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Companies Act 2013: Time To Reboot?

Saket Shukla and Akshay Sachthey
31 Jan 2020 9:41 AM GMT
Companies Act 2013: Time To Reboot?
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The Finance Minister of India has one of the least enviable jobs in the country at the moment. With GDP growth on the decline and other macro-economic indicators not suggesting a quick recovery, Ms. Sitharaman has her task cut out. She is set to present the Union Budget for 2020 which is likely to face close scrutiny and will indicate the approach that the Modi government proposes to take to address the current, rather stubborn, economic downturn.

While the economy has been the subject matter of much debate recently, there is no doubt that the Government has shown intent for major policy and structural reforms. With reforms in the areas of foreign investment, corporate laws, insolvency, arbitration, MSMEs and other aspects, India has jumped up the World Bank's Ease of Doing Business rankings and now stands at the 63rd spot of 190 countries in 2020. An overhaul of archaic employment laws and new data protection and privacy regime are also underway.

With the Budget around the corner, we look at the numerous amendments made to the Companies Act, 2013 (Act), which has had a tumultuous journey in its short existence. Every policy framework needs to evolve to deal with practical challenges but this one has been marred with ambiguities that could have been avoided with clearer drafting and foresight from the outset.

Background to the Act

The Act was introduced with the objective of meeting the changed national, international and economic environment and to accelerate the expansion and growth of the economy in India. The Act is armed with 470 sections and was passed to overhaul the previous companies law, the Companies Act, 1956 (Old Act) which had 658 sections.

The Act is a culmination of much deliberation and debate, its provisions having been introduced first in the form of the Companies Bill, 2009, to which amendments were recommended by a Parliamentary Standing Committee, followed by the Companies Bill, 2011. Despite this, the Act has seen more than 150 amendments in the 7 years after its enactment. This does not include clarifications, circulars and orders issued by the executive, which have been a source of constant interpretation and modifications of the law.

Amendments to the Act

A few notable areas in the Act that have seen a fair share of amendments over the years are discussed below.

  • Company Incorporation

The company incorporation process, the infant stage of doing business, has seen a vast number of amendments.

At its inception, the Act provided 5 separate forms for incorporation which included separate applications for reserving a name, appointing first directors and registering an office. This was simplified in 2015 with an integrated form (INC-29) which covered allotment of director identification number (DIN), reservation of name and incorporation. Two years later, another overhaul came to be, with the introduction of SPICe (Simplified Proforma for Incorporating Company Electronically) which covered various services along with tax registrations under 1 form and eliminated the need for physical submission of documents. A separate process was introduced for a company to reserve a unique name (RUN). This was hailed as a bold step towards Digital India but practical difficulties meant that officials have been raising frivolous queries which have delayed the process and often culminated in applications being rejected without substantive basis. The procedure is proposed to be overhauled yet again with a new SPICe+ form and the RUN being done away with.

Well-thought out processes that eliminate the need for incessant revisions are required. A clearer set of instructions to the concerned officials handling incorporation procedures should also perhaps be considered in order to avoid practical snags.

It's also time to rethink the need for a physical registered office especially considering the Government's emphasis on the Digital India program and encouragement of innovation. With the introduction of compliance requirements and transparency measures that involve strict oversight over the identity of directors and promoters, the requirement of physical offices is losing significance.

  • Commencement of business declaration

Originally, the Act required that before a newly incorporated company commences business, the company's directors should declare that every subscriber to the memorandum of association has paid the value of shares agreed to be subscribed to by him/her. This requirement was deleted in 2015.

In 2019, the requirement was sought to be reintroduced by way of an amendment with certain additional qualifications. The rationale for the reintroduction is not clear. The requirement adds unnecessary compliance steps which are best avoidable.

  • Private company exemptions

The Act originally imposed relatively high compliance standards on private companies. This was in contrast to the Old Act in which private companies were given relaxations from compliance in many respects.

The compliances that applied to private companies under the Act included: an obligation to file copies of board resolutions with the Registrar of Companies, an obligation to comply with various procedural requirements while accepting deposits from members, a restriction on appointing 2 or more directors through one resolution, a restriction on interested directors in participating in board meetings, a restriction on advancing loans to directors or granting security for director loans and a restriction on purchase by the company of its own shares.

The enhanced compliance standards were largely considered burdensome, unnecessary and counter-intuitive for private companies. They were met with heavy negative feedback. Ultimately, the government issued 2 rounds of exemption notifications, in 2015 and 2017, in which compliance for private companies was relaxed.

