Companies Act, 2013 Bringing Paradigm Shift in Corporate Governance

Companies Act, 2013 Bringing Paradigm Shift in Corporate

Governance

N K JainB.Sc., LLB.,DCL,FCS,FCPS

Corporate Advisor

Former Council Member and Secretary & CEO, ICSI

Cell: 09818348811

Landline: 0120 - 4263965

E-mail: [email protected]

CG Issues

Corporate Structure Board Composition Board Committees Directors Duties of Directors Board Evaluation Vacation of Office of Directors Management [MD/CEO/KMP]

[email protected] 9818348811 2

CG Issues

Statutory Audit Auditing Standards Rotation of Auditor Audit Committee & Vigil Mechanism Secretarial Audit Secretarial Standards Duties of Company Secretary


CG Issues

Internal Audit Related Party Transactions Disclosure & Transparency E-Governance Investor Protection Corporate Social Responsibility


Governance more than Board Processes & Procedures To most of us CG is just a set of codes to be

practised by companies to ensure changes in their Board structures & procedures to make company more accountable to shareholders.

However, governance is more than just board processes and procedures. It involves the full set of relationships between a company’s shareholders, its board, management and its other stakeholders.


Governance more than Board Processes & Procedures In such a scheme of things governments play

a crucial role in making the legal, institutional & regulatory framework within which governance systems are kept in place.

Its efficiency will depend on framework conditions, which would include legal rights of shareholders and how these were protected when violated by managements.


Governance more than Board Processes & Procedures

Poor governance, for instance, can wreck havoc on the performance of national economies and corporations.

Poor governance undermines investor confidence in the markets and holds the whole financial system hostage. It severely impacts flow of capital into poorly governed economies affecting their economic growth.


Corporate Governance Issues

CG has different meaning to different people. But to all, CG is a means to an end, the end

being long term stakeholder value. Thus, all authorities are one in recognising

the need for good CG practices to achieve the end for which corporates are formed.


Corporate Governance Issues

Separation of Ownership from Management: Promoters/Shareholders should exercise

their ownership rights in the general meetings of the company and ought not to throw their weight in the Board meetings.

Boards should be allowed to function and decide with complete freedom what is good for the company and its various stakeholders.


Corporate Governance IssuesDistinguishing the roles of board and management:

The business of a company is to be managed ‘by or under the direction of’ the board. The responsibility of managing the business is delegated by the board to the CEO, who in turn delegates the responsibility to other senior executives. Thus, the board occupies a key position between shareholders (owners) and company’s management.


Corporate Governance Composition of Board Executive/non-executive chairman Executive director Non-executive director Nominee director Independent director/ Lead ID Woman director- Gender diversity


Composition of Board Minimum Number of Directors: a. Public Company : 3 directors b. Private Company : 2 directors c. One Person Company : 1 director Maximum number of directors restricted to 15 Maximum directorships: 20 including 10 in public

companies(including alternate directorship). Number of directorships may be reduced by

passing a special resolution by [email protected] 9818348811 12

Independent Directors

The purpose of induction of Independent Director on the board of a company is to improve objectivity, transparency and accountability in the governance of the company.



Number of IDs

Every listed public company shall have at least 1/3rd of the total number of directors as IDs.

Following companies shall have at least 2 IDs:- Public Companies having:

i. paid up share capital of 10 crs ₹ or more; or

ii. in aggregate, outstanding loans, debentures and deposits exceeding 50 crs₹ .

iii. turnover of 100 crs ₹ or more; or Nominee directors not to be treated as an ID.


Tenure of IDs

ID can hold office for 2 terms of up to 5 consecutive years each (total 10 years).

IDs shall be eligible for re-appointment after cooling period of 3 years.

ID shall not be associated with the company in any capacity during the cooling period.

Any tenure of an ID on the date of commencement of the Act not to be counted.

Every existing company to have IDs within one year from commencement of the Act or from the date of notification of Rules, as may be applicable.


IDs- Rewards & Liability

IDs may receive sitting fee, reimbursement of expenses for attending meetings & profit related commission but no stock option.

IDs shall abide by the Code of Conduct contained in Schedule 4 of the Act.

An ID shall be held liable only for such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board Processes, and with his consent or connivance or where he had not acted diligently.

Separate Meetings of IDs

IDs shall hold at least 1 meeting in a year without non-ids and management personnel.

All IDs shall strive to attend such meeting. The meeting shall review the performance of:

a. Non-IDs and the Board as a whole;

b. Chairperson of the company, taking into account the views of EDs and non-EDs;

c. Asses the quality, quantity and timeliness of flow of information to the Board.


