The Companies Act 2013 has shaken the way business was conducted
in India. The governance ecosystem of the Companies Act, 1956
("Old Act"), with its laissez
faire approach to privately held companies, is now history.
The Companies Act, 2013 is driven by three key objectives: Firstly,
to make the law modular and reduce the need to send amendments to
Parliament; to this end, the Ministry of Company Affairs
("MCA") has been empowered not only to
clarify the law but also to make detailed provisions by way of
rules in order to amplify and give effect to most of the sections.
Secondly, to avoid scams such as Satyam and 2G that have rocked the
country in the recent past, principles of related party
transactions, raising of capital and directors' liability have
been restated considerably. Thirdly, there is a strong push for
shareholder democracy and this has been applied with a broad brush,
regardless of the nature and size of the company.
Each of these drivers has led to anxiety amongst the business
community. A modular law, while good in concept, places heavy
responsibility on the MCA to address business interests while at
the same time respect the company law jurisprudence which has
evolved over decades. Delegated legislation carries a significant
uncertainty risk of roll backs and aggressive interpretation of the
provisions of the statute by the Ministry. Increasing compliances,
with an emphasis on disclosures have made the way companies
function in India vulnerable. This major corporate reform
necessitates dusting off the Limited Liability Partnership Act 2008
("LLP Act"). It has been seven years
since the dawn of the LLP Act, but we have very few Limited
Liability Partnerships ("LLPs")
registered in India.
There are several reasons for the slow adoption of LLPs. When
the LLP Act was introduced, the concept of taxation of LLPs was
still hazy. Moreover, another significant discomfort about LLP was
prohibition of Foreign Direct Investment
("FDI") under the automatic route.
Nonetheless, with the advent of the Companies Act 2013
("New Act") and increased burden of
restrictions and compliances, a gradual rise in the number of LLPs
may not come as a surprise. The LLP structure's advantages of
flexible governance coupled with limited liability have now been
strengthened by its recognition as a pass through entity for tax
purposes and its recognition as an FDI entity.
Company vs. LLP
Equity funding and sharing has become the preferred route for
entrepreneurs aiming to execute their business plans and the
difference between an LLP and a Company is nowhere more evident
than here. Prior to the coming into force of the New Act, the most
common method of equity funding in private companies was the
preferential allotment route. A preferential allotment is
understood to mean an issue of shares to persons, other than to the
existing shareholders. Under the Old Act, a private company was
only required to pass a board resolution in order to raise capital.
However, under Section 62 (1)(c) of the New Act and Rule 13 of the
Companies (Share Capital and Debentures) Rules, 2014, a company can
issue shares by way of preferential allotment by obtaining approval
of three fourth of its shareholders in general meeting. Rule 13
also states that issue on preferential basis should also comply
with conditions laid down in Section 42 of the New Act. This is
interpreted to mean that any preferential issue, even if to a
single investor, is required to comply with the provisions
applicable to a private placement. A key condition to a private
placement under Section 42 is the compulsory filing with the
Registrar of Companies ("ROC") of
sensitive disclosures such as details of any litigation, related
party contracts, any inquiry, inspections, investigations
initiated, etc. This substantially increases the compliance and
litigation risk of companies wishing to issue shares to private
investors. To further add to the lengthy compliance procedure, a
valuation certificate by a registered valuer is mandatory to decide
the price for preferential allotment of shares by a private
On the other hand, contribution to the capital of an LLP is
fairly simple and can be done through executing an agreement
providing particulars of new partners and their contribution to the
LLP. Accordingly, the existing partners need to revise the LLP
agreement and register the amendment due to admission of a new
partner. Moreover, concepts such as sweat equity, employee options
and contributions other than cash are fairly
straight forward since the principles of partnership follow the
common law maxim of consensus ad idem. Indeed, the
partners are free to agree to a procedure for induction of a new
partner and the manner of governance of the firm.
* Avimukt Dar, Partner and Chitvan Bakshi, Associate.
The views expressed in this article are the personal views of the
authors and do not reflect the views of the Firm.
The Ministry of Corporate Affairs notified on June 5, 2015 that certain provisions of the Companies Act, 2013 shall not apply to private limited companies or shall apply with such exceptions or modifications as directed in the notification.
Whilst trade and barter have existed since early times, the modern practice of forming business relationships through the means of contract has come into existence only since the industrial revolution in the West.
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