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Fundamental Tenets and Laws of Succession Planning

Succession planning is essential for any organization to ensure continuing management, growth and development of the business without disruption.

Succession planning for safeguarding and optimal transitioning of wealth and control are emerging as a critical consideration for businesses in India, many of which are family owned/controlled and are characterized by significant promoter family stakes. While wealth preservation, ring fencing key assets and tax-optimized transfer to the next generation were the guiding features of such exercises earlier on, modern businesses look at corporate succession planning with the added lens of ensuring business continuity and operational competitiveness. In this context, promoters and companies need to reflect upon additional factors such as choice of successors (who may not necessarily be only from the family), composition for the board post-transition and rights of the promoters (including their successors), amongst others.

The entire Raymond group dispute between the father-son duo is a prime example. A recent statement made by the promoter and chairman Gautam Hari Singhania highlights the gravity with which the succession planning needs to be looked at: “Tomorrow morning if I die, God forbid, there are identified people who will take charge of everything. Raymond can run independently and competitively. My children are very young. I have a responsibility to my wife and children, to my employees and shareholders, my banks, institutions and customers”. Similarly, Yes Bank is deciding the fate of who will be at the helm of affairs after the erstwhile promoter and managing director Rana Kapoor had to step down after the RBI’s directions.

BRIEF OVERVIEW OF LOCAL SUCCESSION LAWS

The origin of Indian succession laws can be traced back to the year 1865 when a draft of the Indian Succession Bill was first submitted by the third law commission in its first report for the year 1854-55. Originally it was proposed as the Indian Civil Code, a title which was later altered to Indian Succession Act, 1865. A number of legislations relating to succession were passed from the year 1865 to 1925 and all these legislations were consolidated in the year 1925 and the Indian Succession Act, 1925 (Succession Act) was enacted.

A separate legislation governing Hindus – including Buddhists, Jains and Sikhs – was enacted in the year 1956, namely the Hindu Succession Act, 1956 (Hindu Succession Act). Accordingly, Hindus are governed by the Hindu Succession Act and certain other provisions of the Succession Act. Muslims have their own textual law of inheritance, while Parsees, Christians and the persons whose marriage is solemnized under the Special Marriage Act, 1954 are covered under the Succession Act.

SUCCESSION IS PRIMARILY OF TWO TYPES:

— Testamentary succession: This means succession by way of a ‘Will’. A Will is a legal declaration of the intention of the testator (an individual who makes a will) with respect to his property which he desires to be carried into effect after his death. The registration of a Will is not compulsory but if so desired it may be registered by the testator during his lifetime.

— Intestate succession: When a person dies without making a Will, his property devolves as per the provisions of Succession Act and Hindu Succession Act (applicable to Hindus) and it is known as intestate succession. In case of intestate succession, (a) if the deceased was governed by Succession Act, a letter of administration is required to be obtained from the court of competent jurisdiction for administration of the property of the deceased; or (b) if the deceased was governed by Hindu Succession Act, the property devolves in accordance with the provisions of the Hindu Succession Act, to Class I heirs, Class II heirs, agnates or cognates, as the case may be.

CRITICAL DISCUSSION POINTS AND TAKEAWAYS

A weak succession plan can lead to adverse implications for both the successors as well as the business. The following factors need to be borne in consideration:

— Nominees vs successors: On many occasions, the underlying wealth in a succession plan comprises of shares held by promoters. In such instances, the nominee of shares should not be confused with the successor as per the succession laws. While the Companies Act provides for a provision to nominate a person, the Division Bench of the Bombay High Court in its ruling pronounced on December 1, 2016, held that successor under the succession laws will prevail even if there is a nominee provided by the shareholder. It held that the object of the nominee provision is to ensure that the deceased shareholder is represented by someone, as the value of the shares is subject to market forces, and to ensure that the commerce does not suffer due to delay on the part of the legal heirs in establishing their rights of succession and claiming the shares of a company. It also clarified that usage of the term ‘vesting’ under the Companies Act is not intended to create a third mode of succession and that the Companies Act has nothing to do with the law of succession.

— Income-tax considerations: As of today, India’s Income-tax Act, 1961 (IT Act) does not contain any provisions pertaining to inheritance tax and no tax implications will arise on legal heirs on receipt of any property under a Will or pursuant to intestate succession. However, it is rumoured that an inheritance tax is being contemplated by the government. If and when such legislation is enacted, succession plans will need to account for inheritance tax and undertake efforts to optimize the potential impact.

— Use of ‘trusts’ in succession planning: While preparation of a Will indeed helps reduce disputes between legal representatives and heirs, devolution of assets still needs to be structured appropriately to ensure smooth transition. A private trust under the Indian Trusts Act, 1882, is a popular route to structure succession planning. Trust structure is quite flexible (offering the possibility of various permutations to meet stated objectives of any succession plan) and is also tax neutral. Following the amendments to the IT Act, it has been provided that any property received from an individual by a trust created solely for the benefit of the relative of the individual (the term ‘relative’ has also been defined under the IT Act) will not give rise to any tax implications in the hands of the trust. Tax implications on the beneficiaries at the time of distribution of assets will, of course, have to be analysed based on the trust structure.

— IPR arrangements in succession plans: Promoter interest in a business can also be in the form of intellectual property rights (IPRs), where family members have IPR sharing arrangements for their separate businesses. In such cases, the importance of dealing with IPR arrangements becomes a critical factor and should be accounted for properly, in order to avoid litigation and disputes.

— Timing of the plan coming into effect: While choosing a successor is important, it is equally imperative to decide the time when the planning should be put in place, keeping in mind the dynamic economic and legal circumstances.

CONCLUSION

Many companies have announced the presence of such plans recently, in order to assure their investors and other stakeholders that promoters and management are thinking ahead to the future. Succession planning should indeed be considered as a must-have for any organization for ensuring continuing management, growth and development of the business without any disruptions.

This article has first been published in ET Online.

Contact:

Darshan Upadhyay

E:

Bhavin Gada

E:

Manendra Singh

E:

www.elplaw.in

Legally India's 2019 InLegal 50 Issue

The 2019 print and digital edition of Legally India is a joint publication by Global Legal Media and Legally India. The issue introduces the InLegal 50, which is an annual fully-transparent tracking of India’s corporate law firms. Browse and click through below for more market and legal analysis in this issue.

InLegal 50 Editorial:

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