Union Budget 2021-22 – Impact on the Corporate Law

 

By Akash Kumar Prasad, for Legal Corner LLP. Akash is a fifth year student of NALSAR University of Law and will be graduating in 2021. 

The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me (chetana@legalcornerllp.com) to get legal advice that is specific to your business needs. 

On 1 February 2021, the Hon’ble Finance Minister presented the Union Budget 2021-22. While the Union Budget for the FY 2021-2022 was focused on infrastructure development, it also brought in several significant changes in the area of corporate laws. Changes have been proposed to decriminalize the LLP Act, 2008, increase in the threshold of the definition for small companies, introduction of an updated version of the MCA, changes in the OPC framework, increase in the FDI limits in an insurance company, etc.

Change in definition of ‘small company’

Section 2(85) of the CA, 2013 defines the term ‘small company’ as any company other than public company having paid up share capital not exceeding fifty lakh rupees and turnover not exceeding two crore rupees. It has been proposed in the Budget, to revise the definition of Small Companies by increasing the thresholds for paid up share capital from “not exceeding fifty lakhs rupees” to “not exceeding two crore rupees” and turnover from “not exceeding two crore” to “not exceeding twenty crore rupees”. The increase in thresholds will bring more than 2 lakh additional companies under the definition of ‘small company’ which can have a lower compliance burden including lower penalties for violations and lower filing requirements. Therefore, this proposal can surely be seen as an important drive for ease of doing business.

Changes to One Person (OPC) Company Network

Rule 6(1) of the Companies (Incorporation) Rules, 2014 provides for mandatory conversion of OPC into a Public Company or a Private Company as where the paid up share capital of an One Person Company exceeds fifty lakh rupees or its average annual turnover during the relevant period exceeds two crore rupees, it shall cease to be entitled to continue as a One Person Company. Now, by the Union Budget, Government has removed the limit of paid up share capital and turnover for conversion of OPC which is mostly done by the start-ups. Another important change for OPC has been proposed by relaxing the eligibility of person for such company. The criterion of 182 days has been reduced to 120 days to allow Non-Resident Indians to operate OPCs in India. These amendments with respect to OPC will give relief to these companies as the threshold limit of paid up share capital and turnover burdened the companies with the burden of conversion. Furthermore, it has also been proposed to allow Non-Resident Indians to operate OPCs in India and also some tax Incentives for start-up and Innovators like claiming tax holiday till March 31, 2022 has been proposed.

Decriminalization of offences under Limited Liability Act, 2008 (LLP Act)

Considering the fact that the Government has completed taking its steps for decriminalization of offences by amending the Companies Act, 2013, Finance Minister in her speech mentioned that it is now the time for decriminalization of the offences under the LLP Act. Having said that, it is important to note that the Government has already started taking tangible steps for giving effect to this proposal. The Company Law Committee (CLC) has presented/issued its Report of the Company Law Committee on Decriminalization of the Limited Liability Partnership Act, 2008 to the Ministry of Corporate Affairs on 4th January, 2021 for decriminalization of certain compoundable offences and shifting them to the In-house Adjudication Mechanism. The said Report proposes to decriminalize 12 offences and 1 penal provision has been proposed to be omitted. The motive behind the same is to de-clog the courts or the NCLTs thereby reducing their burden from non-serious matters. Further, the Report not only contains changes in the LLP Act for decriminalization of offences but also travels much beyond. Some of the other major changes in this regard consists of introduction of explicit provisions for issuance of secured NCDs by LLPs, restricting the merger of LLPs with companies, introduction of accounting standards for certain classes of LLPs, etc. Besides this, the Report also introduces changes in the definition of business of LLPS, alignment of the reference with that of the Companies Act, 2013 (CA, 2013) and much more.

Increased FDI in insurance companies

The main proposal for insurance companies in the Budget is to increase the permissible FDI limits such companies from the current 49% to 74%. Further, the said increased limit has been proposed with several safeguards with respect to ownership and control which includes: majority of Directors on the Board and Key Managerial Persons (KMP) to be resident of India; independent directors- at least 50% of the directors to be independent directors; and specified percentage of profits being retained as general reserve. Further, it is also imperative to mention about the IRDA (Indian Owned and Controlled Guidelines) which currently provides a limit of 49% of foreign shareholding in an Indian insurance company. Considering the aforesaid proposal, the said limit will be changed to reflect the increased limit.

Strengthening of NCLT framework

It has been proposed to strengthen the NCLT framework to ensure faster resolution of cases. In light of the new normal and increased emphasis on Digital India, e-Courts have been proposed to be implemented. Further, with a similar intent and to further provide an alternate mode of debt resolution, a separate framework is also proposed for the cases involving the MSMEs.

