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ESG concerns in corporate governance in India

Sikha Bansal, Partner (sikha@vinodkothari.com) and Payal Agarwal, Executive (payal@vinodkothari.com)

Introduction

ESG (where, E stands for Environment, S for Society, and G for Governance) is a term that has earned a lot of attention in the recent years. Related terms used are ESG investing, ESG reporting, ESG rating, etc. – all focussing on and circumscribing same factors.

The ESG analysis is sought as a measure of responsible investing, and goes beyond the traditional method of using only financial factors for evaluation of an investment or potential investment.  ESG, in essence, recognises financial relevance of various non-financial elements which impact business in several ways. With sustainable development being the desirable result of whatever we do, efforts have been made to incorporate ESG issues in the analysis of the business performance as a whole.

In context of the same, we have tried identifying ESC concerns in India, in relation to corporate businesses. While in India, we have already something called ‘business responsibility reporting’, we need to see if this sufficiently captures the spirit of ESG and where it stands vis-à-vis global practices.

What is ESG?

Before we go on to the question why we need ESG, we need to understand what ESG, and also, why and how it has assumed so much of importance.

The emergence of ESG dates back to earlier years of 2000s. A report titled Who Cares Wins: Connecting Financial Markets to a Changing World[1], highlighted the emerging ESG issues and made several recommendations, including – (i) financial institutions should commit to integrating environmental, social, and governance factors in a more systematic way in research and investment processes, (ii) the companies a leadership role by implementing environmental, social and corporate governance principles and polices and to provide information and reports on related performance in a more consistent and standardised format, and (iii) investors shall explicitly request and reward research that includes environmental, social and governance aspects and to reward well-managed companies. Further, the report recommended that the financial analysts shall not only focus on ESG risks and risk management, but also consider ESG issues as a potential source of competitive advantage. The report also identified the following drivers through which good management of ESG issues can contribute to shareholder value creation[2].

Later, UNEP FI, in its 2005 Report[3], highlighted the distinction between ‘value-driven’ vs. ‘values-driven’ investment, and observes, “ESG considerations are capable of affecting investment decision-making in two distinct ways: they may affect the financial value to be ascribed to an investment as part of the decision-making process and they may be relevant to the objectives that investment decision-makers pursue.” This report noted that, the movement towards mainstream consideration of ESG issues in investment decision-making is a response of variety of factors, including, increasing evidence of the nexus between performance on ESG issues and financial performance, reputational concerns, consumer pressure, public opinion, introduction of corporate environmental reporting obligations, etc.[4]

Some institutional investors believed that environmental, social and governance (ESG) issues were not relevant to portfolio value, and were therefore not consistent with their fiduciary duties. However, in report titled “Fiduciary Duty in the 21st Century[5], issued by UN agencies and PRI[6], it was clarified that the assumption is no longer supported, and that, failing to consider long-term investment value drivers, which include environmental, social and governance issues, in investment practice is a failure of fiduciary duty. The said report identifies critical importance of incorporating ESG standards into regulatory conceptions of fiduciary duty, for mainly three reasons – firstly, ESG incorporation is an investment norm; second, ESG issues are financially material; and thirdly, policy and regulatory frameworks are changing to require ESG incorporation.

Presently, there are several organisations, projects and reports focussing on ESG issues. These organisations may be governmental as well as independent. For instance, Global Reporting Initiative (GRI)[7] has formulated several standards[8] for sustainability reporting. See also, OECD (2017), Investment governance and the integration of environmental, social and governance factors.

Pillars of ESG

ESG, as stated above, has 3 pillars – Environmental, Social and Governance Each of these pillars comprises of several factors which would be a ‘parameter’ in ESG analysis.

  • “environmental” pillar focusses on creating a sustainable environment, where parameters such as impact of a company’s activities on the climate, company’s liability towards the environment, creating eco-friendly products, etc are checked and measured;
  • “social” aspect focusses on creating value for the society, by laying emphasis on the human rights issues, workplace health and safety, labour training and management, interaction with communities, customer relationship etc;
  • “governance” aspect covers issues on the corporate governance of a company and has two main elements: corporate structures, and corporate behaviour.

We have compiled a list of such factors[9] as below –

ESG Reporting

EU law requires large companies to disclose certain information on the way they operate and manage social and environmental challenges. EU’s directive, 2014/95/EU also called the non-financial reporting directive (NFRD), acknowledges that disclosure of non-financial information is vital for managing change towards a sustainable global economy by combining long-term profitability with social justice and environmental protection and lays down the rules on disclosure of non-financial and diversity information by large companies[10]. The Directive amends the accounting directive 2013/34/EU (by inserting Article 19a) so as to mandate inclusion of non-financial statement containing information to the extent necessary for an understanding of the undertaking’s development, performance, position and impact of its activity, relating to, as a minimum, environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters, etc.

It further provides, “Where the undertaking does not pursue policies in relation to one or more of those matters, the non-financial statement shall provide a clear and reasoned explanation for not doing so.”

The EU has issued its guidelines to help companies disclose environmental and social information, and published guidelines on reporting climate-related information. Also, EU has also launched a public consultation on the review of the NFRD[11].

The OECD Report of 2017[12] compiles ESG reporting requirements (voluntary as well as mandatory) across the world by institutional investors, and by way of corporate disclosures. The report observes that the reporting requirements are usually voluntary (“comply or explain”) and are not prescriptive on the methods or metrics to be used.

The Financial Reporting Council (FRC) of UK released a discussion paper – “A Matter of Principles: The Future of Corporate Reporting” (2020). The discussion paper proposes a network of interconnected reports based on objectives rather than a single comprehensive annual report. The proposals include 3 reports – Business report, the full Financial Statements and a new Public Interest Report. It also focuses on widening the definition of materiality so that it does not remain limited to accounting standards only, but covers other wider range of activities that affect a company significantly. Section 6 of the this Report deals extensively with non-financial reporting, stated to include information relating to employees, suppliers, customers, the community, the environment and human rights.

In a study, “The consequences of mandatory corporate sustainability reporting: evidence from four countries (2015)”, it has been observed that even though the regulations often allowed companies, via comply or explain clauses, to choose not to make greater disclosure, there was a 30%-50% average increase in ESG disclosure as a result of the regulations being introduced (albeit from a low starting base). The greatest increase came in the first year of the regulations coming into force. All three types of disclosure – environmental, social and governance – increased.  The findings, therefore, suggest that, contrary to popular belief that an increase in disclosure regulation imposes significant costs on companies and, therefore, has a negative impact on shareholders, the reality is that improved disclosure creates value for companies, not destroys it.

ESG Rating

Investors, institutional institutions, etc. would generally make use of ESG information for investment decisions through ESG ratings provided by ESG rating agencies[13]. This assessment and measurement often forms the basis of informal and shareholder proposal-related investor engagement with companies on ESG matters[14]. ESG factors can provide valuable insights into possible current and future environmental and social risks and opportunities for corporate entities, given the impact and dependence entities have on the environment and society. These ESG issues in turn have the potential to lead to a direct or indirect financial impact on the entity’s profits and investment returns[15].

See Boffo, R., and R. Patalano (2020), “ESG Investing: Practices, Progress and Challenges”, OECD Paris, for an elaborate discussion on ESG rating and indices and the methodologies adopted for the same. The paper also compiles ESG Criteria as used by major index providers as follows[16]

Even though there are countries where ESG Reporting has been initiated as a voluntary or mandatory measure, the requirement of ESG rating has not been found to be mandated in any country by way of explicit regulations on the same.  However, institutional investors, proxy advisor firms etc., are largely using these ratings while making investment decisions as part of making socially responsible investment.

ESG in Indian Context

The Indian legislation has been trying to cover the various aspects of ESG in a fragmented manner.

For instance, the board’s report shall disclose the conservation of energy, technology absorption, etc.[17] The aspects have to be dealt with in detail – the company shall disclose steps taken or impact on conservation of energy, steps taken to utilise alternate sources of energy, capital investment in energy conservation equipments, efforts towards technology absorption, etc. Besides, a director owes a fiduciary duty towards the community as well as for the protection of the environment[18]. Also, CSR activities include various socio-economic activities, required to be disclosed separately in the annual report[19]. However, the closest requirement is that of Business responsibility Reports (BRR) which has been mandated from ESG perspective only, as discussed below.

What is Business Responsibility Report (BRR)?

BRR or Business Responsibility Report can be said to be the foremost step in India in promoting non-financial reporting in India, on a mandatory basis. The initiative was one of the responses to India’s commitment towards the United Nations Guiding Principles on Business & Human Rights (UNGPs) and Sustainable Development Goals.

The BRR is based on the 9 principles in line with the ‘National   Voluntary   Guidelines   on   Social, Environmental and Economic Responsibilities of Business’ (NVG)[20] issued by MCA. The guidelines state that the companies should not be just responsible but also socially, economically and environmentally responsible. Through such reporting, the guidelines expect that businesses will also develop a better understanding of the process of transformation that makes their operations more responsible. The NVG were further revised and the MCA formulated the ‘National Guidelines on Responsible Business Conduct’ (NGRBC)[21]. The said guidelines stipulated that the businesses should –

  • conduct and govern themselves with integrity in a manner that is Ethical, Transparent and Accountable,
  • provide goods and services in a manner that is sustainable and safe,
  • respect and promote the well-being of all employees, including those in their value chains,
  • respect the interests of and be responsive to all their stakeholders,
  • respect and promote human rights,
  • respect and make efforts to protect and restore the environment,
  • when engaging in influencing public and regulatory policy, should do so in a manner that is responsible and transparent,
  • promote inclusive growth and equitable development, and
  • engage with and provide value to their consumers in a responsible manner.

The Securities and Exchange Board of India (SEBI), in 2012[22], through its listing conditions mandated the top 100 listed entities by market capitalisation to file BRR from ESG perspective. This was extended to top 500 companies in FY 2015-16[23]. The coverage has been extended to 1000 companies now[24]. In the year 2020, MCA issued Report of the Committee on the Business Responsibility Reporting, and SEBI issued a Consultation Paper on the format for Business Responsibility and Sustainability Reporting (BRSR, suggesting that BRR shall be renamed as BRSR). See our detailed analysis of the recommendations made in these reports.

See also, our earlier article on BRR. The eventual development in BRR framework is shown below –

BRR – Identifying ways to improve

ESG has no statutory definition, per se. We have tried identifying possible factors, based on various reports, indices, etc. which would reflect a holistic ESG perspective of an entity.

