Companies (Amendment) Act, 2019 - CSR Provisions become more stringent

The Amendment Act replaces the ordinance which was issued in February this year ,the validity of which was extinguished by the dissolution of parliament consequent upon the holding of General elections in the year. Apart from reaffirming some of the provisions in the ordinance , the Act springs a major surprise by way of  making  significant amendments to the provisions of Section 135 relating to corporate social responsibility(CSR).The amendments thereto have literally  set, the cat among the pigeons and caused consternation in corporate circles in particular, the introduction of sub-section(7) under Section 135 which contemplates imposition of penal deterrents including punishment by way of imprisonment for non-compliance of the Section. Through the insert of sub-section (8)the Central Govt. has clothed itself with powers to give directions to ensure compliance with the provisions by the companies which fall within the ambit of Section 135.In this exposition we shall articulate on the implications of the changes, their appropriateness against the backdrop of the dynamics of the  ecosystem. Lest it be assumed that we are running away with the story  in a hurry,herewith an  in-depth analysis of each of the changes made to Section135.

 

 

Readers are aware that once a company records a net profit of Rupees five crores or more  in the immediately preceding financial year, it becomes a candidate for the CSR spend  which has to be computed@2% of the average net profits made during the three immediately preceding financial years .The minimum spend  forCSR would be pegged down to 2% of the average net profits for the  preceding years. The linkage of the quantum of the CSR spend to the track record  of the Company’s  profitability for the preceding three years  has  led to the  conclusion in corporate circles  that a company which was in existence for less than three years would not be liable to incur any expenditure for CSR  since it did not have a three year average. To make it abundantly clear that even a company which is less than three years old would be drawn into the vortex of Section 135, after the expression”three immediately preceding financial years” as appearing  in Sub-section(5)  the following words have been  inserted  by the Amendment Act in the sub-section” or where the company  has not completed the period of three financial years since its incorporation, during such immediately preceding financial years’. The insert of the above words makes it clear thateven  a newly constituted company would be liable to incur CSR costs once it achieves the minimum profitability norm of Rupees five crores. Where a company has been in existence for say two years  the quantum of spend will be determined with reference to the average profitability for the preceding two financial years.

 

It is pertinent to note that the above amendment is prospective and becomes applicable from the date of its notification in the official Gazette. No law for that matter is retrospective unless it is expressly so stated. Having said this, the question  that comes to mind is what would be the response of the Ministry of Corporate Affairs (MCA)when it is confronted with a situation in which a company has proceeded on the assumption that it would not be a candidate for the CSR spend despite the fact that it  has satisfied the norm of minimum profitability , considering that in existence for  less than three years . The absence of clarity in the law on this point has led to the bona fide belief in corporate circles that the obligation for mandatory CSR spends is fastened on only  upon the completion of  three years of existence of a company and not when the company is in its embryotic stage. Considering the above, it is expected that the  MCA will take a pragmatic view and deal with the issue appropriately.

 

 

The second proviso as it stood before the amendment brought about now stipulated that where a company  hasfailed to incur the required amount towards CSR, it would be necessary for the Board of Directors to specify in their Report to the shareholders in Section 134(3)the reasons for not spending the amount. This proviso is being fortified by the Amendment Act to provide that the amount remaining unspent in respect of an on-going project which satisfies the conditions to be fulfilled taken up by the company pursuant to its CSR Policy shall be transferred by the company within thirty days from the close of a financial year to a special account to be opened with a scheduled Bank .The special Account shall bear the nomenclature ”Unspent Corporate Social Responsibility Account”. The amount lying in the said Account shall be spent by the company within three years from the date of the deposit  for meeting its obligations towards CSR.It is not clear from the amendment whether the utilization should be specific to the project undertaken by the company which is on-going. Logic   suggests that it should be so.If the amount remains unspent either partially or in full after the period of three years, the amount will have to be transferred to a fund specified in Schedule VII to the Act.Such transfer shall be made within thirty days from the date of completion of the period of three years. Under Schedule VII the funds specified are as under:

 

a) Prime Minister’s National Relief Fund or any other fund set up by the Central Govt for socio-economic development and relief and welfare of the Scheduled Castes ,the Scheduled tribes , other backward classes ,minorities and women

 

b) Contributions   to funds provided to technology incubators located within academic institutions which are approved by the Central Govt.

c) Contribution to the Swach Bharat Kosh set up by the Govt. of India.

