EXEMPTIONS TO PRIVATE COMPANIES UNDER COMPANIES ACT 2013 – IMPACT ANALYSIS

[Bhavik Gala]

INTRODUCTION

Good rules are always essential to allow businesses to function with ease just as they are required to allow traffic to flow smoothly, but the challenge is to strike the right balance between regulation and relaxation.

Regulators always strive to achieve a balance so that a reasonable level of oversight is achieved without excess cost of compliance.

Section 462 of the Companies Act, 2013 (“the Act”) empowers the Central Government to exempt certain class or classes of companies from any of the provisions of the Act and also to provide exceptions, modifications and adaptations that shall apply to certain class or classes of companies.

Under the Companies Act, 1956, private companies were subjected to a substantially relaxed and relatively straightforward compliance regime. The 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 and keeping in line with the theme of “Ease of Doing of Doing Business” and “Make in India” Campaign, the Ministry of Corporate Affairs, Government of India had recently vide its Notifications from time to time provided relaxations to Private Limited Companies to reinstate the relaxed policy regime for private companies. Needless to say, the private company exempting notification of June 05 2015 is the most important, as this covers nearly 90% of the companies by number.

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.

In this article, the major relaxations granted to private companies have been analysed in detail pursuant to issue of Notification of June 05, 2015 and also other notifications issued thereafter by the Ministry of Corporate Affairs granting relaxation.

RELAXATIONS GRANTED TO PRIVATE COMPANIES

1. FILING OF BOARD RESOLUTIONS WAIVED FOR PRIVATE COMPANIES [CHAPTER VII – SECTION 117(3)(g) - REDUCTION OF COMPLIANCE BURDEN & RESTRICTION OF PUBLIC ACCESS TO PROCEEDINGS OF BOARD MEETINGS]:

Section 117(3)(g) of the Act requires companies to file copies of Board Resolutions passed in connection with certain matters dealt with under section 179(3) and the rules framed thereunder with the Registrar of Companies.

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

One of the major relaxations for private companies is exemption from complying with the requirements of Section 117(3)(g) of the Act i.e. filing certain Board resolutions under provisions of Section 179 (3) of the Act. This section requires companies to file certain specified board resolutions with the Registrar of Companies in the requisite form MGT 14 which has completely been exempted in case of private companies, by snapping the connection between Section 117 (3)(g) and Section 179(3).

The exemption from filing is a major relief as private company board minutes are a internal matter for the company and the filing requirement was perceived as a huge compliance burden.

No such provision was there in the Companies Act, 1956 with regard to the filing of resolutions with the Registrar which have been passed by the Board. Only the Special Resolution and the specified resolutions / agreement were required to be filed with.

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 that sub-section, the resolution of the board will still be required and can not be passed through circulation. All that is exempted is that there will be no need to file a resolution with the Registrar.

2. RESTRICTION ON PURCHASE OF OWN SHARES

[CHAPTER IV, SECTION 67 – EXEMPTED SUBJECT TO CERTAIN CONDITIONS]

Section 67 of the Act inter alia provides that no company limited by shares and no company limited by guarantee and having share capital shall buy its own shares.

The private company has now been exempted from complying with the provisions of section 67, subject to the following conditions:

a. no other body corporate has invested any money in share capital of the Company;

b. Borrowing from banks, Financial Institutions or Body corporate is less than twice of its paid up capital or ₹ 50 crore, whichever is lower; and

c. such a private company should not have defaulted in repayment of borrowings as may be existing on the date of the transaction under the section.

Section 67 is similar to Section 77 of the Companies Act, 1956 which had exempted private companies (which are not subsidiaries of public companies) from the provisions of this section. However, the aforesaid three conditions mentioned in Section 67 now are new.

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 (subject to the above conditions) implies that the private limited company may buy its own shares without consequent reduction in capital.

Since both Section 100 of the 1956 Act and Section 68 of the Act contemplate consequent reduction in capital, the question remains whether the intent of Notification by exempting private companies from Section 67 also exempts it from the compliance of the provisions of section 68 of the Act, for buying its own shares!!!

3. KINDS OF SHARE CAPITAL AND VOTING RIGHTS

[CHAPTER IV, SECTION 43 & 47 – EXEMPTION IF PROVIDED IN MEMORANDUM OR ARTICLES OF ASSOCIATION]

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.

