CORPORATE LAW — INCREASED
RESPONSIBILITIES AND
SAFEGUARDS/PROTECTIVE MEASURES
MAHAVIR LUNAWAT*
1. CHANGING SCENARIO AND MULTIPLICITY OF LAWS
Limited liability and separation of management from ownership, the two peculiar
features of limited liability companies, require special attention for governance of such
companies. With the advent of “Global Village”, company form of organisation has
undergone considerable changes. Over the last few decades nature and form of a
corporate sector has grown complex. Cataclysmic changes have occurred in the
composition of the governing boards of the companies. A plethora of statutes have been
made applicable to a company. The existing laws are being amended to be made more
stringent, at the same time new legislations are being passed quite frequently.
Governance processes have been codified and made mandatory.
2.
CORPORATE GOVERNANCE & STATUTORY COMPLIANCE – CONTINUOUS STRENGTHENING
“Strong Corporate Governance is indispensable to a resilient and vibrant corporate
market and is an important instrument of investor protection. It is the blood that fills the
veins of transparent corporate disclosure and high quality accounting practices” – Kumar Mangalam Birla
Committee Report on Corporate Governance.
To fulfill the societal expectations and provide good governance, statutory
compliance by the companies is a pre-requisite. A measure of good Corporate
Governance lies in bridging the gap between the precept and practice of multiple
statutes by the company effectively and to comply with various statutes and regulations
framed thereunder, towards the ultimate aim of protecting the interest of investors’
democracy.
The concept of investors’ democracy in the corporate world denote their supreme
authority in the governance of the business and affairs of their respective companies
either directly or through their elected representatives. The Act has armed them with
very effective and powerful weapons so as to enable them to ensure that the business
and affairs of the company are properly managed. Some of the weapons in their
armoury are:— Section 38 provides that no member shall be bound by an alteration in the
Memorandum or Articles of Association of the company if the alteration requires
him to take or subscribe more shares or in any way increases his liability.
— Section 167 provides that in the event of default in holding an AGM by the
company in accordance with the provision of Section 166, a shareholder may
approach the CLB for calling of or directing the calling of the AGM of the
company.
— Section 169 makes it obligatory on the board of the directors of a company to
proceed forthwith to hold an extra ordinary general meeting of the company on a
requisition of the members.
*
B.Com.(H), ACS (Gold Medalist), DBF, DEM, Secretarial Officer, ITC Limited.
— Section 171 entitles shareholders to receive a minimum of clear 21 days’ notice in
writing for every general meeting of the company. Further, Section 173 makes it
obligatory on the part of the company to attach an explanatory statement to the
notice of the meeting in respect of all matters of “special business”, setting out
all the material facts concerning each item of such business.
— Section 179 enables a member to demand poll before or on declaration of the
results of the voting on any resolution by show of hands. Further, Section 183
enables a member entitled to more than one vote to cast their vote differently.
— Section 235 confers upon the shareholder the right to apply the CLB to appoint one
or more competent persons as inspectors to investigate the affairs of the
company. They may also lodge complaints with CLB under Sections 397 and 398
seeking relief in cases of oppression and mismanagement.
— Section 256 allows a member himself or through some other member to propose
candidature of a person other than a retiring director to stand for directorship.
— Section 284 confers upon the shareholders the right to remove directors of a
company by way of ordinary resolution.
— Sections 297, 299 and 301 regulate the transactions, contracts, arrangements etc,
wherein one or more of the directors are concerned or interested. Applicable
requirements like proper disclosures, maintenance of register etc. as required
under the said sections should be fulfilled. Approval of Board, Central
Government etc., wherever necessary, should also be obtained.
— As a last resort, the shareholders may, in terms of the provisions of Section 439
read with Section 433, file a petition for the winding up of the company, based on
the specified ground(s).
The list is an indicative one but not exhaustive.
In India, the process of corporate governance gained momentum with the
submission of Report on Corporate Governance by Kumar Mangalam Birla Committee
appointed for the purpose. Based on the recommendations of the Committee, the
governance processes have been codified and made mandatory by way of incorporating
a new Clause, i.e., Clause 49, in the Listing Agreement. Since then, there have been
frequent changes in the field of corporate law aiming at better corporate governance.
Some of the key changes, introduced recently, in the field of corporate law are Companies (Amendment) Act, 2000
— Form of companies : Sections 3, 43A have been amended by virtue of which the
concept of deemed public companies has been done away with. Definitions of
public and private companies have also been amended.
