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Corporate Governance in India

The subject of corporate governance leapt to global business limelight from relative obscurity after a string of collapses of high profile companies. Enron, the Houston, Texas based energy giant, and WorldCom, the telecom behemoth, shocked the business world with both the scale and age of their unethical and illegal operations. Worse, they seemed to indicate only the tip of a dangerous iceberg. While corporate practices in the US companies came under attack, it appeared that the problem was far more widespread. Large and trusted companies from Parmalat in Italy to the multinational newspaper group Hollinger Inc., revealed significant and deep-rooted problems in their corporate governance. Even the prestigious New York Stock Exchange had to remove its director, Dick Grasso, amidst public outcry over excessive compensation. It was clear that something was amiss in the area of corporate governance all over the world. Corporate governance has, of course, been an important field of query within the finance discipline for decades. Researchers in finance have actively investigated the topic for at least a quarter century and the father of modern economics, Adam Smith, himself had recognized the problem over two centuries ago. There have been debates about whether the Anglo-Saxon marketmodel of corporate governance is better than the bankbased models of Germany and Japan. However, the differences in the quality of corporate governance in these developed countries fade in comparison to the chasm that exists between corporate governance standards and practices in these countries as a group and those in the developing world. Corporate governance has been a central issue in developing countries long before the recent spate of corporate scandals in advanced economies made headlines. Indeed corporate governance and economic development are intrinsically linked. Effective corporate governance systems promote the development of strong financial systems irrespective of whether they are largely bank-based or market-based which, in turn, have an unmistakably positive effect on economic growth and poverty reduction. There are several channels through which the causality works. Effective corporate governance enhances access to external financing by firms, leading to greater investment, as well as higher growth and employment. The proportion

of private credit to GDP in countries in the highest quartile of creditor right enactment and enforcement is more than double that in the countries in the lowest quartile. As for equity financing, the ratio of stock market capitalization to GDP in the countries in the highest quartile of shareholder right enactment and enforcement is about four times as large as that for countries in the lowest quartile. Poor corporate governance also hinders the creation and development of new firms. Good corporate governance also lowers of the cost of capital by reducing risk and creates higher firm valuation once again boosting real investments.There is a variation of a factor of 8 in the control premium (transaction price of shares in block transfers signifying control transfer less the ordinary share price) between countries with the highest level of equity rights protection and those with the lowest. Effective corporate governance mechanisms ensure better resource allocation and management raising the return to capital. The return on assets (ROA) is about twice as high in the countries with the highest level of equity rights protection as in countries with the lowest protection. Good corporate governance can significantly reduce the risk of nation-wide financial crises. There is a strong inverse relationship between the quality of corporate governance and currency depreciation. Indeed poor transparency and corporate governance norms are believed to be the key reasons behind the Asian Crisis of 1997. Such financial crises have massive economic and social costs and can set a country several years back in its path to development. Finally, good corporate governance can remove mistrust between different stakeholders, reduce legal costs and improve social and labor relationships and external economies like environmental protection. Making sure that the managers actually act on behalf of the owners of the company the stockholders and pass on the profits to them are the key issues in corporate governance. Limited liability and dispersed ownership essential features that the joint-stock company form of organization thrives on inevitably lead to a distance and inefficient monitoring of management by the actual owners of the business. Managers enjoy actual control of business and may not serve in the best interests of the shareholders. These potential problems of corporate governance are universal. In addition, the Indian financial sector is marked with a relatively unsophisticated equity market vulnerable to manipulation and with rudimentary analyst activity; a dominance of family firms; a history of managing agency system; and a generally high level of corruption. All these features make corporate governance a particularly important issue in India.

