Introduction: The Registrar of Companies, Maharashtra, Mumbai, recently issued an order penalizing WURKNET PRIVATE LIMITED for a Section 62(3) violation under the Companies Act, 2013. The case revolves around the company’s interpretation of convertible notes and the subsequent penalties imposed by the Ministry of Corporate Affairs (MCA).
Detailed Analysis: The violation stems from the company’s misinterpretation of Section 62(3) while proposing to raise funds through convertible notes in December 2019. The Extra Ordinary General Meeting approved the issuance, but the company mistakenly followed procedures under Section 62(1)(c) instead of Section 62(3). The discrepancy was identified during internal due diligence, leading to a suo-moto compounding application.
During the hearing, WURKNET PRIVATE LIMITED, represented by Ashwini Shah, cited its startup status, limited legal knowledge, and unintentional error in interpreting sections. The company argued for a penalty reduction under Section 446B due to its startup classification.
The presenting officer contested this, highlighting that the Companies Act, 2013, provides for convertible notes under Section 62(3). The officer argued against a penalty lower than the prescribed minimum, emphasizing Rule 12 of the Companies (Adjudication of Penalties) Rules.
Conclusion: The Adjudicating Officer, Benudhar Mishra, concluded that WURKNET PRIVATE LIMITED and its officers violated Section 62(3) and imposed penalties in accordance with the Companies (Amendment) Ordinance, 2018. The penalty, totaling INR 18,42,000, reflects the duration and severity of the non-compliance. The company is directed to pay the penalty within 90 days, with potential legal consequences for non-compliance.
This case highlights the importance of accurate statutory interpretation, especially for startups, and emphasizes the legal consequences of non-compliance under the Companies Act, 2013. Companies must ensure meticulous adherence to applicable sections to avoid penalties and legal ramifications.
GOVERNMENT OF INDIA
MINISTRY OF CORPORATE AFFAIRS
OFFICE OF THE REGISTRAR OF COMPANIES
100, “EVEREST”, MARINE DRIVE,
MUMBAI – 400 002
Website : www.mca.gov.in
e-Mail ID : email@example.com
No. ROC(M)/CMC/NJN/ADJ-ORDER/5319 TO 5321/RD-57
Dated: 17 Nov 2023
Order for Penalty under Section 454 for Contravention of Section 62 (3) of the Companies Act, 2013.
IN THE MATTER OF WURKNET PRIVATE LIMITED (CIN: U74999MH2019PTC333001).
1. Adjudicating Officer: B. Mishra, ICLS, ROC, Mumbai
2. Presenting Officer: Rujuta Bankar, ICLS, AROC, Mumbai
3. Authorized person on behalf of the Company: – Ms Ashwini Shah, partner of HAS & Co. Practicing Company Secretaries.
APPOINTMENT OF ADJUDICATING OFFICER: –
1. Ministry of Corporate Affairs vide its Gazette Notification No. A-42011/112/2014-Ad.II dated 24.03.2015 appointed the undersigned as Adjudicating Officer in exercise of the powers conferred by section 454 of the Companies Act, 2013 [herein after known as the Act] read with Companies (Adjudication of Penalties) Rules, 2014 for adjudging penalties under the provisions of this Act.
2. The Company WURKNET PRIVATE LIMITED [herein after known as Company] is registered with this office under the provisions of Companies Act, 2013 having its registered address at office of the 204, 2nd Floor, Shalaka, Juhu Tara Road, Santacruz (West), MUMBAI, Mumbai City, Maharashtra,400054, India., as per the MCA portal.
FACTS ABOUT THE CASE:-
3. In the month of December, 2019, the Company being a “Start-Up” proposed to raise the funds by issue of Convertible Notes. Convertible Notes are in the form of loan which would be converted into shares as per the terms and conditions agreed between the parties.
4. In the Extra Ordinary General Meeting held on 09.12.2019, the proposal for issue of 4 convertible notes of Rs. 25,00,000 I- (Rupees Twenty-Five Lacs) each for raising funds was approved by the members by passing of Special Resolution.
