Friday, August 22, 2014

A Radical Idea for Restructuring Corporate Boards

Last week’s Schumpeter column in the Economist carries a provocative idea that involves a complete relook at the way boards of companies are structured and operated. It borrows a proposal from an article titled “Boards-R-Us: Reconceptualizing Corporate Boards” authored by two leading US corporate law academics. The column summarizes the proposal as follows:

In the May edition of the Stanford Law Review Stephen Bainbridge of the University of California, Los Angeles, and Todd Henderson of the University of Chicago offer a proposal for fixing boards that goes beyond tinkering: replace individual directors with professional-services firms. Companies, they point out, would never buy legal services or management advice from people only willing to spare a few hours a month. Why do they put up with the same arrangement from board members? They argue for the creation of a new category of professional firms: BSPs or Board Service Providers. Companies would hire a company to provide it with “board services” in the same way that it hires law firms or management consultants. The BSP would not only supply the company with a full complement of board members. It would also furnish it with its collective expertise, from the ability to process huge quantities of information to specialist advice on things such as mergers.

Messrs Bainbridge and Henderson argue that this would require only a simple legal change but could revolutionise the stick-in-the-mud world of boards. It would replace today’s nod-and-a-wink arrangements with a market in which rival BSPs compete. It would create a new category of professional director. And it would allow BSPs to exploit economies of scale to recruit the best board members, introduce more rigorous training programmes and develop the best proprietary knowledge. Now, even the most diligent board member can only draw on his or her experience. BSPs would be able to draw on the expertise of hundreds. This would increase the chances that corporate incompetence will be corrected, corporate malfeasance found out and corporate self-dealing, in the form of inflated pay, countermanded.

While this proposal is an interesting one and merits further consideration, it also evokes a great deal of skepticism. A few concerns are discussed here. First, merely because there are problems with current board structures that place an overemphasis on board independence, it may not necessarily justify a complete overhaul. Perhaps it may be preferable to address the problems with the current structure through refinements that may involve less cost and may be more efficient. For example, the focus may be on revamping institution of independent directors and the support systems available to independent directors to carry on their role more effectively.

Second, the BSP concept would encounter the same agency problems as other third party intermediaries that operate as “gatekeepers”. In that sense, the incentives of BSPs are likely to operate in a manner that is similar to those of auditors, credit rating agencies and the like. If instances of corporate governance failures have provided the impetus for a total overhaul of board structures, history is replete with instances where such intermediaries, despite their strong reputation incentives, have themselves partaken in responsibility for such failures. Corporate governance scandals involving board failures are usually also accompanied by deficient conduct on the part of the auditors. Hence, by creating an institution such as the BSPs, it is likely that the problem with individual directors may be relocated to corporate intermediaries who may suffer from distorted incentives that may cause a different set of governance problems.

Third, the concept of having corporate directors is not novel. For instance, in some jurisdictions, it has been possible for one company to be a director of another company. Closer home, historically the concept of “managing agency” was prevalent in India for nearly 150 years even before every company was required under law to have a board of directors. Managing agents were appointed by companies under a contract to manage and control companies. Each managing agent could undertake such a function across a portfolio of companies. However, the concept of managing agency ran into significant governance issues and problems, and was ultimately abolished in India as long ago as 1970. Readers interested in the historical role of managing agencies in Indian corporate governance may refer to (i) “Chapter 2: Evolution of Corporate Governance in India” in Subhash Chandra Das, Corporate Governance in India: An Evaluation, and (ii) Kamal Ghosh Ray, “The forgotten managing agency system: a nineteenth century model of Indian corporate governance”, Social Responsibility Journal, Vol. 5 Iss 1 pp. 112 – 122 (subscription required) (where the author is somewhat sanguine about the ability of the managing agency concept to address modern-day corporate governance problems).

Finally, the answer to the shortcomings of corporate boards may lie somewhere in-between. While professionalization of corporate boards is desirable, a total outsourcing to an outsider service provider may not be. One option, which has been considered before would be the appointment of professional independent directors (as I have argued elsewhere).

Despite the doubts raised regarding the viability of the BSP model, the discourse and scholarship towards a total overhaul of the current board governance mechanisms cannot be ignored. A deliberation of such ideas, as radical as they are, could help shape the direction in which board and governance structures are likely to shift.


