The history of legislation on inter-corporate investments has been one of gradual liberalisation.
Earlier, the Companies Act, 1956, regulated investments with limits of 10 per cent of the investee company's capital and 20 per cent of its net worth for aggregate investment in companies in the same group and 30 per cent of its net worth for aggregate investment subject to the board's approval. For investment beyond these limits, shareholder and central government approval was necessary. Similar limits were laid down for inter-corporate loans separately.
Subsequently, the law was liberalised to give flexibility to the board of directors, by unanimous vote, to give aggregate inter-corporate loans or investments as one pool up to 60 per cent of its net worth or 100 per cent of its free reserves and to exceed these by special resolution of the shareholders. This liberalisation enabled Satyam to sanction the huge Maytas investment.
Section 297 would still have required central government approval for transactions with related parties. However, whether investing the bulk of its net worth in a new business (on a group basis) violates the spirit of Section 149 -- ie commencing a new business which requires shareholders' approval -- is a moot question. The letter of the law does not, but certainly corporate governance does. How does the Companies Bill, 2008, change the law on inter-corporate investments?
The restrictions on inter-corporate loans and investments have been increased substantially, while a serious drafting error has also occurred. It now restricts investments and loans to or providing security for or guaranteeing to any 'person' and not just to a body corporate as at present.
Such investments, to be approved unanimously by the board, to a person or company cannot exceed 60 per cent of its net worth or 100 per cent of its free reserves, except by the shareholders' consent. The proposed utilisation has to be disclosed in the financial statements. Currently, share premium is classified by a deeming provision as free reserves; this legal provision has been omitted, thus reducing investment capacity.
The major drafting error is that the upper limits of 60 per cent and 100 per cent, which are currently applicable to all aggregate corporate investments etc, have now been made applicable to investments etc, to one person and not in the aggregate. Thus, a company may give three loans to three corporates, each equal to 50 per cent of the net worth aggregating 150 per cent of the net worth!!
Thanks to Ketan Parekh, a welcome amendment is that all notified classes of capital market intermediary companies including share brokers, merchant bankers, etc, cannot take any inter-corporate loan or deposit exceeding the prescribed limit. These should be extended to commodity market exchange intermediaries also. The commodity price bubble worldwide is recent history.
In a controversial move, the Bill does not allow deposits from the public by not providing for the process for acceptance of deposits from the public by any non-NBFC company. For NBFCs, the credit rating and repayment record has to be disclosed in the information circular.
Prohibitory penalties ranging from Rs 1 crore (Rs 10 million) to Rs 10 crore (Rs 100 million) have been provided for on the company and officer responsible in case of default; personal liability extends to responsible officers for all losses and damages to depositors in case of fraud.
Deposits, which are outstanding with companies at the commencement of the new Act, have to be repaid within 12 months of such commencement; or of reschedulement sanctioned by the Tribunal. For violations, prohibitory penalties follow.
Shares with differential voting rights were introduced in the Companies Act, 1956, in 2000 but find no place in this Bill. In 2008, two large corporates including Tata Steel successfully came out with such issues; and it is now becoming popular. Indeed it is an ideal instrument for companies with low promoter voting control or for the public sector banks and companies to use, whereby they raise equity without losing promoter or government control on voting power. Status quo ante should be restored.
The institution of professionals (CAs, lawyers, etc) as administrators is being given a regulatory framework by the Bill as a fast-track professionally-managed mechanism for business recovery.
Unsuccessful secured creditors demanding repayment of 50 per cent or such companies themselves can move application to the tribunal. An interim administrator gets appointed within seven days. A revival plan is to be filed by the company or the interim administrator; it then needs the approval of the secured creditors of 75 per cent of the dues; thereafter a regular administrator gets appointed.
He has the right to manage under the consultative advice of a committee of creditors.
If the plan is approved by the committee of creditors and thereafter by the tribunal, then all proceedings under SARFAESI Act, BIFR, or the liquidator abate. The revival scheme can plan for sale of the whole of the undertaking and the proper application of these proceeds.
In case the scheme fails in its implementation, the tribunal may refer the company to liquidation. This new process gives primacy to the creditors; gives management powers to professionals; and can provide for mergers, takeovers and change of shareholding. It should be much more effective. The process time at each stage needs to be reduced and made efficacious.
Most importantly, it will have to be supported by an RBI policy of extending fresh credit support on the lines of the corporate debt restructuring schemes. RBI's rules on the provisioning of the NPA totally discourage any bank from giving fresh credit to any NPA company even in turnaround mode or even after one-time settlement payment as the borrower is classified as substandard asset for one year. Perhaps, a quota of 1 per cent of credit should be made for such loans in OTS cases without provisioning being required subject to viability study. This is the single most crucial factor for revival together with good management infusion.
The author is managing partner of S S Kothari Mehta & Co. He can be contacted at ks.mehta@sskmin.com
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