Company Law

[By Ria Chaudhary & Aayush Akar]  Ria Chaudhary is a student at National Law University, Jodhpur and Aayush Akar is a student at National Law University, Odisha.  Introduction  In commonly accepted usage, auditing of books of accounts is taken to mean the verification and assessment of a company’s books and financial statements by an impartial, independent and qualified auditing professional. . It is undertaken with the primary objective of ensuring that the books of the company and transactions entered into, are in accordance with relevant regulatory frameworks as well as to form an opinion about the truth and fairness of the state of affairs reflected by these financial statements and accounts. This is done to appraise and enhance the trust of stakeholders of the organization. Need for Regulation of Auditing – The Existing Legal Framework Presentation of precise and true financial condition in the books of accounts is critical to the credence of the company and the soundness of investors’ investment decisions. As a result, it is but a necessity that preparation and audit of the financial statements maintained by the management of the company be governed by law, with legal consequences to follow for non-compliance. The Companies Act, 2013 (‘the Act’), Chapter X (S. 138 to 148) read with Companies (Audit and Auditors) Rules, 2014 (‘Audit Rules’) as well as Companies (Accounts) Rules, 2014  (‘Accounts Rules’) form part of the basic framework under which the process of auditing is regulated on aspects like appointment, remuneration, removal, powers and duties, qualifications, etc. Recent Amendments & Their Implications – An Analysis Through recent notifications in March 2021, the MCA has amended this regulatory framework, which has, at the most rudimentary level, significantly enhanced the ambit of statutory disclosure and reporting responsibilities to be complied by auditors. In furtherance of this, the following is an analysis of the Companies (Audit and Auditors) Amendment Rules, 2021 read with Companies (Accounts) Amendment Rules, 2021. Rule 11 of the Audit Rules enlist certain circumstances other than those specifically provided, that are necessary to be included in the auditor’s report. While sub-rule 11(d), relating to the company’s disclosure of specific banknotes held by it during a specified period after demonetization in 2016, has been omitted, new sub-rules have been inserted:- Rule 11(e) – It requires the Auditor’s report to contain a statement regarding whether the management has made a representation that except for those transactions mentioned in the books – pertaining to transactions which the company has entered into for an ultimate beneficiary whose identity is sought to be kept hidden, by routing of the transaction through an intermediary – the company is neither acting as nor has employed, such an intermediary entity for channelization of funds to a beneficiary identified by the company. Such lending or financing transactions, that is, where outgoing or incoming loans, advances, or investments are anticipated to be relayed through an intermediary acting on the company’s directives of channelizing financial resources are not prohibited under law. However, the MCA has enacted this amendment to maintain transparency through adequate disclosure of the ultimate real beneficiary in the books, so as to keep a check on the financing of illicit activities like terrorism, illegal trade, etc. which have a high incidence of occurring through this route. It is also pertinent to note that this amendment not only places a duty of representation upon the management but also a double verification duty upon auditors to evaluate this representation through auditing procedures and substantiate whether no material misrepresentation has been made by the directors in relation to the abovementioned transactions. In the case of the contrary, auditors may be held liable/penalized. Rule 11(f) – It requires the Auditor’s report to contain comments regarding payment or declaration of dividend by the company as to whether compliance with S. 123 of the Act has been observed. Rule 11(g) – It implies that the Auditor’s report shall contain the auditor’s observation and opinion on whether the company has, with respect to, financial years beginning from 1st April 2022 maintained its books of accounts using such accounting software which has the facility of recording the audit trail (i.e. log of every change made in the books) and whether the same has been used for all transactions recorded in the software throughout the year. Secondly, it is also required to be taken into consideration that whether the audit trail has not been tampered with and finally that it has been preserved by the company in accordance with statutory requirements to retain such records. In addition to this requirement under Rule 11(g), another pertinent change has been made by insertion of a proviso to Rule 3(1) of the Accounts Rules. It holds significance for companies that use accounting software to maintain electronic records of their books of accounts (which practically almost every company does), in as much as that such company, commencing from the financial year beginning April 1, 2021, ‘shall only’ use such accounting software that has the facility of recording audit trail and edit log of every transaction/change made in the books, along with the date of such change. It further states that it must be ensured that such edit trail facility cannot be disabled. The compulsory requirement to have an audit trail has been introduced because it is a technique to prevent book falsification, fabrication or manipulation and subsequent overwriting in the same. Any individual inspecting the books of accounts may readily follow what modifications have been made to the accounts, by verifying with the audit trail and seek an explanation from the company for any discrepancies/reasons for such change. Several additional and corresponding modifications have also been made in the entries under,  Schedule III of the Act which establishes the framework for compiling of books of accounts (e.g., manner of maintaining income statements, cash flow statements, balance sheet, etc.), making it a crucial amendment for the auditors as well. Examining the Conundrum Surrounding the Amendments vis-à-vis the Role of an Auditors in a Company While these amendments may appear to be mere additions requiring a