5. However, the Company submitted that since no specific provision has been prescribed under the Act for issue of convertible notes, it was interpreted by the Company that the said issue would fall under the provisions of the Section 62(1)(c) in place of Section 62(3) of the Act. Accordingly, all the compliances were carried out as per provisions of Section 62(1)(c) in place of Section 62(3) of the Act.
6. While carrying internal due diligence of the Company, the Directors/Officers-in-default were made aware of such non-compliance. Since the proposal for issue of Convertible Notes was already approved in the extra ordinary general meeting convened on 09.12.2019, the directors noted said non-compliance in the Board Meeting and decided to file a suo-moto compounding application with the Registrar of Companies, Maharashtra, Mumbai, India which was subsequently considered for adjudication.
RELEVANT SECTIONS OF THE ACT ARE REPRODUCED AS UNDER: –
7. Section 62 Further issue of share capital. —
(1) Where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered —
(a) to persons who, at the date of the offer, are holders of equity shares of the company in proportion, as nearly as circumstances admit, to the paid-up share capital on those shares by sending a letter of offer subject to the following conditions, namely: —
(i) the offer shall be tirade by notice specifying the number of shares offered and limiting a time not being less than fifteen days and not exceeding thirty days from the date of the offer within which the offer, if not accepted, shall be deemed to have been declined;
(ii) unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a right exercisable by the person concerned to renounce the shares offered to him or any of them in favour of any other person; and the notice referred to in clause (i) shall contain a statement of this right;
(iii) after the expiry of the time specified in the notice aforesaid, or on receipt of earlier intimation from the person -to whom such notice is given that lie declines to accept the shares offered, the Board of Director’s may dispose of diem in such manner which is not dis-advantageous to the shareholders and the company;
(b) to employees under a scheme of employees’ stock option, subject to special resolution passed by company and subject to such conditions as may be prescribed; or
(c) to any persons, if it is authorized by a special resolution, whether or not those persons include the persons referred to in clause (a) or clause (b), either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report of a registered valuer subject to such conditions as may be prescribed.
(2) The notice referred to in sub-clause (i) of clause (a) of sub-section (1) shall be dispatched through registered post or speed post or through electronic mode to all the existing shareholders at least three days before the opening of the issue.
(3) Nothing in this section shall apply to the increase of the subscribed capital of a company caused by the exercise of an option as a term attached to the debentures issued or loan raised by the company to convert such debentures or loans into shares in the company:
Provided that the terms of issue of such debentures or loan containing such an option have been approved before the issue of such debentures or the raising of loan by a special resolution passed by the company in general meeting.
(4) Notwithstanding anything contained in sub-section (3), where any debentures have been issued, or loan has been obtained from any Government by a company, and if that Government considers it necessary in the public interest so to do, it may, by order, direct that such debentures or loans or any part thereof shall be converted into shares in the company on such terms and conditions as appear to the Government to be reasonable in the circumstances of the case even if terms of the issue of such debentures or the raising of such loans do not include a term for providing for an option for such conversion:
Provided that where the terms and conditions of such conversion are not acceptable to the company, it may, within silty days from the date of communication of such order, appeal to the Tribunal which shall after hearing the company and the Government pass such order as it deems fit.
(5) In determining the terms and conditions of conversion under sub-section (4), the Government shall have due regard to the financial position of the company, the terms of issue of debentures or loans, as the case may be, the rate of interest payable on such debentures or loans and such other matters as it may consider necessary.
(6) Where the Government has, by an order made under sub-section (4), directed that any debenture or loan or any part thereof shall be converted into shares in a company and where no appeal has been preferred to the Tribunal under sub-section (4) or where such appeal has been dismissed, the memorandum of such company shall, where such order has the effect of increasing the authorised share capital of the company, stand altered and the authorised share capital of such company shall stand increased by an amount equal to the amount of the value of shares which such debentures or loans or part thereof has been converted into.
