The Major changes affecting Private Companies

Introduction

The 1956 Act could not keep up with the burgeoning Indian Economy post the 1991 economic reforms. Many foreign investors eyed India as the next big market, however, the Act lacked robust investor protection laws and necessary corporate governance laws. The Government of India after due deliberations decided to repeal the Act and enact new legislation to meet the germinating national and international economy. Incorporating the recommendations of the Parliament Standing Committee on Finance and suggestions of stakeholders, the Companies Act, 2013 was passed in the Parliament. The new Act is landmark legislation with far-reaching consequences. Some experts even called the legislation as a blessing in disguise.[1] The 2013 Act has been developed with a view to enhance self-regulation, improve corporate governance, enhance accountability on the part of corporates and auditors, raise levels of transparency and protect the interest of investors, particularly small investors. The Act introduced new provisions pertaining to One Person Company, Corporate Social Responsibility, Independent Directors, etc. The 2013 Act has ushered in a new era of corporate democracy making a titanic shift from “government control’ to ‘self-governance”. Let us discuss the changes affecting Private Companies.

What is a Company?

“Like any juristic person, a company is legally an entity apart from its members, capable of rights and duties of its own, and endowed with the potential of perpetual succession.”[4] Section 2(20) of the Act states that “Company” means a company incorporated under the Companies Act, 2013 or under any previous company law. There are different types of Companies. Under Section 3 of the Act, a Company may be formed for any lawful purpose, it includes Public Company, Private Company, and One Person Company. In this Article, my focal point will be limited just to Private Companies.

What is a Private Company?

Section 2(68) of the Act expounds what is a Private Company. It means a Company whose Articles of Association contain the following restrictions:

1. Restriction of transferability of shares. The restriction is not mandatory for in case of Private Companies not being limited by shares.
2. Limits the maximum number of members to 200, which shall be exclusive of members who are or were in the employment of the Company. Joint holders of shares are treated as a single member.
3. Prohibits any invitation to the public to subscribe for any securities (debentures or shares) of the Company.

A Private Company was required to have a minimum paid up share capital of ₹1 lakh, However, post the Companies (Amendment) Act, 2015, the requirement has now been omitted. Examples of Private Companies are, Google India Pvt. Ltd., Forbes Marshall Pvt. Ltd., Adobe Systems India Pvt. Ltd., etc.

Procedure to register a Private Company

1. Obtain Director Identification Number (DIN) from proposed directors and each of their digital signature.
2. Promotor suggests suitable name to the Registrar. The name shouldn’t be similar or identical, be prohibited under the Emblems and names Act, 1950, and must have ‘Pvt. Ltd’ as a suffix in its name.
3. Submission of Articles of Association, Memorandum of Association, Declaration of Directors, and their affidavits, along with prescribed fees. The information regarding the Company’s registered office must be provided to the Registrar within 15 days.
4. Subscriber must sign their names on the Memorandum in the presence of at least one witness. Furthermore, each subscriber must have at least one share in the company.
5. After filing of the abovementioned documents and payment of prescribed fees, the Registrar of Companies shall issue a Certificate of Incorporation.

