A couple of days back Ministry of Corporate Affairs issued a press note stating that it is waiving the approval requirements for managerial remuneration of unlisted companies where there are no profits or inadequate profits. In my opinion, Ministry of Corporate Affairs has not considered a few implications of the changes.
1. Reason for change
The first aspect that needs attention is the reason for change. As per the press note, the Ministry is receiving a number of applications for this, hence does not have the manpower to deal with it. Below is the statement:
“A substantial number of the applications coming to the Ministry fall under this category and the Ministry’s limited manpower is disproportionately involved in this exercise.”
Is this sufficient reason to change a law? In a country with over a billion population and an unemployment rate in double digits, the Ministry is not finding resources for approving critical applications covering managerial remuneration. I suspect that some more critical clauses might be waived to reduce workload. This statement clearly tells me one thing that adequate attention was not paid to the impact of the changes.
2. Section 198 of Indian Companies Act
According to Section 198 of Indian Companies Act, 1956, public limited companies, listed and unlisted, are required to obtain permission of Ministry of Corporate Affairs for paying remuneration to directors if the company has no profits or inadequate profits. This section effectively restricts directors and CEOs of an organization approving high salaries to them if the company is not performing adequately. It protects the rights of the minority shareholders.
Now the clause in respect to unlisted companies was changed stating that since they have limited number of shareholders the organization is similar to a private limited company. Hence, now unlisted companies, which are not subsidiaries of listed companies, will not require government approval before declaring managerial remuneration if they were making loss or have inadequate profits. Requirement of paying creditors stands. Secondly, the maximum pay out for the loss making companies per person managerial remuneration of Rs 1,050,000 per annum or Rs 87,500 per month stays. Hence, magnitude of the change is within limits. Provisions of Schedule XIII continue to apply and a special resolution of shareholders is required.
3. Corporate Governance of Unlisted Companies
My concern is simple, if numerous unlisted companies are making losses and are seeking approvals to pay managerial remuneration; there is a possibility of some fraudulent activity. The question is why are these companies loss making, is it just a one year kind of situation or are they continuously making losses. If the company is continuously making losses, the concept of going concern is negatively impacted.
The second aspect that needs consideration, is that if the organization cash flows are sufficient to pay creditors, should one delve deeper into reasons for losses? Is it that the unlisted company is passing dubious expense bills to reduce income tax liability and then availing benefits of high remuneration? Unlisted companies are not required to follow corporate governance norms listed in Clause 49 of SEBI. Hence, overall governance is not high in these companies as shareholdings is of family and friends. Due to the concentrated shareholdings pattern, it is easier to obtain board approval. The propensity of wrongdoing increases with the removal for approval requirements of Ministry of Corporate Affairs.
Overall, though one can be happy with the attempt of the Ministry to liberalize and provide freedom to corporate sector, I have my reservations. In my view these piecemeal changes of company law should not be done. Less than 10% of the companies in India are listed, the remaining does not have adequate corporate governance norms applicable to them. In my view, corporate governance applies to customers, employees, government and community besides the shareholders and creditors. I would be more comfortable if the Ministry of Corporate Affairs provides a wholesome solution for corporate governance in respect to private and unlisted companies.
What is your opinion regarding these changes? Do you think this is a step in the right direction?
- Press Note: 4/2011 dated 8.2.2011 : Managerial Remuneration in unlisted companies having no profits/ inadequate profits Ministry of Corporate Affairs http://www.mca.gov.in/Ministry/press/press/Press_Note_No.4_08feb2011.pdf