Entrenchment Clause In Article of Association

ENTRENCHMENT (Section 5 (3), (4), (5))

The article may contain entrenchment provision. This is new concept under Indian companies act, as there was no such concept under the old act.

The word Entrench is not defined under companies act 2013. As per oxford Dictionary the word entrench means to establish ( an attitude habit or belief ) so firmly that change is very difficult or unlikely. It may require form of super majority or referendum submitted to the people, or the consent of another party.

Use of word ‘may’ suggests that a company has discretion to include entrenchment provisions in its articles

CONSENT

If such entrenchment provisions are intended to be incorporated in its Articles after Incorporation then consent of members is mandatory in the prescribed manner. In case of a ‘private company’, consent of all the members of the company is required and in case of ‘public company’ consent of its members by way of special resolution is required.

It may be noted that any amendment of articles requires consent of members by way of special resolution, be it a private company or a public company [under section 14(1)]. However in case or private company intending to alter its articles to provide for aforesaid entrenchment provision, it shall obtain consent of all its members.

INTIMATION TO ROC

According to Rule 10 of companies ( Incorporation) rules 2014 where the article contain provisions for entrenchment the company shall give notice to the registrar within 30days from the date of formation or amendment of articles of such provision in Form INC-2 or Form INC-7 as the case may be at the time of incorporation of the company.

Where the articles of an existing company altered to include entrenchment, the notice of entrenchment shall be filed in Form MGT -14 within 30days from the date of entrenchment of the articles as the case may be along with the fees as provided in the company’s rules 2014.

EFFECT OF ENTRENCHMENT PROVISION

Entrenchment provision puts Articles in a very strong position. To understand the impact of this provision let us take an Example:

ABC Private Limited can do certain transaction without consent of XY ventures those are Issue of shares, creation of new subsidiaries borrowing more than limit. In real life these rights are called AFFIRMATIVE RIGHTS (CONFIRMATORY RIGHTS) which are given to any private equity Investor. As a part of contract these rights are included in the Articles of ABC Private Limited.

IMPACT OF AFFIRMATIVE RIGHTS:

Outsiders are also aware of these rights for example Banks.

Tomorrow if ABC private limited approach any Bank for Loan, Bank officials would read the Articles & would ask to get the consent of XY ventures.

Now there is problem with this control Mechanism. XY ventures only holds 10percent equity in ABC private limited what if other 90% holders by passing special resolution remove affirmative rights from   the articles then XY ventures don’t have control over ABC private Limited.

NOW IN THE ABOVE CASE ENTRENCHMENT PROVISION MAY HELP XY VENTURES. (MINORITY)

At the time of Investment XY ventures may ask ABC private Limited to Include Entrenchment provisions in its Articles. This provision provides that any affirmative rights such as issue of shares, creation of new subsidiaries, borrowing more than a limit in the articles only be done with consent of XY ventures.

CONCLUSION:

1. It is more positive for Joint Ventures & private equity Investors.
2. It provide strong footing for Minority Interest
3. Entrenchment provision puts article in such place that even affirmative rights will be executed only with the consent of Associate company her it is XY ventures