Flying solo with one person companies

Introduction

Adam Smith in the ‘Wealth of Nations’ (1776) declared “Individuals always weigh their own interest more than the group”. He made this statement at a time when tradesmen in Europe were organizing themselves into groups to enhance their scale of business and leverage  potential markets available for their goods in exotic, far away colonies. This organized trade would later be christened as a ‘joint stock company’ and lead to the birth of company law. However, with the passage of time, it appears legislative draftsmen paid heed to what the Father of Economics had contemplated then and the outcome is  the legal acceptance of the concept of a ‘One Person Company’- now part of the Companies Act, 2013 (2013 Act) in India.

Concept under the 2013 Act

A One Person Company (OPC) under the Act means a company that has only one person as the member [see end note1]. An OPC formed under the 2013 Act has been accorded the status of a private company [see end note 2] and shall be treated accordingly except for certain explicit exemptions or restrictions. Such an OPC may be limited by shares or guarantee or may even be an unlimited company.

OPC may be formed only by a natural person who is a citizen and resident of India [see end note 3] by subscribing to the Memorandum of Association (MOA) of the company. The single member is required to nominate another natural person meeting the criteria as his nominee who shall continue the business of the company in the event of the member’s death or incapacity to contract [see end note 4]. The single shareholder is also required to take the written consent of the nominee before including his name as the nominee in the MOA. The nominee may further withdraw his consent or the member may change the nominee by informing the Registrar of Companies (ROC) of the change and following the prescribed procedure. As per the Draft Companies Rules, 2013 (Draft Rules) circulated by the Ministry of Corporate Affairs, a single individual cannot incorporate or become member in more than five OPCs [see end note 5].

The name of the OPC shall be followed by the suffix ‘One Person Company’ [see end note 6]. The individual member of the OPC shall be deemed to be its first director until the director or directors are duly appointed by the member [see end note 7]. Although not specifically provided, as per Section 5, the OPC may adopt all or any of the regulations contained in the model articles provided under Table F to J in Schedule I of 2013 Act.

Where the paid up share capital of an OPC exceeds fifty lakh rupees or its average annual turnover during the relevant period exceeds two crore rupees, it shall cease to be entitled to continue as an OPC. An OPC which exceeds the said prescribed limits is mandated to convert itself within six months to a private company with minimum two members or a public company with seven members or more and appoint requisite number of directors by following the procedure under Section 18 of the 2013 Act.

The definition of ‘Small Companies’ under the 2013 Act is also a new concept and it  provides for the same restrictions [see end note 8], hence , an OPC will  also  come within its purview. The exemptions and restrictions on OPCs and Small Companies is almost the same but this inclusion of OPCs as Small Companies may impact OPCs with regard to any future notifications  regarding  Small Companies.

Where an OPC limited by shares or guarantee enters into a contract which is not in writing with the sole member of the company who is also its director, the company shall, ensure that the terms of the contract or offer are contained in the memorandum or are recorded in the minutes of the first Board meeting held after entering into the contract. The company shall inform the Registrar of Companies about every contract (whether written or otherwise) entered into by the company and recorded in the minutes [see end note 9].

Relaxations

An OPC is eligible for the following procedural and compliance related relaxations:

• The Annual Returns of OPC may be signed only by the director where there is no Company Secretary [see end note 10]           
• Not required to hold Annual General Meetings [see end note11]. Required to conduct only one board meeting every six months in a year with gap between both meetings not less than ninety days (in cases where the sole member is not the only director) and not required to hold Board Meetings where the member is the only director of the OPC [see end note 12].
• Resolutions to be passed at general meetings and board meetings (in case the sole member is also the only director) is only required to be communicated to the company and further signed, dated and entered into the minutes book of the company[see end note 13].           
• Need not prepare a detailed Board Report. Is only required to explain or comment on every qualification, reservation or adverse remark or disclaimer made by the auditor in his report[see end note 14].           
• Need not include a cash flow statement in its financial statement[see end note 15].           

Reflections  

Due to acknowledgement of the OPC as a body corporate under the 2013 Act, the definition of the term body corporate under Section 2(11) now does not exclude a ‘Corporation Sole’ from its scope. Although an OPC is now a body corporate, treating a ‘one member enterprise’ as an artificial person separate from its member may have its own problems. If the sole shareholder and/or the OPC becomes insolvent, its impact on  those who dealt with the business on a corporate basis and those who dealt with the sole shareholder as an individual, the liabilities will be different for both. The equities of the former are no greater than those of the latter. The former will be limited to the corporate assets; the latter, to the individual assets. Moreover, no special provision has been made for winding up of OPCs and the creditors and members shall be bound to follow the tedious winding up process prescribed for all companies in general under the 2013 Act.

Also, as Lord Acton pointed out: ‘Power corrupts, absolute power corrupts absolutely’. When the sole shareholder is separate from the OPC, the sole shareholder may lend money to the business and share as a corporate creditor upon the subsequent insolvency of the venture. Indeed, the sole or principal shareholder may become a secured corporate creditor and thus acquire priority over the unsecured corporate creditors and history shall repeat itself as in the case of the famed House of Lords decision of Solomon v. Solomon & Co [see end note 16].

However, all is not lost. Generally, courts have allowed the concept of corporate personality to sustain only so long as it is invoked and employed for legitimate purposes. Courts will probably not sanction a perversion of the concept to improper uses and as a device to perpetuate fraud, to evade the law, or to escape obligations and will in rare circumstances lift the corporate veil.

Further, the OPC regime may face practical difficulties in implementation. The 2013 Act categorizes an OPC as a private company from the beginning. The Draft Rules further provide that upon exceeding a limit of share capital or turnover, the OPC shall again have to follow procedural requirements and convert to a private or public company. The caps placed are also stringent considering the scale of businesses being conducted presently. OPCs shall be forced to convert to private or public companies upon exceeding the prescribed limits or receiving investment from investors upon expansion of business. Hence, many entrepreneurs may prefer to establish a private company from the start to avoid such compliance hassles.

No special provisions related to amalgamation and restructuring of OPCs has been provided in the 2013 Act or the Draft Rules circulated as of now. Hence, the transactions shall be governed by the general procedure applicable to companies under the 2013 Act. Also, since OPCs come within the definition of ‘Small Companies’, any merger or amalgamation of OPCs with any other small company may be governed by the simpler procedure prescribed under Section 233 of the 2013 Act.

Tax-wise, since the OPC is taxed as a company, it shall be liable to pay income tax at 30.9% or Minimum Alternate Tax (MAT) as may be applicable.  Any dividend paid may also be subject to dividend distribution tax. On the other hand, sole proprietors have the advantage of the tax slabs prescribed for individuals. Hence, whether individual entrepreneurs shall prefer stability of form over income tax benefit is something which remains to be seen.

It must be acknowledged that the legal sanctity given to OPC’s will allow  small sole proprietorship firms to shift to this new concept of corporatization.

[ The author is an Associate, Corporate Practice, Lakshmikumaran & Sridharan, Hyderabad ]

End Notes:

1. Section 2(62) 
2. Section 3(1)(c) 
3. Para 2.1(1), Draft Companies Rules, 2013 
4. Section 3 
5. Para 2.1(2) 
6. Section 12(3) 
7. Section 152 
8. Section 2(85) 
9. Section 193 
10. Section 92 
11. Section 96(1) 
12. Section 173(5) 
13. Section 122(3) and (4) 
14. Section 134(4) 
15. Section 2(40) 
16. [1897] AC 22