Possibility of Abuse of Corporate Governance in Promoter Driven Companies and its Treatment in Present Law
Corporate governance became popular in India after globalization in early 1990’s and most of the literature pertaining to corporate governance were based either on the Sarbanes-Oxley Act of the U.S or on the Cadbury committee report of the U.K. However, in Indian Companies like Reliance group, Tata Sons, Bajaj, etc. family ownership or concentrated ownership of some people remains very much common. This is a potential reason which could result in mismanagement and might lead to a situation where affairs of the company can be performed for the personal gain of the promoters, promoters family, top management and directors thereby affecting transparency, accountability and ethics in business operations. An attempt is made in this paper to argue how promoter driven companies are likely to abuse the corporate governance which could result in mismanagement of company by this controlling behavior. For clarity, this paper is divided into four parts, firstly, the paper would explain and describe the need for better corporate governance for smooth functioning of a corporate structure by looking at reasons which made this concept popular in US and UK and explore the legislative intent of adapting this in India by looking at Kumar Mangalam Birla Committee report and JJ Irani Committee report. Second part will discuss various cases like the Tata-Mistry tussle, Infosys, Coffee Day Enterprise amongst other companies to show how stubbornness of the controlling members of company lead to mismanagement of company. Third part will discuss the play-out of mismanagement in such companies and how Independent directors are also having limited power in such structure and lastly, this paper will observe how the Companies Act of 2013 helps or avoids the above-mentioned problems and what were the lessons learnt by scams like Satyam making it legally possible to insulate a company from abuse by its promoters.
Sir Adrian Cadbury defined Corporate Governance as the system by which companies are directed and controlled. He defined “Corporate governance essentially involves balancing the interests of the many stakeholders in a company by allocating the corporate resources in a manner that maximizes the value for all stakeholders – these includes its shareholders, management, customers, suppliers, financiers, government and the community.”
Corporate governance in the west emerged decades back to control irregularities in management of companies and it was considered important to keep management and shareholders in a company intact. Indian principles of corporate governance are based on the Sarbanes-Oxley Act (hereinafter referred as SOX) which was passed to curb number of cases which started arising in U.S . The fact that implies SOX as the basis of arising requirement of corporate governance in India is the common objective of protecting investors by having better disclosure rules and giving powers to a regulating body like U.S. Securities and Exchange Commission in U.S. and SEBI in India.
Similarly, Cadbury committee of UK recognized the need of efficient principles of governing corporate bodies and laid out detailed provisions for corporate governance which also influenced or can be said is still influencing India’s present law on corporate institutions for example non-executive directors in Cadbury committee report influenced mandatory appointment of independent directors in India. However, the problems arising in corporate governance in the US, UK are different from corporate problems in India which will be discussed further. Robert Clark discusses that in USA, the fact that board of directors composition is a discretionary power of CEO which is a major reason of shareholders being dissatisfied with the management of company and felt need to control/discipline the activities of board of directors. Similar problem was arising in UK which paved way for SOX report in USA and Cadbury report in UK, which is why, both these reports are focused on narrowing down the gap between shareholders and management of company. In Indian context, other issues regarding corporate governance mainly deal with creating discipline within normal minority shareholders and majority/controlling shareholders who dominate the company.
In USA, as pointed out by Gregory Jackson, “the 1960s and 1970s were decades characterized by strong managers and weak owners” which he refers as ‘managerial capitalism’. This led to separation in those having ownership and those having control leading to something we call ‘agency approach’ so that those having control have a fiduciary duty towards those having ownership and make decisions in best interest of company, which is basis of corporate governance around the world. Kumar Mangalam Birla committee report(hereinafter Birla report) in 1999 was set up by Securities Exchange Board of India(SEBI) to look at ways in which efficiency and profits could be increased by minimum differences between management and shareholders. Birla report after studying foreign and Indian firms came to the conclusion that public responds positively to a company with a well-managed system in place which gives sufficient power to boards and management for taking decisions in the best interest of company. The Committee recognized three important aspects of corporate governance, which were accountability, transparency and equality amongst stakeholders. One such mandatory recommendation of report was appointment of independent directors on board which became section 149 of Companies Act of India, 2013.
