Introduction:
Directors are appointed by the shareholders of the company and they are trustees of shareholders. As such they are in a fiduciary position and can not take undue advantage of their position using their office. There are some sections in the companies Act which are intended to put a check on misuse of the position of directors. These Sections are 297,299,300,314,302 and 307. This article’s focus is on sections dealing with the interested directors’ obligations and compliance of requirements with regard to Directors’ interested transactions.
Analysis of Section 299:
Section 299 is wider in scope as it covers all kinds of contracts and arrangements including contracts mentioned in Section 297.
Director to disclose his interest:
Section 299(1) casts an obligation on a director to disclose nature of his concern or interest in any contract or arrangement which is proposed to be entered into or entered into on behalf of the company. Such disclosure is to be made at the meeting of board of directors. Now let us read the language used in the Section.
Section 299(1) of the companies Act, reads as under:-
Every director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement, or proposed contract or arrangement, entered into or to be entered into, by or on behalf of the company, shall disclose, the nature of his concern or interest at a meeting of the Board of directors.
The words ‘in any way”, “whether directly or indirectly, proposed contract or arrangement” “entered into or to be entered into“ would indicate that scope of the section is wider and covers all possible transactions with relatives, firms, companies in which the director is associated by virtue of his office or other wise.
Method and manner of disclosure:
Section 299(2) (a) indicates the method and manner of disclosure of interest by a director:
In the case of a proposed contract or arrangement: Disclosure shall be made at the meeting of the Board at which the question of entering into the contract or arrangement is first taken into consideration.
a. In the case of contracts or arrangements already made: Disclosure in this case has to be made at the first meeting of the Board held after director becomes so concerned or interested in the contract or arrangement.
b. In the case of any other contract or arrangement: There may be some contracts which are already in existence and a director looks at such contracts and perceives that there may be a conflict of duty and interest having assumed office as director. Some times Board may not be the sanctioning authority and such contracts also are to be brought to the notice of the Board. Disclosure in this kind of contracts shall be made at the first meeting of the Board held after the director becomes concerned or interested in the contract or arrangement.
General notice of disclosure:
Section 299(3) provides that if a general notice is given by a director to the effect that he is a member or director of a specified body corporate or he is a member of a specified firm and be regarded as concerned or interested in any contract to be entered into with them, it shall be deemed to be a sufficient compliance of Sub-section (1) and (2). In other words a director, need not follow the procedure of disclosing at the board meeting nature of his concern or interest, each time a contract is entered into with the disclosed firms or bodies corporate in which he is either a member or Director.
It would be obvious from the above that the interest disclosed under the above subsection is a pre-determined one and general in nature but not related to the contracts or arrangements
Law makers must have thought that it may be very difficult for a director to give notice of his concern or interest in each and every contact or arrangements to be entered into by the company in which he may be directly or indirectly interested. Section 299(3) thus gives a relaxation to the strict requirements of sub-section (1) and (2) as violation will result in vacation of office of the director.{Refer to section 283(1)(i)}
Format of General notice of disclosure:
Companies (Central Government’s) General Rules and Forms, 1956 have prescribed Form 24 AA for giving a General notice of disclosure by directors. As per Section 299(3) (c), the Director concerned must ensure that his General notice of disclosure or its renewal is given at the board meeting or must take steps to ensure that such notice is read at the board meeting to make it effective.
Validity of General notice of disclosure:
General notice of disclosure given u/s 299(3) by a director is valid for the financial year in which it is given. However such disclosure can be renewed in the last month of the financial year i.e. before 31st March to extend its validity for subsequent financial year. This renewal of disclosure enables the directors who join the board subsequently to know of the director’s interested parties.
Comparison of the language used in Section 299(1) and Section 299(3):
It may be interesting to note that Section 299(1) does not speak of firms or bodies corporate but uses the words indicating that all contracts even with individuals (may be relatives or may not be relatives) in which a director is concerned or interested. Section 299(3) makes a reference of bodies corporate and firms leading to a narrow interpretation and assumption that transactions with relatives are not covered. This interpretation in the author’s view will dilute the true spirit of the section. One must go to the object of the section which wants that company should not be subjected to loss due to the conflict of personal interest and duty. A director may be interested indirectly or indirectly not only in the contracts with bodies corporate but also contracts with firms or individuals. The drafting of Section 299(6) (blanket exemption) appears to be a flaw in drafting and also escaped the attention for a long time.
