The Law relating to significant beneficial ownership in Shares - Some perspectives

Introduction

It would be a travesty to state that the Companies Act, 2013 (hereinafter “the Act”) has stabilized in its operation since it received the stamp of approval as of April,1, 2014.The basic weakness in the law, in our view, stems from the fact that it is dependent substantially on  a surfeit of sub-ordinate legislation which is, by itself , an anathema, given the fact that the Act  is  a procedural legislation. To add to the predicament   of the Stakeholders ,MCA has been issuing clarifications, notifications etal on the various provisions  at the drop of a hat, so to say. The irony also   is that some of the Rules   and notifications issued travel beyond the scope of the Mother law and are also inconsistent with the Law.

It was widely felt that the slew of changes brought in by the Companies (Amendment) Act of 2017 would put an end to much of the existing adhocism with which changes were being administered. Unfortunately, the expectations have been belied by the fact that amendments made are being notified piece-meal on different dates and at an excruciatingly slow pace.

Be that as it may, the notification of the  Companies(Significant Beneficial Owners )Rules, 2018,(hereinafter the “SBO Rules) has, in a manner of speaking, set the cat amongst the pigeons. The above Rules have been notified on 13th June 2018 and have come into immediate effect. The Rules have been issued in exercise of the powers conferred on the Central Govt. under Section 90 of the Act read with Section 469. Companies are gearing up to meet the timelines notified in the face of the grey areas that exist in the above Rules.

Our endeavor in this Exposition is to critically examine the Rules, bring home the areas where there is need for clarity.

Before we go into the nitty-gritty  , suffice to say that the Rules are intended, to lift ,in a sense, the veil of opacity which characterizes the  shareholdings  of some persons who choose to remain in cognito and  obscure and do not wish to own up that they hold the beneficial interest in respect of their holdings which are held in the name of others whose names appear in the Company’s Register of members. Holdings which may   also be clandestine in nature are sought to be brought to the forefront.  The Rules regulate Section 90 of the Act   , a revised  version of which has been introduced by the Amendment Act, 2017.Section 90 in the Act corresponds  to Section 187C in the Companies Act, 1956.However, in its revised form , the Section is more potent than Section 187C of the predecessor Act.

Beneficial interest in a share-Section 89(10)

Sub-section(10) has been inserted to Section 89 by the Amendment Act 2017 to clarify what constitutes , for the purposes of this Section and Section 90,”beneficial interest in a share”. The term has been defined inclusively to refer to the beneficial interest held directly or indirectly through any contract, arrangement or otherwise, the right or entitlement of a person alone or together with any other person to-

(i) exercise or cause to be exercised any or all of  the rights attached to such share or

(ii) receive or participate in any dividend or other distribution in respect of such share.

It is pertinent to note that Section 89(10) is yet to be notified in the Statute.

The sub-section refers to the beneficial interest held by a person acting either alone or in tandem with others. The term “person” has not been defined in the Act. Hence the term should be given the extension provided   by Section 2(31) of the Income Tax Act, 1961 and  would include,  apart from an Individual who is a natural person, a Hindu undivided family(HUF),a firm, a company, an association of persons (AOP), a body of individuals whether incorporated or not, a local authority and every artificial judicial person not referred to above.

Further, the interest has to be in a share. The term “share” shall carry the meaning given to it by Section 2(84) of the Act. Section 2(84) defines Share to mean a share in the share capital of a company and includes stock.

The beneficial interest can be exercised both directly or indirectly through a contract or arrangement by a person acting either alone or collectively with other persons. The contract can obviously be verbal or in writing.

The beneficial interest has to be manifested through exercise of all or any of the rights attached to shares or by the receipt or the right to participate in any dividend or other distribution in respect of such share.

It is interesting to note that while the term “beneficial interest” has been used comprehensively in Section 90(1), it does not indicate the manner in which holding of such interest has to be demonstrated. That the person who holds beneficial interest has to be one whose name is not entered in the  Register of Members as a holder of the shares is clear from the definition provided to the term “significant beneficial owner” by Rule 2(1)( e) of the SBO Rules.

Two definitions to “Significant beneficial Owner”

Section 90 of the Act has been substituted fully by the Amendment Act 2017 and has been notified for application from June,13, 2018.It is intriguing to note that the term “significant beneficial owner” has been defined both in Section 90(1) as also by Rule 2(1)(e ) of the SBO Rules.The definitions are not identical though. Whereas Section 90(1) contemplates holding of a beneficial interest in not less than 25% or such other percentage as may be prescribed. Rule 2(1)(e ) ibid speaks about holding of an ultimate beneficial interest in not less than 10% in the share capital.

