September 19 2011 Ministry proposes guidelines for conversion of Section 25 companies Singhania & Partners LLP | Corporate & Commercial - India Corporate & Commercial Creation of Section 25 companiesConversion of Section 25 companies to ordinary companiesCommentIn a recent circular (F.NO.17/178/2011-CL-V), the Ministry of Corporate Affairs proposed the issuance of guidelines for the conversion of Section 25 companies into ordinary companies under the Companies Act 1956. These guidelines are at the proposal stage and have not yet been notified.Creation of Section 25 companiesSection 25 companies are formed following the issuance of a licence by the central government. Following the granting of the licence, the government further directs them to dispense with the addition of words 'Limited' or 'Private Limited', as the case may be, at the end of their company name.Such licences may be granted to new companies or existing companies, subject to certain conditions. For licences to be granted, the company must: be engaged in the promotion of objects of commerce, art, science, religion, charity or any other useful objects; apply its profits or other income in promoting such objects; and prohibit the payment of any dividend to its members.The licence may be granted by the central government on such conditions as it thinks fit, following which those conditions will be binding on the company. Unlike for an ordinary company, a firm can also be a member of a Section 25 company.A company intending to procure such a licence must include a stipulation in its memorandum of association that if, on winding-up or dissolution of the company, any property remains (after satisfaction of all the debts and liabilities), the same will not be distributed among the members of the company, but will be transferred to such other company that has similar objects. This must be determined by the members of the company, at or before the time of dissolution or default thereof, by the high court that has or may acquire jurisdiction in the matter.A Section 25 company is a non-profit organisation and may engage in charitable activities, such as running non-governmental organisations, educational institutions or hospitals. Due to its non-profit nature, it enjoys certain benefits over ordinary companies and receives contributions from various sections of the society, in the form of donations for the furtherance of its charitable and philanthropic activities. It can also avail of tax exemptions under Sections 11 and 12 of the Income Tax Act 1961, after registering with the income tax authorities for such purpose. Furthermore, certain benefits are also available from various government and local authorities. A Section 25 company therefore enjoys the advantages of incorporation, yet remains free from indicating through its name that it is incorporated with limited liability.Conversion of Section 25 companies to ordinary companiesWhile the act contains a provision under Section 25(3) for the conversion of an existing company into a Section 25 company, subject to certain conditions, it makes no provision for the reverse situation - that is, the conversion of a Section 25 company into an ordinary company. However, under Section 25(7), the act empowers the central government to revoke any licence granted to a company under the section. When revoking the licence, the central government must afford the company an opportunity of being heard. Therefore, although not explicitly stated in the act, this power must be invoked by the central government on bona fide considerations, in harmony with the principles of natural justice. If the revocation is arbitrary, the aggrieved company has an option to challenge such revocation by filing a writ under Article 226 of the constitution.As a consequence of revocation under Section 25(7), the company loses all privileges available to it by virtue of the licence and it may be tantamount to conversion of a Section 25 company into an ordinary company, subject to certain conditions. However, the sub-section only empowers the central government to revoke the licence and does not provide an option to the Section 25 company to apply for its conversion into an ordinary company.Therefore, the ministry has proposed guidelines to develop a procedure for the conversion of existing Section 25 companies into ordinary companies, if they so desire, considering that a number of Section 25 companies have carried out no activity after obtaining their licence under Section 25 or have stopped such activities. The proposed guidelines provide that a Section 25 company may apply to the registrar of companies for revocation of a licence under Section 25(7), subject to fulfilment of the following conditions: The company must have passed a resolution in a general meeting to convert into a non-Section 25 company, approved by all members of the company, and have adopted a revised memorandum and articles of association. The company must have not commenced any activity or operation since its incorporation. The company must have not received any donation, grants or contribution, other than from its members. Where the company has obtained special status from any authority (eg, income tax, commissioner of charity, any government organisation or department, state government, municipal body or any recognised authority) then a no-objection certificate must be obtained from the concerned authority. Existing assets must be transferred to a company with similar objects before it is converted into a non-Section 25 company. The company must have filed up-to-date balance sheets and annual returns. The directors must have filed an affidavit confirming the above status and compliances, accompanied by a certificate from a practising chartered accountant, company secretary or cost accountant. The registrar of companies may consider revoking the licence in exercise of its power under Section 25(7) of the act on merits after submission of the afore-mentioned documents to his or her satisfaction.CommentAlthough the proposed guidelines provide the conditions under which conversion of Section 25 companies into ordinary companies may be considered, it does not elaborate on the effects and consequences of such conversion. For instance, where a firm is a member of a Section 25 company that is converted into an ordinary company, the guidelines do not indicate whether the firm will continue to be a member or cease to be a member upon such conversion, or whether certain steps will be required to effect the cessation of its membership. This question is bound to arise on the conversion of any Section 25 company into an ordinary company, as an ordinary company cannot have a firm as its member. A stipulation to this effect may therefore be inserted in the guidelines itself or a direction may be contained in the order for conversion. The consequential effects of the proposed guidelines should therefore be considered before they are notified.For further information on this topic please contact Rohit Jaiswal or Monica Das at Singhania & Partners LLP by telephone (+91 11 4153 1000), fax (+91 11 4153 1001) or email ([email protected] or [email protected]).