— Section 55A confers exclusive powers on SEBI to administer the provisions relating
to issue and transfer of securities, payment of dividend etc.
— Sections 117A to 117C dealing with debenture issue have been inserted.
— Section 192A provides for passing of resolution by the shareholders by way of
postal ballots. Voting at the doorstep helps to expand the concept of
shareholders democracy, which would go a long way to protect the shareholders
interest, by enabling all the shareholders to participate, sitting at their own
places.
This will, perhaps have larger shareholder participation protecting their own
rights in their desired ways. To enable companies to implement the voting by
postal ballots the Central Government has framed Rules in this regard. The
Institute of Company Secretaries of India has also come out with a Guidance Note on Postal Ballot
describing very minutely the nitty-gritty to enable companies to handle the issue effectively in the
sake of protection of investor interest.
— To strengthen the governance processes, several provisions relating to corporate
management, like Sections 217, 274, 275, 292A etc. have been amended/inserted. It
has been made mandatory for directors to give responsibility statement in the
Directors’
Report.
Additional
grounds
of
disqualification,
restriction
on
maximum number of directorship etc. are some of the further changes
introduced to strengthen governance processes. Provisions relating to Audit
Committee have been incorporated in the Act.
— Section 252 has been amended in terms of which a Public Company having paid up
capital of Rs. 5 crore or more and one thousand or more small shareholders (i.e.,
shareholders holding shares of nominal value of Rs 20000 or less) may have at
least one director elected by such small shareholders in the manner as may be
prescribed. Consequently, Companies (Appointment of Directors by small
shareholders) Rules have been notified detailing the procedural aspects in this
regard.
— Sections 58AA & 58AAA cast an obligation on the company, which accepts deposits
from a small depositor (a depositor who has invested in a financial year a sum
not exceeding Rs. 20,000/-) and later defaults in its repayment or any interest
thereupon to furnish all details to the CLB on monthly basis. On receipt of such
intimation the CLB shall pass an appropriate order within a period of thirty days.
The Companies (Amendment) Act, 2002
Conversion of Co-operative Societies into Companies : A new Part
IXA is being
inserted in the Companies Act. The new provisions deal with various aspects of
functioning of Co-operative Societies which choose to incorporate themselves as limited
liability companies (in the form of private companies only) under the Act, to be
thereafter known as ‘producer companies’. All the provisions of this Act, other than
those specifically provided under this Part, shall apply to such a company, as if it is a
private limited company.
The Companies (Second Amendment) Act, 2002
— Imposition of Annual Cess on all Companies : There has been introduced a
Rehabilitation Fund for revival of sick companies in which every company will be
required to contribute, annually, by way of cess at a rate not less than 0.005
percent and not more than 0.1 percent on the value of its annual turnover or its
annual gross receipt, whichever is more, as the Central Government may specify.
Non payment of such contribution may invite a penalty not exceeding 10 times
of the amount in arrears.
— Setting up of NCLT : A National Company Law Tribunal (NCLT), is being set up, with
all powers that were earlier entrusted with CLB/ Central Government / High
Court under the Companies Act. The decisions of the NCLT can be appealed at
the Appellate tribunal, called National Company Law Appellate Tribunal, whose
decision, in turn, can only be challenged in the Supreme Court.
— Provisions relating to Winding-up : Based on the recommendations of Iradi
Committee, the provisions relating to winding up have also been amended.
— Revival and Rehabilitation of Sick companies : A new Part VI A on ‘Revival and
rehabilitation of sick industrial company’ is being inserted in the Companies Act.
The provisions of this Part are in replacement of the provisions of Sick Industrial Companies
(Special Provisions) Act, 1985, which will cease to be in force from the date of notification of
this Bill.
Other Significant Changes in the Companies Act and Rules thereunder :
— Managerial Remuneration – Amendment to Schedule XIII : The limits on
managerial remuneration for companies, not having adequate profits or with no
profits, have been revised with additional conditions, including approval of
Remuneration Committee. Payment of remuneration, as stated above, shall also
be subject to the other conditions specified in the Notification.
