Complexities of Significant Beneficial Ownership and Corporate Control

The implication of contractual arrangements concerning management and control of a company or group companies requires a proper understanding of the determination of ‘beneficial ownership’ and ‘significant beneficial ownership’. Disclosure and compliance constitute only one aspect. Intricacies may be involved concerning such contractual arrangements, and corporate and commercial legal advisors may require their implication and assistance.

Introduction

There is a distinction between holding or acquiring ‘legal interest’ and holding or acquiring ‘beneficial interest’ in a company. In order to understand behind-the-scenes decision-makers with respect to a company, the identity of beneficial owners must be disclosed. Disclosure of ‘beneficial interest’ aids transparency and accountability, and is a step towards tackling measures and practices adopted by persons to misuse corporate vehicles to evade tax or launder money for corrupt or illegal purposes. 

The Companies Act, 2013 (‘Act’) requires disclosure by the person holding only ‘legal interest’ and by the person holding or acquiring only ‘beneficial interest’ in the company. It also enjoins an obligation on the company to take necessary action in relation to the disclosure of ‘significant beneficial owner’ (‘SBO’). 

This article examines the legal framework governing SBOs in the context of the adjudication order passed by the Registrar of Companies of Delhi and Haryana (‘RoC’) on May 22, 2024 against LinkedIn India Technology Private Limited (‘Subject Company’ or ‘LinkedIn India’) for not fulfilling the compliances under Sections 89 and 90 of the Act. The said RoC order does raise questions regarding the ambit for determination of SBOs.

Background

The origin of ‘Beneficial Ownership’ can be traced to the recommendations of the Financial Action Task Force (FATF) in 2012 on the issues pertaining to ‘transparency and beneficial ownership of legal person and arrangement’. FATF is an intergovernmental organization founded in 1989 at the initiative of the G7 to develop policies to combat money laundering. This organisation formulates international standards that aim to prevent illicit funding activities.

The FATF recommended that “…Countries should ensure that there is adequate, accurate and up-to-date information on the beneficial ownership and control of legal persons that can be obtained or accessed rapidly and efficiently by competent authorities, through either a register of beneficial ownership or an alternative mechanism…”. 

In 2013, the Act was revamped, and Section 89 was introduced to address the issue of disclosure of beneficial interest. A person holding only ‘legal interest’ (that is, a person registered as a shareholder in the Register of Members of the company) and a person holding only ‘beneficial interest’ in a company is required to disclose such interest to the company. Further, the company is required to maintain a record of such disclosures in a Register maintained for the purpose.

However, Section 89 did not impose any independent obligation on the company to take any action regarding a person holding only a ‘beneficial interest’ in such a company. In 2017, following the recommendation of the Report of the Companies Law Committee, 2016, Section 90 was amended in respect of an individual holding a ‘significant’ beneficial interest in the company. ‘Significant’ is defined as holding at least 10% beneficial interests. 

Section 90 of the Act

Key elements of Section 90 of the Act:

• An individual meeting any of the specified conditions is a ‘significant beneficial owner’.

Such specified conditions are:

• Individuals holding beneficial interest of not less than 10%¹ in the shares of a company, or
• Individuals with the right to exercise, or exercise, significant influence or control over the company. 
• The term ‘control’ includes: “the right to appoint majority of the Directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.”

• Every SBO must make a declaration to the company specifying the nature of his interest and other particulars, failing which attracts a penalty. 
• The company must take necessary steps to identify an individual who is an SBO in relation to a company by issuing a notice.
• Where a person fails to give information (or information given is not satisfactory) as required by such notice, the company shall apply to the Tribunal seeking an order directing that the shares in question be subject to restrictions with regard to transfer of interest, suspension of all rights and other matters. 
• The company must maintain a register (open to inspection by any member) of such SBOs and file with the relevant Registrar of Companies a return of SBOs in Form No. BEN-2. 

Determination of SBO

¹ While Section 90 of the Act specifies a threshold of not less than 25%, the Companies (Significant Beneficial Owners) Rules, 2018 reduce this threshold to 10%.

