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The Act means business

N. R. Moorthy on the dilemmas before deemed defunct companies

COME December 13, 2002, a new class of companies will emerge. The Companies (Amendment) Act, 2000 has made a significant amendment to the Companies Act, 1956. Clause (iii) of sub-section (1) of Section 3 has been amended defining a ``private company'' as one having a minimum paid-up capital of Rs 1 lakh or such higher paid-up capital as may be prescribed, and so on. Clause (iv) has been added to include ``public company'', meaning one which a) is not a private company; b) has a minimum paid-up capital o f Rs 5 lakh or such other higher paid-up capital as may be prescribed; and c) is a private company which is a subsidiary of a company which is not a private company.

It should be noted that for the first time in corporate history a benchmark has been prescribed for incorporating a company. This is done in order to discourage companies being incorporated with no immediate intention to carry on any business but to be s old as such off the shelf.

The amendment does not end there. Sub-Section (3) of Section 3 commands that every private company existing on the commencement of the Amendment Act, that is, December 13, 2000, with a paid-up capital of less than Rs 1 lakh, shall, within two years from such commencement (that is, before December 13, 2002) enhance its paid-up capital to Rs 1 lakh.

Sub-Section (4) adumbrates that every public company with a paid-up capital of less than Rs 5 lakh should enhance its paid-up capital before the designated date to the stipulated level of Rs 5 lakh. Sub-Section (5) says that where a private or public com pany fails to enhance its paid-up capital as specified above within the stipulated time it ``shall be deemed to be a defunct company within the meaning of Section 560'' of the Act.

It is needless to emphasise that the paid-up capital can include preference share capital or equity shares issued with differential rights pursuant to the provisions of Section 86 of the Act, including non-voting shares.

It would have been simpler if the new dispensation was made applicable to companies incorporated after the commencement of the Amendment Act and not applied retrospectively. This is where the dichotomy starts. What are the implications and ramifications of the new order?

No specific penal provision is made for contravention of this provision. Consequently, Section 629A has to be invoked if any penal action, apart from striking the name of the company, is contemplated. Under this provision, the company which is in default or such other person shall be punishable with fine that may extend to Rs 5,000 and where the contravention is a continuing one with a further fine which may extend to Rs 500 for every day after the first during which the contravention continues.

Obviously, a defunct company cannot be penalised. Who then is ``such other person''? Whether it is the director of the company or the ``officer in default'' is a moot point.

The crux of the problem is the modality to be followed for striking off the name of such companies which do not meet the minimum capital criterion. The language of the section creates a riddle. Such companies shall be deemed to be defunct within the mean ing of Section 560 of the Act. Companies which have not enhanced their paid-up capital to the entry level but are in fact in operation cannot be considered as defunct within the meaning of Section 560.

For the purpose of Section 560, the test to be satisfied is that the Registrar of Companies (RoC), after following the procedure outlined in the said Section, must be satisfied that ``he has reasonable cause to believe that a company is not carrying on b usiness or in operation.'' The companies which are functional and file their balance-sheets, annual returns and such other documents/returns regularly cannot be bracketed with those which do not adhere to such requirements.

In the case of Section 560 defunct companies, the RoC will set the ball rolling by writing a letter ``enquiring whether the company is carrying on business or in operation''. In the case of Section 3 companies, failure to meet the capital adequacy for re gistration is visited with the fate of being deemed defunct and, accordingly, their names being struck off the register pursuant to a legislative diktat.

The policy followed with regard to weeding out the defunct companies is: Where it appears from the latest available balance-sheet of a defunct company that it has adequate realisable assets, steps are taken to push the company into compulsory liquidation . On the other hand, if the company has no assets or has such assets as would not be sufficient to meet the cost of liquidation, steps are taken to strike its name off the register under Section 560.

Insofar as the creditors are concerned, they are not denied the right of recourse to the directors or any other officer of the company or members. Therefore, the RoC has to ensure before striking off the name of a company pursuant to Section 3 that the c reditors' claims are satisfied in full. This process will take some time. There may be ongoing jobs in hand which will need to be completed.

So, adequate time has to be allowed to fulfil the requirement and, as a consequence, any lapse can be safely said to be deliberate. On the other hand, the companies can contend that hitherto they had carried on business without much equity capital and th at they do not find the need to do so.

Another vital aspect is that Sub-Section (6) of Section 560 provides that if any member or creditor feels aggrieved by the company having been struck off, an application can be made to a competent court before the expiry of 20 years for restoration of th e name of the company. The court can order restoration of the name of the company. Such a relief will not be available to those companies falling under Section 3.

In sum, it must be stressed that a detailed procedure needs to be outlined and, if necessary, rules may be prescribed so that the modalities are clear. This will need an amendment to the existing provision. There is still time to set matters right and it is hoped that the Department of Company Affairs will act within reasonable time so as to bring about clarity.