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The author is Shivesh Didwania, a fourth-year student at Maharashtra National Law University, Mumbai.
Introduction
Recently, the Registrar of Companies of the National Capital Territory of Delhi and Haryana (“RoC”) passed 2 contentious adjudication orders under section 454(3) of the Companies Act, 2013 (“Act”). The first order was passed against Leixir Resources Private Limited on May 6th, 2024 and the second order was passed against LinkedIn Technology Information Private Limited on May 22nd, 2024. The penalty orders were with respect to the disclosures required under section 90 of the Act, which pertains to the concept of significant beneficial ownership. In this article, the author aims to briefly discuss the concept of Significant Beneficial Owner (“SBO”) as laid down in Section 90 of the Act and Companies (Significant Beneficial Owners) Rules, 2018 (“Rules”) in the light of the 2 orders, and present an analysis of the 2 orders.
The concept of Significant Beneficial Ownership
It is important to note that an SBO is always an individual, i.e., only a natural person, and not artificial and juristic persons. Rule 2(h) of the Rules lays down a twin test (objective and subjective) to determine whether an individual can be held as an SBO. The individual acting alone or together, shall fulfil either the objective test or the subjective test. To fulfil the objective test, it must either be an indirect holder of a minimum 10% of the company’s shares; or an indirect holder of a minimum 10% of the voting rights; or an indirect recipient of a minimum 10% of the total distributable dividend.
Even if an individual fails to qualify as an SBO under the objective test, it can still be held as an SBO under the subjective test. To fulfill the subjective test, it must have the right to exercise ‘significant influence’ or ‘control’ other than through direct shareholding, over the reporting entity. According to Rule 2 of the Rules, ‘significant influence’ means the power to participate in the financial and operating policy decisions. According to section 2(27) of the Act, ‘control’ means the right to appoint the majority of the directors or control the management or policy decisions.
The RoC Against Leixir India
In the order against Leixir Resources Private Limited (“Leixir India”), RoC expanded the scope of bare text of the Rules for interpretation of the subjective test. Leixir India, is a subsidiary of Leixir Intermediate Corp. (US entity), whereas, the ultimate holding company of Leixir India is Comvest Leixir Holdings LLC (US entity). The majority shareholder of the ultimate holding company is Comvest Investment Partners V LP, a pooled investment vehicle (“PIV”). Accordingly, it can be said that Leixir India is controlled by a PIV (based in a member State of the Financial Action Task Force on Money Laundering, with the regulator of the securities market in such member State being a member of the International Organization of Securities Commissions). Comvest Investment Partners V LP does not have any individual that serves as its general partner (“GP”), investment manager (“IM”) or chief executive officer (“CEO”). Instruction kit of the Form BEN-2, which is to be filed under section 90 and the Rules, also states that the GP or the IM or the CEO must be of the PIV.
Rule 2 of the Rules states that in case an entity is controlled by a PIV, then the GP, IM or the CEO in relation to the PIV, will be the SBO of the reporting entity. The IM for Comvest Investment Partners V LP is Comvest Advisors LLC (US entity). Therefore, there is no individual who is the GP, IM or CEO of the PIV, thus there should not be any SBO of the reporting entity. However, the RoC expanded the interpretation of the bare text of the law to hold that Mr. Michael Falk, CEO of Comvest Advisors LLC, which is the IM of the PIV, is the SBO of Leixir India. It resorted to SEC filings of the companies in the US to conclude that Mr. Michael Falk owns Comvest Advisors LLC. It levied penalties since Leixir India failed to report Mr. Michael Falk as its SBO.
Problems with the Order Against Leixir India and Suggestions
There are several problems with the RoC order against Leixir India. Firstly, RoC failed to take into account the fact that the functioning and governance of Comvest Advisors LLC was undertaken by investment committees and not by Mr. Michael Falk. This is because, being the CEO of the company does not give the right to control the entire functioning of the company. CEOs are hired by companies in a professional capacity and the companies do not divulge ownership rights to the CEOs. Hence, to equate a professional CEO with the owner of the company is problematic. It is also important to note that Mr. Michael Falk has nothing to do with how Leixir India is functioning. Secondly, the RoC went beyond the bare text of Rule 2, to conclude that the SBO is not only the CEO of the PIV, but the individual who is the CEO of the IM of the PIV can also be held as the SBO of the reporting entity. This interpretation is not supported by any previous ruling, and thus it can be understood as something new, which is not in line with the bare text of the law. The entity is thus penalised for a completely new interpretation of the law, which can very well lead to a fear of the unknown.
The RoC Order Against LinkedIn India
In the order against LinkedIn Technology Information Private Limited (“LinkedIn India”), RoC expanded the scope of interpretation of the subjective test. LinkedIn India is the Indian subsidiary of LinkedIn Corporation. However, the parent company does not have any shares held in its name in the Indian subsidiary. Moreover, LinkedIn Corporation is in turn owned by Microsoft Corporation. It is important to note that no individual held 10 or more percentage of the shares of the Indian subsidiary. Additionally, according to the Indian subsidiary, no person fulfilled the subjective criteria as well and thus the company did not report any SBO.
