Companies (Amendment) Act, 2017 – An analysis

The Central Government has notified Companies (Amendment) Act, 2017 (“Amendment Act”) on January 3, 2018 that was passed by the Parliament in its winter session [see End Note 1]. The Companies Act (Amendment) Bill, 2016 (“Bill”) was first introduced in the lower house of Parliament in March, 2016. The Bill, when presented before the Parliament, sought to make important revisions to the Companies Act, 2013 (“Act”) in relation to structuring, disclosure, and compliance requirements for companies. The Amendment Act has been able to largely uphold the objectives that the Bill had sought out to achieve. These are discussed in detail in the present article.

The Bill, after it was introduced in the Lower House of parliament, was referred to the Standing Committee on Finance in 2016 and after incorporating its feedback, along with relevant expertise from the respective government chambers of commerce and industry and professional bodies, it was finally approved by the Lower House as the Companies Act (Amendment) Bill, 2017 on July 27, 2017. The Bill, though was passed by the Lower House in the Monsoon Session, due to the adjournment of the houses, could not clear the scrutiny of the Upper House until December 19, 2017. The Bill was eventually passed and received the President’s assent on January 3, 2018.

The Bill was moved in the Lok Sabha by the Hon’ble Minister of State for Finance and Corporate Affairs, Mr. Arjun Ram Meghwal. While moving the Bill, he had stated that the main purpose of the Bill is for promoting businesses and for helping ease of business in India. He said that it was hoped that after passing these amendments, the procedure will be simplified, compliance will become easy and defaulting companies would be adequately punished.

Following the objectives and the purpose of the Amendment Act, it provides for prescribing a simple form of annual return for small companies, one-person companies and private companies with less than annual sales turnover of Rs. 100 crore from the previous limit of Rs. 20 crore. This may also apply to other form of companies to avoid repetitive information. The Standing Committee of the Parliament, while reviewing the Amendment Act, had recommended that this benefit should be provided to other companies as well if the Central Government, at a later point of time, decides to provide this leeway to such companies. The Government accepted the recommendation of the Standing Committee and provided for it in the Bill. The Amendment Act thus extends the power of the Central Government to prescribe abridged form of annual returns for other types of companies, in addition to one-person company or a small company.

The Amendment Act provides in clause 34 that the accounts of a company prior to eight years from the date of examination must not be reopened. This will be highly beneficial for companies as they will not have to carry on the cumbersome task of maintaining books of accounts for several years as they were required to do under the Act. Further, In order to resolve the problems faced due to unharmonized laws, the amendments in the Amendment Act are geared towards doing away with dual requirements under the SEBI Act, 1992 and the Act, especially in the context of separate prescriptions for prospectus and the contents of the board report. The Amendment Act omits the provision of prohibition on forward dealing and insider trading since those are relevant for listed entities which are already regulated by SEBI. The Amendment Act also allows unlisted companies to convene their annual general meetings at any place in India, and not necessarily at the place of their registered office, as provided earlier.

The Amendment Act has completely replaced Section 185 of the Act [see End Note 2], that governs loans granted to, and security and guarantees provided on behalf of, directors and other parties in whom the directors are interested. The section in its form under the Act, provided that the companies could grant loans to, or provide loans or security on behalf of directors or entities they are interested in, provided the requisite permission was taken. Exemptions to this provision were provided to ‘wholly owned subsidiaries’ if such loans were utilised for the subsidiary’s principal business activities. The Act also provided for exemptions for loans granted to a managing or whole-time director and to a company that provides loans or gives guarantees or securities for the due repayment of any loan in its ordinary course of business. Now the Amendment Act has bifurcated the regulatory framework into two categories: the first contemplating certain transactions which are prohibited and another consisting of transactions which may be permitted, subject to approval of the shareholders by way of a special resolution passed at a general meeting. The prohibition applies to loans, guarantees or security provided to a director of the company or a director of its holding company or any partner or relative of such director, and in any firm where such person is a partner.

The transactions pertaining to a private company wherein a director of the company provides loans, guarantee or security is also a director or member is now permitted by passing of a special resolution. This is subject to the condition that the explanatory statement for the general meeting, contains detailed disclosures regarding the proposed transaction. The permission given under the Act for providing such loans is also retained if the loans are utilised by the borrowing company for its principal business activities.

The amendment also retains its provisions under the Act applicable to managing or whole-time directors and companies providing loans and guarantees to its wholly owned subsidiaries or in its ordinary course of business. One difference in the exemptions is in the provision relating to the "ordinary course of business" where under the existing position of the Act such exemption could be availed of if the interest charged on the loans granted was at least equal to the bank rate declared by the Reserve Bank of India. The Amendment Act now provides for the interest to now at least at the rate of prevailing yield of one year, three year, five year or ten year Government securities, that is closest to the tenor of the loan. Though this amendment was much awaited from the industry and is highly beneficial from the perspective of large groups with a number of companies acting under its wing in different departments, as on February 20, 2018 this section has not been notified by the Ministry and hence is not into effect.

