Sunday, July 12, 2015

Exemptions to Government Companies: A Corporate Governance Perspective

[The following post is contributed by Shriya Jain, Fourth year student & Param Pandya, Fifth year student of Gujarat National Law University, Gandhinagar, Gujarat. The authors can be contacted at & respectively].

A government company is defined under section 2(45) of the Companies Act, 2013 ('2013 Act') as a company in which not less than 51% of the paid-up capital is held by the Central Government or a State Government or partly by both or one or more state governments.

Government Companies can be divided into primarily two categories - Central Public Sector Enterprises ('CPSEs') which are completely owned and managed by the Central Government and State Level Public Enterprises ('SLPEs') which are completely owned and managed by the State Government. These may be listed or unlisted. In case of CPSEs, for both listed and unlisted, the Corporate Governance Guidelines issued by the Department of Public Enterprises in 2010 are applicable. Listed CPSEs have a higher requirement of compliance in the form of Clause 49, SEBI Listing Agreement. It is vital to note that compliance by government companies, including those that are listed, with corporate governance norms is far from satisfactory. Apart from failure to comply, board autonomy is seriously compromised. Political interference and lack of vision and planning on the side of the government are the biggest hindrances to their growth.[1]

In case of SLPEs, there are no guidelines and compliance with corporate governance norms is much more uneven. Since 2013 Act is applicable to these unlisted SLPEs, at least on a few indicators of corporate governance it could have been effective. Baring a few exemptions like number of directors, related party transactions which apply to all, various exemptions are effectively applicable to unlisted CPSE and SLPE. These would certainly make corporate governance inferior.

By virtue of the powers conferred by section 462 of the 2013 Act on the Central Government, a notification was issued on June 5, 2015 exempting government companies from various provisions of the 2013 Act. A detailed analysis has been already posted earlier. This post attempts to examine a few of the key exemptions from a corporate governance perspective.

Disclosures:  Section 134 provides for the contents of the Financial Report, Directors Report etc. Section 134(3)(e) pertains to a statement on the Board's policy as regards to the positive attributes of directors, independence of directors and remuneration of directors and key managerial personnel. Government companies have done away with the requirement of a remuneration and nomination committee under the 2013 Act, but disclosures on such vital topics, such as this, which are indicators of corporate governance should not have been exempted.

Self-assessment by the Board: Section 134(3)(p) provides for self-assessment of directors by the board. However, this evaluation is left to the Central Government or State Government in case of CPSEs and SLPEs, as the case maybe. When all companies require their board to assess themselves, allowing a controlling shareholder to evaluate the board not only appears somewhat strange but could be less protective of the interests of the minority shareholders. This is because the Government’s evaluation could be susceptible to a reflection of its own vested interest, which may not necessarily be consistent with the interests of the company as a whole or the other shareholders.

Limit on number of directors: Section 149(b) and the first proviso mandates a cap of 15 directors. An exemption in this case means more than 15 directors can be appointed in a government company which would create board governance problems. More importantly, various ministries appoint directors and they can have conflicting interests leading to more setbacks in an already slow system. 

Threshold of managerial remuneration:  A government company is not required to comply with limits for overall maximum managerial remuneration and managerial remuneration in case of absence or inadequacy of profits laid down in section 197. A key managerial person should always have his or her incentives proportional to their deliverables. Providing security of incentives even for senior positions would enhance inefficiency in an already inefficient mechanism.

Absence of pecuniary interest: Section 149(6)(c) provides for the absence of pecuniary interest in any holding, subsidiary or associate company or its promoters or directors for two preceding/current financial year as a requisite for being appointed as an independent director. This is a very important criterion for selection of an independent director which is being relaxed. Already, independence is questionable due to political appointments; this would further dilute it.  

Safeguards against inter-corporate loans: Section 186 enlists various safeguards regarding inter-corporate loans. This is also exempted under the guise of a mere permission from the relevant government (i.e. the concerned ministry). This decision is taken away from the board, leaving no room of disclosure or dissent by other minority investors. Also in this case, the board's duty to act in general interest of the company cannot be questioned for the decision does not lie in the realm of the board.

Related Party Transactions - Section 188(1) and (2) states that as regards to the transactions which are enlisted, if they are conducted with a related party, board approval is required. This includes sale and purchase of goods, availing or rendering of services, buying, disposing or leasing of properties, appointment of a related party to a office or place of profit etc. Here, the exemption that is carved out is when a government company transacts with another such company; on these points they would not require board approval. This is indirectly stating that since they are exempted, arm's length principle shall not applyClause 49, SEBI Listing Agreement excludes listed CPSEs & SLPEs from the obtaining board approvals in case of related party transactions among government companies. The present exemption shields unlisted CPSEs & SLPEs from board approval. A approval from the concerned ministry is the only requirement for clearing related party transactions. 

This could potentially cause exploitation of minority shareholders because of the so-called welfare oriented practices which leads to loss of revenue. This could jeopardize the minority shareholder's interest just as in the case of The Children’s Investment Fund (UK) LLP ('TCIF') and Coal India.[2] The Government of India is the controlling shareholder in Coal India Limited which entered into contracts to sell coal which was far lower than the market price. TCIF which was a 1% investor protested for the said transaction was against the interests of the company as it lead to a huge loss of revenue. Hence TCIF decided to resort to a class action suit under common law in Calcutta High Court in 2012. Also, from an investment point of view it is not a good move and is harmful for disinvestment prospects.

Finally, the notification concludes with a clause which requires that these changes need to be read in line with the interests of the shareholders. This is set to further create a conflict as to whether controlling or minority shareholders’ interest gains precedence.

- Shriya Jain & Param Pandya

[1] See generally, Corporate Governance in Public Sector – The Road Ahead, KPMG, (June, 2010); Lalita Som, Corporate Governance of Public Sector Enterprises in India, ICRA BULLETIN, MONEY & FINANCE, (June,2013); Umakanth Varottil, Corporate Governance in State-Owned Enterprises, Quarterly Briefing, National Stock Exchange, (April, 2015); Over 100 public sector companies fail to give corporate governance reports for 2010-11, THE ECONOMIC TIMES, (September 17, 2012); Manu Kaushik, BT 500: Most PSUs have lost value over the past year, THE BUSINESS TODAY,(October 25, 2013).
[2] For details, see generally Param Pandya, The Predicament of Corporate Governance in India: Coal India Limited - A case study, NIVESHAK, IIM Shillong, (April, 2015). This analysis is merely adopted from these allegations available in public domain and is only undertaken for purely academic purpose. The legal action is withdrawn since TCIF has exited the investment.     


snup said...

Your idea of encouraging young people to write about corporate law is very understandable and commendable. But I think you also have to keep in mind the authoritative position that your blog holds in the current legal blogosphere of India. I request you to look at the real original content of the posts that come from students and then publish them.

I hope you publish this comment.

Anonymous said...

Are government companies subject to RTI?

Umakanth Varottil said...

@Snup. Thanks for your feedback. We will take this into account while reviewing our policies.

Umakanth Varottil said...

@Anonymous. Section 2(h)(d)(i) of the Right to Information Act, 2005 encompasses "a body owned, controlled, or substantially financed" by an appropriate government, which would bring within its purview government companies. See also a World Bank Report (at p. 14):