Corporate Governance in India a background

The history of the development of Indian corporate laws has been marked by interesting contrasts. At independence, India inherited one of the worlds poorest economies but one which had a factory sector accounting for a tenth of the national product; four functioning stock markets (predating the Tokyo Stock Exchange) with clearly defined rules governing listing, trading and settlements; a well-developed equity culture if only among the urban rich; and a banking system replete with well-developed lending norms and recovery procedures. In terms of corporate laws and financial system, therefore, India emerged far better endowed than most other colonies. The 1956 Companies Act as well as other laws governing the functioning of joint-stock companies and protecting the investors rights built on this foundation. The beginning of corporate developments in India were marked by the managing agency system that contributed to the birth of dispersed equity ownership but also gave rise to the practice of management enjoying control rights disproportionately greater than their stock ownership. The turn towards socialism in the decades after independence marked by the 1951 Industries (Development and Regulation) Act as well as the 1956 Industrial Policy Resolution put in place a regime and culture of licensing, protection and widespread red-tape that bred corruption and stilted the growth of the corporate sector. The situation grew from bad to worse in the following decades and corruption, nepotism and inefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates encouraged creative accounting practices and complicated emolument structures to beat the system. In the absence of a developed stock market, the three all-India development finance institutions (DFIs) the Industrial Finance Corporation of India, the Industrial Development Bank of India and the Industrial Credit and Investment Corporation of India together with the state financial corporations became the main providers of long-term credit to companies. Along with the government owned mutual fund, the Unit Trust of India, they also held large blocks of sha res in the companies they lent to and invariably had representations in their boards. In this respect, the corporate governance system resembled the bank-based German model where these institutions could have played a big role in keeping their clients on the right track. Unfortunately, they were themselves evaluated on the quantity rather than quality of their lending and thus had little incentive for either proper credit appraisal or effective follow-up and monitoring. Their nominee directors routinely served as rubber-stamps of the management of the day. With their support, promoters of businesses in India could actually enjoy managerial

control with very little equity investment of their own. Borrowers therefore routinely recouped their investment in a short period and then had little incentive to either repay the loans or run the business. Frequently they bled the company with impunity, siphoning off funds with the DFI nominee directors mute spectators in their boards. This sordid but increasingly familiar process usually continued till the companys net worth was completely eroded. This stage would come after the company has defaulted on its loan obligations for a while, but this would be the stage where Indias bankruptcy reorganization system driven by the 1985 Sick Industrial Companies Act (SICA) would consider it sick and refer it to the Board for Industrial and Financial Reconstruction (BIFR). As soon as a company is registered with the BIFR it wins immediate protection from the creditors claims for at least four years. Between 1987 and 1992 BIFR took well over two years on an average to reach a decision, after which period the delay has roughly doubled. Very few companies have emerged successfully from the BIFR and even for those that needed to be liquidated, the legal process takes over 10 years on average, by which time the assets of the company are practically worthless. Protection of creditors rights has therefore existed only on paper in India. Given this situation, it is hardly surprising that banks, flush with depositors funds routinely decide to lend only to blue chip companies and park their funds in government securities. Financial disclosure norms in India have traditionally been superior to most Asian countries though fell short of those in the USA and other advanced countries. Noncompliance with disclosure norms and even the failure of auditors reports to conform to the law attract nominal fines with hardly any punitive action. The Institute of Chartered Accountants in India has not been known to take action against erring auditors. While the Companies Act provides clear instructions for maintaining and updating share registers, in reality minority shareholders have often suffered from irregularities in share transfers and registrations deliberate or unintentional. Sometimes non-voting preferential shares have been used by promoters to channel funds and deprive minority shareholders of their dues. Minority shareholders have sometimes been defrauded by the management undertaking clandestine side deals with the acquirers in the relatively scarce event of corporate takeovers and mergers. Boards of directors have been largely ineffective in India in monitoring the actions of management. They are routinely packed with friends and allies of the promoters and managers, in flagrant violation of the spirit of corporate law. The nominee directors from the DFIs, who could and should have played a particularly important role, have usually been incompetent or unwilling to step up to the act. Consequently, the boards of directors have largely functioned as

rubber stamps of the management. For most of the post-Independence era the Indian equity markets were not liquid or sophisticated enough to exert effective control over the companies. Listing requirements of exchanges enforced some transparency, but non-compliance was neither rare nor acted upon. All in all therefore, minority shareholders and creditors in India remained effectively unprotected in spite of a plethora of laws in the books.

