Subject Group on Administrative And Legal Simplifications

Report on
Implementable Action Plans in the area of
Administrative and Legal Simplifications.

With the advent of foreign investment following liberalisation in 1991, Indian industry experienced global competition within the country and it had to reorganise its own business in the manner best suited to competition and collaboration

Competing with global majors was a formidable task and continues to be so given the fact that the protection which the Indian industry enjoyed is no longer available. The lowering of tariff barriers has further compounded the situation.

There is a school of thought which is of the strong view that relaxation of capital controls and liberalisation of economy ought to have been done first for the entire industry within the country before throwing open the door for foreign investment. This school believes that such a method would have enabled the Indian industry to adjust itself to the changed scenario and it would have helped the industry to better gear itself to meet the challenges that liberalisation would bring. The Indian industry, to its credit, faced this task bravely and has managed to survive despite all odds. It is for the continuation of this survival that urgent attention is warranted.

In the liberalised scenario, foreign corporations which provided technology are no longer interested in being mere technological partners but would rather invest in the equity of the venture. It has therefore, become inevitable for Indian companies to increasingly accept the reality of having to do business with foreign partners. The real problem arose in the case of existing business which was carried on by the Indian industry either as a separate company or as a division of its business. Hiving off became inevitable due to the need for infusion of foreign technology as also to provide opportunity to infuse funds.

Reorganising and restructuring of business has been an on-going process over the past few years and corporates have resorted to restructuring in one form or another. The need to restructure has been driven by various factors such as:

Consolidation of business in highly fragmented industries like cement where volumes play a pivotal role in order to make optimum use of the capacities and to achieve economies of scale in marketing.

Companies which have diversified into unrelated business due to the licensing system, regulatory controls and high corporate taxes are now looking at the possibility of grouping of these business under one corporate entity, or moving out of their non-core business.

The same business when spread over various companies of an industrial group proves to be an operational handicap, since in the liberalised scenario it would not be possible to support the same business of another entity in the group, with financing and other related business supports without first having to go through the legal procedures of inter corporate loan, guarantees etc. In short restructuring brings about a high degree of focus and flexibility of approach.

The other advantage of encouraging restructuring is to enable weak players in a given industry to seriously consider the option of aligning with or disinvesting in favour of the major players thereby helping industry to consolidate, which in turn prevents sickness in that industry.

For all these reasons, Indian industry needs to significantly restructure and reorganise. The existing legal provisions no doubt covers reorganisation and restructuring, but the cost and the delay are so enormous that it either prevents or dissuades the parties from pushing ahead with their proposals.

To cite an example, if a particular business is to be hived off to another corporate entity it involves certain procedures contemplated by Companies Act and Articles of Association of the company which are not difficult to follow. The resolution of Board of Directors, shareholders and even the approval from FIPB happen at a much faster pace, but thereafter things seems to come to a grinding halt because of the delay in getting approvals for inter corporate investments by the Indian entity.

Companies (Amendment) Ordinance, 1998

The industry was waiting with bated breath for the Government to relax the restrictions on inter-corporate investment contained in section 370 and 372 of the Companies Act. Following the Prime Minister’s initiative, an ordinance was promulgated on 31st October, 1998 amending certain provisions of the Companies Act and also introducing certain new sections. Six new sections have been added in the Act. These additions deal with:

Buy back of Shares;

Issue of sweat equity shares;

Nomination of shares;

Establishment of Investor Education and Protection Fund for transfer of unpaid dividend, application money on any securities, matured deposits, matured debentures etc.

Adherence to accounting standards prescribed while preparing annual accounts; and

Inter Corporate loans and investments.

In addition, certain amendments have been made in the existing provisions of the Act, viz:

Recognition of Infrastructure Development Finance Company Limited as a public financial institution.

Extending facility of nomination by a depositor.

Transfer of unpaid dividend to Investor Education and Protection Fund.

Auditor’s to report for compliance of accounting standards while preparing the annual accounts.

Regarding the provisions relating to buy-back the new section 77-A states that buy back should not exceed 25% of the total paid up capitals and Free Reserves. The Expression Free Reserves has not been defined for the purposes of this section 72-A though the said expression has been defined for the purposes of the new section 372-A.

It is also to be noted that the expression Securities should be defined separately under section 2 of the Companies Act to include Shares.

The existing provisions of the Companies Act, 1956 do not prohibit buy-back of debentures. The debentures which are bought back by a Company can be re-issued. Besides this, a Company has the right to keep the debentures alive for the purposes of re-issue as provided under Section 121. The expression own securities mentioned under sub-section (7) should be modified to read as own shares, failing which a Company has no avail but to cancel the debentures, if any, bought back by it. Perhaps, this was not the intention. Otherwise, the very purpose of Section 121 would be defeated and would be rendered nugatory.

