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Rupa Jacob

The proposals in the Bill to strengthen corporate governance are a bit drastic, and not in keeping with the current economic mood of reducing government role in corporate decision-making.

THE Department of Company Affairs proposes to make far-reaching changes to the Companies Act, 1956 through the Companies (Amendment) Bill, 2003 which is through the Lok Sabha and with the Upper House. The effort taken by the framers to enhance investor protection is laudable. However, some restrictions imposed appear unreasonable.

Further, the proposals to strengthen corporate governance practices — though a step in the right direction — are a bit drastic, and not in keeping with the current economic mood of reducing government role in corporate decision-making. It may also affect the India Inc's industry growth. Some salient features of the Bill are:

Curtailment of board of directors' power

To safeguard the investors, the Bill seeks to curb the powers of the board of directors through amendments to the Act. Section 292(d) of the Act, which confers on the board the power to invest the company's funds, has been qualified to state that such investment shall not exceed 20 per cent of the paid-up capital and free reserves in a financial year. The amended clause further provides that the resolution to invest the company's funds should be passed with the consent of all the directors present at the meeting.

An amendment to Section 293 provides that the board of a public company, or its subsidiary which was previously empowered to sell, lease or dispose the company's undertaking up to any extent with the shareholders' consent cannot do so now in excess of the higher of 20 per cent of the total assets of the undertaking or 10 per cent of the company's total assets in any financial year. It is unclear as to what is to be achieved with this amendment, as it appears that the board cannot now transfer or dispose off the company's assets beyond the prescribed limit even if it is in consonance with all the shareholders. The power of the board to declare dividends and interim dividends under Section 205 is also subject to restrictions. One, if in any financial year the board proposes to declare dividend out of the reserves, as per the Bill, such declaration shall be made only in accordance with a special resolution of the board with the consent of all the directors present at the meeting, and in accordance with a special resolution passed by the shareholders at the annual general meeting. The approval of the financial institutions that have made term loans to the company is also required.

The Bill provides that the amount of declared interim dividends should be deposited in a separate bank account within five days, and that these cannot be revoked or modified once declared. These hurdles can be a hindrance to the declaration of dividends, and may, in fact, affect investors.

Enhancing investor protection

The Bill has introduced several provisions to protect investors. Sub-clause (6), which has been added to Section 72 of the Act, prevents the revocation of applications made by promoters, directors and their relatives to subscribe to the securities of the company in pursuance of a prospectus issued to the public. The Bill also prescribes for attachment of the bank account or accounts of any intermediary or any person associated with the securities involved in violation of any of the provisions of this Act, rules or regulations by the Centre in the interest of investors and the security market.

The penalty for various offences under the Act has been enhanced, and more persons connected with the company, including the chief accounts officer, debenture trustees, share transfer agents, bankers, and merchant bankers — in respect of the issue or transfer of any securities of the company — have been brought within the definition of "officers in default". The Bill also imposes several restrictions on remuneration and loans to the directors.

The Bill has further introduced provisions to deter fly-by-night operators and prevent companies from vanishing suddenly. The Bill stipulates that two recent photographs of all subscribers to the Memorandum and Articles of Association as well as those of the witnesses should be affixed to the same and signed, and submitted along with the subscriber's proof of identity. These clauses are positive amendments and seem to be well thought out. However, others appear unreasonably restrictive and may need a re-think.

For instance, a proviso to Section 3 (5), which makes the liability of every director, manager and shareholder of companies that are not carrying on business or in operation even after its name is struck off in accordance with Section 560, seems to be too harsh. Further, the inclusion of shareholders among persons held liable goes against the very grain of the protection that the Bill proposes to provide the investors.

The Bill defines independent directors as a separate category. The newly-added Section 252A lays down that an independent director has to be someone who inter alia did not have any previous transaction with the company, and does not hold 2 per cent or more of the company's securities having voting rights. Further, an independent director cannot be a person who has been a director or independent director for nine years or more. This requirement will disqualify many persons with considerable corporate experience from being appointed as independent directors thereby preventing them from providing valuable input to a company's growth, especially public companies having a paid-up capital and free reserves of Rs 5 crore or more, or a turnover of Rs 50 crore or more, as the Bill makes it mandatory for a majority of directors that constitute the board of such companies to be independent.

Transfer of shares

Restrictions imposed on the acquisition and transfer of shares, including those held in a foreign company by certain body corporates, individuals and firms appearing in Sections 108A through Section 108H, have been removed.

However, by the addition of a new sub-clause to Section 111, the Bill makes an absolute stipulation that a private company shall not approve the transfer of any shares unless it is approved by all the shareholders at its meeting.

This clause could effectively prevent the smooth transfer of shares in a private company by empowering even a single shareholder to stall the proceedings relating to the transfer of a single share. The endeavour to reform company law by laying emphasis on enhancement of investor confidence and strengthening of corporate governance practices are commendable.

However, in order to encourage the growth of a progressive economy and boost market activity, the framers must keep in mind that investor protection must not be at the cost of the smooth functioning of companies.

(The author is an attorney.)

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