: October 26, 2010 |
: Company Law
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The Three Major and Recent Developments in Indian Corporate Law
Over the past few years, there has been a lot of debate and discussion in the larger public domain over corporate laws in India. A significant and unprecedented evolution of corporate India is expected over the coming years and optimism is evident. There are several reasons for the stimulation of so much hoopla, reasons ranging from the bubble burst of the massive western markets, constant growth of the Indian market and yet growing inequalities evident in the midst of the growth, dynamic international power politics and climate change is no longer just a threat but an actuality.
In this paper, the author will be dealing with three topics, which though seemingly distinct, are in certain ways mutually related and having significant effects on the evolution of corporate India.
The first part of the paper deals with Supreme Court verdict on the tribunalisation of company law in India. The second part of the paper deals with independent directors with regards to the companies bill, 2009. And the final part of the paper deals with the actual position of Statutory Auditors in a Company.
An Analysis of the watershed Supreme Court judgment on the Tribunalisation for company law in India.
The author in the following part will deal with the case for and against the Tribunalisation of company law in India. The following discussion culminates from the recent Constitutional Bench Judgment of the Supreme Court that upheld the establishment of the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT), in an appeal filed by the Union of India against a Madras High Court judgment. The case in discussion is Union of India v. R. Gandhi. What was effectively held in the judgment was to uphold the legislative competence of the Parliament to create the NCLT and NCLAT. However, the particular structure of the tribunals has been held to be unconstitutional. Thus, in order for the NCLT and the NCLAT to come into existence, the Union of India will have to carry out several amendments beyond what was mandated in Chapters 1A and 1B of the Companies Act, 1956 inserted by the Companies (Second Amendment) Act, 2002. The decision does not decide on the constitutionality of the National Tax Tribunal.
What the Constitution Bench has held is that “the creation of National Company Law Tribunal and National Company Law Appellate Tribunal and vesting in them, the powers and jurisdiction exercised by the High Court in regard to company law matters, are not unconstitutional…” However, “We declare that Parts 1B and 1C of the Act as presently structured, are unconstitutional (and) may be made operational by making suitable amendments, as indicated above, in addition to what the Union Government has already agreed in pursuance of the impugned order of the High Court…”
It is claimed by some that this judgment that has several ramifications, is historic in the company law justice.
The judgment draws its basis from a seven judge bench of the Supreme Court in L. Chandra Kumar v. Union of India. This judgment held that to constitute a tribunal only of judicial members beats the purpose of setting up of tribunals and hence is untenable.
In the R. Gandhi judgment, Supreme Court with respect to technical members in the tribunal held as follows:
“Clauses (c) and (d) of sub-section (2) and Clauses (a) and (b) of sub-section (3) of section 10FD which provide for persons with 15 years experience in Group A post or persons holding the post of Joint Secretary or equivalent post in Central or State Government, being qualified for appointment as Members of Tribunal is invalid.”.
“A `Technical Member' presupposes an experience in the field to which the Tribunal relates. A member of Indian Company Law Service who has worked with Accounts Branch or officers in other departments who might have incidentally dealt with some aspect of Company Law cannot be considered as `experts' qualified to be appointed as Technical Members. Therefore Clauses (a) and (b) of sub-section (3) are not valid.”.
“The first part of clause (f) of sub-section (3) providing that any person having special knowledge or professional experience of 15 years in science, technology, economics, banking, industry could be considered to be persons with expertise in company law, for being appointed as Technical Members in Company Law Tribunal, is invalid.” “Persons having ability, integrity, standing and special knowledge and professional experience of not less than fifteen years in industrial finance, industrial management, industrial reconstruction, investment and accountancy, may however be considered as persons having expertise in rehabilitation/revival of companies and therefore, eligible for being considered for appointment as Technical Members.”
The selection committee as per Section 10FX must consist of the following members:
(a) Chief Justice of India or his nominee - Chairperson (with a casting vote);
(b) A senior Judge of the Supreme Court or Chief Justice of High Court - Member;
(c) Secretary in the Ministry of Finance and Company Affairs - Member; and
(d) Secretary in the Ministry of Law and Justice - Member.
Further, it was held that the term of office of three years shall be changed to a term of seven or five years subject to eligibility for appointment for one more term. This is because considerable time is required to achieve expertise in the concerned field
And two-Member Benches of the Tribunal should always have a judicial member. Whenever any larger or special benches are constituted, the number of Technical Members shall not exceed the Judicial Members.
The judgment for several pragmatic reasons can be appreciated, but several issues and contentions crop up. The two main issues are as follows:
Whether the Parliament has the legislative competence whatsoever to vest intrinsic judicial functions being performed by the High Court in a quasi-judicial tribunal?
Whether the transfer of the entire company law jurisdiction to quasi-judicial tribunal is violative of the doctrine of separation of powers and the Independence of Judiciary.