However, many legal scholars have recognized issues or challenges with the present system of corporate governance in India with one of the most common deterrent in Indian context being ‘conventional dominance of majority stakeholders’ which disturbs the purpose of separation of ownership and control, leading to problems in the management of company, some instances of which will be discussed in further paper. The JJ Irani committee report in 2005 was more focused on new small and private companies and providing a legal framework inclusive of them. It also recommended management reforms like the number of directors necessary in different kinds of companies, the requirement of their presence and suggested class action suits and derivative action to be recognized by law to protect minority interests. However, Umakanth Varottil argues that adoption of SOX report of USA and Cadbury report of UK in Indian corporate governance followed ‘outsider approach’ and has not been ‘Indianized’. This argument will be explored further with the help of examples of mismanagement in promoter-driven companies like Tata, Infosys etc.
The control of promoters can be portrayed through the shareholding structure of the company. In a country such as India, where concentrated ownership dominates the corporate landscape, the main rationale for the independence of board and directors is to protect the minority shareholders from possible exploitation by the promoter or controlling shareholder (CS), who may also act as the CEO A huge amount of shareholding/controlling stake in a company by promoters at times gives them the power to influence the functioning of the board. The promoters feel emotionally attached to the company and this attachment frequently leads to their stubbornness with reference to the workings of the company. The promoters decide to make the company function for their personal interest which is frequently prejudicial to the interest of the company. This leads to a failure in corporate governance.
One of the examples of this kind of failure in corporate governance is by Tata Sons Ltd. Issues of the stubbornness of the promoter were brought to light during the Tata- Mistry tussle. Cyrus Mistry was a director of Tata Sons Ltd. since 2006. The majority of shareholding was held by trusts of the Tata family. This was to ensure that the control remains with the family even when Cyrus Mistry joined. The Board frequently disagreed with the decisions of Cyrus Mistry and ousted him during one such board meeting. Cyrus Mistry alleged that there was dominant control by the nominee directors of the trust. These nominee directors were Ratan Tata and the trust’s trustee, they were the ‘super board and other directors were shadow directors’. The control of the promoters was tightened through the clauses in Articles of Association of the Tata Sons Ltd. which Cyrus Mistry wanted to do away with. One of the clashes was regarding the Tata Nano project which was a dream project of Ratan Tata. Ratan Tata was more involved in the reputation of the projects rather than their economic viability. According to Cyrus Mistry, he was never provided with a free hand by the promoters to manage the company and work for its interest and the promoters were always stubborn with their projects. The control in the company was always exercised by the family. He also alleged that there was no independence in the working of the independent directors. During this case, there was also some light shed on the independence of the independent directors in the company. Mr. Nusli Wadia, who was an independent director was also fired for standing up for Cyrus Mistry to maintain his chairmanship in group companies. This shows the clear abuse of power by the promoters.
Another example is the failure of corporate governance by the promoter V.G. Siddhartha of Coffee Day enterprise and he was searched by the Income Tax authority. He was found to be in heavy debt for which he wished to buy back shares of the Coffee Day enterprise and he was forced by one of his private equity partners. For this, he borrowed a huge sum of money in his private capacity which shows the power of promoter.
The failure of corporate governance also took place in Infosys Ltd. when the company acquired Panaya, a software company at a higher price than the valuation of the company. This was done despite the disagreement of the CFO of the company. Also, no reason was given for the high-priced valuation to the board and there were allegations of insider trading during the same time period. It was alleged that there were multiple offers of hefty severance packages provided to some former executives. These issues lead to Infosys dealing with multiple claims regarding unaccountability and non-disclosure.
Examples discussed in part II are the cases highlighting the acts of mismanagement. Mismanagement is said to be done if the act/acts of the management are such that they are prejudicial to the interests of the Company or where there has been a structural change in the management of the company whether by the alteration of the Board of Members, constitution or control of the body corporate and so on. The cases that have been referred to earlier in this paper are used as examples to highlight the corporate governance abuses which highlight a distinct agency problem that are prevalent in India and it becomes necessary to analyze the ownership structure of the companies to further our arguments. The promoter and promoter groups exercise their control and dominance over the day-to-day business of the company through the majority shareholding. Therefore, whatever measures of corporate governance India adopts, it needs to be ‘Indianized’ and tackle these agency problems.