LinkedIn Corporation was the parent company of LinkedIn India, however, it did not have shares in the subsidiary company. The RoC held that since it is claimed to be the parent company, it then must have a control over the composition of the board of directors (“Board”) of LinkedIn India. There were 2 Board members in LinkedIn India (out of a total of 5) who were also the Board members of LinkedIn Corporation. The RoC held that the parent company cannot exercise control through its own common Board members. Hence, it held that the control is exercised by way of the CEO of LinkedIn Corporation – Mr. Ryan Roslansky, who heads the Board of LinkedIn Corporation as the CEO. It thus held that Mr. Ryan Roslansky has the right to exercise significant influence and control over the Indian subsidiary. In addition to this, it also held that since Mr. Ryan Roslansky reports to Mr. Satya Nadella, the CEO of Microsoft Corporation, Mr. Satya Nadella is also an SBO of the Indian subsidiary. It relied upon the test of reporting channel, which ultimately ends at Mr. Satya Nadella and the test of financial control, which according to the RoC, is exercised by Microsoft Corporation. The failure of LinkedIn India to disclose the 2 SBOs led to penalties levied by the RoC under section 90 and the Rules.
Problems with the Order Against LinkedIn India and Suggestions
There are several problems with the order and the reasoning of the RoC. Firstly, it has completely ignored the differentiation between an owner of a company and a professional employee of a company. Both the CEOs are hired by the company only in their professional capacities as employees of the company. They can only retain their positions till they enjoy the confidence of the Board members. This is very different to a setting in a promotor led company wherein the reasoning of the RoC may still stand because of the status of the individual in the company. By way of this reasoning, the RoC can very well hold the ultimate CEOs of the parent companies of all the Indian subsidiaries, who might have nothing to do with the functioning and control of the respective Indian subsidiaries. Secondly, the RoC has completely ignored the possibility that Boards can function independently in their respective countries even if there exists a parent company.
Thirdly, there is a dire need to properly define and illustrate the scope of ‘significant influence’ and ‘control’ under the Rules. The interpretation of the ROC is very wide and goes beyond what could have been expected by the Indian entities. Fourthly, such an interpretation is clearly not in line with what could be anticipated keeping in mind the objective test. This is to emphasise that Mr. Satya Nadella does not hold more than 0.1% in Microsoft Corporationn and does not hold any share in LinkedIn India. Similarly, Mr. Ryan Roslansky does not hold any share in LinkedIn India. Such lack of parity and balance between the objective test and subjective test leaves a lot of scope for misuse of the subjective test. The RoC is holding the companies liable for something that is not yet established and hence, this could lead to a fear of the unknown in the future. The subjective test interpretation has to be limited in some manner and thus it must be clearly defined and illustrated.
Appeal Provisions Against the Order of RoC
Section 454(4) of the Act lays down the provision for appeal against the order of RoC. The appeal can be made to the Regional Director, within 60 days of receiving the copy of the order. There is no provision in the Act or the Rules for further appeal against the order of the Regional Director. However, the company can then resort to writ petition under Article 226 of the Constitution of India seeking for a writ of Mandamus.
Bigger Problems with the RoC Orders
The RoC is resorting to purposive interpretation going beyond the reasonable and literal interpretation of the Rules. The purposive interpretation however, seems scary because Mr. Satya Nadella or Mr. Michael Falk who might not have anything to do with how the Indian subsidiaries are working are being held as SBOs, just because they are the CEOs of the ultimate holding company. The SBOs can be held liable in cases of money laundering etc. and thus this might have an impact on the ease of doing business in India. The companies might get apprehensive of the idea of setting up Indian subsidiaries because of the risk of such wide interpretations of the SBO provisions.
Secondly, it might make the objective test under Rule 2 of the Rules redundant. SBOs will now be seen as people who might have any type of control, but interestingly not a substantial shareholding. In case of such a wide interpretation of the subjective criteria, the objective criteria of 10% seems redundant because irrespective of shareholdings, individuals can be held as SBOs, even if they have miniscule shareholdings (example, Mr. Satya Nadella). The companies cannot even rely on the objective test to get an idea of how the subjective test can be interpreted, because there is no parity between the both.
Thirdly, Section 90(5) of the Act states that the company must give notice to any person, if the company has reasonable cause to believe that the individual is an SBO. Now, in light of the recent RoC orders, this reasonableness got overshadowed by such wide interpretation, which would not have been anticipated by the companies. Additionally, Rule 2A of the Rules states that the company must issue notices to members with a right to at least 10% shareholding, or voting rights or dividends. Surprisingly, in these orders, the individuals did not have any such rights.
Conclusion
The government is working tirelessly to improve the ease of doing business in India. In such a scenario, when foreign companies and CEOs are met with these types of orders, the companies may feel a huge burden to report the SBOs which even they might not be aware of. In such cases, ease of doing business also takes a blow, potentially leading to large-scale apprehension about setting up subsidiaries in India as discussed above. The laws and rules with respect to SBOs are constantly evolving in India. Thus, it will be interesting to see what the Regional Director decides if the orders in these cases are appealed.
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