MCA's olive branch to Private Companies - Notification dated June,5,2015 – A Commentary

Introduction

It is an admitted fact that small and marginal companies have been up in armsfrom the time the Companies Act,2013 (hereinafter referred to as the “Act”) was unleashed in the year 2013 partiallyto substitute what was considered as an antiquated piece of legislation - theCompanies Act,1956,which had supposedly outlived its usefulness. While opinions may be varied as to the veracity of the latter assertion, it is fair to state, at the outset that the present Act is replete with provisions which are perceived to be draconian and unfriendly, especially for the private companies. To speak metaphorically, the Act is analogous to setting a cat amongst the pigeons, where private companies are concerned.

It is an admitted fact that private companies are, essentially extensionsof partnership forms of business which have catapulted into the corporate form essentially to give themselves the benefits of limited liability and perpetual existence. The predecessor Act of 1956 was very friendly to the private companies , lighter on procedure –a sharp contrast to its successor . Ever since the present Govt. took over the reins of the country in May last year, efforts have been afoot to ease the rigors of procedure for private companies. The draft notifications to ease the law were put in place in July last year, and thanks to the maze of procedure which precede any change in legislation , we finally have the Notification of June 5,2015 which exempts private companies from the onerous requirements of some of the provisions of the Act.

It is pertinent to note that the said notification has not yet been published in the official Gazette and is not yet legally enforceable.

In this exposition, we shall objectively analyse the implications of the notification issued by the MCA on June,5,2015, evaluate the extent to which private companies will actually benefit there from and also look at some more changes which may be needed to increase the ease of doing business in this Country.

· Partial reprieve from Section 188 - Related party transactions

The general expectation was that the entire procedure of seeking approval of the Board and in certain cases, where the prescribed threshold values laid down in Rule 15 of the Companies(Meetings of Board ) Rules,2014 were being breached, the provisions ,laid down in Section 188 would be dropped altogether for private companies. What has been provided by way of a concession in the notification is only partial. Only sub-clause (vii) in Section 2(76) of the Act which provides the definition of “Related parties” is being withdrawn with the result that contracts of the genre laid down in Section 188(1) under clauses (a) to (g) by a private company with its private holding company, subsidiary company or its associate company or with the subsidiary of its holding company to which the concerned private company is a subsidiary will alone be taken out of the purview of Section 188.This clearly implies that contracts entered into by the private company with all its related parties as listed out in clauses (i) to clause (vii) in section 2(76) will still have to be approved by the Board and if the value of the contract or arrangement exceeds the thresholds provided in Rule 15 ibid ,as stated above by the shareholders, if such contracts do not satisfy the following litmus test as laid down in Section 188:

a) the contract is in the ordinary course of business.

b) the transaction is not at arm’s length.

Further where approval of the shareholders is called for , it would be adequate if such approval is by way of an ordinary resolution as opposed to a special resolution as provided in the Act originally. This is consequent upon the amendments made to the Act vide notification dated May 26,2015.

Thus contrary to popular perception, the reprieve to private companies from the rigors of Section 188 are in our view only illusionary and cosmetic .The ghost of Section 188 will continue to haunt private companies which have to ensure that contracts with related parties are in the ordinary course of business and at arm’s length –a daunting task, given the stark reality that private companies are invariably extensions of partnerships.

· Concessions under Section 62

The Section speaks about the procedure to be adopted where a company seeks to increase its subscribed capital by a further issue of shares. Such shares are to be offered in the first place to the existing holders of the equity shares of the company.

Sub-clause (i) under clause (a) provides that such offer shall be made by notice which will, inter alia, state the number of shares offered, provide a window of a minimum of 15 days within which the members can respond to the offer. The offer period shall not exceed thirty days from the date of the offer. If the members do not respond within the above time frame, it will be construed that they have declined the offer.

By the notification of June 5, 2015 ,a proviso is being added to clause (a) under sub-clause(i) which will apply only to private companies which will have the effect of reducing the time lines stated in the preceding para, in case 90% of the members have given their consent to the reduced time lines either by writing or through electronic mode.

Clause (b) Section 62(1) contemplates that issue of further shares can be made to the company’s employees under a stock option scheme with the approval of members by special resolution.

The notification provides that the requirement of taking approval of the members by special resolution shall be substituted by an ordinary resolution.

Section 62(2) which provides that the Notice for the offer contemplated should be sent at least three days prior to the opening of the offer will also be exempt for a private company.

As may be observed from the above, the impact of the changes brought about in Section 62 will be ,in our view, minimal.

· Exemption from Section 67

This Section imposes restrictions on the purchase by a company or giving of loans by it for purchase of its shares.

