COMPANY LAW REFORMS – A LONG FELT NEED

The Advisory Commission on Company Law appointed in terms of Section 422 of the Companies Act No. 17 of 1982, on a request made by the Hon. Minister of Trade has taken steps to recommend reforms to the present Companies Act. The purpose of the reforms are to ensure that legislation would facilitate commercial activities in the present day economic environment. These reforms have been proposed with a view to have the following resulting effects

1. to minimise barriers for small businesses seeking the benefits of incorporation,

2. to encourage efficient and innovative management of the companies by conferring on Directors a wide discretion in matters of business judgment, at the same time having an effective control by share holders and creditors against abuses of such management powers,

3. not to impose unnecessary limits on the ability for small business enterprises to structure those ventures,

4. in the most appropriate way to make provision for the possibility of rehabilitating businesses facing temporary difficulties, and

5. to provide simple, quick and fair procedures for realising and distributing effects of defunct companies.

With these criteria in mind, the Advisory Commission on Company Law having invited representations from the general public and professional organisations, having considered recommendations of a Sub-Committee appointed to identify the areas needed to be reformed, and also with the assistance of a foreign expert in the field of company law reforms, prepared a draft Companies Act, which may replace the existing somewhat outdated legislation of 1982.

In this draft of the Companies Act, certain new concepts have been introduced. This article briefly describes some of the contemplated reforms.

At present the minimum number of share holders necessary to form a private limited liability company has been stated as two.[1]

It has been observed that family businesses are carried on in the form of private companies. There is one controlling share holder and one or more other persons who would be made share holders merely to comply with the aforementioned statutory requirement. It has been observed that as far back as the last century, this type of ‘one man company’ did exist.[2]

* LL.M (Lond).,Senior State Counsel

1 Section 2 of the Companies Act No. 17 of 1982.

2 See Salamon Vs. A. Salamon & Company Limited 1897 A.C. 22.

Even though there was general acceptance of the Commercial reality of ‘single share holder companies’, much opposition was experienced in introducing single share holder companies into the local system. In North American jurisdictions, legislation has provided for the existence of such companies. The main reason for which many objected to this suggestion was, the delay experienced in appointing an executor or administrator for the estate of a deceased shareholder.

After considerable delebrations there was general agreement that in the following instances single shareholder companies could be incorporated.

* when the single shareholder is a body corporate

* a natural person to incorporate a single shareholder company with a body corporate as the designated nominee to succeed him as the shareholder until an executor or an administrator to his estate is appointed by Court.

A large number of companies registered in Sri Lanka fall into the category of private companies. This fact would demonstrate the practical importance of private companies. In the present economic environment the need to provide a legal network in order to encourage the incorporation of such corporate bodies and to effectively regulate those is clearly evidenced in the representations made to the Advisory Commission. Despite certain minor relaxations of applicable legal procedures the present Act does not contain provisions which would serve as incentives to encourage the incorporation of private companies.

A look into the present position shows a great need for improvement.

Private companies could be broadly divided into two main categories, namely, the properly structured Companies and Small Family Companies. The later could definitely be developed to the state of the former, by prudent investment and proper management. This would result in an increase in the investment in the domestic economy and a significant increase in employment generation.

Therefore, in the new draft of the Companies Act it is suggested that:

1. Lower and upper limits of membership is maintained at 1 and 50 respectively, and continues to prohibit the public issue of shares. However, there is no prohibition to transfer the shares.

2. A private company can dispense with the requirements to keep an ‘interest register’ by unanimous resolution of share holders.[3]

3. A private Company does not have to deliver copies of annual financial statements to the Registrar of Companies, unless, the Registrar on his own accord requires a private company to do so.

These would enhance the ability of a private company to take business risks and enable them to obtain equity participation from willing investors or distribute ownership more effectively than through a partnership or a non corporate structure.

Provisions have also been made enabling the share holders to take any of the following actions by way of Agreement in writing.

1. Issue of shares.

2. Making of Distributions.

3 Interest register is a new measure through which the disclosure requirements relating to Directors and shareholders could be monitored.

3. Re-purchase or redemption of its share.

4. Giving financial assistance to purchase its own shares .

5. Enter into any transaction which would confer benefits on a Director.

However, such liberties are given only if the Company can be kept solvent after such action is taken.

