[The following post is contributed by Vinod Kothari of Vinod Kothari & Co. He may be contacted at firstname.lastname@example.org]
The issue of ownership and control of insurance companies in India has been in a state of flux since early this year. While the intent of the Government was clear – to permit FDI up to 49% in the insurance sector – the Rules framed by the Ministry of Finance in February 2015 created a flutter with confusion about the manner of computation of foreign ownership of Indian insurance companies. There was an attempt to clarify the issue by an amendment carried out in early July 2015. Now, the regulator, the Insurance Development and Regulatory Authority of India (IRDA), has brought a new set of rules to define “Indian control” of insurance companies. These rules, framed as Guidelines for “Indian Owned and Controlled” insurance companies, were notified by IRDA on October 19, 2015 (Control Guidelines).
In the opinion of the author, the language of the Control Guidelines is far from clear. The Control Guidelines may lead to several changes in the manner of nomination of directors to boards and quorum requirements for board meetings. That the present articles of association may not have quorum requirement matching with the Control Guidelines may actually drive several insurance companies to change their articles of association. In addition, changes in shareholders’ agreements may also be required because existing shareholders’ agreements may run counter to the requirements of the Control Guidelines. All these changes are expected to be given effect to within 3 months from the date of notification of the Control Guidelines, and are to be supported by an undertaking of the Chief Executive Officer and Chief Compliance Officer, supported by a board resolution, as also amended copy of the shareholders’ agreement, where applicable. If at all companies are advised to implement the changes by appropriate amendment of articles of association, the time frame of 3 months may be grossly insufficient. In short, the Control Guidelines may create yet another flutter in the insurance fraternity.
The genesis of the Control Guidelines is in section 2(7A) in the Insurance Act, 1938 inserted by the 2015 amendment. This section defines an Indian insurance company as follows:
“Indian insurance company” means any insurer, being a company which is limited by shares, and, -
(a) which is formed and registered under the Companies Act, 2013 as a public company or is converted into such a company within one year of the commencement of Insurance Laws (Amendment) Act, 2015;
(b) in which the aggregate holdings of equity shares by foreign investors, including portfolio investors, do not exceed forty-nine per cent of the paid up equity capital of such Indian insurance company, which is Indian owned and controlled, in such manner as may be prescribed.
Explanation – For the purpose of this sub-clause, the expression “control” shall include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreement or voting agreements;
(c) whose sole purpose is to carry on life insurance business or general insurance business or re-insurance business or health insurance business.
As is evident, there are twin conditions of ownership and control in the definition above.
Indian ownership is defined by way of Indian Insurance Companies (Foreign Investment) Rules, 2015. Rule 2(l) of the said Rules requires more than 50% ownership either by Indian residents, or Indian companies which are in turn beneficially owned by Indian residents. Apparently, there is a need to look at the second layer of investors above an Indian company owning shares in an insurance company. Rule 2 (l) was subsequently amended by way an amendment dated July 3, 2015 to seemingly provide that the manner of computation of indirect foreign investment in case of insurance companies will not be the same as in usual cases of foreign direct investment. Irrespective of such intent, the confusion about reckoning indirect foreign investment in case of insurance companies survives.
In the meantime, IRDA has come up with Control Guidelines.
The overarching theme of the Control Guidelines seems to be the same as laid down in the Explanation to section 2(7A)(b). However, given the fact that IRDA has gone about micro-regulating the issue of board control, particularly laying down a peculiar requirement as to quorum, the Control Guidelines may lead to substantial difficulties in implementation. The language of the Control Guidelines is also suboptimal, leaving scope for interpretation issues.
Scope of Applicability
The interpretation difficulties start from the very clause pertaining to scope of applicability.
Clause 1 lists out three cases where the Control Guidelines apply, which are connected by a conjunctive “and”. Generally speaking, “and” is used in conjunctive sense – that is, each of the elements specified in clause 1 must be satisfied in order to attract the scope of applicability.
However, a basic analysis of the three sub-clauses of clause 1 will indicate that the “and” is actually an “or”. However, the three sub-clauses of clause 1 will possibly include the entire universe of Indian insurance companies.
The Control Guidelines stipulate that a majority of directors, excluding independent directors, shall be “nominated” by the Indian promoter/Indian investor.
Black’s Law Dictionary defines a nominee thus: “One who has been nominated or proposed for an office. One designated to act for another in his or her place.”
Reference to “nomination” in the Control Guidelines cannot to be taken to mean a “nominee director” as commonly used in corporate parlance. A nominee director is one who is placed on the board at the discretion of the nominator. The nominator is the one who decides who will be a director, and for how long. Any resignation of such nominee is placed before the nominator, and removal of such nominee is also effected by the nominator.
Note that an insurance company has to be a public company. In case of public companies, section 152(6) of the Companies Act, 2013 mandates at least two-thirds of the directors be appointed by the company in general meeting; therefore, the question of “nomination” of a majority of directors by either the Indian investor or the foreign shareholder, does not arise at all. The only meaning of “nomination” in the context of the Control Guidelines is that the proposal for the appointment of a majority of the directors will come from Indian promoters. The actual appointment will still have to be undertaken through the regular process of the Companies Act and Listing Regulations, including recommendation by the Nomination and Remuneration Committee (where applicable), and approval by shareholders.
