Since the notification of the Companies Act, reactions from industries and the business community are a constant. Demands to amend the Companies Act of 2013 have also found a responsive ear from the NDA Government. But let us take a look at what the new Companies Act means for the majority SMEs that contribute to our economy.

There are three main areas in which the Companies Act 2013 substantively impacts SMEs. The First one relates to loans and deposits from friends and relatives. The second is loans and guarantees that a Company can provide and a third pertains to Related Party transactions by such a Company. However, a distinction has to be made between SMEs that are closely held by the promoter family and those that have inducted external investors to propel their growth.

The practical impact of some of the new guidelines is likely to be different under the two scenarios described below. Additionally there are some fresh compliances that will need to be adhered to by Private companies relating to Corporate Social Responsibility (CSR) and while raising Capital.

1) Loans and Deposits from Friends and Relatives

• The new Companies Act treats any loans from Non-Director Individuals as “Deposits” and places severe restrictions on the raising of these Deposits by Companies. Loans from relatives (and even non-Director shareholders) are therefore also now treated as Deposits.

• Under the Companies Act, 2013, a small Company cannot accept Deposits from relatives (can only do so from its shareholders), only a large public Company meeting certain financial criteria can raise Deposits from non-shareholders. A small Company’s deposits from its shareholders are also restricted to 25% of its networth. Any Company that already has such deposits in contravention of the new Guidelines is expected to wind down these loans within one year else the Company Directors could face some tough consequences, prosecution as per law.

• What this ends up doing is severely restricting a legitimate source of funding for SMEs. The regulators should at least consider allowing loans from shareholders, not to be treated as Deposits. Any relative/friend of promoter could then while providing a loan also legitimately seek a share in the upside of Company’s fortunes.

• Given these restrictions, the following is further likely to happen:
1.) Convoluted ways are likely to get devised to raise non-deposit loans- through Directors and thrrough Inter Company Loans.
2.) Small Companies would be tempted to approach regular banking channels to raise loans-this would raise cost of funding and would also necessitate provision of security (which we know is usually tough for a small company)
3.) Small companies who inadvertently breach rules are likely to be susceptible to prosecution.

2) Inter Company Loans and Guaranees:

• This issue has created a lot of confusion amongst SMEs and their bankers

• The Companies Act, 2013 prohibits (under most conditions) a company from giving loan to, providing guarantee or security to any related body corporate/person or entity (section 185).

• However the Companies Act, 2013 (section 186) allows companies to provide loans/give guarantee/security to corporates either if this meets the company’s net worth criteria or if they take prior approval by a special resolution passed at the general meeting of the Company (section 186)

• However while the government has notified section 185, it has not yet notified section 186. This has caused a lot of confusion, particularly with the Company’s bankers as many SMEs have guarantees or securities provided by other group/related companies of these SMEs. Subsequently the government clarified that while section 186 is not yet notified, section 372 (A) of Companies Act 1956 remains in force. Section 372 (A) does allow companies to provide loans/guarantees/securities to other companies under certain networth/special resolution requirements. However confusion still exists amongst the Private cos and their bankers whether loans, guarantees and securities can be provided by Private cos to their group companies. Clearing this confusion is much expected of the Government.

• In case special resolutions are indeed required to provide such loans/guarantees/securities, it would be easier to negotiate those for a closely held family run business. The same situation would be tougher for an SME where external investors (including Private Equity funds) may be involved.

3) Related Party Transactions

• Specified Related Party Transactions can be entered into by a Company with Paid Up Capital > 1 Crore only if approved through a special resolution. Interestingly, the involved shareholders will not be entitled to vote on such resolutions. This provision is intended to protect minority interest and at times the minority shareholders may well end up successfully resisting any adverse related party transactions by the majority.

• The above restrictions will not apply to any transactions entered into by the company in its ordinary course of business which are at arm’s length basis.

• As can be easily visualized, the above special resolutions would be easier to negotiate if the SME is closely held by the Promoter family, but trickier if there are external investors (including Private Equity funds) involved.

4) Capital Raising

• Stipulations relating to Private Placement and Preferential Allotment which were earlier applicable only to Public companies have now been extended to Private Companies. With most SMEs being Private Companies, this will increase Compliance requirements of SMEs as they expand their Capital base.

• These compliances essentially relate to need for valuation reports, the number of people these equity offerings can be made to and time lines of completion of the offering.

5) Corporate Social Responsibility (CSR)

• Any Company which has a net profit of Rs.5 Crore or more during any financial year will constitute a CSR committee. The CSR committee will consist of three or more directors and at least one of them will be an independent director. This committee will ensure that the company in every financial year spends at least 2% of its average net profits made during the three immediately preceding financial years in pursuance of Company’s CSR policy.