Hurry leads to a harried India Inc

A new law usually provides reasonable time for familiarisation and compliance by those required to do so. This ‘good practice’ has not been followed while notifying the Companies Act, 2013 (“Act”), which replaced the Companies Act 1956.

Nearly 100 sections were notified to come into force immediately in August and September, 2013, and the corporate social responsibility provisions were notified in February to come into effect on April 1, 2014. During March 26-31, 183 sections (6 Schedules and various rules) were notified, with the majority coming into force from April 1 and others from the date of publication.

To add to the confusion, several rules on the website of the ministry of corporate affairs, which come into force from the date of publication in the Gazette, continue to carry the legend “To be published in the Gazette of India”.

Despite this, there are several provisions that are welcome, such as the removal of government approval for certain transactions with related persons, and the requirement to have a woman director for listed and certain public companies.

The requirement of one-third independent directors for listed and certain public companies, as well an internal auditor for listed and certain companies with specified turnover or having borrowings in excess of specified amounts are also positive.

So is the introduction of electronic voting and electronic mode of communication, and the provision for creating a one-member company, although this is available only to an Indian citizen resident in India for 182 days during the preceding year.

However, some provisions are unnecessary, for example, the requirement to print the corporate identification number on the company’s business letters, billheads, notices and official publications in addition to the name and address of the registered office, telephone, fax, e-mail ID and website. So too the requirement to print all former names during the previous two years, in case of name change. Equally unnecessary is the requirement to have not more than a gap of 120 days between board meetings and that even a private company must have a director who has stayed in India for not less than 182 days in the previous year.

Several important sections are clumsily drafted.

Loans to subsidiaries Under the 1956 Act, the limits on loans and investments did not apply to ‘holding company-subsidiary’ transactions and to private companies.

This exemption was removed by the Act, with the result that if the limits were exceeded, shareholder approval became necessary. Due to numerous representations, the Companies (Meetings of Board and its Powers) Rules, 2014 ‘rolled back’ these provisions, stating that special resolution will not be required by a company for: (i) loans given to wholly owned subsidiaries; (ii) guarantee or security given to a bank or financial institution for a subsidiary; (iii) loan, guarantee or security given to a wholly owned subsidiary or joint venture; and (iv) investments in the securities of a wholly owned subsidiary. However, the ‘roll-back’ questions the wisdom of the change in sections 185 and 186.

Related party transactions Similar lack of pragmatism (and poor drafting) is evident in the related party provisions. Sub-clauses (a) to (g) of section 188 specify seven instances, including contracts or arrangements of sale, purchase or supply of goods, materials or rendering of services and leasing of immovable property (earlier exempt) where if the contract is with a related party, apart from Board approval, 75 per cent affirmative vote of shareholder (special resolution) is required. More importantly, the related party shareholder cannot vote.

Thus, the concept of ‘interested shareholders’ (alien to shareholders in company law jurisprudence) has been introduced for the first time and is entirely un-pragmatic in the context of private, closely held companies. Further, section 188 applies to a company having a paid up capital of ₹10 crore or where the individual transactions specified in sub-clauses (a) to (g) exceed the prescribed financial limits. The use of the word “or” renders the individual financial limits meaningless except for companies with a paid up capital of less than ₹10 crore. Therefore, if a company’s turnover is ₹10 crore (or more), a special resolution is necessary even for a token financial transaction of one rupee. This too appears to be the result of poor drafting rather than a deliberate consequence.

Additionally, due to the new definition of “holding company”, foreign companies incorporated outside India are outside the ambit of ‘related party’. Consequently, transactions between foreign companies and their Indian subsidiaries are not ‘related party’ transactions for purposes of section 188 (although they may be related parties under the Income-tax Act and Accounting Standard 18).

Therefore, corporate India will have to untie several knots to unravel the true meaning and ensure compliance. The redeeming feature, however, is that arm’s length transactions entered into in the ordinary course of business are exempt from the ambit of the unhappily worded section 188!

The writer is a senior partner at Associated Law Advisers