Main features of a Private Company

1. Restriction on transferability of shares: In the 1956 Act, a Private Company, by its articles, prohibited any invitation to the public to subscribe for any securities of the Company or acceptance of deposits from persons other than its members, directors, and relatives. This requirement has been omitted under the 2013 Act. However, though articles are not required to contain the prohibition, the same shall apply by virtue of Section 73 (Prohibition on acceptance of deposits from public) and Section 76 (Acceptance of deposits from public by certain companies) of the 2013 Act. Hence, a Private Company cannot raise capital from the public. Likewise, there is no need to issue a Prospectus. However, a Private Company may raise capital in the following ways:
2. By issuing right shares to existing shareholders.
3. By issuing bonus shares.
4. By issuing private placement offer letters to not more than 200 persons in a financial year. While estimating the number, the following shall not be considered:
5. Qualified Institutional Buyers;
6. Employees of the Company to whom offer for securities is made under the employee’s stock option scheme.
7. Restrictions on number of members: For incorporation of a Private Company, two persons shall subscribe their name to the Memorandum of Association. They will be the first members of the Company. The maximum number of members must be limited to 200, this excludes those who are in the employment of the Company, and were in employment of the Company, and those who have continued to be members after their employment has ceased.  In the 1956 Act, this limit was 50. Joint holders of shares shall be treated as a single member. If more than one person apply for shares in a Company and shares are allotted to them, each one of such applicants becomes a member.[5] It may be pointed out that debenture-holders are not considered as members of the Company. Section 450 provides that if the number of members of a Private Company falls below 2, the Company and every officer who is default shall be punished with a fine which may extend to ₹10k, and if the contravention is a continuing one, they shall be fined to an extend of ₹1k every day till the contravention prolongs. Section 450 is a general provision. Likewise, under Section 3A, inserted by the Companies (Amendment) Ordinance, 2018, if the members of a Private Company are reduced below 2 and the Company carries on operations for more than six months; it is conscious that it is doing so while being below the given statutory limit, then the remaining member shall be held severally liable for the whole debts contracted by the Company in the 6-month duration and may be individually sued accordingly. In such a case, a Private Company does not axiomatically become a One Person Company, as it is a special form of Company. In computing numbers of Private Limited Company, joint shareholding members, and shareholding of employees or transfer of shares by employees in favor of their family members or otherwise will have to be excluded.[6]
8. Number of Directors: As per Section 149(1)(a), a Private Company must have at least two  directors. According to Section 149(1)(b), every Company can have a maximum of 15 directors. However, a Company may appoint more than 15 directors after passing a special resolution. As per Section 149(3), every Company shall have at least one director who stays in India for a total period of not less than 182 days during the financial year. Prior to the Companies (Amendment) Ordinance, the requirement stood as previous ‘calendar year’ instead of ‘financial year’. A Private Company is not required to have independent directors in conformity with Section 149(4) and directors of a Private Company are not required to retire by rotation according to Section 152(6). In accordance with Section 165(1), a Private Company can appoint a person as a Director who intends to hold maximum directorships in 20 Companies at a time. As per Section 164(3), a Private Company may by its articles provide for any disqualifications for appointment as a director in addition to those mentioned in the Act. Furthermore, Section 167(4), permits a Private Company, may, by its articles, provide any other ground for the vacation of the office of a director in addition to those specified in the Act. Moreover, a Private Company need not have a director elected by small-shareholders. Further, a Private Company can appoint all its directors en-block through a single resolution.
9. Minimum Subscription: A Private Company can allot securities even before receiving the minimum subscription.
10. Prospectus: Raising capital is crucial for the incorporation of a Company. The funds generated are then invested to aid the business of a Company. Post the Companies (Amendment) Act, 2015, the requirement of minimum paid-up share capital has been relaxed. Securities may be issued by contacting the parties privately or maybe issued to the public at large to subscribe. For the latter, a Company needs to issue a Prospectus inviting offers from the public for the subscription or purchase of any securities. A Private Company need not, more importantly, cannot issue a prospectus for its securities. A Private Company must prohibit any invitation to the public to subscribe for any securities of the Company. However, a Private Company may opt for issue of shares on private placement purposes. A Private Company can issue shares both in physical and dematerialized form. Section 42 comments on the issue of shares on private placement basis. According to Section 42(7), there shall not be a release of any public advertisements, or utilization of any media, marketing, or distribution channels or agents to give information to the public for securing issue of shares in private placement basis. As per Rule 14 of the Companies (Prospectus and Allotment of Shares) Rules, 2014, a Company cannot offer securities to more than 200 persons. While calculating the number, Qualified Institutional Buyers and share allottees under the Employment Stock Option Scheme, shall be excluded. The allotment shall be made within 60 days from receipt of the application. Upon lapse, there shall be repayment of application money to subscribers within 15 days from the expiry of 60 days. Section 42(2) reads that private placement shall be made only to a selected few identified by the Board. The number of people part of the Board shall not exceed 50 in a financial year. If a Private Company makes offer to subscribe its securities to more than 200 persons, it becomes a deemed public offer.[7]Issue of shares to outsiders without special resolutions is illegal and void.[8]However, as per Section 73, it can accept deposits from its members.
11. Name:  The name of a Private Company must end with, ‘Pvt. Ltd.’ to connote that it is a Private limited liability Company.
12. Meetings: Section 103(1)(b), states that unless the articles of a Private Company provide for a larger number, 2 members physically present, shall be quorum for meeting of the Company. As per requirements given in Section 121, a Private Company is not required to file a report on each Annual General Meeting with the Registrar.
13. Key Managerial Person:A Private Company is not required to appoint all key managerial person, except for a whole time Company Secretary, only if, it has a paid up share capital of ₹5 crore or more.
14. Other essentials of a Private Company: Every Private Company has all other essentials of a Public Company. Every Private Company is legal entity as much as Public Company. It cannot be called a property of some individuals or of a Joint Hindu Family.[9] All provisions in the articles to maintain the basic characteristics of a Private Company in terms of Section 2(68) will continue to govern the affairs of the company even though it is a subsidiary of a Public Company. One basic characteristic is that restriction on transfer of shares will apply even if a Private Company is a subsidiary of a Public Company.[10]

