Control based SBO identification beyond the current legislation

Critical analysis of a recent RoC’s Order u/s 90 of the CA, 2013

– Neha Malu, Deputy Associate | corplaw@vinodkothari.com

Background

The requirement of identification of Significant Beneficial Owners (“SBOs”) for companies in India kicked in with effect from 13th June, 2018[1]. It marks its origination based on the recommendations issued by the Financial Action Task Force (“FATF”). However, since its inception, neither the regulator nor the regulatees have been able to take a sigh of relief when it comes to implementing the directive for identifying an SBO for their company. There were several rounds of amendments[2], followed by extending the requirement to identify such SBO for LLPs[3] and thereafter introducing the concept of ‘designated persons’[4] for sharing the information of beneficial owners. Not only that, but to ensure companies do not miss their identification spree, the RoC has been sending advisory to several companies since the last year being 2023 seeking clarification on why they have not or whether they have identified the company’s SBO.

In the present article, the Author discusses the legal framework governing SBOs in the Indian parlance with a specific focus on the identification of SBOs who have or is said to have control  without any shareholding or voting rights in the light of the Adjudication Order[5] issued by the Registrar of Companies, NCT of Delhi and Haryana (“ROC”), in the matter of LinkedIn Technology (“Order”) and also delves into the discussion under the FATF guidance in this respect.

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The Detachment Dilemma: Cooling-off period for 2 term Independent Directors

Avinash Shetty, Manager l corplaw@vinodkothari.com

Table of contents
Introduction
Role of IDs
Appointment and Tenure
Cooling Off period
Conclusion

Introduction 

The year 2024 will witness one of the first and biggest board transitions when it comes to Independent Directors (“IDs”) serving for a decade in the Indian public companies, either listed or unlisted. This is because the applicability of Section 149 of the Companies Act, 2013 (“Act”)  became applicable from the 1st of April, 2014 wherein IDs were allowed to hold office for a maximum tenure of upto 5 consecutive years and be associated as such for not more than 2 such terms. The tenure of IDs held before the applicability of the Act was grandfathered.

Following the conclusion of the two terms on March 31, 2024 (or, if the appointment was effective till the 2024 AGM, then the AGM date), more than 130 IDs across nearly 75 companies have ceased their roles[1]. As of March 31, 2023, there were 198 companies within the NIFTY 500 that had 375 IDs whose tenure exceeded 10 years. Notably, 14 of these directors had served on their respective boards for 30 years or more.[2] As the maximum tenure for IDs is two consecutive terms of five years each, followed by a cooling-off period of 3 years, an extremely pertinent question comes up on the continued association of these outgoing IDs with such companies.

Role of IDs

If corporate governance is all about rising above the interests of limited stakeholders, IDs as an institution form the very lynchpin of corporate governance. IDs perform a number of critical functions, including but not limited to bringing independence,, expertise and objectivity to Board discussions, balancing stakeholder interests, and offering unbiased opinions during board discussions on issues such as risk management, related party transactions and board performance. Appointment and participation of IDs in decision-making proceedings have been kept at a higher pedestal as compared to other categories of directors when it comes to board independence and ensuring a proper mix of independent and non-independent directors. 

Several requirements are linked with appointment and presence of IDs under the Act as well as the SEBI Listing Regulations, including the following:

  • The presence of IDs is a must to constitute a quorum for the meetings of the Board of Directors of top 2000 listed entities.
  • The composition of the Audit Committee, Nomination and Remuneration Committee (“NRC”), Stakeholders Relationship Committee, and Risk Management Committee of listed entities must include IDs.
  • Only IDs have the power to approve Related Party Transactions (RPTs) of listed entities in Audit Committee meetings.
  • IDs of listed entities are required to be appointed to the Boards of their material subsidiaries[3].
  • IDs are also responsible for reviewing the performance of non-IDs and the Board as a whole.
  • Whistleblowers have direct access to the Chairman of Audit Committee, who is responsible for addressing their concerns/ grievances, including potential fraud allegations.
  • The committee of IDs is required to provide a report, which is to be filed with the stock exchange, recommending the draft scheme of arrangement, ensuring that the scheme is not detrimental to the shareholders of the listed entity and has compensated the eligible shareholders for fractional entitlement.[4]

Appointment and Tenure

The appointment of IDs on the Board of an unlisted public company requires an ordinary resolution to be passed by the shareholders and a special resolution in case of re-appointment, based on the recommendation of NRC and the approval of the Board.

