INTRODUCTION:

Beneficial ownership is defined as ownership in which the possessor retains control over the asset and ultimately benefits from its revenue. In 2019, guidelines were issued by the Ministry of Corporate Affairs, which is responsible for the enforcement of Indian corporate law, regarding the recognition of substantial beneficial ownership or ownership in Indian firms. Despite the fact that beneficial ownership is acknowledged in for an extended period of time. Indian corporate law predominantly relied on the self-admitted admissions of registered shareholders regarding the beneficial ownership of those shares.

According to Section 90(1) of the Act1, an individual is considered a significant beneficial owner if they "hold beneficial interests in company shares amounting to at least 25% or another specified percentage, either directly or indirectly, whether alone or in conjunction with one or more other persons or trusts, including trusts and persons residing outside India." Additionally, they must have the authority to exercise or actually exercise substantial influence or control, as defined in the Act. The Central Government may, at its discretion, relax the restrictions outlined in this paragraph for particular categories. As an illustration, Mr. Ajay possesses Substantial Beneficial Ownership in OPQ Limited if he owns a majority stake in ZMD Limited exceeding half of the shares and ZMD Limited owns 12% of the shares in OPQ Limited.

In the SBO Regulations, "significant influence" and "control" will mean: The ability to directly or indirectly influence a reporting firm's financial and operational policy choices is called "significant influence," not control or joint control. Control must include the ability to choose a majority of the management or policy-making board of directors. This power may be exercised via ownership or management rights, shareholder or voting agreements, or other mechanisms. A person or organisation must exercise rights or entitlements, except significant influence or control, indirectly, directly, or both. This law applies to SBOs, which must be acknowledged. A person must indirectly exercise rights or privileges to be an SBO. Direct shareholders of the Company's common shares do not get 15% owner status. The Act defines Significant Influence and Control. Significant Influence is the ability to directly or indirectly influence the reporting firm's financial and operational policy choices without control.

SBO EVOLUTION

The 1989 Financial Action Task Force released proposals on beneficial ownership to fight money laundering, terrorism financing, and other financial crimes threatening the global financial system. The FATF defines beneficial ownership as both the client's ultimate owner or controller and the natural person benefited by a transaction. Members of a legal body or agreement who make decisions are also included. The Companies (Significant Beneficial Owner) Amendment Regulations, 20192, released by the MCA3. Company disclosure responsibilities for substantial beneficial owners are outlined in Section 90 of the Companies Act of 20134. The Financial Action Task Force (FATF) guidelines announced Section 905 and Regulations in June 2018 to combat money laundering and terrorism funding. According to the FATF, nations should avoid employing legal companies for money laundering or terrorism financing and ensuring authorised authorities have access to accurate and timely information on legal company ownership and management.

UNDERSTANDING OF RIGHTS AND PRIVILEGES

A group of individuals or an individual seeking SBO status must utilise the rights and privileges granted by the Act, which can be of assistance in that regard. The following are the privileges or entitlements:

  • An SBO is a person or group with at least 10% of the company's outstanding shares. The percentage of shares owned by the SBO in the Reporting Company is determined by the number of shares held by the SBO. Equity shares, global depository receipts, forced convertible preference shares, and CCDs are considered shares for SBO purposes.
  • Note that convertible instruments may contribute to the 10% or greater limit without being converted into equity shares. Further limits of 10% or more limit the number of equity shares, CCPS, and CCD. They must own at least 10% of the voting power in the Reporting Company's shares, either directly or indirectly.
  • Direct or indirect owners of 10% or more voting rights in the Reporting Company's shares must be declared as SBOs proportionally. Since neither CCPS nor CCD has voting rights, only equity voting rights will be considered. Owners of redeemable or convertible preference shares cannot exercise their acquired voting rights. It is entitled to receive or share at least 10% of all dividends or other payments in a fiscal year, directly or indirectly.
  • If a shareholder gets or has the right to receive 10% of the Reporting Company's total distributable dividend, either directly or indirectly, they are considered an SBO for the proportion of dividend rights possessed. Although not specified, another distribution aligns with the interests reported on CCD forms.

The Rules have changed the beneficial ownership concept from just relying on shareholder disclosure to requiring firms to identify SBO. Identifying SBO may be challenging when people, including shareholders, collaborate without disclosing beneficial ownership at the business. The Regulations do not prescribe any steps in this unique scenario, and it is unclear how the business might expose SBO. It is unclear whether connected parties' shares will need to be clubbed for future SBO eligibility. This situation requires massive influence to determine SBO.

The Guidelines do not define what constitutes involvement in financial and operational policy choices made by the organization:

  • Reducing the threshold to 10% is an extra-statutory breach of the Act:

The Rules have changed the beneficial ownership concept from just relying on shareholder disclosure to requiring firms to identify SBO. Identifying SBO may be challenging when people, including shareholders, collaborate without disclosing beneficial ownership at the business. The Regulations do not prescribe any steps in this unique scenario, and it is unclear how the business might expose SBO. It is unclear whether connected parties' shares will need to be clubbed for future SBO eligibility. This situation requires massive influence to determine SBO.

