Ankit Sharma[1], Himanshu Pabreja[2]
Introduction
The prohibition on the grant of financial assistance by a company to any person for the purpose of purchasing or acquiring the company’s own shares is typical of common law jurisdictions.[3] The practice was originally introduced in the United Kingdom after the Greene Committee expressed its disaffection with the practice of ‘asset stripping’ takeovers,[4] whereby the resources of the target company and its subsidiaries are used directly or indirectly to assist the purchaser financially to make the acquisition. Indeed, as the target company remains to be an empty shell, the practice is seen as liable to prejudicing the interests of the creditors of the target company, or of any shareholders who do not accept the offer for their shares to be acquired, or the existing shareholders of the company who are not extended an offer for purchase of their shares by such purchaser.[5]
Indian company legislation – which finds its origin in the UK Companies Act 1948[6] – also provides for this financial assistance prohibition.[7] Section 77 of the Indian Companies Act 1956[8] – which later found its way into section 67 of the Companies Act 2013[9] – prohibited financial assistance by both private and public companies under the following terms:
“No public company shall give, whether directly or indirectly and whether by means of a loan, guarantee the provision of security or otherwise, any financial assistance for the purpose of, or in connection with, a purchase or subscription made or to be made, by any person of or for any shares in the company or in its holding company.”[10]
Whilst a major overhaul in UK law resulted in the modification of ‘financial assistance’ provisions by means of the subsequent enactment of company legislations 1985[11] and 2006,[12] India retained the original legislation with minor changes, such as the removal of the ban for private companies.
The provision on financial assistance above is drawn in terms so wide so as to include a large gamut of transactions in its sweep. Confusingly, it applies to (i) all “financial assistance”, provided (ii) “for the purpose of, or in connection with” a purchase or subscription relating to any shares in the company (or holding company).
Regrettably, also considered its criminal nature, this wide-ended diction results in profound ambiguity, which makes it an uphill task to determine if a transaction falls into the definition of “financial assistance” and is therefore liable to include some innocent transactions.
The following paragraphs discuss the two conditions precedent ((i) and (ii) above) for the application of the prohibition provided under Section 67 of the Companies Act 2013. The post will conclude that it is time for the legislator to better define the scope of the prohibition on the grant of financial assistance, to avoid the indictment of harmless transactions.
The absence of an express definition of ‘financial assistance’ is ambiguous and liable to disregard by clever perpetrators
The first element to configure a breach of the financial assistance prohibition is the grant of “financial assistance”.[13] The Indian Companies Act 2013 does not define what is to be regarded as “financial assistance”, and so the concept remains open to interpretation. Also, Indian law does not prescribe any standard or test for determining this “financial assistance”, as other jurisdictions do. For instance, the ‘net asset’ test in section 677(1)(d)(i) of the UK Companies Act 2006[14] provides that if the transaction results in the reduction of the net assets of the company to a material extent, the said transaction can constitute “financial assistance”.
Contrarily, section 67 of the Companies Act 2013 only makes a general reference to “loans, guarantee and security or otherwise”, contributing to the further broadening of the scope of the Indian provision. An attempt to determine the meaning of “or otherwise” can be made by resorting to the interpretation rule of noscitur a sociis,[15] which provides that the meaning of a doubtful word in a provision can be ascertained from meaning and scope of words accompanying it,[16] or in immediate connection with it.[17] By applying the aforementioned rule, certain transactions, like indemnities, may qualify as “financial assistance” because a well-understood nexus can be established between “loans, guarantee and security” and a transaction of indemnity. However, this interpretative tool finds its limitation in that it is liable to excluding transactions that are not similar enough to the instances enumerated above so as to form a discernible nexus to be covered under “or otherwise”. The application of the noscitur a sociis rule to section 67 may thus have the paradoxical effect of excluding from the scope of “financial assistance” a gamut of transactions like gifts, releases or waivers of substantial amounts. For instance, the interpretation rule would exclude the practice of the transferal of shares at a price lower than their market value when the transferal is qualified as a ‘gift’. This result would clearly make a fool of the law. Similar considerations apply regarding releases or waivers of companies’ rights.
Hence, the lack of a precise definition for ‘financial assistance’ can forfeit the purpose of the legislation, while allowing room for perpetrators to carve out innovative defenses.
Vague Statutory pre-requisites
The second element constituting breach of the prohibition on financial assistance under section 67 of the Companies Act 2013 is the provision of assistance by a company to any other legal person ‘for the purpose of, or in connection with purchase or subscription of shares’ of the same company.[18] Under Indian law, the validity of financial assistance is thus determined on the basis of its purpose in regards to, or its connection with, the purchase or subscription of company shares.
