Sunday, August 2, 2015

Status of Subsidiary Private Companies in India – Cross Border Holdings


[The following guest post is contributed by Siddharth Raja, Founding Partner of Samvad Partners. Views are personal, and comments are welcome]

The Ministry of Corporate Affairs’ (“MCA”) recent issuance of a notification providing for exceptions, modifications and adaptations in the application of the Companies Act, 2013 (the “2013 Companies Act”) to “private companies” has once again revived the debate in India (here, here and here) on the status of Indian incorporated private companies, especially those that are subsidiaries of foreign bodies corporate. The key issue is this: do such “private companies” retain their incorporation status for all purposes of the 2013 Companies Act; or do they become “public companies” under the 2013 Companies Act? 

The issue, thus framed, might appear to present a purely legal debate, or one of semantics.  The need for clarity on which companies fall into the bucket of “private companies” (and, conversely, which don’t and are to be treated as “public companies”) has now come to acquire great significance given the exceptions or exemptions provided to those companies regarded as “private companies”.  For instance, “private companies” do not now need to follow the strict differentiations between equity and preference share capital (and their respective segregated economic and, in particular, voting rights), which has a direct impact on the range, scope, efficacy and enforceability of a wide range of such economic and other rights attaching to investors’ share capital.

Upon a review of the applicable legal provisions and the current state of the law, it would be fair to conclusively conclude – it is argued in this post – that a private company subsidiary in India of an overseas body corporate holding company will continue to be a “private company” for purposes of the 2013 Companies Act, and such a private company is not caught-up in those provisions of the 2013 Companies Act deeming it to be a “public company”.  

The reasoning is as follows:

A)        Under the 2013 Companies Act [proviso to Sec. 2(71))], a “company” which is a subsidiary of a company, not being a private company (emphasis added), is deemed to be a public company for the purposes of that Act, even where such subsidiary company continues to be a private company by its articles. In this post, for ease of reference, this provision is called as the “deeming provision”.

In other words, the incorporation status in India of a “company” (which term refers only to those companies incorporated in India under applicable Indian law at the relevant time [Sec. 2(20)]), is irrelevant when it comes to deeming any such Indian private company as an Indian public company on the basis of it being a “subsidiary” of a “company, not being a private company”.

This word (“subsidiary”) and this phrase (“company, not being a private company”), as used in this context, are important to analyze, as follows:

B)        A “company, not being a private company” must be taken to be a reference only to an Indian company – as the definition of “company” [Sec. 2(20)] and “private company” [Sec. 2(68)] make expressly clear, these provisions and this phrase are restricted in operation under Indian law only to those entities, thus described, as incorporated in India and having the necessary features under Indian law.  

The Companies Act, 1956 (the “1956 Companies Act”) [Sec. 3(1)(iv)(c)] had the same provision – a “public company” covers even a private company which is a subsidiary of a company which is not a private company – where the coverage of the term “public company” in the holding - subsidiary matrix did not extend to overseas holding companies.  A fine counter argument in this behalf as to inclusion of “bodies corporate” (i.e., entities incorporated overseas) within the ambit of the holding -subsidiary relationship is dealt with in point # (D) below.

C)        The interpretation of the term “subsidiary” used in the above deeming provision, can, therefore, only mean be in reference to an Indian holding company, as the phrase “company, not being a private company” clearly demonstrates.  

In other words, the focus shifts from purely an interpretation of just the term “subsidiary”, to an appreciation that the deeming provision only kicks in when the nature or type of the holding company is clear – that holding company must be one which is a “company, not being a private company”.  

And, it is manifest that that phrase and the reference to “company” and “private company” therein, covers only Indian incorporated holding companies; thereby, meaning that the deeming provision is only triggered in the Indian subsidiary - holding context, and not in the overseas holding context. 

This conclusion of mine is further corroborated if one were to examine the legislative background leading up to the 2013 Companies Act. The deeming provision language in the concept paper in 2004 on the draft Companies Bill issued by the MCA stipulated that an Indian company subsidiary of an overseas body corporate incorporated outside India (which would be a public company within the meaning of Indian law, if incorporated in India), shall be a public company.  