Performance Evaluation of IDs Performance Evaluation of IDs shall be done

by the entire Board of Directors excluding the director being evaluated.

On the basis of the report of performance evaluation, it shall be determined whether to extend or continue the term of appointment of the ID.

Nomination & Remuneration Committee shall carry out evaluation of every director’s performance(Sec.178).



Resident Director

Every company shall have at least one director who has stayed in India for a period of not less than 182 days in the previous calendar year.

Woman Director

The following companies shall appoint at least one WD :-

i. every listed company;

ii. every other public company having: - paid-up share capital of 100 crs or more; or ₹ turnover of 300 crs or more. ₹


Vacation of Office Director to vacate his office if he fails to

attend all Board Meetings for a consecutive period of 12 months even when the leave of absence has been granted.

If all directors have vacated the office, the promoter shall appoint minimum number of members.

Directors’ Development Programmes

Schedule IV provides for the duties of IDs which includes that IDs shall undertake appropriate induction programmes and regularly update and refresh their skills, knowledge and familiarity with the company.


Duties of Directors Sec.166

..act in accordance with articles of company; ..act in good faith to promote company’s

objects in interest of company, employees, shareholders, community & environment;

..exercise his duties with due and reasonable care, skill and diligence…;

.not to involve in conflict of interest with comp .not to achieve any undue gain or advantage; ..not to assign his office..


Non cash transactions involving directors Sec. 192

A company shall not enter into any arrangement by which a director of the company or of its holding company or any person connected with him can acquire company’s assets for consideration other than cash & vice versa without the approval of company in GBM.

Where the director or connected person is a director of its holding company, then resolution from holding company will also be required.


Prohibition on Forward Dealings Sec.194 Sec.194(1) imposes a prohibition on forward

dealings in securities of the company, or in its holding, subsidiary or associate company by any director or KMP of a company.

A director/KMP shall be liable to surrender the securities acquired in contravention of Sec, 194(1) which shall continue to remain in the name of the transferor.

Punishment: Imprisonment up to 2 years or fine of 1lac to 5 lac or with both. ₹ ₹


By: N K Jain 26

No person including any director or KMP of a company shall enter into insider trading in respect of securities of the company.

Punishment for contravention: imprisonment up to 5 years or with fine of 5 ₹lac to 25 crs or 3 times the amount of profit ₹made out of insider trading, whichever is higher or with both.

Prohibition on Insider Trading Sec.195

Separation of the roles of Chairperson & CEO

The practice of combining role of Chairman with CEO leads to conflicts in decision making; too much concentration of power in 1 person results in unhealthy consequences.

In the UK & Australia, the CEO is prohibited from being the chairman of the company.

The role of the CEO is to lead the senior management team in managing the enterprise.


Separation of the roles of Chairperson & CEO The role of Chairperson is to lead the board. The board evaluates the performance of

senior executives including the CEO. Combining the role of both the CEO and the

Chairman removes an important check on senior management’s activities.

The Chairman should be an ID to provide the appropriate counterbalance and to check the power of the CEO.


Separation of the roles of Chairperson & CEO Sec.203 provides that an individual shall not

be appointed or re-appointed as Chairperson as well MD or CEO of the company at the same time after the date of commencement of the Act unless the:-

a. article of the company provide otherwise; or

b. company does not carry multiple businesses Prescribed classes of companies engaged in

multiple businesses with CEO for each such business may be exempted by Govt.


Key Managerial Personnel

“KMP” in relation to a company means:–

i. The Chief Executive Officer or the Managing Director or the Manager;

ii. The Company Secretary;

iii. The Whole Time Director;

iv. The Chief Financial Officer; and

v. Such other officer as may be prescribed.


Key Managerial Personnel

Board of every listed company and every other public company having a paid-up share capital of 10 crs or more shall appoint the ₹whole time (i) MD or CEO and in their absence a WTD (ii) a CS and (iii) a CFO.

A WT KMP not to hold office in more than one company except in its subsidiary company at the same time.

Vacancy of WT KMP to be filled up in 6 months.


Rotation of Auditors Sec.139

No listed company or prescribed classes of companies excluding small and one person companies shall appoint/ re-appoint:-

i. an individual as an Auditor for more than 1 term of 5 consecutive years; and

ii. an audit firm as an Auditor for more than 2 terms of 5 consecutive years.

A period of 3 years from the commencement of the Act has been provided to comply with this provision.