In case of listed entities, the appointment and re-appointment of an ID on the Board will require the approval of shareholders by way of a special resolution. However, if the resolution for the appointment of an ID fails to be passed by a special resolution, it may still be considered passed if the following dual conditions are satisfied:

  1. There is an ordinary majority of all the shareholders, including the promoters and promoter group;
  2. There is an ordinary majority of the public shareholders, that is, disregarding the voting of the promoters and promoter group.

Cooling Off Period 

The cooling-off period for IDs is prescribed under the Act as well as Listing Regulations. It can be categorized as: (a) Pre-appointment cooling-off period and (b) Post -appointment cooling-off period.

Pre-appointment cooling-off period for an ID:

  1. The Act prohibits IDs from having any pecuniary relationship with the company, its group, their promoters or directors, during the present or past two preceding financial years preceding the appointment. However, remuneration as a director or any other transaction not exceeding 10% of IDs total income is permitted.
  1. The Listing Regulations are more stringent and require IDs to have no material pecuniary relationship with the company, its group, their promoters, or directors, during the present or past three financial years preceding the appointment, apart from remuneration.
  1. Further, the Act and Listing Regulations prohibit the appointment of a person as an ID if he/she is or has been a KMP or employee of the company or group entities during the past three financial years. However, relatives of employees other than KMPs are permitted to become IDs.
  1. The proposed IDs in the last three FYs should not be an employee, proprietor, or partner of :
    • Any legal or consulting firm that has had transactions with the company or group entities amounting to ten percent or more of the gross turnover of such firm.
    • A firm of auditors, company secretaries in practice, or cost auditors of the company or group entities.
  2. In respect of relatives of IDs:
    • They should not be indebted to the Company, its group, their promoters or directors beyond a specified amount, nor should they have given a guarantee or provided any security in connection with the indebtedness of any third person to these entities or individuals in the current or past three financial years.
    • The pecuniary transaction or holding of securities by relatives in the listed entity or its group should not exceed 50 lakh rupees or two percent of the paid-up capital during the current or past three financial years, nor should they have any other pecuniary transaction or relationship with these entities amounting to two percent or more of their gross turnover or total income.

Post-appointment cooling-off period for an  ID:

Unlike the pre-appointment cooling-off period which is evaluated and examined almost every year irrespective of whether there is a new appointment or not, the post-appointment cooling-off period has assumed a never-before noteworthiness. The obvious reason is as mentioned above, i.e. due to the first mega ID transitions on the board of a significant number of IDs in public companies. The relevant extract of Section 149(11) of Act which lays down the requirement is reproduced below:

“(11) Notwithstanding anything contained in sub-section (10), no independent director shall hold office for more than two consecutive terms, but such independent director shall be eligible for appointment after the expiration of three years of ceasing to become an independent director:

Provided that an independent director shall not, during the said period of three years, be appointed in or be associated with the company in any other capacity, either directly or indirectly.”

Going by the language of the law, it seems an ID who has completed two consecutive terms of 5 years cannot be associated with the company in any manner during the cooling-off period. Further, it is understood that the provisions start with a generic reference by saying “no director” but then become specific to say “such independent director”. However, in the proviso, the reference again becomes generic. Also the phrase “any other capacity” is broad, barring any possible positions such as a consultant or an adviser. These positions cannot be occupied indirectly too, the term “indirectly” seems to include the appointment of any company or firm where the ID has a substantial stake. The possible intent of these provisions is that the IDs should not exploit their past relationship with the company (during the time of being an ID) to gain an advantage after their term, as this may create a conflict of interest with their duties as an ID.

