Author Archives: novojuris

CO-FOUNDER LEAVING THE COMPANY? FEW THINGS TO CONSIDER[1]

Co-founders, separating, is a harsh reality in early-stage companies, due to a plethora of reasons ranging from differences in opinion with regards the conduct of affairs, daily administration and management of the Company, to the relationship not working out organically, or in some instances simply due to personal reasons. The trouble in paradise gets worse when such separation is due to bad reasons such as non-compatibility between the founders and their inability to work with each other.

Structuring exit terms of a co-founder could be quite challenging, given the same is greatly dependant on ownership stakes, involvement in finances/intellectual property and/or other functional/operational/strategic matters in the company. As such, separation terms need to be carefully negotiated and structured to protect the rights of all parties involved and especially that of the company. We typically suggest entering into and executing a written agreement clearly laying down the terms of the separation and settlement thereof. Getting to the signature stage of this document becomes relatively easier if there is any signed founders’ agreement/shareholders’ agreement in place. To refer to our earlier post on founders’ agreement please see here.

There are various points of consideration that should be kept in mind for structuring separation terms, which, many a time, go a long way in either making or breaking a company.

If you are a continuing founder, you may begin by asking yourself the following questions:-

  1. How much equity is the exiting co-founder holding?

Typically, if there is a founders’ agreement/shareholders’ agreement in place, vesting related clauses get triggered and that serve as a good starting point for negotiations/discussions on the rest of the points. In the absence of such agreement, equity distribution discussions may prove to become major roadblocks as emotions run high during such events. While it is true that equity is the most preferred compensation mechanism in early-stage companies and therefore, it is inevitably required for attracting talent and getting future co-founders, it is also only fair to ask for what one deserves. Continuing founders may push for a complete exit, but exiting co-founder would want value for sweat, time, reduced remuneration, etc. Also, any retained equity by the exiting co-founders may be considered as “dead equity” in an early stage company, wherein investors invest in the caliber and business idea of the founders, more than anything else.

There are various means through which equity of an exiting co-founder is given back to the company/remaining founders/incoming co-founders depending on various parameters, and especially the value that the company has generated till the time of such exit.

  1. What is the exiting co-founders’ contribution to the development of the business? Is there any IP involved?

In early-stage companies, intellectual property (IP) could be the main stock in trade and therefore it is essential to establish that the company is the owner of the IP. The presence of an employment agreement or founders’ agreement makes this process simpler, as they typically contain clauses on ownership and assignment of the IP in the favor of the company, by the founders. However, in the absence of a clear contractual assignment, it becomes essential during a separation event, to get all IP assigned in favor of the company.

  1. Is the exiting co-founder also a director in the Company?

If the exiting co-founder is a member of the board of directors of a company also, the separation terms should address the issue of his/her resignation and filing of such resignation within 30 days with the registrar of companies having jurisdiction. The continuing founder shall ensure that there continues to be at least 2 (two) shareholders and 2 (two) directors in the company, even after the separation, in compliance with the provisions of the Companies Act, 2013.

  1. Taking stock of liabilities and indemnities:

During separation, it is important to take note of the stock in trade, books of accounts, statutory and contractual dues, pending litigations, indemnification obligations under any existing agreements and other financials of the Company. The exiting co-founder may be held liable for any and all statutory and contractual dues, especially for any defaults of the company during his/her tenure of association with the company. In instances such as fraud, wilful misrepresentation etc. the exiting co-founder may also be held personally liable for any damage, loss caused to the company (any existing shareholders’ agreement must also be evaluated in this regard).

  1. Other Considerations:-

In addition to above, the other material issues for consideration could be:-

  • Non-disparagement: This obligation is generally mutual in nature. Instances of disparagement may lead to bad name and reputation of all parties involved in the separation.
  • Non-compete, non-solicit: Typically, these flow from employment agreements/founders’ agreement, if executed.
  • Confidentiality: The exiting co-founder should be contractually restricted from disclosing any confidential information obtained by such co-founder during the course of his/her association with the Company. Any such disclosure of confidential information may lead to irreparable harm to the business of the Company.
  • Branding: The exiting co-founder post such exit, should not brand himself/herself as being associated with the company. The company should always intimate other parties working with the company and revise (to the extent practicable) all agreement, commercials, vender contracts and any other such document where the exiting co-founder has been a party in his capacity as a founder.
  • If an exiting co-founder retains equity in the company, post-exit;
  • the duration of non-compete, non-solicit in some instances should be linked to shareholding in the Company.
  • there should be a power of attorney in favor of one or more of the continuing founders, for ease of operational matters.
  • there should be transfer restrictions and provisions for treatment of equity (especially in case of an exit event for the company or a drag situation).