Sub-section (8) provides that a Company which completes a buy-back of its securities shall not make any fresh issue of securities within a period of 24 months except by way of bonus issue or in the discharge of subsisting obligations to issue further shares.

As the expression securities includes debentures also, a Company should not be precluded from issuing further issue of debentures which are non-convertible into equity shares, failing which corporate sector will not be in a position to raise resources for its operations by issuing non-convertible debentures. In fact, even issuance of convertible debenture should not be debarred if such conversion is taking place after the said period of 24 months. It appears that what is sought to be prohibited under sub-section (8) is making of further issue of securities which would result in issue of equity shares and not otherwise. Therefore, it is suggested that the expression further issue of securities is replaced by further issue of shares.

The new section 372-A permits a body corporate to acquire/purchase the securities of any other body corporate upto a limit not exceeding 60% of its Paid-up Capital and Free Reserves or 100% of its Free Reserves which ever is more.

This new Section has clubbed the provisions of Sections 370 and 372 of the Companies Act, 1956. The separate limits of 30% specified in the respective sections for making inter-corporate loans or investments, as the case may be, has been aggregated and accordingly the level of 60% has been arrived at and kept under this Section - of course, with one more alternative limit, thus enabling companies to make inter-corporate loans or investments up to 100% of its free reserves, if elbow room is available. These limits under Section 370 or 372 did not include guarantee facilities, although approval of the shareholders was always necessary before granting such guarantees. Aggregation of the guarantee facilities, therefore, is not advisable and it would be in the fitness of things if guarantees are excluded from the limits specified. Further, corporate guarantees, if any given, are contingent liabilities and it is not advisable to fasten such facilities as a fund based item by including them within the limits stipulated.

It is recommended that the expression Securities be defined to include Shares and exclude guarantees and corporate guarantees to avoid ambiguity.

Restructuring and Amalgamation

The scheme of arrangement for hiving off through process of court under sections 391 to 394 of the Companies Act or transfer of an undertaking with the approval of the shareholders as a going concern attracts enormous amount of stamp duty running to crores of Rupees depending upon the value of the business to be transferred.

Different States in India have different rates of stamp duty and there is a need to harmonise the duty structure so that in the case of reorganisation and restructuring of business, there should be a ceiling on the stamp duty payable on the value of transferred business. Levying stamp duty on ad valerom basis is detrimental and does not supplement the efforts made by the Government to attract foreign investment and state of art technology.

On a legal issue, the Task Force also looked at the provisions of the Companies Act where after a scheme of arrangement is examined and approved by the court under section 394 the entire business along with rights and obligations would vest in the transferee company (section 394(2)) and all that is required to be done thereafter, is filing of the Certified copy of the order with the Registrar of Companies, for registration within 30 days.

An order passed under section 394 is of a vesting nature. It is found that the entire court proceedings take a long time to conclude and after the order is passed, the scheme of arrangement does not take effect. This is because, certain consents, approvals, permits and licenses (collectively called, permits) which the transferor company had obtained in relation to the business to be transferred, will not accrue to the benefit of the transferee company, except through a painful process which both the transferor and transferee companies must go through, before the permits are transferred to, or endorsed, in favour of the transferee company. For e.g. if a cement unit is involved, the transfer of mining lease will require the consent of both State and Central Government and in the case of private lands, the consent of the owners for transfer of surface rights would be required. This is in addition to the transfer of other permits relating to environment, air / water pollution, electricity, water and other contracts with various Governmental agencies.

The Task Force is of the view that an amendment must be made suitably to section 394, to the effect that upon the court passing the vesting order, without any further act or deed all permits and approvals will stand transferred from the transferor to the transferee company and the Government agencies should merely carry out the act of endorsing the transferees name in place of the transferor’s name. If such an amendment is made, then the investing community will benefit and the companies can implement the scheme without delay.

Implications of Stamp Duty on Restructuring

The order passed under section 394 being of a vesting nature, it is inconceivable that the court order should be classified as ‘conveyance’ under the stamp act and subject to payment of exorbitant amounts of stamp duty.

The implications of such provisions of the stamp act is two fold;

It seeks to impose stamp duty on an instrument which is not an executed document between the parties but an executable order of the court and;

By implication it seeks to override the vesting effect of the order under section 394 and make it subject to payment of stamp duty.

It leads to an incongruous position of a State enactment on stamp duty, amending the provisions of Companies Act.

The Task Force has also noted that there exists a provision in the Companies Act under section 396 wherein the Central Government has the power for amalgamation of companies in national interest. The Task Force has not come across any case where this provision has been invoked to enable reorganisation and restructuring of business. The Task Force therefore recommends that the Government either take immediate steps to exempt restructuring of business from stamp duty or rationalise the Stamp Duty structure or issue appropriate guidelines whereby two companies desiring to reorganise and restructure their business can approach Central Government under Section 396.

