India has a brand new company law that's more appropriate for the 21st century and its challenges. With the passing of the Companies Bill, 2012, by the Rajya Sabha on Thursday , which will become the Companies Act, 2013, when formally notified into law, several things change for the Indian corporate sector (Download the full bill here).
Among them: corporate boards will have to have a third of their members as independent members; some boards will have to include more women; auditors will have to be compulsorily changed after 10 years; spending on corporate social responsibility (CSR) will be mandated for companies of a certain size and minimum profitability; directors of a company will have to become more accountable; and, most important, minority shareholders and depositors in a company can launch class action suits against managements to defend their interests.
The best thing about the new Companies Act is that it is simple, with greater clarity of intent and purpose. It replaces the old law with over 700 conflicting clauses with something shorter and sweeter: 470 clauses and all of it in 309 pages. Not bad for something that will govern all listed and unlisted companies in the country.
However, a modern law does not by itself become a great law, for success depends on implementation. Here are the main issues that will make or mar the success of the new law.
#1: Independent directors: The provision to make companies have one-third of their board members as independent directors is fine in principle. Independent directors (IDs) are also more stringently defined, and their tenures will be limited to two terms adding up to 10 years. IDs can also hold a maximum of 20 directorships.
Sounds good? But there are pitfalls. For three reasons. First, how independent can IDs be when they are appointed and paid for by the promoters? Will promoters appoint truly independent people on boards? Second, are there enough persons available to be appointed as IDs? In theory, yes, because there are no qualifications for becoming an ID. But, in practice, once you tell the prospective person the responsibilities he will bear, the actual number of competent and willing IDs diminishes. Most IDs, in fact, end up adorning corporate boards without the time or commitment to work in the interests of shareholders. Third, if eligible IDs end up taking up 20 directorships each, how can they really serve each of those companies’ shareholders diligently? According to a CNBC TV18 report, Analjit Singh of Max India, for example, attended only one out of 14 board meeting of Dabur in three years, before he resigned. How did he really help protect Dabur’s shareholder interests by remaining absent?
The conclusion: it is good to have many IDs, but corporate governance will need a heavy dose of regulation too to complete the picture.
#2: Corporate social responsibility: Sure, the Bill does not make 2 percent spending on CSR mandatory, but it comes close. As we noted before, the real issue is not in the percentage, but that the bill makes no effort whatsoever to define CSR. The only obligation is to earmark the funds, form a committee, formulate a CSR policy, and spend the cash. If you don’t spend the money, you have to explain why in the annual report. So, it seems the law has no problems whether a company uses profits to help commercial sex workers in Mumbai or build places of worship as part of CSR.
According to a Business Standard study in January, 457 of the 500 companies on the BSE 500 Index will have to provide for CSR, and based on the average net profits for three preceding years, they will have to fork out Rs 6,751 crore in CSR spends. ONGC would have to spend around Rs 405 crore a year and Reliance Rs 377 crore, the newspaper says. Rs 6,751 crore is not a small amount. But it is chickenfeed compared to what ONGC and other oil and gas companies have spent (wasted, rather) in subsidising fuel consumers in India under UPA (over 30 times the total mandated CSR for India Inc put together). So, beyond inculcating a corporate conscience, what difference will it make to society?
#3: Excessive bureaucracy: In order to make directors accountable, the new Companies Bill mandates that every director shall register himself or herself with the government and obtain a Director Identification Number (DIN). Like the UID, which is supposed to give every Indian resident a unique identity and prevent fraud, the DIN will enable the government to monitor the number of directorships any person holds and also his track record. Given India’s track record, where bureaucratic monitoring of corporate affairs lead to corruption and bribery, how many directors will want to risk being on the government’s watch-list? Will DIN deter more competent people from taking up directorships or encourage them?
#4: Women directors: It is important for corporate boards to ensure gender diversity, but before that happens, a supply of women eligible for board positions needs to be created. According to GMI Ratings’ Women on Boards Survey 2013, even on the world’s best-known companies, women account for only 11 percent of total directorships. In India, a sample of 89 companies with more than $ 1 billion in market valuation, the women percentage is less than 7 percent. And we are talking only about the biggest companies here. Clearly, major efforts will have to be made to create more women directors, but before that there have to be more women reaching the top of the corporate hierarchy. The legislation should act as a spur to women’s empowerment, but compliance could be years away.
#5: Class action suits. Perhaps the best new provision in the Companies Bill is the enabling of tort action and class action suits. If this provision had been on the statute book in 2008, Satyam’s Indian shareholders could have filed a class action suit against the Rajus, or even the Mahindra-run company that took over Satyam’s assets. Mahindra Satyam settled lawsuits in the US and UK since these countries enable class action suits, but in India shareholders were left twiddling their thumbs while foreign shareholders were paid off.
This can’t happen in future, but the moot point is whether shareholders of government-owned companies can sue the government for squashing minority interests. It is worth recalling the Coal India has been sued by a minority shareholder (The Children’s Investment Fund) for following the government’s diktat to lower coal prices in 2012. There is ample scope for class action suits against ONGC, Oil India and GAIL, which are subsidising losses in the oil marketing companies.
Class action suits have to be filed before the National Company Law Tribunal first, but banking companies are excluded from such action.
In the weeks ahead, as companies pore over the fine print of the Companies Bill, more issues will surface. But for now the best sum-up is this: it’s a great start, but, as always, the proof of the pudding is in the eating.
The writer is editor-in-chief, digital and publishing, Network18 Group