Corporate Law Global Developments and the Way Forward MAHAVIR LUNAWAT*

Transcription

1 Corporate Law Global Developments and the Way Forward CORPORATE LAW GLOBAL DEVELOPMENT OPMENTS AND THE WAY FORWARD MAHAVIR LUNAWAT* A. Global Developments in Corporate Law and Governance Corporate and securities laws, including norms on corporate governance, are having the taste of dynamism and undergoing far reaching changes keeping in pace with the changing circumstances world over and for other specific reasons. Corporate law being one of the fundamental legal streams, is an established law in the sense that many countries have got their corporate law drafted as many as 50 years back. Market dynamics, corporate forms, corporate transactions, ways and means of corporate management and governance, investment mechanism etc. have undergone cataclysmic changes over the years and there is no change in the changes. As a result, a need was felt globally to review corporate laws and related norms not only to align the same with the changing circumstances but also to put in place forwardlooking legal framework for corporates and concerned stakeholders. Moreover, some of the major corporate scams including those in developed economy like US have forced the regulators world over to take up a review of their existing laws and affect suitable changes, both corrective as well as preventive. Some of the significant global developments in the field of corporate law and governance are covered below United States : The global movement for better corporate governance progressed speedily subsequent to the Enron debacle of 2001, followed by other scandals involving some other large US corporations such as WorldCom, Qwest etc. In June 2002, less than a year from the date when Enron filed for bankruptcy, the US Congress introduced the Sarbanes-Oxley (SOX) Bill, which was assented to by the US President on July 30, The SOX Act brought with it fundamental changes in various areas of corporate governance. Some of the major provisions of the SOX Act include the following Prohibition on Non-Audit Services by Auditors Detailed stipulations on determination of Auditor Independence Norm relating to Composition of the Audit Committee CEO / CFO Certification Prohibition of Loans to Directors / Executive Officers Internal Control Report of Management Code of Ethics Real Time Company Disclosures Establishment of Public Company Accounting Oversight Board The SOX Act has enormous implications not only for US corporations but also for non-us corporations with ADR listings, as the provisions of the Act extend to such non-us corporations as well. United Kingdom : In 1998, the UK Government commissioned the Company Law Review (CLR), an independent group of experts, practitioners and business people, to * ACS (Gold Medallist), DBF, DEM, working with Corporate Secretarial, Reliance Industries Limited. A 1

2 33rd National Convention of Company Secretaries take a long term and fundamental look at the system of Company Law and to see how it could be brought up to date. CLR has been universally recognised as providing a thorough and authoritative assessment of the changes which need to be made and it provides the essential blueprint for the reforms proposed. The UK Company Law reform programme is focussed on the following 4 key objectives : 1. Enhancing shareholder engagement and a long term investment culture. 2. Ensuring better regulation and a Think Small First approach. 3. Making it easier to set up and run a company. 4. Providing flexibility for the future. In March 2005, the Secretary of State for Trade and Industry, Government of UK presented, to the Parliament, a White Paper on Company Law Reform; the White Paper was open for public comments till June 10, The White Paper provides a description of the policy so that all those with an interest in the area can understand what is intended through the proposed Company Law Reform Bill. This White Paper builds closely on the work of the CLR and of the Government s White Paper of India : Playing a pro-active role, the Department of Company Affairs, on August 21, 2002, appointed Naresh Chandra Committee to examine various corporate governance issues. As reported by the Naresh Chandra Committee, When in doubt, disclose is probably the simplest and best yardstick for evaluating good corporate governance. Naresh Chandra Committee presented its Report to DCA in December, 2002 culminating finally into the Companies (Amendment) Bill, 2003, presented before the Rajya Sabha on May 7, However, industry expressed lot of concerns on various issues involved in the Bill and it couldn t see the light of the day. DCA had also constituted an Expert Group under the chairmanship of Shri Shardul Shroff to suggest guidelines on valuation of corporate assets and shares in connection with amalgamation, merger, de-merger, acquisitions, buy-back, etc. and/or restructuring of capital of companies. On January 31, 2003, the Committee presented, to DCA, its Report containing several recommendations in the context of valuation. Transactions for which independent valuation by the Registered Valuer(s) has been recommended to be mandatory, inter alia include all schemes of Compromise and Arrangement under Sections 391 to 394 of the Companies Act, 1956 (the Act). The Ministry of Company Affairs (MCA), in the meanwhile, undertook the task of revising the entire Companies Act and on August 4, 2004, came out with Concept Paper on Draft Companies Bill, followed by draft Concept Rules in On December 2, 2004, the Ministry constituted an Expert Committee on Company Law (the Committee) under the Chairmanship of Dr. J. J. Irani. The Committee submitted its Report to the Ministry on May 31, A Committee headed by Shri O.P. Vaish has also been constituted to consider ways and means to improve the process of prosecution under the Companies Act, This Committee is yet to submit its report. On the other hand, in order to identify deficiencies / inconsistencies in the existing provisions of the SEBI Act, 1992 and also to suggest new provisions that can be incorporated into the Act in order to make it more effective and investor friendly, taking into account the recommendations of the other expert groups constituted by SEBI from time to time, the SEBI Board had constituted an Expert Group under the chairmanship of Mr. Justice M. H. Kania (the Group). After a series of meetings, the Group has submitted its Report to SEBI; the Report was open till July 26, 2005, for public comments. B. J J Irani Committee on Company Law Irani Committee was constituted to make recommendations on the following : (a) Issues arising from the revision of the Companies Act, 1956 (the Act). (b) Responses received from various stakeholders on the Concept Paper. A 2