Further, if a
company having negative effective capital intends to pay any managerial
remuneration, it shall also require Central Government approval. [GSR No. 36(E)
dt. 16/01/2002]
— Disqualification under Section 274(1)(g) and Nominee Directors : Nominee
Directors (appointed by the Central or State Government/ Banking companies/
Public Financial Institutions and companies established under the Acts of
Parliament having overriding effect over the Companies Act), have been
exempted from the purview of disqualification under Section 274(1)(g). [Circular
No: 8/2002 dt. 22/3/2002]
— Appointment of Wholetime Secretary under Section 383A - Revision of ceiling :
Now, a company having a paid-up share capital of Rs.2 crores or more (earlier limit –
Rs. 50 lakhs) shall be required to have a wholetime Company Secretary. [GSR 419(E), dated 1106-2002]
— Debenture Redemption Reserve (DRR) : Section 117C requires every company to
create a DRR to which ‘adequate amounts’ shall be credited out of its ‘profits’
every year until such debentures are redeemed. DCA has issued a clarification
stipulating creation of DRR on the basis of value of debentures, pending
redemption. [Circular No. 9/2002, Dated 18-04-2002, issued by DCA]
—
Amendments in Schedules
—
Alteration in Schedule VI
— Substitution of ‘Unclaimed Dividends' by the ‘Investor Education and
Protection Fund’ (with its sources) under the category of ‘Current
Liabilities and Provisions’. [GSR 762(E), dt. 13-11-2002]
— Introduction of different slabs of turnover for rounding off of the figures
in Balance Sheet. (earlier the figures were permitted to be rounded off to
’000 or ’00, irrespective of turnover) [GSR 545(E), dt. 1-8-2002 ]
— Disclosure of the name(s) of small scale industrial undertaking(s) to
whom the company owes any sum (as against earlier limit of a sum
exceeding Rs.1 lakh) together with interest outstanding for more than 30
days. [GSR 376(E), dt. 22-05-02]
— Schedule V : Substitution of ‘General Revenue Account of the Central
Government’ by ‘Investor Education and Protection Fund’ [G.S.R. 751(E) –
dt. 02-11-2002]
— Schedule II : Directors, in every Prospectus to be issued by a company, to
give a declaration of compliance with relevant provisions of the SEBI Act,
1992 and guidelines issued thereunder, in addition to, what was required
earlier – the Companies Act and guidelines issued by the Government. [G.
S. R. 650(E) – dt. 17-09-2002]
— Director’s Relatives (Office Or Place Of Profit) Rules, 2003 : Central
Government vide Notification No. G. S. R. 89(E), dated 5-2-2003, in exercise
of the powers conferred under Section 642(1)(b), read with sub-section (1B)
of Section 314 of the Act, has notified Director’s Relatives (Office or Place of
Profit) Rules, 2003.
Any appointment, which carries a monthly remuneration exceeding Rs.
50,000 p.m., of (a) Partner or relative of a Director or Manager; or (b) Firm in
which such Director or Manager, or relative of either is a partner; or (c)
Private company of which such Director or Manager or relative of either is a
Director or Member, shall have to be approved by the Central Government.
The said Rules require inter alia selection of a relative of Director, for holding
place of profit in case of a public company, to be approved by a Selection
Committee, the majority of which shall consist of Independent Directors and
an expert in the respective field from outside the company. Further, following
undertakings shall also have to be given — An undertaking from the appointee that he/she will be in the exclusive
employment of the company and will not hold a place of profit in any
other company.
— In case of the appointment of a relative, an undertaking from the
Director/Company Secretary of the company, that the similarly placed
employees are getting comparable salary, shall also be enclosed along
with the application.
— Companies (Auditor’s Report) Order, 2003 : The Manufacturing and Other
Companies (Auditor’s Report) Order (MAOCARO) has been replaced by the
Companies (Auditor’s Report) Order, 2003 (CARO) with effect from July 1st,
2003. CARO has introduced some additional items for coverage by the
Auditors in their Audit Report.
— Increase in Maximum Amount of Sitting Fee : DCA, by Notification G.S.R.
580(E), effective from 24th July, 2003, has increased the amount of
maximum sitting fees that can be paid to the Directors. Accordingly,
companies having Paid-up share capital and free reserves of Rs.10 crore and
above or Turnover of Rs.50 crore and above, can pay sitting fees upto Rs.
20,000/- and other companies upto Rs. 10,000/-.
