Companies Act 2013 amended: private company exemptions reinstated

The Ministry of Corporate Affairs (“MCA”) notified on June 5, 2015 that certain provisions of the Companies Act, 2013 (“2013 Act”) shall not apply to private limited companies or shall apply with such exceptions or modifications as directed in the notification (the “Notification”). Under the Companies Act, 1956 (“1956 Act”) private companies were subjected to a substantially relaxed and relatively straightforward compliance regime. The 2013 Act, however, constrained the operational flexibility hitherto available to private companies bringing them at par with public companies on several counts of compliances. Finally, on the back of several representations by industry associations, the parliament has amended the 2013 Act to reinstate the relaxed policy regime for private companies. This Hotline sets out the changes and the key takeaways from each such change.

These exemptions and relaxations are applicable only to a private company which is not a subsidiary of public company. The existing compliance requirements and restrictions will continue to apply to a public company and a private company which is a subsidiary of public company.

1. RESTRICTIONS ON PURCHASE OF OWN SHARES

Existing position

Section 67(1) of the 2013 Act imposes restrictions on the companies limited by shares or by guarantee and having a share capital including a private company to purchase its own shares unless the consequent reduction of capital is effected and sanctioned under the provisions of this Act.

Revised position under the Notification

The Notification has exempted private companies from the applicability of provisions of Section 67 subject to fulfilment of the following conditions:

• The company shall have no shareholder which is a body corporate; and
• Borrowings of the company from banks, financial institutions or body corporate should not exceed twice the amount of paid up share capital or INR 500 million, whichever is lower; and
• There shall be no subsisting defaults in repayment of such borrowings at the time of making transaction.

Analysis

• Neither a private company, nor a public company was permitted to buy its own shares either unless coupled with consequent reduction of capital under the provisions of Section 67(1). With the Notification now exempting private companies from the application of Section 67 (1), there is ambiguity on whether the intent was to allow a private company to buy its own shares without consequent reduction in capital.
• Since both Section 100 of the 1956 Act and Section 68 of the 2013 Act contemplate consequent reduction in capital, it remains to be seen what the intent of Notification was by exempting private companies from Section 67(1).

2. ISSUE OF SHARES WITH DIFFERENTIAL RIGHTS

Existing position

• Under the 1956 Act, private companies could issue equity shares with differential voting rights without having to comply with certain rules and restrictions that otherwise applied to public companies and had full flexibility in structuring their securities.
• However, Section 43 of the 2013 Act prescribes that a company is allowed to have only two kinds of share capital - equity shares (with or without differential rights to dividend, voting or otherwise) and preference share capital. Further, all companies are required to fulfil certain conditions to be eligible to issue equity shares with differential rights. This section is essentially in the same form as it was under the 1956 Act, the only difference being that the 1956 Act exempted private companies from the equivalent provision, and the 2013 Act (until recently) did not.
• Section 47 of the 2013 Act provides that the equity shareholders shall be entitled to vote on all resolutions, while preference shareholders are permitted to vote only on resolutions which would affect their rights or are in relation to winding up or reduction of capital of the Company as prescribed under the 2013 Act.

Revised position under the Notification

The Notification provides that Section 43 and Section 47 of the 2013 Act will not apply to a private company if the memorandum of association or the articles of association of such private company provides so.

Analysis

• This relaxation would provide major relief, especially for private equity funds since they typically want priority on dividend, liquidation and entitlement to vote on an as-if-converted basis. Post the 2013 Act, there was difficulty in structuring instruments with such rights, which will now be possible.
• This exemption will also help in structuring returns and liquidation preference to foreign investors. While dividends on compulsorily convertible preference shares issued to foreign investors entitle them to receive dividends at about 17%, there is no such limitation if structured by way of equity shares with differential rights.

3. LOANS TO DIRECTORS AND INTERESTED ENTITIES

Existing position

Section 185 of the 2013 Act prohibited companies from advancing loans to directors and to persons in whom directors are interested or give any guarantee or provide any security in connection with any loan taken by him or such other person, a few exceptions aside.

