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Home > Business > Special

Companies Bill: Drastic results of poor drafting

Jayant M Thakur | May 26, 2003

The Companies Amendment Bill 2003 has proposed yet another series of amendments chosen from a variety of sources including the preceding lapsed Bills and recent committee reports.

However, unlike preceding amendments, this Bill is more far-reaching in proportions judged not just by the number of amendments proposed (174) nor by its length (126 pages ) but also in terms of substance and breadth. Crucial amendments have been made for all types of companies-- private, public and listed.

Directors, shareholders, auditors, company secretaries and so on will all be affected. However, companies and professionals will not just have to examine the implications of the amendments but also attempt to cope with the confusion and drastic consequences of some very poor drafting.

Let us examine some of them.

Transfer of shares of private companies will require all shareholders' approval: This is a brief but sweeping amendment in terms of practical implications. It has been provided that all private companies can transfer shares only after receiving approval from all its shareholders at a meeting.

There are several implications to this. Even if 49 of 50 shareholders holding 99.99 per cent shares favour a transfer of shares on fair terms, after following the normal pre-emptive procedure where all shareholders are offered the shares proposed to be transferred, one person, holding just one share, can stop the transfer.

He is not required to give any justification for his refusal. Consider the turning of the tables where an absolute majority would now be at the mercy of each of the minority shareholders, though only for transfer of shares.

Shares may have been innocuously given to employees as part of an stock option plan, to friends or associates, and here too the same consequences follow.

There is no provision for any exception or appeal. The amendment is not restricted to new companies but applies to existing companies also. Consider the implications for numerous companies that are really partnerships or even joint ventures (with foreign partners in some cases).

What are the ways out, assuming this draconian provision with justification neither conceivable nor provided by the lawmakers, goes through? One way is to convert your company into a public company. This may appear drastic but it solves the problem! Fortunately, conversion into a public company requires a 75 per cent and not 100 per cent majority.

Another possible, though somewhat uncertain, route is to approach the Company Law Board. An attempt may be made to convince the Board of the circumstances and pray, at the very least, that either the transfer be allowed or the shares of the dissenting shareholder be bought back at a fair price. Ideally, the amendment should not come into force at all.

Unlimited liability for directors etcetera of companies that are not in business or do not have minimum capital: It may be recalled that in 2000, an amendment was made under which private and public companies were required to raise, within two years, their paid-up capital to at least Rs 200,000 and Rs 500,000 respectively.

This period expired on December 13, 2002 and according to the department of company affairs, almost 200,000 companies have defaulted. The mandatory consequence of this was that such companies were to be struck off the register of companies by the Registrar.

It appears that the department of company affairs has not carried out such striking off-- which itself appeared to be a drastic measure-- but has come out with a simplified exit scheme that puts the ball in the court of the companies, which are now required to come forward and get themselves struck off.

Nevertheless, there were no punitive or other consequences for not raising the capital. Now, a strange amendment has been proposed. Under this amendment, the liability of the directors, managers and shareholders of such companies will become unlimited.

Effectively, this means that they would have to pay for all liabilities that the resources of company cannot meet. The provision, to reiterate, is applicable to all companies, whether public or private. The directors may be executive or non-executive and may be even nominees of outsiders.

The strange thing is that the provision would apply only to acts that have already been committed since the date for raising the capital has long passed in 2002. In other words, a punishment is being proposed for acts and omissions that took place in the past. Even raising the capital today would not result in the liability becoming limited-- not even for future transactions.

In fairness, the department has valid concerns for companies not falling in line and striking off the names of such companies can only harm outsiders. A positive fallout of this could also be that eligible defaulting companies may quickly avail of the simplified exit scheme. If they do not, they have one less argument for resisting the new provision.

There are some more unanswered questions. Will the liability be unlimited in respect of future transactions or all past transactions also? Will the liability of directors, managers and shareholders who are no longer so continue to be unlimited? Will people who now become directors also face unlimited liability?

The liability of the directors, shareholders and managers becomes unlimited under one more circumstance. This will be so when the company "is not carrying on any business" or is not "in operation". Many of the concerns expressed for the earlier category equally apply here too.

There are some additional questions that would also need to be answered. Will the provision apply also to companies not in business owing to strikes, temporary stoppages, non-availability of opportunities and so on? Will the liability become limited if the company starts business again?

In this case, will the liability for transactions before the commencement of business remain unlimited? What is the level of business expected? Are existing companies not in business also covered or will the provision apply only to companies that go out of business hereafter?

The answers to these questions are not available or, even if they are, are so unjust that one hopes that appropriate clarifications are given.

Chain of subsidiaries eliminated: The concept of chain of subsidiaries works like this. If company C is a subsidiary of B and, in turn, if B is a subsidiary of A, then C is also deemed to be a subsidiary of A.

There can be any number of levels, though the example gave just two levels. There can be many reasons for having such a chain. There may be an ultimate holding company that may prefer to have its divisions in the form of subsidiaries. Some of these subsidiaries may prefer to have subsidiaries of their own and thus there would be two or more levels.

It is now proposed to prohibit this altogether but in a strange way. First, it is proposed that henceforth, no company shall be a holding company if it itself is a subsidiary of another company. Hence, in the future, there cannot be a fresh chain of subsidiaries.

Secondly, second-level subsidiaries will now no longer be subsidiaries. Thus, now, in the given example, C will no longer be a subsidiary of A.

These provisions raise several concerns. Will foreign companies investing in India who themselves are subsidiaries not be able to take a majority stake in an Indian company?

Similarly, will Indian companies not be able to have a holding company abroad for down-level subsidiaries (apart from requirements under the Foreign Exchange Maintenance Act)? Will disclosures of second-level subsidiaries (which will no longer be subsidiaries) no longer be required in the accounts of ultimate or second-level parents?

Mandatory imprisonment for certain violations: The Companies Act, 1956, contains a few provisions that attract the drastic consequences of imprisonment if they are violated.

This was also the case with the SEBI Act but numerous scandals forced the government to amend it a few months back so that mandatory imprisonment was provided for, apart from hefty fines. While fines under the Companies Act, 1956 will continue to be meagre, there are many new areas where there will be mandatory imprisonment and that too, of at least the specified minimum months.

This would be under many provisions but particularly for stock market related offences. Even shareholders who make false disclosures such as giving false names in share application forms would face a mandatory imprisonment of at least six months. Promoters making fraudulent statements in prospectuses also face such minimum imprisonment.

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