[By Umang Agarwal & Anchal Bhatheja]  The authors are students at the National Law School of India University, Bangalore.  There has been an undesirable but convenient switch of roles of the government and corporates, which is reflected quite starkly in section 396 of the companies act 1956 (‘CA1956’) (which has now been replaced by section 237of companies Act 2013 (CA13) On one hand, this provision empowers the government to take decisions regarding the restructuring of the companies in terms of being able to order an amalgamation in “public interest” which is a right that should technically vest with the board of directors (‘BOD’) and the shareholders of the company in the interest of corporate autonomy. On the other hand, it mandates the companies to amalgamate in the public interest, when the state directs them to do so, even when the preamble vests responsibility furthering social justice and public interest with the state. In this article, we aim to discuss the effect of this switch of roles. It is submitted that section 396 of CA56 and 237 of CA13 assail the very fundamental tenets of corporate law in various ways. The macro-economic Challenge: Richard Posner suggests that the wealth of the society maximizes when the resources vest in the hands of those who value them the most. Here, value alludes to both willingness and the ability to pay. However, sections 396 CA56 and 237 CA13 are counter-intuitive when viewed from a wealth maximization perspective. S Balasubramanian, former chairperson of the Company Law Board suggests that the government often invokes section 396 of CA56 to salvage a company in distress. Even the 2016 amalgamation between FTIL and NSEL, which was eventually struck down by the SC in 63 Moons Technologies v UOI, was to salvage NSEL which was an electronic platform for buying and selling of goods and had run into losses and defaulted on payments to its 13000 investors amounting to nearly Rs. 5600 crores. The central government “jugaad” to resolve the problem was to amalgamate unhealthy NSEL with its healthy parent company FTIL so that the assets of the latter could be used to salvage the losses of the former. Herein the idea was to revive a company, which might have the willingness to recover but not the ability to do so. This transfer of wealth would have eventually led to a net loss as two companies would have become unhealthy. But such outcomes are not desirable from an economic standpoint. The motive of every business is to make profits. But every business has the inevitable downside of failing. If the online platform, NSEL was unable to avoid fraudulent transactions and ran into debt due to its mismanagement or inefficiency or in other words lost its “ability” to stay functional, it would be in the interest of wealth maximization to subject it to a resolution process or just dissolve it as per the IBC instead of affixing its liability on a healthy company. The approach adopted by the central government is economically unsustainable. For instance, over 280 companies have been declared insolvent amidst the pandemic in India. If one were to replicate the FTIL-NSEL approach of merging an unhealthy company with a healthy one to save the former from dying down, for all these 280 companies, this would result in a net of 560 unhealthy companies and would render alternatives provided under the IBC useless. The micro-economics challenge: Further, the wording of section 396 CA56 and section 237 CA13 indicates a concern for “public interest”. However, as Milton Friedman puts it, the purpose of a business is only to increase its profits. In essence, the purpose of a corporate is to further the shareholders’ interest and nothing more than that. Corporates are business vehicles for profit maximization and re-structuring them to secure public interest is contradictory to the purpose of a corporate. The preamble of the Constitution puts the onus of being “socialist” and “welfarist” on the state and not on private entities. It is better to restrict the role of corporates in ensuring shareholders’ wealth maximization, instead of making them work towards “public interest”. In this regard, it is pertinent to note that section 396 CA1956 and section 237 CA13 change the value of the shares and quite often to the detriment of the shareholders, especially when the amalgamation happens between a healthy and an unhealthy company. In such scenarios, the shareholders of the healthy company lose out as the value of the shares diminishes due to the increased liabilities of the company. The financial value of shares is a great concern for the shareholders, as it decides the prospects of selling shares to get profits as well as the dividends, they eventually get on the shares they own. Therefore, the provision is economically unsustainable. The Jurisprudential Challenge: Furthermore, since the only purpose of a corporate is to further the shareholder’s interest, CA13 provides for a regime to ensure the efficacy of this idea. Towards this end, various provisions of CA13 like section 232 and 233 envisage the role of BOD in proposing a resolution for amalgamation. At a principal level, these provisions allude to the idea of liberalism where the BOD which is elected by the shareholders gets to decide the fate of the corporate and its formal structure. Sections 396 CA56 and 237 CA13 further a more paternalistic approach, wherein the state gets to decide what is best for the companies and the society at large. In 63 Moons Technologies v UOI, the two companies were parent and subsidiary companies respectively. If they felt the need to amalgamate, CA13 gave them full autonomy to do so. And since the fundamental assumption of law and economics is that individuals and firms are rational and act in their best interest, they could have taken a decision regarding amalgamation on the basis of their own incentives and interests. Thus, there was no need for the intervention of the state to determine the companies’ best interests. Conclusion: Considering the foregoing