3 Corporate Law Global Developments and the Way Forward (c) Bringing about compactness by reducing the size of the Act and removing redundant provisions. (d) Enabling easy and unambiguous interpretation by recasting the provisions of the Law. (e) Providing greater flexibility in rule making to enable timely response to ever-evolving business models. (f) Protecting the interests of stakeholders and investors, including small investors. (g) Any other issue related or incidental to the above. The Committee has submitted its Report on May 31, The Report comprises 13 chapters divided into 7 parts. The Committee has made several recommendations towards the scheme of legislation. It has suggested the areas in respect of which separate laws are required and the areas which should be covered under the Companies Act itself. These recommendations are captured in the following chart : Separate Legislations in respect of the following : No separate Legislations in respect of the following : Producer Companies Investor Education and Protection Limited Liability Partnerships (LLPs) Financial Services Public Financial Institutions (PFIs) Liquidation of Companies Nidhi companies To be Regulated by RBI Rehabilitation of Potential Insolvent Companies Serious Fraud Investigation Office In addition to the above, the Committee has made several policy measures to be adopted under the new Company Law. The recommendations broadly intend at a simplified regulatory regime backed by strengthened disclosure norms without much of State. A bird eye view of the major policy recommendations of the Committee are summarised as under Simplified regulatory regime of self-regulation by corporates without much of Government intervention. Strengthened disclosure norms. Extended governance norms including CEO/ CFO Certification, prohibition on non-audit services, independent directors, Directors and Officers insurance etc. Time-bound deemed approval mechanism, where if approval is not received within the time prescribed, it will be deemed to be received. Shareholders approval for related party transactions beyond threshold and disclosures of related party transactions in Directors Responsibility Statement. E-governance, where filings, despatch of annual report, maintenance of records etc. are possible electronically. Simplified regulatory regime for private and small companies. Recognition to One Person Company, as prevalent in UK. Elaborate regime of Governance and disclosures for holding-subsidiary companies without any restriction on number of subsidiaries. Introduction of Tracking and Treasury Stocks and Perpetual Preference Shares. Recognition to Contractual and Cross Border Mergers. Strengthening of Serious Fraud Investigation Office through a separate legislation. Replacement of mandatory cess by an optional contribution to Insolvency Fund. C. Need for Harmonisation Certain recommendations of the Committee are in conflict with the corresponding regulatory provisions. The provisions on Board Committees may be taken as an example. Irani Committee has recommended to make provisions for three Board Committees Audit Committee, Remuneration Committee and Stakeholders Relationship Committee. It would be worthwhile to note in this context that, under Clause 49 of the Listing Agreement, Audit Committee and Shareholders /Grievance Committee are mandatory whereas Remuneration Committee is A 3

