Corporate Law Review Commission to Redraft Companies Ordinance - International Law Office

Introduction
Key Features
Comment

Introduction

The Corporate Law Review Commission - a body established by the Securities and Exchange Commission of Pakistan (SECP) on November 6 2005 to carry out a thorough review of the Companies Ordinance 1984 - has commenced redrafting the ordinance.

The redrafting is being carried out in accordance with the objectives set out in the concept paper submitted by the commission to the SECP. The paper emphasizes the need for a holistic review of the ordinance. The aim is to (i) reassess the objectives and provisions contained in the ordinance in light of the economic environment, and (ii) facilitate the creation and maintenance of a liberal, deregulated and efficient corporate sector.

Although the redrafting process has already started, it is unclear whether the provisions of the ordinance are to be amended or whether a new law altogether will replace the ordinance.

Key Features

The main recommendations proposed by the commission in the concept paper are as follows:

• The objectives of company law should be clearly specified and defined. Provision should be made to:
  
  
  • facilitate the growth of companies;
    
    
  • promote higher standards of corporate governance and good management practices;
    
    
  • provide adequate protection for small investors and minority shareholders;
    
    
  • simplify and strengthen the legal, regulatory and auditing requirements and the procedures applicable to companies; and
    
    
  • foster and promote healthy competition.
    
    
• Company law regulates all aspects of 'entities', irrespective of their corporate structure and size, based on their activities. The commission has proposed that only substantive matters be included in core company law (eg, matters relating to the classification of companies; the relationship between subsidiary, holding and associated companies; the formation and conversion of companies; the raising and maintenance of capital; the management and governance of companies; the requirements and procedures for conducting an audit of company accounts; the provisions on corporate disclosures and prevention of oppression and mismanagement; mergers and acquisitions; restructuring and liquidation; and the regulation and supervision of companies). Further, all procedural matters should be excluded from core company law and be expressly identified and included in secondary legislation (eg, rules or regulations issued by the SECP).
  
  
• The restriction on the number of members in a private company (50 members) should be removed and the category of 'public unlisted companies' should be abolished.
  
  
• Factors distinguishing small, medium and large companies should be elaborated on. A test for determining the category within which a company falls should be prescribed based on:
  
  
  • the capital or turnover of the company;
    
    
  • the number of members or employees of the company;
    
    
  • the control of the company;
    
    
  • the nature of liability; and
    
    
  • access to capital.
    
    
• The law should be amended to prevent companies from being considered to be 'associated' simply on the basis of common directorship. The concept of 'association by dominant influence', which is prevalent in the United Kingdom, should be considered. Under the ordinance, companies are deemed to be associated if (i) the relationship between the companies is that of 'holding company' or 'subsidiary' (ie, the company owns or controls more than 50% of the voting shares or has the power to appoint more than 50% of the directors), or (ii) a director of one company either is a director of the other company or holds or controls 20% or more of the shares of the other company.
  
  
• With regard to the formation and registration of companies, the commission has recommended that the procedure be streamlined, simplified and made cost effective in order to minimize the physical interface with the registering authorities. It is suggested that this will prevent the potential for abuse of discretionary powers by the authorities. In addition, an e-filing system should be introduced to complement the traditional filing system.
  
  
• The conversion of public companies to private companies (and vice versa) and of limited companies to unlimited (and vice versa) should be facilitated by a simple process of re-registration after the fulfilment of certain specified requirements (with minimal procedural requirements). Under the present system, the conversion procedure is narrow in scope and depends heavily on the discretion of the SECP.
  
  
• The procedures for increasing or reducing the share capital of a company are lengthy and cumbersome and should thus be amended. The commission has recommended that:
  
  
  • the requirement for a company to have authorized share capital be abolished for companies incorporated in Pakistan;
    
    
  • the procedures for the issuance of shares at a discount or at a premium be simplified and streamlined; and
    
    
  • companies have autonomy in determining the rights attached to their equity and other instruments.
    
    
• The provisions on the extent of the directors' fiduciary duties and individual liability for the decisions of the board of directors are inadequate. The commission has recommended that a twofold test (as applied in the United Kingdom) should be applicable in Pakistan. The test stipulates an objective standard (ie, the minimum standard of care required of a director), as well as a higher subjective standard where the director has particular skills or expertise. Additionally, the 'business judgement rule' (as applied in the United Kingdom) should also be introduced in Pakistan. Under this rule, a court will refuse to review the actions of the board unless it is alleged that (i) an action violates the directors' duty of care and loyalty and duty of good faith, or (ii) a decision of the directors lacks a rational basis.
  