The Amendment Act also brings in line the provisions relating to the qualification of technical members of the National Company Law Tribunal (“NCLT”) and composition of the selection committee for appointment of technical members of the NCLT and the National Company Law Appellate Tribunal (“NCLAT”) with the judgment of the Supreme Court which had held them to be invalid in Madras Bar Association v. Union of India [see End Note 3].

Some of the other major amendments proposed to the 2013 Act are outlined below:

Definition of ‘associate company’ – 

Under the Act, the definition of an associate company’s significant influence is derived from its control of share capital. The Amendment Act substitutes the explanation to Section 2(6) of the term ‘significant influence’ to having control of at least 20 percent of the total voting power or control of or participation in business decision-making [see End Note 4]. This potentially impacts and affects the financial accounting of its holding company, if any. This will also be significant in lines of the insolvency management under the Insolvency and Bankruptcy Code, 2016. Amendment Act further defines a ‘Joint Venture’ also to mean a joint arrangement whereby the parties that have joint control of the arrangement, have rights to the net assets of the arrangement.

Definition of ‘related party’– 

The Amendment Act provides for expanding the existing definition of related party and now includes “an investing company or the venture of a company” also in the existing position [see End Note 5]. The section clarifies that an investing company or the venture of the company means a body corporate whose investment in the company would result in that company becoming an associate company of the body corporate.

Definition of a ‘small company’

 – The Act provides a large number of benefits to companies falling within the definition of ‘small company’ like exemptions from filing cash flow statements, auditor regulations, reducing the number of board meetings etc. For a company to qualify as a ‘small company’, the Amendment Act has now raised the firm’s maximum paid-up share capital amount from Rs. 5 crore (rupees five crore) to Rs. 10 crore (rupees ten crore). It also increases the prescribed turnover amount substantially from Rs. 20 crore (rupees twenty crore) to Rs. 100 crore (rupees hundred crore) [see End Note 6].This provision will ensure that the benefits provided to these small companies are provided to a substantially larger number of companies.

Definition of a ‘subsidiary company’ –

The Act lays down that a company shall be deemed to be a subsidiary of another, if the holding company controls the composition of the Board of Directors or exercises or controls ‘more than half of the total share capital’. The Amendment Act has amended Section 2(87) to now substitute the words ‘total share capital’ to ‘total voting power’ [see End Note 7] This amendment was expected since various controversies relating to companies exercising voting power without holding share capital in the recent past.

Members severally liable

– The Amendment Act has added a new section regarding liability of members in situations wherein if the number of members in a company is reduced from the statutory minimum number prescribed, i.e. below 7 in the case of a public company, and below 2 in case of a private company.  It provides that every person who is a member during that time the company carries on business and if they are cognisant of the fact that the company does not meet the minimum statutory criteria of members, shall be severally liable for the payment of whole debts of the company contracted during that time and can be severally sued [see End Note 8].

Private placement process – 

The Amendment Act has substituted Section 42 of the Act that deals with the issue of subscription of securities on private placement. The Amendment Act has taken away the right of investors to renunciate their investment rights in favour of another entity, so that only investors whose names are mentioned in the information memorandum, filed by the issuer, can subscribe to the shares. It also provides that return of allotment has to be filed with the Registrar of Companies within 15 days instead of 30 days and the money received under the private placement shall not be utilized unless such return of allotment is filed [see End Note 9].

Annual Return -

The Amendment Act provides for prescribing a simple form of annual return for small companies, one-person companies and private companies with annual sales turnover of less than Rs.100 crore from the previous limit of Rs.20 crore. This may also apply to other form of companies to avoid repetitive information. The amendment extends the power of the Central Government to prescribe abridged form of annual returns for other types of companies, in addition to one-person company or a small company. The Amendment Act also provides that the accounts of a company prior to eight years from the date of examination must not be reopened [see End Note 10].

Issue of Sweat Equity Shares –

The Act prohibits the issuance of sweat equity shares for a period of one year from the date of commencement of business of the company. The Amendment Act has taken away this prohibition so that such shares can be issued at any time after registration of the company. This amendment will be beneficial for start-ups as these companies can issue such shares to directors or employees for providing their know-how and can attract talent by providing such incentives from the period it commences business [see End Note 11].

Meeting

– Relaxation has now been provided to unlisted companies to hold their annual general meeting at any place in India, instead of the requirement under the Act of it being held at its registered office or in the city, town or village where the registered office is situated. This relaxation is subject to the condition that all the members of the companies have given their consent for the same in writing or by electronic mode in advance [see End Note 12]. The Amendment Act also provides an option for a wholly owned subsidiary of a company incorporated outside India to hold its extraordinary general meeting at a place outside India [see End Note 13].

Corporate Social Responsibility

– The Amendment Act has amended the eligibility criteria for the purpose of constituting the corporate social responsibility committee and incurring expenditure towards CSR. Till now, the Act provided for calculation of such eligibility criteria on the basis of preceding three financial years. However, the Amendment Act has now amended this to be based on only the immediately preceding financial year [see End Note 14].

