The Hindu Business Line : Switches in the statutes

ECONOMIC legislation prescribes trigger levels for attracting statutory provisions, or for entry and exit from regulatory norms. Generally, all these legislation relate to economic reforms. The perceived objective is protection of investors and/or public/national interest.

The trigger levels ought to be investor, compliant friendly. In some instances, they facilitate the administration of legislation. Examined herewith are a few illustrations where trigger levels are prescribed to see whether they fit the above requirements, or are otherwise meaningful.

Section 3(1)(iii) of the Companies Act, 1956 describes a "private company" as one which has a minimum paid-up capital of Rs 1 lakh or such higher amount as stipulated in its articles of association (AoA). The objective of this is to avoid the mushrooming of shelf companies and their being offered as readymade products. The rationale is that any enterprise embarking upon a business would not venture on a miniscule capital base.

Section 269 of the Act mandates the appointment of a managing director, whole-time director or manager (managerial personnel) by a public company when its paid-up capital reaches a trigger level of Rs 5 crore or such other sum as may be prescribed by the Central Government. Ostensibly, this is to protect public interest as well as the interests of creditors and investors. But what is the basis on which such as sum is determined? Is a company with a lower paid-up capital but with huge accumulated reserves and a substantial turnover not exposed to public interest? Conversely, a company with a much larger paid-up capital and having only a select group of members, with little transfers taking place and not doing substantial business, will be expected to obey this mandate. Is net worth not a better alternative?

For a change, Section 73A of the Act which permits buyback of shares by a company on satisfying certain prescribed conditions, permits an exit option not exceeding 10 per cent of the paid-up equity capital and free reserves.

Pursuant to Section 383A of the Act, when the paid-up capital of a company, private or public, reaches the trigger level of Rs 2 crore, as prescribed, such companies are mandated to appoint a qualified company secretary as a secretary of the company. Under the proviso to sub-section (1) of the said section, a company which is not required to appoint a company secretary but has a paid up capital of Rs 10 lakh or more but not more than Rs 2 crore is mandated to appoint a company secretary in whole-time practice to carry out secretarial audit and submit a compliance certificate.

Observe the folly. Paid-up capital is always flexible and can be moved upwards or downwards at any given time. When this eventually arises, this provision loses its significance. This trigger norm has to change more or less based on what is suggested above for appointment of managing director.

While Section 310 of the Act deals with hikes in directors' remuneration, Section 309 is on remuneration aspects in general. Any increase over and above what is stipulated under Section 309 will have to be supported by a resolution of the shareholders and approval of the Central Government. To avoid undue burden on the administrative mechanism, regulatory guidelines are proposed to filter and control the flood of such applications.

Accordingly, rules are issued from time to time prescribing payment of sitting fees to directors for attendance at board meetings or committees thereof. Such fees are determined under the rules on the basis of paid-up capital of the company. There is an apparent contradiction in this Rule. If one were to look at Schedule XIII, it is clear that remuneration is decided on the basis of "effective capital" as defined in the said schedule. This criteria looks more realistic.

Again, a trigger level that attracts the SEBI takeover code is prescribed. When any person acquires more than 5 per cent of the shares having voting rights, the regulatory norms come into play.

Fallacy of paid-up capital trigger

Triggers levels based on paid-up capital were obviously arrived at on the perception that companies with large paid-up capital were financially robust and, therefore, had a progressive future.

To gauge the financial health of a company merely on paid-up capital is illusory. There are companies which are into large-scale businesses with commensurate reserves and surplus. The working capital of such companies is either self-generated or from internal accruals. Or, the business of the company is such that it is self-financing.

Ironically such companies are out of the regulatory net. Another aspect of the fallacy is that the paid-up capital includes capital issued by way of preference shares which are redeemable any time after, say, 18 months of the issue.

A number of new and innovative financial instruments/products are now being offered to the public which form part of the paid-up capital. And these are capable of being redeemed any time depending upon the terms and conditions of offer. There are issues with call and put options. When the option is exercised either by the issuer or by the holder, then the paid-up capital of the company will drop.

Take the case of a company with a paid-up capital of 9,99,000 preference shares of Rs 10 each fully paid-up, and equity share capital of Rs 1 lakh. Upon redemption of preference shares, the paid-up capital of the company will drop to one lakh. Is that what the legislature intended? It is time the Department of Company Affairs indulged in some rethink.

(The author is a Pune-based company secretary.)

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