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Companies Act, 2013: Impact on Private Equity Investors
Sanjay K.Asher
Crawford Bayley & Co.

The pace of development in India of Company law has certainly not been as impressive since the promulgation of the Companies Act, 1956. Though the 1956 Act was amended around 25 times to meet with the requirements of modern innovative concepts of structuring of business organisations, trade and transactions, it barely could address all concerns and challenges thrown at it. At times the inordinate delay in making the amendments and enforcing them not just caused delays in enforcement of rights of investors but also made investors rethink of their investment strategies. Uncertainty in law, has always been a huge concern for private equity investors for investing in companies in India. Lack of clarity and diverse judicial interpretation of certain basic and conceptual provisions of the 1956 Act, have not favoured investments in Indian companies. Ultimately and though belatedly, at the end of August, 2013 a brand new law, called the Companies Act, 2013, was promulgated by the Parliament of India to govern incorporated entities or companies in India. The Companies Act, 2013, at least optically, tries to address various concerns which were either heavily litigated in Courts of law or which were considered to be dated and infective for investors in a Company.
It has been more than three years since the private placement issue by the two Sahara Group Companies to over 2 crore investors by way of private placement was adjudicated and first determined, the observations made by the Court whilst striking down such allotments yet are as fresh in the minds. The fact that even after more than 50 years since the 1956 Act was brought in force, the 1956 Act failed to determine the difference between a private placement and a public issue. The 2013 Act, finally answers the question by capping a limit of offer being made to 200 persons in a financial year for private placement purpose.

Enforceability of common clauses that are often seen in the modern day shareholder’s agreement which protect and are framed with a view to provide an Exit to the Investors such as Tag along rights, drag along rights, call options, put options, right of first refusal and right of firs offer, was always unclear and remained to be so under the erstwhile company law. The Companies Act, 2013 also endeavours to put to rest the controversial issue in relation to transferability restrictions (which impacts Exit Options available with the investors) imposed on shareholders of a public company. Introduction of Section 58 (2) of the Companies Act, 2013, now statutorily recognizes and permits all such transferability restrictions, as may be contractually agreed between the Investor and other shareholders in a public company as well. There is no need to incorporate any of the terms of the shareholders agreement in the articles of association of the Company. In fact it is not even necessary for the Company to be a party to the shareholders agreement or similar arrangement for the investor to enforce the transferability restrictions. The provisions of the 2013 Act therefore endeavour to provide for much greater and more effective enforcement of transferability restriction and Exit Option in Public Companies as well. In terms of other forms of Exit, one of Exit Options available to investors was Buy Back of shares. The Companies Act, 2013 provides for a cooling off period of one year between two offers of buy back. Further, Buy-Back restricted to 25% of the aggregate paid up capital and free reserves of the company in a financial year. The Investor needs to ensure that there is no possibility of any earlier Buy Back which could delay its Exit from the Company.
Akin to the concept of special rights (mainly relating to affirmatives), a new concept of Entrenchment is introduced in the Companies Act, 2013. The concept essentially means that the provisions of the Articles of Association of the Company which are identified as ‘Entrenched’ cannot be amended without the much more difficult and stringent provisions as may be contractually agreed between the investors, other shareholders and the company. It be noted that, (a) such provisions needs to be identified and informed to the Registrar of Companies, and (b) the restrictions / process to amend the entrenched provisions of the articles of association must be more stringent and restrictive than what is provided by law. This concept of entrenchment essentially gives statutory recognition to the affirmative voting rights which the investor had in relation to amendment of the articles of association of the company.
When compared to the 1956 Act, the 2013 Act does seem to be more investor friendly and pro-investor/minority shareholder, however, investors must be watchful of provisions which expose the Company to more liability that what could have been envisaged. The Companies Act, 2013 puts a Private Limited company on the same pedestal as a public company, when such private companies are subsidiaries of Public Companies. A Private Equity Investor must check the true status of the investee company as various provisions of the Companies Act, 2013 (including that of corporate governance, free transferability of shares, etc.), which otherwise wouldn’t apply to a standalone private company, by virtue of being a subsidiary of a public company may become applicable to Private Companies.
The 2013 Act also for the first time ventures into the territory of Corporate Governance. Similar to the listing agreement (of stock exchanges), the concept of Independent and Non- Independent Director appears in the 2013 Act. It is usual for private equity investors to appoint nominee directors on the Board of the company. Typically, private equity investors provide for immunity to their nominee directors from any liability or acts of the Board by designating them as independent directors. However, unlike the erstwhile Listing Agreement, Nominee Directors of Private Equity investors are no longer considered as Independent Directors under the Companies Act, 2013 and therefore the immunity granted to Independent Director under the Companies Act, 2013 shall not protect the Nominee Directors of the Investors. Especially, with the incorporation of the concept of class action suits, it is incumbent that robust procedures are kept in place to safeguard the Nominee Directors who otherwise does not participate in the day to day affairs of the Company. It therefore remains to be seen whether corporate lawyers can safeguard the interest of nominee directors and provide immunity to such directors against liability.
Though the 2013 Act in certain aspects, which mainly relate to highly litigated issues concerning Company law in India, provides clarity, however, at the same time various new concepts introduced by the 2013 Act remain unclear, doubtful and leave huge scope of interpretation and therefore judicial intervention. The newly defined terms ‘Control’ and ‘Promoter’ leave an avenue open for the equity investors to be called as Promoters of the Company by virtue of special rights available to manage or exercise control over the affairs of the Company.
As per the 2013 Act, investment is not permitted through more than two layers of investment companies. Though the incorporation of this clause aims to prevent diversion of funds through webs of complex corporate structures, the greatest blow will be felt by real estate companies. It remains to be seen as to whether in the future an exception will be carved out for genuine multi-layered corporate structures.
Finally, based on the few changes highlighted above and several other new concepts and change, the overall verdict of the 2013 Act is said to be investor friendly and pro-minority shareholder whilst at the same time it does leave lot of scope of scope interpretation especially in relation to the new concepts introduced under the 2013 Act. In order to make the 2013 Act more effective and acceptable to the Private Equity investors it is incumbent that the Government periodically reviews the performance of the 2013 Act and keeps addressing (on timely basis) the shortcomings of the 2013 Act to ensure effective implementation and greater protection to private equity players in India.

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