We continue our examination of various laws and the issues arising therein in respect to an LLP.
1. Infrastructure projects :
1.1 Can an LLP be an SEZ Developer under the Special Economic Zone Act, 2005 ? S. 2(g) of this Act defines the term developer to mean a person who has been granted a letter of approval. S. 2(v) of the Act defines a person to include a company, a firm, an association of persons or body of individuals, whether incorporated or not. An LLP is none of the above but it is a ‘body corporate’. Again an amendment to the SEZ Act would be highly desirable to accommodate LLPs.
1.2 Can an LLP be the entity for developing, operating, maintaining an infrastructure facility such as a road, port, rail, airport, industrial park, etc. ? S. 80-IA(4) of the Income-tax Act which provides for the income-tax deduction specifies that the infrastructure facility must be owned by a company or a corporation or a body established under a Central or State Act. An LLP is none of these. However, if one looks at the Industrial Park Scheme, 2008 and Form IPS-1, then there is no restriction in the Scheme that the entity must be only a company.
2. Consolidation of accounts :
2.1 The LLP Act allows a company to become a partner in an LLP. What if the company owns more than 50% of the voting power of the LLP or controls the composition of the governing body of the LLP ? The issue is : Whether Consolidation of Accounts will be required ?
2.2 Accounting Standard 21 on Consolidated Financial Statements prescribed under the Companies (Accounting Standard) Rules, 2006, speaks about control by a company over an enterprise which may or may not be a company. Hence, the accounts of any entity over which the company exercises control should be consolidated with that of the parent.
2.3 The Expert Advisory Committee of the Institute of Chartered Accountants of India has given an opinion as regards investment by a company in a partnership firm. It opined that if a company is required to prepare consolidated financial statements (CFS) under any statute or it does so voluntarily, then the consolidation should be done in accordance with AS-21 by consolidating the financial statements of the firm with that of the company. The same EAC Opinion should hold good for an LLP.
3. Takeover regulations :
3.1 Reg. 3(1)(k) of the SEBI Takeover Regulations, 1997, exempts an Acquirer from making a Public Announcement in the case of acquisitions of voting power in an unlisted company. However, if the unlisted company is in control of a listed company and by virtue of the acquisition of the unlisted company, the acquirer acquires shares/voting power/control over a listed company, then the acquirer is required to make an offer for the listed company’s shares.
3.2 Now, if a person acquires ‘control’ over an LLP (by virtue of change of partnership in an LLP or otherwise) and the LLP owns shares/voting power/control over a listed company, whether any change in the Partners of the LLP would trigger the provisions of the Takeover Code ? As LLP is not expressly covered by the R.3(1)(k), as it talks about only a company, hence, it is a moot point whether any change in the control of an LLP leading to change in control of a listed company would require a Public Announcement.
4. SARFAESI Act :
4.1 One of the aspects of SARFAESI Act is Enforcement of security interest by banks/financial institution for recovery of a secured debt from a borrower in case of default in repayment.
4.2 An LLP can also be a borrower and if it fails to discharge its liability, the secured creditor may recover his debt in the manner prescribed by the Act, without intervention of the Court or Tribunal.
5. CCI for Mergers of LLP :
5.1 The Competition Act also provides for the regulation of Mergers and Acquisitions to prevent an adverse effect on competition. The Competition Commission of India (CCI) is authorised to approve and regulate the M&A exceeding the prescribed networth and turnover limits. The Act applies to all enterprises including firm, AOP, etc. engaged in any activity relating to production, storage, supply, distribution, acquisition or control of articles or goods, or the provision of services and so on. Therefore, amalgamation of LLPs will also be covered under Competition Law and thereby would be regulated by CCI.
6. Related party transactions :
6.1 S. 295 and S. 297 of the Companies Act, 1956 require the previous approval of the Central Government in case a company makes any loan/guarantee/security to, or enters into certain contracts with certain prescribed persons, being related to the directors of the lending company. The provisions of S. 370 of the said Act will also have to be complied with.
6.2 The list of prescribed persons u/s.295 includes a body corporate in which not less than 25% of the voting power is exercised by one or more directors of the lending company as well as a body corporate which is accustomed to act on the instructions of the Board of Directors or one or more directors of the lending company. An LLP is a body corporate. Therefore, any loan/guarantee/security given by a public company to an LLP which acts as aforesaid would require previous approval of the Central Government.