This section will be exempt as per the notification to a private company which satisfies the following conditions:

a) The company does not have a corporate as a shareholder.

b) If the borrowings of the company from banks or financial Institutions or body corporates is less than twice its paid-up share capital or Rupees fifty crores whichever is lower and

c) such company has not defaulted in repayment of borrowings which subsist at the time the Section applies.

It may please be noted all the above conditions have to be cumulatively satisfied so that the exemption can apply.

It is pertinent to point out that both Section 66 which deals with reduction of share capital and Section 68 which is concerned with the powers of the company to purchase its own securities will continue to apply to private companies. Therefore the exemption granted under Section 67 will have only a limited effect.

· Conditional exemption from Section 73

Clauses (a) to (e) under Section 73 (2) shall not apply to a private company which accepts from its members, deposits not exceeding 100% of its paid up share capital and its free Reserves and the company files with the ROC the details of such receipts..

In consequence of the above, the following requirements shall not apply to a private company provided it satisfies the limit set out above. :

a) Issuing of a circular to its members incorporating the information set out in Form-DPT-1.

b) Filing DPT-1 with the ROC.

c) Depositing 15% of the amount of deposits which are falling due in the financial year into unencumbered Securities and Accounts as per Rule 13 of the companies(Acceptance of Deposits)Rules,2014.

d) provision of deposit insurance as required under Rule 5 of the companies(Acceptance of Deposits)Rules,2014.

e) certification to the effect that the company has not committed any default in the repayment of deposits taken either before or after the commencement of the Act and the interest thereon.

The above relaxations should find favour with the private companies. One shift from the previous law which is conspicuous by its presence is that deposits from members of a private company will now come within the ambit of the Rules .Private companies should also ensure meticulously full compliance of the conditions relating to acceptance of deposits as the penalties enshrined in Sections Sections 74 and 75 are very stiff and non-compoundable in nature.

· Exemption from Sections 101 to 107 and Section 109

Provisions relating to General Meetings covering the following issues shall not apply unless specifically provided in the respective sections or by the company’s Articles of Association :

a) Notice for General Meeting(Section 101)

b) Statement to be annexed to Notice(Section 102)

c) Quorum for General Meetings(Section103)

d) Appointment of chairman for the Meetings(Section 104)

e) Provisions relating to proxies.(Section 105).

f) Restrictions on voting rights(Section 106)

g) voting by show of hands(Section 107)

Section 109 which speaks about the demand for a poll shall also not apply.

In consequence of the above, it follows that Secretarial standard - 2 relating to General meetings which kicks in from July,1, 2015 would not hold much significance on the conduct of General Meetings of Private companies..

· Exemption from clause (g) under sub-section (3) of Section 117

This exemption should bring a lot of cheer to private companies which were being subjected to the requirement of filing the resolutions passed by the Board on matters covered under Section 179(3) of the Act. Such resolutions need not be filed any longer with the ROC consequent upon the withdrawal of clause (g) in Section 117. There will also be considerable savings in the form of filing fees arising out of the above.

Lest it should be misconstrued that the entire requirement of seeking approval of the Board for the matters covered under Section 179(3) has been done away with , we would point out that Section 179(3) has not been given an honorable burial where private companies are concerned. What has been dispensed with is only the requirement of filing the resolutions of the Board on matters covered under Section 179(3) .

· Ceiling on number of company audits-Section 141

The ceiling of twenty companies on the number of statutory Audits shall not apply to one person companies, dormant companies, small companies and private companies with a paid up capital less than Rupees one hundred crores. This is a very welcome development for practicing Chartered Accountants.

· Exemption from Section 160

The 2013 Act had brought with it like the mythical Pandora’s box a lot of miseries for the private companies. One such thoughtless requirement was the need that, for appointing a person who was not a retiring director , the person concerned or any member of the company had to propose his candidature by leaving a notice along with a deposit of Rupees one lac, 14 days prior to the date of the General Meeting. 25% of the Deposit would stand forfeited in case of failure of the person to get elected at the meeting. This requirement is now mercifully being withdrawn with the result that Section 160 would apply only to public companies as was the case with its predecessor provision Section 257 in the 1956 Act.

· Exemption from Section 162

The 1956 Act provided that there was no need for the appointment of a director to be voted individually in the case of a private company. Inexplicably the situation was reversed under Section 162 of the Act. Wiser counsel has now prevailed leading to the restoration of the status quo ante.

