India changes Companies Act to make doing business easier but challenges remain

India has passed a Bill to change its Companies Act to simplify disclosure and compliance requirements in order to facilitate doing business in India and to strengthen corporate governance requirements. Important new requirements include the registration of significant beneficial interests and changes to the definition of an associate company. Lawyers in India point to ambiguities in deciding what constitutes associate relationships and beneficial interests. They also suggest areas where the Bill could be improved to help businesses by removing investment restrictions.

Origin of Bill

A call from businesses to eliminate dual or divergent requirements under different sets of legislation by harmonising company law with other regulations in India, prompted the government set up the Company Law Committee to review and recommend changes to the Companies Act. Businesses had been reporting several issues in implementing the provisions of the 2013 Act that significantly added to the cost of doing business.

Implications of register of significant beneficial interests

The Bill defines the concept of “beneficial interest in a share” for the first time in India. This is a broad and inclusive definition that recognises direct and indirect rights or entitlement of persons.

Mohit Saraf

“This concept requires identification of persons who collectively hold beneficial interests,” explains Mohit Saraf, senior partner at Luthra & Luthra. “Apart from the right to receive or participate in any dividend or distribution, the definition requires identification of any rights in shares as beneficial interests.” It legally recognises that for the same shares, there may be multiple beneficial interest holders.

The change demonstrates a paradigm shift in two legal principles under traditional corporate law. “The company law generally prevented companies from taking on record any notice of trust on register of members; and a share of a company was considered to be an integrated bundle of rights, privileges and obligations, which cannot be separated, and assigned to different persons,” says Saraf.

“The requirement of maintenance of a register of significant beneficial interests in a company will certainly bring a complete transparency about individuals, including trusts and persons not resident in India who either have significant influence or control over the company,” he adds.

While an enquiry is going on about the identification of significant beneficial interest holders, the National Company Law Tribunal may restrict transfer of the concerned shares and may also suspend all rights comprised in the shares. This is likely to be a serious deterrent for non-disclosure of real interest holders. Section 90 also imposes a heavy burden of enquiry into beneficial interest holders, which may be difficult to implement.

Definition of associate companies

The concept of “total voting power” has been brought into the definition of associate, holding and subsidiary company.

“This was presumably to ensure that only shareholders with voting rights are considered while ascertaining whether a company is an associate, holding and subsidiary company,” says Saraf.

The definition of associate company includes control of or participation in business decisions under the agreement. This will require analysis of shareholders’ agreements, which are often confidential, to determine whether a company is an associate.

Exercise of ‘significant influence’, which determines the associate company relationship, has been changed to include participation in business decisions under any agreement. “This has led to controversies relating to the ambiguity around the meaning and scope of the word ‘participation’, as the law does not provide any clarity. Companies would now be grappling with uncertainty around whether the additional compliance requirements with respect to associate companies would be applicable to them or not,” says Saraf.

Sharad Abhyankar

“Particularly, this will impact several investing companies holding much less than 20% of the voting power but having even minimal protective/participative rights,” says Sharad Abhyankar, partner at Khaitan & Co. “This issue assumes greater relevance due to the fact that the accounts of associate companies are also required to be consolidated with that of the reporting company. Also, given that ‘associate companies’ are regarded as ‘related parties’, the expansion may lead to certain other implications, which were probably not entirely intended, such as widening the ambit of related parties.”

Where are the changes lacking?

Observers point to a number of points which could have been included in the amendment to help businesses. The Bill in its original form included a proposal to remove the restriction on investments under section 186 of the Companies Act. However, the proposal was subsequently rejected, because the authorities there were the practical issues in tracing the source of funds, their ultimate use and the lack of enforcement abilities. “These governmental actions towards the drive against money laundering transactions are undoubtedly urgent and imperative,” says Abhyankar. “This move, however, has not, for apparent reasons been positively received, given that an imposition of such blanket restriction would cause severe obstruction in undertaking even the bona fide business transactions aimed at achieving efficiency.”

Saraf points out that one of the aspects which policy makers should look at again is the permissibility of providing a loan by a company to its wholly owned subsidiary. The existing law allows companies to give such loans provided that they are used by the borrowing companies for their ‘principal business activities’, which is limiting. This is particularly disadvantageous for businesses that want to expand. There is also no clarity on the meaning of ‘principal business activities’.

Businesses will need to grapple with the broadened definition of ‘associate companies’ and decide whether their relationships such as participation in business decisions of a company under an agreement would lead to associate relationships. While a definition of ‘beneficial interest’ has now been included in the Bill, it may lead to uncertainty as to the intended scope and extent of such disclosure requirement.