New Companies Bill fuells rush for hike in royalty payments

Now royalty payments can't be decided by resolution passed with support of promoters alone

Proposed changes to the Companies Bill 2012 has led to a rush among companies to increase royalty payments to their foreign parents. Under the new bill, if changes are approved, promoters will have to take approval of 75% of the non-promoter shareholders on any such proposal. The new regulations will make it harder for the promoters to charge such fees from the company as royalty payments or technology transfer fee, say legal experts. 

The most recent examples of companies that have planned to raise royalty fee to their parent are Gujarat Ambuja, ACC and Hindustan Unilever Ltd. (HUL). Gujarat Ambuja and ACC will pay 1% royalty against current 0.5% to Swiss cement major Holcim for providing technology know-how. HUL has more than doubled the royalty that it will pay to the Anglo–Dutch multinational consumer goods company Unilever to 3.5%.

The new Companies Bill, passed by the Lok Sabha and pending approval of Rajya Sabha, has tightened the norms for related party transactions, such as introducing the requirement of a special resolution to be passed in favour of the transaction by shareholders. If the resolution pertains to a transaction with a shareholder, such interested shareholder has to abstain from voting. Effectively, it means that issues like royalty payments cannot be decided by a resolution passed with support of promoters alone and companies will require a majority consent from minority stake holders too.

While this proposal empowers shareholders, an exception has been carved out. If the transaction is in the ordinary course of the business and is at an arm's length, no such resolution is required. The term arm's length has been defined in the bill to mean a transaction between two related parties, which is conducted as if they were unrelated so that there is no conflict of interest.

Legal experts say, cases like that of Gujarat Ambuja, ACC and HUL would fall under the category of related party transactions and may not be able to take benefit of the exception in the bill.

"Since Holcim is the holding company of ACC Ltd and Ambuja Cements Ltd, any transaction between them would be considered as a related party transaction," said proxy advisory firm SES. 

SES believes that size of both ACC and Ambuja is sufficiently large and it is most likely that these companies would be covered and be required to comply with the provisions.

Manoj Kumar, Assistant vice president, Corporate Professionals said, "In the new companies bill, they have inserted a clause where related party transactions beyond a limit, which will be prescribed in the rules, will require shareholder approval. Further the concept paper issued by Sebi recently on the corporate governance framework also prescribes stringent conditions in this regard. Both these regulations are likely to take effect simultaneously. That is probably the reason behind the rush."

Through Holcim (India) Pvt. Ltd. and Holderind Investments Ltd, Holcim Ltd holds 50.30% stake in ACC Ltd and 50.60% in Ambuja Cements Ltd. The company has stated that it has decided to seek the Members’ approval in this regard by the way of good Corporate Governance practice. However, instead of moving a special resolution (as mandated by the soon to be implemented Companies Bill), the companies have moved an ordinary resolution.

"Since an ordinary resolution requires only majority approval, Holcim Ltd has sufficient shareholding at both the companies to approve an ordinary resolution, even if all other shareholders vote against the resolution. Therefore, by proposing the resolution as an ordinary resolution and stating that even though the matter is within the powers of the board and the same is being done as a measure of good Corporate Governance practice, the promoters are practicing good Corporate Governance only on paper and not in spirit," said J N Gupta, founder director of SES and former executive director at Securities and Exchange Board of India.

If the companies were really intending to adopt good Corporate Governance practice, they would have kept the proposed law in mind and moved a special resolution, which would have required an approval from 75% of the voting members. Further, being a related party in this transaction, Holcim Ltd should abstain from voting on the resolution and the companies should take approval from non-interested members only, says SES.

HUL paid Rs 300.90 crore for FY12. Assuming some growth, it is estimated that company will pay royalty as high as Rs 900-1,000 crore. Post 2009, Indian companies were allowed to pay whatever royalties they like to their MNC promoters. This has meant a 140% aggregate increase in royalties paid by the 25 companies in our analysis since FY08, with no commensurate improvement in growth or margins, says foreign broking house Espirito Santo. MNC subsidiary companies listed in India; in total 59 of the BSE 500 companies have a foreign MNC ‘promoter’ with a stake of 26% or more.