ADVERTISEMENT

Companies Act Sees Another Makeover! The Top 5 Changes And Their Impact On India Inc.

Do the changes to the Companies Act make doing business easier?

File photo of haze  over the skyline in Mumbai, India. (Photographer: Brent Lewin/Bloomberg)
File photo of haze over the skyline in Mumbai, India. (Photographer: Brent Lewin/Bloomberg)

The Companies Act, 2013 has now been amended twice in the three years since it came into force. The second amendment bill received presidential assent on Jan. 3 and is expected to be notified soon.

Here are the top 5 key changes to watch out for.

Relief For Creditors Of Distressed Companies

The first proposed change brings relief to creditors hoping to convert their debt into equity during an insolvency or restructuring process. Creditors will be able to convert debt to equity of a distressed companies at a discount to face value. Currently, company law mandates that such conversion has to happen either at par or premium.

Section 53, that provides for issuance of shares at a value not below face value, had raised concerns in the lender community, Nishchal Joshipura, partner at law firm Nishith Desai Associates told BloombergQuint.

For financially distressed companies where the lenders have triggered either the insolvency and bankruptcy code or some other restructuring mechanism, the book value of the company is typically lower than the face value of the shares of the company owing to accumulated losses incurred by the company, Joshipura said.

In such a situation, if the lenders are allowed to convert their loan into equity only at face value then this would lead to a breach of the borrowing company’s contractual commitment which pertains to conversion of debt at the lowest possible price. This condition is found in most financing documents but due to Section 53, the commercial objective between the parties failed to be met, he added.

Trilegal’s Harsh Pais agreed.

The amendment to Section 53 is meant to address a gap between the Companies Act and IBC. Because clearly under the bankruptcy code and under RBI’s guidelines for restructuring there are scenarios where lenders have to convert their debt into equity and given that these companies are effectively bankrupt, the question is at what value should it be converted.
Harsh Pais, Partner, Trilegal

Leniency In Loans To Directors And Interested Parties

Another significant change relates to loans that a company can extend to its directors and persons that a director is ‘interested’ in.

The law prohibits a company from granting a loan to its director or his relatives or to

  • any firm where such director or his relative is a partner
  • a private company where the director is shareholder or director
  • a corporate where the director has 25 percent and more voting rights or management control

But now, a carve out to this provision will allow a company to extend loans and security to such entities but on approval by a special resolution, that is, approval by 75 percent of shareholders present and voting. The other condition is that the loan funds can be used by the borrower only for its principal business activity. However, loans given directly to a director or his relatives will continue to be prohibited.

The problem is that the present section does not allow any type of loan between a holding company or a subsidiary company where there is a common director, explained Joshipura. Therefore, the only option left with the holding company to fund the subsidiary company is by way of equity shares or preference shares which may have adverse tax implications, he said.

Pais believes that the proposed amendment is positive since it gives shareholders the discretion to approve such transactions.

This is a very progressive amendment. In respect of the transactions contemplated under this section, there are only two stakeholders who are involved in this. One is the board of the lending company and second are its shareholders.  With the proposed amendment, the shareholders can confirm that the company will not lose money because of directors’ arbitrary decision, satisfying the needs and requirements of all stakeholders. This is how it should ideally be. 
Nishchal Joshipura, Partner, Nishith Desai Associates

Related Parties Transaction: A Mixed Bag

The third important change is a mixed one for related party transactions – on the one hand it brings relief to closely held companies and on the other it expands the definition of a ‘related party’.

The existing law prohibits a related party from voting on a related party transaction involving that party. All related party transactions need 75 percent approval from non-interested shareholders.

The first change to this provision relaxes the voting restriction in the case of a company where 90 percent or more shareholders or members, in number, are relatives of promoters, or are related parties.

This change to Section 188 is to overcome a practical issue, Pais said. How do you get shareholder approval if the related party owns almost all the shares but is excluded from the vote, he queried.

Another important change is the expansion of the ‘related party’ definition to include any other body corporate, Indian or foreign, apart from companies. Such body corporate could include a LLP, registered society, trust etc.

The new definition means that foreign entities that have at least 20 percent of total voting power, or control over the company will also have to comply with related party transaction requirements.

Transactions that were deliberately structured to get around the related party transaction requirements under the present company law will be impacted. But typically foreign investors dealt with the Indian companies on an arms-length basis, so this will not impact them much, Suneeth Katarki, partner at IndusLaw told BloomberQuint. .

Relaxation For Independent Directors

Creditors are not the only beneficiaries of the changes to the Companies Act, 2013. Independent directors too have reason to cheer.

Companies law bars a person from acting as an independent director of a company if such person has a pecuniary relationship with that company. Experts say that the interpretation of the term ‘pecuniary relationship’ often led to confusion.

The amendment now clarifies that a person who has transacted with a company will not be barred from acting as independent director, provided the value of such transaction is less than 10 percent of the independent director’s total income.

There were several transactions for comparatively small amounts and in ordinary course of business that previously barred an independent director from acting in such capacity, Katarki said.

Often independent directors are also people with a consultancy role. These individuals are sometimes chartered accountants or lawyers. So as long as that relationship is not significant from a director’s perspective that should not impact his independence. 
Suneeth Katarki, Partner, IndusLaw 

The proposed changes also clarify that a director’s remuneration will not be considered for determining if such person has a ‘pecuniary relationship’ with the company.

Easier To Fund Subsidiaries And Joint Ventures

The fifth key change makes it easier for holding companies to give loans and financial assistance to their subsidiaries and joint ventures. Once the amendments take effect, no shareholder approval will be required for such transactions.

Experts point out that the proposed changes will make structuring of transactions easier and will further ease of doing business.