Introduction
Law, it is often remarked, is a facilitator for rational human behaviour and action. Economic laws in particular are intended to foster economic growth and any ambiguities and fetters artificially created in them have the dysfunctional impact of retarding growth as opposed to encouraging progression. Surely the former cannot be the intent of the legislature.
It is in the above context that there is a new need to look at some of the contentious provisions in the Companies Act, 2013 (hereinafter "The Act") which has substituted what had, become an antiquated piece of legislation- namely the Companies Act, 1956.The 1956 Act,in all fairness, servedthe industry very well for over half a century and in terms of content, it had far greater clarity than the present Act has to offer in respect of several contentious aspects .
Indeed, by the same token, it had several provisions which had survived in the Statute Book well past their shelf life ,such as for instance, the thresholdscarved out in the Act for various purposes which needed to be made contemporaneous. There was also a need to remove the dead wood that existed in the Act in the form of some antiquated provisions.Besides, there was an urgent need to usher in provisions relating to corporate governance in the law , given the pace with which reforms were being put through especially from the time the winds of change started to blow in the Economy way back in the 1990s which led to the introduction of clause 49 in the Listing agreement- perhaps the first initiative towards codifying the principles of corporate governance .Of course, this reform was inspired by the happenings in the advanced western economies and the consequent need for India to take a leaf out of them so that as a Nation, we could stand shoulder to shoulder not only in terms of growth but also through judicial reforms.
It must be pointed out that the introduction of Clause 49 was preceded by several initiatives more particularly the Desirable Corporate Governance Code (1998) drawn up by the Confederation of Indian Industry(CII).
The Report was largely based on the Report of the Cadbury Committee in the U.K under the chairmanship of Sir. Adrian Cadbury which emphasised on the need for codification of certain principles relating to best practices which would sub-serve the interests of stakeholders in companies where a substantial public stake was involved.
Over two decades or so, we have come a long way from the embryotic stages of economic reforms and have ushered in reforms of significance which have made the Indian Economy one of the most resilient in the World which has been able even to tide over an earth shattering calamitous event such as the pandemic.
A lot has been done but we have still a long way to go.One area which needs immediate attention is to weed out the imperfections in the present Act.
For one there is preponderance of delegated legislation which has meant that the law has been tinkered along far too frequently for any one’s comfort. Secondly, in many cases, the sub-ordinate legislation has not been consistent with the Act resulting in disharmony in interpretation.Many of the clarifications issued by the MCA may not be legally sustainable once challenged.There is a need to remove the ambiguity caused by some of the provisions.
A discussion paper suffers from the inherent problem of space being amajor constraint. A focussed review ion a host of provisions is rendered impossible for this reason. Hence we have adopted a sectoral approach for our discussion with a focus being on understanding the nuances of the law in Section 186 of the Act. We have carried out an introspection threadbareon some of the pain points in Section 186 , thus justifying the need for a legal review.
Section 186 of the Act - A deep dive
Section 186 of the Actcorresponds conceptually to Section 372A of the predecessor Act. In reality, it traverses a path which is much wider than its predecessor clause and its tentacles extend much wider than perhaps was intended by the legislature. Further ,it is replete with drafting anomalies which still need to be addressed. It is also much more rigid and inflexible , making it an arduous obligation for Corporates to fulfil as opposed to its avowed intention essentially to regulate investments and lending by companies essentially to corporates.
In this exposition we shall seek to make a deep dive into some of the portions in the Section which give rise to ambiguity still and also point out the rigidity and inflexibility in the Section, which makes its acceptance by companies an unconscionable burden.
Difference in Marginal notes to the Section as against predecessor provision is indicative of its overarching reach
Headings prefixed to Sections or sets of Sections serve as an useful internal aid to the construction of Statutes in that they are preambles to those Sections.However, the marginal heading to a Section cannot control the interpretation of the words of the Section, in particular if the language of the Section is clear and unambiguous.(ChandrajiRao v CIT(AIR 1970 SC 1582).
Where there is doubt, the marginal heading can be relied upon as an aid to construction .They cannot control the plain words in the Statute but may explain ambiguous words.(Western India Theatres Ltd v Municipal Corporation of the City of Poona(AIR 1959 SC 586).
The marginal note or heading to a Section cannot be applied for construing a Section but it certainly can be relied upon as indicating the drift of the Section or to show what the Section is dealing with.
Juxtaposition the above aid to construction, we can make out the difference in the marginal heading as appearing in Section 186 and compare it with that in Section 372A to appreciate the amplitude of the former. Section 186 starts with the heading"Loan and investment by company".
