Charles Darwin has rightly said,
“It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.”
The odyssey to innovate the almost six decade old Companies Act 1956(“old Act”) stared in year when the Ministry of Corporate Affairs (“MCA”) issued a “Concept paper on new Company law” on 4th August 2004. The journey thereafter experienced a series of consultative procedures and intellectual discussions till June 2012 when the Parliamentary Standing Committee on Finance, headed by Mr. Yashwant Sinha submitted its report. Based on Standing Committee recommendations, the Companies Bill 2011 was amended and was introduced as the Companies Bill, 2012 (“the Bill”). The Bill was passed in Lok Sabha on 18thDecember 2012 and by the Rajya Sabha on 8th August 2013. The final icing to the cake was done and the Bill acknowledged the assent of the Honorable President of India on 29th August 2013, was notified in the Gazette of India on 30th August 2013 as the Companies Act, 2013(“the Act”). The cake is finally ready for the feast. The Act typifies an entire shift regarding matters such as how Companies would be regulated and, in particular, on various aspects of governance. The Act intends to promote self-regulation amongst the corporate world, investor protection and transparency by including concepts of insider trading, class action suits and also offers some novel concepts like one-person company, small company and dormant company. The reporting framework under the Act has been enhanced with a common financial year, consolidated financial statements and definition of subsidiary, associate and joint venture. Reporting on internal control and provision relating to mandatory internal audit has been introduced to ensure that the disclosure requirements and the acceptance of onus of financial statements by the companies, is more accurate. The Act defines fraud in a vivid manner and lays down stricter provisions relating to fraud. The role, responsibility and accountability of directors and auditors have been significantly enhanced in the Act. The Act also envisages embodiment of three very crucial regulatory bodies, National Company Law Tribunal, National Financial Reporting Authority and Serious Fraud Investigation Office. The Act intends to significantly raise the benchmark on Corporate Governance, which is clearly pronounced by the provisions relating to Corporate Governance. The entire Act is a bouquet of iridescent flowers with a fresh aroma, presented to greet the dynamic corporate sector. Two new concepts which include (I) One person Company and (III) Registered Valuers under Companies Act and two concepts related to auditors which include, (II) Rotation of Auditors and (IV) Auditors responsibility in case of fraud by corporates, have been discussed in detail in this article.
(I) ONE-PERSON COMPANY
It sounds like an oxymoron when it is said, one person company (OPC), as the word Company always paints a picture of a group ofpersons coming together for a common goal. The all new innovative concept of an OPC has now been legalized in the Act. Section 2 (62) of the Act defines "One Person Company” as, “a company which has only one person as a member.” Ironically, OPC creates an idea of a legal fiction of incorporating oneself. The concept of a single person company is already prevalent to other parts of the world like the US, China, Singapore and some European countries. The OPC model provides with a simpler regime through exemptions so that the single entrepreneur is not compelled to fritter away his time, energy and resources on procedural matters. The process of setting up an OPC is simple and more or less similar to that for a private limited company.
Since the company is owned by a single person, he must nominate someone to take charge of it in case of his death or disability. The nominee must give his consent in writing, which has to be filed with the registrar. Of course, the owner can change the nominee any time he wants to, but he will have to inform the registrar. The nominee, too, can back off at a later stage, in which case the owner will have to make a fresh nomination. Once the paperwork is complete, the registrar will issue a certificate of incorporation within seven days of receiving the documents, after which OPC can start its business.
An OPC is exempt from certain procedural formalities, such as conducting annual general meetings, general meetings and extraordinary general meetings. No provisions have been prescribed on holding board meetings if there is only one director, but two meetings need to be organized every year if there is more than one director (an OPC can have more than one director and up to a maximum of 15). There is, however, no relief from the provisions on audits, financial statements and accounts, which are applicable to private companies.
The two biggest advantage of OPC are, firstly, its identity is distinct from that of its owner and secondly, it has a limited liability. These two advantages give an edge to the OPC over a proprietorship concern. Talking about the other side of the coin, an OPC is not easy to set up as it requires a lot of paperwork, plus it is a costly affair as professional assistance is required for certain formalities for instance, drafting of memorandum and articles. Apart from this, the company will be taxed at 30%, which may be higher than the 10-30% for a business that is not incorporated. Other types of taxes, such as the minimum alternate tax and dividend distribution tax, may also be applicable.
(II) ROTATION OF AUDITORS
Another important area that the Act focused to enhance auditor independence and audit quality is rotation of auditors. The auditing fraternity came under a cloud after a spate of accounting scandals, such as Satyam Computer and Reebok India. This prompted the Government to mandate rotation of auditors. The Act stipulates that an individual cannot be appointed as an auditor for more than one term of five consecutive years. Shareholder ratification is also a must every year. Further, an audit firm cannot be appointed as an auditor for more than two terms of five consecutive years. There also has to be a five-year cooling period before an audit firm is reappointed after completion of two terms of five consecutive years.
