[The following guest post is contributed by Vinod Kothari and Aditi Jhunjhunwala of Vinod Kothari & Co. The authors may be contacted at firstname.lastname@example.org and email@example.com respectively.]
The 9-lakh (0.9 million) odd private companies in India have already been subjected to unprecedented compliances required under the Companies Act, 2013 (the “Act”) given the financial year-end deadline of March 31, 2015. Ever since July 2014 when the draft of an exempting notification was placed before the Parliament, the corporate sector in the country, primarily the small and medium companies, and the thousands of foreign-owned or controlled companies which are mostly private companies, have been anxiously waiting for this notification. However, as the archaic process of exempting notifications requires, a copy of the draft notification had to be placed on the floor of the Parliament for minimum of 30 business days, and then one more session of the Parliament had to end before the notification could have been issued.
Finally, with the completion of the Budget session of the Parliament, the decks were cleared for the exempting notification for 4 different classes of companies – (i) private companies, (ii) section 8 companies, (iii) government companies, and (iv) Nidhi companies. Needless to say, the private company exempting notification is the most important, as it covers nearly 90% of the companies by number.
This post discusses the major changes brought out by the Notification for private companies issued by the Ministry of Corporate Affairs (MCA) on June 5, 2015. The notifications for the other three types of companies listed above can be found on the MCA website.
Compliance Burden Reduced: Filing of Board Resolutions Waived for Private Companies
One of the major relaxations for private companies is the exemption from filing board resolutions under section 179(3) of the Act. This section, whose philosophical foundations are difficult to understand, requires companies to file some 14 items of board resolutions with the Registrar of Companies in a form called MGT 14, has completely been exempted in case of private companies, by snapping the connection between section 117(3)(g) and section 179(3). Therefore, private companies will now need to file only MGT 14 in case of special resolutions. In terms of compliance burden, this is a major relief.
Note, however, that section 179(3) itself has not been exempted. That is, wherever there is a matter being one of the items listed in this sub-section, the resolution of the board will still be required. All that is exempted is the need to file a resolution with the Registrar. Despite this, the exemption from filing is a major relief as private company board minutes are a internal matter for the company.
Participation of Interested Directors: Section 184
Yet another related exemption relates to section 184(2). This section provides that the directors of a private company must refrain from participating in a board meeting where a matter in which they are interested is to be discussed. This is absolutely counter-intuitive in case of private companies, which actually do not have any independent directors, and therefore it is not expected that there will be any director who is uninterested in the matter. The original draft of the notification did not provide an exemption from section 184(2), but the final text does provide the exemption. The final notification thankfully retains the same with the condition that an interested director may participate only after disclosure of such person’s interest. However, curiously, one of the most burdensome disclosures in case of private companies – disclosures by all directors about their shareholdings, and every time there is a change therein – still remains intact [section 184 (1)]
Restriction on Powers of Board No Longer Applicable to Private Companies
This relaxation brings us back to the position as under section 293 of the Companies Act, 1956 (the “Act 1956”). That is to say, the exercise of borrowing powers by private companies will not necessitate any special resolution.
Loans by Private Companies
Section 185 is serving as a major hurdle for banking transactions, particularly for guarantees and collaterals. This is one provision where banks themselves are greatly concerned as they are finding it increasingly difficult to seek guarantees and collaterals from related entities.
A partial exemption has now been granted to private companies giving a loan, providing a guarantee or offering a security in connection with a loan taken by a sister concern. There are 3 cumulative conditions for availing the exemption:
(a) There is no body corporate shareholder in the lending/guaranteeing company;
(b) The lending company’s aggregate borrowings from other bodies corporate or banks or financial institutions is limited to the lower of:
(i) 2X net worth of company; or
(ii) Rs. 50 crores; and
(c) There is no pending default in repayment of such borrowings by the lending company.
Note that the limit on borrowings includes borrowings by way of inter-corporate deposits as well, thereby effectively serving as a limit on the debt-to-equity ratio. Also the fact that the private company should not have a corporate shareholder makes the exemption largely meaningless, since inter-corporate shareholdings are a preponderant reality of the corporate world. Moreover, what malaise is this limitation seeking is redress is far from clear. These futile limitations in granting exemptions puts a big question mark on the philosophy of the new Act in extending all provisions to all companies, and keeping carve-outs to a power of administrative notification.
It may be noted that the restriction on lending by private companies was not present under the Act 1956. The underlying argument was simple – since a private company is essentially a pool of private capital, there cannot be a regulatory reason as to why a private company cannot lend to other entities in which directors have interest. After all, if private companies do not lend to their own entities, whom else will they lend to? Disregarding the economic rationale of the argument, the conditional exemption to private companies seems to prevail on an argument that even though a private company is a private pool of capital, the directors or the shareholders are still not free to lend money to other sister companies. This is one restriction that seems to fuel the boom of limited liability partnerships (LLPs) in the country.
Loans Against Its Own Securities
Section 67 of the Act prohibits the purchase of a company’s own shares, or the providing of loans against its own shares. There are, actually, 3 related sections – section 66 prescribing the process of reduction of capital, section 67 prohibiting a company from buyback of its shares unless section 66 is complied with, and from lending against its own shares, and section 68 laying down the conditions and process of buy back of shares.