Under the present system, two comprehensive documents namely, a Memorandum of Association and the Articles of Association should be filed with the Registrar of Companies. Even though it is sufficient under the present system to file a Memorandum of Association and state that the Articles according to table A would be adopted, it may not reduce the volume of work that is involved. A Memorandum of Association by itself is a lengthy document which consists of a detailed statement of objects of the company. Due to this nature of the document it has been the practice to obtain prior approval of the Registrar of Companies as to the acceptability of the contents of the constituent documents which more often than not caused unnecessary delays in the process of incorporation.

It was also observed that the object clauses have become practically redundent. It was decided that unless a company wished to narrow down the scope of operation by stating the objects, the constituent documents could merely state that the company can engage itself in any lawful commercial activity.

With a introduction of this, a company could be incorporated with a simple application form which states basic details relating to the company, if it adopts the Articles in the prescribed form which is contained in a part of the proposed Act.4

This is a totally new concept which is suggested to be introduced. The main aim is to increase the efficient use of investment capital. This has been done with a view to give the majority shareholders a greater say in the business activities and direction of the company, and in the use of the company funds. This task has to be achieved ensuring adequate protection to minority shareholders who do not share the same view with majority shareholders.

Any major change in the direction of the company or the alteration of the initial purpose for which the minority has invested has to be firstly approved by the shareholders. This confers authority on the company in respect of the change desired by the majority of the shareholders. Thereafter, the shareholders who voted against the resolution would get the right to be bought over at a fair price.

Under the suggested scheme, the company can buy those shares and reduce the share capital by that amount, or could initiate a process through which a third party could be arranged to purchase the shares.

Similar schemes are found in the legislation of other jurisdictions as well[5] which have withstood the test of time and effectiveness of their implementation.

4Similar to the present Table A.

5eg. Section 190 of the Canadian Business Corporations Act and Part XIII A of the UK Companies Act of 1985

There is no doubt however, that such a new concept should be worked out with adequate safeguards. In setting such safeguards consideration should be given to both minority rights and interests as well as to the future well-being of the company. This is to be achieved in the following manner:-

A dissenting shareholder could within 10 days of passing of a relevant resolution could set the buying out procedure in motion by serving notice on the company that he desires to be bought out at a fair price.

If a dissenting shareholder does not give notice within that period, it is presumed that although such shareholders were not in favour of the resolution they have opted to remain in the company.

If the buying out of shares of a dissenting shareholder is to have a damaging effect on the company[6 the company could make arrangements for a third party to buy the shares or could obtain a suitable conditional Court Order exempting the company from the obligation to purchase its shares.

The price at which the shares of a dissenting shareholder to be bought should be a fair one both by that shareholder and the company. This is to be achieved by an effective system to check such a situation. A shareholder who is not satisfied by the price offered by the company can resort to arbitration or that matter could be referred to the Company Law Disputes Board[7].

This provides a suitable mechanism to guide innovative investors in new avenues of business. This effectively provides a legal framework for diverting business directions into more profitable ventures which would be a boost to the slagging economy of today.

Section 55 of the present Act[8] prohibits the granting of financial assistance by the company to purchase it’s own shares. The proviso to this section permits such grants where,

the company in its normal course of business lends money for such purposes,

the company is providing money under an existing scheme for employees to purchase fully paid shares.

The suggested scheme recognizes the universal principal to prohibit a Company giving financial assistance to acquire its shares, if the company fails to satisfy the solvency test after such grant. However, the need to provide financial assistance is also seen in certain circumstances which are commercially beneficial to the company. The report of the Jenkins Company Law Committee[9] suggested, whilst recommending to retain the principal restriction, that companies should be provided with certain practical alternatives, which would enable them to give financial assistance in permissible circumstances.

This need is amply demonstrated in the cases of Brady V Brady[10] and Charter House Investment Trust V. Tempest Diesels Ltd.[11], where two simple company reconstruction arrangements were

6such as the purchase of shares resulting in the company becoming insolvent

7which is a conciliatory body intended to be established to expeditiously dispose off such disputes.

8which is identical with Section 54 of the 1948 UK Act

9 1962 British Command Paper No. 1749.

10 1989 AC 755

11 1987 BCLC 1,

attempted to be brought within the scope of the prohibition. The possibility (or the probability) of bringing in commercially and rationally unobjectionable arrangements within the narrow meaning of prohibited granting of financial assistance is due to the ambiguity of the existing law on the one hand, and the type of developments in the commercial field of today being not comprehended at the time of drafting the present legislation on the other.