With respect to the legislative competence of the Parliament, the Constitutional provision dealing with Tribunals is Article 323A and 323B. The l.Chandrakumar judgment also holds in Para 81 that apart from the authorization that flows from Art 323A and 323B, Parliament possess legislative competence under the Schedule 7 of the Constitution. It was also stated in the R. Gandhi judgment that Art 323B is not exhaustive.
This reasoning however is problematic due to the following reasons. The language in Art 323B is plain and unambiguous, it is a well known principle that when only one meaning of statutory construction arises, the Act speaks for itself. The principle of Casus Omissus has also been ignored, which states that if a matter which should have been done by the law makers but has not been provided for, cannot be supplied with by courts, as to do so will be a legislation and not construction. Even if for practical reasons, Article 323B should have been left open and non-exhaustive, such a modification or construction will lead to legislation and not just judicial interpretation.
Further, the issue is with respect to conflict between Schedule VII and Art 323B. Firstly, is there a conflict between Art 323B and Schedule VII? Schedule VII lays down and divides the legislative competence between the State and Union. Article 323B on the other hand deals with Tribunals, the provision is elaborate and detailed and more importantly is an enabling provision. Article 323B when read with Schedule VII, merely clarifies as to which legislature is competent to legislate on what types of tribunals provided it is done within the scope of Article 323B. Thus there is no real conflict between the provisions.
However, even if there is a conflict between the two provisions, the solutions would still be different. Harmonious construction of provisions must be adopted in case of conflict and the judiciary must avoid such a head on clash between provisions. When provisions are read harmoniously, effect must be given to both provisions in such a way so as to promote the intention and object of the legislature. But in the present case, a conflict is being created where there is none, further, instead of harmoniously constructing them; Schedule VII has been given preference over inter alia Article 323B, powers of the High Court and more importantly, an independent judiciary and the separation of powers. Entry 11A of List III as mentioned in State of Karnataka v. Vishwabharathi House Building Society Limited judgment deals with ‘Administration of Justice, constitution and organization of all Courts, except the Supreme Court and the High Court’. But this provision has to be read with Article 323B and read within its scope, the power to do so is merely provided for in this provision.
This issue is connected to the next issue that the author would like to expand upon. Even if it said that the Tribunals can be vested with powers substituting the High Court, the issue is can the powers be vested in the hands of mere technical persons, not qualified or even suitable to independently exercise judicial powers? Bhagawathi CJ in Sampath Kumar v. Union of India held that “it van no longer be disputed that total insulation of the judiciary from all forms of interference from co-ordinate branches of Government is a basic essential feature of the Constitution.”
In State of UP v. McDowell & Co., a three judge bench of the Supreme Court observed that a law made by the legislature can be struck down on two grouynds and two grounds alone, they are: (1) lack of legislative competence and (2) violation of any fundamental right in Part III or any other Constitutional provision. The author’s argument is on these two very specific points and the rest are irrelevant for this discussion. The judgment is still vague about whether the Parliament has the competency and whether it is violative Art 323B of the Constitution. The other concern however is with respect to non-judicial persons as the adjudicating authority.
Here, it is ‘separation of powers’ embodied in the basic structure of our Constitution has been put at stake. The point in a lot of ways is very self-explanatory and the author would not be treading into the same.
This section of the paper deals with independent directors. The concept of independent directors is a notable innovation in corporate jurisprudence. It is the cornerstone of corporate governance and stability. However, this concept in under a serious threat and needs some serious and innovative re-working.
The SEBI defines independent directors in Clause 49 and has mandated all listed companies to have independent directors. But the definition itself is not adequate and fails to actually give meaning to the word “independent”. In practice, Independent Directors in India have largely remained independent only on paper. The Chairman of the audit committee of Enron was the Dean of Stanford Business School, and even he could not really see the murky dealing of the company? The recent Satyam fraud has turned out to be more than just a failure of corporate governance. The word Satyam today is symbolic of the fissures and fractures in the Indian economic system and its corrupted instability. It has created a fear psychosis, shaking off the hallucinations of financial growth and progress in India Inc.
Some of the suggestions for amendments in this field which have been made are summarized as follows:
Statutory Protection against Arrest- The State Government of A.P’s move to arrest former Independent Directors of Nagarjuna Finance for alleged default in repayment of public deposits has raised several serious moot points. The judicial response in the Nagarjuna Finance case has been anything but reassuring to Independent Directors. Many Independent Directors in India have left and those who are continuing are not quite happy continuing. Unless the situation is remedied, there is a real danger of losing this nascent institution.
The Companies Act does not differentiate between the types of Directors and hence Independent Directors are treated just as any other directory and the fiduciary duty and liabilities towards the company for all of the Directors are the same. The expectations out of independent directors today are too unrealistic. Is it possible to actually claim that they are the bulwark to corporate governance today? Corporate structures are too complex and when the Independent Directors do come for the meetings, they have a limited ability to actually figure out what the operations of the company have been.
