The Hindu Business Line : Amendment to Companies Act — Should reflect the spirit of times

That the proposed amendment of the Companies Act, 1956 envisages fewer sections, instead of more, is welcome in itself. In all other areas too, the new Act should reflect the spirit of the times — a liberalised regime and voluntary compliance consistent with sufficient safeguards to protect public interest, says R. Parthasarathy.

THE Government proposes to amend the present Companies Act, 1956 and simplify it by reducing the number of sections. Simultaneously, certain new provisions may be introduced. In the past, amendments to the Act were done piecemeal, such as the provision relating to inter-corporate borrowings, managerial remuneration, and so on. A holistic view needs to be taken of the entire Act and changes brought about in tune with the changing global conditions.

In the past five decades, the Companies Act has been amended more than 20 times, the last one being in 2002 based on the recommendations of the Sachar Committee. Instead of reducing, the changes have only increased the number of sections.

The Concept Paper, prepared by the Department of Company Affairs, indicates that the number of sections will be brought down from the present 658 to 289. If carried out faithfully, this is to be welcomed.

Besides the substantive Act, the Government has issued a large number of rules to administer the law . Yet, quite often, there is a conflict in interpretation by different authorities including the Benches at the appellate level.

No doubt, any law, more so that relating to taxation and company affairs, needs to be supported by rules issued under the rule-making power of the government. As they say, the devil lies in the detail! Therefore, rules must be framed with least ambiguity or scope for multiple interpretations.

In today's globalising economy, it is necessary that corporate managements are treated with a certain degree of trust and, towards that end, the law must provide for flexibility in management decisions, of course, with safeguards in the form of guidelines to be voluntarily complied.

Already, the statutory meeting, which is a mere formality and the first milestone after incorporation essentially to inform shareholders that all legal formalities have been completed and that the company has had a trouble-free birth, has been dispensed with.

Restrictions on the conduct of annual general meetings on Sundays and public holidays may also go and this will ensure better attendance by members. There is also a suggestion in the Concept Paper to expand the scope for postal ballot. This is to be welcomed. Section 285 stipulates that the board meeting should be held at least once in three months.

In keeping with advances in technology, it is proposed to allow video-conferencing for board meetings with valid minutes being kept as stipulated. However, the government may specify powers that cannot be exercised in meetings held through video-conferencing. These are new provisions dictated by the advances in communication technology that help in speedy decision-making.

However, in certain other areas crucial to the functioning of corporate institutions in a fast-changing global environment where they have to plan for mergers and acquisitions or restructuring and expansion of business, there may be certain limitations. The proposed restriction on the subsidiary structure is one such.

For example, the Concept Paper stipulates that a subsidiary of a parent company cannot have a subsidiary of its own. In other words, a multi-layered subsidiary structure is ruled out. The reason is not clear. If it is feared that this may lead to concentration of power through interlocking directorships, that can easily be taken care of by restricting the numbers.

Similarly, any fear that funds from one entity may be diverted to another is also unwarranted since this will be subject to provisions of the Act and shareholder's approval. In today's business environment, corporates must enjoy the freedom to alter the structure in line with profit expectations and specialisation.

Then, there is the question of independent directors. Their role has been the subject of discussion for quite some time now.

Essentially, independent directors on the boards of companies receiving loans from financial institutions has been the conventional practice. Such directors, appointed by the financial institutions, are supposed to act as the custodians of the FIs' interests in the company.

It is proposed that while the number of directors for a public limited company be kept at a minimum of three, a public company with paid-up capital or turnover of a prescribed level (to be specified), this number may be fixed at seven of whom not less than three, or nearly 50 per cent of the board strength, shall be independent directors. They do not function in an executive capacity and receive only director's remuneration and no other pecuniary benefits.

The problem in India is the absence of an adequate number of qualified and experienced senior executives who can function effectively as independent directors without becoming captive to managements interests. Not being an organic part of the company, such independent directors have to depend on their intuition and business acumen to deal with tricky situations.