Each separation is unique in its own way and the dynamics vary depending on the relationship between the parties, many times they are just friends, family or ex-colleagues. Arriving and implementing the separation terms is a tricky affair that most importantly requires a neutral perspective and there have been various situations where mediation have come handy to resolve complex situations. To know more about mediation, you may see our posts available here.

[1] Please note that this post is a marker of reference points, only. Each separation requires customized advice and readers are requested to kindly seek professional advice in this regard.

Authors: Ms. Ayushi Singh, associate at NovoJuris Legal and Ms. Sohini Mandal, Junior Partner at NovoJuris Legal.

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APPLICABILITY OF LIMITATION ACT UNDER IBC (BK EDUCATIONAL SERVICES PVT. LTD Vs. PARAG GUPTA ASSOCIATES)

Background

Under the Insolvency and Bankruptcy Code 2016 (the Code), there has been an ambiguity with respect to applicability of the Limitation Act, 1963 (the Limitation Act). This has been deliberated upon in several judgments of the National Company Law Tribunal (the NCLT) and the National Company Law Appellate Tribunal (the NCLAT). In the case of Mis Deem Roll Tech Limited, the NCLT held that the Limitation Act is applicable to proceedings under the Code and dismissed the debt of the petitioner as being time barred and in the case of Neelkanth Township and Construction Private Limited Vs. Urban Infrastructure Trustees Limited, the NCLAT held that the provisions of the Limitation Act, 1963 would not apply to the Code. As observed above, it may be noted that applicability is being interpreted on the merit of each case and this has led to the confusion. The Supreme Court in case of Parag Gupta Vs. B. K. Educational Services held that the provisions of the Limitation Act is applicable for initiation of Corporate Insolvency Resolution Process.

Facts of the Case

  • There was a dispute on liability between Parag Gupta & Associates, Chartered Accountants (Financial Creditors) and B. K. Educational Services Private Limited, (Corporate Debtor).
  • The Corporate Debtor denied the financial liability and contended that the all the financial claims were false except one genuine debt, being immovable property allotted by Greater Noida Industrial Development Authority (GNIDA).
  • The Corporate Debtor further alleged that the records were tampered and manipulated by the relatives of the Financial Creditors.
  • The amounts claimed were time-barred.
  • It was showed that there was nothing on record that would extend the limitation to recover the same since the period was between 01 October 2012 to 05 February 2013.

The NCLT held that documents produced by the applicants were not justifiable for the purpose of extending limitation. Therefore, the amounts stated by the petitioner are not legally recoverable. But with respect to liability of sum which was given by petitioner on 25 February 2015, it was entitled to be recovered.  However, that amount the debtor had liquidated the recoverable after admission of the application. Subsequently, the NCLT held that there were no further actions acquired and disposed of the application.

Challenging the order of NCLT, the Financial Creditor had appealed the said order of the NCLT and filed an appeal before the NCLAT. Contrary to the NCLT order, the NCLAT held that the provisions of the Limitation Act were not applicable for initiation of Corporate Insolvency Resolution Process (CIRP) under the Code and passed an order to accept the application for initiation of CIRP. Consequent upon this, the Supreme Court stayed the order of the NCLAT dated 7 November 2017. The Supreme Court[1] pointed out that ‘NCLAT Order has erred in holding that the right to apply under Section 7 of the Code for initiating Corporate Insolvency Resolution Process, accrues from 1 December 2016 i.e. from the date the Code came into force. It is submitted that in the event the rational given by the NCLAT is given effect to, it will lead to an anomalous situation where even in case of defaults in respect of debts more than fifty years ago a party will be able to initiate Corporate Insolvency Proceedings under the IBC.

