A Law For Corporates And By Corporates

The new companies bill neglects the interests of all stakeholders in a company "� like minority and institutional shareholders and employees "� except one. Shripad R Halbe, an expert on company law, looks at the provisions in a series of articles

The faulty theoretical canvas and the lopsided logic on which the new companies bill has been built indicates a strong bias on the part of the expert group that conceived it. It has sought to deliver a statute that has been written for the corporate sector and by the corporate sector, with scant regard for the interests of other groups like labour, minority shareholders and even institutional shareholders. Significantly, the word creditor is missing from the whole report! And employees makes an appearance just twice.

 

On many important issues, the report resorts more to jugglery and less to logical arguments. The classic case relates to the deletion of Section 43A which deems private companies (whose average annual turnover is over Rs 10 crore, or whose holding in or of a public company is over 25 per cent) as public companies. Recommending the deletion, the report states "the rationale was opaque at the time it was introduced and it is certainly misplaced in the context of 1990s.

One fails to understand the use of the adjective opaque to a rationale that was clear since its introduction subsequent to the Shastri committee's report.

The report states: "Private companies, which employ public money, directly or indirectly, to a considerable extent, should be subject to the same restrictions and limitations as to disclosure and otherwise as apply to public companies." Thus size as well as public ownership were to be the criteria for determining the control/regulations of such companies. The report also does not tell us why and how the rationale is misplaced in the 1990s.

Significantly in the very next sentence the report gives away the real reason: Various associations, chambers of commerce and professional bodies have deposed before the group demanding that the section be scrapped.

Tomorrow, by this logic, any act can be scrapped as soon as the associations and professional bodies make a representation. What about giving a similar opportunity to workers, creditors, shareholders et al? Company law amendments cannot begin from the depositions by CII and end with the pressure from Ficci.

The group does not want to give any protection to small shareholders or creditors as exists in the Companies Act of the UK but when it wants to usher in the buy-back of shares, it draws support from a Bank of England document. When it wants to remove the restriction on inter-corporate loans and investment, it notes: "The post-war experience of Great Britain, the US, Germany, Japan, Korea and more recently Malaysia, Singapore and Indonesia clearly demonstrate the positive role of inter-corporate loans and investments." But employees' equal representation on the executive board in Germany does not attract its attention.

Most importantly, it ignores Indian realities

In mature economies scamsters get booked speedily, in India it takes ages. There is no recognition of the compulsions that this introduces.

Non-executive directors: The duplicity of the whole exercise is further highlighted when it recommends one thing in the report but the draft bill proposes something else, even when the issue is as important as the liability of non-executive directors. This is more than gross negligence. It is deliberate mischief.

Says the report, Typically, a non-executive director has far less information about the day-to-day running of the company and whether it is complying with all provisions of the various corporate laws than a managing or whole-time director.

The group recognises this informational asymmetry, and recommends that there should be an explicit provision in Section 5 (officer who is in default) which excludes non-executive directors, except in cases where such a person is a signatory of any declarations made by the company.

Now, turn to the clause 2(39) in the draft bill. It defines that Section 2(39) Officer who is in default.... means all the following offices of the company, namely the managing director or managing directors, the whole-time directors and any other director in respect of any decision of the board to which he is a party....

An explanation below this provision makes it clear that the director is liable if any default takes place with his consent, or connivance or is attributable to his neglect.

One fails to understand what transpired between the submission of the report and the preparation of the draft bill.

Indeed, the plight of the non-executive directors who occupy their office at the pleasure of the executive directors is precarious. On all matters in which executive directors have an interest, they will neither participate nor vote. Nor will their presence be counted for quorum.

Only the non-executive directors will vote on matters involving aggrandisement of executive directors and by virtue of sub-section (c), will become liable for the same. No doubt, every director should be held responsible, including the non-executive one.

But if the expert group wants to hold, as in the bill, the non-executive directors liable, what extra rights, authority or remuneration does it give them?

They cannot be made liable without authority. This will surely sound the death knell of non-executive directors because, anyone who values these qualities, will not venture to be on the boards of most companies.

Objects and registered office

The recommendation of allowing alterations to the object clause and registered office clause of the memorandum of association smacks of deceit. These alterations require the mere passing of a special resolution by the shareholders. However, for a listed company, if its registered office is to be altered to another state, it is provided that company law tribunals permission is to be obtained.

One does not understand why for a change of registered office alone a permission from the tribunal is necessary. The report brusquely concludes that it makes sense for public/listed companies. It does not specify or explain what sense it makes. If the group wants to do away with the permission from the tribunal altogether it is fine, but to provide it only for the inter-state change of registered office of the listed companies does not make any sense.

But the amendment that relates to the alteration of the object clause by a mere special resolution is more sinister. Why? To understand this let us first understand what ultra virus and doctrine of constructive notice mean.

The English as well as India law provide for the doctrine of ultra virus. Since the company is not a natural person, it can act only within the powers delegated to it by its charter which is the memorandum of association. Therefore, any act done outside the memorandum of association by the company will be regarded as void ab initio and an outsider cannot have any claim on an ultra virus transaction.

As per the doctrine of constructive notice, all documents (memorandum of association being one of them) that are registered with the registrar of companies (public authority) would be deemed to have been read by the persons dealing with the company.

The purpose of the doctrine of ultra virus has been succinctly describe by professor Gower thus: Its purpose was two-fold. First to protect investors in the company so that they might know the objects for which their money was to be employed; and second to protect creditors of the company by ensuring that its funds, to which alone they could look for payment in the case of a limited company, were not dissipated in unauthorised activities.

The English law which the expert group has tried to copy always kept in mind the twin objectives. In 1985, the UK Companies Act was amended to provide for alteration of object clause by a special resolution without confirmation by court.

But it gave protection to the dissentient shareholders whereby the holders of not less than 15 per cent of the share capital can approach the court within 21 days of the passing of the resolution. If the ground of objection is that it does not satisfy one of the grounds similar to the ones from (a) to (f) of Section 17 of the act (now clause 10 in the draft bill) then even one shareholder can approach the court.

Creditors

The English law also protected the creditor. It may be interesting to note further that when the UK act was amended to do away with the court approval, it also amended section 9(1) of the European Communities Act to specifically provide that the creditors will be protected. It follows the first directive of the European Union according to which the third party entering into a contract with a company can continue to presume that the company is always acting within its objects and not otherwise.

In other words till such a time the company specifically notifies the creditor of the change in the object clause, the creditor has nothing to fear.

Given the limited liability of a company the ordinary creditor is already taking risks, though he harbours an illusion that he is safe because he is dealing with a limited company. By dispensing with the mandatory notices to creditors and not abandoning the doctrine of ultra virus, the ordinary creditor is much worse off. And the group does not even appear to be aware of this.