Merely prescribing that 50 per cent of the board may consist of independent directors will only open the floodgates to several persons not adequately equipped to do that function. Per contra, several board-managed public companies have a good track record of ethical standards. Therefore, the need of the hour is to induct greater professionalism and accountability.

New compulsions such as compliance with environment standards, quality of products or services, global competition, and so on, call for specialised knowledge and skill at the board level.

It is worth considering if a training institution, under the aegis of financial institutions, can be set up to create a cadre of independent directors who may be professionally well equipped. As recommended by the Naresh Chandra Committee, the Concept Paper proposes to introduce an audit committee in public companies with a prescribed level of paid up capital.

Independent directors may have a role in such audit committees. Also, accepting the Naresh Chandra Committee recommendation, a special audit concept will be introduced. The present Section 79 of the Companies Act governs "related party transactions". The scope of this Section may be amplified to cover provision of services, loans, leasing, underwriting, and appointment of agents.

A proposal has also been mooted to levy and collect cess on turnover or gross receipts of companies to using such money for the rehabilitation or revival or protection of assets of sick industrial companies. Such levy may not be less than 0.005 per cent and not more than 0.1 per cent on the value of annual turnover or gross receipt, whichever happens to be more. This is a proposal in the Companies Amendment Act 2000, which has so far not been implemented. The moot point here is not so much about the levy of cess as how it will be administered.

How will one decide whether the assets of sick companies can be rehabilitated? Is the bureaucracy well-equipped to handle this job? Would it not be better to ensure such a revival to market forces to be brought about by healthy companies taking them over or inducting better management on mutually acceptable terms? In extreme cases, it might even be better to let chronically-sick units to die rather than throw good money after bad in the hope of revival.

Obviously, there has been opposition to the proposal from the corporate sector and chambers of commerce on the ground that it is unfair to penalise healthy companies for the cause of removing sickness in industry without a quid pro quo. No such system seems to exist in other countries. The bureaucracy's extended arm of patronage at somebody's cost cannot be the right approach. This provision, therefore, needs to be carefully examined.

There is a proposal to make defaults in repayment of public deposits a cognisable offence, resulting in arrests of such defaulting managements. In recent times, there have been not only cases of even the so called reputed companies defaulting in their obligations to repay fixed deposits but companies were formed with misleading names essentially to defraud innocent public depositors and disappear with their cash.

There is no doubt a need for power in government hands to take appropriate action in cases of wilful fraud or reckless management action. Such a provision has to be built into the Act. But in times of business uncertainty caused by market failures, technological limitations or product obsolescence there has to be some flexibility to allow managements to reschedule payments within reasonable time under Government scrutiny.

Prosecutions as a first step may not be warranted though tightened supervisory mechanism as in the banking sector may be justified to prevent fraud or misappropriation of public deposits. Here, the institutions may be too large and widespread.

One way to simplify the Act is, wherever feasible, prescribing guidelines for company managements to adopt and comply with. In such cases, experience will lead to the evolution of right procedures. The Concept Paper has indicated that, as per Section 52 of the Act, a holding company shall have the option to prepare consolidated accounts, including balance-sheets and profit and loss accounts for its subsidiaries and for itself.

This shall be in sufficient compliance with the Act. But, elsewhere, under Section 53, the directors are obliged to prepare separate annual accounts for the holding company and its subsidiaries.

There seems to be an apparent contradiction between the two sections and needs to be resolved. A consolidated accounts with highlights of financial results, in brief, of its subsidiaries in a prescribed format, can be an alternative.

There are several other provisions of the Act such as appointment of managerial personnel and fixing their remuneration, passing of resolution, and so on, where there are no major discrepancies to warrant detailed discussion.

Suffice it to state that a stage has been reached when the new Act should reflect the spirit of the times — liberalised regime and voluntary compliance consistent with sufficient safeguards to protect public interest.

Good corporate governance should, in major part, take care of these requirements. The Government should quickly come out with the draft Bill and open it for public debate before passing the law.

(The author is a New Delhi-based management and financial consultant.)