Sprucing up the Companies Act, 2013 and the rules thereunder: A long journey ahead

Readers   are aware that endeavours  to bring in a new law to replace the Companies Act of 1956 on the ground that it had become antiquated and outlived its usefulness were on for quite some years. Despite the prolonged period of incumbation ,  one must honestly confess that the Companies Act 2013(herein after ”the Act”) and the Rules there under , appear to be a hastily put  together  document , given the whole lot of anomalies, blatant grammatical errors and  the ambiguities that have crept into the same. By approving the Companies (Amendment) Bill,2014, on December,2,2014,the Union Government has spelt out clearly its intentions to remove the road blocks and confusion created by the new Law.

”Well begun” it is often said means the job is only “half done”. It is therefore fervently hoped that the “cleansing operation   ”, in a manner of speaking, will continue unabated  in the  same spirit of the “swatch bharat” campaign which  has been launched with so much zeal and gusto by the Govt.

We wish to list out  in this exposition, some of the imperfections in the Act and in the Rules so that these could be examined by the powers that be, leading to appropriate amendments being made to the Act and the Rules before long.

Amendments to important definitions

Associate Company - Section2(6)

An Associate company has been defined to include a ‘Joint Venture Company”. This term has not been defined anywhere in the Act. The need to define the term arises due to two reasons. Firstly the proportion of interest held by an Entity in a Joint venture should logically decide the question as to whether the Joint venture Company is an Associate or not. Secondly the Explanation under Section 129(3) of the Act considers a joint venture as a “subsidiary “ for the purpose of drawing up the consolidated financial statement of the company for presentation to the members.

Independent Director-Section 2(47)

As per the Section  an “Independent Director” means an Independent Director referred to in subsection (5) of Section 149.Ironically if one looks at Section 149,the attributes of an Independent director are to be found in subsection(6) there under and not in subsection(5).Section 2(47) needs to be modified accordingly.

Relative- Section 2(77)

The list of Relatives has been amplified by Rule 4 in the companies (Specification of Definitions Details) Rules,2014.As per the list whereas, the term “son” includes a step-son, a daughter does not include a step daughter!. Ironically the term “sister” in the same list includes the step-sister! Obviously this is a drafting error which can be addressed easily.  

Total Share capital - Rule 2(r ) -  companies (Specification of Definitions Details)Rules,2014

As per the above Rule, for the purposes of clause (6) in Section 2 which defines an Associate company and clause(87) of section 2 which defines a “subsidiary company”, total share capital represents the aggregate of the paid up equity share capital and convertible preference share capital.

It follows from the above that for determining whether a company is an Associate company and a subsidiary company respectively under Sections 2(6) and 2(87) aggregate of both the equity and convertible preference share capital shall be considered.

In as much as the above definition sets out the bench marks for determining the Associate and Subsidiary status of a company, it should be   appropriately placed  in the mother Act as an Explanation under Section 2(6) and Section 2(87) instead of finding a wrongful  place in the Rules.

Two different  Definitions of a “Courier”- Explanation  under Section 20 and Rule 35(5) of companies (Incorporation) Rules,2014

It is most unusual to see two definitions being given to the same expression under the aegis of the same Statute. Nothing should surprise a reader of the Act and the Rules especially when one reads the two definitions of “courier”.

Explanation contained under Section 20 of the Act which speaks about service of documents correctly defines a “Courier” as   “a person or agency which delivers the document and provides proof of its delivery”.

It is bewildering, to say the least ,  to note that  Rule 35(5) of the companies (Incorporation)Rules ,2014 defines a courier as under:

“For the purposes of sub-sections (1) and (2) of section 20 “courier” means a document sent through a courier which provides proof of delivery”.

It is beyond our comprehension as to how on earth a courier could be described as a document sent through a courier!! .

Section 135-contradiction with Section 149

Section 135 applies to every company  , both  public and private alike as long as it  satisfies  any one of the three mutually exclusive conditions set out in the Section.

The Section provides that a company covered u/s 135 will have to set up a Corporate Social Responsibility (CSR) Committee of the Board which should have three or more directors of whom at least one should be an Independent director. This requirement runs contrary to Section 149 which mandates that only listed companies and other unlisted public companies satisfying the conditions laid down in Rule 4 of the companies (Appointment and Qualification) Rules, 2014 need to appoint Independent directors.

Rule 5 of the companies(corporate Social Responsibility Policy)Rules,2014 has eliminated the anomalous situation created by Section 135 by providing that a private company having only two Directors on its Board can constitute the CSR Committee with the same directors without having to appoint an independent director on the Committee. However, in as much as Rule 5  above  has carved out an exception for private companies without compliance of the procedure suggested by Section 462 of the Act, its legal sustainability is suspect. It is therefore submitted that Section 135 itself may be amended to the effect that a private company need not have an Independent director in its CSR Committee.

