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The application of company law and the problems in foreign-invested enterprises

July 01, 2021
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This article is written by Pranav Sethi, from SVKM NMIMS School of law, Navi Mumbai. This article analyzes the application of Company Law and the problems in foreign-invested enterprises.

Introduction 

“Great companies start because the founders want to change the world not make a fast buck” 

– Guy Kawasaki

The word ‘company’ denotes a group of people working together to achieve a common goal. In reality, there are a variety of reasons why people may want to associate. However, under the Companies Act, 2013, the word ‘company’ usually refers to partnerships formed for economic purposes, such as carrying on a business.

A company is a legal term used to refer to a business that is established or licensed under the ‘Companies Act, 2013′ or any other company legislation. The rule, in its legal context, generates an artificial entity, a corporation. It has a meaning that is distinct from that of its members.

As a result, like any other ordinary human being, this artificial legal person:

Companies come in the form of categories such as:

In the above form of categories of companies, the three forms of businesses are all private. This indicates that they are a private corporation, as opposed to a ‘public limited company.’ 

A private corporation that is originally classified as a private company can be changed to a public company. Conversion may take place by choice, default, or by operation of law. The legal identity of a corporation is not affected by a company’s conversion.

Meaning of private limited company

According to Section 2(68) of the Companies Act, 2013, a ‘private company’ is defined as a corporation with a minimum paid-up share capital of one lakh rupees or other such higher paid-up share capital as may be recommended and by its articles.

These are some characteristics that set private corporations apart from other forms of businesses:

(a) restricts the right to transfer its share;

(b) limits the number of its members to two hundred; and

(c) prohibits any invitations to the public to subscribe for any shares in, or debentures of, the company.

However, following a 2015 amendment to the Companies Act, all forms of businesses are exempt from the minimum capital provision.

Restriction on the right of members to transfer their shares

A clause limiting the ability of shareholders to change their shares must be included in the Articles of Association (AoA) of a private corporation. This suggests that private shares in the company are not as freely transferable as public company shares. However, this does not rule out the possibility of transferring a private company’s stock. Furthermore, the AoA mandates that if a member of a private company wishes to sell his or her shares, he or she must give them to the current members at a price agreed by the directors.

The maximum number of members is limited

A private limited company must also keep its membership to a maximum of two hundred people. It means that a private corporation may have from two to two hundred members depending upon the work culture & deals that they are working upon.

The following are not to be counted when calculating the number of members:

  1. Persons who are employed by the company and are members of the company as a result of their jobs, and
  2. Persons who were members of the company when employed by the company and proceeded to be members after the employment ended.

To calculate the number of members, two or more individuals who jointly own one or more shares of the company are counted as a single member.

Public invitations are strictly prohibited

This means that a private limited company cannot issue a financial statement or any other public invitation to the general public, either directly or indirectly, inviting them to invest in its securities or debentures.

Any segment of the public can be included in the public, whether they be shareholders of the corporation or debenture holders, or customers of the individual issuing the prospectus, or in any other way.

In simple terms, it implies that a private corporation cannot invite the general public to an event. To collect funds, it must make its private agreement.

Application of the company law to insurance, banking, and other specially regulated areas 

Companies Act, 2013 applies to all types of businesses that are regulated by Special Acts of Parliament, such as banking, insurance, and companies that provide electricity, as long as there are no inconsistencies.

Though Section 1(4) of the Companies Act is concerned with the requirements relating to the application of Company law to various sectors, some aspects relating to financial statements, loans and investments, deposit acceptance, and so on do not apply to certain sectors because they are governed by the principle legislation that governs them.

The Companies Act, 2013 states in Section 1(4) that the provisions of the Act refer to-

  1. Corporations formed under such an Act or any preceding company law;
  2. Insurance companies, except to the extent that the above provisions conflict with the Insurance Act, 1938 or the Insurance Regulatory and Development Authority Act, 1999
  3. Banking firms, except to the extent that the regulations conflict with the Banking Regulation Act, 1949;
  4. Companies involved in the production or generation of power, except to the extent that the foregoing provisions conflict with the Electricity Act, 2003;
  5. Any other corporation controlled by any special Act in effect at the time, except to the extent that the said provisions conflict with certain special Act’s provisions; and
  6. Such body corporate, formed under any Act in effect at the time, as the Central Government may decide in this regard by regulation, subject to any deviations, amendments, or adaptations stated in the confirmation.