Secondly, Section 90(1) talks about an individual who holds beneficial interests. Rule 2(1)(e )speaks about an individual referred to in Section 90(1) who holds ultimate beneficial interest  (Emphasis supplied) of not less than 10%. What is “ultimate” has not been explained but if one looks at the meaning of the term ”ultimate” as given in the Lexicon, it refers, as an adjective, to the “ last, furthest or farthest, ending a process or series”. The use of the term ”ultimate” in the Rules suggests that it is the responsibility of the last or the farthest individual holding beneficial interest to ensure compliance with the Rules. The reduction in the threshold to qualify as a significant beneficial owner from 25% as contemplated in Section 90(1) to 10% as per the SBO Rules is obviously intended to widen the scope of coverage under the Rules.

Another major point of divergence between the Act and the Rules on the definition of “SBO” is that Section 90(1) does not say that the term refers to one whose name is not entered in the Register of members.The definition provided in the Rules makes it clear that for the purposes of Section 90(1) only a person whose name does not figure in the Register of members of the company and who holds ultimate beneficial interest over the threshold share capital would be construed as the “SBO”.

In addition, Explanation II under Rule 2(1)  (e )provides an extension to the term ”shares” and clarifies that instruments in the form of global depository receipts(GDRs), compulsorily convertible preference shares (CCPS)or compulsorily convertible debentures(CCDs) shall be treated as shares for the purpose of the definition clause. The above differences in the definition of SBO as between the Act and the Rules leads us to the pertinent question whether any extension given by the Rules to a definition provided in the mother legislation is legally sustainable. It is a settled law that Sub-ordination legislation cannot be inconsistent with provisions of the mother legislation or travel beyond the scope of the mother provision..

Determination of Significant Beneficial Ownership

Explanation I under Rule 2(1)(e )of the SBO Rules sets out the ground Rules for the determination of the significant ownership in case of persons other than individuals or natural persons.

The use of the expression “natural persons” synonymously with “individuals” in the above Explanation makes interesting reading. In Jurisprudence, a natural person is referred to as a person legally referring to one who has its own legal personality, i.e,  an individual human being as opposed to a legal person who may be a private or public organization.

Clause(i) in the Explanation provides that where the member is a company, the significant beneficial owner(SBO) shall be the natural person or individual who acts either alone or together with other natural persons namely individuals or through one or more persons  or trusts who holds not less than 10% of the share capital of the company.

From the above, it follows that the SBO who in this instance is a natural person would be one who acts either by himself or together with other individuals or acts through the intermediary of one or more persons or trusts shall be the one who will be called upon to file the declaration in form BEN-1. The above clause is quite wide in that it contemplates holding of beneficial interest through a cobweb of complex relationships. That the clause makes use of the expression  ”person” suggests that the beneficial owner could also make use of the interface of a legal person for camouflaging his holding.

Clause (i) has another limb which does not contemplate any holding of shares in a company by the SBO. The status of an SBO could also emerge through the process of exercising significant influence or control in the company through other means. The term “control” as used in this clause shall carry the meaning given in Section 2(27) of the Act. Thus any person who exercises control in the manner laid down under the above Section would also be an SBO. As Form BEN-1 only contemplates significant holding through shares it is difficult to comprehend how an individual who is an SBO through the process of exercise of control under Section2(27)will ensure compliance with the Rules. The form needs to be obviously amended to provide for disclosure through control exercised u/s 2(27)of the Act.

Clause(ii)provides that where the member is a partnership firm, the SBO would be the natural person who either by himself or together with other individuals or trusts holds not less than 10% of the capital of the firm or has an entitlement to not less than 10% of the profits of the partnership. It follows from the above that SBO in this clause is one who has beneficial interest over 10% of the share capital of the company, apart from holding 10 or more percent of the capital of the firm or can exercise his rights over 10% of the net profits of the firm.

Clause (iii) of the Explanation postulates that if a natural person is not identifiable in clause (i)or (ii)above ,the SBO would be the relevant natural person who holds the position of the “Senior managing official”. The term senior managing official has not been defined by the Rules and the relevant question which arises is –who would don the mantle of the SBO as per clause (iii) Form BEN-1 also does not offer any clue as to who would be the SBO. It is therefore fair to conjecture that the onus of being the SBO in this situation shall fall on the CEO/MD /WTD of the company. Even the KMPs of the company could be roped in within the ambit of the term ”senior managing official”.

