The Corporate & Commercial Law Society Blog, HNLU

Tag: Company Law

  • Corporate’s Social Commitment: Corporate Social Responsibility And The Covid-19 Aftermath

    Corporate’s Social Commitment: Corporate Social Responsibility And The Covid-19 Aftermath

    BY ROOPAM DADHICH and PRANSHU GUPTA, Fourth-YEAR Students AT NALSAR University of Law, Hyderabad

    The Ministry of Corporate affairs (‘MCA’) has allowed the inclusion of corporate expenditure utilised for the purposes of fighting COVID-19 pandemic under Corporate Social Responsibility (‘CSR’) spending requirements. Expenditure incurred on activities such as sanitation, pandemic management, preventive healthcare, etc, would now be covered under the same.  A greater part of the CSR spending of the top 300 companies of India has been distributed to Covid-19 alleviation measures, a majority of which was donated to the PM CARES Fund. This post briefly discusses the evolution of CSR regime in India and how it may take a revolutionary turn in times of COVID-19.

    Evolution of the CSR Framework

    Prior to passing of the Companies Act, 2013 (‘the Act’), the Central Government passed guidelines for the companies to allocate funds for creating a voluntary CSR policy. The intention behind this was to gradually make the corporate sector embrace the CSR guidelines voluntarily. Later, a stronger body of rules was presented by SEBI in its circular in 2012 in which it became mandatory for the top 100 listed companies in BSE and NSE to report the business responsibility.

    According to the Companies Bill, 2011, corporate bodies to which the CSR arrangements applied were required to establish a CSR council to detail a CSR approach. The council would have the function of utilising the funds for CSR activities which were to be affirmed by the board. At the point when it came to CSR spending, proviso 135(5) of the 2011 Bill stated that companies under this section will make every attempt to spend at least 2 per cent of its average profits of the past three years on CSR exercises.

    At the underlying phases of this discourse by the Standing Committee, it seemed that the CSR spending would be made a mandatory affair under which the companies violating this rule would be made liable under penal provisions. However, such a recommendation got a lot of criticism from the corporate world which was fervently against any such kind of legislation. The opposition from the corporate sector prompted a semi compulsory methodology whereby companies are pegged to the 2 percent rule without being under any commitment to exercise it.  Disclosing the reasons behind non-spending was instead made mandatory.

    There has been an amendment in 2019 in the 2013 Act which bought several changes to the CSR provisions by penalising non-compliance of the CSR policy. Spending funds accumulated for CSR exercises in a financial year became necessary. All the unspent funds are to be transferred to a special account which is to be absorbed for the completion of its CSR goals within three years. If the company fails to utilise the sums, it has to transfer the same to the government for social welfare schemes. Punitive measures by imposing fines and imprisonment are also added if the company is in default or is unable to make a CSR policy.

    Since the change in 2019, the companies have fervently opposed the alterations made to the CSR provisions because of the addition of stringent punitive measures. Considering the opposition, the Government has appropriately concluded that it would not notify the alteration to section 135 of the Act, and that it will rather review the scenario in the time being.

    Analysing the Impact of the CSR Regime

    Observing the quantitative parts of CSR expenditures, surveys show that before the authorisation of the Companies Act, 2013, the sums included for CSR were very insignificant. In light of the moderate, yet relentless, development of CSR exercises in India, both as far as CSR policies and disclosure are concerned, the presentation of an administrative order towards CSR move can be said to invigorate further development and thus subsequently has been endorsed by analysts.

    However, a major critique of CSR prerequisites is that there are no reasonable criteria to examine the sufficiency and propriety of CSR spending. More importantly, there was no proper system for the study of the disclosures in the Act, until the 2019 amendment where CSR spending was made mandatory. While corporate have surely not done their fair share with regards to indulging themselves in social ventures under CSR, having being compelled to make a contribution to central funds for non-compliance is very much same as a corporate assessment. It only acts in a creation of one more formality for the corporate. The corporate sector takes it as a mandatory expenditure which does not really lead to any profitability, and thus it is a 2% tax spent by the companies themselves and not given to the government.

    From the viewpoint of compliance, some companies precisely allocate 2 percent of their average profits, whereas some companies who used to spend more than 2 percent of their average profits before the law, have now started to bring it down close to the 2 percent mark. While from one perspective this might be characteristic of consistence, it may then again likewise be reminiscent of mechanical adherence equal to a “check the box” frame of mind.

    Thus, providing tax deductions for CSR activities may change the outlook of the corporate sector for social commitment. Moreover, imprisoning company officials for default appears to be somewhat over the top for what is supposed to be a civil liability. Further, it is crucial to take note of the point that a mere fund allocation does not really fulfill a social obligation.

    The Government should explore different suggestions apart from tax deductions for CSR spending, for example, carrying forward the unspent sums up to three budgetary years and making a CSR exchange portal. The base of CSR exercises should further be expanded to incorporate activities such as sports advancement, senior residents’ and specially-abled persons’ welfare, etc.

