Private limited companies: End of an era?

A private company under the Companies Act, 2013 (2013 act), is a company that has a minimum paid-up capital of ₹100,000 (US$1,640), restricts the rights to transfer its shares, limits its number of members to 200, and prohibits any invitation to the public to subscribe for any securities of the company. Under the Companies Act, 1956 (1956 act), a private company was a preferred vehicle for closely held entities that did not need to tap public funds.

This article examines whether the private company will continue to be a preferred vehicle for promoters given the sweeping changes that have been made to the benefits and exemptions enjoyed by private companies. The key benefit enjoyed by a private company under the 1956 act was the ease with which it could conduct its business given the relaxed corporate law regime, limited interference from the regulator, lower compliance costs and minimal disclosure requirements to the general public.–

Benefits withdrawn

The 2013 act has substantially modified the regulatory regime as far as private companies are concerned. Some of the key changes that disallow benefits enjoyed by private companies are as follows: (a) exercise of certain powers by the board of directors (including the sale, lease or disposal of the whole or substantially the whole of the undertaking of the company) requires shareholder approval; (b) the concept of interested directors and prohibition against their participation in board meetings is applicable to private companies; (c) private companies are prohibited from giving loans to directors; (d) inter-corporate loans and investments among private companies are restricted; (e) further issuance of share capital through a preferential issue will require a special resolution along with a valuation for the price of the shares; (f) the exemption available to private companies to issue shares with differential rights, as regards dividend, voting or otherwise, has been withdrawn; (g) the prohibitions relating to insider trading and forward dealing are applicable to private companies; (h) various conditions for private placement of shares and debentures have become applicable to private companies; (i) any member of the general public can inspect or obtain the copies of the profit and loss accounts of the private company; and (j) compliance requirements for the appointment of directors and conduct of general meetings have increased.

Continuing advantages

Private companies however continue to enjoy lower thresholds as far as minimum paid-up capital and minimum numbers of directors on the board are concerned. Additionally, a private company is not required to have independent directors (even for the constitution of the corporate social responsibility committee) or appoint key managerial personnel. A private company is also not prohibited from giving a loan or financial assistance to a person for buying shares of the company or its holding company.

As far as directors of private companies are concerned, they are not liable to retire by rotation and are free to hold similar positions in 19 other private companies, and there is no restriction on managerial remuneration. A private company can also provide for additional disqualifications for directors in its articles of association.

Weighing cons against pros

Given the above, it appears that the key factors that weigh in favour of setting up a private company are: (a) its ability to restrict transfer of shares, which is enforceable not only against the shareholders but also the company; (b) flexibility in managerial remuneration; (c) not having to appoint independent directors; (d) increase in the number of members permitted in a private company from 50 to 200, which is beneficial for the private raising of funds; and (e) dispensation from the requirement to appoint key managerial personnel. The prohibition against participation of interested directors in board meetings will pose a challenge for promoter-run or closely held private companies that engage in related-party transactions in a routine manner. Such companies will be required to broaden the base of their board of directors to ensure that a quorum is available at meetings where such transactions are considered.

Conclusion

The provisions of the 2013 act relating to private companies are highly restrictive and cumbersome. They defy reason because in closely held private companies considerations relating to minority investor representation or protection are non-existent. Hence, private companies should not be subjected to compliance requirements that hinder flexibility and diminish the benefits attached to the status of the entity. One can only hope that the government uses its discretionary powers of exemption to exempt private companies from some of the onerous provisions mentioned above.

Akila Agrawal is a partner and Anjali Puri is an associate at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.