In India, laws governing Companies are mainly to be found in the Companies Act, 1956. Voluminous and containing 658 Sections, 15 Schedules and several Rules, the Companies Act, 1956 is modeled on the English Companies Act.
Any entrepreneur desirous of doing business in India has an option to form a Company, Private or Public with limited liability under the provisions of the Companies Act.
A Private Limited Company must have a minimum number of 2 and a maximum number of 50 shareholders whilst a Public Company needs a minimum number of 7 shareholders with no upper limit. Before commencing any business, a Public Company is obliged to obtain a certificate from the Registrar of Companies, whilst a Private Company can commence its business and exercise borrowing powers immediately upon its incorporation. The shares of a private limited company are not freely transferable and it cannot offer its shares or debentures to public for subscription. However, there are major exemptions and privileges enjoyed by a Private Limited Company under the Companies Act, 1956.


Exemptions To Private Limited Companies

1) Financial assistance can be given for the purchase of or subscribing for its own shares or shares in its holding company - Sec. 77 (2).

2) Further shares can be issued without passing a special resolution or obtaining the Central government's approval and without offering the same necessarily to existing share holders - Sec.81 (3).

3) Provisions as to the kinds of share capital (Sec. 85), the further issue of share of capital (Sec.86), voting rights (Sec.87), the issue of shares with disproportionate rights (Sec.88) and the termination of disproportionate excessive rights (Sec.89), do not apply to private companies - Sec. 90 (2).

4) Business can be commenced immediately on incorporation without obtaining a certificate of commencement from Registrar - Sec.149 (7).

5) It is not necessary to hold a statutory meeting and to send a statutory report to shareholders and file the same with the Registrar - Sec.165 (10).

6) Articles of a private company may provide for regulations relating to general meetings which need not conform to the provisions of Sec 171 to 186 - Sec.170 (1).

7) Any amount can be paid to the directors as remuneration and the same is not restricted to any particular proportion of the net profits - Sec.198 (1).

8) A private company need not have more than two directors - Sec.252 (2).

9) A proportion of directors need not retire every year - Sec.255 (1).

10) Statutory notice etc., is not required for a person to stand for election as a director - Sec.257 (2).

11) The Central Government's sanction is not required to effect an increase in the number of directors beyond 12 or the number fixed by the articles of association-Sec. 259.

12) The Central Government's sanction is not required to modify any provision relating to the appointment of managing, whole-time or non-rotational directors - Sec.268.

13) The Central Government's approval is not required for appointment of managing or whole-time director or manager - Sec. 269 (2).

14) Directors of a private company need not possess any share qualifications, in terms of section 270- Sec. 273.

15) Restrictive provisions regarding the total number of directorships which any person may hold do not include directorships held in private companies which are not subsidiaries of public companies - Sec. 275 to 279.

16) Certain restrictions on powers of board of directors do not apply - Sec. 293(1).

17) The prohibition against loans to directors does not apply - Sec. 295 (2).

18) The prohibition against participation in board meetings by interested directors does not apply - Sec. 300 (2).

19) The date of birth of director need not be entered in the register of directors - Sec. 303(1).

20) There is no restriction on the remuneration payable to directors - Sec. 309 (9).

21) There is no restriction on any change in remuneration of directors - Sec. 310.

22) Any increase in the remuneration not being sitting fees beyond the specified limit of directors on appointment or reappointment does not require the Central Government's approval - Sec. 311.

23) There's also no restriction on the appointment of a managing director - Sec. 316(1) and 317 (4).

24) There is no restriction on making loans to other companies - Sec. 370 (2).

25) There is no prohibition against the purchase of shares, etc. in other companies - Sec. 372 (14).

26) The Central Government cannot exercise its power to prevent change in the board of directors, which is likely to affect the company prejudicially - 409 (3).



Part XI of the Companies Act, 1956 containing Section 591 to 608 deals with the Companies incorporated outside India i.e. a "Foreign Company." The provisions of this part of the Companies Act, 1956 prescribes that its Sections 592 to 602 shall be applicable to Companies who are incorporated outside India which after the commencement of the Companies Act, 1956 establishes a place of business within India and Companies incorporated outside India having established place of business within India prior to the commencement of the Companies Act, 1956 and continue to have the said establishment. It says that a Company incorporated outside India and having an established place of business in India in which 50% or more paid up share capital is held by Indians then provisions of those sections shall apply to such Companies also.

Sections 592 to 602 applicable to such Foreign companies provide that they have to file with the Registrar of Companies:

- Various documents giving particulars,
- Returns regarding any alterations in the company,
- Balance-sheet and Profit & Loss Accounts of the company,
- Charges on any of the Companies' properties in India.

