Authors: Pranshu Gupta* & Harshal Chhabra**
Second-year law students at National Law School of India University (NLSIU), Bangalore* and Gujarat National Law University (GNLU), Gujarat**
I. Introduction
In November 2023, the Ministry of Corporate Affairs (“MCA”), in a significant step, notified the new Limited Liability Partnership (Significant Beneficial Owner) Rules, 2023 (“the Rules”). This development follows the 2022 MCA notification that introduced the framework for identifying and declaring “beneficial ownership," extending its scope from companies to include Limited Liability Partnerships (“LLPs”). This was facilitated by extending Section 90 of the Companies Act, 2013 (“the Act”) to LLPs.
Although the Rules were introduced to improve the existing regulatory framework for significant beneficial owners (“SBOs”) in LLPs, their efficacy in resolving existing gaps in the law remains questionable. At the same time, examining the merits and demerits of the new Rules would be incomplete without analysing them in the backdrop of the preceding 2022 MCA notification.
Thus, this article aims to critically analyse the Rules in three parts, focusing on critical issues and proposing solutions. First, we decode the new Rules, scrutinising their implications in light of the 2022 Notification and the Act. Second, we delve into the erroneous application of Section 90 of the Act to LLPs in the 2022 Notification, arguing for including the supporting “package of provisions”. Third, we highlight inaccuracies in deriving definitions for SBOs from the Act and conclude with our suggestions.
II. Decoding the New LLP (SBO) Rules
The amended rules for LLPs introduce critical operational requirements. Reporting LLPs must meticulously identify “SBOs” and prompt them to submit detailed declarations. If a partner, excluding individuals, holds at least 10% in contribution, voting rights, or profit entitlement, the LLP must issue comprehensive notices aligning with Section 90 of the Act. Following identification, an SBO must file a declaration within ninety days. LLPs must then file returns, containing SBO particulars, with the Registrar within thirty days. Simultaneously, an updated register of SBOs must be maintained. Designated partners face penalties for non-compliance. The Registrar, wielding authority, may issue notices seeking information within thirty days. Non-compliance to the notices may lead to the Tribunal imposing restrictions on SBO interests.
The Rules were notified to increase transparency and accountability of beneficial owners in LLPs. To build a robust LLP framework, the Rules have mandated strict procedural requirements for identifying and reporting SBOs. However, mere procedural requirements would not fulfil the said objectives; they require rectification of fundamental issues arising due to the erroneous extension of the Act to LLPs by the 2022 Notification.
III. Missing Pieces: Importing the SBO “Package” into LLPs
Typically, individuals who receive beneficial rights also register the legal ownership of shares in their own name. However, the title might sometimes be vested in one person while the benefits accrue to a different party. Recognising the need to tackle such hidden ownership structures in companies, the Act prescribes a multi-pronged approach to identify and investigate beneficial ownership. We argue that a ‘package of provisions’ encapsulating Sections 89, 90 and 187 of the Act, read with the Companies (SBO) Rules, 2018, form a holistic framework for regulating SBOs.
Firstly, Section 89 introduces the concept of beneficial interest in companies. It differentiates between registered owners of shares and the actual beneficiaries, mandating disclosure of the same. Both the registration holder and the owner of the beneficial interest are required to make declarations to the reporting company. Subsequently, the company shall note it in the Register and file returns on such declarations to the Registrar. Clause 10 of Section 89 defines “beneficial interest” as the rights of a person to exercise any right attached to shares or collect any dividends and distributions in respect of such shares.
Secondly, Section 90 deals with persons holding such beneficial interest (defined in Clause 10 of Section 89). It has defined “SBOs” as persons holding a minimum prescribed threshold in shares or voting rights or exercising “significant influence or control”. Rule 2(h) of the Companies (SBO) Rules, 2018 elaborates on this definition and delineates a minimum threshold of 10% using four parameters for identifying SBOs: shares, voting rights, dividends and other distributions, and significant influence and control.
To deal with a situation where the beneficiary is a company and not an individual, the Act under Section 187(2)(d) permits companies to retain investments through a depository while obligating them to maintain a register detailing such holdings. Section 187 is vital because it achieves the twin objectives of allowing companies to be beneficial owners and parallelly creating a regulatory mechanism for their registration. This illustrates how the Act’s framework comprehensively accommodates various situations with varying beneficial ownership structures.
