INTRODUCTION
As SEBI and MCA continue to sharpen corporate governance standards, companies are required to demonstrate complete transparency and accountability, which are crucial pillars of corporate governance, in their compliance efforts. One of the prominent compliance issues relating to transparency and accountability that has been buzzing on the internet and occupying the Registrar of Companies (ROC) and companies is the identification of Significant Beneficial Ownership. Recently, the ROCs have begun scrutinizing SBO reporting by companies under their jurisdiction and has started imposing heavy penalties on companies that have not complied with the SBO provisions as laid down in the Companies Act, 2013 (“the Act”).
These recent ROC orders underscore the obligation of companies to take rigorous steps to identify their Significant Beneficial Owner (SBO). In this context, this article intends to discuss the legal provisions relating to the obligation of companies under Section 90 of the Act for identifying their SBO, the scope of due diligence required, practical challenges, and the way forward.
OBLIGATIONS ON COMPANIES FOR SBO IDENTIFICATION
Before delving into the synthesis, it is pertinent to briefly understand the obligations imposed on companies under the SBO provisions in Section 90 of the Act.
To be clear, as per the Act, an SBO is an individual who holds at least 10% indirect ownership or voting rights in a company or has significant influence or control through direct or indirect means. Upon identification, a company is required to share its SBO details with the ROC.
Initially, sub-section (5) of Section 90 of the Act imposes a duty on every company to serve a notice to individuals whom the company knows or has reasonable cause to believe to be an SBO or possess relevant information about the same, provided such individuals are not registered as SBOs with the company.
Such a notice serves two objectives:
First, as a due diligence exercise, it imposes an obligation on the noticee to disclose the information sought by the company. Failure to comply can have serious implications, as the company can apply to the NCLT to impose restrictions on the shares in question.
Second, the Act, through the Companies (Amendment) Act, 2019, has added a new sub-section (4A) in Section 90. This requires every company to take necessary steps to identify individuals who are significant beneficial owners in relation to the company and ensure they comply with the provisions of Section 90
TEXT OF SUB-SECTION (4A) AND SUB-SECTION (5)
Sub-section (4A) reads as under:
“Every company shall take necessary steps to identify an individual who is a significant beneficial owner in relation to the company and require him to comply with the provisions of this section.”
And Sub-section (5) reads as under:
“A company shall give notice, in the prescribed manner, to any person (whether or not a member of the company) whom the company knows or has reasonable cause to believe—
(a) to be a significant beneficial owner of the company;
(b) to be having knowledge of the identity of a significant beneficial owner or another person likely to have such knowledge; or
(c) to have been a significant beneficial owner of the company at any time during the three years immediately preceding the date on which the notice is issued,
and who is not registered as a significant beneficial owner with the company as required under this section.”
REQUIREMENTS AND OBLIGATIONS UNDER SUB-SECTION (5)
Sub-section (5) has been part of the SBO provisions since their coming into force in 2018. It obligates companies to identify SBOs if there are reasonable grounds to believe an individual is an SBO. The company is required to act upon acquiring such knowledge which is based on reliable materials or information.
Under this sub-section, the company must serve a notice to the individual it believes to be an SBO. The form for this notice is prescribed in the rules associated with the Act. If the individual fails to respond to the notice, sub-section (6) places an obligation on the individual to provide the requested information. If the individual does not comply, the company is required under sub-section (7) to apply to NCLT for the suspension of the rights attached to the shares held by that individual.
This process is designed to ensure that companies identify SBOs once they have reasonable grounds to believe an individual is an SBO. However, the section does not specify any penalties for non-compliance by either the company or the individual who is an SBO.
REQUIREMENTS AND OBLIGATIONS UNDER SUB-SECTION (4A)
Within one year of the SBO provisions coming into force, the Companies (Amendment) Act, 2019 inserted sub-section (4A) and simultaneously amended sub-section (11) to include penalties if the company fails to take necessary steps under sub-section (4A). This places an obligation on the company to identify SBOs and ensure they comply with the SBO law.
CONFUSION BETWEEN SUB-SECTION 4(A) AND (5)
Sub-section (4A) appears to be very stringent, as it requires the company to identify SBOs even if it does not have any grounds or reasons to believe an individual is an SBO, as required under sub-section (5). It is not clear whether sub-section (4A) is a general provision or if it specifically relates to sub-section (5) of the Act. Sub-section (4A) does not outline a specific process for identifying an SBO within a company, but it does mandate compliance with the provisions of the SBO law.
The above confusion has been further aggravated when ROC Delhi in the matter of Linked India and Leixir Resources imposed penalties under sub-section (4A) as well as sub-section (5) whereas other ROCs in the matter of Samsung SDI India and Eider PWI imposed penalties only under sub-section (4A).
The intent behind the insertion of sub-section (4A) appears to be to ensure the identification of an SBO even when there is no material on record to believe any person to be an SBO in a company. The Act expects every company to continuously search for SBOs. If this interpretation is correct, even if the company fulfills its role under sub-section (5) by giving notice and being satisfied with the reply, sub-section (4A) does not provide any exemption or immunity from identifying SBOs in a company. Therefore, the company is always under the obligation to identify SBOs, regardless of whether compliance under sub-section (5) has been carried out or not.
From the foregoing explanation, it is clear that the identification of SBO is a complex process. Companies must carry out due diligence to identify SBOs, and when in doubt, it is advisable to issue a notice to the person in question. Subsequently, the Managing Director or, if he is involved, the Board or Audit Committee should review the reply submitted by the person and communicate its decision to that person.
CONCLUDING THOUGHTS
Recent ROC orders involving companies like LinkedIn India and Samsung SDI India have opened a Pandora’s box, raising serious concerns among companies about revisiting their SBO positions. These orders prompt companies to freshly apply the intricate parameters used by the ROC to identify SBOs within their own organizations.
Even if companies apply the same parameters as the ROCs in recent orders, it is currently difficult for them to argue before the ROC that they have rightly discharged their obligations and notice duties. Section 90 does not define the extent of due diligence required from a company, making it challenging to establish compliance. Therefore, Government intervention is necessary to clarify these obligations. Until then, all companies should be extremely cautious regarding SBO identification.
Going forward, it will be interesting to observe whether companies facing stringent ROC actions under Section 90 will challenge such orders in appellate bodies. Additionally, it remains to be seen if the ROCs will continue to impose penalties on other companies for violation of SBO provisions.