    CSR in COVID-19

    The MCA through its notifications and a circular has clarified that any expenditures made towards COVID-19 would come under the ambit of CSR activity under schedule VII of the Act pertaining to disaster management, healthcare, and sanitation. Further to encourage such activities the MCA also exempted all donations made towards PM CARES Fund under the Income Tax Act, 1961. The result of which is that a lot of companies have donated a heavy sum in the PM CARES Fund as part of their CSR obligation including Tata trusts, Reliance Industries, Wipro, JSW Group, etc.

    The pandemic also brings opportunities for those with an acumen and mindful approach towards CSR. For instance, manufacturing companies in the UK have undergone a transformation in their factories as they are now also producing protective equipments, ventilators, sanitizers, etc, and mostly making a donation of these items instead of selling them. Vodafone provided free unlimited data to most of its customers in the UK. Supermarkets have allotted specific opening time only for health workers and old people, and are continuously distributing food items to NGOs. Companies have also waived off their commercial airtime to contribute more for the cause. Even some banks have waived off interests on loans for a period of time.

    The drastic consequences of the pandemic on the Indian economy will be unprecedented. Thus, it marks a crucial event which has the potential of significantly changing the nature of CSR. Even though the pandemic has driven many companies on the verge of a breakdown, it have also presented a completely new set of opportunities which could be further harnessed for the interests of corporate as well as the society.

    An authentic and genuine CSR from a company will lead to a stronger relationship with the general public since people will develop great expectations from these companies and their brands with respect to the special efforts made by them to fight the pandemic. Customers can take pride in the fact that the brands they trust are contributing in these difficult times by donating health equipments or helping financially. The relationship nurtured between a stakeholder and a company during this pandemic would indeed be more meaningful as compared to that of ‘normal’ times.

    Post-COVID, there will be an acceleration in CSR in the long run since the corporate world will eventually understand that their survival in the long run depends on accomplishing a balance between revenue and cordiality among different stakeholders. The important question is not about investing in CSR or not, but more regarding the manner in which to invest to derive benefits mutually from the interdependent society.  The common learning we all can take from the pandemic is that everyone is embroiled in this man-made disaster together. This will definitely raise the expectations of the stakeholders from the corporate being more responsible. Thus, we can imagine the post-COVID era to be an era where those firms are thriving who has a stronger commitment with society and effective CSR agendas.

    Conclusion

    The 2019 amendment brings in a greater risk of rigidity which eventually alters the real purpose of CSR. However, the effects of this amendment would be interesting to observe in the current COVID-19 environment where corporate responsibility has become an indispensable affair in tackling the drastic repercussions of the pandemic.

  • NPA Crisis: Pressing Need For Bad Bank

    NPA Crisis: Pressing Need For Bad Bank

    BY ADITI SINGH, GRADUATE FROM SYMBIOSIS LAW SCHOOL, PUNE

    Indian banks especially the public sector banks are heavily burdened with bad loans and an ongoing pandemic is further making the crisis worse. For banks to effectively operate, it’s imperative that they continue lending loans and advances which are categorised as a standard asset or a non-performing asset (‘NPA‘). In an event when the borrower defaults in payment of interest or principal amount of loans and advances made by the bank for more than 90 days, the asset which was earlier categorized as a standard asset is then converted to an NPA.

    According to the Financial Stability Report the Gross NPA ratio of Scheduled Commercial Banks may rise from 8.5% in March 2020 to 12.5% by March 2021 under the baseline scenario however the same may be escalated to 14.7% under a very severely stressed scenario. Banks suffer enormous losses in provisioning for already existing NPAs, due to the Covid-19 pandemic, the world has been facing economic slowdown which has forced the Reserve Bank of India (‘RBI’) to allow a moratorium period and the government to suspend resolution procedure under Insolvency and Bankruptcy Code which will further burden the already burdened banks with NPAs.

    Asset Reconstruction Companies away from Efficient Resolution of NPAs

    There are Asset Reconstruction Companies (‘ARC’) registered with the RBI and regulated under the SARFAESI Act, 2002 that purchase NPAs from the banks at a discounted price and then focus on realising such financial assistance. In order to secure finances, ARCs under section 7 of SARFAESI Act, 2002 are authorised to issue security receipts to qualified buyers evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation. However, ARCs have not been able to provide relief to the stressed banking sector. ARCs have been poorly capitalised to purchase NPAs from the banks and to make 15% of upfront payment as required. Even if ARCs have capital to purchase NPAs the price offered by them after haircut is far too less for banks to agree upon which is why the banks delay and avoid to put NPAs for auction. Delay by the banks in selling NPAs to ARCs leaves restrictive space for ARCs to realise the stressed assets, ultimately defeating the entire purpose behind ARCs existence. Looking at the near future, Indian Banks’ Association has proposed to set up a ‘Bad Bank’ for the recovery of banking sector from the financial distress.

    How will Bad Bank resolve NPAs? How will it work differently from already existing ARCs? Who will fund the Bad Bank in India? These are some of the questions that come hand in hand with the discussion of establishing Bad Bank.

    The Bad Bank Approach

    A Bad Bank essentially is an ARC which aims at reducing NPAs from the books of banks thereby reducing the load of stressed assets upon the banks. The banks will first segregate their assets and then transfer their stressed assets to the Bad Bank. The Bad Bank will then focus on realizing those stressed assets.