It also provides that the following provisions shall apply to Indian business of a Foreign Company:

- Registration of charges,
- Right to obtain copies of and inspect the trust deed,
- Books of account to be kept by the Company,
- Annual returns to be made by the Company,
- Inspection of books of accounts,
- Power of Central Government to direct special audit,
- Audit of cost accountants,
-Power of Registrar to call for inspection and investigation
(Contained in Sections 124 to 145, 125, 127, 118, 209, 159, 209-A,, 233-A, 233B, and 234 to 246 of the Companies Act)

Section 603 of the said part XI puts certain restriction on a foreign company offering documents for subscriptions in India.

Though under the Companies Act, 1956, no formalities are required to be carried out for a Foreign Company establishing place of business in India except the filing of the documents provided for in Part XI; under the provisions of Section 29 of the Foreign Exchange Regulation Act, 1973 general or special permission of the Reserve Bank of India for continuing any place of business or establishing any place of business for carrying on activities of trade and Commercial nature by a foreign company is required.



The limit of the foreign equity in an Indian Company is now increased up to 51% from the earlier 40%. In certain cases 100% foreign equity participation is also now allowed. The Government of India has entered into agreements with major foreign countries including USA for avoiding double taxation.


List of Countries with whom India has Double Taxation Agreements

A: Austria • Australia
B: Belgium • Bangladesh • Brazil
C: Canada • Czechoslovakia
D: Denmark
F: FRG • Finland • France
G: Great Britain • Greece
H: Hungary
I: Indonesia • Italy
J: Japan
K: Kenya • Korea(South)
L: Libya
M: Malaysia • Mauritius
N: Nepal • Netherlands • New Zealand • Norway
P: Poland
R: Romania
S: Singapore • Spain • Sri Lanka • Sweden • Syria
T: Tanzania • Thailand
U: United Arab Emirates • USA
Z: Zambia


• Types of Companies

• Private Limited Company
• Public Limited Company
• Unlimited Company
• Partnership
• Sole Proprietorship

Applicable law The Indian Companies Act of 1956

Corporate Documents & Registration of a Company
An application for registration should be submitted to the registrar of companies with the following documents:

1. Memorandum of Association;

2. Articles of Association;

3. a declaration signed by a person named in the articles of the proposed company as a director, manager, or secretary of the company, or by an advocate of the Supreme Court or High Court, or by an attorney entitled to appear before the High Court, or by a chartered accountant practicing in India stating that all the requirements of the Companies Act 1956 and the applicable rules with respect to the registration and other matters have been complied with;

4. a list of persons who have consented to act as directors of the company.

5. if the proposed company is a public company, consent of very person prepared to act as a director must be submitted in a prescribed form;

6. information about directors, managing directors and managers and secretary must be submitted in a prescribed form;

7. information about the registered office in a prescribed form;

8. power of attorney in favor of one of the promoters or any other person, authorizing him/her to make corrections in the documents submitted to the registrar of the companies, if it becomes necessary; and

9. applicable registration fee payable to the registrar of the companies.

Private Limited Company

A private company is a company which has the following characteristics:

• shareholders’ right to transfer shares is restricted;

• the number of shareholders is limited to fifty; and

• an invitation to the public to subscribe to any shares or debentures is prohibited.


Public Limited Company

A public company is defined as a company which is not a private company. The following conditions apply only to a public company:

• It must have at least seven shareholders.

• A public company is not authorized to start business upon the grant of the certificate of incorporation. In order to be eligible to commence business as a corporation, it must obtain another document called "trading certificate".

• It must publish a prospectus or file a statement in lieu of a prospectus before it can start transacting business.
A public company is required to have at least three directors.

It must hold statutory meetings and obtain government approval for the appointment of the management.
There are several other provisions contained in the Companies Act 1956 which are applicable only to public companies and should be consulted

Corporate Governance Assessment And ROSC Module

Section Contents:
1. Summary fact sheet
2. Market overview
2.1 Structure of the corporate sector and capital market in the country
2.2 Legal, regulatory and professional/best practice bodies
3. Registration and listing requirements
3.1 Capital markets regulator
3.2 Stock exchange

4. Treatment of shareholders
4.1 Legal rights/treatment of shareholders
4.2 Minority shareholders
4.3 Statutory and other remedies
4.4 Insider trading and self-dealing
4.5 Share registration

5. Oversight of management
5.1 Structure and powers of the ultimate body governing the corporation
5.2 Legal duties owed by the members of the governing body
5.3 Process for nominations to the governing body
5.4 Independent oversight of management

6. Disclosure and transparency
6.1 Disclosure of material financial and non financial performance
6.2 Independent audit
6.3 Disclosure of ownership
6.4 Disclosures relating to the company’s directors and managers
6.5 Disclosures for related party transactions
6.6 Other disclosure provisions, risk management


