5 Important Takeaways from Companies (Amendment) Act, 2017

In this article, Aarthi S, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on important takeaways from the Companies (Amendment) Act, 2017

Introduction

The Companies Law Committee (“CLC”) was constituted by the Ministry of Corporate Affairs (MCA) in 2015 to submit recommendations on the functioning of Companies Act, 2013. The CLC submitted its recommendations in a report on 1 February 2016. (see here) The Companies (Amendment) Bill, 2016 was not approved by the Parliament but on subsequent presentation in 2017, the Companies (Amendment) Act, 2017 (“Amendment Act”) (see here) was passed upon approval of the Parliament and assent of the President on 3 January 2018.

The provisions of the Amendment Act are to come into force on different dates that the Central Government may appoint by notification in the Official Gazette. The Amendment Act makes significant changes in the Companies Act, 2013 (“the Act”) with a view to inter alia facilitate ease of doing business in India.  

According to World Bank’s Ease of Doing Business Index, India has been ranked at 100 out of 190 nations, moving up 30 places from its initial position. Therefore, this amendment will foster prominence of India’s role in the global economy.  

This article aims to discuss 5 key takeaways from the Amendment and the impact that it has on the corporate sector.

Important Takeaways

Loans to directors

Section 185 embodies the provision related to grant of loans to directors. The erstwhile section prohibited a company from granting loans, guarantee or securities to any of its directors or other persons to whom the director is interested.

The purpose behind the introduction of the provision is to ensure that persons who hold a fiduciary relationship with the company, such as directors do not misuse their powers by facilitating loans towards themselves or companies they are interested in so that any conflict of interest between the company and directors can be avoided. The CLC observed the provision to be highly disproportionate as the overarching effect of this provision is not restricted to the intent behind its enactment.  Company laws across the world do not contemplate for such restrictive provisions on the grant of loans to directors. If the shareholders themselves approve of such transactions regarding utilization of their funds in a certain manner, the law need not be overly restrictive. The CLC acknowledged on the one end that this provision obstructed genuine transactions between a holding company and its wholly-owned subsidiaries with common directors and that at the same time this route was adopted to draw off funds by controlling shareholders. Therefore, a middle ground was adopted by relaxing the provision with increased safeguards.

On this pretext, the section has been replaced in its entirety. The new section is divided into 4 parts.

1. The first part prohibits the companies from providing loans, guarantees and securities connected with such loans to a director of the holding company or any partner or relative of the director or a firm in which the director or relative is a partner.
2. The second part removes prohibitions on lending to companies and body corporates in which director is interested. It is now subject to fulfilment of certain conditions instead. The conditions being that it must be approved by a special resolution passed by the company in a general meeting and that the loans are being used by the company in its principal business activities and not for further investment or grant of loans.
3. The third part provides four cases in which the prohibitions and restrictions of the above two parts would not apply: loans granted to managing Directors or Whole Time Directors as part of their conditions of service or pursuant to scheme approved by a special resolution; companies providing loans in the ordinary course of business; loans made by holding company to its wholly owned subsidiary or guarantee or security by a holding company on loans made to its subsidiary.
4. The fourth part lays down penalties for breach of this provision.  

Therefore, the amended provision is partly prohibitive and partly restrictive as opposed to the erstwhile provision which was prohibitive in entirety.

Private placement process

Section 42 of the Companies Act, 2013 primarily governs the private placement of securities. The procedure has often been criticized for being time-consuming, cumbersome and requiring elaborate and sensitive public disclosures. Although the purpose of the provision was to prevent the grave misuses of the earlier private placement procedure under the Companies Act, 1956 yet the CLC recommended substantial changes to the provision to simplify the procedure. Private placement has now been defined under section 42 as “any offer or invitation to subscribe or issue of securities to a select group of persons by a company (other than by way of a public offer) through private placement offer-cum-application, which satisfies the conditions specified in this section.”

Some of the key changes are:

1. Non-requirement of private placement offer letter (“PPOL”). PPOL was circulated amongst investors to give them sufficient information about the company. The explanatory statement prepared under Rule 13(2)(d)  of Companies (Share Capital and Debenture) Rules, 2014 for preferential offer is relied on instead.
2. More than one issue can be made to identified persons at a particular time.
3. The right of renunciation of private placement has been barred.
4. Return of allotment under Form PAS-3 is to be filed within 15 days as opposed to the erstwhile 30 days.
5. The penalty for accepting monies or making an offer in contravention of the Section has been reduced to 2 crore rupees or amount raised through such private placement whichever is lower as opposed to the erstwhile provision which imposed the higher of the two as penalty.  
6. The money obtained from allotment cannot be used until the return of allotment has been filed with the Registrar.

Insider trading and forward contracting

Section 194 and 195 of the Act were penal provisions which prohibited forward contracting of securities by directors or Key Managerial Personnel and insider trading of securities respectively. These provisions applied to both public and private companies. Additionally, these provisions have been covered under SEBI regulations as well. Certain jurisdictions have justifiably included insider trading prohibitions in their company laws as well, in addition to their securities law owing to the fiduciary duty of directors and KMP who may abuse this duty furthering their interests over the best interests of the company. However, the CLC noted, given that private companies do not have marketable securities affecting trade on the stock market and the insider trading prohibitions being unwarranted, adversely affecting capital raising activities, causing hindrances to the right of first refusal of shareholders etc. these provisions have been omitted. It is now comprehensively governed by the SEBI Act and corresponding SEBI regulations.