[By Rishi Raj & Mehek Wadhwani]  The authors are students at MNLU, Aurangabad.  Introduction The ideal of corporate democracy envisages that a company governs its affairs based on majority voting, with the shareholders voting to decide on the course of action. Under these circumstances, the intervention of law may be required to address the possibility of the majority decision departing from the standards of fair dealing or conducting the company’s affairs in a manner contrary to the public interest or oppressive to any of its members. The Indian law acknowledges this possibility. Consequently, the minority shareholders have the statutory right to bring any action against the majority shareholders to prevent the majority from oppressing and mismanaging the company. As an integral part of corporate governance, these special provisions are contained in Part XVI of the Companies Act, 2013 (hereinafter referred to as the Act). In particular, Section 241 of the Act contains the provision for the prevention of oppression and mismanagement, whereas Section 242 of the Act grants tribunals the power to make an order for the smooth management of the company, and this power can be exercised if the oppressed member (shareholders) fulfils certain conditions. We seek to analyse how the construct of the clause under Section 242 of the Act places an undue burden through the just and equitable standard to substantiate the issue raised in the Tata Consultancy Service Ltd. v. Cyrus Investments Pvt. Ltd. and Ors. Further, we propose certain changes that may be considered while reforming the law. Invoking the oppression & mismanagement remedy: An undue burden on the shareholder The inefficiencies and perils of winding up a company have long been recognized under the company law jurisprudence, leading to the introduction of remedies such as the oppression and mismanagement clause under Section 241 of the Act. The prudent realization that such winding-up would not help the aggrieved minority shareholders led to the inclusion of this clause under the English Companies Act, 1948. Thereafter, the common law countries, including India, adopted the remedy with certain changes. 2.1. Oppression, Prejudice, and Mismanagement (Substantive elements)  ‘Oppression’ is said to be caused when the company’s conduct is opposed to the public interest as well as the principles of fair dealing, including the imposition of new and risky objects by the majority shareholders in an autocratic way. Further, the oppressed shareholder is under a persistent burden to prove the oppressive act, which makes redressal under Section 241  wrongful, harsh, and burdensome. The scope of ‘oppression’ was outlined in  V.S. Krishnan v. Westfort Hi-tech Hospital Ltd., and adopted verbatim in several judgments that followed under the Act. Accordingly, ‘oppression’ entails the absence of probity, good conduct, or an act that is mala fide or for a collateral purpose.  Further, while making winding-up orders, the court may follow rational principles to decide if the conduct is unjust, inequitable or unfair.  Ultimately, this is a question of fact, and accordingly, we have seen several unique positions taken by the courts. Adding to the jurisprudence on the scope of ‘oppression’, in a very recent judgment of Tata Consultancy (Supra) wherein the Apex Court held that the mere removal of a person from the post of Executive Chairman cannot be termed as oppressive and cannot trigger the provisions of Section 242 of the Act. Any single act of oppression cannot enable a Company Law Board (CLB) to intervene; rather,  “the oppression must be the commutative results of continuous acts,” and there must be no scope of debate in the facts of the case. We believe that the existence of undue burden on the aggrieved shareholder owing to their obligation to establish the substantive elements discussed above, along with the conditional limb discussed below, severely restricts the remedy that the law seeks to provide. In the next section, we reflect on this aspect to substantiate our argument that lawmakers must reform the clause in a well-balanced manner to avoid deadlocks. 2.2. Just & Equitable Clause (Conditional Limb) The remedy that the shareholder seeks, requires more than establishing the substantive elements. Section 242 of the Act, which is the conditional limb of this remedy, places a heavy burden on the oppressed members to satisfy the following two conditions: firstly, the affairs of the company must have been conducted in a manner that is prejudicial or oppressive to the members of the company, or prejudicial to the public interests; secondly, even if the winding-up order would unfairly prejudice some members, it would be fair to wind up the company if it is justifiable under the ‘just and equitable clause. In Ebrahimi v. Westbourne Galleries Ltd., the Court ordered the winding up of a company, as the majority was guilty of abuse of power. However, the House of Lords, while reversing the decision, applied the test of (i) bona fide use of power in the interest of the company and (ii) whether a reasonable man could think that the removal was done in the interest of the company. Further, under the “just and equitable” clause, the winding-up order may be made if there is an entire “functional deadlock” or an irretrievable breakdown of “trust and confidence”  raised in the management of the company. For a better understanding of the term ‘just and equitable clause, the Scottish Court of Session in Baird v. Lee observed that the shareholders invest their money on certain conditions which are mentioned in the Memorandum of Association of the company, including that the business shall be conducted in accordance with the principles of commercial administration that assures commercial probity and efficiency. It is noteworthy that only if these conditions are intentionally violated that it would be justifiable to wind up the company. Further, as opined by the Apex court while considering whether to admit an application, the interests of the company’s shareholders as a whole have to be kept in mind. This, however, means that the tribunal can make an order to bring an end to the oppression or prejudice complained of,  only if