Proposed amendments to India’s companies law would do away with much bureaucracy and bring India a step closer to modern international practices. By Bijesh Thakker in Mumbai

Since the Indian Companies Act was passed in 1956, it has been amended several times to keep pace with changing business realities. In spite of this, the 52-year-old law has many redundancies and is often viewed as a hindrance to the operational freedom of modern companies.

This has led to repeated calls for the act to be simplified and brought into line with international best practices. The result is the proposed Company Law Amendment Bill, which is based on a report compiled by the JJ Irani Committee.

The draft of the bill is not yet available for public comment. It is, however, possible to glean many of the likely implications of the bill from some of the Irani report’s more significant recommendations.

Welcome relief for foreign investors

One of the fundamental difficulties facing large international corporations with Indian ventures is geography. Directors may be located anywhere in the world, making it difficult to hold the required four board meetings a year. And as the number of financial investors grows, private equity and venture capital funds are finding it increasingly inconvenient to send their nominated directors to every board meeting of every company.

The Irani Committee proposes to alleviate this burden by allowing board meetings to take place via teleconference or videoconference. It also recommends abolishing the current requirement for businesses to obtain government approval before appointing a non-resident to a managerial position.

These moves will be widely welcomed by the international business community, but another of the committee’s recommendations – that at least one director of any company must be an Indian resident – is likely to be received with less enthusiasm.

Most multinational companies currently appoint Indian managers but keep directorial positions reserved for their international staff, particularly in the early stages of their operations in India. They see this as a necessary safeguard for ensuring that they meet international reporting and compliance requirements, but the amended regulations may oblige them to find Indian directors from the outset.

Independent directors

The recommendations also call for at least a third of directors in companies with significant public stakeholders to be independent. This is inconsistent with the current Listing Agreement of the Securities and Exchange Board of India (SEBI), which requires half of the directors of a listed company to be independent. It remains to be seen whether the final bill will bring these conflicting requirements into line.

The new provisions relating to local and independent directors would certainly be beneficial for corporate governance reasons, but in practice, they may prove problematic to implement. In view of the stringent liability norms for directors of Indian companies, many professionals are reluctant to take on the role. Companies may therefore struggle to find the required number of good independent directors.

Another hurdle that must be overcome is the establishment of an agreed definition of “independent directors”. A definition that has been suggested by the committee excludes personnel of audit firms and law firms appointed by the company from becoming independent directors.

Observers fear that a poor or weak definition could leave loopholes that would render the provision useless.

Corporate governance

The Irani report places a great deal of emphasis on strengthening corporate governance in India and makes several recommendations with this in mind.
The first relates to the financial year, which the Irani Committee would like to standardize for all Indian companies. The existing act does not prescribe a particular term for a financial year, but if the new recommendations are adopted, 31 March will become the standard date on which all financial years must end.

The greatest impact of this move may be felt by international companies, many of which synchronize the financial year of their Indian subsidiaries with those of their other units in different countries. Significant internal adjustments may be necessary for companies to implement the change, but the suggestion has been welcomed from a corporate governance standpoint as it would put all companies on the same calendar.

Another proposal in the report would give statutory recognition to consolidated accounts. Holding companies would have the option of consolidating the accounts (including balance sheet and profit and loss account) of a subsidiary. However, they would still be required to present and file separate annual accounts. Currently, only listed companies have to consolidate their accounts as a matter of law.

Many of India’s current governance requirements are set out in SEBI regulations that only apply to public listed companies. The Irani Committee would like to see parliamentary backing given to some of these norms, a move it believes would foster the internalization of strong corporate governance principles within companies, rather than simply relying on external checks by the government.

Protecting minority interests

In its current form, the Companies Act allows shareholders who hold 10% of a company to file for prevention of oppression and mismanagement by the majority shareholders. The Irani Committee would like to see this taken a step further. It recommends the creation of a statutory basis for class action suits as a measure to prevent the oppression of minority shareholders and improve overall corporate governance. There is concern, however, that interested parties could use these provisions to initiate frivolous litigation that would distract company management and place a heavy burden on India’s courts.

It remains to be seen whether these changes would give strategic investors or large financial investors any particular rights.

Freedom and confidentiality

For transaction lawyers, some of the proposals of the Irani Committee are of particular interest because they would allow greater freedom for transactions to be structured in a flexible and commercially sensitive manner.