Drawbacks provided for different industries within the Companies Act, 2013

The parts of the Companies Act, 2013 that exclude those industries from the application of that provision are mentioned below.

Financial support for the acquisition of shares under Section 67(3)

Section 67(2) states that no public corporation shall provide financial assistance to any people for the intent of, or following, a purchase or arrangement made or to be made, by any person of or for any shares in the company or its holding company, whether directly or indirectly and whether by way of a loan, guarantee, the provision of security, or otherwise.

Nothing in Section 67 (2) applies to a financial firm lending money in the ordinary course of business, according to Section 67(3).

Prohibition on accepting deposits from the public  proviso to Section 73(1)

Section 73(1) states that “no company shall invite, accept, or renew deposits under this Act from the public except in the manner given under this chapter on and after the commencement of this Act.”

Nothing in Section 73(1) applies to a banking company or a non-banking financial company as specified in the Reserve Bank of India Act, 1934, or to any other company that the Central Government can specify in this regard after consultation with the Reserve Bank of India.

Financial statements proviso to Section 129(1)

The financial statements must provide an accurate and reasonable view of the company or companies’ financial situation, comply with the accounting requirements notified under Section 133, and be in the form or forms as may be given for various groups or classes of companies in Schedule III, according to Section 129(1).

Nothing in Section 129(1) applies to any insurance or banking firm, any company involved in the production or generation of power, or any other class of company for which a type of budgetary reporting has been defined in or under the Act regulating such a type of company, according to the provisions of the section. Furthermore, the financial statements shall not be regarded as not revealing an accurate and reasonable view of the company’s state of affairs solely because they do not reveal such information:- 

  1. Any issues not needed to be reported by the Insurance Act of 1938 or the Insurance Regulatory and Development Authority Act of 1999 in the case of an insurance company;
  2. Any matters that are not expected to be reported by the Banking Regulation Act, 1949 in the case of a banking company;
  3. Any matters not required to be reported by the Electricity Act, 2003 in the case of a company involved in the production or supply of electricity;
  4. Any issues that are not expected to be disclosed by any other legislation currently in effect in the case of a corporation regulated by that law.

Issues in foreign investment enterprises

The Indian economy has shifted progressively from a restrictive to a liberal system as a result of numerous policy initiatives. The current legal structure makes it simple for a foreign investor to enter India.

The liberalization of India’s foreign investment policy began in 1991, and successive governments have steadily liberalized it since then. Some of the key factors that have served as major catalysts in attracting foreign investments include deregulation, privatization, and the relaxing of restrictions on foreign investments and acquisitions. India is now implementing second-generation reforms to deepen and speed up the country’s economic integration with the global economy.

According to the United Nations Conference on Trade and Development (UNCTAD), India was ranked third for global Foreign Direct Investments (FDI) in 2009, following the economic meltdown, and would continue to be among the top five attractive destinations for international investors over the next two years, according to a new report on world investment prospects titled, “World Investment Prospects Survey 2009-2011”.

Issues regarding FDI in India

FDI is allowed through the following investment types:

In India, FDI is openly permitted in all sectors, such as the service sector, except for a few sectors where the current and notified sectoral policy prohibits FDI beyond a certain limit. For the most part, FDI can be brought in via the automatic route, using the RBI’s powers, and for the cases mentioned, as explained below, through government approval.

Foreign investment of up to 100 percent is allowed under current rules almost in all business sectors. Only a few industry sectors still allow no or restricted FDI – these are typically ‘sensitive’ sectors, such as defence or telecommunications, or agriculture, retail, real estate, finance, and insurance, which are prohibited for security or political reasons. Furthermore, the government has been streamlining procedural aspects such as the FDI approval process.

