#Wake-up MCA – Act Amended Through Removal of Difficulties Power Under Section 470

Companies Act, 2013 empowers the Central Government to issue orders to remove any difficulty arising from effectuating the provisions of the Act (Section 470). The CG can make such provisions which are not inconsistent with the provisions of the Act.

The power to remove difficulties has been the subject of judicial interpretation:

In Jalan Trading Co. Private Limited Vs. Mill Mazdoor Union, 1967 AIR  691, 5 member Bench of Supreme Court dealt with this issue and observed that “Power to remove the doubt or difficulty by altering the provisions of the Act would in substance amount to exercise of legislative authority and that cannot be delegated to an executive authority. Sub-section (2) of s. 37 which purports to make the order of the Central Government in such cases final accentuates the vice in sub-section (1), since by enacting that provision the Government. is made the sole judge whether difficulty or doubt has arisen in giving effect to the provisions of the Act, whether it is necessary or expedient to remove the doubt or difficulty, and whether the provision enacted is not inconsistent with the purposes of the Act.

Similarly in Mahadeva Upendra Sinai Etc. vs Union Of India & Ors, 1975 AIR 797, the Supreme Court observed as under-

(2) The existence or arising of a ‘difficulty’ is the sine qua non for the exercise of the power under clause 7 of the 1963-Regulation. The ‘difficulty’ contemplated by the clause must be a difficulty arising in giving effect to the provisions of the Act and not a difficulty arising aliunde. Further, the Central Government can exercise the power under the clause only to the extent it is necessary for applying or giving effect to the Act and no further. It may slightly tinker with the Act to round off angularities and smoothen the joints or remove minor obscurities to make it workable, but it cannot change, disfigure or do violence to the basic structure and primary features of the Act. Under the guise of removing a difficulty, it cannot change the scheme and essential provisions of the Act.”

The above judicial interpretation leads us to conclude that the Central Government is not empowered to exercise legislative power, that is, it cannot change the basic structure and primary features of the Act.

Recently, the Central Government has issued two orders under Section 470 of the Act on 9th July, 2014 and 24th July, 2014.

The order issued on 9th July, 2014 is known as The Companies (Removal of Difficulties) Fifth Order, 2014 and the one issued on 24th July, 2014 is the next in series, i.e., The Companies (Removal of Difficulties) Sixth Order, 2014.

The Fifth Order amends Section 2(76)(v) by replacing the words “or holds” with the words “and holds”.

The Sixth Order amends Section 2(76)(iv) by adding the words “or his relative” after the word manager.

The old and new clauses (iv) and (v) read as under:

Old Clauses

(iv) a private company in which a director or manager is a member or director;

(v) a public company in which a director or manager is a director or holds along with his relatives, more than two percent of its paid-up capital;

New Clauses

(iv) a private company in which a director or manager or his relative is a member or director;

(v) a public company in which a director or manager is a director or and holds along with his relatives, more than two percent of its paid-up capital;

 

Clause (iv)

In clause (iv) ‘or his relative’ has been added on the pretext that “his relative” appears in all sub-clauses (i), (ii), (iii) and (v) and non-occurrence of this phrase has resulted in disharmonious construction.

The reasoning given is without any substance for following reasons:

1. It was a clear legislative intent to leave out the phrase “or his relative” from clause (iv) as it relates to private companies and it would be too burdensome for companies to identify and maintain fair record about membership or directorship of relative of a director or manager. How would a director or manager gain knowledge of his relatives’ membership and directorships in private companies. What if the relatives and the concerned director or manager are not on talking terms? Even if they have good relations, why would any relative disclose his shareholding or directorship in private companies to his relative? This was precisely the reason, the phrase “or his relative” was deliberately and intentionally left out from clause (iv).

2. If we read clause (v), the phrase “or his relative” has been used only in the context of holding shares beyond 2% of the share capital of the Company. It does not per se brings the relatives’ shareholding or directorship within the related party definition. The context is entirely different. The text and the context does not match with the reasoning stated by the Central Government.

Clause (v)

By replacing “or” with “and”, the flavour of the entire clause stands altered. In the garb of difficulty of removal, the Central Government  has changed the entire meaning and construction. The reasoning stated is that ‘or’ has appeared inadvertently and therefore defeats the intention of this clause. How it defats intention is beyond comprehension? In previous clause (iv), the words ‘or’ appears indicating that directorship and membership conditions are in the alternative. In clause (v), how can the Central Government interpret it in its own discretionary way? By replacing “or” with “and”, the conditions have been made simultaneous, resulting in a diametrically opposite meaning.

The Central Government is expected to issue the Orders within purview of law and boundaries laid down by Hon’ble Supreme Court and not tinker with the provisions twisting and turning their meanings on the head.

The seriousness attached with the power needs serious legal attention and the Central Government cannot disfigure the basic structure of the legal provisions as legislated by the Parliament.

