New Companies Act safeguards shareholders' interests

The new Companies Act of 2007 gives ample freedom to directors to act in the best interests of the company and also emphasises the responsibilities to safeguard the interests of the shareholders, said Partner PricewaterhouseCoopers Sujeewa Mudalige. He was addressing a seminar on 'Who passes the solvency test?' organised by Ceylinco Shriram Asset Management Ltd.

Mudalige said the New Companies Act deals extensively on the solvency test where directors need to act cautiously and make prudent decisions in the best interests of the company and the shareholders.

The emphasis on solvency in the New Companies Act brings in the checks and balances that are needed for a company and makes it vital that directors consider a solvency test before making a distribution or benefit to shareholders and in other circumstances.

In the previous Companies Act the directors did not have to obtain the concurrence or approval from shareholders before entering into a major transaction. The New Act has done away with that liberty of directors who now have to be more accountable. The underlining principle now is 'let managers manage but make them accountable, Mudalige said.

Directors are made personally accountable, made to repay out of their own personal money if the company cannot when they are careless, reckless, negligent or indifferent to the claims of others.

As set out in the New Act a company should be able to pay its debts as they become due and the value of the assets should exceed liabilities.

The solvency test is to assess the company's long term obligation to remain solvent and avoid bankruptcy. This does not mean a company should be solvent daily when it trades but the solvency test must be met when certain transactions are proposed.

He said undercapitalisation, low operating cash flow, low earning capacity, accounting and auditing treatments not done properly and liquidity under pressure affects the solvency of a company.

A company that makes profits finalises its accounts quickly and announces its profits. Lower the solvency ratio the closer a company is to the danger zone, he said.

LF