Clause(iv)under Rule 2(1)(e ) applies where the member in the company is a Trust with the shares being held in the name of the Trustees. The identification of the beneficial owner shall include identification of the author of the Trust, the trustee, the beneficiaries of the Trust with not less than 10%interest in the Trust and any other natural person who is exercising effective control over the trust through a chain of control or ownership.

The above clause, we submit has not been happily worded. A plain reading of the clause suggests that all the persons referred to in the clause shall be considered as beneficial owners and therefore liable to file form BEN-1.In our view as the intention of the Rules is to track down the ultimate beneficial owner, the natural person who holds not less than 10% of the interest in the Trust shall be treated as the ultimate beneficial owner.

Filing of Forms in compliance with SEBO Rules

As stated earlier, the individual holding ultimate beneficial ownership in not less than 10% of the share capital of the company in any manner contemplated under Clauses(i)(ii) and (iii) to Rule 2(1)( e ) as elaborated above shall be responsible for filing BEN-1 within 90 days from the date of introduction of the Rules. This timeline would be in respect of the existing holdings. Further when there is an acquisition of the specified threshold beneficial interest BEN-1 shall be filed within thirty days from the date of such acquisition.

Upon receipt of Form BEN-1, the onus would be on the company to file BEN-2 within thirty days from the date of receipt of the declaration.

In addition, it shall be the obligation of the company to maintain a Register of Significant Beneficial Owners in Form BEN-3. The above Register shall be open for inspection by the members during business hours against payment of an amount not exceeding Rupees fifty for each inspection.

Non-applicability of SBO Rules to Mutual Funds etc.

The above Rules shall not apply in respect of shares held in a company/body corporate in case of pooled investment vehicles such as Mutual Funds, Alternative Investment funds(AIFs), Real Estate Investment Trusts(REITs)and Infrastructure Investment Trusts(InvITs) which are all regulated under the SEBI Act.

Some unanswered Questions

We have captured above the salient features of the Rules and the compliances that are expected thereunder. Having said that, the Rules leave a trail of unanswered questions which will make compliance difficult. We shall deal with some of the issues and will wait for posterity to provide the right answers.

Firstly, despite the fact that Section89(10)provides the dimensions of what constitutes a beneficial interest in a share, for reasons not known, the sub-section is yet to be notified.

Secondly, the Rules provide an extended connotation to the term “Shares” by including instruments like GDRs, CCPs, CCDs. Given the fact that the expression “shares” is restrictively defined by Section 2 (84) of the Act, the question is whether the amplitude of the definition can be extended by an Explanation in the Rules-whether such extension is legally sustainable. The other related question is whether the underlying interest in the equity in respect of the above instruments is to be considered before the conversion option is exercised or should the dilution be considered only upon exercise of conversion rights. If the answer to the above is the former proposition i.e. even before the exercise of conversion, it may well have the effect of reducing the holding of the significant beneficial owner in the company below the prescribed threshold, given the wider base of the Company’s share capital thus negating the objective behind the Rules.

Thirdly, Section 90(1) makes it obligatory for person resident outside India to file the required Return in case they are the SBO. In this way, both the Act and Rules are armed with jurisdiction which extends beyond the territory of India. The question is whether the enforcement of the penal provisions for non-compliance as laid down in Section 90 be effective for person resident outside India.

Fourthly, as pointed out in the Exposition there is a difference between “significant beneficial owner “ as defined by Section 90(1) and Rule 2(1)(e ) which raises the question as to which definition shall have legal precedence. More crucially Rule2(1) (e )speaks about the SBO holding ultimate beneficial interest in the shares whereas the adjective ”ultimate” is missing in the definition provided by Section 90(1).

Further as provided in clause (iii)where the natural person is not identifiable in clause (i) or (ii) above, the SBO would be one who holds the position of Senior Managing Official. The question which comes up is –who should be considered as “Senior Managing Official”.

Further instruments like GDRs are inherently fungible and the procedures governing their issue make it impossible to ascertain as to who holds the ultimate interest in them. Will it, therefore, be possible through the enforcement of the Rules to pierce the veil and go behind the person holding ultimate significant interest.

Conclusion

There are no easy answers to some of the issues. In the meantime, the deadline for ensuring compliance is drawing close and companies are still struggling to find some answers which are proving to be elusive. While the objective behind the legislation is laudatory, what has queered the pitch is that the drafting of the Rules leaves a lot to be desired. Like it or lump it, the Rules have come home to stay, leaving the Companies with no option but to ensure compliance.