Wake-up MCA!!

Ashish Makhija: ashish@ashishmakhija.com

Disclaimer: The views expressed here are views based on my personal interpretation and should not be deemed as legal or professional advise on the subject. If relied upon, the author does not take any responsibility for any liability or non-compliance.

 

 

 

 

 

 

 

 

Implications for Auditors under Companies Act, 2013

Companies Act, 2013 is a huge step forward in the history of corporate legislation. It indicates the way the governance of companies will shape in future. Replacement of the Companies Act, 1956 was on the mind of the legislature for quite some time. Several attempts were made to bring in the new Companies Act but none achieved success. Satyam fiasco was the last nail in the coffin and the Central Government became hugely serious to bring in some semblance of stricter corporate governance rules. The success was achieved in the form of passing of Companies Bill 2011 by Lok Sabha in 2012 and by Rajya Sabha in 2013. The new Act is certainly going to change the way the companies are governed and managed. The seriousness will dawn upon the Corporate Promoters and Directors to effectively treat the companies as a separate legal entity and ensure that the interest of all stakeholders is taken care of. The focus in the new Act is on formation of independent view for the benefit of the Company and its stakeholders. Corporate Governance no longer remains restricted to creation wealth for the shareholders. The new Act ushers in second generation of Corporate Governance practices (2GCG).

 Provisions relating to Auditors

When the change happens, it blows its winds and no one remain unaffected. The auditors have a dominant role to play in corporate governance. The stakeholders place their faith in the report of auditors and the underlying factor for this faith is the independence of the auditors. The auditors have come under flak after series of financial and governance scams in India and the World. The role of auditors has been questioned and it was imperative that changes be made in the Companies Act to strengthen the hands of auditors besides ensuring transparency in their functioning. This objective is sought to be achieved through major changes in the Companies Act. These changes are, however, perceived as strict and draconian by some section of auditors.

Change is always resisted

Any change in status quo always faces stiff resistance. The new era brings in some apprehensions, some confusion and some resistance. Many new provisions, which are bringing joy to the Chartered Accountants in the form of opportunities, are likely to be lost sight of in view of stricter regime favored by new Companies Act. The Chartered Accountants have to unlearn Companies Act, 1956 and relearn Companies Act, 2013. This offers huge opportunity to the youngsters who can take up practice of Corporate Law as their career choice. The Chartered Accountants will have to gear up to compete with their legal counterparts in terms of appearances before the proposed National Company Law Tribunal (NCLT). The resistance to change, in my opinion, will be temporary and fade out with the passage of time.

Term Appointment for Auditors

The new Act brings in major changes relating to appointment of auditors. The auditors will not seek their reappointment at every Annual General Meeting (AGM) of the company. Instead the appointment of auditor will be for tenure until the conclusion of sixth Annual General Meeting. The Annual General Meeting where auditor is appointed will be treated as first Annual General Meeting. This means that auditor’s appointment will now be for a period of 5 years (it could be shorter or longer depending upon when the Annual General Meetings are held) bringing in some sense of security and independence to the auditors. The tenure appointment, however, comes with a rider that at every AGM, the appointment of the auditor is to be ratified. This is minor hiccup as compared to seeking reappointment at every AGM.

Rotation of Auditors

The new Companies Act now provides for rotation of Auditors in certain class of companies. The companies include listed companies without any threshold capital limit and unlisted public companies having paid-up share capital of Rs. 10 Crores or more. Even private limited companies having paid-up share capital of Rs. 20 Crore or more will also require to rotate its auditors. Besides the threshold limit of the paid-up share capital of all companies having pulic borrowings from financial institutions, banks or having public deposits of Rs. 50 Crores or more will also have to rotate their auditors on the expiry of their term. Mercifully the rotation of auditors is not to be done by one-person companies (OPC) and small companies. Small companies are those companies which either have paid up share capital of not exceeding Rs. 50 Lacs or whose turnover does not exceed Rs. 2 Crores. These threshold limits can be enhanced by the Central Government. The auditors face a rotation in the above mentioned class of companies. Within the fraternity, there is a lesser cheer for the provisions relating to the rotation of auditors. The auditors who have been nurturing the companies for a very long period now face the exit from such companies. Even the promoters who have built trust and faith over a particular auditor during last so many years will now have to scout for new and trusted auditors. The rotation of auditors has its own pros and cons. From the corporate governance angle, the rotation of auditor is a welcome step ushering in new era and shaking the complacencies. On the flip side, the auditors who have invested their time and effort in the companies for such a long time will not be allowed to reap benefits when the companies are aiming higher growth. However, this argument may not sustain, as the rotation of auditors will ultimately benefit all auditors.