3. GLOBAL MOVEMENT FOR BETTER GOVERNANCE – IMPACT IN INDIA
A. Companies Act
The global movement for better corporate governance progressed subsequent to the
Enron debacle of 2001, followed by other scandals involving large US companies such as
WorldCom, Qwest etc. In June 2002, less than a year from the date when Enron filed for
bankruptcy, the US Congress introduced the Sarbanes-Oxley (SOX) Bill, which was
assented to by the US President on 30 July 2002. SOX Act brought with it fundamental
changes in virtually every area of corporate governance.
Playing a pro-active role, the Department of Company Affairs, on 21 August 2002,
appointed Naresh Chandra Committee to examine various corporate governance issues.
Among others, this Committee has been entrusted to analyse and recommend changes,
if necessary, in diverse areas such as:
— the statutory auditor-company relationship, so as to further strengthen the
professional nature of this interface;
— the need, if any, for rotation of statutory audit firms or partners;
— the procedure for appointment of auditors and determination of audit fees;
— restrictions, if necessary, on non-audit fees;
— independence of auditing functions;
— measures required to ensure that the management and companies actually
present ‘true and fair’ statement of the financial affairs of companies;
— the need to consider measures such as certification of accounts and financial
statements by the management and directors;
— the necessity of having a transparent system of random scrutiny of audited
accounts;
— adequacy of regulation of chartered accountants, company secretaries, and cost
accountants, and other similar statutory oversight functionaries;
— advantages, if any, of setting up an independent regulator similar to the Public
Company Accounting Oversight Board in the SOX Act, and if so, its constitution;
and
— the role of independent directors, and how their independence and effectiveness
can be ensured.
As reported by the Naresh Chandra Committee, “When in doubt, disclose” is
probably the simplest and best yardstick for evaluating good corporate governance.
The Committee presented its Report to the DCA in December, 2002 culminating
finally into the Companies (Amendment) Bill, 2003, presented before the Rajya Sabha on
7th May, 2003.
Companies Amendment Bill, 2003
Based on the reports of the above Committee and Joshi Committee, the Companies
Amendment Bill, 2003 has been presented before Rajya Sabha on 7th May, 2003. Some
of the broad amendments sought to be carried out by the Bill are :— Electronic
maintenance/filing
conferencing etc.
of
documents,
Board-meeting
by
tele-
— Mandatory requirement of having Independent Directors and Women Directors
on the Board
— Training of Independent Directors
— Additional disqualification of directors, retirement age, additional disclosure in
Directors’ Report etc.
— Consolidated Financial Statements
— Only one tier of holding-subsidiary companies
— Well-defined duties of company secretaries
— Pre-certification of statutory documents by secretaries in wholetime practice
— Mandatory appointment of Chief Accounts Officer
— Additional disqualifications of auditors, prohibition on providing non-audit
services by statutory auditors etc.
— One investment arm only
— Notice and Agenda for Board-meetings, ratification of resolution by circulation
etc.
Valuation Committee Report
The Central Government (DCA) had constituted an Expert Group under the
chairmanship of Shri Shardul Shroff to suggest guidelines on valuation of corporate
assets and shares in connection with amalgamation, merger, demerger, acquisitions,
buy-back, etc. of shares and / or restructuring of capital of companies.
On 31st January, 2003, the Committee presented, to DCA, its Report containing
several recommendations in the context of valuation. This report does not seek to limit
the management’s prerogative of taking decisions as long as they are reasoned, logical
or justifiable in the interest of the company.
The recommendations made are in addition to the valuation or pricing requirements
which may be contained in SEBI Laws or Regulations, foreign exchange or other laws and
regulations and these recommendations are supplementary and not in derogation of
existing laws. Transactions for which independent valuation by the Registered Valuer(s)
has been recommended to be mandatory, inter alia include all schemes of Compromise
and Arrangement under Sections 391 to 394 of the Companies Act.
— Major Factors influencing the Valuation : The valuer should mention the key
factors which have a material impact on the valuation. All valuations carried out
in compliance with the requirements set out in the Report are to be carried out in
sufficient details to comply with the “duty of care”.
— Rejection/Modification of Valuation Report : If an independent valuer renders a
valuation report, then it shall not be open to a company or its management to
summarily disregard or reject such a Report and appoint another valuer, without
disclosing the valuation and its findings to the Board of Directors and the
Shareholders. Board can disregard / modify the valuation and can enter into a
transaction at a valuation price or exchange ratio, which is in variance with what
is assessed by the valuer(s), with sufficient justification being presented at the
meeting of the Board of Directors and disclosure to that effect is made in the
Explanatory Statement of shareholders notice, if any.