Under the current law, the details of any joint venture agreements must be disclosed in a company’s articles of association in order to be enforceable. The articles of association are publicly available, which means that sensitive details of joint venture agreements can be accessed by members of the public and even competitors. The Irani Committee has responded to this concern by proposing that joint venture agreements should be enforceable in their own right, and that details of such partnerships need not, therefore, be included in a company’s articles of association.

It is not yet certain, however, whether the Registrar of Companies would require the parties to file the joint venture agreement, making it a public document. Such an action by the registrar may negate this important objective of the amendment.

The issue of differential voting rights between parties to a joint venture has also come under the scrutiny of the Irani Committee. Joint venture partners commonly agree to different rights between them in terms of voting, dividends, etc, but from a legal perspective, this has always been a grey area. It remains unclear whether shares can legally have differential rights and if so, how the system should function. The committee has called for greater clarity in this area and has proposed amendments that will give legal backing to transactions structured in consonance with agreements between the parties.

Streamlining mergers

Under current Indian laws, acquisitions are considered to be contractual matters but mergers are deemed to be court-driven processes. As a result, mergers are costly and time-consuming to implement and many companies have shied away from this route as a result.

The Irani Committee has rightly identified the problem and has recommended that contractual mergers be given statutory recognition under the new act. If this is accepted, it would not only reduce the burden on the Indian courts but also provide a tangible boost to mergers and acquisitions in India.

It should be noted, however, that parties to mergers would still be required to adhere to the provisions of the Competition Act, 2002, which makes it mandatory for mergers beyond a certain size to be approved by the Competition Commission of India, another time-consuming process.

Start-ups and shutdowns

Among its other notable recommendations, the Irani Committee suggests streamlining the process of moving a registered office from one state to another. New companies are often established at the offices of their advisers, and moved to another location once their financial viability is assured and their number of employees has grown. This can result in a lengthy and costly bureaucratic process that the committee would like to see simplified.

Furthermore, the requirements for operating and shutting down a business require much attention. In recent years, regulations associated with starting a business in India (from a domestic and foreign investment perspective) have become much easier to navigate. But the regulations related to the operation, management and liquidation of companies remain cumbersome and difficult.

Indeed, it is not uncommon for the unwinding of a special purpose vehicle to take longer than the project it was initially set up for, and the current procedure for a liquidating a business is so tedious that many now-defunct corporate entities are still listed in the Register of Companies.

The Irani Committee has recognized these problems and proposed a simpler exit mechanism for defunct companies. It has also proposed giving the Registrar of Companies the power to strike off defunct businesses.

Small companies

Many of the greatest implications of the Irani report are likely to be felt by small companies.

The report proposes a new system of multiple classifications for companies and calls for more lenient compliance requirements for smaller businesses.
One of new classifications may be for single-person companies. The existing act requires private limited companies to have a minimum of two shareholders (but in reality, many single-person businesses have got around this restriction by having a second shareholder who is merely a nominee of the first).

Under the current regime, companies of all sizes, from a small US$2,500 enterprise to a multi-million dollar conglomerate, have virtually the same statutory requirements for compliance. But as compliance costs increase, a system of multiple classifications and lower requirements for smaller companies could contribute to greater efficiency by enabling small companies to spend less time dealing with complex compliance issues.

It should be noted that smaller companies may be required to appoint independent directors, depending on the classification they are given under the new system.

Sooner or later?

If implemented, the recommendations outlined in the Irani report will mark a significant step towards bringing India’s Companies Act into line with modern international practices and business requirements. The proposed amendments will simplify many of the complex procedures mandated by the current statute and create a firm grounding for better corporate governance in India.

There are concerns, however, over the speed with which the new law will be enacted.

The subject is not politically sensitive and once introduced in parliament, the bill is likely to progress smoothly. Furthermore, the government has made it clear that it’s optimistic about introducing the bill during the budget session this year. But several factors conspire to suggest otherwise.

Foremost among these is the general election scheduled for 2009. As important as a new company law undoubtedly is, it’s not an issue with great populist appeal and its enactment is likely to pass unnoticed by the electoral masses.

It won’t be at all surprising therefore, if when electioneering takes centre stage, the company bill temporarily slips from the government’s list of priorities.

Bijesh Thakker is a partner with Thakker & Thakker, a Mumbai-based law firm. He can be reached at [email protected]