Section 47 of the 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.

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.

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. Before this exemption was granted, 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.

4. DEFINITION OF RELATED PARTY

[CHAPTER I - SECTION 2(76)(VIII) IS NOT APPLICABLE WITH RESPECT TO SECTION 188 OF THE ACT]

Certain related party transactions as specified in Section 188(1), require the approval of the Board of Directors at Board meeting, besides disclosure of certain information pertaining to such related party transactions in agenda of board meeting and that the interested director shall not remain present during discussion of related party transactions. In addition, transactions whose value is beyond prescribed limits, require prior approval of shareholders.

Clause (viii) of Section 2(76) of the Act includes in the list of related parties :

i. Holding company

ii. Subsidiary Company

iii. Associate company

iv. Fellow Subsidiary company

Section 2(76)(viii) is now not applicable to a private company with respect to Section 188. Accordingly, a contract by a private company will not be regarded as a related party transaction if it is entered into by a private company with its holding company, subsidiary company, associate company or a fellow subsidiary company.

Although holding, subsidiary, associate company and subsidiary of holding company are excluded from definition of ‘related party’, the Director (other than an independent Director), Key Managerial Personnel of holding company or their relative(s) are still included in definition of related party.

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).

Further, compliances with respect to disclosure requirements of related party transactions shall be applicable to a private company.

5. RELATED PARTY TRANSACTIONS:

[CHAPTER XII – SECOND PROVISO TO SECTION 188(1)]

With regard to related party transactions, second proviso to Section 188(1) which states that no member of the company shall vote on the ordinary resolution to approve any contract or arrangement which may be entered into by the company, if such member is a related party, has been exempted for private companies.

A special feature inserted in respect of RPTs in Companies Act, 2013 is that in general meeting for approval of a related party transaction, a member who is a related party is not allowed to vote on such a resolution. This provision shall not apply in case of private companies.

This implies that, if a private company enters into any contract or arrangement with a related party requiring prior approval of the company, the related parties are now allowed to vote on such a resolution.

Most of the contracts or arrangements by a private company with its other related parties like its directors, a firm in which its director is a partner, a private company in which its director is a member or director, will still require either consent of the Board or a resolution of the general body depending upon the threshold of the transaction. But members who are related parties will be allowed to vote on such resolutions.

This is a big relief to the private companies as having disinterested members was not at many times possible in private companies where there are few members who are mostly related to each other.

6. LOAN TO DIRECTORS ETC.

[CHAPTER XII- SECTION 185 – SHALL NOT APPLY (IN CERTAIN CONDITIONS)]

Section 185 of Companies Act, 2013, prohibits a company from advancing loan (including represented by book debt) to any of its directors or to any other person in which the director is interested. Prohibition even extends to giving of guarantee or providing any security in connection with any loan that the directors avail in their personal capacity.

The exemption has now been granted to private companies from compliance of provisions of Section 185 provided it complies with the following conditions:

(a) There shall be no other body corporate shareholder in the lending company;

(b) if the borrowings of such a company from banks or financial institutions or any body corporate is less than twice of its paid up share capital or fifty crore rupees, whichever is lower; and

(c) Such a company has no default in repayment of such borrowings subsisting at the time of making transactions under this Section.

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 corporate shall be a shareholder and debt – equity ratio shall not be 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.

Section 185 of Companies Act, 2013 is parallel to Section 295 and 296 of Companies Act, 1956 and it is interesting to note that Private Companies were exempted from Section 295 and 296 of Companies Act, 1956 without any conditions.

7. PARTICIPATION OF INTERESTED DIRECTORS IN MEETING

[CHAPTER XII –SECTION 184(2) – SHALL APPLY WITH CERTAIN EXCEPTION]

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 he/she shall abstain from participation in discussions pertaining to such contract or arrangement.

The MCA Notification now provides that an interested director of a private limited company 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.

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 two 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.

Although, this provision will certainly lead to ease of decision making by private companies, there seems to be some anomaly. Such an interested director may participate in a Board meeting of a private company after disclosure of his interest but he cannot be counted for the purpose of ascertaining quorum under section 174(3) since section 174(3) provides Directors who are not interested and present at the meeting shall be the quorum. Whereby, there can be a situation where a Board Meeting of a private company may not be held for want of quorum of disinterested directors although exemption has been given for an interested director to vote in a matter where he is interested.