450. Punishment where no specific penalty or punishment is provided. —
If a company or any officer of a company or any other person contravenes any of the provisions of this Act or the rules made thereunder, or any condition, limitation or restriction subject to which any approval, sanction, consent, confirmation, recognition, direction or exemption in relation to any matter has been accorded, given or granted, and for which no penalty or punishment is provided elsewhere in this Act, the company and every officer of the company who is in default or such other person shall be I fliable to a penalty of ten thousand rupees, and in case of continuing contravention, with a further penalty of one thousand rupees for each day after the first during which time contravention continues, subject to a maximum of two lakh rupees in case of a company and fifty thousand rupees in case of an officer who is in default or any other person]
446B. Lesser penalties for One Person Companies or small companies. Notwithstanding anything contained in this Act, if penalty is payable for non-compliance of any of the provisions of this Act by a One Person Company, small company, start-up company or Producer Company, or by any of its officer in default, or any other person in respect of such company, then such company, its officer in default or any other person, as the case may be, shall be liable to a penalty which shall not be more than one-half of the penalty specified in such provisions subject to a maximum of two lakh rupees in case of a company and one lakh rupees in case of an officer who is in default or any other person, as the case may be.
Explanation. — For the purposes of this section-
(a) “Producer Company” means a company as defined in clause (I) of section 378A;
(b) “start-up company” means a private company incorporated under this Act or under the Companies Act, 1956 and recognised as start-up in accordance with the notification issued by the Central Government in the Department for Promotion of Industry and Internal Trade.
HEARING AND REPLY OF THE COMPANY:
8. Ashwini Shah Partner of HAS & Co, Practicing Company Secretaries, being authorized representative of the Company attended the hearing in person on 16.05.2023.
9. She submitted that being a Startup Company, the initial months were largely occupied in trying to gain a foothold for its business in the market and trying different strategies to raise funds. Hence, the promoters and directors were engaged in the business development.
10. With limited legal and compliance knowledge, the Directors were absolutely unaware of non-compliance under the Act.
11. The reference to Section 62(1)(c) and compliance under said Section in place of Section 62(3) was an unintentional error, committed inadvertently due to limited knowledge of the subject matter and without any malafide intention.
12. Section 62(1)(c) prescribes issue of shares on preferential basis which requires in detail disclosures of the proposed issue of shares. However, Section 62(3) has limited disclosures to be made. Though, the Company has inadvertently complied with erroneous sub section, however, effectively has given additional disclosures. The Directors admit their lapse of interpreting the correct Section for issue of Convertible Notes and necessary compliance thereunder.
13. She stated that since no specific provision with a reference to the terminology “Convertible Notes” has been prescribed under the Act, it was interpreted by the Applicants that the said issue would fall under the provisions of Section 62(1)(c) in place of Section 62(3) of the Act.
14. Further, she submitted that on 04.04.2020, the Company allotted 96 Equity Shares of a Face value of Rs. 10/- each at a premium of Rs. 1,04,157.67/- each pursuant to the conversion of 4 (Four) Convertible Notes.
15. She also stated that the Company is a small company as well as registered as a “Startup” and submitted a copy of the Registration certificate. She requested that in terms of section 446B of the Companies Act, 2013, one-half of the total penalty should be levied on the company.
16. She submitted that the Company has not generated any revenue till date and is burdened with substantial accumulated losses. Additionally, the Company has deemed its primary information and technology asset as unrecoverable due to a failed business model. In light of the challenging circumstances and severe financial constraints, it was requested to levy minimum penalty.
17. During the hearing, the authorized representative has cited the order of the Hon’ble Supreme Court in the case of Adjudicating officer v. Bhavesh Prabari (2029) wherein it was held that in fixing penalties for offences under the SEBI Act, the Adjudicating officer shall not be constrained by the minimum extent of penalty laid in the SEBI Act. The Hon’ble Supreme Court interpreted the SERI Act as giving discretion to the Adjudicating officer keeping in view the period of default as well as the aggravating and mitigating circumstances. On the basis of this judgement, it was requested that less than minimum penalty as per the discretion of the Adjudicating Officer should be levied.
