Ten Monsters in the Companies Act, 2013 – Part 3

[The following
post, which is the third in a three-part series, is contributed by Vinod Kothari of Vinod Kothari &
Co. The author can be contacted at vinod@vinodkothari.com
This follows
Parts 1
and 2]
7.         Casual approach to special majority
Let us realise that Companies Act was
drafted decades ago in England by luminaries. These people, who lived corporate
laws in every breath of theirs, had a well-devised distinction between matters
that require ordinary majority, and matters that require special majority.
Strategic issues where minorities need to be protected would need a special
resolution; but general operational issues have to move on with ordinary majority.
The new Act casually crosses the borderline
between ordinary and special resolutions. For example, even something as
ordinary and operational as extension of bank borrowing limits needs a special
resolution. The difficulties in obtaining such a resolution is already
adversely affecting the corporate sector – most banks are asking companies to
produce a special resolution for extension of their borrowing limits in terms
of the new sec 180 of the Act. Most companies do not have such a special resolution
right now. Convening a members’ meeting is not an easy thing for companies –
large companies with few lakhs of shareholders may spend crores of rupees –
merely to renew or extend the power to borrow money in ordinary course of
business from banks.
8.         Corporate litigation will increase
The new Act contains several provisions
where litigation enthusiasts, corporate blackmailers or pressure-mongers will
find it easy to take companies into corporate litigation. While it may be easy
for the plaintiffs to make an apparent case against companies, companies will
have to spend a good fortune in defending their case, with expensive corporate
There are at least 3 such matters which
corporate litigation will rise manifold. First is the power granted to the NCLT
to relax the minimum shareholding requirement for filing minority protection
sections – called oppression and mismanagement. The new section gives an
unbridled power to NCLT to relax the minimum shareholding requirement, which is
currently 10% of the share capital. Technically, therefore, even a shareholder
holding 1 share may bring a case of oppression – however bad the case may be,
the NCLT will have to give an opportunity of hearing to the applicant and the
company – whereby the company will have to spend a lot on defending. There is
no check on frivolous litigation here.
Second is the very vague, very widely
worded provision of section 221 on freezing of assets of the company. While the
placing of the section, as also the predecessor section in the 1956 Act,
suggest that the section is to be used only in case of adverse findings in an
investigation, the wording of the section is so wide that any creditor with
just Rs 1 lac of debt due from the company, and in fact, even a stranger, may file
an application to NCLT claiming that there is a movement of funds or assets occurring
in the company, and that the NCLT must pass freeze orders. This is an open
invitation for litigation, which may seek to stop important business decisions
such as foreign investments, creation of security interests, acquisitions, etc.
Lastly, shareholders’ associations will
make good use of class action suits. In the USA, class action suits are meant
to recover damages. In India, class action suits are injunctive – that is, to
stop the company from doing certain things. This is where the real problem
lies- there may be orders of injunction based on an ongoing class action suit.
Currently, the CLB imposes such injunctions in case of corporate rivalries, but
imagine an injunction imposed based on an ongoing class action suit with 100
shareholders (who may actually be a group of professional blackmailers, holding
1 share each) on important business decisions – this will affect corporate
functioning to a great extent.


9.         Breaching the borderline between civil
wrongs and criminal offences
The law seems to have breached the
borderline between civil wrongs and criminal offences. This is actually not new
– as the amendments that have been passed to the law from year 2000 onwards
have really caused the blurring to happen. One prominent example is the failure
to pay interest on debentures or redeem them. Unlike fixed deposits, where
small investors’ money is involved, debentures may actually be, and commonly
are, institutional debt. Several companies rely on debentures as a part of
their treasury model. Now, the failure to pay interest or redeem debentures is
something which is surely dependent on the finances of the company. There may
be systemic risk that may affect the company; there may be a cyclical problem,
or simply the company may not have the money to pay interest on debentures, or
to redeem them when they are due. Not having money to pay one’s debts is a
civil wrong – it is not a crime. However, strangely, the law imposes an
imprisonment of up to 3 years for not meeting obligations on debentures,
whether on account of interest or principal. Conversely, there is nothing
similar in case of loans, whereas debentures are practically nothing but
securitised loans.
10.       Death-knell for the Bond market
The bond market will be killed by
enthusiastic and reckless rules framed under sections 73 pertaining to
deposits, and section 71 (3) pertaining to secured debentures.
We have already mentioned above that OCDs
have completely been killed by the enthusiastic rule-making that happened in
the wake of Sahara’s misuse.
There is yet another strange, and
apparently mindless, set of rules that have come under sec 71 (3) pertaining to
secured debentures. This rule says that if the company issues secured
debentures, the debentures must be secured on “specific” property of the
company. A charge on specific property means a fixed charge – which would mean
current assets do not qualify for the purpose of securing debentures. In case
of several bond issuers such as NBFCs, there are no assets other than current
assets to secure the debentures – hence, it would be impossible for NBFCs to
issue secured debentures.
One needs to understand that the major
issuers of bonds in India are financial entities – be it banks or NBFCs. In
either case, the provisions of sec 71 (3) are mandatory in nature, and do not
have any exemption in case of banks or NBFCs. One also needs to understand that
the only bonds that can be issued in India are secured bonds, as unsecured
bonds hit public deposit rules. Thus, a combination of the two rules would
mean  – bonds cannot be anything but
secured, and secured bonds have to be secured on “specific assets”, which means
NBFCs will never be able to issue these bonds. This would virtually mean a
death-knell to the bond market.
There is yet another way in which the MCA
seems to be working exactly at cross purpose with SEBI. The latter is trying to
promote bond market in the country by making it possible for companies to list
privately-placed fixed income securities. Privately-placed bonds are listed by
private limited companies too, but the moment a private limited company lists
its bonds, it becomes a “listed company” under the 2013 Act, thereby invoking
several of the corporate governance norms which are patently unsuitable for
private companies. SEBI has carefully drafted the debt listing agreement not to
impose too much of corporate governance burden on companies that seek to list
their debt securities – however, this distinction has not been taken care of in
defining “listed companies” in the 2013 Act. In essence, listing of privately
placed bonds by unlisted companies will be discouraged by the new Act.
Law is not a gift of omnipotence, or a
product of providence that we have to take as given. We give ourselves the law.
The Indian corporate sector was running fine enough for nearly 6 decades with
the 1956 Act. If at all we needed a new law, we needed it for bettering the
working of companies, not battering them with regulations which compromise on
essential business freedom. Today, we sit in an environment where geographical
borders have become unprohibitive – international investors may simply opt out
of entering India, and several Indian businesses may think of relocating
themselves elsewhere. Corporate regulation has to be pragmatic; it cannot serve
its own need, or the needs of some shaky mentality inspired by a
“no-mistake-henceforth” attitude. It is still time to resolve some issues by
rulemaking and some by amending the law, but it would be really a colossal
mistake if we allow the law and the rules to be implemented the way they right
now are.

–  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.

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