It is interesting to note that corresponding Section 300 of Companies Act, 1956 was totally not applicable to private companies under earlier regime.

8. RESTRICTIONS ON POWERS OF BOARD

[CHAPTER XII – SECTION 180]

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.

Now, the provisions of Section 180 of the 2013 Act are not applicable to Private Company. The similar provisions of the section 293 of Companies Act, 1956 were not applicable to private companies.

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.

9. CONDUCT OF GENERAL MEETINGS

[CHAPTER VII – SECTIONS 101-107 & 109 – SHALL APPLY UNLESS OTHERWISE SPECIFIED IN RESPECTIVE SECTIONS OR THE ARTICLES PROVIDE OTHERWISE]

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.

• Notice of General Meeting (Section 101)

• Statement to be annexed to notice (Section 102)

• Quorum for meeting (Section 103)

• Chairman of meetings (Section 104)

• Proxies (Section 105)

• Restriction on voting rights (Section 106)

• Voting by show of hands (Section 107)

• Demand for poll (Section 109),

Now, the said provisions of Sections 101 to 107 and Section 109 of the Act shall not apply to a private company unless otherwise specified in the respective Sections or the articles of a private company provide otherwise.

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 MCA 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. APPOINTMENT OF DIRECTORS

[CHAPTER XI – SECTION 160 & SECTION 162 – NOT APPLICABLE]

Section 160 deals with right of persons other than retiring directors to stand for directorship subject to 14 days notice in writing before the meeting along with the deposit of rupees 1 lac.

This section has been exempted for private companies. Thus persons other than retiring directors may now stand for directorships in private companies:-

• without leaving a written notice 14 days before the meeting; and

• without deposit of ₹ 1 lac.

This is similar to Section 257 of Companies Act 1956 which was not applicable to private companies.

Further, Section 162 of the Act prohibits companies from passing a single resolution for appointment of two or more directors unless such a motion has first been agreed to unanimously by all the shareholders.

Now, private company is exempted from the applicability of Sections 162 of the 2013 Act.

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

11. NUMBER OF COMPANIES IN WHICH A PERSON CAN ACT AS AUDITOR

[CHAPTER X, SECTION 141(3)(g) - SHALL APPLY WITH MODIFICATIONS]

Section 141(3) prescribes the eligibility of a person for appointment as an auditor of the Company. Further, Section 143(3)(g) states that following person shall not be eligible for appointment as an auditor:

a. who is in full time employment elsewhere, or

b. person or partner of a firm who holds at the date of appointment or reappointment, appointment as auditor of more than twenty companies.

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.

Now, the words “other than one person companies, dormant companies, small companies and private companies having paid up share capital of less than one hundred crores rupees” have been inserted after the words ‘twenty companies’. It implies that while calculating the limit of twenty companies, the one person companies, dormant companies, small companies and the private companies with the paid up share capital of less than rupees 100 crores will be excluded.

This means a private Company having paid-up share capital of less than ₹ 100 crores may appoint its Auditor irrespective of the limit of 20 audits provided under section 141(3)(g).

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. ACCEPTANCE OF DEPOSITS

[CHAPTER V – SECTION 73(2)(a) to (e) – NOT APPLICABLE SUBJECT TO CERTAIN CONDITIONS]

As per the provisions of section 73(2), a company is allowed to accept deposits from its members subject to certain conditions as prescribed under clause (a) to (f) of the said section. The said conditions are as below:

a) Issuance of circular to the members containing required particulars / disclosures;

b) Filing of circular with the Registrar of Companies;

c) Opening of Deposit Repayment Reserve Account with scheduled bank and depositing the prescribed amount therein;

d) Deposit insurance;

e) Certificate regarding no default committed by the company in repayment of deposits and/or interest thereon; and

f) Creation of security, if any, and registration of charge thereon.

The Notification has exempted private companies from the requirements of clause (a) to (e) of Section 73(2) above, 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.

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 MCA Notification, there appears to be a conflict between the provisions of the Notification and those of the Deposit Rules in respect of private companies.

