Finally, Some Exemptions to Private Companies

[The following
guest post is contributed by Vinod
Kothari
and Aditi Jhunjhunwala of
Vinod Kothari & Co. The authors may be contacted at vinod@vinodkothari.com and aditi@vinodkothari.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[1]
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.
Other Exemptions
Provision
Comments
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.
Section
62(1)(a)(i)
Provisions
with regard to time period of offer in case of rights issue are exempted for
private companies.
Section 62(2)
Requirement
of sending the notice 3 days prior to opening of the issue by way of
specified means under rights issue is now exempted.
Section 62(1)(b)
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.
 
Conclusion
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



[1] The number
was reduced from 19 by way amendments in the Rules brought out recently vide
Companies (Meetings of Board and its Powers) Amendment Rules, 2015
.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

10 comments

  • Is there any indication of any logic behind this exception in the case of having a corporate shareholder? It seems absolutely arbitrary and accordingly foul of Article 14.

    As regards interested directors and RPTs – There seems to be sound logic in the fact that such transactions may be used to divert funds of the company by say, paying an unduly large amount for a certain transaction. Thus the majority shareholders/directors may divert funds/profits to a company that they may own entirely and thereby unjustly enrich themselves at the cost of the other shareholders. I'm not sure if I understood the article's argument in this regard. Merely because there are no independent directors, I dont think that implies that every director is interested in every transaction of the company (apart from by virtue of their shareholding in the Company – which I dont really think ipso facto makes them 'interested'for the purpose of these provisions)

  • Have this been notified? What is the effective date of this notification. Para 3 says the notification has been laid in draft form before both houses. Whats the relevance of that?

  • Now in private Company, all the interested Directors can participate and vote at the Board meeting, subject to prior disclosure of interest in the Meeting. However, the corresponding provisions about the "Quorum of Board Meeting" has not been changed. So the net effect is that interested Directors cannot be part of the valid quorum. If such is the position, then how this exemption will be useful to the private companies, having two directors and both of them are interested?

  • These exemptions have not been notified yet as Point 3 of the said notification expressly provides that it has been laid before both houses of Parliament under section 462(2) of the Companies Act 2013.

  • these exemptions are in effect… the draft was laid in the parliament and no change was proposed by the parliament accordingly as per S.462, MCA has not issued these notifications.

  • when have these notifications been published? what is the date of the official gazette when these notifications have been published?

  • sir
    what is the lending power of a private limited company (not listed)
    co. is currently providing safe deposit facility .

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