Company Law II Parvathi Bakshi

B.A., LL.B. | 2015-2020

Company II

Corporations and Corporate Governance (Friedman on objectives of a company)

- Agency problems in a corporation – when welfare of one party termed the
principal depends upon actions of the agent i.e. the problem is in motivating
the agent to act in the principal’s interest rather than in their own.
1. Conflict between the firm’s owners and its hired managers – whether
the managers are responsive to owners interests
2. Conflict between, owners who possess the majority or controlling
inters and minority or non-controlling owners. (Non-controlling as
principals and controlling as agents) – former should not exploiting the
latter
3. Conflict between the firm itself – including its owners-and the other
parties with whom the firm contracts such as creditors, employees and
customers – whether the firm as an agent behaves opportunistically
towards other principles
- Core difficulty – agent often has better information than the principal about
relevant facts and thus actions might not be precisely as promised
- Multiple principals will face coordination cost – coordination difficulty
amongst principals leads to delegating to agents – further when principals
can’t agree then delegating the work to the agent becomes difficult

Legal Strategy for Reducing Agency Costs

- Disclosure requirements from agents
- Facilitating actions against agents
- Penalties for agents
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

Regulatory
- Prescriptive
- Substantive terms which govern
the content of the principal-agent
relationship
- Direct effect on agent’s behaviour
(i.e. usually constraint)
- High dependency on external
authorities such as courts or
regulatory bodies/institutions
- Rules & Standards – prohibition
of specific behaviour; general
standards; protection of principals
interests
Governance
- Facilitate principals’ control over
agent’s behaviour
- Depends on the principals ability
to exercise their control rights
- However this results in high
coordination costs between
principals and thus less effective
against agency costs

Key Points
• Information Asymmetry
• Majority
• India has a closely held shareholding
• Coordination costs amongst disbursed shares is high
• Protection of non-controlling shareholders
• Why are companies willing to go for stronger governance rules?
o Helps in a better reputation as a good company
• Regulations
o Intended consequences
o Unintended consequences
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

Potential Problems With Different Shareholding Patterns

§ Closely held business – Owners with long term interests in the company can
offer stability and proprietary oversight to ensure efficiencies but can also
potentially inflict costs of extraction of private benefits of control to the
exclusion of other shareholders.
§ What are the forms it takes –
a. raises probability of price manipulation.
b. Also, by making it easier for the controlling shareholders to use related party
transactions (RPTs) as a vehicle for illegitimate expropriation of corporate
value at the cost of minority shareholders’ interest.
c. This pattern of ownership gives rise to serious potential conflicts of interest
between the promoter group and the minority investors.

Dispersed Shareholding Problems - The managerial model of the corporation

prevalent in the US and UK, with dispersed ownership, while avoiding the demerits of
the dominant ownership can and often does exhibit agency costs arising from
fundamental non-congruence between shareholder and manager interests. These are
generally manifested in the form of unconscionable executive compensation, bonuses
and severance terms, besides use of corporate funds and resources for personal
aggrandisement, self-seeking philanthropy, overly risky business practices, leveraged
buyouts and manipulative gains on stock options through creative earnings
management, self-dealings, and so on

Shareholding pattern in India - The share of promoters in NSE listed companies

rose from 47.7 percent in March 2002 to 57.8 percent in March 2010, but fell
subsequently to 53.7 percent in March 2013. The picture is not very different for the
top companies. Second, a large number of companies in India are grouped together
under the common control of a single shareholder or family. In other words, not only
are most firms effectively controlled by a promoter group, but the same promoter
group often controls a large number of firms.
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

DIRECTORS

Section 2(34) of the Companies Act, 2013 (Companies Act) – ‘director’ means a
director appointed to the Board of a company.

Section 2(10) of the Companies Act – ‘Board of Directors’ or ‘Board’, in relation to a

company, means the collective body of the directors of the company.

