Corporate and Allied Laws Vol. II (Practice Manual)_g1

PRACTICE MANUAL

CORPORATE AND

ALLIED LAWS

The Institute of Chartered Accountants of India(Set up by an Act of Parliament)

New Delhi

FINAL COURSE

PAPER 4

VOL. II

i

PRACTICE MANUAL

Final Course

PAPER : 4

CORPORATE AND ALLIED LAWS

Volume – II

BOARD OF STUDIES THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

Get Free SMS Updates. To Join type- ON<space>SIDRUTIYA and send it on 9870807070.Downloaded form www.SidRutiya.blogspot.com [Source: www.icai.org]

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This Practice Manual has been prepared by the faculty of the Board of Studies. The objective of the study material is to provide teaching material to the students to enable them to obtain knowledge and skills in the subject. Students should also supplement their study by reference to the recommended text books. In case students need any clarifications or have any suggestions to make for further improvement of the material contained herein, they may write to the Director of Studies.

All care has been taken to provide interpretations and discussions in a manner useful for the students. However, the Practice Manual has not been specifically discussed by the Council of the Institute or any of its Committees and the views expressed herein may not be taken to necessarily represent the views of the Council or any of its Committees.

Permission of the Institute is essential for reproduction of any portion of this material.

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this book may be reproduced, stored in retrieval system, or transmitted, in any form, or by any means, Electronic, Mechanical, photocopying, recording, or otherwise, without prior permission in writing from the publisher.

Edition : January, 2011

Website : www.icai.org

Department/ : Board of Studies Committee

E-mail : [email protected]

ISBN No. : 978-81-8441-371-7

Price : Rs. 150/-

Published by : The Publication Department on behalf of The Institute of Chartered Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg, New Delhi-110 002, India.

Printed by : Sahitya Bhawan Publications, Hospital Road, Agra 282 003 January/2011/ 20,000 Copies


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A WORD ABOUT PRACTICE MANUAL

The Board of Studies, the academic wing of the Institute of Chartered Accountants of India has been taking proactive initiatives in imparting the distance education to the students pursuing the Chartered Accountancy course. Keeping in view of the requirements of the curriculum the time available with the students, integration of training vis-à-vis industrial expectation, it is necessary that students should holistic learning and not a mere rote learning. CA students have a wide choice in learning the subject through the mode of text books, study modules, compilation of answers to the past years examination questions, revisionary test papers, supplementary study material on the subject updates, teleconference classes and other reference inputs. Despite the various options, it is found that when it comes to the examination requirements, most of them do not come to the expectation level even though students have put in their best efforts. There may be several causes as to their performance in the examination and it is therefore necessary that a student from the very beginning of his career need to know as to what is the best way of approaching the examination.

The plan, preparation and proceeding with each of the subject differ widely and therefore one should customize his study accordingly. At the Final level, Paper-4 deals with Corporate and Allied Laws, where the level of knowledge prescribed is that of ‘Advanced knowledge’ The paper consists of two sections i.e. Section A relating to Company Law carrying a weightage of 70 marks with the objective that students are ‘able to analyze and apply various provisions of the Companies Act, 1956 in practical situations’ and Section B carrying weightage of 30 marks dealing with allied laws and the objective is ‘to develop ability to analyze the requirements of laws stated in the Section’. In brief, the students are expected to have not only analyzing skills but also application skills in company law, while in allied laws they are expected to have the analyzing skills (an overview of various allied laws) stated in the syllabus. Accordingly, preparation should be proceeded with care, concern and caution.

The study material serves as a basic input for the subject and the student’s study is complete when he synchronizes with other related publications of the institute as mentioned above. It is in this context, the Board of Studies thought it fit that there should be common material which should provide him all the inputs at one place and for this purpose, a new avatar of study requirements have been introduced for the benefit of students community, which is known as ‘Practice Manual’.

What is Practice Manual?

As the name suggests, that examination is an art, where you require constant practice in solving as many problems as possible. After studying the basic study material, a student has to synchronize it with examination. It is in this context, the Practice Manual will fill up the gap. As the name suggests, the practice manual contains lot of solved questions and some practical exercises with hints wherever necessary. It is in fact a compilation of various practical problems whether it is from


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past years or practical or based on amendments in relevant laws and other problems culled from different sources. As compared to the study material, this practice manual proceeds with the subject from beginning to end. In other words, since it is a law subject, Chapterization in this Practice Manual has been done as per the order of sections given in the Companies Act, 1956 and also in respect of allied laws. You will come across definitional clauses, important provisions which have bearing on application and interpretation and so forth. By this method of study you will know the genesis of

• The analysis part

• The application part

• The interpretation part

• The judgement part

• The sequence part

• The logical part

• The clarity part

• The concise part

• The Secretarial part

And above all the conclusion part.

Contents of Practice Manual

This practice manual is segregated into two sections, i.e. Section A dealing with the Company Law starting from Chapter on Accounts and ending with Chapter on Winding-up. Besides there is a chapter on Corporate Secretarial Practice. Section B covers an overview of the various allied laws covering 9 statutes and a chapter on interpretation of statutes, deeds and documents. All the questions given in the practice manual goes by the sections that have been arranged and given in the respective statute. Before reading the question, remember the sequence of the chapter in the statute, section number, and its subject-matter. This will help you in not only having a grasp of the subject, your grip in the subject will ultimately be reflected. Problems have been carefully chosen from various sources so that you come across different application and its implication in practical situations.

A Word of Wise advice

While you start reading the practice manual, keep by your side, the relevant Bare Act and you will come across the wordings as given in the section, with explanation if any and more important whether the section has any proviso and exemptions. This you can correlate and relate with the question and answer given in this practice manual. The answer may also highlight if there is any land mark judgement by the Court which only illustrates that section(s) are capable of interpretation


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where clarity is sought for based on practical situations. These in brief are the nuances of law and sought to be tested at the Final level.

Your valuable suggestions

All steps have been taken to make reading of practice manual, resourceful and useful. Since amendments in law are a continuous process, we endevaour to update the answers in tune with the changes wherever necessary. In case if you have any suggestions for fine tuning, mail us through e-Sahaayataa or call us at toll free number 1800-200-2501 or write to The Director, Board of Studies.

To end, Remember the words of Sir Francis Bacon, ‘Reading maketh a full man, Conference a ready man, and Writing an exact man. We hope the Practice Manual will facilitate the students in understanding where they lack in their self-study and steps to overcome them. Read the practice manual wholly with diligence and attention. Start attempting a question a day which keeps the examination tension away.

We wish you a resourceful reading and good luck.

Happy Reading and Best Wishes!


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CONTENTS

UNIT – I : COMPANY LAW

CHAPTER 1: DIVIDEND (Sections 205 – 207) ................................................... 1.1 – 1.6

CHAPTER 2: ACCOUNTS (Sections 209 – 223) ...............................................2.1 – 2.14

CHAPTER 3: AUDIT (Sections 224 – 233B)......................................................3.1 – 3.14

CHAPTER 4: POWERS OF REGISTRAR TO CALL FOR INFORMATION OR EXPLANATION (Sections 234 – 234A) ........................................ 4.1 – 4.2

CHAPTER 5: INVESTIGATION (Sections 235 – 251) ......................................... 5.1 – 5.4

CHAPTER 6: DIRECTORS (252 – 323)..............................................................6.1 – 6.24

CHAPTER 7: SHARE QUALIFICATION (Sections 270 – 273) ............................ 7.1 – 7.8

CHAPTER 8: DISQUALIFICATION OF DIRECTORS (Section 274)....................8.1 – 8.10

CHAPTER 9: RESTRICTION ON THE NUMBER OF DIRECTORSHIPS (Sections 275 – 279) ................................... ………………………...9.1 – 9.6

CHAPTER 10: VACATION OF OFFICE BY DIRECTORS (Sections 283 – 284) ...............................................................10.1 – 10.6

CHAPTER 11: MEETINGS OF BOARD (Sections 285 – 290) ........................ 11.1 – 11.20

CHAPTER 12: BOARD’S POWERS AND RESTRICTIONS THEREON (Sections 291 – 293) ............................................................. 12.1 – 12.22

CHAPTER 13: POLITICAL CONTRIBUTIONS (Sections 293A – 293B) ...........13.1 – 13.2


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CHAPTER 14: APPOINTMENT OF SOLE SELLING AGENTS (Sections 294 – 297) ............................................................. 14.1 – 14.30

CHAPTER 15: PROCEDURE, ETC., WHERE DIRECTOR INTERESTED (Sections 299 – 302) ............................................................. 15.1 – 15.12

CHAPTER 16: REMUNERATION OF DIRECTORS (Sections 309 – 311) ....... 16.1 – 16.12

CHAPTER 17: MISCELLANEOUS PROVISIONS (Sections 312 – 314) .......... 17.1 – 17.10

CHAPTER 18: COMPENSATION FOR LOSS OF OFFICE (Sections 318 – 321) ...............................................................18.1 – 18.4

CHAPTER 19: DIRECTORS WITH LIMITED LIABILITY (Sections 322 – 323) ...............................................................19.1 – 19.2

CHAPTER 20: POWERS OF CG UNDER (Sections 388B – 388E) ...................20.1 – 20.4

CHAPTER 21: ARBITRATION, COMPROMISES ARRANGEMENTS AND RECONSTRUCTIONS (Sections 389 – 396A) ........................ 21.1 – 21.18

CHAPTER 22: PREVENTION OF OPPRESSION AND MISMANAGEMENT (Sections 397 – 407) ............................................................. 22.1 – 22.20

CHAPTER 23: MISCELLANEOUS PROVISIONS (Sections 416 – 424) ............23.1 – 23.4

CHAPTER 24: WINDING – UP (Sections 425 – 560) ..................................... 24.1 – 24.22

CHAPTER 25: PRODUCER COMPANIES (Sections 581A – 581ZT) .............. 25.1 – 25.10

CHAPTER 26: COMPANIES INCORPORATED OUTSIDE INDIA (Sections 591 – 608) ...............................................................26.1 – 26.8

CHAPTER 27: LEGAL PROCEEDINGS (Sections 632 – 635AA) .....................27.1 – 27.2

CHAPTER 28: APPLICATION OF SECRETARIAL PROCEDURE AND PRACTICES .......................................................................... 28.1 – 28.14


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UNIT – II : ALLIED LAWS

CHAPTER 1: THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 ........................................................................ 1.1 - 1.40

CHAPTER 2: THE SECURITIES CONTRACTS (REGULATION) ACT, 1956 ..................................................................................2.1 – 2.24

CHAPTER 3: FOREIGN EXCHANGE MANAGEMENT ACT, 1999......................3.1 – 3.38

CHAPTER 4: THE COMPETITION ACT 2002....................................................4.1 – 4.16

CHAPTER 5: OVERVIEW OF BANKING REGULATION ACT, 1949, THE INSURANCE ACT, 1938, THE INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY ACT, 1999, THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, 2002 ...................................................................................5.1– 5.16

CHAPTER 6: PREVENTION OF MONEY LAUNDERING ACT, 2002 .................. 6.1 – 6.4

CHAPTER 7: RULES AND INTERPRETATION OF STATUTES DEEDS AND DOCUMENTS ............................................................................7.1 – 7.20


SECTION A

COMPANY LAW


CHAPTER 1

DIVIDENDS AND MANNER AND TIME OF PAYMENT THERE OF (SECTIONS 205 – 207)

Manner and time of payment Question 1 The shareholders at an annual general meeting unanimously passed a resolution for payment of dividend at a rate higher than that recommended by the directors. Discuss the validity of the resolution. Answer Articles of companies usually contain provisions with regards to declaration of dividend on the pattern of regulations 85 to 94 of Table A of the Companies Act, 1956. Under the regulation 85, the power to declare a dividend vests with the general meeting, but it has no power to declare a dividend exceeding the amount recommended by the Board of Directors. Transfer of higher percentage of profits to reserves Question 2 Advise on the following situations: (i) A company wants to transfer more percentage of profits to reserves. (ii) A company wants to declare dividends out of past reserves instead of current year

profits. (iii) A company wants to provide depreciation higher than the rates provided in Schedule

XIV. Answer (i) A company can make a transfer of more than 10% to reserves provided it ensures the

minimum distribution specified in Rule 3 of the Companies (Transfer of Profits to Reserves) Rules, 1975. (a) The minimum distribution is the rate of dividend equal to the average of the rates

of dividend for the last 3 financial years. (b) Where bonus shares have been issued during the financial year, minimum

distribution would be the average of the amount of dividend for the last three financial years.


Corporate and Allied Laws

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(c) Where, however, the net profits after tax for the financial year are lower by 20% or more than the average net profits after tax for the last two financial years, it will not be necessary to ensure the minimum distribution for making a higher transfer to reserve.

(ii) Dividends may be declared out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in accordance with Section 205 of the Companies Act, 1956. However, the Central Government may in the public interest relax the payment of the profits without providing for depreciation. The Companies (Declaration of Dividend out of reserves) Rules, 1975 provided that

(iii) The rate of dividend declared does not exceed the average of the rates at which dividend was declared by it in the 5 years immediately preceding that year or 10% of its paid-up capital, whichever is less.

(iv) The total amount to be drawn from the accumulated profits earned in previous years and transferred to the reserves does not exceed an amount equal to 1/10th of the sum of its paid-up capital and free reserves and the amount so drawn must first be utilized to set off losses incurred in the financial year before any dividend in respect of preference or equity shares is declared.

(v) The balance of reserves after such drawal does not fall below 15% of its paid-up capital. (vi) The rates contained in Schedule XIV are the minimum rates below which companies are

not permitted to charge for depreciation and therefore there is no bar in providing a higher rate of depreciation.

Declaration of Dividend out of Past Reserves Question 3 A Public Company has been declaring dividend at the rate of 20% on equity shares during the last 5 years. The Company has not made adequate profits during the year ended 31st March, 2009, but it has got adequate reserves which can be utilized for maintaining the rate of dividend at 20%. Advise the Company as to how it should go about if it wants to declare dividend at the rate of 20% for the year 2008-2009. Would your answer be different if the company utilized only the profits made in the previous yars and retained in the profit and loss account for the purpose of payment of dividend at the rate of 20% for the year 2008-2009? (November 2009) Answer

As per Rule 2 of the Companies (Declaration of Dividend out of Reserves) Rules, 1975 dividend may be declared by a company for any year out of the accumulated profits earned by it previous years and transferred by it to the reserves subject to certain conditions. One of the


Dividends (Sections 205 – 207)

1.3

conditions is that the rate of dividend declared shall not exceed the average of the rates at which dividend was declared by it in the 5 years immediately preceding that year or 10% of its paid-up capital which ever is less. As the proposed dividend exceeds 10%, it is necessary to seek the approval of the Central Government as required under section 205A(3) and only after obtaining the approval of the Central Government, the company may declare dividend at rate of 20% for year 2008-09, even if the other conditions relating to the amount that can be drawn from the reserves and minimum balance in the reserve are fulfilled. However, the credit balance, if any, carried in the profit and loss account will be available for declaration of dividend without any restriction. Hence in such a case dividend may be declared at the rate of 20% for 2008-09, without approval of the Central Government.

Declaration of interim dividend Question 4 Board of Directors of M/s. RPP Ltd. in its meeting held on 29th May, 2009 declared an interim

dividend payable on paid up Equity Share Capital of the Company. In the Board Meeting scheduled for 10th June, 2009, the Board wants to revoke the said declaration. You are required to state with reference to the provisions of the Companies Act, 1956 whether the Board of Directors can do so. (May 2009)

Answer Prior to the passing of Companies (Amendment) Act, 2000 only Regulation 86 of Table “A” to

the Companies Act, 1956 dealt with the question of interim dividend. The said Regulation empowered the directors to declare interim dividend. i.e. dividend in between two annual general meetings. The said amending Act introduced sub-Section 14A in Section 2 of the Companies Act, 1956 whereby interim dividend is now part of dividend. Accordingly, all provisions of the Companies Act, 1956 relating to dividend have become applicable to interim dividend also.