The Indian jurisprudence opines that if a law is a complete code, then an express or necessary exclusion of the Limitation Act should be respected. In light of the confusion in this regard, the Insolvency Law Committee, set up on 16 November 2017 deliberated on the issue and unanimously agreed that the intent of the Code could not have been to give a new lease of life to debts which are time-barred. It is settled law that when a debt is barred by time, the right to a remedy is time-barred. This requires being read with the definition of ‘debt’ and ‘claim’ in the Code. Further, debts in winding up proceedings cannot be time-barred, and there appears to be no rationale to exclude the extension of the principle of law to the Code.

Conclusion

In view of the above the Committee recommended that it would be fit to insert a specific section applying the Limitation Act to the Code. The relevant entry under the Limitation Act may be on a case to case basis. However, in the absence such explicit provisions in the Code, the creditors would get a right to make an application for time-barred debts too. Given this, a need is felt for more clarity pertaining to entry under the Limitation Act as it is vague and criteria is not recommended, which once again leaves the question unanswered.

It is pertinent to note that the non-application of the law of limitation creates the following glitches: (i) It re-opens the right of financial and operational creditors holding time-barred debts under the Limitation Act to file for CIRP, the trigger for which is default on a debt above INR One Lakh. The purpose of the law of limitation is “to prevent disturbance or deprivation of what may have been acquired in equity and justice by long enjoyment or what may have been lost by a party’s own inaction, negligence or latches”. Though the Code is not a debt recovery law, the trigger being ‘default in payment of debt’ renders the exclusion of the law of limitation counter-intuitive.  (ii) It re-opens the right of claimants (pursuant to issuance of a public notice) to file time-barred claims with the Insolvency Resolution Professional/Resolution Professional, which may potentially be a part of the resolution plan. Such a resolution plan restructuring time-barred debts and claims may not be in compliance with the existing laws for the time being in force pursuant to Section 30(4) of the Code.

[1] http://supremecourtofindia.nic.in/supremecourt/2017/41322/41322_2017_Order_10-Jan-2018.pdf

Withdrawal Application after Initiation of Corporate Insolvency Proceedings under the IBC

Introduction

In case of any disputes between the parties, there are probabilities that parties might compromise and settle the matter during the pendency of the case before the Court.  In this blog, we analyse the situation where the application has been made before the National Company Law Tribunal (the NCLT) or National Company Law Appellate Tribunal (the NCLAT) under the Insolvency and Bankruptcy Code 2016 (the Code) and in case if such application has been admitted and the Corporate Insolvency Resolution Process (the CIRP) is initiated by the NCLT and the parties with consensus ad idem wish to withdraw the said application.

On July 24, 2017, the Hon’ble Supreme Court in case of Nisus Finance and Investment Managers LLP (“Facility Agent” or “Financial Creditor”) and Lokhandwala Kataria Construction Pvt. Ltd. (“Debtor”) ordered that the application for CIRP could be withdrawn or the subject matter could be settled by the parties even after the CIRP have been initiated.

Facts of the Case:

Nisus Finance and Investment Managers LLP (“Facility Agent” or “Financial Creditor”) filed an application before the National Company Tribunal (“NCLT”), Mumbai against the Lokhandwala Kataria Construction Pvt. Ltd. (“Debtor”) for initiation of insolvency proceedings. The Debtor was acting as a guarantor of Vista Homes Pvt Ltd. (“Principal Debtor”) with respect to amount owed by the Principal Debtor. The Financial Agent, the Debtor and the Principal Debtor are one among the parties to the Debenture Trust Deed executed between the Principal Debtor, Facility Agent and other Debenture holders. The Debtor was acting as a guarantor to redeem the debentures in the event if Principal Debtor, fails to pay to the debenture holders. The Facility Agent had the authority to invoke its rights to ensure that the returns are reached to the debentures holders. The Principal Debtor failed to redeem the debentures which were due for its redemption and the Facility Agent filed application under the Code for CIRP with the NCLT, Mumbai. The NCLT admitted the application of Facility Agent on being satisfied that the Debtor defaulted in redeeming the debentures.