4 33rd National Convention of Company Secretaries optional. Director s Relatives (Office or Place of Profit) Rules, 2003 effective February 5, 2003, provide that in case of public companies, selection of a relative of director for holding place of office or profit in the company shall have to be approved by a Selection Committee, of which majority of members shall be independent Directors and an expert in the respective field from outside the company. SEBI Guidelines on Stock Options provide that a Compensation Committee, consisting of a majority of independent directors, shall be constituted for administration and superintendence of the ESOS. Divergent requirements stipulated under different provisions, as highlighted, need harmonisation. For effective implementation and compliance with regulatory provisions, it is a pre-requisite that they should be harmonised with each other. Situation of conflict gives rise to doubts and creates confusion. Further, compared to the provisions of the Concept Paper and recommendations of Naresh Chandra and Narayana Murthy Committees, the Irani Committee has extended the scope of the qualifications of independent director by including relatives of director in the list of prohibited items. The extended definition may be difficult to monitor and should, therefore, be reviewed. D. Certain Unattended Areas Single Incorporation Document : A major policy shift has been proposed by the Department of Trade and Industry, Government of UK, based on the recommendations of CLR that there should not be a requirement of having separate memorandum and articles. Consequently, doctrine of ultra vires will no longer be in vogue. The relevant recommendation of the Steering Group, CLR has been reproduced below - We recommend that companies formed under the new legislation should not have a separate memorandum and articles of association. Instead, the constitution should be in a single document. When the founder members (in present terminology, the subscribers to the memorandum) apply to form a company, they would have to deliver to the Registrar the proposed constitution, along with additional information set out in the Act. This would include : the proposed name of the company; whether it is to be situated in England and Wales (or Wales) or Scotland; the address of the registered office; details of the share capital (or guarantee); the names of the founder members; and details of the first directors and of the secretary if there is to be one. There should be a power for the Secretary of State to vary by order the information required. Apart from the move away from the separate memorandum and articles, there would be one significant change from the present law. The details of share capital given by companies with shares would no longer be of authorised share capital a concept which would disappear from the statute but of the share capital to be allotted to members on formation. [Chapter 9] In today s liberalisation and globalisation, the above proposal should be considered for adoption in India as well. No Authorised Capital : The Department of Trade and Industry, Government of UK in its White Paper on Company Law Reform, 2005, presented before the UK Parliament, has suggested to remove the illusionary concept of authorised capital. The relevant excerpt of White Paper is reproduced hereunder At the moment all companies with shares are required to have a limit on the maximum amount of shares they can allot, called the authorised share capital, which can be raised with shareholders approval. In practice it is normally set at a level that is much higher than it is anticipated the company will need. This means that authorised share capital normally serves no useful purpose. As recommended by the CLR, the Government proposes to remove the requirement on the basis that it is an unnecessary piece of regulation. It will of course continue to be possible for shareholders to include provisions with a similar effect in a company s articles if the special circumstances of that company make such restrictions important to the shareholders. The above proposal of the UK Government seems very practical and logical and may be considered for adoption in India as well. Removal of Sections 108A 108H of the Existing Companies Act : The Companies (Amendment) Bill, 2003 as also the Concept Paper 2004 sought to remove the provisions of Sections 108A to 108H. However, the Committee has left the issue unattended. In the changed scenario, the aforesaid provisions A 4