Types of Private Companies

1. Independent Private Company: A Private Company which is not under the control or a subsidiary of a Public Company. Such Companies enjoy all privileges and exemption granted under the Act.
2. Dependent or Subsidiary Private Company: A Private Company which is under jurisdiction or a subsidiary of a Public Company. According to the proviso in Section 2(71), if a Private Company is a subsidiary of a Public Company, then it shall be deemed to be a Public Company for the purposes of the Act, although it continues to be Private Company in its articles.

Exemptions granted to Private Companies

The Companies Act, 2013 is a revolutionary statute. It has altogether reformed corporate concepts in reference to Private Companies. Initially most exemptions which were available to Private Companies under the 1956 Act, had been taken away by the 2013 Act. Eventually, the Ministry of Corporate Affairs actualized the need to reinstate some of the exemptions available to Private Companies under the 1956 Act.

The Ministry of Corporate Affairs vide notification dated 5thJune, 2015 granted the following exemptions and privileges to Private Companies, some of them are:

1. Issue of shares with differential rights: If the Memorandum or Articles so provide (Section 43), then a Private Company can as per Section 43, issue both equity and preference shares with differential right to dividend without complying with the specified conditions.
2. Voting rights to shareholders: If the Memorandum or Articles so provide (Section 47), then a Private Company may issue shares with differential voting rights without complying with the specified conditions.
3. Further issue of share capital: A Private Company may keep the rights issue open for less than 15 days [Section 62(1)(a)(i)], if 90% of the members give their consent. Furthermore, a Private Company need not dispatch of further issue of shares to its members at least three days before the opening of the issue [Section 62(2)]. Consent can be given in writing or in electronic mode.
4. Loans to directors and interested entities: Section 185 shall not apply to a Private Company satisfying all of the following conditions[11]:
   a. If no body corporate shall have invested any money in the share capital of the company; and
   b. If the borrowings of the company from banks, financial institutions or anybody corporate shall not exceed twice the amount of paid-up share capital or ₹50 crores, whichever is lower; and
   c. If the Company is not in default in repayment of such borrowings subsisting at the time of making transactions under Section 185.
5. Exercise of powers in Board Meetings: A Private Company can exercise all those powers, available to a Public Company given in Section 180. However, this can only be done with the consent on the Company after passing a special resolution.
6. Indemnities granted to directors: An interested director of a Private Company after disclosing his interest in a contract can participate in the Board meeting at which such contract is to be considered (Section 184).[12]Furthermore, a Private Company need not get approval for appointment and remuneration of managing director, whole-time director or manager from its general meeting or the Central Government [Section 196(4)]. Moreover, acts done by the managing director, whole-time director and manager of a Private Company whose appointment is not approved by its general meeting shall not be deemed to be invalid.

While some of these compliances will go a long way in increasing the accountability of Private Companies; the concerns are also raised as to the need for increasing the complexities for Private Company, especially where public at large is not interested.[13]

Ministry of Corporate Affairs by adopting its power under Section 462, vide its notification dated 13th June, 2017, amended its former 2015 notification by providing further exemptions to Private Companies. They are:

1. Cash flow statements not mandatory: Private Companies (Start-Ups only) are not required to provide cash flow statement along with financial statements. Start-ups are those Companies which are incorporated under the Act and duly recognised by the Department of Industrial Promotion and Policy, Ministry of Commerce and Industry [1st Proviso to Section 2(40)]
2. No quarterly Board Meetings: A Start-up Company is permitted to hold a Board Meeting in each half of the calendar year. The gap between two consecutive meetings should at least be 90 days [Section 173(5)]. Furthermore, an Interested director may also be counted in the quorum of the meeting after disclosure of his interest under section 184 [Section 174(3)].
3. Acceptance of deposits from members: The Act prohibits Private Companies from accepting deposits from the public. However, it may accept deposits from its members [Section 73(2)(a)].
4. The amount accepted does not exceed 100% of aggregate of its paid-up share capital, free reserves and securities premium; or
5. It is a Start-up company up to 5 years from the date of its incorporation; or
6. It fulfils all the following conditions:
7. It is not an associate or a subsidiary company of any other Company,
8. Its borrowings from banks or financial institutions or anybody corporate is less than twice its paid up share capital or ₹50 crores, whichever is lower, and
9. It has nosubsisting default in repayment of such borrowings at the time of accepting deposits.

It will have to file a return with the ROC in the prescribed form.

• Annual return: A Private Company which further classifies as a Small company may only disclose aggregate remuneration paid to all its directors [Section 92(1)]. Moreover, for Start-ups, in absence of a Company Secretary, the annual return can be filed by the Director as well [Section 92(1)(g)].
• Auditor Report Inclusions: The following class of Companies have been exempted from on internal financial controls in the auditor’s report.
• A One Person company or a small company; or
• a Company which has
• Turnover less than ₹50 crores as per its latest audited financial statement; or
• aggregate borrowings of less than ₹25 crores from any bank, financial institution or other body corporate, at any point of time during the financial year.

Majority of the aforementioned exemptions, are available to Start-ups, were earlier available to small companies, dormant companies or one-person companies. The Amendment notification seeks to enhance existing exemptions and improve the governance standards, for those private companies which have not committed default in filing financial statements and annual return with the Registrar of Companies.[14] The relaxations will aid Start-ups and help uplift their entrepreneurial spirit. Most Start-ups find it cumbersome to borrow from banks due to lack of collaterals. Therefore, the exoneration to raise funds from members as deposits is a welcoming step.Most early companies have time and cost constraints. Therefore, these amendments will aid new companies to be more efficient by reducingtheir compliance burden, paperwork and improve efficiency of the management for start-ups.[15]

Major Amendments or changes affecting private company

1. Companies (Amendment) Act, 2015[16]: Omitted the requirement for minimum paid up share capital. Common seal made optional.
2. Companies (Amendment) Act, 2017[17]: Introduced Section 3A in the Act. The fresh section made existing members liable if the minimum number of members fell below the statutory limit. Surprisingly, this section was there in the 1956 Act. Under Section 42, private placement offer letter shall not contain any right of renunciation. Furthermore, the return of allotment has to be made within 15 days instead of 30, Additionally, money received under the placement shall not be used unless the return of allotment is filed with the Registrar of Companies.
3. Companies (Amendment) Ordinance, 2018[18]: Insertion of Section 10A. this was promulgated again under the Companies (Amendment) Ordinance, 2019[19]. The Section restricts any Company having a share capital, from commencing any business or exercise any borrowing powers unless a declaration is filed by a director of such company with the Registrar of Companies. Such declaration has to be filed within 180 days of incorporation.
4. Companies (Amendment) Act, 2019[20]: Application under Section 2 and 5 are now to be filed with the Central Government, not the NCLT. This was done to de-congest the workload of NCLT.

Conclusion

The Companies Act 2013 is a landmark legislation but the concern has always been about its implementation. No act is helpful if it is not implemented in its spirit, similarly there is also a need to have unified laws for corporate sector to remove ambiguities due to the existence of multiple acts and statutes. Companies Act 2013 overcomes some of the major loopholes of company act 1956.[21]A careful and educated consideration and analysis of future implications and challenges coupled with clearer and comprehensive drafting would minimize the need for constant review.[22]

With the introduction of several relaxations and exemptions, Private Companies stand at ease[23], with more Companies converting to Private Companies or incorporating themselves as Private corporate bodies. With frequent and crucial amendments, the Act fails to provide Companies with a sturdy platform to operate their businesses. Amendments through the years, have been rephrased through several interpretations. This makes the Act vague, heavy on procedural aspects, and makes it difficult for investors or stakeholders to keep up with the reforms. Recently, the Central Government tabled the Companies (Amendment) Bill, 2020[24]. The bill has been passed by the Lok Sabha. The recurrence of amendments hints at the need for a more thorough statute, more suitable to this time, instead of introducing new notifications over time.

