Companies Act takes a revolutionary step forward in the corporate arena

The New Companies Act formed in line with international company law has introduced several significant changes to local company legislation. The new Act also promotes better corporate governance and protects the rights of the minority shareholders.

The director’s duties being catalogued in a statutory form for the first time in Sri Lanka in the new Act is a revolutionary step forward in the corporate arena, said President’s Counsel Dr: Harsha Cabraal when he addressed a recent seminar on the “Stated capital - Solvency and duties of Directors’. He added that the new Act has provisions for directors to rely on information and advice of experts to enable them to act in good faith.

By law a director should not act in any manner which is reckless or grossly negligent and shall exercise a degree of skill and care that may be reasonably expected of a person of his knowledge and experience, he added.

Outlining the main features of stated capital and solvency of a company, Partner of PwC Sujeewa Mudalige disclosed that the concept of par value of shares has been abolished by the new Act and the new concept of stated capital has been introduced by section 58 of the Act. Stated capital is defined as the total of all amounts received by the company or due and payable to the company in respect of the issue of share.

He pointed out that under the previous legislation each share continues to have the same nominal value throughout the life of the company. However the value of a share considered as a defined proportion of the undertaking will in most cases have lost any correspondence it might have had to the nominal value.

Inflation alone can bring about that result. He argued that if the real value of a share declines below the nominal value someone who doesn’t have much knowledge and who contemplates in investing in shares may be misled into thinking that the nominal value is the real value of the share.

Mudalige said that the solvency test introduced in the new law deals with the solvency of a company, where it requires the Board of a company to satisfy the solvency test and to obtain a certificate of solvency from the auditors before any dividend distribution is made.

A mechanism called the solvency test which must be undertaken by the board of directors has been brought into the Act depending on two cardinal issues. First whether the company is able to pay its debt as it becomes due in the normal course of business and secondly whether the value of the company’s assets are greater than its liabilities and stated capital.

He asserted that not only do the directors have to certify that there is solvency of the company but the auditors have to also certify the same. So there is always a check and balance to make sure that the company’s solvency is maintained.

He pointed out that newly offered devices like the solvency test aims to give a better view of the business prospects of the company but they suffer from a limited time horizon and a wide range of discretion of directors.

This makes them particularly problematic when long-term obligations have to be addressed. He noted that a combination of balance sheet tests and solvency tests seems to be a reasonable solution to this problem.