Exemption has been given from the provision of section 67, subject to the following conditions:
(a) Where no other body corporate has invested any money;
(b) Borrowing from banks, financial institutions or body corporates is less than double of its paid up capital of Rs. 50 crore, whichever is lower.
(c) The above qualifying private company should not have defaulted in repayment of borrowings as may exist on the date of the transaction under the section.
Interestingly, there is no exemption either from section 66 or section 68. This implies that the exemption is only one for lending against shares. If the idea of the exemption was to relax the conditions for buy back of shares, there would have been exemption from section 68 or section 66 as well. It does not sound reasonable that a limited liability company would have been let free to buy its shares without any restraint at all.
Deposits From Members
Until March 30, 2015, there was a lot of debate on whether deposits taken by private companies from its members taken under the Act 1956, that is, before April 1, 2014 also had to comply with the strict provisions of new Act and hence requiring compliance with filing and repayment pursuant to section 74 and its allied rules. MCA vide the General Circular 05/2015 dated March 30, 2015 granted to private companies relief from this compliance clarifying that such amounts taken from directors/directors’ relatives and members under the provisions of the Act 1956 will not constitute deposit under the new Act.
The proposed exemption to private companies for accepting loans/deposits from their shareholders, up to a limit of 100% of net worth, had found its place in the final text and is also now a part of the final notification. It is notable that shareholders’ loans in case of private companies were fully exempted from the purview of deposit restrictions under the Act 1956. The Deposit Rules under the new Act brought that restriction, purportedly owing to deposit scams in the Eastern region. As it stands in the final text of the notification, a private company may accept deposits from its shareholders, up to a limit of 100% of its net worth. This is, of course, subject to a filing requirement. Note that a violation of sections 73 and 74 attracts major penal consequences, with imprisonment up to 7 years and a fine up to Rs. 10 crores. The offence is non-compoundable.
Limit on Company Audits
The limit of 20 on company audits will now exclude all one person companies, dormant companies, small companies, and private companies having a paid up share capital of less than Rs. 100 crores. In the draft notification, private companies were completely excluded from the limit.
Right of Persons Other Than Retiring Directors to Stand for Directorship
Provisions of section 160 shall not apply in case of private companies. Similar was the position under section 257 of the Act 1956.
Appointment of Directors No Longer to be Voted Individually
There was no specific exemption to a private company under section 263 in the Act 1956. However, seemingly the lawmakers thought this to be a very vital provision of concern to private companies and have therefore removed private companies from the ambit of section 162.
Relaxation Withdrawn in Case of Related Party Transactions
There is a major step back in the exemption pertaining to related party transactions (“RPTs”). The draft notification had proposed a full exemption to private companies from section 188 pertaining to RPTs. The final notification restores restrictions on RPTs in case of private companies, with the following riders:
(a) One of the special features of general meeting approval in case of RPTs is that the resolution has to be approved by a vote of the minority only. Related parties are not allowed to vote on such resolution. This provision has been taken off in case of private companies.
(b) Another relaxation is that in the definition of “related parties” in section 2(76), holding-subsidiary relationships, and investor-associate relationships have been excluded from related party relationships. The net result of these changes will be as follows:
(i) It is most commonplace in case of private companies to enter into RPTs. Private companies cannot be dealing with parties at arms-length, as it is sheer commonsense to say that private companies deal with parties close to them, rather than those who are unrelated.
(ii) Most transactions by or between private companies will still come within the ambit of section 188 since most of these transactions are covered by the “common director” or “common shareholder” clause of section 2(76), and not by holding-subsidiary or investor-associate relationships.
(iii) Once a transaction comes under section 188, it will require board and general meeting approval, if the transaction size, thresholds are crossed. RPTs may come under the section due to the relative contract value.
(iv) Hence, most RPTs will require prior general meeting resolution. The only saver is that in such a general meeting, even related parties may vote. Thus, getting the sanction of the general meeting may not be a problem, but the section will remain a sheer compliance burden on private companies.
Section 43 and 47
Unless the memorandum of association (“MoA”) or articles of association (“AoA”) of private companies provides for it, the same shall not be applicable. Alternatively, where the MoA/AoA of a private company provides exemption from the same, it shall not be applicable.
Provisions with regard to time period of offer in case of rights issue are exempted for private companies.
Requirement of sending the notice 3 days prior to opening of the issue by way of specified means under rights issue is now exempted.
Shall apply except that instead of special resolution, ordinary resolution would be required
Sections 101 to 107 and section 109
Unless a section specifically requires or it is provided in the articles of a private company, the provisions with respect to general meetings shall not apply.
Section 196(4) and 196(5)
Provisions with respect to approval of terms and conditions of appointment including remuneration of managerial personnel and validity of actions done by them where appointment is not in accordance with the provisions of the said section, is not applicable to private companies.
The companies’ legislation, obviously one of the most important instruments of doing business in India, must occupy a key place in the Prime Minister’s objective of making India a good place to do business. Scare little has been done by way of the exempting notification, even less by the Companies (Amendment) Act 2015. Therefore, all eyes are now on the Committee, which is to review the implementation of the Act.
- Vinod Kothari & Aditi Jhunjhunwala