Update on India - November 2013

Highlights of the Companies Act 2013

• The Companies Bill was passed by the Indian Parliament in December 2012 and received assent by the President of India on 29 August 2013.
• The Companies Act 2013 (the “Act”) will replace the Companies Act 1956, on a date to be specified by the Government of India (the “Government”) in the Official Gazette of India. The Government has the right to make different provisions of the Act applicable on different dates.
• The Act has 470 sections and 7 schedules as against 658 sections and 15 schedules in the 1956 Act. Many parts of the Act will be explained in rules that the Government will issue over the next few months.
• 74% of the provisions of the Act require further legislation as a means of implementing the provisions. One of the main challenges of the Act is the absence of transitional provisions. Therefore further legislation will need to be passed to streamline the transition between the 1956 Act and the Act.

Highlights of the Act are as follows:

Key Managerial Personnel

• Certain companies will now have to appoint full time Key Managerial Personnel, such as a Managing Director or Chief Executive Officer, a full-time director, a Chief Financial Officer and a Company Secretary, as well as other officers that may be prescribed. The Act requires the Key Managerial Personnel to disclose to the Board of Directors all contracts or arrangements in which they have a direct or indirect interest.

Purchase of minority shareholdings

• A squeeze out provision has been introduced whereby once an acquirer or person acting in concert with an acquirer becomes the registered holder of 90% of the issued equity share capital of a company, such acquirer must notify the company of its intention to buy out the minority shareholding (this is not compulsory and only applies if it intends to buy out the minority shareholding). The price of the shares is determined by a registered valuer based on prescribed rules. Minority shareholders may also offer the majority shareholders an opportunity to purchase this minority shareholding, at a price determined by a registered valuer.

Class Action Suits

• The Act provides for class action suits by a requisite number of members or shareholders if they believe that the management of the company is detrimental to the company’s interests or that of its members or shareholders. They can claim damages from directors, auditors or expert or any other person whose actions have been detrimental.

Corporate Social Responsibility (“CSR”)

• Every company having a net worth of INR 5 billion, a turnover of INR 10 billion or a net profit of INR 50 million or more during any financial year must create a CSR board committee with at least one independent director.
• This committee will formulate the CSR policy, including activities specified in Schedule VII to the Act, which includes the promotion of education, social business projects and employment enhancing vocational skills. The Act states that companies affected will have to spend at least 2% of their average net profits of the preceding three years on CSR activities or alternatively make an explanation for why they did not in the Directors’ Report.

National Companies Law Tribunal (“Tribunal”)

• The Act contemplates the creation of the Tribunal and an Appellate Tribunal to conduct any proceedings relating to the Act, which were previously exercised by the High Courts.

Power of a Company to buy back its own securities

• A company may not buy back its shares within one year from the date of the closure of any preceding buy-back offer.
• A company also has to wait for a compulsory period of 3 years after cessation of and remedying a default in repayment of any term loan or interest thereon to any financial institution or banking company, repayment of deposits or payment of dividends to its own shareholders, before making an offer to buy back its own shares.

Reduction of Share Capital

• The Act consolidates the capital reduction provision and introduces some more checks and balances for any reduction in capital.
• A company cannot undergo a reduction if it is in arrears of repayment of principal or interest on any deposits accepted by it.
• The reduction involves an application to the Tribunal, which must give notice of this to the company’s creditors, to the Government, to the Registrar of Companies, and, in the case of listed companies, to the Securities Exchange Board of India (“SEBI”). The Tribunal is required to take into consideration any representations made by these parties within a period of 3 months from when they received notice of the application. If no representation is received within such time, the Tribunal will presume that none of the above has any representations to make in respect of the reduction.
• Each application for a reduction of capital must include an auditor’s certificate certifying conformity with prescribed accounting standards.

Put and Call Options

• Directors and key managerial personal are prohibited from buying put and call options in the company of which they are involved, and group/associated companies. This may well have an impact on existing exit arrangements with promoters.