In Rajnarain Singh v Chairman6, Patna Administration Committee ('Rajnarain Singh'), the Supreme Court ruled that administrative authorities may only make modest changes to present or future laws. There are several interpretations on what constitutes an important trait, but one thing is clear: it cannot include policy changes. According to Supreme Court rulings in Re: The Delhi Laws Act, 19127 and Raj Narain Singh v Chairman,8 the legislature has the "essential legislative role" of creating and expressing legislative policy, which cannot be delegated to the executive branch. Section 90(1)9 asserts that the Parliament has the power to lower the threshold to less than 25%, as it is an "essential legislative function" that cannot be delegated to the MCA.

  • Misuse is possible under Section 90(7)

According to Section 90(5)10 of the Act, a company must notify any individual believed to be an SBO, who knows the identity of an SBO, or who was an SBO within three years of the notification date and is not listed as a significant beneficial owner. After the notice expires, the firm must request limitations on interest transfers, suspension of share rights, and any other relevant restrictions from the NCLT within 15 days. The corporation can request limitations on share rights, including transfer restrictions, dividend suspension, voting rights suspension, and other restrictions, through the NCLT, as per Rule 7 of the SBO Rules11.

Section 90(7) of the Act is very susceptible to exploitation, especially in cases of majority-minority shareholder disagreements. In such circumstances, the majority shareholder might petition the NCLT under Section 90(7)12, arguing that the minority shareholder has not completed an SBO declaration or provided inadequate information. If the NCLT makes the same ruling, minority shareholders may face substantial consequences, including suspension of voting, dividend, and other rights.

Section 90(7) poses a danger to Indian private equity investors with a strong minority stake in Indian firms. If the promoter and PE investor disagree, the promoter may petition the NCLT to suspend the PE investor's voting, dividend, and other rights and transfer their shares to the Investor Education and Protection Fund if the PE investor's SBO claims were wrong or inadequate.

  • Equity and Preferred Shares or Equity only:

Depending on the concept of beneficial interest in Sections 89(10)13 and 9014, opinions vary on whether equity and preference shares, or simply equity shares and convertible instruments, should be considered for SBO determination. One theory suggests that for determining the ownership criterion for SBO recognition, both equity and preference shares should be considered. According to Part VI of the SBO Rules, only equity shares, Global Depository Receipts, Cumulative Convertible Preference Shares, and Cumulative Convertible Debentures may be utilised to determine the 10% requirement.

The opposition suggests evaluating Redeemable Preference Shares (RPS) through the definitions of beneficial interest under section 89(10) and majority stake under Rule 2(1)(d)(iii) of the SBO Rules15 if the individual has rights to receive or participate in more than 50% of the distributable dividend, including RPS dividends. The phrase "shares" appears in Act Sections 8916 and 9017. In Telco v Gramme Panchayat, Pimpri18, the Supreme Court declared that guidelines created under parent law might be used to interpret the parent statute.

CONCLUSION:

The new Regulations enhance regulatory burden by enforcing beneficial ownership criteria to limit multi-layered corporate organisations for money laundering and tax evasion. Additionally, they have increased rules and impediments for legal commercial activities. In addition to due diligence, investors must verify that all parties have completed appropriate documents and disclosures to prevent future disputes about the seller's ability or authority to transfer shares. Declaring an SBO is not only based on the percentage of ownership, since the regulation may be subjectively interpreted. The SBO definition and section 90 duties require each share to be recognised as a bundle of rights, including voting and dividend rights, which are transferable. Thus, one share may have several beneficial owners. Reviewing shareholder agreements and voting agreements may be necessary to determine whether they trigger filing responsibilities under sections 89 and 90 of the Act.

BIBLIOGRAPHY/ REFERNCES:

  • Companies Act 2013, s 90.
  • Companies Act 2013, s 89.
  • Companies (Significant Beneficial Owners) Amendment Rules 2019.
  • Companies (Significant Beneficial Owners) Rules 2018
  • Rajnarain Singh v ChairmanAIR (1954) SC 569.
  • Re: The Delhi Laws Act, 1912 [AIR (1951) SC 332].
  • Raj Narain Singh v ChairmanAIR (1954) SC 569.
  • Telco v Gramme Panchayat, Pimpri(1976) AIR 2463.

Footnotes

1. Companies Act 2013, s 90(1).

2. Companies (Significant Beneficial Owners) Amendment Rules 2019.

3. Companies (Significant Beneficial Owners) Rules 2018.

4. Companies Act 2013, s 90.

5. Companies Act 2013, s 90.

6. AIR (1954) SC 569.

7. 1912 AIR (1951) SC 332.

8. AIR (1954) SC 569.

9. Companies Act 2013, s 90(1).

10. Companies Act 2013, s 90(5).

11. Companies (Significant Beneficial Owners) Amendment Rules 2019.

12. Companies Act 2013, s 90(7).

13. Companies Act 2013, s 89(10).

14. Companies Act 2013, s 90.

15. Companies (Significant Beneficial Owners) Amendment Rules 2019.

16. Companies Act 2013, s 89.

17. Companies Act 2013, s 90.

18. (1976) AIR 2463.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.