There is yet another difficulty. If the number of directors on the board of a company, excluding independent directors, is an even number, the test of control on appointment of a majority will fail. Therefore, companies will need to ensure that their board strength is so fixed, that the number, excluding independent directors, is an odd number.
The Control Guidelines are completely silent about the nomination of independent directors (IDs). Insurance companies, being substantially capitalised public companies, are most likely to need at least two IDs. Foreign JV partners may not be well placed to nominate IDs: therefore, IDs will most likely be identified by the Indian investor. While IDs are expected to be independent, coupled with the majority control over the ex-IDs board by the Indian promoter, this gives the Indian promoter significant board strength.
Appointment of CEOs and other KMPs
The Control Guidelines provide that the appointment of the CEO/Managing Director or Principal Officer will be done by either the Indian promoter or by the Board. Note that by virtue of section 179(3) of the Companies Act, 2013, appointment of key managerial personnel (KMPs) will necessarily require board approval. However, the Control Guidelines seem to be indicating that the nomination of the CEO must be done by the Indian partner.
The Control Guidelines go on further to state that the nomination of KMPs other than that the CEO – for example, the CFO, may be done by the foreign partner. The next requirement – that such appointment will need to be approved by the Board – is superfluous because that is anyways the requirement of the law in section 179(3).
The most curious part of the Control Guidelines is the requirement pertaining to quorum. It is notable that special provisions with regard to quorum are a common feature of all shareholders’ agreements (SHAs). SHAs typically provide that in any meeting of the board, at least one representative of either side must be present to constitute valid quorum. There are typically requirements for affirmative votes on specific matters, irrespective of whether the matter comes before a board meeting or not. However, it is not common for SHAs to provide the requirement of a majority from either side.
The Control Guidelines say: “Quorum shall mean and include presence of majority of the Indian directors irrespective of whether a foreign investor’s nominee is present or not.”
Several aspects about the provision are unclear:
- First, it does not state what sort of meeting is being referred to. It might only be inferred that the meeting is a meeting of the board. But then, given that several significant decisions are taken at committees of boards, can it be that there is absolutely no rule applicable to meetings of committees of boards? In many cases, decisions of a committee virtually bind the board – for example, audit committee decisions [See section 177(8) of the Companies Act, 2013].
- The expression “Indian director” is an example of inappropriate language. It should mean “directors nominated by the Indian promoter/investor”. It may be alright for a quorum requirement to stipulate the presence of at least one director from either side, but it will be quite challenging to require “majority” of Indian investors’ nominees. Once again, if, excluding the independent directors, the number of directors present from both sides is equal, it does not satisfy the requirement of the Control Guidelines. It is mostly difficult to ensure presence of the full board in most board meetings – so, if the board of a company has two IDs, four Indian investor nominees, and three foreign investor nominees, the meeting will fail the quorum if even one of the Indian investor nominees fails to attend the board meeting, assuming that all the three foreign investor nominees either make it to the meeting, or attend by video-conferencing. It seems odd to require one of the foreign investor nominees to also be absent from a meeting, if one from the Indian side is absent.
- It is a well-established rule of board meetings that quorum is required not only to commence a meeting, but at all times. Assuming that before the conclusion of the business, one of the Indian investor nominees has to leave the meeting, this may cause the quorum requirement to fail. It is also a canonical rule that an interested director on a particular business is not counted for the purpose of quorum. It is quite likely that one or more of the Indian investor nominees are not to be counted for quorum for some particular matter –which breach their majority in the board. This will be an impossible situation to handle, as even adjournment of the board meeting otherwise required by the Control Guidelines will not redeem the situation.
- The biggest issue is – in what way are the requirements as to quorum are to be enforced? Section 174(1) of the Companies Act, 2013 lays down the requirement for quorum. In case of insurance joint ventures, there will obviously be a provision in the articles of association which will reflect the clause of the SHA. No SHA would have ever envisaged what the Control Guidelines provide. Hence, most articles of association of insurance companies will not be explicitly providing what the Control Guidelines stipulate. The question, therefore, is – is the quorum requirement of the Control Guidelines applicable sans any amendment of the articles of association? Or, will it be necessary or desirable to amend the articles of association in line with the provisions of the Control Guidelines?
Obviously, there is no answer to any of these questions. As a matter of stating the policy, having laid down a rule about composition of board of directors, requiring the actual majority presence in board meeting is a very curious case by itself. Control is a question of ability, and not necessarily actual exercise. If the Indian investor has a majority, that is sufficient control, as the ability to control is established. Whether the Indian investor actually ensures sufficient board presence in board meetings is like insisting upon a routine demonstration of strength, which is unnecessary.
Confirmation of Compliance and Time Limits
In order to ensure that the Indian insurance companies are in compliance with the Control Guidelines, IRDA has come out with an additional requirement of filing an undertaking duly signed by CEO and COO. Such undertaking needs to be appended with a certified true copy of board resolution and amended certified copy of agreement/ JV agreement, if applicable.
Companies existing prior to issuance of Control Guidelines: comply within a period of 3 months;
Companies existing post issuance of Control Guidelines: before grant of certificate of registration.
The Control Guidelines are a step towards micro-regulation. The insurance sector is quite a sensitive sector, and in the opinion of the author the Control Guidelines barely give out a signal of the ease of doing business in India.
- Vinod Kothari