Section 205 of the Companies Act, 1956 has also been amended by the said amending Act to provide as follows: (i) The Board of Directors may declare interim dividend and the amount of dividend

including interim dividend shall have to be deposited in a separate bank account within five days from the date of declaration of such dividend. [Section 205(1A)]

(ii) The amount of interim dividend so deposited as stated above shall be used for payment of interim dividend. [Section 205(1B)]

(iii) The provisions of Sections 205, 205A, 205C, 206, 206A, and 207 of the Companies Act, 1956 have also become applicable to interim dividend to the extent possible. [Section 205(1C)]



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In view of the above legal position, the Board of Directors of RPP Ltd. must have deposited the amount of interim dividend declared on 29th May, 2009 into a separate bank account on or before 3rd June, 2009 i.e. within five days from 29th May, 2009 when the interim dividend was declared. As stated above, the amount once deposited into a separate bank account, can be used only for payment of interim dividend.

As per provisions of the Companies Act, 1956, the Board of RPP Ltd. has no power to revoke the interim dividend declared on 29th May, 2009 and shall not have any power to use the interim dividend amount transferred to a separate bank account for any other purpose.

In case the amount of interim dividend has not been transferred to a separate bank account and is not paid within the time, the company and its directors have exposed themselves to the applicable penal provisions of the said Act.

Question 5 SKD an employee of M/s Moreh Ltd. met with an accident and died. The accident occurred when SKD was on Company’s duty. He held one hundred S shares partly paid. Normally the Company has a first and paramount lien on the shares. The Board of Directors, however, relaxed the said provision with regard to the hundred shares held by SKD as a goodwill gesture on the part of the Company. Is the action of the Company valid? State the reasons. Also state whether the Company’s lien can be extended to dividend payable on such shares. (November 2009) Answer

A Company cannot have lien on shares unless provided in the Articles of Association. Therefore provision to this effect should be in the articles. As per Regulation 9 of Table A of the Companies Act, 1956 the Company has first and paramount lien on every share (which has not been fully paid up for all monies (whether presently payable or not) called or payable at a fixed time in respect of that share and on all shares which are not fully paid up standing registered in the name of a single person, for all moneys presently payable by him or his estate to the Company.

The Board of Directors may, however, at any time declare any share to be wholly or in part exempt from the said provision. Hence the decision of the Board of Directors of M/s Moreh Ltd to relax the provisions of lien in respect of shares held by SKD is in order and valid (Vide Regulation 9 of Table A). Further the Company’s lien is extended to all dividends payable on such shares as per regulation 9(2) of table A of the Companies Act, 1956.


Dividends (Sections 205 – 207)

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EXERCISE

Question 1 The agenda for the meeting of the Board of Directors of M/s. Packsafe Enterprises Ltd. held on 20-3-2010 for adopting the annual accounts for the year ended 31-12- 2009 included an item relating to payment of dividend. At the meeting it became apparent that the profits made during the year ended 31-12-2009 were inadequate to declare dividend. The Board was keen to maintain the rate of 20% dividend on the equity shares as declared in the previous years so as to maintain the image of the company. The company has some accumulated profits earned in previous years, which were transferred to reserves. Advise the company as to how it should go about to achieve the objective to pay dividend at the rate of 20% on the equity shares.

Answer Dividends out of past profits/reserves can be declared as per the Companies (Declaration of dividend out of Reserves) Rules, 1975. These Rules, inter alia, provide that the dividends to be declared out of reserves shall not exceed average of dividends declared during the last 5 years or 10% of its paid up capital whichever is less. Since, in the present case, it is proposed to declare dividend @ 20%, it shall not be possible without previous approval of the Central Government as per section 205A (3). The company is advised to make an application to the Central Government, seeking approval for payment of dividend at 20%. It is presumed that the paid-up capital of the company consists of only equity share capital.


CHAPTER 2

ACCOUNTS (SECTIONS 209 – 223)

Books of Accounts to be kept by company (Section 209) Question 1 The Board of Directors of M/s Bharat Ltd. has a practical problem. The registered office of the company is situated in a classified backward area of Maharashtra. The Board wants to keep the account books of the company at its corporate office in Mumbai which is conveniently located. The Board seeks your advice about the feasibility of maintaining the accounting records at a place other than the registered office of the company. Advice. (November, 2008) Answer According to Section 209 of the Companies Act, 1956 every company shall keep the books of accounts at its registered office. However, the books of accounts can be kept at such other places in India as the Board of directors may decide and when the Board of directors so decide, the company shall within 7 days of the decision file with the Registrar of Companies a notice in Form No. 23AA in writing giving full address of the other place. Thus in the present case, the company can follow the above procedure and keep its accounts book at Mumbai office. Question 2 The Board of Directors of a company propose to charge the Chief Accountant of the company with the duty of ensuring compliance with the provisions of the Companies Act, 1956 relating to maintenance of proper Books of account and preparation of Balance Sheet and Profit & Loss Account in accordance with the law. Draft a Board Resolution for this purpose.

What are the consequences in case of default, when such a resolution is passed? Is it possible for the Board of Directors to pass such a resolution, when the company is managed by Managing Director? (November, 2003) Answer Draft Board Resolution for charging a person with the duty of Compliance with the requirements of Section 209 & 211 of the Companies Act. Resolved that pursuant to section 209(7) and 211(8) of the Companies Act, 1956, Mr./Ms._______ Chief Accountant of the company be and is hereby changed with the duty of



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seeing that the requirements of Sections 209 and 211 of the Companies Act, 1956 are duly and fully complied with. Resolved further that the said Mr./Ms.__________ is hereby entrusted with the authority to do such Acts, through and deeds as may be necessary or expedient for the purpose of compliance with the requirements of the said Sections 209 and 211. Consequences in case of default: According to Section 209(6), the following persons are responsible to ensure that the company duly complies with the provisions of Section 209: (a) the managing director or managers of the company, if any; (b) all officers and other employees of the company; or (c) if the company has no managing director, every director of the company. Penalty for default is imprisonment upto 6 months or fine upto Rs.10,000/- or both, if the persons mentioned above fail to take all reasonable steps to ensure that the provisions of Section 209 are duly complied with by the company or default has been committed by their own wilful Act. Further a person shall be sentenced to imprisonment only if the offence was committed wilfully [Section 205(5)]. In any penal proceedings, it shall be a defense to prove that a competent and reliable person was charged with the duty of seeing that these requirements are complied with and that he was in a position to discharge that duty [proviso to Section 205(5)]. The person so charged with responsibility of compliance with provisions of Section 209 is punishable with imprisonment upto 6 months or fine upto Rs.10, 000/- or both [Sections 205(7)]. Similar provisions are therein Section 211 [Section 211(7) and (8)]. Hence the above Board resolution makes the Chief Accountant responsible for compliance with the provisions of Section 209 and Section 211. Even if the company is managed by Managing Director, it is possible for the Board of Directors to make the Chief Accountant responsible to ensure compliance with Sections 209 and 211 [Section 209(7) and Section 211(8)]. Managing Director may also charge the Chief Accountant with such duty by issuing a memo or office order. Question 3

An allegation was leveled against PQR Ltd. that the funds of the company are misused. Mr. Z, one of the Directors of the company wants to inspect the books of account of the company in order to ascertain whether the allegation was true. But since Mr. Z does not have the knowledge of accounting, he appoints Mr. A, his friend and a practicing Chartered Accountant to go through the books of account of the company on his behalf. The company seeks your advice as to whether Mr. A may be allowed to inspect the books of account of the company on behalf of Mr. Z. You are required to give your advice to the company on behalf of Mr. Z. You


Accounts (Sections 209 – 223)

2.3

are required to give your advice to the company keeping in view the provisions of the Companies Act, 1956.

What would be your advice if Mr. Z would have been a shareholder only and not a Director of the company? (May 2007) Answer

Section 209 (4) of the Companies Act 1956 provides that the books of account and other books and papers shall be open to inspection by any director during the business hours.

The right of inspection given by this sub-section is not so restricted that it can only be exercised personally by the director in Vakharia Vs Supreme General Film Exchange CO. Ltd it was held that a director is entitled to take inspection of accounts personally or through an agent provided that there is no reasonable objection to the person chosen and the agent undertakes not to utilize the information obtained by him for any purpose other than the purpose of his principal.

As the right of inspection is a statutory right given under this sub-section, a director who is prevented from or refused inspection may enforce his right through court.

As such, Mr. Z being the director, can appoint Mr., A to inspect the Books of accounts of the company.

In case Mr. Z is the member of the company

As per the provisions of the Act the board shall from time to time determine whether and to what extent and at what times and places and under what conditions or regulation, the accounts and books of the company, or any of them, shall be open to inspection of members not being directors. No member (Not being a director) shall have any right to inspection any account or books or document of the company except as conferred by law or authorized by the board or by the company in general meeting.

In case Mr. Z is a member of the company, he shall be able to inspect the books of account only if he is given such a right by ordinary resolution of the members or if authorized by the board. But even in such case Mr. Z would have to exercise the right personally and not through a proxy i.e. he can himself inspect the books but cannot ask Mr. A to inspect the books in his behalf. Question 4

A Public Company sought extension of time from the ROC for holding AGM upto a period of 3 months and it was granted. However, when the AGM was held and the accounts were presented, it was found that the annual accounts were upto a period beyond which it is permissible. The Company contended that since ROC granted extension of time for holding AGM up to a period of 3 months, the same would also be applicable for presentation of



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accounts as well. Referring to the relevant provisions of the Companies Act, 1956, whether the contention of the company shall/may hold good?

Answer While a company may hold its AGM in a year within the time limit of 15 months as provided by Section 166(1), it may still contravene Section 210. A company and its director may commit offences if it does not fulfil the three requirements and failure to comply with any of them constitute an offence unless an extension of time has been granted for h9olding the meeting by the ROC. However, the extension of time for holding the AGM is only with reference to the meeting and not to that of submission of accounts

Question 5 Advise: (a) XYZ Ltd. wants to maintain its books of account on cash basis; (b) It has a branch office outside India and wants to maintain accounts over there; (c) A shareholder of a company wants to inspect books of account. Would your answer be

different if he is acting as an agent of the director of the company? Answer a) In the absence of any express provision in the Act, hitherto it was open to a company to

maintain its accounts on 'cash basis' or 'accrual basis' or on hybrid basis i.e. partly on cash and partly on accrual basis. Under the Income-tax Act, an assessee can, even now, maintain its books of account by adopting any of the aforesaid methods. The controversy in so far as maintenance of accounts pursuant to the provisions of Companies Act, 1956 has now been set at rest by the amendment of sub-section (3) of section 209. Every company is now required to keep its books of account on accrual basis and according to the double entry system of accounting, popularly known as mercantile system of accounting which alone discloses a true and fair view of the state of affairs of a company.' The responsibility for the preparation of accounts giving a true and fair view of the company's financial statement is placed fairly and squarely on the shoulders of the directors’ (Caparo Industries plc vs. Dickman, (1990).

b) Maintenance of books of account. Books of account shall be maintained at the company's registered office unless the Board of directors decides to keep them at another place in India [Proviso to section 209(1)]. It will be the duty of the company to inform the Registrar of Companies within 7 days of the decision in case the Board decides to maintain books at a place other than the registered office. This has to be done by filing Form No. 23AA.



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Where a company has a branch office whether in or outside India, it may maintain books of account with respect to the transactions effected at such branch, at that branch itself. However, in such a case, proper summarized return made up at an interval of not more than three months should be sent to the registered office or to the other place where the Board has decided to keep the books of account.

c) The clear cut answer shall be 'no' except where he represents a director and the inspection is not malafide or for some ulterior motive or against the interest of the company. In Sugrabai Alibhain v. Amtee Properties (P) Ltd. [1984] 55 Comp Cas. 734 (Bom.), the Bombay High Court observed that a director is entitled to ask for inspection of books either personally or through an agent subject to the condition that the agent must give an undertaking to the company that he shall not pass on any information to any person other than the director who had appointed him to carry out the inspection.

Form and Contents of balance-sheet and profit and loss account (Section 211) Question 6 (i) Define the expression ”Accounting Standards” within the meaning of Companies Act,

1956.

(ii) XYZ Limited did not prepare its Balance Sheet as at 31st March, 2007 and the Profit and Loss Account for the year ended on that date in conformity with some of the mandatory Accounting Standards issued by the Institute of Chartered Accountants of India. You are required to stat with reference to the provisions of the companies Act, 1956, the responsibilities of directors and statutory auditor of the company in this regard. (May 2007)

Answer (i) As per sub-section (3c) of Section 211 of the Companies Act, 1956, the expression

“accounting standards” means the standards of accounting recommended by the Institute of Chartered Accounts of India Constituted under the Chartered Accountants Act, 1949 as may be prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards established under sub-section (1) of section 210 of the said Act.

Proviso to the above sub-section further the states that the standards of accounting specified by the Institute of Chartered Accountants of India shall be deemed to be the accounting standards until the according standards are prescribed by the Central Government under this sub-section.

(ii) Sub-Section (3A) of the said section states that every profit and loss account and balance sheet of the company shall comply with the accounting standards.

(a) the deviation from the accounting standards;



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(b) the reasons for such deviation; and (c) the financial effect, if any, arising due to such deviation.

Accordingly to sections 211 (7) and (8) read with section 209 (6) of the Companies Act, 1956 following persons are responsible for complying with the above requirements: (a) the managing director or manager of the company, if any, (b) all officers and employees of the company, and (c) if the company does not have a managing director or manager, then every

director of the company. In view of the above provisions of the Companies Act, 1956, the managing director/directors have a responsibility to ensure that in case of non-compliance of any mandatory Accounting Standard, proper disclosure is made in the profit & loss account and the balance sheet. Moreover, the board of directors is also required under section 217 of the companies Act, 1956 to include a Directors Responsibility Statement indicating therein that in the preparation of the annual accounts the applicable accounting standards have been followed along with proper explanation relating to material departures.

Responsibilities of auditors: As per section 227(3) (d) of the Companies Act, 1956, the statutory auditor’s responsibility is to state in his report, whether, in his opinion, the profit and loss account and balance sheet comply with the accounting standards referred to in sub-section 211 of the Companies Act, 1956. Financial year of holding company and subsidiary (Section 213)

Question 7

Sunrise Limited is a subsidiary company of Hotline Limited. The financial year of Sunrise Limited is 1st July to 30th June, whereas the financial year of Hotline Limited is from 1st April to 31st June, whereas the financial year of Hotline Limited is from 1st April to 31st march every year. To maintain uniformity and consolidation of annual accounts the Board of Directors of Hotline Limited decided that the accounting year of Sunrise Limited for the year 1st July,2007 to 30th June, 2008 be extended from present 12 months to 21 months i.e. 1st July,2007 to 31st March,2009.

Mention, in the light of the provisions of the Companies Act, 1956, the steps to be taken by the Hotline Limited in this regard (November 2003, May 2009)



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Answer EXTENSION OF FINANCIAL YEAR:

Where it appears to the Central Government that it is desirable for a holding company or a holding company’s subsidiary to extend its financial year so that the subsidiary’s financial year may end with that of the holding company, and for that purpose to postpone the submission of the relevant accounts to a general meeting , the Central Government may on the application or with the consent of the Board of Directors of the company whose financial year is to be extended, direct that in the case that company the submission of accounts to a general meeting, the holding of an annual general meeting or the making of an annual return, shall not be required to be submitted or made, earlier than the dates specified in the direction not withstanding anything to the contrary in the Companies Act, 1956 or in any other Act for the time being in force.

Thus the management can extend the financial year of Sunrise Limited from 12 months to 21 months. Following steps are required to be taken for this purpose. 1. To convene a meeting of the Board of Directors of Sunrise Limited whereat the

resolution for extending the financial year is to be passed so that the year ending matches with the year ending of Hotline Ltd.

2. To make an application under Section 213 of the Companies Act, 1956 to the Central Government giving full details and specific reasons for seeking the extension in year ending.