Filing of Multiple Petitions before High Courts

In matters of restructuring, another factor contributing to delay relates to filing of two different petitions before two High Courts under whose jurisdiction the registered offices of the transferor and the transferee companies are located. It is submitted that if the shareholders have approved the disinvestment leading to restructuring or amalgamation, it should not be made a requirement that two separate petitions should be filed. In the opinion of the Task Force, which is based on the views expressed by various people, it would save a lot of time and expense, if both companies filed a single petition. This will obviate the need to file multiple petitions and hold multiple court convened meetings. The Task Force therefore suggests that in the proposed Company Bill, suitable provisions can be inserted facilitating filing of a single petition before the High Court under whose jurisdiction the registered office of the transferor company is located.

In this context, the Task Force had a dialogue with industry associations and industry representatives who expressed the view that if such a procedure could not be implemented through the Companies Act provisions, then the entire jurisdiction over such matters should be vested with the Company Law Board which can exercise the same powers as the High Courts have. This will bring about expediency, uniformity of approach, besides reducing the burden on the various High Courts, which are already reeling under the load of heavy backlog of cases.

The Section 10 E of the Companies Act deals with the constitution of the Company Law Board. Though the Central Government constitutes the Board, the provisions indicate that it is independent of government intervention in matters of exercise of its jurisdiction. Section 10 F provides that appeals against orders of the Company Law Board can be filed before the concerned High Court. The Company Law Board has been empowered to make its own regulations and accordingly regulations have been framed in 1991. All of this would indicate that there is substantial freedom and independence for the Company Law Board to perform its function independent of ministerial intervention. If this Board is vested with the powers of the High Court on matters relating to re-organisation and restructuring, then it will truly create an agency which deals with affairs relating to companies with a greater degree of focus and alacrity.

Commercial Insolvency – Need for a Separate Tribunal

The need to continue with the body like BIFR was also scrutinized by the Task Force in the context of restructuring and reorganisation of business. The BIFR proceedings tend to convert debt into equity and it also deprives the creditors, secured and unsecured, from proceeding against the company for recovery of money or for bringing about creditors winding up.

The general feeling of the industry was that ‘sickness’ has become a gateway for promoters who have no serious intention of continuing business, but to make quick money. The Task Force does not deny that there may be genuine cases of ‘sickness’, but the fact remains that there has not been much work done in effectively rehabilitating industry which have become sick due to mal-administration, or because they have been exposed to global competition without adequate assistance and expertise to remain in the reckoning.

The Task Force had meetings with the Department of Company Affairs and found that the Department was also in general agreement with the thinking of the Task Force that instead of different agencies, like the Department of Company Affairs, High Court in a winding-up proceeding, BIFR acting under SICA, dealing with situations of sickness bordering on insolvency, these could be dealt with by a single agency.

After going through the provisions of the relevant sections in Companies Act and Sick Industrial Companies Act (SICA), the Task Force has come to the conclusion that the time has come to create a separate tribunal called the Commercial Insolvency Tribunal which will not only take up the cases relating to winding up of company but also deal with revival of companies which have become sick. At the moment a company winding up, has to go separately through the High Court. The tribunal must have the powers which a High Court has, as also the powers which the existing BIFR has. There should be provision making it mandatory for the Tribunal to give its judgment within a period not exceeding one year and the decision of the tribunal should be appealable only to the Supreme Court and that too, on a question of law or for certain errors apparent on the face of the record.

The BIFR was constituted under the Sick Industrial Companies (Special Provisions) Act, 1985. The purpose of BIFR was to deal with potentially sick companies and to take remedial measures. From experience it is found that BIFR is unable to attract any company or agency to take over a sick unit and the current recession is also not helping matters. In addition to this, economies of scale and volumes drive the market in a global competitive scenario and as such the proposition of investing in sick units does not appeal to industrialists. As a result of this, the BIFR will have to take a decision under Section 20 to wind-up a sick company. Here lies the problem, in the sense, that BIFR cannot order winding up but, it has to record its opinion and send it to the concerned High Court and thereafter the High Court will have to proceed in accordance with the provisions of the Companies Act. It therefore serves no purpose to create dual agencies which deal with commercial insolvency.

Just as an indebted individual is open to insolvency proceedings, a corporate which is incapable of meeting its liabilities should be threatened with a strong provision of insolvency, and the Task Force believes that bringing into existence such Tribunal with ample powers, not only to declare the company insolvent but also penalise opportunistic promoters for mismanagement, will help bring about a sense of discipline in corporate behaviour and public accountability.