Section 151-Appointment of Director elected by small shareholders

The section provides that a listed company may have a Director who is elected by the small shareholders .Rule 7(4) of the companies (Appointment and qualification)Rules,2014 states that the Director so appointed shall be considered as an Independent director and that he should submit his declaration of independence in the manner contemplated by Section 149(7) in the Act.

Rule 7(5) ibid clarifies that the small shareholders’ Director shall not be in office for a tenure beyond three years and shall not be eligible for re-appointment upon expiry of the tenure. In addition during his tenure of association, he shall not be liable to retire by rotation.

It is submitted that any person representing a particular constituency, in this case, the  small shareholders, cannot be considered as an Independent  director. It is pertinent to note that as per the Explanation under Section 149(7) , a “Nominee Director” means a Director nominated by any financial Institution in pursuance of the provisions of any law for the time being in force ,or of any agreement ,or appointed by any Government ,or any other person to represent  its interests.(Emphasis supplied).Considering that the small shareholders’ Director essentially represents the interest of the small shareholders, in our view, he should be considered as a “Nominee director”. It would be a paradox to treat  him on par with  an Independent director.

Assuming but not admitting that he is an Independent director, the tenure laid down in Rule 7(5) above is also not in consonance with the tenure provided by Section 149(10) for an Independent director which is two consecutive terms of five years. Even after the completion of two terms ,  an Independent director is eligible for  appointment after a “cool-off” period of three years. On the other hand ,  as per Rule 7(5) a small shareholders’ director is not eligible for appointment after completing a stint of three years.

Considering the above contradictions, in our view a small shareholders’ director cannot merit consideration as an Independent director and it is necessary to review his status in the Statute.

Appointment of Director to fill up casual vacancy-law applicable for private companies

There exists a very obvious drafting error in Section 161(4) which makes it necessary for a private company to go through the   additional procedure of  holding  a meeting of the shareholders to fill a casual  vacancy in  the Board. The above inference can be easily drawn   from the sub-section which  provides that in the case of a public company, if the  office of any director appointed by the company in general meeting is vacated before his term of office expires in the normal course, the resulting casual vacancy   may, in default of and subject to any regulations in the articles of the company , be filled by the Board of Directors at a Meeting of the Board.

When a public company I authorized to fill up a casual vacancy in the directorate through the procedure of a meeting of the Board, it defies logic when the pitch is queered for a private company for undertaking the same activity.

In our view, there is an unintended drafting anomaly in the provision which needs suitable rectification.

Need for congruence between   section 164 and 167 - Disqualifications and vacation of office by Directors

Section 164 (1) lays down the circumstances in which a director becomes ineligible for appointment as a Director. Where the disqualification arises in the   circumstances specified in clauses(d),(e) and (f) of  the above subsection , as stated in the proviso under subsection(3) ,the disqualification does not take effect for thirty days  from the date of conviction/disqualification. The disqualification is also held in abeyance during the pendency of an  appeal and for a further period of seven days until any further appeal against the order of conviction is disposed off.

On the other hand Section 167 lays down that if the Director incurs, inter alia, any of the disqualifications laid down in Section 164 the office of the Director will stand automatically vacated even if an appeal has been preferred by the director against the order of conviction.

It is necessary that Section 167 should run in tandem with Section 164.When disqualification can be stalled under Section 164 through the process of law, we do not see any reason why   vacation  of office should  be visited immediately  upon conviction, notwithstanding the outcome of an appeal.

Section 186 -cannot apply for loans/guarantees  given to any person

Readers are aware that Section 186 is the composite code which regulates the making of loans and investments by a company.

There is a serious drafting error in Section 186(2) where it comes to the provision of loans and guarantees.

Clauses (a ) and (b) in subsection (2) of Section 186 read as under:

“(a)give any loan to any person or other body corporate

(b) give any guarantee or provide security in connection with a loan to any other body corporate or person”

The term “body corporate” has been defined inclusively  in Section 2(11) to include a company which is incorporated outside India. “Person”  as stated in the above clauses (a) and (b) would refer to an individual as also to   other non-corporate Entities. From the above it follows that the provision of loans and guarantees by a company to individuals and non-corporate entities would also get drawn into the vortex of Section 186(2).

Surely the law makers would not have intended that the Board should pompously decide on loans to employees of the company and that too at a duly convened Meeting and not even through a resolution passed by circulation, given the complexities of modern business and the demands on their time!.  

It is therefore necessary to delete from the above two clauses, references to a person so that effectively only the provision of corporate loans and guarantees would come under the surveillance of the Board.

Section 194-Prohibition on forward dealings in securities by director or Key Managerial personnel-Significance of Explanation in the Section

Section 194(1) provides, inter alia, that no Director or key Managerial personnel (KMPs)shall indulge in forward dealing in the securities of the company, or its holding, subsidiary or associate company.

