India: The Companies (Amendment) Act 2017 – Incremental Reform Continues

Introduction

The Companies Act, 2013 (Act) was the legislative outcome of a process that had begun a decade earlier. Desiring a simplified and compact law with flexible rule making powers for 'ever changing business models', the Central Government constituted the JJ Irani Expert Committee on Company Law (Irani Committee). Unfortunately, the process from committee report to enactment resulted in a rather voluminous statute with reams of rules, riddled with drafting ambiguities and regulatory overlap.

Consequently, numerous stakeholders reported challenges in implementing the provisions of the Act. Despite an initial amendment and a flurry of clarifications, orders and rules, the Central Government set up another committee, the Companies Law Committee[1] (CLC) in 2016 to see where 'the shoe pinches'.

Based on the CLC report, an amendment to the Act (Amendment Act) was passed by the Lok Sabha last year, and thereafter by the Rajya Sabha on 19 December 2017. The Amendment Act received presidential assent yesterday and will come into force pursuant to notifications in the official gazette.

The key changes brought about by the Amendment Act are highlighted below:

Provision

Amendment

Implication

Definition of 'Associate Company'

The term 'significant influence' has been amended to mean control of at least twenty per cent of the total voting power, or control of or participation in taking business decisions under an agreement.

Exemption has been given to convertible preference capital holders (who are not entitled to voting) by replacing total share capital with total voting power.

However, the words control over or participation in business decisions will require scrutiny of (i) shareholders agreements and their de facto implementation; and (ii) corporate governance practices of a company.

This may lead to increase in the number of associate companies, thereby enhancing the compliance risk and necessitating consolidation of accounts.

Change to total voting power from total share capital made to align the definition with IND AS 28.

It appears that the intention is to align the definition with IND AS 28, which defines 'significant influence' as the power to participate in the financial and operating policy decisions of the investee, but is not control or joint control of those policies. There are also the following guidance factors provided in IND AS 28 for determining significant influence:

(a) board representation, (b) participation in policy making process, (c) material transactions between entity and investee, (d) interchange of managerial personnel, or (e) provision of essential technical information.

Definition of 'Subsidiary Company' and 'Joint Venture'

The test for a subsidiary now includes, "exercise or control more than half of the total voting power", and not total share capital.

A new definition of 'joint venture' has been introduced as meaning a joint arrangement, where parties have joint control of the arrangement and have rights to the net assets of the arrangement.

This change was brought to remedy practical problems faced by companies with substantial preference share capital. Because of the concept of total voting power, it is intended for equity share capital to be the basis for determining whether a company is a subsidiary.

However, the Amendment Act fails to take the provisions of section 47 of the Act into account. Under Section 47, where dividend in respect of a class of preference shares has not been paid for a period of two years or more, preference shareholders gain voting rights in respect of all shareholder resolutions, putting them at par with equity shareholders.

Definition of 'Holding Company' and provisions relating to foreign bodies corporate

The scope of the term has been expanded to include a body corporate

Foreign bodies corporate are now considered as holding companies.

This remedies the situation where a subsidiary could be a foreign company, but a holding company excluded foreign companies.

With this change, all transactions between an Indian company and its foreign holding company, as well as the transactions between Indian companies and the other subsidiaries of the foreign holding company will now be within the realm of 'related party' transactions. Further, for determining the status of an Indian subsidiary of a foreign company, it is pertinent to understand whether the parent satisfies the definition of a private or public company under the Act.

The restriction on a holding company having two layers of subsidiaries has been retained, subject to the provisions of Companies (Restrictions on number of layers) Rules, 2017.

The provisions of Chapter XXII of the Act, which deal with registration and filing of financial statements with Ministry of Corporate Affairs by foreign companies, have been extended to all foreign companies having a place of business in India. These provisions were previously applicable to only those foreign bodies corporate which were controlled by Indian residents or Indian companies.

