Thursday, November 6, 2008

Companies Bill: New Entities

The Companies Bill, 2008, which has been introduced in the Lok Sabha, contains two entities that are fairly novel in the Indian corporate scenario, and it might be useful to briefly discuss these two types of entities. They are: (i) one person company (OPC); and (ii) “small” company.

One Person Company

Under the existing Companies Act, 1956, a company can be incorporated with a minimum of two shareholders (in the case of a private limited company) and seven shareholders (in the case of a public limited company). Similarly, there is also a requirement to have minimum number of directors, which is two directors in the case of a private limited company, and three in the case of a public limited company. This often gives rise to several practical difficulties. For instance, certain affairs of the company cannot be carried out without the presence of at least two shareholders or directors at shareholders general meetings and board meetings respectively.

However, these requirements have, to some extent, lost their relevance in recent times, especially in the case of very closely held companies, because they can simply be overcome by introducing nominee shareholders and nominee directors. For instance, if one person (i.e. a legal person, being an individual or company) intends to form and operate a company, all that person needs to do is to find another person to act as a nominee to satisfy the two-shareholder requirement. Similarly, it is possible to find one or more friendly individuals to act as directors to satisfy the minimum director requirement. Since these requirements have become largely procedural in nature, the introduction of an OPC is welcome.

The OPC will act as a useful substitute to sole proprietorships, whereby single individuals carrying on business activity can take advantage of limited liability, which is not available in the case of a traditional sole proprietorship. In the case of an OPC, since the company would be a separate legal entity, the shareholder will not be liable for the debts of the OPC itself, subject of course to certain exceptions such as lifting of the corporate veil. This will perhaps help individuals structure their businesses in a more organised fashion, which would also help them raise finances from time to time in the form of equity or debt.

In the Bill, the OPC has certain special provisions applicable to it. The name of an OPC should carry the words “OPC Limited” so that the persons of dealing with it are aware of its character. The OPC is also exempted from some of the procedural requirements under the Bill, such as the need to hold a shareholders’ annual meeting. The OPC is required to have only one director on its board.

Relevant clauses in the Bill: 3(1), 5(1)(a), 13(1), 85(1), 120(1), 132(1)(a), 171, 421

Small Company

The Bill defines a small company as a company, other than a public company, whose (i) paid-up share capital does not exceed a prescribed amount that shall not be more than Rs. 5 crores (Rs. 50 million), or (ii) turnover does not exceed a prescribed amount that shall be no more than Rs. 20 crores (Rs. 200 million). The reference to a company “other than a public company” would mean that a “small company” would necessarily have to be a private company or an OPC.

Small companies are eligible to take advantage of certain simplified provisions of company law. The most significant of these benefits relates to a simplified procedure for amalgamation of small companies (in clause 204 of the Bill) that can be effected without prior approval of the National Company Law Tribunal.

Relevant clauses in the Bill: 2(1)(zzzg), 204, 421

How Far Does This Benefit OPCs and Small Companies?

Apart from the simplified provisions discussed above, both OPCs as well as small companies are required to comply with all the provisions of the Bill as in the case of other companies. However, clause 421 of the Bill provides that the Central Government may direct that certain provisions of the Bill shall not apply to a private company, OPC or small company. Hence, the simplification process is largely left to subordinate legislation and in the hands of the executive. The flexibility available to these entities can be determined only once such exemptions have been granted.

While the introduction of such new entitles are welcome in that they assist small businesses, there is a fundamental question regarding the approach adopted. One of the objectives of simplifying company law is to ensure that it caters all types of businesses at different points in the spectrum, i.e. with large listed companies at one end and small companies at the other. However, the starting point in the Bill seems to be the law as it applies to large listed companies, replete with all the detailed provisions. From that starting position, exceptions and carve outs are being made for small types of entities.

This does not account for the fact that a substantial number of companies that are registered in India are small private companies as opposed to the large public and listed companies. For example, the Annual Report (2007-08) issued by the Ministry of Company Affairs indicates that as of March 31, 2007, there were 7,43,678 companies, out of which 6,53,024 were private limited companies, while only 90,654 companies were public limited companies (out of which only a small percentage would be listed companies).

Therefore, unless OPCs and small companies are exempt by the Government from the operation of a large number of onerous provisions in the Bill (that are otherwise meant to apply to public companies and in certain cases to private companies), the objective of achieving simplification of company law for small and medium-size business would be difficult to achieve.

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