Cracking the Whip on Shell Companies a Move That Was the Need of the Hour

Sufficient checks and balances have been introduced in the current legislative regime to curb the menace of shell companies but whether their implementation will be as ambitious, only time will tell

The Companies Act, 2013 (2013 Act) does not define 'shell' companies, however, as commonly understood, shell companies are those companies that are formally registered with the relevant authority, but which do not carry out any business activity or do not commence any business operations. This common understanding regarding shell companies is synonymous to the definition of shell companies given by the Organization for Economic Cooperation and Development (in the OECD Benchmark Definition of Foreign Direct Investment).

In the recent past, the regulator has been active in cracking down on shell companies, which have been causing menace to the economy by being the vehicle for money-laundering and other financial wrongdoings. First, the regulator struck down lakhs of shell companies across India and disqualified lakhs of directors of such shell companies, and thereafter, it came up with certain progressive amendments (discussed below) to the 2013 Act to keep a check on such companies.

Legislative Background

Section 248 of the 2013 Act, which was enforced with effect from 26 December 2016, empowers the relevant Registrar of Companies (RoC) to strike off from the register of companies (Register), the names of such companies which (the RoC has reasonable cause to believe to) have inter alia failed to commence their business within one year of their incorporation or which are not carrying on any business or operation within a period of two immediately preceding financial years and have not made applications for obtaining the status of a dormant company under the 2013 Act. Further, Section 248 also empowers a company (having the consent of at least seventy five per cent of its members) which has defaulted in respect of the aforesaid provisions to (upon extinguishing all its liabilities) make an application to the RoC to remove the name of such company from the Register.

The legal effect of such a provision is that a company whose name has been struck off from the Register ceases to operate as a company and the certificate of incorporation issued to it is deemed to have been canceled (except for the purposes of realizing any amount due to the company or for discharge of its liabilities). Accordingly, several RoCs issued lists of companies under Section 248 whose names had been struck off due to non-compliance of the provisions thereof.

It is noteworthy that the 2013 Act already contained provisions relating to disqualification of directors of companies that did not make annual filings for a continuous period of three years.

However, these provisions were clearly not enough for tackling the issue, as despite such provisions, there were numerous shell companies mushrooming in the economy.

Recent Amendments

On 21 February 2019, the Ministry of Corporate Affairs (MCA) came up with the Companies (Amendment) Second Ordinance, 2019 (Second Ordinance). The MCA, by way of the Second Ordinance (retrospectively effective from 2 November 2018), introduced sections 10A and 12(9) in the 2013 Act, whereunder a company incorporated after the Second Ordinance shall not commence any business or exercise any borrowing powers unless a declaration is filed with the RoC by its director within a period of one hundred and eighty days of the date of its incorporation that every subscriber to its memorandum has paid the value of shares agreed to be taken by him on the date of making of such declaration, and that the company has filed with the RoC within thirty days of its incorporation a verification of its registered office. A non-declaration thereof entitles the RoC to remove the name of such company from the Register.

Simultaneously with the advent of the Second Ordinance, the MCA also issued the Companies (Incorporation) Amendment Rules, 2019 (Incorporation Amendments) on the same date. The Incorporation Amendments introduced (with effect from 25 February 2019) a new Rule 25A under the Companies (Incorporation) Rules, 2014, wherein every company incorporated on or before 31 December 2017 shall file with the RoC the prescribed particulars of its registered office in Form INC-22A [Active Company Tagging Identity and Verification (ACTIVE)] on or before 15 June 2019. A nonfiling to this effect entitles the RoC to ultimately remove the name of such a company from the Register.

Therefore, by way of the Second Ordinance and the Incorporation Amendments taken together, the MCA has strongly dealt with the existing shell companies and has taken steps to deter the formation of any future shell companies.

Analysis Of Recent Amendments

On a review of the form ACTIVE, it seems that this form is a comprehensive checklist for numerous vital legislative requirements under the 2013 Act. For instance, as a prerequisite for filing of form ACTIVE, a company must have filed its annual returns and/or financial statements with the RoC (except when the company is under a management dispute). Further, the company is required to mention the number of directors, (thereby ensuring that the minimum number of directors' criteria is met) and their Director Identification Number (DIN) [thereby ensuring that their DINs are approved (and not de-activated)]. The form also requires details of the statutory auditors, chief financial officer, managing directors, whole-time directors and company secretaries, thereby ensuring their appointments, wherever required under the 2013 Act. This seems to add an extra (in addition to the already existing penalty regime) and severe consequence (of removal of the name of a company from the Register) for the foregoing noncompliances. The companies are also required to attach along with form ACTIVE, the photograph of registered office showing external building and inside office and showing therein at least one director/key managerial personnel.

It is interesting to note that whilst the non-filing of form ACTIVE on or before 15 June 2019 would end up in the non-compliant companies being marked as "ACTIVE Non-Compliant", they very well have the option to become "ACTIVE Compliant" later by filing form ACTIVE along with payment of rupees ten thousand. Further, the new amendments also provide that an "ACTIVE Non-Compliant" company shall be liable to be struck off by the RoC. However, no time period has been provided within which a company must avail the option of payment of the said amount and achieving the "ACTIVE Compliant" status in order to avoid being potentially struck off by RoC.

In light of the lesser difficulties and checks one has to face while incorporating a company in India, burgeoning of shell companies in the economy was a natural consequence. Further, the removal of the requirement of minimum paid up share capital for companies, was touted by many as a move which may give way to shell companies to thrive.

Therefore, it was the need of the hour to introduce sufficient checks and balances in the current legislative regime to curb the menace of shell companies. However, whether the implementation of the new amendments would be asambitious as the amendments themselves, is a story that only time will tell.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.