Guest Post - Proposed Amendments to Arbitration Law: Part 1

[The following post is contributed by Prachi Narayan and Aditi Pal of Vinod Kothari & Company. They can be contacted respectively at prachi@vinodkothari.com and ringee@vinodkothari.com]

Introduction

On August 5, 2014, the Law Commission submitted to the Law Minister its 246th report on “Amendment to the Arbitration and Conciliation Act, 1996.

There has been much back and forth with respect to the proposed amendments to be carried out in the existing Arbitration and Conciliation Act, 1996 (“Act”). The Government had earlier accepted the recommendations made by the Law Commission in its 176th Report on the same subject and had introduced the ‘Arbitration and Conciliation (Amendment) Bill, 2003’(‘Bill”) in the Rajya Sabha in December 2003.

Subsequently the Ministry of Law and Justice constituted the Justice Saraf Committee on Arbitration to study in depth the implications of the recommendations of the Law Commission of India contained in its 176th report. In the wake of the Saraf Committee recommendations, it was suggested that the Bill in its present form should be withdrawn and reintroduced since the provisions of the Bill were insufficient and contentious. The Bill was consequently withdrawn from Rajya Sabha and the Ministry of Law and Justice issued a consultation paper in April, 2010 inviting suggestions from eminent lawyers, judges, industry members, institutions and various other stakeholders.

On the basis of various comments and suggestions received, the Ministry prepared a “Draft Note from Cabinet ” and the Law Commission was asked to review the said draft notes. Following an extensive study of the draft note, the Law Commission submitted its latest 246th report.

Part III of the report contains the proposed amendments to the Act. This post is an attempt to enlist the proposed amendments in comparison to the existing provisions of the Act for easy perusal and reference. The brief highlights have been provided for understanding the intent behind the amendments.

Brief Highlights of the Proposed Amendments

Institutionalization of Arbitration Proceedings: Arbitration may be conducted ad hoc or under institutional procedures and rules. Institutional arbitration as the name suggests refers to arbitrations conducted in accordance with the rules and procedure of an arbitration institution, this being opposed to ad-hoc arbitration that includes arbitration where the parties may choose on their own to devise and agree upon a tailored arbitral process or alternatively to incorporate existing rules of procedure. The institutions provide arbitration services as well as other general business functions and in some cases assist in the administration of the arbitration through its infrastructure. Some examples of institutional arbitration are the ICC based in Paris; the London Court of International Arbitration, the Dubai International Arbitration Centre (DIAC) created in 1994; and the Bahrain Chamber for Dispute Resolution (BCDR) created on 10 January 2010. In India, however the concept of institutional arbitration is limited to the Delhi High Court International Arbitration Centre; The Punjab & Haryana High Court Arbitration Centre; Indian Council of Arbitration (ICA); Nani Palkhivala Arbitration Centre in Chennai. With a view to promote the culture of institutional arbitration, the commission has recommended the following:

- Amendment of section 11 of the Act so as to encourage parties to refer disputes to arbitration.

- Introduction of the concept of emergency arbitrator by broadening the definition of arbitral tribunal.

- Formation of new arbitration centres for trade bodies and commerce chambers with their own rules, which can be modeled on the rules of the more established centers

Fees for Arbitrators: One of the major constraints for effective ad-hoc arbitration in India is high cost associated with arbitrary, unilateral and disproportionate fixation of fees by several arbitrators. The Commission suggested that rationalization of fees for arbitrators would prove beneficial in achieving a cost effective solution for dispute resolution. The Commission has thus suggested a model schedule of fees empowering the High Court to frame appropriate rules for fixation of fees for arbitrators.

Conduct of Arbitral Proceedings: Chapter V of the Act deals with provisions relating to conduct of arbitral proceedings. However, despite existing provisions in the Act, arbitration in India has been largely inadequate and disappointing for all stakeholders. The proceedings primarily have become replica of court proceedings, rooted with unnecessary and frequent adjournments. There have been numerous rulings by the High Courts and the Supreme Court wherein the arbitrators have been nudged to hear and decide matters expeditiously, and within a reasonable period of time. Similarly, counsel for parties must refrain from seeking repeated adjournments or insisting upon frivolous hearings or leading long-winded and irrelevant evidence. The Commission thus recommended the following:

- Addition of the second proviso to section 24 (1) to the Act, discouraging the practice of frequent and baseless adjournments, and to ensure continuous sittings of the arbitral tribunal for the purposes of recording evidence and for arguments.

