Published Editorial

Corporate governance: Act brings directors on ‘board’

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The Financial Express

by

Neville Dumasia
Leader – Risk Advisory Services
EY

Parul Soni
Leader – Development Advisory Services
EY

The Companies Act 2013 sets higher standards of Corporate Governance with the introduction of provisions regarding composition and functions of the board, duties/liabilities of directors (including independent directors) and performance evaluation of independent directors. Another addition is the widely spoken about Section 135 on corporate social responsibility (CSR) which also enhances the role of the board of directors of a company.

The Act recognizes the role of Board as a key component of corporate governance and entrusts it with significant responsibilities in order to establish a strong internal controls and risk management framework in the companies, formulate the CSR policy of the company and play a significant role in reporting.

Board of directors

The Act has introduced stringent reporting provisions by the Board of directors and lays strong emphasis on the internal controls, risk management and compliance related matters.

As a part of directors' responsibility statement, the directors in listed companies need to state that they have laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively (adequacy of policies and procedures, adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records and timely preparation of reliable financial information).

In addition, the Board report should include a statement indicating development and implementation of a risk management policy for the company (including identification therein of elements of risk) and design/enablement of proper systems to ensure compliance with the provisions of all applicable laws. Besides the audit committee, the constitution of nomination and remuneration committee and stakeholder relationship committee has also been made mandatory in the case of listed companies & prescribed class of companies.

The Act also stipulates at least one woman director’s appointment on the Board of a company for listed and prescribed class of companies.

Independent directors

The concept of independent directors has been introduced for the first time in the Companies Act. The Act also lays down the Code of Conduct, performance evaluation mechanism and duties of independent directors. Courtesy the new set of provisions, independent directors would now have greater responsibility to ensure a more vigilant & active board.

Corporate social responsibility

The concept of corporate social responsibility (CSR) is still evolving in India; the inclusion of section 135 on CSR in the Companies Act 2013 has sparked many discussions on its implications on the CSR landscape in our country. The draft rules have now been put up on the ministry of corporate affairs website and are open to public comment and suggestions after which they will be applicable from FY 14-15.

The rules state clearly that the spend will be 2% of net profit, where net profit shall mean net profit before tax and shall not include profits arising from branches outside India. The Act states that for the purpose of Section 135, the calculation of the net profit will be based on the provisions of Section 198. The rules further clarify that donations and charity will not be considered as CSR, any surplus or profit arising out of CSR activities to be allocated only for CSR.

The allocation of this expenditure will be based on a Board-level CSR committee’s recommendations. A CSR committee, constituting three or more directors with at least one independent director, will be responsible for formulating a CSR policy. The onus of first formulating a robust CSR policy, then monitoring its implementation and finally reporting the achieved goals will ultimately lie with the Board of directors of a company.

Therefore the ability of a company to adhere to this change will depend upon how efficiently the Board can adapt to, and understand what is required of them. The Company’s Act should be recognized for its merits in improving a company’s governance. The intention of Section 135 must simply be interpreted as integration, a move in a positive direction towards inclusive growth.