Wednesday, January 1, 2014

Private Subsidiary of a Foreign Company: Status and Consequences

Since the enactment of the Companies Act, 2013 (the “2013 Act”), several issues relating to its interpretation have been coming up for consideration. One such issue relates to the status of a private company in India that is the subsidiary of a foreign company (being a public company). The specific question relates to whether the Indian private company can continue with its status or whether that would become a public company by virtue of becoming a subsidiary of another public company.

Under the Companies Act, 1956, by virtue of section 3 any private subsidiary of a public company becomes a public company. A subsidiary is defined in section 4 of that Act. For the purposes of that section, the expression “company” includes a body corporate thereby encompassing a subsidiary of a foreign company as well. However, the considerably wide scope of this provision was mitigated to a large extent by specific provisions (sub-sections (5), (6) and (7) of that section) that dealt with cross-border parent-subsidiary relationships. More specifically, by virtue of section 4(7), an Indian private company could continue to maintain its private status if it was held entirely by two or more bodies corporate. Using the benefit of this dispensation, many foreign companies established private subsidiaries in India by ensuring that the shares in the Indian company were held by two or more foreign companies (and not individuals) so as to ensure that the Indian subsidiary maintained its private status. This market practice was well established and did not pose much practical difficulty in structuring group holdings.

Moving to the 2013 Act, there seems to be some amount of ambiguity on whether the Indian private subsidiary can continue its status even if its shares are held by one or more foreign companies with the parent being a public company. While the substantive provisions (that I will discuss shortly) are somewhat straightforward, the ambiguity arises because there are no specific provisions in the 2013 Act similar to sub-sections (5), (6) and (7) of section 4 of the 1956 Act that elucidate the legal treatment in case of cross-border parent-subsidiary relationships. The legislative intent is unclear as well.

The proviso to section 2(71) of the 2013 Act provides that a subsidiary of a public company will be deemed to be a public company even if its articles of association provide otherwise. In order to determine what is a subsidiary it is necessary to refer to section 2(87) where the reference to a “company” includes a body corporate, which reference is however limited to that clause (i.e. definition of a subsidiary). Taking these two sections together, since the reference to a body corporate is limited to the definition of a subsidiary and not extended to the definition of a public company, by taking a technical interpretation it may be possible to conclude that a private subsidiary of a foreign company may continue with its status without being deemed a public company.

In terms of legislative history, the Concept Paper notified by the erstwhile Ministry of Company Affairs in 2004, as well as the J. J. Irani Committee Report make a reference to this question. The Concept Paper had a draft bill for consideration, which defined 'public company' in line with the definition under the 1956 Act. Further, Explanation 1 to the definition of 'public company' provides that any company which is a subsidiary of a public company or a body corporate incorporated outside India, if incorporated in India, to be a public company within the meaning of this Act, shall be a public company. 

Though the Concept Paper had partially incorporated the language of section 4(7) of 1956 Act, the draft Companies Bills of 2008, 2009, 2011 and 2012 have all excluded any reference to the same. Further, the 21st and the 57th reports of the Parliamentary Standing Committee on Finance are also silent on the aspect.

A literal and technical interpretation would lead to the conclusion as above. While that is a compelling one, the legislative intent on this behalf is not altogether clear. An opposing argument may be adopted that in the absence of provisions similar to sub-sections (5), (6) and (7) of section 4 of the 1956 Act, the intention appears to be through an overall reading of the provisions that all private subsidiaries of public companies (whether Indian or foreign) will be deemed to be public companies.

Given this ambiguity, there are two possible views:

Option 1: A literal and technical interpretation of the 2013 Act would suggest that a subsidiary of a foreign company will not fall within the purview of the definition of a public company in section 2(87) and hence it will continue its status as a private company.

Option 2: A broader interpretation of the 2013 Act would suggest that a private subsidiary of a public company (whether Indian or foreign) would be deemed to be a public company.

Rather than to state any preferences, I would like to solicit the views of our readers by way of comments. I would welcome readers to leave their comments on this issue and also share any views that may have been adopted by the Government/ regulators that they may be aware of.