The stricter treatment of private companies under the Act did not tie-in with the broader objectives for which it was introduced, i.e., streamlining the regime and accelerating growth. If the deviations were deliberate, the government should perhaps have made greater efforts to consult and take inputs from industry stakeholders before the new law was brought into force.

  • Related party transactions

The Act imposed conditions for companies to enter into 'related party transactions'. Certain prescribed transactions relating to supply of goods, sale, purchase or leasing of property, availing services, appointing agents, appointments to offices of profit or underwriting subscription to securities, which were entered into by a company with 'related parties' required approval from the company's board of directors and, where the transactions exceed prescribed monetary thresholds, shareholders' approval as well. The Old Act did not expressly recognize related party transactions although it required board consent for contracts in which directors were interested.

Here again, while the concept of a 'related party' was introduced, the definition of the term led to confusion. The original definition treated only Indian holding companies, subsidiaries or associate companies as 'related parties'. Holding companies, associates or subsidiaries outside India did not qualify as 'related parties'.

A report of the Companies Law Committee in February 2016 confirmed that the exclusion was unintentional. The definition had to be amended so that companies outside India or 'body corporates' also qualified as 'related parties'. The amendment also included investing companies and venturer companies within the definition. Clearer drafting of statutes from the outset can easily avoid the need for these sorts of issues.

  • Auditors' obligations

The Act substantially increased the obligations imposed on auditors. Auditors were required to report any offence involving 'fraud' to the Central Government.

Given the broad definition of 'fraud', the obligation to report could potentially have triggered for even smaller and inconsequential matters. The provisions were amended in 2015 and the Central Government was given the power to specify a monetary threshold beyond which reporting to the Central Government triggered. Matters falling below this threshold were required to be reported to the board of directors or the audit committee of the company. Subsequently, the rules relating to the auditors were also amended and INR 10 million was prescribed as the threshold for reporting to the Central Government. The threshold could also perhaps have been contemplated from the outset.

  • Significant beneficial owners

The significant beneficial owner (SBO) regime was introduced under Section 90 of the Act with the aim of identifying ultimate individual owners behind corporate structures. Individuals who qualify as SBOs need to make a declaration to the company. Companies were obligated to proactively seek information about SBOs from shareholders, maintain registers and file returns. The move was lauded for its attempt to bring in transparency and bring in a stricter regime for preventing financial crimes. That said, the SBO regime is also fraught with lack of clarity.

The first arises from the definition of an 'SBO'. Section 90 of the Act defines an SBO as an individual who (alone or jointly with others) holds beneficial interests of not less than 25% in shares, or exercises significant influence or control over a company. Section 90 permits the Central Government to prescribe a different percentage threshold of beneficial interests (other than 25%) to qualify as an SBO. The rules under Section 90 have effectively replaced the definition of SBO under Section 90. As per the rules, an SBO is an individual who holds the following rights and entitlements: not less than 10% shareholding, not less than 10% voting rights, right to receive not less than 10% dividend and exercise of significant influence or control (amongst other things). The rationale for reducing the threshold below the one prescribed by Parliament is unclear and could potentially present grounds for challenge. The rules also do not contemplate holders of other rights or entitlements qualifying as SBOs, which situation cannot be ruled out under the definition of SBO as per Section 90.

Another issue in the SBO provisions is that they do not clarify whether an individual 'acting in concert' with another would qualify as an SBO even where s/he does not by himself/herself hold an indirect stake in the subject company.

On the procedural front, it seems there was also a lack of preparedness for implementing SBO provisions since various forms and disclosure formats were not published until recently despite the regime having come into effect much earlier.

It is interesting to note that the Prevention of Money Laundering Act, 2002 and SEBI circulars also define a "beneficial owner" and the definitions there are different from the Act. Given the ambiguity in the Act, the definitions across various statutes could be aligned in order to ensure consistency. Existing jurisprudence on the definitions under the other statutes could also be used to understand its interpretation and ensure clarity in the definition.

Yet further, it is also worth considering limiting public disclosure of SBO filings made by private companies. Currently, the filings are accessible to the public on the Ministry of Corporate Affairs' website upon payment of a fee. Disclosures for private companies need not be made accessible to the public although the obligation to disclose SBOs and make reporting/filings with the authorities could continue.

  • Disqualification of directors

Under the Act, directors of companies which have not filed their financial statements or annual returns for 3 continuous years are disqualified from reappointment as directors in the same company and appointment as directors in other companies for 5 years. The Old Act contained similar provisions except that the provisions applied only to public companies and not private companies.