Revised position under the Notification

The Notification currently provides that Section 185 shall not apply to a private company satisfying all of the following conditions:

• No body corporate shall have invested any money in the share capital of the company; and
• The borrowings of the company from banks, financial institutions or any body corporate shall not not exceed twice the amount of paid-up share capital or INR 500 million – whichever is lower; and
• There shall be no subsisting defaults in repayment of such borrowings at the time of making transaction.

Analysis

• The restriction under Section 185 was one of the most significant pain points under the 2013 Act. This has probably been the most resisted provision by the industry. Considering the closely held nature of private companies and the way in which such companies function, it was expected that intra-group transactions between private companies be relaxed
• However, exemption from Section 185 being contingent on the condition that no body corporate being a shareholder and debt – equity ratio being no more than 2:1 substantially restricts the applicability of the exemption. It also remains to be seen whether convertible debt on the books of the company will be seen as debt or equity.

4. RELATED PARTY TRANSACTIONS

Existing position

• Section 2(76) of the 2013 Act includes a holding company, subsidiary, associate company (including a joint venture company) and a subsidiary of a holding company to which the company is also a subsidiary (collectively, the “Group Companies”), within the definition of the term ‘related party’ of a company.
• If a private company intended to enter into a contract/ arrangement with any of the Group Companies with respect to sale, purchase or supply of any goods or materials, selling or otherwise disposing of, or buying, property of any kind, availing or rendering of any services, etc., such transaction would require the approval of the board (as well as the shareholders of the company, if the contract/ arrangement meets certain conditions as specified under the Companies (Meetings of the Board and its Powers) Rules, 2014) in accordance with Section 188(1) of the 2013 Act.
• As per the second proviso to Section 188(1), a shareholder interested in such contract/ arrangement would be prohibited from voting on the resolution to be passed to approve the contract/ arrangement in which such member is interested.

Revised position under the Notification

• The Notification provides that, in relation to a private company, the entities specified in Section 2(76)(viii) of the 2013 Act (i.e., the Group Companies) would not be considered related parties for the purposes of Section 188. As a result of this relaxation, private companies shall not be required to obtain the approval of the board or the shareholders, for the purpose of entering into a contract/ arrangement with a Group Company.
• The Notification also exempts private companies from the ambit of the second proviso to Section 188(1). This exemption will permit members of the company interested in the contract/ arrangement to vote on the resolution for authorizing the related party transaction.

Analysis

• This relaxation would make transactions between closely-held group private companies smoother, without the requirement for any cumbersome approvals process. Intra-group transactions would be made simpler, considering the frequent sharing of manpower and other business resources amongst closely-held group companies.
• The Notification also addresses the practical challenges of obtaining consent for related party transactions in closely held companies, as many of them lacked disinterested directors as well as members. With this relaxation, an interested director and member would now be free to vote on resolutions with respect to related party transactions.
• Since the Notification does not exempt private companies from the applicability of Section 2(76)(iv) of the 2013 Act, if the directors or managers in one private company are directors or members in another private company, a transaction between the two such companies would be considered as a related party transaction despite the exemption granted from Section 2(76)(viii).

5. FURTHER ISSUE OF SHARE CAPITAL

Existing position

• Section 62(1)(a)(i) of the 2013 Act provides that the offer period for a rights issue should be for a minimum period of 15 days from the date of opening of the offer. Section 62(2) of the 2013 Act also requires the company to dispatch the offer letter in respect of the rights issue through speed post or registered post or electronic mode to all the shareholders at least 3 days before the date of opening of the issue.
• Further, the approval of the members of the company by way of a special resolution was required for the purpose of issuance of ESOPs. 1

Revised position under the Notification

• The Notification introduces a new proviso to Section 62(1)(a)(i), which provides that if at least 90% of members of a private company give their consent in writing or in electronic mode, a period lesser than that specified for minimum offer period and period for dispatch of rights issue offer letter can be adopted in respect of the rights issue.
• In respect of issue of ESOPs, the Notification now requires the members of the private company to approve such issuance by way of an ordinary resolution.