Definition of 'Debentures'

The below mentioned instruments have been specifically excluded from the definition of 'debentures':

(a)the instruments referred to in Chapter III-D of the Reserve Bank of India Act, 1934, i.e., derivatives and money market instruments; and

(b)such other instrument, as may be prescribed by the Central Government in consultation with the Reserve Bank of India (RBI).

The amendment is intended to obviate the dual regulation of certain financial / investment instruments.

Definition of 'Key Managerial Personnel' (KMPs)

By default, the term has been restricted to officers designated as KMP by the board of directors (Board) who are not more than one level below the directors (who are in the whole-time employment).

This allows companies to develop their own policy / criterion for designating specific officials as key managerial personnel.

Definition of 'Related Party'

An investing company or the 1enture of a company is also included in the definition of related party.

Change in the definition made to align the definition with IND AS 24.

An investing company or the 1enture of a company is the counterpart of an associate company. Previously, only an associate company was treated as a related party. But the converse relationship was not covered.

Effectively, all off-shore relationships will now be subject to related party compliances. This has been expressly stated in the CLC report as well. This will provide additional protection to private equity and other investors in case related party transactions are carried out without their consent.

By replacing the word 'company' with 'body corporate', the confusion as to whether companies incorporated outside India should be a related party or not, is put to rest.

Illustration: Currently if company X exercises significant influence over company Y, then Y will be an associate company and thereby, a related party of X. But this position will not make X a related party of Y. However, the amendment through the new language will make X a related party of Y. In effect, both X and Y will become related party to each other.

Section 35- Civil liability for mis-statements in prospectus

Clause © to Section 35 has been introduced to allow directors, promoters, and other parties under Section 35(1) to rely on statements, report or valuation of experts, as a defence for civil liability for misleading statements. This defense is available if the relevant person is able to prove that the statement or the extract of the report or valuation was a correct and fair representation, the person relying on such statement/report had reasonable grounds (up to the time of issue of the prospectus), to believe that the person making the statement was competent to make it and consent from such expert (as required under Section 26(5)) was given and not withdrawn before delivery of a copy of the prospectus for registration, or to the defendant's knowledge, before allotment under such prospectus.

Directors, promoters and other parties under Section 35(1) will be able to rely on expert statements as a defence for civil liability for misleading statements in a prospectus, unless the prospectus has been issued with an intention to defraud applicants.

Experts identified in the prospectus would be solely liable for statements prepared by them.

The CLC had recommended that it would be appropriate to hold experts liable for statements prepared by them, and on which the directors relied upon (as long as such experts were identified in the prospectus).

Section 42 – Issue of shares on a private placement basis

The section has been completely revamped.

Section 42 now contains an express provision that a company cannot utilise the monies raised through private placement unless such return of allotment is filed.

Clarification to the effect that the private placement offer and application shall not carry a right of renunciation.

Section 53- Prohibition on issue of shares at a discount

of the term 'discounted price' in sub-section 2 of Section 53 has been changed to 'discount',

Further, a new sub-section 2A has been introduced, which exempts applicability of Section 53 to shares issued pursuant to conversion of debt to equity, pursuant to any statutory resolution plan or debt restructuring scheme in accordance with any guidelines/directions/regulations specified by RBI.

The usage of the words 'discounted price' could have been interpreted to mean a price lower than the market value of shares, and not lower than its nominal value. To remove the ambiguity, the word 'discount', has been replaced with 'discounted price'.

Sub-section 2A has been inserted to facilitate restructuring of a distressed company, when the debt of such a company is converted into shares in accordance with any specified regulations or guidelines.

Section 89– Declaration of beneficial interest

The term 'beneficial interest in a share' has been defined: (a) to include 'direct and indirect' rights or entitlement of persons; (b) to factor in 'any' rights in shares as 'beneficial interests'; and (c) to include persons who 'collectively' hold beneficial interests.

The amendments are in furtherance of India's obligation to comply with Recommendations 24 and 25 issued by the Financial Action Task Force[2] (FATF) regarding transparency and beneficial ownership of legal persons/ legal arrangements.

