Implementation issues of MCA’s mandate for compulsory DEMAT in case of WOS

– Shares required to be credited in personal demat accounts of nominee holders

CS Vinita Nair (corplaw@vinodkothari.com)

This is in continuation to previous write up ‘Physical to Demat: A move from opacity to transparency’. With just 10 days left for the timeline set by Ministry of Corporate Affairs (MCA) to expire, Companies initiate steps for facilitating transfer of securities in demat. The first step being obtaining of ISIN for each of the securities issued and thereafter, intimating the shareholders about the same in order to facilitate transfer on and after October 2, 2018.

This article discusses the implementation difficulty that is being faced by holding companies complying with the aforesaid requirement for its wholly owned subsidiaries.

Relevance in case of WOS

Shareholding pattern

Typical shareholding structure in case of WOS is a under:

  1. Nominee shareholder holding jointly with the holding company

a. Nominee shareholder submits declaration in Form MGT-4 declaring that it holds shares on behalf of the beneficial owner being the holding company;

b. The company , being the beneficial owner as well as registered owner (joint holder) is not required to submit Form MGT-5 as the name reflects in the register of members

  1. Nominee shareholder holding singly on behalf of the holding company

a. Nominee shareholder submits declaration in Form MGT-4 declaring that it holds shares on behalf of the beneficial owner being the holding company.

b. The holding company submits declaration in Form MGT-5 declaring that it beneficially holds the shares registered in the name of the nominee shareholder.

c. The WOS files eForm MGT-6 with the Registrar on receipt of aforesaid declaration.

In case of private companies, there is atleast 1 nominee shareholder and in case of public companies, there are 6 nominee shareholders for the purpose of complying with the requirement of minimum number of shareholders.

The nominee shareholders holding the shares on behalf of the holding company are employees of the holding company or of the WOS. Most commonly, these shares are held in physical form and the share certificates of the nominee shareholders are also with the holding company for safekeeping. In the event where the nominee shareholder ceases to be the employee, the shares are transferred in the name of new employee, and aforesaid forms are re-submitted.

Mandatory demat neither adds value nor provides further transparency in case of WOS.

Practical issues

Following practical issues are likely to be faced:

In case of nominee shareholder holding jointly with holding company:

  • The Company as well as the nominee shareholder must be having their respective demat accounts. However, for the purpose of joint holding in demat, both the company and the nominee shareholder will have to jointly open a demat account. Where the employee ceases to be nominee, the account may have to be closed or modified to have the new nominee shareholder as first holder.

In case of nominee shareholder holding singly, on behalf of holding company:

  • The shares will have to be credited in the personal demat account of the nominee shareholder. In that case, the holding company will not have any control on the shares. Where the employee resigns and the holding company intends to have new nominee shareholder, the transfer can be effected in the demat account of the new shareholder only where the Delivery Instruction Slip (DIS) is signed by the transferor nominee. Therefore, it is prudent to have the DIS signed beforehand to avoid any difficulty while effecting the transfer later.
  • Additionally, the depositories should also have a mechanism to mark/ lock such securities in the manner done in case of pledge, in order to disable the nominee from transferring shares without the consent of the holding company.

Conclusion

There is an urgent need for MCA to exempt several provisions, including the current one, in case of WOS, as these are perfunctory compliance given the shareholding pattern of the WOS. A WOS is similar to a One Person Company with the only difference that the member is a Company instead of a natural person. Accordingly, the requirement to hold AGM, passing of special resolutions, holding shares in demat adds no further transparency. The holding is entirely reported in the balance sheet of the holding company. Corporates may appropriately represent the same before MCA to implement appropriately.

Managerial Remuneration: A five decades old control cedes

Revised guidelines for companies to facilitate the claimant’s refund by IEPF Authority

By Nikita Snehil (corplaw@vinodkothari.com)

The Ministry of Corporate Affairs (‘MCA’) Vide its Notification[1] No. 07/05/2017-IEPFA, dated July 19, 2018 has revised and updated the guidelines for the company to facilitate the refund of the claims by IEPF Authority in light of the resubmission option provided in e-form IEPF-5.

Read more

Disqualification Before The Deadline: Seemingly A Never Ending Debate!

By Pammy Jaiswal, Partner & Smriti Wadehra, Assistant Manager

corplaw@vinodkothari.com

Background

While MCA has been on a spree to disqualify lakhs of directors on the Board of companies across the nation, the aggrieved directors have been knocking the doors of High Courts and Supreme Courts for getting some sort of relief in this regard.

It is interesting to note that the order passed by various High Courts and even Supreme Courts have clearly reflected the perplexity over interpreting the provisions of section 164 (2) of the Companies Act, 2013 (‘CA, 2013’) or section 274 (1) (g) of the erstwhile Companies Act, 1956 (‘Erstwhile Act’). In most of these judgements, one of the heated discussion has been to comment on the applicability of the provisions of section 164 even prior to the commencement of the said section.