2 Market overview

2.1 Structure of the corporate sector and capital market in the country
There are 24 registered stock exchanges in India. he Bombay Stock Exchange (BSE), and the National Stock Exchange (NSE) matter most in terms of size, efficiency and liquidity. As of March 31, 2000, BSE’s market capitalization stood at Rupee (Rs) 9,128.42 billion (US$ 209.3 billion) or 52 percent of 1999 GDP and its turnover ratio was 75 percent. As of June 30, 2000 some 5,886 companies were listed on the exchange, of which 81 were large companies controlled by the government. The top 10 percent of private sector companies accounted for 92 percent of total private sector market capitalization. NSE’s market capitalization was Rs. 10,204.26 billion (US$ 233.9 billion) or 82 percent of 1999 GDP; its turnover ratio was approximately 82 percent. There were 685 companies listed on the exchange and approximately 1200 stocks traded. As of January 1, 2000, the number of public limited companies (PLCs) was 72,632, which represented 13.6 percent of all companies and 66.4 percent of total estimated paid-up capital (Rs. 272,865.2 crores). Only PLCs can be listed.


Source: BSE (July 2000)

Trading on BSE can be narrow and share prices are volatile. On average, approximately 30 percent of the shares of a company are freely tradable; on any active day some 20
percent of the free float of an actively traded company change hands. Typically, only the holdings of retail investors and mutual funds are freely tradable.

A substantial proportion of the equity of private sector companies is held by development financial institutions (DFI), the General Insurance Corporation (GIC), and the Unit Trust of India (UTI) — the government owned mutual fund. To date, pension funds are not allowed to invest in the stock market. Foreign institutional investors are estimated to own approximately 24 percent of the equity of the highly traded companies. Pre-investment approval is required from the Securities Exchange Board of India (SEBI) for non-resident Indians, overseas corporate bodies, and foreign institutional investors. Foreign investors cannot hold more than 24 percent of the paid-up capital of a company, unless a specific resolution is passed by the company and approved by the Reserve Bank of India (RBI), in which case the limit rises to 40 percent.

Both BSE and NSE have weekly account settlement cycles. Dematerialized trades are settled on a rolling settlement basis on trade date plus five working days (T+5). For physical settlements, the cycle is longer. All trades during an account period are settled on a net basis on "end of account period" plus eight days for BSE and NSE. BSE and NSE do not fully comply with ISSA G30 recommendations and regulatory initiative is required for a complete shift to G30 standards on all stock exchanges. There is an ongoing ambitious program of dematerialization. Currently approximately 583 companies can be traded in dematerialized form, and another 2,562 are being compulsorily dematerialized. Market analysts expect that in the next few years at least 90 percent of shares will be traded in dematerialized form - thereby eliminating delays and risks of fraudulent transfer which accompany the physical transfer of shares.

There are two ways for investors to settle trades. The first is through the clearing house where investors, via their sub-custodian, settle cash and stock movements with the exchange directly. The main clearing agencies are the National Securities Clearing Corporation Ltd (NSCCL) for trades done on NSE, and Bank of India (BOI) for trades done on BSE. Both guarantee the financial settlement of trades regardless of members complying with their obligations. The other way to settle trades is the so called "hand delivery" where investors settle on a DVP basis with local brokers. In this instance brokers often fund their large clients for an average of four days.

2.2 Legal, regulatory and professional/best practice bodies

India is a common law country. Five acts govern corporate activity in the country: the Companies Act, 1956 with its periodic amendments; the Securities Contracts (Regulation) Act, 1956; the Securities and Exchange Board of India (SEBI) Act, 1992; the Depositories Act, 1996; and the Sick Industrial Companies (Special Provisions) Act (SICA), 1985-which is outside the scope of this assessment.

The Companies Act regulates the pre-incorporation, incorporation, operations and duties of companies. It also deals with the rights and obligations of directors and shareholders. It is administered by the department of company affairs (DCA) and enforced by the company law board (CLB), a quasi-judicial body.

The Securities Contracts (Regulation) Act 1956, was enacted to "prevent undesirable transactions in securities by regulating the business of dealings therein". It is enforced by the Securities and Exchange Board of India (SEBI), the securities market regulator which also enforces the SEBI Act. SEBI is a corporate body managed by a board of six members; including a chairman, two members from the ministries of finance and law, two members appointed by the central government, and one nominated by the reserve bank of India (RBI). The board is appointed for a five years’ term. It can only be removed by parliament. Annual reports are tabled in parliament. SEBI finances its current expenses through fees and levies and receives government grants for capital expenditures.

SEBI promotes and regulates stock exchanges and other securities markets. It registers and regulates the working of stock brokers, share transfer agents, merchant banks, underwriters, portfolio managers, investment advisers and other intermediaries, and the working of collective investment schemes. It prohibits fraudulent and unfair trade practices, including insider trading and self-dealing; promotes investors’ education and training of intermediaries; and regulates the substantial acquisition of shares and takeovers. SEBI can call for information, undertake inspections, conduct inquiries and audits of stock exchanges; levy fees and perform such other functions as may be prescribed by the government. Under its "omnibus powers", SEBI can take action against anybody involved in the capital markets, if that person or entity does not act in the best interest of investors or markets. SEBI can conduct investigations, prepare reports and impose fines. However, SEBI does not have judicial powers of a court and its rulings can be overturned by the ministry of finance.