An extremely wide definition has been included to reduce ambiguity as to what would constitute a beneficial interest. Further, there is a legal recognition for the concept that for the same shares, there may be multiple beneficial interest holders.

Corporate vehicles such as companies, trusts, foundations, partnerships and other types of legal persons conduct a wide variety of commercial and entrepreneurial activities. However, in certain scenarios, they have been misused for various illegal and illicit purposes such as money laundering, bribery and corruption, insider dealing, tax fraud and terrorist financing. FATF has established transparency standards to deter and prevent misuse of corporate vehicles and recommended countries to ensure that there is adequate, accurate and timely information on beneficial interest and control of legal persons which is easily accessible.

Although KYC/AML measures are in line with 'international standards', the concept of 'beneficial interest in a share' has been defined for the first time.

The definition has been worded broadly to reduce ambiguity as to the meaning of the term 'beneficial interest'. Further, there is a legal recognition for the concept that for the same shares, there may be multiple beneficial interest holders.

Section 90– Register of Significant Beneficial Owners

The whole of Section 90 has been revamped and the new concept of 'significant beneficial owner' and related reporting requirements (by companies and shareholders) has been introduced.

Holders of beneficial interest of not less than 25% of the shares, or the right to exercise, or the actual exercise of significant influence or control are now classified as 'significant beneficial owners'.

Beneficial owner refers to a natural person who ultimately owns or controls an entity and/or the natural person on whose behalf a company conducts its activities or transactions. It also includes (a) those persons who exercise ultimate effective control over a legal person or legal arrangement; or (b) situations in which ownership / control is exercised through a chain of ownership or by means of control other than direct control.

While we await the notification of rules from the MCA for maintaining the register of beneficial owners, the following duties are cast on the company under the new provisions:

  1. Identify the persons with significant beneficial ownership or control over the company and confirm their information;
  2. Record the details of the persons with significant beneficial ownership/control on register;

Update the information promptly on the company's own register when it changes.

The requirement of the register is an evolution in company law jurisprudence since:

  1. Generally, companies were prevented from taking on record any notice of trust on register of members; and
  2. Historically, 'share' of a company has always been considered an integrated bundle of rights, privileges and obligations, which cannot be separated, and assigned to different persons.

The requirement of maintenance of a register of significant beneficial ownership will certainly bring about complete transparency about holdings of shareholders including individuals, trusts and persons not resident in India, who may have significant influence or control.

While the FATF recommendations expected the basic information to be available generally and the details of beneficial ownership be available only with regulators or financial institutions, the Amendment Act seeks to make the register of beneficial owners open for inspection by any member. Further, we will have to await notification of rules as to whether the politically exposed persons can seek any protection / secrecy of their data.

It is desirable and recommended that the companies and shareholders are made aware of their obligations through guidance and awareness raising activities.

Section 135

A new proviso has been inserted after section 135(1), where a company that is not otherwise required to appoint an independent director under Section 149(4), can constitute a CSR committee with two or more non independent directors.

The wording of the previous clause conflicted with the statutory requirement of section 149(4) dealing with independent directors.

As a result, unlisted public companies such as JV's, WOS's or dormant companies which are not mandated to have independent directors for an NRC / AC or any other corporate governance were mandated to have independent directors solely for the purpose of setting up CSR committees.

The Amendment Act rationalises the language and facilitates constitution of CSR Committees for companies which are not required to appoint independent directors.

The provisions of Corporate Social Responsibility have also been extended to foreign companies.

Section 149– Independent Directors

In Section 149(6)(c), pecuniary relationships up to 10% of the total income of the independent director are now permitted

In Section 149(6)(d), the scope of the restrictions on 'pecuniary relationship or transaction' entered into by a relative has been expanded.

Further, the calculation methodology of residency requirement for directors has been changed from 'calendar year' to 'financial year'.