Analysis

• The Notification enables private companies to meet their funding requirements at a shorter notice, without the requirement of complying with a minimum offer period of 15 days.
• The Notification remains ambiguous as to whether the consent of 90% of the shareholders by value or by number has to be obtained. It would be prudent to assume that the Notification implies that consent of 90% of the shareholders by value would be required for the reduction of the time periods mentioned in Sections 62(1) and 62(2).
• The Notification would also ease the process of issuance of ESOPs to employees of private companies.

6. EXEMPTION FROM PROVISIONS DEALING WITH CORPORATE BORROWINGS AND CREATION OF CHARGE ON ASSETS

Existing position

Section 180(1) of the 2013 Act provides that the board may exercise its power in respect of the following matters only with the approval of members by way of special resolution:

• Sale, lease or disposal of the whole or substantially whole of the undertaking of the company;
• Investment of the amount of compensation received by the company as a result of merger or amalgamation in trust securities;
• Borrowing money exceeding the aggregate of the company’s paid-up share capital and free reserves; and
• Remittance or granting time for the repayment of, any debt due from a director.

Revised position under the Notification

The Notification exempts a private company from the applicability of provisions of Section 180 of the 2013 Act.

Analysis

This exemption will avoid unnecessary delays in obtaining shareholders’ approval by way of special resolution for the specific matters in Section 180 of the 2013 Act, thereby facilitating ease of operation of private companies. On a practical note, this would ease approvals for slump sale and asset sale transactions by private companies.

7. PARTICIPATION OF INTERESTED DIRECTORS

Existing position

Section 184(2) of the 2013 Act requires interested directors to disclose his/ her interest at the board meeting in which the contract or arrangement is discussed and abstain from participation in discussions pertaining to such contract or arrangement.

Revised position under the Notification

The Notification provides that an interested director may participate in the board meeting after disclosing his/ her interest. This relaxation however, is subject to the director providing disclosures of his interest in the prescribed form before he/ she participates in the meeting.

Analysis

• Prior to this exemption, many private companies have found it difficult to comply with the provisions of Section 184(2), especially in a situation where there are only 2 directors and either one or both of them are interested.
• Absence of disinterested directors often led to certain peculiar compliance issues in private companies with two directors, such as not being able to enter details of contracts in the register of contracts, as the board of directors was not permitted to take note of related party contracts. Such issues have been solved under the Notification.

8. ACCEPTANCE OF DEPOSITS

Existing position

Under Section 73(2) of the 2013 Act, the acceptance of deposits by a company from its members requires the approval of the members by way of ordinary resolution and the fulfilment of certain conditions, including the issuance of circular including a statement showing financial position of the company, creation of a deposit repayment reserve account, obtaining deposit insurance, obtaining a certificate from the directors that the company has not defaulted in repayment of deposits accepted etc.

Revised position under the Notification

The Notification has exempted private companies from the above requirements provided that the amount of deposit accepted by the private company does not exceed 100% of aggregate of paid-up capital and free reserves of the private company and the relevant filings with the Registrar of Companies has been made.

Analysis

• Rule 3(3) of the Companies (Acceptance of Deposits) Rules, 2014 (“Deposit Rules”) provides that a company cannot accept or renew any deposits from its members, if the amount of such deposits together with the amount of other deposits outstanding as on the date of acceptance or renewal of such deposits exceeds 25% of the aggregate of the paid-up capital and free reserves of the company. Since the Deposit Rules have not been amended by the Notification, there appears to be a conflict between the provisions of the Notification and those of the Deposit Rules in respect of private companies.
• Although this relaxation does not liberalize acceptance of deposits by private companies to the extent of the position under the 1956 Act, it eases the acceptance of deposits by private companies from its members as a mode of catering to their immediate funding requirements.

9. CONDUCT OF GENERAL MEETINGS

Existing position

Sections 101 to 107 and Section 109 of the 2013 Act deal with the requirements of convening and conducting of general meetings by all companies, such as service of notice of general meeting, explanatory statement, quorum, chairperson of the meetings, appointment of proxies, restriction on voting rights, voting by show of hands and demand for poll.

Revised position under the Notification

As per the Notification, the provisions of Sections 101 to 107 and Section 109 of the 2013 Act shall apply to a private company unless otherwise specified in the respective Sections or the articles of a private company provide otherwise.

