Governance Issue – Multidisciplinary Case Studies Important Questions
Question 1.
In United Kingdom, the Combined Code on Corporate Governance of 2008 is the result of studies made from time to time by various committees to prevent the recurrence of scandals and financial collapses experienced in 1980s and early 1990s, when Cadbury Committee was first set-up in 1992 which gave a new dimension to the Corporate Governance.
List out the three important recommendations made by Cadbury Committee and outline atleast five major landmarks in the historical development since the setting-up of the Cadbury Committee for improvement in the Corporate Governance.
Answer:
(i) The Cadbury Report 1992 – Due to several scandals and financial collapses in the UK in the late 1980s and early 1990s, London Stock Exchange setup the Cadbury Committee in may 1991 to raise the standard of corporate governance in future. This committee in its report known as Cadbury Report, recommended mainly:
- Separating the role of CEO and Chairman of the Board.
- Balanced composition of Board of Directors with executive and non executive directors.
- Selection process for non executive directors.
(ii) The Greenbury Report 1995 – The Confederation of British Industry set up a group under the Chairmanship of Sir Richard Greenbury to examine the remuneration of the directors. It recommended the formation of Remuneration committee composed of non executive directors. Its recommendations were incorporated in the Listing Rules of The London Stock Exchange.
(iii) The Hampel Report 1998 – The Hampel Committee was set up to review the implementation of Cadbury and Greenbury Reports and to see that their purposes were being achieved. The Recommendations of the committee coupled with further consultations by the London Stock Exchange resulted in a combined code on Corporate Governance, the original combined code 1998.
(iv) The Turnbull Report – A working group under the Chairmanship of Niger Turnbull recommended the internal Control Guidance for Directors which were included in the combined code.
(v) Higgs Report – The combined code was reviewed in July, 2007 by Derek Higgs about the role and effectiveness of non – executive directors.
(vi) Smith Report – A group under The Chairmanship of Sir Robert Smith was set up to develop guidance for Audit Committee in the combined code.
(vii) The Tyson Report – The Tyson Report was recommended on the recruitment and development of non -executive directors.
(viii) The combined code on Corporate Governance as revised in 2003 – The basis of recommendations of all the reports the combined code was revised in 2003.
(ix) The combined code on Corporate Governance 2006 – The combined code on Corporate Governance was again revised in 2006.
(x) The combined code on 2008 Governance 2008 – The combined code on Corporate Governance 2008 sets out standards of good practice in relation with shareholders. All companies incorporated in the UK and listed on the London Stock Exchange are required to report in their annual reports and accounts about the implementation of the combined code on Corporate Governance.
Question 2.
XYZ Ltd. is a listed company having turnover of ₹ 1,200 crores during the financial year 2015-16. The CSR committee of the Board formulated and recommended a CSR project which was approved by the Board. Company finalised the project under its CSR initiatives which require funds @5% of average net profit of the company for last three financial years. Will such excess expense be counted in subsequent financial years as a part of CSR expenditure? Advise.
Answer:
In terms of Section 135(5), the board of every company, to which Section 135 is applicable, shall ensure that the company spends, in every financial year, at least 2% of the average net profits of the company made during the three preceding year.
There is no provision of spreading over the expenditure incurred in a particular year over the next few years. The words used here is at least. Therefore, any Expenditure over 2% could be considered as voluntary higher spend. However, in case, a company does not want to spend the 2% in the subsequent year on account of it having spent a higher amount in the previous year, the Board’s report may state so.
Question 3.
The elder son of Prem Kumar Biswas was a truck driver with one Bidhan Chander Roy. He met with an accident while on his way to deliver consignment of the owner in the truck from Kolkata (West Bengal) to Lucknow (Uttar Pradesh). He sustained severe injuries on the head and died on the spot.
Prem Kumar Biswas filed, for compensation under the Employees State Insurance Act, 1923 and the Commissioner allowed a compensation of ₹ 15,20,268. Aggrieved by the order, the Insurance company preferred an appeal before the High Court in Kolkata. One of the contentions of the insurance company was that the deceased lost his life as a result of his own negligence and that Prem Kumar Biswas was not entitled to any compensation.
There was no document on record to prove the exact amount of wages being earned by the deceased at the time of the accident. But it was proved that the deceased was a highly skilled workman and was often required to undertake long journeys outside the State in the line of duty. The vehicle he used to ply had a registred National Route Permit.
The High Court set aside the order of the Commissioner for workmen’s compensation and reduced the amount of compensation to ? 11,00,000. Prem Kumar Biswas intends to prefer an appeal before the Supreme Court challenging the correctness of the impugned judgement of the High Court. Will he succeed? Give reasons in support of your answer.
