Further Changes Expected in Indian Companies Act 2013

Background:

For more than fifty years Companies were in India were governed by the Companies Act, 1956.However there was need to replace the old legislation with a new act which could address the changing landscape of the Indian corporate world.  The majority of the provisions of the new Indian Companies Act 2013 (‘Act’) came into effect in two phases- 98 sections of the Act were brought into effect in October 2013 and 183 sections were notified and brought into effect in April 2014.  However the Act was seen by many as restrictive and cumbersome- particularly for closely held private companies.  Private Companies were finding it increasingly difficult to comply with the various procedural requirements prescribed for aspects like raising of further capital, private placement of shares etc. Further some of the compliance requirements under the Act were considered to be too onerous on private and small companies.

In June 2015, the Ministry of Corporate Affairs of the Government of India, constituted the Companies Law Committee (‘CLC’) to make recommendations on the issues arising from the implementation of the Act. The CLC released its report on February 1, 2015 and recommended as many 100 changes to the Act.

Significant Recommendations of the CLC

While the CLC has suggested several changes, some of the more significant recommendations of the CLC are as follows:

1. Changes in some key definitions: Under the Act, an associate company has been defined as one in which another company has control of: (i) at least 20% of shares, or (ii) business decisions. It is now proposed that this definition should be changed and an associate company should be defined as one in which another company has: (i) control of at least 20% of voting power, or (ii) control or participation in business decisions.

1. Raising of Further Capital by Private Companies: The two sections that deal primarily with raising of further capital under the Act are section 42 and section 62. Section 42 deals with private placement of securities.   Under section 42, Companies were required to go through a long drawn out procedure for raising capital by way of private placement of securities. This procedure included  opening of a separate designated account where the consideration for the securities could be transferred, obtaining certificate of valuation of securities and  submission of separate offer letters disclosing certain information about the company. It has now been recommended that this procedure should be simplified for private companies.

Section 62 of the Act deals with further issues of shares on preferential basis. Under the erstwhile Companies Act 1956, private companies were not required to follow the procedure specified for preferential allotment. However the present Act makes no difference between public and private companies in terms of the procedure to be followed for preferential allotment.  This created hardships for closely held private companies and in view of this is now proposed that procedure for preferential allotments for private companies should be simplified.

1. Investment through subsidiaries: As per the Act, Companies were restricted from making investments through more than two layers of investment subsidiaries. The CLC has recommended removal of restrictions on layering of subsidiaries. The CLC has explained that the existing restrictions were having a substantial   bearing   on   the   functioning, structuring and the ability of companies to raise funds .This is a positive development as this will allow Companies to undertake corporate restructuring which shall benefit their business.

1. Forward Dealing Forward dealing involves purchasing securities of a company for a specific price at a future date which is currently prohibited under the Act for directors and key managerial personnel of a company. The Act through Sections 194 and 195 has restricted forward dealing by directors and key managerial persons (‘KMP’s) of a company and insider trading by any person including directors and KMPs respectively.  The CLC has noted that since the securities in private companies would not be marketable, they  would  not qualify  as  securities  within  the  meaning  of  Section  195,  and  thus  would  exclude private  companies  from  the  ambit  of  the  said  provision.  The CLC observed that it would be unjustified to apply the insider trading regulations to private companies. The CLC further noted that  insider  trading  prohibitions  can  be  problematic  in  the  context  of  the  rights of first refusal that are frequently contained in the shareholders’ agreements of private companies. The  CLC has  also  noted  that the regulations specified by the Securities Exchange Board of India in terms of insider trading are comprehensive in the matter (and also apply to companies intending  to  get  listed),  and  in  view  of  the  practical  difficulties  expressed  by stakeholders, sections 194 and 195can be omitted from the Act. While logically this seems to be a sound recommendation, it does not take into account the fact that that there are valid reasons for including the insider trading prohibitions in company law in addition to securities law, as directors have  fiduciary responsibilities and there may be  directors even in private companies and unlisted who may abuse their  position  and  use  confidential  information,  which  have  come  to  them  through their  position,  for  personal  profit  and  not  act  in  the  best  interests  of  the  company. While the CLC noted this, they did not take this aspect into consideration while making their recommendations.

1. Thresholds for pecuniary relationships of Independent Directors: The Act specifies that an independent director must not have any pecuniary relationship with the company, its holding, subsidiary or associate company or their promoters or directors, during the two immediately preceding financial years or during the current financial year. There were no thresholds specified and even minor pecuniary relationships were covered due to this provision even though such transactions may not impact the independence of directors. The CLC has proposed to introduce a threshold for pecuniary relationships in relation to qualification for an independent director. Further Clauses  149(6)(e)  (i) of the Act restricted the  appointment  of  an  individual  as  an Independent  Director  in  case  his  relative  is  or  was  a  KMP  or  an  employee  in  the company,  its  holding,  subsidiary  or  associate  company  during  any  of  the  preceding three  financial  years. In  this  regard,  the  CLC has  recommended  that  the  scope of  the  restriction should  be  modified and the   restriction   should be   only with respect to   relatives   holding  Board   or KMP/one   level   below   board   positions   prior to the appointment of such Independent Directors. However, the CLC has clarified that  as it would be possible to influence an Independent Director in case  his  relative  is  also  working  in  the  situations  referred  to  in  the  section irrespective of the position he holds, the scope of restriction after appointment of such Independent Directors should, therefore, be retained as originally prescribed.

Conclusion:

The Companies Act 2013 is one of the key and important legislations in the country. Through notifications, circulars, amendment orders and clarifications, the Ministry of Corporate Affairs, has brought about approximately 140 changes to the original legislation since its inception. While the recent recommendations are very positive, it must be noted that if brought into effect, these will result in another 100 amendments and significantly alter the landscape of governance of companies in the country. The number of amendments has caused hardships to companies and their advisors as the regulatory and compliance structure remains unclear. Many companies have taken steps to ensure compliance with the existing provisions, only to be told subsequently that the provisions are not applicable to them. One hopes that this is the final major exercise with respect to the amendments to the Act and the act gets a sense of finality.