Five year/ Ten year term for auditors

The rotation of auditors deals with replacing the auditors/ audit firm after one term/ two terms of 5 years each. The rotation of auditor will happen in the class of companies mentioned above after a period of 5 years in case the auditor is an individual and ten years in case the auditor is an audit firm. These provisions are applicable w.e.f. 1st April 2014. It has been clarified by the Ministry of Corporate Affairs (MCA) that for calculating the period of 5 consecutive years or 10 consecutive years, as the case may be, the period for which the individual or the firm has held office as auditor prior to the commencement of the new Act, the same shall be taken into account. The auditor can be re-appointed in the company only after he completes a cooling off period of 5 years, which should be continuous.

Restrictions in Appointment

The new Act disqualifies any auditor or audit firm from appointment in a company if it is associated with the outgoing Auditor of audit firm under the ‘same network’ of audit firms. The term ‘same network’ includes the firms operating or functioning under the same brand name, trade name or common control. The new Act also restrains a partner who is in charge of the firm and certifies the financial statement of the company from being appointed as an auditor for next 5 years. Infact, even if he retires from the said firm and joins another firm of chartered accountants, such firm shall also be ineligible for appointment as auditor for a period of 5 years.

Interestingly the new Act mandates that the class of companies falling under the requirement of mandatory rotation of auditors must comply within 3 years from the date of commencement of the Act. In other words, the companies have been allowed a transitional period of 3 years. This means that even though an auditor has completed his tenure i.e. he has been the auditor of the company for a period of 5 years or more, he can continue to be the auditor for the transitional period as per the choice of the company. The benefit of the transitional period will not be available to any auditor if the company chooses to comply with the provisions of rotation from the word go. The provisions relating to rotation of auditors are revolutionary and mark the beginning of new era for which the auditors have not been used to so far. The reality is here and its acceptance will do a lot of good to the auditors.

Certificate by the Auditor

 Every auditor is now required to submit a certificate indicating:

a)    That he is eligible for appointment and is not disqualified for appointment under the Companies Act, 2013, Chartered Accountants Act, 1949 and the Rules and regulations made thereunder;

b)   The Appointment will be as per the term provided under the Act;

c)    The appointment is within the limits laid down by the Act;

d)   The list of proceedings against the auditor or audit firm or any partner of the audit firm pending with respect to professional matters of conduct.

There has been some confusion as to interpretation of term “professional matters of conduct”.

Significance of ‘Relative’ for the Auditors

The transactions with the relative always occupy significant attention under any corporate law. Transactions with relative required disclosure as well as special permission in the form of special resolution and/or Central Government approvals. Certain transactions with relatives were prohibited. The concept of Related Parties and relatives has attained a different level under the new Companies Act. There are severe restrictions for transactions by a company with related parties. The focus of having transactions with Related Parties has always been connected with the management and governance of the Company. The auditors had largely remained untouched with the concept of ‘Relative’. The new Act, however, brings in the concept of the relative for the auditor and it makes ineligible a person for appointment as an auditor of the Company if his relative:

a)   Holds any security or interest in the company, its subsidiary, its holding or associate company or its co-subsidiary for more than Rs. 1 Lac;

b)   Is indebted to the Company its subsidiary, its holding or associate company or its co-subsidiary in excess of Rs. 5 Lacs;

c)    Has given a guarantee or provided any security to the Company its subsidiary, its holding or associate company or its co-subsidiary for amount of Rs. 2 Lacs or more.

The implication of the above provision is that now every auditor will have to keep a tab on the financial relationship of his relatives with the company in which he is the auditor or aspires to be the auditor. Unfortunately the requirement is not one time –  to be seen at the time of appointment – but the provisions mandate that as and when the auditor incurs any of the disqualifications, he shall vacate his office as auditor. In other words, the disqualification provision including the financial transaction of relatives with the company are to be checked on a continuous basis. This makes the process very complicated, difficult and impracticable for auditors to comply. In my opinion these provisions require amendment to bring in some relief to the auditors.

Auditor not to render certain services

 An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:—

(a) accounting and book keeping services;

(b) internal audit;

(c) design and implementation of any financial information system;

(d) actuarial services;

(e) investment advisory services;

(f) investment banking services;

(g) rendering of outsourced financial services;

(h) management services; and

(i) any other kind of services as may be prescribed

These services do not include services rendered by the Auditor connected with taxation and corporate law. In other words, rendering of such services is not prohibited under the new Companies Act.

Conclusion

 The provisions relating to auditors have large ramifications on the auditors. Auditors must embrace these provisions and take them into their stride. In long term, the provisions will prove to be fruitful for the entire fraternity. It is, however, imperative that concerns of the auditors is addressed by way of amendments or clarifications, which will go a long way in lifting the stifled spirits of the auditors. The auditing fraternity, on its part, must send out a signal of re-assurance to the stakeholders that they will remain independent and will not allow any minor irregularity to escape their attention. The last word is yet to be written on this.