— Role of Chairman of the Audit Committee
— The Chairman of the Audit Committee shall be entrusted with the duty to
appoint the valuer and shall also be the signing authority for such
appointment and the mandate letter.
— The Chairman of the Audit Committee shall have the duty to verify the
independence of the valuer for the purposes of an independent valuation.
— The disclosure principle and the appointment norms for valuers enunciated
above will apply to all companies whether listed or unlisted, where an Audit
Committee is appointed for purposes of good governance.
Report of the Naresh Chandra Committee – II on Regulation of Private Companies and
Partnerships
The Committee has already submitted its Report, which is open for public
comments. All suggestions must, however, reach the DCA (by post or by emaildirv.dca@sb.nic.in) latest by midnight of 12th September, 2003.
With a view to further simplify the regulatory framework, particularly in respect of
small entities, the DCA, by its Order dated 10th January, 2003, constituted Second
Naresh Chandra Committee on regulation of private companies and partnerships. The
Committee was also given the task to submit its recommendation regarding those
matters where companies are required to approach Central Government for its approval
with the view to see whether these procedures can be reformed / liberalised. The
Committee has already submitted its Report and the recommendations, if implemented,
would have far reaching impact in the corporate world.
B. Other Laws
Global developments aiming at liberalisation and simplification have also influenced
not only the Companies Act but also other pertinent statutory framework as a whole.
Competition Act, 2002 : In the present era of globalisation and liberalisation, the
Indian Market has to gear itself to promote and sustain fair competition. Accordingly,
the existing law on matters relating to competition, namely the MRTP Act, 1969, has
been replaced by the Competition Act. In the light of international economic
developments (particularly to competition laws), the focus of the Competition Act, 2002
(the Act) is on promotion of fair competition rather than curbing monopolies.
— Scheme of the Act : The Act seeks to ensure fair competition in India, by
prohibiting
trade
practices
which
cause
appreciable
adverse
effect
on
competition. Three such practices have been identified and shall be regulated by
the Act which are discussed below:(i) Anti-competitive Agreements,
(ii) Abuse of Dominant Position,
(iii) Elimination / reduction of competitors in market achieved through Combination.
An option has been given to the person/enterprise entering into a combination
(above the prescribed limits as given in the Table), to give intimation of the
proposed combination to the CCI. CCI, on receipt of information or suo motu,
shall determine the effect of the combination. In terms of the Act, if a
combination has or is likely to have adverse effect on competition within the
relevant market in India, such combination shall be void.
— International Transactions : The Act empowers the CCI to inquire into
agreements, abuse of dominant position, or combinations taking place outside
India, if they have or are likely to have an appreciable adverse effects on
competition in India. Example : If we consider a situation where there is a
merger between two enterprises abroad, such as Company A in U.K. and
Company B in U.S.A., which have subsidiaries in India, the CCI will have the
power to inquire into such a combination.
— Establishment of Competition Commission of India (CCI) : There shall be
established Competition Commission of India to prevent practices having
adverse effect on competition. The CCI shall replace the existing MRTP
Commission under the MRTP Act, 1969.
Central Listing Authority : A Central Listing Authority (CLA) has been set up under the
SEBI (Central Listing Authority) Regulations, 2003, to bring about uniformity in the
varied practices followed by different Stock Exchanges in respect of listing of securities.
[SMD/Policy/Cir-7/2003, dated 17-2-2003]
4. STATUTORY COMPLIANCE & DIRECTORS / OFFICERS OF COMPANIES
Supremacy of directors in corporate management has been embodied under section
291 of the Companies Act, 1956. Accordingly, their powers are co-extensive with those
of the company itself. At the same time, they are made responsible for the acts done by
or on behalf of the company.
Under Section 253 only individuals can be appointed as directors of a company. The
idea behind section 253 is that as the office of a director is to some extent an office of
trust, there should be somebody readily available who can be held responsible for the
failure to carry out the trust and it might be difficult to fix that responsibility if the
director was a corporation or an association of persons. ( Oriental Metal Pressing Pvt.
Ltd. v. Bhaskar Kashinath Thakoor).
