Exemptions to private companies -- Sections 43 and 47

My earlier article dealt with procedural exemptions to private companies in the Companies Act, 2013. In this article, I deal with the exemptions relating to Sections 43 and 47.

Non-applicability of Sections 43 and 47

Section 43 deals with the kinds of share capital. The section provides for the different types of share capital and for preference shareholders’ rights during the winding up of the company.

Section 43 has to be read in conjunction with the corresponding rules, specifically, Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014, which deals with equity shares with differential rights.

Among others, the rule provides for certain pre-requisites for issuing shares with differential voting rights, such as that the company should have (i) a consistent track record of distributable profits for the last three years, (ii) not defaulted on dividend payments to preference shareholders or any term loan repayment to a public financial institution among others, and (iii) not been penalized in the last three years by a court, a tribunal, the RBI, the SEBI or any of the other specified sectoral regulators.

The exemption notification provides that this section shall not apply to a private company where its Articles of Association (AoA) provide that this section is inapplicable.

The simplest interpretation of this exemption could be that none of the pre-requisites for the issue of shares with differential voting rights need apply to a private company. So technically, a private company which has defaulted on dividend payments to preference shareholders is allowed to issue equity shares with differential rights.

Further, the AoA could also provide that preference shareholders need not have any right to participate if the company is being wound up. While this is theoretically possible, it would be commercially unviable for a preference shareholder to subscribe to preference shares that do not have priority in winding up.

Section 47deals with the voting rights, and provides that every member having an equity share has the right to vote in proportion to his share. I urge the reader to please read these sections to have a better understanding of the provisions. Exempting private companies could mean that an equity shareholder need not have the right to vote at all, or a vote that is not in proportion to his shareholding.

In many venture capital and private equity investments, investors hold a higher number of preference shares and a smaller portion of the equity shares. In a round of funding by investor/s, the AoA can be amended to state that the investors can have a greater voting right for important matters of the company. Of course, in any case, all the important matters are already covered as ‘an affirmative vote item’ in most cases. (Affirmative vote items are items over which the investors have a definite vote without which the company cannot proceed, for example any merger or acquisition, or any purchase of property over a certain threshold, etc. can only be effected with the approval of the investor.)

The extent to which the new Act coincides with the Companies Act, 1956, post the introduction of these exemptions is quite clear.