In other words, the proposal as contained in the concept paper was to do away entirely with the benefit of Sec. 4(7) of the 1956 Companies Act, and include ALL overseas body corporate-held subsidiaries (including wholly owned ones) within the rubric of “public company” in India on such deemed basis.  It may be mentioned in passing that there are striking similarities in this position with that of a discussion recorded by the Companies Act Amendment Committee of 1957 that preceded the insertion of Sec. 4(7) into the 1956 Companies Act, which stated (all emphasis added):

“As regards the treatment of private companies, the entire share capital of which is owned by one or more foreign bodies corporate, it is a matter of economic and financial policy for Government to decide, having regard to the position of foreign investments in this country generally, whether or not such private companies should continue, as at present, to remain outside the restrictions imposed on private companies which are subsidiaries of Indian public companies or whether they should henceforth be made subject to these restrictions.  If an alteration of law in this respect is considered desirable, a provision should be inserted in section 4 to the effect that “a private company, which is registered in India and which is a subsidiary of a foreign public company, shall be deemed to be a subsidiary of a public company for all purposes of this Act”

So it seems that, despite the passage of almost fifty years (as in 2000), the Government of India (or, at least, some parts of the Government) was still willing to go by the economic logic of a vastly different, much earlier era, in our nation’s development; and that too a view which, ultimately, came to be rejected by the Government of the day, as evident in Sec. 4(7) of the 1956 Companies Act!

However, this proposal as in the concept paper was dropped (and no further discussions on this topic were elicited in the various subsequent committee reports that redrafted the law) and instead, the provision as now enacted simply referenced “a subsidiary of a company, not being a private company” – meaning thereby that the legislative intent, as can be discerned from a plain reading of the statute, is also demonstrated (or underscored) by the way in which the current provision found itself onto the statute books.

D)        As a result, it is not surprising to find – and, indeed, on the basis of point #s (B) and (C) above and in order to read the statute harmoniously – that the reference in the definition of “subsidiary” [Sec. 2(87)] to cover the holding relationship even qua an overseas “body corporate” is only for purposes of that clause (and not for the entire 2013 Companies Act), which does not, therefore, extend to the deeming provision; and which this author believes (regardless of whether this is a drafting error or an oversight), to be a restrictive stipulation that needs to be interpreted correctly in context, as regards its applicability to the entire 2013 Companies Act.  This analysis does not even then need to examine the issue as to whether that particular provision in Sec. 2(87) has to be read into the deeming provision, as even the basis for such reading together does not arise, if the scheme separating the deeming provision and 2(87) is properly appreciated in the case of an overseas body corporate holding company.    

In other words, since Sec. 2(87) includes a substantive provision that enables the Government to prescribe such class or classes of holding companies that will not have layers of subsidiaries beyond a number they can prescribe (a provision not yet notified to be in force), it is for such prescriptive requirements that the overseas holding - subsidiary relationship falls within the definition of “subsidiary”; not with a view to impinge on the status of the Indian private company subsidiary of such overseas holding body corporate in such cases, which is a deeming requirement entirely in the Indian holding context as properly interpreted in point #s (B) and (C) above. It is pertinent to note that the 1956 Companies Act also had a similar stipulation – that the expression “company” in this section (i.e., Sec. 4) includes any body corporate; although, the 1956 Companies Act did have the benefit of Sec. 4(7).

So, to address those who would seek to interpret an incorporation of “body corporate” into the term “company” for purposes of the deeming provision, there is actual legislative force as to why Sec. 2(87) makes such inclusion only for purposes of that clause – and for no other provision of the 2013 Companies Act.  Consequently, there can be no reason not to follow the principle of giving effect to such express words of Sec. 2(87) (especially where no other conflict with other provisions arise); meaning, thereby, that the position of an India incorporated private company subsidiary of an overseas body corporate is untouched by the deeming provision and, as a result, for all consequent purposes of the 2013 Companies Act.

The clarification issued by the MCA admittedly affirms this position; but, its analysis is incomplete and does not do full justice to the scheme of the 2013 Companies Act, as explained above.  To the extent its conclusion may be regarded as matching the above analysis, this circular may be considered (although merely persuasive in effect), with reliance being better placed on a proper appreciation of the harmonious working (and proper comprehensive reading of the wording) of the appropriate provisions of the 2013 Companies Act itself lending greater credibility to the conclusion this article makes – to reiterate, that private company subsidiary in India of an overseas body corporate holding company will continue to be a “private company” for purposes of the 2013 Companies Act. 

- Siddharth Raja

13 comments:

Deepak Kumar Thakur said...

So, does that mean, any private company which is a subsidiary (Indian) public company, would be a public company only, and no exemptions as notified by MCA would be available to such subsidiary private company?

Siddharth Raja said...

Yes.

vswami said...

SPORADIC

In one's understanding, the whole discussion is, contrary to the real point calling for an incisive expert consideration and conclusion, found summed up in, - "... will continue to be a “private company” for purposes of the 2013 Companies Act. ". To make it clear enough, the crux of the issue is that , not what the 2013 Act envisages and provides, -with no clarity though,- but , in the ultimate interests of all stakeholders, inclusive of those 'third parties' who have a certain identifiable not so insignificant stake/ risk who deal with such type of companies, should or should not be continued to be treated as 'a private company' , for all purposes in toto or most of those; so much so, the intended common objective of 'good governance' is seen to be ensured /vouched for, at least 'on paper'/ in theory.
The point of great doubt or complicity in mind is, in today's context, could a company, howsoever 'closely held' as per old school of thought, but feared to have become outdated for long, be continued to be given any lenient treatment, than a public company, in the matter of compliance with disciplinary and other provisions to serve the purpose of 'checks and balances'.