As
far
as
the
Companies
Act is concerned, Section 5 of the Act deals with
‘Officers in default’. The said Section specifies seven categories of officers of a
company, who shall be treated as officers in default, irrespective of whether they were a
party to the default or not. It includes, inter alia, managing director(s), whole time
director(s), manager, secretary, person in accordance with whose directions the Board of
Directors is accustomed to act, any person charged by the Board with the responsibility
of complying with a particular provision. As soon as it is shown that statutory
compliance is not in order, they come under the mischief of the Section.
Apart from the Companies Act, various other statutes contain identical penal
provisions making directors and officers in charge responsible for the offences
committed by the companies. In terms of such provision, where an offence has been
committed by a company, every person who, at the time when the offence was
committed, was in charge of and was responsible to the company for the conduct of the
business of the company, as well as the company, shall be deemed to be guilty of the
offence and shall be liable to be prosecuted against and punished accordingly.
As soon as it is proved that at the time of commitment of offence the person was in
charge of and responsible for conduct of business of the company, the burden of
proving that he had no knowledge or exercised diligently shifts on him.
Further, Schedule XIII to the Companies Act provides that no person shall be eligible
for appointment as a managing or whole-time director or a manager of a company if he
had been sentenced to imprisonment for any period, or to a fine exceeding Rs. 1,000/under any of the following Acts1. The Indian Stamp Act, 1899
2. The Central Excise Act, 1944
3. The Industries (Development and Regulation) Act, 1951
4. The Prevention of Food Adulteration Act, 1954
5. The Essential Commodities Act, 1955
6. The Companies Act, 1956
7. The Securities Contracts (Regulation) Act, 1956
8. The Wealth-tax Act, 1957
9. The Income-tax Act, 1961
10. The Customs Act, 1962
11. The Monopolies and Restrictive Trade Practices Act, 1969
12. The Foreign Exchange Regulation Act, 1973 (replaced by FEMA)
13. The Sick Industrial Companies (Special Provisions) Act, 1985
14. The Securities and Exchange Board of India Act, 1992
15. The Foreign Trade (Development and Regulation) Act, 1992
Detention for any period under the Conservation of Foreign Exchange and Prevention
of Smuggling Activities Act, 1974 shall also be a ground for the above disqualification.
Legislation imposes numerous duties upon directors. The directors are responsible
for ensuring that the company complies with all relevant legislations. Directors are
presumed to know the law and it is immaterial whether the director had knowledge of
the law or not. (Ignorance of law is no excuse). He is bound to know what the law is. It
will be no defence that the person was a sleeping director or a mere name lender to
prosecutions for violation of the provisions of the Companies Act or other laws. Before
deciding to become a director of a company a person should make himself familiar with
the liabilities of the director and penalties for wrongful acts.
It was held in Calcutta Central Bank Limited that the Directors cannot divest
themselves of their responsibilities by delegating the whole management to the Agent
and abstaining from all enquiry; if the agent proves unfaithful under certain
circumstances the directors cannot be absolved from all liabilities.
The personal liabilities which can be imposed upon the directors for both civil and
criminal
offences are
potentially very great and
may arise
in
the following
circumstances:
— abuse of powers – by acting beyond the scope of Memorandum and Articles.
— breach of duty – he’ll be liable to pay / reimburse the company the profit made
or loss suffered.
— liabilities to shareholders – if person suffers a loss as a result of directors
knowingly contravening or pre-empting rights of members.
— liabilities to investors – where directors fail to disclose material information or
give misleading information.
— generally – compliance under various other laws.
Apart from specific legislations, the Directors of reputed companies endeavour to
follow basic principles of Good Corporate Governance. They understand that
transparency and detailed disclosure of a Company’s financial position and operation
allow the investors to better assess the performance of the Board and management
which in turn enable them to make informed corporate decisions.
Emanating from the aforesaid principles of transparency, a number of changes have
been introduced, viz., in the Listing Agreement with Stock Exchanges, introduction of
Accounting Standard on Related Party Disclosures, on Segment Reporting, Transfer
Pricing, etc.
However, with the increasing requirement for transparency, disclosures and the need
for following best practices in the industry, the responsibilities and liabilities of
Companies, Directors and Officers have increased manifold.
5.
SAFEGUARDS / PROTECTIVE MEASURES
Various safeguards are required to be adopted to comply with the laws and to avoid
harsh penal provisions. It has become important to take all the appropriate measures on
time for ensuring statutory compliance and thereby providing good corporate
governance. Some of the safeguards / protective measures that the directors or the
senior officers of a company may adopt are summarised hereunder :
1. Directors’ Liability Insurance :
(a) A company may take insurance policy against loss caused to it by directors, for
its own protection.