Securities Market Code

The Budget has proposed to consolidate the provisions of following laws relating to securities market into a rationalized single Code to be termed as “Securities Market Code”: SEBI Act 1992, Depositories Act 1996, Securities Contracts (Regulation) Act 1956, and Government Securities Act 2007.

Conclusion

Small company status offers relaxation from various provisions of CA 2013 and eases compliance burden on them. As mentioned in the budget speech, the increase in the threshold limit for a small company is likely to benefit 200,000 companies. Changes to the OPC regulatory framework offers motivation to grow without any restriction of paid-up capital and turnover, augmenting foreign capital and technology. Recognition of Start-up Company as a class of company for the purpose of fast track merger allows start-up option to explore restructuring without necessarily going to the National Company Law Tribunal (NCLT) for sanction. Overall, the thrust of budget on company matters aims at facilitating ease of doing business.

If you have any questions, please email me at chetana@legalcornerllp.com . I will be happy to set up a free consultation.

Introduction to Equity Crowdfunding

 

By Charith Reddy, for Legal Corner LLP. Akash is a fifth year student of NALSAR University of Law and will be graduating in 2021. 

The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me (chetana@legalcornerllp.com) to get legal advice that is specific to your business needs. 

Equity crowdfunding refers to a method of financing often utilized by startups and other early-stage companies, wherein, the company issues shares to a broader set of unsophisticated individual investors in exchange for the required funds. Equity crowdfunding focuses on obtaining nominal amounts from a larger pool of investors, who are often referred to as “the crowd”. Although an age-old practice, the concentrated presence of crowdfunding on websites, social media platforms and other internet-based forums points towards the importance of the digitalization of world economies in facilitating and advancing crowdfunding. With its growing prominence – the global crowdfunding market is expected to reach a valuation of $28.8 billion by 2025.

Characteristics of Equity Crowdfunding.

Equity crowdfunding sets itself apart from the other forms of raising capital by laying greater emphasis on raising funds from a larger and more diverse pool of unaccredited investors. By giving the larger public an opportunity to participate in the investment processes, equity crowdfunding also democratizes the process of raising funds. Another major distinction is that equity crowdfunding does not fit into the conventional forms of raising funds through the issuance of shares. It neither resembles a public offering as it enables private companies to raise funds from the larger public nor does it resemble a private placement of shares as the companies raise funds from the larger public. Equity crowdfunding remains an exception to the conventional rule of only permitting public companies whose shares are listed on stock exchanges to raise funds from the public as it lets private companies do the same. Equity crowdfunding also gives the companies complete autonomy and control over the offering of shares – from pricing and quantity of shares to the valuation of the company. The highly digitalized process also reduces the financial and regulatory burden imposed on a company raising funds through equity crowdfunding. In this manner, equity crowdfunding remains to provide easy access to capital while also ensuring lucrative returns.

Risks with Equity Crowdfunding.

The risks and drawbacks associated with equity crowdfunding have often overshadowed the benefits derived from it in the eyes of the various stakeholders. For instance, for the market regulators, the biggest risk is that of the investors being defrauded or scammed in the absence of a defined legal framework. This has prompted various market regulators to either restrict or prohibit crowdfunding in their respective jurisdictions. This risk is further aggravated by the digitalization of the process and the subsequent relaxation in disclosure requirements. This puts the investors at a higher risk of fraud as this enables information asymmetry between the company and the investors. Apart from that, the investors also face a problem of low liquidity as there might be very limited exit options. Finally, in the eyes of the borrowers, equity crowdfunding leads to a dilution of equity without any dilution in the managerial powers in the company. However, this might be a disincentive for those companies as they might lose out on the expertise and professionalism that is derived from Venture Capitalists and Angel Investors investing in them. Due to the abovementioned reasons, equity crowdfunding has remained a contentious issue in most jurisdictions. Although the importance and value of equity crowdfunding is slowly being realized – the market regulators have remained reluctant to introduce the necessary reforms in the securities regulations or have introduced restricted reforms. In this context, the article will now look at the status of crowdfunding in India.

Equity Crowdfunding in India

In India, the securities market regulator (SEBI) has prohibited equity crowdfunding, while allowing for other methods of crowdfunding such as donation and reward-based crowdfunding. This exclusion mainly stems from the reasoning that the other models of crowdfunding do not present any element of financial returns.

The Securities and Exchange Board of India (SEBI) had released a consultation paper on the introduction of equity crowdfunding in 2014. The paper focused on established a regulatory framework for Small and Medium Enterprises (SMEs) and startups to raise funds through equity crowdfunding. The paper proposed guidelines to regulate various aspects – such as the eligibility of investors and companies, and limits on the capital that can be raised etc.