Mergers and Amalgamations

• The Act introduces a fast track procedure for mergers and amalgamations involving certain classes of companies, such as between a holding company and its wholly owned subsidiary. The approval of the company court is no longer necessary as long as the official liquidator and the Registrar of Companies have no objection, and government approval has been given.
• It is now possible for Indian companies to merge into foreign companies if they fulfil certain conditions and have the prior approval of the Reserve Bank of India (“RBI”). The foreign company must also be incorporated in a jurisdiction to be notified by the Government.
• In the case of a compromise or arrangement between a listed transferor company and an unlisted transferee company, the Tribunal may now provide that the transferee company shall remain an unlisted company until it becomes listed. Further, if the shareholders of the transferor company decide to exit, the exit price cannot be less than the price under any regulations framed by the SEBI.
• The prohibition on insider trading has been incorporated in the Act, and now applies to unlisted public companies. This may have unintended consequences.

Layering restriction

• Groups may not have more than two layers of investment subsidiaries (except for regulatory compliance, and for acquisitions outside India.) This may have unintended consequences and group structures may need to be revisited.

Directors

• Composition: The Act introduces a residency test of at least 182 days’ stay in India in the previous calendar year, for at least one director on the board. Certain classes of companies (to be determined by the Government) must have at least one female director on their board. The Act requires at least one-third of the appointed directors of a listed company to be Independent Directors, to ensure transparency and independence in the decisions taken by the board
• Maximum Limit: The maximum limit on the number of directors for a public company has been raised from 12 to 15, which may be increased beyond 15 by shareholders voting with a 75% majority.
• Number of Directorships: The Act has increased the number of directorships a person can hold to 20, with a maximum of 10 of these being in public companies.
• Independent Directors: The Act stipulates that the Independent Directors may be selected from a data bank of persons eligible and willing, to be maintained by any institute or association as determined by the Government. The appointment of directors has to be approved by members in a general meeting and the explanatory statement to the notice should explain the background to such appointment. Independent Directors will not retire by rotation and can hold office for up to 2 consecutive terms of 5 years each following which, there would be 3 year “cooling off” period before the Director is reappointed. Independent directors will be eligible for fees, commission from profits and reimbursement of expenses. However they would no longer be eligible for stock options (they currently are). The Act also provides a code of conduct for Independent Directors, including a description of their roles, functions and duties, the manner of their appointment and resignation, and evaluation requirements.
• Liability of Independent Directors: The Act has drawn a distinction between the liability of an Independent Director and Non-Executive Director from the rest of the Board. The Act has limited the liability of Independent Directors only for all such acts of omission or commission by a company that had occurred with his knowledge (through board processes) and with his consent or connivance or where there has been a lack of due diligence. The burden of proof is on the director.
• Liability of Directors: The liability of a company and any officer in default for any contravention for which no penalty is stated, has been increased from INR 50,000 to INR 500,000.
• Duties of Directors: The Act has attempted to codify the duties of directors (with directors being required to act “in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment”). However this is not an exhaustive codification. Therefore many Common Law principles of duty such as “acting in good faith”, “exercise of due and responsible care”, “skill and diligence” and “exercise of independent judgment” will still be relevant.
• Disqualification of Directors: New criteria for the disqualification of directors have been introduced. For example, a director is now disqualified from being appointed as a director of any company if any of the companies on the board of which he is a director has not filed any financial statements and annual returns for 3 continuous financial years or has defaulted in the payment of debentures.
• Vacation of office: The Act requires a director to vacate his office on a conviction of any offence involving immoral behaviour, or otherwise, where he is sentenced to 6 months’ imprisonment or more.
• Resignation of Directors: The resignation of a director (although effective from the date of receipt by the company) has to be placed before the next general meeting of members. Directors are required to forward their resignation to the Registrar of Companies within 30 days of the date of resignation.

