In this blog post, Souradeep Mukhopadhyay, a student at Rajiv Gandhi National University of Law, Punjab and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the role of Corporate Governance and Compliance Requirements for selling a business unit.
What is a business unit?
A business unit may be defined as “a part of a company that operates as a separate part of the whole business”. It may also be defined as “a logical element or segment of a company (such as accounting, production, marketing) representing a specific business function, and a definite place on the organizational chart, under the domain of a manager”. Thus, a business unit may be considered as a part or whole of a business entity which has independent business functions and works with some independence with respect to the business entity. Thus, a company may have several divisions and departments engaged in different businesses. A conglomerate may contain diverse business units functioning in largely separate fields or targeting distinct markets. For instance, ITC Ltd. is a conglomerate with varied business interests and is one of India’s foremost multi-business enterprise with a market capitalization of US $ 40 billion and a turnover of US $ 8 billion. Now, ITC has several divisions and brands. So, while it owns several cigarette brands like Wills Navy Cut, Gold Flake, etc, it also owns major food brands like Aashirwad, Sunfeast, Bingo!, etc. Each such brand or division in the company may be considered a business unit. The selling of a business unit is, thus, different from selling the entire business entity itself. However, one may sell the entire business entity which is a business unit as a whole. So, the selling of a business unit entails the sale of an independent part or the whole of a business entity to some other person, natural or artificial. The term ‘business unit’ may be thought of as synonymous to the term ‘business undertaking’ as used in S.180 of the Companies Act, 2013.
Now, a business unit may be a sole proprietorship, partnership, LLP, or a company. It may also function as a Hindu Undivided Family (HuF), in which case, the sale of the unit will be largely governed by Hindu personal laws. The various requirements for selling a business unit and the compliance obligations will differ depending on the business structure it follows and while the requirements are the lowest and the procedure the simplest in case of sole proprietorship, it become progressively complex through partnership, LLP and finally, a company.
In case of a sole proprietorship, a business unit is considered as the personal property of the individual who owns and operates the business. The property of the business is the personal property of the individual and the business itself has no identity separate from the owner. A business unit may be sold to any other person by the owner of the business following the general laws in the regard. For instance, the property of the business, which may include warehouses, land holdings, shops, machinery, furniture, etc, may be sold by the owner through a simple contract of sale without any general compliance requirements though the sale may be subject to registration as per the Indian Registrations Act, 1908 or governed by laws specific to the particular sale or item which is being sold. The provisions of Indian Contract Act, 1872 and the Transfer of Property Act, 1882 are generally applicable to such sales. Over and above all this, the goodwill of the business as well as any intellectual property like trademark, patent, etc. used in the business and lying with the owner of the business may be sold through contract.
In case of a partnership, the business unit itself has no separate identity except for special purposes as provided for in the Income Tax Act, 1961. The partnership is nothing but an association of persons who come together to collectively conduct a business with the intention to share the profits arising out of the business. The ownership of the property of a business, including its goodwill and other intangible properties, lies with the partners of the firm collectively and no one person or entity owns all the property. Thus, when a property belonging to the firm is sold, it is sold on behalf of all the partners and only such a partner may sell such property, if he has the consent of the other partners or is allowed to dispose of the property on behalf of all the partners as he deems fit by the partnership deed or some other agreement. The property right vests on all the partners collectively. Thus, in case a business unit belonging to the partnership firm is to be sold, the provisions of the partnership deed must be followed or consent of all the partners must be taken before it may be sold and usually, the proceeds of the sale are distributed amongst the partners. Just like sole proprietorship, however, there exist no general compliance requirements in case of sale of business unit by a partnership firm.
Limited Liability Partnership (LLP):
Unlike a partnership firm or a sole proprietorship concern, an LLP is a separate legal entity which needs to be incorporated and once that is done, it is given an identity separate from the LLP partners by the concerned statute, that is the LLP Act, 2008. An LLP is much like a company in several aspects, and it is regulated by the Ministry of Corporate Affairs, Government of India and some of the provisions of the LLP Act, 2008 bear semblance to provisions of the Companies Act. Being an incorporated body having separate legal entity, it is not only capable of being vested with rights independent of partners, in fact, the rights over the property owned by the business devolves on the LLP and not on its partners. Thus, the property of the business belongs to the LLP. Now, in case an LLP consists of several business units functioning separately, it is possible to sell a business unit by the consent of all the partners of the LLP as provided for by the partnership deed and the laws of the land. This would entail a contract between the LLP and the purchaser which will transfer the rights associated with a business unit from the LLP to the purchaser. This may include property, movable or immovable, as well as tangible or intangible and is likely to include the goodwill of the business and other intellectual property rights like trademarks of the business, if any. This is a simple contract, however, regulated by the general laws as well as the provisions of the partnership deed and the LLP Act, 2008.