The lack of financial education and awareness in the general public in India has ensured that none of the reforms suggested in the consultation paper have come to fruition. India’s reluctance to introduce a regulatory framework to allow for equity crowdfunding has cost India the opportunity to capitalize on the emergence of the startup culture in India which has a constant need for funding.

The major roadblocks in India have been the existing legislations. The stringent clauses regarding the raising of funds in these legislations have been shaped by a history of corporate scandals that had devastated the Indian economy in the past. For instance, the Companies Act, 2013 requires companies to comply with and adhere to a cumbersome and expensive process before they can raise funds from the general public. This whole process is not only time consuming but is also expensive and intrusive as it consists of a host of disclosures and compliances. In this manner, despite SEBI’s interest in creating a restricted legislative framework for equity crowdfunding, it has never been able to gain a foothold in India. Hence, equity crowdfunding has proved to be a regulatory conundrum for the market regulators in their attempt to balance the needs of the startups and SMEs on one hand and the interests of the investors on the other. For instance, to protect the interests of the investors, it would require the market regulator to impose disclosure requirements and compliances which would then make it a costly affair for startups. Hence, it is important that the regulatory framework be introduced which not only satisfies the funding needs of these startups, but also safeguards the interests of the investors.  At the present however, equity-based crowdfunding is largely restricted to private placement of shares by companies and these crowdfunding platforms are to be registered as Alternate Investment Funds (AIFs). These improper classifications have their own share of restrictions and drawbacks which further impede the growth of equity crowdfunding in the country.

If you have any questions, please email me at chetana@legalcornerllp.com . I will be happy to set up a free consultation.

Equity Crowdfunding in the US

By Sparsh Khosla, for Legal Corner LLP. Sparsh is a second year student of NALSAR University of Law and will be graduating in 2024. 

The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me (chetana@legalcornerllp.com) to get legal advice that is specific to your business needs. 

Since the beginning of the 21^st century, there has been an exponential increase in the digitisation of most activities. So much so, that purely financial activities such as transactions which need high security have shifted to the online mode. This has been used by some businesses to break the conventional methods of raising capital, particularly by small companies who might want to raise capital in exchange of securities as debt financing is not a good option for them. This method of raising capital in exchange of securities is called equity funding. When it is done on a platform where it is accessible to a large number of people, it is called Equity Crowdfunding.

Equity Crowdfunding under the JOBS Act

Title 3 of the Jumpstart Our Business Start-ups (JOBS) Act is wholly devoted to Equity Crowdfunding for Start-ups. The Equity Crowdfunding operation under the JOBS Act has two parties and an intermediary. The two parties are the investor and the start-up, which is known as the issuer. The issuer sells securities over an internet platform to an investor with the help of an intermediary, a broker or a funding portal. A securities transaction would require registration with the commission and compliance arising out of the same under the Exchange Act. But there is an exemption under the JOBS Act for registration of the securities offered through Equity Crowdfunding. This exemption will only be applicable if the investor and start-ups have followed the SEC’s monetary restrictions.

Restrictions for the Investor

The monetary restrictions are in place for both the investors and the issuer. With respect to the investors, the SEC’s significant restriction is on the amount of money invested by an individual in a one or more issuers over a year. The limitation is as low as 2000 dollars or 5 per cent of the annual income/net worth, whichever is higher, for individuals whose annual income or net worth is lower than 100,000 dollars. This stringent rule has been put in place because the shares of small businesses have higher volatility and are considered to be high-risk investments. Even if an individual has an annual income higher than 100,000 dollars, he can only invest 10 per cent of the annual income or net worth, whichever is lower.

Balance of interests

There are two interests which the US Securities and Exchange Commission (SEC) has to balance while formulating the rules for Equity Crowdfunding. The first is the start-up’s interest which is to raise money to expand its operations or in some cases, survive. The second interest is of the investors to earn profits from the money that has been invested by them. The mandate of the SEC motivates the commission to prioritise the investor’s interests. Hence, most of the rules have been formulated to protect the investor’s interest in such transactions which increases the compliance requirements for the issuer.

Compliance for the issuer

The compliance for the issuer is manifold. First, there are the requirements to disclose certain information in order to gain access to crowdfunding as stipulated by section 4 of the Securities Act. This information concerns the basic functioning of the start-up. It includes a wide array of topics from the issuer’s legal status and address to the issuer’s financials. This data is collected to give the investors an idea about the standing of the start-up. Additional compliance requirements relate to the disclosure of ongoing activities at the start-up in the form of annual reports and filling out other forms. These rules have been put in place to ensure that the investors are well-equipped with the information regarding the issuer before buying the securities. Such a requirement does increase the overall time taken and costs involved for raising capital. But the issuer is the entity seeking investment, and it is incumbent upon the SEC to ensure that the investors are not making ill-informed decisions.

