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Omkar Goswami: Broken beyond repair

Hurriedly legislated by the UPA-II, the Companies Act, 2013, is fatally flawed. Salvation lies in redrafting it, removing excess rule-making and making it fit for our times

Omkar Goswami 

Omkar Goswami

In 1956, the best master tailors in India got together to make a magnificent three-piece suit. Despite many alterations, it wore well for many years. But by the second decade of this century, it was well past the sell-by date with the cloth and stitching having come apart. So, the country's distinguished designers and tailors were consulted on how to fashion a modern suit, fit for the times. They made many suggestions about the cloth, the cut, the fit, the stitching and the buttons. Having heard them all, the government's own tailor then took up the task. After years of labour, the sarkari darzi unwrapped a package with great flourish, and pronounced, "Here is the suit!" What did everyone see? A wonderfully tailored left sleeve and an elegantly stitched right lapel along with 50 pairs of socks, each of different colour, the left not matching the right, but all having daintily sewn suit buttons.

That is an apt parable for The Companies Act, 2013 (TCA 2013). The object of a new law was to sustain rapid economic growth "by putting in place a modern legal framework that would enable India's corporate sector to operate in an environment of best international practices in a globally competitive manner, while fostering a positive environment for investment"*. However, instead of crafting a best-in-class legislation that could have served the needs of modern corporations and their stakeholders, it is in many parts a shabbily drafted law, defined not by clear principles but by an enormous and unwieldy edifice of myriad central government rules.

If there is a solid example of the resurrection of the control and permit raj under the United Progressive Alliance (UPA)-II, it has to be TCA 2013. Here is an Act with 470 sections and seven schedules that is supposed to define the life of corporate India, in which 337 sections are empowered through rules. This dysfunctional rule-making structure has given enormous discretionary powers to the Ministry of Corporate Affairs (MCA). Worse still, since hundreds of micro-focused rules invariably end up in a cauldron of contradictions and inconsistencies, the MCA staff at the level of assistant directors are sending one circular after another to clarify the sections and their rules - many of which are more difficult to comprehend than the rules themselves. Between May 7 and June 18, 2014, the MCA has issued 11 clarificatory notes on topics ranging from election of independent directors (IDs) to electronic voting.

This is the beginning. Expect many more, because discretionary rule-making, covering a pantheon of corporate activities, necessarily requires scores of arbitrary and inconsistent clarifications. Please refer to the fat excise and customs rules and the import control handbooks pre-1991, and you will know what I mean.

Let me give some examples. Consider the election of IDs. Section 149 (10) and (11) states that an ID's term will be five years; she will have two such consecutive terms; and that the second term will only be after the passing of a special resolution by the shareholders.

A member of the Lok Sabha is a directly-elected representative of the people from a constituency. Other than being at least 25 years old, nothing prevents multiple terms, so long she wins each election. Directors, of whom IDs form a sub-set, are also voted by shareholders, who are the owners of companies. If shareholders freely opt to vote for an ID for three, four, five or six consecutive terms, what is the legal basis for TCA 2013 to limit it to two? Is it because the MCA thinks that an ID can only remain "independent" for 10 years? To promptly give up all vestiges of independence from the eleventh? What canon of common law is this? And in which civilised nation's corporate laws do you see such a provision?

Now consider board resolutions. According to TCA 2013, under section 117 read with 179 (3), all board resolutions, including those involving moves towards going for a merger, acquisition, takeover or diversification must be submitted to the Registrar of Companies (RoC) within 30 days of these being passed. Why will any company publicly disclose confidential information about a deal that is being approved in principle by its board, but is far from being closed? It won't. So, what's the outcome: bland resolutions that give nothing away, and are fit for nobody but the RoC. Who thought of this? The MCA.

Yet another example. According to section 177 (4) (iv), the Audit Committee (AC) of the board of directors must pre-approve all related party transactions of a company. Any large listed corporation in India has many subsidiaries, often located abroad. All such transactions, even if it is in the ordinary course of business and at arm's length, will need prior approval of the AC and then, under section 188 (1), of the board. What kind of pre-approvals will these be? Obviously, ACs and boards will ratify upper bound amounts, so that transactions between the company and its various subsidiaries, especially relating to sale of goods, materials and services, are not held up for the want of prior approvals. Is this what was intended? If not, where did the MCA leave its thinking cap?

I can go on. But let me end with two other bizarre examples from TCA 2013. Last week, a company secretary asked me to attend a 10-minute board meeting in Mumbai to issue and allot shares to employees under a shareholder-approved employee stock option scheme. Earlier, it was done by circular resolutions. The drafters of TCA 2013 decided that any issue of securities needs a meeting of the board. It can neither be delegated to a board committee, nor be passed by a circular resolution.

Finally, after allowing for board meeting participation through a prescribed process of video conferencing, the MCA has decided that the venue of such a meeting must be in India. If you read the rule, it is clear that "which shall be in India" is a perfect sarkari insertion. Quite meaningless, but so what?

With an act like this, how can one expect "fostering a positive environment"? How many piece-meal ratifications and clarifications will there be? It won't work.

Instead, let us get a tight team of recognised experts; draft a new Bill in 90-120 days while keeping the good sections of TCA 2013; and get it passed in Parliament as The Companies Act, 2014. Living with TCA 2013 will be agonising for companies and dreadful for investments. The only gainers will be those issuing clarifications every week, believing that they stitched a great suit.

The writer is a noted economist and chairman of CERG Advisory Private Limited
*21st Report of the Standing Committee on Finance, August 31, 2010

First Published: Thu, June 26 2014. 21:46 IST