- Addition to the preamble of the Act, which does not directly affect the substantive rights and liabilities of parties, but however does serve as guidance for arbitral tribunals and courts to interpret and work the provisions of the Act.

Judiciary and Arbitration: The judicial machinery was intended to provide essential support to arbitration process. However, time and again the arbitration proceedings have been frustrated in the ambush of judicial machinery. There is strikingly an imbalance between the judicial machinery and arbitration proceedings. In the words of Lord Mustill[1]It is equally important that the balance is maintained by a recognition by the courts that just as arbitration exists only to serve the interests of the community, so also their own powers are conferred only to support, not supplant, the extra-judicial process which the parties have chosen to adopt”. The Commission has strived to adopt a middle path to find an appropriate balance between judicial intervention and judicial restraint. In order to combat delays due to intervention of judicial machinery the Commission has suggested the following:

- The existing scheme of the power of appointment being vested in the “Chief Justice” to be changed that to the “High Court” and the “Supreme Court” and has expressly clarified that delegation of the power of “appointment” shall not be regarded as a judicial act.

- Amendment to section 11 (7) of the Act, so that decisions of the High Court (regarding existence/nullity of the arbitration agreement) are final and non-appealable where an arbitrator has been appointed.

- Addition of section 11 (13) to the Act, so that the Court endeavors to dispose of the matter within sixty days from the service of notice on the opposite party.

- Addition of sections 34 (5) and 48 (4) to the Act, that would help an application under such sections be disposed off expeditiously and in any event within a period of one year from the date of service of notice.

- A time limit under section 48 (3) of the Act has been introduced, which is aimed at ensuring that parties take their remedies under this section seriously and approach a judicial forum expeditiously and not by way of an afterthought.

Scope and nature of pre-arbitral judicial intervention: The Act recognizes situations where the intervention of the Court is envisaged at the pre-arbitral stage, i.e. prior to the constitution of the arbitral tribunal, which includes sections 8, 9, 11 in the case of Part I arbitrations and section 45 in the case of Part II arbitrations. Such sections directly affect reference to arbitration and thereafter constitution of arbitral tribunals. There have also been many deliberations over scope and nature of permissible pre-arbitral judicial intervention and whether such power constitutes a “judicial” or “administrative” power. The Commission has suggested amendments to sections 8 and 11 of the Act. With respect to the scope of the judicial intervention, it has suggested that the same be restricted to situations where the Court/Judicial Authority finds that the arbitration agreement does not exist or is null and void. In so far as the nature of intervention is concerned, it is recommended that in the event the Court/Judicial Authority is prima facie satisfied against the argument challenging the arbitration agreement, it shall appoint the arbitrator and/or refer the parties to arbitration, as the case may be.

Setting aside of domestic awards and recognition/enforcement of foreign awards: Section 34 of the Act deals with setting aside a domestic award and a domestic award resulting from an international commercial arbitration whereas section 48 deals with conditions for enforcement of foreign awards. Currently, the Act treats all three types of awards in a similar way i.e. judicial intervention where awards even have been made by a foreign judicial body. In order to legitimate the judicial intervention with respect to domestic awards resulting from an international commercial arbitration and enforcement of foreign awards, the Commission has proposed amendments that would deal with purely domestic awards, including setting aside by the Court if the Court finds that such award is vitiated by “patent illegality appearing on the face of the award”, subject to that “an award shall not be set aside merely on the ground of an erroneous application of the law or by re-appreciating evidence.” Further, time and again courts have set aside awards on grounds of “public policy”. The Commission has suggested restriction of the scope of “public policy” and that an award be set aside on such grounds only if it is opposed to the “fundamental policy of Indian law” or is in conflict with “most basic notions of morality or justice”.

Judicial Intervention in foreign- seated arbitrations: Part I of the Act, states that “This Part shall apply where the place of arbitration is in India”. The Supreme Court in this regard has held that Part I mandatorily applied to all arbitrations held in India, however, Part I also applied to arbitrations conducted outside India unless it was expressly or impliedly excluded. Further, there have been many deliberations with regard to seat and venue of arbitration. The Commission has therefore, has suggested amendments to sections 2(2), 2(2A), 20, 28 and 31 of the Act.