Rotation of Auditors- Class of Companies

a. Listed company;

b. Unlisted public companies having paid up share capital of 10 crs or more;₹

c. Private limited companies having paid up share capital of 20 crs or more;₹

d. Companies having paid up share capital of below threshold limit mentioned in (b) & (c) above, but having public borrowings from FIs, banks or public deposits of 50 crs or ^₹


Rotation of Auditors Sec.139

An auditor/ audit firm which has completed its term shall not be eligible for re-appointment as an Auditor in the same company for 5 years.

Freedom has been provided to the members of a company to resolve that:-

a. in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members, or

b. the audit shall be conducted by more than one auditor.


Auditor not to render certain services - Sec. 144

An Auditor appointed under the new law shall provide to the company only such services as are approved by the BOD or the AC but which shall not include any of the following services:-

Auditing and book keeping services; Internal audit; Design & implementation of any financial

information system;[email protected] 9818348811 35

Auditor not to render certain services - Sec. 144

Actuarial services; Investment advisory and banking services; Outsourced financial services; and Management services. An Auditor or Audit Firm which has been

performing any non-audit services shall comply with this provision before the closure of the 1st FY after commencement of the Act.



Secretarial Audit Sec. 204

Every listed and every public company having a paid-up share capital of 50 crs or more or turnover of ₹ ₹250 crs or more :-

shall annex with its Board’s Report, a Secretarial Audit Report given by a PCS.

The company shall give all assistance and facilities to PCS, for auditing the secretarial records of the company.

The BOD in its report shall explain in full any qualification or observation or other remarks made by the PCS in his report.


Secretarial Audit Sec. 204

The provisions of Sec.143(powers and duties of auditors..) shall mutatis mutandis apply to PCS conducting secretarial audit u/s 204.

If a company or any officer of the company or the PCS, contravenes the provisions of Sec. 204, the company ,every officer of the company or the PCS, who is in default, shall be punishable with fine which shall not be less than

1 lac but which may extend to 5 lac.₹ ₹

Secretarial Audit Sec. 143(12),(15) & 204

If a PCS conducting SA, has reason to believe that an offence involving fraud is being or has been committed against the company by its officers/employees, he shall immediately report the matter to the Central Government.

If a PCS does not comply with the above provision, he shall be punishable with fine of minimum 1 lac and may extend to 25 lac. ₹ ₹


Internal Audit Section 138 of the Act provides that

prescribed classes of companies shall be required to appoint an internal auditor, who shall either be CA/CMA/ other professional to conduct internal audit of the functions and activities of the company.

The central government may prescribe the manner and the intervals in which the internal audit shall be conducted & reported to board.


Internal Audit-Class of Companies to appoint IAa) Every listed company;

b) Every unlisted public company having, during the preceding financial year, :-

i. paid up share capital of 50 crs or more; or₹ii. turnover of 200 crs or more; or₹iii. outstanding loan or borrowing from banks or

public FIs exceeding 100 crs or more ; or₹iv. outstanding deposits of 25 crs or more. ₹


Internal Audit-Class of Companies to appoint IA

c) Every private company having:-

i. turnover of 200 crs or more during the ₹preceding financial year; or

ii. outstanding loans or borrowing from banks or public FIs exceeding 100 crs or more at ₹any point of time during the preceding FY ;

Existing company covered under any of the above criteria shall comply with requirement within 6 months of commencement of se.138.


Audit Committee Sec.177 The BOD of the following classes of

companies shall constitute an AC:- Every listed company; All public companies having:-

(i) paid up capital of 10 crs or more;₹ (ii) turnover of 100 crs or more;₹ (iii) in aggregate, outstanding loans or deposits or borrowings or debentures exceeding 50 ₹crs or more.


Audit Committee Sec. 177 AC shall consist of minimum 3 directors with

ID forming majority. Majority members of AC including its

Chairman shall be persons with ability to read and understand financial statement.

KMPs shall have right to be heard before AC. Every existing AC shall be reconstituted

within 1 year of commencement of the new Act. [email protected] 9818348811 44

Nomination & Remuneration Committee The BOD of the following classes of

companies shall constitute a NRC:- Every listed company; All public companies having:-

(i) paid up capital of 10 crs or more;₹ (ii) turnover of 100 crs or more;₹ (iii) in aggregate, outstanding loans or deposits or borrowings or debentures exceeding 50 ₹crs or more. [email protected] 9818348811 45

Nomination & Remuneration Committee Composition: at least 3 NEDs out of which

not less than ½ shall be IDs. Chairperson of the company may be a

member but shall not chair the NRC. The NRC shall formulate and recommend to

Board a policy, relating to remuneration for the Directors/KMPs/other employees which shall be disclosed in the Board’s Report.

The Chairman of NRC shall attend General Meetings of the company.


