ARE START-UP COMPANIES AND SMALL COMPANIES SUBJECT TO LESSER PENALTIES?

August 17, 2023

Background:

Recently, under the ROC Adjudication mechanism we have seen adjudication orders being passed with respect to start-up and small companies. In one such case, Registrar of Companies Tamil Nadu -Coimbatore (‘ROC’) passed an order against M/s. Konwert India Motors Private Limited (‘Company’/’Konwert’) on May 18, 2023.
In this case, the Company was in violation of section 42(3) of the Companies Act, 2013 [‘the Act’] read with Rule 14(8) of the Companies (Prospectus and Allotment of Securities) Rules, 2014.
Section 42(3) of the Act read with Rule 14(8) of the Companies (Prospectus and Allotment of Securities) Rules, 2014 states that companies making private placement under section 42 of the Act shall, before circulating the private placement offer letter i.e., PAS-4 to the identified persons, file the MGT-14 with ROC.
In the aforesaid case, the Company had circulated the private placement offer letter on April 24, 2021 but it filed form MGT-14 with the ROC on August 24, 2021, thus it was a case wherein the Company issued the PAS-4 to identified persons before filing relevant special resolution in form MGT-14. Hence the Company had violated Section 42 (3) read with Rule 14 (8) of the Companies (Prospectus and Allotment of Securities) Rules, 2014.
Penalty for violation of section 42 (3) of the Act is specified under section 42(10) of the Act. However, since Konwert was a small company as well as registered on Start-up India Portal, the relaxations in penal provision provided under section 446B of the Act were made applicable for purpose of levying of penalty.

Penal provisions for Small & Start-up companies

In this regard first let us understand meaning of Small Company and Start Up Company.
- Small Company is defined under section 2(85) of the Act – Small Company means a company, other than a public company whose:
  - paid up share capital of which does not exceed two crore rupees or such higher amount as may be prescribed which shall not be more than ten crore rupees, and
  - turnover of which as per profit and loss account for the immediately preceding financial year does not exceed twenty crore rupees or such higher amount as may be prescribed which shall not be more than one hundred crore rupees:
  - Provided that nothing in this clause shall apply to:
    - A holding company or a subsidiary company;
    - A company registered under section 8; or
    - A company or body corporate governed by any special act.

Start Up Company: The term ‘start-up company’ has been defined in various sections and Rules under the Act with minor modifications in wordings, but conveying the same meaning. As per the Explanation given under section 446B (which is the most relevant section in the context of this article), 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(‘DPIIT’).

Konwert was having a paid-up capital of Rs.1,00,000. It was incorporated in the year 2019 and was registered on the start-up portal provided by DPIIT. Hence the Company was considered as small company and start-up company.

Now going ahead further let us look at how penalties are applied to small companies and start-up companies under the Act. section 446B of the Act speaks about lesser penalties for one person companies, start-up companies, producer companies and small companies. section 446B states as follows:

“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 , as the case may be , shall be liable to a penalty which shall not be more one half of the penalty specified in such provision subject to maximum of two lakhs rupees in case of company and one lakh rupees in case of an officer who is in default or any other person, as the case may be.”

The section starts with the wording, “notwithstanding anything contained in this act”, the meaning of this clause is that the provision is added in order to uphold its enforceability over another provision that is contradictory to it. This is considered as non-obstante clause. Hon’ble Delhi High Court had stated that, “A non obstante clause is a legislative device which is usually employed to give overriding effect to certain provisions over some contrary provisions that may be found either in some enactment or some other enactment, that is to say, to avoid the operation and effect of all contrary provisions.”[i]
In this context we would now see difference in penalties levied for violation of section 42 by a small company or start-up company and rest of the companies. Let us understand what is the penalty mentioned under section 42(10)

Section 42(10) prescribes penalty as: “If a company makes an offer or accepts monies in contravention of section, the company ,its promoters and directors shall be liable for penalty which may extend to the amount raised through the private placement or two crore rupees , whichever is lower and the company shall also refund all monies with interest as specified under section 42(6)to subscribers within a period of thirty days of the order imposing the penalty.”

In cases where section 446B was not applicable the penalty was imposed as per section 42(10) which was much higher as the companies were neither small companies nor start-up companies.
Some of the orders passed in case of companies where penalty was imposed under section 42(10) of the Act were as follows:

Date of Order	Name of the Company	ROC	Violation of Section	Penalty
November 24, 2021	Valley Monks Private Limited.	ROC Bengaluru	42 r/w Rule 14 (8)	On Company: Rs 50,00,000/- On 2 directors: Rs 50,00,000/- each Also ordered to refund Rs 50,00,000/- i.e., the Amount which was raised.
May 15, 2023	Payswiff Technologies Private ltd.	ROC, Hyderabad	42(4) & 42(6)	On company- 80,00,000/- On Managing director-20,00,000/- On 5 Directors-20,00,000 /- each Also directed to refund all money accepted in contravention of section 42(6) along with interest.
September 5, 2022	Herb Nutra. Lab Private ltd	ROC,Tamil Nadu	42 r/w 62	On Company-9,00,000 On 3 Officers in default:9,00,000 each

As seen above, the relaxation in penalties for small and start up entities is provided under Section 446B of the Act. Accordingly, penalty levied on the Konwert was Rs.2,00,000/- and on two Directors cum promoter of Rs.1,00,000 each. [i.e., total penalty levied was Rs 4,00,000/-.]. Hence it can be seen that maximum penalty prescribed under section 446B of the Act has an overriding effect over the penalty prescribed under section 42(10) of the Act.

In our present example of adjudication order of Konwert we can see that the ROC also upheld that provision of section 446B gives overriding effect over section 42(10) of the Act since the Company, though contravened provisions of section 42 and was otherwise liable to be penalised under section 42(10), but was subjected to the relaxation being provided under section 446B in penalty for being start up and small company, which in turn lead to a lower penalty on the company. Therefore, it can be said that small companies and start-up companies are subject to lesser penalties as compared to other companies.

This was just one instance where we made a comparison between the penalty provisions provided for under section 42 (10) with the penal provision provided for in Section 446B. But it must be noted that the relaxation in penal provisions provided for in section 446B shall have overriding effect over all other penalty provisions provided for in the entire Act if the defaulting company is one within the classes of companies as prescribed for in section 446B i.e., if the defaulting company is a one person company, small company, start-up company or producer company.

CONCLUSION

To conclude it can be said that the above orders indicate that if any Company is classified under Start-up Company, Small Company and such other companies as mentioned in section 446B only then the penalty levied is lesser compared to other companies. Thus, though the Act provides for penalties depending upon the type of violation in various sections or where no such penalty is prescribed for general penalty is levied under section 450, it also takes into account the probable difficulties in getting professional guidance etc., which may be faced by certain categories of companies and thus even in case of violations being committed by such companies, there is a limit being set on the maximum penalty which can be imposed on such category of companies. Hence it can be said that the relaxations given in Section 446B should be looked at as a warning given by the Regulator, instead of levying heavy penalty prescribed in the relevant provision of the Act, and irrespective of how small a company is, it must ensure to comply with all the applicable provisions of the Act, in law and spirit!!!

[1] Kishori Lal and Mukat Behari Lal… vs Siri Krishan, S.N. Nigam and Anr on 26^th February,1996: 63 (1996) DLT 577.

This article is published in taxmann. The link for the same is: –

https://www.taxmann.com/research/company-and-sebi/top-story/105010000000023186/are-start-up-companies-and-small-companies-subject-to-lesser-penalties-experts-opinion

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