(b) A director may take insurance policy against loss caused to it because of his
liability to the company.
— Premium on such policy may be paid by company also.
— There is no bar against taking out policy against loss arising out of liabilities
for which a director cannot be indemnified.
2.
Officer in Default : Board being the apex body of the corporate management and its
constituent sitting at the helm of corporate affairs, it would be difficult rather
impossible for them to ensure compliance with each and every legal provision,
procedural aspect and system. In this backdrop, Clause (f) of Section 5 of the Act
provides that ‘any person charged by the Board with the responsibility of complying
with that provision is an officer in default, provided that person has given his
consent in that behalf to the Board. Thus a Director may be relieved from his liability
by specifying a proper officer of the company who will be considered as officer
responsible for the purpose of ensuring compliance with the relevant provisions.
3.
Annual Accounts : In terms of Section 210 of the Act, it shall be a defence to prove that
a competent and reliable person was charged with the duty of seeing that the
provisions of this section were complied with and was in a position to discharge that
duty and must be substantiated by some document. [State v. Linkers Pvt. Ltd.].
Similar kind of defence may be taken under sections 209 (Keeping of Books of
Account), 211(Form and Contents of Balance sheet and Profit & Loss Account),
212(Balance sheet of Holding company to include certain particulars of its
subsidiaries), 217(Board’s Report), etc.
4.
Relief from Liability (Section 633) : In a proceeding for negligence, default, breach of
duty, breach of misfeasance, if it appears to the court that an officer is or may be
liable for the act complained of but that :
— he has acted honestly,
— he has acted reasonably, and
— having regard to the circumstances of the case, he ought fairly to be excused,
the Court may relieve him from the liability vide section 633.
In Swarmal Goenka and another v. ROC and others, it was held that the directors can
be granted relief from liability, where loss has been caused to the company and such
relief shall be granted only from civil liability and not against prosecution. The High
Court can grant anticipatory relief and if a case is actually initiated, only the Court
before which the complaint or trial is going on can grant relief. [ Sri Krishna Parshad
v. ROC (1978)]. The granting of relief under the Section is discretionary. It may be
partial or complete, or on certain terms or unconditional. [ Ramkrishan Dalmia v.
Registrar of Joint Stock Companies, Delhi (1962)]
5.
Compounding of Offences (Section 621A) : If the scrutiny and enquiry proceeds despite
suitable reply filed by the concerned company and if the enforcement agency still
considers the reply unsatisfactory, then the option available is under section 621A to
get the offence compounded and get rid of prosecutions.
6.
Indemnity against Officers’ liability : It is not permitted to a company to make its funds
available to the managing directors etc. in connection with any civil or criminal case
instituted against them unless they are found by a competent court to be innocent
and the question of reimbursement will arise only after the termination of the
proceeding in favour of the officers of the company concerned. [Circular No. 8 of
1972, dtd. 8-5-1972]
A company can not help financially in defending its officers in civil or criminal
proceedings. But, companies can indemnify its directors/officers against any liability
incurred in defending any proceedings in which judgement is given in his favour or
in which he is acquitted or discharged or in
connection with
any application
under section 633 in which relief is granted to him by the court. If the directors had
acted in a reasonable way taking all reasonable care, a man of ordinary prudence
would have taken,
[Duomatic Ltd., Re.] and say, in particular case, sincerely
believed, on the opinion of the council, that their act was intra vires the company,
they cannot be held liable and they must be indemnified.
7.
Offences by Companies under other statutes (e.g. FEMA, Depositories Act, SEBI Act, Securities
Contracts (Regulation) Act, etc.) : In terms of the standard penal provision existing in
various statutes other than the Companies Act on offences by companies, nothing
contained shall render any person liable to any punishment, provided under such
statute if he proves that the offence was committed without his knowledge or that
he exercised all due diligence to prevent the commission of such offence.
8.
Defence for untrue statements in prospectus: It shall be a defence to prove that either the
statement was immaterial or that he (concerned person) had reasonable grounds to
believe, and did upto the time of the delivery for registration of the statement in lieu
of prospectus believe, that the statement was true.
9.