  Therefore, the application of the business judgment rule would create a strong presumption in favour of directors, freeing them from liability where they:
  
  
  • have acted in the best interest of the company;
    
    
  • have exercised judgment in good faith and for a proper purpose;
    
    
  • have no material personal interest in the subject matter;
    
    
  • have informed themselves of the subject matter to an extent that they reasonably consider to be appropriate; and
    
    
  • rationally believe that the business judgment is in the best interest of the company.
    
    
  Provided that directors have acted in good faith and in the best interest of the company, the courts will not interfere with the directors' decisions.
  
  The commission also recommended that in order to introduce greater flexibility, the application of the rule should be extended to the exercise of powers outside directors' meetings. Moreover, directors should be allowed and encouraged to delegate their powers to individual directors or a committee of directors.
  
  
• With regard to the holding of meetings, the commission recommended that the rules be relaxed for small private companies (selected or identified according to criteria prescribed by law). Moreover, such companies should be allowed (through elective resolutions) to dispense with certain requirements of company law (eg, the holding of an annual general meeting, the laying of accounts and reports before general meetings and the majority requirement in order to authorize meetings at short notice). All companies should have the option to pass a resolution by circulation under the ordinance.
  
  
• The requirement that a shareholder maintain a minimum shareholding of 20% in the company in order to file a complaint before the High Court should be reduced to 10%. Jurisdiction to hear such complaints against oppression and mismanagement should reside in the SECP, and not in the High Court as is currently the case.
  
  
• Schemes of arrangement for mergers and acquisitions should be subject to subsequent approval by shareholders through a special resolution (rather than approval by the High Court); any aggrieved party representing 10% or more of the shareholding of the company should be entitled to file objections with the SECP. With regard to the valuation of shares, the commission recommended that the SECP be empowered to prescribe the approved methods of valuation; any challenge to the valuation should be heard by the SECP. The commission also recommended that the provisions of the Monopolies and Restrictive Trade Practices Ordinance 1970 be examined in order to ensure compatibility with the ordinance once amended. The Monopolies Control Authority has recently framed rules whereby prior approval of the authority is required for all mergers and acquisitions where:
  
  
  • the value of gross assets of the undertaking (excluding the value of goodwill) is no less than PRs300 million and/or the combined value of the acquiring undertaking and the undertaking whose shares are proposed to be acquired, or the undertakings being merged, is no less than PRs1 billion;
    
    
  • the annual turnover of the undertaking in the preceding year is no less than PRs500 million and/or the combined turnover of the acquiring undertaking and the undertaking whose shares are proposed to be acquired, or the undertakings being merged, is no less than PRs1 billion; or
    
    
  • the undertaking (including an individual) holds no less than 30% of the shares in the equity of the undertaking which intends to acquire or purchase no less than 30% of shares in the equity of another undertaking.
    
    
• The process of winding up or liquidation, which is time consuming and cumbersome, should be simplified and be considered as subject matter for independent legislation.
  
  
• The penalties prescribed under the ordinance should be made commensurate with the severity of the offence. Moreover, the commission recommended that (i) the offences which may be investigated be specified under the ordinance, and (ii) the provisions on investigation be made more effective and less cumbersome. Additionally, a system of self-regulation should be introduced, with penalties for failure to comply.
  
  
• The commission did not favour the formation of special tribunals to hear company law disputes. A balance should be struck between the powers of the High Court and those of the SECP in order to ensure that only complex matters are referred to the court. Additionally, efforts should be made to ensure that special benches are created in the High Court, as required by the ordinance. The commission also recommended that other alternative dispute resolution mechanisms be developed and encouraged.

Comment

If and when incorporated, the commission's recommendations will bring about significant changes to the system. However, the impact of these changes remains unclear at this stage. It is hoped that when drafting the law, the commission will consider the need to provide greater freedom to companies with regard to capital structure and management, with minimum interference from regulators. This will encourage local and foreign investment; it will also allow investors to incorporate companies and provide for management and operation in a manner which, according to sponsors and other members (eg, primary stakeholders), is best suited for achieving the business objectives of the company.

The commission's final proposals are yet to be seen. It is expected that all stakeholders will have the opportunity to comment on such changes before the new legislation is presented to Parliament.

For further information on this topic please contact Aisha Ghazi at Vellani & Vellani by telephone (+92 21 580 1000) or by fax (+92 21 580 2120) or by email (aisha.ghazi@vellani.com).