    Experiences of United States of America, Ireland, Germany, Sweden, Malaysia suggests various significant features behind success of Bad Bank. Mellon Bank of USA was the first bank to use the Bad Bank approach to resolve stressed assets. Further, The United States established, the Resolution Trust Corporation in the year 1989 funded by government and a few private investors. Thereafter, in the year 1992 Sweden incorporated Securum, a state sponsored company to resolves stressed assets, which successfully resolved ailing assets and was closed in the year 1997. Some of the major factors behind its success were state intervention, well framed laws and policies, transparency and political unity.

    Another significant model is Danaharta, established by the Malaysian government in the year 1998, a government funded asset management company with finite life to resolve stressed assets and recapitalisation. Malaysian government focused on strengthening its laws to support the effective operation of Danaharta. Malaysian government also stressed upon involving experts around the world which contributed immensely towards its success. However, there is no correct model for Bad Bank but intervention of state in ownership of Bad Bank needs to be carefully determined before establishing Bad Bank in India.

    The structure of the Bad Bank will be the main area which will distinguish it from the already existing ARCs in India. Indian Banks Association has proposed three stages of Bad Bank which includes an Asset Reconstruction Company (‘ARC‘) which will house the NPAs, an Asset Management Company (‘AMC’), and an Alternate Investment Fund (‘AIF’). The ARC will be owned by the Government of India, the AMC will be a professional body with participation from public and private sector, and the AIF is where a secondary market can be created for security receipts. The association recommended that the capital of Rs. 10,000 for Bad Bank to start operating shall be funded by the government.

    The idea of Bad Bank has been avoided for a long time in India. However, looking at the enormous number of distressed assets it becomes significant to find a way to resolve them. The role of ARCs and IBC has been significant yet not sufficient to resolve enormous number of NPAs. Bad Bank which is essentially an ARC has the potential to get financial sector ready to release funds. Some of the significant factors that will help the Bad Bank to effectively operate and resolve the enormous amount of bad loans in India are as follows:

    Structure of the Bad Bank

    The structure is the significant feature that will distinguish it from ARCs. Amid Covid-19, it is unreasonable to expect state owned Bad Bank, even otherwise Bad Bank requires minimum state intervention. However, Experiences around the world are a testimony that the state cannot be entirely excluded from the ownership structure of Bad Bank.

    The suitable structure for Bad Bank would be a Public-Private Partnership (‘PPP‘) to maximise recovery. Size of NPAs in public sector banks is such that the Government cannot be entirely excluded from the ownership but can stand as a minority stake holder so that the bank has the commercial freedom and transparency to avoid red-tapism while resolving the stress of bad loans.

    Adequate guidelines and Framework: For Bad Bank to resolve NPAs effectively there must be adequate guidelines and frameworks from the very beginning, firstly, to determine the value at which assets shall be transferred and secondly, to determine how these NPAs shall be resolved. The major issue ARCs have been facing is to reach an agreement on the value at which banks can sell off the NPAs. Moreover, in the case of ARCs, the RBI launched guidelines on sale of stressed asset by banks in 2016 much after the enactment of SARFAESI Act.

    Banks have been selling NPAs to ARCs either by an auction or bilateral negotiations. However, auction cannot be a suitable way for Bad Banks to acquire NPAs as it will further complex the entire time bound procedure the Bad Bank needs to follow.

    One of the key aspects of having PPP structure is the profit sharing link between the owners of the Bad Bank. Framework may include links of profit sharing between the owners of the Bad Bank so that once the bad asset has been resolved by the Bad Bank the profit will accrue to the owners of Bad Banks i.e. the banks, the original institution itself. If the banks have a profit sharing link then they would not shy away from transferring assets to Bad Bank without any unnecessary delay.

    Timeline: Timeline in which the assets need to be resolved by the Bad Bank is crucial to the entire resolution process and must be strict. Bad Bank should be able to resolve the acquired NPAs within 5 years which can be extended up to 7 years in special circumstances. The extension must not give any leverage otherwise it can start a vicious cycle of bad loans all over again.

    No Barriers to foreign skills and capital: The valuation mismatch between ARCs and bank is because ARCs have been under capitalised due to stringent policies for foreign investors to invest in ARCs which were relaxed only in 2016. This has been the major cause for ARCs limited role in resolving NPAs. The same shall not be done with the Bad Bank, foreign investors must allowed to invest in the Bad Bank from the very beginning so that the Bad Bank does not remain under capitalised.

    Along with the investors, Bad Bank shall also include experts from all around the globe to deal with complex NPAs. Also, in an event when it takes time to resolve NPAs, it’s the experts who can use their expertise to deal with the assets meanwhile a suitable buyer can be found.

    Having a Bad Bank will let the banks continue the lending however, it will bring its own challenges but this seems be to be the best suited time for its incorporation for the recovery of the banking sector. It’s also significant to not completely rely on a successful model of a foreign nation as India will need its Bad Bank to meet its own challenges. Since, the resolution procedure stands suspended in such circumstances banks specially the Public sector banks need to have confidence to keep up the lending. In such circumstances it’s important to segregate distressed assets and let them be realised by the experts.