Role of Directors -
• Directors as Agents – the general principle of agency is applicable – where the
director(s) contract in the name, and on behalf of the company, it is the company
that is liable on it and not the directors.
• The acts of the directors can only be attributed to the company if the directors
were, like an agent, authorized to do the same on behalf of the company –
Doctrine of Ultra Vires
• Like agents, the directors are required to disclose their personal interest, if any, in
any transaction of the company.
• Directors as Trustees – the directors are persons selected to manage the affairs of
the company for the benefit of the shareholders (And not stakeholders?? –
Charanjit Lal Chowdhury v. Union of India, AIR 1951 SC 41). It is an office of
trust, which if they undertake, it is their duty to perform fully and entirely.
• Some of their duties to the company are of the same nature as those of a trustee.
For example – the power (1) to make business decisions, (2) to forfeit shares, (3)
to issue further capital, (4) the general powers of management, and (5) the power
to accept or refuse a transfer of shares – are all powers in trust, which have to be
exercised in good faith for the benefit of the company as a whole.
• Yet directors are not trustees in the real sense of the world – a trustee is the legal
owner of the trust property and contracts in his name. A director, on the other
hand, is a paid agent or officer of the company and contracts for the company.
• Further, it is important to note that the directors are the agents and trustees of the
company and not of its individual members
• Directors as Officers of the company – the directors are also treated as an
employee for the purposes of the Company Act.
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

Cases:
1. RNRL vs. RIL
2. Tristar Consultants vs. V Customer Services India Pvt.

KINDS OF DIRECTORS – Appointment & Qualification

a. S 149 – Board of Directors + Independent Director

b. S 151 – Small Shareholder Director
c. S 152 – Appointment of Director + Retirement
d. S 161 – Additional, alternate and nominee director
e. S 162 and S 163 – Voting for appointment
f. S 164 – Disqualifications for appointment
g. S 165 – Number of directorships
h. S 166 – Duties of Directors
i. S 169 – Removal of directors
j. S 170 – Shareholding of directors and KMPs

“Section 149 of the Companies Act – Company to have Board of Directors – (1)
Every company shall have a Board of Directors consisting of individuals as directors
and shall have …”

The director has two sources of power:

Ø The Articles of Association
Ø The Board Resolution conferring power: If the board approves the director’s
actions, the company cannot then say that the action was not authorized even
if it against the AOA

1. Executive – Rule 21(k) Companies Specification of Definition Rules

a. S. 2(94) - Whole-time director is whole-time employment of the company

2. Independent – S.149 - Who? – means a director other than a managing director

or a whole-time director or a nominee director
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

a. Eligibility/qualification under S. 149(6)

i. Appointment Rule 5 of Companies (appointment & qualifications
of directors) rules 2014 - An independent director shall possess
appropriate skills, experience and knowledge in one or more fields
of finance, law, management, sales, marketing, administration,
research, corporate governance, technical operations or other
disciplines related to the company’s business.
ii. Appointment should be done in accordance with Section 150 of the
Companies Act, Rule 6 of the Companies (Appointment and
Qualifications of Directors) Rules, 2014 [Rule 6 - creation and
maintenance of databank of persons offering to become
independent directors] and Schedule IV of the Companies Act.
b. Duties – Schedule IV
c. Committees:
i. CSR - The Act provides that every company having net worth of
rupees five hundred crore or turnover of rupees one thousand
crores or more or a net profit of rupees five crores or more during
any financial year shall constitute a CSR Committee of the Board
consisting of three or more directors, out of which at least one
director shall be an independent director. This provision has been
included so that independent directors can keep a check on the
workings of the CSR committee.
ii. Audit Committee S.177 - The Act requires that the Board of every
listed company & such other companies as may be prescribed shall
constitute an Audit committee which shall consist of a minimum of
three directors with independent ones forming a majority
iii. Nomination & Remuneration Committee S.178 - The Act requires
that the Board of every listed company & such other companies as
may be prescribed shall constitute an NRC consisting of three or
more non-executive directors out of which not less than one-half
shall be independent directors.
d. S.149(3) & (4) Why is the requirement of independent director limited to a
few? Because this director becomes liable for all the penalties etc. and
more likely to keep the other directors in check.
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

e. S.149(6)- Independence and professional independence

i. As to qualifications – people in relation to the company are
allowed and the definition is very broad so it can be a post
occupied by friends etc.
f. Pecuniary interest is specific to the amount/remuneration the director
receives on their own i.e. it is directly correlated with them.
g. Mandatory roles are towards the shareholders i.e. audit committee and
nomination & remuneration committee
h. The rest are discretionary roles

Appointment of first directors and directors at general meeting - Non-rotational

and Rotational Directors

Retirement by rotation is a process whereby at each Annual General Meeting (AGM)

one third of the directors must retire from their position and seek re-election as a
director.

