Yesterday, the government has placed a draft notification for comments on the MCA Website relating to exemptions granted to private companies. Private companies are closely held business entities that are not permitted to invite the public to subscribe to their shares or accept deposits from the public. Private companies are defined under the Companies Act, 2013 (Companies Act) to inter alia mean a company, which restricts the right to transfer its shares and limits the number of its members to 200.
The earlier Companies Act had a separate class of companies, namely, private companies that are subsidiaries of public companies on whom certain additional regulatory requirements were imposed in line with public companies. Under the Companies Act have been included in the definition of public company. The proposed amendments would not cover these companies.
The proposal is to create a separate class of companies having 50 or less members. Certain restrictions have been proposed to be withdrawn only for companies with 50 or less members. This will make the applicability of the provisions fluid and the benefit of having companies with 200 members for a private company is diminished. Interestingly, the proposals do not mention a small company and are considering the creation of a third class of private companies that have 50 members or less.
In general, the objective of the proposed amendments appears to be to allow private companies to regulate their own affairs, as was the case under the previous companies act. The real impact of the proposals will be seen only through the actual text of the legislative amendments. The move is certainly something that would be applauded by industry, corporates as well as professionals like company secretaries, auditors and legal professionals.
The major changes proposed to be made are highlighted below:
1) Kind of Capital and Voting Rights
The provisions of Section 43 and 47 of the Companies Act dealing with equity and preference share capital and voting rights have been made wholly inapplicable to private companies. This takes it back to the position under the Companies Act, 1956 (the previous Companies Act) in respect of kinds of share capital that may be issued by companies and voting rights available to members. Private companies may issue differential shares with differential voting rights, which will be governed largely by its articles. This would offer a big relief to companies that are starting a new business or to investors, who can minimize their risk by subscribing to shares with differential rights as compared to shares with same rights. This should be welcomed by industry and other practising professionals.
2) Further issue of shares
Timelines have been reduced for acceptance of rights shares under Section 62(1)(a) by members. This would also be a welcome move as it will speed up the process in private companies where the shareholding is not diverse or scattered. However, the suggested amendment goes beyond the prescription of the previous Companies Act, by making the timeline the maximum time for reference.
There is a reference to amendment of timelines under Section 62(2) but no suggestions appear in the table. It appears to have been missed out.
3) Issue of ESOP in Private Companies
The requirement of a special resolution for issuing shares to employees under an ESOP scheme has been done away with. If the suggested change is implemented private companies may issue ESOP by way of an ordinary resolution of its members. In addition to the special resolution, the Companies (Share Capital and Debenture) Rules, 2014 require certain other requirements as well of an unlisted company including inter alia the following:
a) Restriction on quantum of sweat equity shares to be issued at 15% of existing paid up share capital or value of INR 5 crore whichever is higher, with a total cap of 25% of paid up share capital at all times,
b) Lock-in of 3 years on the sweat equity issued,
c) Valuation of intellectual property to be made by a registered valuer, and
d) Treatment of sweat equity as part of compensation package of the concerned employee.
In addition to the proposed changes to the Companies Act in this behalf, appropriate modifications would need to be made to the Companies (Share Capital and Debenture) Rules, 2014, if any real respite is proposed to be offered to private companies as the other conditions imposed seem to be more onerous than the passing of a special resolution. However, the government may choose to keep reporting requirement of such ESOP issue to ensure that appropriate information in that behalf is captured.
The regulation prohibiting acceptance of deposits from public, specifically, section 73 (2), which permits a company to accept deposits from its members subject to certain conditions stipulated therein, will not applicable to private companies having 50 or less members. Such a company, however, cannot accept monies exceeding 25% of aggregate paid up capital and free reserves or 100% of paid up capital whichever is higher, subject of course to compliance with reporting requirements.
5) Notice of meetings and other business of companies
Sections 101 to 107 and 109 that deal inter alia with notice of meetings, quorum, chairman, voting at meetings and poll, have now been made applicable only to public companies except in the event that:
a) it is otherwise specified in the section; and
b) unless the articles of association of the private company otherwise provide.
This amendment was necessary as it is against the very spirit of, functioning of private companies, for the law to regulate their internal processes and mechanisms. The idea here appears to be to arrive at the same position as the 1956 Act. However, appropriate amendments to the rules may also be mandated
6) Qualification of auditor
The restriction contained in Section 141(3) (g) which disallows a person who is in full time employment elsewhere, or a person or a partner of a firm holding appointment as auditor, if such person is at the date of appointment holding appointment of more than 20 companies, has now been made inapplicable to a private limited company. This would be a big relief to auditing firms as well as private companies, particularly auditors of large group companies.
7) Appointment of directors
The government has suggested that Section 160 and 162 be wholly made inapplicable to a private company. This move is positive and in keeping with the spirit that private companies should be allowed to regulate its own business. Proposal for moving resolution for appointment of two or more directors as well as provisions relating to non-retiring director seeking appointment to the office of director do not make any sense in the context of a private company which is closely held.
The original position under the previous Companies Act has been sought to be reinstated.
8) Restriction on the power of board
Restriction of powers of the board, hitherto applied to all companies. The suggestion of the government is that the requirement of special resolution for matters of importance listed in Section 180 shall not apply to private companies having 50 or lesser number of members. The matters referred to section 180 are:
a) to sell, lease or otherwise dispose of the whole or substantially the whole of the undertaking of the company or where the company owns more than one undertaking, of the whole or substantially the whole of any of such undertakings.
b) to invest otherwise in trust securities the amount of compensation received by it as a result of any merger or amalgamation,
c) to borrow money, where the money to be borrowed, together with the money already borrowed by the company will exceed aggregate of its paid-up share capital and free reserves, apart from temporary loans obtained from the company’s bankers in the ordinary course of business:
d) to remit, or give time for the repayment of, any debt due from a director.
The proposed change is in line with the provisions under the previous Companies Act.
9) Loans to directors
The much talked about and debated provisions of Section 185 providing restriction on a company from advancing any loans or providing any other security to any of its members have now sought to be made inapplicable to a private limited company subject to the following conditions:
a) the private company not having borrowings from other body corporates or financial institutions of more than twice its paid up capital or INR 50 crore whichever is lower;
b) the private company not having any investment by another body corporate in its share capital.
This seems like a half-hearted attempt at righting a wrong. The problem with the thresholds provided is that the section could not be applicable at the time of issuing the loan but could be subsequently applicable. The rationale for such fluid thresholds is not clear. The actual amendment may provide some clarity. If an amendment is brought in lines of the aforesaid thresholds of exemption, it will cause a lot of confusion in implementation.
10) Related Party Transactions
The most dreaded provision of all in respect to operations of private companies that are largely family run businesses is now done away with in toto. The suggestions provide that Section 188 shall not apply to private companies.
This is a welcome move and will be largely applauded by stakeholders, corporate professionals and industry as a whole. (In an older post, the issue of related party transactions as applicable to private companies and the disclosures required to be obtained by private companies to ensure compliance with Section 188 is available here.)
11) Appointment of managing director, whole time director and manager
The requirement of taking Central Government approval where the remuneration was in variance with Schedule V in case of managing directors, whole-time directors and managers has sought to be done away with.
The move is in keeping with the provisions of the previous Companies Act.
12) Appointment of key managerial personnel
The restriction of a whole-time key managerial personnel holding office in more than one company (except the subsidiary of such company) is now sought to be made inapplicable to a private company. The Act also requires that a KMP choose 1 of the 2 or more positions held by such KMP in any different companies.