Why private companies stand at ease: Companies Act

In this final article, I deal with the remaining exemptions to private companies under the Companies Act, 2013 (“New Act”) not covered in my earlier two articles. Some restrictions that could have led to better ‘governance’ have been lifted thereby easing private companies’compliance requirements.

Restrictions to purchase and loans to directors

Section 67 under the New Act deals with restrictions on the purchase of shares by a company or providing loans by the company to purchase shares. Section 185 under the New Act restricts the issuance of loans to its directors or any person in whom the director is interested. Both have been made inapplicable to private companies that fall under the following criteria:

These sections do not hold for private companies where

• no other body corporate has invested,
• the borrowings from banks/financial institutions/body corporate is less than (the lower of) twice its paid up share capital or Rs 50 crore, and
• such a company is not in default of repaying such borrowings existing at the time of undertaking a transaction under this section.

Effectively, through the exemption, such private companies shall be allowed to purchase their own shares and also issue loans to directors.

The legislative intent has been well-reasoned in Ramaiya, the bible for corporate lawyers. The objective of Section 77 under the Companies Act, 2956 (“Old Act”) (that corresponds to Section 67 under the New Act) was to minimise trafficking if not to avoid such a purchase as that could influence the price of the shares and also lead to a reduction in the capital. This has also been espoused in Ramaiya, the leading bible on corporate law. As some know well, the capital reduction can only be effected through the routes as laid down in the Companies Act which is typically a court process. One of the main interests envisaged was to protect the interest of the public considering the money borrowed from them, as was also noted in some judgements.

For the private companies that fall in the above categories, the rationale could be very simple: they have only a handful of shareholders who are mostly related, so the restriction is not meaningful as the share price needn’t be influenced as in the case of listed entities, or

Loans to directors covered under Section 295 of the Old Act (that corresponds to S.185 under the New Act) was in any case not applicable to a private company. But as Ramaiya points out, the reason behind this prohibition to ostensible public companies is that while the director of the lending company may not be directly associated with the management of the company, the director could be the moving spirit behind it.

It may be important to note here that earlier if there was a common director for two companies, he would not be given a loan without a special resolution. However, with the exemption to private companies from Section 185, a special resolution is no longer necessary.

Acceptance of deposits

Clauses (a) to (e) of Section 73(2) have been made inapplicable to a private company that accepts a maximum of 100 per cent of aggregate of the paid-up share capital and free reserves from its members as deposits.

These clauses deal with issuance of circulars that describe the financial position of the company, and details regarding credit rating among others, filing of these circulars, and deposits and provision of deposit insurance. Regardless, such private companies will still need to file the details of the deposits accepted with the registrar, in any other specified manner.

This just appears to allow more flexibility to a private company. Considering there are normally only few persons as shareholders or members, simplifying such processes indeed makes a lot of sense.

Powers of the Board

Private companies have also been exempt from the compliance that is required under Section 180 that provides specified powers to the board of a company. For instance, this section requires a special resolution to sell/dispose of whole or part of an undertaking of the company or to borrow money etc. Private companies would no longer need a special resolution to undertake such transactions.

The rationale could be that private companies have only few members but such an exemption could prove risky considering such transactions may be undertaken without the knowledge of some shareholders.

Related party transactions

The second proviso to 188(1) is no more applicable to private companies. Before the exemption, it excluded members of a company who were a related party (as defined in the New Act) to vote for any of the transactions listed in sub-section 1 of Section 188, i.e., sale and purchase or supply of any goods and services, leasing of property of any kind, rendering of services, selling, disposing or buying of property.

However, the exemption of June 5 effectively disables this rather principled decision. What this exemption does is dilute the base of related party transactions as it has the chance to create a skewed vote on transactions.

On the other hand, suppose a company has only two members and if one of them happens to be a related party to the transaction, then the exemption could help rather than hamper. Why? This is so because the meeting would only then meet the requisite quorum (the minimum mandatory number of members that needs to be present at a meeting).

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