In the present UK Act the provisions as suggested by the Jenkins Committee have been adopted in respect of private companies. The much more elaborate provisions in respect of public companies have resulted in certain wholly unobjectionable transactions being shot down as unlawful,[12]

Other jurisdictions such as Singapore and New Zealand, have adopted schemes mainly based on the recommendations of the Jenkins Committee. They do not make any distinction between a private or a public company. So is the Canandian system.

The suggested reforms whilst recognizing the rule prohibiting the providing of financial assistance, sets out the circumstances under which such financial assistance could be granted. The reforms outline the procedure for treating a transaction as an exception to the rule, and spells out the requirements which may prepare the “ground conditions” for the Board’s decision to grant financial assistance for the acquisition of shares. The responsibility cast on the board of Directors would compel them to monitor the smooth operation of the system. This would provide us with a legal regime which would be adequate to cover the gross violators of the system whilst permitting bona-fide attempts to give a “kick start” to companies facing genuine problems.

A new organ by the name of ‘Companies Disputes Board’ is recommended to be established in the proposed Draft. This Board shall be appointed by the Minister, and should comprise of persons with expertise in the law and practice.

This Board,

* has the power to conduct mediations and arbitrations,

* is expected to deal with all minor commercial disputes and effectively resolve them in a practical manner.

* is expected to reduce the backlog of companies disputes pending before court.

* could encourage mediation or arbitration wherever possible and discourage time consuming adjudicating procedures.

The Companies Disputes Board is an Organ which is expected to take all necessary conciliatory efforts to resolve a dispute relating to a company. This would encourage disputes relating to companies being referred to it rather than seeking certain interim reliefs being granted until the conclusion of an ordinary process of litigation which may virtually cripple the normal operations of a Company.

In considering the nature and powers of this Organ, the operation of such bodies in other jurisdictions were taken into account. In India Company Law Board 13 exercises certain parallel functions to a full-fledged Court of Law. However, such parallel bodies can not be established in Sri

12 As described by Professor Gower in Principles of Modern Company Law 5th Edition at page 227.

13. A body substituted to carry out certain specific functions carried out by Court previously, by Companies (Amendment) Act No. 41 of 1974.

Lanka due to legal impediments. Furthermore, the reason behind the establishment of such an Organ was primarily to avoid time consuming and an expensive legal procedure being followed and to have the dispute resolved in a friendly conciliatory atmosphere. The members of the Boardar to be appointed by the subject Minister giving due regard to the Legal and Commercial knowledge of Members so appointed.

It has been often noticed that companies enter into certain transactions beyond their financial capabilities. The liabilities created by such transactions more often than not would exceed the asset value of the company. Such situations are generally not considered as healthy, from the company’s point of view. The board of Directors who would be in charge of the company’s affairs could place a company in such a situation without being held responsible for any ill effects caused to the company, by making such business decisions. Some unscrupulous directors may even indirectly benefit from such transactions.

Under the suggested system, the Board of Directors of a company is under a statutory duty to resolve under certain specific circumstances14 that the company would be solvent after the taking place of such event. Breach of this statutory duty results in the responsible directors even becoming liable to penal sanctions.

These measures would not only ensure the adherence of the directors to such statutory duties, but also prevent a company from falling into incurable financial difficulties.

In addition to the new concepts discussed above, it is also expected to, abolish the separate type of companies known as ‘Peoples Companies’ and for the Directors duties to be properly codified. The new concept of solvency test would run through the entire Act, which would provide adequate protection to the company itself, to its creditors and its shareholders in all the vital circumstances. There are mandatory requirements to disclose interests of directors and shareholders. A document known as the ‘interests register’ would have to be maintained at the main place of business, Shareholders, creditors and certain other interested parties are entitled to peruse this register during a permitted time.

The main idea of introducing the new regime, is to cope with the new developments in this field and to simplify the process of incorporation which would immensely benefit the commercial community. We are hopeful that the introduction of this new legislative regime, will provide the most suitable legal infrastructure in the commercial field for corporate structures to meet the pressures of an open economy and face the challenges of the next millennium.

14such as, in the event of exercising the option of minority buy-out rights, granting of financial assistance to purchase company’s own shares, in entering into major transactions where the liabilities created exceed half the value of the total assets of the company, reduction of stated capital.