  • Converting Preference Shares into Debts: Tax Evasion or Tax Planning?

    Converting Preference Shares into Debts: Tax Evasion or Tax Planning?

    BY YASH MORE AND HITOISHI SARKAR, THIRD-YEAR STUDENTS AT GNLU, GANDHINAGAR

    In December 2019, the National Company Law Appellate Tribunal (“NCLAT“) in Joint Commissioner of Income Tax v. Reliance Jio Infocomm Ltd. & Ors., while approving a demerger under s. 230-232 of the Companies Act, 2013, allowed the conversion of preference shares of a company into debt during the scheme of arrangement. However, the tribunal failed to adjudicate and determine the legal validity of such a transaction. The ramifications of such conversion include a considerable reduction in the profitability of the demerged company and a consequent estimated loss of Rs 258.16 crores to the public exchequer which would otherwise have received such payment in the form of dividend distribution tax under s. 2(22)(a) of the Income Tax Act. 

    The main thrust of the argument before the NCLAT was that by the scheme of arrangement, the transferor company sought to convert the redeemable preference shares into loans, i.e., conversion of equity into debt, which is contrary to the principles in s. 55 of the Companies Act, 2013. However, the NCLAT dismissed this contention stating such a determination is not a subject matter of the Income Tax Department. It noted that such an objection could be raised only by the competent authorities, i.e., Regional Director, North Western Region and the Registrar of Companies.

    This article aims to determine the legality of such a conversion of preference shares into debt under the scheme of the Companies Act. In doing so, the authors have first expounded on the nature of preference shares and delineated on the vanishing line of distinction between tax evasion and tax planning. The authors have concluded the discussion by highlighting the problems faced in law while such conversion transactions are carried out.

    Preference Shares under Companies Act

    As per Explanation (ii) to s. 43 of the Companies Act, 2013, preference share capital refers to those shares which carry a preferential right with respect to (a) payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, and (b) repayment, in the case of a winding-up or repayment of capital, of the amount of the share capital paid-up or deemed to have been paid-up.

    The problem that arises when preference shares are converted into a loan is that the shareholders turn into creditors of the company. This leads to two main consequences – firstly, the shareholders who are now creditors can seek payment of the loan irrespective of whether there are accumulated profits or not and secondly, the company would be liable to pay interest on the loans to its creditors, which it otherwise would not have had to do to its shareholders.

    Tax Evasion v. Tax Planning

    S. 2(22)(a) of the Income Tax Act, 1961, taxes any distribution of accumulated profits by a company to its shareholders, if such distribution entails the release of all or any part of the assets of the company. By way of converting preference shares into loans, there is an “indirect release” of assets by the demerged company to its shareholders without appropriating funds from the accumulated profits of the company. Thus, the conversion aid companies to circumvent payment of dividend distribution tax which would have otherwise been attracted in light of s. 2(22)(a). Further, the payment of interest on such vast amounts of loans would lead to a reduction in the company’s total income in an artificial manner.

    The order of the NCLAT reminds one of the Supreme Court’s landmark verdict in Vodafone International Holdings BV v. Union of India wherein the Court had frowned upon artifice, which leads to tax avoidance. However, this has to be read in consonance with the ruling of the Gujarat High Court in Vodafone Essar Gujarat Ltd. v. Department of Income Tax, where it was held that the mere fact that a scheme may result in a reduction of tax liability does not furnish a basis for challenging the validity of the same.

    The Supreme Court in McDowell & Co. Ltd. v. CTO had acknowledged and dwelled upon the fine although significant distinction between tax planning and tax evasion and expounded that ‘tax planning may be legitimate, provided it is within the framework of the law.’ Therefore, in order for us to determine the validity of the scheme of arrangement, we must look into the legality of the conversion of equity into debt under the scheme of s. 55 of the Companies Act.

    Legal Validity of the Conversion under the Companies Act, 2013

    The pertinent question that needs to be addressed is whether such a conversion of preference shares to a loan is in contravention of s. 55 of the Companies Act, 2013. It deals with the issue and redemption of preference shares. However, it does not state anything about the conversion of preference shares. In fact, in the event where a company is not in a position to redeem any preference shares or to pay dividend, it may either (a) further issue redeemable preference shares equal to the amount due, including the dividend thereon, or (b) convert the preference shares into equity shares.

    S. 55(2)(a) of the Companies Act, 2013, necessitates the requirement that preference shares cannot be redeemed except out of the profits of the company. Likewise, s. 80(1) of the Companies Act, 1956, provided a similar requirement. Thus, when the preference shares are converted into loans, the problem lies in the fact that shareholders who would now have become the creditors of the company will have to be paid irrespective of the availability of profits, thereby presenting a prima facie conflict with provisions of the Companies Act, 2013.

    However, the courts have refused to construe such a conversion as a contravention of company law. In PSI Data Systems Ltd., the Kerala High Court while adjudicating upon a conversion held that the requirement under s. 80(1) of the Companies Act, 1956, is to protect the preference shareholders from a company’s unilateral action. However, if the preference shareholders consent to such a conversion of preference shares into loans, no contravention of s. 80(1) can be established. The same has been affirmed by the Andhra Pradesh High Court in In Re: SJK Steel Plant Ltd., where the Court refused to read a conversion of preference shares into Funded Interest Term Loan (FITL) as a contravention of the law.