Stakeholders Relationship Committee BOD of a company which consists of more

than 1000 shareholders, debenture-holders, deposit-holders and any other security holder at any time during a FY shall constitute SRC.

SRC shall consist of a chairperson who shall be a NED and such other members as may be decided by the Board.

SRC shall consider and resolve grievances of security holders of the company.



Functions of Company Secretary Sec. 205 The functions of a CS shall include:-

a. To report to the Board about compliance with the provisions of the Act/ Rules and other laws applicable to the company;

b. To ensure that the company complies with the applicable secretarial standards;

c. To discharge such other duties as may be prescribed.

Duties of Company Secretary

1) To guide the directors, about their duties, responsibilities and powers;

2) To convene and attend board, committee and general meetings, and maintain their minutes;

3) To obtain approvals from the Board, general meeting, the government and such other authorities as required under the Act.


Duties of Company Secretary

4) to represent before various regulators and other authorities under the Act ;

5) to assist the Board in the conduct of the affairs of the company;

6) to assist and advise the Board in ensuring good corporate governance;

7) to discharge such duties as have been specified under the Act or Rules; and

8) duties as may be assigned by the [email protected] 9818348811 50


Secretarial Standards Sec. 118(10) Every company shall observe secretarial

standards with respect to General and Board meetings specified by ICSI constituted under section 3 of the Company Secretaries Act,1980 and approved as such by the Central Government.

Vigil Mechanism Sec. 177 Following classes of companies shall

establish a vigil mechanism for their directors and employees to report genuine concerns:-

i. Every listed company;

ii. Companies which accept deposits from the public; and

iii. Companies which have borrowed money from banks and public financial institutions in excess of 50 crs.₹


Vigil Mechanism Sec. 177

The companies which are required to constitute an AC shall operate the Vigil Mechanism through the AC.

In case of other companies, the BOD shall nominate a director to play the role of AC.

Adequate safeguards shall be provided against victimisation of employees/directors.

Suitable action against repeated frivolous complaints including reprimand.


Related Party Transactions

Approval of the Audit Committee Consent of the Board by a resolution at a

meeting of the Board Prior approval of the company by a special

resolution Exception: Transactions entered into by the

company in its ordinary course of business and on an arm’s length basis.


Fraud (Sec 447)•“fraud” in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss;•Director shall be held guilty of fraud

Actions for which punishment for fraud is provided for in the Act Incorporation of a company - furnishing any false or

incorrect information or suppression of any material information.

Mis-statements in Prospectus – Where a Prospectus, issued, circulated or distributed includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead.

Fraudulently Inducing persons to invest money - Any person who, either knowingly or recklessly makes any statement, promise or forecast which is false, deceptive or misleading, or deliberately conceals any material facts, to induce another person to invest money

Deposits had been accepted with intent to defraud the depositors or for any fraudulent purpose.

Where business of a company has been or is being carried on for a fraudulent or unlawful purpose, every officer of the company who is in default shall be punishable for fraud

Furnishing of False Statement- If in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of this Act or rules thereunder, any person makes a statement,-- Which is false in any material particulars, knowing it to be

false; or Which omits any material fact, knowing it to be material,he shall be liable under clause 447.

Actions for which punishment for fraud is provided for in the Act

Penalty for fraud (Sec 447)

Any person who is found to be guilty of fraud, shall be punishable:•imprisonment not less than six months but which may extend to ten years •fine not less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud:Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.


Class Action Sec. 245 Class action is a collective action filed by the

plaintiff on behalf of a class of shareholders or users of goods or services or in relation to matters of public interest, seeking collective remedy.

Requisite number of members or depositors may file an application before NCLT, if they are of the opinion, that the management or conduct of the affairs of the company are being conducted in a manner prejudicial to the interest of the company or its members or depositors.


Class Action Sec. 245 The application for class action may claim

damages or compensation or demand any other suitable action from :-

i. the company or its directors;

ii. the auditor including audit firm of the co;

iii. any expert or advisor or consultant or any other person for any incorrect or misleading statement made to the company etc.

Disclosures & Transparency Additional disclosures in:- Prospectus u/s 26 & Annual Return u/s 92; Promoters’ Stake Changes u/s 93; Statement with AGM Notice u/s 102; Report on AGM u/s 121; Board’s Report and DRS u/s 134; Failure to spend requisite amount on CSR; RPTs u/s 188; Merger & Amalgamation u/s 232.

[email protected] 98 18348811 61

E-Governance for various company processes

Maintenance and inspection of documents in electronic form;

Option of keeping of books of accounts in electronic form;

Financial statements to be placed on company's website;

Holding of board meetings through video conferencing/other electronic mode;

Voting through electronic means [email protected] 9818348811 62

E-Governance

Online services would reduce the need for hard copy paper forms and have a positive impact on the environment.