Barriers and recommendation

The following FDI barriers in India have been listed by the Asian Development Bank:

  1. Bottlenecks in the networks
  2. Characteristics of India’s labour laws
  3. Land and environmental clearances for industrial production are difficult to come by

The three major obstacles for foreign investors, according to a survey conducted by FICCI (2010), are bureaucratic delays, the tax regime, and labour laws. The following are some of the survey’s recommendations to the government:

The resource challenge  

India is renowned for its vast resources. Manpower is available, as is a considerable amount of fixed and working capital. At the same time, certain services are underutilized or unutilized. Both rural and urban areas have plenty of money. The emphasis is on expanding infrastructure over the next ten years, with a budget of around US$ 150 billion required. This is the first step toward overcoming the difficulties that larger FDI faces.

Political obstacle 

The political system must assist the foreign funding countries. This can be determined as foreign investors present their case for increased FDI capital in numerous sectors such as banking and insurance. As a result, the Parliament and foreign countries investing in India must find a common ground. This will accelerate changes in the country’s FDI sector.

Federal obstacle

The need to accelerate the adoption of policies, laws, and regulations is one of the most significant challenges facing larger FDI. The most important aspect is to ensure that policies are implemented consistently across India’s states. As a result, it is important to demand that all Indian states adopt policies at the same time.

Case laws

The most significant Takeover Regulations and Companies Act, 1956 (“Companies Act”) decisions from 2010 are summarised below.

Subhkam Ventures v. Securities and Exchange Board of India (SEBI)

In this case of takeover regulations, the Subhkam Ventures case altered the legal regime for rights related to public company investments. In that case, private equity investor Subhkam Ventures appealed a SEBI order to make an open offer because Subhkam’s purchase of 15% of MSK Projects, Ltd. gave it a veto right in MSK Projects the need for an open offer under Regulation 10 of the Takeover Regulations. Subhkam argued that the company was merely a financial investor and that acquiring a larger stake would not result in a change in control under Regulation 12 of the Takeover Regulations. SEBI dismissed Subhkam’s contention and asked the company to amend its offer document to comply with the Takeover Regulations.

Subhkam took his case to the Securities Appellate Tribunal (“SAT”), which looked at the difference between ‘positive control’ and ‘negative control’, concluding that the Takeover Regulations only protected “positive control.” The SAT determined that the right to nominate a nominee director, standstill clauses and protective rights granted to the company were not equivalent to owning or exercising power, after considering the substantive rights available to the company. The case has been appealed to the Supreme Court of India by SEBI. The SEBI Takeover Regulations would be affected by the Supreme Court’s ruling.

W. Maharashtra Dev. Corp. v. Bajaj Auto Ltd.

Western Maharashtra Development Corporation (WMDC) is a public-private partnership based in Mumbai, Maharashtra. “The Bombay High Court held in the WMDC” case that “a limitation on the transferability of shares in a private company must be contrasted with cases involving public corporations, where the law provides for free transferability.” It was also stated that “In the case of shares of a public company, free transferability of shares is the norm,” and that the rules under Section 111A of the Companies Act are based on the principles that the public must have the freedom to buy and shareholders must have the freedom to transfer shares of a public company.

In a case involving the constitutionality of preemption clauses and their incorporation into a public company’s charter documents, the Bombay High Court ruled that any provision in the memorandum, papers, agreement, or resolution that seeks to limit a shareholder’s right to transfer shares is invalid. The court’s decision raises serious questions about the enforceability of transfer limits on public company shares (including pre-emption rights), whether or not they are included in the charter documents, as well as how joint ventures and public M&A transactions will be organized in India.

Conclusion 

The current Companies Act, 2013 aims to strengthen the regulatory apparatus by establishing ‘vigil systems’ within businesses. Certain unique grey areas, however, continue to pose a challenge to implementation. The Act, it is believed, has brought in significant and desirable changes in company law. This transition, however, cannot be said to be complete. Furthermore, once the act is fully applied in the Indian sense, new areas for change will arise.

Foreign Direct Investment (FDI) plays an increasingly important role in the advancement of technology, expertise, and managerial capabilities. The contribution of FDI to economic growth is a significant influence. FDI has a significant impact on a country’s trade balance, raising labour standards and skills, transferring technology, and generating innovative ideas. Additional investments made with domestic resources help to create much-needed job opportunities. India needs Foreign Direct Investment (FDI) as a strategic component of investment for economic growth and development through job creation, expansion of existing manufacturing industries, and short and long-term capital investment.

References


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