Upon Moratorium being declared by the NCLT, Mumbai, the parties approached the NCLAT with a plea requesting to set aside the order of the NCLT and allow them to withdraw the case as the parties had settled the dispute and the dues are paid by the Debtor.

The NCLAT rejected the plea that the Adjudicating Authority may permit withdrawal of the application on a request made by the applicant before its admission and same cannot be withdrawn once the order for admission is issued and Moratorium is declared. Contesting the order of the NCLAT, the parties appealed the said order with the Hon’ble Supreme Court highlighting that NCLAT could utilize the inherent power recognized by Rule 11 of the National Company Law Appellate Tribunal Rules, 2016 to allow a compromise between the parties after admission of the matter.

Judgement:

The Hon’ble Supreme Court highlighted that the Rule 11 of the National Company Law Appellate Tribunal Rules, 2016 was not notified as on the date of order passed by the NCLAT. However, the Hon’ble Supreme Court utilised its powers under Article 142 of the Constitution of India, which states that Supreme court in the exercise of its jurisdiction may pass such order or decree as is necessary in doing complete justice. The Hon’ble Supreme Court while exercising its powers allowed the parties to withdraw the application. The Hon’ble Supreme Court disposed the appeal after accepting and recording the consent of the parties, where parties undertook to abide by the consent terms and the debtor agreed to pay the sums due. It is important to note that the intention of law is to provide the justice, therefore depending on the facts and circumstances, an application may be withdrawn even after the admission of the application.

Some thought provoking facts from the case:

  1. One of the objections raised by the Debtor before the NCLT, Mumbai was that the Facility Agent has no locus standi to file the case as no liability has been shown as owed and Facility Agent is not an authorised agent and not permitted under the law to file an application, hence application is not maintainable. The NCLT, Mumbai highlighted that since all the parties being privy to the Debenture Trust Deed, the Debtor cannot backout saying that the Facility Agent cannot act as Financial creditor on behalf of or as Debenture holders to initiate the CIRP against the Debtor.

 

  1. The NCLAT dismissed the appeal of the Debtor for withdrawal of application on the ground that before admission of an application under Section 7, it is open to the Financial Creditor to withdraw the application but once it is admitted, it cannot be withdrawn and is required to follow the procedures laid down under Sections 13, 14, 15, 16 and 17 of the Code. Therefore, parties cannot be allowed to withdraw the application once admitted, and matter cannot be closed till claim of all the creditors are satisfied by the corporate debtor. However, as explained in this blog, the Supreme Court may on a case to case basis, allow to withdraw the application which is already admitted by applicable authority.

 

  1. It is pertinent to note that the Supreme Court while passing order highlighted and agreed to the view of the NCLAT on Rule 11 has not been adopted at that point of time and in the absence of no inherent power, the question of exercising inherent power does not arise. Therefore, the Supreme Court took the cognizance of Article 142 of the Constitution of India where the Apex Court has authority to pass such order or decree as is necessary in doing complete justice.

Authors: Ms Shivani Handa and Mr Ashwin Bhat.

Cross Border Mergers – Key Regulatory Aspects to Consider

Introduction

Cross-border mergers and acquisitions have rapidly increased reshaping the industrial structure at the international level. A cross-border merger means any merger, amalgamation or arrangement between an Indian company and a Foreign Company[1] in accordance with the Companies Act, 2013 and the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016.

The Ministry of Corporate Affairs notified Section 234 of the Companies Act, 2013 thereby enabling cross-border mergers with effect from 13 April 2017. Thus, it was a matter of time that the Reserve Bank of India notified the regulations in order to operationalize the cross-border merger.

Regulatory Framework

In India, Cross border is majorly regulated under (i) the Companies Act 2013; (ii) SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011; (iii) Competition Act 2002; (iv) Insolvency and Bankruptcy Code 2016; (v) Income Tax Act 1961; (vi) The Department of Industrial Policy and Promotion (DIPP); (vii) Transfer of Property Act 1882; (viii) Indian Stamp Act 1899 (ix) Foreign Exchange Management Act 1999 (FEMA) and other allied laws as may applicable based on the merger structure.

