The Companies Law Committee (“CLC”) constituted by the Ministry of Corporate Affairs (“MCA”) has placed its report dated February 1, 2016 (“Report”) on the MCA website for public comments. This Report provides CLC’s recommendations on amending over 100 provisions of the Companies Act, 2013 (“2013 Act”) and the rules framed there under, which had in the past, resulted in practical difficulties for Indian companies in legal and regulatory compliances. This article discusses certain recommendations by the CLC that in the view of the authors are significant from a commercial and transaction perspective.
Definition of ‘Holding Company’ and ‘Subsidiary’
A ‘holding company’ as currently defined under Section 2(46) of the 2013 Act refers solely to companies incorporated under the 2013 Act or any previous Indian company law legislation. Given that the definition excludes offshore incorporated holding companies, the Report recommends amending the definition of ‘holding company’ to include a body corporate within the definition of the term ‘holding company’. This amendment, if accepted, would address the existing drafting anomaly and bring foreign holding companies within the ambit of ‘holding company’.
CLC has also recommended amending the definition of a ‘subsidiary company’ to address the practical difficulties faced by investors while investing through convertible preference shares. The current definition of ‘subsidiary’ under Section 2(87) of the 2013 Act recognizes a company as a holding company to another company, if the holding company ‘exercises or controls more than 50% of the ‘total share capital’ of another company. Considering that ‘total share capital’ has been defined to mean ‘aggregate of paid-up equity share capital and convertible preference share capital’, investors, particularly, financial investors were often exposed to the risk of being deemed a ‘holding company’ to an Indian investee company, where the investment was structured through convertible preference instruments that exceeded the total number of equity shares. Interestingly, Section 2(87) and the relevant rules disregarded the aspect of limited voting rights that investors holding preference shares have under Section 47 of 2013 Act. Recognizing the anomaly, the Report recommends substitution of the expression ‘total share capital’ with ‘total voting power’ for determining holding-subsidiary relationship under the 2013 Act. This is definitely a positive move and should eliminate structuring complications in the context of investments through convertible preference shares.
Reforms in the regime for private placement of securities
Process of private placement of securities
The CLC’s proposal to revamp the private placement process under the 2013 Act stands out as one of the most significant changes proposed in the Report. Currently, all companies intending to issue securities (whether shares or debentures or hybrids) on a private placement basis (i.e. to identified investors) or by way of a preferential allotment are required to comply with the procedure specified under Section 42 and/or Section 62(1)(c) of the 2013 Act read with applicable provisions of the Companies (Prospectus and Allotment of Securities) Rules, 2014 (“PAS Rules”).
However, a private placement requires an investee company to make multitude compliances, which amongst others, includes: (i) issuance of a private placement offer letter by the investee company in form PAS-4 (“PPOL”) along with an application form to the investors to who such offer is made; and (ii) filing of the PPOL along with the details of the investors with the Registrar of Companies (“RoC”) within 30 days from the date of the offer. Given that, the PPOL is a considerably detailed document which requires a number of disclosures in the nature of management’s perception of the risk factors; details of interest of the directors in the offer; information in respect of pending litigation, related party transactions, inquiries pending against the company; details regarding the financial position of the company; and multiple declarations by directors in respect of compliance with laws, investee companies are therefore, required to undertake processes in parallel to identify declarations required for filing the POPL. Often, Investee companies that are not properly advised on the process miss out on making appropriate filings, intimations and records.
Further, in the context of a company issuing listed non-convertible debentures (“NCDs”) on a private placement basis, the company is not only required to file an information memorandum with the stock exchange in accordance with the Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations, 2008, but also file a PPOL with the RoC. However, the formats for the information memorandum required to be filed with the stock exchange and the PPOL have not been reconciled, and makes the filing process very cumbersome.
The CLC has acknowledged the time-consuming nature of the private placement process which has forced (private) companies to disclose sensitive and significant information to the public. Therefore, the Report recommends doing away with the requirement of a PPOL. Under the Report, certain crucial information such as objects of the issue, price and basis of the valuation, time period for offer, change in control, if any (that would occur consequent to the preferential offer) should be incorporated in the explanatory statement to the notice served to the shareholders (in case of preferential allotment of shares) and board of directors (in case of NCD issuances).