Automatic stay of enforcement of the award upon admission of challenge: The scheme of Act is such that the pendency of a section 34 application renders an arbitral award unenforceable. This virtually paralyzes the process for the winning party/award creditor and frustrates the very objective of alternate dispute mechanism. The Supreme Court with regard to such an anomaly has opined “the moment an application challenging the said award is filed under section 34 of the Act leaving no discretion in the court to put the parties on terms, in our opinion, defeats the very objective of the alternate dispute resolution system to which arbitration belong”. Therefore, in order to rectify this mischief, the Commission has suggested certain amendments to section 36 of the Act that would provide that the award would not become unenforceable merely upon the making of an application under section 34.

[to be continued]

- Prachi Narayan and Aditi Pal




[1]Law Commission Report on Amendments to Arbitration and Conciliation Act.

Wednesday, August 20, 2014

"Make in India" frustrated by regulations "Made in India"

The Delisting Regulations applicable in India have been controversial since inception.  Earlier this year, SEBI published a discussion paper seeking to review them.  This Blog commented on the discussion paper here.

Earlier this week, in my column in Business Standard, I wrote about how tinkering with the Delisting Regulations will not be of help. The Delisting Regulations is a body of law unique to India, and in its interplay with the Takeover Regulations and the law on minimum public shareholding, it adjusts the adjective from "unique" to "peculiar".  The column can be accessed here.


OECD Report on Related Party Transactions in India

The topic of related party transactions (RPTs) has acquired tremendous importance lately and has been the subject matter of intense discussion and debate both on this Blog (here) and elsewhere (here, here and here). The discussions focus on the specifics and the interpretation of the Companies Act and the Rules promulgated by the Ministry of Corporate Affairs (MCA) that deal with RPTs.

In the meanwhile, the OECD has issued a report entitled Improving Corporate Governance in India: Related Party Transactions and Minority Shareholders Protection (h/t: Corporate Law and Governance). The OECD report studies the current state of the law in India regulating RPTs, and makes some suggestions for reform. While the report takes into account the enactment of the Companies Act, 2013 and the reforms introduced thereunder, it does not deal with the nitty-gritties of the issues relating to rule-making and practical implications on companies as contained in the earlier mentioned literature. Nevertheless, it provides a macro-level perspective on the more significant reforms required to rein in RPTs given their prominence in the Indian context due to the presence of corporate groups and concentrated shareholdings.

The macro-level policy matters highlighted in the OECD report may help guide the resolution of some of the more specific issues that have arises in the Companies Act and the MCA Rules on RPTs.


Tuesday, August 19, 2014

Guest Post - Delhi Airport Metro Case: Twilight Zone of the “pro-arbitration” trend

[The following post is contributed by Sujoy Chatterjee who is an Advocate in New Delhi and an alumnus of the National Law University Jodhpur (’13)]

In recent times, there has been a propensity towards characterizing judgments of the Indian judiciary either as “pro-arbitration” or “against the pro-arbitration trend” (for example, see here, here and here). The rationale behind this tendency of binary characterization seems to be that a judgment which, inter alia, upholds the validity of an arbitration agreement, allows arbitration proceedings to commence or continue, etc, is a step in the right direction. However, as pointed out on this Blog (see here), a facially “pro-arbitration” judgment may yet create or propagate principled confusion, giving rise to further litigation in future. This author believes that rather than focusing solely on the outcome of a judgment, it is the contribution the judgment makes towards our arbitration jurisprudence which ought to determine whether the judgment is truly pro-arbitration.

It is in this background that the Delhi High Court’s judgment in Delhi Airport Metro Express Limited v. CAF India & Anr., pronounced on 14 August 2014 is significant. The judgment, which in its outcome allowed an Indian party to proceed with arbitration proceedings in London against another Indian party, ironically arrives at this conclusion by keeping its analysis of arbitration jurisprudence to a minimum. Therefore, while its ultimate ruling is undoubtedly “pro-arbitration”, Delhi Airport Metro’s rationale for this ruling is grounded in contractual provisions and principles of contract law as opposed to the nitty-gritties of arbitration law.