The Bombay Stock Exchange is the oldest stock exchange in Asia. Like all other SROs in India, BSE’s governing board must include 50 percent non-broker members. Brokers are to be in the minority on all committees handling matters of discipline, default, etc. The executive director is not a broker and he/she is accountable to SEBI for implementing the policy directions of the government/SEBI. BSE has taken the decision to demutualize and corporatize by March 2001. NSE is the largest exchange in India. It has been promoted by leading financial institutions at the behest of the government and has been incorporated as a tax paying company. It is not listed. Ownership and management are completely divorced from the right to trade on the exchange. There is no broker representation on the board of directors which comprises of senior executives from the promoter institutions and banks; professionals in the fields of law and accountancy; three SEBI nominees; and two full time executives. The day-to-day affairs are managed by an executive committee comprising broker-members.

Recently SEBI founded a committee made up of prominent private sector leaders and senior policy-makers to propose recommendations on how to foster the development of corporate governance. In January 2000, SEBI endorsed some of the committee’s recommendations and made them mandatory. Other recommendations which are either desirable, such as the setting up of a remuneration committee, or which may require change of laws, remain voluntary. The mandatory recommendations will be enforced in a phased manner with specific dates, through the listing agreement. Companies will also be required to disclose a separate report on corporate governance in their annual reports, delineating the steps they have taken to comply with the recommendations of the SEBI committee.
The Confederation of Indian Industry (CII) — one of India’s associations of industry and business — was the first organization to produce a voluntary code of best practices (Desirable Corporate Governance: A Code). This code includes recommendations on the organization and compositions of the board of directors and on desirable disclosures. CII also established a corporate governance committee which addresses issues including the role/rights of shareholders, the media, audit and accounting issues.


3 Registration and listing requirements

3.1 Capital markets regulator

Companies seeking a listing must submit a prospectus to SEBI which sets the disclosure standards. SEBI follows a merit approach insofar as it requires issuers to demonstrate a profitability track record. The company must have generated positive net results in three of the last five years. It also requires issuers to appoint a lead merchant bank to issue a due diligence certificate to SEBI. More generally, SEBI is responsible for ensuring that issuers comply with the provisions of the Securities Contracts (Regulations) Act, 1956, the Securities Contracts (Regulations) Rules, 1957; and the guidelines issued by SEBI from time to time. Issuers must file their prospectus with the registrar of companies and publish it in the newspapers.

During the capital market boom period of 1993-95 many companies tapped the capital market to collect funds from the public. A number of these companies have defaulted in their commitments. SEBI has identified 159 listed companies which are not available at their registered offices – they simply vanished.

3.2 Stock exchange

The Securities Contracts (Regulations) Rules 1957 specify the minimum requirements for listing securities. A company must offer at least 25 percent of each class of securities to the public for subscription. This requirement has recently been relaxed for companies in the information technology, media, entertainment, and telecommunication sectors. It is mandatory for a company to be listed on the regional stock exchange where it is registered before it can apply for listing on other exchanges. Additional terms and conditions are specified under the listing agreement entered into with the relevant stock exchange and cover a series of minimum requirements, including minimum capital, number of shareholders, and trading volume. The agreements also require companies to provide facilities for prompt share transfer and registration; to give proper notice of closure of transfer books and record dates; to forward unabridged annual reports and balance sheets to shareholders; to file a distribution schedule with the exchange annually; to furnish financial results on a quarterly basis; and to promptly report any event which may materially affect financial performance and stock price.

4 Treatment of shareholders

4.1 Legal rights/treatment of shareholders

Corporate law is based on the premise that all shareholders are equal within each class. There are two types of shares: preference shares and ordinary shares. Preference shares give the holder the right to a fixed dividend but no right to vote, so long as dividends are paid. They are not popular in India. Ordinary shares owners run the risk of variable dividends, but have the right to vote. Shares cannot be granted multiple voting rights.

Matters of importance in corporate functioning and governance require shareholder approval. There are two classes of resolutions — ordinary and special. Ordinary resolutions are passed with the approval of more than 50 percent of the shareholders present and voting. Special resolutions require 75 percent of those present and voting. Decisions involving election and removal of directors, appointment of external auditors, remuneration of directors, payment of dividends, approval of annual accounts and the routine matters relating to the conduct of a company require the passing of ordinary resolutions. More important matters, such as capital increases, buy-back of shares, proposed mergers, changing the name of the company, altering the memorandum and articles of association or the registered address from one state to another, voluntary winding up of the company, and similar decisions require special resolutions.

