In recent months, there has been a flurry of orders against companies across India on account of defaults in making "significant beneficial owner" (SBO) filings. These orders, including against the likes of LinkedIn India and Samsung India, represent the first substantive rulings on the SBO regime following its inclusion in the Companies Act a few years back. While these orders are all case-specific and some of them may well be reversed in appeal, there are a few overarching themes covered in this note which are relevant to other corporate groups.
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The last three months of May, June and July of 2024 have witnessed a flurry of orders by the Registrar of Companies in India (RoC) against various companies across the country on account of defaults in making "significant beneficial owner" (SBO) filings pursuant to the corresponding rules (SBO Rules) under the Companies Act, 2013 (Companies Act). While the order against LinkedIn Technology Information Private Limited (LinkedIn India) holding the Global CEO of Microsoft Corporation and the Global CEO of the LinkedIn division within Microsoft Corporation to be SBOs of LinkedIn India has understandably grabbed the headlines, there have been similar adverse orders against several other companies. Even leaving aside cases of routine and admitted defaults, other cases such as the ones against Leixir Resources Private Limited (Leixir Resources), Metec Electronics Private Limited (Metec Electronics), Shree Digvijay Cement Company Limited (Digvijay Cement), two Samsung subsidiaries in India (together, Samsung India) and Finar Limited (Finar) have involved substantive rulings on the SBO regime. While the orders are all case-specific and may well be reversed in appeal, there are a few overarching themes which are relevant to other corporate groups.
Onus of compliance for Indian investee companies and significant shareholders
In several cases where the RoC has passed adverse orders, the relevant companies appear to have convinced themselves of the non-existence of any SBO without seeking the relevant details from their shareholders. Given that the determination of an SBO involves an assessment of direct and indirect holdings (aggregating to at least 10% of the shares, voting rights or dividend rights) as well as the right to exercise or actual exercise of "significant influence" or "control" other than through only direct holdings, an Indian investee company is invariably not in a position to conclusively determine by itself the existence of an SBO.
Indeed, as per the Companies Act and the SBO Rules, Indian companies are required to seek details from any person who it has "reasonable cause to believe" is an SBO (or has knowledge of the identity of the SBO or another person likely to have such knowledge). Therefore, in order to ensure its own compliance with the SBO Rules, an Indian investee company has to send a notice in the specified form (i.e., Form BEN-4) to every shareholder who directly holds 10% or more of the shares, voting rights or dividend rights in the company. This would effectively shift the onus of compliance onto the shareholder, who will need to either respond itself with a "no SBO" declaration or ensure that the relevant SBO provides the relevant details to the investee company (i.e., in Form BEN-1), which will then need to be relayed onwards to the RoC by the investee company (i.e., in Form BEN-2).
In the normal course, non-compliance with the reporting requirements would result in the relevant SBO and investee company being subject to nominal monetary penalties under the Companies Act. In cases involving wilful disclosure of false / incorrect information or wilful suppression of material information, the relevant persons would be liable to face criminal action for fraud. Importantly, incorrect disclosure of SBO-related information may potentially result in tax and other regulatory complications, both in India and abroad.
No safe harbour for listed holding companies
The SBO-related changes, introduced in 2018 under the Companies Act, were meant to be based on the corresponding rules under the Prevention of Money Laundering Act, 2002 (PMLA) dealing with identification of beneficial owners. However, while the PMLA rules provide an express carve out from the beneficial ownership identification and verification requirements for companies which are controlled by a publicly listed corporate shareholder, the SBO Rules do not include such an exemption.
Tellingly, the RoC's orders in respect of LinkedIn India and Samsung India do not extend the safe harbour in respect of listed holding companies to the SBO Rules. In LinkedIn India's case, the matter seems to have been complicated by the fact that the listed entity Microsoft Corporation was not identified in the financial statements as the ultimate holding company. However, in Samsung India's case, the RoC's order draws an adverse inference from the fact that the executive chairman of the group and his family held more than 25% of the shareholding and voting rights of the listed parent entity. It is unclear if the regulator was guided by the 25% threshold for open offers under SEBI's takeover regulations. Going forward, for the purpose of compliance with the SBO Rules, Indian companies with listed parents will not be able to rely on the exemption provided under the PMLA rules and will need to carry out the necessary checks to determine if there is indeed an SBO for the purposes of the Companies Act. Arguably, listed holding companies which have individuals as promoters (or equivalent) will be required to name the relevant individuals as SBOs in all Indian investee companies.
Professional CEOs as SBOs
The rulings in the Leixir Resources and LinkedIn India cases use different approaches in holding the CEOs of the respective parent entities to be SBOs of the Indian companies. The finding in the Leixir Resources case hinges on an expansive reading of the SBO Rules in relation to shareholders which are pooled investment vehicles (PIVs). The SBO Rules provide for a CEO of a PIV to be named as the SBO in cases where the investment manager of the PIV is a body corporate. However, since the parent PIV of Leixir Resources did not have a CEO itself, the RoC ruled that the CEO of the PIV's investment manager will be deemed to be an SBO, even though the SBO Rules do not expressly provide for this. The finding in the LinkedIn India case, on the other hand, relied on the fact that the CEOs of Microsoft Corporation and LinkedIn US had "general charge and supervision" of the business and that the majority of the directors of LinkedIn India were employees of LinkedIn Corporation / Microsoft Corporation and ultimately reported to the CEOs of these overseas group entities.