Contrast this with Section 372A in the former Act which was introduced by the Companies (Amendment) Act, 1999 to consolidate two Sections 370 and 372 which were regulating , respectively, the provision of inter corporate loans and inter-corporate investments. The heading in Section 372A namely" Inter-corporate loans and investments" clearly indicates the drift of the provision in that it intended only to regulate the inter-corporate loans and investments which is exactly what a legislation which regulates companies ought to do.
By contrast, Section 186 simply speaks about loans and investments to be made by a company which clearly is an indication that its purpose is not only to regulate the provision of loans and investments into companies but also to embrace lending to non-corporate entities. Where it relates to making of investments, Clause (c ) in sub-section (2) limits itself to providing the thresholds for investments into any other body corporate.
We shall subsequently articulate on the use of the expression "body corporate" which also gives rise to some amount of trepidation.
The Notes on Clauses relating to Section 186 contemplate its applicability to "persons"
In contrast to Section 372A ,which was clearly intended only to regulate loans and investments to Bodies corporate, the Notes on clauses to the Companies Bill, 2011 clearly provided that its application was contemplated to cover ,apart from bodies corporate , provision of loans to persons as well.
Normally the statement of objects and reasons to a proposed legislationare a pointer to the legislative intent.The language used in clause (b) of subsection (2) of Section 186 itself is unambiguous and covers the provision of loans to "Persons’.
Considering the above, the statement of objects and reasons provided cannot be applied as an aid to construction of the provisions of the Act though it may be used to ascertain the objects underlying the legislation and the conditions which necessitated the enactment.(A.ThangalKujuMusaliar v M.VenkatachalamPotti,ITO (AIR 1956)(SC 246).
"Without prejudice to the provisions contained in the Act"- Significance of the starting words in Section 186
The significance of the opening words as quoted above in the Section need to be understood.The above words indicate that the Section operates in an independent field and will not in any way prejudice the operation of any other provision in the Act.The use of the above expression has been rendered necessary since there are some segments in Section 185 which apparently overlap with Section 186.It is abundantly now clear that Section 185 and 186 operate on separate fields and do not overlap.
It is pertinent to note that in ITO v Gwalior Rayon Manufacturing(Weaving)Co.Ltd (AIR 1976 SC 43 at page 47) the Apex Court has explained that where a provision has been enacted "without prejudice toanother provision" it does not have the effect of affecting the operation of the other provision and any action taken under it must not be inconsistent with such other provision.
Reference may also be made to the ratio in Institute of Chartered Accountants of India v Vimal Kumar Sharma (1 SCC 534) where it was noted that the use of the words "without prejudice" as appearing in Sections 24A, 25 and 26 of the Chartered Accountants Act, 1949 show that the offences defined in the said Act do not bar the prosecution of offences under the Penal Code.
Term "Person" is not defined in the Act.-Limited exclusion of "employee" is a clear after thought!
Clause (b) in sub-section(2) of Section 186 covers provision of loans, guarantees or security in connection with a loan to not only a body corporate but also to a person.
The term "person" has no definition in the Act. One of the principles of statutory interpretation is that where a word is undefined, it must be construed in its popular sense if it is a word of everyday use or accorded the meaning as per the Lexicon. Popular sense refers to that sense which people conversant with the subject matter with which the statute is dealing with it attribute to it.The meaning or definition of words in a different provision or statute cannot automatically be imported for the interpretation of the same word in another statute.(CIT V Venkateshwara Hatcheries (P)Ltd(237 ITR 174(SC).
Having said the above, one must appreciate that the term "person" cannot be limited to its application in common parlance, given that it has a much wider connotation in law as provided in the General Clauses Act, 1897.
The General Clauses Act, is a consolidating and amending Act whose purpose is to avoid superfluity and repetition of language.(Rayarappan v MadhaviAmma(AIR 1950 FC 140). The definitions and general rules of interpretation contained in the said Act have to be read in any other statute governed by it unless the statute contain anything repugnant to them in the subject or context.(Dulichand v CIT)(AIR 1956 SC 354).
It would be improper in the context of Section 186 to limit the meaning of the term "person" as understood in common parlance, given that the term includes a juristic person such as a company also.
Section 2(42) in the said Act defines the term "person" inclusively to include any company or association or body of individuals , whether incorporated or not.
From the above, it follows that the term person includes a natural individual , a company, a body of individuals such as a partnership firm, Association of persons as well.
The term "person" also includes a juristic person such as an idol or the Gurugranth sahib installed in a temple(ShromaniGurudhwaraPrabandhak Committee v ,Amritsar v ShriSomNathDass(AIR 2000 SC 1421)or a company(Union Bank of India V Khader International Construction (AIR 2001 SC 2277).
As Section 186 intends to impose fetters on the provision of loans as also on making of investments, it is clear that loans or guarantees to firms, Association of persons etc. made by a company shall also been taken into consideration for determining the company’s capacity to lend and invest.