In 1997, SEBI issued the Substantial Acquisition of Shares and Takeovers Regulation, known as the Takeover Code. Among the most significant provisions of the Code figure the requirement for investors to inform the relevant stock exchange and SEBI when they cross the five percent ownership threshold. If an acquirer’s shareholding crosses 15 percent, he/she must make an open offer for an extra 20 percent of shares at a minimum offer price equal to the average market price for the last six months. Within a 12 months’ period a maximum of five percent may be acquired, without it being considered a "creeping acquisition". Management may also consolidate its holdings through the secondary market up to a maximum of five percent. Finally, acquirers have to deposit 25 percent of the value of their total bid in an escrow account.

Even though the concentrated ownership structure still translates into certain material restrictions to takeovers, it no longer acts as an important deterrent in preventing them and takeover activity is on the rise.

4.2 Minority shareholders

Minority shareholders are guaranteed the right to participate and vote in company meetings by the Companies Act which mandates an annual general meeting (AGM). The notice has to be posted to all shareholders 21 days before the date of the meeting, and must contain the company’s reports and accounts, the agenda, all resolutions that are to be discussed in the meeting, and a proxy form. Shareholders accounting for at least one-tenth of the paid-up share capital have the right to call an extraordinary general meeting. So long as the request is supported by reason and signatures, it is incumbent upon the board to announce such a meeting and hold it within 45 days.

Shareholders are entitled to appoint another person as his/her proxy, irrespective of whether the proxy is a shareholder or not. No notarization is required. The proxy has to be in writing, signed by the appointing shareholder, and must be registered with the company at least 48 hours before the meeting. A proxy has the right to attend and vote, but not speak at the meeting. Cumulative voting is prohibited in India.

Voting is by the show of hands. If any shareholder attending a meeting chooses to dispute the result and can prove that he/she represents ten percent of the voting rights or Rs.50,000 (US$1,100 approximately) of paid-up capital, whichever is less, he/she has the right to demand a poll. In this case, it is incumbent upon the chairman of the meeting to arrange for such a poll and the show of hands is overturned by the proxy votes.

Market analysts have argued that the absence of postal ballots has restricted shareholders’ rights, since India is a large country and companies hold their AGMs where they are registered –including small towns in remote areas. Of late, there has been talk of mandating postal ballots for certain important resolutions such as mergers and
acquisitions and buy-back of shares. However, at present, there is no law that mandates postal ballot.

4.3 Statutory and other remedies

Shareholders and equity investors can take derivative actions and sue the management and controlling parties for oppression. These remedies are available at the level of CLB, the civil courts, the high court where the company is registered, and the supreme court of India. They can apply to CLB for redress against oppression by management, provided that the plaintiffs comprise at least 100 shareholders accounting for ten percent of voting rights. If CLB establishes that oppression of the minority by the majority has taken place, it can, under Section 402 of the Act, intervene in the regulation of the affairs of the company as it deems fit. For example, it can instruct management to buy out the dissenting shareholders at a fair price; terminate or modify agreements entered into by the company; set aside any transactions; or remove or appoint directors. CLB's decisions are appealable to the high courts and, thereafter, the supreme court.

Equity investors can also apply directly to SEBI for redress against violation of shareholders’ rights. They are encouraged to do so if the company or registrar have not responded to their complaints in spite of having sent two reminders over a period of one month. SEBI has the power to hear companies and give rulings, and has often done so for the benefit of shareholders. Delays in making timely announcement of results or share transfers have been punished by suspension of trading.

Although the term ‘class action’ does not exist in the Indian legal lexicon, there is nothing in law that prevents shareholders from initiating such suits. Class action suits have been initiated in high courts in merger transactions where shareholders were unsatisfied by the proposed share-swap ratio. In some of these cases, the judges have seen merit in the shareholders’ arguments and have ordered the companies to modify the ratio.

Prolonged delays are the norm in court proceedings. According to market analysts, it is not unusual for the first hearing to take six years and the final decision up to 20 years. The Indian investors association files cases on behalf of minority shareholders as "public interest litigation". This approach apparently speeds up the judicial process.

4.4 Insider trading and self-dealing

SEBI prohibits fraudulent and unfair trading practices, including insider trading and self-dealing. Insider trading is defined as "tak[ing] place when insiders or other persons who, by virtue of their position in office or otherwise, have access to unpublished price sensitive information relating to the affairs of a company and deal in the securities of such company or cause the trading of securities while in possession of such information, or communicate such information to others who use it in connection with the purchase or sale of securities".

However, implementation of the Act is problematic. Despite BSE’s and NSE’s full-fledged electronic trading facilities, it is difficult to flag a trade as a possible case of insider trading. Given the number of brokers and intermediaries who operate in the market, a person with insider information can create fire-walls between himself and the regulators. An additional factor making surveillance more difficult, are multiple listings which are common. The main surveillance responsibility rests with the principal stock exchange. If the principal regional exchange does not have a sophisticated surveillance mechanism, monitoring compliance becomes almost impossible. Despite this handicap, SEBI has initiated several cases of insider trading. In 1999 for example, Hindustan Lever Ltd, a subsidiary of Unilever, merged with Ponds. The swap ratio provided for arbitrage opportunities and insider trading was alleged. SEBI fined Hindustan, whereupon the latter appealed to the ministry of finance.

