Closing the Section 42(7) Gap: A Case for Extending Platform Liability under the Companies Act 2013
Introduction : Section 42 of the Companies Act 2013 defines private placement and provides provisions for issue of shares on private placement basis. Section 42(7) of the Act prohibits the company issuing securities from using public advertisements, media, marketing or distribution channels or agents to inform the public at large about the private placement issue. Section 42(10) imposes a penalty on the company, its directors and promoters for contravention of the Section 42. However, it leaves the crowdfunding facilitator platforms unattended, imposing no liability. The Adjudicating Officer has confirmed this gap in Anbronica Technologies Pvt Ltd and Solargridx Ventures Pvt Ltd. Registrar of Companies explicitly recorded in Anbronica, “the provisions of Section 42 of the Act do not allow the undersigned to impose any penalty on Tyke Technologies Private Limited, which has clearly facilitated the subject company in the act of commission of default of sub-section (7) of Section 42.” This paper argues that Section 42 should be amended to extend the prohibition in sub-section (7) to facilitating platforms and to impose corresponding penalty under sub-section (10) on the platform, its directors, and its promoters.
I. Section 42(7) prohibits distribution-channel use but does not reach the platform that enables it
SEBI Consultation Paper on Crowdfunding in India predicted in 2014, that with tightened private placement requirements the crowdfunding platforms may not adhere to their restrictions. This prediction has been borne out by Anbronica and Solargridx. In addition, SEBI itself through press release (Aug 30 2016) cautioned that unauthorized electronic platforms are allegedly facilitating investment in the form of private placement with companies, as the offer is open to all the investors registered with the platform amounting to a contravention of the provisions of Securities Contracts (Regulation) Act, 1956 (SCRA) and the Companies Act 2013. Section 42 of the Companies Act 2013 read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 characterises private placement as issue of securities to a group of persons not more than two hundred persons in the aggregate in a financial year. Section 42(7) prohibits use of public advertisements, media etc for private placement not only for final offer or invitation but also “informing public at large” about such an issue. Therefore, SEBI’s prediction in 2014 and caution in 2016 is all the more relevant as crowdfunding platforms are directly facilitating violation of the sub section (7) using their wide subscriber base to facilitate private placement for the companies.
II. Anbronica and Solargridx show the gap producing escalating, structurally shielded harm
This gap shields the crowdfunding platform from the penalty even though it contributes substantially to the violation of Section 42. This is demonstrated by the Anbronica and Solargridx cases. Anbronica issued 125,000 Compulsorily Convertible Debentures to raise Rs. 12,50,000 utilizing Tyke, a technology based community platform. The Company displayed pitching information and conducted “Ask Me Anything” sessions on Tyke, which has a community of approximately 1.5 lakh members. Even though 28 subscribers were identified for securities allotment, the issue was oversubscribed as more than 200 members were interested. Tyke’s terms of use state that transactions in securities that companies offer using Tyke shall be in strict compliance with private placement rules. The platform has an internal mechanism to restrict the number of investors viewing detailed profiles to 200 by default. Tyke submitted that it is not an intermediary or agent of the company to inform about private placement offers. ROC held that “terms of use” is not true as Tyke’s representative admitted that community members showing interest often exceeded 200, which is termed “over-subscription” on the site. Since accessibility of the information is provided after user logins, information about the issue was accessible to Tyke’s 1.5 lakh members. ROC further held that Tyke was an active facilitator as it was used by the company as media/marketing/distribution channel/ agent to inform the public at large about the issue of securities. Thus, it is an active facilitator to raise investments.
Similarly in Solargridx, it used Tyke to raise securities and conduct an online pitching session. The company itself admitted using Tyke for publicizing its CSOP issue to the users of Tyke. The platform was in direct contact with the subscribers at invitation as well as completion of the issue as revealed through the email. In Solargridx, Tyke fostered the company beyond mere facilitation for fund raise. It provided a “legal opinion” through its legal team which the company relied on as a defence . It directly emailed subscribers with subject lines “SustVest has invited you to invest in SolarGridX Ventures Private Limited”. In addition, it launched a “Tyke Square” peer-to-peer platform to facilitate transfer of Stock Appreciation Rights (SARs). Through this peer to peer platform, Tyke was building a secondary market for unregulated instruments, which is exactly the structural risk SEBI flagged in 2014.