Company Meeting:Definition: A company may be defined as a gathering of two or more persons by a previous notice or by mutual arrangement. For the discussion and transaction of some business. Types:(i). Statutory Meeting (ii).Annual General Meeting (iii). Extra Ordinary General Meeting.

1.Statutory Meeting:- (Section-157)

Every company limited by shares and every company limited by guarantee and having a share capital must hold a statutory meetings of the members of the company within a period of not less then and not more then 6 months, from the date of entitlement of company to commence business. At least twenty one (21)

before meeting a report called statutory report must be sent to every share holder and there after forthwith to the registrar. (i).Statutory Report:Statutory shall state. (a).Total number of shares allotted and consideration for which allotment of shares was made. (b).Total amount of cash receipt in respect of shares allotted. (c).An receipt and payments made there up to a date within seven days of the date of report. (d).The names, addresses and occupation of directors, chief executives, secretary,auditors and legal advisers of company. (e). Participation of contract needing approval for modification. (f ). The extend to which underwriting contracts if any have been carried out. (g) Particulars of any brokage or commission along with the above particulars the report shall contain a brief account of state of affairs of company since its incorporation. Future and current business plans and changes in those plans should be put beforemembers in statutory meetings. Distinguishing Features Of Statutory Meetings Are As Follows:(i).Law relating to statutory meeting is contained section 157 of ordinance 1984. (ii).This meeting is held only by public company. Public Company need not to held meeting. Its is held once in whole life, of company. For this twenty one days notice is essential: (iii).The business at this meeting is to consider as statutory report. (iv). this meeting can be convinced only by the directors and members have no power To call such meeting. (v).How ever in case of default file petition to court for winding up of company. OBJECTIVE OF STATUTORY MEETING:Object of statutory meeting is to give the members an opportunity of learning , at early stage in companies carrier. (a).Details of formation of company. (b).To what extent the financial appeal to the public has been successful. (c ).What property has been appoint by the company in exchange of its issued capital. (d).What has been done with the actual money receipt in payment of shares. (e). Approve the modification of terms of any contract disclosed in the prospectus. (f).To discuss these or any matter arising there in. 2.ANNUAL GENERAL MEETING:7

It means a meeting conviened and held by every company whether public or private or Guarantee for the first time after incorporation with in eighteen (18) months of event andThere after every calendar year through out its existence. (Section 158).This section demandsThat there shall be one general meeting in every year and there shall be as many generalMeeting years in existence of company. The annual general meeting is in addition to any.If default is made holding such meeting in SECP on application of any member of the Company call or direct recalling of general meetings.SECP in case of a listed company and Registrar in case of private or other companies may extend the time for holding such meeting.No extension of time guaranteed to any company in the first meeting. An ordinary meeting is Meeting which by the ordinance and the article of association of company must be held Periodically. As a general rule ordinary general meeting are conviened by directors passing a Resolution at a dully constituted meeting of the board ordering that the necessary notices Be issued.Section 158 provide that every company shall hold a general meeting as its Annual general meetings. Annual general meeting is to be call by the orders of directors and Not under the instruction of any individual shareholders notice convenied this meeting.Is to be given to every member at least twenty on days (21) before meeting. Distinguishing Features Of Annual General Meetings:(I).The law concerning annual general is contained in section 158. (a). The meeting is to be held by the every company limited by shares whether public or Private. (b). Every company limited by guarantee. (II).First meeting is to be held within 18 months of its incorporation. (III).The business is to be transacted at this meeting either only ordinary business or both Ordinary or special business. (IV).For this 21 days notice is given, this can be conviened by directors, and in case of default And every officer is liable to penalty. 3.EXTRA ORDINARY GENERAL MEETING:It is a meeting which is not an ordinary meeting and not the statutory meeting, The directors of company having share capital are bound to conduct an extra ordinary general Meeting on the requisition of holders of not less then one-tenth (1/10) of issued share capital. If the directors do not with in twenty one days of deposited of requisition at the registered Office of the company convened the meeting, the requisitions or majority of them in value May with in three months from the date of deposit of the requisition conviening the meeting

