CORPORATE LAW AND GOVERNANCE

A. B. Suraj
PGP Business Law

Relevant Themes

Form of Business entity: Proportional regulation

Role and Responsibility of Actors: Promoters;
Directors and Shareholders Enforcement mechanisms

Corporate Governance: Normative framework to Process and Procedure of Corporate Restructuring:

Transparency requirements

Formation of a Company

Company = organization of persons and funds for common purpose

Only an Incorporation makes it a legal entity registration under Companies Act, 1956 conclusive proof of valid formation

Memorandum and Articles of Association also shareholders agreement

Promoter of a Company

Promoter = one who promotes the formation of the company entrepreneur Personally liable for contracts before completion of the incorporation process Fiduciary relationship and legitimate expenses are payable sweat equity

Objects Clause

MoA Main, Ancillary and Other Objects

Investor protection and as caution to outsiders Doctrine of Ultra Vires exceeding the legal power

Ultra vires actions are not binding on the Company however beneficial they are

Articles of Association

For internal management rules for day-to-day activities

Rule of Constructive notice = presumed knowledge of the AoA by anybody dealing with the Company Rule of indoor management an exception of procedural compliance to protect external interests with reasonable efforts

Corporate Entity Principles

Independent of shareholders Saloman case

Capacity to sue and to be sued Perpetual succession; common seal; limited liability Multiple relationships possible with an individual Director, Creditor, Shareholder, Employee

Company Contracts

Company can authorize any person to enter into contracts on its behalf express or implied or ostensible authority
Even oral agreements even without seal

Pre-incorporation contracts valid only if ratified freshly by the Company

Role of Directors

Board of Directors Principal Body

Remuneration generally not >11% of net profits

One Director chosen for management need not be a shareholder

Fiduciary Duty to take care and statutory duties

Difference between ownership and control elected and voting powers except for nominees; government; debenture trustee

Control

Controlling stake = treated as Promoters

Control Powers = Proactive (positive) and Reactive (Negative)

Regulation 2(1)(c) of the Takeover Code to include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner Full and effective control usually the Board of Directors

Protective rights of financial investors Negative in nature

Board representation; quorum rights; supermajority rights Not absolute; at best a veto power; usually by a single nominee

Corporate Veil

Natural persons behind the legal entity Commission of Crimes Tax evasion Fraudulent intent To distinguish between holding and subsidiary Where the Company is being used as an agent of the shareholders/directors
Corporate Criminal Liability principles Corporate Manslaughter and Corporate Homicide Act, 2007 in UK = if Company is negligent - senior management liable Whistleblower policy still at infancy in India

Criminal Liability

Tests for Prosecution of a Corporation:

Nature and seriousness of crime Complicity and pervasiveness within the Company History of similar conduct Corporations timely, voluntary disclosure and cooperative efforts Presence of a compliance and ethics code

Prosecution = combined efforts of the Corporation and the Investigating Authorities

Concern of confidential information

Criminal Liability

Rationale for Criminal liability = enormous influence on economy

Gross negligence or breach of duty Test of Organizational approach

Strict degree of Vicarious criminal liability attribution of collective mens rea of Executives

Applies to Partnerships/Trusts/Unions too Statutory compliances also covered for liability

Criminal Liability

Fundamental Rights of a Corporation

Fair trial = Procedural safeguards Issue of Political funding

Punishments for Corporations:

Restitution; Fines; Probation under Court supervision; Forfeiture clauses; and Public apologies

Culpability of Corporations

Crime committed by an employee despite strong Corporate policy against it?

Crimes committed by contractors/ consultants? Crimes committed in understanding of law? ignorance or wrong

Serious frauds committed by senior management?

Enforcement of Corporate Governance

Review of Managerial Decisions

Concept of Fiduciary duty different from best practices; norms; aspirations

Due care and good faith to be demonstrated in all actions

Interest of the company and law as an objective

Compliance requires fiduciary discharge of functions

Document actions/decisions extensively

Legal Duty of Care Director Vs. An Agent

Fiduciary in nature
Has to only benefit Companys interest

Contractual nature
Self-interest may also be served

Has to make up Losses caused + Profits made

Unequal position with shareholders Responsible to minority shareholders and Society as well

Has to compensate only for the losses

Equal negotiating capacity of parties Responsible only to the other Party

Elements of Corporate Governance

In India Clause 49 of the Listing Agreement between a Company and Stock Exchanges introduced in 2000

In addition to other SEBI Rules and Regulations

In the US Public Company Accounting Reform and Investor Protection Act, 2002 also known as Sarbanes-Oxley Act

DIP Guidelines of SEBI in 2000 itself

Accountability imposed on Public and Companies monitor aggregation of capital

Listed

Elements of Corporate Governance

Composition of the Board 1/3rd to 50% of IDs on the basis of nature of leadership
Independent Directors elaborate guidelines to determine independence Qualified and Independent Audit Committee for mainly Financial matters Management Discussion and Analysis Report on Company prospects as evaluated by the Board CEO/CFO certifying compliance by a declaration

Mandatory disclosures

On related party transactions and arms length justifications

Accounting and Risk Management practices Complete details of Directors remuneration including Stock options; other perks and perquisites Disclosure of any Contingent Liability

Trends in enforcement

Moving from principles-based to rule-based Weak regulatory oversight and monitoring Prevalent management override Empower IDs more exclusive meetings Minority shareholders not strong despite legal powers Skill sets of Auditors and Managers Effectiveness of the Board of Directors needs to be evaluated Risk management no process in place Remuneration of top management (CEOs) Ethical values and their relevance/enforcement CG specialists to be built as a professional team

Issues for Discussion

Objective of Corporate Governance maximization of shareholder value vs. governance norms

Various stakeholders interests especially of a big company

Directors of a Company are like Ministers of the Government Collective responsibility Accountable to not only the enfranchised stakeholders Enforceability of CG adequacy of institutional and legal regime SEBI is the only regulator Corporate Social Responsibility a much wider and timely initiative OECD Guidelines and related mechanisms

Corporate Restructuring

Companies Act allows for any scheme restructuring and reorganization of company

of

Internal restructuring/ Winding up/ M&As/ Takeover

Fairness is the basis for evaluating the entire process

Does not cover buy-back of shares; mere acquisition of property

Any arrangement facilitated even if ultra vires the MoA Objects benefit evaluated Fair value of assets and shares contextual and based on relevant facts; no set rule or process

Restructuring

High Court to approve the scheme of merger

NCLT proposed as a single-window Fair, just and reasonable review not on merits Public policy; Third Party interests (creditors, employees)

Due diligence based process

Fair disclosure of bases for valuation

Best judgement by BoD of the target

Regulated by Competition Law principles

Case Study Issues

Regulatory bodies in Indian Corporate Law

Ministry of Company Affairs; Company Law Board; High Court; SEBI; and the Competition Commission (in specific circumstances) What if foreign Companies are involved? Public interest domain scope and content?

Validity and legitimacy of a personal contract and shareholder resolutions

Have not the Companies endorsed the Contract? Remedy available for Minority shareholders? IT benefits available only if transfer is by a minimum of 75% of the shareholders of the transferor towards maintaining majority and uniting of interests and seamless continuity

Case Study Issues

Standing of creditors and employees/ labour workforce

Not in decision-making; but in protection of interests What if the transferor-Company is declared as being a Sick Company?

Transfer of all assets and liabilities

Rights; IPRs; Privileges; Powers; beneficial Contracts Does it amount to Sale? Capital gains? Benefits of contracts? Status of Employees?