    Did the NCLAT erroneously sanction the Scheme of Arrangement?

    It is beyond doubt that any scheme of arrangement needs to satisfy the requirements of s. 230-232 of the Companies Act, 2013, so as to be sanctioned by a competent court. The corresponding provisions of the erstwhile Companies Act, 1956 in this regard were s. 391-394 of the Companies Act, 1956. Thus, for a scheme of arrangement to be denied sanction, a violation of the aforementioned statutory provisions must be established.

    It is a well-settled position of law post the Supreme Court’s ruling in Miheer H. Mafatlal v. Mafatlal Industries that a scheme of compromise and arrangement which is in violation of any provision of law cannot be sanctioned and the Court has to first satisfy itself that any scheme of arrangement does not contravene any law or such compromise is not entered into in breach of any law. However, juxtaposing the legal pronouncements in PSI Data Systems Ltd. and SJK Steel Plant Ltd., it is evident that s. 55 nowhere prohibits conversion of the preference shares into a loan.

    A pertinent objection which was raised before both the NCLT and NCLAT was that the conversion of preference shares by canceling them and converting them into a loan would substantially reduce the profitability of the demerged company. The Andhra Pradesh High Court in In Re: T.C.I. Industries Ltd., laid down that while exercising powers under s. 391 and 394 of the Companies Act, 1956 the Court cannot sit in appeal over the decision arrived at by the shareholders or the secured creditors or the unsecured creditors, and minutely examine whether the proposed scheme as approved by the shareholders should be sanctioned or not. Thus, it is beyond the powers of a court under s. 230-232 of the Companies Act, 2013, to examine the implications of a particular scheme on the profitability of the company.

    Conclusion

    The authors duly acknowledge that conversion of preference shares into loans may lead to a massive loss to the public exchequer as the payment of loans to the creditors (who were formerly preference shareholders) cannot be taxed as opposed to payment of dividend under s. 2(22)(a) of the Income Tax Act. However, as detrimental as it may be to the exchequer, the courts have not found any explicit or implicit statutory provision that prohibits such transactions. The opposite, i.e., conversion of loan into shares, although, has statutory recognition under s. 62(3) of the Companies Act, 2013 by way of issuance of convertible debentures.

    Nevertheless, the NCLAT should have been careful while allowing such conversion and must not have dismissed the contention of Income Tax Authorities merely on the grounds of locus standi. The NCLAT alone is empowered and responsible for ensuring that no scheme of arrangement is carried out in contravention of any law even though shareholders or creditors agree to such terms. At the same time, there is a need to further deliberate upon the legality of such conversion and courts must not approve of such transactions merely because they have not been expressly prohibited.

  • The Requirement of ‘Intention’ in Special Resolutions

    The Requirement of ‘Intention’ in Special Resolutions

    By Gunjan Bahety and Tanmay Joshi, fourth-year students at MNLU, Nagpur

    Introduction

    Under the Companies Act, 2013 (‘Act’), decisions are taken and executed with the consent of the shareholders through resolutions. The consent of the shareholders is duly taken by the casting of votes. Special Resolution under the Act has been defined as:

    “A resolution shall be a special resolution when

    1. the intention to propose the resolution as a special resolution has been duly specified in the notice calling the general meeting or other intimation given to the members of the resolution; 
    2. the notice required under this Act has been duly given; and 
    3. the votes cast in favor of the resolution… are required to be not less than three times the number of the votes, if any, cast against the resolution by members so entitled and voting.”[i]

    The very first requirement that the section provides is for “intention to propose the resolution as a special resolution” which needs to be “duly” mentioned in the notice. Going by the literal text of the statute, prima facie it seems that the requirement of intention is mandatorily an element for classification of a resolution as a special resolution. However, the courts have interestingly taken an opposite view of the same. 

    Is Intention Really a Mandatory Requirement?

    The Courts have time and again held that the requirement of “intention” under clause (a) of section 114 is not a mandatory requirement.[ii]

    The Andhra Pradesh High Court had held in a case:

    “requirement of setting out the intention to move a resolution as a special resolution in the notice could not be said to be such a mandatory requirement, that the failure to comply with it would invalidate the resolution.”[iii]

    The Court then differentiated between a directory requirement and a mandatory requirement. The Court held:

    “There is no general rule for determining whether a particular provision in a statute is mandatory or directory. The court must look at the purpose of the provision, its nature, and intention of the Legislature to find out whether it is directory or mandatory.”[iv]

    The Court was of the view that even the use of the word “shall” is not decisive of the matter and many other aspects have to be looked into.[v] However, there are other aspects that the Courts need to consider while reaching this conclusion. The Supreme Court (‘SC‘) recently has stated that:

    “the Legislature inserts every part of a statute with a purpose & the legislative intention is that every part thereof should be given effect to. If the words used are capable of only one construction, it is not open to the court to adopt any other hypothetical construction on the ground that it finds it more consistent with the alleged object and policy of the Act.”[vi]