There is further escalation between the two cases. Anbronica involved 28 subscribers and Rs 12.5 lakh raised. Solargridx involved 565 subscribers and Rs 61.86 lakh raised, with the ROC ordering a refund of Rs 69.03 lakh including interest. Despite the same platform, officer, and modus operandi, the gap is producing increasingly large violations affecting large numbers of retail investors. This is not an isolated regulatory accident.
The penalty disproportionality is striking. Both companies qualified as small companies under Section 446B, capping the maximum penalty at Rs 2 lakh on the company and Rs 1 lakh per director. Anbronica paid Rs 4 lakh in total. Solargridx paid Rs 10 lakh across two violations. Tyke, which earned commission on every transaction in both cases, paid nothing. The ROC’s reasoning was express: Section 42 does not allow penalty on the platform despite its facilitation of the breach. The penalty regime is structurally incapable of capturing the platform’s gain.
III. Amending Section 42 closes the gap through the existing adjudicatory machinery
Section 42 should be amended to extend the Section 42(7) prohibition to facilitating platforms and to impose corresponding penalties under Section 42(10). Penalty should be imposed equal to three times the fees earned by the platform subject to a minimum of Rs 5 lakh and a maximum of Rs 2 crore. This floor will prevent under deterrence as well as disproportionate punishment in higher transactions. In addition to the primary penalty, disgorgement of all the fees earned by the crowdfunding platform should be enforced. For the directors and promoters of the platform individual liability mirroring Section 42(10)’s treatment of company directors should be applied.
Section 42(10) is currently enforced by the Registrar of Companies acting as Adjudicating Officer under Section 454(1) read with the Companies (Adjudication of Penalties) Rules 2014. The Anbronica and Solargridx orders were both issued by ROC NCT of Delhi and Haryana, in this capacity. Since the amendment extends the substantive prohibition in Section 42(7) and the penalty provision in Section 42(10), the Registrar of Companies enforces the proposed penalty the same way. Appeals lie to the Regional Director under Section 454(5), and onward to NCLT and NCLAT.
Mirroring the no-fault liability Section 42(10) already imposes, the proposed amendment imposes the same strict standard on crowdfunding platforms and their directors and promoters. Regardless of the platform’s knowledge of contravention of Section 42(7) it is liable under Section 42(10). The objection for the no-fault liability standard could be the chilling effect on legitimate fintech facilitation. The proposed penalty design addresses the concern by pegging it to fees earned by the platform.
SEBI in its crowdfunding paper proposed a registration framework for crowdfunding platforms in 2014. However, regulation has not been issued. The 2016 press release acknowledged the platforms operate unauthorised, but has not been followed by enforcement. On the other hand, the proposed Companies Act amendment closes the gap within a statute and machinery that already work, without requiring SEBI to develop a parallel regulatory regime.
Conclusion
Section 42(7) aimed to prevent the use of distribution channels to circumvent the private placement framework. Crowdfunding platforms have done precisely what the provision was meant to prevent. The regulator has admitted it, the SEBI 2014 paper predicted it, and the Adjudicating Officer has twice acknowledged it in writing. Anbronica and Solargridx have shown it produces escalating retail harm shielded by platform design. Twelve years of SEBI inaction makes the case for amendment within the Companies Act itself. Extending Section 42(7) to facilitating platforms, with no-fault liability under Section 42(10) calibrated to platform earnings, closes the gap through the machinery that already adjudicates the issuer side.
Author: Apurva Pradip Damle in case of any queries please contact/write back to us via email to content@khuranaandkhurana.com or at Khurana & Khurana, Advocates and IP Attorney
Endnotes
Statutes and Rules
Companies Act 2013
Companies (Adjudication of Penalties) Rules 2014.
Companies (Prospectus and Allotment of Securities) Rules 2014.
Securities Contracts (Regulation) Act, 1956.
Cases
Anbronica Technologies Pvt Ltd, In re Order of the Registrar of Companies, NCT of Delhi and Haryana, ROC/D/Adj/Section 42/Anbronica/964–967 (1 March 2023).
Solargridx Ventures Pvt Ltd, In re Order of the Registrar of Companies, NCT of Delhi and Haryana, ROC/D/ADJ/Section 42/Solargridx/3646–3650 (22 September 2023).
Consultation paper
SEBI, Consultation Paper on Crowdfunding in India (Consultation Paper, 17 June 2014) para 5.7.3.
Press Release
SEBI Press Release of 30 August 2016 (cautioning public against unauthorised electronic platforms offering investments in unlisted companies).
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