Although it appears to be a somewhat technical issue, it can have a substantial impact on structuring of Indian subsidiaries by multinational companies.

(I would like to acknowledge my discussions with one of our readers Prateek Mohapatra that were very helpful in refining the issues and positions contained herein)

Update: This issue has been clarified by the Ministry of Corporate Affairs by a Circular issued on June 25, 2014, as discussed here.

11 comments:

Anurag Pareek said...

Argument in favour of the first option is appealing particularly the one relating to legislative history.

However, I would go in favour of the second option because Section 2(71) and 2(87) of the 2013 Act have to be read together. When the explanation to Section 2(87) provides that for the purpose of that clause (i.e., the definition) the expression company includes body corporate, then that explanation should be read and interpreted in all such clauses where the term subsidiary is used including Section 2(71).

So when proviso to Section 2(71) says that a company which is a "subsidiary of a company" in such case the term company used later in conjugation with subsidiary should also include body corporate and not simply Indian companies.

V. Umakanth said...

@Anurag. Thanks for these observations. Your analysis embellishes the interpretation in Option 2 that I had simply referred to as the "broader" interpretation.

Pushing your conclusion further, another aspect that just came to mind is that even in the 1956 Act, the definition of subsidiary in section 4 contained a similar clause to state that the expression "company" includes a body corporate. On the other hand, section 3 of that Act defining a public company does not carry the same language. To that extent, on this specific interpretational issue, there is parity between the 1956 Act and the 2013 Act.

Anonymous said...

We actually had this issue in a recent transaction, and were stuck since there was no clear view on what would be the right interpretation.

To add to the comments here, even though the language in Section 2(87) of the 2013 Act does indicate that for the purpose of that clause (i.e., the definition) the expression company includes any body corporate; unlike in Section 4(7) of the 1956 Act, neither Section 2(71) and 2(87) of the 2013 Act adds the further language - "a body corporate incorporated outside India, which, if incorporated in India, would be a public company within the meaning of this Act." Hence, the 2013 Act does not seem to clarify under what circumstance a foreign body corporate would satisfy the requirements to be considered an equivalent of a public company in India.

Anurag Pareek said...

@Umakant: Yes, I do note that Section 4(5)of the 1956 Act provides that for the purpose of that section a company will include a body corporate and Section 3 provides that a private company which is a "subsidiary" of a public company will be a public company.

Going by the rationale provided by me in the post above, we would have never needed Section 4(7) of the 1956 Act specifically. However, we did have Section 4(7) under the 1956 Act which formed the basis to establish that an Indian private subsidiary of a foreign public company is a public company.

Now, that there is no parallel of Section 4(7) of the 1956 Act under the 2013 Act can we rely merely on the interpretation provided in my post above (which was also applicable under the 1956 Act) to state that a private subsidiary of a foreign public company will continue to be public?

Your thoughts please.

Vimal said...

I would like to ask one question, particularly considering the fact that there is a parity between the 1956 Act and the 2013 Act. Going by the interpretation of Anurag, if Section 4(7) is removed from the 1956 Act, the same principle will apply to 1956 Act as well and even in the absence of Section 4(7) in the 1956 Act, subsidiary of a foreign public company (body corporate) will be deemed to be a public limited company.

Section 4 of the 1956 Act dealt with defining subsidiary holding relationships except for Sub section (7) which dealt with the case where a private company, being a subsidiary of body corporate incorporated outside India, was to be treated as Public Company. It was a specific sub section which dealt with the matter and Section 3 of the 1956 Act was not required to be referred in the matter.

In the 2013 Act also, the definition of Subsidiary deals with the subject of defining holding subsidiary relationships, however, the language which formed part of Section 4(7) is absent in the new act. The definition of Public Company is separate and it nowhere includes body corporate in the term 'company' used in the section.

Please answer the question taking the provisions of 1956 act into consideration, in the absence of Section 4(7) in the said Act.

Anurag Pareek said...

