Corporate Governance from the prism of Companies Act 2013

woman with binocularsIn India, the archaic Companies Act, 1956 was in direct need of a complete revamp especially after a string of high profile scams in the Corporate World. Indian Government, realising the need for a better and comprehensive governance policy for businesses in India that has some global prominence approved the Companies Act, 2013 with the approval of the Indian Parliament and the Executive. In this post read about how Companies Act, 2013 strikes the right chord with prevalent issues in business administration and brings in sweeping changes in the way Companies are governed in India.

Corporate Governance has become imperative in today’s globalized business world especially where corporations need to access global pools of capital, attract & retain the best human capital from across the world, partner with vendors on mega collaborations and to live in harmony with the community.

Corporate Governance gained global business prominence from relative obscurity after a string of high profile scams in the Corporate World.  The Companies Act 2013 strikes the right chord with such prevalent issues and brings in sweeping changes in the way Companies are governed in India.

We are getting close to 1 million registered companies in India and therefore, being a strong company legislation is imperative.  The new Companies Act intends to bring the governance standards at par with the developed nations especially with the introduction of several key provisions (such as Composition and functioning of Board of Directors, Code for Independent directors,  performance evaluation of independent directors, Class Action Suits, Auditor Rotation and Independence and establishment of Serious Fraud Investigation Office).

Board of Directors

The Act recognizes the role of Board as a key component of Corporate Governance & entrusts it with significant responsibilities in order to establish strong internal controls & risk management framework in the Companies.

Besides the Audit Committee, the constitution of Nomination and Remuneration Committee and Stakeholder relationship committee has also been made mandatory in the case of listed, prescribed class of companies.

The new Act also stipulates at least one woman director’s appointment on the Board for listed and prescribed class of companies.

Independent Directors

Concept of Independent directors has been introduced for the first time in Companies Act. The Act also lays down the Qualification, Code of professional conduct (includes assisting companies in implementing best Corporate Governance practices), performance evaluation mechanism and duties of independent directors.  While this is a welcome step, there may be an element of subjectivity while enforcing compliance to these provisions.

Courtesy the new set of provisions, Independent directors would now have greater responsibility to ensure a more vigilant & active board.

Class action suit

The Concept of Class Action suit is prevalent in the Countries like US and UK.  The Indian Companies Act now allow requisite number of members or depositors or any class of them to file an application before the National Company Law Tribunal (NCLT); if they are of opinion that the Management or control of the affairs of the company are being conducted in a manner prejudicial to interests of the Company or its members or depositors.

The average value of a settlement in the US in first half of 2012 was $71 million, a sharp rise from the average value of $46 million over the period 2005-2011.  Major allegations in suits were for Operational shortcomings/product defects (45%), followed by Accounting, Breach of fiduciary duty and Customer / vendor issues.

Audit and Auditors

Auditor rotation has been made mandatory for listed companies and companies belonging to the prescribed class of companies.  In addition, severe penal provisions have been introduced in the act on the Auditors to enforce compliance to the Act.

Most of the Countries do not have the mandatory rotation of audit firms, while they mandate the rotation of audit partners.  Regulators in the UK, the US, and Germany have discussed the topic in the past, but conclude that the potential benefits of mandatory rotation do not outweigh its risks and costs.

Establishment of Serious Fraud Investigation Office (“SFIO”)

Central Government shall establish an office (SFIO) to investigate frauds relating to a company.  Stringent penal provisions have been defined for fraud related offences.

In summary, the Act is a landmark judgment in the Indian Corporate landscape and sets higher standards of Corporate Governance.   The impact of the new pronouncement should not be underestimated and companies and other stakeholders should start evaluating its impact and swift action.  The MCA will have to proactively issue circulars and clarifications so that Companies do not have any difficulty in implementation and henceforth act can be implemented in the right spirit.

Also, click here for detailed information on Companies Act, 2013

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