18. The presenting officer submitted that the ratio of the said judgement is not applicable in the present case. Quoting from para 7 of the judgement,”… Normally the expression “whichever is less” would connote absence of discretion by prescribing the minimum mandatory penalty, but in the context of Section 15A(a) as it was between 29th October, 2022 till 7U, September, 2014, read along with explanation to Section 15(9 added by Act No. 7 of 2017, we would hold the legislative intent was not to prescribe minimum mandator my penalty of Rs. 1 lakh per day during which the default and failure had continued…”(emphasis supplied), It was submitted that Companies Act 2013, being a special enactment, adjudication is to be conducted as per Section 454 and Rules made thereunder. Further, the presenting officer submitted that Rule 12 of the Companies (Adjudication of Penalties) Rules states that “… in no case the penalty imposed shall be less than the minimum penalty prescribed if any, under the relevant sections of the Act.” Thus, less than minimum penalty should not be, imposed.
19. The presenting officer also stated that Section 62(1) deals with the various ways of issue of shares such as issue of right shares to existing equity shareholders. It also provides for issuance of shares to employees under Employees’ Stock Option Scheme and issue of shares on preferential basis. Rules 12 and 13 of Companies (Share Capital and Debenture) Rules, 2014 prescribe detailed procedure to be followed in case of issue of shares under Section 62(1). Whereas, Section 62(3) of the 2013 Act excludes increase in the subScribed capital of the company pursuant to an option attached to the debentures issued or loans raised by the company for conversion of such debentures or loans into shares of the company, on the condition that the terms of issue of such debenture or raising of loan have been approved by the members by means of special resolution.
20. The presenting officer submitted that it would be incorrect to state the Companies Act, 2013 does not provide for issue of Convertible Notes. The Explanation to Rule 2(1)(c)(xvii) of Companies (Acceptance of Deposits) Rules, 2014 defines Convertible Note as “an instrument evidencing receipt of money initially as a debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of the start-up company upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument.” Thus, Convertible Note, being a debt instrument, ought to be dealt with under Section 62(3) since it is in the nature of a loan which was subsequently converted into equity shares on 04.04.2020
21. The Company has submitted the Certificate of Registration issued by Department of Promotion Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry bearing certificate No. DIPP 49670. Thus, provisions of Section 446B will be applicable to the Company, being a startup recognized by the Government of India.
22. On the issue of whether less than minimum penalty can be levied in the case of adjudication of offences under Section 454 of the Companies Act, 2013, attention is drawn to the proviso to Rule 12 of Companies (Adjudication of Penalties) Rules, 2014 which states that “… in no case the penalty imposed shall be less than the minimum penalty prescribed if any, under the relevant sections of the Act.”
23. The default under section 62(3) is punishable under section 450. In light of the language of Section 450 which prescribes a penalty of Rs.10,000 and in case of a continuing contravention with a further penalty of Rs.1000 per day, a plain reading makes it clear that no discretion has been provided to the Adjudicating Officer by prescribing a fixed penalty.
24. Further, guidance may be taken from The Company Law Committee Report, 2019 wherein Section 450 has been classified as a “Category H” offence and the aim behind decriminalizing it is that procedural, technical, and minor non-compliances ought to be dealt with through civil jurisdiction. The said civil jurisdiction i.e. the in-house Adjudication Mechanism (IAM) is intended to be objective, cost-efficient and time-efficient. By importing a subjective determination which allows the Adjudicating Officer to impose less than minimum penalty, in addition to contravening the statutory bar under Rule 12 of Companies (Adjudication of Penalties) Rules, 2014 will also be against the legislative intent of the Companies (Amendment) Act, 2020. It is therefore the considered view that less than minimum penalty may not be imposed under this section.
