By Lalit Kumar

There is little doubt that the new Companies Act, 2013, which came into effect on April 1, 2014, has deserved the accolades bestowed upon it, particularly those that predict it is going to change the corporate landscape in India for the better. Conversely, however, there isequally little doubt that the Act suffers from many defects including careless drafting errors which posesignificant challenges in its implementation.

Section 2(46) of theAct defines a “holding company”to be “a company” of which other companies are subsidiaries. “A company,”is defined under this section as a company incorporated under the Act, that is to say, a company incorporated in India. . So the question arises of whether aforeign holding companythat is not incorporated in India, but hasIndian subsidiaries,is a holding company under the Act. Moreover, under the Act “related parties,”includesubsidiaries of a common holding company. If the definition of “holding company” does not include a foreign holding company then transactions between two Indian fellow-subsidiary companies of a foreign holding company will not constitute transactions between related parties. In the view of most practitioners this cannot have been the intent of the Act. Thus, poorly drafted or not, the better view of Section 2(46) is that foreign companies, which by definition are not incorporated in India, should be included within the meaning of the term “holding company” even though the section uses the words “a company” which under the section means only companies incorporated in India.

Another issue is the definition of “listed company.” Section 2(52) of the Act defines “listed company” as a company whose securities are listed on a recognised stock exchange. Unlike the old Companies Act 1956, Section 2(52) of the new Act makes no distinction between a “listed public company”and a private company whose securities (e.g., non-convertible debentures)are permitted to be listed on a special window/segment of a recognised stock exchange. There is no evidence of a legislative intent to regulate private companies as if they were public ones. Yet this would be a reasonable conclusion in light of the glaring omission of the word “public” in the definition of a “listed company,”

Next, Section 2(71) provides that a private company which is a subsidiary of a public companyshall be deemed to be public company. This provision appears to adopt similarlanguage from a judgment of Bombay High Court in Jer Rutton Kavasmanek & Anr vs Gharda Chemicals Ltd.The Act, however, is silent on whether such private company mustconvert itself into a public company or whether it can continue to function under its original articles of incorporation as a private company. Interestingly, the Jer Rutton Kavasmanekcasewas also silent on this issue.

Then there are the much discussed problems with Sections 185 and 186. Section 185 prohibits a company from giving loans to its directors and providing guarantees or securities on their behalf, including to any other person in whom the director is interested. Many practitioners believe that this language can be construed to prohibit aholding companyfrom giving loans, securities and guaranteesto its non-wholly owned subsidiarywhere both have common directors. Section 186, on the other hand, allows a holding company to give loans of a specified amount with a special resolution if the amount to be lent exceeds the thresholds prescribed.Section 185 seems to resolve the conflict between itself and Section 186 with the prefatory clause, “save as otherwise provided in this Act.” This, in effect, cedes the issue to Section 186, which does “otherwise provide.” This, in turn, makes section 185 redundant or even void, which begs the question of why Section 185 was adopted in the first place. Moreover, the Act does not define “in the ordinary course of its business”within the context of Section 185. Many transactions especially project and asset financingare structured in the ordinary course of business in a way that loans taken out by subsidiaries are secured by their parent holding companies. It can be difficult for subsidiaries to secure loans without such guarantees.The omission of a definition of “ordinary course of business” has left subsidiaries wondering whether they need to amend their articles of incorporation to include as a business purpose having their parent holding companies guarantee their loans (or even if they amend will it stand the test of law), lest regulators invalidate such guarantees as not being the ordinary course of the subsidiaries’ business.

The intention of section 194 which prohibitsforward dealings in the securities of a company by directors or key managerial personnel is still not clear and is awaiting clarification. Section 195 on insider trading in shares of private limited or unlisted public companies suffers from the same fate; it is not clear how and why prohibition on insider trading of securities will apply to such companies.

Section 233 which deals with merger or amalgamation between two or more small companies or between a holding company and its wholly-owned subsidiary company should have also provided for a demerger of a unit of a wholly-owned subsidiary from its holding company.

Section 236 which deals with the purchase of minority shares should have been better worded to leave no doubt that a squeeze out of the minority shareholders is not permitted. The language of Section 236 is ambiguous in this regard.

The language of Section 465 which provides for repeals and savings is most ambiguous and providesno clarity regarding the survival of resolutions already passed and actions already concluded and approved under the Companies Act, 1956. The ambiguous language of Section 465 is making it difficult to correctly interpret the new law.