The two most relevant regulations under FEMA from a merger & amalgamation perspective are Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (the FDI Regulations) and Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (the ODI Regulations). In addition to this, the Reserve Bank of India (the RBI) has notified Foreign Exchange Management (Cross-Border Merger) Regulations, 2018 (the Cross-Border Regulation) under the Foreign Exchange Management Act, 1999 to include enabling provisions for mergers, demergers, amalgamations and arrangements between Indian companies and foreign companies covering Inbound and Outbound Investments. This is a significant move as there will be a massive surge in the flow of Foreign Direct Investment with the enactment of new laws and tweaking of existing policies.

Inbound & Outbound Merger

Cross-Border Merger could be either Inbound merger or Out-bound Merger. Inbound Merger means a cross-border merger, where the resultant company is an Indian company. An outbound merger means a cross-border merger where the resultant company is a foreign company. A resultant company means an Indian company or a foreign company which takes over the assets and liabilities of the companies involved in the cross-border merger.

Key provisions of the Cross-Border Regulation in case of Inbound Mergers

Issuance of Securities

As a consideration, the Indian company would issue or transfer of securities to the shareholders of transferor entity which may include both persons resident in India and person resident outside India. In case of a person resident outside India, the issuance of securities shall be in accordance with the pricing guidelines, sectoral caps and other applicable guidelines as prescribed under the Cross-Border Regulation. However, if the foreign company is a JV/WOS then it shall comply with the conditions prescribed as specified in Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004. Further, if the inbound merger of the JV/WOS results into an acquisition of the one or more step-down subsidiary of JV/ WOS of the Indian party by the Resultant Indian company, then such acquisition should be in compliance with Regulation 6 and 7 of the ODI Regulations.

Vesting of Assets & Liabilities

  • Any borrowings or guarantees of the transferor company shall become the borrowings or guarantees of the resultant company. A timeline of two years has been provided to conform with the external commercial borrowings compliance. The end use restrictions would not apply in such cases.
  • Any asset acquired by the resultant company can be transferred in any manner as permissible under the Act or regulations. Where such asset is not permitted to be acquired, the resultant company shall sell the same within two years from the date of sanction of order by the National Company Law Tribunal (the NCLT) and the sale proceeds shall be repatriated to India immediately through banking channels. Where any liability outside India is not permitted to be held by the resultant company, the same may be extinguished from the sale proceeds of such overseas assets within the period of two years.
  • The resultant company is permitted to open a bank account in the foreign country’s jurisdiction for overseeing transactions related to the merger for a maximum period of two years from the date of sanction of scheme by the NCLT.

Valuation

The valuation shall be done as per Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016 i.e., by Registered Valuers who are members of recognized professional bodies in the prescribed jurisdictions of the transferee company and such valuation is in accordance with internationally accepted principles on accounting and valuation.

Key provisions of the Cross-Border Regulation in case of Outbound Mergers

Issuance of Securities

(a) As a consideration, the Foreign Company would issue securities to the shareholders of Indian entity which may include both persons resident in India and person resident outside India. In case if shares are being acquired by a person resident in India, then such acquisition shall be subject to the ODI Regulations as prescribed by the RBI.

Vesting of Assets & Liabilities

  • The guarantees or borrowings of the resultant company shall be repaid as per the scheme sanctioned by the NCLT. Further, they should not acquire any liability not in conformity with the Act or regulations as prescribed. A no objection certificate to this effect should be obtained from the lenders in India of the Indian company.
  • Any asset acquired can be transferred in any manner as permissible under the Act or the regulations thereunder. In cases where it cannot be held or acquired by the resultant company, it shall be sold within two years from the date of sanction of the scheme by the NCLT and the sale proceeds shall be repatriated outside India immediately through banking channels. Repayment of Indian liabilities from sale proceeds of such assets or securities within the period of two years shall be permissible.

Opening a Bank Account

The resultant company is permitted to open a Special Non-Resident Rupee Account (SNRR Account) for the purpose of for overseeing transactions related to the merger for a maximum period of two years from the date of sanction of a scheme by the NCLT.