By way of background, Delhi Airport Metro Express Limited had entered into a Maintenance Services Agreement on 30 June 2008 with Construcciones Y Auxiliar De Ferrocarriles, SA (CAF), a company incorporated in Spain. The Maintenance Services Agreement contained an arbitration agreement, which inter alia provided:

(i)         the seat of the arbitration as London, i.e., a place outside India; and

(ii)      the express exclusion of Part I of the Arbitration and Conciliation Act, 1996 (the Act).

(The double layer of protection, i.e., a foreign seat as well as the express exclusion of Part I of the Act, was presumably included in the arbitration agreement to avoid any confusion regarding jurisdiction of Indian Courts, since the Maintenance Services Agreement was executed at a time when Bhatia International v. Bulk Trading held the field in India.)

On 17 May 2010, CAF executed an Assignment Agreement in favour of CAF India, a wholly owned subsidiary of CAF and an entity incorporated in India, whereby the rights and obligations of CAF under the Maintenance Services Agreement were transferred to CAF India. Thereafter, certain contractual disputes arose between Delhi Airport Metro Express Limited and CAF India with regard to the Maintenance Services Agreement, and on 21 January 2014 CAF India submitted its request for arbitration jointly with CAF as per the arbitration agreement contained in the Maintenance Services Agreement. Delhi Airport Metro Express Limited approached the Delhi High Court challenging the validity and enforceability of the arbitration agreement, thereby questioning the legality of the arbitration proceedings and requesting for a restraint on CAF India from pursuing arbitration proceedings in London.

Delhi Airport Metro Express Limited argued, inter alia, that both it and CAF India were Indian companies and therefore it would go against the public policy of India if the arbitration agreement was given effect to. The rationale behind this argument was that two Indian parties could not, either by choosing a foreign seat or by expressly providing so in their agreement, exclude the applicability of Part I of the Act or attempt to avoid the applicability of the laws of India.

Per contra, CAF India contended, among other things, that Section 5 of the Act mandated minimal judicial intervention and that this principle applied equally to international commercial arbitration as well as domestic arbitration. CAF India also argued that Delhi Airport Metro Express Limited’s suit was barred by Section 14(2) of the Specific Relief Act, 1963 and that the High Court did not have jurisdiction to entertain an anti-arbitration suit.

Manmohan Singh, J. begins his analysis of Delhi Airport Metro by crystallizing the issue as follows:

the question which falls for consideration is as to whether pursuant to the Assignment Agreement dated 17th May, 2010, the rights and obligations of the Defendant No. 2 which is a Spanish Company are completely discharged under the Maintenance Agreement and other agreements between the parties so as to say that it has no role to play in the rights and obligations of the parties under agreement and had exit completely from the agreement. If the answer to the said question is in affirmative, then only the case of the plaintiff and grounds stated therein merits further consideration and on the other hand if the answer is in negative, then the case of the plaintiff is not even required to be further considered as the entire premise of the suit may fail.

(emphasis added by this author)

Framing the issue thus, Manmohan Singh, J. pre-empted an arbitration-centric discussion and proceeded on an astute analysis of the terms of the Assignment Agreement and the Maintenance Services Agreement, as well as Section 62 and Section 43 of the Indian Contract Act, 1872.[1] This analysis culminates with the Court’s conclusion that the obligations of CAF had not been completely discharged under the Maintenance Services Agreement and that CAF continued to have obligations under the Maintenance Services Agreement. On this basis the Court concluded that CAF remained a party to the Maintenance Services Agreement, and therefore the Assignment Agreement did not have the effect of transforming the nature of the arbitration agreement in the Maintenance Services Agreement from an international commercial arbitration to a domestic arbitration.

The only aspects of arbitration law which were briefly touched upon in Delhi Airport Metro were (i) the doctrine of separability, and (ii) the applicability of Section 5 of the Act to the present case. The Court, albeit en passant, opines how an arbitration clause may survive the novation of the main agreement and how section 5 may operate as a hurdle to the maintainability of the suit in the present case. However, even this brief discourse is subjected to a broad rider, i.e., the Court’s finding on these points is independent of the fact that there was no novation to the Maintenance Services Agreement in the present case and that the issue of maintainability did not require adjudication at this stage.

In conclusion, the Court held that since one of the parties to the arbitral proceedings (i.e., CAF) was a party incorporated under the laws of Spain, therefore the proceedings fell within the realm of Section 2(1)(f) of the Act as an international commercial arbitration. The Court ruled that the arbitration agreement as well the arbitral proceedings did not fall foul of Indian public policy by choosing London as the seat of arbitration and by excluding the applicability of Part I of the Act.

