Business Today

Overdoing the vigilance

In its zeal to prevent fraud, the new Companies Act has made normal corporate functioning near-impossible, feels industry.
Tina Edwin   Delhi     Print Edition: June 22, 2014
Overdoing the vigilance

India Inc's unhappiness with the Companies Act 2013 is not limited to issues such as appointing independent directors, a woman director, audit rotation or even the mandatory corporate social responsibility (CSR) requirement. It's everyday operational issues that are raising anxiety levels of promoters, professional managers and their legal teams and auditors.

The problems started with the manner in which the Act was rolled out. There were two problems with the approach. First, the United Progressive Alliance (UPA) government opted for a phased implementation of the new Act instead of full-scale one. Two, most rules that make the Act effective were made public only in the last week of March and companies were expected to comply with them from April 1. This is in sharp contrast to a globally accepted practice of giving companies a year or two to familiarise themselves with a new regulatory regime before it comes into force. To make matters worse, in some instances, the final set of rules were more stringent than the draft rules put to discussion, and in other instances, they seemed to be in conflict with the Act itself. It also turns out that the government did not follow the prescribed practice of notifying the rules through the gazette before the effective date - and this is causing some confusion whether the effective date should be read as the date of the gazette notification.

The industry is in a situation where it has to refer to both the 1956 and the 2013 versions of the Companies Act and their rules before taking or acting on any decision, says Harinderjit Singh, Partner, Price Waterhouse in a recent media briefing. But that's a small problem. Bigger problems arise in complying with the law. Major areas of concern include laws on related-party transactions, capital raising, directors' liabilities, prison terms for contravention of the law, fraud reporting and whistle blowing. The fear is the new law will make carrying on business extremely cumbersome and even restrict normal operations.

Consider, for instance, the rules on related parties. The definition of relatives is compact in the final set of rules but what's worrying industry is the wide ambit of related-party dealing. That affects not just who can be an independent director of a company or its auditor but who can vote on board and shareholder resolutions where it involves certain transactions between companies. Private, closely held companies would be worst hit by the tightening of rules on related-party transactions.

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The new law requires some related-party transactions to be cleared by a special resolution of shareholders of the company and bars a shareholder who is a related party from voting. However, all related parties may not be an interested party in the relevant transaction but that distinction has not been made in the law. "This can create a problem in smaller or closely held companies where all shareholders are related parties. Therefore, obtaining shareholder approval in such instances for related-party transaction may not be possible," points out Bharat Anand, partner at law firm Khaitan and Co.

These rules, he added, were imported from UK Listing rules, where it applies only to UK-listed companies. It is, therefore, illogical to apply these rules to closely held companies in India.

Capital raising is another area of concern, and particularly preferential allotment of shares. The rules have been changed to make it similar to private placement, where the company is required to issue an offer letter, make various disclosures and specify dates when the preferential offer will open.

Another issue is that non-convertible debentures (NCD) can be issued for a five-year term, which many see as restrictive as it is a norm to issue long-term debentures.

Companies have also been restricted from extending loans to directors as well as to other companies with which a director of the company is associated. The new law also places some restrictions on lending to subsidiaries and associate companies and specifies when exceptions can be made. Likewise, inter-corporate loans have also been restricted and such loans can be extended at a specified rate of interest. This measure will hurt private companies the most.

Restrictions placed on setting up multiple layers of subsidiaries is another pain area for companies. The new law allows companies to have only two layers of investment subsidiaries, with an exception allowed for foreign acquisitions. This means corporate groups will need to change the structure of their businesses in the future.

Indian subsidiaries of multinational corporations will face problems committing funds to CSR requirements because such contributions are not allowed under the Foreign Exchange Management Act. Their contributions under CSR requirement to charitable organisations will be subject to the Foreign Contribution Regulation Act.

Most changes in the Companies Act were made to enhance the level of corporate governance and protect minority shareholders' interests, as a reaction to corporate scandals such as promoters siphoning out funds from companies as in the case of Satyam Computer. The CSR requirement was meant to ensure companies' growth is linked to sustainable development.

But the government seems to have gone too far with its concerns. Companies had raised many concerns and sought many clarifications of the draft rules, most of which were overlooked when the final rules were issued, they complain. Their last hope is that the new Finance and Corporate Affairs Minister, Arun Jaitley, will postpone implementation of the law for a year and review each rule before it is implemented.

@tinaedwin

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