The Companies (Amendment) Act, 2017 introduces several amendments to the Companies Act 2013, realigning provisions to improve corporate governance and ease of doing business in India while continuing to strengthen compliance and investor protection.
One of the most significant legal reforms in recent times is the enactment of the Companies Act, 2013 (2013 Act) which overhauled the erstwhile Companies Act, 1956 (1956 Act). Though the 2013 Act was a step in the right direction as it introduced significant changes in areas of disclosures, investor protection, corporate governance, etc., there were multiple instances of conflicts and overreach within the legislation leading to difficulties in its implementation. In fact, since its enactment, more than 100 amendments have been made to the 2013 Act.
Accordingly, the Companies Law Committee (CLC) was constituted in June 2015 with the mandate of making recommendations to resolve issues arising from the implementation of the 2013 Act. Based on the recommendations of the report of the CLC, the Government introduced the Companies (Amendment) Bill, 2016 (Bill) in the Lok Sabha on 16 March 2016 which was passed by the Lok Sabha on 27 July 2017 and by the Rajya Sabha on 19 December 2017. The Companies (Amendment) Act, 2017 (Amendment Act) received the assent of the President on 3 January 2018, but different provisions of the Amendment Act will be brought into force on different dates by the Central Government. Proposing a slew of changes, the Amendment Act seeks to realign many provisions to ease corporate governance and doing business in India while continuing to strengthen compliance and investor protection.
In this newsletter, we analyse some of the key changes effected by the Amendment Act and their impact on corporate India:
1. ASSOCIATE, HOLDING AND SUBSIDIARY COMPANIES – AMENDMENTS TO DEFINITION AND IMPACT
(a) Associate Company
(i) An associate company, in relation to another company, was defined under the 2013 Act as a company in which that other company has a 'significant influence' and included a joint venture company.
'Significant influence' was defined as control of at least 20% of the total share capital or business decisions under an agreement.
The Amendment Act widens the definition of 'significant influence' by, (a) referencing, control of 20% of the total voting power as opposed to the total share capital; and (b) including participation in (and not only control of) business decisions.
The inclusion of participation rights as a test of 'significant influence' has been made to align the definition with that in the Indian Accounting Standard 28 (IndAS) which deals with investments in associates and joint ventures. While the IndAS is applicable only to public listed companies, the amended definition of an associate company and its consequent ramifications under the 2013 Act, such as consolidation of accounts, coverage under related party transactions, etc. are applicable to all companies.
From a practical perspective, such a broad definition of 'significant influence' could result in a minority investor with a board nominee, but having no affirmative or special rights, being classified as exercising 'significant influence' on the investee company and consequently, making the investee company an associate of such minority investor.
Interestingly, a recent amendment to the FDI Policy states that if a foreign investor intends to specify a particular auditor or audit firm having an international network for the Indian investee company, then the audit of such investee company should be carried out as joint audit wherein one of the auditors should not be part of the same network. The foreign investor's ability to specify the auditor of the investee company could also be viewed as an exercise of 'significant influence' by the foreign investor over the investee company.
The Amendment Act defines the term 'joint venture' as a joint arrangement whereby parties that have joint control of the arrangement have rights to the net assets of the arrangement.
While the words 'arrangement' and 'joint control' have not been defined in the Amendment Act, guidance may be sought from the IndAS 28 which defines the terms 'joint arrangement' as 'an arrangement of which two or more parties have joint control' and the term 'joint control' as 'the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control'.
Accounting Standard 27, which deals with Financial Reporting of Interests in Joint Ventures and applies to all companies which are not mandatorily required to adopt the IndAS, defines 'joint control' as the contractually agreed sharing of control over an economic activity and does not make reference to decisions requiring the unanimous consent of the parties sharing
control. These differing definitions could lead to challenges in interpreting the term joint venture.
(ii) The concept of associate company has assumed additional significance with its inclusion in the definition of 'financial year', allowing companies which are associates of foreign companies to make an application to align their financial years with the financial years of such foreign companies.
Under the 2013 Act, Indian companies could make an application to adopt a financial year different from the 1 April - 31 March year, only if they were required to consolidate accounts with a holding or subsidiary company incorporated outside India. This was a roadblock for companies that wanted to align their financial year with a group or sister concern or a shareholder, but, owing to ownership of less than 50% and lacking management control rights, did not satisfy the holding-subsidiary test. With the inclusion of the term 'associate company' the definition of 'financial year', this issue has now been resolved.