3. To attach the following to the application:- (a) A certified copy of the Last Balance Sheet and Profit & Loss Account of Hot Line

Limited and Sunrise Limited. (b) A certified copy of the Memorandum of Association and Articles of association of

both the companies. (c) A certified copy of the resolution of the Board of Directors proposing the

extension of the financial year. (d) Requisite fee payable to the Central Government under Rules.

Laying of Annual accounts and balance sheet Question 8 State giving reasons whether the following are true or false? The Board of Directors of ABC Ltd. wants to circulate unaudited accounts before the Annual General Meeting of the shareholders of the Company.



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Answer False. The accounts must be audited. Section 218 of the Companies Act, 1956 clarifies that any copy of balance sheet cannot be issued, circulated or published without the annexures and attachments. The attachments and annexures are – Profit and Loss account, balance sheet of subsidiary, auditor’s report and Report of Board of Directors. Thus, a balance sheet without auditor’s report or without report of Board of Directors cannot be issued, circulated or published. It, therefore, follows that unaudited accounts cannot be sent to members or unaudited accounts cannot be filed with the Registrar of Companies. Question 9 Sunshine Ltd., whose year ended on 31st March, held its annual general meeting on 30th September. The meeting transacted all other businesses except the accounts as they were not ready and adjourned the meeting to 20th December for consideration of accounts. The Registrar of Companies issued show cause notice for violation of section 210 of the Companies Act, 1956. Advice. Answer As per Section 166(1) of the Act, every company must hold its first annual general meeting within 18 months of its incorporation and subsequently one in each calendar year. Not more than 15 months shall elapse between the two annual general meetings. Powers are vested in the Registrar of Companies to grant extension of time up to 3 months for holding an annual general meeting for genuine reasons (Accounts not being ready is considered as a valid reason for this extension). Section 210(3)(b) provides that every company should lay before every subsequent annual general meeting its annual accounts within six months or the extended period for holding annual general meeting, if any, granted by the Registrar of Companies, from the date of closure of the accounts. In the given case, Sunshine Ltd. convened and held the annual general meeting within six months from date of closure of the accounts, but failed to lay the accounts within the six months and it had also not obtained permission for extension of time for holding annual general meeting under second proviso to sub-section (1) of Section 166 from the Registrar of Companies. Hence, it has violated the provisions of section 210 of the Act and Registrar of Companies was justified in issuing the show-cause notice. Authentication of balance sheet and P/L a/c (Section 215) Question 10 The Profit and Loss Account and Balance Sheet of Acre Limited has been signed by two directors A and B. The Board comprises of a third director C, who is also the Managing Director. The company has also employed a Full Time Secretary. Examine whether the authentication of the financial statements is in accordance with law. (May 2000)



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Answer Except in the case of a banking company, the balance sheet and profit and loss account of a company must be signed on behalf of the Board of directors by two directors and the Manager or Secretary, if any. If the company has a Managing Director, he should be one of the signing directors, as per Section 215. In the instant case, the profit and loss accounting and balance sheet have been signed by A and B, the directors. In view of Section 215 of the Companies Act, 1956, C, the managing director should be one of the two signing directors. Since the company has also employed a secretary, he should also sign the profit and loss account and balance sheet in addition to the managing director C, and one of the directors, either A or B. Directors’ Responsibility Statement [Section 217 (2 AA)] Question 11 The Companies (Amendment) Act, 2000 has prescribed an additional duty on the Board of Directors to include in the Board’s Report a `directors’ Responsibility Statement’. Explain briefly the details to be furnished in the said statement. (November, 2001) Answer The Companies (Amendment) Act, 2000 has prescribed additional duty on the board of directors to include in the director’s report the additional particulars by way of Directors’ responsibility statement. The details are:- (i) That in the preparation of the annual accounts the applicable accounting standards had

been followed along with proper explanation relating to material departures. (ii) That the directors had selected such accounting policies and applied them consistently

and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year and of the profit or loss of the company for that period.

(iii) That the directors had taken proper and sufficient care for the maintenance of adequate accounting standards in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities.

(iv) That the directors had prepared the annual accounts on a going concern basis. [Section 217 (2AA)]

Filing of Balance-sheet etc with the Registrar (Section 220) Question 12 The Annual General Meeting of M/s Robertson Ltd., for laying the Annual Accounts thereat for the year ended 31st March, 2010 was not held, as the accounts were not ready. In this context:



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(i) Advise the company regarding compliance of the provisions of Section 220 of the Companies Act, 1956 for filing of copies of Annual Accounts with the Registrar of Companies.

(ii) Will it make any difference in case the Annual Accounts were duly laid before the Annual General Meeting held on 27th September, 2010 but the same were not adopted by the shareholders? (May 2005)

Answer Under section 220(1) of the Companies Act, 1956, after the balance sheet and profit and loss account have been laid before the annual general meeting, three copies thereof be filed with the Registrar of Companies, within 30 days from the date on which the Accounts were laid at the Annual General Meeting. Where the Annual General Meeting for any year has not been held, the accounts shall be filed with the Registrar of Companies within 30 days from the latest date when the Annual General Meeting ought to have been held in accordance with the provisions of the Act, namely, sections 166 and 210 of the Act. Under section 220(2), it is also provided that if annual general meeting does not adopt the annual accounts or if the Annual General Meeting for any year is not held, a statement of that fact and of the reasons shall be annexed to the accounts filed with the Registrar of Companies. Accordingly, (i) In the present case though Annual General Meeting was not held, it ought to be held by

30th September 2010 under sections 166/210 of the Act. Thus, the balance sheet and profit and loss account for the year ended 31st March 2010 be filed with the Registrar of Companies by 29th October 2010 along with a statement that Annual General Meeting was not held by 30th September 2010 as the accounts were not ready.

(ii) Since the Annual General Meeting has been held in time on 27th September 2010, the balance sheet and profit and loss account as at 31st March 2010 be filed with the Registrar of Companies by 26th October 2010. A statement be also annexed to the balance sheet that the accounts were not adopted at the Annual General Meeting held on 27th September 2010 giving reasons there for.

Question 13 The Comptroller and Auditor-General of India made certain adverse comments on the audited financial statements of a Government company. Explain with reference to the relevant provisions of the Companies Act, whether it is possible for the government company to revise the audited but unadopted financial statements in the light of the adverse comments made by the Comptroller and Auditor-General of India and also whether it is necessary for the board of directors to give explanations in the board’s report in respect of such adverse comments. (May, 2000)



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Answer Rectification of accounts after completion of audit: The Institute of Chartered Accountants (Compendium of Guidance Notes, September 1985) has opined that it is entirely within the competence of the Board of Directors to amend the accounts already audited. Hence the original accounting statements may be revised to remove reservations of Comptroller and Auditor General (C&AG). Such revised statements should be resubmitted to the auditors before placing them before the annual general meeting. The Institute has recommended that in such cases, the auditor should ensure that all copies of the original set are returned to him, and he should also make an adequate disclosure of the fact of revision of accounts in the amended set.

Explanation by Board of Directors: Section 217(3) imposes a duty on the Board of Directors of a company to submit give the fullest information and explanations in the Board’s report regarding every reservation, qualification or adverse remark contained in the auditor’s report. In the absence of any similar specific provision regarding the comments of C&AG on the audit report of a government company, the Board of directors of such a company is not bound to give information or explanation in respect of such comments.

Even the C & AG’s comments would not have been required to be placed before the annual general meeting of a Government Company but for the express provisions contained in Section 619(5) of the Companies Act. Similar express provision would be necessary in the Act if it were intended that the provisions of Section 217(3) should also apply in the case of a Government Company. This is the view expressed by Department of Company Affairs in File No. 15/3/69 (G.C.). Hence the Board of Directors of a Government Company are not required to give explanations in the Board’s Report.

EXERCISE

Question 1 Can Books of Accounts of a company be kept anywhere in India?

Answer The books of account are required to be kept at the registered office of the company. However, the books can be kept at any other place in India as the Board of Directors may decide. In such a case, the company should file with Registrar of Companies a notice in writing giving the full address of the place where the books are kept. This notice should be filed within 7 days of the Boards’ decision.

Question 2 (a) Who are the persons who can inspect books of account?



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(b) Can a director make inspection of the books of account through an agent?

(c) Can a shareholder inspect books of account?

Answer The following persons have the right to inspect the books of accounts. (a) Directors of the Company [Section 209(4)] (b) Registrar of Companies (Section 209 A) (c) Such officer of Government as may be authorized by the Central Government in this

behalf (Section 209A). The books of account and other books and papers shall be open to inspection by any director during business hours. Inspection shall be made by the SEBI in respect of matters covered under sections referred to in Section 55A. Shareholder has no statutory right of inspection of the books of account unless the articles specifically provides for. Question 3 XYZ Limited did not prepare its Balance Sheet as at 31st March, 2009 and the Profit and Loss Account for the year ended on that date in conformity with some of the mandatory Accounting Standards issued by the Institute of Chartered Accountants of India. You are required to stat with reference to the provisions of the companies Act, 1956, the responsibilities of directors and statutory auditor of the company in this regard.

Answer Sub-Section (3A) of the said section states that every profit and loss account and balance sheet of the company shall comply with the accounting standards. (a) the deviation from the accounting standards; (b) the reasons for such deviation; and (c) the financial effect, if any, arising due to such deviation. Accordingly to sections 211 (7) and (8) read with section 209 (6) of the Companies Act, 1956 following persons are responsible for complying with the above requirements: (a) the managing director or manager of the company, if any, (b) all officers and employees of the company, and (c) if the company does not have a managing director or manager, then every director of

the company. In view of the above provisions of the Companies Act, 1956, the managing director/directors have a responsibility to ensure that in case of non-compliance of any mandatory Accounting



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Standards, proper disclosure is made in the profit & loss account and the balance sheet. Moreover, the board of directors is also required under section 217 of the companies Act, 1956 to include a Directors Responsibility Statement indicating therein that in the preparation of the annual accounts the applicable accounting standards have been followed along with proper explanation relating to material departures. Responsibilities of auditors: As per section 227(3) (d) of the Companies Act, 1956, the statutory auditor’s responsibility is to state in his report, whether; in his opinion, the profit and loss account and balance sheet comply with the accounting standards referred to in sub-section 211 of the Companies Act, 1956.


CHAPTER 3

AUDIT (SECTIONS 224 – 233B)

Re-appointment of retiring auditor [Section 224(1)] Question 1 Ram & Company was appointed as auditor of ABC Ltd. at the Annual General Meeting held on 30th September, 2004. Can Ram & Co. continue as auditor of the company in case the next annual general meeting has not been held in time? What would be the position in case the next annual general meeting was held on 30th September, 2005, but adjourned without considering the business of appointment or re-appointment of auditor? (November 2006) Answer Tenure of auditor The tenure of an auditor is laid down in section 224(1) of the Companies Act, 1956. It is from the conclusion of the annual general meeting to the conclusion of the next annual general meeting. Therefore, the tenure of office of the auditor does not expire on the last date on which the annual general meeting was due to be held in terms of Section 166. Hence Ram & Co. can continue as auditor even if the AGM for the year 2005 has not been held in time. In case AGM for 2005 was held on 30.9.05 that adjourned without considering the business of appointment or reappointment of auditor, the tenure of Ram and Co. will extend till the conclusion of the adjourned meeting. Question 2 Ceiling on number of audits [Section 224(1B)] Mr. Independent who is an individual auditor wants to compute the specified number of audits under the Companies Act, 1956 and for this purpose, he has drawn out a list of which identify, the company which shall be/not be taken into account for the purpose of calculating specified number of audits:

(i) Audit of Private Company

(ii) Guarantee companies not having share capital

(iii) Audit of non-profit companies

(iv) Special Audits

(v) Audits- of Foreign Companies



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(vi) Branch Audits

(vii) Company audit where he is appointed as a joint auditor

Further, he wants to know that as a member of the ICAI, whether there are any other restrictions on him as a member in the matter of inclusion/exclusion of audit of private companies for the purpose of calculating specified number of audit assignments. Advice.

Answer As per Section 224(1B) of the Companies Act, 1956, private companies have been exempted from the provisions with respect to ceiling on number of audits. Therefore, according to this section, only audit of public companies would be taken into consideration while computing the ceiling limit of number of audits. This, however, is subject to guidelines of the Institute of Chartered Accountants of India (ICAI) which provide restriction in respect of private companies as well. According to notification issued by ICAI, the specified number of audit assignments means- (a) in the case of a chartered accountant in practice or a proprietary firm of chartered

accountant, thirty audit assignments whether in respect of private companies or other companies.

(b) in the case of a firm of chartered accountants in practice, thirty audit assignments per partner in the firm, whether in respect of private companies or other companies. Provided that out of such specified number of audit assignments, the number of audit assignments of public companies each of which has a paid-up share capital of rupees twenty-five lakhs or more, shall not exceed ten.

Students may note that while the law excluded private companies from the specified limits but the ICAI has issued the above notification restricting the overall limit to 30 company audits including private limited companies. It may be noted that a member of ICAI who fails to comply with the notification shall be liable for professional misconduct In computing the specified number of audits for the purpose of Section 224(1B), the following audit shall not be taken into account: (a) Audit of private company. (b) Audit of Guarantee Companies not having share capital. (c) Special Audits. (d) Audit of Foreign Companies. (e) Branch Audits.


Audit (Sections 224 – 233B)

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Though the audit of private companies has been excluded for the purpose of calculating the specified number of audits, as a member of ICAI, the Audit of Private Companies will come under the purview of calculating the ceiling limit as a matter of self-regulation. Question 3 An audit firm, comprising of two partners, holds office as auditor of 41 private companies out of which paid-up capital of 20 companies exceeds Rs. 50 Lakh. Decide whether this is in consonance with the applicable law.

Answer As per Section 224(1B) of the Companies Act, 1956, private companies have been exempted from the provisions with respect to ceiling on number of audits. As per the section, an audit firm is entitled to 20 audits per partner (i.e. 40 audits in the given case) out of which not more than 10 companies per partner should be having paid-up capital of Rs. 25 Lakhs or more. The firm can do audit of any number of private companies. Thus, there is no problem in audit firm holding office of 41 private companies. Appointment of First auditor [Section 224(5)] Question 4 State the procedure for the following, explaining the relevant provisions of the Companies Act, 1956:

(i) Appointment of First Auditor, when the Board of Directors did not appoint the First Auditor within one month from the date of registration of the company.

(ii) Removal of Statutory Auditor (appointed in last Annual General Meeting) before the expiry of his term.

What difference it would make, if the Auditor was First Auditor appointed by the Board of Directors? (November, 2004) Answer (i) Section 224(5) of the Companies Act, 1956 lays down that the first auditor of a

company shall be appointed by the Board of Directors within one month of the date of registration of the company.

If the Board of Directors fails to exercise its power, the company in general meeting may appoint the first Auditor or Auditors.

Subsequently Auditor or Auditors of a company are appointed every year by the shareholders in annual general meeting by passing an ordinary resolution.

(ii) Auditor appointed in an Annual General Meeting may be removed from office before the expiry of his term only by the company in general meeting, after obtaining the previous



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approval from the Central Government in that behalf [Section 224 (7)]. Further the company has to follow the following procedure prescribed in Section 225 (2)

and (3) as explained below: No special notice under section 225 (1) is required for a resolution in the general

meeting to remove the auditor, hold the general meeting etc. The auditor shall be informed of the Board’s decision immediately. [Section 225 (2)]. The auditor can make a representation. The copy of the representation should be sent

to all the members to whom notice of meeting is sent. If the copy of the representation is not sent as it was received late or because of the company’s fault, the auditor may insist that the representation may be read at the meeting. [Section 225 (3)].

If company does not wish to send the representation to the members or read at the general meeting, the company has to apply to Central Government/Company Law Board. If Central Government/Company Law Board is satisfied that the right of representation is being misused by auditor to secure needless publicity for defamatory matter, the Central Government/Company Law Board may order that the representation need not be sent and the representation need not be read at the meeting. (Proviso to Section 225(3)].