It is important to note that there are certain structural differences between the body corporates that are incorporated in India and in the UK and US. Since there is a difference in the ownership structure, it becomes necessary to have different regulations for corporate governance. But the major problem arises here, the Companies Act, 2013 has taken Regulations from the Sarbanes Oxley Act of the US and the Cadbury Committee report of the UK and sometimes these regulations are not applicable to the situation that may be faced by Indian companies. The shareholding patterns of such promoter-driven companies in India indicates who holds the control over the operations of the company.
In many Indian companies, the fact that promoters have a higher shareholding, it is considered as one of the main reasons corporate governance abuses have taken place. SEBI recently passed a regulation stating the maximum percentage of shareholding to be 75 percent of the total shareholding while 25 percent will be available to the public. It has been observed that in this ownership structure, the dominant shareholding is always held by the families who own that business and are the promoters of the same. With the power that such families have, they tend to have an influence on the board and interfere in the business of the company. This sort of dominance is quite obvious in the Indian Corporate Sector.
This paper will further analyze the Tata-Mistry case, specifically on the issues of mismanagement that panned out in it. The case had raised the issue of feasibility of minority shareholders in India. As it has been observed, the dominant shareholding is held by the Hindu Undivided Family, trusts owned by the family, body corporate and so on. So, in the same manner, the maximum shareholding was held by the Tata trust, while Cyrus Mistry along with his family held around 18% of the shares. Mistry had filed for oppression and mismanagement for ousting him from the chairman position since, he alleged that it was done in a wrongful manner as the procedure was not followed i.e., he was not served with effective notice. Due to the dominance of the promoter (Tata Family), the directors were unable to discharge their fiduciary duties as well as the regulation of corporate governance could not be followed effectively. He stated that the promoters were in a position to muster enough support since the promoters were the dominant shareholders.
But the order passed by the NCLT is disturbing since the decision gave an impression that the minority shareholder could not question the conduct of the majority or in other words – the minority is bound by the rule of the majority. Oppression and mismanagement were a factual issue but since the evidence and threshold to prove is too high, the minority cannot prove that in the court of law and question the conduct of the majority. Though it may be visible that the promoters acted in a prejudicial manner to the interests of the company, the corporate governance goes unquestioned. This just goes on to show that when the power is concentrated in the hands of promoters, the interest of the company and minority shareholders may be compromised.
As stated earlier, board’s independence is shadowed by the promoter dominance. The role of an independent director is complex when it concerns the family-run business. They may have to navigate through the family-issues to decide what is in the best interest of the company and its shareholders. The case with Infosys was a similar one whereby a former board member has stated that the company was being mismanaged, but due to lack of proper evidence against the allegation made, therefore no strict action could be taken against the company. This just indicates that there is a need for higher standards and regulations of corporate governance for the promoters and the other holding companies. The decision of the NCLAT in the Tata- Mistry case highlights the gaps and shows the need for a change in the standard of corporate governance in India due to the ownership structure of the business prevailing here.
The promoter groups often control a large number of companies at once. Under the 1956 Act, when a director is acting on behalf of the Company engaged in related party transactions with any other company he was interested in, he had to disclose his interests to the board of directors and similarly, the assent of the board of directors was required for conducting certain types of transactions. Disregard of this disclosure leads to failure of corporate governance and one such example of a failure of corporate governance and the Act of 1956 is the Satyam scandal. Ramalinga Raju, chairman of Satyam Computer services, set up two companies in the real estate sector. Ramalinga’s family managed these two companies. Satyam Inc. decided to buy out these two companies for $1.6 billion. The Board was concerned about the valuation but failed to be bothered about the conflict of interest or corporate governance. The funds of the company were going to Ramalinga Raju’s family. When the failure of corporate governance broke out to the news, the shares fell to the extent that the deal had to be withdrawn. Ramalinga Raju and other key managerial executives of the company were arrested. The promoters did not even have a controlling stake in this case, but they still managed to influence the management of the company.