The provision now reverts to a recommendation of the JJ Irani Committee which had suggested the test of material pecuniary relationships for an independent director's disqualification.

The blanket ban on pecuniary relationships gave rise to practical difficulties owing to different regulations (such as the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015) prescribing materiality thresholds.

Section 177- Audit Committee

For related party transactions not covered within the scope of section 188, and where they do not approve such transactions, the audit committee is required to provide its recommendation to the Board.

Further, the Amendment Act seeks to empower the audit committee to ratify any transaction, other than RPTs under section 188, involving an amount not exceeding INR 10,000,000 if it was entered into by a director or officer of the company without obtaining the approval of the audit committee.

The audit committee was empowered to give omnibus approval for related party transactions whose value did not exceed INR 10,000,000. It is not clear whether ratification will still be required where a related party transaction is permitted under omnibus approval route. Rules to be notified by the MCA for this section might clear this confusion.

Section 185- Loan to directors

The section has been completely revamped.

The new section 185 seeks to restrict the prohibition on lending etc. only to certain individuals and firms.

Further, the prohibition on lending to companies and body corporates (in which any such director is interested) has been removed subject to fulfilment of certain conditions.

Section 186– Loans and Investment by company

A proviso has been added to state that, where a company provides loan, guarantee, security to (a) a joint venture company, (b) wholly owned subsidiary, or (c) invest in a wholly owned subsidiary, prior approval of shareholders by way of a special resolution is not required.

The carve out will simplify intra group financing for closely held companies.

Section 188– Related Party transactions

A clarificatory proviso has been introduced to exempt the blanket ban on a member voting on related party transactions, if 90% or more members (in number) are relatives of promoters or are themselves related parties.

This carve out for promoters and family members is pragmatic. An overwhelming majority of businesses in India are promoter driven and heavily reliant on debt/equity funding from family and friends, since not all businesses have access to institutionalised funding.

Sections 194 and 195- Prohibition on dealing in securities by directors or KMP/ Prohibition of Insider Trading

These sections are omitted under the Amendment Act.

The deletions are welcome since there were practical issues such as private companies being bound and listed public companies having dual regulatory compliance. This change seeks to reduce the regulatory overlap as prohibitions on forward dealing and insider trading will now be governed solely by the Securities and Exchange Board of India (SEBI).

Section 197– Managerial remuneration

The requirement for obtaining the Central Government approval for payment of managerial remuneration to its directors has been removed.

The proposed amendments in section 197 bring in a new regime where approval of the Central Government is no longer necessary.

While payment of managerial remuneration is freed from a regulatory hurdle, the approval process remains in the control of the shareholders who, in modern times, are only one of the multiple stakeholders in a company. The onus of balancing conflicting interests of various stakeholders continues to rest with the Board while recommending such proposals.

Missed Opportunities

  • Generic objects' clause

The CLC report had observed that there were adequate corporate filings that mandated disclosure of the current objects. In addition, sectoral regulators were always empowered to prescribe restrictive criteria and regulations on the nature of business. Therefore, a more liberal operational regime was recommended for companies. However, the requirement of including a generic objects clause / no objects clause has been not been included in the Amendment Act.

  • Monetization of goods and services for CSR activities

The Amendment Act could have addressed issues such as assigning a monetary value to a company's own goods and services for carrying out corporate social responsibility obligations.

Comment

Rather than pursue radical reform, the legislative intent of the amendment exercise appears to have been to liberalise where possible, and harmonise the compliance requirements with other laws. By carrying out over a hundred amendments to over 70 sections of the Act, it is fair to state that these objectives have been largely met.

Footnotes

[1]Companies Law Committee constituted by the Ministry of Corporate Affairs dated 4 June 2015.

[2]The Financial Action Task Force ("FATF") (www.fatf-gafi.org) is an independent inter-governmental body that develops and promotes policies to protect the global financial system against money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction. The FATF Recommendations are recognized as the global anti-money laundering (AML) and counter-terrorist financing (CFT) standard.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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