    Parallelly, the SC had held in a case that “the first and primary rule of construction is that the intention of the legislation must be found in the words used by the legislature itself.”[vii] Citing various case laws, the Apex Court had concurred, “when the Legislature has employed a plain and unambiguous language, the Court is not concerned with the consequences arising therefrom”[viii] and construal is to be done only when the text is incomprehensible. The Court further held that “it is a cardinal principle of interpretation of statutes that the words of the statute is to be given prima facie meaning, irrespective of the consequences”. However, equally it is important to look at the interpretation from another perspective, as cited by the SC:

    “In matters of interpretation one should not concentrate too much on one word and pay too little attention to other words. No provision in the statute and no word in any section can be construed in isolation. Every provision and every word must be looked at generally and in the context in which it is used.”[ix]

    The above-mentioned method of interpretation would obviously make it reasonable to give effect to the legislative intent and the purpose of the provision while keeping in mind to not focus much on the wordings of the section so as to defeat the purpose of the legislation. In light of the above analysis, even the court opined that the inconveniences which would arise if the resolution would fail even after being passed as a special resolution were certainly not the intention of the legislature.[x] Hence, the requirement of intention under section 114 cannot be said to be a mandatory requirement but only a directory requirement. Further, the Court held that the decisions which require a special resolution to be adopted are mandatory but the notice convening the meeting and implying the intention that the resolution is to be passed as a special resolution is only directory. The Court thus, adopted harmonious construction in practice. 

    Hence, what would be of material importance would be the contents of the resolution and the consent of the members and certainly not what the irregularities in the notice would say. Therefore, it would be sufficient if the provision is only substantially complied with. The Gujarat High Court had also observed that the requirement of intention in the notice under section 114 to move a special resolution could not be said to be such a strict and necessary requirement that the failure to comply with it would invalidate the resolution.[xi]

    It would be of relevance to discuss here the Duomatic Principle as was laid down in In Re Duomatic Limited 1969[xii]. Buckley J. held that given the shareholders who had a right to attend and vote at a general meeting, had informally assented to a decision in the meeting, that assent is binding and a formal meeting cannot be insisted upon.[xiii] The English Court took the view of In re Express Engineering Works Ltd.[xiv] and other cases[xv], wherein it was held that “where all the corporators in fact approve, the mere absence of the technicality of a formal resolution in general meeting is immaterial”. The Court accordingly held that “the agreement between all shareholders of the company had the effect of overriding the articles so far as was necessary.”[xvi] However, for the application of this principle, the existence of consensus-ad-idem among all the shareholders of a company for a particular course is a condition precedent.[xvii] The scope of this principle has been defined in various foreign cases. In Stakefield (Midlands) and others v. Doffman and another[xviii], it was held that “the principle cannot be applied for a transaction amounting to an unlawful return of capital”. In some cases, it has been held that the principle can be employed to alter the company’s articles.[xix] It has also been accepted as a defense for violation of fiduciary duties.[xx] It is to note that, “the Duomatic principle does not permit shareholders to do informally what they could not have done formally by way of written resolution or at a meeting.”[xxi]

    In India, there have been numerous cases wherein the learned counsels have taken the aid of the Duomatic Principle.[xxii]The Indian Courts too applied the principle, for example in Darjeeling Commercial Co. Ltd. v. Pandam Tea Co. Ltd.[xxiii] the court while applying the principle concluded that the company adopted the loan in its annual general meeting through its members and now cannot take the defense that the said loan is fictitious or fraudulent. Even the Delhi HC had applied this principle and cited various English cases to back its view.[xxiv] Additionally, the Andhra Pradesh High Court in another case held that the principle in essence provides that if a statute provides that a course can be taken by the sanction of a certain number of members which is to be given in accordance with the prescribed procedure under the statute, then provided that the required number of members of that group sanction the decision, the prescribed procedure is not normally treated as being essential.[xxv]  However, extending the proposition, the Court concurred that “this should be the case when the Court is satisfied that the purpose of the given procedure is for the benefit of the members” of that group and enables a majority of that group to bind the minority in relation to the course in question.

    Conclusion

    Hence, what can be said is that the requirement of intention setting out in the notice under section 114 of the Companies Act, 2013 though not mandatory, but to avoid future instances of disputes, it would be better to declare such a notice as convening a meeting for the passing of a special resolution as there is no Supreme Court judgment to that effect. As we have seen the different approaches that the courts adopt while interpreting a statute and there is no straight-jacket formula to that, at times even plain text of the statute requires interpretation to mark it as “plain”. What is necessary to understand is to read the purpose of the section and not to fuss about the procedural requirements when can be easily resolved given the sanctions of the members.

    Endnotes:

    [i] Section 114, Companies Act 2013.

    [ii] In Re: Novopan India Limited 1997 88 Comp Cas 596 AP, Brilliant Bio Pharma Limited v. Company Petition No.91 Of 2012; In Re: Maneckchowk And Ahmedabad [1970] 40 Comp Cas 819; C. Rajagopalachari v. Corporation of Madras [A.I.R. 1964 S.C. 1172].

    [iii] In Re: Novopan India Limited 1997 88 Comp Cas 596 AP.

    [iv] Ibid.

    [v] Ibid.