Importantly, the RoC's orders disregard the contentions made by the respective companies that the global CEOs were acting in a purely professional capacity and did not in fact have any shareholding or exercise any control or significant influence over the affairs of the Indian companies. It is worth highlighting that under the Companies Act, there is an express carve out in the definitions of 'promoter' and 'related party' for any person whose advice, directions or instructions the board of directors is accustomed to act in accordance with, if such person is acting in merely a professional capacity. It does not stand to reason that a professional who is not considered as a promoter or even a related party under the Companies Act could be regarded as an SBO based on having the ability to exercise 'significant influence' or 'control'. It is worth highlighting that these cases were different from say the case involving Samsung India where the executive chairman had a significant shareholding in the parent company.
In the LinkedIn India case, rather oddly, the RoC's order then goes on to highlight the existence of common directors between the parent and the Indian subsidiary to conclude that "the Board of LinkedIn Corporation does not control the Board of the subject company and the control has to be seen elsewhere." The order then refers to certain statements on LinkedIn's website and the annual report of Microsoft Corporation (which identified the CEO of LinkedIn Corporation as a director and officer of Microsoft Corporation) to identify the Global CEO of LinkedIn Corporation and the Global CEO of Microsoft Corporation (to whom the LinkedIn Corporation's CEO reports) as the individuals who exercise such control, resulting in the two individuals being considered as SBOs of LinkedIn India.
Again, it is unclear if the RoC would have reached a different conclusion if there was no common directorship between the Indian and US entities. The RoC did not accept the contention of LinkedIn India that the business operations of LinkedIn India operate under the decentralized supervision of the LinkedIn India board.
Nominee directors anomaly
The RoC's orders in both the LinkedIn India and Leixir Resources cases seem to draw an adverse inference from the fact that the non-executive directors on the boards of the respective Indian companies (in both cases, being the employees of the respective overseas group entities) were not shown as "nominee directors" under Section 161(3) of the Companies Act. It is unclear whether Section 161(3) would indeed apply in cases where a director is appointed in the normal course by the board of directors (e.g., as an additional director) and / or by the shareholders of the company (i.e., either as a director liable to retire by rotation or otherwise). In those cases, the appointment of the concerned director should be governed by the terms of approval of the board or shareholders (i.e., as opposed to directors nominated under Section 161(3) whose appointment is governed by the relevant statute or the relevant agreement between the company and the nominating party).
In any event, the RoC's orders do not clearly spell out how the categorisation of a board member as a "nominee director" of a group company is relevant in determining the SBO of the Indian company. Even if a group company were to nominate any directors on the board of an Indian company, so long as the group company itself is not majority owned or controlled by an individual, such board nomination should not have any bearing on the SBO analysis for the Indian company.
Board authority and blurring of reporting lines
In several cases, the RoC has relied on various secondary sources, including KYC filings with Indian banks, filings with the US securities and exchange commission and foreign corporate registries, press releases and media statements, bylaws of foreign holding companies and, in one instance, even trademark registry records, to determine the SBOs of the respective Indian investee companies. While cases involving indirect shareholding in excess of 10% (such as the ones involving Digvijay Cement and Finar) are relatively straightforward, the cases involving individuals indirectly having the right to exercise or actually exercising "significant influence" or "control" are more nuanced.
In LinkedIn India's case, when determining the significant influence of the global CEOs, the issue appears to have been complicated by certain officers of Microsoft Corporation having the power to operate bank accounts of LinkedIn India. The RoC's order infers that such power confers Microsoft Corporation with financial control over LinkedIn India and then extends the CEO's overall supervisory role to conclude that he has the "right to exercise" significant influence or control over LinkedIn India.
In the case of Metec Electronics, a Chinese individual who was neither a shareholder nor a director had a non-statutory designation of "Operations Director" and was found to be at the top of the Indian company's organizational chart. Accordingly, the RoC's order concluded that he was a "strategic decision maker" and held him to be an SBO of the Indian company on the basis of exercising "control" in its functioning".
While the inference drawn by the RoC in several of these cases is debatable, Indian companies would be well advised to ensure that all reporting lines within the organisation eventually end at the board of directors of the company. In the case of large conglomerates and MNCs, the reporting and approval matrix often provides for company officials to seek inputs from relevant individuals in the same function within the parent / group companies. It is important to ensure in such cases that the inputs from the parent / group companies are obtained before the relevant proposal is placed for the approval of the board of directors of the Indian company. This would effectively mitigate the risk of the Indian company's board of directors being superseded by such parent / group company individuals.
Concluding thoughts
Indian companies as well as significant shareholders of Indian companies will need to be careful in ensuring compliance with the SBO Rules. Indian companies can ensure their own compliance by seeking the SBO details from every shareholder who directly holds 10% or more of the shares, voting rights or dividend rights, and then duly filing the relevant details received from the SBOs with the RoC. The shareholders themselves will need to apply the indirect shareholding test as well as the "control" and "significant influence" criteria to determine if there is any individual who qualifies as an SBO. While the shareholding criteria is relatively straightforward, the assessment of "control" and "significant influence" will require a more nuanced and case-specific analysis. It is important for companies to carefully parse through all internal documents (e.g., board minutes, powers of attorneys, organisation chart) as well as public documents (e.g., annual reports, filings with other regulators, media statements) in determining if there are any SBOs. As far as feasible, it is helpful for companies to have in place a relatively simple board governed organisational structure.
As for the regulatory regime, the recent orders serve to highlight the maze of overlapping and often inconsistent rules in identifying significant beneficial owners of Indian companies. Apart from the beneficial ownership requirements under the PMLA and SEBI rules governing clients of market intermediaries, Press Note 3 of 2020 issued by the Government of India introduced its own beneficial ownership test to regulate foreign investments from land bordering countries. While the substance of the beneficial ownership criteria across these regulations are similar to the ones under the SBO Rules, there are several discrepancies in the requirements. In the interest of rule certainty, it is imperative that the beneficial ownership requirements across the different regulatory regimes are fully harmonized at the earliest.
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