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Shell Shocked

Registration Cancellation of over 2 lakh inactive companies is a display of the government's cavalier attitude

Sanjay arora (name changed) looks hassled by the situation he finds himself in. Hes a director in an inactive company whose registration has been cancelled recently by the registrar of companies (RoC). We are sitting in a coffee shop in the bustling office complex of Nehru Place. Arora, between many phone calls, painstakingly refers to relevant sections of the Companies Act, 2013 to explain why the government's decision to cancel registration of several 'shell' companies and disqualify their directors for five years is a travesty of the law of natural justice.

Arora, investor director in an e-commerce company facing the music, is also a director of another company. The government action has led to him being barred from being a director of any other company for five years. Now Arora says he faces an existential crisis. "For an entrepreneur, five years of 'banishment' could mean the end of road for his commercial interests," he says. Visibly distraught, he is already thinking of leaving the country and shifting base to Singapore. "This is no ease of doing business," he bemoans.

Arora's (and many others like him) problems arise from the government's decision to crack the whip on companies which have not filed their returns for three or more years. The registration of 2.17 lakh such companies have been cancelled at one go and as many as 3.2 lakh directors disqualified. The government also restricted the use of bank accounts of these companies by their directors or their authorised representatives. Several companies - such as Gold Sukh Trade India Limited, Shanti Infrastructure and Colonisers Private Limited, Aptive IT Solutions and Swarnalabh Trade Link, among others - had multiple accounts.

While the government has earned political brownie points by showcasing it as another bold move to curb generation and circulation of black money by shell companies, businesses and entrepreneurs in the firing line are not impressed. They call it a draconian step taken without thinking of the consequences.

'Shell company' narrative

It's not that cancellations of inactive and non-compliant companies have not happened earlier (See table) but a crackdown on such a large scale has happened for the first time.

The government formed a task force on shell companies under the chairmanship of revenue secretary and secretary, ministry of corporate affairs in February this year. It was assigned the task of identifying non-compliant companies with the help of various enforcement agencies. The objective was to investigate the role of shell companies in money laundering, especially after demonetisation. The list of two lakh companies, it seems, is the result of work done by this committee.

In his Independence Day speech Prime Minister Narendra Modi had said: "You will be surprised to know that black marketers used to own shell companies. Post demonetisation, the reports from data mining astonishingly revealed that there are three lakh shell companies dealing in Hawala transactions. Can anyone imagine? Out of these 3 lakh shell companies, registration of 1.75 lakh companies were cancelled."

However, businesses and corporate law experts have questioned the government's attempt to project all these companies as shell companies indulging in fradulent activities. "These are inactive companies with no business activities or financial transactions. Therefore, the director and promoters of these companies did not bother to file returns and those who failed to do so for three years, their names have been struck off from the list of RoC (Registrar of Companies)," says Amarjit Chopra, former president, Institute of Chartered Accountants of India and partner in CA firm GSA Associates. And there are wheels within wheels. Even if these companies were involved in any wrongdoing, cancelling registration would prevent the government from taking any legal action, points out Chopra.

Another corporate law expert says on the condition of anonymity that there is no clear definition of shell companies, and this term is loosely used to refer to companies that are mostly inactive with no operational or financial transactions. Section 248 of the Companies Act, 2013 - under which the registration of companies have been cancelled - clearly says that RoC has the right to remove the name of a company if it fails to start any business within one year of incorporation or does not carry out any operations for three years. The section doesnt talk about cancelling registration for money laundering or any wrong doing.

The government, however, in its effort to justify the move continues to come out with statements linking it to demonetisation. It has recently received information, the government said, from 13 banks that about 6,000 companies (of the 2 lakh plus that were struck off) with 13,140 accounts allegedly made large deposits worth Rs 4,574 crore after demonetisation was announced on November 8, 2016. But Arora argues that depositing cash in bank after demonetisation doesn't prove that it was ill-gotten money.

Defending the governments move to cancel registration of inactive companies, P. P. Chaudhary, Minister of State, Corporate Affairs, says what has been done is in accordance with the law passed by Parliament. It is a process of cleaning the system and restoring credibility of the corporate sector. "When we say shell company, we only mean companies with no business or operations. We don't mean that all shell companies are indulging in money laundering." he adds

Left in the lurch

It is not uncommon for same person to be director of multiple companies. Therefore, there are many who will have to vacate the post of directors in other companies because they have been disqualified for five years due to non-compliance by one company in which they were directors. And this was done without giving the directors any hearing to prove their innocence. A Lucknow-based manufacturer of cables and a member of Federation of Indian Micro, Small and Medium Enterprises (FISME) says that the way directors were disqualified is a mockery of the principle of natural justice.

There is also a case of retrospective use of Section 164 (2) of the Companies Act, 2013, on private companies. According to legal experts, the section which deals with disqualification of directors, came into force only from April 1, 2014. A similar provision (Section 274) under the Companies Act, 1956, was not applicable to private companies. Therefore, legal experts say that any action on non-compliance before 2014/15 would mean the act has been used retrospectively. However, Inder Mohan Singh, Partner, Shardul Amarchand Mangaldas has a different view. He says that the Act nowhere says that the counting of the period (for non-compliance) would commence from the date the act came into force. The law is silent on that. "In my opinion, if the law doesn't specifically say from when it is applicable, it means the law can be used retrospectively," he says. This is expected to lead to a lot of litigations in future. Amarjit Chopra of GSA Associates, says that the government has not thought of the implications.

Need to be considerate

Sanjay Arora says his e-commerce company was inactive because he and his other partners failed to agree on the way the business should be run. "Closing a company in India is not easy and therefore, we let the company exist on paper without caring to file returns," he explains. Should the government, therefore, be more considerate in cases of genuine grievances? Atul Pandey, Associate Partner in law firm Khaitan & Co, says that government has shown flexibility in handling some cases. Meanwhile, the legal recourse that the companies whose registration has been cancelled is to file an appeal to the NCLT within a period of three years from the date of cancellation. In case of director's disqualification, though, the only option is to file a writ petition in the high court and get a stay.

Many still see the government action as an act of cleaning the system. Saurabh Jain, a company secretary, says it will make companies more serious about RoC filings. But already, some aggrieved parties have moved the high court. The last word has not been said on the issue.