The Companies (Significant Beneficial Owners) Rules, 2018 (‘SBO Rules’) were notified for said Section 90. Under the SBO Rules, an individual is considered to be an SBO if they, acting alone or together, possess one or more of the following rights or entitlements in the reporting company:

• holds indirectly, or together with any direct holdings, not less than ten per cent of the:
• shares, or
• voting rights in the shares.
• has the right to receive or participate in not less than ten percent of the total distributable dividend, or any other distribution, in a financial year through indirect holdings alone, or together with any direct holdings. 
• has the right to exercise, or actually exercises, significant influence or control, in any manner other than through direct holdings alone.
• Under Rule 2 of the SBO Rules, ‘significant influence’ means the power to participate, directly or indirectly, in the financial and operating policy decisions of the reporting company but is not control or joint control of those policies’.

An individual shall be considered to hold a right or entitlement indirectly in the reporting company if he satisfies any of the following criteria in respect of a member of the reporting company, namely: 

• where the member of the reporting company is a body corporate (whether incorporated or registered in India or abroad), other than a limited liability partnership, and the individual,
• that holds majority stake in that member; or 
• that holds majority stake in the ultimate holding company (whether incorporated or registered in India or abroad) of that member;

• where a member of the reporting company is either a pooled investment vehicle or an entity controlled by the pooled investment vehicle, based in member State of the Financial Action Task Force on Money Laundering and the regulator of the securities market in such member State is a member of the International Organization of Securities Commissions, and the individual in relation to the pooled investment vehicle,-
• is a general partner; or
• is an investment manager; or
• is a Chief Executive Officer, where the investment manager of such pooled vehicle is a body corporate or a partnership entity.

Accordingly, two tests have evolved with respect to SBOs:

• Objective test: Linked to a shareholding threshold, which is presently 10% (directly or indirectly held).
• Subjective test: Linked with ‘significant influence’ or ‘control’. The determination of ‘significant influence’ or ‘control’ is based on the factual scenario and is determined on a case-to-case basis. 

LinkedIn case

The RoC passed an order imposing a penalty for violations under Section 89 and Section 90 of the Act in the matter of LinkedIn Technology Information Private Limited (‘Subject Company’ or ‘LinkedIn India’).

May 22, 2024 Order of the RoC

The RoC imposed a penalty under powers vested pursuant to Section 454 of the Act read with Companies (Adjudication of Penalties) Rules, 2014 against the Subject Company and its officers, including non-executive directors. The said Order has received much attention from the stakeholders as the approach adopted by the RoC seeks to widen the ambit of SBOs to include global employees of all group companies as SBOs.

The RoC appears to have relied on the subjective test laid down in the SBO Rules to pass the said Order.

Facts

The Subject Company was found to have filed a return with the RoC in respect of declaration under Section 89 received by the Subject Company in form no. MGT-6 dated January 29, 2024. The said Form reported LinkedIn Ireland Unlimited Company as the beneficial owner of one share of the Subject Company as of January 11, 2024 in respect of which the registered holder was LinkedIn Technology Unlimited Company. 

However, according to the financial statements of 2022-23 filed by the Subject Company vide form AoC-4 XBRL, dated October 20, 2023, the beneficial interest had arisen much earlier. 

Further, the Subject Company had failed to disclose the significant beneficial owner as mandated under the provisions of section 90 of the Act. 

On February 15, 2024, a Show Cause Notice was issued under Section 90 of the Act to the Subject Company to investigate compliance with Sections 89 and 90 of the Act.

The RoC applied three tests to determine the SBOs in respect of the Subject Company. 

Holding-Subsidiary test

• LinkedIn Corporation had been reported as the ‘holding company’ of the Subject Company, therefore, the control over the Board of the Subject Company had to be situated in LinkedIn Corporation and not in its holding company, i.e. Microsoft Corporation. LinkedIn Corporation is the holding company of LinkedIn Technology Unlimited Company and LinkedIn Ireland Unlimited Company. 
• The Board of LinkedIn Corporation and the Subject Company had two common directors, Mr. Dolliver and Mr. Orndorff. The RoC stated that it was impossible for a person or group or persons to control themselves, implying that LinkedIn Corporation does not control the Board of the subject company. Therefore, the control had to lie elsewhere. 
• Mr. Ryan Rosalansky was the senior-most officer of LinkedIn Corporation, and served as the CEO and President, while Mr. Dolliver and Mr. Orndorff were Vice-Presidents. The website of LinkedIn Corporation stated Mr. Ryan Rosalansky as their leader. Since Mr. Ryan Rosalansky had the ability to exercise control on the Board of the Subject Company, therefore, he was considered to be an SBO under Section 90 of the Act on account of his ability to exercise control on the Board of the Subject Company.
• Mr. Ryan Rosalansky reported to Mr. Satya Nadella, the CEO of Microsoft Corporation, and was also a part of Microsoft’s senior leadership team. This was disclosed on LinkedIn’s website and corroborated by Microsoft’s annual report. Therefore, Mr Satya Nadella was also held to be an SBO of the Subject Company under Section 90 of the Act.

