The Legal Danger To Crowdfunding Platforms
Stern action from Registrar of Companies, lack of regulatory clarity from SEBI—the future of crowdfunding platforms is in doubt.
Start-ups and small companies in India are always on the lookout for viable sources of capital. At the same time, small investors are interested in diversifying their portfolios and betting on promising new ventures. This has led to the mushrooming of many platforms offering companies the opportunity to connect with investors to crowdsource their funding goals.
Equity crowdfunding is not explicitly regulated under Indian law. In light of this, the platforms have taken the considered view that, so long as they and the companies using them comply with the provisions of the Companies Act, 2013 and the applicable SEBI regulations, their activities would be permissible. After all, most such platforms merely act as technology intermediaries connecting the investors and the companies with each other.
However, a couple of recent orders passed by the Registrar of Companies, NCT of Delhi, and Haryana in the matter of Anbronica Technologies Private Limited and Septanove Technologies Pvt. have put this model of raising funds through crowdfunding under the scanner.
Crowdfunding Under The ROC Scanner
Tyke is a technology-based community platform that enables companies seeking investment to run a fundraising campaign to connect with potential investors registered as members on Tyke. These may comprise of professionals, corporate executives, and individuals looking to make investments. Tyke also provides certain other services to facilitate the campaign and charges a fee from the companies for the usage of the platform.
Anbronica and Septanove had initiated fund-raising campaigns on Tyke. After certain members expressed interest, the two companies issued and allotted compulsorily convertible debentures to about 28 and 196 members, respectively, on a private placement and preferential basis, raising approximately Rs 12 lakh and Rs 32 lakh, respectively.
This prompted a notice from the ROC to both companies on December 27, 2022, contending that the issuance and allotment of CCDs were actually in contravention of the Companies Act, 2013. The companies and Tyke were asked to explain the model adopted for this fund raise.
The companies clarified that Tyke was only used by them as a platform for garnering interest from members. Tyke was not used to invite the public to subscribe to the securities or to inform the public at large about the private placement offer being issued by them.
Tyke indicated that the platform currently boasts about 1.5 lakh members. Its terms of use put the onus of ensuring compliance with the provisions of the Companies Act on the entities using the platform to seek funding. Further, nothing on the platform was intended to constitute an offer or solicitation of an offer to purchase or sell any securities, Tyke said.
Tyke Not Just An Intermediary: ROC
The ROC found Anbronica and Septanove to be in violation of a company law provision which restricts the company issuing securities from releasing any public advertisements or utilise any media, marketing or distribution channels or agents to inform the public at large about the issue.
The law, it said, prescribes a limit of 200 persons who can ultimately subscribe to the securities of such a company. But this limit of 200 persons also applies to the maximum number of persons to whom an offer or an invitation to offer can be made for subscribing to the securities of the company.
As a campaign on the platform ostensibly includes an offer or an invitation to offer to all the members of the platform (which, in Tyke’s case was about 1.5 lakh persons), the campaign was held to be in contravention of the above restrictions.
The ROC also pointed out that a campaign on the platform allows all members of the platform to indicate interest in the company by transferring the investment amount to an escrow account. Such escrow accounts are usually managed by the platform on behalf of the companies.
While the company may only allot securities to a maximum of 200 persons in compliance with the Act, more than 200 persons can potentially apply to this campaign allowing the campaign to be “oversubscribed”, again falling afoul of the company law provisions.
In saying so, the ROC dismissed the the companies' argument that Tyke was just a technology platform.
Tyke cannot be relegated to a mere intermediary, but instead it was an active facilitator allowing the companies to raise investments through its portal and it is providing end-to-end services to the companies.ROC Order
The ROC imposed penalties on the companies but was unable to prosecute Tyke as the relevant provision of company law does not provide for any penalty which can be imposed on any person other than the company, its promoters and directors.
The Future Of Crowdfunding Platforms
Most crowdfunding platforms largely follow the same model for their operations. While the platforms themselves seem to not be directly liable under the law, if the companies undertaking the campaign are deemed to be in contravention of the Act, the same will ultimately impact the manner in which such platforms operate.
In short-term though, the platforms will definitely have to review their existing operational framework, internal norms and their role to ensure compliance with the provisions of the Companies Act, 2013 and Rules under it.
Further, any issuance of securities in contravention of the private placement provisions under company law is deemed to be a public offer. This would entail compliance with the provisions of the Securities (Contract) Regulation Act, 1956 and the SEBI Act, 1992.
This may make such companies also subject to further regulatory action and scrutiny by SEBI. It will be interesting to see whether this ROC order is further appealed by either of the companies.
Another interesting point to note is that as per Section 42(10) of the Companies Act, in addition to the penalty, the company in default is also required to refund all the monies raised within a period of 30 days of the order. However, surprisingly the present order is conspicuously silent in regard to such refund. It is unclear whether the ROC has a discretion to only impose a penalty without requiring refund of amounts.
Lastly, since the days of SEBI’s consultation paper on crowdfunding in India back in 2014, the regulator has been concerned with companies misusing the private placement route to issue a huge number of debt securities to public under the garb of private placements.
While SEBI has acknowledged the usefulness of the crowdfunding model, it has still been wary of the same considering a lack of regulatory framework, oversight and potential for investor abuse. However, it has been almost a decade and the regulator seems nowhere close to coming up with a viable framework for crowdfunding.
This overall ambiguity is not helpful for anyone. Platforms providing crowdfunding solutions will not be able to scale up if they are going to constantly be afraid of regulatory action. This will also scare aware potential investors and affect the burgeoning startup ecosystem in the country.
Anupam Shukla is a partner at the law firm Pioneer Legal. Vedika Shah, an associate, and Shreya Masalia, a paralegal at the firm, also contributed to this piece.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.