5 Corporate Law Global Developments and the Way Forward should no longer be there on the statute book. The rationale behind this may be found out from the following excerpt of the Joshi Committee Report, : Sections 108A-108H were introduced in the Companies Act, 1956, by the Amendment Act of 1974 to regulate the acquisition and transfer of shares of a body corporate owning any undertaking to which the provisions of Part A of Chapter III of the MRTP Act apply. They were intended to prevent acquisition or take over of companies leading to further concentration of economic power. These sections were omitted from the Companies Act and incorporated in Chapter III-A of MRTP Act in They witnessed yet another shift in 1991 when these were restored again to Companies Act by MRTP (Amendment) Act, 1991 primarily because the concept of MRTP undertaking was omitted from the MRTP Act through this amendment. The Committee, therefore, noticed that the MRTP (Amendment) Act, 1991, removed the concept of MRTP undertakings. SEBI has also since issued SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 1997 to provide greater transparency in the acquisition of shares and the takeover of the companies through a system of adequate disclosure of information. Moreover, combinations beyond a high threshold limit inter-alia through the process of acquisition of shares including voting rights etc. are proposed to be subject of scrutiny by the Competition Commission of India in terms of Competition Bill, 2001 which is presently under consideration of Parliament (the Bill has been assented to by the President but yet to be made operational by the Government). In these changed circumstances, it is felt that the sections 108A-108-I have outlived their utility and thereby become redundant and consequently need to be deleted. [Para 4.8]. Removal of the aforesaid sections would also be in line with the Competition Policy of the Government, inter alia, to promote and sustain healthy competition and ensure freedom of trade for economic development of the country. Targeted Buy Back of Odd-Lot Shares : The concept of targeted buyback, where an issuer may buyback shares from a subset of shareholders on a preferential basis was examined by the Committee. The facility is used in some countries like USA, Australia etc. (a) effecting a block repurchase from large shareholders (b) effecting purchases from employees (c) thwarting takeover attempts. This concept is not yet addressed in Indian Law. Irani Committee has felt that this concept could come in the way of proper operation of a competitive market for management control which is an essential ingredient of the Capital Market. However, use of the above mechanism for reducing odd-lot holdings seems to have been missed out. Targeted buy-back may be an effective mechanism to reduce odd lot shares and should be given statutory recognition for this purpose. Advance Ruling : Advance Rulings mechanism is in vogue under the tax law; Informal Guidance is prevalent in securities law. Advance Rulings should also be introduced under the company law. Such a mechanism will be instrumental in the desired interpretation and implementation of the regulatory provisions and will reduce litigations. Investor Protection : While Irani Committee has made certain recommendations regarding investor protection, further reform is desired in this area. Provisions regarding investor protection should be strengthened like dividend should be made payable only to the bank accounts of the shareholders and therefore, shareholders should mandatorily be required to provide their bank particulars. At the same time, there should be a check on the powers of investors which are being grossly misused like removal of auditors/appointment of a person as director who is not a retiring director etc. In fact, shareholders take the benefit of the loose wording of the provisions of the Section for malafide purposes. In the case of Phillips India Limited v. Rakesh Mahato & another, a shareholder holding one share had sent a notice under the Section to 31 companies seeking removal of some directors. To uphold the spirit of the legislation, not only suitable minimum shareholding requirement should be prescribed but shareholders should also be required to provide valid reasons when making their demand as to removal of director/ auditor, poll etc. A 5

6 33rd National Convention of Company Secretaries On the other hand, Kania Committee has suggested that a separate Investor Protection Fund under the SEBI Act, on the lines of Subscriber Education and Protection Fund under Pension Fund Regulatory Development Authority (PFRDA) Ordinance, 2004, may be established for the purpose of investor education and awareness and for compensation to small investors in respect of fraud or misrepresentations or misstatements by companies or intermediaries. Such a fund should be administered by SEBI. While the JPC Report, 2002, had suggested to shift the investor education and protection fund established under the Companies Act to SEBI, Kania Group has suggested to set up a separate investor protection fund under the SEBI Act. The proposal to create a separate investor protection fund, when there are similar funds in existence under the Companies Act as also under the rein of the Stock Exchanges, should be weighed carefully before implementation. E. Way Forward The new Company Law should be a comprehensive one without having any redundant provisions. Substantive provisions should be covered in the Act itself. Only procedural aspects should be left to be stipulated through rules. A consultative approach may be recognised in the Act itself for any future amendment to the Act as well as amendment / issuance of any provision(s) of the Rules. The issues / grey areas involved should be addressed effectively. Variations between the Company Law and other provisions of Law including Clause 49 of the Listing Agreement should be avoided. Governance aspects like composition of Board of Directors, number and attributes of independent directors etc. should be approached within a pragmatic framework. The Law should be clear and unambiguous. Advance Rulings Mechanism as provided under the Income Tax Act and SEBI Laws may also be considered to be brought into the Company Law. Although it is stated in the Kania Committee Report that it is desirable to have consolidation of securities laws governing primary issues, secondary market, Collective Investment Schemes and listed companies into one enactment on the lines of Financial Services and Market Act, 2000 of UK, yet the Committee has refrained itself from any recommendation in this regard under the guise that the issue involves a policy matter on which only the Central Government can take a view. Similarly, the Committee has also remained silent on the SEBI s sole authority to administer the provisions of the Securities Contract (Regulation) Act, Consolidation of Securities Laws into a single legislation will be an ideal legal framework leading to better understanding, reduced doubts and effective implementation. Like the Ministry of Company Affairs has initiated the process of revising the entire Company Law, robust steps should be initiated for revamping of Securities Law as well. Last but not the least, effective implementation without undue harassment for corporates and their directors/officers should be ensured. The new Company Law and Securities Law should be facilitating laws rather than restrictive laws and should not put any undue speed-breakers to corporate functioning. A 6