4.5 Share registration

The Companies Act requires all shares and all share transfers to be registered. Shareholders rights to dividends, bonus shares and subscription to rights issues are held in abeyance pending the registration of share transfer. Companies are required to maintain registers which must be available for public scrutiny. If a company’s shares are dematerialized, it must furnish a register of beneficial owners maintained by a depository. Currently, 1,218 companies have signed on with the National Securities Depository Limited (NSDL) and 1,083 with the Central Depository Services Limited (CDSL) for dematerializing their shares. Share transfers and registration in smaller companies are carried out by physically sending the shares to the company secretary or the registrar. This involves filling in a share transfer form that includes name, address and occupation of the new owner. This system often results in delays — of the post, of verification of the folio and numbering, and of the physical entry in the share register; as well as increased probability of fraud and theft. SEBI has mandated the appointment of compliance officers to monitor the share transfer process and ensure compliance.

5 Oversight of management

5.1 Structure and powers of the ultimate body governing the corporation

The board of directors is the ultimate governing body in a corporation. It is a single tier structure. Sections 252 and 253 of the Companies Act stipulate that boards must comprise a minimum of three directors and that only individuals can be appointed.

The board of directors enjoys extensive powers as provided under the Companies Act and the company’s articles of association. The powers exclusive to the board include: the power to make calls on shareholders; to issue debentures; borrow money; to invest the company’s funds and make loans; to fill casual vacancies of the board; to appoint a managing director; to give consent to contracts with directors or his relatives, firm or private company; and to invest in shares or debentures of companies under the same management. The powers exercisable only with the consent of shareholders include: the power to sell, lease, or dispose of the whole or part of the company; to remit debt to a director; to borrow in excess of the net worth of the company; and to appoint sole-selling agents. The board may, through a board resolution, delegate its powers to the managers. However it is the duty of the board to set out limits to these powers. In addition, the board has the exclusive power to declare a dividend. Unless the board recommends such payments, the shareholders have no power to declare a dividend.

SEBI’s new mandatory recommendations on corporate governance include the appointment of independent directors and the setting up of audit committees. As from March 2001, large companies whose chairman and chief executive are two distinct persons, will be required to have one third of board members be independent directors; this ratio increases to 50 percent for companies who combine the chief executive and chairman’s post in one person. The time frame for compliance by smaller companies is March 2003. Similarly, audit committees will become mandatory for large listed companies as from March 2001 and March 2003 for smaller companies. SEBI will also limit the maximum number of committees a director can serve on, given the time and dedication required to do so. Anecdotal evidence suggests that some companies and business groups plan to rename committees "groups" in order to circumvent this rule.

The boards of the top 20 or 30 private sector listed companies already have a majority of independent directors. Most of them have an audit committee comprised of a minimum of three independent directors; a few even have remuneration and nomination committees. However, as of December 1999, non-executive directors do not constitute a third of the boards of most companies. Non-executive directors are often family members, recently retired CEOs or company managers, representatives from the firm that offers legal advice, and nominees of DFIs, LIC, GIC and UTI.

5.2 Legal duties owed by the members of the governing body

Directors are appointed as fiduciaries of their company. Board members are "expected to display the utmost good faith towards the company whether their dealings are with the company or on behalf of the company". They may not use the company’s money, other property or information to gain advantage for themselves at the expense of the company. They must avoid conflicts of interest in their duties and obligations without limitation. In addition to their fiduciary duties of loyalty, directors also owe a duty of care to the company. They may not act negligently in the management of the company’s affairs. These generalities appear insufficient as far as the definition of directors’ liabilities are concerned. This is evidenced by the increasing number of independent directors who take a policy insurance against their personal liabilities as directors.

The board of directors is legally bound to meet at least once every three months and to disclose board members' shareholdings, and their interests in any transaction of the company. It must convene the AGM, provide the directors' report attached to the annual report and ensure the accuracy of statements made therein. The board is responsible for signing off the company’s balance sheet and profit and loss statement, ensuring that these documents are filed with the registrar and sent to shareholders. Minutes of shareholder and board meetings have to be prepared within 30 days, with every page initialised or signed. Directors are liable for the statements made in the directors’ report.

Directors owe their duties to the company and its shareholders. Directors are obliged to comply with shareholders’ resolutions and can be removed by them from office; but they are bound to look after the interests of both. Directors can be personally liable if they contract in their own name without disclosing that they are acting on behalf of the company; if they act beyond their powers; and if they knowingly enter into an illegal contract. Disqualification for non-performance can be obtained through the central government, CLB, SEBI and the courts. CLB can remove directors if it determines a case valid for oppression by management. CLB can also remove directors or other managerial personnel on the basis of the high court's decision. Shareholders have the unmitigated legal right of appeal to SEBI and the high courts. SEBI has the power to hear companies and give rulings, and has often done so for the benefit of minority shareholders.