Deposits from Directors’ relatives exempted:

‘MCA’ vide its notification dated 15th September, 2015 (yet to be gazetted) has issued the Companies (Acceptance of Deposits) Second Amendment Rules, 2015, which inter alia amended Rule 2(1)(c)(viii) thereby exempting deposit received from the relative of director of private company provided such relative furnish a declaration that the amount is not being given out of funds acquired by him by borrowing or accepting loan or deposits from others and that the company shall disclose money so accepted in the Board’s Report.

Although these aforesaid relaxations 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 company as a large number of private companies are formed as closely held companies. In these types of entities, loans and advances from relatives who are members are the most important sources of finance. This in turn would ensure free flow of hassle-free resources to private companies.

12.FURTHER ISSUE OF SHARE CAPITAL

[CHAPTER IV – MODIFICATION UNDER SECTION 62(1)(a)(i), 62(2) AND 62(1)(b)]

Section 62(1)(a)(i) of the Act provides that the offer period for a rights issue should be for a period not less than 15 days and not exceeding 30 days from the date of opening of the offer. Section 62(2) of the 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, under Section 62(1)(b), the approval of the members of the company by way of a special resolution was required for the purpose of issuance of Employee Stock Option Schemes(ESOPs).

The MCA 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. Further, in respect of issue of ESOPs, now the members of the private company can approve such issuance by way of an ordinary resolution.

The modification to the Section 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 and may close its offer for rights issue in less than 15 days period [the period may be reduced to less than 15 days but cannot be extended beyond 30 days]. Further, The notice for making the rights offer may be despatched in less than 3 days period before opening of the issue. Such exemption to private companies was also provided under Section 81(3)(a) of the Companies Act, 1956.

The Notification remains ambiguous as to whether the consent of 90% of the shareholders by value or by number has to be obtained.

The Notification would also ease the process of issuance of ESOPs to employees of private companies.

13. APPOINTMENT OF MANAGERIAL PERSONNEL

[CHAPTER XIII - SECTION 196(4) & (5)]

Section 196(4) deals with approval of the terms and conditions of appointment of Managing/Whole time Director/Manager by the Board/General Meeting/Central Government as the case may be.

Section 196(5) deals with validating actions of Managing/Whole time Director/Managers, if the appointment is not approved by a company in general meeting.

Now pursuant to MCA Notification, Section 196(4) and Section 196(5) are not applicable to private companies. Thus, in case of private companies the appointment or remuneration of the Managing Director, Whole time Director or the Manager does not require approval at the Board Meeting/General Meeting and subsequently the approval of Central Government is also not required, even if the conditions for appointment are not as per the requirements of Schedule-V of the Act. 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.

Section 196 of Companies Act, 2013 is similar to sections 197A, 267, 269, 317, 384, 385 and 388 of the Companies Act, 1956 read with Schedule XIII. Broadly they were not applicable to private companies which are not subsidiaries of public limited companies.

14. MINIMUM CAPITAL REQUIREMENT – CHAPTER I – SECTION 2(68)

Another relief to private companies has been brought through the Companies (Amendment) Act, 2015, whereby for the ease of doing business in the country, the requirement of minimum paid- up share capital of rupees 1 lac for private companies has been dispensed with. However the MCA has reserved the right to specify the same by way of its rule making authority.

As a result of the omission of the requirement of having a minimum paid up capital, special purpose vehicles can now be formed with a nominal capital, which provision is present in various countries.

CONCLUSION

Private companies have a critical role to play in the growth of the economy. Most of the start-ups are floated as private companies and therefore it is essential that such companies are not burdened with cumbersome compliances.

The Companies Act, 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.

In this context, the exemption notification for private companies are a much awaited one. With these exemptions, it is expected that many companies would be able to carry on their businesses with ease. The Ministry of Corporate Affairs is mindful of the stakeholders’ voice and it does consider the suggestions received and concerns expressed. The Ministry of Corporate Affairs has constituted Companies Law Committee to make recommendations to the Government on issues arising from the implementation of Companies Act, 2013.

Therefore, all eyes are now on the Committee which is to review the implementation of the Act.

DISCLAIMER:

This write up is the personal property of the author to this article. If this write-up is circulated, content of this disclaimer and credit to CS Bhavik Gala shall be retained.

The content of this write up is purely academic and is intended to provide a general guide to the subject matter and not intended to be a professional advice and should not be relied upon for real life facts and the views are of personal opinion in nature. Specialist advice should be sought about your specific circumstances, if any.