Background: In the forefront of the problems faced by developing countries like India during the change from a regulation-driven economy, to a market-driven; economy is the need to effectively tackle the complex financial management problems of the corporate sector. These problems are not merely restricted to curbing monopolies or ensuring regulation but also protecting the interests of shareholders and the investing public.[1]
An investor is a person who is an individual or a corporate legal entity investing his capital in another venture or business but does not do the business himself or itself. The investor has no role to play in the day-to-day management of the business or its control except as permitted by the law. Investor carries on business when they buy and sell assets, arranges for other to buy and sell assets, manages assets belonging to others, or operates collective investment schemes. These activities are engaged by an investor, but they are not having any control over the day to day activities of any corporates. Normally, an investor is a blind person; they do not know any activities made by the company. Investor cannot guide the fate or destiny of the money invested. An investor to that extent is quite fragile and is exposed to certain risks because the company with his money can commit mistakes. Normally they are contributing the funds for productive purpose of the company, and they are exposing him to the business decisions that the company has taken or will be taking. There are no doubt laws some of which are adequate but some are not. An investor obviously needs some protection per se.[2]
“Investor protection” is a very popular phrase which everyone concerned with regulation of the capital markets uses these days, be they the Securities and Exchange Board of India, Stock Exchanges, Investors associations or for that matter of fact the companies themselves.[3] The term Investor Protection is a wide term encompassing various measures designed to protect the investors from malpractices of companies, merchant bankers, depository participants and other intermediaries. “Investor Beware” should be the watchword of all programmes for mobilization of savings for investment. As all investment has some risk element, this risk factor should be borne in mind by the investors and they should take all precautions to protect their interest in the first place. If caution is thrown to the winds and they invest in any venture without a prior assessment of the risk, they have only to blame themselves. Investors are a heterogeneous group, they are large or small, rich or poor, expert or lay and not all investors need equal degree of protection for their invested amount from the corporate securities.[4]
An investor has three objectives while investing his surplus money, namely safety of invested money, liquidity position of invested money, and return on investment in selected securities. An investor can be classified as individual or professional who manages the funds on behalf of others. First there are inexperienced investor who needs to be properly advised about the intricacies of investment avenues and opportunities in corporate securities. Secondly, there are the experienced investors who understand the risks involved in the selected investment avenues and who need no advices from others, his response / order just to be executed without much time. Thirdly, there are occasional investors who seek advice and assistance once in a while with no desire to create a long term perspective. In this paper author will discuss about the changes in the companies law introduced by the parliament to curb the risk factor and maximize safety, returns and liquidity of fund. The author has divided the paper in various segments such as role Of Independent Directors, Procedure for private placements,
Independent Director: The Cadbury Committee in 1992, which itself was set up following the corporate scandals involving BCCI, Poly Peck and Maxwell, provided respectability to the concept of independent directors, by focusing on independent directors as a part of the new practices for better governance. Independent directors function as an oversight body in monitoring the performance and should raise red flags whenever suspicion occurs.
They are expected to be more aware and question the company on relevant issues in their position as trustees of stakeholders. The institution of independent directors is a critical instrument for ensuring good corporate governance and it is necessary that the functioning of the institution is critically analyzed and proper safeguards are made to ensure efficacy.
Companies Act 2013 mandates appointment of independent directors by listed companies and other class of companies. It also prescribes other aspects such as maximum tenure of independent directors, separate meeting of independent directors, tenure, their qualifications, liability, appointment, remuneration and other aspect.[5] The one important revolutionize is that nominee directors are removed from the definition of independent directors the act clearly states that an independent director, in relation to a company, means a director other than a managing director or a whole time director or a nominee director, who is not a promoter of the company nor he nor his relatives have any pecuniary relationship with the company.[6] The code for independent directors has been specified in schedule IV of the 2013 Act. The independent director shall uphold ethical standards, act objectively and constructively, exercise responsibilities in bona fide manner, devote sufficient time and attention for informed and balanced decision making, exercise objective and independent judgment in the paramount interest of company, not abuse his position, not to lose his independence and assist company in corporate governance.[7] The change in the role of the independent directors is sign of relief for investors, the new company law has focused more on the word Independent and the one very important change is nominee director will no more be an independent director, because the practice followed by the company was they used to nominate the director from parent company to its subsidiary and he used to be director in parent company and also an independent director in its subsidiary. Now the big question is how can a director be independent if he is already a director in the parent company and nominated by same board itself? But section 149 of new company law has curbed the problem by removing nominee director from the definition of independent director.
