Company Law Committee Report 2022 Suggests Many Amendments, Including Issue Of Fractional Shares

The Company Law Committee has been constituted by the Ministry of Corporate Affairs (MCA) and entrusted with responsibilities including promotion of greater ease of doing business for law-abiding corporates and improving the operational efficiency of the Companies Act, 2013 and Limited Liability Partnership Act,2008 ("LLP Act, 2008").

The recent CLC report aims to overhaul the existing framework, recognize as well as introduce new concepts (such as fractional shares), improve ease of doing business and address certain intricacies present in the existing provisions of the Companies Act, 2013.

Amending Chapter IV; Recognizing The Issuing And Holding Of Fractional Shares

Section 4 of the Companies Act 2013, as well as paragraph 4 of Table F, currently limit the issuing and holding of fractional shares. A fractional share is a fraction of a share that is less than one unit. Fractional shares can result from business acts such as mergers, issue of bonuses, or rights issues. Given the growing role of retail investors in the Indian financial market, the Company Law Committee has proposed that the Companies Act be amended to include provisions that allow for the issuance, holding, and transfer of fractional shares in dematerialized form for a class or classes of companies in the manner prescribed. Such prescriptions may be made in consultation with the Securities Exchange Board of India for listed companies. CLC also highlighted that this proposal only applies to cases in which the company issues new fractional shares, not to cases in which fractional shares are formed for the time being as a result of corporate action.

The proposal to allow the issuance and holding of fractional shares would benefit small investors who do not have the budget or purchasing power to purchase a whole share due to the high price of a single unit, as it would allow them to invest precise and predetermined budgeted amounts in companies whose shares are otherwise inaccessible to them due to high prices. Secondly, because the issuance of fractional shares is an international practice, it will assist India in aligning its norms with internationally established standards and norms. Furthermore, it would increase stock market investment and allow companies to raise capital from a previously untapped pool of retail investors.

Proposal to recognise the issue of Restricted Stock Units (RSUs) and Stock Appreciation Rights (SARs) to employees by amending section 62 (1)

Currently, Employees' Stock Options ("ESOPs") and Sweat Equity Shares are the two types of stock options recognised by the Companies Act of 2013 for employees. The Act does not specifically recognise any other manner of issuance. The Committee suggests that additional employee compensation schemes linked to the value of a company's share capital be recognised. Employees can subscribe to the company's equity capital through RSUs and SARs, for example. SARs are presently specified under the SEBI (Share Based Employee Benefits and Sweat Equity)Legislation, 2021, while RSUs are not covered by any regulations. RSUs are not a scheme in which the employee can buy or subscribe to a share directly; rather, they are a scheme in which the employee will be entitled to the shares at the completion of the vesting term, as long as the constraints on employment tenure and performance standards are met. SARs, on the other hand, are a type of incentive or deferred compensation related to the stock performance of the employing company. They give employees the right to the monetary equivalent of the appreciation in the value of a specified number of shares over a set period of time. Settlement of SARs can also be done in the form of company shares.

If these schemes need the issuing of additional securities by the company, the committee further proposed that such issuance be permitted only after shareholder approval via a special resolution. The provisions should also provide for a yearly omnibus approval by the company's shareholders, so that no new approvals are necessary for each allotment of such schemes. Certainly, this is a positive step because employees are the firm's most valuable asset, and similar to the benefits of providing employee stock options, issuing SARs and RSUs to employees will increase their morale, resulting in higher performance and, in turn, better results for the company as a whole.

Amendments in Section 132 – National Financial Reporting Authority (NFRA)

According to the Companies Act, the Union Government has the authority to establish the National Financial Reporting Authority to handle issues pertaining to corporate accounting and auditing standards. The NFRA works to safeguard the public interest as well as the interests of creditors, investors, and other parties connected to the companies or other corporate entities. While taking note of the NFRA-related legislation, CLC has suggested that by enforcing penalties against auditors, creating a specific NFRA fund, and establishing regulations, NFRA's operational autonomy can be increased.

• Amendment In Section 132(4) – Taking Penal Action

The NFRA does not have the authority to take appropriate action against a member or company in cases of professional or other misconduct as defined in the first and second schedule of the Chartered Accountants Act (CA),1949, in accordance with the provisions of section 132. The only authority NFRA has is to look into any member's or firm of chartered accountants' misconduct that is registered under the CA Act of 1949. If any misconduct is established, the NFRA has the authority to penalise a member or firm or to prevent them from being selected as the company's auditor. As a result, the CLC has suggested that the NFRA be given the authority to enforce compliance with the Companies Act and its related regulations. If its orders are not followed or an appeal has not been filed against one of its orders with the NCLAT, it shall also be able to take the proper punitive measures.

With this adjustment, it will be made sure that professionals provide accurate and effective services to companies. The NFRA will now have more authority to punish any members or companies that engage in unethical behaviour.

