Companies Act, 2013: Decoding Challenges faced by Foreign Companies – Part I

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Companies Act, 2013: Decoding Challenges faced by Foreign Companies – Part I

Amitava Banerjee | April 2014

THE introduction of the Companies Act, 2013, has altered the landscape of corporate regulation in India. From April 1, vital sections of the new company law have been made effective. The Ministry of Corporate Affairs (MCA) recently released a set of draft rules related to certain provisions in the Act. It also notified 98 more sections from the Act.

With so much focus on the new law and very little time for corporate to understand the ramifications of the details in the final rules, it becomes pertinent to analyze the impact of the Act with focus on some of its critical aspects.

This article is the first part in the series of two to critically examine differing facets of the Act including incorporation of a subsidiary, status of an Indian subsidiary of a foreign company i.e. whether they are public or private companies under the law, management structuring and borrowings, among others.

The present article looks into two aspects — incorporation of a subsidiary and status of an Indian subsidiary of a foreign company within the Act.

THE INCORPORATION BLUES

Incorporating a company as subsidiary of a foreign company will now require planning and adherence to certain aspects of the new Act, which inter alia include:

No previous convictions: Section 7(1) (c) of the Act requires an affidavit from the subscribers of the memorandum and first directors stating that they have not been convicted of any offence in connection with the promotion, formation or management of any company. Besides, they should state they have not been found guilty of any fraud or misfeasance or of any breach of duty to any company under the Act or any previous company law during the preceding five years.
A resident director: Under the Companies Act 1956, it was possible to have a company with only foreign/non resident directors. However, Section 149 (3) of the 2013 Act makes it mandatory for every company to have a director who has stayed in India for a total period of at least 182 days in the previous calendar year. Therefore, a foreign owned subsidiary will be under an obligation to have at least one such director at the time of incorporation itself.
Going beyond physical presence: As regards foreign entities undertaking business in India, the 2013 Act contains much more expansive provisions as compared to the 1956 Act. The government hereby intends to regulate all foreign entities that carry out business in India by establishing a place of business or virtual presence either through electronic mode or an agent. The current provisions are extremely broad and can cover within their ambit unintended foreign entities like foreign limited liability partnerships incorporated outside India. This is because the 1956 Act did not refer to a ‘body corporate’ in Section 591 while defining the classes of companies to which the 1956 Act applied, thereby making it inapplicable for foreign limited liability partnerships. Further the draft rules state that for the purposes of clause (42) of Section 2 of the Act , the phrase ‘electronic mode’ means carrying out business electronically including, but not limited to:-

Business-to-business and business-to consumer transactions, data interchange and other digital supply transactions;
Offering to accept deposits or subscriptions in India or from citizens of India;
Financial settlements, web-based marketing, advisory and transactional services database services and products, supply chain management;
Online services such as telemarketing, telecommuting, telemedicine, education and information research; and
All related data communication services, whether conducted by e-mail, mobile devices, social media, cloud computing, document management, voice or data transmission or otherwise.

However, it is unclear as to what kind of agency relationship in India or what type of presence in India through electronic mode will constitute a place of business as the list in the draft rules is not exhaustive. These provisions can come into play when a foreign entity appoints a service provider who, in the performance of its services, acts as an agent of such a foreign entity. For instance, shipping/airline companies that operate through their booking agents in India can be subject to the above provisions.
Body corporate/LLP being subscriber to memorandum: Draft rule 2.10 provides that “where the subscriber to the memorandum is a body corporate, the memorandum and articles of association shall be signed by director, officer or employee of the body corporate duly authorized in this behalf by a resolution of the board of directors of the body corporate and where the subscriber is a Limited Liability Partnership, it shall be signed by a partner of the Limited Liability Partnership, duly authorized by a resolution approved by all the partners of the Limited Liability Partnership, provided that in either case, the person so authorized shall not, at the same time, be a subscriber to the memorandum and articles of Association”. The phrase “provided that in either case, the person so authorized shall not, at the same time, be a subscriber to the memorandum and articles of Association” is confusing as the literal meaning is that two officials will have to be authorized, one for signing the MOA and other for AOA. What seems to be the prudence behind such provision is not clear.

“The current provisions are extremely broad and can cover within their ambit unintended foreign entities like foreign limited liability partnerships incorporated outside India. This is because the 1956 Act did not refer to a ‘body corporate’ in Section 591 while defining the classes of companies to which the 1956 Act applied, thereby making it inapplicable for foreign limited liability partnerships”

WILL A FOREIGN COMPANY HAVE THE LIBERTY TO OPERATE AS PRIVATE COMPANY?