Section 152

• Non- rotational directors – • Generally non-rotational –

o Independent Directors o Managing Director
o Small shareholders director o Full-time Director
appointed u/s 151; o Directors appointed under S.
o Director appointed u/s 161
242(1)k of this act by the
NCLT;
o Director appointed By BIFR
u/s 16(4) of SICA

Section 152(6)(a) – a person whose period of office is liable to determination by

retirement of directors by rotation;
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

Total no. Total no of Total no. of Total no. of No of Whether

of executive non- rotational retiring executive
directors directors rotational (arrived at S.152(6)(c) director will
(assumed) [Independent] by 10-4) retire.1
10 3 4 10-4 = 6 4 x 1/3 = 1 No
6 x 2/3 = 4
12 3 3 12-3 = 9 6 x 1/3 = 2 No
9 x 2/3 = 6

This is an important exercise to help in drafting of appointment letters.

Sec. 152(7)(a) – vacancy of retiring director

Appointment of Director, other than a retiring director

Section 160 – right of persons other than retiring directors to stand for directorship

Rule 13 of the Companies (Appointment and Qualifications of Directors) Rules, 2014

- notice of candidature of a person for directorship

3. Additional – S.161
a. Any person appointed by the power of the Board, which comes from the
Articles. No person who is rejected in a GM. Holds office up to the date of
the next AGM.
b. Tenure – If a meeting is not held, the earlier of the following dates
i. Section 96 – within 6 months of ending of financial year i.e. 30th
September
ii. 15 months from AGM

4. Alternate – S.161(2) – only absence of another director

1
There is no need to retire an executive director because of the 6 rotational directors
(10-4 = 6), 3 are executive (given) and 3 are non-executive. Thus the non-executive
director would be retired.
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

a. Powers are precisely the same as an original director

5. Nominee – S.161(3)
6. Vacancy – S.161(4)
7. S.149(1)(b) – cannot be more than 15 members. In case of vacancy and alternative
especially, the original appointment is he/she is the 16th director is invalid.
8. Small-shareholder – S.151
a. Because independent directors didn’t address small-shareholders i.e.
brings up agency cost of majority/minority controlling issue
b. It is still a discretionary power since it is not mandatory to have the
director appointed for representing small-shareholders
c. Rule 7 Clause 5 of Companies Rules (Appointment and Qualification of
Directors)
i. The appointment of small shareholders’ director shall be subject to
the provisions of section 152 except that- (a) such director shall not
be liable to retire by rotation; (b) such director’s tenure as small
shareholders’ director shall not exceed a period of three
consecutive years; and (c) on the expiry of the tenure, such director
shall not be eligible for re-appointment.
9. India resident – S.149
a. For taxation purposes of the director
10. Woman – S.149 – this is problematic as qualified women are overstepped and the
appointment is given to a relative.

Section 162 – Appointment of Directors to be Voted Individually

Section 163 – Option to Adopt Principle of Proportional Representation for
Appointment of Directors
Representative Voting – by one of two ways:
Single Transferable voting Cumulative Voting
Under this system, each shareholder Under this system, each shareholder is
irrespective of his shareholding is entitled entitled to have number of votes as per
for one vote per post of directors to be his shareholding. For example, let us take
appointed. For example, let us take a a situation where a shareholder has 500
situation where there are five posts of number of shares in a company and there
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

directors to be appointed in a company are 05 number of directors to be elected

out of a total of eight candidates. Here out of a total of 08 candidates. Here he is
each shareholder irrespective of number eligible to cast 500*5=2500 number of
of shares he holds can cast one vote each votes. He can use all these votes for a
in favour of up to five candidates. Five single candidate or he can divide his
candidates getting the highest number of votes amongst all the candidates.
votes in order will get elected.

Disqualification for Appointment

Section 164 – disqualification for appointment of director (to both public and private
companies) and contrary to its predecessor (1956 act), these disqualifications cannot
be relaxed by the Central Govt. and are absolute
164(d) ‘Otherwise’ includes conviction for any offence under the 2013 or 1956 Act
by the Court

Section 176 – All acts of a director under this section are not invalidated till the
company gets to know about it.
o Subsequent to the appoint
o Till you find out the act, it is not invalidated

Vacation of office of a director – provides the grounds and circumstances under

which (1) the office of a director shall become vacant/a person shall vacate the office
as a director.

Section 167 – Vacation of office of Director

How is the 12 month period counted? a.) Financial year, or b.) 12 months from
the AGM, or c.) 12 months from every Board Meeting?

Section 167(4) - A private company cannot circumvent the provisions of Section 169
of the Companies Act in the guise of including additional grounds in its AOA for the
vacation of office by directors. Whenever any such additional grounds included in the
AOA virtually results in the removal of a director, the company can only exercise the
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

power in this behalf in general meetings as contemplated by Section 169 of the

Companies Act. Any power given in the AOA to the BOD in the manner would not
be effective in law in view of Section 6 of the Companies Act.