Well considered and deeply thought out expert legal views from competent circles might help in , if nothing else, understanding the underlying philosophy of the 2013 enactment, more particularly the logic of it.

KEY NOTE: In a manner of strict viewing, the worrisome aspect of ‘third party‘s stake/risk’ raised above, is not different but is akin to that of an issue arising in relation to LLPs or OMCs; suggest to refer comments posted on the said topics, - personally considered to be not irrelevant.

Anura Gupta said...

What happens in the following scenario:

There is a foreign body corporate registered outside India. The foreign body corporate has a subsidiary company registered under the Indian companies Act. The same foreign body corporate also has a subsidiary company registered outside India.

Will the two subsidiary companies (i.e. the subsidiary company outside India and the subsidiary company inside India) be covered under 'related party' as defined under section 2(76) of the Companies Act, 2013? Or should the definition of "company" be read more expansively in this context to also include a foreign subsidiary?

Siddharth Raja said...

I think the answer to Anura's two questions is Yes; Sec. 2(76)(viii)(B) covers this scenario of two subsidiaries of a common holding company being related parties. Question is then whether this definition of "related parties" applies in the cross-border context as well. Examining Sec. 2(76)(viii)(B) closely, the reference is to "subsidiary of a holding company", which is squarely covered by Sec. 2(87), which includes bodies corporate. And, remember, Sec. 2 begins with the words, "In this Act, unless the context otherwise requires" -- which is another reason to support my logic as in my article. The context there was different; hence, my conclusion -- the context here is squarely covered by "subsidiary of a holding company", which includes bodies corporate. The consequence of my analysis is that the members of the related parties can now vote on approving resolutions for contracts with such related parties as the exemption notification provides. So, succour for "private companies" there too, in keeping with my analysis!

RRP said...

Mascon Global, an Indian listed IT company, underwent restructuring in the United States where part of the company became Quadrant 4 Systems Corp. This new company listed on the NASDAQ. As part of the deal some Indian branches of Mascon Global became a new subsidiary called Quadrant 4 Software Solutions, classified as a Subsidiary of a Foreign Company and is registered at Hyderabad as a private company.

So what happens when a subsidiary is formed out of a listed Indian company, which was separated in the United States?

Siddharth Raja said...

Some missing details in your query, RRP........Quadrant 4 Software Solutions is a private company? If so, I think my analysis applies. In such cases, I don't see how the emergence of an entity affects its legal status; as long as its incorporated as a private company in India, then my analysis applies in the case of a foreign holding company.

Siddharth Raja said...

I should add........you should seek specific legal advice, RRP, on the basis of the exact facts / circumstances matrix in your situation.

Nandita said...

So your conclusion is that contextually, the words 'for the purposes of this clause' should not be restrictively construed, but must reflect that every reference to 'subsidiary company' and 'holding company' in the Companies Act must be deemed to include subsidiary/holding body corporates (foreign companies included)? Section 185 is also a problem if your proposed interpretation is not accepted, i.e. a company incorporated in India would not be empowered under any circumstances to give loans or extend guarantees or any security to its foreign subsidiary. (The Companies (Meetings of Board and its Powers) Rules, 2014, R.10 makes reference to 'subsidiary company' only.) This would create a direct conflict with the relevant RBI circulars.

Chirag Chhabra said...

what happens if a public company in India has a foreign subsidiary? will that subsidiary be under the ambit of a public company under section 67
(2) of the companies act 2013 which restricts the giving of loans by the company to buy its own shares?

Siddharth Raja said...

The reference in Section 67(2) is to a "public company", and if one reads that with the definition of a "public company", the situation when a private company subsidiary is deemed to be a public company by virtue of its "holding" by the parent public company, is only in the Indian context (i.e., through the use of the word "company" in Section 2(71) proviso). So, in answer to your question: that overseas subsidiary cannot fall within the ambit of the proscription on "public companies" in Section 67(2). I believe this analysis fits with the conclusion in my article.

Siddharth Raja said...

I'm not quite sure I understand your comment Nandita. What you state to be my conclusion is not what I say in the article, but I thought my conclusion in the article addresses your query on Section 185. Can you please clarify your point on Section 185 on the basis of what I state in my article? I'd like to test my hypothesis for sure as to its accuracy in all situations, including under Section 185! Thank you.

Anonymous said...

What happens in a scenario where an Indian company is not a wholly owned subsidiary of a Foreign Co. but has public shareholders as well? Will that affect its status and make it a public company?