It will substantially improve the standards of disclosure and transparency, involve more and more stakeholders in the company processes and provide real time information and service to the shareholders and other stakeholders.



Corporate Social Responsibility Sec. 135

Every company having net worth of 500 ₹crs or more or turnover of 1000 crs or more ₹or a net profit of 5 crs or more during any ₹FY shall constitute a Corporate Social Responsibility Committee(CSRC).

The CSRC shall recommend to the Board a CSR Policy and the amount to be incurred on the activities provided in the policy.



Board shall approve the CSR Policy and disclose it in the Board’s Report and on its website.

Board shall ensure that the activities included in the CSR Policy are undertaken by the company.

Board to ensure that company spends, in every FY at least 2% of average net profits of the company made during 3 immediately preceding FYs.

In case of failure to spend the amount, necessary reasons shall be disclosed in Director’s Report.

The company shall give preference to the local areas where it operates while spending the amount.

CSR Committees CSRC shall consist of at least of 3 directors

including at least 1 ID. An unlisted public company or private

company not required to appoint an ID shall constitute CSRC without an ID.

A private company having only 2 directors shall constitute CSRC with 2 such directors.

CSRC of a foreign company shall comprise of 1 person as specified u/s 380 + another person nominated by the foreign company.


Corporate Social Responsibility Sec. 135 Activities for CSR Policies-Schedule VII :- Eradicating hunger, poverty and malnutrition; Preventive health care, sanitation, safe

drinking water; Education, employment enhancing vocation

skills and livelihood enhancement projects; Gender equality, empowering women, homes

for women, orphans, old aged;[email protected] 9818348811 67


Environmental sustainability, quality of water, air & soil, ecological balance, animal welfare;

National heritage/art/culture, public libraries; Benefit of armed forces veterans, war widows Promote rural sports, Olympic sports etc.; Contribution to PM’s National Relief Fund; Contributions to CG approved technology

incubators & rural development [email protected] 9818348811 68

Companies (CSR Policy) Rules, 2014 Rules shall come into force wef 01.04.2014. CSR Policy includes activities specified in

Sch. VII but excludes activities undertaken in the normal course of business of a company.

“Net Profit” shall not include the following:-

i. profit arising from any overseas branch;

ii. dividend received from other companies in India, which are covered and complying with the provisions of Sec 135 of the Act.


Companies (CSR Policy) Rules, 2014 Board of a company may decide to undertake

its CSR activities through a:- Registered Trust; Registered Society; Company established by it u/s 8 of the Act; Company having an established track record

of 3 years in undertaking similar programmes Company may also collaborate with other

companies for CSR activities.


Companies (CSR Policy) Rules, 2014

CSR projects/programs/activities done in India only shall amount to CSR expenditure.

CSR projects/programs/activities that benefit only the employees/their families shall not be considered as CSR activities.

Contribution to any political party u/s 182 of the Act shall not be considered as CSR activity.


Companies (CSR Policy) Rules, 2014

CSR does not include activities undertaken in normal course of business of a company.

CSR Policy shall specify that the surplus arising out of CSR activities shall not form part of the business profit of a company.

Board Report shall include an AR on CSR. Company shall display its CSR Policy on its

website.


McKINSEY Survey on CG There has been a continuing debate among

those who hold divergent positions on CG practices whether there is any quantifiable connection between good CG and the market valuation of the company. McKinsey, carried out a survey of 188 companies from India, Malaysia, Mexico, South Korea, Taiwan and Turkey to determine the correlation between good CG and market valuation of company.


McKINSEY Survey on CG The results of the survey pointed out to a

positive correlation between the two and brought out that good CG increases market valuation of the company in following ways:-

Increases financial performance; Transparency of dealings, thereby reducing

the risk that boards will serve their own self interest;

Increasing investor confidence.


McKINSEY Survey on CG-Findings

Investors are willing to pay premium of as much as 28% for share of a well managed and well governed company.

Studies of 6 emerging markets show that investors world over look for high standards of good governance.


Other Advantages of Good CG Easy/ cost effective finance from Banks & FIs Better price for their products & services Attract and retain talent Global market access Confidence of governments & regulators Brand equity Reputation & Credibility Sustainability


THANK YOU

N K JainB.Sc, LLB.,DCL,FCS,FCPS

Corporate Advisor

Cell: 09818348811

Landline: 0120 - 4263965

E-mail: [email protected]

Documents

Companies Act, 2013 Bringing Paradigm Shift in Corporate Governance