Changes in the Indian Companies Act

Recently, based on the recommendations of the Committee to Review Offences under the Companies Act, 2013 (Committee), the Companies (Amendment) Ordinance, 2018 (Ordinance) was passed on November 2, 2018, to effect certain changes in the Companies Act, 2018 (CA 2013). Around the same time the Ministry of Corporate Affairs (MCA) also issued a notice, seeking comments/suggestions from stakeholders on additional amendments of an “urgent nature” that are required to strengthen the corporate governance and enforcement framework (Notice). This article discusses some of the key amendments proposed in the Notice, which would have far reaching impact if approved in their current form.

Significant Beneficial Ownership

In the last round of amendments pursuant to the Companies (Amendment) Act, 2017 (Amendment Act), the concept of significant beneficial owners and their disclosure obligations was introduced in section 90 of CA 2013. Further, section 90 (as amended by the Amendment Act) provided that if an individual either fails to provide or provides unsatisfactory information pertaining to his beneficial ownership, an application can be filed by the company before the National Company Law Tribunal (NCLT) to subject the underlying shares to certain restrictions.

Now the Ordinance further provides that if the NCLT imposes restrictions on the shares pursuant to such application, and no subsequent application is filed before the NCLT for lifting of such restrictions within a period of one year, such shares would mandatorily be transferred to the Investor Education and Protection Fund. It is also relevant to note that in addition to a monetary fine, the Ordinance has introduced imprisonment of up to one year as a penalty in cases where an individual who is considered to be a significant beneficial owner under the CA 2013 fails to make the necessary declarations.

Earlier this year, the MCA notified the Companies (Significant Beneficial Owners) Rules, 2018 (Rules), which placed stringent disclosure obligations on individuals holding a certain percentage of beneficial interest in Indian companies. On account of several representations having been made to the MCA regarding the disclosures prescribed in the Rules, the declarations to be filed by significant beneficial owners and companies pursuant to the Amendment Act read with the Rules have been put on hold.

While the MCA mulls over the declarations to be made with respect to significant beneficial ownership, and addresses the concerns raised by stakeholders, the Notice now proposes another significant amendment to section 90 of CA 2013. The proposed amendment places an obligation on companies to take steps to identify if there is any significant beneficial owner and require such individual to comply with the provisions under CA 2013 in this regard. This kind of obligation will be quite onerous for companies, who will now presumably have to undertake the unusual task of investigating into the ownership of its shares in order to discharge its obligations under CA 2013. Further, the level of investigation required to be undertaken by companies to ascertain the beneficial ownership of shares is not clear.

Corporate Social Responsibility

The Notice also proposes a noteworthy change to the extant provisions governing corporate social responsibility (CSR), which is mandatory for prescribed classes of companies. CA 2013 requires prescribed classes of companies to spend at least 2% of their three-year annual average net profit on social welfare activities. Presently, in case the entities concerned fail to spend the requisite amount, the reasons for not spending the amount is required to be specified in the Board’s report. Thus, a “comply or explain” principle was adopted.

Now, pursuant to the amendments proposed in the Notice, amounts which are to be allocated towards CSR activities, but which remain unutilised in a given financial year are required be transferred to a special account to be opened by the company in this regard with any scheduled bank. This account is to be called the ‘Unspent CSR Account’, and the amounts therein will have to be spent by the company in pursuance of its CSR policies within a period of three financial years from the date of such transfer.

This effectively makes CSR spend mandatory. Further, wide powers have been given to central government to issue directions to companies to comply with the CSR provisions under CA 2013. It is interesting to note that while the amendments proposed in the Notice are stated to have emanated from the recommendations of the Committee, the Committee has not dealt with such CSR-related matters in its report.

Remuneration of Independent Directors

CA 2013 initially barred a person from acting as an independent director of a company if such person had a ‘pecuniary relationship’ with that company. Subsequently, this provision was revised pursuant to the Amendment Act and it was clarified that an independent director cannot have any pecuniary relationship with the company other than (i) remuneration payable to such person, and (ii) transactions with the company, which do not exceed 10% of his total income. Under CA 2013, an independent director is entitled to receive remuneration in the form of sitting fees for attending board meetings and a profit-based commission. The Committee considered compensation received by an independent director from the company to rank as one of the most important factors that is likely to influence an individual’s ability to exercise unbiased and independent judgement. Therefore, while the Amendment Act stopped at clarifying that receipt of remuneration was a permissible pecuniary relationship between the independent director and the company, the Notice now proposes a cap on the maximum remuneration payable.

Accordingly, to ensure that there is no material pecuniary relationship between an independent director and the promoter group that can impair his independence, the maximum remuneration of an independent director payable by a company (including its holding, subsidiary or associate company) or its promoters or directors is proposed to be capped at 25% of such independent director’s total income. For computation of this cap on the maximum remuneration, the sitting fees payable to the independent directors would not be counted. Further, within the total cap on the maximum remuneration payable (i.e., 25% of the total income), fees payable for any professional or other services rendered by the independent director (except those prescribed) cannot amount to more than 10% of his total income. It remains to be seen what kind of professional or other services will be excluded from this cap of 10%.

Such a move to cap remuneration of independent directors may further accentuate the problem of attracting the best talent. Further, since the caps are tied to the total income of a given independent director, the proposed amendment will result in several practical difficulties in assessing and monitoring the maximum fees and/or commissions payable to each independent director. Since the cap prescribed would be a percentage of the total income being earned by a given independent director, it may force companies to pay different amounts to independent directors on the same board even though they are performing more or less the same functions.