In one of the recently decided writ petition filed by Bahgwan Das Dhananjaya Das against Union of India and RoC, Tamil Nadu[1], the Madras High Court has given rationale for not applying the provisions of section 164 (2) of the CA, 2013 with retrospective effect.

This write-up pin points the rationale behind the judgement of the Madras High Court and also discusses the counter view of the Apex Court in a similar matter.

Commencement of the provisions of section 164(2) of the CA, 2013

Birdies and Eagles Sports Technology Private Limited (the Company in question) had no operations and was dormant till 2012. It had filed its annual return and financial statements till the FY 2011-12 and not thereafter. Under the Erstwhile Act, private companies were exempted from section 274 (1) (g) and it was only on and after 1.04.2014 that the provisions of section 164 (2) of CA, 2013 was notified.

As rightly pointed out in the instant judgement, by virtue of the new section 164(2)(a) of the CA, 2013, the word ‘company’ was used instead of ‘public company’ that was used under the Erstwhile Act. Accordingly, where a private company fails to file its annual return or financial statements for three financial years, on or after the first day of commencement of section 164 (2), the directors on the board of such companies will also be disqualified. Therefore, the financial years that should be covered for determining the filing status under the said section are:

  1. 1st April, 2014 to 31st March, 2015
  2. 1st April, 2015 to 31st March, 2016
  3. 1st April, 2016 to 31st March, 2017

Having said so, it should also be noted that section 92 and section 137 provides a time frame of 60 and 30 days respectively for filing the annual return and financial statements respectively. In order to determine the failure of a private company under the said section, MCA should have waited for the filing period allowed by law to get over. In the instant case, MCA had issued the notice reflecting the names of disqualified directors on 08.09.2017 while the Company had time till 30.11.2017 for completing the filing requirements. Therefore, even though it was sine quo non to have failed filing requirement for three financial years for disqualification to take place, the disqualification happened before the deadline.

Additional time-period of 270 days

On the contrary, companies also had the liberty of filing the annual return or financial statements within a time period of additional 270 days as allowed under section 403 of the CA, 2013 which though have now been amended by virtue of Companies (Amendment) act, 2017.

In view of the same it has been rightly mentioned in the judgement that:

“…… the second respondent, on a wrong interpretation of Section 164(2)(a), has disqualified the petitioners even before the provision came into force.”

Article 20 of the Indian Constitution

Article 20 of the Indian Constitution deals with protection in respect of conviction for offences. It states the following:

(1) No person shall be convicted of any offence except for violation of the law in force at the time of the commission of the act charged as an offence, nor be subjected to a penalty greater than that which might have been inflicted under the law in force at the time of the commission of the offence

XX.”

The judgement clearly discusses that the act of the RoC, Tamil Nadu is against the principles of Article 20 of the Indian Constitution as applying the provisions retrospectively would attract penal provisions for the company and the directors for such period wherein the law in force at the time of commission/ omission of the offence was not treated as an offence at all. Further, it is a fundamental rule of law that no statute shall be construed to have a retrospective operation unless such a construction appears very clearly in the terms of the Act, or arises by necessary and distinct implication. Further also, in the matter of Govind Das and others v. Income Tax Officer and another[2], AIR 1977 SC 552, the Apex Court had ruled that retrospective operation should not be given to a statute so as to affect, alter or destroy an existing right or create a new liability or obligation unless that term of the statute expressly so provide or necessarily require it. Accordingly, the act of the RoC was unconstitutional and arbitrary.

MCA forgot its own clarification

MCA by virtue of its own circular dated 4.04.2014[3], had clarified that financial year prior to 01.04.2014 shall be governed by Erstwhile Act and those on or after 1.04.2014, shall be governed by CA, 2013. The extract of the said circular is as follows:

Although the position in this behalf is quite clear, to make things absolutely clear it is hereby notified that the financial statements (and documents required to be attached thereto), auditors report and Board report in respect of financial years that commenced earlier than 1st April, 2014 shall be governed by the relevant provisions/ Schedules/ rules of the Companies Act, 1956 and that in respect of financial years commencing on or after 1st April, 2014, the provisions of the new Act shall apply.”

On reading of the aforesaid circular it was all the more clear that there is no provision in the CA, 2013 to disqualify the petitioner for the financial year 2013-14 for a period covered by the Erstwhile Act. Further, the Companies Act, 2013 ought to be read prospectively and cannot relate to occasions prior to its coming into force, failing which the said provision would become unconstitutional.

Definition of financial year

In the instant case it was submitted that although Section 274(1)(g) of the Erstwhile Act was brought into the statute with effect from 13.12.2000, that section had clearly stated that “three financial years commencing on and after the first day of April 1999”, whereas the Section 164(2)(a) of the CA, 2013 uses the words “for any continuous period of three financial years”. Therefore, one needs to look into the definition of financial year”. Section 2(41) defines a financial year to mean “in relation to any company or body corporate, means the period ending on the 31st day of March every year XX”. The definition also makes it quite explicit that the three financial years post the commencement of section 164 (2) of the CA, 2013 shall be the one ending as on 31st March, 2017.