Since the enactment of the Companies Act 2013, several issues related to its interpretation have been coming up for consideration. One such issue is — whether an Indian private company which is a subsidiary of a foreign public company can continue with its status of a private company or whether it would become a public company by virtue of becoming a subsidiary of another public company.

In the past, foreign companies mostly operated in India by opening their subsidiaries which enjoyed the status and privileges of a private company. However, with the passage of the Companies Act, 2013, the position of an Indian subsidiary of a foreign company has been significantly altered. A comparative reading of the 1956 Act and the 2013 Act brings out the differences in details:

Companies Act, 1956

Section 4 (7) stated that a private company, being a subsidiary of a body corporate incorporated outside India, which, if incorporated in India, would be a public company within the meaning of this Act, shall be deemed for the purposes of this Act to be a subsidiary of a public company if the entire share capital in that private company is not held by that body corporate whether alone or together with one or more other bodies corporate incorporated outside India. This implied that the subsidiary would continue to remain a private company if the foreign holding body corporate, alone held or in conjugation with other foreign body corporate held the entire share capital of the subsidiary.

Companies Act, 2013

There is no corresponding provision with respect to Section 4 (7) and as per clarification by the MCA vide general circular No. 16/2013, the entire Section 4 stands repealed w.e.f 12th September, 2013.

This means the government has taken its stand on defining all combinations under the Holding and Subsidiary route as of now. Further Section 2 (71) defines a “Public company” to mean a company which—

is not a private company;
Has a minimum paid-up share capital of five lakh rupees or such higher paid-up capital, as may be prescribed:

Provided that a company which is a subsidiary of a company, not being a private company, shall be deemed to be public company for the purposes of this Act even where such subsidiary company continues to be a private company in its articles.

Section 2 (87) defines a “subsidiary company” or “subsidiary”, in relation to any other company (that is to say the holding company), as a company in which the holding company….

Explanation.—For the purposes of this clause,—

the expression “company” includes any body corporate.

Since a foreign company is not a company under the 2013 Act (it is a body corporate), the proviso to Section 2 (71) is clearly applicable to foreign companies making all private companies which are subsidiaries of foreign public companies to be treated as public companies for all compliances under the 2013 Act even though it may retain the basic characteristics enumerated in Section 2 (68) of the 2013 Act in its articles of association.

To further complicate matters the definition of a “foreign company” as in Section 2 (42) has not been made effective under the new Act, therefore provisions applicable under the 1956 Act to foreign companies are still in effect. In such a situation, it is unclear whether one would need to look at the 1956 Act for the definition of “foreign company” and apply this to the new law.

DOUBLE JEOPARDY FOR FOREIGN COMPANIES

A foreign entity which by virtue of the above discussed scenario is already in a dilemma is given no respite under the sections dedicated to foreign companies. The reason can be better analyzed if a comparison of the 1956 and 2013 Acts is made, as below:

Companies Act, 1956

Section 591 (2) provides that “notwithstanding anything contained in sub-section (1), where not less than fifty per cent of the paid-up share capital (whether equity or preference or partly equity and partly preference) of a company incorporated outside India and having an established place of business in India, is held by one or more citizens of India or by one or more bodies corporate incorporated in India, or by one or more citizens of India and one or more bodies corporate incorporated in India, whether singly or in the aggregate, such company shall comply with such of the provisions of this Act asmay be prescribed with regard to the business carried on by it in India, as if it were a company incorporated in India”.

Companies Act, 2013

Section 379 provides “Where not less than fifty per cent of the paid-up share capital, whether equity or preference or partly equity and partly preference, of a foreign company is held by one or more citizens of India or by one or more companies or bodies corporate incorporated in India, or by one or more citizens of India and one or more companies or bodies corporate incorporated in India, whether singly or in the aggregate, such company shall comply with the provisions of this Chapter and such other provisions of this Act as may be prescribed with regard to the business carried on by it in India as if it were a company incorporated in India”.

Therefore, it can be seen that certain provisions apply to foreign companies as if they were companies incorporated in India, based on shareholding just like the 1956 Act. What is noteworthy, however, is that the 2013 Act explicitly states that the same company will also have to comply with provisions of Chapter XXII additionally.

This will mean that such entities will have to undertake prescribed compliances of an Indian Public Company and be further subject to other provisions of Chapter XXII in this regard, including seeking registration with the RoC, maintaining books of account, submitting audited accounts periodically, registration of charges, investigations, etc., as applicable.

There seems to be some anomaly in prescribing the compliance regime too. How can an entity be following two sets of standards for compliance, one made for entities incorporated in India and simultaneously with those for companies incorporated outside India?

About Author

Amitava Banerjee

Amitava is a member of ICSI and former Deputy Director, Corporate Governance, CII.