However, if the sale involves the sale of the entire business of the LLP, the scenario is different. Technically, it is not possible to sell and purchase an LLP itself. What can be bought and sold however, is the interest of the partners in the LLP firm. The transfer of a partner’s rights, however, is not unlimited and only certain rights are transferable as provided for in the statute.
S.42 of the LLP Act, 2008 provides-
“The rights of a partner to a share of the profits and losses of the limited liability partnership and to receive distributions in accordance with the limited liability partnership agreement are transferable either wholly or in part. (2) The transfer of any right by any partner pursuant to subsection (1) does not by itself cause the disassociation of the partner or a dissolution and winding up of the limited liability partnership. (3) The transfer of right pursuant to this section does not, by itself, entitle the transferee or assignee to participate in the management or conduct of the activities of the limited liability partnership, or access information concerning the transactions of the limited liability partnership.”
This clearly lays down that what is transferable is the partner’s right to have a share in the profits or losses of the LLP. This transfer itself does not allow the transferee or assignee to participate in the management or conduct of business of the LLP. Thus, they do not become a partner of the LLP but only wield certain rights of a partner, which are generally financial in nature. Thus, even if the transferable rights of each and every partner of an LLP are purchased by a single person, this person does not become the owner of the LLP or even a partner. He simply remains a person with rights over the profits or losses of the business. For one to become a partner, he must enter the firm as per the partnership deed or an agreement between the partners must be entered into to inculcate the person as a partner. If all the partners are removed and only the purchaser remains as a partner, the LLP stands dissolved due to lack of minimum number of partners necessary to form an LLP. The LLP Act, 2008 however, provides for amalgamation of LLPs and restructuring in Chapter XII of the Act. The Act provides that any such amalgamation or compromise leading to restructuring of the LLP must occur with active involvement of the National Company Law Tribunal which sanctions the compromise or the scheme of amalgamation, as the case may be, and has wide powers to pass requisite orders in this regard which is binding on the concerned parties like the partners of the LLPs and the creditors.
Thus, it is not possible to sell an LLP, but the business unit belonging to an LLP may be sold to any person by contract between the LLP firm and the purchaser governed by general laws relating to sale and transfer as well as the LLP Act and the Partnership Agreement.
Corporate governance in case of companies has for long been much more stringent and detailed as compared to any other business structure. Thus, it comes as no surprise that the compliance requirements of selling a business unit is also more complex and detailed case of companies as compared to all other business structures discussed so far. Much like an LLP, a company too cannot be sold or purchased itself, at least technically. So, the sale of a company would mean the acquisition of a majority shareholding stake in the company by some other person. This can happen in case of private companies through transfer of shares to a person as per the Companies Act and other rules governing the same, as well as per the provisions of the Memorandum of Association and the Articles of Association of the company, which must include provisions restricting free trade of shares of the company as per the Companies Act, 2013. In case of public companies, the sale of shares, equity as well as preferential, are regulated by a plethora of provisions contained not only in the Companies Act, but also in the various rules by the Central Government or other authorities like SEBI. However, this is not the same as the sale of a business unit. It has already been discussed that a company or a business entity may have several business units (For example, ITC Ltd.) and these units may be independently sold by the company without any change in the shareholding of the company itself. This sort of sale, however, is heavily regulated and is subject to certain restrictions and compliance requirements.
- Provisions of S.180 of the Companies Act, 2013
S.180 of the Act enumerates the restrictions on the power of the Board of Directors (BoD). It states-
“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.
Explanation.—For the purposes of this clause,—
- “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;
- the expression “substantially the whole of the undertaking” in any financial year shall mean twenty per cent or more of the value of the undertaking as per the audited balance sheet of the preceding financial year…”
The SC in Rustom Cavasjee Cooper v. U.O.I discussed the extent of the word ‘undertaking’ and held that it means the entire organization and that the provision of the Act indicate that the company is considered as one whole unit and the entire business of the on-going concern is embraced in the work ‘undertaking’ and it would 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. An ‘undertaking’ is not defined comprehensively in the Companies Act, however, in the Income Tax Act it is stated that an ‘undertaking’ shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.
The HC of Madras further stated that the business or undertaking of the company must be distinguished from the properties belonging to the company and thus, the Karnataka HC in International Cotton Corporation (P) Ltd. v. Bank of Maharasthra held that the properties belonging to the company that were dealt with by the board of directors in the case under the deeds of hypothecation and mortgage in favour of the bank were distinct from the business of the company and thus, no part of the undertaking of the company was disposed of in favour of the bank in the case. Thus, not all property of the company may be considered a business undertaking or a business unit, but only the properties which together form a business concern as a whole. This distinction between company property and undertaking is important since only the sale of business undertakings requires a special resolution as per S.180, Companies Act, 2013.