An ordinary resolution is to be passed at the general meeting for the removal of the auditor.

The first auditors appointed by Board can be removed by the company at a general meeting. (Proviso (a) to Section 224 (5). The provisions in respect of removal as contained in Section 225 (2) & (3) are applicable for removal of first auditors also. (Section 225 (4). However, in case of removal of first auditor appointed by the Board of Directors, only an ordinary resolution is sufficient to remove the auditor and Central Government’s approval is not required. Question 5 Explain how the auditor will be appointed in the following cases:

(i) A Government Company within the meaning of Section 617 of the Companies Act, 1956.

(ii) The Auditor of the company has resigned on 31st December, 2003, while the Financial year of the company ends on 31st March, 2004.

(iii) A company, whose shareholders include the following:

(a) Bank of Baroda (A Nationalized Bank) holding 12% of the subscribed capital in the company.



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(b) National Insurance Company Limited (carrying on General Insurance Business) holding 10% of the subscribed capital in the company.

(c) Maharashtra State Financial Corporation (A Public Financial Institution) holding 8% of the subscribed capital in the company. (May, 2004)

Answer (i) The appointment and re-appointment of auditor in the case of a Government Company

is governed by the provisions of section 619 of the Companies Act, 1956. The said section states that the auditor of a Government Company shall be appointed or re-appointed by the Comptroller and Auditor General of India. Accordingly, the auditor of a Government Company shall be appointed by the Comptroller and Auditor General of India. The provision for appointment of auditor by Central Government on the advice of Comptroller and Auditor General of India has been amended by the Companies (Amendment) Act, 2000 with effect from 13.12.2000.

(ii) The situation as stated in the question is covered by the provisions of section 224(6) of the Companies Act, 1956. Clause (a) of the said section states that the Board of Directors may fill any casual vacancy in the office of an auditor, but proviso thereto states that where such vacancy is caused by the resignation of an auditor, the vacancy shall only be filled by the company in general meeting. Hence, in the case of resignation by the auditor, the company is required to convene and hold a general meeting and appoint the auditor thereat.

(iii) The case of appointment of auditor of a company whose 25% or more of the subscribed capital is held by Government, financial institutions, nationalised banks, General insurance companies is governed by the provisions of section 224A of the Companies Act, 1956. According to the provisions of the said section in the case of a company in which not less than twenty-five per cent of the subscribed share capital is held, whether singly or in any combination, by- (a) a public financial institution or a Government company or Central Government or

any State Government, or (b) any financial or other institution established by any Provincial or State Act in

which a State Government holds not less than fifty-one per cent of the subscribed share capital, or

(c) A nationalised bank or an insurance company carrying on general insurance business, the appointment or re-appointed at each annual general meeting of an auditor or auditors shall be made by a special resolution.

In view of the above provisions of the Companies Act, 1956, since the combined holding of the nationalised bank, general insurance company and the financial institution covered by the said provisions is 30% which exceeds the limit of 25% of the subscribed capital of



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the company, the company has to appoint its auditor in the Annual General Meeting by passing a special resolution.

Question 6 Parkash Carriers Limited appointed Mr. Raman as its auditor in the Annual General Meeting held on 30th September, 2009. Initially, he accepted the appointment.. But he resigned from his office on 31st October, 2009 for personal reasons. The Board of Directors seeks your advice for filling up the vacancy by appointment of Mr. Albert as auditor. Advise.

Also suggest the procedure to be adopted in case Mr. Albert is proposed to be removed from his office before the expiry of his term. (November 2009) Answer Under section 224(6) of the Companies Act, 1956, the Board may fill any casual vacancy in the office of an auditor. However, where such vacancy is caused by resignation of an auditor, the vacancy shall be filled by the company in general meeting. Thus, in the present case, the company may convene an Extra Ordinary General Meeting to appoint Mr. Albert as its auditor consequent upon the resignation by Mr. Raman. In term of section 224(7) of the Act, 1956, Mr. Albert may be removed from office before the expiry of his term only by the Company in General Meeting after obtaining previous approval of the Central Government. Auditors not to be appointed except with the approval of the company by special resolution in certain cases. (Section 224 A) Question 7 How would you deal with the following situations in the matter of appointment of Auditors?

(i) The shareholding of L.I.C. and U.T.I. increased from 23 per cent to 27 per cent of the subscribed share capital of the company after issue of notice of the Annual General Meeting, but before the date of the Annual General Meeting.

(ii) Ordinary resolution is passed at the Annual General Meeting of a company when a special resolution is required to be passed for appointment of Auditor?

(November, 2003) Answer (i) Section 224A of the Companies Act, 1956 provides that in case of a company in which

25 per cent or more of the subscribed share capital is held whether simply or in any combination by: (i) a public financial institution or a Government Company or Central Government or any State Government; or (ii) Any financial or other institution established by any provincial or State Act in which a State Government holds not less



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than 51 per cent of the subscribed share capital or (iii) a nationalised bank or an insurance company carrying on general insurance business, the appointment of an auditor shall be made by a special resolution only.

Section 224A does not specify the date on which 25 percent of the subscribed capital must be held by the specified institution(s). The Department of Company Affairs has clarified that the material date is the date of the annual general meeting at which the special resolution is required to be passed. Thus, even though, the shareholding of LIC and UTI increased beyond 25% only after issue of notice, Section 224A shall be required to be complied with. Fresh notice of the meeting shall become necessary.

(ii) If the company fails to pass a Special Resolution where it is required to be so passed for appointment of auditor, it shall be deemed that no auditor(s) had been appointed by the company at its annual general meeting and the Central Government will be empowered to make the appointment [Section 224A(2)].

Question 8 Provisions as to resolutions for appointing or removing auditors (Section 225) State the procedure for the following, explaining the relevant provisions of the Companies Act, 1956:

Removal of Statutory Auditor (appointed in last Annual General Meeting) before the expiry of his term.

What difference it would make, if the Auditor was First Auditor appointed by the Board of Directors? (November 2004) Answer Auditor appointed in an Annual General Meeting may be removed from office before the expiry of his term only by the company in general meeting, after obtaining the previous approval from the Central Government in that behalf [Section 224 (7)]. Further the company has to follow the following procedure prescribed in Section 225 (2) and (3) as explained below: No special notice under section 225 (1) is required for a resolution in the general meeting to remove the auditor. The auditor shall be informed of the Board’s decision immediately. [Section 225 (2)]. The auditor can make a representation. The copy of the representation should be sent to all the members to whom notice of meeting is sent. If the copy of the representation is not sent as it was received late or because of the company’s fault, the auditor may insist that the representation may be read at the meeting. [Section 225(3)].



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If company does not wish to send the representation to the members or read at the general meeting, the company has to apply to Central Government/Company Law Board. If Central Government/Company Law Board is satisfied that the right of representation is being misused by auditor to secure needless publicity for defamatory matter, the Central Government/Company Law Board may order that the representation need not be sent and the representation need not be read at the meeting. (Proviso to Section 225(3)]. An ordinary resolution is to be passed at the general meeting for the removal of the auditor. The first auditors appointed by Board can be removed by the company at a general meeting. (Proviso (a) to Section 224 (5). The provisions in respect of removal as contained in Section 225 (2) & (3) are applicable for removal of first auditors also (Section 225 (4). However, in case of removal of first auditor appointed by the Board of Directors, only an ordinary resolution is sufficient to remove the auditor and Central Government’s approval is not required. Disqualifications of auditors (Section 226) Question 9 (i) What is the liability of an auditor for failure to point out in his report that dividend is paid

out of capital?

(ii) Can an auditor be disqualified for indebtedness in the following cases?

(a) Where he is recovering his fees on a progressive basis even though the job is not complete.

(b) Where the auditor's firm has purchased goods from the auditee company and not paid for them for over six months. (May, 2003)

Answer (i) An auditor who is party to such payment of improper dividend to liable to proceedings

by action or in case of winding up, to misfeasance summons and that the improperly paid dividend may be recovered from him with interest.

(ii) (a) The Auditor cannot be said to be indebted within the meaning of section 226 (3)(d) of the Companies Act, 1956.

(b) In this case the auditor of the company is said to be indebted if the amount outstanding from him regarding goods and services purchase form the company audited by him exceeds Rs.1000/- irrespective of the nature of purchase or period of credit allowed to other customer. The provisions regarding disqualification of auditor as contained in section 225 (3) (d) will be attracted. (Guidance Note on Independence of Auditors). Also when the firm is indebted to the company each and every partner of the firm also is deemed to have been indebted.



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Powers and Duties of auditors (Section 227) Question 10 The auditors of PQR Ltd. accepted the Certificate of the Manager, a person of acknowledge competence and high reputation, as to the value of the stock in trade. The stock was grossly overstated for several years in the balance sheets of the company. As a result of this over valuation dividends were paid out of capital. The Auditors did not examine the books of account very minutely. If they had done so and compared the amount of stock at the beginning of the year. With the purchases and sales during the year, they would have noticed the over valuation. The company subsequently went into liquidation and the auditors were sued to make good the loss caused by the wrongful payment of dividends relying on the balance sheets figures. Based on the above facts, you are required to decide. With reference to the provisions of the Companies Act, 1956 and the decided case laws, the following issues:

(i) Whether auditors of the company will be liable for the loss caused to the company by the wrongful payment of dividends based on the Balance Sheets duly audited by the Auditors.

(ii) What are statutory duties of the Auditors in this regard? (November 2007) Answer The answer of the problem given in question is mainly relates to the duties of the auditors. Section 227 of the Companies Act, 1956 provides that the main duty of the auditor is to make a report to the members of the company on the accounts examined by him and the balance sheet and the profit and loss account of the company and on every document which is annexed to the balance sheet or profit and loss account laid before the company in general meeting. The auditor owes a duty to the members to stake whether the accounts give a true and fair view of the affairs of the company at the end of the financial year and of the profit and loss account of the year. The duty of an auditor is to give information in direct and express terms (Crichton’s Oil Co. Re (1902) 2ch 86) and not merely to arouse inquiry. If he discovers that any illegal or improper payment papers to have been made, his duty will be to tape it public by reporting. The auditor occupies a fiduciary position in relation to the shareholders and in auditing the accounts maintained by the directors, he must act in the best interest of the shareholders who are in the position of beneficiaries. But there is a limitation relating to perform the duties by the auditors. An auditor is not bound to be a detective, as loss laid to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watchdog but not a bloodhound. He is justified in believing tried servants of the company in whom confidence is placed by the company. He is entitled to assume that they are honest and to rely upon their



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representations, provided he takes reasonable care. If there is anything calculated to excite suspicion, he should probe it to the bottom, but in the absence of any thing of that kind he is only bound to be reasonable cautious and careful. The above problem is related to case of Kingston Mill Co. Re (No 2) (1896) 2 ch 279. In this case it was held that, the auditors were not liable. It is not auditor’s duty to take stock. There many matters in which he may rely on the honesty and accuracy of others. Further they (auditors) do not guarantee the discovery of all frauds. Signature of audit report, etc. (Section 229) Question 11 The auditors of a company refuse to make their report on the annual accounts of a company before it is signed on behalf of the board of directors. Advice the company. Answer The auditor is right. Theoretically, accounts are presented to auditors only after they are approved by the Board and signed by authorized persons. The auditor is only expected to submit his report on the accounts presented to him for audit. In practice, the checking of accounts is already completed before accounts are approved by the Board. Auditor informally approves the draft account with notes etc., before the accounts are approved by the Board. However, auditor signs the accounts only after these are approved by Board and signed by persons authorized by Board of the company. Power of Central Government to direct special audit in certain cases (Section 233A) Question 12 A group of shareholders approaches you for advice regarding the affairs of Fashion Apparels Ltd. According to the shareholders, the management of the company is not exercising its powers properly and that the statutory audit is being carried out in a routine manner. They want that a special audit should be conducted so that the real nature of transactions carried out by the management will come to light. Advice, with reference to the provisions of the Companies Act, 1956, as to when a special audit can be directed and by whom. (May 2001, November 2005, November 2006, May 2008) Answer According to Section 233A of the Companies Act, 1956 the Central Government has the power to direct special audit in certain circumstances. They are: (i) if the Government is of the opinion that the affairs of the company are not being

managed in accordance with sound business principles or prudent commercial practices; or

(ii) that the company is being managed in a manner likely to cause serious injury or damage to the interests of the trade, industry or business to which it pertains or



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(iii) that the financial position of the company is such as to endanger its solvency. Thus the group of shareholders can make a complaint about the affairs of Fashion Apparels Ltd., to the Central Government. If the Government is satisfied, it may order a special audit to be carried out either by the statutory auditors of the company or by any Chartered Accountant. The special auditor appointed under this section will have the same powers as an auditor of the company has under Section 227 of the Act. Question 13 A group of shareholders has approached you for advice regarding the affairs of LPM Paper Mills Ltd. According to them, the management of the company is not carrying out its functions in accordance with the prudent commercial practice and if the affairs of the company are allowed to run in future in the same manner, the company’s solvency would be in danger. They want that a Special Audit be conducted to find out the actual nature of the transactions.

(i) You are required to state with reference to the provisions of the Companies Act, 1956, as to when a special audit can be directed and by whom ?

(ii) Draft an application to be submitted to the appropriate authority in this respect.

(May 2008) Answer (i) Provision regarding Special Audit: Section 233A of the Companies Act, 1956 deals

with the matter relating to Special Audit. The Special Audit can be ordered by Central government if it is of the opinion:

(i) that the affairs of the company are not being managed in accordance with sound business principles or prudent commercial practices, or

(ii) that the company is being managed in a manner likely to cause serious injury or damage to the interests of the trade, industry or business to which it pertains, or

(iii) that the financial position of the company is such as to endanger its solvency.

Thus, the dissatisfied group of shareholders may make a complaint to the Central Government requesting for conducting the special audit. If the Central Government is satisfied that there exist sufficient reasons, it may order a special audit to be carried out by a Chartered Accountant who may or may not be company’s statutory auditor or who may or may not be in practice.



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(ii) DRAFT APPLICATION Dated ……………………….

To The Secretary, Ministry of Corporate Affairs, Government of India, New Delhi.

Sir, We, the undersigned, the shareholders of LPM Paper Mills Ltd. would like to bring to your kind notice that for a long time the affairs of the said company are not being managed in accordance with sound business principles and prudent commercial practices. We are of the view that certain expenditures which are being incurred by the company are not related to the business of the company and the company is not getting any benefit out of such expenses. Moreover, we have the apprehension that there are certain business transactions which are being entered into by the directors with the concerns which are owned by the relatives of the Directors and the prices charged for such transactions are not comparable with the prices charged by the other parties for similar transactions. If such state of affairs is allowed to be carried on for long, the financial position of the company will reach a stage where it will endanger its solvency. We feel that the modus operandi of the transaction is such that it may be difficult for the regular statutory auditor to detect them in course of normal audit. It is, therefore, prayed that the Central Government be pleased to appoint, pursuant to Section 233A of the Companies Act, 1956, a Special Auditor to properly audit the accounts of the Company and find the real nature of the transactions and determine the losses so far sustained and being sustained by the company on this account.

Yours faithfully 1…………………………… 2…………………………… 3…………………………… 4…………………………… 5…………………………… (Shareholders)



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EXERCISE

Question 1 How is the first auditor of a company appointed?

Answer The first auditor or auditors of a company shall be appointed by the Board of directors within one month of the date of registration of the company; and the auditor or auditors so appointed shall hold office until the conclusion of the first annual general meeting. However the company may, at a general meeting, remove any such auditor or all or any of such auditors and appoint in his or their places any other person or persons who have been nominated for appointment by any member of the company and of whose nomination notice has been given to the members of the company not less than fourteen days before the date of the meeting and if the Board fails to exercise its powers, the company in general meeting may appoint the first auditor or auditors. Question 2 Who is empowered to sign auditor’s report?