Every company will need to comply with these requirements within three years from the date when these provisions come into force.
In deciding on the timeline as to when mandatory auditor rotation should kick-in, the draft rules, have proposed that the period of holding office prior to the commencement of the new law will be counted. It implies that the Act provides for retrospective application of the aforementioned provision. Prior to the new law, an auditor/audit firm could be appointed by shareholders for a maximum period of one year. Interestingly, the Act is silent on the class of companies (besides listed entities) to which auditor rotation will be mandatory. This is under consideration of the Government, as per the draft rules.
Further, the Act announces some common conditions for appointment of auditor in listed and specified class of companies such as the Incoming audit firm should not have any common partners who were the partners of the outgoing audit firm i.e. the audit firm whose tenure expired in the immediately preceding FY by virtue of mandatory rotation requirement.
Meanwhile, it has been stipulated that an incoming auditor will not be eligible, if such auditor is associated with the outgoing auditor under the same network of firms or is operating under the same trade mark or brand.
(III) REGISTERED VALUERS UNDER COMPANIES ACT
Registered Valuer is one among the many new concepts introduced in the Act, to provide for a proper mechanism for valuation of the various assets and liabilities related to a company and to standardize the procedure thereof. This will not only help in eliminating doubts relating to arbitrary valuation and window dressing but will also act as an assurance to the concerned stake holders and regulators regarding the authenticity of the valuation of the asset or liability under consideration. It also throws open a new area of professional opportunity.
Section 247 of the Act, contains provisions exclusively regarding registered valuers.
Definition: ‘Registered Valuer’ means a person registered as a Valuer under Chapter XVII of the Act.
Who can act as a registered valuer?
A person who is registered as a Registered Valuer in pursuance of Section 247 of the Act with the Central Government and whose name appears in the register of Registered Valuers maintained by the Central Government or any authority, institution or agency, as may be notified by the Central Government only can act as a registered valuer.
Any property, stocks, shares, debentures, securities or goodwill or any other assets or net worth of a company or its liabilities which requires valuation under the provision of the Act, shall be valued by a registered valuer.
A registered valuer shall make a valuation of any asset as on valuation date, in accordance with the applicable standards, if any, as may be stipulated for this purpose.
The registered valuer needs to be appointed by the audit committee or in its absence, by the Board of Directors.
(IV) AUDITORS RESPONSIBILITY IN CASE OF FRAUD BY CORPORATES
Prior to the Act, fraud was largely seen as a broad legal concept. But with economic crime assuming newer and bigger forms, exclusive definition of fraud in Section 447 of the Act has been widened to include any act, omission, concealment of fact or abuse of position to deceive, gain undue advantage from, or injure the interests of the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss. Fraud could now include corrupt practices, deceit, conflicts of interest and bribery.
Until now, auditors did not have to legally determine whether fraud has occurred or not, and had to primarily report material fraud related to fraudulent reporting and/ or misappropriation of assets. There is now onerous responsibility on auditors to act as whistleblowers by reporting directly to the Central Government if they have reason to believe a fraud is being, or has been committed against the company by its officers or employees. “Materiality”, according to the Act, refers to frauds happening frequently or frauds involving (or likely to involve) not less than 5 per cent of the net profit or 2 per cent of the turnover in the preceding year.
The Act provides setting up of a Serious Fraud Investigation Office (SFIO), a statutory body with power to arrest for offences specified as fraud. The penalties are not compoundable, and are more severe now. Punishment can include imprisonment ranging from six months to 10 years; and fine not less than, and up to three times the amount involved in the fraud.
A National Financial Reporting Authority is also prescribed to be set up to regulate auditors, and has extensive powers to investigate professional or other misconduct by any member or firm of chartered accountants.
The Act has been brought out in an all new form and is all set to revolutionize the modus operandi in which the corporate world works. While the provisions have been made stringent and are expected to act as a deterrent, there are several challenges involved too. These include the need to educate and train independent directors and audit committees; set up robust internal controls to identify, prevent and report fraud; use of information technology for monitoring; use of internal audit to strengthen internal control systems; strong code of conduct and ethics policies; and auditor’s reporting of fraud and the extent of intimidating liability prescribed for the auditor. The Act promises to significantly raise the benchmark on Corporate Governance and will radically alter the framework in a positive sense, as Brigham Young has rightly said, “True independence and freedom can only exist in doing what's right.”