After dealing with situations like the Satyam scam, the law makers realized that the Companies Act 1956 was ineffective in handling such scenarios. One of the changes brought about in the 2013 Act is the incorporation of Section 188 which protects shareholders against abusive transactions by directors. This section provides a three-layered protection against these transactions, the firstly, it does not allow related party transactions without the consent of the shareholders. A resolution has to be passed if such a scenario is to take place. Secondly, members related to these parties are not allowed to vote in the said resolution. Lastly, the Board of the Company has to incorporate in its report given to shareholders, the number of such related party transactions entered into and its justification for the same. The shareholders of a company are entitled to such information as it affects them. Transparent disclosure of such information points to the credibility of the company too. If this information is not provided to the shareholders, they cannot raise concerns over it which results in eliminating their right to be heard. However, there needs to be a balance between the rights of minority and interests of the company, and they should not act against each other.
Sections 241 to section 246 protects the rights of shareholders against actions of oppression and mismanagement and gives power to the tribunal to deal with these issues. To restrict acts of oppression and mismanagement, any member of the company who claims that business matters of the company are being done in a manner that is oppressive to either the member himself or his interests or against the interest of the Company itself, he can file an application to the tribunal for an order. A member of the company can also file such application if there is a material change in the management of the company which is not for the benefit of any class of shareholders or for the benefit of debenture holders or for creditors and such change would likely result in the affairs of the company being conducted in a prejudicial manner against the interests of the company or any member. The Central Government can also apply to the Tribunal if it feels that the management of affairs of the company are going against the public interest.
While Section 244 of the Act lays down some restrictions on who can file an application to the Tribunal, it may waive off the requirements mentioned thereunder. Class action suits have also been allowed by courts where one member can file on behalf of many shareholders, forming a class of shareholders where they all have common grievances and claims. The Tribunal is empowered to take action on applications by individual shareholders or a class action as mentioned before by Section 242 of the Act where they, inter alia, provide for regulation of the future affairs of the company or make any order as they see fit. Thus, using these provisions, the Act helps to reduce instances of abusive transactions where the majority shareholders oppress the minority shareholders if they mismanage the company. Section 241 ensures that even the majority shareholders can apply in instances of oppression and mismanagement in situations where the minority shareholders oppress the majority shareholders. An instance of dominance of promoters would be the shareholding pattern of Tata Steel Bsl Ltd whereas of March 2020, the promoter group held 72.65% shares and public shares were 27.35%. In such a scenario, with the consent of a few minority shareholders, the promoter group can easily achieve the 75% requirement in cases of special resolution and in case of a simple resolution, they can easily influence other minority shareholder. The promoters can also get sufficient support for removal of directors as the resolution requires a majority of shareholders present and voting, so if a good number of shareholders don’t come for the meeting, it would work in favor of the promoters.
The exception to dealing with related party transactions is the principle of ‘arms length’ transactions. This says that if a related party transaction is conducted as if the parties were not related to each other, then the transactions are fine. This however seems to be a very vague concept and is upon the interpretation of the courts.
To conclude, the problem thus remains that even after the incorporation of the Companies Act 2013, chances of abusive transactions by promoters may have reduced but still a possibility. As Umakanth Varottil suggested that molding the concepts of corporate governance according to Indian playfield is a necessary step to remove such ambiguities. Currently, the appointment and removal of independent directors is done through election by a majority. Thus, independent directors occupy their position at the request of the controlling shareholders and therefore must act in accordance with the will of the majority. Mechanism to select independent directors should also be improved to help them function without being influenced by dominant promoters. The shareholder democracy is being hampered by the prevalence of the dominant shareholding existing with the families that run the business. Due to promoters’ attachment to the company, they along with their families often consider the company as a family heirloom and tend to forget that there are other stakeholders too. The companies like Tata Sons Ltd., Coffee day enterprises and Infosys some of the cases that act as evidence for abuse of corporate governance and indicate the loopholes in governance regulations and makes it important to reconsider independence of board, accountability, transparency etc. We cannot blindly follow the regulations that are taken from the US and the English legislation since there is a difference in the ownership structure of the companies. The gap and relationship between ownership and management is a key requirement of an efficient company and a dominant attitude does not help in growth of a company. The SEBI also came up with some constructive measures like Class action suits, whistle blower policy, independent audit and so on but the results of these measures is yet to be ascertained.