The omissions, ambiguity and lack of clarity of the Act have also carried over to the final Rules issued by the Ministry of Corporate Affairs. For example, Rule 24 of Companies (Incorporation) Rules, 2014 requiresthat when registering and making a declaration at the time of commencing business,a company mustalso provide separate and specific approvals from sectoral regulators such as the Reserve Bank of India andthe Securities and Exchange Board of India. A copy of the registration from these regulators where such registration is required should have been sufficient.

Rule 8 of Companies (Issue of Global Depository Receipts) Rules, 2014 states that a company which has issued depository receipts prior to the commencement of these Rules shall comply with the requirements under this Rule within 6 months of such commencement. Yet the Rules fail to recognize that a company that has already issued a depository receipt can hardly remit those previously received and remitted funds into a bank account in India.

Rule 4 of Companies (Share Capital and Debentures) Rules, 2014 prohibits a company from converting its existing equity share capital withvoting rights into equity share capital carrying differential voting rights and vice–versa.
The Rule leaves unclear, however, whether the prohibition applies to convertible securities such ascompulsory convertible debentures issued prior to the effective date of the Act being converted into shares carryingdifferential voting rights after the effective date of the Act. Further, an “Explanation” at the end of Rule 4 states: “For the purposes of this rule, it is hereby clarified that differential rights attached to such shares issued by any company under the provisions of Companies Act, 1956, shall continue till such rights are converted with the differential rights in accordance with the provisions of the Companies Act, 2013.” The explanation fails to clarify how that conversion is to take place, for example,in the case of private limited companies, which were unregulated by the 1956 Act as far as the issuance of shares with differential voting rights was concerned.

Rule 13 of Companies (Share Capital and Debentures) Rules, 2014states that a preferential issue (an issue of shares or other securities, by a Company to any select person or group of persons on a preferential basis) under Section 62 has to comply with the conditions of a private placement under Section 42. It is unclear why such provision is made and making fund raising extremely challenging for companies.

Rule 13(1)(ii) of Companies (Share Capital and Debentures) Rules, 2014defines “shares or other securities” to mean equity shares, fully convertible debentures, partly convertible debentures or any other securities, that can be convertible into or exchanged with equity shares at a later date. It is unclear whether this rule covers loansfor which no securities are issued, but which, under the financing agreement, may be converted equity after a period of time.

Rule 13(2)(h) of Companies (Share Capital and Debentures) Rules, 2014 states that with respect to convertible securities offered on a preferential basis, with an option to apply for and get equity shares allotted, the price of the resultant shares must be determined beforehand on the basis of a valuation report of a registered appraiser. But the rule sets forth no formula by which that valuation is to be made. The Foreign Exchange Management Act and Foreign Direct Investment rules permit a pricing formula in this regard with a condition that pricing at the time of conversion will not be less than at the time of issue.Asimilar provision should be provided here for convertible securities offered on a preferential basis with an option to convert to equity shares. The rule also unreasonablyrequires compliance with Section 42 of the Act under which securities must be allottedwithin 60 days of receipt of the application money. Here again, the FEMA and FDI rules provide guidance in that they permit allocation within 180 days.

Rule 18(1)(b) of Companies (Share Capital and Debentures) Rules, 2014states that secured debentures shall be secured by creation of a charge on the properties or assets of the company. It is unclear whether this prohibits a parent company of the borrower company from providing security on the parent company’s properties and assets. Such a prohibition will adversely affect the financing transactions by subsidiary companies.

“The way the Companies Act, 2013 was drafted has led, whether intentionally or not, to provisions that are ambiguous and even contradictory. This is a very sorry state of affairs, particularly when so much has hinged on this new law. The new Act is an exemplary example of great intentions being badly translated into words and awfully implemented by the Ministry of Corporate Affairs (MCA). The devil of excessive delegation through rule making power is evident from many rules where the MCA has overstepped its power and made provisions contrary to the Companies Act, 2013. It is quite an unfortunate situation. Another very odd element of the new Act is its phased implementation resulting in huge confusion and uncertainty. With all this, one cannot say with certainty today – what is the corporate law of India?

It will require some time not only on the part of the MCA but the judiciary as well to sort through the drafting omissions, errors and ambiguities to finally give a clear and cogent voice to Parliament’s intention to enact the most significant statute in the field of company law in India in over half-a-century.”

Lalit Kumar is a partner at the Indian law firm J. Sagar Associates and is based in Delhi National Capital Region, India. He specialises in M&A transactions and is also an acknowledged expert in company law matters. His views expressed above are personal and not of the firm. He can be reached at lalit@jsalaw.com.