Explanation under the Section, however, tells a different story. It covers only the whole time Directors and key managerial personnel. Non-executive Directors are outside the ambit of the above restriction. Further, the restriction on forward dealing would be over the shares and debentures of the company, its holding company and its subsidiaries. Securities   of  Associate companies are   also not to be considered.

The contents of Section 194(1) are different from the Explanation to the Section.

The purpose of an Explanation   was  explained by the Supreme court in S.Sundaram Pillai Vs.pattabhiraman  (1 SCC 591 at page nos.611,613).An Explanation is at times,  appended to a Section is to explain the meaning of words contained in the section. Where an Explanation added towards   the end of the Section  ,opens with the words ”For the purposes of this Section” or ”nothing in this Section” it will prima facie indicate that the Explanation applies to all the clauses of the Section as held in CIT vs. Plantation corporation of India Ltd (AIR 2000 SC 3714 at p.3717).

In the instant case the Explanation in Section 194 appears towards   the end of the Section and begins with the words ”For the purposes of this Section”. Hence it applies to all the subsections in Section 194 and  the Section should therefore  be restricted in its application to only whole time Directors and KMPs and relate to the securities of only the Company, its Holding company and its Subsidiaries.

In view of the above, it is necessary that Section 194(1), (2) and (3) should be aligned with the Explanation.

Section 195-Prohibition on Insider Trading of Securities

The Section, ironically applies to every company. It is common knowledge that insider trading is a malady that   can afflict   only listed Entities. The Section ought to be expressly made applicable only to listed companies.

Further Section 195(1) states that no person including any director or key managerial personnel of a company shall enter into insider trading. It is not clear from the above who  are the persons other than Directors and KMPs who are to be considered as Insiders. Obviously they cannot be amorphous or allowed the luxury   of remaining   anonymous. The SEBI (Prohibition of Insider Trading ) Regulations 1992 brings with the ambit of its coverage, persons who could be considered as “connected persons”,  Insiders, ”persons deemed to be connected persons” all of whom may be reasonably expected to unpublished price sensitive information concerning a company.  For the sake of ensuring consistency, the easiest   thing would have been to replicate the concepts that find a place in the SEBI Regulations on the subject. Curiously the term “insider” though not defined in the Section, finds amplification in the definition to the term ”Insider Trading” as provided by the Explanation after subsection(1).

The definition to the term  ”price sensitive information” as in clause (ii) under the Explanation is a partial lift off from the SEBI Regulations. Regulation 2(ha) in the SEBI Regulations provides the definition to “price sensitive information”. The above Regulation also   contains a deeming provision by which certain episodes or milestones which would cause upheavals to the prices of the company’s securities have been identified as being price sensitive in nature .We do not know why it was not possible to insert the same Explanation as   appearing  in Regulation 2(ha) in   Section 195 . This would have ensured a seamless integration of the concept with the already existing allied legislation on the subject.

Section 203 –Appointment of Key Managerial Personnel

The Section mandates the appointment of certain functions who are collectively bracketed as “key managerial personnel”(KMPs). Rule 8 in the companies (Appointment and Remuneration)Rules,2014,provides that the requirement of appointing KMPs shall apply only to listed companies and unlisted public companies with a paid-up capital of Rs 10 crore or more.

We find it inexplicable that when most of the provisions of the Act have been  made applicable to private companies why they have been spared the obligation of appointing KMPs. As a typical knee-jerk reaction to the widespread protests from the fraternity of the young professional company secretaries, the Govt. back tracked on the provision and restored the status quo ante  in so far as appointment of full time company secretaries in private companies with a capital base of Rs 5 crore or more was concerned. How could the legislature be under the presumption that KMPs are not required in private companies. In our view, this is a retrograde step and should be rectified.

Further there is no clarity in the provision as to whether the same person can hold more than one designation of a KMP in the same company. For instance,  whether one person can be Company Secretary and Chief Financial officer in the same company or be the Manager and Company Secretary. Logically this should seem possible, given the fact that Section 203(3) allows the same person to be a KMP both in the holding company as also in the Subsidiary. Further the last proviso in Section 203(3) allows the same person to be Managing Director of two companies, albeit with the unanimous approval of the Board .  Notwithstanding the above possibilities it would be most welcome if the Govt’s   stand on this is made known, given the cleavage of opinion on this point which exists in the professional fraternity.

Conclusion

In this exposition we have brought to the fore some issues which we consider as important which merit immediate resolution. It is not as if we have cherry picked the issues –these are the issues that agitate our minds as also the minds of several professionals. There are many more contentious issues in the new Act which merit a review.”Brevity” they say,  ”is the wit of the soul”. Lest we should be accused of being munificent in the use of verbiage , we end with the optimism that the powers that be shall take remedial action on the issues that we have brought to the forefront.

Ramaswami Kalidas