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More Exemptions For Private Companies?

Published on Tue, Jul 15,2014 | 21:13, Updated at Tue, Jul 15 at 21:13Source : Moneycontrol.com 

By: Vinod Kothari, CEO, Vinod Kothari & Co

The final text of the notification exempting private companies from provisions of the Companies Act 2013 is a mix of pleasure and pains for private companies. While the scope of exemptions to private companies has considerably been enhanced in certain cases, in case of related party transactions, the law will continue to regulate private companies.

The draft notification was placed in the Parliament on the 14th July 2014. (this draft notification can be viewed here - http://www.companiesact.in/PGInformation/NewsDetailsInfor.aspx?545 )

The earlier draft was placed by the MCA for public comments on 24th June 2014 - http://www.mca.gov.in/Ministry/pdf/Draft_Notification_24062014_1.pdf

The notification, required to be placed in both the houses of the Parliament in terms of sec 462 (2), will be kept with the Parliament for a period of 30 days before it will be notified finally. If neither House of the Parliament objects to the notification, the notification will be final.

There are proposed exemptions in case of government companies, Sec 8 companies (not for profit companies) and Nidhi companies, which also, likewise, will be notified soon after the required period of Parliamentary notification is over.

Compliance burden reduced - Filing of board resolutions waived for private companies
One of the major relaxations will be that private companies will not be required to file board resolutions. There were 19 items of board resolutions, required to be filed under sec 117 (3) read with sec 179 (3).

The draft notification now proposes to fully exempt private companies from sec. 117 (3)(g), consequent to which private companies will not  be required to file MGT 14 pursuant to board meetings. The MGT 14 filing was seen as a major new compliance burden created by the 2013 Act. This requirement will now be waived off in case of all private companies.

As a result, the law is now the same as it was under the 1956 regime in case of private companies – only special resolutions and certain agreements will require filing.

Relaxation withdrawn in case of Related party transactions
There is a major stepping back of exemption pertaining to related party transactions (RPTs). The draft notification had proposed a full exemption to private companies from sec 188 pertaining to RPTs.

The final text now restores restrictions on RPTs in case of private companies, with the following riders:
(a)   One of the special features of general meeting approval in case of RPTs is that the resolution has to be approved by a vote of the minority only. Related parties are not allowed to vote on such resolution. This provision has been taken off in case of private companies.

(b)  Another relaxation is that in the definition of “related parties” in sec. 2 (76), holding-subsidiary relationships, and investor-associate relationships have been excluded from related party relationships.

The net result of these changes will be as follows:
(a)   It is most commonplace practice in case of private companies to enter into RPTs. Private companies cannot be dealing with parties at arms-length, as it is sheer commonsense to say that private companies deal with parties close to them, rather than those who are miles away.

(b)  Most transactions by or between private companies will still come under the ambit of sec. 188 since most of these transactions are covered by the “common director” or “common shareholder” clause of sec. 2 (76), and not by holding-subsidiary or investor-associate relationships.

(c)   Once a transactions comes u/s 188, it will require board and general meeting approval, if the company size/transaction size thresholds are crossed. The company size threshold under sec 188 is paid up capital of Rs 10 crores, which is quite easily crossed in case of larger private companies. Even this trigger is not crossed, RPTs may come under the section due to the relative contract value.

(d)  Hence, most RPTs will require prior general meeting resolution. The only saver is that in such a general meeting, even related parties may vote. Thus, getting the sanction of the general meeting may not be a problem, but the section will remain a sheer compliance burden on private companies.

Yet another related exemption is sec 184 (2). This section provides that the directors of a private company will refrain from participating in a board meeting where a matter in which they are interested is to be discussed. This is absolutely counter-intuitive in case of private companies, which actually do not have any independent directors, and therefore, it is unexpected that there will be any director who is uninterested in the matter. The original draft of the notification did not provide an exemption from sec 184 (2) – the final text does provide the exemption.

However, curiously, one of the most burdensome disclosures in case of private companies – disclosures by all directors about their shareholdings, and every time there is a change therein – still remains intact. This is sec. 184 (1).

Loans by private companies
The partial exemption as proposed in the draft notification from sec 185 continues almost the same in the final text of the notification. On the contrary, the conditions have only been intensified. As the revised conditions stay, a private company will be prohibited from giving any loans to directors or other companies in which there are common shareholdings or common directorships, unless the lending company satisfies each of the following conditions:

(a)   There is no body corporate shareholder in the lending company;

(b)  The lending company’s aggregate borrowings from other bodies corporate or banks or financial institutions is limited to lower of (i) 2X net worth of company; or (ii) Rs 50 crores

(c)   There is no pending default in repayment of borrowings by the lending company.

It may be noted that the  restriction on lending by private companies was not there under the Companies Act 1956. The underlying argument was simple – since a private company is essentially a pool of private capital, there cannot be a regulatory reason as to why a private company cannot lend to other entities in which directors have interest. After all, if private companies do not lend to their own entities, where else will they lend? Disregarding the economic rationale of the argument, sec. 185 imposes a full restriction on lending by private companies to their directors, or other companies where directors are directors or members. Common shareholding or common directorship is the most common occurrence in groups of private companies.

Deposits from members
The proposed exemption to private companies for accepting loans/deposits from their shareholders, upto a limit of 100% of net worth, finds its place in the final notification.

It is notable that shareholders’ loans in case of private companies were exempted from the purview of deposit restrictions under the Companies Act 1956. The Deposit Rules under the new Act brought that restriction, purportedly owing to deposit scams in the Eastern region.

As it stands in the final text of the notification, a private company may accept deposits from its shareholders, upto a limit of 100% of its net worth. This is, of course, subject to a filing requirement.

Note that a violation of sec. 73 and 74 attracts major penal consequences, with imprisonment upto 7 years and a fine upto Rs 10 crores. The offence is non-compoundable.

Limit on company audits
The limit of 20 on company audits will now exclude all small companies, and private companies having a paid up share capital of less than Rs 100 crores. In the original draft of the notification, private companies were completely excluded from the limit.

Note that the so-called “small company” may be far from small, as the law requires either of the two qualifying criteria to be satisfied to be treated as a small  company – paid up capital upto Rs 50 lacs, or turnover upto Rs 2 crores.

 
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