    [vi] N Sampath Ganesh v. Union of India (2020) Cr. Writ Petition NO. 4144 OF 2019.

    [vii] Kanai Lal Sur vs Paramnidhi Sadhukhan 1957 AIR 907.

    [viii] N Sampath Ganesh v. Union of India (2020) Cr. Writ Petition NO. 4144 OF 2019.

    [ix] Illaichi Devi v. Jain Society, Protection of Orphans India, (2003) 8 SCC 413.

    [x] In Re: Novopan India Limited 1997 88 CompCas 596 AP.

    [xi] Maneckchowk and Ahmedabad Manufacturing Co. Ltd. [1970] 40 Comp Cas 819.

    [xii] In Re Duomatic Ltd. [1969] 2 Ch 365.

    [xiii] Re Duomatic, Buckley J at page 373.

    [xiv] In re Express Engineering Works Ltd. [1920] 1 Ch. 466.

    [xv] In Re Newman (George) & Co. Ltd. [1895] 1 Ch. 674, C.A.; Parker & Cooper Ltd. v. Reading [1926] Ch. 975; Salomon v. Salomon & Co. Ltd.[1897] A.C. 22, H.L.

    [xvi] Ibid.

    [xvii] Euro Brokers Holdings Ltd. v. Monecor (London) Ltd. [2003] 1 BCLC 506.

    [xviii] Stakefield (Midlands) and others v. Doffman and another [2010] EWHC 3175.

    [xix] Cane v. Jones [1980] 1 WLR 1451, The Sherlock Holmes International Society Ltd. v. Aidiniantz [2016] EWHC 1076 (Ch). 

    [xx] Sharma v. Sharma [2013] EWCA Civ 1287.

    [xxi]  Madoff Securities International Ltd v Raven & Ors. [2013] EWHC 3147 (Comm).

    [xxii] Urban Infrastructure Trustees Ltd. v. Joyce Realtothers Pvt. Ltd. LNIND 2015 Bom 776; Dr. Renuka Datla And Others Versus M/Biological E Limited And Others Lnindord 2017 Ap 258; Advansys India Private Limited & Others Versus M S Ponds Investment Limited & Others Lnind 2014 Bom 434.

    [xxiii] Darjeeling Commercial Co. Ltd. vs Pandam Tea Co. Ltd. 1983 54 CompCas 814 Cal.

    [xxiv] Adobe Properties Private Limited vs Amp Motors Private Limited CO.APPL.(M) 150/2016.

    [xxv] In Re Torvale Group Ltd. [1999] All ER (D) 944, In Re Brilliant Bio Pharma Limited [2013] 180 Comp Cas 168 (AP).

  • Cross Border Demergers In India: Analysing the Legislative Intent

    Cross Border Demergers In India: Analysing the Legislative Intent

    By Abhishek Wadhawan and Devarsh Shah, second-year students at Gujarat national law university, Gandhinagar

    Conceptualising Demergers under Indian Laws

    A demerger is a type of restructuring strategy through which a single company gets divided into two or more entities and the resulting companies are registered as separate corporate entities under the law and function independently. However, neither the Companies Act, 1956 nor the Companies Act, 2013 (‘the Act’) define the term demerger.  Thus, before examining the idea of cross border demergers and their legality in India, it is necessary to analyse the status quo. Section 2(19AA) of the Income Tax Act, 1961 defines demerger in relation to companies as ‘a transfer by the demerged company of its one or more undertakings to any resulting company as per the scheme of arrangement under sections 391 to 394 of the Companies Act, 1956’. The Bombay High Court in Renuka Datla v. Dupahar Interfran Ltd. acknowledged the formal recognition of the definition of  demergers in Indian jurisprudence by its inclusion in the Income Tax Act and noted that the same are relevant to the Companies Act as well.

    To allow demergers in India, the Courts have often taken the aid of section 232(1)(b) of the Act that corresponds to the Companies Act, 1956 which clearly states that a scheme of arrangement may also propose to divide the undertaking among one or more companies.

    Dissecting the debate over cross-border demergers in India

    In 2017, the Ministry of Corporate Affairs had notified section 234 of the Act and also inserted Rule 25A in the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016 (Merger Rules) (‘Companies Rules, 2016’) to allow the cross-border mergers and amalgamations in India. While this solved the issues pertaining to cross border mergers, the debate over the legality of cross border demergers under the Indian laws is not yet settled. This debate has been further fuelled by the recent series of contrary decisions given by the National Company Law Tribunal of Ahmedabad (‘NCLT’). In the matter of Sun Pharmaceutical Industries Limited (2018) of 2018, (‘2018 Order’) the Bench allowed an application for an inbound cross border demerger by making reference to section 234(1) of the Act which specifies that the provisions of Chapter XV of the Act, dealing with Compromises, Arrangements, and Amalgamations, will apply to it mutatis mutandis unless otherwise provided. Thus, the scheme of arrangement as provided under section 232(1) of the 2013 Act can be read into it. It further noted that since an ‘arrangement’ includes a demerger, a cross border demerger was allowed by the Act. Reference was also made to Regulation 9 of FEMA (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (‘TISPROI Regulations’) which provides that the Tribunal may allow a company subsequent to its scheme of merger or demerger to issue capital instruments to the shareholders of the existing company, even if they are residing outside India. Thus, the scheme for an inbound cross border demerger was allowed.

