Understanding Shell Companies

What is a Shell Company?

There is no clear definition of what shell company is in the Companies Act, or any other Act. But typically, shell companies include multiple layers of companies that have been created for the purpose of diverting money or for money laundering. Most shell companies do not manufacture any product or deal in any product or render any service.
They are mostly used to make financial transactions. Generally, these companies hold assets only on paper and not in reality. These companies conduct almost no economic activity.

Indian Scenario

After Prime Minister Narendra Modi's decision to demonetise ₹500 and ₹1000 rupee notes on 8th November 2016, various authorities noticed a surge in shell companies depositing cash in banks, possibly in an attempt to hide the real owner of the wealth. In response, in July 2017, the authorities ordered nearly 2 lakh shell companies to be shut down while Securities and Exchange Board of India (SEBI) imposed trading restrictions on 162 listed entities as shell companies. A high-level task force found that hundreds of shell companies were registered in a few buildings in Kolkata. Many of those were found to be locked, with their padlocks coated in dust and many others which had office space the size of cubicles.

What actions can be initiated against shell companies?

Companies can be removed from the rolls of the Ministry of Corporate Affairs by two means: strike off by Registrar of Companies (RoC) — (Section 248 (1) of the Companies Act, 2013) and voluntary strike off — (Section 248 (2) of the Companies Act, 2013). Voluntary closure can be done with the approval of the board and shareholders and the firm should have nil liabilities.

However, not all shell companies may be money laundering vehicles. There are many shell companies that work within legal limits and do not have financial irregularities. For example, a company may separate its HR function into another company altogether. The second one is a legal entity, which operates like any other company. If you are an equity investor, it is better to stay away from investing in shell companies that have financial irregularities. Conduct proper due diligence of companies that you have invested in, and try to research their operations, businesses and financials.

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