References:

[1] Companies Act 2013 is a blessing, says expert, THE HINDU available on https://www.thehindu.com/news/cities/Madurai/companies-act-2013-is-a-blessing-says-expert/article6766405.ece (Accessed on 07/04/2020)

[2] Roji Kanungo & Sakti Ranjan Dash, A CONCEPTUAL VIEW ON COMPANIES ACT 2013: WITH SPECIAL REFERNCE TO SHARE CAPITAL, VOLUME 4, INTERCONTINENTAL JOURNAL OF FINANCE RESEARCH REVIEW, page 78, 2016

[3] CS. Mal Kumari Upadhyay, The Indian Company’s Act 2013 – a boon or bane to Sustainable Development, Volume 19, International Organisation of Scientific Research, page 8, 2017

[4] Hahlo and Trebilcock, HAHLO’S CASEBOOK ON COMPANY LAW (2nd Edn) 42

[5] Narandas V. India Mfg. Co. AIR 1953 Bom 433

[6] Darius Rutton Kavasmaneck V. Gharda Chemicals Ltd., Mumbai (2017) 141 CLA 212 (Bom.)

[7] Sahara Indian Real Estate Corporation Ltd. V. SEBI (2012) 10 SCC 603

[8] V S Krishnan V. Westfort Hi-Tech Hospital Ltd. (2008) 83 SCL 44 (SC)

[9] Vikas Jain V. Nucon Industries Pvt. Ltd. (200) 103 Comp Cases 343 AP

[10] Hillcrest Realty SDN.BHD V. Hotel Queen Road (P) Ltd. (2006) 72 CLA 245 (CLB)

[11] Nikhil Joseph, Ruchir Sinha & Sangeeta Rana (Nishith Desai Associates), Companies Act 2013 amended; private company exemptions reinstated, LEXOLOGY available on https://www.lexology.com/library/detail.aspx?g=28c4b6ff-bbf6-4961-bd84-18bad339c86d (Accessed on 07/05/2020)

[12] Nolakha Ratan, COMPANY LAW AND PRACTICE, Page 4.7 (1st ed. 2015)

[13] Vishwas Panjiar, Amitava Banerjee, Sandeep Mehra, Divya Malhotra (Grant Thornton India LLP), Status of Private Companies under the Companies Act, 2013, Page 3, October 2015

[14] Deloitte, Relaxations for private companies under Company Law, Regulatory Alert Stay Ahead… Issue no: RA/12/2017 available on https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/Regulatory%20Alert/in-tax-regulatory-relaxation-to-private-companies-noexp.pdf (Accessed on 07/05/2020)

[15] Vineet Singhal & Shweta Dwivedi (Khaitan & Co.), MCA Notifies Additional Exemptions For Private Companies (Including Start-Ups), MONDAQ available on https://www.mondaq.com/india/corporate-governance/607354/mca-notifies-additional-exemptions-for-private-companies-including-start-ups(Accessed on 07/05/2020)

[16] Companies (Amendment) Act, 2015 available on

http://www.mca.gov.in/Ministry/pdf/AmendmentAct_2015.pdf (Accessed on 07/05/2020)

[17] Companies (Amendment) Act, 2017 available on

http://www.mca.gov.in/Ministry/pdf/CAAct2017_05012018.pdf (Accessed on 07/05/2020)

[18] Companies (Amendment) Ordinance, 2018 available on http://www.mca.gov.in/Ministry/pdf/NotificationCAO2019_26032019.pdf(Accessed on 07/05/2020)

[19] Companies (Amendment) Ordinance, 2019 available on http://www.mca.gov.in/Ministry/pdf/NotificationCAO2019_26032019.pdf (Accessed on 07/05/2020)

[20] Companies (Amendment) Act, 2019 available on http://www.mca.gov.in/Ministry/pdf/AMENDMENTACT_01082019.pdf (Accessed on 07/05/2020)

[21] Dr. Rajesh Kumar Aggarwal, A COMPARATIVE STUDY OF UK COMPANIES ACT,2006 AND INDIAN COMPANIES ACT,2013, International Education & Research Journal, Page 33, Volume 1, November 2015

[22] Phoenix Legal, Companies Act, 2013: Time to Reboot?, MONDAQ available on https://www.mondaq.com/india/shareholders/890282/companies-act-2013-time-to-reboot (Accessed on 07/05/2020)

[23] Harini Subramani, Why private companies stand at ease: Companies Act, YOURSTORY, available on https://yourstory.com/2015/09/companies-act (Accessed on 07/05/2020)

[24] Companies (Amendment) Bill, 2020 available on http://www.mca.gov.in/Ministry/pdf/Amendment_18032020.pdf (Accessed on 07/05/2020)