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Introductory Business Guide: India’s Legal Overview

Ahlawat & Associates

Interlegal Permanent Officer

First published in 2019 - Updated from time to time.

Introduction

In 2019, Interlegal published its first joint book called Legal and Tax Issues Around the World - Starting and Growing a Business. It is the result of collective work with the accountants' firms network EuraAudit. This article aims to introduce the legal environment of India for entrepreneurs who are interested in forming and financing their business in this country. Note that it is not equivalent to a complete professional analysis. Through this introductory guide, the network intends to help entrepreneurs to craft the questions they need to ask themselves in order to start, operate, and see their business thrive on the global stage. Therefore, Interlegal encourages entrepreneurs to obtain legal advice with Ahlawat & Associates' firm on the issues arising from starting and running a business in India.

Legal Overview

Executive Summary

The Foreign Direct Investment (FDI) policy has been dramatically liberalised since the evolution of economic reforms in India.

FDI up to 100 percent is allowed under the automatic route in most sectors/activities. However, for FDI in activities not covered under the automatic route, prior government approval is required to be obtained. Recently, the FDI norms have been tightened for the neighboring countries and now the investors from countries that share land border with India would be required to obtain prior government approval before infusing FDI in India.

Company incorporation in India has been simplified, as all filings are completed electronically, making the process more economical and smoother.

Registered Companies and Partnerships

A foreign body corporate can use the following corporate structures to enter the Indian market:

  • Incorporating a wholly owned subsidiary or through a joint venture;
  • Incorporating a Limited Liability Partnership; or
  • Setting up a liaison office/project office/branch office.

A company that is incorporated in India is deemed as a resident of India for taxation purposes.

A foreign company is deemed as a resident of India for taxation purposes if its ‘Place of Effective Management’ is in India in a given financial year.

Some business trade as partnerships. Following the introduction into Indian law of Limited Liability Partnerships (LLPs) as a legal entity, traditional partnerships are, however, becoming less popular because of the unlimited liability, and therefore significant potential exposure, of the individual partners.

LLPs enjoy various tax advantages such as lower tax rates, no dividend distribution tax or wealth tax, hence, it is more economical in comparison to a company.

Classification of Registered Companies

In India, companies are incorporated under the following three broad categories:

Companies limited by shares can be either private or public companies. The majority of companies registered in India are private companies limited by shares.

Companies limited by a guarantee. These companies are normally incorporated for non-profit making functions, with no share capital and members rather than shareholders. The members contribute a predetermined amount towards the assets of the company in the event of the company being wound up. Examples of companies which fall under this category are trade associations and co-operative societies for promoting social objects.

Companies with unlimited liability which may or may not have share capital. These companies are not very popular nor prevalent since the shareholders/members have unlimited liability in the event of the company being wound up.

Memorandum and Article of Association

The memorandum of association and the articles of association form the constitutional documents of a company.

The memorandum of association forms the foundation on which a company’s structure is built. It defines the scope of a company’s activities and provides basic details about the initial subscribers of the company.

The articles of association form the by-laws and rules which in turn define the rights, duties and powers of the management of a company, the form in which the business of the company is to be carried on and how the shareholders can exert their control over the board of directors.

There are statutorily prescribed formats for the memorandum and the articles of association, however, companies can amend them according to their business requirements.

Share Capital

Share Capital is categorized into authorized and paid-up/subscribed share capital.

The paid-up share capital of a company refers to the contribution invested by the shareholders from time to time. The subscribed share capital determines the liability of the shareholders towards the company.

Public Offer of Shares

A public offer is the offer of shares of a company to the general public and can be initiated through an Initial Public Offer. A public company can offer to sell its shares in the primary market by listing its shares on recognised stock exchanges, such as the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE). The listing of shares helps to enhance the company’s value in the long term, however, the company must comply with detailed listing regulations if it wishes to publicly list its shares.

Overall, listing is an expensive and extensive process, which involves many complex legal rules and procedures that must be followed in order to sustain in the public share market.

General Meetings

There are various decisions relating to a company that require the assent of the shareholders, particularly matters which directly concern the interests of the shareholders. Therefore, it is necessary to hold a general meeting/shareholders meeting to approve such decisions.

Each financial year, every company is required to hold an annual general meeting (AGM) in order for financial statements to be approved by the shareholders. The quorum of a valid AGM varies depending on whether the company is public or private. In a public company the mandatory quorum is 5/15/30 members (on the basis of the total number of members), however in a private company its only 2 members.

In addition to the AGM, the board of directors may, whenever it deems necessary, call an extraordinary general meeting (EGM), so that the members of the company can approve specific matters. However, over the past few years, private companies have been exempted from obtaining shareholders’ approval in an EGM, for certain decisions and these can be approved in a board meeting.

Directors

A public company must have a minimum of three directors and a private company must have a minimum of two directors.