Meetings of the Board and its powers

• Notice of board meetings: Seven days’ notice must be provided for convening board meetings. A board meeting may be called at shorter notice if at least one Independent Director will be present at the meeting. In the absence of an Independent Director at a meeting with shorter notice, the decision can be circulated to all directors and will be treated as final when it is ratified by at least one Independent Director.
• Circular resolution: The circular resolution has to be approved by a majority of directors. Where any resolution has been put to vote by circulation and not less than one-third of the total number of directors require that the same be decided at a meeting, then the resolution shall be decided in such manner.
• Loans to directors: There is a blanket prohibition for a company for making any loan or providing any guarantee or security to any director or person in whom the director is interested in connection with a loan taken by any director or the person in whom the director is interested.
• Related party transactions: The Act has widened the scope of transactions included in this category but has done away with the requirement of governmental approval. An arm’s length transaction in the ordinary course of business continues to remain an exception, would be outside the scope of the section and would constitute a related party transaction. The Board’s report to the shareholders must include details of all the related party transactions including reasons for entering into such transactions. In listed companies, the related party transactions are required to be reviewed and approved by the Audit Committee.

Shareholders’ meetings

• Notice: The Act provides for clear 21 days’ notice for all general meetings, which should be served on directors and may be sent electronically.
• Quorum: The quorum requirements for general meetings of members have been altered, linking the number of members that will constitute a quorum to the number of shareholders of the company. 5 members present in person shall be the quorum for public companies if the total number of members does not exceed 1000, 15 members if the total number of members is up to 5000 and 30 members if the total number of members exceeds 5000.
• Proxies: The Government may prescribe a class of companies whose members shall not be entitled to appoint another person as proxy. Further, 1 person cannot be proxy for more than 50 members.
• Voting through electronic means: The Government will specify which classes of companies are permitted to use this option and how it is to be organised.
• Poll: The distinction between private and public companies’ eligibility to demand a poll has been removed. One member having not less than one-tenth of the total voting power, or holding shares of an aggregate of not less than INR 500,000 can demand a poll.
• Postal Ballot: This has been extended to all companies. A company may pass any resolution by postal ballot, with an exception for ordinary business, and business in which directors and auditors have to be heard.

Audit

• Appointment of Auditors: The Act requires an auditor to be appointed for a period of 5 years and this appointment must be ratified at each AGM, unlike under existing law where they are appointed at each AGM.
• Rotation of Auditors: The Act has introduced the concept of mandatory rotation of auditors and audit firms to ensure independence of the audit process.
• Removal of Auditors: The Act empowers the Tribunal, either on its own accord, or on the application from the Government or a person concerned, to direct a company to change its auditor, if it is satisfied that the auditor has acted in a fraudulent manner.
• Restriction on auditors from performing non-audit services: The Act proposes that any services to be rendered by an auditor should be approved by the board of directors or audit committee. The auditor is restricted from providing non-audit services.

Dividends

• Under the 1956 Act, companies had to transfer a specified percentage of profits to reserve. These provisions have been dispensed with and companies are now free to choose the amount they wish to transfer to reserve. The Government will pass rules in relation to declaring dividends out of accumulated profits from earlier years and transferring them to reserves.
• A company which has incurred any loss during the current financial year up to the end of the quarter immediately preceding the date of the interim dividend declaration cannot pay an interim dividend at a rate higher than the average dividends declared during the immediately preceding 3 financial years.