• Amendments In Section 132 – Having A Dedicated Constitution Of NFRA Fund

At the present time, the Union Government provides the NFRA with all of its funds. These funds are used for (a) the Chairperson, Members, and other officials and staff of NFRA's salaries, allowances, and other benefits; and (b) additional expenses related to the NFRA's functions and objectives. Regulatory agencies like NFRA need the required competencies to carry out their duties due to their specialised nature. Now, the CLC has recommended that NFRA include the same financial autonomy clauses that apply to other regulatory organisations. Thus, the CLC has advised that necessary amendments be made to the Companies Act in order to establish an NFRA Fund, in accordance with the "Board Fund" under the Insolvency and Bankruptcy Code ("IBC") and "Competition Fund" under the Competition Act.

• Amendments In Section 132 - Making Regulations

The NFRA is not allowed to independently create any regulations under the current norms. The CLC recommends granting NFRA the authority to enact some regulations - a) the format and method of filing information with NFRA and b) the place, time, and protocol for NFRA meetings. The Committee further recommends giving the NFRA chairman, the powers of general superintendence and direction within NFRA. The amendment seeks to improve the NFRA's internal operations; necessitating subject-matter expertise and immediate requirement for regulation.

Amending Section 149: Commencement Of Tenure Of An Independent Director (ID) From Date Of His Appointment As Additional Director

As per Section 149(10) of Companies Act, 2013, the maximum tenure of an Independent Director (ID) is 5 consecutive years. He is eligible for re-appointment for next 5 years only with a prior approval of the shareholders of the company.

Section 149(11) mentions that an Independent Director shall not be allowed to continue its tenure as an ID for more than 2 consecutive terms of five years unless the requisite cooling-off period of 3 years has been expired, after which he can be re-appointed.

The committee clarified that the period of 5 years will start from the date of appointment of Independent Director as an Additional Director. The period of Independent Director working as an Additional Director before regularization will be also included while calculating the total tenure of Independent Director.

This clarification provided by Company Law Committee (CLC) is welcomed by India Inc. and has resolved the ambiguities.

Provision For A Mandatory Cooling-Off Period: Proposal Of CLC To Amend Section 196(3)

The existing framework of the Companies Act, 2013 provides no limitations with reference to appointment of the Independent Director as a managerial person in the same company or group of companies after he ceases to be an ID of that company. An Independent Director is a Director other than a managing director or a whole time director or a nominee director who is eligible as according to the criteria mentioned in Section 149(6) along with Rule4 and 5 of the Companies (Appointment and Qualification of Directors) Rules,2014.

Regulation 25(11) of SEBI(Listing Obligations and Disclosure Requirements), 2015 specifies the mandate of not appointing an ID as an executive director or WTD on the board of company, its holding, subsidiary, associate company or any other company from its promoter group who has resigned from a listed entity. The restriction is up till 1 year from the resignation date.

In order to restrain an ID from becoming a managerial person up till 1 year from his resignation date, the Company Law Committee suggested that similar provisions could be also inserted into the Companies Act, 2013. This will help in harmonizing the provisions of Companies Act, 2013 with the Regulation 25 of SEBI (Listing Obligations and Disclosure Requirements), 2015. The compulsory cooling period will ensure that no compromise is being done in the independence of the director during his tenure as an ID.

Recommendation To Amend Section 366 Of The Companies Act, 2013

Section 366 permits the conversion of cooperative societies into a company without fresh incorporation. In its contradiction, the RBI's scheme permits the conversion of a Primary (Urban) Co-operative Banks (UCB) into Small Finance Banks (SFB) only after incorporation of a fresh company under the Companies Act, 2013 because the license of UCB cannot be directly converted into that of the SFB. Therefore, the banking license is transferred after RBI gives an approval to the SFB which is a newly incorporated company.

As it is evident that the existing provision of the Companies Act is not in consonance with the RBI's policy, the Company Law Committee proposed a recommendation to amend Section 366 in order to prohibit the conversion of co-operative societies into a company.

The proposed recommendation will ensure that the existing provisions are in line with the RBI's policy and therefore, it will bring uniformity within the existing norms.

Recommendation Of The Committee To Bring Clarity In Provisions

Setting up of a Risk Management Committee – The Companies Act, 2013 lacks a specific provision for setting up a risk management committee. However, Part D of Schedule II of SEBI (LODR) Regulations, 2015 specifies for setting up of a risk management committee responsible for formulating a framework to identify risks faced by entity, suggesting measures to reduce the same and evaluating adequacy of risk management systems.

The committee came up with the proposal to incorporate new provisions in the Companies Act, 2013, for setting up of a risk management committee, as a separate committee on the board, after it has noted that risk management allows efficient working of every company.

The proposed recommendation will help the Board to fulfil its corporate governance responsibilities in terms of risk evaluation and risk control.

Proposing amendments to address inconsistencies – The committee acknowledged the need to remove inconsistencies in various provisions of the Companies Act, 2013 by amending certain provisions such as :

1. Section 136 (1)
2. Section 164(1) (g)
3. Section 187

The proposed amendment will ensure uniformity in provisions and help in removing ambiguities.

. The effective implementation of the suggested recommendations would mark a significant turning point in India's corporate governance and regulatory framework, enhancing the overall effectiveness of the Companies Act 2013 and proving advantageous to all the stakeholders involved in the corporate business structure.

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