Role of Funding portals and their role

The funding portals are intermediaries which are specific to equity crowdfunding. The SEC has made the registration of these funding portals mandatory in its supplementary rules. The existing brokers were also given the rights to become intermediaries in such transactions after complying with the regulations. There is one obvious stipulation to eliminate bias and chances of collusion. This stipulation is that the intermediary or its directors should not have a financial interest in the issuer. One exception is made to this rule where the issuer can compensate the intermediary for its services. This compensation has to be in the form of securities similar to those issued in the crowdfunding operation. The benefit of this exception is two-fold. First, the exception gives the smaller start-ups who could not have otherwise afforded the funding portals’ services, a chance to conduct a crowdfunding operation. Second, alignment of the interests of the investor and the intermediary reduces the scope for fraud or collusion between the intermediary and the issuer.

Provisions for tackling fraud

Several restrictions have been put in place to ensure that the incidence of fraud is minimum in equity crowdfunding operations. These regulations include the requirement of a reasonable basis for the intermediary to believe that the issuer as complied with the rules and it has established a means to create a record of all the present and future security holders. Additionally, the rules also compel the intermediary to deny access to its platform if it has a reasonable basis to believe that the compliance is inadequate or the issuer is eligible for disqualification. Such provisions do make an effort in a decent direction but put a hefty burden on the intermediary to tackle fraud. This increases the chances of collusion between the intermediary and the issuer because of the absence of other actors keeping a check on fraud-related activities.

Conclusion

Internet-based Equity crowdfunding is an innovative way tuned to the modern needs of both the investors and start-ups. The SEC making rules for keeping illegal activities in check and requiring disclosure from the issuer makes this method, safer and more reliable. This creates another way of raising capital more lucrative and empowers small businesses, especially youth innovators and entrepreneurs. But the heavy compliance makes the whole process complicated and more expensive. This has motivated several scholars and lawyers to believe that the rules do more harm than good to the entrepreneurs. The effectiveness of this operation is highly uncertain, and there should be research conducted on the same. The publication of reports on its effectivity might help the SEC develop the rules, and the balance might shift towards the issuers. On the other hand, the SEC may keep the protection of the investors’ interest as its priority, and there is a chance that the rules may remain unchanged.  In summation, the provisions and regulations have opened up a new avenue for raising capital, and comprehensive legal discussion on the same may lead to the development of the same in the future.

If you have any questions, please email me at chetana@legalcornerllp.com . I will be happy to set up a free consultation.

An Introduction to Investment Arbitration

By Harshvardhan Tripathi, for Legal Corner LLP. Harshvardhan is a fifth year student of NALSAR University of Law and will be graduating in 2022.

The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me (chetana@legalcornerllp.com) if you are planning to consider incorporate or expand your existing business in the US so as to get legal advice that is specific to your business needs

Investment arbitration is a procedure to resolve disputes between foreign investors and the host States. It is more specifically called investor-state dispute settlement mechanism. The possibility for a foreign investor to sue the host state is a guarantee for the foreign investor that in case there occurs a dispute between them the investor will have access to arbitrators who are independent and possess sufficient experience and qualification to resolve the dispute in an effective manner and render A final enforceable award.

This mechanism allows the foreign investors to circumvent domestic codes of the country which might otherwise be perceived to be biased towards the state, or lack sufficient independence. It allows resolution of disputes as per international treaties which provide different kinds of protection to the investor.

The Crucial element of consent in Investment arbitration

In order  for the foreign investor to initiate and investment arbitration  the host state must consent to such an arbitration.

Such consent to investment arbitration is usually given by the host States in international investment agreements, bilateral investment treaties(BITs), as well as free trade agreements and multilateral agreements such as The Energy Charter Treaty.

Other ways in which the consent can be given is through an investment agreement concluded directly between a state and a foreign investor, or when such a consent is contained in the domestic law of the host state such as in the Mining or the investment law. The United Nations UNCTAD maintains a list of International treaties and instruments which provide for the host state consent to investment arbitration and this should be consulted at the outside of any potential dispute to see whether investment arbitration is envisaged under such laws.

The substancial protections provided to foreign investors are dependent upon the international investment agreement under which the claims have been raised by the investor. Such protection is different from the protections that are provided by the domestic law of the host state and there may be such scenarios where the protection provided by the former may in fact be greater than the  latter.