(b) Holding Company
A holding company, in relation to one or more other companies, was defined under the 2013 Act as a 'company' of which such companies are subsidiary companies. The term 'company' refers to a company incorporated under the 2013 Act or any previous company law and does not refer to an entity incorporated outside India. Accordingly, while Indian companies qualify as subsidiaries of foreign holding companies as per the definition of subsidiary under the 2013 Act, foreign holding companies were not covered within the ambit of the definition of holding company.
The CLC in its report observed that though this was a minor anomaly, it could lead to uncertainties in ascertaining the status of a foreign holding company and in determining the applicability of the 2013 Act to such a company.
The Amendment Act has therefore introduced an explanation to the definition of holding company to clarify that a holding company includes any body corporate.
Foreign companies which meet the prescribed test under the 2013 Act will consequently qualify as holding companies.
Accordingly, provisions of the 2013 Act which refer to holding companies, such as issuance of ESOPs of a holding company to employees of the Indian subsidiary, the restriction on auditors and audit firms providing certain non-audit services wherein they are engaged directly or indirectly by the holding company (or any of the holding company's associates or subsidiaries), the restriction on an Indian company giving loans to a director of its holding company, etc. will apply to a foreign holding company as well.
One of the tests of a subsidiary company under the 2013 Act was the control of more than one- half of its total share capital by the holding company.
The Amendment Act has changed the criteria to control of 'voting power' instead of control of 'share capital'.
The voting power of a shareholder in a company may not always be proportional to the number of shares held by the shareholder (because of differential voting rights attached to shares or voting through other instruments such as convertible instruments on a fully diluted basis). Accordingly, under the 2013 Act, it was possible for a corporate shareholder to own majority voting rights in a company, but not qualify as a holding company. The amendment seeks to plug this loophole.
2. ISSUANCE OF SHARES
(a) Issue at a Discount
Issue of shares at a discount to face value was prohibited under the 2013 Act.
The Amendment Act permits companies to issue shares at a discount to its creditors under a statutory resolution plan or debt restructuring scheme in accordance with any guidelines, directions or regulations specified by the Reserve Bank of India (RBI).
Though the 1956 Act allowed companies to issue shares at a discount with the prior approval of the Company Law Board, the CLC noted that this facility was hardly used. The CLC therefore felt that such a relaxation would help restructuring of a distressed company. However, the intention behind limiting the relaxation to a Strategic Debt Restructuring Scheme and other such schemes issued by the RBI is unclear, especially with the introduction of the Insolvency and Bankruptcy Code, 2016 which has led to a paradigm shift in debt recovery in India.
(b) Issue of Sweat Equity Shares
Under the 2013 Act, sweat equity shares could not be issued within 1 year of commencement of business of the company.
The Amendment Act seeks to remove this restriction.
This amendment will enable companies, particularly start-ups, to issue sweat equity shares immediately after incorporation and consequently enable them to attract talent and procure know how and other value additions without any cash flow issues.
(c) Private Placement Process
The Amendment Act has substantially revised the provisions on issuance of shares through a private placement process with a view to make the provisions reader friendly.
- The Amendment Act expressly states that a private placement offer cannot be renounced in favour of a third party.
- The 2013 Act provided that funds raised through private placement could not be utilised until the shares were allotted.
The Amendment Act provides an additional restriction prescribing non-utilisation of funds until the requisite filing has been made with the RoC. The timeline for the filing has also been reduced to 15 days (from 30 days under the 2013 Act).
- The 2013 Act restricted a company from making a fresh private placement offer while a previous offer was pending.
The Amendment Act seeks to provide flexibility to raise funds by permitting companies to make more than one issue of securities to such class of identified persons as may be prescribed, subject to a maximum of 50 identified persons.
3. CHANGES SPECIFICALLY IMPACTING LISTED COMPANIES
(a) Public Offer
The 2013 Act listed matters that needed to be stated in the prospectus while making a public offer, resulting in an overlap between the 2013 Act and the requisite Securities and Exchange Board of India (SEBI) regulations.
The Amendment Act seeks to omit the provisions that require specific matters to be stated in the prospectus and proposes that the company should provide such information as required by the SEBI in consultation with the Central Government.
(b) Liability for Misstatement in the Prospectus
While the 2013 Act prescribed civil liability for directors, promoters and experts for issuing misleading statements in a prospectus, it did not allow directors who relied on the statements made by experts in a prospectus to use such reliance as a defence.
The CLC examined the provisions under the 1956 Act as well as laws of other jurisdictions and recommended that it would be appropriate to hold experts liable for statements prepared by them, and on which directors relied upon, as long as such experts were identified in the prospectus.