Thus, in case a company intends to sell a business unit or sale any substantial part of the same, the Board of Directors do not have the power to do the same unless sanctioned by a special resolution of the company at a general meeting. However, the section also provides for certain exceptions to the restrictions and the requirement of special resolution is not necessary in case the selling of property is part of its ordinary business. Thus, in case a company associated with selling residential complexes built by it sells a completed complex, it does not require a special resolution of the company and such sale may be authorized by the board of directors. Also, in case a buyer buys some undertaking from a company in good faith without knowing that the sale has not been authorized by a special resolution necessary for the purpose, then the title of the buyer is not affected by the fact.
Further, since the sale of undertaking(s) is crucial and of concern to the members of a company, section 110(1)(a) of Act, 2013 read with Rule 22(16)(i) of the Companies (Management and Administration) Rules, 2014 provide that the said item of business has to be transacted only by means of voting through postal ballot. This is in order to encourage wider participation of the members in the matter. It must be noted here that in Companies Act, 1956, a an ordinary resolution by the shareholders was sufficient for the sale of a business undertaking, however, the Act of 2013 requires a special resolution. It must also be noted that the provisions of Section 293(1)(a) of Act, 1956 was applicable to public and deemed public companies while section 180(1)(a) was initially applicable to all companies. However, the Ministry of Corporate Affairs vide exemption notification dated 5 June 2015 rendered section 180 inapplicable to private companies.
These provisions exist so as to ensure that the major concerns of a company are not sold off by the board of directors while keeping the shareholders in the dark. Also, the sale of a substantial part or whole of a business unit has implications for the company and as such, on the interests of the shareholders. Thus, corporate governance requires that the shareholder’s consent be taken through a special resolution at a general meeting.
- Mandatory Disclosure by Directors:
S.184 of the Companies Act, 2013 provides that the director must disclose all his interests, if any, in any contract or arrangement with any entity in case the same is to be decided upon by the board. This includes contracts or arrangements with any entity where the director or such director in association with any other director owns more than 2% of the shareholding, or is a promoter, manager, CEO, or a partner, owner or member, as the case may be. He can also not take part in discussions and decisions regarding relations with such entities. This is to ensure that a conflict of interest does not result in a director failing to perform his obligations towards the company, whose best interest must be his only consideration while conducting business on its behalf. Thus, any contract entered into by the company without disclosure by the director or with participation of the said director is voidable at the instance of the company. S.184 also provides for personal liability of directors contravening the provisions and imposes up to 1 year of imprisonment and fine ranging from Rs. 50,000 to Rs. 1 Lakh.
- Related Party Transactions:
There also exist certain provisions with regard to related party transactions which are meant to ensure that personal interests do not undermine the company’s interests in any business transaction. The Companies Act, 2013 defines a ‘related party’ in S.2 (76) of the Act and S.188 imposes certain restrictions on related party transactions. The provisions mandates that certain related party transactions must not be entered into by a company except by resolution passed by the board of directors to that effect. This ensures that all the directors are made aware of the transaction and a majority supports such action. However, an important exception to this requirement is a transaction made in the ordinary course of business entered into in an arm’s length basis. Thus, if a business unit is to be sold to a related party, the board must pass a resolution to that effect. It may be noted here that as per S.180, in case the whole or substantial part of a business undertaking is to be sold, a special resolution of the shareholders is required. However, this does not include sale of a business unit less than the substantiality threshold of 20% of the interest. These transaction, however, will be covered by S.188 in case it is being sold to a related party and by S.184 in case the directors of the company have some interest in the transaction. These transactions to which S.184 or/and S.188 apply, however, are to be recorded in a special register made for this very purpose along with the particulars of the contracts or arrangements and should be made available for inspection by any member of the company at the registered office of the company during working hours. However, the sale, purchase or supply of any goods, materials or services need not be recorded if the value of such goods and materials or the cost of such services does not exceed five lakh rupees in the aggregate in any year.
Thus, a business unit may be sold either by selling the entire business entity or all the properties, tangible as well as intangible, as a whole belonging to one or more business undertakings of a business entity. The sale of the entity itself cannot be done in case of incorporated entities like LLPs and Companies since one may only obtain position as a partner or shareholder respectively, nothing more. Even if all the shares of a company are bought by an individual, he remains the controlling shareholder of the company and not the owner. The company always continues to remain an entity separate from the shareholders. The sale of business units or undertakings, however, is regulated in case of companies through corporate governance rules. Further, corporate governance and compliance requirements for the sale of business units are most complex and stringent in case of companies, while such requirements are much lower in case of other business structures. The need for such strict corporate governance requirements in case of sale of business units has been made so that the management of a company cannot misuse its position of power with regard to actions of the company to act in a manner prejudiced in favour of their own personal interests and cause substantial prejudice to the interests of the company and its shareholders. The most important provision in this regard is contained in S.180 of the Companies Act and means to ensure that a special majority of shareholders are taken into confidence before a substantial part or whole of an undertaking is sold.