Private Placement – Chapter III, Part II of Companies Act, 2013: Private placement is one of the most favored methods used by companies to raise funds. The Companies Act, 1956 and SEBI guidelines and regulations govern conditions for private placement, depending upon the nature of the company. Loopholes in the existing laws have been misused by companies and their promoters to indulge in malpractices, thereby compromising the interest of innocent stakeholders. Over the last two years, the controversy over the money raised by Sahara group companies played out with the markets regulatory SEBI where it termed the said funds raised as ‘private placement’. The regulator ordered the Sahara group companies-Sahara India Real Estate Corporation (now known as Sahara Commodity Services Corporation Ltd) and Sahara Housing Investment Corporation to refund Rs. 19,400 crore raised from 2.21 crore investors. The Sahara Group companies stated that the funds were raised through private placement of optionally fully convertible debentures, which were outside the definition of ‘securities’ specified in SEBI regulations. These companies also contended that since they were unlisted companies, the issues of these debentures were outside the jurisdiction of SEBI. SEBI however contended that the method of raising capital violated various regulations and given that the offer was made to more than 50 persons at a time, it could not be termed as a private placement and was required to abide with the conditions prescribed by SEBI to such issuance. The Securities Appellate Tribunal (SAT) and the Supreme Court has also upheld the SEBI order regarding funding money to investors.[8]
Private placement means any offer of securities or invitation to subscribe securities to a select group of persons by a company (other than by public offer) through issue of private placement offer letter and which satisfies the conditions specified in this section.[9] The Act, 1956 did not define the term ‘private placement’ rather certain offers of shares or debentures/invitation to subscribe for shares or debentures to any section of the public were not regarded as public issues[10] i.e. where shares or debentures are available for subscription or purchase only to those receiving the offer/invitation and offer/invitation is a domestic concern of the issuer and those receiving the offer/invitation, were termed as private placement. However, as per the proviso to section 67(3)[11], when a company made an offer or invitation to subscribe for shares or debentures to 50 or more persons, such offers was treated as made to public. Under the Act, 1956 the conditions relating to private placement were applicable only to public companies. On the contrary Act, 2013 provides various conditions for private placement of shares and debentures which apply to both private companies and public companies.
It is to be noted that the provisions for private placement applies to the issue of “securities” and not “shares”. Thus the new provisions have widened the scope and cover a whole host of instruments such as shares, bonds, debentures and other marketable securities etc. The Act, 2013 under section 42(4) mandates a company to comply with the provisions of SEBI Act & SCRA, if any offer or invitation is not in compliance with the provisions of the section and such offer or invitation shall be treated as a public offer.[12] The Act, 2013 stipulates that all monies payable towards subscription of securities under this section shall be paid through cheque or demand draft or other banking channels but not by cash.[13] It also lays down the time limit for allotment of securities i.e. a company making an offer or invitation under this section shall allot its securities within sixty days from the date of receipt of the application money on such securities and if the company is not able to allot the securities within that period, it shall repay the application money to its subscribers within fifteen days from the date of completion of sixty days and if the company fails to repay the application money to the subscribers within fifteen days from the date of completion of sixty days, it shall be liable to repay that money with interest at the rate of twelve percent per annum from the expiry of sixtieth day. The above provision is sign of relief for investors investing under private placement scheme as the allotment time is sixty days and any such default attracts penalty.
The section further lays down that no company offering securities under private placement shall release any public advertisements or utilize any media, marketing or distribution channels or agents to inform the public at large about such an offer[14] and no fresh offer or invitation under this section shall me made unless the allotments with respect to any offer or invitation made earlier have been withdrawn or abandoned by the company[15] and any offer not in consonance with this part shall be treated as public offer[16]. The violation of the provision attracts high penalty whereas the minimum penalty itself is two crore and not only company even its directors and promoters are also liable for such breach[17] because private placement is done at the initial stage so it is important to attract promoters and directors liability. Whereas the rules prescribes that such offer or invitation shall be made to not more than two hundred persons in the aggregate in a financial year but the restriction would be reckoned individually for each kind of security that is equity share, preference share, or debenture and the value of such offer or invitation per person shall be with an investment size of not less than twenty thousand rupees of face value of the securities.[18] With the new company law, the procedure for private placement has become comparatively more structured, crystal clear and investor friendly.
