarchand Mangaldas and Homburger.

Shroff has worked on a wide range of matters including insurance, tax, trusts, property/real estate, foreign investment and other laws.

Amarchand Mangaldas
Peninsula Chambers
Peninsula Corporate Park
Ganpatrao Kadam Marg
Lower Parel
Mumbai 400 013
India

T: +91 22 2496 4455, 6660 4455
F: +91 22 2496 3666, 6662 8466
am.mumbai@amarchand.com