The use of the word"person" in the Section also meant that employee loans would come within the ambit of the Section. It would be calamitous if the distinguished Board of a large company were to sit in soulful judgement to decide on the request for a loan from an employee in the opulence of a grandiose Board room!.
As this set off a furore in Corporate India , as a knee jerk reaction , MCA clarified vide its circular no.4/2015 dated 10.3.2015 that loans and advances to employees other than the managing or whole time directors would not be covered under Section 186.Wiser counsel thus prevailed to reduce the agony of corporate India on this score.
The above circular was doubtful of legal sustainability since it contradicted the Act but as it was a benevolent circular , it passed muster since no one wanted to stir the hornet’s nest!.
This was clearly a case of the legislature biting more than what it could chew and eventually an Explanation was inserted under subsection (2)to clarify that the term "person" shall not include for the purposes of this subsection any individual who is in employment with the company.
Purpose of inserting an Explanation in the Statute
The above Explanation was added through the Companies (Amendment)Act 2017 with effect from May 7,2018.
The purpose of inserting an Explanation in a statutory provision is to clear any ambiguity.Even though it was inserted subsequent to the introduction of the Act, considering that it is clarificatory, it can be considered to have retrospective operation as held in Abdul latif Khan v Abadi Begum (Mrs.)(AIR 1934 PC 188).
Whether the limited exclusion of an employee from the scope of the term "person" is good enough is also a matter of debate considering that loans to other individuals who are not employees including non-executive directors could still come under the sweep of the Section! .
This gives scope for the Section to intrude into the jurisdiction of Section 185, conflict with which is sought to be avoided through the usage of the words"without prejudice to the provisions contained in this Act" as explained above.
Where a managing director or whole time director is concerned, loans could be provided as either a part of their conditions of service or with the approval of shareholders through a special resolution.
Section covers loans and investments into a body corporate
Can the definition of "Body Corporate" in the LLP Act be imported to extend the concept
The Section takes into its stride the provision of loans, guarantees and making of investments into a body corporate.A "Body Corporate" has been defined by Section 2(11) to include a company incorporated outside India but does not include a co-operative society registered under any law relating to such Societies or to any other body corporate not being a company as defined in the Act , which the Central Govt. may by notification specify in this behalf.Vide Notification no.SO 1592(E ) dated 12.4.2018 , the Central Govt. has clarified that the Asian Development Bank referred to under Section 2 of the Asian Development Act, 1966 shall be a specified body corporate.
It is pertinent to note that a "limited liability Partnership"(LLP) is not specifically covered under Section 2(11).However, the Limited Liability Partnership Act, 2008 provides under Section 2(d) a "means " definition to a "Body corporate" which not only includes an LLP constituted in India but also outside India.Thus by importing the definition given in the LLP Act , for the purposes of Section 186 ,we can state that an LLP is a body corporate.
Whether one can import the definition given to a term in an allied legislation when the mother legislation has a specific definition is however, a matter of debate.
Having said this, consistent with the objective of the Section which is to regulate loans and investments not only in companies but also to persons, we can say that it would be appropriate that LLPs are covered within the ambit of the Section, notwithstanding that they are not bodies corporate under the Act.
Should Preference Share capital form part of aggregate of paid up share capital and free reserves
Under Section 186(2), no company can make any loans, extend guarantee or provide any security to a body corporate either directly or indirectly and acquire by way of subscription , purchase or otherwise the securities of any other body corporate in excess of the prescribed threshold exceeding sixty percent of its paid up share capital, free reserves and securities premium or one hundred percent of its free reserves and securities premium whichever is more.
Up to the above threshold, the decision to make loans and/or investments in securities shall be taken by the board at its meeting convened for the purpose with the unanimous approval of the directors present at the meeting.
If the above threshold needs to be breached , the board will have to take the consent of the shareholders by special resolution.
The paid up share capital of the company is one of the components that is considered for determining the aggregate threshold. Paid up share capital carries the meaning provided by Section 2(64).
It refers to the aggregate amount of money credited as paid up or its equivalent to the amount received as paid up in respect of shares issued. It also includes the value of bonus shares issued against which no payment is received by the company.
As per the definition , there is no distinction between equity and preference share capital since the reference is to the amount of aggregate amount of money credited as paid up capital.
The moot point that arises is whether preference share capital which carries with it, hues of debt capital and is considered in accounting parlance, as sub-ordinate debt or mezzanine capital should be included in the aggregate of the paid up share capital.
It is pertinent to note that the Act does not permit issue of irredeemable preference shares and hence preference capital cannot be considered as permanent capital.
If preference share capital is included in paid up share capital, it follows that the ability of the company to make investments into other companies’ securities and to lend / guarantee debts goes up at least for the duration of the tenor of the preference shares.