Ratification by Company of irregularities : An action which has been done with a technical
irregularity but in the interest of the shareholders, can be ratified by them provided
it is within the vires of the company and no specific provision to the contrary exists.
For instance, allotment of shares made by the directors in excess of their powers
may be subsequently ratified by the shareholders at a general meeting.
10. Dividend Payment : Department through Company News & Notes, dt. 01-07-1962
expressed its view that the directors should exercise proper supervision over the
staff so that delay in posting dividend warrants does not take place. The penal
provisions of the law is intended as a deterrent so as to ensure proper compliance.
Prosecution under this section is not a common feature; only those who knowingly
and willfully commit a default will be prosecuted. Therefore, if it is proved that no
mens rea existed on the part of the directors, no prosecution would lie against them.
11. Absence From Meeting : If any Director
can prove that he was not present at the
meeting and did not know the irregularity, he will not be liable even though at a
subsequent meeting he voted confirming the minutes.[Burton v. Bevan]
12. Directors not personally liable for fine on company : A director cannot be made individually
liable to pay the fine imposed on the company. [Dwarka Das v. Crown, A 1924
Lahore 489].
13. Defamatory Circular : Directors are not liable for any libel contained in any notice or
circular issued under the provisions of the Act bona-fide and in the interest of the
company. [Lawless v. Anglo-Egyptian Cotton & Oil Co.(1869)]
14. No Responsibility of Post-Resignation Acts : Resignation of a director takes place from the
date of his resignation. [P. R. M. Abdul Huq v. Katpadi Industries Ltd.]. The directors
are not responsible for what happened after they had vacated their office. [Chettiar
v. Official Liquidator]
15. Business Judgement Value : Apart from what is provided specifically in the law, Directors
and Officers can take the guard of ‘Rule of Business Judgement Value.’ The Rule
provides immunity to the Directors and/or Officers from the liability where the
transaction is within the vires of the company.
The Court will not interfere with internal management and will not set aside the
transaction entered into by the Directors or will not nullify the decisions of the
Directors or charge them with resulting loss if they acted in good faith, in their
independent discretion and judgement and uninfluenced by any consideration other
than what is honestly believed to be in the best interests of the company.
16. Undivided Loyalty Rule : Undivided Loyalty Rule forbids the Directors from usurping a
corporate opportunity. Directors should not take personal benefit of an opportunity in which the
company has got any right, property, interest or expectation or which belongs to the company by
rule of law or equity.
However, it shall be a proper defence to prove that such opportunity appeared
unexpectedly and was offered personally to them and at that time they happened to
be Directors and corporate funds were not involved in financing the opportunity.
17. Fraud versus Negligence : Fraud and negligence are the two most common grounds
which lead to liability on managerial personnel in their personal capacity. Therefore
they should ensure absence of both the grounds as well as establish measures to
prove the same, in the day to day management.
However the two carry different sense and can not be used interchangeably. The
distinction, between fraud and negligence under the Common Law, may safeguard
accused Directors in the sense that in the case of fraud, the presence of mens rea
must also be proved. [Derry v. Peek (1889)]
6.
CONCLUSION
To sum up – While, being appointed as a Director of a reputed company bestows
great honour and brings recognition to the talent and skill of an individual - ‘uneasy
lies the head that
wears the crown’ – he should understand that by being in that
position, the responsibility of all the compliances with the laws of the land attaches to
him.
The increased emphasis on corporate governance has further compelled the boards
of the companies to develop systematic and procedural aspects to ensure statutory
compliance and at the same time establish extended governance practices. Where the
position of law is ambiguous, legal opinions, expert views etc. should be sought to be
doubly sure about the legal provisions and their practical applicability. It is also
advisable to follow the relevant judicial pronouncements, as they also provide
precedents.
Mere following the codified provisions may not deliver the desired results.
Rather, good corporate governance and effective management should be reflected in the
day-to-day corporate functioning enmeshed with ethics and a sense of accountability
towards various stakeholders. The corporate action should be within the four corners of
the law. Companies should not only follow letter of law but the spirit should also be
honoured. A proactive play on the part of company boards would go a long way to
achieve high standards of governance and effective corporate management to structured
finance, trade finance and export finance and finance for infrastructure, and the last few
years saw emergence of fee based services in form of merchant bankers, financial
advisers and managers to the public issue and private placement of shares debentures
and bonds, syndication of loan facilities, external borrowings.