Resignation - Section 168 – resignation of a director

Removal – Section 169 – Removal of directors

Duties Of Directors S.166

- There was no provision like section 166 in the 1956 act.

- The J.J. Irani committee was of the view that the Indian law should be in-line
with international practices that contain few duties of directors inviting civil
consequences for non-performance. The committee was in favor of a non-
exhaustive list of duties.

Section 166 – duties of directors

- Fiduciary duty – Clause III(12) of Sched.IV prescribes that a director should
act within the authority and assist in protecting the legitimate interests of the
company, shareholders and employees
o Utmost good faith
o Utmost care, skill and diligence
o In the interest of the company they represent.

Section 170 – shareholding of directors and KMPs

Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

BOARD
a. S 173- Meetings of Board
b. S 174 – Quorum for meetings of Board
c. S 175 – Passing of Resolution by Circulation
d. S 176 – Defect in appointment
e. S 177 – Audit Committee
f. S 178 – Nom. and remuneration comm. + Stakeholders R. Comm
g. S. 179 – Powers of Board
h. S. 180 – Restriction on Power of Board
i. S 184 – Disclosure of interest by director
j. S 188 – Related party transactions
k. S 189 – Register of contracts with interested directors
§ Chapter XIII – Appointment and remuneration Key Managerial Personnels
a. S 197 – Overall max. remuneration
b. S 199 – recovery of remuneration in cases
§ Chapter IX – Accounts of Companies
a. S 129 – Financial statements
b. S 138 – Internal audit

MEETINGS OF THE BOARD - Section 173

Section 173 provides a bare minimum that the BoD must accomplish (one meeting
every 120 days). After incorporation, a meeting must be held within the first month.

Clause 2 provides for video conferencing or audio visual means in the event that a
director may not be able to physically attend. However, these are subject to Rule 4
which cannot be attended by audio visual means. 173 cannot be read in isolation.
Must be read with 174 (minimum presence). So video conferencing a director and that
being a valid meeting is only possible when the quorum is physically met.

Clause 3 provides that a notice is mandatorily required (unlike an agenda) which

denotes date, place, and location of the meeting a minimum of 7 days before notice. A
shorter notice may be served in case of emergency i.e., anything less than 7 days.
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

However, a short notice meeting must have an independent director or be ratified

by one of the directors.

Section 174
Section 174 defined a valid quorum of a board meeting. Most important requirement.
If not met, the business at the meeting will be stayed/have a permanent injunction.

Minimum- 2 (or 1/3rd whichever higher). If there are vacancies on the board, since
the law requires 1/3rd or 2 whichever higher, as long as quorum requirements are met,
vacancies will not affect the meeting. If there isn’t a sufficient amount, all the
directors can do, is have a meeting to get more directors to fulfil the minimum
requirement. No other business can be conducted until the quorum is sufficient.

Note:
With respect to Section 184 (interested director- who disclose their interest in the
company and then are excused or may be allowed to attend in special situations), if
2/3rds of them are interested in the meeting, the minimum you require is 2. So in a 9-
member board, if 6 are interested directors, the quorum is 2 even though 3 un-
interested are present.

Section 175 and 176 – If the termination/ invalid appointment of a director is

apparent to the company, whatever acts done by him will not bind the company (i.e.,
his actions will be invalid to the extent of the company’s liability). But if the acts are
done before notice of his termination/invalid appointment comes to the company, his
transactions will not be rendered invalid (Doctrine of indoor management). i.e., the
company is accountable for those actions.

In addition to this, the company will not be held liable for the actions of the director
towards a third party if:
-­‐ The intended effect is to validate forgery and incompetent acts;
-­‐ Where the appointment is illegal or no appointment at all;
-­‐ Where the director continues in his office knowing that his term has expired;
-­‐ Where the director knew from the beginning that his appointment was
defective; and
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

-­‐ Where the third party was aware of the irregularity

Possible acts attributable to the company- Every act which he is authorized to do.

Section 177 – Audit committees (also made up of directors) are mandatory for
companies which are publicly listed in addition to what the central govt. may
prescribe.
Ø Main function – Keeping a tab of the company’s money. Why it came, where
it went and for what reason.
Clause 4 is an inclusive list. Instructions are to be provided by the Board.

