‘Beneficial interest’ is not so beneficial under the Companies Amendment Act

‘Beneficial interest’ is not so beneficial under the Companies Amendment Act

By Puneet Shah

With the rising concerns over misuse of black money in financing illegal activities and with an objective to tackle the issue of benami properties, the recently enacted Companies Amendment Act, 2017 (Amendment Act) has introduced a new definition of term ‘beneficial interest’.

Beneficial interest in shares of a company has been defined to mean right to exercise any or all rights attached to such shares; or right to receive or participate in any dividend or other distributions in respect of such shares. The idea seems to track the persons who are ultimately exercising rights over such shares or those who are entitled to economic benefits arising from such shares. The newly introduced definition of beneficial interest is outcome of the recommendations made in the Report of the Companies Law Reforms Committee issued in February 2016.

However, linking beneficial interest in shares purely to exercise of voting or other rights attached to such shares may have some unintended consequences. For instance, voting right arrangements or pooling arrangements are very common in any M&A or private equity transaction where few non-active members of a family or a shareholders group may assign voting rights with respect to their shares to active members of family or active promoters who are managing the day-to-day affairs of the company. In most of these cases, it may be a part of the overall commercial understanding agreed between a financial investor and the active promoters a company looking to raise funds or private capital for such company.

The objective may be to retain the overall control of the management and affairs of the company in fewer hands to ensure ease of governance and administration of the company post investment by a financial investor. Although, the active promoters exercising such voting rights on behalf of non-active shareholders under a pooling arrangement may not be reaping the economic benefits of such shares but it may be an advantageous proposition for a financial investor while enforcing his rights under the investment transaction documents against fewer counterparties as oppose to a large chunk of scattered shareholders group.

Besides, the voting right arrangements are also very common in third party asset management business such as those of alternative investment funds or mutual funds or discretionary portfolio management; where the investor clients normally authorise the asset manager to undertake all voting decision with respect to their portfolio investments by issuing a power of attorney in favour of the asset manager.

With the newly introduced definition of ‘beneficial interest’, there is a possibility of such active promoters exercising voting or other rights on behalf of non-active shareholders and the asset managers exercising voting rights on behalf of their investor clients getting categorised as holding beneficial interest in respect of their portfolio investments, which cannot be the regulatory intent. Hence, before treating a person as holder of the ‘beneficial interest’ in respect of certain shares both the tests of voting and other rights as well as economic benefit entitlement attached to such shares should be met.

The Amendment Act also requires the holder of at least twenty five percent beneficial interest or having right to exercise ‘significant influence’ in shares of a company to make a declaration of his nature of interest to such company treating him a ‘significant beneficial owner’ in the company. The term ‘significant influence’ has been defined to mean control of at least twenty percent of total voting power, or control of or participation in business decisions under an agreement.

Again, the idea seems to trace the person who exercises specified voting control on the company or participates in the business decision-making process in terms of a contractual understanding. Associating the concept of participation in business decision making with significant influence may be erroneous as parties can participate in decision-making process by exercising veto rights on certain matters. Decision-making through veto rights or exercise of negative control over certain matters does not lead to having control as has been historically held by the Indian judiciary.

Exploiting the multi layered corporate structures for the purpose of tax evasion or money laundering for corrupt or illegal purposes, including for terrorist financing has been a serious concern for Government. Its recent crackdown on thousands of shell companies was a result of the same. However, the way the term beneficial interest, significant beneficial owner and significant influence has been defined in the Amendment Act, it leads to certain unintended consequences. A clarification in this regard is very much desirable to avoid confusion and misinterpretation in practice going forward.

Puneet Shah
Puneet Shah

Author is principal associate with law firm – IC Universal Legal based in Mumbai. Views are personal.

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