· Exemption from Section 180

Section 293 in the predecessor Act which imposed fetters on the exercise of certain substantial powers by the Board such as the power to dispose off an undertaking, the power to borrow in excess of the company’s paid up capital and free reserves etc was applicable only to public companies. Ostensibly with a view to provide more teeth to the legislation, it was considered appropriate to make such provisions applicable to private companies. In fact ,Section 180 which corresponds to Section 293 was one of the first to get off the blocks and was made effective from September 12,2013. This had led to considerable resentment from the private companies and there was a widespread clamour for its withdrawal and as a measure of appeasement, the Govt. has succumbed to popular sentiments.

· Disclosure of Interest by director- Section 184(2)

Section 184(2) enjoins upon a director to disclose the nature of his interest or concern in any contract or arrangement entered into by the company with entities which come within the ambit of clauses (a) and (b) under the said Section. The Section further provided in its original form that the interested director shall not participate at the meeting of the Board at which the subject contract or arrangement is discussed.

The notification provides that while the requirement of disclosure of interest by the director of a private company u/s 184(2) shall continue as before, the interested director shall be allowed to participate at such meeting after disclosing his interest.

The above change, in our view, is in sync with the partial exemption allowed to private companies from the operation of Section 188. The notification has the effect of continuing with the requirement of Board approval and members’ approval , if any, where the thresholds are breached with the only difference that the interested Director shall be allowed to participate in the discussion relating to the impugned contract or arrangement. It should be borne in mind that the notification allows the interested director only the right to participate in the discussion and not to vote thereon. In that view of the matter, the interested Director should not form a part of the quorum where it comes to grant of approval to the subject contract or arrangement.

· Exemption from Section 185

If a poll were ever conducted amongst private companies to select the most unpopular provision in the Act, Section 185 would have been the winner in a canter. It puts an end to the provision of loans and extensions of Guarantees to Directors or other persons in whom the Director is interested if such loan or guarantee is drawn into the vortex of the Explanation there under. The Section is totally unforgiving in that the provision of any loan or guarantee cannot be sanctified even by governmental approval if it falls within the ambit of the Explanation . Its predecessor Section 295 was less vicious. It at least ,had the provision for Governmental approval.

Against the above backdrop, the exemption provided by the notification, albeit with some riders, comes up as a veritable life line and will ameliorate the hardships of private companies.. Exemption from Section 185 will become available if :

a) there is no corporate investor in the company’s share capital.

b) if the borrowings of the company from banks, financial institutions or bodies corporate does not exceed twice the aggregate of its paid up capital and free reserves or Rupees fifty crores whoever is lower.

c) the company has not defaulted in making repayments against such borrowings at the time of making transactions under this Section.

· Exemption from second proviso under Section 188(1)

As a logical corollary to the partial reprieve given by the notification in so far as related party transactions are concerned, the second proviso to Section 188(1) which debars a member of the company from voting on any resolution for approving any contract or arrangement ,if such a member is a related party is being withdrawn. This will render Section 188 bereft of much force and somewhat in fructuous particularly in respect of contracts which need the approval of the members as even the interested member can now vote.

· Sub-section (4) and (5) to Section 196 not to apply

When the provisions relating to the overall ceiling on managerial remuneration laid down in Section 197 read with Schedule V of the Act are not applicable to private companies ,it is somewhat paradoxical that subsections (4) and (5)under Section 196 which speak about the need for seeking the approval of the members and in applicable cases the Central Govt. for the appointment and remuneration payable to Managerial personnel should have been made applicable to private companies. This was clearly, in our view, a drafting anomaly which has been finally been set right.

Conclusion

The Companies Act,2013 in its original form went on an overdrive where it came to endeavoring to regulate companies. Perhaps the underlying logic behind the hyperbole in the original version was the notion that companies ,in particular, private companies were untrustworthy, recalcitrant ,and that they could be reined in only through the crack of the whip. Hence the overkill by way of increased procedures and compliances. As the French philosopher Rousseau said, ”Man is only born free -everywhere he is in chains”. Through the introduction of the new Act , an attempt was made, in a manner of speaking, to reinvent the wheel when there was no real need to do so. The 1956 Act had acquitted itself admirably, notwithstanding its prolonged period of existence .All that was needed was that to tweak some of the provisions to make them contemporary and also by eliminating the dead wood of some antiquated provisions. In an endeavour to add more muscle and teeth to the law, the architects of the statute overplayed their card particularly in the matter of bringing the private companies under their reins. In the process almost all the provisions in the Act were made applicable to them. In our view, statutes work well only if they are attuned to the economic environment of the country. Obviously realization has dawned that there was excess of legislation where it concerned private companies. Hence the notification under discussion is clearly a case of righting a wrong and it has not come a day too sooner. In fact it should have come much earlier. As the adage goes, ”better late than never’’..Amen.

Ramaswami Kalidas
Senior Vice-president and Company Secretary
Reliance Power Limited.