Section 178 – Two committees; 1-4 (Nomination) 5 onwards till penalty provision
(Stakeholders)

POWERS OF THE BOARD – S.179

-­‐ Board cannot do anything that is required to be done by the company in
general meeting.
-­‐ No subsequent regulation can invalidate a valid action done by the board prior
to regulation being passed.
-­‐ Can exercise functions provided that a resolution is passed to that effect
-­‐ The right to borrow money, to invest the company’s funds and to grant
loans/guarantees/securities can be delegated to a committee of directors, the
MD, manager or any other principle officer
-­‐ Restrictions and conditions may be placed on the Board at a general meeting
regardless of the powers they can exercise.

Section 180 – Restrictions on the Board

Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

RELATED PARTY TRANSACTIONS

Section 184
- Everyone discloses interests but for independent directors, if the disclosure is
contrary to s.149, they would be disqualified
- Interest is what determines the appointment
- Interested directors can’t participate in discussions for a matter before the
board in which they have interest [the validty of said meeting has to compute
the number of directors into 1/3rd quorom requirement s. 174]
- Interest at director level is defined as the pecuniary interest of the director
He even has to disclose his non-interest in the company i.e., my interests are not
conflicting with the interest of the company. If the interests are changed, the
immediately next held meeting he will have to declare that his interests/circumstances
have changed.
Sub-section 2 indirectly defines who an interest director is:
a) Either one or two or combination of two directors have an interest of 2 or
more percent in another company they are interested parties and they are
required to disclose it to their company.
b) If they are partners, members or owners of another company.

The interest needs to be disclosed and the person having such interest has to be kept
away from a meeting regarding the transaction in which he has such interest. This
does not mean that we prevent you from acquiring interest (as long as it is below 2%).
Contract in contravention to these conditions is voidable at the option of the company.
Director may also be punished if he fails the disclosure requirements. (Dabhol –
Disclosure requirements do not apply to private companies)

Note: How to end the Governance Model

Ø Common law is not needed
Ø It is needed to interpret the sections
Ø Exist as a parallel governance mechanism over and above companies act

Section 185 – Loans to director

Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

A company cannot give a loan to a director, nor can it help the director procure a loan
from somewhere else (indirect loan). The exception is that if as part of employment
contract, there is a clause agreed to giving loan or where the shareholders have agreed
to it that a loan be given (same thing because appointment has to be approved).
Shareholders cannot pass a resolution effectuating a loan to an independent director.
Exception applies to whole-time or managing directors.
Companies who provide loans in their ordinary course of business are also exempted.
Also, a loan made by holding company to its wholly owned subsidiary provided that
the money is utilized towards principle business activities.

Section 188
Transactions can still be entered into with related parties, provided that the Board
consents to it.
When it is just the director on his own as an interested party; 188 includes director as
an interested party; interested director has a different implication than a director as a
related party. Related party director will be one who enters into related party
transaction under 2 (76)).
Consent of board or if Board is not there the general body i.e., shareholders (which is
difficult but not impossible) of the company, related party transactions (defined in 2
(76)) cannot be held.
Arm’s length basis: Dealing with a related party as you would with an unrelated party.
You still do your DD.
If a related party transaction is entered into by board or general body (which reserves
some related party transactions for its purview by way of proviso one which says that
if the transaction is beyond a certain sum we get to scrutinize, that cannot be voided
by the board), it is voidable on the behest of the general body or board as the case
may be.

- Indian governance/agency problem – closely held shareholding patterns

- If you have majority, related party transactions don’t apply
- Refusing shareholders right to vote in interested transactions
Company Law II Parvathi Bakshi
B.A., LL.B. | 2015-2020

STEPS:
Step 1:
S.184 – It is different from S.149 which provides for qualifications of a director
(mostly. Independent directors)
- Qualification is different from disclosure (the persons affected by S.184 are
already directors)

Step 2:
S.184(2) – in the event an interested director participates in a meeting, he/she is hit by
S.184. If such an interested director participates, the contract is voidable at the option
of the company.

Scenario: If the wife of a director is in the board of another company, that may be an
‘interest’ for an (independent) director, it would not be hit by S.184, since this section
covers the ‘pecuniary interest’ of the director.

Step 3:
If the transaction is between persons mentioned in S.2(76) i.e. “Related parties” then
it may be hit by Section 188.
S.188 includes independent directors and is any of the topics provided in S.188(1) are
part of the agenda of the meeting (post all disclosure requirements) then next will be –

Step 4:
Where we check for “Arms Length Transaction” as provided in provisio 4.
If it is an arms length transaction, then S.188 will not apply.

Step 5:
In the event it is not an arms length transaction then, we need to check the approval
and whether if it was given by the BoD or in AGM [S.188(1)].

Step 6:
Somewhat an exception, provisio 3 provides that there is no conflict if 90% of the
members of the company are relatives of the promoters.