Answer:
The present problem is similar to the case of Jaya Biswas & Ors. V Branch Manager, IFFCO Tokio General Insurance Company Ltd. (SC) – (Civil Appeal No 869 of 2016 (Arising out of S. L.P.(C) No.1903 of 2015 decided on 04/02/2016). In this case Supreme Court inter-alia observed that the Employees’ Compensation Act, 1923 is a welfare legislation enacted to secure compensation to the poor workmen who suffer from injuries at their place of work. The Preamble of the Act reads, “An act to provide for the payment by certain classes of employees to their amount of compensation for injury by “accident”. By increasing the importance for the employer of adequate safety devices, it reduces the number of accidents to workmen in a manner that cannot be achieved by official inspection.
The Act is a social welfare legislation meant to benefit the workers and their dependents in case of death of workman due to accident caused during and is the cause of employment. It has to be proved by the employee that
- There was an accident
- The accident had a casual connection with the employment
- The accident must have been suffered in the course of employment.
In the instant case, the’deceased was on way to deliver the consignment during the course of employment when he met with the accident. The accident squarely arose out of and in the course of employment. The contention of the insurance company that the deceased died as a result of his own negligence, doesn’t hold ground.
Section 3 of the Act, doesn’t create any exception of the kind, which permits the employer to avoid his liability if there was negligence on the part of workman. The act does not envisage a situation where the compensation payable to an injured or deceased workman can be reduced on account of contributory negligence. Mere negligence does not entitle a workman to compensation.
There was no evidence to prove that there was negligence on the part of the driver. Even if there was any negligence on his part, it would not entitle his dependents from claiming compensation under the Act. It can be said that the avail of compensation by the Commissioner was well reasoned and elaborate. The High Court should not have reduced the amount of compensation. It appears the judgement of the High Court suffers from gross infirmity.
In view of the above Prem Kumar Biswas should prefer an appeal before Supreme Court and should succeed.
Question 4.
Ramakrishnan was employed by the Mukateshwara Silk Company Ltd. at its registered office in Mumbai in the dyeing section in the year 1988. He was later on promoted in 1992 and again in 2000 and continued to be located at the company’s registered office in Mumbai. The company in its orders of transfer located Ramakrishnan at the company’s establishment in Panjim (Goa) in 2005 and again transferred him at company’s another establishment in Jamnagar (Gujarat) in 2006. However, Ramakrishnan’s services, were terminated in 2007 due to the closure of the establishment in Jamnagar.
Aggrieved by the order of termination Ramakrishnan intends to institute a suit in the Labour Court in Mumbai under the Industrial Disputes Act, 1947. Will he succeed? Give reasons in support your answer.
Answer:
The fact of the case is similar to the case of Nandram vs. Garware Properties Ltd (SC) Civil Appel No. 1409 of 2016 (Arising out of SLP (C) No. 33917 of 2011) [Decided on 16/02/2016].
Ramakrishnan was employed at the office in Mumbai. He was only transferred to its establishment in Jamnagar. The decision to close down the establishment at Jamnagar was taken by the company in Mumbai. The decision to terminate the services of Ramakrishnan was taken in Mumbai. Thus, part of cause of actions has arisen in Mumbai. No doubt, the Labor Court in Jamnagar has the jurisdiction to consider the case of Ramakrishnan if he prefers to institute the suit there.
But that does not mean that the Labor Court in Mumbai within whose jurisdiction the management of the company has taken the decision to close down the establishment in Jamnagar and pursuant to which services of Ramakrishnan were terminated does not have the jurisdiction.
Hence, both the Labor Courts in Mumbai and Jamnagar have the jurisdiction to deal with the matter. Ramakrishnan can institute the suit in the Labor Court in Mumbai.
Question 5.
Luke Graves (Luke) is the long-serving Chief Executive Officer (CEO) of Hornbill pic, a UK listed company. He had a meeting with the newly-appointed Chairman of the company, Ross Plank (Ross), who is married to Luke’s sister. A number of different items were on the agenda for discussion. Luke said that he had recently had a meeting with two institutional shareholders in the company, who together held 5% of the equity shares. He had also discussed the company’s performance over the past few months with them and they had been pleased by the profit forecasts that he had given them.
The company’s results would be announced to the stock market within the next two weeks. Luke added that he had also discussed the company’s main business strategies with these shareholders and had informed them that he intended to establish a strategy committee within the company, consisting of the executive directors and other senior executives. Luke and Ross later on discussed the retirement and re-election of Board of Directors at the next annual general marketing of the company. Luke said there was an issue with John, one of the directors, who would be retiring by rotation. John had been an independent non-executive director for almost nine years.