Delhi Airport Metro has very subtly highlighted the importance of (i) identifying and addressing the core issues in a dispute, rather than delving into the technicalities of arbitration law merely because the dispute is arbitration-centric; and (ii) reading in-between the lines of a judgment rather than fixating only over the outcome.

As an aside, a question which comes to this author’s mind after reading Delhi Airport Metro is that keeping all the other facts and circumstances of the case constant, if CAF India had initiated arbitration proceedings against Delhi Airport Metro Express Limited by itself and not along with CAF, would the arbitration proceedings still have been valid? A simpliciter “pro-arbitration” finding would probably be inclined towards answering in the affirmative, but a substantive analysis may yield otherwise (see here).

- Sujoy Chatterjee




[1] An analysis of the rationale for Delhi Airport Metro is beyond the scope of this post.

Monday, August 18, 2014

Guest Post - MCA amends RPT rules: Makes provisions stricter

[The following post is contributed by Vinod Kothari and Shampita Das of Vinod Kothari & Company. They can be contacted respectively at vinod@vinodkothari.com and shampita@vinodkothari.com]

The latest setback from the MCA has come by way of the amendments to the Companies (Meetings of Board and its Powers) Rules, 2014 (MBP Rules) vide its notification dated 14th August, 2014, which is yet to be gazette.[1] The key highlight of the amendment was the complete substitution of the Rule 15(3) of the MBP Rules relating to conditions for obtaining approval from members for entering into related party transactions (RPTs).

Lets’ start over!

Section 188 of the Companies Act, 2013 (Act) provides that approval of the Board would be required for entering into certain related party transactions. The first proviso to Section 188 provides that no contract or arrangement shall be entered into by a company having paid-up share capital of not less than such amount, or transactions not exceeding such sums, as may be prescribed, except with the prior approval of the company by a special resolution.

To this effect, Rule 15 (3) of the MPB Rules (prior to the amendment) had laid down dual conditions for passing of special resolution for entering into RPTs. The conditions were:

(a)        Companies having paid up capital of Rs. 10 crores or more; or

(b)       Transaction value exceeds certain prescribed limits.

This meant that fulfillment of either of the conditions (i.e. paid up capital or transaction limits) would have necessitated the approval of the RPT by way of a special resolution. Thus even if my transaction value is Re. 1, if my paid up capital exceeded Rs. 10 crores, I would have had to approach my members for passing the related party contract.

The Amendment

The amendment seeks to substitute this sub-rule (3) to Rule 15 by completely removing the paid up capital criteria of Rs. 10 crore.

Further, the transaction limits of the various related party contracts as listed under Section 188 (1) of the Act has also been reduced. The table below shows the limits of the RPTs before and after the amendment:

­
Before
After
Sale, purchase or supply of any goods or materials, directly or through appointment of agents, as mentioned in Clause (a) and Clause (e), respectively of Section 188 (1)

Exceeding 25% of the annual turnover
Exceeding 10% of the turnover of the company or Rs. 100 crores, whichever is lower.
Selling or otherwise disposing of, or buying, property of any kind directly or through appointment of agents as mentioned in Clause (b) and Clause (e), respectively of Section 188 (1)

Exceeding 10% of the net worth of the company
Exceeding 10% of the net worth of the company or Rs. 100 crores, whichever is lower
Leasing of property of any kind as mentioned in clause (c) of Section 188 (1)
Exceeding 10% of the net worth or 10% of turnover of the company
Exceeding 10% of the net worth or 10% of turnover or Rs. 100 crores, whichever is lower.

Availing or rendering of any services directly or through appointment of agents as mentioned in Clause (d) and Clause (e) of Section 188 (1)

Exceeding 10% of the net worth of the company
Exceeding 10% of the turnover of the company or Rs. 50 crores, whichever is lower.

Further, an Explanation has been added after the above sub clauses as follows:
‘It is hereby clarified that the limits specified in sub-clauses (i) to (iv) shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.’

