India: Companies Act 2013: A New Sail In LLP Regime?

Last Updated: 4 February 2015
Article by Avimukt Dar and Chitvan Bakshi


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 company.

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.

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