Analysis

• Under the 1956 Act, a private company could lay down its own procedure in respect of conduct of its general meetings. This power was not available under the 2013 Act.
• The Notification has restored this power and provided private companies with the flexibility to decide their own procedure for conducting general meetings by incorporating the provisions in their articles of association.

10. FILING OF BOARD RESOLUTIONS WITH AUTHORITY:

Existing position

Section 117(3) (g) of the 2013 Act requires companies to file with the Registrar of Companies, copies of board resolutions passed in connection with certain matters dealt with under section 179(3) and the rules framed thereunder. These matters include:

• making calls on shareholders in respect of money unpaid on their shares
• authorizing buy-back of securities under Section 68
• issuance of securities, including debentures, whether in or outside India
• borrowing of monies
• investing the funds of the company
• granting loans or giving guarantee or providing security in respect of loans
• approving financial statement and the Board’s report
• diversifying the business of the company
• approving amalgamation, merger or reconstruction
• taking over a company or acquiring a controlling or substantial stake in another company
• additional matters as prescribed under Rule 8 of Companies (Meetings of Board and its Powers) Rules, 2014

Revised position under the Notification

The Notification now provides that Section 179(3) of the Act shall not apply to a private company.

Analysis

• This exemption would restrict public access to board proceedings of private companies and thereby help in maintaining the confidentiality of the board proceedings.
• This exemption would also reduce the compliance burden on private companies.

11. COMPANIES UNDER AUDIT SCOPE

Existing position

Section 141(3)(g) of the 2013 Act restricted the number of companies, including private companies, for which a person could be statutory auditor to 20. An auditor who engages himself for the purpose of statutory audit in more than 20 companies, would attract to disqualification and liable to vacate office.

Revised position under the Notification

The Notification excluded one-person companies, dormant companies, small companies and private companies having paid up share capital of less than INR 1 billion in determining the audit limit threshold of 20 companies.

Analysis

In addition to removing restrictions on auditors, this relaxation would permit private companies which are part of the same group to retain the same statutory auditor.

12. APPOINTMENT OF DIRECTORS

Existing position

• Section 160 of the 2013 Act prescribes certain processes to be followed by a person who intends to stand for directorship of the company.
• Further, Section 162 of the 2013 Act prohibits companies from passing a single resolution for appointment of 2 or more directors unless such a motion has first been agreed to unanimously by all the shareholders.

Revised position under the Notification

The Notification exempts a private company from the applicability of Sections 160 and 162 of the 2013 Act.

Analysis

This exemption would ease compliance requirements for private companies in respect of appointment of directors.

13. APPOINTMENT OF MANAGERIAL PERSONNEL

Existing position

Sub-sections (4) and (5) of Section 196 of the 2013 Act deal with the procedure and approval requirements for appointment managing director, manager or whole-time director (“Managerial Personnel”) and requires companies to comply with the provisions of section 197 and Schedule V with respect to remuneration payable to Managerial Personnel. The provisions require approval of board at a meeting followed by approval of members in the next general meeting for appointment of Managerial Personnel. The company is also required to file return of appointment of Managerial Personnel within 60 days from the date of such appointment.

Revised position under the Notification

The Notification exempts private companies from the applicability of sub-sections (4) and (5) of Section 196 of the 2013 Act.

Analysis

With this exemption, private companies are set free from the following requirements with respect to appointment of Managerial Personnel:

• Requirement of seeking approval of members and of Central Government where the appointment of Managerial Personnel is not in accordance with the provisions of Schedule V.
• Requirement for notice convening the board or general meeting for considering Managerial Personnel's appointment shall include terms and conditions of such appointment, remuneration payable and other matters including interest of a director or directors in such appointment.
• Requirement of filing return of appointment of Managerial Personnel with the Registrar of Companies.
• Provisions governing validity of acts of Managerial Personnel not being approved by the members.

CONCLUSION

The Notification is a welcome move towards easing the operations of private companies. It may be observed that in many of the cases above, certain provisions of the 2013 Act caused difficulties in the very operations of private companies. The Notification attempts to remove the same and has succeeded to a great extent.