Appointment to any office or place of profit in the company, its subsidiary company or associate company as mentioned in clause (f) of Section 188 (1)

At monthly remuneration exceeding Rs. 2.5 Lakh.
At monthly remuneration exceeding Rs. 2.5 Lakh.
-       No Change
Remuneration for underwriting the subscription of any securities or derivatives thereof of the company as mentioned in clause (g) of Section 188 (1)
Exceeding 1% of the net worth of the company
Exceeding 1% of the net worth of the company.
-       No Change
















































Understanding its Impact

The amendment has changed the entire essence of the earlier Rule. Now, any company – big or small, public or private, irrespective of its paid up capital will be required to pass a special resolution in case the transactions being entered into with related parties come within the amended limits of Rule 15(3) of the MBP Rules.

Also, most of the contract limits have been reduced to bring more RPTs within the scanner of the members and the government. This includes putting an upper cap for transactions worth Rs. 100 crores or Rs. 50 crores to necessarily require special resolution, notwithstanding its percentage value to the networth or turnover of the company.

Further, the Explanation that has been added to the amended Rule provides that the contract limits shall apply to both individual transactions, and transactions taken together in a financial year with a related party. The question here arises is whether the same needs to be assessed for ‘all contracts with one related party’ or ‘all contracts with each related party’.

That is, suppose a company has A, B and C as related parties and it enters into sale of goods agreement with each of them. The aggregate value of the contract with A comes to Rs. 70 crore, with B to Rs. 102 crores and with C to Rs. 25 crores, in a financial year. The aggregate value of such contracts with each related party comes to Rs. 197 crores. However the threshold (i.e. Rs. 100 crores) of all contracts with one related party is breached only for B.

Here, the special resolution will be required for entering into transactions with only B, i.e. all contracts with one related party needs to be seen. This is because the Section 188 (1) uses the phrase ‘….no company shall enter into any contract or arrangement with a related party with respect to -’. Hence the merit of transactions with individual related parties needs to be seen and not the aggregate of the all such transactions.

Further, the MCA has clarified in its Circular No. 30/2014 dated 17 July 2014[2] that only the related party to such contract or arrangement will refrain from voting on the special resolution.

A Critical Take on the Amendment

With the amendment in Rules, Section 188 has become completely futile. There was absolutely no case for dropping the "large company" criteria - in fact, there was a very strong case to make the "large company" and "large contract" criteria cumulative, rather than alternative. However, the section as it now stands is counterproductive - as it will be tougher for small companies to comply with, than for large companies.

We are surprised as to how the amendment is a case of dilution of the provisions of law. The change in the Rules has exactly gone opposite to the essential philosophy of control over RPTs. It has made section 188 lighter for larger companies and harder for small companies. If you see the discussions before the Parliamentary Committee, MCA has represented there that section 188 is meant for larger companies. Now, as the situation prevails, small contracts by large companies do not need sanction; however for small companies, smaller contracts need sanction (as the limit reduced from 25% to 10%). Dichotomy between listing norms and the Act continues - as SEBI's rules still continue to define "material RPTs" differently. The implication of Section 188 as it now stands defies all logic - smaller companies, for whom every small contract will be relatively large, as they themselves have small aggregate turnover and networth, will have to run to get general meeting resolutions every now and then. Proposed exemption notification for private companies was also diluted before going to Parliament to deny complete exemption to private companies. Hence, private companies will also need to run to their general bodies to approve contracts with related parties. Worst hit will be smaller public companies, which do not have any exemption from the Rule that requires a related party to refrain from voting.

Also, as the change of Rules happened mid way during the financial year, what about those contracts which have already been signed/approved during the financial year, before the Gazette notification?

How could larger companies and smaller companies, particularly those with no public stakes at all, be painted with the same brush? Is there clarity as to the direction in which the Companies Act is moving?

This is the biggest concern that had been mentioned in Mr. Vinod Kothari’s article titled "Ten monsters of the Companies Act, 2013[3]". He had mentioned that as lawmaking moves from the domain of the Parliament to the domain of the MCA, the executive arm of the government starts doing what the Parliament of the country is supposed to do. How could such massive changes take place, completely without any deliberation or public discussion? Had it been the time-tested, globally followed Parliamentary process, this change would have required a Bill, debate in Parliament, and so on. Now, since rule making is absolutely in the clutches of the MCA, all that it needed was one simple notification, and there is such a substantive swing in substantive rights and liberties of businesses.

- Vinod Kothari & Shampita Das