Whether a “Sale of Shares” Amounts to a “Sale of an Undertaking”: Has the Conundrum Been Resolved?

[Bharat Vasani is Senior Advisor – Corporate Laws and Varun Kannan an Associate in the General Corporate Practice, both at the Mumbai office of Cyril Amarchand Mangaldas.

An earlier version of this post was published on the Cyril Amarchand Mangaldas Blog]

“What would constitute an ‘undertaking’ of a company” has been among the most hotly debated topics in the history of India’s company law regime. This question arises while evaluating whether a transaction falls within the purview of section 180(1)(a) of the Companies Act, 2013 (“2013 Act”), which corresponds to section 293(1)(a) of the Companies Act, 1956 (“1956 Act”).

Section 180(1)(a) of the 2013 Act provides that shareholders’ approval by a special resolution is required 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 such undertakings. Section 180(1)(a) is applicable to public limited companies, with the Ministry of Corporate Affairs (“MCA”) exempting private companies from complying with the requirements of Section 180.

While neither section 180(1)(a) of the 2013 Act nor section 293(1)(a) of the 1956 Act define the expression “undertaking” – there is one important difference between the two statutory provisions. Section 180(1)(a) now provides numerical criteria to determine what would constitute an “undertaking”, by stating the following:

  • undertaking” shall mean an undertaking in which the investment of the company exceeds 20% of its net worth as per the audited balance sheet of the preceding financial year (“FY”) or an undertaking which generates 20% of the total income of the company during the previous FY;
  • substantially the whole of the undertaking” in any FY shall mean 20% or more of the value of the undertaking as per the audited balance sheet of the preceding FY.

The introduction of the above numerical criteria was expected to resolve all the ambiguities surrounding the scope and meaning of “undertaking”. However, it has proven to be insufficient as the provision is silent on whether “undertaking” should be construed in a watertight sense (to only include the entire business/ division/ unit, on a going concern basis), or liberally, to include even individual assets that meet the numerical criteria.

While there are a host of contentious issues under section 180(1)(a), an important one that companies grapple with frequently is whether “sale of shares” would constitute “sale of an undertaking” under that provision. In this post, the authors delve deeper into this issue, and argue why “shares” would not constitute an “undertaking” under section 180(1)(a).

Legislative Background

In the Indian context, the requirement to obtain shareholder approval for a sale or disposal of an undertaking has its genesis in section 86H of the Indian Companies Act, 1913, which provided that the directors of a public company (or a subsidiary of a public company), shall not, except with the consent of the company in a general meeting, sell or dispose of the undertaking of the company.

The Bhabha Committee Report, which led to the introduction of the 1956 Act, recommended that along with “sale” and “disposal” of an undertaking, even “leasing” should be brought within the purview of shareholders’ approval (in paragraphs 102 and 104 of the report). The rationale was that as the company would be formed inter alia for operating the undertaking, even leasing out the undertaking should require shareholders’ approval.

A reading of the Bhabha Committee Report highlights the original legislative intent, where “undertaking” was envisaged to cover a transfer of a business/unit/division on a going concern basis only, and would not include transfer of individual assets that are held or owned by the company. It is also interesting to note that while the provisions of the 1956 Act were substantially borrowed from the English Companies Act, 1948 (“1948 English Act”), section 293(1)(a) did not directly resemble any provision of the 1948 English Act.

Further, specifically in the legislative context of the 2013 Act, while the Irani Committee Report (2005) notes that “certain additional items that should require shareholders’ approval may include sale/transfer of investment in equity shares of other bodies corporate which constitute 20% or more of the total assets of the investing company”, this recommendation has not been expressly incorporated into the scheme of section 180(1)(a). The Parliamentary Standing Committee Reports of 2010 and 2012 (which discuss threadbare various new provisions later inserted by the 2013 Act) also do not in any way provide that “undertaking” should be read expansively to cover transfer of individual assets held or owned by the company.

Interestingly, section 1161 of the English Companies Act, 2006, and its predecessor in the form of section 259 of the English Companies Act, 1985, define “undertaking” in an even narrower sense, to only include (a) body corporate or partnership, or (b) an unincorporated association carrying on a trade or business, with or without a view to profit.

A view may accordingly be taken that in the absence of a specific deeming provision stating that “shares” would constitute an “undertaking” for the purpose of section 180(1)(a), it can be argued that sale/ disposal of shares, exceeding the numerical threshold prescribed under section 180(1)(a), would not be deemed to be a sale/ disposal of an “undertaking” of the company.

Whether “Shares” Constitute an “Undertaking” – Jurisprudence

In view of the above legislative background, it is instructive to refer to case law, which also suggests that “shares” would not constitute an “undertaking”. In Brooke Bond India Limited v. U. B. Limited, the Bombay High Court held that “…the sale of shares, whatever be their number, even if it amounts to a transfer of the controlling interest of a company, cannot be equated to the sale of any part of the ‘undertaking’ so as to come within the mischief of section 293(1)(a)”. These observations were supported in a subsequent decision of the Bombay High Court in CDS Financial Services (Mauritius) Limited v. BPL Communications Limited.