Co-relation between strike off order and notice of disqualification

In the instant case, MCA issued a Show Cause Notice (‘SCN’) under section 248 of the Act, 2013 on 18.03.2017. Accordingly, the said Company was struck off by the MCA vide its gazetted notice dated 5.07.2017. The order also throws light on the relation between striking of and disqualification of director. The relevant extracts from the judgement is as follows:

“This apart, even the second respondent issuing a notice under Section 248(1) of the new Act for striking off the name of the company from the Register of Companies stating that the company has not been carrying on any business or operation for a period of two financial years, has got nothing to do with the disqualification under Section 164(2)(a), for the foremost reason that a company can be struck off when it has not been carrying on any business for a period of two financial years, whereas for disqualification, the criteria is three financial years. Quoting an example, it is pleaded that if the company has not been carrying on business for two financial years ending 31.3.2015 and 31.3.2016, after giving due notice, the company can be struck off, whereas a director cannot be disqualified because only two financial years have come to an end. But for the disqualification, there should be three financial years. In other words, it is pleaded that if the company is struck off after 31.3.2016 but before 31.3.2017, there would not be any disqualification, because, before the third financial year, the company has been struck off.”

Principles of natural justice

In the matter of A.K. Kraipak and others v. Union of India[4], AIR 1970 SC 150, it was held that the “rules of natural justice operate in areas not covered by  any  law validly made, that  is,  they  do not supplant  the law of the land but supplement it.” The instant case wherein petitioners have been disqualified does not affects the directorship position of such director in the said struck off companies but also has far reaching impact. By virtue of the provisions, such director is forced to vacate his office as a director from all other companies where the offence has not taken place. Therefore, the principles of natural justice ought to have been followed so far as their continuance in other company which have followed the provisions of the CA, 2013.

Further, in the matter of Dharampal Sathyapal Limited v. Deputy Commissioner of Central Excise and others[5], (2015) 8 SCC 519, the Apex Court held that the show cause notice and personal hearing is necessary before saddling an assessee with additional demand.

Also referring to the case of Maneka Gandhi v. Union of India[6], (1978) 2 SCC 248, it was submitted that the act of the RoC, Tamil Nadu in disqualifying the directors without even providing them an opportunity of being hear is absolutely unreasonable and against the principles of natural justice.

Respondents only submission: Condonation Schemes

With a view to enable and provide an opportunity  file various pending documents and avoid penal action under the CA, 2013, MCA had issued the General Circular No.34/14 on 12.8.2014 with the introduction of Company Law Settlement Scheme, 2014 (CLSS-2014).

Further, the Respondents also mentioned that the Ministry had issued the Condonation of Delay Scheme 2018 to provide yet another opportunity to the defaulting companies and the same should be appreciated

It further stated that Section 164(2)(a) have two limbs, the words “no person who is or has been director of a company” which are used in the present continuous and present perfect continuous form, respectively and the words “has not filed financial statements or annual returns for any continuous period of three years” which are used in present perfect tense.

Therefore, this Court does not have any jurisdiction to undo the disqualification which had occurred on account of operation of law.

Intervention of the Supreme Court by putting a Stay Order on a similar case

While the Madras High Court was very clear in pronouncing its order for prospective application of section 164 (2) of the CA, 2013, in one of the similar writ petition filed by Shailendrajit Charanjit Rai & anr against the Registrar of Companies[7], Maharashtra, the Bombay  High Court also, had put a stay on the notice of disqualification issued by RoC, Mumbai

In the said matter, petitioners were directed to take immediate steps in consonance with the provisions under Section 248(2) of the said Act, 2013 and under the CODS­ 2018. The Bombay High Court had directed the RoC to accept physical documents of these struck-off companies and treat them as applications for voluntary striking off. This would essentially mean that the directors of these companies, who had been disqualified by the MCA, would no longer be considered disqualified till the date allowed by the High Court.

In supersession of the order of the Bombay High Court, the Apex Court on a Special Leave Petition filed by the RoC, Maharashtra, on 6th August, 2018 passed the stay order[8] on the order of Bombay High Court, thereby nullifying the stay order of the Bombay High Court and making the petitioners disqualified again from the date of notice of disqualification.\

Conclusion

While the Supreme Court had put a stay on the order, it has not mentioned any grounds for putting the stay. It seems that the Apex Court will transfer these cases to itself. Whatever may the call be, the situation is back to square one after continuous rulings on the subject matter and there seems to be no relief to the directors of the private companies.

 


[1] http://judis.nic.in/hcs/content.asp [Order can be seen at Judis]

[2] https://indiankanoon.org/doc/762617/

[3] http://www.mca.gov.in/Ministry/pdf/General_Circular_8_2014.pdf

[4] https://indiankanoon.org/doc/639803/

[5] https://indiankanoon.org/doc/159622873/

[6] https://indiankanoon.org/doc/1766147/

[7] http://www.amitadesai.com/uploads/Bombay%20High%20Court%20Order%20for%20CODS.pdf

[8] https://www.sci.gov.in/supremecourt/2018/23101/23101_2018_Order_06-Aug-2018.pdf