6.3 However, the approval u/s. 297 will not be required in case a company enters into the prescribed transactions with an LLP.
6.4 Further, S. 299 on Disclosure of Interest by directors would require a director to give a general notice to the Board of Directors if he is a partner in an LLP. Also, if a director is directly or indirectly interested in any contract or arrangement entered into by the company with an LLP, the director should disclose the nature of his interest in the relevant Board Meeting.
7. Clause 49 requirements :
7.1 Clause 49 of the Listing Agreement lays down certain compliances to be made in case of a material unlisted subsidiary of a listed company. These include appointing an independent director of the listed company on the board of such a subsidiary.
7.2 The term ‘material non-listed Indian subsidiary’ has been defined to mean an unlisted subsidiary, incorporated in India, whose turnover or net worth (i.e. paid up capital and free reserves) exceeds 20% of the consolidated turnover or net worth respectively, of the listed holding company and its subsidiaries in the immediately preceding accounting year. Since the term subsidiary has not been defined under the Listing Agreement, one should refer to s.4 of the Companies Act. According to this section, only a company is covered within the definition of a subsidiary. Hence, an LLP cannot be a subsidiary of another company and accordingly it would not be covered within the ambit of Clause 49 of the Listing Agreement.
8. Security Interest on Conversion of a Company into LLP :
8.1 According to Para 2 of the Third Schedule to the LLP Act, a company can be converted into an LLP only if it does not have any security interest subsisting in its assets at the time of application.
8.2 It may be noted that this restriction is not laid down in case of conversion of a firm into an LLP.
8.3 The practical problem that arises in this regard is firstly that “Security Interest” has not been defined in the LLP Act. Secondly, if we take “Security Interest” to mean as understood in common parlance, hardly any company would be able to convert itself into an LLP. This cannot and should not be the intention of the legislature.
8.4 Let us analyse the meaning of the term ‘Security Interest’.
8.4.1 Definition under SARFAESI Act :
According to S. 2(zd) of the Securitisation and Re-construction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) —
“security interest means right, title and interest of any kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in S. 31.”
S. 31 of this Act lays down the following cases wherein the provisions of SARFAESI Act shall not apply :
a) a lien on any goods, money or security given by or under the Indian Contract Act, 1872;
b) a pledge of movables within the meaning of S. 172 of the Indian Contract Act, 1872;
c) creation of any security in any aircraft as defined in clause (1) of S. 2 of the Aircraft Act, 1934;
d) creation of security interest in any vessel as defined in clause (55) of S. 3 of the Merchant Shipping Act, 1958;
e) any conditional sale, hire-purchase or lease or any other contract in which no security interest has been created;
f) any rights of unpaid seller under S. 47 of the Sale of Goods Act, 1930
g) any properties not liable to attachment (excluding the properties specifically charged with the debt recoverable under this Act) or sale under the first proviso to Ss.(1) of S. 60 of the Code of Civil Procedure, 1908;
h) any security interest for securing repayment of any financial asset not exceeding Rs. one lakh;
i) any security interest created in agricultural land;
j) any case in which the amount due is less than 20% of the principal amount and interest thereon.
8.4.2 Definition under Black’s Law Dictionary
Security Interest is a form of interest in property which provides that the property may be sold on default in order to satisfy the obligation for which security interest is given.
In other words, the term ‘security interest’ means any interest in property acquired by contract for the purpose of securing payment or performance of an obligation or indemnifying against loss or liability.
8.5 Thus, from the above definitions, it is seen that the definition of ‘Security Interest’ is very wide. At the same time, one cannot conclude that the charge which is created on the assets of a company in order to avail loans especially loans from banks and financial institutions can be treated as security interest subsisting in the assets of the company for the purposes of LLP Act.
In this regard, it is important to note that under the LLP Act, all the liabilities of the private limited company become the liabilities of the LLP. Further, both the entities have limited liability. So there is no difference in the nature of liability of the private limited company and its shareholders on one hand and the LLP and its partners on the other hand. Moreover, Schedule II which provides for conversion from a firm (where its partners have unlimited liability) into an LLP, does not put any such restriction. Therefore, it is difficult to understand the real intention of legislature in putting this restrictive clause in case of conversion of company into an LLP. It would be advisable if the MCA issues a clarification in this respect since this is holding up the conversion by several companies into LLPs.
(Concluded)