Answer Only the person appointed as auditor of the company, or where a firm is so appointed in pursuance of the proviso to sub-section (1) of section 226, only a partner in the firm practicing in India, may sign the auditor’s report, or sign or authenticate any other document of the company required by law to be signed or authenticated by the auditor.


CHAPTER 4

POWER OF REGISTRAR TO CALL FOR INFORMATION, ETC.

(SECTIONS 234 – 234A)

Power of Registrar to call for information or explanation (Section 234) Question 1 A group of creditors of M/s XYZ Co. Ltd. makes a complaint to the Registrar of Companies, New Delhi, alleging that the management of the Company is indulging in destruction and falsification of the accounting records of the Company. The complainants request the Registrar to take immediate steps to seize the records of the Company, so that the management may not be allowed to tamper with the records. Examine the powers, if any, of the Registrar in such circumstances. (November, 2001) Answer The power of Registrar of Companies to seize the records of a company is contained in Section 234 of the Companies Act, 1956. According to that section, if the Registrar has reasonable grounds to believe, upon information in his possession or otherwise, that the records of the company may be destroyed, mutilated, altered, falsified or secreted, he may make an application to the Magistrate of the first class or the Presidency Magistrate as the case may be having jurisdiction for an order for the seizure of the books and papers. After getting permission, the registrar has power to enter the place where the books and records of the company have been kept, and search and seize the books and papers as he considers necessary. The Registrar has to return back the books and papers within 30 days of seizure and he can place identification marks on the records and take copies or extracts from the records as he considers necessary. The Registrar has to follow the procedure laid down in Criminal Procedure Code relating to search and seizure of the records. [Section 234A (4)]. Seizure of Documents by Registrar (Section 234A) Question 2 The Registrar of Companies, West Bengal has received a complaint from a group of creditors of a company. The complaint alleges that the Directors of the company, in order to prevent the unearthing of their embezzlement of company’s funds, are engaged in falsification and



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destruction of original accounting books and records. The complaints urged the Registrar to seize the accounting books and records of the company so that the Directors may not be able to tamper the same. You are required to state the powers, if any, of the Registrar in this respect. (May, 2004) Answer The powers of the Registrar of Companies in respect of seizure of books and records of any company are governed by section 234A of the Companies Act, 1956. Sub-section (1) of the said section provides that if, pursuant to the information in his possession, the Registrar has reasonable ground to believe that books and papers of a company may be destroyed, mutilated, altered, falsified or secreted, the Registrar may make an application to the Magistrate of First Class or the Presidency Magistrate, as the case may be, having jurisdiction for an order for the seizure of such books and records. According to Section 234(2), the Magistrate, after considering the application and hearing the Registrar, may authorize the Registrar to do the following: (i) To enter the place or places where such books and papers are kept. (ii) To search the place or places in the manner as provides in the Magistrate’s order. (iii) To seize the books and papers as he considers necessary. Section 234(3) authorises the Registrar to keep the seized books and papers for a period of thirty days, after which the same have to be returned to the person from whom the seizure was made. But the Registrar is empowered, before returning the said books and papers, to take copies of or extracts from them or place identification marks on them or deal with them in the manner he considers necessary. Section 234(4) states that the Registrar, while conducting search and seizure, has to follow the provisions relating to search and seizure as prescribed in the Code of Criminal Procedure, 1898. In view of the above provisions of section 234A of the Companies Act, 1956, the Registrar of Companies is empowered to seize the books and papers of the company against whom the complaint has been made by following the procedure laid down in the section.


CHAPTER 5

INVESTIGATION (SECTIONS 235 – 251)

Investigation of company’s affairs in other cases (Section 237) Question 1 A majority of the Board of Directors of M/s High Value Infotech Ltd. have realised that some of the business activities carried out in the name of the company are not in the interest of either the company or its members. They want that the company should make an application to the Central Government to appoint an Inspector to carry out and so as to find out the whole truth. Explain the steps that should be taken to achieve the purpose and draft the application. (November, 2001, May 2005, May 2007) Answer According to Section 237 of the Companies Act, 1956 the Central Government shall appoint one or more persons as inspectors to investigate the affairs of the company if the company by a special resolution or the court by an order declares that the affairs of the company should be investigated. The Central Government may also appoint an inspector if in the opinion of the Company Law Board, there are circumstances suggesting that: (i) the business of the company is being conducted with intent to defraud creditors,

members or any other persons. (ii) the persons concerned in the formation of the company or the management of its

affairs have been guilty of fraud, misfeasance or misconduct towards the company or its members.

(iii) the members have not been given all information with respect to its affairs. Thus the directors of High Value Infotech Ltd have three options before them to get the company’s affairs investigated. Firstly, they can get a special resolution passed in a general meeting of the company. Secondly they can approach the court with a petition so that the court directs the Central Government to order investigation. The directors can also approach the Company Law Board with a petition. However, the Central Government may order an investigation on the recommendation of the Company Law Board. Thus the Central Government has a discretionary power in the last case; whereas in the first two instances the Central Government has no such discretion and it has to order the investigation.



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Draft Application: High Value InfoTech Ltd. (Address)

Dated 1st April, 2001 The Secretary, Department of Company Law Affairs, New Delhi Sir, At a meeting of the shareholders of the company, the members have passed the following special resolution unanimously: “Resolved that the Central Government be approached to appoint an Inspector to carry out an investigation whether the following activities carried out in the name of the Company is or is not in the interest of either the company or its members.

“(Name a couple of activities)” The said unanimous resolution was passed at an extraordinary general meeting of the Company held on 10th March, 2001. It is, therefore, prayed that the Central Government be pleased to appoint as per Section 237 of the Companies Act an inspector to investigate the affairs of the company regarding the matters mentioned in the above resolution and communicate its decision to the company. Yours respectfully, For and on behalf of High Value InfoTech Ltd. Secretary. Proceedings for recovery of damages or property (Section 244) Question 2 The report submitted by the inspector appointed under Section 235/237 of the Companies Act, 1956 to investigate the affairs of a Company revealed that substantial funds of the Company have been misappropriated by the Managing Director of the Company. The Central Government is of the opinion that effective action may not be taken the company for recovery of the funds misappropriated by the Managing Director. Examine with reference to the provisions of the Companies Act, 1956 the action that can be taken by the Central Government for recovery of damages or funds misappropriated by the Managing Director. (November 2009)


Investigation (Sections 235 – 251)

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Answer Section 244 of the Companies Act, 1956 provides that where from the inspectors’ report it appears that a fraud or misappropriation of property has been committed and the Company is therefore, entitled to bring an action for damages for misconduct or for the recovery of any property, which has been misapplied or wrongfully retained, the Central Government may itself in public interest bring proceedings for that purpose in the name of the Company. Thus, the Central Government is empowered to bring civil proceedings in the name of the Company in any case where it appears that such proceedings ought in the public interest to be brought, even if the company does not take such action. In such a proceeding, the inspector's report shall be admissible as evidence of the opinion of the inspection in relation to any matter contained in the report (Section 246). The Central Government should indemnify the company against any cost or expenses incurred by it or in connection with any proceedings brought by it. [Section 244 (2)]. Imposition of restrictions upon shares and debentures and prohibition of transfer of shares or debentures in certain cases (Section 250) Question 3 ABC Limited, over years, enjoys high reputation and its General Reserve is many times more than the paid up capital of the company. There is apprehension of cornering the shares of the company by some persons likely to result in change in the Board of Directors which may be prejudicial to the Public interest.

Advise, as to how can ABC Limited block the transfer of shares of the company under the provisions of the Companies Act, 1956. (May 2008, CA Final, New Course, May 2010) Answer Restrictions and Prohibition of transfer of shares or debentures: As per provisions of section 250(4) of the Companies Act, 1956, where the company Law Tribunal (Company Law Board till the Company Law Tribunal becomes operational, referred to as CLB hereinafter) has reasonable grounds to believe that a transfer of shares in a company is likely to take place whereby a change in the composition of the Board of Directors of a company is likely to take place and the CLB is of the opinion that any such change would be prejudicial to the public interest, the CLB may, by an order, direct that any transfer of shares in the concerned company during such period not exceeding three years, as may be specified in the order, shall be void. As per section 250 (1) & (2) of the Companies Act, 1956, if the CLB is of the view that there are good reasons to find out the relevant facts about any shares and the CLB is of the opinion that such facts cannot be found out unless the restrictions are imposed, as an interim measure, it may, by an order, direct that transfer of any such shares shall be void and no voting rights shall be exercised in respect of such shares. However, the CLB is empowered to vary or rescind its order any time.



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The facts given in the question squarely fall within the provisions of section 250 of the Companies Act, 1956. The management of ABC Ltd. may make a complaint to the CLB and convince it that the transfer of shares in favour of the group of unscrupulous persons would change the composition of the Board of Directors of the company which shall be prejudicial to the public interest and if the CLB is convinced with the plea of the company, it may pass an order as stated above which would block the transfer of shares as stated in the question.


CHAPTER 6

DIRECTORS (SECTIONS 252 – 323)

Constitution of Board of Directors (252- 266) Minimum Number of Directors (Section 252) Question 1 The Board of Directors of M/s ABC Limited, an unlisted company having a paid-up capital of Rs.6 crores consisting of equity share capital of Rs.5 crores and preference share capital of Rs.1 crore and also 1,100 ‘Small Shareholders’ holding equity shares seeks your advice on the following:

(i) Is it necessary for the Company to appoint a Director to represent the ‘Small Shareholders’?

(ii) In case the Company decides to appoint such a Director. The procedure to be followed by the company for such appointment and the period for which such appointment can be made.

(iii) Can such a director be removed by the Company before the expiry of his period of appointment without the consent of the ‘Small Shareholders’?

Advise explaining the relevant provisions of the Companies Act and the Rules.

(May, 2004, November 2008) Answer Director elected by small shareholders (1) A public company (i) having a paid up capital of Rs.5 crores or more; (ii) One thousand

or more shareholders, may have a director elected by small shareholders in the manner prescribed by rules [proviso to Section 252(1)].

(2) Paid-up capital includes both equity and preference share capital. In this case, the total paid up share capital including the preference share capital exceeds Rs.5 crores and the equity share capital is also Rs.5 crores. The company has also got more than 1000 small shareholders. Hence the provisions of Section 252(1) are applicable to this company.

(3) Since the words used in proviso to Section 252(1) are “may have a director “, the appointment of small shareholders’ director is voluntary Rule 4(1) of the Companies



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(Appointment of the Small Shareholders’ Director) Rules, 2001, a company can act suo motu to elect such director. It may also act upon notice of small shareholders and have proposed name of a person as director. However, if a notice is received from required number of shareholders, it will be mandatory to appoint small shareholders’ director, otherwise it is discretionary.

(4) The director in this case is the small shareholders’ nominee and he is elected by the small shareholders only in the manner provided in Rule 4. The director so elected is appointed by the company. (Rule 4(5). Small shareholders intending to propose to person shall give notice to company at least 14 days before meeting. The notice should be signed by at least 100 small shareholders and it must contain the prescribed particulars. The person whose name is proposed as director will sign and file with the company his consent in writing to act as a director (He must be a small shareholder). In case of unlisted company, appointment of small shareholder, director can be made at the general meeting, if may oath of small shareholders recommend his candidature for the post of director in the meeting.

A nominee director is normally removed by the person who has got authority to make such nomination [e.g. UTI, LIC nominee]. But in view of Rule 6(viii) relating to vacation of office, small shareholders director can be removed by the share holders at a general meeting under section 284 of the companies Act, 1956 before the expiry of his tenure.

He cannot be considered as a director appointed by the company in general meeting within the meaning of section 255. It can, therefore, be said that small shareholders’ director is like and nominee director.

(5) Small shareholders’ director can be appointed for a maximum period of 3 years subject to meeting the requirements of provisions of Companies Act except that he is not required to retire by rotation (Rule 4(6). But on expiry of his tenure, the same person, if so desired by small shareholders, may be elected for another period of 3 years [Rule 4(7)].

(6) He cannot be considered as a director appointed by the company in general meeting within the meaning of Section 255. It can, therefore, be said that small shareholders’ director is like and nominee director.

Question 2 Some small shareholders of TRG Ltd., a company listed with Mumbai Stock Exchange, want to appoint Mr. Raj, who is holding 1,000 Equity Shares of Rs.10 each in the Company as a Director as their representative on the Board of Directors of the said Company. You are required to state the relevant provisions of the Companies Act, 1956 in respect of such proposal to appoint Mr. Raj as a Small Shareholders’ Director. (November, 2004)


Directors (Sections 252 – 323)

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Answer The provisions of section 252 of the Companies Act, 1956, and the Companies (Appointment of Small Shareholders' Director) Rules, 2001 in respect of appointment of Small Shareholders' Director are as follows: (1) The provisions of appointment of Small Shareholders' Director are applicable to public

companies having paid-up share capital of Rs.5.00 Crores or more and having 1000 or more small shareholders. In case, TRG Ltd. is fulfilling both these conditions, then only its shareholders shall be eligible to proceed in the direction of appointing Mr. Raj as a Small Shareholders' Director. [Proviso to section 252 (1)]

(2) Small Shareholder for this purpose means a shareholder holding shares of nominal value of Rs. 20,000/- or less.[Explanation to section 252(1)].

(3) Small Shareholders who intend to propose Mr. Raj as a Small Shareholders' Director have to leave a notice of their intention with TRG Ltd. at least 14 days before the meeting and such notice has to be signed by at least 100 small shareholders.

(4) According to the rules, the person whose name is to be proposed for the post of Small Shareholders' Director should himself be a small shareholder. Since Mr. Raj is holding shares of nominal value of Rs.10,000/- only, which is less than Rs.20,000, he is eligible to be nominated as such.

(5) The said notice shall contain the name, address, number of shares held, of Mr. Raj whose name is to be proposed as a Small Shareholders Director and also that of other shareholders proposing Mr Raj.

(6) Before the meeting, Mr. Raj has to sign and file with TRG Ltd., his consent in writing to act as a director.

(7) Since TRG Ltd. is a company, which is listed with Mumbai Stock Exchange, it shall elect small shareholders' nominee through the postal ballot.

(8) On scrutinizing the postal ballot, if Mr. Raj secures the requisite number of votes, he will elected as a director for a term of 3 years and on expiry of the term shall be eligible to be re-appointed if small shareholders so wish at that time. However, he need not have to retire by rotation.

(9) Mr. Raj shall be treated as director for all other purposes except for appointment as whole time director or managing director.

Appointment of directors and proportion of those who are to retire by rotation (Section 255) & Ascertainment of directors retiring by rotation and filing of vacancies (Section 256)



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Question 3 A company has 11 directors on the Board consisting of the following:

(a) Mr. Active, Mr. Archive as nominees from two Public Financial Institutions.

(b) Mr. First, Mr. Second, Mr. Third appointed at the 2nd AGM.

(c) Mr. Fourth, Mr. Fifth appointed at the 3rd AGM.

(d) Mr. Addition was appointed as additional director subsequent to 3rd AGM.

(e) Mr. Casual was appointed as director in place of Mr. Soul who died and was earlier appointed during the 3rd AGM.

(f) Mr. Excellent was appointed as Managing Director for 5 years w.e.f. 2nd AGM.

(g) Mr. One more was appointed as additional Director soon after Mr. Addition was appointed as Additional Director.

List out in order, who shall be vacating the office at the 4th AGM of the company.

Answer Section 255 of the Companies Act, 1956, provides that unless the Articles provide for retirement of all the directors at every general meeting, not less than two-thirds of the total number of directors of a public company, or of a private company which is a subsidiary of a public company, shall retire by rotation. In terms of section 256 of the Act, one-third of the directors liable to retire by rotation shall retire at the Annual General Meeting of the Company. If the number of directors liable to retire by rotation is not three or a multiple of three, then the number of nearest to one-third shall retire from the office of director. In order to determine the directors who shall retire by rotation at every general meeting, it is provided that the persons who have been longest in office since their last appointment shall be liable to retire. As between the persons who became directors on the same day, the directors who shall retire may be determined by agreement among themselves. In the absence of any such agreement the persons liable to retire shall be chosen by lot. Of the 11 directors mentioned in the question, Mr. Active and Mr. Archive, who are nominees of Public Financial Institutions respectively, are non-rotational directors and are not liable to retire. Mr. Excellent being the Managing Director, is also not liable to retire. The position in regard to the remaining 8 directors is as under: (i) Mr. Addition & Mr. One More who were appointed as Additional Directors in subsequent

to 3rd Annual General Meeting respectively, shall vacate office on the date of 4th Annual General Meeting.