Evaluation of the Role of SFIO: SFIO is a specialist organization that investigates only the most serious type of corporate frauds. It has been empowered by the Companies Act, 2013 to investigate all the matters pertaining to frauds occurred in any company where the investors lost their hard earned money. An inspector can examine on oath any person involved in the fraud and may thereafter be used in evidence against him.
In this work of inspector, the officers of the Central Government, State government, police or statutory authorities shall provide assistance to him.[19] They enjoy all the powers as are vested in a civil court under the Code of Civil Procedure, 1908,while trying a suit in respect of the following matters, namely[20]:—
- The discovery and production of books of account and other documents, at such place and time as may be specified by such person;
- Summoning and enforcing the attendance of persons and examining them on oath; and
- Inspection of any books, registers and other documents of the company at any place.
Here, it is worth to mention that investigation proceedings are not judicial proceedings but only Investigatory and quasi-judicial in nature[21], if any director or officer of the company disobeys the direction issued by the Registrar or the inspector, the director or the officer shall be punishable with imprisonment which may extend to one year and with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees.
If a director or an officer of the company has been convicted of an offence under section 217, the director or the officer shall, on and from the date on which he is so convicted, be deemed to have vacated his office as such and on such vacation of office, shall be disqualified from holding an office in any company. The notes of examination of the person as mentioned above are to be taken down in writing and to be read over to, or by, and signed by, the person examined, and may thereafter be used in evidence against him. If any person fails without reasonable cause or refuses—
(i) To produce to an inspector or any person authorized by him in this behalf any book or Paper which is his duty to produce; or
(ii) To furnish any information which is his duty to furnish; or
(iii) To appear before the inspector personally when required to do so or
(iv) To answer any question which is put to him by the inspector in pursuance of that; or
(v) To sign the notes of any examination referred to;
He shall be punished with imprisonment for a term which may extend to six months and with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees, and also with a further fine which may extend to two thousand rupees for everyday after the first during which the failure or refusal continues.[22]
SFIO is performing well to find out the corporate frauds, during recent time which reflects the good corporate governance in our country. Minister of State for Corporate Affairs Nirmala Sitharaman has informed the Lok Sabha on 25 July, 2014, in a written reply that corporate frauds worth more than Rs 10,800 crore have been detected by SFIO during its probes in nearly three-and-half years. It has completed probes in 78 cases of corporate frauds since 2011-12 till June-end of this year. Now, Market Research and Analysis Unit (MRAU) has been set up in SFIO to analyse media reports relating to financial frauds and for conducting market surveillance of such corporate. In order to strengthen MRAU’s functioning, an expert committee was constituted and on the basis of its recommendations a forensic lab with appropriate technology and skilled technical manpower has been set up in SFIO. This will, certainly protect the investor’s interest and will also bring back the confidence of investors in Indian capital market.
