The Corporate Governance in the Companies Act, 2013

The corporate Governance in the Companies Act, 2013 The Companies Act, 2013 reinforces and redresses laws pertaining to companies[1]. The Companies Act, 2013 was passed by the parliament and received Presidential assent on 29th August, 2013. Some of the provisions of the Companies Act, 2013 were notified in the Official Gazette on 30th August, 2013. Many of the provisions of the Companies Act, 1956 continue to be in force[2]. Corporate Governance is an important aspect in the Companies Act, 2013. Under the Corporate Governance, the Board of Director’s report will include disclosures involving payment of directors, service contracts and stock options details[3]. The Companies Act, 1956 existed for more than 50 years and now it is proving to be inefficient when it comes to handling challenges of a growing industry and complexities involving stakeholder interests. Therefore, the new act improves the status on governance and raises the responsibility on the Board of Directors and the Management. There are six crucial aspects to improve corporate governance. First, there must be an increase in the reporting framework.

Secondly, there must be a requirement for higher auditor accountability. Thirdly, there must be availability for easier restructuring. Fourth, there must be emphasis on investor protection. Fifth, there must be an increase in the wider directors and management responsibility and there must be an inclusive CSR agenda[4]. Under the Reporting Framework[5], subsidiary, associate and joint venture companies are explained according to section 2(6) and 2(87)[6]. If the holding company owns more than 50% of the total share capital or exercises control over the board, it becomes a subsidiary company while a holding company owns at least 20% of the total share takes business decisions under an agreement, the company becomes an associate company. Also under this scheme, exemptions to a company are given only when the holding of a company is outside India. Under section 129[7], there is a compulsory requirement for “consolidated financial statement” (CFS). CFS is the combination in the financial statements including assets of the parent company and its subsidiaries[8]. Every company has to prepare a CFS if it either has a subsidiary, associate or joint venture companies.

However, when it comes to preparing a CFS, there is no exemption given. Under sections 130 and 131, there is a need for revision in the financial statement.

Revision of financial statements is either made by the directors of the company when financial statements and the report made by the board contradict each other or voluntary restatement made by the board of directors for at least three years or can be made by the central government when it comes to fraudulent reporting or mismanagement in the financial statements[9]. This scheme also looks into the changes in the depreciation regulation mentioned under section 123(2) and schedule II. This includes useful life which is given preference over other standard compulsory rates. Useful life is generally defined as the time or the duration for which a particular item will be useful to business. When the meaning of useful life is taken, it should not be considered as to how long that item will last[10]. According to section 138 of the companies act, 2013[11]; it requires mandatory internal audit and reports on internal financial controls. It requires adequacy and efficiency of the internal financial controls in the reports made by the directors or the auditors only for listed entities and must be included only in auditor’s reports for other listed entities. It requires internal audit to be made companies which are listed and all other public limited companies. The second scheme for the corporate governance is higher auditor accountability which allows maximum twenty audits for an individual partner of a firm[12]. An individual auditor is eligible for at least five years and for partnership audit firms, it involves another five years. The auditor will also be given a five year cooling time after completion of the previous term.

The new auditor cannot be related to the leaving auditor in terms of an associate or a network firm. According to the rules of the draft, the pre-commencement term will apply for calculating the balance validity of the present auditor’s occupancy. A large number of restrictions regarding non-audit services can be supplied by the auditors. Most of the non-audit services have to be approved by the board before itself[13]. Responsibility of the auditor’s report mainly depends on what the auditor report will cover. The auditor’s report will have to cover six sections. First, it must contain observations, comments involving financial transactions. Second, they must cover qualification or the remark regarding the maintenance of the accounts.

Third, whether there is adequacy of internal financial control systems and its efficiency. Fourth, it must contain the disclosure of pending litigation on the financial post. Fifth, it must explain the provisions made for foreseeable losses on a long term and sixth it must cover the delays in depositing money into the IEPF. IEPF is the Investor Education and Protection Fund which was established under section 205C of the Companies Act, 1956[14]. Under the second scheme, there must be a report made to the Audit Committee when it is related to fraud committed by the companies own employees against it and must be made to the central government if done frequently. The third scheme involves easier restructuring which refers to rationalizing multilayered structures[15]. Under these structures, it allows at most only two investment SPV company levels which are allowed between the investor company and the invested company. SPV is the special purpose vehicle which is a subsidiary of a company that tries to separate the risk from the parent company by looking after the assets and its liabilities through a separate balance sheet.[16]Exemptions can be given while acquiring overseas subsidiary with multilayers which is allowed by the foreign law and when multi-layering is considered by any law in force. Under this scheme, there is a need for simplifying procedures when it involves a merger which is provided under section 232 of the companies act, 2013[17]. The National Company Law Tribunal (NCLT) can approve the schemes made by the restructuring companies instead of the High Court (HC)[18]. The Auditor must ratify that the accounting treatment mentioned in the scheme made by these companies comply with the accounting standard for either the listed, unlisted or private companies. Also, for the merger to take place there must be consent from the majority of the members.