This is one possible view, and obviously, a conservative one. This view is premised on the principle that the association of the ID in any form is likely to get his some pecuniary interest, and this continuing pecuniary interest during the cooling off is alien to the whole principle of cooling off. Hence, the cooling off is like sampoorna vairagya.

There is another view, however. This view seeks to connect the cooling off with the “come back director”. That is, the ID who intends to come back after the 3 years’ cooling off and occupy the position as an ID should maintain abstinence during the cooling off. However, for the one who is content at not coming back, there should be no objection to the ID occupying a position other than as an ID.

This interpretation is based on the interpretation of the language of the proviso to Section 149(11). Since, the language of the proviso – it does not say “such independent director shall not”; instead, it says “an independent director shall not”. Therefore, the bar in the proviso is an independent bar, and not a mere qualification of the cooling off period itself.[5]

There are merits in both the views. The first view is grounded on the principle that indispensability is fatal to independence. If the ID during his term creates a continuing necessity of his services, his independence is bound to be questioned. The ID serves limited stint, during which he serves the company with objectivity and independence, and once his twin terms are over, he should allow the inevitable – a change. After all, what could be the justification for the company to lean on him to the extent of needing his services even during cooling-off?

The other view is based on the possibility of the ID having developed an understanding of the company’s business model and its functioning to the extent that losing his association after 10 years will be adverse to the company’s interest. After all, he does not intend to come back as an ID even after 3 years.

A question comes – can the ID offer one-off consulting services or professional advice to the company during the cooling off? Offering of professional advisory services, without any fixed relationship or commitment, is allowed pre, during and post retirement. As the safe harbour provision under the Act and Listing Regulations allows IDs to have a pecuniary relationship with the company and its group entities upto 10% of their total income, in addition to their remuneration.

Since the word in the proviso is “associate himself with the company in any other capacity”, a person offering one-off professional services does not have an “association”.

The real issue is not professional services. Quite often, these IDs are actually transitioned to other roles in the companies.  For example, the erstwhile ID is appointed as NED, or, in some cases, ED. As regards the change of role into an ED, Listing Regulations mandate a cooling-off period of one year for the transition of IDs who have resigned from the Board and then joined as an executive director or WTD in the same company,  holding, subsidiary, associate company or any company belonging to the promoter group. SEBI in its Board Meeting[6] noted that there could be valid reasons for an ID to transition to an ED or WTD, such instances where an ID knows that he/she may move to a larger role in the company in the near future, may practically lead to a compromise in their independence.

Cooling-off period in foreign jurisdictions

As far as the cooling-off restrictions in foreign jurisdictions are concerned, one can only notice the pre-appointment cooling-off period and not vice-versa. Some of these have been discussed below:

  1. The UK Corporate Governance Code, 2018[7] provides the cooling-off condition for the appointment of a non-executive director. The director should not have been an employee of the company or group in last five years; have no material business relationship with the company, either directly or indirectly in last three years; and has not served on the board for more than nine years from the date of their first appointment. However, provisions are required to be followed on a ‘comply or explain’ basis.
  1. The NASDAQ [8]and NYSE[9] Listing Standards restrict a person from being appointed as an ID, if they have been an employee of the listed company or had a material relationship with the listed company in the past three years.
  1. The Luxembourg Stock Exchange Principles[10] sets out the criteria to be considered by companies for appointment of ID which requires the director to not be an executive or MD of the company or an associated company in the last five years; should not be an employee in last three years; and has not served on the board for more than twelve years as non-executive or supervisory director.
  1. The SGX Code of Corporate Governance 2018[11] requires that an ID must not have served as a director or employed in the same company or related corporations for the past three financial years.