Recognition of Entrenchment Provisions in the Articles of Association: An entrenched clause or entrenchment clause of a basic law or constitution is a provision which makes certain amendments either more difficult or impossible, i.e., inadmissible. It may require a form of supermajority, a referendum submitted to the people, or the consent of another party.[23] The recognition of entrenchment provisions in the articles of association of a company, the purpose of shareholder agreements is to secure certain rights for shareholders which have not otherwise been made available to them under law. For example, an investor holding 20% shares in a company may want to say in the alteration of the articles which affects the right of the investors. Whereas the law mandates 3/4th majority of shareholders present and voting for any alteration to the articles to be approved, the consent of the investor may not be required. In such a situation, the shareholders agreement may mandate an affirmative vote of all shareholders for any such alteration to be approved. While inclusion of such rights has been the norm in most shareholder agreements, the same has been granted legal sanctity under the new companies act.[24] According to rules[25] where the articles contain the provisions for entrenchment, the company shall give notice to the Registrar of such provisions, as the case may be, along with the fee as provided in the rules.[26] There has been a debate on the validity of affirmative rights in favor of minority shareholders, for a company to perform certain actions or to bring in such a change. The justification behind the debate being that such affirmative rights place a higher threshold on the company than what is required under the law, the court[27] has, in the past, ruled that a company is not prohibited from providing a higher quorum for board meetings in its articles than that prescribed under the law. The underlying principle which may be inferred from this decision is that it is permissible for a company to adopt a higher threshold of compliance than that required under the law. However, the company law board decision in the jindal vijaynagar case[28] invalidated the affirmative rights of a minority shareholder from preventing a change in the location of the registered office of a company. The new provision for entrenchment does not expressly grant recognition to affirmative rights in the hands of the minority shareholders in situations where the statute provides for voting thresholds. But, it at least grants legal sanction to affirmative rights on amendment of the article of the company.[29]
Exit Option for Dissenting Investors: There have been many instances of the companies changing their deployment strategy for funds raised through an IPO (Initial Public Offer) after securing shareholders’ approval with majority of votes, despite some minority shareholders being opposed to such moves. Therefore, it was felt that the dissenting shareholders should also be given an exit opportunity, if they are not happy with such developments at the company whose shares they own.[30] The new company law has carved out the problem a clearly states that in case of the change of the objects of the company the dissenting shareholders shall be given an opportunity to exit by the promoters and shareholders having control in accordance with regulations to be specified by the Securities and Exchange Board.[31]
Investor Education and Protection Fund: The IEPF fund has been set up under the Ministry of Corporate Affairs for promotion of investor awareness and protection of investor interests.[32] Unclaimed dividend, refund of application money, matured company deposits and debentures, and interest on them are moved to the IEPF fund if not claimed within seven years but the new company has given a right to investors to claim the amount after the expiry of seven years also by establishing their claim.[33] Whereas the above clause has not been enforced yet, The IEPF is monitored by a trust, which decides how the money will be utilized for specific activities of investor awareness and education. Once the amount is credited to the IEPF fund, an investor can’t recover the unclaimed amount. However, he can view the amount credited to the fund on the IEPF website. Investors can claim unpaid amounts from the company before they are credited to the IEPF account by following the procedure prescribed by the company.[34]
Conclusion: In the forefront of the problems faced by developing countries like India during the change from a regulation-driven economy, to a market-driven; economy is the need to effectively tackle the complex financial management problems of the corporate sector. These problems are not merely restricted to curbing monopolies or ensuring regulation but also protecting the interests of shareholders and the investing public.[35]
The new Company law is more investor friendly. The disclosure in prospectus, private placement and role of independent directors, recognition to entrenchment provisions, exit options for investors in case of change in objects of the company etc. have shifted gears in favor of the investors. There was an urgent need to bring a change and parliament has come up with a good and positive change. Yes, there are some stringent and hard to comply provisions as companies have to disclose the source of funds by the promoters which in fact I believe would be easy for a new company to disclose but the same would be difficult for company which is in already in market for let say more than 15 years..
By Kunal Godhwani and Nidhi Singla Final Year, B.B.A LLB (Hons), School of Law, KIIT University
[1] Manupatra Newsline Articles, Vol. 5, Liberalization v. Regulation, An Appraisal of SEBI and Guidelines for Investor Protection Available at http://www.manupatra.co.in/newsline/articles/Upload/3294C9D3-B74E-4B77-9FDA-CE55B9C70E8C.pdf Last Visited on (15th Feb 2015, 11.02 A.M)
[2] Vashisht, A.K. and Gupta, R.K. (2005) “Investment Management and Stock Market: Strategies for Successful Investing” Deep & Deep Publications Pvt. Ltd., New Delhi, I Edition, p.5, 10
[3] Delhi Business Review, An investors Requirements in Indian Securities Market, X Vol. 8, No. 1 (January – June 2007) Available at http://www.dbr.shtr.org/v_8n1/v8n1c.pdf Last Visited on (18th Feb 2015, 1.15 pm)
[4] Prithvi Haldea , A beginners Guide’ “First Step to Investing” Available at Investor education and protection fund website http://www.iepf.gov.in/IEPF/pdf/First_Steps_to_Investing_A_Beginners_Guide_Prithvi_Haldea.pdf Last visited on (23rd Feb, 9.00 am)
[5] Institute of Company Secretary, Study Material on Law of Investment, Pg. 254, 2013 Available at Icsi website http://www.icsi.in/Study%20Material%20Executive/SLC.pdf Last Visited on (25th Feb, 3.15 pm)
[6] Chapter XI, Appointment and Qualifications of Directors, Section 149 of Companies Act, 2013
[7] Taxman Publication, V. S Datey, A comprehensive Ready Reckoner on Companies Act 2013 and Rules framed, Ed. 2nd Pg. 510, 2014.