(ii) Mr. Casual was appointed in place of Mr. Soul who died and will, therefore, hold office till the date. Soul would have held office.



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(iii) Of the 6 rotational directors, [viz., Mr. First, Mr. Second, Mr. Third, Mr. Fourth, Mr. Fifth and Mr. Casual, 2 directors who constitute one-third, and who have been longest in office are liable to vacate office. Accordingly, two amongst Mr. First, second and third who were appointed in 1st AGM and have been longest in office, shall vacate office. Amongst themselves, either they can decide by mutual consent or by draw of lots.

Question 4 ABC Ltd annual general meeting has been scheduled in compliance with the requirements of the Companies Act, 1956. In this connection, it has some directors who are rotational and out which some have been appointed long back, some have been appointed on the same day.

Decide in this connection,

(a) Which of the directors shall be retiring by rotation and be eligible for re-election?

(b) In case two directors were appointed on the same day, how would you decide their retirement by rotation?

(c) In case the meeting could not decide how the vacancies caused by retirement to be dealt with, what shall be consequences?

(d) What will be your answer, assuming that the matter could not be decided even at the adjourned meeting?

Answer According to Section 256, out of the 2/3rds rotational directors only 1/3rds must retire by rotation at one general meeting. If the number is not three or multiple of three, then the number nearest to 1/3 must retire from office. First those directors who are the longest in office must retire. If two directors have been appointed on the same day, their retirement will be determined either mutually or by lot. The vacancies caused by such retirement may be filled in the same annual general meeting by appointing either the retiring directors or some other person. But the meeting may also decide that the vacancies shall not be filled. Where, however, the meeting has not done either of two, and then the meeting is deemed to have been adjourned for a week. If at the adjourned meeting held after the said week, fresh appointment is not made and if no resolution against appointment is passed, then the retiring directors shall be deemed to have been appointed except in the following cases: (a) Where at the meeting or at the previous meeting the resolution for the reappointment of a particular director was put to vote but lost; (b) where the retiring director has expressed his unwillingness to be reappointed by a written notice addressed to the company or its Board of Directors; (c) Where he is unqualified or has been disqualified for appointment; and (d) where any special or ordinary resolution is required for his appointment or reappointment.



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Question 5 The Articles of Association of M/s AB Ltd provides for five directors and all the five directors are in positions. How many directors are liable to retire at the ensuing annual general meeting? Will it make any different if Mr. A, a Whole Time Director is not liable to retire by rotation. Explain.

Answer Section 255 and 256 of the Companies Act, 1956 govern the retirement of directors. As per section 255, not less than two-thirds of the directors of a public company or of a private company which is a subsidiary company are liable to retirement by rotation. It would therefore, mean that one-third of the directors need not retire at the annual general meeting. In the question given, it is presumed that all the 5 directors are liable to retire by rotation. As per section 256, one-third of such directors for the time being are liable to retire by rotation or if the number if not three or a multiple of three, then the number nearest to one-third shall retire from office. The directors who are longest in office shall retire first. Keeping in view of the above provisions, where all the 5 directors are liable to retire by rotation, 2 directors ie. 1/3rd of 5(nearest) will retire by rotation, as this number is nearest to 1/3rd of 5. As per second part of the problem, if Mr A is not liable to retire by rotation, then, those liable to retire by rotation1/3rd of 4 (ie. rotational directors) and this work out to1. It means at the ensuing annual general meeting only one director will be liable to retire by rotation. Earlier, it was presumed that all the 5 directors were liable to retire by rotation. If, however, the articles provided that one-third of the directors would not be liable to retire by rotation, then only 2/3rd of 5 would be liable to retire by rotation at the every annual general meeting. It means onlt 3 out of 5 are liable to retire and out of these 3, 1/3rd (one) directors will be liable to retire by rotation at every annual general meeting. Question 6 ABC Company Ltd. in its First General Meeting appointed six Directors whose period of office is liable to be determined by rotation. Briefly explain the procedure and rules regarding retirement of these directors. Will it make any difference, if ABC Company Ltd. does not carry on business for Profit? (November, 2002) Answer According to section 255 of the Companies Act 1956, unless the articles provide for the retirement of all directors in every general meeting, at least 2/3rds of the total number of directors of the public limited company in question must, in the first place, be appointed,



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save as otherwise expressly provided in the Act by the company in general meeting; Secondly, they must be persons whose period of office is liable to be determined by rotation. According to section 256, out of 2/3rd rotational directors only 1/3rd must retire by rotation at one general meeting. If the number is not three or multiple of three, then the number nearest to 1/3 must retire from office. Yes it will make a difference if ABC company does not carry on business for Profit. Provisions of Section 256 do not affect those companies which do not carry on business for profit or those which by their articles prohibit the payment of dividend to their members. Such companies are not affected by Section 255 also which provides that at least 2/3rd of the directors shall retire by rotation while section 256 provides that 1/3rd of the retiring directors shall retire every year. Question 7 ADJ Company Limited has 10 directors on its board. Two of the directors have retired by rotation at an Annual General Meeting. The place of retiring directors is not so filled up and the meeting has also not expressly resolved 'not to fill the vacancy'. Since the AGM could not complete its business, it is adjourned to a later date. At this adjourned meeting also the place of retiring directors could not be filled up, and the meeting has also not expressly resolved 'not to fill the vacancy'.

Referring to the provisions of the Companies Act, 1956, decide:

(i) Whether in such a situation the retiring directors shall be deemed to have been re-appointed at the adjourned meeting?

(ii) What will be your answer in case at the adjourned meeting, the resolutions for re-appointment of these directors were lost?

(iii) Whether such directors can continue in case the directors do not call the Annual General Meeting? (May, 2010)

Answer Retiring director – When to be deemed director? In accordance with the provision of the Companies Act, 1956, as contained in Section 256(3) at the annual general meeting at which a director retires as aforesaid, the company may fill up the vacancy by re-appointing the retiring director or some other person thereto. If the place of retiring director is not so filled up and the meeting has not expressly resolved not to fill the vacancy, the meeting shall stand adjourned to same day in the next week, at the same time and place, or if that day is a public holiday, till the next succeeding day which is not a public holiday. If at the adjourned meeting also, the place of the retiring is not filled up and that



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meeting also has not expressly resolved not to fill the vacancy, the retiring director shall be deemed to have been re-appointed at the adjourned meeting, unless at the adjourned meeting or at the previous meeting a resolution for the re-appointment of such directors was put and lost. Therefore, in the given circumstances answer to the questions as asked shall be: (1) In the first case, applying the above provisions, the retiring directors shall be deemed to

have been re-appointed. (2) In the second case, where the resolutions were lost, the retiring directors shall not be

deemed to have been re-appointed. (3) In the third case the directors due to retire shall vacate their offices latest on the date

on which AGM was to be held. (B.R. Kundra v. Motion Pictures Association, 1976, 46 Comp. Cas. 339)

Right of persons other than retiring directors to stand for directorship (Section 257) Question 8 One of the members of ADB Ltd. has proposed the name of Mr. Fame for appointment as a Director of the Company in the Annual General Meeting and given a notice under Section 257 of the Companies Act, 1956. Mr. Fame is one of the partners of the Fame & Fame, Chartered Accountants, who are the retiring auditors of the company. But the audit of the company is being looked after by another partner of the firm. Examine whether Fame & Fame can be reappointed as auditors, if Mr. Fame is appointed as Director (May 2006) Answer Appointment of a partner of the company’s auditors as a director: Problem as asked in the question is based on the provisions of Companies Act, 1956 as contained in Section 2(30) read with Section 226(3)(b) and (c). Accordingly, Mr. Fame is appointed as a director of the company ‘Fame and Fame’ cannot be reappointed as company’s auditors. It is so because a director is an officer of the company within the meaning of section 2(30) of the Companies Act, 1956 and the audit firm becomes disqualified under section 226(3) (b) and (c) even if any of its partner is also an officer of the company. It is immaterial that the audit of the company is being looked after by another partner of the firm and not by Mr. Fame. Therefore, if Mr. Fame is appointed as a director of the company, ‘Fame and Fame’ cannot be reappointed as company’s auditors. Question 9 The management of ATP Ltd., a company listed with The Stock Exchange, Mumbai wants to appoint Mr. BDF as a Director of a Company at the Annual General Meeting of the Company to be held on 24th May, 2007. It maybe noted that Mr. BDF is not a retiring Director. The



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Management seeks you guidance regarding the procedure to be adopted for the purpose. You are required to state the procedure to be followed for giving effect to such proposal and formalities to be observed after appointment of Mr. BDF as Director, by the management of ATP Ltd., as per the provisions of the companies Act, 1956. (May 2007) Question 10 Mr. Wilson was appointed in ABC Ltd. as a director and he was to retire by rotation on 1st September, 2008. On account of some unavoidable reasons the annual general meeting of the company could not be held on the said date, nor the vacancy caused be retirement could be filled up at the adjourned meeting .State the relevant provisions of the Companies Act, 1956 and decide whether Mr. Wilson shall be deemed to be retired on 1st September, 2008 when the meeting was scheduled to be held or it will become a case of deemed reappointment. (November 2008) Answer DEEMED REAPPOINTMENT OF DIRECTOR: Section 256 of the Companies Act, 1956 deals with deemed re-appointment of a retiring director. The vacancies caused by retirement of a director by rotation should be filled up at the same meeting or at an adjourned meeting. If it is not so done, the retiring director shall be deemed to have been reappointed at such adjourned meeting except in the following cases- (i) at any previous meeting, a resolution for his reappointment was put to vote but was

lost, or (ii) the retiring director has, in writing expressed his unwillingness to continue, or (iii) he is not qualified or is disqualified for the said appointment, or (iv) a special or ordinary resolution is necessary for his appointment or reappointment by

virtue of any provisions of the Companies Act 1956, or (v) it is resolved to appoint two or more directors by a single resolution, or (vi) it is resolved not to fill the vacancy. In the instant case the above mentioned exceptions are not applicable and hence Mr. Wilson cannot be deemed to be retired. He is deemed to be re-appointed as director. The directors of a company are appointed by the shareholders at the general meeting. Though the retiring directors are normally re-appointed, it may sometimes become necessary to appoint a person other than the retiring director as director. The shareholders also have a right to propose the appointment of a person as a director. This power may be exercised in order to increase the strength of the Board or to permit the shareholders to exercise this important right available to them.



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In the case of private company which is not a subsidiary of a public company, the producers given below are not applicable and the appointment shall be in accordance with the Articles of Association. Procedure to be adopted:

1. A person, other than the retiring director, shall be eligible for appointment to the office of director only if he or some other member intending to propose him has, at least 14 days before the meeting, left at the office of the company a special notice in writing under his hand signifying his candidature for the office of director along with a deposit of Rs. 500 as required under section 257 of the Companies Act, 1956.

2. On receipt of the special notice, information should be sent to all the members of the company not less than 7 days before the meeting. Alternatively, an advertisement may be issued regarding the candidature or intention not less than 7 days before the meeting in at least in two newspapers circulating in the place where the registered office of the company is situated both in English and in the local language.

3. The resolution for the appointment should be move before the annual general meeting and an ordinary resolution should be passed for this purpose. If the resolution is not passed, no further action needs to be taken in this regard.

4. In case the resolution is passed, the deposit money is Rs. 500 should be refunded to the person who made the payment.

5. In the case of a listed company, copy of the minutes of the meeting and intimation regarding the appointment should be sent to each of the stock exchanges in which the securities are listed.

6. Within 30 days of the appointment, a return in Form No. 32 should be filed electronically, with the Registrar of Companies together with the prescribed filing fee.

7. The Company and the director has to complete the formalities as prescribed under Companies (Director Identification Number) Rules, 2006.

8. A genial notice of disclosure of interest in Form No. 24AA indicated the names of bodies corporate of which he is a director or member (holding more than 2% of paid-up capital) or firms in which eh is a partner should be obtained. The said disclosures should be placed before the Board and a resolution taking the notice on record should be passed. The notice shall expire at the end of the financial year but may be renewed by giving a fresh Form No. 24AA in the last month of the financial year in which it would otherwise expire.

9. Articles of Association should be check and in case it provides for acquiring of qualification shares, the same should be acquired within two months of appointment, if the new appointee does not hold the same.



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10. Particulars regarding directors should be entered in the Register of Directors and the Register of Directors’ Shareholdings.

Increase in the number of directors to require Government sanction (Section 259) Question 11 The maximum number of Directors of each of the following Companies as per their Articles of Association is 11.

(i) ABS Company Ltd.

(ii) DSP Trading Private Ltd.

(iii) Traders Association (a Company registered under Section 25 of the Companies Act, 1956)

(IV) Hindustan Paper Ltd. (a Government Company under Section 617 of the Companies Act, 1956)

The Board of Directors of the Company wants to increase the number of Directors to 15.

State with reference to the provisions of the Companies Act, 1956 whether the Directors can do so. (November, 2003) Answer According to the provisions of section 259 of the Companies Act, 1956, in the case of a company incorporated after 21st July, 1951, any increase in the number of its directors beyond the maximum fixed by its Articles of Association as originally adopted and registered and in the case of a company existing prior to that date, any increase in the number of directors shall not have any effect unless approved by the Central Government and it is to become void to the extent to which it is disapproved by the Central Government. However, such approval from the Central Government is not required if the number of directors is increased to 12 or less than that. From the reading of the provisions of the said section 259 of the Companies Act, 1956, it can be concluded that these provisions are applicable to only public companies or private companies which are subsidiaries of public companies. Based on the above provisions, following can be stated in respect of various types of Companies as mentioned in the question: In the case of ABS Company Ltd., the Directors have to obtain the approval of the Central Government for increasing the number of Directors from 11 to 15. In the case of DSP Trading Private Ltd., a private company; Traders Association, a section 25 company and Hindustan Paper Ltd. a Government Company, the provisions of section 259 of the Companies Act, 1956 are not applicable to them, hence the Directors of



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these companies can increase the number of Directors from 11 to 15 without approval of the Central Government subject to fulfilment of other procedural requirement. Question 12 As per their Articles of Association the maximum number of Directors of each of the following companies is 9:

(i) Goodheart Company Limited.

(ii) Frontline Trading Private Limited.

(iii) Hindustan Zink limited (a Government company under section 617 of the Companies Act, 1956).

The Board of Directors of the aforesaid companies proposes to increase the number of Directors to 15. Advise, whether under the provisions of the Companies Act, 1956, the Board of Directors can do so? (June 2009) Answer As per Section 259 of the Companies Act,1956, in the case of a company incorporated after 21st July, 1951, any increase in the number of its directors beyond the maximum fixed by its Articles of Association as originally adopted and registered and in the case of a company existing prior to that date, any increase in the number of directors shall not have any effect unless approved by the Central Government, and it is to become void to the extent to which it is disapproved by the Central Government , However, such approval from the Central Government is not required if the number of directors is increased to 12 or less than that. The above mentioned provision of the Companies Act, 1956 are applicable only to public companies or private companies which are subsidiaries of public companies. Based on the above mentioned provisions, following conclusion can be drawn in respect of companies as mentioned in the question. In the case of Good heart company Limited the Directors have to obtain the approval of the Central Government for increasing the number of Directors from 9 to 15. In the case of Front Line Trading Private Limited (Which is a Private company) and Hindustan Zink Limited (a Government company) the provisions of section 259 of the companies Act, 1956 are not applicable and hence the directors of these companies can increase the number of directors from 9 to 15 without the approval of the Central Government, subject to fulfillment of other procedural requirements Question 13 The Articles of Association of Rajasthan Toys Private Limited provide that the maximum number of Directors in the company shall be 10. Presently, the company is having 8 Directors.