Independent directors – 

The Act defines an independent director as a person who has or has had no ‘pecuniary’ relationship with the company, its holding, subsidiary, or associate company, or their promoters, or directors during the two immediately preceding financial years or during the current financial year. The Amendment Act has excluded remuneration and transactions – not exceeding 10 percent of the independent director’s total income – from what is defined as a pecuniary or financial relationship [see End Note 15]. The requirement to deposit Rs. 1,00,000 (rupees one lakh) with respect to nomination of directors as provided under section 160 of the Act shall also not be applicable now in case of appointment of independent directors or directors nominated by nomination and remuneration committee [see End Note 16].

Director identification number –

The Amendment Act provides the central government the power to prescribe any other identification number to be treated as director identification number for the purposes of the Act and if the person holds such a number, he shall not be required to hold a director identification number. This amendment would potentially permit Aadhar number to be used as an alternative to the director identification number [see End Note 17].

Forward dealings and Insider trading -

  Sections 194 and 195 of the Act which prohibit forward dealings in securities of company by director or key managerial personnel and prohibits insider trading of securities are now omitted as these actions fall under the domain of SEBI and are adequately provided for under its regulations [see End Note 18]. It was also decided to omit these sections as it has no impact on private companies.

Loans to Directors and related companies –

The Amendment Act has completely replaced Section 185 of the Act [see End Note 19], which governs loans granted to, and security and guarantees provided on behalf of, directors and other parties in whom the directors are interested. The original section in its form under the Act, provided that the companies could grant loans to, or provide loans or security on behalf of directors or entities they are interested in provided the requisite permission was taken. The Amendment Act has now provided to bifurcate the regulatory framework into two categories: the first contemplating certain transactions which are prohibited and another consisting of transactions which may be permitted, subject to approval of the shareholders by way of a special resolution passed at a general meeting.

Conversion into Companies –

The Act in section 366 provides for partnership firms, limited liability partnerships, cooperative society, society or any other business entity to be converted into a company if it is consisting of seven members or more. The Amendment Act provides for such a conversion if they consist of two members or more provided that in that case, the company shall register as a private company and not a public company [see End Note 20].

Members of NCLT and NCLAT -

The Amendment Act also brings in line the provisions relating to the qualification of technical members of the National Company Law Tribunal (NCLT) and composition of the selection committee for appointment of technical members of the NCLT and the National Company Law Appellate Tribunal (NCLAT [see End Note 21] with the judgment of the Supreme Court which had held them to be invalid [see End Note 22].

There were a few clauses that were present in the Bill that couldn’t eventually see the light of the day in the Amendment Act as they couldn’t pass the scrutiny of the members of parliament. Some of these clauses were game changing and would have certainly helped in achieving the aim of the Bill. For example, the Bill had initially sought to provide for a universal objects clause for companies wherein if the company only specifies its object as to “Engage in any lawful act or activity or business or any act, activity or business to pursue any specific object or objects”, it can be allowed to do so. This clause would have helped the genuine issues faced by growing companies wherein before starting any new vertical of business, they had to painfully amend their Memorandum of Association and intimate the registrar of companies before starting such vertical.

Companies could have easily ventured into any area that is legally allowed in India without any such compliances. However, Standard Committee on Finance recommended that such a clause on universal objects may lead to creation of bogus entities. Therefore, it was said that such an amendment should not be accepted and status quo should be restored. Hence in the Amendment Act, the universal objects clause couldn’t find its place.

The Bill had also sought to remove the leash reigned upon companies relating to layering of investment companies and subsidiaries through section 186 of the Act which provides that a company is restricted to make investment through more than two layers of investment companies. Number of Committees and their reports have suggested that this restriction, which was included to address practices of creating subsidiaries aimed at making it difficult to trace the source of funds and their ultimate use, and to reduce the usage of multiple layers of structuring for siphoning off funds, has failed at its objective.

The Bill initially sought to amend this provision so that genuine structuring issues faced by the corporates can be corrected and so that Indian companies are not put at a disadvantage in relation to structuring vis-à-vis their international counterparts. However, during the course of debates, a number of parties raised objections for removal of these restrictions. It was stated that removal of such a restriction will aid in creating shell companies which will in a way promote the conversion of black money. Though such a claim is not backed by factual proof, and such a restriction will only create hindrance in genuine business practices of Indian corporates, the Amendment Act thus continues to rein in the layering of both investment companies and subsidiaries. Interestingly, the Central Government, the proponent of removal of such a restriction in the initial stages, notified proviso to section 2(87) of the Act that provided that subsidiaries cannot have layers of subsidiaries beyond the numbers as may be specified [see End Note 23]. It further notified the Companies (Restriction on number of layers) Rules, 2017 [see End Note 24] in September, 2017 thus bringing out the regulatory framework for these restrictions.

As of February 23, 2018, 45 sections out of the total 93 sections of the Amendment Act have been notified. Although the Amendment Act will definitely be helpful in promoting ease of doing business in India, however, in our opinion, if the Bill was passed without amending the original wording, it would have been much more efficient and helpful to the current corporate regime in India. Although this Amendment Act is a game changer, it genuinely feels like that the present Amendment Act is an opportunity only half utilized.     

[The author is an Associate in Corporate law Practice, Lakshmikumaran & Sridharan, Mumbai]