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Conundrum over Section 42(7) of the Companies Act 2013: ROC Delhi adjudication order reiterates that Fintech startups whose business model that focus/helps on raising funds/ secondary transactions for unlisted public /private companies violates the Section 42(7) of the Companies Act 2013 by acting as a distribution channel

Conundrum over Section 42(7) of the Companies Act 2013: ROC Delhi adjudication order reiterates that Fintech startups whose business model that focus/helps on raising funds/ secondary transactions for unlisted public /private companies violates the Section 42(7) of the Companies Act 2013 by acting as a distribution channel

Section 42(7) of the Companies Act 2013 states that No company issuing securities under this section shall release any public advertisements or utilize any media, marketing or distribution channels or agents to inform the public at large about such an issue.

In this article, I would like to throw a light on the recent adjudication order on the above subsection (7) of Section 42 of the Companies Act 2013 which has been decided by the ROC, Delhi on two companies namely Mayasheel Retail India Limited/ Planify Capital Limited dated 3rd April 2024.

Read: 

1. MCA imposes Rs. 2.89 Cr penalty for Shares’ Private Placement via Advertisement

2. MCA imposes Penalty of Rs. 7 Crore for Violation in Private Placement of Shares of Rs. 1 Crore

Issue in hand- whether the funds raised by unlisted/ Private companies using the Fintech Start up platforms such as planify, Tyke is in accordance with section 42(7) of the Companies Act 2013?

Facts of the case is as follows:

1. The Subject Company Mayasheel Retail India Limited under the brand name “BAZAR INDIA” has raised funds through planify platform (run by Planify Capital Limited) for the business purpose to the tune of INR 5,04,80,000 by allotment of 10,00,000 shares at 50.48 per share.

2. Accordingly, show cause notice was issued to the company and its directors seeking explanation for the same. Moreover, Section 42(2) of the Companies Act 2013 read with rule14 of the Companies (Prospectus and allotment of securities) Rules, 2014, a company making private placement offer shall not make it to not more than 200 persons in aggregate in a financial year.

3. The Subject Company has denied the allegations as mentioned in the above said show cause notice that the company has raised the funds in compliance with section 42 and section 62(1) (c) of the Companies Act 2013. In addition, the Subject company has allotted securities to only one subscriber Planify Capital Limited.

4. The increase in number of shareholders was due to transfer of shares not pursuant to the allotment of shares. Moreover, The Subject Company has not given any advertisement regarding the fund raise and allotment of shares to the Planify has been completed by the Subject Company before any advertisement released in Public Media/ Newspapers as alleged in the show cause notice.

5. The videos on Youtube (published in the December 2021 and subsequently) wherein pitch information for investment was completely denied by the subject company and did not authorize Planify Capital India Limited or any affiliated entity.

6. In addition, the Promoters of the subject company has sold shares to the Planify Capital Limited by way of secondary transaction 10,00,000 equity shares at the rate of 14.625 per share before the issue of shares raised through Private Placement method.

7. On the basis of documents submitted by the subject company, it was understood that subject company had first issued shares to the Planify, which in turn used its platform for selling the shares to people at large and buying and selling of securities of the subject company, taking place on the Planify Portal were actually secondary market transaction.

The ROC adjudication officer has referred to the relevant clause under the fundraising agreement executed between the Planify Capital Limited and the subject company (Seller) which as follows

Seller engages Planify as its exclusive partners to find potential investors of the securities “Buyers” from 15th Jan 2022 to 14th Jan 2023 (hereinafter “term”)

Pursuant to this agreement, it is mutually understood and agreed between Planify Capital Limited and the Company that Planify may, subsequently approach potential investors, inviting them to subscribe to the equity shares of the company. Additionally, it is expressly stipulated and agreed upon by both parties that the outreach to identify potential buyers shall be directed towards those who have established substantive and pre- existing relationship with Planify capital limited.

The fundraising agreement and the financial statements clearly indicate that the role of planify was to find potential investors for the subject company. Most of the shares acquired by the Planify have been shown as inventories. Thus, planify had no other intentions in buying the shares of the subject company, other than to sell it on portal.

Section 42(7) of the Companies 2013 lays down the certain prohibitions, one of them is the use of “distribution channel”. The present facts clearly indicate that Planify acted as the distribution channel for the Subject Company to inform the public at large since the relevant information about the pitch, financial ratios, news etc were hosted on the Planify Platform. The real intention was to issue the shares to the Public at large. Thus, the first transaction whereby the shares of the Subject Company were issue to planify was merely a smokescreen. Thus the provisions of section 42(7) of the Companies Act 2013 stood violated.