The merger of the company is allowed to be under the unlisted companies only when there is an exit opportunity that is given to the public shareholders and when the valuation is done accordingly by the SEBI guidelines. Section 236 of the companies act, 2013 requires all shareholders owning more than 90% of the share capital will have to declare the intent to buy-out the balance equity shares. Under section 247, exit assessment can be done by the “Registered Valuer”. The registered valuer is to issue mechanisms for the valuation of several assets and liabilities involving the company[19]. Under section 234, cross border merger is allowed which involves merger of an Indian company with a foreign company. Here, the central government has to make rules for consultation with the RBI and it is important that the merger is approved by the NCLT and the consideration can be made only in cash or depository receipts[20]. Under section 233 of the Companies Act, 2013; the merger between two companies without the approval of the NCLT is possible when there are two or smaller companies or when there is a holding and completely owned subsidiary or when there is prescribed types of companies. There must be a declaration of the solvency that has to be submitted. The consent has to be given by members who own more than 90% of the shares owned. Section 66 of the companies act requires that no share capital reduction will be allowed for a company that has overdue deposit. It does not allow buy- back within a year nor does it allow buy-back after three years from rectifying any defaults on deposits or term loans. In case of buy-back or capital reduction, there is a requirement of the auditor’s certificate involving conditions from either section 66 or 68. Buy-back is the repurchase of outstanding shares by a company in order to reduce the number of shares in the market and companies will attempt to buy-back in order to increase the value of the shares[21]. The fourth scheme is on emphasizing investor protection[22]. Section 188 of the Companies Act, 2013 permits transactions to be made in an ordinary course of business on arm’s length transactional basis.

Arm’s length transaction is a transaction where there is no control over one another[23]. It is a transaction that is made between the seller and the buyer who act independently and are in no relation with each other[24]. Here there is no requirement to get the approval of the central government. Approval will be required from the board only when there are no transactions made in the ordinary course or is not at arm’s length. A special resolution is required for non- arm’s length transactions and if they are not in the ordinary courses where the share capital is greater than ten million or if the goods acquired, leasing of property transactions exceed 20% of the net worth or appointment to any office involving profits where the monthly payments is more than one lakh. Sections 125, 194 and 195 of the companies act, 2013 requires directors or the Key Managerial Personnel (KMP) to refrain from forward dealing or buying options in shares or debentures of a company.

Here, Key Managerial Personnel are the employees of a company who have play as key players in the company and show great responsibility in the functioning of the company inclusive of protecting the interest of the stake holders[25]. Here, the forward deal is a transaction which includes the purchase or sale which comes with a settlement that will arise in the specified future[26]. Debentures hold no collateral and the only source of backing them is through the reputation of the issuer and buyers purchase debentures depending upon the issuer thinking that the issuer will not default on the repayment[27]. No employee or employer including the director and the KMPs having entry to information that is not public should be allowed to have insider trading relationships. Sections 241 to 246 of the Companies Act, 2013 specifies that members or the depositors have to declare to the tribunal if the company conducts have bias for their own interests. In case of fraudulent acts or any other wrongful acts, action suits can be filed on the company or its directors, the auditor or the audit firm and the advisor or the consultant. Only 10% of the members of the total number of members or 10% of the depositors of the total depositors or members who own more than 10% of the issued share capital or depositors who own more than 10% of the outstanding value of deposits are allowed to file an action suit. A company’s stocks owned by the shareholders that include both restricted shares as well as share blocks are the outstanding shares[28]. The Senior Fraud Investigation Officer (SFIO) is made a statutory body with important powers and under this scheme; the idea of fraud risk mitigation requires the compulsory establishment of mechanisms to directors or managers to report any kind of concerns. Under the next theme, it lays down mandatory management responsibility and wider director[29] where under section 149 of the companies act, 2013, there is stricter responsibility and accountability imposed by the code of professional conduct. A maximum of only five more years can be extended by another five years only through a special resolution. The directors can be held liable for acts with knowledge and is extractable from the board and only with his consent. Under this scheme, declaration of independence is compulsory every year and stock options are not permitted when there are fees and commissions made from profits.

All independent directors must hold an annual meeting and no non-independent directors or KMP or senior management are allowed. Section 177 of the companies act, 2013[30] explains the composition of the audit committee. It is compulsory for the mentioned companies to constitute an audit committee and there should be more than three directors with the majority being independent directors. Both the chairperson as well as the independent directors must be well efficient in reading and understanding financial statements. Finally, the responsibilities given to the audit committee is to recommend appointment, payment of the auditors and monitor their independence and efficiency. Then, examine the financial statements and the auditor’s report, approve party transactions, undertake asset valuation, assess internal financial controls and risk management systems and finally supervise the use of funds through public offers. Section 134 explains the contents in the director’s report under which all companies require devised proper systems to ensure proper compliance with the laws made in India. Director’s report must also include taking proper and sufficient care for maintaining ample accounting records for protecting assets and preventing and identifying fraud and must include the development and implementation of a risk management policy. In the report, the specified and listed companies must express that the internal financial controls are laid and are functioning efficiently and that the performance evaluation of the board members have been carried out. The final theme included for the corporate governance in the companies act, 2013 is the inclusive CSR agenda[31]. The CSR agenda is the Corporate Social Responsibility which aims to help companies achieve in creating wealth jobs and answers to many challenges faced[32]. The CSR covers all companies if either the turnover is more than INR 10 billion or net worth is more than NR five billion or net profit is more than INR fifty million is fulfilled.

