[2013] 38 taxmann.com 75 (Article)
The absurdity of 'Private Listed Companies'Under New Companies Act
PRASHANT PRANJAL
ABHINAV KUMAR
In this write-up authors have tried to point out a fallacy in the New Companies Act, 2013. This fallacy has befallen due to upward change brought about in the ceiling of members in a private company from 50 to 200 while missing out on the requirements of deposits. The fallacy can have serious repercussions as to the concept of a private company. The whole concept of a private company would be endangered by such provisions. To engineer a private limited company as a publicly traded company would not only be contradictory and absurd but would be against the established corporate jurisprudence. Authors want to assure the readers that the title is not their creativity, but what is there in the New Companies Act, 2013 (hereinafter referred as "New Act"). Authors will elaborate on the same in this article.
PRIVATE COMPANY: SHAREHOLDING AND TRANSFER BARRICADES
1. Private company under the Old Companies Act, 1956 (hereinafter referred as "Old Act") is defined under section 3 of the Act one which has to incorporate in the articles various limitations provided for under section 3, read with section 27(3) of the Old Act.
One of the distinguishing characteristics of a private company in relation to a public company is the fact that there are certain restrictions in the transferability of shares. Though this restriction is not an absolute one, yet as judicially observed, a restriction which precludes a shareholder altogether from transfer may be invalid, but a restriction which does no more than give a right of pre-emption is valid.1
Though it is fairly well accepted that the right of pre-emption does not amount to prohibition upon transferability2, yet it must be pointed out that this restriction does not apply to two situations, viz., if the transfer is to his personal representatives on whom his shares have devolved and who are seeking the registration of shares in their favour3, the restrictions may not apply which are proposed to be issued on rights basis, conferring upon the members the right to renounce in favour of their nominees. This is done because renounced shares will be allotted to the renouncee for the first time and not transferred to him, though in practical situations such a right barely exists.4
So, in continuation of the above feature of private companies, it should also be pointed out that shares of a private company do not possess liquidity, because the purchaser of the shares cannot be guaranteed that he will be registered as a member of the company, hence, such shares cannot be easily sold in the market. Although the Securities Contract Regulations Act, 1956 in section 2(h) provides that marketable shares can be of any incorporated company or body corporate, in fundamental reality it only includes public listed companies.5
Hence, essentially private companies have barricades as to the transfer of shares to over 49 people and also regarding its marketability. But, on other hand, it eases them from the heckles of listing their shares in a recognized stock exchange. The rationale is to allow the private companies to function within a protected circle, independent of any outsider intervention by purchasing of shares.
PUBLIC PLACEMENT VIS-À-VIS PRIVATE PLACEMENT OF SHARES BY PRIVATE COMPANIES
2. Before going into the fallacy of the New Act, it is necessary to point out the subtle difference of rationale between public placement and private placement of shares. A public issue is one where the company intends to invite shares from the general public, whereas private placement is one where the capital is accumulated from a select group of investors. Generally, an offer is made to the kith and kin of a director, or to private individuals in a 'strictly confidential' marked letter as a private offer, though it is a question of fact varying from case-to-case.6 Private placement of shares may also be done vide the services of a broker, but the same must not be to more than 50 persons.7
Even if a prospectus is marked confidential for private placement only, but if it is done for pulling out capital from the public in disguise, then such a placement shall be treated to be a public issue.8 The Securities Appellate Tribunal in the case of Toubro Infotech and Securities9held as follows:
(a) if there was a calculated offer on the part of the company to bring in an uninvited guest to subscribe to the share/debenture. (b) persons other than those receiving the offer or invitation had in fact actually subscribed to the offer. If these two conditions are fulfilled, then no amount of camouflage in the letter of offer can make a public issue into one of a private issue.
These two cases stand as the only exceptions, where a private offering becomes a public offering. Hence, it is well understood that the watchdogs of India's corporate behaviour take the difference between public and private offer very seriously. Even for a toe outside the line,i.e., invitation to more than 50 persons or through an indirect invitation to the general public, a private placement of shares can be characterized as a public placement.