 Palaniappan Shanmugam, Velmurugan and Veeraraghavan, R. and Champramary, Rinku, “Corporate Governance Abuses and the Ownership Structure of Indian Companies” (May 31, 2017). Available at SSRN: https://ssrn.com/abstract=2977834
 Ibid Pg. 2
 Bhasin, Madan Lal, “Corporate Accounting Fraud: A Case Study of Satyam Computers Limited” (October 20, 2015). Open Journal of Accounting, 2013, 2, 26-38. Available at SSRN: https://ssrn.com/abstract=2676467
 1992. Cadbury Committee Report On The Financial Aspects Of Corporate Governance. 1st ed. [ebook] London: Gee Publishing Ltd, p.2. Available at: http://www.ecgi.org/codes/documents/cadbury.pdf
(Accessed 13 May 2020).
 Robert Charles, “Corporate Governance Changes in the Wake of the Sarbanes-Oxley Act: A Morality Tale for Policymakers Too” (December 5, 2005). Harvard Law and Economics Discussion Paper No. 525. Available at SSRN: https://ssrn.com/abstract=808244 Pg. 3
 Cadbury (n4) Pg. 21
 Clark (n5) Pg. 9
 Gregory Jackson, “Understanding Corporate Governance in the United States” (Arbeitspapier 223, October 2010) https://www.boeckler.de/pdf/p_arbp_223.pdf Pg. 11
 Birla Committee Report, “Report of the Kumar Mangalam Birla Committee on Corporate Governance” 2000 Para. 2.7
 Pnakaj Kumar Gupta and Singh Shallu, ‘Evolving Legal Framework of Corporate Governance in India – Issues and Challenges’ (2014) 4 Juridical Trib 239 Pg. 249
 JJ Irani Committee Report, “Report of the Expert Committee on Company Law 2005” 2005 Para. 6,10.2
 Unmakanth Varottil, ‘A Cautionary Tale of the Transplant Effect on Indian Corporate Governance’ (2009) 21 Nat’l L Sch India Rev 1 Pg. 4
 NSE, “Issues in Board and Director Independence” (No.16 Centre for Excellence in Corporate Governance 2016)
 Cyrus Investments (P) Ltd. v. Tata Sons 2018 SCC Online NCLT 546
 Abhishek Manu Singhvi, “From the trenches” (Juggernaut Books 2020) Pg. 136
 Ibid. 145
 Ibid. 147
 Ibid. 146
 Taxmann, “IT dept raids Coffee Day founder’s house, offices” (2017) https://jguelibrary.informaticsglobal.com:2307/filecontent.aspx?Page=|NEWS&isxml=N&id=222330000000012976&search=cafe+coffee+day&tophead=true (accessed on 13 May 2020)
 Velmurugan (n1) Pg. 5,6
 Companies Act, 2013
 Velmurugan (n1) Pg. 6
 Umakanth (n12) Pg. 4
 Pratip (n21)
 Deva Prasad, ‘Did NCLAT Go Overboard In Providing A Remedy To Cyrus Mistry’s Grievances?’ (The Wire, 2020) https://thewire.in/business/nclat-cyrus-mistry-remedy-overboard
 Umakanth Varottil, “The Tata Episode: Corporate Governance And The Continuing Influence Of Promoters – Indiacorplaw” (IndiaCorpLaw, 2016) https://indiacorplaw.in/2016/11/corporate-governance-in-india-and.html
 Deva (n26)
 OECD, “Improving Corporate Governance in India: Related Party Transactions and Minority Shareholder Protection, Corporate Governance”(2014 OECD Publishing). http://dx.doi.org/10.1787/9789264220652-en Pg. 31
 Deva (n26)
 Vanshaj Jaln “Who Will Watch the Watchmen- A Study of the Law on Self-Dealing Transactions By Company Directors” 2016 NLS Bus L Rev 49 Pg. 53
 Ibid. Pg. 64
 Javaid Talib and Aqa Raza “Right of Minority Shareholders Under the Companies Act, 2013: A Jurisprudential Analysis” 23 ALJ (2015-16) 34
 Section 244, Companies Act 2013
 Prof. Umakanth Varottil, “The Tata Episode: Corporate Governance And The Continuing Influence Of Promoters” (LiveLaw 14 November 2016) https://www.livelaw.in/tata-episode-corporate-governance-continuing-influence-promoters/?infinitescroll=1) accessed 15 May 2020