Must be paid by the company. This can retain them out of any remuneration due to directors Who were in default? COMPANY RESOLUTION:1.Motion Or Proposed Resolution:Motion is a proposed resolution, in other words a motion is simply a proposal which Is placed before the meeting for discussion and decision. After a motion is agreed by the meeting With or without any change amendment or modification, the final document becomes the resolution Of the meeting. 2.Resolution:Resolution may be defined as the formal decision o f meeting or any motion or Proposal before it, there are four kinds of resolution which may be deal by general meeting. (i).Ordinary Resolution. (ii).Extra Ordinary Resolution (iii).Special Resolution (iv).Resolution requiring a specified majority or (Class Resolution) 1.Ordinary Resolution:A resolution shall be an ordinary resolution when the votes cost, in favor of resolution By the members present in person or where the proxies are allowed by proxy, exceed the board. If Any which are cost against the resolution such a resolution is passed by a simple majority of votes of Members, or by the proxy. Notice of 21 days must be given for passing a ordinary resolution. Following Matters May Be Decided By An Ordinary Resolution:(i).Declaration of dividends. (ii).Consideration of annual account. (iii).Auditors and directors report. (iv).Appointment of auditors and fixed session of their remuneration. (v).Election of directors. (vi).Issue of shares at discount (vii).Alteration of share capital.


2.Extra Ordinary Resolution:It is passed at general meeting. It has following contents: (i).Notice to propose the resolution as an extra ordinary resolution has been given. (ii).By majority of th of such members entitle to vote or present or by proxy where proxies are Allowed. (iii).The notice must be a twenty one (21) days notice in case of public company. 3.Special Resolution:It is also passed at general meeting. It has followed contents. (i).When not less than 21 days notice has been given. (ii).When notice specifies the intention to proposed the resolution as a special resolution. (iii).By a majority of the th of such members entitle to vote as present in person or by proxy. (iv). If all the members entitle to attend and vote as any such meeting so agree, a resolution may Be proposed and passed as a special resolution. (v).It is required to carry out any of the following: (a).To change in the name of company. (b).To changes the registered office from one place to an other. .Alteration of Article Of Association. (d).Reduce the share capital of company. (e).Make the liability of directors, unlimited. (f).Initiate a winding up by court. (g).Winding up a company voluntarily. (h).Enable a liquidator in members voluntarily up execute some of its powers. (i). Enable voluntarily liquidators to make compromises with creditors. (j).Decide how in a voluntary winding up the books and papers of company to be disposed of . 3.Class Resolution:The article some times required that some thing which may be done shall require a A majority of special characters whether of the whole number of members or of a certain proportion Of the issued capital or classes of capital.


Winding Up Of Company (1).The winding up to company may be either by the court. (2).Voluntarily which may be gain (a).Members voluntarily up (b).Creditors voluntarily winding up. (3).Subject to supervision of court. These various winding up differ from each other as regards. (i).The ground for winding up. (ii).Commencement and effect of winding up. (iii).Effect on the power of directors. (iv).Appointment and powers of liquidators. (v).Dissolution of the company. Grounds On Which A Court May Order The Winding Up Of Company:Section 305 provides that a company from and registered under companies ordinance May be bound up by a court if (i).It has by special resolution. Resolution to wound up by court. (ii).In case of a public company default is made: (a).Delivering the statutory report to registrar. (b).In holding statutory meeting (c ).In holding any two consecutive. OR It does not (a).Commence business with in a year of its incorporation. (b).Suspends business for a whole year. (iii).The number of members is reduced in case.