The Amendment Act incorporates a defence against the liability of a director for misleading statements in the prospectus made by an expert, provided the director can prove that he had reasonable ground to believe that the expert making the statement was competent to make it, that such expert had given consent to issue the prospectus and had not withdrawn such consent before registration of the prospectus.
(c) Relaxation in Filing of Returns
Under the 2013 Act, every listed company was required to file a return with the RoC with respect to change in the number of shares held by promoters and top 10 shareholders of such company, within 15 days of such change.
The Amendment Act has done away with this requirement with a view to simplify compliance.
4. DIRECTORS AND KEY MANAGERIAL PERSONNEL–COMPLIANCE AND RESTRICTION ON TRANSACTIONS
(a) Key Managerial Personnel–Definition
The term 'key managerial personnel' (KMP) was defined under the 2013 Act to mean the chief executive officer, managing director, manager, company secretary, whole time director and chief financial officer.
The Amendment Act expands the definition of KMP by giving the board of directors the power to designate an officer of the company, who directly reports to a director in whole time employment of the company, as a KMP.
This provision is aimed to enable the board to designate officers in senior leadership as KMP. However, the above phraseology creates ambiguity as to whether the requirement to be in the company's whole-time employment applies to the director or the officer proposed to be designated as KMP. Given that the intention is to empower the board to designate an officer of the company as KMP, the requirement should apply to the officer in question and not the director to whom such officer reports.
(i) Resident Director
The 2013 Act required every company to have at least one resident director, i.e., a director who has stayed in India for a total period of not less than 182 days during the previous calendar year.
The Amendment Act seeks to modify the residency requirement, by making it applicable to the current financial year instead of the previous calendar year.
While the CLC had recommended a change from using calendar year to financial year to determine the residency status of a director, the Amendment Act has taken this one step further by requiring the director to stay for at least 182 days in India in the current financial year (as opposed to the previous financial year). The change brings about flexibility for non-residents, especially those forming part of the senior management of a foreign company, to act on the Board of the Indian company without any gestation period and reduces the dependency on external persons already resident in India. Having said that, such action comes with an increased burden of compliance on the Indian company to ensure that a director appointed as a resident director meets the mandatory requirement to not fall foul of the law.
(i) Independent Director
Under the 2013 Act, a person appointed as an independent director and his relatives were not permitted to have any pecuniary relationship or transaction with the company in which such a person was appointed as an independent director.
Based on the CLC's recommendation, the Amendment Act has introduced a materiality threshold for determining whether pecuniary relationships could impact the independence of a person to act as an independent director.
The Amendment Act permits an independent director to have limited pecuniary relationships with the company without compromising his independence, such as receiving remuneration as an independent director and having transactions with the company not exceeding 10% of his total income.
(ii) Number of Directorships
Under the 2013 Act, a person was not allowed to hold office as a director, including alternate directorship, in more than 20 companies.
The Amendment Act excludes directorship in dormant companies in determining the limit of 20 companies, so that directorships in dormant companies is not discouraged.
(iii) Alternate Director
The 2013 Act permitted a director of a company to be appointed as an alternate to another director of the company in case the latter is absent from India for a period of 3 months.
To avoid any potential conflict of interest, the Amendment Act prohibits the appointment of an existing director of the company as an alternate for a director during his absence.
(iv) Disqualifications for Appointment of a Director
Under the 2013 Act, a director could not be reappointed as a director in a company which had failed to file financial statements and annual returns for a continuous period of three years or had not repaid deposits or interest or redeemed debentures on the due date, etc. for a year or more.
The Amendment Act provides that a newly appointed director of a company in default should not incur such disqualification for a period of six months from his appointment, which gives him an opportunity to rectify the defect and avoid this disqualification within such period.
Further, if the existing director of such a company in default incurs disqualification, the office of such director would become vacant in all other companies, except the company which is in default, to ensure that the defaulting company has the requisite number of directors to remedy the default.
(vi) Resignation of Director
In addition to the requirement of a company undertaking a filing with the ROC on resignation of any of its directors, the 2013 Act, also required the resigning director to forward a copy of his resignation, along with reasons, to the RoC within 30 days of the resignation.
The Amendment Act makes such filing optional for the resigning director.
(c) Forward dealing by Whole-time Director and KMP
The 2013 Act restricted forward dealing by whole-time directors and KMP, i.e., whole-time directors and KMP were restricted from having a right to call for, or put, the securities of the company at a pre-determined price on a future date.
The Amendment Act has deleted this restriction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.