In Rustom Cavasjee Cooper v. Union of India, the Supreme Court of India distinguished between an “undertaking” and individual assets that constitute the undertaking, stating as follows: “‘undertaking’ clearly means a going concern with all its rights, liabilities and assets as distinct from the various rights and assets which compose it… the undertaking means the entire organization… it is an amalgam of all ingredients of property and are not capable of being dismembered… That would destroy the essence and innate character of the undertaking…..”.

In P. S. Offshore Inter Land Services Pvt. Ltd. v. Bombay Offshore Suppliers and Services Ltd., the Bombay High Court had provided an asset-based test for determining what would constitute an “undertaking”, stating as follows:

“…… the expression ‘undertaking’ used in this section is liable to be interpreted to mean “the unit”, the business as a going concern, the activity of the company duly integrated with all its components in the form of assets and not merely some asset of the undertaking…”.

In Commissioner of Income Tax v. UTV Software Communication Limited 2019 SCC OnLine Bom 2225, the Bombay High Court provided the distinction between “transfer of shares” and “transfer of an undertaking”, in the context of the Income Tax Act, 1961, stating that the transfer of shares cannot be considered to be a slump sale of an undertaking under section 2(42C) of the Income Tax Act. Reference was made to the Supreme Court decisions in Vodafone International Holdings BV v. Union of India and Bacha F. Guzdar v. CIT, which reiterate the cardinal principle that since a company is a separate legal person in the eyes of law, a shareholder does not exercise ownership interest over the assets of the company.

In Tracstar Investments Limited v. Gordon Woodroffe Limited, the Company Law Board (“CLB”) held: “The main object of the company is not even to engage in the business of investing in shares. Consequently, the disposal of these shares would not bring the business of the company to a standstill. Thus, the sale of the shares does not certainly pass through the test prescribed…”. In an interesting decision in Gujrat NRE Mineral Resources Ltd. v SEBI, the Securities Appellate Tribunal, in the context of the definition of unpublished price sensitive information (“UPSI”) under the SEBI (Prohibition of Insider Trading) Regulations, 1992, held that the words ““disposal of the whole or substantial part of the undertaking”…would mean when a company decides to dispose of the whole or substantial part of its business activity or project in which it is engaged. The word ‘undertaking’ cannot possibly mean investments held by an investment company which are its stock-in-trade”.

The Gujarat NRE Case supports the view that a “sale of shares” would not constitute a “sale of an undertaking” even for an investment company, which acquires or sells shares in its ordinary course of business, and whose assets predominantly comprise of its holdings in other investee companies. Even if the investment company has a controlling stake in the investee company, pursuant to the Supreme Court decisions in Vodafone and Bacha Guzdar, its shareholding will be considered as distinct from the undertaking or  assets of the investee – and the investment company would not exercise ownership interest over the undertaking or assets.

Additional Considerations for Listed Companies

The recently introduced regulation 37A of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) provides that shareholders’ approval by special resolution, along with consent of the “majority of minority shareholders” of the listed entity is required in case of sale, lease or disposal of an undertaking or  substantially the whole of the undertaking by a listed company. Given that regulation 37A provides that the expressions “undertaking” and “substantially the whole of the undertaking” shall have the same meaning as assigned to them under section 180(1)(a) of the 2013 Act, the above analysis on why “shares” would not constitute an “undertaking” will also be applicable in this context.

However, it may be noted that in terms of regulation 24(5) of the LODR Regulations, a listed entity shall not dispose of shares in its material subsidiary, resulting in reduction of its shareholding (either on its own or together with other subsidiaries) to less than or equal to 50% or cease the exercise of control over the subsidiary without passing a special resolution in its general meeting. The requirement to obtain shareholders’ approval (by special resolution) in the above scenario is an independent compliance requirement applicable to listed entities. Further, listed companies are also required to examine implications under regulation 24(6) of the LODR Regulations, which provides that selling, disposing and leasing of assets amounting to more than 20% of the assets of the material subsidiary on an aggregate basis during a financial year shall require prior approval of shareholders by special resolution.

Concluding Thoughts

Based on the case law and the legislative context discussed above, there are strong legal grounds to take a view that “shares” would not constitute an “undertaking” under section 180(1)(a), and the law therefore does not mandate shareholders’ approval by special resolution in case of sale or disposal of shares exceeding the numerical criteria prescribed under the Explanation to section 180(1)(a).

Unfortunately, given that section 180(1)(a) does not provide a specific definition of the nature or type of assets that would constitute an “undertaking”, the introduction of numerical criteria under the explanation to section 180(1)(a) has failed to settle the long-standing debate on the precise scope and ambit of the term “undertaking” under the said section. The ambiguities surrounding the precise scope and ambit of what would constitute an “undertaking” is yet another example of how inadequate drafting of various provisions of the 2013 Act has resulted in unforeseen interpretative challenges, along with the lack of consistency in the practices followed by India Inc.

For ensuring consistency in the practices followed by companies the MCA should, in the next round of amendments to the 2013 Act, consider inserting an explanation to section 180(1)(a) to clarify that “shares” would not constitute an “undertaking”  and issue a clarification in the interim to facilitate the ease of doing business in India.

Bharat Vasani & Varun Kannan

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