Francisco A. Laguna & Annapurna Nandyal
In last week’s post, we highlighted some of the new concepts and changes introduced by India’s Companies Act, 2013 (the “Act”). Today, we explore some of the critiques of the Act and its potential impacts.
Many detractors of the Act still consider it inadequate compared to the legislation governing companies in many jurisdictions. Moreover, several provisions will not enter into force immediately: public comments continue to be reviewed, and the Indian Government must draft various rules and regulations to implement them.
The Act was rolled out in two sessions, with feedback on the 1st Phase rules to be submitted by 10 October and feedback on the 2nd Phase rules to be provided by 23 October. Many have argued that the whole Act should have entered into force at one time, to avoid confusion. In addition, the lack of clarity in certain provisions has resulted in criticism by auditors, lawyers and finance professionals.
For instance, the Act now prohibits an investment structure that involves more than two layers of “investment companies” in India, subject to two specific exceptions: (a) allowing Indian companies to acquire offshore companies, which, in turn, have subsidiaries beyond two levels; and (b) in cases where a company needs to have more than two layers of investment companies in order to comply with the law. The change is to limit tax avoidance through multiple holding company structures. However, it will have an impact on structuring down-stream foreign investment through holding companies in India. It may particularly affect sectors such as infrastructure and mining where it is common to have multiple subsidiaries for implementing projects and fund-raising. Also, there is a lack of clarity on the fate of existing structures, and whether they will be grandfathered.
The Act provides that foreign companies in India need to furnish incorporation papers, among others, to the Registrar of Companies, display their names indicating country of origin, etc., but since the term “foreign company” is not defined clearly, it has created confusion leaving interpretation problems between former laws and the Act.
Another major impact of the Act is in the area of Corporate Social Responsibility (CSR). Before the introduction of the Act, CSR remained voluntary. Companies typically engaged in CSR projects to mitigate risks, boost employee morale, make business practices more sustainable and impact the consumer market. However, the Act makes CSR a governmental policy, threatening the fundamentals of the basic concept. Opponents worry that mandatory CSR could lead to indirect lobbying, whereby Indian corporations attempt to use CSR spending to benefit politicians in power, thereby continuing to fuel corruption.
To protect investors and to tackle corporate fraud, the Act now allows “class action” lawsuits and gives the government’s investigative arm, the Serious Fraud Investigation Office (“SFIO”), additional statutory powers. Experts argue that class action suits may be misused for frivolous litigation and note that the courts will need to be judicious when considering whether to accept such cases. Many wonder whether the government will provide the SFIO the necessary infrastructure to exercise its oversight power, or whether it is just another gimmick by the authorities.
The Act provides for mandatory auditor rotation for listed and other prescribed companies every five years, depending on whether the auditor is an individual or a firm. One of the risks posed by mandatory audit term is the loss of historical expertise in the manner in which the company operates. This could have a huge negative impact on the functioning of a company.
Though the Act poses challenges to corporate India, it is largely seen as an initial step to meeting the much-needed objective of improving the country’s investment climate. TransLegal has assisted clients in India on issues involving corporate law, genetically modified organisms, franchises, food labeling and importation requirements. Call us with your questions on doing business in India.