Image source: https://vakilsearch.com/advice/exemptions-private-limited-company/

This article has been written by Riya Dubey, pursuing the Diploma Programme in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

The concept of “undertaking” plays a very significant role under the Companies Act when the question arises whether the ‘sale of shares of a subsidiary company will amount to the sale of an undertaking’ by the seller. Under the Companies Act, 2013 Section 180 defines “undertaking”. In this article, we will deal with the whole concept of the undertaking, whether the “sale of shares” will amount to ‘sale of an undertaking’, and the situations in which the sale deed will be void. 

Restrictions on powers of the board of directors

Section 180 of the Companies Act, 2013 imposes restrictions on the powers of the board of directors of a company. It says that the board of directors should exercise certain powers only with the consent of the company passed by a special resolution. The following powers of the board of directors are restricted-

  1. Selling, leasing, disposing of whole or substantially the whole of the undertaking of the company or if in case the company owns two or more undertaking, of the whole or substantially whole of any of these undertakings,
  2. Investing in trust securities the compensation amount received by it from any merger or amalgamation;
  3. To borrow money, where the money to be borrowed, jointly with the money already borrowed by the company will be more than the aggregate of its paid-up share capital and free reserves, aside from temporary loans obtained from the company’s bankers in the ordinary course of business
  4. Revoking or giving time for the repayment of any debt that is due from a director of the company.

The concept of “undertaking” and “substantially the whole of the undertaking” as per Companies Act, 2013

“Undertaking” as per the explanation of Section 180(1)(a) means an undertaking in which the investment of the company goes beyond 20% of its net worth as per the audited balance sheet of the previous financial year or an undertaking which makes 20% of the total income of the company during preceding financial year.

And “substantially the whole of the undertaking” in any financial year means 20% or more of the value of the undertaking as per the audited balance sheet of the previous financial year.

For considering any transaction as the “undertaking” under the Companies Act, 2013 it has to go through the following and pass these two tests-

  1. The numeric condition under the Companies Act, 2013;
  2. Definition of an ‘undertaking’.
  • The numeric condition under Section 180(1)(a) of the Companies Act, 2013-

“Undertaking” as per Explanation of Section 180(1)(a) means an undertaking in which the investment of the company goes beyond 20% of its net worth according to the audited balance sheet of the previous financial year or an undertaking which makes 20% of the total income of the company during preceding financial year.

And “substantially the whole of the undertaking” in any financial year means 20% or more of the value of the undertaking as per the audited balance sheet of the previous financial year.

Thus we can say that-

  1. There should be an ‘undertaking”;
  2. There should be selling, leasing, or disposing of an undertaking;
  3. There should be the fulfillment of numeric conditions i.e., the investment of the company goes beyond 20% of its net worth as per the audited balance sheet of the previous financial year or an undertaking which makes 20% of the total income of the company during the preceding financial year.
  • Definition of an ‘undertaking’-

We shall refer to the following case laws of Section 293(1)(a) of the Companies Act, 1956 (we can take the reference while going through Section 180(1)(a) of the Companies Act, 2013)-

  1. Yallamma cotton, woollen, and silk mills Co. Ltd.

In this case, it was held that the word “undertaking” under Section 293(1)(a) of the Companies Act, 1956 (now Section 180(1)(a) of the Companies Act, 2013) does not mean anything which may be described as a tangible part of property such as equipment, machinery, or land; instead, it’s an activity done by man which in commercial or business parlance means an activity in which you are engaged with a view of earning profit. And the property which is used in this course of business whether it is a movable property or immovable property can be called the tools of business or undertaking.

2. International cotton corporation (P.) Ltd. v. Bank of Maharashtra  

In this case, the Bombay court held that the word “undertaking” means any business or any work or any project in which one engages in or attempts as an enterprise similar to business or trade. The business and undertaking of the company must be differentiated by the properties which belong to the company.