Miscellaneous

• Acceptance of Deposits: Companies can accept deposits only from members if this has been approved by members in a general meeting and complies with certain conditions including: depositing at least 15% of the amount maturing during the current and next financial year in a deposit repayment reserve account, providing deposit insurance in the manner to be prescribed and providing security, if any, for the repayment.
• Only public companies which have a net worth or turnover as the Government will prescribe can raise deposits from the public. In addition to complying with the above requirements these companies will also have to procure a credit rating for accepting deposits.
• For other companies, deposits accepted before the commencement of the Act, or any interest due on these, will have to be repaid either one year from the Act or from the date such payments are due, whichever is earlier.
• Restrictions on accepting deposits will not apply to banking companies, non-banking financial companies and any other companies specified by the Government.
• Dormant companies: The Act has introduced the concept of a dormant company which has fewer compliance requirements. Dormant companies are ones that are formed for a future project, or hold an asset or intellectual property right, and have no significant accounting transactions. In such a case, the company may make an application to the Registrar of Companies to obtain the status of a dormant company. The Act also provides that in the case of a company which has not filed its financial statements or annual returns for 2 consecutive financial years, the Registrar of Companies shall have the power to issue a notice to that company and enter the name of such company in the register maintained for dormant companies.
• One Person Companies: The Act has introduced a new business vehicle in the form of a single member company, which should encourage entrepreneurship. This dispenses with the current need to have a minimum of two shareholders.
• Small Companies: “Small companies” are defined as companies other than public companies with a paid-up share capital that does not exceed INR 5,000,000 or such higher amount as may be prescribed, not exceeding INR 50,000,000 and turnover which does not exceed INR 20,000,000 or such higher amount as may be prescribed, not exceeding INR 200,000,000. These companies are exempt from certain compliance requirements such as information to be provided in their financial statements and the manner of filing returns.
• Sick Companies: The Act provides that any company, as opposed to just an industrial company as under the previous legislation, the Sick Industrial Companies (Special Provisions) Act, 1985 can now be declared a sick company. Sickness is now defined by reference to an inability to repay debt, as opposed to the erosion of the net worth of a company. If a debtor company fails to repay its debt within 30 days from the receipt of a demand from a secured creditor representing 50% in value of the outstanding debt of the company, the debtor company is considered a sick company.
• A secured creditor whose debt is not repaid, or the debtor company itself, can apply to the Tribunal for a declaration of sickness. If the debtor company cannot offer a scheme for its revival, an interim administrator may be appointed by the Tribunal.
• The Tribunal is empowered to consider measures for the rehabilitation of the sick company and to permit an interim administrator or applicant to furnish a draft scheme for its revival and rehabilitation. A scheme may include the takeover of the sick company or rescheduling its debts. After considering all the possible measures, if the Tribunal concludes revival is not possible it can order the winding up of the company by the appointment of a company administrator.
• Winding up: The provisions of the Companies (Second Amendment) Act 2002 which sought to introduce changes to the winding up regime under the 1956 Act have now been brought into force with certain new provisions.
• Eligibility for summary procedure: Companies having assets of book value not exceeding INR 10,000,000 and belonging to the classes of companies which the Government may prescribe, may be wound up through a summary procedure.
• Appointment of an Official Liquidator: The Government may appoint an official liquidator of the company to be wound-up following a summary process.
• Powers of an Official Liquidator: On appointment, the official liquidator is required to take control of all the assets, effects and actionable claims of the company. It must then submit a report to the Government, within 30 days of its appointment, including its opinion on any fraud committed in the management of the company. The Government can then direct further investigation into the affairs of the company if it suspects fraud.
• Sale of Assets: The official liquidator is required to dispose of all the assets expeditiously within 60 days of its appointment.
• Recovery of Debt: The official liquidator must serve a notice requiring debtors of the company to deposit the amount payable by the company within 30 days.
• Settlement of claims: Creditors of the company are required to prove their claims within 30 days of receipt of the official liquidator’s notice. The official liquidator then prepares a list of claims and informs each creditor of any exceptions or rejections to his claim. Creditors aggrieved by the official liquidator’s decision may appeal to the Government.

We are very grateful to Khaitan & Co, the leading Indian law firm with offices in Mumbai, New Delhi, Kolkata and Bangalore, for allowing us to use their newsletters to prepare this briefing note.

You can contact Khaitan & Co at [email protected] for further information or specific advice on the issues covered by this briefing note.