The Report has also recommended steps to prevent circumvention of the private placement and preferential allotment process. Indian companies have often circumvented the private placement norms as applicable to a preferential allotment by undertaking a rights-issue which is subsequently renounced by the existing shareholders of the company. Thereafter, the board of directors would, in terms of Section 62(1)(a)(iii) of the 2013 Act, offer the renounced shares to a third party, achieving a preferential allotment without complying with the private placement process. The CLC has, in line with Section 756 of the UK Companies Act, 2006, suggested that securities issued on a rights-basis could be renounced only in favour of a person who is connected with the company (such as member, employee, relative of a member, existing debenture holder). This recommendation proposes to make a clear distinction between a rights-issue process and a preferential allotment process, leaving no room for investors and investee companies to wriggle out from the compliance required in the context of a preferential allotment.
Making of new offers pending an earlier offer/ allotment
Section 42 of the 2013 Act read with applicable PAS Rules restricts a company from making a fresh offer of securities until the withdrawal, abandonment or completion of an earlier offer of securities. This restriction has significantly strained equity and debt fundraising ability of Indian companies, as companies could not structure multiple fundraisings processes simultaneously.
The Report recommends the option of keeping multiple offers open simultaneously, provided that the number of investors is within the limit specified under Section 42(2). The CLC has also made suggestions for ensuring transparency and accountability in the fundraising process, for example, recommending restrictions on the use of investment proceeds until the company files the return of allotment with the RoC.
Simplifying debt issuances under the private placement regime
Currently, allotment of NCDs on a private placement basis also requires compliance with Section 42 of the 2013 Act and the relevant PASRules. Recognizing the obvious distinction between NCDs and equity securities that form part of a company’s share capital, the Report recommends doing away with the requirement to seek prior shareholder approval for issuing NCDs on a private placement basis.
CLC has only suggested the requirement a board resolution under Section 179(3)(c) for NCD issuances, subject to board’s compliance with the borrowing limit specified under Section 180(1)(c) of the 2013 Act. The proposed change in respect of issue of NCDs is definitely a positive step towards easing the debt raisings by companies.
Multi-layering of investments by investment companies
Subject to limited exceptions, Section 186(1) of the 2013 Act restricts a company from making investments through more than two layers of investment companies. In the backdrop of the Purti scam, the Government’s endeavor was to prohibit multi-layered investment structures that curtained details of ultimate beneficial owners from the regulatory purview. While acknowledging the pitfalls associated with multilayered investment structures, the Report recommends doing away with layering restrictions that often become too obtrusive and impractical in the modern business world, and restrict legitimate business structures.
The CLC has aimed to strike a balance by recommending that, the terms “beneficial interest in a share” and “beneficial ownership in a company” should be defined in the 2013 Act, so that the ultimate interest in the shares are disclosed even in the context of multi-layered structures. Further, the Report has suggested companies to maintain a register of beneficial owners as a mandatory requirement. These recommendations are a welcome move, as it seeks to strike a balance between the regulatory supervision of companies and conduct of legitimate business operations.
Private companies with listed non-convertible securities
Under the 2013 Act, a sore point for private companies has been their inclusion as a “listed company” under Section 2(52) of the 2013 Act, consequent to issue of listed non-convertible securities. In terms of the 2013 Act, such private companies are required to comply with certain onerous company law compliances, including for example, appointment of independent directors, woman director, constitution of specific board committees (audit, nomination and remuneration committee), appointment of key managerial personnel etc. The Report partially acknowledges the concerns of the private company and provides that the thresholds for corporate governance requirements for private companies with listed debt securities may be examined and relaxed.
Even under the recently notified SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”), SEBI has made a distinction between companies issuing listed equity shares and convertible securities and private companies that have issued non-convertible securities such as NCDs. The disclosure and compliance requirements in respect of the latter are less stringent in comparison to the former. For instance, requirements in respect of disclosure of material events or information; compliance certification by chief financial and executive officers; constitution of a stakeholder relationship committee and a risk management committee; formulation of a policy on materiality and treatment of related party transactions; etc. have not been made applicable to private companies that have issued listed non-convertible securities.
Conclusion – a welcome change
The CLC recommendations are a welcome change that acknowledge the practical concerns faced by companies under the 2013 Act, attempt to align the provisions of the 2013 Act with the other recently enacted laws (such as reforms proposed under the Bankruptcy Law Reforms Committee and High Level Committee on Corporate Social Responsibility) and seek to promote “ease of doing business in India”. The public comments to the Report are awaited, which would determine the public reaction to the Report, and the extent to which these recommendations are considered by the government.
Author: Harsh Kumar and Rukmani Sheth
Harsh Kumar is a Partner and Rumani Sheth is an associate at the Delhi office of Cyril Amarchand Mangaldas
Views expressed herein are personal.