II) If Boards bring in Independent Directors who are reputed and bring a certain brand value to the company, if the independent directors maintain a cozy relationship with the Board, are given Stock Options, percentage from profits, other perquisites etc, where goes the legitimacy of the Director? Further, the over-arching role of the promoters or majority shareholders and their effect of appointing Independent Directors is problematic especially given that the biggest corporate’ in India are mostly closely held family based organizations. Unless a well thought out transparent process of selecting and appointing Independent Directors is put in place, the institution of Independent Directors will soon become a big farce with the small number of good Independent Directors also leaving the field, disillusioned with the lack of credibility in the whole system. Corporate India would do well to adopt a stiffer prescription on independent directors as a wise preparation for a challenging but a rewarding future.
Retirement policies for Independent Directors have to be put in place. It has been opined by many that an independent director should not continue as such for more than two terms of three years each. It is normally argued that such a move would not ensure proper experience in a particular industry, as the independent director has to move away after six years. This argument would not always hold good if one were to look at independent directors as enlightened generalists who bring to bear upon everything that they do and think a certain freshness of approach without the bias of traditional experience and conventional thinking.
The third issue being dealt with is with respect to Statutory Directors:
The role of statutory directors has been a subject of debate worldwide. The liability and accountability of the Statutory Auditors are put to question in case of corporate financial irregularities. In India, there is a lot of confusion with respect to the liability and position of Statute. The author will be dealing with one of these issues in this part of the Paper. The issue is whether Statutory Auditors occupy an “office of profit” under Companies Act.
The phrase “office of profit” is not defined in the Constitution of India. By a series of decisions the Supreme Court of India has laid down the tests for finding out whether the office in question is an office of profit under the Government. These tests are:
1. Whether the Government makes the appointment;
2. Whether the Government has a right to remove or dismiss the holder;
3. Whether the Government pays the remuneration;
4. What are the functions of the holder? Does he perform them for the Government; and
5. Does the Government exercise any control over the performance of those functions?
In ordinary parlance, an office or place of profit means an office or profit or position, which brings to the person holding it some pecuniary gain or advantage or benefit. It will be an office or place of profit if it carries some remuneration, pecuniary advantage, benefit etc. The amount of such profit is immaterial.
Reading Sections 224 and 225 of the Companies Act, it is clear that the statutory auditors are appointed by the shareholders. Although the remuneration is paid by the Company itself, the auditors function for and on behalf of appointed shareholders of the company and not for the Company as such. Furthermore, under the scheme of Companies Act 1956 read with Section 227 of the Act, it becomes quite clear that the function of the statutory auditors does not come under the control of the Company at all. In fact, the purpose of Statutory Auditors is precisely meant to be independent and devoid of any relationship with the company that may jeopardize the quality of the audit.
Moreover, the first principles of corporate jurisprudence are that a company is different from its shareholders. The company is a separate legal entity, an artificial person capable of holding rights and liabilities. A company can buy and sell property, sue and be sued etc. Therefore, if the Statutory Auditors are appointed by the shareholders, and the shareholders are different from the Company, it can then be said that the Statutory Auditors of a company do not hold an office of profit under the company.
However, a reasoning such as this, will bring to question issues arising out of Section 314 of the Companies Act.
While holding office necessarily implies the exercise of some authority, whether eminent or subservient, by or on behalf of the company, the holding of a place or position need not carry any authority with it. In this context, it cannot be legally said that the statutory auditors of a company hold a place of profit under the company. In terms of Section 314(1), approval of shareholders by passing a special resolution in general meeting will be required for appointment of the specified persons to an office or place of profit such as the relative of the Independent Director being appointed at an office of profit under the company.
Based on the above reasoning and when read with Section 314 of the Companies Act, a statutory auditor can be appointed without a resolution from the shareholders even if the auditor is related to one of the Directors. This may adversely affect the independence of Statutory Auditor and there autonomous functioning without interference from the Company itself.
 Civil Appeal No. 3067 of 2004 with Civil Appeal No. 3717 of 2005, unanimous, judgment dated May 11, 2010, per Justice Raveendran)
 AIR 1997 SC 1129
 AIR 1997 SC 1129 at Para 95.
 State of UP v. Vijay Anand Maharaj AIR 1963SC946 at p. 950.
 Waliram Waman v. Justice B Lentin AIR 1988 SC 2267.
 See (2003)3SCC 57 at P. 74.
 (2003)2 SCC 412.
 (1987)1 SCC 124
 (1996)3SCC 709
 The reasoning put forth in this part of the paper is that of the author and hence no source for this reasoning has been given.
 See Maulana Abdul Shakur v. Rikhab Chand and another (1958) SCR 387; M Ramappa v. Sangappa & others, (1959) SCR 1167; Guru Govinda Basu v. Sankari Prasad Ghosal & Others, (1964) 4 SCR 311; and Shivamurthy Swami Inamdar & another v. Agadi Sanganna Andanappa & Another, (1971) 3 SCC 870, Pradyut Bardolai v. Swapan Roy, JT (2001) 1 SC 136.
 See Kamal Gupta; Vol 3; C.R Datta on Company Law; 4974 and 4978, 2008 ed.
 Rendell v. Went 2 All ER 464(HL)
The author can be reached at: email@example.com
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