Do NBFCs Qualify as Small Companies?

Mahak Agarwal | corplaw@vinodkothari.com

Introduction

Recently, there has been considerable discussion regarding whether NBFCs can qualify as small companies. This debate erupts from point (c) of the proviso to Section 2(85) of the Companies Act, 2013 (‘the Act’), which excludes “a company or body corporate governed by any special Act” from being eligible as a small company.

Small is simple

Small companies are private companies operating on a small scale, having paid up share capital and turnover limits not exceeding Rs.4 crs and Rs.40 crs respectively. These companies contribute significantly to the economy, carrying the potential of becoming large corporations. The idea behind providing various relaxations to small companies was to remove the burden of additional compliances otherwise applicable to large public listed companies. The same has also been discussed in the 2005 Report on Company Law by Dr. J.J. Irani:

“The small companies have to be enabled to take quick decisions, be adaptable and nimble in the changing economic environment, yet be encouraged to comply with the essential requirements of the law through low cost of compliance. The Government may prescribe special regime for such companies through a system of exemptions.”

Presently, several provisions of law such as preparation of cash flow statement, requirement of holding 4 meetings in a FY, rotation of auditors, appointment of IDs, among others, are exempt for small companies. In addition to these, the most significant exemptions happen to be dematerialisation of shares and CARO reporting.

The requirement of dematerialisation of shares, earlier applicable only to public companies, was later extended to private companies as well. (See our article on Diktat of demat for private companies) However, small companies, despite being private companies, are exempt from this requirement. Further, the requirement of CARO report: a report containing additional requirements for reporting by statutory auditors is also exempt for small companies.

Having discussed the privileges enjoyed by a small company, the crucial question that arises here is whether NBFCs fall under the definition of being “governed by a special Act,” thereby placing them outside the scope of small companies. If an NBFC was to be treated as a company “governed by a special Act” then, the same would deny it of all the exemptions and relaxations otherwise available to a small company, despite it meeting the prescribed requirements. This article deals with our views on this issue.

Understanding the meaning of ‘governed by special Act’?

The term ‘company governed by special Act’ has long standing roots in legal frameworks, not only under Section 2(85) of the Companies Act, 2013, but also under Section 1(4)(e) which extends the Act’s applicability to such entities, provided it does not conflict with their special Act. This concept also existed in the erstwhile Companies Act, 1956. In fact, the concept originated under the Halsbury’s Laws of England where companies were created under a Royal Charter (a special Act of a Parliament which defines the objects, constitution and powers of Corporation). Overtime, the Companies Act became the general governing law for companies incorporated in India and the companies specifically incorporated under the Royal Charter became companies ‘governed by special Act’. The same has also been discussed in Para 7 of Ranjit Narayan Haksar vs Surendra Verma on 7 September, 1994 as under:

“In Halsbury’s Laws of England, Fourth Edn., Vol. 7 at page 11, it is stated as follows :

:………The second category (which is a large and growing one and which is economically a very important one) companies that are known as public corporations. These are each the creation of a royal charter or, more commonly, a special Act of a Parliament which defines the objects, constitution and powers of Corporation. They are created to fulfil in each case some special social or economic purpose.”

Therefore, the intent of the existing company law in referring to companies ‘governed by a special Act’ was to provide a carve out to such companies which were incorporated and governed by the Royal Charter as opposed to those governed by the general law i.e. the Companies Act.

Having said that, in the context of NBFCs, it is pertinent to note that NBFCs were far from existence in the era of Royal Charters and therefore, there could not be any possibility of entities ‘governed by a special Act’ referring to NBFCs.

Governing law vs Regulatory law in the context of NBFCs

The enactment of the RBI Act in 1934 was primarily aimed at establishing the Reserve Bank of India and overseeing the operations of banking institutions across the country. While its initial focus was on regulating the activities of the RBI and supervising banking firms, its scope was subsequently extended to include the regulation of NBFCs (See our article on NBFC Regulation turned sixty). However, this does not imply that the RBI Act was specifically enacted as a special act for NBFCs. In fact, it is noteworthy that NBFCs were only brought under the purview of the RBI Act in 1963, three decades after the Act’s enactment, indicating that the original intent of the RBI Act was not directly linked to NBFC governance.

It is also pertinent to note that NBFCs are also companies established under the Companies Act with the primary distinction that they are involved in financing and investment activities. Given the distinct nature of their operations, NBFCs were brought under the regulatory ambit of the RBI through specific regulations, such as the RBI Scale Based Regulations of 2023. However, it is essential to note that this does not make the  RBI Act the exclusive legislation governing NBFCs. The same is also evident in the definition of NBFC under Section 45I(f) of the RBI Act, which mandates that a financial institution must be registered as a company under the Companies Act. Moreover, NBFCs are subject to regulation and oversight by various authorities, such as the Insurance Regulatory and Development Authority of India (IRDAI) for those acting as corporate agents and the Securities and Exchange Board of India (SEBI) for those engaged in investment advisory. The regulatory landscape governing NBFCs is multifaceted, involving various regulatory bodies and statutes, each serving distinct purposes within the financial ecosystem. However, considering each of these Acts or regulations as special laws exclusively governing NBFCs would be inaccurate.

In essence, entities like the RBI, SEBI, and IRDAI serve as sectoral or functional regulators depending on the specific area of operation, and labeling them as special Acts for NBFCs would be unjustified. Additionally, it is important to highlight that besides the financial activities of an NBFC, all corporate actions undertaken by them, including incorporation, changes in share capital, changes in objects, etc are governed by the Companies Act, with RBI directions coming into play only for specific provisions explicitly mentioned.

All in all, while the RBI undoubtedly wields authority over NBFCs, it is erroneous to classify the RBI Act as a special Act intended for NBFC governance. In fact, it can be said to be only a regulatory law, supplementing the Companies Act, which in fact is the governing legislation for NBFCs as well.

Do NBFCs rightfully qualify as small companies?

Having discussed the above, we come to the crucial question: can NBFCs rightfully be classified as small companies?

As mentioned earlier, the designation of a small company carries significant advantages, including exemptions from various regulatory requirements such as the Companies Auditor’s Report Order (CARO) reporting, dematerialization of shares, and rotation of auditors, among others. However, the current practice of denying NBFCs these exemptions under the pretext that they are governed by a ‘special Act’ raises questions regarding the validity of such categorization.

It is pertinent to note that RBI has consistently played a pivotal role in prescribing stringent norms and regulations, particularly where it deems necessary. Further, the Companies Act explicitly excludes NBFCs from applicability of certain provisions such as the Deposit Rules [Rule 1(3)(ii)], applicability of provisions with respect to loans and investments [S.186(11)(iii)], etc. If the intention of the law were to exclude NBFCs from the category of small companies due to their governance under a ‘special Act,’ one would expect explicit mention of this in the Companies  Act or the RBI directives. However, the absence of such explicit provisions, and the arguments presented earlier, casts doubt on the justification for denying NBFCs the status of a small company, provided they meet the requisite criteria.

Concluding remarks

In essence, the rationale behind withholding small company status from NBFCs appears to lack a solid foundation in the absence of explicit directives from the RBI and considering the nuances of NBFC regulation within the broader regulatory landscape. As discussions on this matter continue, it remains imperative to carefully examine the implications and considerations involved in categorizing NBFCs as small companies.

Also refer to our other resources on NBFCs here

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