25. In the Extra Ordinary General Meeting held on 09.12.2019, the proposal for issue of 4 convertible notes of Rs. 25,00,000 1- (Rupees Twenty-Five Lacs) each for raising funds was approved by the members by passing of Special Resolution pursuant to the provisions of Section 62(1)(b). The said section deals with issue of shares on a preferential basis. However, Convertible Notes will not fall under Section 62(1)(b).
26. The Companies (Acceptance of Deposits) Amendment Rules, 2016 exempted money received through the issuance of Convertible Notes from the definition of deposits. Sub-Clause (xvii) of Rule 2 of the said Rules states that the following will not be considered a deposit: “an amount of twenty five laklz rupees or more received by a start-up company, by way of a convertible note (convertible into equity shares or repayable within a period not exceeding [ten years] from the date of issue) in a single tranche, from a person.
Explanation.- For the purposes of this sub-clause,-
I. “start-up company” means a private company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognised as such in accordance with notification number [G.S.R. 127 (E), dated the 19th February, 2019 issued by the Department for Promotion of Industry and Internal Trade];
II. “convertible note” means an instrument evidencing receipt of money initially as a debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of the start-up company upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument.
The said Amendment gave legal recognition to Convertible Notes which are an emerging financial tool used by start-ups to raise funds. The money received through a Convertible Note is initially treated as a debt that is convertible into equity shares of the start-up company upon fulfilment of certain terms and conditions.
27. Section 62(3) provides inter alia that subject to the passing of a special resolution approving it, the increase of the subscribed capital of a company caused by the exercise of an option as a term attached to the loan raised by the company to convert such debentures or loans into shares in the company will be excluded from the applicability of the said Section.
28. The Company and its Officers in default have violated Section 62(3) by making disclosures under section 62(1)(b). Therefore, they are liable for penalty under section 450.
29. The period of default is being considered from the date of passing of special resolution under section 62(1)(b) in the EGM held on 09.12.2019 till date of application for compounding.
Having considered the facts and circumstances of the case and after taking into account the factors above, I hereby impose a penalty on Company and its Officers in default, as per Companies (Amendment) Ordinance, 2018, for violation of provisions of Section 62(3) read with Section 446B of the Companies Act, 2013 as per table given below. The order is being passed beyond a period of 30 days from the date of hearing for administrative reasons.
(•) The period of violation of provisions under Section 62 (3) of the Companies Act, 2013 is from 09-Dec-2019 till 04-Aug-2021. Delay = 604 days.
|Penalty imposed on Company/ Director(s)||First default Penalty in (Rs.)||Default
Levied in (Rs) [S.450 read with S.446131 1,00,000
|604||1. WURKNET PRIVATE LIMITED (COMPANY)||10,000||604 X 1000
|604||2. VIVAN PURI
|10,000||604 X 1000
|604||3. SANJAY DINKAR RAMUGADE, (DIRECTOR)||10,000||604 X 1000
(•) I am of this opinion that, the penalty is commensurate with the aforesaid failure committed by every officer of the Company.
31. The Notice shall pay the said amount of penalty through “Ministry of Corporate Affairs” portal and proof of payment be produced for verification within 90 days of receipt of this order.
32. The Company is directed to file revised MGT-14 in compliance with S.62(3) of the Companies Act, 2013.
33. Please note that as per Section 454(8)(i) of the Companies Act, 2013, where company does not pay the penalty imposed by the Adjudicating Officer or the Regional Director within a period of ninety days from the date of receipt of the copy of the order, the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees.
34. Where an officer of a company who is in default does not pay the penalty within a period of ninety days from the date of the receipt of the copy of the order, such officer shall be punishable with imprisonment which may extend to six months or with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees, or with both.
35. Therefore, in case of default in payment of penalty, prosecution will be filed under Section 454(8)(i) and (ii) of the Companies Act, 2013 at your own costs without any further notice.
(BENUDHAR MISHRA )
Registrar of Companies and Adjudicating