How effective is the present framework of BRR can be understood by way of the following table:

BRR vs ESG – Hits and Misses

Hits Misses
Climate change Carbon emissions
Resource use , sustainable sourcing Green building
Environmental protection and restoration Biodiversity and land use
Renewable energy Discharge of effluents
Water use ————-
Energy efficiency —————
Clean tech —————-
Safety of employees, customers Privacy and data security
Skill upgradation training Financial product liability
Labour management ————
Practice against child labour, sexual harassment, forced labour ————
Protection of human rights ————-
Satisfactory redressal of customer complaints ————
Stakeholder engagement ————
Ethics and bribery Board structure
Anti competitive behaviour Executive pay
Unfair trade practices Codes and values
—————– Tax transparency

 

Most of these gaps in the present BRR format are covered under the proposed BRSR. The BRSR has provisions for reporting on the carbon emissions of a company, discharge of other effluents by the company, and reporting relating to the privacy and data security of the customers etc. Also, the BRSR defines the scope of reporting for every item very precisely.

However, matters such as financial product liability and various aspects of governance still needs a dedicated space.

NSE Study of BRR Reporting in India

A study of NSE, while conducting the ESG analysis of Indian companies, has checked the disclosures provided under the BRR framework by the companies as part of its ESG analysis.

Some significant findings of the study has been pointed below:

  • Among the nine principles, the least number of sample companies responded positively for disclosures on principle 7 (i.e., public advocacy). It had the lowest score on all four measures.
  • One of the recurring reasons for not framing a policy on the principle 7 is that there is no specific/ formal policy on public advocacy. However, companies have stated that they indirectly covered aspects of principle 7 under other policies. This may be attributed to the fact that in India, advocacy, if at all done, is done in a non-transparent manner.
  • The second worst response was with respect to the principles relating to ‘respect and promoting human rights’ and ‘engagement and providing value to customers and consumers’. Once again, probably, these concepts are yet to be assimilated in our system.
  • Higher positive responses were found across principle 1 (ethics), principle 3 (employees), principle 4 (stakeholder), principle 6 (environment), and principle 8 (growth and equitable development – social responsibility). This can be attributed to the fact that some of these policies flow from various legal mandates in India. Hence, most companies have formal policies to comply with the law on these principles.

The study highlights that companies have largely scored better on policy disclosures followed by governance factor, compared to environment and social factors. This can be attributed to the fact that governance reforms have transformed into laws by various regulatory agencies within India, in the last two decades. Similarly, many policies have been mandated to be prepared by regulatory authorities. Hence, companies have scored higher on policy disclosure parameters.

Closing Thoughts

The BRR Reporting in India, in terms of key areas, goes a long way in presenting a holistic ESG scenario. Some structural changes in the extant format may facilitate better reporting.

Further, the Indian companies are found to perform well in the governance related matters, in comparison to the environmental and social factors, admittedly for the presence of various statutory requirements and regulatory supervision on the governance requirements of a company. However, the companies need to improve their environmental and social scores as well.

[1] December, 2004. The Report was a joint initiative of financial institutions which were invited by United Nations Secretary-General Kofi Annan to develop guidelines and recommendations on how to better integrate environmental, social and corporate governance issues in asset management, securities brokerage services and associated research functions. See also, “Who Cares Wins” : One Year On” – A Review of the Integration of Environmental, Social and Governance Value Drivers in Asset Management, Financial Research and Investment Processes, published by the International Finance Corporation.

[2] Refer, page 12 exhibit 9 of the said Report

[3] A legal framework for the integration of environmental, social and governance issues into institutional investment”

[4] Refer, page 24 of the said Report.

[5] The website is https://www.fiduciaryduty21.org/ . The report has been last updated in the year 2019.

[6] Principles of Responsible Investing (PRI) is a United Nations-supported initiative, launched in 2006 by UNEP Finance Initiative and the UN Global Compact.It  is a network of international investors working together to put the six Principles for Responsible Investment into practice. The PRI were devised by the investment community and reflect the view that environmental, social and governance (ESG) issues can affect the performance of investment portfolios and therefore must be given appropriate consideration by investors if they are to fulfill their fiduciary (or equivalent) duty. In implementing the Principles, signatories contribute to the development of a more sustainable global financial system.

[7] GRI was founded in Boston in 1997 following public outcry over the environmental damage of the Exxon Valdez oil spill.  The aim was to create the first accountability mechanism to ensure companies adhere to responsible environmental conduct principles, which was then broadened to include social, economic and governance issues. The first version of what was then the GRI Guidelines (G1) published in 2000 – providing the first global framework for sustainability reporting. The following year, GRI was established as an independent, non-profit institution. In 2016, GRI transitioned from providing guidelines to setting the first global standards for sustainability reporting – the GRI Standards.

[8] The GRI standards can be accessed here https://www.globalreporting.org/standards/

[9] The list is a compilation of the various factors identified by various organisations and reports such as, PRI, MSCI Research, NSE-SES report on ESG analysis of 50 Indian companies, etc.

[10] EU rules on non-financial reporting only apply to large public-interest companies with more than 500 employees. This covers approximately 6,000 large companies and groups across the EU.

[11] See here.

[12] OECD (2017) Investment governance and integration of environmental, social and governance factors

[13] Some well- known ESG rating providers include: (a) Dow-Jones Sustainability Index, (b) S & P Global Ratings, (c) MSCI ESG Research etc.

[14] https://corpgov.law.harvard.edu/2017/07/27/

[15] S&P Global Ratings: Exploring Links To Corporate Financial Performance

[16] Source: Boffo, R., and R. Patalano (2020), “ESG Investing: Practices, Progress and Challenges”, OECD Paris

[17]Companies Act, 2013, section 134(3)(m), read with rule 8 of the Companies (Accounts) Rules, 2014

[18] Ibid, section 166.

[19] Ibid, section 135 read with Companies (Corporate Social Responsibility Policy) Rules, 2014.

[20] 2011. A refinement of earlier Corporate Social Responsibility Voluntary Guidelines 2009, released by the Ministry of Corporate Affairs in December 2009.

[21] 2019. See Press Release.

[22] CIR/CFD/DIL/8/2012 dated 13th August, 2012

[23] See update, and notification.

[24] See notification.

Corpus contributions: Whether CSR?

Ajay Kumar K V | Vinod Kothari and Company

corplaw@vinodkothari.com

Introduction

Corporate Social Responsibility (‘CSR’) is a concept whereby an entity integrates its business with the social goals in order to achieve a socio-economic balance. In India, section 135 of Companies Act, 2013 (‘Companies Act’) and the rules made thereunder govern CSR activities to be mandatorily undertaken by companies which fulfill the criteria as specified in the said Act. The CSR norms have recently undergone substantial changes[1].

When the CSR provisions were initially notified, corpus contribution to specific funds & activities was considered to be CSR expenditure under the extant CSR Rules (see, Rule 7 before amendments). The term ‘contribution to corpus’ led to confusion among the industry and MCA came out with a clarification letter (No. 05/01/2014- CSR) dated 18th June, 2014[2] clarifying that the contribution to Corpus of a Trust/ society/ section 8 companies etc. will qualify as CSR expenditure as long as (a) the Trust/ society/ section 8 companies etc. is created exclusively for undertaking CSR activities or (b) where the corpus is created exclusively for a purpose directly relatable to a subject covered in Schedule VII of the Act.

However, the CSR rules, in their present form, do not mention the term ‘corpus’ anywhere. As such, the question is whether corpus contribution is still an eligible CSR expenditure.

What is ‘corpus’?

‘Corpus’, in the context of trusts, etc. would generally mean contributions in the nature of capital. The courts and tribunals have opined that corpus specific voluntary contributions are of capital nature and hence are not taxable at the hands of the trust. In Sukhdeo Charity Estate v. Commissioner of Income-Tax[3], the Rajasthan High Court observed as follows:

“”Corpus” is a Latin word and the English meaning of it is a “body”. In Random House Dictionary, college edition, page 301, one of the meanings of “corpus” is “a principal or capital sum, as opposed to interest or income”. Similar is the meaning of the word “corpus” in Black’s Law Dictionary, 5th edition, page 310, Thus, a capital amount in the form of money, movable or immovable property and the donations received by a charitable trust for specific purposes may be said to be corpus or remained any capital in a fund in contrast to income.

The Technical Guide[4] issued by the Institute of Chartered Accountants of India observes specific features of ‘corpus’ in the context of non-profit organisations (NPOs). The Technical Guide also discussed various kinds of ‘funds’ as may be maintained by the NPOs – restricted funds, unrestricted funds, etc. Restricted funds are subject to certain conditions set out by the contributors and agreed to by the NPO when accepting the contributions. The restriction may apply to the use of the moneys received or income earned from the investment of such moneys or both. Funds, the use of which is subject to legal restrictions, are also considered as restricted funds.

See also, exposure draft on Uniform Accounting & Reporting Framework for NGOs[5] which also makes similar observations.

Corpus contribution under Income Tax Act

Voluntary contributions to trusts, etc. are made taxable vide the definition of income under Section 2(24) (iia) of the Income Tax Act which reads as under-

“2(24)(iia) Voluntary contributions received by a trust created wholly or partly for charitable or religious purposes or by an institution established wholly or partly for such purposes or by an association or institution referred to in clause (21) or clause (23), or by a fund or trust or institution referred to in sub-clause (iv) or sub-clause (v) or by any university or other educational institution referred to in sub-clause (iiiad) or sub-clause (vi) or by any hospital or other institution referred to in sub-clause (iiiae) or sub-clause (via) of clause (23C) of section 10 or by an electoral trust.”

As per Section 12 of the Income Tax Act, any voluntary contributions received by a trust created wholly for charitable or religious purposes or by an institution established wholly for such purposes (not being contributions made with a specific direction that they shall form part of the corpus of the trust or institution) shall for the purposes of section 11 be deemed to be income derived from property held under trust wholly for charitable or religious purposes.

It is a settled legal proposition, in case of a registered Trust under the Income-Tax Act, the corpus specific voluntary contributions are outside the scope of income as defined in section 2(24)(iia) of the Act due to their “capital nature”.

See, Sukhdeo Charity Estate v. Commissioner of Income-Tax (supra).  In ITO v. Shri Sachyaya Mataji Trust [ITA No.538/Jodh/2013,] dated 09/05/2014[6], the Jodhpur bench of ITAT held that if a voluntary contribution is made with a specific direction, it shall be treated as capital of the trust for carrying on its charitable or religious activities. Then such an income falls under section 11(1) (d) as is not liable to tax. If the intention of the donor is to give that money to a trust to keep in trust the account in deposit and utilise the income therefrom for carrying on a particular activity, it satisfies the definition part of the corpus. The assessee would be entitled to the benefit of exemptions from payment of tax.