Undertaking as “the unit”

In P.S. Offshore Inter Land Services (P.) Ltd. v. Bombay Offshore suppliers and services Ltd

The Bombay High Court has interpreted “undertaking” under the Companies Act, 1956 as “the unit”, the business on the going concern and the activity in which the company is engaged is duly integrated with all its assets and not only with some of its assets of the undertaking. The High court stated that-

  1. As per the objectives of the section, an undertaking within it can embrace all the assets of the business as “a unit” or all such components or constituents;
  2. If there is a question that whether the undertaking of the company can be constituted by the major capital assets of the company while examining the authority of the general body, the test would be carried out to see whether after the disposal of the assets the business of the company can be carried out effectively or whether after the disposal of the assets the only husk of the undertaking will remain?
  3. For Section 293(1)(a) of the Companies Act, 1956 [now Section 180(1)(a) of the Companies Act, 2013],  when all the capital assets of the undertaking will be taken together then it will be an “undertaking”, otherwise, it will become very easy to avoid taking off the consent of the general body and defeat the intention of the legislature.
  4. The sale of shares is not equivalent to the sale of undertaking or any part thereof.

Is the sale of shares equivalent to the sale of undertakings?

The provisions mentioned above do not clarify whether ‘sell of share’ is the same as ‘sale of undertaking’. But there are some judicial precedents that have discussed this in detail.

In Brooke Bond India Limited v. U.B. Limited and others, the Bombay High Court held that “whatever be the number of shares sold, even if it amounts to the transfer of the controlling interest of the company it cannot be the same as the sale of any part of the undertaking”.

In C.D.S. Financial Services (Mauritius) Ltd. v. BPL Communications Ltd., the court held that Section 293(1)(a) of the Companies Act, 1956 ( Section 180(1)(a) of the Companies Act, 2013) clearly shows the legislative intention that whenever any subsidiary company owns an undertaking then as per the provision of the Act resolution that is passed in the general meeting organized by the subsidiary company will be valid. It is obvious from the language of the section that the company of which the undertaking is has to pass the resolution in a general meeting.  Thus, ‘sale of shares’ cannot amount to the ‘sale of undertaking’.

Is the undertaking of the company different from the company?

In Hall and Anderson Ltd. v. Union of India, the company’s undertaking was sold and without proper authorization, sale deed was executed by directors. The injunction restraining the company from alienating the property was moved by the shareholder. The Calcutta High Court held that under Section 293 of the Companies Act, 1956 it is compulsory to take the consent of shareholders. Hence, this transaction got covered by the doctrine of indoor management and the sale deed was held void. The Court stated that the undertaking of the company is different from the company itself.

An undertaking as a “going concern”

In Pramod Kumar Mittal v. Andhra Steel Corporation Ltd. , one of the units of the company that was closed for over five years was sought to be sold. The Calcutta High Court held that this cannot be construed as a sale of undertaking as there was no disposal of a profit-bearing organism.

When subsidiaries are merged into the holding company?

No approval is needed to be taken by the members under Section 180(1)(a) of the Act, in the case, where under the scheme of arrangement which has to go through the due process of approval as per the Act after which the businesses of the subsidiary companies are merged with the holding company.

Conclusion

The concept of “undertaking” under the Companies Act, 2013 defines the powers of the board of directors with respect to shareholder’s approval. It’s very important to know whether the sale of some assets of the company or sale of the business of the company will be considered as “sale of undertaking” according to the provisions of the Companies Act, 2013, as it determines the approval process of the transaction deal. If the approval of appropriate authority is not taken, then the transaction would be ultra vires. 

References

  1. https://taxguru.in/company-law/section-180-companies-act-2013-meaning-term-undertaking.html.
  2. https://www.mondaq.com/india/shareholders/763860/selling-shares-whether-sale-of-an-undertaking.
  3. https://www.caclubindia.com/articles/definition-of-undertaking-under-section-1801a-of-the-companies-act-2013-43777.asp.
  4. http://csgauravpingle.com/wp-content/uploads/2018/01/Undertaking-A-Judicial-Perspective-by-Gaurav-Pingle-Practising-Company-Secretary-Pune.pdf.

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.

LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join:

Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.

 

LEAVE A REPLY

Please enter your comment!
Please enter your name here