Planify bought shares from the Promoters/ Directors of the subject company as well for selling the same on its platform. However, those transactions would not be violative of section 42(7) as there is a direct agreement between the Promoters and Planify.

However, it is also clarified that while in the context of secondary market transactions wherein Section 58(2) provides for the free transferability of securities of a public company and also provides for the enforceability of a contract in respect of transfer of securities, such provision would be applicable subject to Section 42(7). Selling of shares of the subject company on planify platform would not get the protection of section 58(2) as this selling was not a simple transaction between buyer and seller as envisaged under section 58(2), rather it emanated out of a private placement which created a distribution channel (a prohibited act) for selling of securities to the public at large. On the other hand, the transaction through which planify bought shares directly from subject company for selling the same on its platform, would get the protection of Section 58(2) of the Companies Act 2013.

Hence, the Subject company has clearly violated section 42(7) of the Companies Act 2013. Hence, the penalty is leviable on company, promoters and Directors under Section 42(10) which states that amount raised through the private placement or 2 crore rupees, whichever is lower.

In the present case securities have been allotted, Hence, the issue of returning money to the subscribers does not arise since clause(b) of the proviso Section 42(6) clearly provides that such an eventuality would arise if the company is unable to allot the securities.

Since the provision does not provide for fixed penalty, the provision of rule 3(12) of the Companies (adjudication and penalties) Rules, 2014 are applicable which considers factors such as the size of the company, nature of business, injury to public interest etc…. Hence the penalty on company and Directors shall be one half of the profits of the company for the FY 2022-23 total amounting to INR 2,88,90,000.

Similar decision was taken by ROC Delhi on Solargridx ventures Private Limited wherein the company has used tyke platform to raise funds. However, the provisions of Section 42 of the Act do not allow the ROC to impose any penalty on Tyke platform, which has clearly facilitated the subject company in the act of commission of default under Section 42(7) of the Companies Act 2013.

However, in the present case, the ROC has issued show cause notice to Planify platform separately and imposed one half of maximum penalty mentioned under the act on the ground that amount raised by selling the shares of Planify enterprises limited (associate concern of Planify Capital Limited) which in turn acted as distribution channel for selling the shares of Planify Enterprises Private Limited to the outside investors which is illustrated as follows:

Planify Capital Limited —–> Planify Enterprises Private Limited ——> 76 Investors

The Present facts clearly indicate that Planify Platform used by the Planify Enterprises Private Limited was a distribution channel of the Planify capital limited to inform the public at large about the issue of the subject company. Planify capital Limited was holding shares of the Planify Enterprises Limited and in turn transferring the shares of Planify capital Limited in Planify Enterprises Private Limited to the outside investors. It cannot be denied that purpose of selling the shares was to only find the potential investors for the subject company. Hence, they would not get the protection under section 58(2) of the companies act 2013 since this is not a simple share transfer transaction rather it has been devised to act as a distribution channel for selling the shares. Morever, the valuation report of Planify Enterprises Private limited was used wherein the subject matter of shares belongs to the Planify Capital Limited to the investors.

Hence, Planify platform has violated the section 42(7) of the Act and imposed penalty on the company and its all Directors whether executive or non-executive since all are aware of this subject matter

As per Section 149(12)(ii) states that a non-executive Director not being a promoter or key managerial personnel, shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through a board process and with his consent or connivance or where he had not acted diligently.

In this case, Non-executive Directors knows about the business model of the company and selling of shares of the planify was well within their purview of their knowledge. Hence, they are also liable for one half of the maximum penalty envisaged under the Act.

In Nutshell, the startup companies should be well aware of the intricacies of the corporate law and shall operate within the framework of the law otherwise huge penalty imposed by the departments shall create detrimental to the growth prospects of the company financially.  In the meantime, the government should come up with relaxations for raising funds for start up companies as we are in the era of digital world where our business pitches have been presented through social media platforms for the business purposes.

Author Bio

Qualified CS & Lawyer with 5 years of post-qualification experience in Corporate Secretarial compliance and Litigation matters and currently associated with Anil Dsouza and Associates as Practice Head- Corporate Law, Multi-Disciplinary Firm based out in HSR Layout, Bangalore You can reach me View Full Profile

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