On an analysis of the above case laws and the provisions of the Income Tax Act, ‘corpus’ would include sums given with specific directions.

Thus voluntary contribution made with a specific direction as in the case of a CSR project contribution is a capital receipt for the Trust and hence not taxable as income. The money received in these funds has a specific purpose and not available for conducting activities that are ancillary to the main objects of the trust.

Corpus Contribution and CSR

The above discussion brings in more clarity with respect to the term ‘corpus contribution’. Corpus contribution, as is generally understood, is a contribution of capital nature, given with specific directions. In respect of CSR, since it has a specific purpose and is mandated by the law, it can be termed as corpus contribution.

The objective of CSR is broad and restricting CSR to only projects/programmes to be undertaken by the company (either directly or through implementing agencies) would narrow down the benefits which CSR provisions intend to offer. As such, fund contributions (of course, subject to certain conditions), should qualify as CSR Expenditure.

In Technical Guide on Accounting of CSR Funds by Third Parties [February, 2021][7], para 26 states as follows –

“26. The third parties i.e. section 8 company, or a registered trust or registered society may receive Corpus donation, which could be a CSR expenditure in the hands of the donor company if the required conditions are complied with. Corpus donations are with a specific direction regarding the use of the funds and characteristically capital in nature. MCA in General Circular No.21/2014 dated 18th June 2014 has clarified that contribution to Corpus of a Trust/ society/ section 8 companies etc. will qualify as CSR expenditure . . .”

Therefore, note that, such corpus contribution will still be subject to the 2 conditions as stated in the MCA Circular of 2014 (see, above). Also, there must be clear directions on the part of the company to the said entity as regards activities to be undertaken, modalities of fund utilisation, etc. and the company shall use appropriate monitoring and reporting measures to satisfy itself that the funds have been utilised for the specified activity/activities.

Here, one should also distinguish between fund contribution to an entity and making disbursement of funds to an implementing agency. In our earlier article titled ‘Understanding the borderline between implementing agencies and beneficiaries’[8], we have discussed distinguishing features of an ‘implementing agencies’, and ‘beneficiaries’ and the consequential impact of the same on the CSR compliances by the company. In case of fund contribution, the entity shall rather be a ‘beneficiary’ and not an ‘implementing agency’.

Conclusion

Basis discussions above, one may view that corpus or fund contributions should qualify as CSR expenditure provided that, the following conditions are fulfilled –

  • (a) the entity is created exclusively for undertaking CSR activities or (b) where the fund/corpus is created exclusively for a purpose directly relatable to a subject covered in Schedule VII of the Act.
  • the company gives specific directions to the entity with respect to activities, etc. to be undertaken, and for utilisation of the funds so contributed;
  • the entity provides proper fund utilisation reports to the company such that the company can assess impact of the contributions and satisfy itself that the funds have been actually used for the specified activities.

The above conditions are in addition to the overarching regulatory requirements of having a CSR committee, and a well-defined CSR policy, etc. Any corpus/fund contribution proposed to be made shall be subject to overall regulatory requirements.

[1]  Read our various articles on http://vinodkothari.com/csr/

[2] https://www.mca.gov.in/Ministry/pdf/General_Circular_21_2014.pdf

3  https://resource.cdn.icai.org/60115csr48973tg.pdf

[3] https://indiankanoon.org/doc/1153358/

[4] See Technical Guide on Accounting for Not-for-Profit Organisations here: https://kb.icai.org/pdfs/PDFFile5b279c36d4ec27.59253395.pdf

[5] https://www.icai.org/post.html?post_id=6832

[6] https://indiankanoon.org/doc/71326209/?type=print

[7] ICAI: https://resource.cdn.icai.org/62997csr50957tg-csrfunds.pdf

[8] http://vinodkothari.com/2021/02/understanding-borderline-between-implementing-agencies-beneficiaries/

SEBI proposes stringent guidelines for IDs in a listed company

-Independence becomes stricter!

Payal Agarwal | Executive (corplaw@vinodkothari.com)

Introduction

The concept of independent directors was first introduced in the Desirable Corporate Governance Code issued by the Confederation of Indian Industry[1] followed by the recommendation in the Corporate Governance Committee constituted by SEBI and headed by Mr. Kumar Mangalam Birla[2] (Kumar Mangalam Birla Committee). Later in the year 2000, SEBI incorporated the recommendations of the Kumar Mangalam Birla Committee under Clause 49 of the Listing Agreement[3]. Independent directors have always been regarded as the means to strengthen the corporate governance framework in a public or a listed company.

 

Keeping in mind the intent of the lawmakers to introduce the requirement for having Independent Directors (IDs) on the board of certain companies, it is understood that SEBI cannot accept a situation where the IDs themselves turnout to either be ineffective for strengthening the corporate governance or act against the interest of the public shareholders. Therefore, with the intent to further strengthen the role and responsibility of IDs, SEBI has introduced a Consultation Paper[4] (Paper) on review of regulatory provisions related to IDs on 2nd of March, 2021. Through this Paper, SEBI has proposed to make stringent regulatory changes in the provisions of the Listing Obligation and Disclosure Requirements Regulations (LODR/ Listing Regulations) relating to

  • eligibility criteria of IDs,
  • role of Nomination and Remuneration Committee (NRC),
  • composition of Audit Committee (AC) and Nomination and Remuneration Committee (NRC)
  • appointment and removal procedure of IDs

The Paper is open for public comments till 1st April, 2021.

This write up critically covers the proposed changes and discusses on the proposed impact of on the working of a company including the corporate governance aspects.  The proposed changes are discussed below under the relevant heads.

1.      Widening the criteria for independence

Currently, Regulation 16(1) of the Listing Regulations provides the definition of “independent director”. SEBI proposes to broaden the criteria of “independence” by expanding the outreach of the restrictions given under the said Regulation and at the same time standardising the cooling off period provided therein.

The Paper proposes two amendments in the independence criteria of IDs in addition to the extant definition:

  • KMPs and employees of companies falling under the promoter group of the listed entity & relatives of such KMPs should not be eligible to act as an ID until a cooling off period of 3 years has passed.

This will be in addition to the existing fetter on the KMP and employee of the listed entity, its holding, subsidiary or associate company.

  • Another proposed amendment is with regard to increasing of the cooling-off period in Regulation 16(1)(iv) and Reg 16(1)(v) of the Listing Regulations.

Currently, the Regulations specify a cooling-off period of 2 years in case of material pecuniary transaction between a person or his relative and the listed entity or its holding, subsidiary or associate company. This is proposed to be increased to 3 years to make it similar to the other provisions of Regulation 16 where a cooling-off period of 3 years is required to be satisfied.

Rationale behind the proposal:

This proposal aims to make the independence criteria more broad so that there is no way by which the promoter group entities can take undue benefit due to any loopholes in the language of law.

On the other hand, the proposal for increasing the cooling off period is for making the same uniform all through the independence criteria.

2.       Dual voting approach introduced for appointment / re-appointment /removal of IDs

The Paper proposes to bring a major change in the procedure of appointment/ re-appointment as well as removal of IDs. Here, let us mention that the IDs are required to be recommended by NRC before their appointment is approved by shareholders in the general meeting. In the present scenario, the IDs are required to be appointed by way of a shareholders’ resolution by simple majority. In case of re-appointment, a special resolution is required to be passed by the shareholders.

  • The proposed procedure for such appointment/ re-appointment is via “dual approval” from shareholders, as follows:
  • An ordinary resolution by shareholders (Special Resolution in case of re-appointment) and
  • A resolution by “majority of minority”

(Note: The Paper defines minority shareholders to mean shareholders other than the promoter and promoter group.)

In a situation where either of the two resolutions fail, the company may either propose another person as ID, or put the same proposal for a second vote

  • Such second vote can be done only after a cooling period of 90 days but within a maximum period of 120 days
  • Such second vote should be passed by a special resolution in which all shareholders can take part
  • Further, the proposal makes the requirement of shareholder’s approval a pre-condition for every appointment of ID.
  • In cases of any casual vacancy of IDs, the Listing Regulations currently provides a time period of upto 3 months or next Board Meeting, whichever is later, for filling up the vacancy. SEBI proposes to limit the time upto 3 months from such vacancy to appoint another ID.

A similar concept of dual voting approach has been prescribed by SEBI for the removal of IDs as well.

Rationale for such proposal

SEBI has, in its consultation paper, specified that the present system of appointment of IDs may be influenced by the promoters – in recommending the name of ID and in the approval process by virtue of shareholding. This may hinder the “independence” of IDs.

Additionally, considering that the primary duty of IDs is to protect the interest of minority shareholders, there is a need for minority shareholders to have greater say in the appointment / re-appointment process of IDs.

Therefore, SEBI has proposed the “dual approval” model in line with the legislative requirements of Israel and UK, especially in interest of the minority shareholders.

Since, the ID may be removed through a simple majority, the promoter may have significant influence in the removal process by virtue of shareholding. So, the “dual approval” model has been proposed to be extended to govern the removal of IDs as well.

Further to this, the requirement of approval of shareholders as a precondition before appointment of any ID is pursuant to the current practice, wherein an ID is appointed as an additional director by the Board of a company, to be subsequently ratified by the shareholders in the ensuing AGM. Such a practice creates a significant time gap between the appointment of an independent director and approval of shareholders, which is not in the best interest of especially the minority shareholders. Therefore, SEBI seeks to do away with this time lag by inserting the requirement of prior approval of shareholders.

3.       Resignation of IDs

Through the Paper, it becomes clear that the intention of SEBI is to strictly monitor the resignation of the IDs where the real cause of resignation should be clearly known in place of the apparent cause the company and ID may try to show.

The Paper provides for a cooling off period of 1 year in two cases:

  • Where the ID resigns on account of discretionary reasons of pre-occupation, other commitments or personal reasons – Mandatory cooling period of 1 year before joining another Board as an ID;
  • Similar cooling period of 1 year in case of transition from ID to WTD in the same company.

Further, the Paper also proposes that the complete resignation letter of the outgoing ID needs to be disclosed to the stock exchange.

Rationale for such proposal

The cooling off period of 1 year before transition of an ID as a WTD in the same company has been proposed to ensure there is no compromise in the independence of the director during his term as an ID.