Conclusion

The provisions around the pre-appointment cooling-off period are pretty clear in terms of being interpreted and examined, however, that does not seem to be the case for the post-appointment cooling-off period where the letters of law suggest a complete exile for the outgoing ID as far as the concerned public company is concerned. However, the practice by the corporates tends to suggest otherwise. Several companies can be found to have allowed the continued association of their ex-IDs in some sort of other positions so as to avail some sort of services whether in consulting or anything like. Eventually, there is also a conscience call for the ID – can he be said to have compromised his independence, if he nurtures an interest in the company after he demits his office.


[1] https://www.business-standard.com/industry/news/from-ril-to-adani-power-top-firms-see-cessation-of-independent-directors-124040400939_1.html

[2] https://cdn.vahura.com/site/media/docs/the-great-board-refresh-2024-roundtable/The-2024-Board-Refresh-Report-by-IiAS.pdf?v=1696864425

[3] “material subsidiary” shall mean a subsidiary, whose income or net worth exceeds twenty percent of the consolidated income or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year.

[4] Reg. 37 of LODR r/w SEBI Scheme Circular

[5] Corporate Governance – Miles travelled and miles to go – Vinod Kothari & Company, 2024

[6] https://www.sebi.gov.in/sebi_data/meetingfiles/jul-2021/1626155485805_1.pdf

[7] https://media.frc.org.uk/documents/UK_Corporate_Governance_Code_2018.pdf

[8] https://listingcenter.nasdaq.com/rulebook/nasdaq/rules/Nasdaq%205600%20Series

[9] https://nyseguide.srorules.com/listed-company-manual/09013e2c8503fca9

[10] https://www.luxse.com/regulation

[11] https://rulebook.sgx.com/rulebook/board-matters-1

Crowdsourcing capital faces stiff penal actions

Nuanced structuring, conduit investor or platform advertising punished with crores of penalties

– Pammy Jaiswal, Partner | pammy@vinodkothari.com

Background

Use of digital platforms for tapping the early stage or ongoing funding  is being seen more often than before, and quite obviously so, in a networked world where crowdsourcing and crowd placing of almost everything is the  norm[1]. Several well-known platforms have been showcasing the immense potential to raise funds for start ups from either private equity investors, reaching very often to retail investors too. Some TV shows that showcase investing in start-ups have become the talk of the town; people who raised funding through these shows are seen as celebrities. In such an environment, if one opens the rulebook to say  that crowdsourcing of funds  by a company is a breach of the law and attracts huge penalties, one may be seen with disdain. However, one needs to note the provisions of sec. 42 (7) of the CA 2013, and five recent penalty orders of the RoC Delhi which, with detailed reasoning, has imposed stiff penalties running into crores for breach of these provisions.

This article explains what is the code of rules for private placements, what are the situations where this code may be breached, in what circumstances the RoC Delhi’s order found the practices legally untenable, etc. However, the author cannot close the article without discussing how start-ups with no past history or a balance sheet to present, but with a promising business plan, can still reach out to a group of people other than friends and families, because holding a different view will be to kill enterprise and innovation.

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Electoral bonds junked: consequences for donor companies

– Payal Agarwal, Senior Manager (corplaw@vinodkothari.com)

In a recent Supreme Court ruling in the matter of Association for Democratic Reforms & Anr. v/s Union of India, Electoral Bond Scheme (EBS/ Scheme) was declared as unconstitutional, including certain amendments to section 182 of the Companies Act, 2013 (“CA”), amended vide the Finance Act, 2017 as arbitrary and violative of the Constitution of India (COI).

Naturally, a question arises: What is wrong? Contributions to political parties? No. It is only the opacity of the recipient which has been hit. Hence, if companies have contributed, they couldn’t have kept a shroud of secrecy over the same.

Two, if companies had to disclose, and the amendments on 2017 are now junked, does it mean companies have to go back and disclose? It doesn’t seem so. In fact, the apex court itself has taken care of the actionables and put the burden of disclosure on the Election Commission of India (ECI).

Corporate houses, apparently, the largest contributors to electoral bonds, have expressed concerns on what will be the implications of the ruling on donor companies. Several questions arise – What has been declared unconstitutional and what is still valid? What would be the fate of the political donations already made? What actionables arise on a company having made donations to political parties through electoral bonds or otherwise? In this write-up, the author has attempted to analyze the same in light of the 232-pager ruling.

Section 182 of CA – Pre and Post Finance Act 2017

In order to understand what has been rendered unconstitutional and why, let us analyse the provisions of section 182 of CA as it stood prior to the amendment pursuant to Finance Act 2017 v/s how it stands today.

ParticularsPosition prior to Finance Act, 2017Position post Finance Act, 2017Whether unconstitutional as per SC ruling?
Limits on political contribution – Proviso to Sec 182(1)Aggregate value of contribution to political parties cannot exceed 7.5% of 3-years’ average net profitsNo maximum limit on political contributionsYes. The SC concluded removal of limits to be “manifest arbitrariness” for removing a classification without recognising the harms thereof.
Disclosure in financial statements – Section 182(3)Contributor company to disclose names of each parties against the total amount contributed to such partiesOnly total amount contributed to be disclosed, without disclosing namesYes. The SC concluded this to be an “essential” information for effective exercise of voting, and hence, non-disclosure as an infringement to the right of information of voter under Article 19(1)(a) of COI
Mode of contribution – Section 182(3A)New insertion pursuant to Finance ActPolitical contributions to be made only through banking channels (account paying cheque/ bank draft/ ECS) and through instruments issued under a scheme for political contributions (electoral bonds)No impact. However, the Electoral Bond Scheme has been declared to be unconstitutional.

Consequences for donor companies

The SC ruling does not declare “political donations” per se as unconstitutional or invalid, what is rendered violative of constitutional rights is the Electoral Bond Scheme and the amendments to section 182 of CA vide Finance Act, 2017 permitting unlimited and anonymous contributions to political parties.

The legal implications of declaring a statute unconstitutional has been discussed in various rulings in the past, such as, re Behram Khurshid Pesikaka v. State of Bombay, and others. These say the consequences are dealt with by the court only. In the present matter of Electoral Bond Scheme, the SC has directed SBI and the Election Commission of India to disclose the details of contributions received through electoral bonds, and refund the non-encashed amounts to the donor.

In essence it does not seem apt that any burden will be cast upon companies for going by a law which was valid till it was scrapped. Hence, no adverse implications should follow for the donor companies. However, for the sake of its corporate duty, a company which has contributed in the past may now do a disclosure in the forthcoming annual report. Thus, The omission of disclosure of particulars of political donations made along with names of the parties, between FY 2017-18 to FY 2022-23, may be made good by companies in the financial statement for the FY 2023-24 giving details of contribution made along with names of the political parties for each of the previous financial years, along with the current FY 23-24.

Principle of “manifest arbitrariness”

Having reference to various rulings and judicial precedents, the SC has summarized that the doctrine of “manifest arbitrariness” can be imposed to strike down a provision. Such a proposition can be applied where:

  1. the legislature fails to make a classification by recognizing the degrees of harm, and
  2. the purpose is not in consonance with constitutional values.

In the context of permitting unlimited contribution to political parties, on the grounds of removing classification between donations by “individuals” v/s “companies”, or between “loss making companies” and “profit making companies”, the degree of potential harm has been ignored. Section 182 was enacted to curb corruption in electoral financing, however, the amendment allowed companies, incorporated for a specific purpose as per their MoA, to contribute unlimited amounts to political parties without any accountability and scrutiny. This may also facilitate incorporation of “shell companies” solely for the purpose of making such political contributions and permit undue influence of companies in the electoral process, thus violating the principle of free and fair elections and political equality.

The hon’ble SC has ruled the deletion of maximum limit as “violative” of COI and “manifestly arbitrary” for not recognising the degrees of harm in removing the classification between –

  1. Political donations by “companies” and “individuals” where the ability to influence electoral process is much higher with the former, since “Contributions made by individuals have a degree of support or affiliation to a political association. However, contributions made by companies are purely business transactions, made with the intent of securing benefits in return.”
  2. “Profit-making” and “loss-making companies” for the purposes of political contributions, since “it is more plausible that loss-making companies will contribute to political parties with a quid pro quo and not for the purpose of income tax benefits.”

The present SC ruling quashes the anonymous political donations and the amendments in CA permitting unlimited corporate donations to political parties. Political donations are not unconstitutional, however a company, making such donations, shall ensure the same does not result into emptying the resources of the company while also ensuring transparency in disclosure of such political donations in its financial statements for the right of information of the concerned shareholders as well as larger stakeholder and voter base.

LEAP to listing: India permits direct listing of shares overseas through IFSC

MCA & MOF notify rules for the same

– Vinita Nair & Prapti Kanakia | corplaw@vinodkothari.com

Indian companies were permitted to raise funds from overseas either pursuant to issue of depository receipts listed overseas or having the non-residents subscribe to issuances made in India or by way of borrowing overseas. As an initiative to provide an avenue to access global capital markets, GoI had announced the decision to ease raising of foreign funds in order to boost foreign investment inflows, unlock growth opportunities and offer flexibility to Indian companies to raise funds. Consequently, an enabling provision for direct listing of prescribed class of securities on permitted stock exchanges in permissible foreign jurisdictions was inserted vide Companies (Amendment) Act, 2020 in Section 23 of Companies Act, 2013 (‘CA, 2013’), that deals with permissible modes of issue of securities, vide notification dated September 28, 2020 and made effective from October 30, 2023. Thereafter, the Ministry of Corporate Affairs (‘MCA’) notified Companies (Listing of equity shares in permissible jurisdictions) Rules, 2024 (‘LEAP Rules’) effective from January 24, 2024. As listing of shares abroad will result in raising funds from persons resident outside India, Ministry of Finance (‘MoF’) notified FEMA (Non-Debt Instruments) Amendment Rules, 2024 amending FEMA (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’) with effect from January 24, 2024. SEBI is also expected to roll out the operational guidelines for listed companies to list their equity shares on permitted stock exchanges.[1]

Additionally, FAQs on direct listing scheme (FAQs) have also been rolled out on January 24, 2024. Further, two of the key recommendations of the working group report on Direct Listing of Listed Indian Companies on IFSC Exchanges submitted in December 2023 was to notify the rules under Section 23 (3) and (4) of CA, 2013 and notify necessary amendments in NDI Rules to permit cross-jurisdiction issuance and trading of equity shares of Indian companies on IFSC exchanges.

Presently, both the LEAP Rules as well as NDI Rules have notified International Financial Services Centre in India (‘Gift City’) as the permissible jurisdiction and India International Exchange and NSE International Exchange as the permissible stock exchange. International Financial Services Centres Authority (‘IFSCA’) had issued the IFSCA (Issuance and Listing of Securities) Regulations, 2021 effective July 19, 2021 (‘IFSC Regulations’) however, in the absence of enabling provision under CA, 2013 and NDI Rules, Indian companies were unable to undertake listing of securities abroad.

In this article we provide an overview of the regulatory regime and deal with the procedural aspect.

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Felicitation Meet and Panel Discussion on Corporate Governance – from 1988 to Now

Register here

Agenda for the Panel Discussion

About the Book

Live on Youtube

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Presentation on Significant Beneficial Owners (for companies & LLPs)

Team Corplaw | corplaw@vinodkothari.com

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Our article corner on SBO: https://vinodkothari.com/article-corner-on-sbos/

Directors’ Responsibility towards Climate Change: Lessons from Recent Litigation

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Online workshop on Significant Beneficial Owners: For Companies and LLPs

Click here to register for the workshop: https://forms.gle/3vdQjaLJY1Sgs4Ps5
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