It may also be noted that under the Act for determining the capacity of a company to borrow for the purposes of Section 180(1)(c ) also ,we use the same yardstick as in Section 186.The inclusion of preference share capital in the paid up share capital artificially increases the capacity of a company to borrow, albeit with members’ approval in excess of the paid up capital, free reserves and securities premium.Upon redemption of the preference shares , the base would obviously go down.
It is pertinent to note that approvals from members under Section 180(1)(c ), Section 186 are generally one time approvals and it is not as if every company takes the precaution of fine tuning its limits upon redemption of preference shares.
There are two schools of thought as regards the inclusion of preference share capital in the capital base.One School advocates that considering that the law does not make any distinction between preference and equity capital while determining the paid up share capital, it is perfectly in order to consider the preference capital as well.
The other view which is conservative considers the characteristics ofdebt which is an integral part of preference share capital,given that it yields generally to a fixed rate of return as dividend and also is liable for redemption upon completion of its tenor.
As per the Companies (Accounting)Rules, 2014 read with the Companies (Accounting standards)Rules, 2015 which now apply to almost all categories of companies, preference share capital is considered as debt capital where it carries a fixed coupon rate of dividend .It is only when the preference capital is participative in nature which opens up a possibility for a variable component in the preference dividend over and above the coupon rate, that preference capital may be considered as part of equity.Otherwise, preference capital is considered as debt capital and is not taken into consideration for determination of shareholders’ funds or the tangible net worth of the company. Reference may be made to Para 15 in Accounting Standard 32(Financial Instruments-Presentation)which considers a vanilla preference share carrying a fixed return as a debt instrument.
Considering the above discussion there is enough logic associated with the exclusion of preference share capital while determining the thresholds under Section 180(1)(c ) and Section 186.
A judicial review is called for, leading to either an amendment in the definition of Paid up share capital expressly eliminating paid up preference share capital therefrom or alternatively a notification can be issued to the effect that for the aforesaid provisions in the Act, Preference share capital shall not be considered.
Investments/Loans to wholly owned Subsidiary should not form a part of the threshold under Section 186
Under Section 372A of the previous Act, loans and investments made by a Holding Company into its wholly owned subsidiary were exempt for the purpose of computing the permitted limits under the above provision. The present Act has withdrawn the above exemption and the only concession that is offered is that in case of investments/loans to a wholly owned subsidiary ,there would be no need to seek approval of the shareholders by special resolution.
However, the loan/investment so made shall be included for ascertaining the threshold.
There is a strong case for the status quo ante to be restored considering that in many cases it may be necessary for the holding company to infuse fresh capital or provide loans to its wholly owned subsidiary for its resuscitation.
Section 186 is inflexible and rigid
As compared to its predecessor clause , the present Act is inflexible for several reasons.For one any loan/investment made into a wholly owned subsidiary will be included for the purpose of determining the thresholds prescribed.The only concession allowed as stated above, is that there would be no need to seek shareholder approval .The former Act eliminated from consideration the lending/ investments made into a wholly owned subsidiary.
Further the Act provides that no loans shall be provided on interest free terms. The rate of interest is to be bench marked against yields for Govt. Security linked to their tenor. It is submitted that in required situations the Holding company should have been allowed to lend to its subsidiaries on either subsidised interest rates or at nil rates in case such a measure was needed for the resuscitation of the ailing subsidiary.
It is pertinent to note that under the Income tax Act waiver of interest is allowed until it accrues as long as the lender has not made the lending out of borrowed funds.
It is intriguing that the Statute should come in the way of what is essentially a business call.
Conclusion
The above is only one instance of the frailties in the present Act which has proved to be dysfunctional for India Inc.
One could take pot shots on the present legislation ad nauseamby poking more holes in terms of drafting anomalies in other provisions in the Statute as well. That, however, is not our intention.
We have therefore cherry picked on the major pain areas and areas of ambiguity in a specific provision of the law so that a better legislation could emerge ironing out the deficiencies in the existing provision.
.In our opinion as expressed earlier, the previous law on the subject was working perfectly well, it had less of clutter as also lesser ambiguity.Change as they say is the only constant in life.At the same time, change for the sake of change is most unwelcome and this is what ails the present dispensation most.
Ease of doing business being the mantra doing the rounds across coffee tables, we should do more than glib talk and introspect on the problems which have come about due to tardy drafting majorly in the present Act.
Hope, as the Bard remarked "is eternal in the human heart".
We sincerely hope that the shortcomings in the present Act should get weeded out over a period of time so that Corporate India does not get bogged down through the weight of sheer procedure and the Statute can live up to the expectation of acting as a growth engine for the Economy.
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