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Compliances to be undertaken for sale of an Undertaking
CS. Devershi Gupta
The Companies Act imposes some restrictions on the general powers of directors. Pursuant to section 180 of Companies Act, 2013 (“Act, 2013”), there are certain powers which the board of directors of a company can exercise only with the consent of the members of the company by means of a special resolution. In this article, sub-clause (a) of sub-section (1) of section 180 of the Act, 2013 has been discussed at length to ascertain the meaning of ‘undertaking’ and compliances to ensure at the time of sale, lease or disposal of undertaking.
The text of the said provision is as follows:
(1) The Board of Directors of a company shall exercise the following powers only with the consent of the company by a special resolution, namely:—
to sell, lease or otherwise dispose of the whole or substantially the whole of the undertaking of the company or where the company owns more than one undertaking, of the whole or substantially the whole of any of such undertakings.
Further, the selling of undertaking(s) being crucial and of concern to the members of a company, in order to encourage wider participation of the members in the matter, pursuant to section 110(1)(a) of Act, 2013 read with Rule 22(16)(i) of the Companies (Management and Administration) Rules, 2014, the said item of business shall have to be transacted only by means of voting through postal ballot.
Here, it is pertinent to read the language of the said rule minutely:
(16) pursuant to clause (a) of sub-section (1) of section 110, the following items of business shall be transacted only by means of voting through a postal ballot-
(i) sale of the whole or substantially the whole of an undertaking of a company as specified under sub-clause (a) of sub-section (1) of section 180;
This means that although sub-clause (a) of sub-section (1) of section 180 pertains to ‘to sell, lease, or otherwise dispose of’ the whole or substantially the whole of undertaking(s), postal ballot is required only in case ‘selling’ of the whole or substantially the whole of undertaking(s).
Prior approval from the members:
Although the word ‘prior’ does not appear in the section, but it is very clear that the consent of the members has to be sought prior to the act of selling, leasing or otherwise disposing of the whole or substantially the whole of the undertaking(s) of the company.
The powers under this section can be exercised by the board only with the consent of the general body. The board cannot exceed the powers in the hope that the general body will ratify their actions. Accordingly, the power shall be exercisable only with the prior consent of the members.
Approval of Audit Committee:
Pursuant to section 177(4)(vi) of the Act, 2013, the undertaking and asset of a company needs to be valued by the audit committee, wherever it is necessary.
Section 180(1)(a) of Act, 2013 vis-à-vis Section 293(1)(a) of Companies Act, 1956:
It is pertinent to note that section 180(1)(a) of Act, 2013 corresponds to section 293(1)(a) of the Companies Act, 1956. Similar provision contained in the Act, 1956 except with the following differences:
Earlier ordinary resolution from the members would suffice as compared to the requirement of special resolution from the members in Act, 2013.
Section 293(1)(a) of Act, 1956 was applicable to public and deemed public companies while Section 180(1)(a) was initalliy applicable to all companies. However, MCA vide exemption notification dated 5th June, 2015 rendered section 180 inapplicable to private companies.
The expression “substantially the whole of the undertaking” and “undertaking” has been defined in section 180 of Act, 2013
Interpretation of the word “undertaking”:
Explanation (ii) to section 180(i)(a) defines the meaning of the expression “undertaking”.
Explanation.—For the purposes of this clause,—
(i) “undertaking” shall mean an undertaking in which the investment of the company exceeds twenty per cent of its net worth as per the audited balance sheet of the preceding financial year or an undertaking which generates twenty per cent of the total income of the company during the previous financial year;
Primarily, for a transaction to be considered within the purview of Section 180(1)(a) of Act, 2013, it has to comply with the following criteria –
should relate to an “undertaking”; and
should be in respect of sale, lease or disposal of such ‘undertaking’ in any other manner.
In the Act, 1956, section 293(1)(a) also gave a very similar rendition; however, it did not furnish any explanation to what an ‘undertaking’ meant. The explanation to section 180(1)(a) of Act, 2013 furnishes only the qualifying criteria of an ‘undertaking’ to be considered under section 180(1)(a), but does not actually define an ‘undertaking’.
For the purpose of concluding on what classifies as an ‘undertaking’ under Section 180(1)(a) of Act, 2013,we thereby have to look to various Court rulings to understand the precedents set by the Courts in relation to what constituted as ‘undertaking’ under Section 293(1)(a) of Act, 1956.
In the decision of Rustom Cavasjee Cooper vs Union of India, the Apex Court provided an insight into what could constitute an ‘undertaking’. The case did not pertain to interpreting undertaking as per Section 293(1)(a) of Act, 1956, it still offered a detailed discussion on this front. The Supreme Court held that by the word ‘undertaking’ is meant the entire organization. The provisions of the stated Act, indicate that the company whether it has a plant or whether it has an organization is considered as one whole unit and the entire business of the going concern is embraced within the word ‘undertaking’. It also held that ‘undertaking’ would clearly mean a going concern with all its rights, liabilities and assets-as distinct from the various rights and assets which compose it for the purposes of the stated Act.
Numerical definition of “undertaking”:
Delving further into the Act, 2013 Section 180(1)(a) also places a numerical definition to the term ‘undertaking’, rendering that even if the asset(s) can be said to be an operating unit or segment, the asset(s) will have to qualify the numerical test given in the Explanation below the said Section; which is, ‘undertaking’ to mean an investment which constitutes either 20% of the net worth or total income of the company during the previous financial year.
What can be deduced from the above is that the very concept of ‘undertaking’ would essentially mean
an asset or group of assets, where the sole ownership right(s) is with the company; and
which when disposed of can have an impact on the working of the company and earning of its profits.
Meaning of the expression “otherwise dispose of”:
The expression “otherwise dispose of” has to be read in a wider sense so as to cover all modes of disposing of a property of the company.
Earlier the Department of Company Affairs vide letter dated 21.7.1964, clarified that in case a company mortgages the whole or substantially the whole of its undertaking for obtaining loans or financial assistance, it need not comply with the erstwhile section 293(1)(a). However, in case of an usufructuary mortgage, the section would be attracted.
Further, in the decision of Mohanlal Ganpatram v Shri Sayaji Jubilee Cotton, execution of equitable mortgages and pledges is not disposition of the whole or substantially the whole of the undertaking of the company.
Also, the ‘business’ or ‘undertaking’ of the company must be distinguished from the ‘properties’ belonging to the company. Where only the properties belonging to the company have been dealt with by the board of directors under the deeds of hypothecation and mortgage in favour of the bank, no part of the undertaking of the company should be considered to be disposed of in favour of the bank.
[Reference – decision of Karnataka High Court in the matter of International Cotton … vs Bank Of Maharashtra And Anr. on 11 April, 1969].
While Act, 2013 provides a quantitative classification for identifying the undertaking, one has to refer precedents laid by the Courts while ascertaining the meaning of undertaking and accordingly ensure compliance under Act, 2013.
Note: This article is purely for academic purpose and shall not be acted upon as a professional advice. The provisions of law referred to in this article may be amended at any time. Thus, I assume no responsibility for the consequences of use of such information without any professional advice. In no event, shall I be liable for any direct, indirect or incidental damage arising in connection with the use of information here in contained.