He was very experienced and had contributed enormously while attending meetings of the Board. He was considered to be too valuable to lose from the Board, but there was now a problem with his independent status. Luke felt that he was still as independent now as he was when he first joined the Board. Luke also informed Ross that he had arranged for additional training for two Board directors: one of the non-executive directors and also the marketing director.
(a) On the basis of above-mentioned facts, what weaknesses are discernible in the corporate governance practices of the company?
(b) What would be your recommendations and suggestions regarding the appropriate practices to be followed on the weaknesses identified by you?
Answer:
(a) On the basis of the facts of the case, following weaknesses in corporate governance are evident in Hornbill pic:
1. The newly-appointed Chairman Ross Plank is brother-in-law of the CEO Luke and therefore has a close family connection with an existing board member. The Chairman cannot, therefore, be considered independent on appointment. The fact that the Chairman is non-independent and the relationship of Chairman and CEO should be disclosed in the annual report of the company.
2. Luke, the CEO has disclosed price sensitive information i.e. the company’s performance over the past few months and profit forecasts with the institutional shareholders before they have been announced to the stock market. Thus, Luke has violated stock market regulations by giving financial information to the shareholders that has not been made publicly available.
If the institutional shareholders trade shares in the company before the , announcement of the annual results, they would be liable for insider trading. Therefore, the institutional shareholders must be informed that they are insiders and should not deal in shares of the company until the information becomes public knowledge. The board should also discuss and consider the breach of rules and discourse of price sensitive information by Luke.
3. The objective of establishing Strategy Committee comprising of executive directors and senior executives is also not clear. It is the responsibility of the board of directors to decide business strategy, and the executive management should implement those strategies decided by the board. Here, it is not clear what Luke means by ‘ establishing a strategy committee, but it should not be for the purpose of deciding strategies.
4. It is also observed that, the CEO is taking on too many roles outside his proper area of responsibilities and there is a risk that the board of the company will be dominated by a single individual. This risk is increased because of the family connection between the CEO and the Chairman.
(b) Some of the recommendations and suggestions regarding the appropriate practices to be followed are –
1. The Chairperson of the board is the individual charged with providing the board with effective leadership on all aspects of its role and setting its agenda. While the chairperson is required to retain an objective viewpoint of the affairs of the company, the CEO is often required to become intimately involved in developing and executing management plans for the company.
CEO’s main responsibilities include developing and implementing high-level strategies, making major corporate decisions, managing the overall operations and resources of a company, and acting as the main point of communication between the board of directors and the corporate operations. This role clarity should be there among the Chairman Ross and CEO Luke in this case.
2. The independence of the chairman is paramount to the successful implementation of good corporate governance practices at board level. Therefore, as a good governance, chairperson of the board should be independent and free of conflicts of interest at appointment.
3. Collective decision making and discussions among the Board is also missing in the Company. It would have been appropriate for Luke to discuss his intentions to establish a strategy committee with the board colleagues before announcing them to a few shareholders. The board as a whole should be responsible for deciding strategy and for deciding whether any new board committee should be set up.
4. The Nomination and Remuneration Committee should consider the selection and re-appointment of Directors and makes its recommendation to the Board. It should assess the current Board’s skills, experience and expertise to identify the skills that would best increase Board effectiveness.
5. The responsibility for selection and appointment of directors should be done by the Nomination and Remuneration Committee and the CEO Luke should not try to influence the Chairman of the board regarding appointment or selection of any particular director.
6. The Chairman or the Nomination and Remuneration Committee should make policy for the induction and training of directors, particularly Non-Executive Directors, although the task of arranging induction and training may be delegated to the company secretary. The CEO may arrange technical training for another executive directors.
Question 6.
ABC Ltd., is a company which has a net worth of INR ₹ 200 crores, it manufactures rubber parts for automobiles. The sales of the company are affected due to low demand of its products.
The previous year’s financial state:
(₹ in crore)
| March 31, 2019 (Current year) | 43189 | 42824 | March 31, 2016 | |
| Net Profit Sales (turnover) | 3.0085 | 8.5095 | 4.009 | 3.008 |
Answer:
It has been clarified that ‘any financial year’ referred to under sub section (1) of section 135 of the act read with Rule 3(2) of Companies CSR Rule, 2014 implies ‘any of the three preceding financial years’.
A company which meets the net worth, turnover of net profits criteria in any of the preceding three financial years, but which does not meet the criteria in the relevant financial year, will still need to constitute a CSR committee and comply with provisions of Sections 135(2) to(5) read with the CSR rules.
