New company law: Funds face 'associate' googly

Funds having significant influence will be subject to provisions relating to Associate Companies

Private equity firms picking substantial minority stakes in companies may have to prepare themselves for additional compliance requirements under the new companies act. The new law introduces a new concept of associate companies.

Associate companies are identified as related parties and the holding companies of these associates are required to file consolidated accounts.

The new law has also provisions that restrict persons relating to associate companies from becoming independent directors or being appointed as auditors.

Section 2 clause 6 of the new companies act says “associate company, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.”

An explanation to this section added that for the purposes of this clause, “significant influence” means control of at least 20% of total share capital, or of business decisions under an agreement.
 
This section is among the 98 sections of the act notified by the ministry of corporate affairs on September 12 and has already come into effect.
 
Accordingly, a company which owns 20% or more of share capital of another will be considered an associate. Secondly, even a company with a lesser shareholding could be covered if by virtue of the shareholders agreement it is able to exert “significant influence” over business decisions.

 
Further, since the 20% will be calculated on entire share capital, many PE players who hold their investments in the form of preference shares will also be covered by the new provision even though their equity holding is less than that number.
 
“The associate company will be identified as a related party and the annual accounts will be consolidated. This could lead to significant changes in the way private equity investors deal with their investee companies. They may be looking for some exemptions,” said Pavan Kumar Vijay, MD, Corporate Professionals.

Vijay said an exemption on the lines given to qualified institutional bidders (QIB) in the definition to private placement can be included in the Act. He added, “As of now, there is no exemption for private equity investors.”

Amish Shah, Transaction Tax leader, EY said the impact for funds based abroad would depend on the requirements of law in their home jurisdiction. However, funds based in India, which are fewer in number, would have to comply with requirements. "We have to wait for the rules to be notified. There is no specific exemption for PEs,” he added.