@Vimal: I agree with you and that is why after a further thought I put the second post which was contrary to my own conclusion derived in my first post.

I agree that in the absence of a specific parallel of S. 4(7) of the 1956 Act in the 2013 Act we can not simply rely on the interpretation or rationale (provided in my first post)to conclude that under the 2013 Act private subsidiary of a foreign public company (body corporate)will be deemed to be a public company.

The Rainmaker said...

I am inclined to take the former view.

The provisions of Section 4 other than Section 4(7) have been incorporated the Companies Act, 2013 under the definition of the term "subsidiary". So, we can safely assume that the intention of the legislature was to omit the concept of a section 4(7) company as understood under the Companies Act, 1956.

If we are to follow Anurag's earlier interpretation of reading sections 2(71) and 2(87) harmoniously, it would essentially mean importing additional words (reference to 'company' to include 'body corporate') to section 2(71) which is clearly absent in this provision. This would, in my opinion, be against the basic rule of interpretation of statutes.

Section 2(71) qualifies the word "subsidiary" with the words "of a company, not being a private company". It is clear that the term 'company' excludes a 'body corporate' and it is only for the purpose of the definition of Section 2(87), 'company' includes a body corporate.

Anonymous said...

Dear all,

If we all agree that the definition of a company under the 2013 Act only includes an Indian company and definition of Public Company does not provide any leeway to read a body corporate into it. The only way to read a body corporate within the definition of a Public Company is to say that a foreign subsidiary of an Indian company which even if it is a private company, would be treated as a public company under the 2013 Act. Implications to be asecertained. Secondly, to take the discussion forward on the definition of subsidiary, the phrase 'holding company' as defined under Section 2(46)again would mean only an Indian company for reasons mentioned above. The interpretation to that could be that foreign subsidiaries (being body corporates) of Indian holding companies would be treated as subsidiaries of the Indian holding company. This would have implications when the Indian holding company consolidates its accounts and includes the foreign body corporates financials also. I doubt we should extend the applicability of the definition of a holding company to include foreign companies. Please let me know your thoughts.

Anonymous said...

Hi,
I have a doubt, what will be the law in case of a claim made by an employee of a subsidiary company against the parent company. Does the employee has locus to file a claim against the parent company?

Umakanth Varottil said...

@Anonymous. Normally an employee of a subsidiary would have a claim only against a subsidiary, unless there is a breach by the parent of any specific obligation it has undertaken to the employee or if there are any circumstances that would permitting the lifting of the corporate veil. In the latter circumstances, a claim may lie against the parent.

Anonymous said...

I fully agree with the opinion in Option 1 and the above views, dt. Jan. 09, 2014 and a subsidiary of a foreign company will not fall within the purview of the definition of a public company in section 2(87) and hence it will continue its status as a private company.. Section 2(71) and 2(87) are independent to each other and should not be read in conjunction with each other. And the definition of 'Company' as defined in 2(20) should be applied for the whole of the Companies Act, 2013 except for 2(87), as there is a separate and specific definition of 'Company' under this clause. And the 'opening words' to explanation to Proviso to Section 2(87) says, 'For the purpose of this clause', means the definition of Company in Section 2(87) is confined to only to that particular Clause and not beyond that.

Moreover, as per the proviso to the definition 'Public Company' under Section 2(71), there are two parts in it i.e. 1st part being: 'which is a subsidiary of a Company' and the 2nd part being: 'not being a private Company'. And it is clearly means that, the 2nd part is subordinate to the 1st part. This means, only if the 1st part is fulfilled or met, only then we have to see whether that Company attracts the 2nd part or not. And only if both the parts are attracted, the private Company will be deemed to be a public company. Means, if any company is not attracted with either of both these parts, then the private Company will not be deemed to be a public company.

In case of a Private Company which is a subsidiary of a body corporate incorporated outside India, then this private Company is not a 'subsidiary of a company' within the meaning of proviso to Section of 2(71), as the body corporates are not Companies for this purpose.

By-
Dattatraya Joshi
Bangalore