It is observed that IDs often resign for reasons such as pre-occupation, other commitments or personal reasons and then join the boards of other companies. There is, therefore, a need to further strengthen the disclosures around resignation of Independent Directors.

4.       Role of NRC in selection of candidates for the role of ID

The NRC is required to recommend the persons to be appointed as IDs in the board of the company. Though the Listing Regulations already requires the NRC to formulate criteria regarding such appointment, the role of NRC, in practice, does not suffice the intent of law properly. Therefore, vide the Paper, SEBI has prescribed the following procedure for selection of candidates for the role of NRC.

  • Evaluate the balance of skills, knowledge and experience
  • On the basis of above evaluation, prepare description of required roles and capabilities required for that particular appointment of ID
  • Identify the suitable candidate fitting the said description
  • For identifying persons, NRC may
    • use services of external agencies
    • May consider candidates from wide variety of backgrounds ( for diversity)
    • And consider time commitment of appointees
  • The person identified and recommend to the Board should possess capabilities as per description.

Rationale for such proposal

While the law requires NRC to lay down detailed criteria of qualifications and attributes for directors, apparently there is a lack of transparency in the process followed by NRC. There is therefore, a need to prescribe disclosures regarding the process followed by NRC for selection of candidates for the post of ID.

5.       Modification in composition of NRC and AC

The Paper also seeks to bring in some changes in the constitution of NRC and AC. The following changes are proposed to be made:

  • NRC to comprise of 2/3rds of ID ( presently alteast one-half IDs required)
  • AC to comprise of 2/3rds of IDs and 1/3rds of Non-executive directors(NED) that are not related to promoter (presently, the AC requires atleast 3 members of which atleast 2/3rds shall be IDs)

Rationale for such proposal

Considering the importance of the Audit Committee with regard to related party transactions and financial matters, it is proposed that audit committee shall comprise of 2/3rd IDs and 1/3rd Non-Executive Directors (NEDs) who are not related to the promoter, including nominee directors, if any.

6.       Enhanced disclosure requirements

The Paper proposes various sorts of enhanced disclosures under different headings. Disclosures leads to transparency which is an important principle to be kept in mind under the arena of corporate governance. The various proposed disclosures has been discussed below:

  • Appointment/re-appointment/ removal of ID subject to second voteNotice calling shareholders’ meeting shall specify reasons for second vote on the same proposal despite failure of the first resolution.
  • Notice for appointment of IDThe notice calling a meeting of shareholders for the purposes of appointment of an ID shall disclose the following:
    • skills and capabilities required for the role;
    • how the proposed appointee fits the role;
    • Channels for searching appropriate candidates
    • Category of person who have recommended the name (in case of recommendation by person)
  • Disclosure on resignation of IDsWhere an ID resigns from a company, the entire resignation letter along with a list of present directorships and members in committees needs to be disclosed to the stock exchanges.

7.       Remuneration of IDs

The consultation paper has made various proposals in relation to the remuneration of IDs. The proposals include the following:

  • Removal of profit-linked commission
  • Increase in sitting fees
  • Issue of ESOPs with long vesting period

Rationale for such proposal

The removal of profit linked commission and increase in sitting fees is proposed with a view that the remuneration to IDs should be on the basis of their value and time-commitments to the company, without linking the same to the profits of the company. This would lead to IDs getting a fixed fee, without having any stake in the long-term growth of the company.

The concern with this approach – that profit or performance linked commission may encourage short-termism and lead to conflicts, may be addressed by permitting ESOPs to IDs (instead of profit linked commission) with a long vesting period of say, 5 years.

Our analysis on the removal of profit-linked commission and substitution of same with ESOPs has been dealt with in our other article and may be referred.

 

Conclusion

The proposed changes are extremely significant and will have a remarkable impact on the corporate governance of listed entities. While on one hand, more transparency may be achieved by means of amendments like enhanced disclosure on resignation, appointment, selection of candidates as IDs, etc, however, proposal relating to dual voting may not serve to achieve the purpose due to the presence of the option for second round of voting. Of all, the proposals seek to check the interference of promoters at all levels of corporate governance and ensures much more independence to the IDs where the IDs will be independent in both letter and spirit. However, in some areas, the proposed requirements seems to be very much stringent, which may hinder the idea of “ease of doing business”.

Our other articles on related topics can be read here –

  1. http://vinodkothari.com/wp-content/uploads/2017/03/FAQ_appointment_of_IDs.pdf
  2. http://vinodkothari.com/wp-content/uploads/role-and-responsibilities-of-independent-directors.pdf
  3. http://vinodkothari.com/2015/01/faqs-on-meetings-of-independent-directors/

[1] http://www.nfcg.in/UserFiles/ciicode.pdf

[2] http://www.nfcg.in/UserFiles/kumarmbirla1999.pdf

[3] https://www.sebi.gov.in/legal/circulars/feb-2000/corporate-governance_17930.html

[4] https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html

SEBI’s move to allow stock options to independent directors – Whether a threat to independence?

Aanchal Kaur Nagpal (corplaw@vinodkothari.com)

 

It is said that when morality has a fight against profit, it is rarely that profit loses. Humans are always looking for more and quite often give in to their greed. This is the underlying rationale when it comes to safeguarding the independence of an independent director– to cut off anything that would lure them to compromise the interests of the company.

At the same time, given the crucial role they play in corporate governance and the increasing expectations for ensuring a balance between stakeholders’ interests and ensuring an independent insider’s view on the company’s affairs, they need to be sufficiently compensated for the time they spend and the risk-taking they do as directors.

While adequate compensation is crucial, there is a fine line to be drawn between ‘compensation’ and ‘pecuniary interest’. A balance is required to be maintained where IDs are paid remuneration in fair proportion to the value they bring to an organization while also not compromising their ability to pass an independent judgement.

Currently, IDs receive remuneration in the form of sitting fees and profit-linked commission[1] subject to certain limits. Currently, they are not permitted to receive stock options under the Companies Act as well as LODR regulations. It is felt that a stock option will put the ID to a position of a shareholder, and there may, therefore, be an alignment of the interest of the IDs with those of the shareholders. This is presumed to threaten the independence of IDs. However, SEBI, vide its Consultation Paper on Review of Regulatory Provisions related to Independent Directors dated 1st March, 2021[2] (Consultation Paper) , has proposed a radical change to the conventional remuneration structure of IDs in India by allowing stock options to be granted to IDs.

In this article, the author attempts to analyse whether SEBI’s move to allow grant of options to IDs as a form of their remuneration, will truly threaten the sanctity of their independence.

We have analyzed the Consultation Paper at length in our article.

Law regarding ESOPs to IDs in India

As discussed above, ESOPs are not permitted to be granted to independent directors. The prohibition comes from both – the Companies Act as well as LODR regulations. According to regulation 17(6)(d), Independent directors shall not be entitled to any stock option. As per section 149(9) of the Companies Act, 2013, notwithstanding anything contained in any other provision of this Act, but subject to the provisions of sections 197 and 198, an independent director shall not be entitled to any stock option and may receive remuneration by way of fee provided under sub-section (5) of section 197, reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members.

Therefore, it is established, that currently, Indian laws expressly and absolutely prohibit granting stock options to independent directors. Further, voting power of more than 2% being held by an ID along with his/her relatives is also prohibited. However, this is in case of listed entities and prescribed unlisted public companies.

The problem regarding remuneration to IDs vs remuneration to EDs

Remuneration to IDs

Currently, the following provisions are existent with respect to remuneration to IDs –

  • According to section 149(9) of the Companies Act, 2013,

Notwithstanding anything contained in any other provision of this Act, but subject to the provisions of sections 197 and 198, an independent director shall not be entitled to any stock option and may receive remuneration by way of fee provided under sub-section (5) of section 197, reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members.

  • As per section 197(5) of the Companies Act, 2013 read with rule 4 of the sitting fees to any director for attending Board or Committee meetings or for any other purpose, as may be decided by the Board, should not exceed Rs. 1 lakh. Further, IDs should not be paid sitting fees that is less than that paid to other directors.
  • As per section 197(1)(ii) of the Companies Act, 2013,

The remuneration payable to directors who are neither managing directors nor whole-time directors shall not exceed, –

(A) one per cent. of the net profits of the company, if there is a managing or whole-time director or manager;

(B) three per cent. of the net profits in any other case.

  • A director or manager may be paid remuneration either by way of a monthly payment or at a specified percentage of the net profits of the company or partly by one way and partly by the other.

The diagram below sums up remuneration that may be paid to an ID:

Thus, the sources of remuneration to IDs have been limited along with further restrictions to the amount of remuneration permitted to be paid. Whereas in case of executive directors, the permissible amount of remuneration is much higher along with lesser restrictions.

The role of both counterparts is paramount and none of the two can undermine the role of the other. However, the compensation received by IDs has been lower than that paid to executive directors. Although the latter are involved in the day to day management of a company’s affairs, the former pitch in their rich expertise, knowledge and unbiased view. Therefore, there should be a way to align or proportionate the remuneration drawn by IDs with executive directors.

However, on the contrary, executive directors are included in the definition of ‘officer in default’ and have a higher liability than that of IDs.

International Practices

As per the Cadbury Committee Report,

On fees, there is a balance to be struck between recognising the value of the contribution made by nonexecutive directors and not undermining their independence. The demands which are now being made on conscientious non-executive directors are significant and their fees should reflect the time which they devote to the company’s affairs. There is, therefore, a case for paying for additional responsibilities taken on, for example, by chairmen of board committees. In order to safeguard their independent position, we regard it as good practice for non-executive directors not to participate in share option schemes and for their service as non-executive directors not to be pensionable by the company.

According to National Foundation for Corporate Governance[3]

To secure better effort from non-executive directors, companies should: • Pay a commission over and above the sitting fees for the use of the professional inputs. The present commission of 1% of net profits (if the company has a managing director), or 3% (if there is no managing director) is sufficient. • Consider offering stock options, so as to relate rewards to performance. Commissions are rewards on current profits. Stock options are rewards contingent upon future appreciation of corporate value. An appropriate mix of the two can align a non-executive director towards keeping an eye on short term profits as well as longer term shareholder value.

UK

According to UK Corporate Governance Code[4] (para 34),

Remuneration for all non-executive directors should not include share options or other performance-related elements.

In exceptional cases where equity is granted, companies should gain shareholder approval prior to grant and the acquired shares should be held for at least 1 year from the director’s departure from the Board.[5]

Thus, in UK, the same is discouraged and not prohibited. The UK Corporate Governance Code represents key corporate governance recommendations of best practice for companies and does not have a statutory force.

