The Companies Act, 2013 (“2013 Act”) was enacted to replace the Companies Act, 1956, with one of its primary objectives being to lighten the compliance burden on businesses in India. Since its enforcement in April 2014, many sections of the 2013 Act have already undergone amendment and several exemptions have been granted by the Ministry of Corporate Affairs (“MCA”) to private companies, with the intention of reducing procedural requirements.

Despite the positive responses to this recent slew of reforms, the industry has called for further amendments to several provisions of the 2013 Act. In this blog, I would like to discuss some compliance ambiguities of the 2013 Act, which do not deter investment transactions but can cause drawn-out discussions on the correct corporate actions to be taken for deal closings.

1. Conversion of preference shares

Typically, private equity / venture capital investors are allotted convertible preference shares in the target company, which are convertible into equity shares upon the occurrence of certain specified events. The reason why investors prefer to purchase convertible preference shares is two-fold: (i) preference shareholders are given priority for repayment in case of liquidation of the target company, and (ii) conversion of preference shares into equity can be timed to occur upon the achievement of performance milestones by the target company, allowing investors some flexibility in the event of any mismatch in future valuation expectations of the investors and the target.

While the 2013 Act permits the issuance of convertible preference shares, it does not specify the manner in which such securities are converted into equity shares. At present, there are divided opinions on the correct procedure for conversion of securities – one point of view is that the preference shares would, by way of an appropriate resolution passed by the target company, convert directly into equity shares, reflecting a simultaneous increase in equity share capital and reduction in preference share capital, while the other interpretation is that conversion is effected by simultaneously redeeming the preference shares and making an issuance of equity shares in lieu thereof.

Investors in particular are keen to have clarity on this issue, and would be reassured by any clarifications that the MCA may issue on the corporate actions to be taken by target companies for effecting such conversion in a manner that is valid and compliant with the provisions of the 2013 Act.

2. Disclosures in explanatory statements

The MCA, vide a notification issued in June 2015, eased compliance burdens on private companies by permitting them to make provisions in their Articles of Association to do away with the requirement of providing their shareholders with detailed explanatory statements along with the notices calling general meetings (“ES Exemption”). This liberalization has been very well received, particularly by closely-held private companies where the small group of shareholders are themselves engaged in running the company.

However, the scope of the ES Exemption in practice remains ambiguous, since several rules framed under the 2013 Act mandate certain disclosures to be made in explanatory statements. For instance, companies are required to obtain the consent of their shareholders prior to making preferential allotments of securities to any persons (including investors). As per the Companies (Share Capital and Debentures) Rules, 2014 (“Rules”), certain disclosures relating to the preferential offer, including details of number of securities, price, valuation, objects of the allotment, pre and post-issue shareholding pattern, etc., must be made in the explanatory statement issued to the shareholders. There is no doubt that these details are relevant and necessary for the shareholders to consider before providing their consent to a preferential allotment. But the question remains – can companies now avoid issuing explanatory statements to their shareholders altogether, by virtue of the ES Exemption? Or will the failure to issue an explanatory statement containing the mandated disclosures amount to a violation of the Rules?

Investee companies would prefer to avail the benefit of the ES Exemption so as to reduce the paper-work required for closing an investment transaction. On the other hand, investors would insist that companies issue such explanatory statements despite the ES Exemption, as they are concerned that allotments made to them without issue of explanatory statements could be struck down as being invalid due to non-compliance with the Rules. Clarifications from the MCA on the intended scope of the ES Exemptions would therefore be welcomed by the investor community and investee companies alike.

3. Compliance with secretarial standards

The 2013 Act mandates all companies to comply with the secretarial standards (“SS”) issued by the Institute of Company Secretaries of India. The SS relating to board and general meetings were approved by the MCA, and made applicable to all meetings held from July 1, 2015 onwards. The SS sets out, in great detail, the practices to be followed by companies in conduct of meetings, and preparation and maintenance of notices, minutes, and other records relating to meetings.

The intent behind the SS appears to be positive, and the SS is primarily aimed at ensuring that good corporate governance practices are followed so that disputes and litigation relating to mismanagement of affairs are minimized. However, private companies are concerned that the SS have raised the compliance burden by imposing greater requirements than currently prescribed by the 2013 Act. For instance, the MCA introduced the ES Exemption for private companies because it recognised that many private companies are owned and managed by a small group of promoters. While such private companies now do not have to prepare and issue explanatory statements for general meetings (which are typically held only a couple of times a year), they are required to prepare extensive notes on the agenda for board meetings (which may be held as often as once a month).

The SS prescribes many more compliances on a similar vein, which seem unnecessary for closely-held private companies, as they impede the making and implementation of day-to-day management decisions. On the other hand, private equity / venture capital investors are afforded added comfort as the SS would boost compliance standards in portfolio companies. From the perspective of investment transactions, the procedures and timelines for corporate actions required for closing of deals would be affected by the additional compliance requirements introduced by the SS. The MCA should consider re-visiting the SS, and attempt to bridge the gap between the exemptions granted under the 2013 Act to private companies and the compliances imposed by the SS.

Reports indicate that the MCA has established a 6 member expert panel to review comments and concerns of stakeholders and recommend further amendments and clarifications to the 2013 Act to make it easier for corporates to do business in India. The panel is expected to focus on easing provisions related to corporate governance and management, amongst other matters, and I hope they would consider clarifying some of the compliance-related issues discussed here.