(a).A public company below seven(7). (b).In case of private company below two (2). (iv).It is unable to pay its debts. (a).It is conceived and involve in lawful or fraudulent business. (b).Carrying on business that is authorized by MOA conducting its business in a manner that is against the members or person concerned with the formation or minority shareholders. (c) .Run and manage by a personal who fails to maintain to profits or commit fraud. (d).Managed by person who refuses to act in accordance with the MOA or AOAs or fails to carry out directions of court. (e).It ceases to be listed company. (f).The court is of opinion that it is right that company should be wound up. PROCEDURE OF WINDING UP:To obtain winding up by court a petition must be presented to the high court, where High court must make an order for winding up.It may direct all the subsequent proceeding to be had in District court and the high court may transfer the proceeding to any district court having jurisdiction to Wind up of company. A wind up petition may be presented by: (i).Company (iii).Contributory (ii).Creditors (iv).Registrar.

A contributory can not present a petition unless: (a).The membership is reduced below 7 in case of public company and below two in case of private Company. (b).His shares were either originally have allotted to him or have held by him and registered in his Name for at least six (6) months during the eighteen months before the commencement of windingUp. Registrar of company is not entitled to present a petition except: (i).On the ground that from financial condition of company as disclosed in the balance sheet or from The inspector appointed under section 263.It appears that company is unable to pay its dents. (ii).Unless previous section of the corporate law commission has been obtained to the presentation Of petition.


(iii).Share holder alone is entitle to present a petition for winding up on the ground of default for not Filling statutory meeting, and then only after the expiration of fourteen days. (iv).After the last day on which meeting ought to have been held. Court may direct instead the company Be wounded up, give directors for statutory report be submitted or statutory been held. 2.VOLUNTARY WINDING UP: (SECTION-444) Power to wind up the company voluntarily is a statutory right, which can not be excluded by any Provision in the articles. An unregistered company can not winding up voluntarily under the ordinance. Railway, there are no share holders. Advantages:It has many advantages over the compulsory winding up. (A).There is no need to accomplish many formalities which are required in case of compulsory Winding up. Circumstances Of Voluntarily Winding Up:A company may be wound up voluntarily if (i).When a period if any fixed for its duration by the articles expires. (ii).When the event if any occurs and on the occurrence of which the article provides that company in General meeting passes an ordinary resolution, to be wound up voluntarily. (iii).If company passes a special resolution that the company will wind up voluntarily. COMMENCEMENT OF VOLUNTARILY WINDING UP: A voluntarily winding up shall be deemed to commenced in the time of passing of the resolution for Voluntarily winding up. There are two kinds of voluntarily winding up (i).Members voluntarily winding up. (ii).Creditors voluntary winding up.

Petition For Voluntarily Winding Up:13


Where a company is being wound up voluntarily a petition for its winding up may be Presented by any person authorized to do so. Note: - In case of voluntarily winding up the members will submit the prove of solvency that they pay All the debts. Prospectus After the receive of certificate of incorporation from the registrar of company, the promoters of public Companies invite the public and financial institutions to subscribe to the capital of the company. This Notice advertisement, inviting offers for the subscription to the share capital of company is called As prospectus. Only Public companies can issue prospectus. Object Of The Prospectus:(i).To brings to the notice of public that a new company has been formed. (ii).To convince those who have saving to invest about the geneunious and its future plans /prospectus. (iii).To keeps authenticated records of the conditions in which capital has been raised. (iv).To secure that the directors of company accept the responsibilities for statements in prospectus. CONTENTS OF PROSPECTUS:1. The history and prospectus. (a).Brief history of company. 2. Main objects of company. 3. Location of plants. 4. Information about the projects, plants, and its machinery, raw material etc. 5. Economic justification and market ability for the goods to be produced. Capital Structure:(a).Share Capital of company. (i), Authorized Capital if company.


(ii).Issued capital (iii).Paid up capital (b).Basis of allotment of shares. (c) .Facilities availability to non-resident Pakistanis for purchase of shares. (d).Information about the company management. (e).Details about the projects. The main information under this heading are the cost of the project means of financing Of projects, utilities like water supply, water nature of products etc. (f).Financial Information: Under heading financial information about the company is provided. a. Auditors Report b. Share holder equity & liability c. Auditors certificates on share capital.

