The Companies Bill, 2012, and corporate governance

By Shweta Diwan, Mulla & Mulla & Craigie Blunt & Caroe
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Since financial liberalization in the 1990s, efforts have been made to introduce corporate governance initiatives by the government of India – through the Ministry of Corporate Affairs and the Securities and Exchange Board of India – and by industry and business associations.

Shweta Diwan
Shweta Diwan

Today, the principles of corporate governance in India encompass voluntary and mandatory requirements. Public listed companies have to comply with corporate governance norms enshrined in clause 49 of the listing agreement while for private companies the regulations are largely voluntary in nature.

Recent financial and corporate scams such as Satyam revealed an urgent need to re-examine and reform the corporate governance regime in India. To this end, the government of India, in tune with international developments and to deal with changing realities, introduced the Companies Bill, 2012, which seeks to impose mandatory corporate governance norms on Indian companies.

The Companies Bill, which is to replace the Companies Act, 1956, was passed by the lower house of India’s parliament on 18 December 2012 and is pending in the upper house.

With a view to improving transparency and accountability, the Companies Bill develops certain extant principles of corporate governance in India and at the same time proposes fresh concepts such as corporate social responsibility.

Independent directors

Previously, the concept of independent directors was found only in the listing agreement. The Companies Bill requires that at least one-third of the directors of a public listed company are independent directors.

The key features of board independence embodied in the Companies Bill include: (a) independent directors must furnish a declaration confirming that they satisfy the conditions of independence at the first board meeting in which they participate and subsequently on an annual basis; (b) the tenure of independent directors is limited to two consecutive terms of five years each, on completion of which they would be entitled to be reappointed only after a hiatus of three years; (c) independent directors are not subject to retirement by rotation; (d) independent directors are prohibited from receiving stock options; (e) the liability of independent directors is restricted to acts of omission or commission which occurred with their knowledge.

Corporate social responsibility

In a bid to inculcate social responsibility in the Indian regulatory framework, the Companies Bill requires companies that have during any financial year a net worth of5 billion (US$92 million) or more, or turnover of ₹10 billion or more, or net profit of ₹50 million or more to establish a corporate social responsibility committee of the board comprising at least three directors of whom one must be an independent director.

The board of directors of such a company must ensure that in every financial year a minimum of 2% of its average net profits made during the previous three financial years is spent on corporate social responsibility activities.

While the corporate social responsibility committee is primarily responsible for preparing the social responsibility policy to be approved by the board and recommending the sum to be spent on such activities, the board must disclose the contents of the policy in the board report and ensure compliance by the company.

Although the Companies Bill does not impose any specific penalties in the event of failure to implement corporate social responsibility policies, board members are obliged to render an explanation for the failure.

Rotation of auditors

The Companies Act, 1956, does not provide for compulsory rotation of auditors. This has resulted in the same audit firms acting for companies for long durations, with annual reappointment reduced to a mere formality.

To overcome this, the Companies Bill prohibits listed companies from appointing or reappointing as auditors an individual for a term of more than five consecutive years and an audit firm for more than two terms of five consecutive years. Further, such individual auditors and audit firms cannot be reappointed unless five years have elapsed from completion of the permitted term.

Shareholders have also been vested with powers to rotate at regular intervals their appointed audit firm’s auditing team, including the auditing partner, to ensure that the audit is conducted by two or more auditors.

The mandatory replacement of auditors, though expected to enhance the quality of auditing and ensure independent reporting, may impose a substantial financial burden on companies.

The Companies Bill, if passed, would afford impetus to India’s corporate governance framework. However, in India, as in other developing countries, the effectiveness of corporate governance is often diminished by inordinate delays in the legal system. A solution to this may lie in the evolution of a stricter penal system coupled with proactive means of enforcement.

Shweta Diwan is a senior solicitor associate at Mulla & Mulla & Craigie Blunt & Caroe in Mumbai.

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