Valuation

The valuation shall be done as per Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016 i.e., by registered valuers who are members of recognized professional bodies in the prescribed jurisdictions of the transferee company and such valuation is in accordance with internationally accepted principles on accounting and valuation.

Other Compliances

  • The resultant company and/or the companies involved in the cross-border merger shall be required to furnish reports as may be prescribed by the RBI, in consultation with the Government of India, from time to time.It is pertinent to note that at the time of sanctioning the merger of a foreign transferor body corporate with an Indian transferee company, the NCLT shall consider the validity of the merger as per the laws of the country in which the foreign body corporate has been incorporated, and any transaction on account of a cross-border merger undertaken in accordance with Cross-Border Merger regulations will be deemed to have prior approval of the RBI.

Conclusion

A range of complex issues must be navigated in an effort to successfully complete cross-border mergers. Each cross-border merger is different and implementation of these issues will greatly depend on the facts, dynamics, scale and geographic scope of both companies. The Cross-Border Regulations being fairly new, a lot of practical issues are yet to be identified and shall be addressed as and when encountered in the due course of time.

Authors: Ms. Ifla. A and Ms. Shruthi Shenoy, associates at NovoJuris Legal.

[1]Section 2(42) of the Companies Act 2013 defines Foreign Company as any company or body corporate incorporated outside India which: (a) has a place of business in India whether by itself or through an agent, physically or through electronic mode; and (b) conducts any business activity in India in any other manner.

Update: Regulatory Department of Industrial Policy and Promotion (DIPP) Notification on Definition of Start-ups

The Department of Industrial Policy and Promotion (DIPP) vide its notification dated 11 April 2018 has amended its previous notification dated 23 May 2017 on the eligibility guidelines for ‘start-ups’. This notification is in suppression of the earlier notification dated 23 May 2017.

Definition of Start-Up:

An entity shall be considered as a start-up:

  • up to a period of 7 years from the date of incorporation/registration, if it is incorporated as a private limited company or registered as a registered partnership firm or a limited liability partnership in India. In the case of start-ups in the biotechnology sector, the period shall be up to 10 years from the date of its incorporation/ registration.
  • The turnover of the entity shall not exceed Rs.25 Crore.
  • The entity should be working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation. However, an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘start-up’.

Income Tax benefits:

Relaxation under section 80-IAC

Prior to this notification, in case of claiming tax benefits under section 80-IAC of Income Tax Act, 1961, the start-ups had to be incorporated on or after 1 April 2016, but before 1 April 2019 but as per the new notification, the period has been extended to 1 April 2021 and can claim 100% tax exemption on profits for 3 out of 7 years. With this new change, the start-ups shall enjoy income tax benefit for 3 out of 7 consecutive assessment years. Further, the Certification from the Inter-Ministerial Board is necessary to avail such exemption.

Tax benefit under section 56 (2) (viib) of Income Tax Act 1961

As per section 56(2) (viib) of Income Tax Act 1961, in case of Company receiving consideration issuance of shares above Fair Market Value (FMV), then the excess of consideration above the FMV would be taxed in the hands of Company as other Income. Prior to this notification, the start-ups were exempted from the aforementioned provisions. The valuation of the Company in such case should be as per 11UA of the Income Tax Act 1961, which states that it should be as per Discounted Free Cash Flow method determined by either Merchant Banker or by Chartered Accountant.

Pursuant to this notification, the start-ups could avail such tax benefits on issue of shares for a consideration above the fair market value, only upon fulfilment of following conditions:

  1. The aggregate amount of paid-up share capital and share premium of the start-up after the proposed issue of shares should not exceed Rs.10 Crore.
  2. The investor/ proposed investor, who proposed to subscribe to the issue of shares, should either have (i) an average returned income of Rs.25 Lakh or more for the preceding three financial years or (ii) Net worth of Rs. 2 Crore or more as on the last date of the preceding financial year.
  3. The start-up has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11 UA of the Income Tax Rules 1962.

Further, start-ups shall have to make an application to Inter-Ministerial Board and obtain the approval for such exemption.

Pursuant to this notification, it shall be expensive for start-ups to obtain merchant banker certificate for such issuance. This may require clarity as rule 11UA allows both Merchant Banker or by a Chartered Accountant to issue valuation certificate. However, this notification mandates such valuation could be done by only merchant banker.