The International Corporate Governance Network allows equity-based remuneration to non-executive directors. [6]

Australia

As per Australian Corporate Governance Principles and Recommendations – (only recommendatory and not mandatory)

Equity-based remuneration to non-executive directors: it is generally acceptable for non-executive directors to receive securities as part of their remuneration to align their interests with the interests of other security holders. However, nonexecutive directors generally should not receive options with performance hurdles attached or performance rights as part of their remuneration as it may lead to bias in their decision-making and compromise their objectivity.

France

According to the Corporate Governance Code of listed corporations by Afep-Medef[7], the principles for determination of compensation of non-executive directors, state that it is not desirable to award variable compensation, stock options or performance shares to non-executive directors. If, despite this, such awards are granted, then the Board must justify the reasons for this and the director cannot be considered to be independent.

USA

In USA, no express guidelines were found to prohibit share options to independent directors.

However, compensation policies of various companies filed with the SEC include stock options, restricted stock units and equity compensation granted to independent directors or outside directors (directors that are not employees of the Company).

Policies can be viewed here –

What can be seen is that global governance norms have mixed views with respect to stock options to IDs.

Are IDs really independent in the first place?

There are various contentions that can question whether IDs are in fact independent at all.

Appointed by the Board

IDs are appointed by the Board of Directors. Although the appointment requires the approval of the shareholders as well, IDs are nominated by the Board or the Nomination Committee. The nomination is then recommended to the shareholders for their approval. Additionally, where promoters hold majority stake in a company, such appointment may be approved and dominated by them. Thus, expecting and ID to be independent of persons who are in fact behind his/ her appointment is a question in itself. Thus, if an ID truly requires to be independent, then he/ she should be appointed by an independent third party. Various changes have also been proposed with respect to appointment, reappointment and removal of IDs, which have been discussed in our article at length.

Profit related commission

IDs are paid commission that should be related to the profit. Thus, their income is dependent on the progress/ growth of the Company making the independent director ‘interested’ in the Company.

The cons of ESOPs

While the global precedence does not expressly prohibit ESOPs, there still lies an anomaly whether ESOPs would make an ID interested in a company.

Additional methods for fair compensation are needed on one hand but on the other, the independence of an ID cannot be compromised. If ESOPs are granted, IDs will become interested as shareholders and would dwell upon the short-term prosperity of a company since share price at the end of the vesting period would be what would matter to them. They would therefore compromise a long-term return along with interest of other stakeholders. There would be too much pressure on short-term performance mostly compromising the long-term good of the company.

Profit related commission to IDs

Profit related commission is contingent in nature and is a way of sharing risks and rewards. Such commission depends and is proportionate to the profitability of the other party and thus aligns the interests of the parties involved the arrangement.

Indian laws allow IDs to be paid by way of profit related commission. The same can be paid up to a maximum of 1% of the profits of the company in that financial year. This means that the amount of income of the ID, in the form of commission, will directly depend on the amount of profit in that financial year. If the company performs better in a particular financial year, the profit will be higher and in turn the proportionate commission of the ID in that financial year will be higher. This shows that the interests of the ID will be rather short term than long term. The ID will only be concerned about the short-term performance of the company for the years he is an ID since his income would be directly dependent on the same, irrespective of any event hampering or damaging the Company in the long run. Therefore, the permissible form of remuneration to IDs by Indian laws, in reality, adversely affects the independence of an ID.

Profit related commission versus ESOPs

Consequently, there arises a question on how the defense of independence can be used against ESOPs alone if IDs are allowed to receive profit related commission.

ESOPs, as compared to commission, would be a better way to remunerate IDs, when it comes to protecting the interests of Company. Where profit related commission makes the ID interested in the short term performance of the Company, ESOPs provide a longer performance goal. Stock options ensure a balance between the short term and medium term performance of a company.

Profit related commission depends directly on the immediate preceding year (i.e. just one year) while ESOPs depend on a relatively longer time frame (more than one year at the least- tenure of the ESOPs can be decided and controlled by the company).

Thus, if companies are allowed to pay profit related commission to IDs, restrictions on allow ESOPs are unwarranted considering the fact that the latter would be a preferred option to align the interests of the IDs with the medium term performance of a company.

Here, the intention behind granting such ESOPs would be to enable IDs to focus on the medium term/ long term performance of the company rather than retention which is usually the rationale behind ESOPs.

However, the maximum limit for granting such ESOPs as well as maximum shareholding should be monitored to avoid IDs from holding huge stakes in companies. Further, ESOPs with longer vesting periods should be allowed, where the exercise period falls after the expiry of tenure of the ID, to ensure ID’s focus on the long term growth of the company.

SEBI’s Consultation Paper to allow stock options –

SEBI contended that linking remuneration to profit or performance linked commission ensures that IDs have ‘skin-in-the-game’ which may encourage short-termism and lead to conflicts between the interests of the IDs and the overall interest of the Company. A better approach would be to instead permit ESOPs to IDs with a long vesting period (say, 5 years,) as this would ensure alignment of interests of the company and IDs. The rationale is that remuneration to IDs should be on the basis of their value and time-commitments to the company, without linking the same to the profits thereof. This would lead to IDs getting a fixed fee, without having any stake in the long-term growth of the company.

Additionally, the limit on the sitting fees to IDs, is also proposed to be increased.

Accordingly, recommendations will be sent to MCA for modification of the existing remuneration structure under the Companies Act as well.

Conclusion

Thus, SEBI is headed in the right direction to allow ESOPs to IDs and is highly welcomed. This would ensure that IDs are rightly compensated for the value they offer while also ensuring that long term interest. However, various checks should be placed by regulators for monitoring the same so as to safeguard the independence of the ID.

 

[1] While the existing requirement under sections 149(9) and 197(3) of the Companies Act, in case of remuneration to non-executive directors, was to pay them upto a percentage of profits, the amendments made by CAA 2020 (section 32) have delinked the compensation and the profits, permitting companies to pay remuneration by way of “minimum remuneration”, that is, irrespective of adequacy of profits (proviso to section 149(9) inserted and amendment to section 197(3))

[2] https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html

[3] http://www.nfcg.in/UserFiles/ciicode.pdf

[4] https://www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.PDF

[5] You may check pay pratices in Europe through this report- https://infokf.kornferry.com/rs/494-VUC-482/images/191206-KF%20-%20NED%20report%202019%20-%20LR%20SPREAD%20mail.pdf

[6] https://www.icgn.org/sites/default/files/ICGN%20NED%20Guidelines%20%282010%29_%20Oct%202013print2_0.pdf

[7] https://afep.com/wp-content/uploads/2018/06/Afep-Medef-Code-revision-June-2018-ENG.pdf

 

 

 

MCA eases the requirement for setting up and conversion of an OPC

-Gift from the Union Budget 2021-2022

-Abhishek Saraf |Deputy Manager| (corplaw@vinodkothari.com)

Introduction

The concept of One Person Company (“OPC”) was discussed for the first time in India in the year 2005 by the JJ Irani Expert Committee[1] which suggested that with increasing use of information technology and computers, emergence of service sector, the entrepreneurial capabilities of the people must be given an outlet for participation in economic activity and was of the opinion that it was not reasonable to expect that every entrepreneur who was capable of developing his ideas and participating in the market place should do it through an association of persons. It may therefore, be possible for individuals to operate in the economic domain and contribute effectively. With this, the Committee recommended the formation of OPC. It suggested that such an entity may be provided with a simpler legal regime through exemptions so that the small entrepreneur is not compelled to devote considerable time, energy and resources on complex legal compliance.

OPC is a combination of a sole proprietorship and an incorporated form of business and takes the form and is registered as a private company.

This concept was then introduced in the Indian company law regime by the enactment of the Companies Act 2013 (“Act”), the earlier laws on companies did not have such concept. It was brought in with the objective of promoting entrepreneurship and help entrepreneurs’ by providing them access to certain facilities like bank loans, thorough market access as a separate entity and legal shield for their business. OPC has been defined under section 2(62) of the Act as “a company which has only one person as a member.”

The graph above shows that there has been an increase in the number of OPCs incorporated in the country on month to month comparison for the last two years barring a portion of the period during the lockdown due to Covid-19 restrictions in the country.

With the intent to benefit start-ups and innovators, the Hon’ble Finance Minister in her speech on Union Budget 2021-22 in the Parliament on 1st February 2021, proposed a measure to directly benefit the aforesaid, by the way of amending certain provisions of OPC to provide relaxations in relation to incorporation of OPCs and its conversion into any other type of companies

Following the same, the Ministry of Corporate Affairs vide its notification dated 1st February, 2021 notified the Companies (Incorporation) Second Amendment Rules, 2021[2] thereby notifying the proposal tabled in the Budget speech which shall come into effect from 1st April, 2021.

This write up briefly discusses on the changes brought under the OPC framework.

Brief discussion on the proposed changes

Residency

The norms for setting up OPC has been eased out considerably by reducing the residency limit for an Indian citizen to set up an OPC from 182 days to 120 days. Secondly, the mandatory criteria of being an Indian resident for being eligible to incorporate an OPC has been done away with. This means that w.e.f.1st April, 2021, even a Non-Resident Indian (NRI) can set up an OPC in India. The aim of these amendments is to make it easy for anyone to set up a company in the form of OPCs in the country and promote entrepreneurship and therefore, boost the economy of the country.

Conversion of OPC into other kind of companies

The Act currently provides that an OPC cannot convert itself into any other kind of company unless a period of 2 years has elapsed since the date of its incorporation. The provision has been removed to allow OPCs to convert into any other type of company except section 8 company, at any time at their own will without any sort of restriction.

The current regulatory framework also provides a fetter that if the paid up share capital of an OPC exceeds Rs. 50 lakhs or its average annual turnover during the relevant period exceeds Rs. 2 crores at any time including even in the first 2 years of its incorporation, OPC has to mandatorily convert into a Private company or a Public company. However, the provision has completely been removed this threshold limits and w.e.f 1st April, 2021 OPCs shall no longer be required to compulsorily go for conversion. They have been allowed to grow without any restrictions on paid up capital and turnover and have been given the freedom to convert at any time.

OPCs will now be allowed to convert into any other kind of company other than section 8 companies by applying in e-Form INC 6 after altering its memorandum and articles, increasing the minimum number of members and directors to the minimum number as provided in the statute for that kind of company and maintaining the minimum paid up capital as per the requirement of the Act for such class of company.