Although the law provides safeguards to shareholders, there is anecdotal evidence that directors’ duties are sometimes followed in letter but not in spirit. The resolutions of the board of directors are often vaguely worded and fall short of giving full information to the owners of the company.

5.3 Process for nominations to the governing body

According to the Companies Act, directors are appointed by the shareholders at the AGM. Each director is appointed or removed by ordinary resolution. Typically, directors are expected to hold office for three years, and every year a third of the directors are retired by rotation — either to exit or be re-appointed. No specific qualifications are expected of directors other than that they should be at least 21 years of age, not insane, nor declared insolvent or have a criminal record. Directors are allowed to hold up to 20 directorships in different companies — a number many market analysts find excessive. Being a non-resident or a foreigner is not a disqualification.

5.4 Independent oversight of management

Oversight of management is exerted through the board of directors and shareholders. The board hires, removes and monitors management. Monitoring takes place through oversight of audit and the company’s accounts which must reflect a true and fair view. Directors, as well as the registrar and government officials, can inspect the books. The registrar is also empowered to call for additional information and explanation of the balance sheet and profit and loss account. Shareholders exercise the oversight function by appointing and removing independent auditors through a special resolution at the AGM.

In compliance with the mandatory recommendations of SEBI on corporate governance, large companies are required to set up audit committees as of March 2001 and smaller companies as of March 2003. These committees will comprise at least three non-executive directors, with the majority being independent together with the chairman. They will meet at least three times a year. Their role will include the oversight of the company’s financial reporting process and the disclosure of financial information to ensure that the financial statements are correct, sufficient and credible; recommending the appointment and removal of external auditors; reviewing with management the annual financial statements before submission to the board; reviewing the adequacy of internal control systems; reviewing internal investigations by the internal auditors on suspected fraud or irregularity and reporting the matter to the board. The audit committee will also be responsible for reviewing the company’s financial and risk management policies and for looking into the reasons of defaults in the payments to depositors, debenture holders, shareholders (in case of non-payment of declared dividends) and creditors.

To date, there is anecdotal evidence that most boards do not satisfy the conditions that accompany the principle of independent oversight. Most companies remain driven by their promoters who act as managers, and not by their boards. Management shares little substantive information with outside directors, who are often selected with the tacit understanding that they will not bother too much about such information. Additionally, it has been argued that the DFIs, which often have institutional nominee directors on the boards of companies, do not bring specialized knowledge and hence contribute little to the deliberation of the boards.


6 Disclosure and transparency

6.1 Disclosure of material financial and non financial performance

Under the Companies Act, all companies have to prepare audited annual accounts which are first submitted to the board for approval, then filed with the registrar of companies. These annual accounts must contain in a prescribed format the balance sheet, profit and loss account, their schedules, the auditor’s notes on accounts and qualifications (if any), together with the directors’ report for the year. If the company has a subsidiary with an ownership interest of 50 percent or more, abridged data on the subsidiary must form a part of the annual report. Consolidation is not compulsory.

Companies must submit their annual accounts together with a cash flow statement and sources and applications of funds to every stock exchange where they are listed. They must prepare un-audited financial summaries quarterly and make timely disclosure of material and price sensitive information to the relevant stock exchanges and to the regulators. Stock exchanges penalize non compliance with temporary trading suspensions, classification and separate trading under the ‘Z’ category indicating ‘investor beware’, de-listings, or winding-up orders.

Indian regulators are increasingly concerned about the standards of financial reporting and disclosures. To address this concern, SEBI has appointed a committee to examine these issues on a continuous basis.

6.2 Independent audit

The Companies Act requires accounts to be audited annually and signed by a certified chartered accountant. The Institute of Chartered Accountants of India (ICAI) lays down the parameters of accounting and auditing standards. The quality of financial disclosure is determined by three agencies: (i) DCA; (ii) SEBI, which mandates special disclosure requirements for listed companies and introduced audit committees; and (iii) ICAI.

The major weaknesses of ICAI’s standards are the absence of consolidation, the lack of segment reporting, the low standards of disclosure of related party transactions, and the lack of information regarding the treatment of deferred tax.

Qualified opinions in the auditor report are quite common and do not affect listing. The punishments for non-compliance of financial disclosures specified in the Companies Act are light. In most instances, the maximum penalty is either imprisonment for six months, or a fine of no more than Rs.2000 (US$ 46), or both. In practice, there has hardly been any instance of imprisonment. For instance, if a company does not comply with proper audit practices or does not make available the necessary financial documents for audit, the penalty is a fine that does not exceed Rs.500 (US$ 12). If the auditor’s signed reports are not in conformity with the law, the maximum penalty is Rs.1000 (US$ 23). Moreover, judicial delays diminish the deterrence that such penalties are supposed to inflict.