The contribution made by the CSR is to be two percent of the average net profit before tax for three years. The contribution made will be listed under schedule VII. The board will appoint a three member CSR committee including an independent director where the committee will devise the CSR policy, recommend CSR activities and monitor CSR expenditure. There must be compulsory reporting on the CSR under section 135. When there is no requirement for companies to appoint independent contractors under section 149 but a company does go to the situation under section 135[33], then it becomes compulsory for the company to appoint an independent contractor. When there is a failure to spend, reasons have to be disclosed and penalties to be imposed for non-disclosures. The Companies Act, 2013 brings about the changes to the structure of the board of directors.

The companies act, 2013 requires the board of directors to be differentiated into resident director, independent director and a woman director[34]. The Companies Act, 1956 did not specify that companies should appoint independent directors but under new provisions such as in clause 49 of the Listing Agreement is a document in which the company will sign when it is being listed on the stock exchange and it promises to follow the rules and regulations set by the stock exchange[35].

[1] Ministry Of Corporate Affairs – The Companies Act, https://www.mca.gov.in/MinistryV2/companiesact.html (last visited Nov 29, 2014).

13] Ibid.

[3] Companies Act, 2013 2(4) part 2. [4]RAISING THE BAR ON GOVERNANCE – COMPANIES ACT, 2013, https://www.kpmg.com/IN/en/Documents/Companies_Act_2013_Raising_the_bar_on_Governance.pdf (last visited Nov 30, 2014).

[5] Ibid. [6]Companies Act, 2013, 2.

[7] Companies Act, 2013, 129. [8]Consolidated Financial Statements Definition | Investopedia, https://www.investopedia.com/terms/c/consolidatedfinancialstatement.asp (last visited Nov 30, 2014).

[9] Supra n(4). [10] Useful Life Definition | Investopedia, https://www.investopedia.com/terms/u/usefullife.asp (last visited Nov 30, 2014). [11] Companies Act, 2013, 131. [12] Supra n(4). [13] Ibid. [14]Investor Education and Protection Fund – Archives – Spotlight: National Portal of India, https://www.archive.india.gov.in/spotlight/spotlight_archive.php?id=21 (last visited Dec 6, 2014). [15] Supra n(4). [16] SPV financial definition of SPV, https://financial-dictionary.thefreedictionary.com/SPV (last visited Dec 2, 2014). [17] Companies Act, 2013, 232. [18] Supra n(4). [19] Registered Valuers Under Companies Act, 2013, https://taxguru.in/company-law/registered-valuers-companies-act-2013.html (last visited Dec 2, 2014). [20] Supra n(4). [21]Buyback Definition | Investopedia, https://www.investopedia.com/terms/b/buyback.asp (last visited Dec 2, 2014). [22] Supra n(4). [23] Arm’s Length Legal Definition, https://www.duhaime.org/LegalDictionary/A/ArmsLength.aspx (last visited Dec 2, 2014). [24] Arm’s Length Transaction Definition | Investopedia, https://www.investopedia.com/terms/a/armslength.asp (last visited Dec 2, 2014). [25] Key Managerial Personnel – Companies act 2013, https://www.corporate-cases.com/2012/07/key-managerial-personnel.html (last visited Dec 2, 2014). [26] What is Forward Deal? definition and meaning, https://www.investorwords.com/2062/forward_deal.html (last visited Dec 2, 2014). [27] Debenture Definition | Investopedia, https://www.investopedia.com/terms/d/debenture.asp (last visited Dec 2, 2014). [28] Outstanding Shares Definition | Investopedia, https://www.investopedia.com/terms/o/outstandingshares.asp (last visited Dec 2, 2014). [29] Supra n(4). [30] Companies Act, 2013, 177. [31] Supra n(4). [32] European Commission – PRESS RELEASES – Press release – Corporate Social Responsibility: a new definition, a new agenda for action, https://europa.eu/rapid/press-release_MEMO-11-730_en.htm (last visited Dec 4, 2014). [33] Companies Act, 2013, 135. [34] Companies Act 2013: Greater Emphasis On Governance Through The Board And Board Processes – Corporate/Commercial Law – India, https://www.mondaq.com/india/x/319480/Corporate+Governance/Companies+Act+2013+Greater+Emphasis+On+Governance+Through+The+Board+And+Board+Processes (last visited Dec 6, 2014). [35]What is Listing Agreement? definition and meaning, https://www.investorwords.com/10199/Listing_Agreement.html (last visited Dec 5, 2014).

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