Conversion of Private companies into OPCs

The most significant amendment has been allowing private companies to convert into OPCs at any time irrespective of its paid up share capital or average annual turnover which earlier was a hindrance for Private companies willing to convert to OPCs.

This shall prove beneficial for such private companies who want funds to grow their business and cross the regulatory threshold because of which they are not able to convert themselves into OPCs and have to devote too much of their time, energy and resources on the complex legal requirements and also miss out on the benefits/ exemptions being given to the OPCs by the various provisions of the Act.

Benefits for an OPC under the Act

The Act provides for number of benefits for a company registered as OPC, some of those are:

  1. Abridged form of Annual Return and Board’s Report shall be prescribed by the Central Government for OPCs.
  2. OPCs are not required to hold Annual General Meeting.
  3. It is not required to hold 4 board meetings in a year, OPC may hold 2 board meetings in a calendar year i.e. one Board Meeting in each half of the calendar year with a minimum gap of ninety days between two meetings.
  4. Secretarial Standards-1 is not applicable on OPCs having only 1 director and Secretarial Standards are also not applicable on OPCs.
  5. Lesser Penalties have been prescribed for OPCs under section 446B of the Companies Act 2013.

Conclusion

As evident from the statistical data, since there has been an increase in the number of the OPCs incorporated, MCA has thought fit to ease the requirements for setting or conversion of an OPCs thereby providing a boost to entrepreneurship as well as the economy.

The move to incentivize OPCs by reducing the residency limit and allowing NRIs to set up companies in form of OPC in the country is expected to provide broader investment opportunities for venture funds, while providing leverage to set up businesses in India. The removal of threshold limit for conversion of OPCs into any kind of companies and private companies into OPCs shall be of huge relief for companies going for funding without the burden of compulsorily converting themselves. It also gives them a freedom and ease of converting at point of time which goes with the Government’s agenda of Ease of Doing Business and Self Reliant India.

 

[1] http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf

[2] http://www.mca.gov.in/Ministry/pdf/SecondAmndtRules_02022021.pdf

Ease of doing business: Debt listed companies slide down to unlisted companies

Companies with listed but privately placed debt paper not to be regulated as ‘listed company’.

FCS Vinita Nair | Senior Partner, Vinod Kothari & Company

With an intent to promote listing of securities and bond market, Ministry of Corporate Affairs (MCA) in consultation with Securities and Exchange Board of India (SEBI), intended to exclude certain class of companies from the definition of ‘listed company’ as defined under Section 2 (52) of Companies Act, 2013 (CA, 2013). The existing provisions of CA, 2013 applicable to a listed company did not distinguish between private companies and public companies. As a result, private companies were unintendedly subject to similar compliance as a public company. A browse through the list of companies with listed privately placed debentures, shows private companies abound in the list[1].  On the other hand, public companies that listed debt securities on a private placement basis, were subject to similar compliances as a public company issuing debt securities to public.

Accordingly, one of major amendments proposed in Companies (Amendment) Act, 2020 (CAA, 2020) was to revisit definition of listed company and provide a suitable carve out to certain class of companies to be determined in consultation with SEBI.

The rationale behind the carve out, as explained in the Report of the Company Law Committee of November, 2019[2] was that private companies listing its debt securities on any recognized stock exchange were subject to more stringent regulations compared to unlisted private companies viz. appointment of auditors, independent directors, woman directors, constitution of board committees etc. that were dis-incentivizing private companies from seeking listing of their debt securities. This was also discussed in the Report of Company Law Committee in 2016[3] wherein the Committee, while acknowledging the anomaly  in the definition of listed company, felt that while the definition of the term ‘listed company’ need not be modified, the thresholds prescribed for private companies for corporate governance requirements may be reviewed. Further, the Committee proposed that specific exemptions under Section 464 of CA, 2013 could also be given to listed companies, other than equity listed companies, from certain corporate governance requirements prescribed in the Act.

Currently, companies issuing non- convertible debt securities (NCDS) or non-convertible redeemable preference shares (NCRPS) on a private placement basis, list the same under SEBI (Issue and Listing of Debt Securities Regulations, 2008 (SEBI ILDS) and SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013 (SEBI ILNCRPS) respectively and are regarded as ‘listed company’ for the provisions of CA, 2013.

Total number of companies with listed debt 

Number of companies, which come under different buckets as per the outstanding value of listed Debt Securities (as per face value) as on December 31, 2020

Present amendment

While the amendment made in Section 2 (52) in the definition of ‘listed company’ was notified with effect from January 22, 2021[4], the class of companies were pending to be prescribed. Ministry of Corporate Affairs (MCA) on February 19, 2021[5] notified Companies (Specification of Definition Details) Second Amendment Rules, 2021 effective from April 1, 2021 to insert Rule 2A excluding following class of companies from the definition of ‘listed company’ under CA, 2013

  1. Public companies with listed NCDS issued on private placement basis in terms of SEBI ILDS;
  2. Public companies with listed NCRPS issued on private placement basis in terms of SEBI ILNCRPS;
  3. Public companies with listed NCDS and NCRPRS issued on private placement basis in terms of SEBI ILDS and SEBI ILNCRPS respectively;
  4. Private companies with listed NCDS in terms of SEBI ILDS.
  5. Public companies with equity shares exclusively listed on stock exchanges in permissible foreign jurisdictions under Section 23 (3) of CA, 2013.

Point to note here is that companies with listed commercial papers were anyways outside the purview of listed companies as commercial papers are excluded from the definition of debentures.

Listed company post amendment

Post amendment, the definition of listed company will mainly comprise of public companies offering securities to public i.e. having listed equity shares in India (with or without ADR/GDR listed overseas), listed debt securities pursuant to public issue or listed NCRPS pursuant to public issue.

Compliances for listed company under CA, 2013

A listed company is required to ensure following additional compliances under CA, 2013:

Amount in Rs/ Other specification Section No. Rule No. Brief of the provision Other thresholds under CA, 2013
1.       Provisions/ exemptions applicable to all listed companies
Exemption for creation of Debenture Redemption Reserve (DRR) 71 18 (7) (b) (iii) (B) of SHA Rules Listed NBFCs need not create DRR for privately placed and public issue of debentures. Refer discussion below
Creation of Debenture Redemption Fund (DRF) 71(4) Rule 18(7)(b)(v) of SHA Rules as amended. No requirement for creation of DRF by listed companies issuing debenture on private placement basis. Refer discussion below
Annual return 92 11 of MGT Rules

 

Company to file Annual Return certified by a PCS in Form MGT-8 Applicable to Company with

  • Paid-up share capital of Rs. 10 crore or more; or
  • Turnover of Rs. 50 crore or more.
Records in electronic form 120 27 of MGT Rules Company may maintain records in electronic form.

Note: Whether companies other than those specified have the option to maintain in electronic form, is not clear.

Company having not less than 1000 shareholders, debenture holders and other security holders.
Investigation by NFRA

 

132 Rule 3(1)(b) of NFRA Rules NFRA shall undertake investigation or conduct quality review of audit.
  • Unlisted public companies
    • having paid-up capital of not less than Rs. 500 crores; or
    • having annual turnover of not less than Rs. 1000 crores or
    • having, in aggregate, outstanding loans, debentures and deposits of not less than Rs. 500 crores as on the 31st March of immediately preceding financial year;
  • insurance companies, banking companies, companies engaged in the generation or supply of electricity, companies governed by any special Act for the time being in force or bodies corporate incorporated by an Act in accordance with clauses (b), (c), (d), (e) and (f) of sub-section (4) of section 1 of the CA, 2013;
Statement in Board report indicating manner of Board evaluation 134(3) 8 (4) of AOC Rules

 

A statement indicating manner in which formal evaluation of Board, committee and individual directors has been done by Board needs to be included in Board’s report. Public company having a paid up share capital of Rs. 25 crore or more calculated at the end of the preceding financial year.
Financial statements in electronic form 136 11

of AOC Rules

Financial statements may be sent in electronic format. Public companies which have

  • a net worth of more than Rs. 1 crore; and
  • turnover of more than Rs. 10 crore.
Internal auditor 138 13

of AOC Rules

Appointment of internal auditor or a firm of internal auditors to conduct internal audit.
  • Every unlisted public company having-
    • paid up share capital of Rs. 50 crore or more during the preceding financial year; or
    • turnover of Rs. 200 crore or more during the preceding financial year; or
    • outstanding loans or borrowings from banks or public financial institutions exceeding Rs. 100 crore or more at any point of time during the preceding financial year; or
    • outstanding deposits of Rs. 25 crore or more at any point of time during the preceding financial year;
  • Every private company having
  • turnover of Rs. 200 or more during the preceding financial year; or
  • outstanding loans or borrowings from banks or public financial institutions exceeding Rs. 100 crore or more at any point of time during the preceding financial year:
Appt/ re-appt of Auditor 139

(2)

5 of ADT Rules

 

Restriction on term of appointment or reappointment of auditor. Rotation of Statutory Auditors mandatory.
  • all unlisted public companies having paid up share capital of Rs. 10 crore or more;
  • all private limited companies having paid up share capital of Rs. 50 crore or more;
  • all companies having paid up share capital of below threshold limit mentioned above, but having public borrowings from financial institutions, banks or public deposits of Rs. 50 crores or more.
Woman Director 149

(1)

3 of DIR Rules

 

Appointment of a Woman Director on the Board.

 

Any intermittent vacancy of a woman director shall be filled-up by the Board at the earliest but not later than immediate next Board meeting or three months from the date of such vacancy whichever is later.

Public company having –

  • paid–up share capital of Rs. 100 crore or more; or
  • turnover of Rs. 300 crore or more:
Small shareholder director 151 7 of DIR Rules

 

May appoint a small shareholder director suo moto or upon notice from shareholder.
Vigil mechanism 177 7 of MBP Rules

 

Company to establish vigil mechanism for their directors and employees to report genuine concerns.
  • the Companies which accept deposits from the public;
  • the Companies which have borrowed money from banks and public financial institutions in excess of Rs. 50 crore.
Disclosure in Board’s Report 197

(12)

5 of MR Rules

 

Disclosure in Board’s report regarding ratio of the remuneration of each director to the median employee’s remuneration and such other details as prescribed in the Rules.
Appointment of KMP 203 8 of MR Rules Appointment of whole-time key managerial personnel.

