Reebok India Company Vs Union of India Through The Secretary (Delhi High Court)
Introduction: In a significant legal development, the Delhi High Court has dismissed a petition by Reebok India Company, challenging the Registrar of Companies’ (RoC) decision to reject its conversion from an “Unlimited Liability Company” to a “Limited Liability Company.” The judgment underscores the stringent regulatory environment governing corporate conversions in India and highlights the court’s emphasis on protecting creditors and stakeholders’ interests.
Detailed Analysis: Reebok India Company, known for its wholesale cash and carry trading of footwear, apparels, and sports equipment, sought judicial intervention against the Companies (Incorporation) Third Amendment Rules, 2016. Specifically, the contention was against Rule 37(8), which outlines conditions under which an unlimited liability company cannot convert into a limited liability entity. The court’s decision to not challenge the rule’s validity marked a pivotal moment in this legal battle.
The RoC’s rejection of Reebok’s application was based on several grounds, including ongoing prosecutions by the Serious Fraud Investigation Organization (SFIO) and non-compliance with Rule 37 of the 2016 Rules. The court highlighted the change in Reebok’s shareholding pattern since the application and the company’s substantial financial losses as crucial factors influencing the RoC’s decision.
The court’s ruling emphasized the curative nature of the 2016 Amendment, aimed at protecting creditors’ interests. It clarified that the amendment should apply to pending applications, reflecting a broader regulatory intent to ensure financial stability and protect stakeholders in corporate restructuring scenarios.
Conclusion: The Delhi High Court’s dismissal of Reebok India Company’s petition reflects the judiciary’s support for regulatory mechanisms designed to safeguard creditors and stakeholders in corporate conversions. This judgment not only affects Reebok’s organizational structure but also sets a precedent for other companies contemplating similar transitions. It underscores the importance of compliance with statutory requirements and the need for corporate entities to consider the broader implications of their restructuring efforts on their financial obligations and stakeholder relationships.
FULL TEXT OF THE JUDGMENT/ORDER OF DELHI HIGH COURT
1. Petitioner has approached this Court with the following prayers:
“(a) issue an appropriate direction, order or writ in the nature of mandamus quashing / setting aside the Impugned Rule, i.e. Rule 37(8) of the Companies (Incorporation) Third Amendment Rules, 2016, notified by the Respondent No.1 on 27.07.2016 as it is ultra vires the Act and the Constitution;
(b) issue an appropriate direction, order or writ in the nature of certiorari quashing / setting aside the Impugned Decision and Order dated 07.08.2020 passed by the Respondent No.2;”
2. Since Rule 37 of the Companies (Incorporation) Third Amendment Rules, 2016, notified by the Respondent 1 on 27.07.2016 is under challenge in the present Writ Petition, the matter was placed before the Division Bench of this Court. On 23.01.2023 Learned Counsel appearing for the Petitioner stated before the Division Bench of this Court that he is not pressing for the relief prayed for in the prayer Clause (a) of the Writ Petition. In view of the submission made by the learned Counsel for the Petitioner the matter was listed before a Single Judge.
3. This Court will, therefore, deal only with the Order dated 07.08.2020, which is under challenge in the present Writ Petition, by which the Registrar of Companies rejecting the conversion of the Petitioner’s company from an “Unlimited Liability Company” to a “Limited Liability Company”.
4. Facts of the case reveal that the Petitioner is a company incorporated under the Companies Act, 1956 and is engaged in the business of wholesale cash and carry trading of footwear, apparels and sports equipment under the “Reebok” brand name through franchise based stores across It is stated that the Petitioner was set up as Joint-Venture (JV) company by Reebok International Limited (hereinafter referred to as ‘the RIL’), a company registered under the laws of the United States of America. It is stated that the investment of RIL in the equity shares of the Petitioner/Company was done through Reebok (Mauritius) Company Limited, a subsidiary of RIL.
5. It is stated that after consideration of the changing conditions in the external environment in which the Petitioner/Company operated and on evaluating its organizational structure and further considering the changes in its strategy and key management of the Company, the shareholders and the Board of Directors of the Petitioner passed a resolution to convert the Petitioner/Company from an unlimited liability company to a private limited company under Section 18 of the Companies Act, 2013. It is stated that on 21.10.2014, the Petitioner filed an application for conversion of the company into a limited liability company along with all the relevant and necessary e- forms INC-1, GNL-1, and MGT-14. It is stated that on 31.10.2014 the Petitioner was informed by Respondent No.1 that its e-form INC-1 has been marked as “pending user clarification” as the Petitioner had not complied with Section 18 of Companies Act. It is stated that on 12.11.2014, the Petitioner wrote a letter to the Respondent No. 2 clarifying and explaining its compliance with Section 18 of the Companies Act.
6. Union of India brought out the Companies (Incorporation) Third Amendment Rules, 2016 (hereinafter referred to as ‘the 2016 Rules’). The said Rules came into force on 27.07.2016 and on that date the application of the Petitioner/Company was pending. Rule 37 of the said Rules deals with Conversion of unlimited liability company into a limited liability company by shares or guarantee. Rule 37(8) of the said Rules specifies as to when An Unlimited Liability Company shall not be eligible for conversion into a company limited by shares or guarantee and the same reads as under:
” (8) An Unlimited Liability Company shall not be eligible for conversion into a company limited by shares or
guarantee in case-
(a) its networth is negative, or
(b) an application is pending under the provisions of the Companies Act1956 or the Companies Act, 2013 for striking off its name, or
(c) the company is in default of any of its Annual Returns of financial statements under the provisions of the Companies Act, 1956 or the Companies Act, 2013, or
(d) a petition for winding up is pending against the company, or
(e) the company has not received amount due on calls in arrears, from its directors, for a period of not less than six months from the due date; or
(f) an inquiry, inspection or investigation is pending against the company.”
