Company Exit: An Overlooked Aspect

– This article was originally published by Ankshita Chaudhary in the Himalayan Times on the August 04, 2019.

As Nepal strides forward to enable the implementation of the new Constitution that transformed the country from the framework of a unitary government to a Federal Democratic Republic, the political leadership is now faced with the challenge of writing hundreds of new laws and amending equally many. For the same, the Company Bill, with amendments to the Act endorsed in 2017, is tabled at the parliament for discussion.

The Company Act is one of the paramount laws governing commercial establishment and operation in Nepal. The Act is designed to enterprise efficiency, create flexibility and simplicity in the formation and operationalization of companies, encourage transparency and high standards of corporate governance as appropriate given the significant role of enterprises within the social and economic life of the nation. Yet, despite the best of intentions to craft an Act that empowers entrepreneurship, the Act is driven by incessant statutory requirements as a criterion for demonstrating regulatory or legal compliances. Consequently, these requirements are unintentionally denounced, side-stepped and violated by many businesses.

While market entry policies are important for an economy to foster, exit policies form an equally critical piece of the puzzle. Policy-makers focus heavily on reforming entry laws but neglect nuances in the exit law, underestimating the role that a fluid exit setting can play in winning the investors’ confidence. This article will focus on highlighting the negative unintended consequences posed by the Company Bill in regards of company exit.

As part of annual filing, businesses incorporated under the Companies Act are required to file an extensive number of documents with the Office of Company Registrar (OCR). According to a clause as stated in the Act, the registrar can punish the director of a company, an officer or an individual who defaults in submitting its books of account, audit, annual reports, annual general meeting, few among many. As this quantum of penalty in response to a delay in the document submission- where the penalty amount is calculated based on the company’s authorized capital- is compounded with shortened penalty bands, an average entrepreneur ends up paying a large sum of money and suffers from injunctions, both of which are fatal to businesses.

Moreover, the inability to submit documents that are subject to penalty are concerned with a company’s exclusive decision and in no way issue injury to public interest. Therefore, it is irrational in part of the government to penalize companies for a delay in submitting their own judgements. In the FY 2074/75, 51,013 out of 1,92,164 companies failed to submit their returns, notice or replies on such headings. So, certainly, it is not that these many companies have disregarded the legal provision of filing the required documents, but it is simply that these companies have not done so as they are unaware of the same.

Acknowledging the cumbersome exit scenario for businesses, the GoN, in 2016 introduced a special provision for such defunct companies to cancel their registration by paying one percent of the paid-up capital or a prescribed fee (whichever is lower) within a year. During this two-year grace period, 546 companies alone deregistered themselves, which approximates to 23 percent of the total deregistered companies till date. This figure demonstrates that companies remained registered even after they had ceased trading due to the fear of clearing the excessive penalty that has been amassed over the years.

This ever-increasing exit expense thus, gives rise to ‘zombie firms’- an uncompetitive company that is unable to grow or repay its debt principal and is functioning unwantedly. Thus, in most cases, such zombie firms find it difficult to exit the market. Amidst all this, what the government fails to recognize is that the tendency to unwantedly operate an uncompetitive business rather than to exit a market, because the latter is more expensive, lowers the average overall productivity of the economy. Also, these zombie firms are detrimental to the economy as they take up market share and lock up scare resources that could be available to more successful and dynamic companies.

These are just a couple of instances on how a harsh provision in a piece of legislation can be a key deterrent for businesses– big or small. While encouraging compliance is high on government’s agenda in its flight to make the economy grow, the current regime of fines, punishments and appeals crafted to encourage compliance might instead discourage several entrepreneurs owing to the excessive cost of compliance. If only the government allowed for amendments that cushioned and not punished failure, exit strategies could finally gain momentum in the corporate ecosystem and in all likelihood, ensure greater fluidity in terms of company exit.

Since the Bill has not been endorsed by the parliament yet, there is time to still bring it to larger public discourse and make amendments that are in the best interests of the entrepreneurs, businesses and the economy as a whole.