 

  • Public company having a paid-up share capital of Rs. 10 crore or more
  • Additionally for appointment of Company Secretary, every private company which has a paid up share capital of Rs. 10 crore.
Secretarial Audit Report 204 9(2) of MR Rules

 

Shall annex with its Board’s report  a secretarial audit report, given by a company secretary in practice
  • Every public company having a paid-up share capital of Rs. 50 crore or more; or
  • Every public company having a turnover of Rs. 250 crore or more; or
  • Every company having outstanding loans or borrowings from banks or public financial institutions of Rs. 100 crore or more.
2.       Provisions applicable only to a listed public company
Report on Annual General meeting 121 31 of MGT Rules

 

Report on AGM to be filed with the Registrar in eForm MGT-15.
Independent  Director 149

(4)

4 of DIR Rules

 

Atleast 1/3rd of total number of Board members shall be independent directors.
  • Public Companies having paid up share capital of Rs. 10 crore or more; or
  • Public Companies having turnover of Rs. 100 crore or more; or
  • Public Companies which have, in aggregate, outstanding loans, debentures and deposits, exceeding Rs. 50 crore
Constitution of certain committees 177 & 178 6  of MBP Rules

 

Constitution of Audit Committee and Nomination and Remuneration Committee.
  • Public Companies having paid up share capital of Rs. 10 crore or more; or
  • Public Companies having turnover of Rs. 100 crore or more; or
  • Public Companies which have, in aggregate, outstanding loans, debentures and deposits, exceeding Rs. 50 crore

 

With the present amendment, the class of companies provided above will not be required to ensure aforesaid compliances unless it meets other criteria/ thresholds prescribed for respective compliance.

As evident from the table above, a public company will hardly have any exemptions if it meets any of the thresholds specified. While the intent of exempting class of companies is benign, it will be of some benefit to public companies only if the other thresholds are also revised. While, the holy wish is for ease of doing business, static thresholds prescribed in 2013 needs to be revisited to assess the adequacy and the intent to regulate such class of companies. For e.g. public companies having paid up capital of 10 crore or borrowing of Rs. 50 crore is a very common phenomena.

Additionally, in case the sectoral regulator prescribes composition of committee or induction of independent directors or other corporate governance requirement, those will override the exemptions.

Applicability of DRR and DRF[6]

Section 71(4) read with Rule 18(1)(c) of the Companies (Share Capital and Debentures) Rules, 2014 (SHA Rules) requires every company issuing debentures to create a Debenture Redemption Reserve (DRR) of 10% (as the case maybe) of outstanding value of debentures for the purpose of redemption of such debentures.

Some class of companies as prescribed, has to either deposit, before April 30th each year, in a scheduled bank account, a sum of at least 15% of the amount of its debentures maturing during the year ending on 31st March of next year or invest in one or more securities enlisted in Rule 18(1)(c) of SHA (DRF).

Pursuant to the present amendment, it is important to ascertain applicability of creation of DRR and DRF in terms of CA, 2013. The exemption in relation to DRR and DRF was applicable to listed companies in case of private placement. While NBFCs continue to enjoy exemption even in case of unlisted companies, pursuant to the present amendment Non-NBFCs listing NCDS will not be eligible to avail the benefit of the said exemption and will be required to maintain DRR and DRF.

The intent of MCA at the time of amending Rule 18 of Companies (Share Capital and Debentures) Rules, 2014 was to extend the exemption to all listed companies i.e. companies having securities listed on stock exchange, in case of privately placed debentures, from maintenance of DRR and DRF.

The intent behind amending the definition of ‘listed company’ under 2 (52) was to reduce the compliance burden of debt listed entities that were regarded as listed entities merely by virtue of listing the privately placed debentures.

The amendment to the definition of ‘listed company’ was subsequent and the same has resulted in an anomaly as corresponding amendment has not been carried out in Rule 18 of SHA Rules. The intent behind mandating DRR and DRF requirement, in case of private placement, was for unlisted companies with unlisted debt and not for unlisted companies with listed debt.

This is surely a matter of representation to be made to MCA as the gap seems inadvertent and not intentional.

Applicability of Rule 9A of PAS Rules

Section 29 of CA, 2013 read with Rule 9A of Companies (Prospectus and Allotment of Securities) Rules, 2014 (PAS Rules)[7] effective from October 2, 2018 mandates unlisted public companies to issue the securities only in dematerialised form and facilitate dematerialisation of all its existing securities. Physical transfer of securities is prohibited for unlisted public companies. Compliance with the said provisions are exempt only in case of a Nidhi, Government company and wholly owned subsidiary.

Pursuant to amendment in the definition of listed company, public companies that were originally exempted from the requirements by virtue of being a listed company, will now be required to comply with Section 29 and Rule 9A.

Status under Listing Regulations and SEBI ILDS

‘Listed entity’ as defined under Reg. 2 (p) of SEBI (Listing Obligations and Disclosures Requirements) Regulations, 2015 (Listing Regulations) means an entity which has listed, on a recognised stock exchange(s), the designated securities issued by it or designated securities issued under schemes managed by it, in accordance with the listing agreement entered into between the entity and the recognised stock exchange(s).

The present carve out under CA, 2013 will not result in any carve out for compliances under Listing Regulations as Listing Regulations anyways provides separate set of compliances equity listed companies (Chapter IV) and only NCDS/NCRPS listed companies ( Chapter V) and those with equity and debt listed (Chapter VI).

Further, SEBI Circulars issued from time to time under SEBI ILDS are addressed to all listed entities who have listed their debt securities or issuers who propose to list their debt securities.

Status under PIT Regulations

SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations) does not define the term ‘listed company’, however, applies to listed company and securities of an unlisted company proposed to be listed. The definition of ‘proposed to be listed’ is as hereunder:

“proposed to be listed” shall include securities of an unlisted company:

(i) if such unlisted company has filed offer documents or other documents, as the case may be, with the Board, stock exchange(s) or registrar of companies in connection with the listing; or

(ii) if such unlisted company is getting listed pursuant to any merger or amalgamation and has filed a copy of such scheme of merger or amalgamation under the Companies Act, 2013.”

The term ‘listed company’ is not being defined under PIT Regulations and therefore, the definition under CA, 2013 should be referred pursuant to Reg. 2 (2) of PIT Regulations[8].  In that case, PIT Regulations will apply only in case of securities issued by a listed company or a company that is proposed to become a ‘listed company’. Accordingly, only debt/ NCRPS listed companies need not comply with requirements of PIT Regulations. SEBI should consider furnishing a clarification in this regard.

However, that is not the intent of law. If a security is listed, its price is subject to change and be impacted by price sensitive information. Accordingly, such exclusively debt/ NCRPS listed companies, on account of private placement of securities, should continue to comply with the requirements of PIT Regulations. SEBI may also consider furnishing a clarification in this regard.

Conclusion

While, the present amendment expands the originally envisaged carve out for private companies to public companies as well, given the other static thresholds prescribed under CA, 2013 public companies have little reason to rejoice. Exemption to comply with PIT Regulations may be a huge relief, however, there is a need for SEBI to clarify the position given the intent of law.

Further, it is very crucial that MCA revisits DRR and DRF related provision for privately placed NCDS and consider to relax the same especially for the benefit of Non-NBFCs. Lastly, suitability of the exemption in case of companies exclusively listed in foreign jurisdiction will be required to be evaluated after a certain lapse of time as the provisions have been recently inserted in CA, 2013.

 

Our other videos and write-ups may be accessed below:

YouTube:

https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

Other write-up relating to corporate laws:

http://vinodkothari.com/category/corporate-laws/

Our  our Book on Law and Practice Relating to Corporate Bonds and Debentures, authored by Ms. Vinita Nair Dedhia, Senior Partner and Mr. Abhirup Ghosh, Partner can be ordered though the below link:

https://www.taxmann.com/bookstore/product/6330-law-and-practice-relating-to-debentures-and-corporate-bonds

 

[1] https://www.bseindia.com/markets/debt/debt_instruments.aspx?curpage=4&select_alp=all&select_ord=1

[2] Ministry of Corporate Affairs, Government of India, ‘Report of the Companies Law Committee’

(November 2019) para 2.

[3] Ministry of Corporate Affairs, Government of India, ‘Report of the Companies Law Committee’

(February 2016) para 1.13.

[4] http://www.mca.gov.in/Ministry/pdf/CommencementNotification_23012021.pdf

[5] http://egazette.nic.in/WriteReadData/2021/225287.pdf

[6] Refer our write up ‘Easing of DRF’ and ‘Provisions relating to DVR & DRR- stands amended’ by CS Smriti Wadehra.

[7] Discussed in our write up ‘Physical to Demat: A move from opacity to transparency’.

[8] Words and expressions used and not defined in these regulations but defined in the Securities and Exchange Board of India Act, 1992 (15 of 1992), the Securities Contracts (Regulation) Act, 1956 (42 of 1956), the Depositories Act, 1996 (22 of 1996) or the Companies Act, 2013 (18 of 2013) and rules and regulations made thereunder shall have the meanings respectively assigned to them in those legislation.

LLPs Slated To More Stringent Reforms

Significant provisions soon to apply on LLPs

 

Payal Agarwal| Executive| Vinod Kothari and Company

 

Introduction

Limited Liability Partnerships (LLPs) being a hybrid form of entity with characteristics of both companies as well as partnerships are governed by the provisions of Limited Liability Partnership Act 2008 (LLP Act).  LLPs are popular since due to less compliance requirements as compared with a company.

In view of the existing framework for LLPs, the Ministry of Corporate Affairs (MCA) has published a news material on its website on 18th February 2021 stating that certain provisions of the  Companies Act 2013 (the Act) will be soon made applicable on the LLPs. Having said that while this news has been flashed, the notification in this regard is still not available.

While the notification in this regard is still not in place as well and so as the rules containing the details of the amendment, however, the notice on the MCA website has indicated the various sections of the Act which may soon be made applicable on the LLPs.

These include some very significant provisions like identification of Significant Beneficial Ownership (SBO), application of the criteria for disqualification, capping on the max number of partners/ DPs, etc.

Are these provisions effective?

No, it is only an advance notice of the proposed changes under the LLP Act.

Whether there is something immediately required as an actionable?

Nothing is immediately required as an actionable on the part of LLP on the basis of this update. The update only seems to be an advance notice of what is proposed to be implemented soon on LLPs.

It has been a trend in the recent years that more and more entities are seeking to be incorporated as LLPs. As against only 2917 LLPs incorporated in December 2019, there has been a sharp increase in the number of LLPs incorporated in December 2020 which amounts to 4322. A downfall was noted in April 2020 on account of Covid 19 outbreak.