As per the criteria to constitute CSR committee:
- Net worth greater than or equal to INR 500 crores: This criterion is not satisfied.
- Sales greater than or equal to INR 1000 crores: This criterion is not satisfied.
- Net profit greater than or equal to INR 5 crores: This criterion is satisfied in financial year ended March 31,2018.
Hence, the company will be required to form a CSR committee.
Question 7.
AB & CD Limited, a Non-Banking Finance Company (NBFC), was a diversified Company having a complex group structure with more than 20 subsidiaries. Each company had its own Finance department which would report to a Central Finance Team headed by the group CFO. All the Companies and different units of AB & CD Limited were functioning in silos, wherein each one was unaware of the performance of other companies.
There were inter-corporate loan arrangements between Companies in the group. The top management consisted of few professionals and family members. All the top executives were being paid higher remuneration in comparison with the industry benchmarks including high number of stock options.
AB & CD Limited had a whistle blower policy monitored by the Audit Committee. Vyom, a qualified Senior Accountant, working in the Company had approached the Director (Finance) with concerns about the financial statements but he could not get satisfactory answers and so threatened to inform the press. When his threat came to the attention of the Board, he was intimidated to keep quiet.
Another employee had written to an independent director stating that the books of the Company had been manipulated. Although this letter was circulated to the Board, no action was taken. The audit committee also failed to take any action.
When the group was not able to repay its loan to banks, there were concerns from bank and forensic audit was initiated. The forensic audit revealed a fraud within the Company and the share price of the Company plummeted. Based on the above facts, answer the following:
(a) What is the role of Independent Directors and Audit Committee for effective oversight of matters pertaining to Whistle blower complaints?
(b) What are the challenges of effective implementation of a Whistle blower policy in a company such as AB & CD Limited? Give your suggestion for devising better Whistle blower mechanism.
Answer:
(a) While the ultimate responsibility of vigil mechanism is with the Board as a whole. Audit Committee is tasked with principal oversight of whistle blowing systems with the direct responsibility for anti-fraud efforts generally residing with management including internal audit. Whistle blowing procedures are a major line of defence against fraud and audit committee should ensure such procedures are effective. By focusing on whistle blowing channels and considering it within the context of the organisations overall approach to enterprise risk management – the audit committee can help strengthen internal controls, financial reporting and corporate governance.
The audit committee must be properly informed and actively engaged in overseeing the process while avoiding taking on the role or responsibilities of the Management. To this end, it should seek input from legal counsel, internal/external audit.
The audit committee should seek to ensure that the management has considered all risks that are likely to have a significant financial, reputational or regulatory impact on the organization. For any such risks, a rigorous assessment of the relevant internal controls including their ability to detect or prevent fraud should be made.
Effective monitoring of these internal controls and periodic re-assessments of their effectiveness are key elements to stay updated, together with management’s active engagement in the process. The audit committee should consider whether effective fraud awareness programmers are in place, updated as appropriate and effectively communicated to all employees.
(b) Some of the challenges of effective implementation of a whistle blower policy are:
Operational : Extent of whistle blowing mechanism within the organization, awareness about it to staff members and whether the hotlines and reporting lines actually work.
Emotional and cultural : Whistle blowers are commonly viewed as snitches, sneaks, grasses and gossips. This perception can make it difficult to blow the whistle even though individuals recognize that it is good for the company, employees, shareholders and other stakeholders.
Potential whistle blowers often fear reporting incidents to Management : Areas such as legal protection, fear of trouble and potential dismissal all play a part when an individual is considering whistle blowing.
Suggestions for devising better whistle blower mechanism:
- Whistle blowing policies and procedures to be documented and communicated across the organization.
- Whistle blowing policy should ensure that it is both safe and acceptable for employees to raise concerns about wrongdoing.
- The whistle blowing procedures should be arrived at through a consultative process. Management and employees should ‘buy into’ the process. Success stories to be publicized.
- Concerns raised by employees are responded to within a reasonable time frame.
- Procedures should be in place to ensure that all reasonable steps are taken to prevent the victimization of whistle blowers and to keep the identity of whistle blowers confidential.
- Dedicated person to be identified to whom confidential concerns can be disclosed. That person should have the authority and statute to act if concerns are not raised with or properly dealt with, by the line management and other responsible individuals.
- Management should understand how to act if a concern is raised. They should understand that employees and others have right to blow the whistle.
- Consideration to be given to the use of an independent advice centre as part of the whistle blowing procedures.
- In case, issues are not reported to the management through whistle blowing channel, then management must have a re-look on the effectiveness of the whistle blowing procedures.