Each director owes a fiduciary duty towards the company. Fiduciary duties are established under law and in the articles of association of each company.

In India, foreign residents can also become directors of a company. However, the company must have at least one director who, during a given financial year, has been staying in India for a total period of not less than 182 days.

Financing of a Company

There are different ways to finance a company which are as follows:

  • Investment in the share capital by shareholders or preferred investors;
  • Issuing debentures;
  • Unsecured loans from directors and their relatives;
  • Inter-corporate deposits;
  • Bank finance; and/or
  • Grants from the government in case of NPOs and start-up companies.

Before availing any financial facility, a company should, however, ensure that it complies with the applicable laws.

Directors may be required to give personal guarantees, in order for the company to take loans from banks and financial institutions. In these cases, the advantage of limited liability is negated.

Commencement of Business

In India, before a company may commence its business, it needs to fulfil various statutory requirements, such as obtaining a Certificate for Commencement of Business from Registrar of Companies along with other relevant licenses for operating its business, applying for tax registrations and opening a corporate bank account.

To make the process smoother, tax registrations are issued along with the Certificate of Incorporation. It takes a maximum of 7 days to register a company in India.

Within 180 days post incorporation, the company is required to file an application for commencement of business, certifying that the share subscription amount from the  initial subscribers has been received and the e-form for verification of registered office has been duly filed with the Registrar.   

For an overseas company to commence its business in India, the entire process of attaining operational status in the market takes around 4 to 8 weeks.

Mergers and Acquisitions

Over the last few years, merger procedures have been simplified and the courts are no longer involved to approve mergers, as all mergers are now approved by the Central Government. Fast track mergers have been introduced for mergers of two or more small companies and mergers of subsidiaries with their holding company. Companies, other than small companies and wholly owned subsidiaries, must follow a slightly more extensive process.

Private limited companies are usually sold or acquired through private negotiations. Share-purchases are where one entity acquires the shares of another. Sometimes it is preferable to purchase the business of another entity, leaving liabilities with the target corporate entity and this is referred to as an ‘asset-purchase’. The sale of shares in a private company are usually conducted confidentially with a small number of interested parties on a preferential basis.

In contrast, takeovers of public listed companies in India are strictly governed by the Takeover Code.

Corporate Insolvency

In India, the law in relation to insolvency and bankruptcy is very creditor friendly and prescribe a time bound process for undertaking insolvency process for a company.

If a company becomes insolvent, the procedures include liquidation of the business, administration or restructuring by a qualified insolvency resolution professional.

Upon commencement of the corporate insolvency proceedings, the company is given breathing space called a moratorium, during which no alienation of assets or initiation of proceedings or any enforcement action may be initiated against the company.

Following the moratorium period, the company may be wound-up.

During the process of insolvency resolution, each director’s conduct is reviewed. If it is found that the business of the company has been conducted with the intent of defrauding its creditors or for any other fraudulent purpose, then persons, including directors who were knowingly party to such business, may be directed to make such personal contributions to the assets of the company, as the concerned authority deems fit. Moreover, parties may face imprisonment in cases of non-cooperation, submission of false information and/or the concealment of facts by the officers/managers of the company during the resolution process.

Hence, it is advisable that a director demonstrates that he took diligence of the affairs of the company and took decisions that were intended to minimize the losses or damages to the creditors of the company.

However, due to recent pandemic situation the government of India has announced to suspend fresh initiation of insolvency proceedings for a period of 1 (one) year. Therefore, no fresh applications for initiating insolvency proceedings can be filed by the creditors in case of default held due to the pandemic situation.

Winding Up of Companies

Although the winding up of a company or liquidation may be the most effective way to recover debts, it is only trigged after the exhaustion of all other remedies available under the law. Therefore, these procedures are considered as a last resort.

There are two types of liquidation, either compulsory liquidation by order of tribunal in cases where a company has defaulted in payment of its debts, or a voluntary liquidation by resolution of the company. Recent changes in India’s law have made the process of voluntary winding up and compulsory winding up more streamlined.

Liquidation or winding up in cases of default in payment of its debts may be initiated by a creditor. This involves the appointment of a qualified insolvency resolution professional, who takes up management of the company. They provide the best possible resolution plan for the company under liquidation.

Recently, the winding up laws have been eased for the small companies, and they can wind up their business without moving to the tribunal. Now the Central Government will grant all the required permissions instead of the tribunal. 

Voluntary liquidation by the company requires the members as well as creditors, if any, of the company who represent two-thirds in value of the debt, to approve the resolution to wind up the company.

The appointed qualified insolvency resolution professional shall endeavor to complete the liquidation process within 12 months.

For more details, please contact Uday Ahlawat, Ahlawat & Associates, uday@ahlawatassociates.in, tel: +91 11 41012214/ +91 11 43024366

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