Sale of an “Undertaking” in Company Law

[This post is
contributed by Nitu Poddar of Vinod
Kothari & Co. The author can be contacted at nitu@vinodkothari.com]
Company law imposes certain
restrictions on the general powers of directors. Pursuant to section 180 of
Companies Act, 2013 (“Act, 2013”), the board of directors of a company can
exercise certain powers only with the consent of the members of the company by
means of a special resolution. In this post, sub-clause (a) of sub-section (1)
of section 180 of the Act, 2013 is being discussed at length to ascertain the
meaning of ‘undertaking’ and compliances to be carried out at the time of sale,
lease or disposal of undertaking.
The text of the said
clause is as follows:
(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.
XXX
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 provided 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.
Here, it is pertinent to read the
language of the said rule minutely:
(16)
pursuant to clause (a) of sub-section (1) of section 110, the following items
of business shall be transacted only by means of voting through a postal
ballot-
XXX
(i)
sale of the whole or substantially
the whole of an undertaking of a company as specified under sub-clause (a) of
sub-section (1) of section 180;
XXX
This means that although sub-clause (a)
of sub-section (1) of section 180 pertains to ‘to sell, lease, or otherwise
dispose of’ the whole or substantially the whole of undertaking(s), postal
ballot is required only in case ‘selling’ of the whole or substantially the
whole of undertaking(s).
Prior approval from
the members
Although the word ‘prior’ does not appear in the
section, it is very clear that the consent of the members has to be sought
prior to the act of selling, leasing or otherwise disposing of the whole or
substantially the whole of the undertaking(s) of the company.
The powers under this section can be exercised
by the board only with the consent of the general body. The board cannot exceed
the powers in the hope that the general body will ratify their actions.
Accordingly, the power shall be exercisable only with the prior consent of the
members.

 

Approval of Audit
Committee
Pursuant to section 177(4)(vi) of the Act, 2013,
the undertaking and assets of a company need to be valued by the audit committee,
wherever it is necessary.

 

Section 180(1)(a)
of Act, 2013 vis-à-vis Section 293(1)(a) of Companies Act, 1956
It
is pertinent to note that section 180(1)(a) of Act, 2013 corresponds to section
293(1)(a) of the Companies Act, 1956.
A
similar provision was contained in the Act, 1956 except for the following
differences:
1.  Earlier ordinary resolution from the members
would suffice as compared to the requirement of special resolution from the
members in Act, 2013.
2.  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 (“MCA”)
vide exemption notification dated 5 June 2015 rendered section 180 inapplicable
to private companies.
3.  The expression “substantially the whole of the
undertaking” and “undertaking” has been defined in section 180 of Act, 2013

 