The disqualification provisions became effective in 2014 but their impact was felt in 2017, when the Ministry of Corporate Affairs issued a notification disqualifying over 300,000 directors associated with companies that had failed to file statements/returns from the years 2013-14 onwards. Since the disqualification provisions had come into force in 2014, the Ministry's notification seemingly gave retrospective effect to the provisions. This was not well received with objections being raised by various stakeholders. The government then came up with schemes for condoning delays by defaulting companies.

Writ petitions were also filed before various High Courts challenging the retrospectivity aspect, with the Delhi and Gujarat High Courts giving conflicting views which resulted in appeals before the Supreme Court of India.

  • Corporate social responsibility

The Act introduced the obligation for companies to make corporate social responsibility (CSR) spends of at least 2% of their average net profits during the immediately preceding 3 financial years, provided they meet certain profit, net worth and turnover thresholds.

The CSR provisions were amended twice since their introduction, with several changes aimed at clarifying ambiguities. Under the initial CSR provisions, the obligation to make CSR spends triggered if a company met profit, turnover or net worth thresholds in 'any' financial year. The unclear drafting led to confusion on whether the thresholds had to be met in any one single financial year since a company's incorporation or only the preceding financial year. An amendment was required to clarify that only the immediately preceding financial year was to be considered. Another amendment was made to rename permissible CSR matters as CSR 'areas or objects'.

The initial CSR provisions also required companies to constitute a CSR committee comprising at least 1 independent director but the provisions did not contemplate relaxations for companies that were not required to appoint independent directors. Similarly, it was not clarified how CSR spends would be calculated for companies incorporated less than 3 years ago. More amendments were required to clarify these issues. Again, better foresight on these matters could have avoided the need for these amendments.

Lastly, and most notably, in 2019, CSR defaults were sought to be punished with criminal consequences. This resulted in an uproar from concerned stakeholders and a high-level committee that was formed to examine CSR provisions ultimately recommended de-criminalisation. The amendment was eventually not given effect.

  • Voluntary liquidation

The Insolvency and Bankruptcy Code, 2016 (IBC) replaced the winding-up regime under the Act and the Old Act. The Act was amended and 'inability to pay debts' was deleted as a ground for winding up. This was replaced with the 'corporate insolvency resolution process' under IBC.

The IBC also introduced provisions for voluntarily liquidation of a company after passing of a special resolution by its shareholders and appointment of a liquidator by its board of directors. Despite this, curiously, the Act continues to have a provision under which a company can be wound up by the National Company Law Tribunal if its shareholders pass a special resolution. The rationale for retaining overlapping provisions in the IBC and the Act is not clear.

Conclusion

What emerges from this discussion is that the Act appears to fall short of providing a stable platform for enabling ease of doing business. The numerous amendments have meant that various provisions have been recast through interpretation and clarifications. This is a far from ideal situation and makes it difficult for businesses and investors to keep pace with reforms.

The Modi government has unmistakably gone all out to overcome the challenges of the past but a more proactive approach is required rather than reactive steps. The frequency of amendments required to be made to the Act is perhaps suggestive of the need to reboot and replace the Act with a more thorough regime.

Active engagement and consultations with relevant stakeholders right from the initial policy formulation stage would perhaps help in understanding potential concerns and challenges and coming up with a framework that is geared for dealing with these issues. The aim should be to ensure consistency across the provisions of the Act, its rules, regulations, circulars, notifications and clarifications, as well as other statues dealing with overlapping subject matters. A careful and educated consideration and analysis of future implications and challenges coupled with clearer and comprehensive drafting would minimize the need for constant review.

The government could also consider issuing clarifications in the form of a consolidated framework (such as the consolidated FDI policy or the RBI's master directions and master circulars) rather than through circulars and notifications issued in piece-meal over time. This could perhaps be done under the purview of the Central Government's power to remove difficulties under Section 470 of the Act.

While policy implementation will remain a major challenge and poses a second layer of roadblocks to the ease of doing business, as the first step, the government needs to turn its attention towards reviving the economy. As we look to the Budget 2020, the hope is for a clear and stable legal and policy framework which is the need of the hour. This would not only go a long way in boosting investor and business confidence but would lay a strong foundation for economic growth.

About the Authors

Saket Shukla is a Co-Founding Partner of Phoenix Legal who specializes in strategic advisory work through various phases of the business cycle including the inherent complexities of the Indian legal and regulatory environment.

Akshay Sachthey is a Senior Associate at Phoenix Legal who focuses on advisory work on a host of issues ranging from general corporate to strategic, contentious and pre-dispute matters.

Maryam Naaz Quadri is an Associate in the corporate team of Phoenix Legal and has worked extensively on corporate and commercial law matters.

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