CORPORATE LAW AND GOVERNANCE

1. CORPORATE LAW AND GOVERNANCE A. B. Suraj PGP – Business Law

2. Relevant Themes Form of Business entity: Proportional regulation Role and Responsibility of Actors: Promoters; Directors and Shareholders Corporate Governance: Normative framework to Enforcement mechanisms Process and Procedure of Corporate Restructuring: Transparency requirements

3. 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 shareholder’s agreement

4. 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”

5. 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

6. 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

7. 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

8. 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

9. 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

10. “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

11. 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

12. Criminal Liability … Tests for Prosecution of a Corporation: Nature and seriousness of crime Complicity and pervasiveness within the Company History of similar conduct Corporation’s 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”

13. Criminal Liability … Rationale for Criminal liability = enormous influence on economy Strict degree of Vicarious criminal liability – attribution of “collective mens rea” of Executives Gross negligence or breach of duty Test of “Organizational approach” Applies to Partnerships/Trusts/Unions too Statutory compliances also covered for liability

14. 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

15. Culpability of Corporations Crime committed by an employee despite strong Corporate policy against it? Crimes committed by contractors/ consultants? Crimes committed in ignorance or wrong understanding of law? Serious frauds committed by senior management?

16. Enforcement of Corporate Governance

17. 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

18. Legal Duty of CareDirector Vs. An Agent Fiduciary in nature Has to only benefit Company’s interest Has to make up Losses caused + Profits made Unequal position with shareholders Responsible to minority shareholders and Society as well Contractual nature Self-interest may also be served Has to compensate only for the losses Equal negotiating capacity of parties Responsible only to the other Party

19. 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 Listed Companies – monitor aggregation of capital

20. 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

21. Mandatory disclosures On related party transactions and “arm’s length” justifications Accounting and Risk Management practices Complete details of Directors’ remuneration – including Stock options; other perks and perquisites Disclosure of any Contingent Liability

22. 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

23. 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

24. Corporate Restructuring Companies Act – allows for any scheme of restructuring and reorganization of company Internal restructuring/ Winding up/ M&As/ Takeover Does not cover buy-back of shares; mere acquisition of property Fairness is the basis for evaluating the entire process 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

25. 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

26. 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

27. 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?