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Company Law Memo Shashwat Jindal

Memo Problem:

Arvind, Yogi and Manish set up a company called Aap-Apps Private Limited (“Company”) onMay 15, 2014, with the object of developing mobile applications, for third parties. Arvind is a

graphic designer and Yogi is a computer programmer, and they have been friends from theiryears together in school. Over one of their many casual conversations, they struck upon theidea of setting up a company that would create mobile applications for businesses; and not longafter that conversation, they quit their respective jobs and decided to start their business.However, they realized that they would not be able to pool together sufficient resources; andtherefore, invited their third friend, Manish, an investment manager, to also join their business.Manish agreed, and accordingly, the Company was set up. Each of them invested INR10,00,000, which was divided into 1,00,000 equity shares of INR 10 each. Arvind, Yogi andManish appointed themselves as directors on the board of the Company.

They worked hard to draw clients and the Company was in early 2015, awarded a contract todevelop a mobile application for ICICI Bank. Its clientele grew increasingly impressive fromthere and soon, it was drawing more work than they could handle. They realized that theCompany needed to hire more people, which in turn, meant that it would need a bigger spacefor its Mumbai office. They also, then discussed the possibility of opening an office in Bangalore,which is where a lot of their clients were based. Expansion of this scale however, neededadditional funds; and so, Manish proposed that each of them invest an additional INR20,00,000, to which Arvind immediately agreed. Yogi however, rejected the suggestion becausehe did not think he would be able to afford such a huge sum. He suggested instead, that theyseek an institutional investor willing to invest a sum of INR 60,00,000. Arvind and Manishhowever, were concerned that it would lead to a dilution in their control over the management ofthe Company and were of the opinion that at least for the moment, they should desist frominviting an institutional investor on board. Thus, despite Yogi’s objections, Arvind and Manishpassed a board resolution for a rights issue of INR 60,00,000. The resolution authorized Manish

to, on behalf of the Company, send a notice to each of the three shareholders offering each ofthem 2,00,000 shares of INR 10, and giving them a time period of 20 days from the date ofreceiving the offer, to accept it. Not unexpectedly, Yogi could not accept the offer within thisperiod, despite his many efforts to arrange the necessary funds to exercise his option topurchase the shares offered. The Articles of Association of the Company did not permit theshareholders to renounce their right under Section 62(1)(a) of the Companies Act, 2013 infavour of another person; and accordingly, it fell upon the Board to decide how to dispose theadditional 2,00,000 shares.Arvind and Manish, at the next meeting of the Board, decided on a preferential allotment of theremaining shares and a resolution was passed that authorized Manish to identify suitablepersons to whom these shares may be issued. This time around, Arvind and Manish were lessconcerned, about introducing new members in the Company, because at the end of the

allotment, they would hold more than 66 percent of the shares of the Company, and the sharesthat would be allotted to the new member(s) would carry only around 22 percent of the totalvoting rights. At the same time, however, Manish was aware that the sum involved was toosmall to draw an institutional investor; and therefore, decided to offer these shares to peopleamong his family and friends.Manish then, called some of their friends enquiring whether they would be interested ininvesting in the Company. After making around 15 unsuccessful such calls, Manish put up astatus message on Facebook saying, “Hoping to expand our office in Mumbai, and set up a new

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one in Bangalore; that is, assuming we manage to put together the necessary funds. So, if youhave some loose change lying around the house, send it our way! On a more serious note, ifyou (or someone you know) is interested in investing a small sum in our Company, let me knowand I’ll be in touch.” The post also carried a link to the website of the Company. Of his nearly500 friends on Facebook, only around 10 responded, and eventually, the Board allotted 20,000shares of INR 10 to each of these 10 friends of Manish.

Meanwhile, Yogi was naturally furious at having been reduced to a mere 11% in the Company.He also thinks that the allotment to Manish’s friends compromises on the need to maintainconfidentiality regarding their business. He approaches you and seeks your advice on whetherthe allotment to Manish’s friends is invalid for being contrary to his and the Company’s interest.He also, wishes to know whether there is ground to argue that the allotment of shares toManish’s friends was contrary to Section 42 of the Companies Act, 2013 (and Rule 14 of theCompanies (Prospectus and Allotment of Securities) Rules, 2014).

Facts:

In the present case, the petitioner, Yogi and the respondents, Arvind and Manish, set up aPrivate Limited Company, which created mobile based applications for mobile phones. As thebusiness was growing, they decided that the company needed more funds, so that they couldexpand both their present office and open new offices. Contrary to the appellants previoussuggestion to get an institutional investor to invest an additional Rs. 60,00,000, it was decidedthrough a board resolution that each one of the owners would invest an additional Rs. 20,00,000each into the company. The appellant was unable to arrange the said amount and thus it wasdecided by the board that shares would be allotted through preferential allotment. As they couldnot find any suitable investors, Manish finally put up a status on Facebook, which could beviewed by his 500 friends on Facebook, to invest in the company, it also had a link to thewebsite of the Company. Out of the 500 friends, only 10 responded, who invested money into

the company.

Issue:

Whether the board was authorized to pass a resolution as to how the shares were to be allotted.

Whether a Private Limited Company, the investment made by the 10 persons is valid onaccount of the company being a Private Limited Company.

Analysis:

According to Section 107 of the Companies Act, decisions of the Company are to be takenthrough voting, which is usually a raise of hands, where the decision of the majority is taken intoconsideration. Thus, in this Company of 3 people, the respondents could have taken thedecision to not go for institutional investor.

According to Section 62(1)(a), the shareholders, i.e. in this case, the appellants and the tworespondents, were given time period of 20 days to accept the offer, which fulfilled the conditionof minimum of 15 days to be given to equity holders in the company, after which the choice of


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how the shares are to be disposed off is given to the board (Section 62(1)(c)), thus giving theboard the right to dispose the shares as per their wishes. Also, Section 62 of the Act, whichgives a Pre-emptive right to existing shareholders, was not violated in this case, as an offer hadbeen made to the appellant.

According to section 42 of the companies Act, in the case of private placement, not more than

50 people can in one issue be invited to subscribe to the shares of the company through privateplacement. Section 2(68)(iii) of the Companies Act 2013, says that a Private Limited Company,is prohibited from inviting general public to subscribe to the shares of the Company. The onlyway for a Private Limited Company to raise share capital is through private placement.According to the case of Sahara India Real Estate Corporation Limited (SIRECL) vs SEBI, thelearned Supreme Court was of the opinion that as the offer to invest in the company was tomore than 50 persons. In the present case, Manish had made an offer to the 500 people on hisFacebook, to invest in the company, the offer had been made to more than 50 persons, thusviolating the basic principal that a Private Limited Company cannot make a public offer, thusinvalidating the purchase of shares by the ten friends of Manish.

Conclusion:

Thus, it may be concluded that, though the Board of Directors, had the right to allot theremaining 200000 shares as per their desire, but the method, which was followed by them, wasnot right as they had made a Public offer, even though they were a Private Limited Company.


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