Controversy surrounding Exemption u/s 299(6):
This subsection provides that the requirements of Section 299 are not applicable to contracts or arrangement entered into or to be entered into between two companies, if any of the directors individually or all of them together hold less than 2% of the paid up share capital in that other company.
The author is of the view that this exemption is available to the director and he may choose not to give his disclosure, if his holding in bodies corporate is less than 2%.Further this exemption is available only for transactions between two companies.
It would be in the interest of a Director and the company, if he gives disclosure of his shareholding even if it is less than 2% so that the company can check whether all of the directors taken together hold more than 2% in a particular body corporate.
Once a director discloses the name of the body corporate, the onus shifts to the company to get the same noted by the Board and to track and trace any transactions. If any transactions are there with interested parties, the company must take steps to enter the details of such transaction in the Section 301 Register. Many people tend to ignore the application of this section with regard to transactions between the two bodies corporate and making entries in Section 301 Register, even when the General notice of disclosure is given on the ground of holding being less than 2%{Section 299(6)}. This view is not a correct view.
Compliance of Section 297:
Section 297 provides that a director or his relative or a firm in which such a director or relative is a partner cannot enter into any contract with the company for the sale, purchase or supply of any goods or materials without obtaining the consent of the Board. If the company’s paid up capital is 2 crores or more, prior approval of the central government is required. However this requirement does not apply in the case of purchase and sale transactions for cash at prevailing market prices but does not include purchase or sale of services.
Compliance of Section 300 and 301:
Now let us shift our focus to the compliance of provisions of Section 300 and 301.
Section 300 prohibits an interested director from participating in discussion in the contract or arrangement in which he is interested. His presence is not counted for Quorum and he can not vote on the resolution of that particular contract or arrangement.
Section 301 casts an obligation on every company to maintain Register of contracts with the companies/firms in which directors are interested. It also specifies what details the said register should contain.
Section 301(2) requires that particulars of every contract to which section 297 or 299(2) applies shall be entered in the register maintained under section 299 within the stipulated time. The exemption under section 301 can be claimed by the company only if the conditions mentioned in Sub-section (3A) are complied with.
To emphasize the point, the relevant portion is extracted below:-
Section 301- (3A) nothing in sub-sections (1), (2) and (3) shall apply-
to any contract or arrangement for the sale, purchase or supply of any goods, materials or services if the value of such goods and materials or the cost of such services does not exceed one thousand rupees in the aggregate in any year; or
To claim exemption from making an entry, the value of the contract or arrangement must be less than 1,000/- which is a ridiculously a low sum in the present context.
What the company should do?
When a general disclosure is given, the author is of the view that it is always safer for the companies to have the disclosure read at the board meeting and note the details of mentioned bodies corporate and firms, in the Section 301 register without look into the fact whether the holding in bodies corporate is 2% or more. This way chances for alleging any violation u/s 301 can be avoided. The director may escape the violation of section 299, since he is giving a General notice but the company can not escape this having noted the director interested parties’ u/s 301(3).
It is also important to note the expressions used such as “who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement, or proposed contract or arrangement. These words “in any way and directly or indirectly” indicate that the scope of section is wide and it can extend to transactions other than transactions between two bodies corporate and includes contract with firms and relatives defined in Section 6(Schedule-1A). Although there are some judgments and clarifications of DCA that the interest has to be pecuniary and if the company is relying on the exemptions without the director clarifying that there is no pecuniary interest, the company may find it difficult to explain why the transaction is not noted by the board and entered in the section 301 register.
Conclusion: It is very strange how it escaped the attention of Law makers the controversy created by exemption u/s 299(6). It defeats the very purpose of this section. Firstly it is not possible for a single director to hold more than 2% of share capital in big companies unless he is a promoter of the company. Thus the criterion of 2% holding does not appear to be a meaningful one. Secondly, one can not ignore the fact that directorship in the other company can also wield influence. It would have been more rational, if some monetary value is fixed for exemption instead of holding of 2% or more.
G S Rao, Chief Manager (Legal),OCL India Limited
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