7.It is stated that the application of the Petitioner was rejected vide communication dated 05.10.2016 without any reasons and justification. It is stated that the Petitioner wrote letters seeking reasons for the rejection and since no reason was forthcoming, the Petitioner approached this Court by filing P.(C) 952/2017 challenging the communication dated 05.10.2016. It is stated that this Court vide Order dated 03.03.2020 directed the Respondent No.2 to decide the application of the Petitioner afresh, in accordance with law, after giving adequate opportunity of being heard to the Petitioner. It is stated that pursuant to the Order passed by this Court, the Petitioner was invited by Respondent No.2 for in-person hearing on 30.06.2020. Material on record discloses that after hearing the Petitioner, the application of the Petitioner was rejected vide Order dated 07.08.2020.
8. It is this Order which is under challenge in the present Writ Petition.
9. The reasons given by the Respondents for rejecting the application of the Petitioner are as under:
a. that various prosecutions have been filed by the Serious Fraud Investigation Organization against the Petitioner for offences under the Companies Act and the IPC.
b. that the e-Form 27 which was to be filed with the Registrar of Companies was not in compliance with Rule 37 of the 2016 Rules.
c. to protect the interest of creditors, stakeholder and public interest and also keeping in view the factual position and the position of law on protection of interest of creditors on conversion of status from one class of company to another class as company as the Petitioner Company was involved in falsification of Books of Accounts & financial statements during the period of 2008 to 2011 by raising fictitious.
d. The Petitioner/Company has not enclosed the list of Creditors, suppliers & Stakeholders to whom amount was payable as on date of conversion nor it has attached any NOC from them on account of conversion of status of company with its conversion The Petitioner had also not filed any public advertisement in the newspaper inviting objections of creditors/stakeholders nor had it filed any undertakings/ declaration of the 3 shareholders of the company giving their guarantee to bring assets to the company if company fails to repay its creditors.
e. That the Auditors of the Company have given serious adverse remarks/qualifications in the financial statements as on 03.2014, i.e. preceding to the date of Company’s application dated 21.10.2014. The Auditor has also stated that accumulated loss at the end of financial year is more than 50% of net worth and company has cash losses in current year & preceding financial year. Further the company has used funds amounting to Rs. 3,50,87,54,000/- raised on a short term basis primarily to finance operating losses.
f. It was also held that on an analysis of financial statements of the company, it was found that the company has a net deficit in current liabilities over the assets amounting to 2117.52 Crores, Rs. 2175.32 Crores & Rs. 2122.14 Crores as on 31.03.2014, 31.03.2015 & 31.03.2019 respectively due to cash losses incurred by the company during the past financial years and the net worth of the company is negative and if company goes into winding up or is unable to pay its debts/liabilities then only the 3 shareholders of company have to bring money to pay the debts of the company and the company will not be able to pay its creditors in full.
10. Since the validity of Rule 37 of the 2016 Rules is not under challenge anymore, the only question which remains for consideration is as to whether the Order rejecting the application of the Petitioner can be sustained or not.
11. It is contended by the learned Senior Counsel appearing for the Petitioner that Section 18(3) of the Companies Act provides for conversion of companies which are already registered and it provides that the registration of a company under this section shall not affect any debts, liabilities, obligations or contracts incurred or entered into, by or on behalf of the company before conversion and such debts, liabilities, obligations and contracts may be enforced in the manner as if such registration had not been done. He, therefore, states that any debts, liabilities, obligations or contracts incurred or entered by or on behalf of the company with unlimited liability will continue to be enforceable against the company with limited liability as if the liability of the company and its members was unlimited. He, therefore, states that there cannot be any concerns regarding the liability of the members of the company on the date of conversion. He states that the laws in Singapore and UK have the same effect that the liability of the members gets limited only from the date the application for conversion gets approved. He, therefore, states that in view of the above, the major concerns raised by the RoC cannot survive.
12. The Senior counsel also states that any pending prosecutions initiated by the SFIO cannot be an impediment for converting the company from an unlimited liability company to a limited liability company inasmuch as the continuation of such prosecutions which have been initiated prior to the conversion of the company will have no effect on the liability of the company.
13. It is pertinent to mention herein at this juncture that this Court on 03.2023 had directed the Petitioner/Company to file an undertaking in terms of Section 18(3) of the Companies Act disclosing the management and shareholding pattern as on the date of the application and post conversion being granted. The Petitioner/Company was also directed to file the details of any changes in the management since 2014.
14. As directed by this Court, an affidavit had been filed by the Petitioner/Company on 04.2023. A perusal of the said affidavit discloses that the shareholding pattern of the company has changed more than once since the date of the application. Paragraph No.2 & 3 of the said affidavit lists out the changes in the shareholding pattern from the date of application and the same reads as under:
