Fly-by-Night Companies in Light of Companies (Incorporation) Third Amendment Rule, 2022.

[By Arham Anwar & Akshay Tiwari]

The authors are students of National Law University, Jodhpur.

Introduction

To fly by night is to pack up whatever you can from the dubious business that you have been carrying and leave under the cover of darkness. So people who have been observing you running your business one day see an empty address with no sign of the business the very next day, leaving behind panicked investors who have no clue about what is happening with the money they had invested into the company.

The term fly-by-night is not specifically defined anywhere in the Companies Act per se but according to the Cambridge Dictionary’s definition a fly by night business is “not able to be trusted and likely to stop operating without any notice”. A fly by Night Company is essentially an unreliable or unscrupulous company which is generally short lived, and once it has raised a minimum amount of money through the market it flies away defrauding its investors.

The common modus operandi that these types of companies follow to raise funds is to issue IPOs in the primary market and wait for investors. Once they reach the point where a sufficient level of funding has been extracted according to the level and scale of the operations being run, they pack up in the night leaving behind no trace, and thus it becomes difficult for the regulatory authorities to trace back these entities or held them responsible for their acts.

According to the definition provided in the MCA website a company is categorised as a vanishing or fly-by-night company the following scenarios.

  • A company fails to file returns with the Registrar of Companies (ROC) for two years.
  • A listed company fails to file returns with the stock exchange for two years.
  • The company doesn’t maintain its registered office at the address mentioned with the RoC.
  • The company’s directors cannot be traced.

There has been a surge in the number of these kinds of entities in recent times and the list keeps on increasing, aggravating the agony of the small investors who came in with the motive of earning returns on their investment but are now seen running from pillar to post to get justice and make these fraudulent companies liable. In light of their plight, there have been a growing number of efforts taken by the regulatory authorities in the last few years to curb this menace. In the series of various legislative and policy reforms, there has been this recent amendment of the Companies(Incorporation) Third Amendment Rules, 2022 (Henceforth “2022 Rules”). 

Efforts being taken

There has been a series of continuous efforts that has been taken in order to solve the problem of fly by night companies right from the beginning. In order to promote and raise the standards of good corporate governance, SEBI established a committee in 1999 Shri Kumar Mangalam Birla, a member of the SEBI Board, served as the committee’s chair. The committee’s main goals were to view corporate governance from the perspective of investors and shareholders and to create a “Code” that would suit the Indian corporate environment

In the year 2006 following measures were added to the then Companies Act 1956 by Ministry of Corporate Affairs to check the incident of Vanishing companies:

  • Sections 266A to 266G were added making it mandatory for every existing or prospective director to obtain a “Director Identification Number” so that traceability of the directors is ensured. Sections 153 to 159 of the 2013 Act contain the provisions relating to the Director Identification Number.
  • In case of incorporation of a new company or change of address of an existing company, Ministry has made it mandatory for the professionals verifying its details to personally visit the premises and certify that the premises are indeed at the disposal of the company. Further, in such cases, proof of registered address has also been made mandatory to be furnished at the time of incorporation or change of registered address.
  • Instructions have also been issued to the Registrars of Companies to scrutinise the Balance Sheets and other records of the Companies which raise money through public issue so as to monitor the utilisation of such frauds.

Increasing instances of vanishing companies has also led to the formation of Serious Fraud investigation Office (SFIO) which was granted statutory status by the Companies Act 2013. There was a need felt for an organisation which would focus entirely on solving such complex white collar crimes. It is against this backdrop that the Government decided to set up the SFIO.

Registered Office

Every company is required to keep a registered office that can receive and acknowledge any government notices pursuant to Section 12 of the Companies Act 2013. During a company’s incorporation, the directors of this entity must specify their registered office in their Memorandum of Association and keep certain records there. The location of the registered office becomes significant as the Registrar of Companies to which the applicant must apply for company registration will be determined by the state in which the company’s registered office is located. Any change to the company’s address or location of the registered office must be reported to the RoC within a certain time frame.

The Companies Act has been amended vide the Companies (Amendment) Act, 2019 to provide a procedure for physical checks. A Registrar of Companies (ROC ) has the authority to physically inspect a company’s registered office in accordance with Section 12 (9) of the Companies Act if they have sufficient reason to suspect that the company in question is not conducting business for which it was incorporated

To further enhance the Companies (Incorporation) Rules of 2014, the Ministry of Corporate Affairs (MCA) has published the 2022 Rules on August 18, 2022. With this modification, the MCA has established a new Rule 25B which pertains to the physical verification of the company’s registered office, i.e., the primary office of the firm, to which all correspondence pertaining to it will be sent by governmental agencies. This new rule will help in curbing the problem as now it will be difficult for these dubious firms to go untraceable as their offices will be physically verified in order to ascertain whether it is a serious company or a façade created just to cheat investors.

Process of Verification

According to the new rule 25B, there has been a process put into place that has to be followed while complying with the provisions of the rule. In the presence of two impartial witnesses, the location of the company’s registered office will be physically verified. If necessary, ROC may seek help from the police of that particular area in order to carry out this exercise.

The copies of the supporting documentation of the address that were obtained during the physical verification and properly authenticated by the owner of the property where the Registered Office is located should be compared to the originals of the papers to ensure their authenticity. By cross-checking the Office’s authenticity with copies of supporting documents obtained during the physical proof and properly authenticated from the owner of the property where the Registered Office is located, ROC will ensure that the Office is legitimate. During the physical verification, the Registrar will also need to take a photo of the company’s registered office. Once all the procedures have been followed, a detailed physical verification report containing all the requisite information including the location details and photographs will be prepared by the Registrar.

The aforesaid physical verification report will contain the name, Company Identification Number (CIN), address as per MCA 21 records, date of authorisation letter issued by the ROC, name of the registrar of the companies, date and time of physical verification, location details along with the landmark and details of the person who was found at the address during the physical verification.

The aforesaid rules also provide for the procedure to be followed if the registered office is unable to respond to or acknowledge all the notices. The ROC will then inform the Company and all Directors of its desire to have the company’s name removed from the ROC and will ask them to send their representation along with the necessary paperwork.

In order to avoid additional ROC action under Section 248 of the Companies Act, which gives the power to the Registrar to remove name of the company from the register of companies, the Director of the company must provide them their representation and the required papers within thirty days of the date of the MCA notice.

 Conclusion

The provision of the Companies Incorporation (third amendment) rule, 2022 is definitely a positive step in the chain of efforts being taken by the government to protect the interests of small investors. We as a country have to realise that capital plays a supreme role in the economy which in turn is helpful in fuelling the ambitions of growth of the country. For the money to trickle down in the economy companies play a very important role especially in a capitalist setup like ours. For the companies to run, investors are needed and they won’t invest in our companies till they are confident of the statutory provisions provided by the legislature to safeguard their interest. Though the efforts taken by the government have borne fruit as the instances of vanishing or fly by night companies have reduced a lot but a lot is still needed in terms of policy implementation. As this is the area where we lack, most of the legislation lay redundant as there is lack of willpower on the part of the executive to implement the already passed legislation strongly. If we look at the recent India’s rank in the Ease of Doing Business Index, it is abysmally low to the rank of 63, though it has improved a lot as compared to the previous rank of 142 in year 2014

Efforts should also be taken by the government to educate the investors about the risky adventures taken by them in order to earn quick returns on their investment. Most of these “too good to be true” offers are made with the ill intention to dupe these innocent investors of their hard earned money. Harsher provisions should be implemented against the directors of these vanishing companies which create a strong impression in the mind of the investors, both Indian as well as foreign, that India is serious about its approach towards corporate governance.

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