 

The requirement to park the unspent amounts ear-marked in respect of a CSR Project which is incomplete  to an Escrow Account is ,in our view, retrograde in view of the fact that it would lead to locking up of precious  working capital resources.  A Company may, as a CSR initiative contemplate  the setting up of a speciality Hospital for the poor involving a large outlay .The project understandably will have a long gestation period. The utilization of funds for the project would be need-based depending upon the milestones achieved for the project thus leading to optimal use of capital.. The stipulation that the unused funds should be kept in the Escrow  would mean that funds needed for the project will  perforce be  locked up for prolonged periods. Admittedly, the funds locked up would accrue interest till their use but the yield thereon would hardly be commensurate with the cost of funds lying clogged in the Escrow.  Companies should have been allowed the flexibility to retain the funds as long as they complied with the requirement of ensuring their obligations towards CSR spends.

 

 

Section 135 as it stood prior to the amendments brought about by the Amendment Act  did not contain any specific penalty clause for non-compliance. Having said that, the second proviso under Sub-section(5)made it necessary for the Board to explain in their Report to the members, the reasons for not spending the required amount towards CSR.The contents of the Board’s Report are laid down in Section 134(3).Clause(o) under Section 134(3) stipulates that the Board should incorporate in its Report the details  about the policy developed and implemented  on CSR initiatives taken during the year. Under sub-section (8) of section 134, penalty by way of fine which shall not be less than rupees fifty thousand but which may extend to twenty five lacs shall be leviable for non-compliance with the requirements of Section 134 and every officer of the  company who is in default shall be punishable with imprisonment for a term which may extend to a term of three years or with fine which shall not be less than fifty thousand rupees but which may extend to five lac rupees or with  both. Considering the above  if the Board failed  to provide a report to the members on the lines of Section 134(3)(o), by a conjoint reading of Section 135 with Section 134, the penalty clause under Section 134(8) would be triggered off.The above view was also taken by the NCLAT in its decision delivered on January,31, 2019, in the case of Peregrine Guarding Private Ltd v Registrar of Companies.

 

It is also pertinent to note that in the absence of a specific penalty clause in Section 135 the   view was that the general penalty clause contained in Section 450 would lie.

 

All the above postulates stand obliterated in the wake of the introduction of Sub-section(7) by the Amendment Actwhich introduces specific penalties for non-compliance with sub-sections(5) or (6) of Section 135.The sub-section provides for a punishment by way of fine which shall not be less than fifty thousand rupees but which may extend to twenty five lacs and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than fifty thousand rupees but which may extend to five lac rupees.

 

The insert of subsection(7) to Section 135 puts an end to the debate on the point whether penal provisions are attracted for non-compliance of Section 135.Considering the fact that penal clauses now exist within the framework of Section 135 itself, it may  not be any longer correct to state that the penal provisions under Section 134(8) as explained above shall run concurrently with Section 135(7) for failure to provide the appropriate explanation in the board’s report as regards failure to make CSR spends.

 

 

Subsection(7) of section 135 as explained above, inter alia, providesthat  the officers of the company who are in default shall be liable to  the penalties stated above. It is important to note that the term ”Officer in default” has been defined under Section 2(60)  to mean, inter alia,  any of the following officers of the company:

 

a) whole-time director

b) Key managerial personnel(KMP)

c) where the company has no KMPs the director(s) specified in this behalf who have consented to the Board to such specification or all the directors if no director has been specified.

 

d) every director in respect of a contravention of any of the provisions of this Act who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same or where such contravention had taken place with his consent or connivance.

 

Under the residual clause stated above every director including independent directors could be roped in and subjected to penalty under Section 135(7) unless they can defend themselves by stating that they had voiced their dissent or that the contravention had happened without their consent or connivance. A case for rebuttal may be inherently weak given that the CSR Report is an integral part of the board’s report responsibility for which is collective.

 

The offence under Section 135 shall be subject to compounding within the framework of Section 441.

 

 

Under this sub-section the Central Govt. is empowered to give such general or special directions to a company or class of companies as it considers necessary to ensure compliance of Section 135 and the companies in turn are required to comply with such directions. The insert of the above subsection makes the provision open ended making it possible for the Govt. to provide more stringent directions to  specific companies who are recalcitrant and not compliant with  the Section.

 

 

It is obvious that the provisions relating to CSR have been made more rigid to ensure firstly that companies answering to the prescribed thresholds are perforce made to be CSR compliant even in their state of infancy. Whether there is any economic logic in imposing the burden on companies in their nascent stage is a matter for conjecture.Secondly, the insert of specific penalty clauses and their applicability to the directors will ensure that companies shall endeavour  willy-nilly to be on the right side of the law, given the downside of non-compliance. The “tightening of the noose” as it were in terms of the rigours in the legislation drive home the fact the CSR provisions are mandatory and adherence thereto is nolonger an option. The Govt’s overdrive on the subject has obviously been triggered off due to empirical evidence of non-compliance of the legislation by a cross section of companies.