Companies Act, a curate’s egg

There are at least five aspects of the Companies Act, 2012, that stand out: the emphasis on independent directors, consolidation of accounts of holding and subsidiary companies, corporate social responsibility, mergers and acquisitions and one person company. These issues are worthy of discussion and debate.

INDEPENDENT DIRECTORS

Take the issue of independent directors. Important features of Clause 49 of the Listing Agreement, mandated by SEBI, are included in the new law.

The Act requires every listed public company and relevant others to have at least one-third the total number of directors to be independent directors.

The concept of appointment of independent directors is being extended beyond listed companies; nominee directors are not considered independent.

While the intention is laudable, the definition of independent director considerably restricts the scope of getting a suitable person.

The code for independent directors, according to Schedule IV, is both exhaustive and, to some extent, unclear.

The functions, duties and responsibilities are so wide and sweeping that an independent director may find it difficult to perform effectively.

One duty is to bring an independent judgment on issues of strategic performance and risk management, as well as to scrutinise the performance of management in meeting the goals and objectives of the company.

To effectively fulfil this role and other functions as required by the Act, the director is required to regularly update and refresh skills, knowledge and familiarity with the company.

Would this be practical if the individual is also a whole-time director performing the CEO’s role in her/his own company? While such persons would be able to add value as independent directors, will they accept this role, given the wide-ranging responsibilities imposed under the new Act?

Consolidating Accounts

As per the amended Act, it is compulsory for a company which has one or more subsidiaries to prepare a consolidated financial statement of the holding company as well as all the subsidiaries.

This is a laudable objective, as shareholders and other stakeholders would get a better understanding of the performance and affairs of the entire group. However, the Act provides that the word ‘subsidiary’ shall include associate company and joint venture.

It is not clear why the holding company should consolidate the accounts of the associate company it does not control. This would actually defeat the purpose of consolidation of accounts of subsidiary companies. In most cases, the joint venture is also controlled by the foreign partner.

Social Responsibility

Another important amendment is that certain specific companies have to spend 2 per cent of the average net profit made in the preceding three financial years on corporate social responsibility (CSR).

While the objective is laudable, the question is: “Should social responsibility be foisted upon companies?”

To the best of my knowledge, there is no other country which has imposed such an obligation, while in several developed countries, companies are required to report about CSR.

In our country, there are already several cascading taxes and duties a company has to grapple with and impose, so one more burden does not seem appropriate.

While inclusive growth is important, the measure should have been more by way of voluntary compliance and reporting rather than compulsory.

In any case, the percentage fixed is high and should have been restricted to 1 per centof profit after tax

Further, the underlying spirit of the draft CSR rules appears to be identification of projects to be undertaken and expenditure on specified activities under Schedule 7, whereas the approach towards CSR should be more broad-based.

According to the rules, the promotion of education, environmental sustainability, enhancing vocational skills and so on may be covered under CSR. However, the rules give the misleading impression that only these activities may be implemented, and only by specified agencies and not directly by the company.

Any expenditure directly incurred by the company for these purposes as well as towards social and community development, improvement of livelihood, welfare of the farmers and so on should also be considered eligible expenditure under CSR.

The CSR rules should be further discussed with companies and amended.

We need a level playing field. Is it appropriate for the Government to keep signing FTAs on the one hand, and on the other make Indian companies less competitive by imposing an additional burden on them?

If this is seen as necessary to encourage CSR activity, a weighted deduction of 200 per cent under the IT Act may be allowed.

Mergers, Acquisitions

Several interesting changes have been made in respect of mergers and acquisitions, including merger of a listed company with an unlisted one, subsidiary with the parent, or between two small companies including cross-border mergers, with prior approval of the RBI.

A detailed mechanism for acquisition of shares by majority shareholders from the remaining shareholders would provide a powerful tool for effective reorganisation.

Objections to arrangements/schemes can be raised by shareholders holding only more than 10 per cent shares, or creditors owed more than 5 per cent which would ensure that only serious objections are considered by the courts.

The recognition to inter se shareholders’ arrangement of transferability of shares of public companies would bring clarity on legal enforceability under joint venture/shareholder agreements.

One Person Company

This new vehicle called one person company (OPC) will provide an opportunity to entrepreneurs to enter the corporate framework along with enjoying the benefits of limited liability. The question of ‘perpetual succession of a company’ has also been appropriately addressed in the Act.

Whether the OPC will have a separate status under the provisions pertaining to taxation remains unclear as of now.

While initiatives undertaken to reduce the approval of Government and strengthen governance such as withdrawal of exemption for interest-free loans between holding and wholly-owned subsidiaries must be commended, some of the provisions require another look.

(The author is President and Group CFO, TAFE. The views are personal.)

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