This omission has 3 essential implications. Firstly, forward contracting and insider regulations do not apply to private companies and public unlisted companies. Reading section 12A of the SEBI Act with Rule 3(1) and 4(1) of  SEBI (Prohibition of Insider Trading) Regulations, (“PIT Regulations”) the insider trading norms only apply to ‘securities that are listed or proposed to be listed.’ Secondly, an appropriate authority for investigating and prosecuting insider trading has been streamlined. Prior to the amendment, SEBI ( under section 458), the Registrar (under section 206 or 207), Central Government (under section 210) and NCLT (under section 222) were bestowed with overlapping powers to deal with insider trading under the Act. However, reading Regulation 10 of the PIT Regulations with section 15G and 15I of the SEBI Act, the authority for prosecution of insider trading offences lies with SEBI. Thirdly, jail term as a penalty for insider specified in section 194 and 195 of the Act has been done away with. As per section 15G of the SEBI Act, the only penalty is a monetary penalty of 25 crores or thrice the amount of profits made out of insider trading. However, a general provision namely, section 24 of the SEBI Act can be invoked for imposing imprisonment if the provisions of the Act are contravened.   

Significant beneficial owner

Quite often, corporate vehicles are used for illegal purposes such as evasion of tax, money laundering, terrorist activities etc. the real owner benefitting from such transactions hide behind the identity of the corporate vehicle. Owing to this, the Financial Action Task Force sought to strengthen the law behind beneficial owner and beneficial interest in the Prevention of Money Laundering Act, 2002 and SEBI guidelines. Section 89 and 90 of the Companies Act, 2013 pertaining to the declaration of beneficial interest and register of significant beneficial owners.  However, there was an absence of comprehensive definitions on beneficial ownership and beneficial interest in these provisions. Owing to this lacunae, several regulatory concerns such as the difficulty of maintaining a Register for the purpose were raised. Taking into consideration the definitions adopted by other nations such as UK for the said purpose, the Amendment now provides comprehensive definitions for significant beneficial owner and beneficial interest.

Beneficial interest in a share has been defined to include directly or indirectly the right of a person acting individually or together with other persons to exercise or cause to be exercised all or any of the rights attached to a share or receive or participate in any dividend or distribution in respect of such share.

Significant beneficial owner (SBO) has been defined to mean individuals acting alone or together (including trusts or person resident outside India) who hold a beneficial interest in not less than 25% of the shares of the company or have the right to or actually exercise significant influence or control over the company.

Implications

1. The SBO is to make a declaration to the company detailing the nature of interest and such other particulars in the manner and within such period as may be prescribed. The Central Government reserves the power to prescribe classes of persons who are not mandated to make the declaration.
2. Register of interest is to be maintained by all companies which will be open for inspection by members.
3. A return of SBOs and the changes therein is to be filed with the Registrar.
4. A company is empowered to give notice to any person if it has reasonable cause to believe the person to be an SBO but is not registered as one. The person is mandated to provide all the information sought for within 30 days of the date of the notice.
5. The penalty by way of a fine has been imposed for non-compliance of these requirements.
6. Willful furnishing of incorrect information or suppression of material information will be treated as fraud and action will be punished under section 447.  

Qualification for independent directors

Test of materiality to determine the pecuniary relationship

Section 149(6)(c) provided that to an independent director must not have had pecuniary relationships with the company, its holding, subsidiary or associate company or its directors or promoters in the two immediately preceding financial years or the current financial years. This imposition tends to cover even minor pecuniary relationships that do not compromise the independence of directors. Therefore, the CLC recommended that the pecuniary relationship must be qualified by the test of materiality to determine to the independence of an individual as an independent director.   

The section now lays down that an independent director must not have the aforesaid pecuniary relationship exceeding 10% of his total income or such other prescribed amount and excludes remuneration as such director.

Pecuniary relationship of relative of ID made more specific

The CLC noted that the requirement under section 149(6)(d)  for an independent director’s relatives do not have “pecuniary relationship” with the company, its holding, subsidiary or associate company or its directors or promoters in the two immediately preceding financial years or the current financial years is to be made more specific by categorizing the types of transactions.

The pecuniary relationship after the Amendment now means:

1. Security or interest not exceeding higher than fifty lakh rupees or two per cent of the company’s (or its holding, subsidiary, associate company) paid-up capital or such higher sum as may be prescribed.
2. Is indebted to the company (or its holding, subsidiary, associate company or promoters or directors)  in excess of the amount prescribed in the current or 2 preceding financial years.
3. Given security or guarantee to the company (or its holding, subsidiary, associate company or promoters or directors)  for a prescribed amount in the current or immediately preceding two financial years
4. other pecuniary relationship with the company (or its holding, subsidiary, associate company)  of two per cent or more of gross turnover or total income singly or in combination with the above three types of transactions.

Relative of a director as KMP or employee in the company  

The erstwhile section 149(6)(e)(i) restricted the appointment of an individual as an independent director if his relative is or was a KMP or employee of the company (or its holding, subsidiary, associate company) in the preceding 3 financial years. The CLC noted that a relative of the independent director operating at a lesser level in the company in comparison to a director or KMP in the preceding years would not impact the independence of a director and was hence recommended to be done away with.

A proviso has now been inserted to the clause which lays down that if the relative is an employee in the company (or its holding, subsidiary, associate company), the restriction shall not apply to his employment in the preceding three financial years.

Conclusion

The amendments brought about through the Companies (Amendment) Act, 2017 is with the aim to provide ease of doing business in India. These changes including the ones explained above facilitate the said purpose and are likely to help our nation secure a more prominent role in the global economy.

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