Cos Act 2013: Field day for minority shareholders

The Indian Companies Act 2013 will have far-reaching implications for domestic Indian companies and overseas investors. Some provisions remain inoperative and might be made effective by the government in due course.

The Act has effected significant changes in the manner in which boards of companies must be constituted by mandating that at least one director must necessarily be resident in India for a minimum of six months during the previous calendar year.

 Also, listed companies and certain other classes of companies as prescribed under delegated legislation would require at least one woman director on their boards. All listed and unlisted Indian companies satisfying certain conditions are now required to have at least a third of their board comprising “independent directors”. The new law prescribes stringent criteria for people to qualify as independent directors. It says a nominee director would not be considered “independent”. 

On legal responsibility, the law has enlarged the scope of the expression “officer in default”, which now includes directors who do not object to questionable decisions taken at board meetings. This means directors can now be held responsible for acts of omission as well. Therefore, existing and future foreign investors need to significantly restructure their boards and bring about a higher degree of care in order to comply. 

Under the old Companies Act of 1956, an ordinary resolution requiring a simple majority of shareholders was sufficient to sell a substantial part of the undertaking or borrow money above certain specified thresholds. 

But under the new Act, these decisions can only be exercised subject to a favourable special resolution requiring a three-fourth majority of shareholders. Special resolutions may also include conditions and the applicability of the provision has been extended to private companies as well. 

Further, there have been several important additions to the list of powers which are to be exercised by directors only at a board meeting, and therefore, cannot be delegated. 

These include approval of financial statements, diversification of business and approval of mergers and takeovers. Foreign investors ought to be wary of these changes, as they significantly curtail the decision-making power of the board and require increased shareholder support for positive company outcomes.

Related party transactions

The range of related party transactions under the new Act has been significantly enlarged when compared to the provisions of the old Act. Now, a shareholder of the company who is a related party vis-a-vis a counterpart in such a transaction, is not permitted to vote while approving the transaction. 

However, “arm’s length transactions” entered into by the company in its “ordinary course of business” are exempt from the related party rule. “Arm’s length transaction” is defined as “a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest”. 

The expression “ordinary course of business” has not been defined in the 2013 Act, and will have to be determined on a case-to-case basis. 

The law, importantly, now includes an “associate company” within the ambit of the term related party. This was a point of clash in the 2G spectrum case between the CBI and the accused corporate entities. An associate company in relation to a company is a company, other than a subsidiary, in which the first mentioned company has “significant influence”, controlling at least 20 per cent of the share capital or business decisions under an agreement, and specifically includes a joint venture company. 

Given that the 2013 Act mandates that no related party can vote on several important company resolutions, it is possible that in certain cases the “majority” related party shareholders could be prevented from voting and minority shareholders would in effect get decision-making power. An interested director cannot remain present at the company’s board meeting when a related party transaction is under discussion and vote. 

Further, the exemption under the 1956 Act for interested directors of private companies has been done away with, thereby extending the application of the provision to private companies as well. 

The 2013 Act also specifically prohibits forward contracts and ‘put’ or ‘call’ options between the directors/key managerial personnel of a company and the company or any holding, subsidiary or associate company. 

The Act has ushered in certain innovative provisions relating to corporate social responsibility (CSR). A company that has a net worth of at least Rs 5 billion or turnover of at least Rs 10 billion or net profit of at least Rs 50 million during any financial year, will be required to constitute a “Corporate Social Responsibility Committee” with three or more directors to frame and oversee the company’s general policy and specific activities.

More conditions

The Act mandates that every such company must spend at least two per cent of the average net profits of the company in every financial year on CSR. However, any profits arising from overseas operations conducted through foreign branches or subsidiaries and dividend received from other companies in India will be excluded. In the event that a company does not comply with its CSR, the board will have to explain why along with the company’s yearly financial statements. 

The law does not prescribe any sanctions for non-compliance with the obligation to spend the 2 per cent as long as the board records reasons for this. For foreign companies present in India, the CSR obligations become directly relevant, because delegated legislation under the 2013 Act has mandated that the provisions will also apply to foreign companies having place of business in India or any business connection with India in any form. 

While it is unlikely that this would include foreign companies other than those in which more than 50 per cent of total paid-up share capital is held by Indian citizens or Indian companies, in the absence of a clarification, all foreign companies with any presence in India would be required to comply. 

The new law also imposes several onerous conditions for inter-corporate loans. It says a special resolution — three-fourth majority — is required for loans exceeding the prescribed threshold of 60 per cent of the paid-up share capital, free reserves and securities premium account of the company, or 100 per cent of free reserves and securities premium account of the company, whichever is higher. 

Unanimous approval

Further, unanimous approval of all directors present at the board meeting is now required. This will apply to private companies as well, and therefore, make it more cumbersome for a private company to give loans to its affiliate companies. The new Act also prescribes some enhanced disclosure requirements for loans, investments, guarantees and securities.

For new businesses in India, private companies used to be the preferred business vehicle due to lesser compliances. However, several of those advantages have been obliterated by the new law. 

For instance, there were no restrictions on private companies issuing shares with differential rights and creating multiple classes. Further, in the earlier regime, as long as there was enough headroom in the authorised share capital, private company boards could themselves issuing shares (regardless of whether it was a rights issue or preferential allotment). Both these processes have now become more cumbersome.
(The writer is an associate with the corporate law team at Khaitan & Co, Mumbai. This is the first of a two-part series that provides a brief analysis of some of the key changes that became largely effective on April 1)