    Subsequently, in 2019, NCLT Ahmedabad (‘2019 Order’) took a completely opposite view of its aforementioned 2018 Order involving the same entity and held that cross border demergers are not allowed in India. In this matter, Sun Pharmaceutical Industries Limited had sought permission for the scheme of arrangement (demerger) from NCLT Ahmedabad, whereby it wanted its two specified investment undertakings to be transferred to its two wholly-owned subsidiaries incorporated in the Netherlands and the USA and hence had a feature of outbound cross border demerger arrangement.  While rejecting the petition, it was specifically noted by the Bench that cross border demergers are prohibited in India as there is no mention of the term ‘demerger’ in either section 234 of the 2013 Act or in the Rule 25A of the Companies Rules. Further, it also stressed upon the legislative intent to not permit cross border demergers in India as the draft FEMA (Cross Border Merger) Regulations, 2018 included the term demerger in the definition of ‘cross border merger’ but the same was removed in the final regulations as notified by the Reserve Bank of India (‘RBI’) which, according to the Tribunal, highlights the intent of the legislature and the RBI to exclude cross border demergers in India.

    Thus, through the two extremely contrary orders, the NCLT Ahmedabad on one hand sanctioned a scheme of arrangement that proposed an inbound cross border demerger and on the other hand, rejected an identical scheme that proposed an outbound cross border demerger. These contrasting decisions are based on different interpretations made by NCLT Ahmedabad on the basis of the legislative intent and accordingly, this conundrum can be solved only by the analysis of the true legislative intent in reference to cross border demergers in India.

    Analysing the true legislative intent

    The 2018 Order appraises Regulation 9 of TISPROI Regulations which deals with merger, demerger, or amalgamation of companies registered in India. The order recognizes that if the legislature had intended to disallow cross border mergers, it would not have been covered explicitly under the regulations. On the contrary, the 2019 Order of the NCLT absolutely ignores the 2017 Regulations while arriving at its conclusion.

    The 2019 Order asserted that the true legislative intention was to disallow cross border demerger of companies. It further justified this assertion by pointing out that though the draft FEMA (Cross Border Merger) Regulations, prepared in April 2017, included the word “demerger” in the definition of a merger, upon the notification in March 2018, they excluded the term ‘demerger’ and the definition remained restricted only to merger, amalgamation, and arrangement. This, according to the NCLT, was enough indication that cross border demergers were not permitted.

    In its order, the NCLT blatantly failed to appreciate the wide scope of the term ‘arrangement’. Section 19AA of Income Tax Act, 1961 explicitly mentions that demerger can be pursuant to a scheme of arrangement. Further, ‘arrangement’ as understood under section 232(1)(b) is inclusive of “whole or any part of the undertaking of any company proposed to be divided among and transferred to two or more companies”.  This implies assent to schemes of demerger as it supports an idea of a restructuring strategy that aims at dividing the undertaking, in whole or in part, between two or more companies. The argument is further strengthened by the fact that despite the absence of the term ‘demerger’ in  Chapter XV of the Act, domestic demergers have been allowed by various tribunals and courts under section 230 read with section 232 of the 2013 Act. Thus, the Courts have essentially read the legality of demerger as a process of restructuring even when it has not been explicitly recognised by the Legislature under the 2013 Act.

    Most importantly, the 2019 Order in paragraph 15 by itself mentioned that ‘arrangement’ is inclusive of the word demerger. The Tribunal’s reasoning that Regulation 2(iii) of the Cross-Border Regulations of 2018 does not include the term demerger explicitly and hence cross border demergers are not permitted in India is contrary to the inclusive and wide interpretation of the term  ‘arrangement’ by the Courts and Tribunals. Furthermore, section 234 of the 2013 Act stipulates that provisions of Chapter XV (which permit demergers) of the 2013 Act shall apply mutatis mutandis to cross border schemes of merger and amalgamations.

    Hence considering all the regulations and the broad ambit of provisions of merger and arrangement in the 2013 Act, it is difficult to assume that the legislature had an intention to prohibit cross border demergers.

    Conclusion

    The Companies Act 2013 neither expressly permits nor prohibits the cross-border demergers. However, Foreign Exchange Management (Cross Border Merger) Regulations, 2018, and Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India), 2017 are supportive of the proposition that cross border demergers are permitted under Indian law.

    The narrow interpretation by the Tribunal in its 2019 Order is against the spirit of the progressive character of the 2013 Act. It seems that the Tribunal, in its 2019 Order, has erred in rejecting the petitioner’s proposal on the ground of lack of legislative intent. The tribunal’s reasoning that it cannot make law is undisputed but adopting a narrower approach by overlooking the law in its entirety is glaringly unfair and creates regulatory uncertainty for companies.

    In essence, though the permissibility of allowing cross border demergers in India can be made out through a proper interpretation of section 232(1)(b) read with section 234 of the Act, the entire debate on this matter can be settled only by a clarification from the Legislature or a decision of the Appellate Tribunal in this regard.