Thursday, February 27, 2014

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

This follows Parts 1 and 2]

7.         Casual approach to special majority rule

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 manifold

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 counsel.

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

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