Source: https://www.startupindia.gov.in/notification.php

Regulatory update: Department of Industrial Policy and Promotion (DIPP) Notification on Definition of Startups

The Department of Industrial Policy and Promotion (DIPP) vide its notification dated 11 April 2018 has amended its previous notification dated 23 May 2017 on the eligibility guidelines for ‘start-ups’. This notification is in supersession of the earlier notification dated 23 May 2017.

Definition of Start-Up:

An entity shall be considered as a start-up:

  • up to a period of 7 years from the date of incorporation/registration, if it is incorporated as a private limited company or registered as a registered partnership firm or a limited liability partnership in India. In the case of start-ups in the biotechnology sector, the period shall be up to 10 years from the date of its incorporation/ registration.
  • The turnover of the entity shall not exceed Rs.25 Crore.
  • The entity should be working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation. However, an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘start-up’.

Income Tax benefits:

Relaxation under section 80-IAC

Prior to this notification, in case of claiming tax benefits under section 80-IAC of Income Tax Act, 1961, the start-ups had to be incorporated on or after 1 April 2016, but before 1 April 2019 but as per the new notification, the period has been extended to 1 April 2021 and can claim 100% tax exemption on profits for 3 out of 7 years. With this new change, the start-ups shall enjoy income tax benefit for 3 out of 7 consecutive assessment years. Further, the Certification from the Inter-Ministerial Board is necessary to avail such exemption.

Tax benefit under section 56 (2) (viib) of Income Tax Act 1961

As per section 56(2) (viib) of Income Tax Act 1961, in case of Company receiving consideration issuance of shares above Fair Market Value (FMV), then the excess of consideration above the FMV would be taxed in the hands of Company as other Income. Prior to this notification, the start-ups were exempted from the aforementioned provisions. The valuation of the Company in such case should be as per 11UA of the Income Tax Act 1961, which states that it should be as per Discounted Free Cash Flow method determined by either Merchant Banker or by Chartered Accountant.

Pursuant to this notification, the start-ups could avail such tax benefits on issue of shares for a consideration above the fair market value, only upon fulfilment of following conditions:

  1. The aggregate amount of paid-up share capital and share premium of the start-up after the proposed issue of shares should not exceed Rs.10 Crore.
  2. The investor/ proposed investor, who proposed to subscribe to the issue of shares, should either have (i) an average returned income of Rs.25 Lakh or more for the preceding three financial years or (ii) Net worth of Rs. 2 Crore or more as on the last date of the preceding financial year.
  3. The start-up has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11 UA of the Income Tax Rules 1962.

Further, start-ups shall have to make an application to Inter-Ministerial Board and obtain the approval for such exemption.

Pursuant to this notification, it shall be expensive for start-ups to obtain merchant banker certificate for such issuance. This may require clarity as rule 11UA allows both Merchant Banker or by a Chartered Accountant to issue valuation certificate. However, this notification mandates such valuation could be done by only merchant banker.

Source: https://www.startupindia.gov.in/notification.php

Codification of Duties of Directors under the Companies Act 2013

Introduction

While the rights, powers, and duties of Directors defined in the Articles of Association of the Company, a need was felt for legal clarity. Under the Companies Act 1956 (the Erstwhile Act), there were no explicit provisions regulating the duties of the directors of the Company.  The J.J. Irani Committee report suggested that the duties of a Director should be “inclusive, and not exhaustive in view of the fact that no rule of universal application can be formulated as to the duties of the directors.”

On the basis of the JJ Irani committee report, a specific provision governing the duties of directors was included in the Companies Act, 2013 (the Act), which applies to directors both individually as well as collectively to the Board.  The section 166 of the Act has consolidated the law governing directors’ duties making it more certain. Although this consolidation is not exhaustive, as certain duties of directors are still enumerated under other sections of the Act, for instance, Section 184 of the Act obliges a director to disclose his interest in a contract with the company, nonetheless, director’s actions are benchmarked against responsibilities explicitly identified under section 166 which directors are expected to abide by, both individually and collectively as a Board.