The most common protections provided to the foreign investors are:

1.  Protection from expropriation
2.  Fair and equitable treatment
3.  National treatment
4.  Most favoured Nation treatment
5.  The freedom to transfer funds
6.  Complete protection and security

Each of the aforementioned protections are defined under the international law and have significant jurisprudence behind them. However one must be mindful that the scope of these protections is hotly debated in the international arbitration jurisprudence and the jurisprudence is non binding upon the arbitral tribunals and is only persuasive.

Cooling off period 

Majority of the investment arbitration agreements provide for a cooling off period of usually six months where the foreign investor and the host state are encouraged to negotiate their disputes and reach upon an amicable solution. This cooling off period begins typically when a notice of intent to initiate arbitration proceedings against the host state is served by the foreign investor upon the host state. The parties engage in negotiation and mediation, and in case they are not able to resolve the dispute amicably through ADR mechanism, the foreign investor then has to file a request for arbitration as per the applicable rules of arbitration in the arbitration agreement.

On the other hand in some cases, the investor may be obliged by the arbitration agreement upon which it claim is based to exhaust all effective domestic legal remedies prior to initiating a claim in arbitration.

Then there are cases in which other arbitration agreements force the foreign investor to either choose to file a suit against the host state before domestic courts or before an international arbitral Tribunal. Such clauses are commonly referred as ‘fork in the road’ clauses. It is important for a foreign investor to review the instrument that contains the consent of the host state before initiating proceedings, because if the investor approaches the domestic courts of the host state first they may later be barred from initiating arbitration.

Institutional investment arbitration versus Ad Hoc investment arbitration

International Centre for Settlement of Investment Disputes (ICSID) is the most popular and the most renowned arbitration institution which administers investment arbitration cases. It is based in Washington DC is utilised by parties from across continents.

Other popular Institutions include the Stockholm Chamber of Commerce, the Permanent Court of Arbitration and the International Chamber of Commerce.

If however the arbitration agreement does not provide for an arbitration institution to adminster the proceedings, then it is considered an Ad Hoc arbitration. In most cases,  such Ad Hoc arbitrations are governed by the UNCITRAL  ad hoc arbitration rules. It is usually considered that ad hoc arbitrations are more cost effective as compared to the ICSID  administered arbitration, however this opinion is not substantiated by statistics released by the institutions.

Time and Cost associated with Investment Arbitration

On an average, investment arbitrations proceeding stretch for slightly above three years. According to the statistics released by ICSID in 2015, the average length of investment arbitration cases was on average 39 months.

Although there are no appeals of investment arbitration awards, the arbitral rules under which the claim is brought do provide for limited grounds for the annulment or setting aside of an arbitral award. For instance,  the ICSID  the rules allow for the annulment of an award if

1.  the Tribunal was not constituted properly
2.  the Tribunal manifestly exceeded its power
3.  there was corruption on the part of a member of the Tribunal
4.  there has been a serious departure from a fundamental rule of procedure
5.  that the award has failed to state the reasons on which it is based

Investment of iterations are known to have significant cost and this may discourage foreign investors from relying upon this mechanism of dispute resolution. As per a available statistic, the average costs for the claimant were USD 4,437,000 and average respondent costs were USD 4,559,000 for investment arbitrations, while average tribunal costs were USD 746,000.

In case the parties are unable to cover their cost for the arbitration,  another option available to them is to obtain funding from specialised third party funders who provide funds to persue investment arbitration cases in return for a stake in the financial outcome of the arbitration. However one must remember that obtaining third party funding is a difficult and a time intensive process and it is only provided in the strongest cases.

According to some studies that have been conducted,  claimants have 41% success rate in investment arbitration whereas respondent win approximately 59% of the arbitrations.  Almost one fourth of the claims are dismissed on the grounds of lack of jurisdiction.

The average claim in investment arbitration is usually under 500 million US dollars. On the other hand the quantum of the average award is usually only 76 million US dollars which indicates that many of the initial claims by the investors are exaggerated.

It is definitely true that the exorbitant cost involved in initiating and responding to an investment arbitration proceeding are a huge detriment towards its popularity . Furthermore, the lack of expertise of legal counsels who specialise in investment arbitration in one’s own jjurisdiction will be huge problem while pursuing investment arbitration cases. However, the countries continue to enter into Bilateral investment treaties and it seems that despite the limitations of the process, investment arbitration is becoming increasingly popular over the years and is here to stay as a popular mechanism of resolving disputes between host states and foreign investors.

If you have any questions on choice of law, please email me at chetana@legalcornerllp.com . I will be happy to set up a free consultation.