Interpretation of
the word “undertaking”
Explanation
(ii) to section 180(i)(a) defines the meaning of the expression “undertaking”.
Explanation.—For the
purposes of this clause,—
(i) “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;
Primarily,
for a transaction to be considered within the purview of Section 180(1)(a) of
Act, 2013, it has to comply with the following criteria –
– should relate to an “undertaking”;
and
– should be in respect of sale,
lease or disposal of such ‘undertaking’ in any other manner.
In the Act, 1956, section 293(1)(a) also gave
a very similar rendition; however, it did not furnish any explanation to what an
‘undertaking’ meant. The explanation to section 180(1)(a) of Act, 2013
furnishes only the qualifying criteria of an ‘undertaking’ to be considered under
section 180(1)(a), but does not actually define an ‘undertaking’.
For the
purpose of concluding on what classifies as an ‘undertaking’ under Section
180(1)(a) of Act, 2013,we thereby have to look to various court rulings to
understand the precedents set by the courts in relation to what constituted as
‘undertaking’ under Section 293(1)(a) of Act, 1956.
In the
decision of Rustom Cavasjee
Cooper vs Union of India
,
the Supreme Court provided an insight into
what could constitute an ‘undertaking’. The case, amongst other matters,
pertained to the interpretation of undertaking for the purpose of Section 4 of
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1969.
Although, the case did not pertain to only interpreting undertaking as per
Section 293(1)(a) of Act, 1956, it still offered a detailed discussion on this
front. The Supreme Court held that by the word ‘undertaking’ is meant the
entire organization. The provisions of the stated Act indicate that the company
whether it has a plant or whether it has an organization is considered as one
whole unit and the entire business of the going concern is embraced within the
word ‘undertaking’. It also held that ‘undertaking’ would clearly 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.
Looking further, the
Karnataka High Court, in the case of International Cotton Corpn.
(P.) Ltd. v. Bank of Maharashtra
, referred to the case of Madras Gymkhana Club Employee’s
Union v. Management
to conclude that the business of the company or
undertaking of the company must be distinguished from the other properties belonging
to the company. In Madras Gymkhana (supra) the meaning of undertaking
was further defined to mean “any business or any work or project which one
engages in or attempts as an enterprise analogous to business or trade”.
The concept of
‘undertaking’ may also be derived from the explanation stated under section
2(19AA) of Income Tax Act, 1961, wherein it has been defined to 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.”
(emphasis supplied)
Numerical definition
of “undertaking”
Delving further into the
Act, 2013 Section 180(1)(a) also places a numerical definition to the term
‘undertaking’, rendering that even if the asset(s) can be said to be an
operating unit or segment, the asset(s) will have to qualify the numerical test
given in the Explanation below the said section; which is, ‘undertaking’ to
mean an investment which constitutes either 20% of the net worth or total
income of the company during the previous financial year.
Illustration
Accordingly, in case of
selling of a leasehold estate by a company which is not used by the company in
its ordinary course of business, the same shall not be considered to be selling
of the undertaking. The rationale of such understanding is that by generic
meaning, a ‘leasehold estate’ is basically a temporary right to hold such
property in which the lessee or the tenant holds rights of real property by
some form of title from the lessor, i.e., owner of the property. Hence, the company
only has a beneficial ownership and not freehold or outright ownership on the
said property. As derived earlier from the Court rulings, the business or
undertaking(s) of the company must not be equated with the other properties
belonging to the company. Accordingly, since such leasehold asset is not owned
by the company and further, is also neither used for any business purpose of
the Company, nor used for generating any productive income. Therefore,
evidently, the said leasehold property does not fall within the very definition
of the term ‘undertaking’.

 

Based on the discussion
above, the very concept of ‘undertaking’ would essentially mean –
– an asset or group of
assets, where the sole ownership right(s) is with the company; and
– which when disposed of
can have an impact on the working of the company and earning of its profits.
Meaning of the
expression “otherwise dispose of”
The
expression “otherwise dispose of” has to be read in a wider sense so as to
cover all modes of disposing of a property of the company.
Earlier the Department of Company Affairs vide
letter dated 21.7.1964, clarified that in case a company mortgages the whole or
substantially the whole of its undertaking for obtaining loans or financial
assistance, it need not comply with the erstwhile section 293(1)(a). However,
in case of a usufructury mortgage the section would be attracted.
Further, according to the decision in Mohanlal Ganpatram vs Shri Sayaji
Jubilee Cotton
, execution of equitable mortgages (also known as
mortgage by deposit of title-deeds) and pledges is not disposition of the whole
or substantially the whole of the undertaking of the company.
Also, the ‘business’ or ‘undertaking’ of the
company must be distinguished from the ‘properties’ belonging to the company.
Where only the properties belonging to the company have been dealt with by the
board of directors under the deeds of hypothecation and mortgage in favour of
the bank, no part of the undertaking of the company should be considered to be
disposed of in favour of the bank. [Reference
– decision of Karnataka High Court in International Cotton v Bank Of
Maharashtra
].
Conclusion
While Act, 2013 provides a quantitative
classification for identifying the undertaking, one has to refer to precedents
laid by the courts while ascertaining the meaning of undertaking and
accordingly ensure compliance under Act, 2013.
– Nitu Poddar

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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