While other jurisdictions have in time abolished the requirements of the “connection with”, deeming sufficient the “purpose of” shares’ purchase or subscription,[19] Indian law preserves this. The retainer of this element contributes to widening the scope of the prohibition on financial assistance.
This criticism was already identified under English law: recognising the difference between “purpose of” and “in connection with” under the English Companies Act, the House of Lords noted that this latter formulation unreasonably extended the scope of the prohibition of financial assistance, affecting even those transactions regarding the acquisition of shares that are merely incidental to it.[20]
An instance of the above could be when a share purchaser has to make an alternative arrangement of borrowing money from the company to repay the amount borrowed for purchasing the company’s own shares after his original repayment plans fall through. This transaction may not have been entered into with the “purpose of” purchasing the company’s shares, yet the wider scope of the prohibition under the “in connection with” standard might invalidate it nonetheless.
Another example of an innocent transaction being caught under this regime is where one company after acquiring another company decides to borrow some assets of the acquired company in order to put the acquired company’s assets under better use. Similarly, this may not be considered financial assistance for the “purpose of” acquiring shares of a company, however, presence of the “in connection with” standard within the provision might indict the same.
Therefore, the phrase “in connection with” contributes to needlessly widening the scope of the prohibition of financial assistance, and is liable to covering innocent transactions.
Conclusion
Overall, section 67(2) is a loosely formulated provision, and this makes it very difficult to interpret correctly and accurately. The case-law also offers little guidance on the term’s scope,[21] so that financial assistance prohibitions are seemingly honoured more in breach than in observance.[22]
The absence of clarity in the legislation is regrettable, especially in view of the provision’s criminal nature. Thus, it is time for Indian legislature to take a bold look at this provision and adopt measures to remove ambiguities regarding its scope, either by embarking on suitable amendments or by replacing tout court the existing legislation with a more comprehensive one, so as to enable the prohibition to serve its ultimate purpose.
[1]5th year, B.Com. LLB. (Hons.), Gujarat National Law University, Gandhinagar, India
[2]5th year, B.Com. LLB. (Hons.), Gujarat National Law University, Gandhinagar, India
[3]Section 76, The New Zealand Companies Act 1993; Section 260A, Australian Corporations Act 2001; Section 678, The UK Companies Act 2006
[4]¶ 30, Report of the Company Law Amendment Committee 1925–26 (Cmnd 2657).
[5]Chaston v SWP Group plc [2002] EWCA Civ 1999; [2003] BCC 140 at [31].
[6] Companies Act, 1948 (United Kingdom), available at http://www.legislation.gov.uk/ukpga/1948/38/pdfs/ukpga_19480038_en.pdf.
[7]U Varottil, ‘The Evolution of Corporate Law in Post‐Colonial India: From Transplant to Autochthony’, 7 Working Paper 2015/001, available at <http://law.nus.edu.sg/wps/pdfs/001_2015_Umakanth_Varottil.pdf>,, accessed on ?
[8] Companies Act, 1956 (India), available at http://www.mca.gov.in/Ministry/pdf/Companies_Act_1956_13jun2011.pdf.
[9] Companies Act, 2013 (India), available at http://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf.
[10]Section 67(2), The Indian Companies Act 2013
[11]Section 151, UK Companies Act 1985.
[12]Section 678, UK Companies Act 2006.
[13]Charterhouse Investment Trust Ltd v Tempest Diesels Ltd (1985) 1 BCC 99544
[14]§ 677(1)(d)(i), UK Companies Act 2006
[15]Maxwell, Interpretation of Statutes, 11th Edition, 321
[16]K. Bhagirathi, G. Shenoy v K. P. Ballakuraya (1999) 4 SCC 135, 138 (SC)
[17]Angus Robertson v George Day (1879) 5 AC 63, 69
[18]Charterhouse Investment Trust Ltd v Tempest Diesels Ltd, (1985) 1 BCC 99544
[19]See Companies Act 1985 (UK) s151 (now repealed by the Companies Act 2006); Companies Act 2006 (UK) ss677 and 678
[20]Brady v Brady [1988] 2 AII ER 617 (HL)
[21]An Indemnity as Prohibited Financial Assistance under Indian Company Law, [2011] I.C.C.L.R., Issue 1, 17
[22]Patterson and Ednie, Australian Company Law, 274. The discussion was with respect to Section 67 of the Australian Companies Act 1961 which imposed a prohibition in the same terms as Section 77 of the Indian Companies Act 1956.