Companies Bill enhances responsibilities

The Bill lays strong emphasis on internal governance, the boards need to be alive to these needs

Finally when after years of deliberations and procrastinations and peripatetic peregrinations across long stretches of skepticisms and uncertainties, the Companies Bill is set to become law, the rhetorical question of Charles Ludwig Dodgson "Which form of proverb do you prefer - "Better late than never," or "Better never than late" can be confidently answered. Notwithstanding the protestations of the critics about of the shortcomings in the Bill, which more often than not, are a function of the interests they serve, there are several reasons to applaud the "much of the muchness" of the newness in the Bill.

The Bill has been widely discussed, and the sections on the mandatory rotation of auditors and their firms (India being one of the few countries globally to make this law), mandatory spending by companies of two per cent of the net profits on corporate social responsibility programmes, women directors on boards, restrictions on directorships more discussed than others. But the sections of the Bill which form the "heart of internal governance" of companies seem to have by and large remained undiscussed. The intention of this piece is to discuss a few of these.

The boards of companies, because they are central to their governance have to carry the cross; the difference now is that the Bill has made the burden several times heavier for the Indian companies. For example, the Bill lays a strong emphasis on the internal controls, risk management and internal audit and includes these concepts for the first time in a legislation. The Directors' Responsibility Statement (DRS) in the Board's report (section 134 (5) (e)) for the listed companies will now have to include a statement from the directors that "they had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively. The explanation of "internal financial controls" in the Bill is elaborate and covers in a broad sweep most of the critical elements of the Integrated COSO Framework. The companies should treat this statement in the DRS far more seriously than a weather report or the disclaimer about smoking on cigarette packets and because of the grave penal consequences for the contravention of this section. The management and the directors would also need to figure out the basis on which the boards would be able to give such a definitive declaration.

DECODING THE NEW COMPANIES BILL

• Bill lays a strong emphasis on internal controls, risk management and internal audit and includes these concepts for the first time in a legislation
• The Directors' Responsibility Statement in the board's report (section 134 (5) (e)) for listed companies will now have to include a statement from the directors saying they had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively
• Section 149 of the Bill and the schedule IV on the Code for Independent Directors deal with the roles and responsibilities of the independent directors. Under these, the performance of the board, the board chairman and non-independent and non-executive directors and of the independent directors prior to re-appointment would have to be evaluated
• There are differences in the compositions and constitutions of the boards and the committees as well. It needs to be seriously deliberated if there is a need to retain both the frameworks on the same subject and if so is there a scope of efficacious harmonisation
• The Bill attempts to overhaul a 57-year-old corporate legislation which had fallen behind the changes in business practices. But it will be quite some time for the new legislation to become effective, for the rules, which are much too many, are to be notified
• There are two views on the Bill - an optimistic view which holds that the Bill when it becomes a law, will help reform some of the arcane systems. The other says that all the provisions will lay waste as we, as Indians, are good at box-ticking compliance

Till now, only the audit committee was mandatory under the clause 49 of the Listing Agreement. It and three other committees have been included in the Bill and all have become mandatory for all companies. The Bill has extended some of the responsibilities laid down for the committee under the clause 49. For example, under the Bill, the committee is required to evaluate (instead of reviewing as in clause 49) the internal controls and risk management systems. The committee can also obtain professional advice from external sources on certain matters specified in section 177 of the Bill. By implication, the committee will be liable to be questioned if it does not exercise this right in matters in which it feels itself to be inadequate. The burden on the audit committee has only increased.

The business judgment rule is a judicially developed doctrine that presumes that directors acted on an informed basis, in good faith and with the best interests of the company in mind; it provides a strong deference to the integrity of those decisions in the face of claims of malfeasance or negligence. This doctrine and the fiduciary duties of a director to act in good faith, with due care and diligence and avoid conflicts of interest have now become a part of the Bill. This is a double-edged sword, which gives protection to the directors on the one hand and enhances their responsibilities on the other.

Then there is the section 149 of the Bill and the schedule IV on the Code for Independent Directors dealing with the roles and responsibilities of the independent directors. Under these the performance of the board, the board chairman and non-independent and non-executive directors and of the independent directors prior to re-appointment would have to be evaluated. These concepts have been fiercely resisted by the corporate sector in India since the time clause 49 sought to make them mandatory.

The last point in this article is about the governance of the frameworks of corporate governance. The Bill incorporates most of the areas covered by clause 49 and even goes beyond it. There are difference in the compositions and constitutions of the boards and the committees as well. It needs to be seriously deliberated if there is a need to retain both the frameworks on the same subject and if so is there a scope of efficacious harmonisation.

The Bill has attempted to overhaul a 57-year-old corporate legislation which had fallen behind the changes in business practices. But it will be quite some time for the new legislation to become effective, for the rules, which are much too many, are to be notified. Writing the final rules will not be easy and quick, even though a large part of the exercise may have been completed informally. There are two views on the Bill - an optimistic view which holds that the Bill when it becomes a law, will help reform some of the arcane systems. The other which says that all the provisions will lay waste as we, as Indians, are good at box ticking compliance. The sceptics who hold this would like to believe that the Bill may seek to increase the overall responsibilities of the board and directors, but for many companies it will still be business as usual even in the future, because of the proverbial laxity in enforcement in this country.

But given the rise of investor advisory services, class action suits becoming a possibility under certain sections of the Bill and growing media pressure, shareholder activism should see a rise and when that happens. When that happens, reliance on laxity and sluggishness of enforcement action would unlikely remain a dependable refuge for the companies. But good governance always would. The design of the Bill is wise and just; that ascertained, let us pursue it resolutely.

(The author was formerly executive director of Sebi and is currently an advisor and consultant to Deloitte Tohmatsu Touche India Pvt Ltd and the World Bank. pratipkar21@gmail.com)