The above analysis demonstrates that any framework for SBOs requires the interplay of multiple sections and rules for effective regulation.
In light of this, we argue that the twin MCA notifications, issued in 2022 and 2023, ignore this fundamental interdependence when they extend Section 90 of the Act to LLPs without importing the rest of the package. This is so because the nuanced definition of “beneficial interest” under Section 89 forms the foundation for understanding and identifying beneficial ownership. Section 90 firmly anchors this framework by explicitly dealing with beneficial owners, outlining the proper procedure and prescribing requisite thresholds.
Hence, the current SBO framework in LLPs is incomplete. Room for ambiguity and error would remain as long as relevant provisions are not adequately incorporated.
IV. One Size Doesn’t Fit All: Recalibrating towards LLP-Specific Voting & Control
Incorporating the SBO framework for companies into the Rules would only be effective if we tailor its underlying parameters to the unique nature of LLPs. This part of the article shall specifically focus on and analyse ‘voting rights’ and ‘control’ in the context of LLPs:
a. Voting Rights
Companies follow a shareholder-driven model, with voting rights determined by the extent of each member’s shares. Section 47 of the Act defines “voting rights”, which are proportional to their share in the paid-up equity share capital of the company. On the other hand, the LLP Act has not defined the voting rights of partners. LLPs are structured around partner expertise, shared responsibility and mutual consent, and the Act embodies the same.
Thus, voting rights are governed by the terms of the LLP agreement and might not always be proportional to each partner's contribution. In case the LLP Agreement does not explicitly state the manner of distribution of voting rights, the same is to be determined as per the provisions of the First Schedule to the Act. Para 8 of the Schedule provides that matters shall be decided by a majority vote, with each partner receiving one vote. Simply put, if the LLP Agreement is silent, then voting rights are to be distributed equally amongst all the partners, irrespective of the extent of their contributions.
In companies, defining SBOs is straightforward, as all parameters align seamlessly, such as in Section 47 of the Act, where voting rights are tied to the number of shares a member holds. This is not the case with LLPs, as voting rights depend on the terms of the LLP Agreement and are not statutorily tied to partners’ contributions. For instance, some partners’ contributions might be less than the 10% threshold mandated by the SBO test, but due to the LLP Agreement being silent on voting rights, all partners become equal voting rights holders as per Schedule I, and are declared SBOs by default. Thus, an inadvertent error while drafting the LLP Agreement might result in all partners being declared SBOs due to the automatic attribution of equal voting rights.
Thus, it is argued that the new Rules do not account for such inconsistencies due to a lack of clarity on the voting rights of partners. This, in our opinion, undermines the measure's effectiveness.
b. Control
The interpretation of the term “control” within Section 2(27) of the Companies Act reveals a two-fold definition encompassing de jure and de facto control. The former confers the right to appoint a majority of directors, while the latter suggests that individuals or groups acting in concert can “positively influence” management or policy decisions. Consequently, applying this definition becomes intricate, contingent upon various case-specific circumstances where such “positive influence” needs to be determined.
Neither the LLP Act nor the new Rules have defined ‘control’. However, relying on the definition given under the Act is a precarious endeavour due to two reasons:
a. the absence of de jure control in LLPs and
b. the nuanced differences in the nature of de facto control.
One could argue that de facto control can be similarly determined on a case-to-case basis for LLPs. However, it must be remembered that such cases were decided against the backdrop of the Companies Act. Thus, their company-specific precedential value cannot be extrapolated similarly to LLPs. Therefore, we argue that a separate definition of “control”, which is tailored for LLPs, is required to serve the regulatory objectives of the new Rules.
V. Conclusion
Our examination of the new LLP (SBO) Rules makes it evident that they lack a holistic approach. The Rules, aiming for transparency, impose stringent operational requirements on LLPs for identifying and reporting SBOs. This article contends that the regulatory framework falls short due to the incomplete incorporation of essential provisions and definitions from the Companies Act. Additionally, nuanced concepts such as “beneficial interest,” “voting rights,” and “control” under the Companies Act have no direct equivalent in the LLP Act, leaving space for ambiguity.
These issues originated in the 2022 Notification and remain unaddressed in the new 2023 notification and the Rules. An effective solution requires incorporating the entire package of SBO provisions for companies along with explicit definitions of SBO parameters independent of the Companies Act. This measure would not only resolve existing issues but also strengthen the regulatory framework of the Rules for the future.