In the end, it was a heartwarming sight. A 35-year-old minister on the floor of the House passionately representing a ministry he took over merely a month ago. Concluding and marshalling almost a decade of discussion and deep deliberation very effectively to finally replace a 56-year-old Companies Act. While the attendance did not reflect it, the Lok Sabha was discussing something that was perhaps more important and certainly, more fundamental than the much-watched FDI (foreign direct investment) in retail debate.
The wait for this legislation has been a long one. Indian companies have been patient with an effort that started in the 1990s.
The 1999 amendments brought in some interesting and welcome concepts. 2008 saw the introduction of a new Bill in the 14th Lok Sabha. And then again in the 15th Lok Sabha in 2009. The Bill has been through standing committees and a plethora of deliberations. And what has emerged now is a new Companies Bill 2011, which after this approval, travels to the upper House for becoming a law.
There are some changes that are almost necessitated by the passage of time. A law of 2012 must recognize that business now is very different from business in 1956. Therefore, there is more self-regulation rather than government approvals—on loans, investments, related party transactions, managerial remuneration, etc. Similarly, a more flexible and board-decision based dividend distribution framework. Or the fact that there can be a one-man company. And that one can set up entities that are inactive—to carry on business in future or to hold valuable assets such as intellectual property.
My objective is not to focus on these changes but to discuss some clear themes that emerge in this Act that impact the way in which businesses will be run.
In keeping with the government’s focus on inclusive growth, the first of these themes is the concept of social welfare that has been introduced through an almost mandatory corporate social responsibility (CSR) spending of 2% of net profit. India would be the first country to introduce a contribution in this format. In concept, this is an interesting move. As a tax on net profits, it is almost like an additional income tax.
Parliament technically has the power to collect 2% more income tax and to then spend it in the way that it would like to. Instead, what it has chosen to do is to have companies (and not, non-corporate businesses) spend this 2% as a part of their CSR programme. Through the Companies Act and not a Finance Bill. This is perhaps better than a higher income tax, since companies would probably spend it with more direct impact than the government would, even if the spending was in its own catchment area.
For its success though, this cannot be allowed to degenerate into another “closely inspected and monitored” government programme. It must be allowed to stay simple and flexible. That it applies to all companies—private and public—that meet defined thresholds, effectively means that the cost of doing business in a corporate structure in India is more than as a non-corporate vehicle. Overall, if this construct is well administered and exceptional situations are adequately addressed, it has the potential to be a good move.
Any law reacts to the issues in the immediate environment. The second important theme that the law has picked up is the accent on addressing the spate of governance deficit issues that one has seen in the private sector. Criminal liabilities against directors and colluding auditors, more teeth to the Serious Fraud Investigation Office (SFIO), closer self-regulation of related party transactions, tighter regimes around fund movements, class action suits and periodic rotation of auditors are some provisions that have now come in.
I look at these as steps inherent in the creation of an overall environment that accords importance to substantive compliance with the law and fosters a sense of higher responsibility. We can already witness these changes in large listed companies. Broad-basing this to a larger number of businesses is welcome, so long as we recognize that the creation of this environment is a phased process.
The third bucket of changes is what I call the globalizing of the law. Consolidated financial statements together with stand-alone ones, cash flow preparation, recognition of contractual share transfer restrictions, the entire gamut of changes impacting restructuring of companies, are a few examples of a globalizing law.
The mandatory squeeze out of a reluctant or non-existent minority is one change in this bucket that has been on the industry ask list for a while. With adequate safeguards, this is a powerful tool for effective reorganization. Increasing threshold limits for objecting to restructuring schemes, helps fight frivolous and sometimes, mala fide objectors.
That said, there was a clear opportunity for achieving more. Developing a thought process for more flexibility on the capital structure is vitally important for capital-starved Indian enterprises.
A number of laws must come together for that, but the Companies Act is the strategic enabler. This is where this Act does not make any bold departures—there is no tracking stock, no hybrid instruments, an express prohibition on treasury stock, restrictions on holding-subsidiary structures and a general overarching lack of flexibility. The law even seeks to dictate the financial year!
In summary, therefore, while I would say that the new Act has a number of positive concepts, overall, my feeling is that it is a conservative effort. It reflects the thinking of a lot of people for a long time. And for that reason, it feels overly safe. More could have been done.
Vivek Gupta is partner, BMR Advisors. The views are personal.