Explanatory statement is the detailed information given by a company, to its shareholders, along with a proposed resolution at a General Meeting, to enable the shareholders to make well-informed decisions, which are backed by facts.
As per the Companies Act, 2013 (the Act), this statement has to be annexed to the Notice of the General Meeting. It should set out all the material facts concerning each item, such as the nature of concern or interest, financial or otherwise, if any, of every Director, Key Managerial Personnel, and/or their relatives. The statement should also set out any other information and facts that may enable shareholders to understand the meaning, scope and implications of the items of business, and to take decisions thereon. In the absence of an explanatory statement, there would be penalties imposed on the key persons of the company.
The rationale behind providing an explanatory statement is to ensure that shareholders are well equipped with necessary information, and as owners of the company, can take informed decisions. It has been held in the case of Sheth Mohanlal Ganpatram v. Shri Sayaji Jubilee Cotton and Jute Mills Co. Ltd that non-furnishing of material facts in an explanatory statement can result in questioning the validity of a resolution that has been passed, even though the General Meeting may have otherwise been validly called and held.
While companies follow the letter of law, and provide such explanatory statements, the spirit behind this provision of law is not respected, in the case of a few resolutions. Information that is provided is either in complicated language, which is not easy to comprehend, or is not complete, thereby defeating the very purpose that these statements have to serve. There have been instances wherein shareholders have rejected resolutions, especially those relating to remuneration of the MD, due to lack of adequate information. In some of these cases, when the company went back to shareholders with more information, the same resolutions were passed with adequate support from them.
There is no standard format for explanatory statements. However, care should be taken to ensure that the explanation to any resolution is in simple and clear language, to enable shareholders to understand the rationale behind the resolution. In the recent proposed amendments to Japan’s Corporate Governance Code, emphasis has been laid inter alia on disclosures to shareholders being in easy-to-understand language.
Companies need to understand that it is their duty to provide complete and transparent information to the shareholders, who are the owners of the company. Rejection of a resolution due to lack of information, may lead to delay in decision-making, which may also result in loss of some opportunity. The items that go to shareholders are very important, and often timebound. These include items such as approval of financials, approval for appointment of Director(s) and/or auditor, approval of some Related Party Transactions, etc. Delay in getting approvals on these could affect the functioning of the company. Also, with increased focus on shareholder democracy, providing incomplete information may impact the reputation of the company adversely, with some voices being raised against the company for not being transparent with the shareholders.
The thumb rule in Corporate Governance is “when in doubt, disclose”. It is equally important for the disclosure to be in “easy-to-understand” language.