Having, prima facie observed the difference between issues meant for public and otherwise, it is to be followed that the companies have to comply with the relevant provisions of the Act concerning public issues and the regulations prescribed. It would be pertinent to note that, pursuant to section 73 of the Old Act, every public company in lieu of inviting capital from the public is required to make an application for listing of shares in one or more registered stock exchanges, and the same is required for a valid allotment of shares.10 Hence, without listing a valid allotment cannot be done as per the existing jurisprudence and even if the stock exchange refuses to grant permission for the listing, the entire allotment is rendered void.11 So, if a company is refused to be listed it cannot validly issue shares to the applicants as such.
AMBIGUITY AND FALLACY VIS-À-VIS NEW BILL
3. Now authors will look into the provisions as prescribed in the New Act, as the premise of the article is based on the changes brought out in by the New Act. Pursuant to clause 2(68) of this New Act, private company's definition has been altered significantly with respect to number of members. Requirement as to minimum number of members have been lowered to "one" with the introduction of "One Person Company" in India whileas the maximum number of members have been quadrupled to 200. However, it should be noted that the New Act still prohibits any public invitation.
Private placement is covered in the New Act and still restricts the invitation of deposits to 50 members as was provided for under section 67(3) of the Old Act. An another provision of the New Act is corresponding provision of section 73 of the Old Act, which provides for compulsory listing of securities offered to public. The relevant provision still is the same, as even now only public deposits are to be listed.
So, here is the paradox - now if the private company after the enactment of the New Act wants to invite deposits from its members, which are now up to 200, it would have to go in for listing pursuant to the provision of the New Act as, even though private company is inviting deposits from its members, yet still it would be considered as a "Public Issue". Hence, the whole essence of a Private Company will be doomed, if pursuant to the new clause it has to list its securities.
ICDR REGULATION 26(4) DO NOT COME TO THE RESCUE OF THE PARADOX
4. In the light of the ongoing highly popular Sahara – Securities Exchange Board of India (hereinafter referred as "SEBI") scuffle, one major legal point that emerged was that vide regulation 26(4) of the Issue of Capital and Disclosure Requirements, Regulation, 2009 (hereinafter referred as "ICDR regulations"),12 for the purposes of public offering, it must be done to a minimum of 1,000 allottees. However, this controversy has been done away with in the SEBI's order. The regulation merely provides that an issuer shall not make an allotment pursuant to a public issue, if the number of prospective allottees is less than 1,000 to ensure that there is sufficient liquidity in the scrip post-listing.13 The same was also prevalent in the DIP Guidelines, clause 2.2.2A.14
Hence, if we look into the legislative intent of regulation 26(4) and provide harmonious construction with section 67(3), it can be understood that the purpose behind the regulation is not to bring offering to allottees between 51–999 under the ambit of private offering, but to stop allocation within that number, so that problems regarding liquidity in post-script listing do not arise. Hence, essentially even with the regulation any offering to over 50 persons is essentially public in nature and not private. The Supreme Court of India clarified this stance in the Sahara's appeal by observing ad verbatim that any offer/invitation made by a public company to 50 or more persons was bound to be considered as having been made "to the public".15
If a company has attracted section 67(3) of the Old Act, then it has to comply with various statutory requirements such as registering the prospectus with Registrar before making the public issue vide section 60, making an application to list their securities to recognized stock exchanges vide section 73, etc.16 Once the same has been done, the issuer will be further required to comply with all the relevant SEBI's guidelines, and therein the ICDR regulations 26(4) will come in the picture. Very obviously, as the wordings provide, the issuer shall be prohibited from making the allotment if the number of allottees is less than 1,000. The regulation in no manner makes the allocation to be private in nature and is in consonance with the relevant statutory provisions laid down.
CONCLUSION
5. Legal eagles of the country might argue that ICDR regulations are sufficient and the statutory requirements should be read in a harmonious construction. But it is to be pointed that the said provisions of the New Act in their current form will put judiciary in conundrum. As a principle of jurisprudence in case of a conflict between a statutory provision and a regulation/rule framed under any Statute, Statute will override the same. Since the Bill has been passed and the New Law has replaced the Old Law, we will be seeing more Private Listed Companies for sure.
Regards
Prarthana Jalan
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