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The Board of Directors of the said company desire to increase the number of Directors to 15. Advise whether under the provisions of the Companies Act, 1956 the Board of Directors can do so. (CA Final, New Course, May, 2010) Answer Increase in the number of directors: As per Section 259 of the Companies Act, 1956 in the case of a company incorporated after 21st July, 1951 any increase in the number of its Directors beyond the maximum fixed by its Articles of Association as originally adopted and registered ad in the case of a company existing prior to that date, any increase in the number of Directors shall not have any effect unless approved by the Central Government. However, such approval from the Central Government is not required if the number of Directors is increased to 12 or less than that. The above mentioned provisions of Section 259 of the Companies Act, 1956 are applicable only to public companies or private companies which are subsidiaries of public companies. In view of the above, since Rajasthan Toys Private Limited is a private company and it is also not subsidiary of any public company, the provisions of Section 259 of the Companies Act, 1956 are not applicable and the Board of Directors of the said company may increase the number of Directors without seeking approval of the Central Government. Additional Directors (Section 260) Question 14 The Articles of Association of a company have fixed the maximum strength of the board as 12 directors. At present the Board has 9 directors of whom 6 are liable to retire by rotation and 3 not liable to retire by rotation. The Board wishes to appoint 3 additional directors. Can they appoint as desired?

Answer As per Section 260 of the Companies Act, 1956, Board can appoint additional directors provided the Articles give power to the Board to appoint such directors, and provided the number of directors and additional directors shall not exceed the maximum strength fixed by the Articles. In the instant case, after the appointment of 3 additional directors, the total strength of the Board will go up to 12, which is within the maximum fixed by the Articles. Hence, Board can appoint the additional directors. Question 15 Can an additional Director Continue to be in office where the annual general meeting is not held as per Section 166?

Answer In Krishna Prasad Pilani vs. Colaba Land Mills Co. 29 Comp. Crs 273, it was observed that an additional Director shall vacate his office latest on the date on which the annual general meeting



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could have been held under Section 166. He cannot continue in office on the ground that the meeting was not held or could not be called within the time prescribed. Question 16 Can an additional Director be appointed in general meeting?

Answer Where the articles have conferred the power of appointing additional directors on the Board of Directors the company in a general meeting is precluded from appointing additional directors [Blair Open Hearth Furnance Co. vs. Reigart, (1913) 108 L.T. 665]. However, though in ordinary circumstances the company in general meeting is precluded from appointing such directors yet if owing to a deadlock or otherwise there is no board capable of making the necessary appointment the company in a general meeting may do so [Barrow vs. Potter, (914) 1 Ch. 895]. Question 17 Prince Ltd., desires to appoint an additional director on its board of directors. The Articles of the company confer upon the board to exercise the power to appoint such a director. As such M is appointed as an additional director. In the light of the provisions of the Companies Act, 1956, examine:

(i) Whether M can continue as director if the annual general meeting of the company is not held within the stipulated period and is adjourned to a later date?

(ii) Can the power of appointing additional director be exercised by the Annual General Meeting?

(iii) As the Secretary of the company what checks would you make after M is appointed as an additional director? (May, 2010)

Answer Section 260 of the Companies Act, 1956 empowers the Board of Directors, if authorized by the Articles to appoint additional directors, provided that such additional directors shall hold office only up to the date of the next AGM of the company, and the number of the directors including additional directors shall not exceed the maximum strength fixed for the Board by the Articles. These directors also must acquire the qualification shares within the statutory period of 2 months. The appointment of such directors must be in the interest of the general body of shareholders. (Anantha Lakshmi vs. Indian Traders Ltd. A 1953 Mad. 567).

Based on the above provisions answers to the given questions shall be as under: (i) M. cannot continue as director till the adjourned AGM, since he can hold the office of

directorship only up to the date of the next AGM. Such an additional director shall vacate his office latest on the date on which the AGM could have been held under



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Section 166. He cannot continue in the office on the ground that the meeting was not held or could not be called within the time prescribed. (Krishna Prasad Pilani v. Colaba Land Mills Co. 29 Comp. Case. 273)

(ii) Where the articles have conferred the power of appointing additional directors on the Board of Directors, the company in a general meeting is precluded from appointing additional director. (Blair Open Hearth Furnance Co. vs Reigart, (1913) 108 L.T. 665). However, though in ordinary circumstances the company in general meeting is precluded from appointing such directors yet if owning to a deadlock or otherwise there is no board capable of making the necessary appointment the company in a general meeting may do so. (Barrow v. Potter (914) 1 Ch. 895). Therefore, in ordinary circumstances the general meeting cannot exercise the power to appointment additional director.

(iii) As the Secretary of the company the following checks would be made after M is appointed as an additional director: (a) Whether the appointment was made by the Board? (b) Whether the maximum strength fixed for the Board was not exceeded by the

appointment? (c) Whether the additional directors held office only up to the date of the next AGM?

Filling of casual vacancies among directors (Section 262) Question 18 The Board of Directors of XYZ Limited appointed Mr. A as a Director in the casual vacancy caused by resignation of Mr. X. Mr. A is proposed to be re-appointed as a Director at the Annual General Meeting, when he vacates his office. Examine with reference to the relevant provisions of the Companies Act, 1956 whether Mr. A can be considered as a 'Retiring Director' and state the legal requirements to be fulfilled to give effect to the proposed appointment of Mr. A as a Director at the Annual General Meeting. (November, 2003) Answer Re-appointment of a person acting against the casual vacancy: If a person who is not a 'retiring director' is proposed to be appointed as a director at any annual general meeting, the formalities prescribed under section 257 of the Companies Act, 1956 are to be followed: The expression 'retiring director' appearing in sections 256 and 257 means a' director retiring by rotation'. (Explanation under Section 256). The expression 'a director retiring by rotation' refers only to a director appointed by the company in general meeting and retiring (Section 255 read with Section 256).



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If office of any director who was appointed at the general meeting is vacated before he is due to retire on normal course, such casual vacancy can be filled in by the Board of Directors [Section 262(1)]. The person so appointed would continue in office until the date when retirement of the original director in whose place the former is appointed would fall due in the usual course [Section 262(2)]. Hence the director appointed by the Board in a casual vacancy is not a 'retiring director' within the meaning of Section 257. When such a person is proposed to be appointed as a regular director in the annual general meeting, a notice to appoint him as director has to be received from the member under Section 257 at least 14 days before the meeting along with a deposit of Rs.500/-. The deposit will be refunded when the person succeeds in getting elected as director at the Annual General Meeting. Question 19 The Board of Directors of XYZ Ltd. filled up a casual vacancy caused by the death of Mr. P by appointing Mr. C as a director on 3rd April, 2009. Unfortunately Mr. C expired on 15th May, 2009 after working about 40 days as a director. The Board now wishes to fill up the casual vacancy by appointing Mrs. C in the forthcoming meeting of the Board. Advise the Board in this regard. (June 2009) Answer Section 262 of the Companies Act, 1956 authorises the Board of Directors to fill up casual vacancies if the office of any director appointed by the company in general meeting is vacated before his term of office and hence the appointment of C was in order. In normal course, C could have held his office as director up to the date to which Mr. P would have held but Mr. C expired on 15th May 2009 and again a vacancy has arisen in the office of director owing to death of Mr. C who was appointed by the board to fill up the casual vacancy. Hence the present vacancy cannot be considered as casual vacancy as stated in section 262 and therefore the board cannot fill up the same. The Board may however appoint Mrs. C as an additional director under section 260 of the Act provided the articles of association authorises the board to do so, in which case Mrs. C will hold the office until the conclusion of the next annual general meeting Appointment of directors to be voted on individually (Section 263) Question 20 XYZ Company Ltd. in its annual general meeting appointed all its directors by passing one single resolution. No objection was made to the resolution. Examine the validity of appointment of directors explaining the relevant provisions of the Companies Act, 1956. Will it make any difference, if XYZ Company was a private company? (May, 2003)



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Answer Section 263 (1) of the Companies Act 1956 requires that the appointment of every director shall be voted on individually. Thus two or more directors cannot be appointed by a single resolution. However an exception has been carried out where under if a resolution has been first passed to the effect that all the directors shall be appointed by a single resolution without any vote being against it. Any resolution, as per Section 263(2), in contravention of the aforesaid provisions shall be void whether or not objection was taken at the time of its being so moved. The aforesaid provision, however apply to a public company or a private subsidiary of a public company. Hence, the appointments so made are void. However if XYZ co. was a private limited company, then the condition of provision of Section 263(1)(2) were not applicable as regards the condition of single resolution is concerned. Consent of candidate for directorship to be filed with the company and consent to act as director to be filed with the Registrar (Section 264) Question 21 Mr. John has been appointed as Additional Director on the Board of MCX Ltd. on 12th January, 2006. Mr. John has filed his consent to Act as a Director, if appointed, only with the company. Examine with reference to the provisions of the Companies Act, 1956 whether he is also required to file his consent with the Registrar of Companies. (May 2006) Answer Filing of consent under section 264: Problem as asked in the question is based on the provisions of Section 264(1) and (2) of The Companies Act, 1956 and also the case ruling in Lalitbhai C. Kapadia Vs. Laljibhai B. Desai. Section 264(1) of the Companies Act, 1956 requires that a person proposed as a candidate for the office of director should file with the company his consent to act as a director, if appointed. Section 264(2) stipulates that a person shall not act as a director unless he has filed with the Registrar of Companies his consent in writing (Form No. 32) to act as such. Additional and alternate directors are not required to file consent under section 264(2) (Lalitbhai C. Kapadia v. Laljibhai B. Desai (1973) 43 Comp. Cases 17). Accordingly, applying the above provisions and the ruling of the case, John is not required to file his consent for accepting Additional Directorship. Question 22 Mr. Sachin was appointed as an additional Director of Conservative Finance Ltd. w.e.f. 1st October, 2009, in a casual vacancy by way of a circular resolution passed by the Board of Directors. The next annual general meeting of the company was due on 31st March, 2010, but the same was not held due to delay in the finalisation of the accounts. Some of the shareholders of the company have questioned the validity of the appointment of Mr. Sachin



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and his continuation as additional director beyond 31st March, 2010. Advise the company on the complaints made by the shareholders. (CA Final, New Course, May, 2010) Answer Appointment of director in a Casual vacancy: Section 262 of the Companies Act which deals with the filling of a casual vacancy provides that a director can be appointed only at a validly convened and constituted board meeting. Hence the appointment of Mr. Sachin by passing a circular regulation is not valid and the shareholders who made a complaint in this regard are correct. The tenure of a director appointed against a casual vacancy will be up to the date to which the original director in whose place he is appointed would have held office. On the other hand, an additional director appointed by the Board will hold office only up to the next date of annual general meeting and he cannot continue in office beyond the last date of the annual general meeting i.e; 31st March, 2010 on the ground the annual general meeting could not be held. (Krishna Prasad Pilani vs. Colaba Land Mills Co AIR, 1960, BOM, 312.) Appointment of directors by proportional representation (Section 265) Question 23 A company has in its Articles of Association provided for appointment of not less than two-thirds of the total number of its directors according to the principle of proportional representation. Can the directors so appointed be removed by the company in general meeting? Answer The articles of a public company or a private company which is subsidiary of a public company may adopt the principal of proportional representation for appointing not less than 2/3rd if the total number of the directors, whether by a single transferable vote or by a system of cumulative voting or otherwise. In such a case, appointments will be so made once in every three years and interim casual vacancies will be filled in conformity with the provisions of Sections 262 and 265. Cumulative voting denotes that if there are five candidates or distributes his five votes. He can cast all the five votes in favour of one candidate or distribute his five votes among different candidates. This system of voting ensures that the Board will have fair representation of the minority interest Resignation of Directors Question 24 Due to internal problems in the working of M/s Infighting Detergents Ltd., Mr. Satyam, the Executive Director, and Mr. Shivam, a Director, have submitted their resignations and decided to dissociate themselves with the working of the company. Mr. Sundram, the Managing Director, decides to refuse their resignations. Examine whether the Managing Director can compel Mr. Satyam and Mr. Shivam to continue as per the provisions of the Companies Act. (November 2001)



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Answer There is no provision in the Companies Act, 1956 relating to the resignation of his office by a director. If there is any provision in the articles giving the right to a director to resign at any time, the resignation shall take effect without any need for its acceptance by the Board or the Company in General Meeting. However, it is not clear what will be the position if the articles do not contain any provision relating to resignation of directors. One view is that the ordinary rule of common law as regards resignation by an officer or agent must be followed namely, resignation by notice given either to the Company or the Board and acceptance of the same. (Glossop V. Glossop; Latchford Premier Cinema Ltd. vs. Ennion). Another view is where the resignation says that it is to take effect immediately, acceptance is not necessary unless the articles or any provision of law makes it necessary. Further the directors do not have the power to refuse the resignation of the co-director unless such a provision is there in the Articles of Association. (Re. Neokratine Safety Explosives Co. of New Ltd. (1891). Hence in the absence of contrary provisions in Articles, the Company (i.e., Mr. Sundaram) cannot compel Mr. Shivam to continue as a director. However, the position is somewhat different in the case of a managing or whole time director. In such a case a formal acceptance of resignation by the company is essential so as to make it compete and effective. This is because the managing director occupies two positions (i) one that of a director and (ii) the other that of a whole time employee. An employee cannot give up office at his pleasure simply by giving notice. The notice or letter of resignation is required to be accepted by the company and the officer concerned has to be relieved of his duties and responsibilities, attaching to the office which he has resigned from. [Achutha Pai vs. Registrar of Companies (1956) 36 comp. Case 598]. Thus as the Executive Director, Mr. Satyam is full time employee of the company, the managing Director (Mr. Sundaram) can compel him to work as per the terms of employment agreed into at the time of appointment. Question 25 Mr. Raj, a director of POL Ltd., submitted his resignation from the post of director to the Board of Directors on 30th June, 2004 and obtained a receipt therefore on the same day. The Board of Directors of POL Ltd. neither accepted the resignation nor did it file Form No.32 with the Registrar of Companies. You are required to state whether Mr. Raj ceases to be the Director of POL Ltd. and if yes, since when? (November, 2004) Answer There is no provision in the Companies Act, 1956 relating to resignation from his office by a director. If there is any provision in the articles giving the right to a director to resign at any time, the resignation will take effect without any need for its acceptance by the Board



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of Directors or the company in general meeting in absence of a specific provision in the articles of association, a director can resign without being required to give reasonable notice. In T. Murari vs. State [(1976) 46 Comp. Cas. 613] the Madras High Court held that even in the absence of a provision in respect of resignation under the Companies Act, 1956 or under the articles of association of the company, the resignation tendered by a director or a managing director unequivocally in writing will take effect from the time when such resignation is tendered. The said judgement was followed by the same court in the case of S.S. Lakshman Pillai Vs. ROC (1997) 47 Comp. Cas. 652. In a judgement in the case of Mother Care (India) Ltd Vs. Prof. Ramaswamy P. Aiyar [(2004) 51 SCL 243] the Karnataka High Court observed that as the appointment of a director is not a bilateral character, the question of acceptance of the request to relinquish the office would arise and filing of Form No.32 in terms of section 303(2) of the Companies Act, 1956 is only a consequential act to be performed by the company in obedience of the statutory provision, but it is not an act to be complied with in order to make a resignation valid. Where the resignation letter states that it is to take effect on acceptance, or where the articles so require, acceptance is necessary to end the tenure of office of a director. In view of the above legal position, Mr. Raj has ceased to be a director of POL Ltd. with effect from 30th June, 2004, provided his resignation letter does not state that the resignation is to take effect on acceptance or the articles of POL Ltd. does not so require. DIRECTOR IDENTIFICATION NUMBER (SECTIONS 266A – 266G) Application for allotment of Director Identification Number (Section 266A) Question 26 What do you understand by the term “Director Identification Number” (DIN)? Describe the procedure to obtain the same as enumerated under the Companies Act, 1956 read with the relevant Rules. (May 2008, CA Final, New Course, June 2009) Answer Director Identification Number (DIN) is a Unique Identification Number given by the Ministry of Corporate Affairs. It is required to be obtained by every person who is intended to become a director of any company. DIN is a pre-requisite for filing various forms with the Registrar of Companies. The electronic system of the Ministry of Corporate Affairs will not allow filing / submitting the forms if DIN of the signatory director is not mentioned in the form being filed / submitted. In order to obtain DIN from the Ministry of Corporate Affairs following procedure is to be adopted:



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(i) To check whether the computer system through which the DIN Application is being made has the requisite hardware and the software as well as the internet facility.