According to market analysts certain auditing firms are rumored to have cast benevolent eyes towards contingent liabilities, and ensured that the notes to the accounts — while on the right side of the law — were sufficiently benign to give comfort to management. Such acts are reported to be routinely overlooked. And, while the ICAI prescribes detailed standards for external auditors, rare are the instances when it has taken any action against its members, while SEBI does not have the power to fine or suspend accounting firms.

6.3 Disclosure of ownership

As discussed in section 4.5, the Companies Act requires companies to maintain a register of shareholders. This register must be updated each time share transfers take place, filed with the registrar, and be open to public scrutiny. However, according to market analysts, in practice consultation is difficult.

Listing agreements require share ownership to be declared on the basis of individual promoters, DFIs, foreign institutional investors, mutual funds, foreign holdings, other corporate bodies, the top 50 shareholders, and other shareholders. In addition, investors crossing the five percent threshold must inform the relevant stock exchange and SEBI.

The ownership classification used by Indian stock exchanges often fails to give a fully transparent picture of share control due to the prevalence of complex cross-holdings across family or group controlled conglomerates. However, there is a trend towards more transparent share ownership. This trend is driven by the aversion of foreign institutional investors for complex cross-shareholdings and reinforced by the desire of Indian corporates to raise funds and access international capital. Moreover, the rise of technologically oriented companies in the information technology, drugs and pharmaceuticals sectors, which often have foreign capital, demonstrates the benefits of transparent ownership structures and motivates companies to follow suit.

6.4 Disclosures relating to the company’s directors, managers and advisers

Details on the aggregate remuneration of directors and managers, including a breakdown between salaries, commissions, and the fees which they have received, must be provided in annual reports. Loans to directors are subject to certain restrictions and may require the prior approval of CLB. The appointment of sole-selling agents can be made by the board, but must be sanctioned by the shareholders at the next AGM. As of March 2001, SEBI mandates large listed companies to disclose the individual remuneration package of their directors including salary, benefits, bonus, stock options and pension in their annual report. Details of fixed component and performance linked incentives must be included, along with the performance criteria and together with service contracts, notice period, severance fees and stock option details. SEBI’s recent directive on independent directors also requires all pecuniary relationships or transactions of non-executive directors to be disclosed in the annual report.

In addition, companies must maintain a register of the holdings of their directors and managers in their securities and those of their subsidiaries. Such register must include the number of securities, their description and value. It must also include information on the nature and extent of the directors’ or managers’ interests or rights over such securities. This register must be made available at the AGM.

However, many of these disclosures are somewhat general or made only at the time of appointment. Others, while technically in the public domain, are not made fully public in the sense of being disclosed in the annual report. Recently, the committee on corporate governance has made disclosures about appointment of new directors mandatory and now the following information has to be given at the time of appointment: a brief resume of the director; expertise in specific functional areas; and names of companies where he/she sits on the board and committee memberships.

6.5 Disclosures for related party transactions

Perhaps the greatest drawback of financial disclosures is the absence of detailed reporting on related party transactions. Section 299 of the Companies Act mandates that a director must give notice of his/her interest in a particular contract or arrangement at a board meeting. If he/she acts in contravention of this section, he/she can lose the directorship and be subject to penalty. However, while the Companies Act requires the maintenance of a register on the company’s business relationships with the directors and sole selling agents, no such disclosures are made in the annual report. Similarly, at the level of the balance sheet, there is no requirement to report which investments and loans were made by the corporation to subsidiaries and associated companies.

6.6 Other disclosure provisions, risk management

Minutes of shareholder and board meetings must be prepared within 30 days, with every page initialed or signed. They must be maintained in official registers and made available to shareholders. However, in practice, these are rarely available for public scrutiny.

Few annual reports include a chapter on management discussion and analysis (MD&A). Most directors’ reports do not go beyond the minimum required by the statutes. However, SEBI has mandated that MD&A reports be an integral part of the annual report and include discussions on industry structure and developments; opportunities and threats; performance per segment or product; outlook; risks and concerns; as well as internal control systems. Additionally, discussion on financial performance with respect to operational performance must be included together with material developments in human resources and industrial relations, including the number of people employed.

Companies must be rated by approved credit rating agencies before issuing any commercial paper, bonds and debentures. At present there are four well established rating agencies. Each of them has a classification range from very safe to poor. The rating has to be made public and must be accompanied by the rating agencies’ perception of risk factors affecting payment of interest and repayment of principal. Company management also has the right to comment on these risk factors. According to market analysts, companies have tended to approach more than one rating agency and then publish the one which is most beneficial to the company. The CII code has commented on this practice, and made recommendations to prevent it.