LLPs are seen to be entities having less regulatory supervisions and more benefits of the corporate forms of entities. Therefore, conversion of companies into LLPs can be sought as a means of regulatory arbitrage. However, it has to be noted that the regulatory authorities are now set to bring LLPs under the ambit of some stricter supervision. The Company Law Committee Report on Decriminalization of LLP Act also indicated that the attention of the regulatory authorities are now shifted towards the LLPs. Our write up on the same can be read here

In India, mostly the professional service providers such as law firms, practising professionals etc are formed as LLPs. Also, the AIFs are mostly formed as LLPs. In the aforesaid report too, fund raising by way of issue of Non-Convertible Debentures (NCDs) by the LLPs were barred except for the entities regulated by SEBI or RBI. So, the intent of the Government seems to monitor the activities of LLPs.

Discussion on the proposed changes

The tabular presentation below discusses the requirements of the provisions which are intended to be made applicable on LLPS along with our analysis on each of them.

Sec No. Deals with Requirement under the provisions Impact analysis
90 except sub-section (12) Significant Beneficial Ownership (SBO) ·      Declaration of beneficial interest by SBO( 25% or more interest or as specified in the Rules)

 

·      Company shall maintain register of SBO

 

·      Inspection of such register by members

 

·      Co. shall file return of SBO with ROC

 

·      Co. shall take necessary steps for identification of SBO

 

·      Notice by co. to persons who are likely to be/have knowledge of/ were SBO and not registered.

 

·      Info to be given by concerned person within 30 days of notice

 

·      Co. shall apply to Tribunal within 15 days if info not provided by the concerned person

 

·      Tribunal may restricts rights on such shares relating to concerned persons after reasonable opportunity of hearing.

 

·      Aggrieved person may apply for lifting/ relaxation of such orders

 

·      Punishment on contravention

 

While this provision is proposed to be made applicable on LLPs, there could be various points to discuss so that the impact can be analysed. Some of these include:

 

·           The Act intends to identify a natural person controlling or exercising beneficial interest on the company. Under an LLP, the ownership and management need not be different as in the case of companies. LLPs can have partners of various categories like Limited Partner (one who only contributes capital) and General Partner (one who manages the LLP). As we understand, the intent behind introducing the SBO identification for LLPs should be similar to that for companies, i.e. to understand the beneficial owner.

 

·           From here, we move to the next point for discussion, i.e. the meaning of beneficial interest. Section 89 of the Act defines beneficial ownership. Again, it has to be seen that the word “Significant” is defined under Section 90(1) to mean an interest of 25% or more or such other proportion as prescribed in the Rules. Currently, the same has been prescribed at 10%. It will be interesting to see if the similar threshold is also brought for LLPs for which one has to see the Rules that will come in this regard.

 

·           Further, sub-section (12) has not been made applicable on account of the fact that it relates to punishment under Section 447 of the Act.

 

164(1) and (2) Disqualification of Directors Cannot be a Director if –

·      Declared unsound mind

·      Undischarged insolvent

·      Applied to be adjudicated as insolvent

·      Convicted and sentenced imprisonment of 6 months or more and 5 years has not elapsed yet from release ( If sentenced for 7 years or more, permanently disqualified)

·      Disqualified by an order of Court or Tribunal

·      Not paid calls in respect of shares held by him for atleast 6 months from last day fixed for payment of call

·      Convicted of offence dealing with RPT u/s 188 during last 5 years

·      Not complied with Section 152(3)

·      Not complied with Section 165(1)

 

Cannot be appointed in any other co./ re-appointed in that co. for 5 years from the date of failure if is/has been a Director of a co. which has

·      Not filed financial statements/annual returns for 3 consecutive FYs.

·      Failed to repay deposits/debentures/pay interest thereon/ dividend declared for 1 year or more

 

·           The grounds of disqualification of Directors will be applicable to the LLPs as well. Since both sub-section (1) and (2) have been proposed to be applicable, the same is likely to cover Designated Partners  (DPs) and not all the partners considering the fact that only individuals can become DPs.

 

·           The various grounds for disqualification are linked with certain personal defaults and filing defaults.

 

·           Here, in our view, the “Director” may mean to cover only the DPs of LLP on account of following parameters:

 

o   Both of them are individuals, and cannot be body corporates.

o   The DP requires DPIN to function, just as the Directors require DIN.

o   Both of them are responsible for the management of affairs of the entity.

o   At time of voluntary liquidation, in case of a company, Directors are required to file a declaration of solvency. In case of LLP, the same duty has been vested upon DP.

 

o   Though these are certain prelim observations at our end, the views cannot be regarded as final on account of absence of any specific language of law in this regard.

 

o   How the word “director” appearing in the Act will link to the “partners/DPs” under LLP Act, how the word “company” will be construed, what will happen to the other provisions of the Act referred in the aforesaid Sections, whether the Rules corresponding to the relevant sections will also be made applicable on LLPs and many more other questions await response till the statute comes with a final text of law interpreting these questions properly.

 

165 except sub-section (2) Number of Directorships ·         Max no. of directorships- 20

o   Of which public cos. – max 10

o   Dormant co. not included

·         Person holding directorships above specified limit shall within 1 year of commencement of Act-

o   Choose to continue in companies within specified limit

o   Resign from other companies

o   Intimate his choice to the companies and the ROC

·         Resignation under (3)(b) will become effective immediately from despatch of notice to the co.

·         No person can hold excess directorship –

o   Once he resigns from the extra companies or

o   Expiry of 1 year from commencement, whichever is earlier

·         Penalty in case of violation

 

 

 

 

By making this section applicable on LLPs, we are of the view that the same intends to put a cap on the maximum number of partnership of an LLP. The question is whether all partners will be given this upper cap or only the DPs.
167 except sub-section  (4) Vacation of office by Director Office of Director becomes vacant when

·      Incurs disqualifications under Section 164

·      Absents himself from BM held in last 12 months

·      Contravention of Section 188

·      Fails to disclose interest u/s 184

·      Disqualified by an order of Court/Tribunal

·      Convicted and sentenced for imprisonment of 6 months or more

·      Removed in pursuance of this Act

·      Having appointed ex-officio, ceases to hold such office

·      Punishment on violation

 

·      Where all Directors vacate, the promoter ( CG in his absence) shall appoint required number of Directors till appointment of Directors in GM

 

On account of disqualification incurred, the partners will be required to vacant their positions.

 

In a given situation where we have one DP and others as ordinary partners, if the said DP becomes disqualified then by virtue of the said provision, will be required to be vacate his office. Once the DP vacates, there will be a question on how will new DP be inducted. In the give situation for a company, the promoter has been given the power to induct a new director, however, in case of an LLP this again becomes a grey area for the rules to clarify.

 

 

206(5) Inspection The Central Government may, if it is satisfied that the circumstances so warrant, direct inspection of books and papers of a company by an inspector appointed by it for the purpose. Powers of inspection into the affairs of LLP has been given to Central Government by way of inclusion of these provisions under the LLP Act.

 

It is to be noted that powers of investigation already lies with the Central Government under Chapter IX of the LLP Act.

207(3) Conduct of Inspection and Inquiry Notwithstanding anything contained in any other law for the time being in force or in any contract to the contrary, the Registrar or inspector making an inspection or inquiry shall have all the powers as are vested in a civil court under the Code of Civil Procedure, 1908, while trying a suit in respect of the following matters, namely:—

(a) the discovery and production of books of account and other documents, at such place and time as may be specified by such Registrar or inspector making the inspection or inquiry;

(b) summoning and enforcing the attendance of persons and examining them on oath; and

(c) inspection of any books, registers and other documents of the company at any place.

Necessary powers with respect to the conduct of inspection and inquiry has been vested upon the concerned officer by way of these provisions.
252 Appeal to Tribunal against strike-off ·      Agg person against order of ROC dissolving a company, may appeal to Tribunal within 3 years to get the name restored

·      ROC may also file app. for restoration if satisfied that name struck off on incorrect particulars

·      Tribunal’s order filed with ROC within 30 days to restore name

·      Company, its member, creditor, or workman, if aggrieved, can apply to Tribunal within 25 years of striking off order.

The striking off of LLPs are governed by Section 75 of the LLP Act read with Rule 37 of the LLP Rules.

 

The inclusion of the given provision will provide a way for restoration of LLPs whose names were struck off.

439 Non-cognizable offences ·      Notwithstanding CrPC, every offence under this Act except u/s 212(6) shall be deemed to be non-cognizable

·      No court shall take cognizance unless complaint made by ROC, a shareholder or member of company, or person authorised by CG

·      Issue and transfer of securities, or non-payment of dividend – court may take cognizance on complaint by SEBI

·      Personal appearance of ROC, or person auth. by CG not necessary unless Court requires the same

·      The provisions of (2) shall not apply on actions taken by liquidator on any offence during winding up.

Section 212(6) of the Act provides that only those offences that are covered under Section 447 of the Act are cognizable.

 

Section 447 of the Act dealing with fraud is not recognised under the LLP Act.

 

This renders a non-cognizable nature to the offences of the LLP.

NO court will be able to take cognizance of any offence by an LLP or its partners/DPs unless complaint is made by some specified persons, such as Registrar, or any person authorised by Central Government.

 

This may be said to be in furtherance of the Report on Decriminalization of offences of LLPs.

 

 

460 Condonation of delay ·      Application to be filed with Central Government not filed within time/ Document to be filed with ROC not filed within time

·      Central Government may condone delay

·      Reasons to be recorded in writing

The same is already made applicable on LLPs vide MCA notification dated 30.01.2020

Conclusion

The provisions of the Act that are sought to be incorporated under the LLP Act seems to have a wide-spread effect. These will bring major changes in the regime of LLPs once they come into effect. However, it is to be noted that though the provisions seem to have far-reaching consequences, the extent and manner of applying them on the LLPs will only be clear once the rules come out in this connection.

The integration of various provisions of the Act with the LLPs indicate an era of LLPs becoming similar with companies.

 

Our write-ups related to the topic can be viewed here-

 

Extending provisions of the Companies Act, 2013 to Limited Liability Partnerships

Vinod Kothari and Company

corplaw@vinodkothari.com

As per MCA news and updates certain provisions of Companies Act, 2013 (“CA, 2013”) will now be extended to Limited Liability Partnerships (“LLPs”). Below is a snippet covering  list of provisions of CA, 2013 extended to LLPs.

Understanding the borderline between implementing agencies and beneficiaries

Sikha Bansal, Partner and Payal Agarwal, Executive

corplaw@vinodkothari.com 

Introduction

Read more