General Information:(a).Appointment of chief executive. (b).Election of directors. (c) .Powers of directors. (d). Voting rights. (e).Transfer of shares. (f).Quorum of general meeting. INVESTIGATION:Though the real owners of a Company are its shareholders,the Management of the Company will be vested in the Board of Directors. This may sometimes lead to abuse of power by a few. Hence the Central Government reserves its right to investigate companies, especially in cases of an alleged fraud or even the oppression of the minority shareholders. Types of Investigation:A. An Investigation into the affairs of the Companies [Section 235 & 237] B. An Investigation into the affairs of the related Companies [Section 239] C. An Investigation into the ownership of the Companies [Section 247]


A. Investigation into the affairs of the Companies 1. Discretionary Powers i. On a Report of the Registrar of Companies under Section 234(6) (Section 235(1)) The Central Government MAY appoint one or more competent persons to investigate into the affairs of the Company, if a report has been made to it by the Registrar of Companies, that a document filed with him, discloses an unsatisfactory state of affairs, or does not disclose the full and fair statement of matters to which it purports to. ii. Based on the Opinion of the Company Law Board (Section 237 (b)) The Central Government MAY appoint one or more competent prsons as inspectors to investigate the affairs of the Company, if in the opinion of the Company Law Board, there are circumstances suggesting: a. Fraud etc in any of the manner given below: _ the business of the company is conducted to defraud its Members, Creditors, or other persons or _ the business of the Company is conducted for a fraudulent or unlawful purpose or is oppressive to any Member or _ the Company was formed for any unlawful or fraudulent purpose b. The persons connected with the formation or management of the Company have been found guilty of fraud, misfeasance, or other misconduct towards the Company or any of its Members c. The Members of the Company are deprived of any information, which they are entitled to including the particulars of commission, if any, payable to the Managing Director or other Director or the Manager. The Company Law Board can form an opinion as aforesaid, even based upon a complaint received from a single shareholder, irrespective of the fact that he didnt have the requisite number of shares as mentioned in Section 235(2). The reason is that Section 235(2) and Section 237(b) are two independent provisions. 2. Mandatory Powers i. Appointment Under Section 237(a) The Central Government SHALL appoint one or more Inspectors to investigate into the affairs of the Company and to report thereon if: a. the company by a Special Resolution (Section 237(a)(i)); or b. the Court by an Order (Section 237(a)(ii)) declare that the affairs of the Company ought to be investigated by an Inspector appointed by the Central Government. Issues


a. The Company itself passing a Special Resolution as aforesaid will be a rare happening. b. Powers of Court Under Section 237(a)(ii) _ The Court can direct an investigation whenever it suspects that all is not well with the company. _ In V.V. Purie Vs.EMC Steel Ltd. ((1980) 50 Comp. Cases 127) it was held that the following classes of persons can approach the court in order to obtain an order as above mentioned: _ A creditor who cannot bring an action under Section 235 of the Companies Act, 1956. _ Aggrieved Members who are unwilling to move to the Company Law Board under Section 235 or are unable to fulfill the requirements under Section 236. _ Persons who have applied to the Company Law Board under Section 235(2) or 237(b) but their application had been rejected. _ A Company which wants an investigation but fails to pass a Special Resolution When Will The Company Law Board Make Such Declaration? For this purpose the following persons can apply to the Company Law Board: 1. Where the Company has share capital _ Not less than 200 Members or _ Members holding not less than 1/10th of the total voting power therein 2. Where the Company does not have Share Capital _ Not less than 1/5th of the persons in the Company Register of Members Before making a declaration as aforesaid, the Company Law Board give the parties concerned an opportunity of being heard. The Application by Members mentioned above, should be supported by the necessary evidence, to show that the Applicants have good and sufficient reasons for requiring an investigation. The Central Government may, before appointing the Inspectors, require the Applicants to give security not exceeding Rs.1000 to meet the costs of such investigation.(Section 236).