On July 31, 2019, the Indian government notified the Companies (Amendment) Act, 2019 (the “Amendment Act”), which amends certain provisions of the Companies Act, 2013 (the “Companies Act”). While a large part of the Amendment Act covers the changes introduced by the ordinance effective from November 2, 2018 (Read our update on Ordinance Act, 2018 here), the Amendment Act has also incorporated certain additional amendments, which are not yet effective. We have discussed the key changes introduced by the Amendment Act in this update.
Changes relating to prospectus issued by public companies
Currently, the Companies Act mandates registration of a prospectus for issue of securities by a public company with the Registrar of Companies (“ROC”). Therefore, public companies making a public offer of securities are subject to a dual prospectus registration requirement, i.e., with the ROC and with the Securities and Exchange Board of India (the “SEBI”) pursuant to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. The Amendment Act has done away with the requirement of registering a prospectus with the ROC prior to issuance and has provided for a mere filing requirement.
In India, the SEBI is the primary securities market regulator. The SEBI scrutinizes a draft prospectus thoroughly before a public offer is announced. Therefore, doing away with the requirement of registering a prospectus with the ROC is very good, as it will streamline and simplify the public offer process.
Issuance of securities in a dematerialized form
Currently, the Companies Act requires every listed company to issue securities in a dematerialized form. Unlisted public companies and private companies do not have to comply with the foregoing requirement. The Amendment Act mandates that all companies must issue fresh securities in a dematerialized form. In addition, the Indian government will notify classes of unlisted companies which will have to convert their existing shares into dematerialized form.
This proposal to introduce mandatory dematerialization of securities has been in the pipeline for a long time. Although it is not entirely clear which classes of unlisted companies will have to dematerialize their securities, we assume that this requirement will be imposed in a phase-wise manner, and companies will be given adequate time to undertake dematerialization. In our view, this is a good move which will simplify the issuance and transfer of securities of Indian companies, and eliminate the concerns that arise with physical title certificates and share transfer forms. Companies and shareholders will also save stamp duty, which is payable on physical instruments but does not apply to dematerialized securities.
Changes with respect to corporate social responsibility
The Companies Act imposes mandatory corporate social responsibility (“CSR”) requirements on Indian companies that cross certain net worth, turnover or net profit thresholds in a given year. However, until now, there was no penal implication for failure to fulfill CSR requirements other than having to make a statement to this effect in the board of director’s annual report. The Amendment Act has introduced the following key changes in respect of unspent CSR amounts:
- If the unspent CSR amount relates to an ongoing project during a financial year, the company will be required to transfer the unspent CSR amount to a special bank account within thirty (30) days from the end of the financial year. If the company is still unable to spend the amount transferred to the special bank account within three (3) financial years, the company will be required to transfer the unspent amount to a fund specified under the Companies Act within thirty (30) days from the date of completion of the third financial year; and
- If the unspent CSR amount does not relate to an ongoing project during a financial year, the company will be required to transfer the unspent CSR amount to a fund specified under the Companies Act within six (6) months of the expiry of the financial year.
Further, the Amendment Act has introduced the following penalties for non-compliance of the requirement to transfer the unspent CSR amounts to the special accounts, and the failure to report the reasons for not spending CSR amounts in the in the board of director’s annual report:
- The company will have to pay a fine of INR50,000 (approx. US$710) which may extend up to INR2,500,000 (approx. US$5350); and
- Every officer in default will be punishable with imprisonment for a term extending up to three (3) years and/or with a fine of INR50,000 (approx. US$710) which may extend up to INR500,000 (approx. US$7070).
In our view, the introduction of stiff penalties for non-compliance with the CSR requirements completely changes the objective of CSR and converts it into a tax that companies have to pay every year. Moreover, the requirement to transfer the unspent CSR amounts can affect the cash flows of Indian companies, who often face a liquidity crunch. Lastly, companies will have to be much more vigilant in ensuring that CSR compliance is completed on an annual basis.