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Dec 20, 2012 at 05:46pm IST

Companies Bill: Corporate Social Responsibility is almost mandatory

The Companies Bill has been approved by the Lok Sabha. The Bill covers everything and replaces the earlier Companies Act of 1956. In an interview to CNBC-TV18, Hitesh Jain, partner at ALMT Legal speaks about the Companies Bill and gives his outlook going forward.

Below is the edited transcript of his interview with CNBC-TV18's Latha Venkatesh and Ekta Batra.

Question: What are the implications on the P&L and the balance sheets of companies? The corporate-social responsibility (CSR) expenditure now is nearly being mandated at 2 per cent. I understand the wording is not mandatory, but companies may spend. Yet a board member will have to be in a committee, which will monitor this expense and give credible explanations, if that 2 per cent is not met. Will this, therefore, begin to impact the P&L in some fashion?

Companies Bill: Corporate Social Responsibility mandatory

The Companies Bill has been approved by the Lok Sabha. The Bill covers everything and replaces the earlier Companies Act of 1956.

Answer: There are two very important provisions in the clause. The first clause is that the board is mandated to ensure that the company will spend on the CSR. Second thing is that they have to give their explanation. So, effectively although there is no mandatory obligation on the company, but a responsibility is cast upon the board members.

Added with the responsibility, to give the explanation for non-implementation or implementation makes it mandatory. When you are not able to give a satisfactory explanation about not spending on CSR activities then the regulator will certainly have a power to question the roles and responsibility of the directors. So, effectively it gives a teeth, it is not just a provision on the paper, but it puts an obligation on the board, which they cannot easily get away. So, one thing is very clear that the new bill has looked into this provision extremely carefully. Although not mandatory, but a binding obligation is on the board to make sure that the company will spend on the CSR.

Question: After the Companies Bill being passed, what are the most common queries that you are facing from clients at this point in time? What are they most worried about in terms of adherence going forward?

Answer: The first query, which we are facing from the client, is about the CSR. The second is about the Memorandum of Association. They are also worried about the roles and responsibility of the independent directors. The fourth concern, which they are discussing, is the provisions pertaining to investor protection mechanism.

There is one very important provision. If you are obtaining the credit facilities and loan from the bank, if incorrect information is provided, it puts a heavy onus on the board. The queries are also directed towards the roles and responsibility of the independent directors. What is the responsibility, whether they are going to be liable, to what extent they will be responsible? The independent directors attend for the sake of attending and there is no positive contribution. For example, when you look into the various examples, you deal with the frauds in the corporate governance or the problems arising in the corporate governance and the independent directors playing just a role on the paper.

Question: If you can make it a little more specific for us, only touching on independent directors. I understand that clause 184 of the Bill requires way more disclosures compared to clause 299 of the Act, the one that is going out. What those disclosures are? How much more onerous they are? Are there are any stiffer penalties? How does the life of independent director become tougher?

Answer: Earlier, it was just pertaining to conflict of interest where they were just required to disclose only in the limited area. But now it has to be voluntarily. When they are facing a particular situation or resolution is placed before the board, the obligation is now on the independent directors to voluntarily provide every possible information, which can come into way of conflict with the board or where he is an interested party. So, the first obligation upon the independent director is about providing the information.

The second is about that if it is found that it has not given the proper disclosure and suppose if there is an action by the shareholders then there is also the penalty and provisions of special court. So, all in all, basically the disclosures are required from independent directors or the directors. The conflict of interest is concerned, that has been widened. The voluntary obligation, which has been cast, is very important because they do not wait, but they have to give upfront all the information.

Question: We were talking about the rotation of auditors. It is now expected to be five years vis-à-vis one year and then mandatory going forward. What sort of repercussions could we see on this and how controversial a change is it?

Answer: In the current scenario, the auditor was appointed every year. Now, once you have a five-year term, it gives a great flexibility to the company and the auditors. So, one can look at a proper result. It was just on paper every year. It was just a formal change that was being made. The first thing is that it ensures stability. One can look at the records and one can question the auditor and the company during this five-year tenure, coupled with the fact that after five year there is going to be a compulsory rotation.

When the new auditor comes in, it also looks at effectively what has been done in the books by the previous auditor. There has been accountability as well as stability. These are the two measures that are addressed in the current scenario by the latest bill.

Question: The much attention given clause is the class action suit. Is that the only investor protection measure or are there others? How strong does this make the investor?

Answer: Class action lawsuit is one measure. But there are two or three important measures, both for majority and minority. For example, when you speak about the minority shareholders, the provision of entrenchment in the Articles of Associations, which means that means that, on a certain items, if the board wants to pass a resolution, it will need close to 100 per cent vote. That means effectively all the shareholders will be required to participate and effectively give a mandate or stamp on the approval taken by the company. That, according to my mind, is a very important provision that has been introduced.

Similarly, when you look at majority shareholders also, as regards the provision of squeezing out, that means if there is a shareholder who has a 90 per cent interest in the company, shares holding in the company, he can purchase the other remaining shareholders. For example, there are shareholders who are like 4-5 per cent, but acting as an obstacle or creating a problem. Effectively, there are provisions for the benefit of the minority shareholders also. There is a very important handle that is given to the majority shareholders in terms of squeezing out remedy.

Question: Basically, a couple of clients want to know the applicability of the Companies Bill. From when do they have to be 100 per cent compliant? When exactly can we see it come into play? Do we see a change in the MoA coming through for all companies in order to comply to the Companies Bill?

Answer: We will have to see the passage of the Bill. When will the Bill receive assent from the President. And then the effective date or the appointed date will be fixed in the bill.

The second thing, as far as any decisions taken under the previous act, they shall continue to remain under the Repeal Act. They shall be continued to be governed under the Repeal Act. The provisions of the new bill will be applicable to the companies that will be incorporated in the future and the decisions that will be taken by the company in the future. Old companies, which will be taking the new decision, once the act comes into force or once the effective date is appointed by the government, from that day, they will have to follow and pass the resolutions, decisions as per the new bill.

As far as the memorandum and articles are concerned, companies, earlier incorporated, will not be required to actually amend the memorandum. So, it will be applicable for the new companies that will be incorporated.

Question: I just want to get a final clarification on this entrenchment clause that you say whereby a minority shareholder can force to require a 100 per cent vote or approval on some measure. The obvious case that comes to the mind is this, hedge fund, The Children's Investment Fund (TCI), which has a 2 per cent stake in Coal India, has been forcing the majority shareholder, the government to change price of coal. Can they force every time a 100 per cent vote to be required for the coal prices to be set? Can TCI get a voice even with 2 per cent?

Answer: No. In this case, TCI won't be able to get a voice because there is no provision of entrenchment in the articles. But, going ahead, the shareholders can bargain and they can make the provision for entrenchment. An option is given to the shareholders. So, basically shareholders agreement and articles in future will have a lot of importance. On the negotiation table, the minority shareholders will have a lot of important role. If they are going to make a significant investment, they can make this as a condition going ahead.