General principles regarding duties of Directors:

A director of a company:

  1. shall, subject to the provisions of the Act, act in accordance with the articles of association of the company.
  2. should act in good faith in order to promote the objects of the company, for the benefit of its members as a whole, and in the best interest of the company, its employees, the shareholders, the community and for the protection of the environment;
  3. shall exercise his duties with due and reasonable care, skill and diligence; shall exercise independent judgment.
  4. shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company.
  5. shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.
  6. shall not assign his office and any assignment so made shall be void.

Classification of duties of directors

These duties can broadly be classified into two categories:

  1. Duty of care, skill and diligence & independent judgement:

The duty of care, skill and diligence require directors to devote the requisite time and attention to affairs of the company, pursue issues that may arise through “red flags” and make decisions that do not expose the company to unnecessary risks.

  1. Fiduciary duties:

Fiduciary duties, on the other hand, require the directors to put the interests of the company ahead of their own personal interests. The rules that prevent conflict of interest and self-dealing on the part of directors are integral to this set of duties.

Section 166 of the Act applies to directors of all types of companies. The aforementioned directors’ duties extend to all categories of directors, including independent directors. However, in addition to Section 166, independent directors have to comply with the Code of Conduct under Schedule IV of the Act.

The Act necessitates a holistic approach to decision-making at the Board level. Codification of directors’ duties forces directors into being more accountable and responsible towards the management of a company, thereby improving transparency and corporate governance standards.

Implications of the codification of directors’ duties:

  1. Use of discretion: Exercise of discretion by a director ought to be well-founded and based on a thorough examination of all relevant facts.
  2. Full disclosure: Directors are likely to expect full disclosure of relevant information for basing their decision.
  3. Impact on nominee directors: A significant impact of section 166 (2) will be on the relationship between a nominee director and his nominating shareholder. Considering the statutory requirement for a director to act in the best interests of the members as a whole and to exercise independent judgment while deciding on a matter, a nominee director may find it difficult to harmonise his statutory, duties under section 166 with such instructions of his nominating shareholder, which most of the times are inconsistent with the interests of the company or a class of shareholders.

Non-adherence to section 166 of the Act

Breach of section 166 is an offense punishable by a fine for an amount not less than rupees one lakh but which may extend to rupees five lakh. However, where a director is guilty of making an undue gain, he will also be liable to pay to the company an amount equal to the gain.

Clarity of directors’ duties may make it easier for shareholders to initiate a class action suit for a claim of damages against the company and/or its directors, if breach of directors’ duties results in the management or conduct of the affairs of the company being run prejudicial to the interests of the company or its shareholders.

Conclusion

Given the liability of directors for non-compliance with their statutory duties, the following measures may be considered by a company and its Board:

  1. The directors should be given a thorough briefing on the statutory duties. The level of the briefing will vary depending on a director’s familiarity with his duties but should be gradually subsumed into a company’s induction process for all directors.
  2. Directors should adopt a balanced approach to decision making, and not act as a ‘Dummy’ director.
  3. If required, the board of directors should seek professional advice to understand the implications of a particular decision for making an informed decision’ after considering all relevant factors.
  4. If the Board is of the view that there is a potential conflict between two provisions of Section 166. In such conflicting situations, perhaps it will also be appropriate for the Board to hear the views of each stakeholder and seek expert advice prior to deciding on a matter.
  5. Directors should attend as many Board meetings as possible so to ensure that they are fully briefed on developments affecting the company’s business.
  6. A Nominations Committee may be constituted which should evaluate applications for directorships on an objective basis while ensuring that any new Board member, particularly an independent director, has the requisite skills and experience required for that particular position.
  7. Directors should consider on a regular basis whether a particular contractual arrangement or role performed by them can reasonably be regarded as likely to give rise to a conflict of interest. If it can be so regarded, the director concerned ought to make appropriate disclosures to the Board, in accordance with the articles of association of the company or provisions of the Act.
  8. The Company Secretary responsible for preparing Board related documents should be made aware of the requirements of Section 166 so that the Board is given adequate information, including of opinion of experts that may be relevant for an informed decision-making process.

Author: Ms. Ifla.A is an associate at NovoJuris Legal.