Company Law: Government Proposes Changes To Expropriate Property Of Shell Firms

Since its notification in April 2014, the Companies Act has seen significant amendments every year. Just last month, the law was amended via an ordinance based on the company law committee report. And now, the government has proposed further changes to it. This time, they are aimed at shell companies, corporate social responsibility provisions and independent directors. Here are the top three proposed amendments and their implications.

Shell Companies: Expropriation Powers

The law allows the Registrar of Companies to dissolve a company. The RoC can do so if the company has failed to commence business within one year of incorporation or has failed to carry on business or operations for preceding two financial years.

But what happens to the assets of the company once it’s dissolved? The law doesn’t spell that out today and the government wants to change that, and that too retrospectively, starting Dec. 26, 2016.

The proposed amendments say that once a company is dissolved, its property will stand transferred to the government. A Board of Administrators will be appointed to dispose of the property and the proceeds from that will go to the Consolidated Fund of India. Any relief for restoration in the register of companies will need to be sought from the National Company Law Tribunal. The relief, if granted, will be limited to refunds and not transfer of property that’s been sold.

The amendment is to target shell companies which are not doing any business and were probably misused after demonetisation, Bharat Vasani, partner at Cyril Amarchand Mangaldas, told BloombergQuint. The section, which gives the RoC powers to dissolve a company, was notified on Dec. 26, 2016. The effect of the proposed amendment will be that the government will get the authority to confiscate the amount deposited during the demonetisation period.

One can easily make out if a company is involved in any substantial business activity and if not, they will go back to Dec. 26, 2016, and from that day any company that has been struck off from the register of companies, the government will get the right to acquire the property of such a company if this amendment goes through, Vasani explained.

Independent Directors: Capping Of Pecuniary Relationship

Excessive pecuniary relationship could lead to potential erosion of independence, the Company Law Committee, chaired by Injeti Srinivas, had pointed this out in its report in August this year. Based on this recommendation, the government proposed that the sum total of pecuniary relationship of an independent director with the company, its holding, associate or subsidiary company in a year, should not exceed more than 25 percent of her income. There’s a further sub-limit proposed to this 25 percent cap— income from professional services cannot be more than 10 percent of the independent director’s income. Sitting fees of independent directors has been proposed to be excluded from the 25 percent cap.

This was potentially prompted by the requirement to have more transparency and clarity, Nandish Vyas, a corporate law partner at Veritas Legal, said. He pointed out that by way of a circular, in June 2014, the ministry had exempted transactions in the ordinary course of business at arm’s length price from the purview of pecuniary relationship of an independent director. The proposed amendment wants to take away this exemption to make it clear that except the board fees, everything else will fall under the 25 percent cap, he added.

But Vasani pointed to several challenges in implementing this amendment – monitoring and unpleasantness, to be precise.

Monitoring will be a huge challenge for companies because in many cases where people are professional directors, they may not be able to estimate the precise amount of income they could be earning in the current year. So, it will be based on previous year’s income, Vasani said.

Directors will come to know the income of other directors and since the cap is 25 percent of the total income, some directors will get more, and some may get less for the same work, he said.

CSR: No More ‘Comply Or Explain’

Currently, the company law has a comply or explain approach to corporate social responsibility spends. Companies, which fall within the prescribed thresholds, need to spend at least 2 percent of their average net profit for the immediately preceding three financial years on corporate social responsibility activities. If it fails to do, the reasons need to be specified in the annual report.

The government has proposed an amendment that will make CSR spends mandatory. It has proposed that the unspent amount will have to be transferred in a special account – which the company will need to open for this purpose – within 30 days from the end of a financial year. This amount will then have to be spent on CSR activities within three years from the date of transfer.

Companies have been giving all sorts of reasons for not making the CSR spend — for example, one company said that before we go about making the full spend, it likes undertaking test projects or pilot projects and that’s the reason it successfully gave for a couple of years, Vyas pointed out.

And finally, there’s an IL&FS-kind-of-situation fix — one that will allow the government to make an application to the NCLT to declare a person not fit and proper to be on any board if certain conditions are fulfilled. The amendment is proposed in the provisions that deal with oppression and mismanagement cases.

If passed, the government will be able to move such an application against any person in charge of the management and affairs of the company who it believes is guilty of fraud, persistent negligence, misfeasance, has failed to carry on the business of a company with prudent commercial practices, has taken actions to defraud creditors or in a manner prejudicial to public interest.