Ten Monsters in the Companies Act, 2013 – Part 2

[The following post, which is the second
in a three-part series, is contributed by Vinod
of Vinod Kothari & Co. The author can be contacted at vinod@vinodkothari.com
The first part in the series is
available here]
3.         Intruding into privacy of private,
unlisted companies
While we have made the point about above about sweeping
regulation applicable to all private companies, we may specifically make a few
more points about regulations sought to be applied, which are highly
inappropriate in case of private companies. One such provision is the
restriction on related party contracts. Once again, given the nature of private
companies, it is a fairly acceptable practice that private companies should be
allowed to enter into contracts with their related parties. The law imposes the
“majority of the minority” rule for such contracts, which is an exceptional
shareholder consent rule applicable to very large companies such as those
listed on NYSE. The law makes the fundamental mistake of importing corporate
governance norms evolved for a handful of NYSE-listed and LSE-listed entities,
and imposing them on the 8 lakh odd tiny companies in India.
There are several provisions which may require a private
company to have independent directors. For example, if a private company
reports profits of Rs 5 crores or more, it becomes subject to the requirement
of corporate social responsibility (CSR) spending, and to frame and monitor a
CSR policy, the company must have a CSR committee, which must have an
independent director. The presence of an independent director on the board of a
private company, which may actually be a family concern, is really a very
strange imposition.
4.         Reactive law-making – killing
instruments to tackle exceptions
This is quite often noted in mob psychology – for example,
if a bus kills a passer-by, the mob catches hold of any bus, and sets it on fire. But to see this reactive law-making
in such a serious field affecting capital markets is quite undesirable. It is a
known fact that several provisions of the Act were inspired by some of the
recent corporate scandals – Sahara’s use of the private placement device is one
example, Satyam obviously shaped the anti-auditor stance of the Act, and later
incidents such as Sharadha were responsible for the rules pertaining to
While reactive law-making occurs in lot of countries, but an
enthused approach where an instrument is completely killed merely because this
instrument was misused in one particular case, depicts a purely myopic and
callous view. The best example of this the virtual bar on issue of optionally
convertible debentures (OCDs), merely because Sahara misused the instrument.
World-over, OCDs are well accepted and respected as an interesting hybrid
between equity and debt, and a way to encourage fixed income investments by
providing them a kicker in form of the equity conversion option. In the past,
in India too, lots of companies have successfully used OCDs to reduce the cost
of debt. However, since Sahara indulged a blatant misuse of the instrument, and
since the Supreme Court sent inquisitives to the regulators about this hybrid
instrument, the result seems to have been a pledge taken by the regulators –
never allow this culprit to see the face of the corporate world again! The RBI
was the first to act – it virtually barred OCDs for NBFCs in June 2013. The
draft deposit rules of the MCA do the same thing – OCDs are now denied the
exemption from deposit rules, which makes them practically impossible.
It does not seem as if the lawmakers ever thought – if
misuse is the only reason why OCDs should become extinct, then what about
hundreds of companies that came with public issue of equity shares, collected
money and vanished? Does that mean, equity shares should be abolished?
5.         Aggressive prosecution regime will lead
to distorporation
It is common knowledge that there are several provisions of
the law that have very aggressive prosecution provisions. There are penalties,
fines, imprisonments galore. There are 18 sections that refer to the dreaded
section 447 that provides for frauds. If a fraud is established, the culprit
cannot escape a minimum 6-month sentence, but on the higher side, he may spend
good 10 years! If one thought a fraud must be something very very serious, and
therefore, this sort of a penal provision must be appropriate, hold that  – even filing of a wrong return with the Registrar
of Companies is a fraud! Borrowing money from a bank or an NBFC, by either
deliberately or recklessly misleading them, is also a fraud. Note that a fraud
is a non-compoundable, non-bailable, cognizable offence. All this means, one,
that the public officer does not need a warrant of arrest for taking someone in
custody, and there is no bail without hearing the public prosecutor, and there
is no composition, that is, paying of money in lieu of prosecution at all.
There are several sections that have fines running to
crores. Violation of the process-ridden private placement provision, which was
obviously inspired by Sahara, attracts a penalty of Rs 2 crores.
There is a trend internationally – distorporation, that is,
corporates opting to un-incorporate themselves, and opt for non-corporate
status. This trend has been noted in the USA already[1]. In
India too, given the rigorous regime of fines and prosecutions, corporates may
be forced to search for easier alternatives – LLPs or even partnership firms.
6.         Perfunctory filing requirements
The new law has mounted loads of new filing requirements on
companies. Particularly disturbing is the new pack of filing requirements in
sec 117 by linking it with all the resolutions of the board of directors passed
in terms of sec. 179 (3). It is notable that in the past, there was absolutely
no filing of board resolutions. In fact, board proceedings were always
understood to be sole domain of the directors – even the shareholders of the
company, let alone members of the public, could not access board proceedings.
Now, the law requires 22 additional items of board resolutions to be filed in
terms of sec 179 (3) read with sec 117. Many of these are periodic – they occur
several times in a year. Thereby, there is a massive perfunctory burden on
companies to file matters with the Registry offices.
It is nobody’s case that as none of these were filed in the
past, there was some gaping hole in the scheme of regulation of companies.
Filing is not merely an operational burden – it can
culminate into very pernicious penal consequences. For example, if a matter
that requires filing is not filed within 300 days, it leads to a mandatory
prosecution, with a minimum fine. Being charged with a fine is like carrying a
criminal record on one’s profile – which will force companies and officers to
opt for compounding, and compounding will mean coughing up of sizeable money.
There is also a provision that repetitive offences cannot be compounded. In
essence, these perfunctory filing requirements may mean huge compliance burden
on companies, the benefits of which are difficult to perceive.

be continued here)

– Vinod Kothari

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.


  • I think point 3 is an exaggeration. The proviso makes it clear that the effect of the related party transactions restrictions will not come in to effect if it is done in the ordinary course of business and is at an arms length price?

    "Provided also that nothing in this sub-section shall apply to any transactions entered
    into by the company in its ordinary course of business other than transactions which are not
    on an arm’s length basis"
    V Aneesh, Hyderabad.

  • On citation of provisions for point 3 in this article, it shall be noted that, Rule 5(1)(i) of Companies (Corporate Social Responsibility) Rules, 2014 clearly states that unlisted public Companies and private companies which are not required to appoint independent director, shall have its CSR Committee without such director.

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