[8] Private Placement, Much needed overhaul, Available at http://www.companiesact.in/PgKnowledge/ClassRoomSeries10.aspx Last Visited on (2nd Feb 2015, 4.10 pm)
[9] Chapter III Prospectus and Allotment of Securities, Part II Private Placement, Section 42 of the Companies act, 2013
[10] Chapter IV, Share Capital and Debentures, Section 67(3) the Companies Act, 1956
[11] Companies Act, 1956.
[12]http://www.mondaq.com/india/x/305626/Securities/PRIVATE+PLACEMENT+UNDER+COMPANIES+ACT+2013
[13] 42(6) of The Companies Act, 2013
[14] Section 42 Clause 7 of The Companies Act, 2013
[15] Section 42 Clause 3 of The Companies Act, 2013
[16] Section 42 Clause 4 of The Companies Act, 2013
[17] Section 42 Clause 4 of The Companies Act, 2013
[18] Companies (PROSPECTUS AND ALLOTMENT OF SECURITIES) Rules, 2014 Clause 14 (Private Placement)
[19] Section 217 Clause 9 of The Companies Act, 2013
[20] Section 217 Clause 5 of The Companies Act, 2013
[21] Coimbatore Spinning & Weaving Co. Ltd v. M.S Srinivasan (1959) 29 Comp. Cases 97 (Mad)
[22] Section 217 Clause (8) of Companies Act, 2013
[23] Aishwarya M Gahrana & Associate, Entrenchment of Article, Available At http://aishmghrana.me/2014/04/25/entrenchment-of-article/ Last visited on (3rd March 2015)
[24] Section 5 Clause (3) of The Companies Act, 2013
[25] Rule 10 of the Companies (incorporation) Rules 2014
[26] Companies (Registration offices and fees) Rules, 2014 at the time of incorporation of the company
[27] Amrit Kaur Puri v. Kapurthala Flour, Oil and General Mills Co. P. Ltd. and Ors., [1984] 56 CompCas 194 (P&H)
[28] In Re: Jindal Vijayanagar Steel Limited , a Company registered under the Companies Act, 1956, [2006] 129 CompCas 952 (CLB)
[29] Cyril S. Shroff, Amarchand & Mangaldas & Suresh A. Shroff & Co., INDIAN UPDATE – COMPANIES ACT, 2013 – IMPACTING M&A DEALS Available at http://xbma.org/forum/indian-update-companies-act-2013-impacting-ma-deals/ Last Visited on (3rd March 2015)
[30] IPO fund diversion: Dissenting investors to get exit offer, Available at http://articles.economictimes.indiatimes.com/2013-09-22/news/42292304_1_exit-offer-public-offer-documents-minority-shareholders, Last Visited on (3rd March 2015)
[31] Section 13 Clause (8) ii of The Companies Act, 2013
[32] Icsi, Study Material, Law of Investment, Pg. 254, 2013 Available at https://www.icsi.edu/Docs/…/1.%20Company%20Law-Executive.pdf Last visited (2nd March 5.20 pm)
[33] Section 125 Clause (3) Proviso, The Company Act, 2013
[34]Girija Gadre, Arti Bhargava and Labdhi Mehta, On protection fund investor awareness and education http://articles.economictimes.indiatimes.com/2014-07-21/news/51830939_1_protection-fund-investor-awareness-investor-education Last Visited on (27th Feb 3.10 pm)
[35] Supra N. 1