Reporting Channel test

• Microsoft Corporation and LinkedIn Corporation employees who have served as directors on the Board of the Subject Company did not take any remuneration from the Subject Company. These Directors resign from the Subject Company once they exit from the parent entity, and these individuals are also associated with the other group entities of Microsoft and LinkedIn across several countries. Hence, such individuals represent the interests of Microsoft Corporation and, thus, nominees. 
• The CEO of Microsoft Corporation, Mr. Satya Nadella, was in general charge and supervised the business and had the authority to prescribe duties to other officers independently. 
• A majority of the directors of the Subject Company were employed with either Microsoft Corporation or LinkedIn Corporation, with their channels of reporting to either Mr. Satya Nadella or Mr. Ryan Roslansky. The established reporting structure affirmed that Mr. Roslansky or Mr. Nadella exercised control over the majority of the directors of the subject company.
• The SBO Rules recognize the “right to exercise” significant influence or control beyond direct holdings, indicating that actual control did not need to be proven.

Financial Control Test

• The Subject Company held a Board meeting on May 2, 2022, in Singapore to modify earlier resolutions to appoint managing signatories, operating signatories, and bank guarantee signatories. The resolution included a clarification stating that it will not supersede or replace any prior resolution adopted by the Board of Directors of Microsoft Corporation related to the authorities of the Chief Financial Officer or Treasurer of Microsoft Corporation, which remained in full force and effect. This indicated the extent of financial control exercised by Microsoft Corporation.
• The Subject Company’s financial statements showed that related-party transactions were being conducted on behalf of other group entities and vice versa. The plausible reason for this would be the financial control exercised by Microsoft Corporation.
• The Microsoft Treasury maintained control over thousands of bank accounts across different entities. The Subject Company’s argument that this arrangement may be a tool for fraud prevention could be true, however, its other argument that this arrangement does not undermine the overarching authority of the Board of the Subject Company does not hold much merit. 
• The resolution dated May 2, 2022, made the Subject Company subservient to the decisions the Board of Microsoft Corporation or its officers took.
• Microsoft Corporation employees designated as signatories were not accountable to the Board of the Subject Company.
• It was clarified that the Order did not intend to comment on the merits of this arrangement but aimed to discern the extent of pervasive control being exercised through it.
• Under the SBO Rules, it was sufficient to establish the ‘right to exercise’ significant influence or control by means other than direct holdings. Given that control over the Subject Company’s financial transactions primarily resided with employees of Microsoft Corporation, who were supervised by its CEO, Mr. Satya Nadella’s position granted him the ‘right to exercise control’ concerning the Subject Company.

The RoC imposed the following penalties:

Penalty for violation of Section 89 of the Act

Penalty for violation of Section 90

Viewpoint

The Order presents an opportunity to study issues surrounding ‘significant influence’. Under the SBO Rules, the words ‘power to participate’ read with ‘directly or indirectly’ in relation to ‘significant influence’ cast a rather wide net and must be examined in the right context. This raises the question of the role of the Board of Directors and the role of individual directors of a company. 

Section 166 of the Act casts an obligation on the director of a company to act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, shareholders, community, and protection of the environment.
Arguably, an individual with ‘significant influence’ can undermine the directors’ role—if that be the case, can the directors be held to such strict standards of governance?

It is debatable whether members of a company’s advisory board or of the flagship company (in the case of a business conglomerate) would constitute individuals having ‘significant influence’ with respect to the reporting company. 

It is necessary to be clear on the objective behind the disclosure in respect of ‘beneficial owner’ and ‘’significant beneficial owner’ – and the rules for determination may be accordingly drafted and interpreted.

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  Complexities of Significant Beneficial Ownership and Corporate Control
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