(ii) Using the internet facility, DIN Application Form has to be downloaded from the website of Ministry of Corporate Affairs

(iii) The DIN application form is to be filled up and submitted electronically

(iv) On electronic submission of the DIN application form, a provisional DIN will be generated and displayed on the said application form.

(v) Thereafter, the form is to be printed, signed and submitted to the Ministry of Corporate Affairs – DIN Cell along with following papers/documents:

(a) Passport size photograph of the applicant duly attested by a Magistrate or a Notary Public or a practicing Chartered Accountant or a practicing Company Secretary or apracticing Cost Accountant or a Gazetted Officer.

(b) Attested copy of an one of the following as a proof of identify

(i) Passport

(ii) Election / Voter Identity card

(iii) Driving Licence

(iv) Income tax PAN card

(v) Ration Card

(vi) Any other document which will prove the identity of the applicant

(c) Attested copy of any one of the following as a proof of residence

(i) Passport

(ii) Election / voter identity card

(iii) Driving Licence

(iv) Ration Card

(v) Electricity Bill

(vi) Telephone Bill

(vii) Bank Account Statement

(viii) Any other document which will prove the identity of the applicant

On submission of the above, the DIN Cell of the Ministry of Corporate Affairs shall allot Final DIN and send an intimation letter to the applicant.



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MANAGING DIRECTORS (SECTIONS 267 – 269) Appointment of managing or whole-time director or manager to require Government approval in only certain cases (Section 269) Question 27 M/s Supreme Technologies Limited propose to appoint Mr. E and Mr. F as whole-time directors for a period of three years with effect from 1st June, 2003. The company proposes to pay a consolidated salary of Rs. 80,000 per month to each of them.

Mr. D, the managing director of the company, has been appointed for a period of five years with effect from 1st January, 2001 on a remuneration payable in the form of commission at the rate of five per cent of net profit subject to a minimum remuneration of Rs. 80,000 per month.

The effective capital of the company at the end of the financial year ending 31st December, 2002 is Rs. 4.5 crores and it has been increased to Rs. 5.5 crores on 1st April, 2003 by way of right issue of equity shares. The company did not repay public deposits on the date of maturity from 1st January, 2003 onwards, but the default was made good on 1st April, 2003.

The company seeks your advice on the steps to be taken to comply with the requirements of Section 269 read with Schedule XIII to the Companies Act, 1956 with regard to the proposed appointment of Mr. E and Mr. F as whole time directors. Advise explaining the relevant provisions. (May 2003) Answer Appointment of whole-time directors Mr. E and Mr. F are proposed to be appointed as whole time directors for a period of 3 years with effect from 1st June, 2003. Each of them will get a consolidated salary of Rs.80,000 per month. It has been stated that both of them satisfy the conditions laid down in Part–I of Schedule XIII. It is necessary to examine whether the proposed payment of remuneration is within the limits laid down under A or B or C of Section II of Part II of Schedule XIII in order to determine the legal requirements to be complied with to give effect to the proposed appointment of Mr. E and Mr. F as whole-time directors. The appointment is to be made on 1st June 2003. According to Explanation II (b) (of Schedule XIII), the effective capital shall be calculated as on the last date of the financial year preceding the financial year in which appointment is made. In this case the effective capital on 31-12-2002 is the last date of the preceding financial year is Rs.4-5 crores. The right issue of equity shares on 1st April 2003 is not relevant here for the purpose of ascertaining effective capital. According to Schedule XIII, Part II, Section II(A) if the effective capital is Rs. 1 crore or more but less than Rs. 5 crores monthly remuneration payable shall not exceed Rs.1,00,000. This ceiling shall apply for each M.D and/or whole-



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time director. The proposed minimum remuneration for each of the directors Mr. E and Mr. F and also the existing director Mr. D is only Rs.80,000 i.e. within the ceiling laid down in Schedule XIII, Part-II, Section II(A). It has been stated that the company has defaulted in repayment of public deposits during the period of 1st January 2003 to 31st March, 2003. According to proviso (ii) if the company has defaulted in repayment of debts including public deposits for a continuous period of 30 days during the preceding financial year (i.e. year 2002) before the date of appointment of the managerial person, then the appointment requires approval of Central Government as one of the conditions laid down in Schedule XIII, Part-II, Section II is not fulfilled. But as there was no default in this regard during the preceding financial year ended 31st December 2002, the company has fulfilled the above condition. Hence the following steps are to be taken to comply with the requirements under section 269 read with Schedule XIII. (i) If there is no remuneration committee, remuneration committee must be formed

consisting of at least 3 non executive independent directors including nominee directors, if any (explanation (iv)).

(ii) The remuneration payable to Mr. E and Mr. F must be approved by a resolution passed by the remuneration committee taking into consideration the matters specified on Explanation V (Proviso (i)).

(iii) Board meeting must be convened to appoint Mr. E and Mr. F as additional directors, if they are not directors and later on appoint them as whole-time directors on a consolidated salary of Rs.80,000 p.m.

(iv) A return in the prescribed form (Form 25C) must be filed with Registrar of Companies within 90 days form the date of such appointment. The form must be certified by the auditor of the company or the secretary of the company or by a secretary in whole-time practice, if there is no secretary. They must certify that the requirements of Schedules XIII have been complied with. [Section 269(2) read with Schedule XIII – Part –III, (2)].

(v) The appointment of Mr. E and Mr. F and remuneration payable to them must be approved by the company in general meeting by an ordinary resolution [Schedule XIII part III(i)]. There is no need to file Form No.25C once again after the general meeting at which the appointment is approved.

Question 28 Explain the action that can be taken by the Central Government, when a complaint is received from some shareholders of a Public Company that a person has been appointed as the Managing Director of the Company without seeking the approval of the Central Government,



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when such approval is required. Also examine the validity of the acts of the Managing Director, if the complaint is found to be true. (CA Final, New Course, November 2009) Improper appointment of Managing Director: On receipt of the complaint, if the Central Government is prima facie, of the opinion that the Managing Director has been appointed without approval of the Central Government, when in fact such approval was necessary, the Central Government may refer the matter to the Company Law Board (Tribunal) for decision [Section 269(7)]. The Company Law Board will issue show-cause notice to the Company as well as the concerned Managing Director [Section 269(8)]. The Company Law Board will hear the case, and if it comes to a conclusion that the appointment is in contravention of requirements of Schedule XIII, it will make an order to that effect [Section 269(9)]. On such order, the appointment of the concerned Managing Director shall be deemed to have come to an end. The person so appointed shall in addition to being liable to pay a fine of Rs 1 lakh, refund to the company the entire remuneration received by him between the date of his appointment and the passing of such an order [Section 269(10)]. But all acts done by him prior to the declaration of invalidity will be valid, if they are otherwise valid [Section 269(12)]. Resignation by MD Question 29 A is Managing Director of APAR Ltd. He gave his resignation letter to the Chairman of the Board of Directors on 31st December, 2005 and requested that he should be relieved immediately. When does the resignation of Mr. A take effect? (May 2006) Answer A director can resign from his office by serving a notice of his resignation upon the Company or the Board. There is no need for its acceptance by the Board or the Company. However, if a Managing Director resigns, he cannot give up his office at his pleasure simply by serving the notice. This is because he occupies two positions i.e., of a director and an employee. In case of Managing Director, the notice or letter of resignation is required to be approved or accepted by the company and he has to be relieved of his duties and responsibilities attaching to his office from which he has resigned. Similar views were accepted in the case of Achutha Pal vs. Registrar of Companies (1956) 36 Comp. Cases 598. Accordingly, in the given case, the resignation of A, the Managing Director shall be effective when approved or accepted by the company and he is relieved of his duties and responsibilities attaching to his office from which he has resigned.


CHAPTER 7

SHARE QUALIFICATION (SECTIONS 270 – 273)

Time within which share qualification is to be obtained and maximum amount thereof (Section 270) Question 1 Mr. A has been appointed as a director in a Public Limited Company? Referring to the provisions of the Companies Act, 1956 state:

(a) Whether the director should possess any share qualification?

(b) If so what is the number of share(s), which he should acquire and at what value?

(c) Whether the articles of the company can insist on the director for compulsory acquiring of share qualification?

Answer It is that number of shares which a shareholder must hold in order to be eligible for election as a director. The Companies Act, 1956 does not prescribe for any share qualification for a director. However, Regulation 66 of Table A provides that the qualification for being a director of a company is the holding of at least one share in the company. The articles of a company usually prescribe for such qualifications so that a director has a personal interest in the company. In the event of such a provision by the articles, it becomes incumbent on the part of every director to hold qualification shares and if does not hold them at the time of his appointment as director, he must acquire them within two months after his appointment as director. Any provision, made in the articles of the company requiring a person proposed for directorship to hold qualification shares either before appointment or within a third shorter than two months after his appointment will be void. The nominal value of qualification shares must not exceed Rs. 5,000 and if the nominal value of each share is Rs. 5,000 or more than the number of shares prescribed, as qualification will be only one. It is, of course, not necessary for any company to insist upon the holding of shares for the purpose of qualification for directors. For the purpose of share qualification, the bearer of a share warrant is not deemed to be the holder of the shares mentioned in the warrant (Section 270). A Director acting without qualification shares is punishable with fine, which may extend to Rs. 500/- for every day during which he continues as director (Section 272). The provisions relating to the share qualification of a director do not apply to a private company, unless it is subsidiary of a public



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company (Section 273): nor do they apply to directors appointed by the Central Government under Section 408. Question 2 Discuss the validity of the arguments of the Director in the following cases:

In the General Meeting of X Ltd., held on 2.5.2000, Mr. A was appointed as a Director. On that day, he was not holding any equity shares in X Ltd. As per the Articles of Association of X LTD, the share qualification is the holding of 500 equity shares. On 15.6.2000 Mr. A applied for 1,000 equity shares in X Ltd and the shares were allotted on 10.7.2000. Mr. A claims that he was holding the qualification shares within the time specified in Companies Act. (November, 2000) Answer Under Section 270 of the Companies Act, 1956, the director must obtain qualification shares within two months from the date of appointment. In this case, he was appointed on 2.5.2000 and therefore he must obtain qualification shares on or before 2nd July, 2000 but the shares were allotted on 10th July, 2000. Only after the date of allotment, he was looking those shares and not on the date of application. Therefore, the argument of A is not correct. Question 3 (i) The Articles of Association of MKP Limited incorporated with an Authorised Share

Capital of Rs.50 crores divided into 5 crore Equity Share of Rs.10 each contained the following clause:

“The qualification of a director shall be the holding of at least 1,000 Equity Shares in the Company and such a director, if not already so qualified shall have to obtain his qualification within a period of 30 days from the date of his appointment as a director.”

Examine the validity of the above clause in the light of the provisions of the Companies Act, 1956.

(ii) Redraft the above clause which would conform to the provisions of the Companies Act, 1956. (November, 2004)

Answer (i) The subject matter of the question is covered by the provisions of section 270 of the

Companies Act, 1956. The Companies Act, 1956 does not provide for any qualification for becoming a director of any company. According to the said section, any person appointed as a director is required to obtain the qualification if it is so provided by the Articles of Association of the company.

The said section states that in case the Articles of Association of a company provides


Share Qualification (Sections 270 – 373)

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for the qualification of a director, then such a director is required to obtain the requisite qualification within a period of two months from the date of his appointment as a director. The section further states that any clause in the Articles of Association requiring the director to obtain the qualification shares within a shorter time than two months shall be void.

The said section also puts a maximum limit on the qualification that can be prescribed by the Articles of Association. Such maximum limit being shares with nominal value not exceeding Rs.5,000 or in a case where the nominal value of one shares exceeds Rs. 5,000 then the qualification share shall be maximum one share.

Based on the provisions of section 270 of the Companies Act, 1956 as explained above, the clause in the Articles of Association as given in the question is void since it stipulates the obtaining of the qualification shares within a period of 30 days which is shorter than two months. Moreover the clause also violates the maximum limit of share qualification by prescribing the same to be 1,000 shares of Rs.10 each totaling Rs.10,000 which is more than the limit of Rs. 5,000 as prescribed in the said section.

(ii) The clause to be included in the Articles of Association regarding qualification of directors conforming to the provisions of the Companies Act, 1956 may be as follows:

“The qualification of a director shall be the holding of shares with a nominal value not exceeding Rs.5,000 or one share with a nominal value of Rs.5,000, and such a director if not already so qualified shall have to obtain his qualification within a period of two months from the date of his appointment as a director.”

Question 4 The Articles of Association of MKP Limited incorporated with an Authorised Share Capital of Rs.50 crores divided into 5 crores Equity Shares of Rs.10 each contained the following clause:

“The qualification of a director shall be the holding of at least 1,000 Equity shares in the Company and such a director if not already so qualified shall have to obtain his qualification within a period of 30 days from the date of his appointment as director.”

Examine the validity of the above clause in the light of the provisions of the Companies Act, 1956. (CA Final, New Course, June 2009) Answer The subject matter of the question is covered by the provisions of Section 270 of the Companies Act, 1956. The companies Act, 1956 does not provide for any qualification for becoming a director of any company. According to the said Section, any person appointed as a director is required to obtain the qualification if it is so provided by the Articles of Association of the Company.



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The said Section states that in case the Articles of Association of a company provides for the qualification of a director, then such a director is required to obtain the requisite qualification within a period of two months from the date of his appointment as a director. The Section further states that any clause in the Articles of association requiring the director to obtain the qualification shares within a shorter time than two months shall be void. The said Section also puts a maximum limit on the qualification that can be prescribed by the Articles of Association. Such maximum limit being shares with nominal value not exceeding Rs. 5,000 or in a case where the nominal value of one share exceeds Rs. 5,000 then the qualification share shall be maximum one share. Based on the provisions of Section 270 of the Companies Act, 1956 as explained above, the clause in the Articles of Association as given in the question is void since it stipulates the obtaining of the qualification shares within a period of 30 days which is shorter than two months. Moreover the clause also violates the maximum limit of share qualification by prescribing the same to be 1,000 shares of Rs.10 each totaling Rs.10,000 which is more than the limit of Rs. 5,000 as prescribed in the said Section. It is pertinent to note that as per Section 9 of the Companies Act, 1956, any clause in the Articles of Association of any company which is ultra virus the Act is void. Question 5 The Articles of Association of MKP Limited incorporated with an Authorised Share Capital of Rs.50 crores divided into 5 crores Equity Shares of Rs.10 each contained the following clause:

“The qualification of a director shall be the holding of at least 1,000 Equity shares in the Company and such a director if not already so qualified shall have to obtain his qualification within a period of 30 days from the date of his appointment as director.”

Examine the validity of the above clause in the light of the provisions of the Companies Act, 1956. (CA Final, New Course, June 2009) Answer The subject matter of the question is covered by the provisions of Section 270 of the Companies Act, 1956. The companies Act, 1956 does not provide for any qualification for becoming a director of any company. According to the said Section, any person appointed as a director is required to obtain the qualification if it is so provided by the Articles of Association of the Company. The said Section states that in case the Articles of Association of a company provides for the qualification of a director, then such a director is required to obtain the requisite qualification within a period of two months from the date of his appointment as a director. The Section further states that any clause in the Articles of association requiring the director to obtain the qualification shares within a shorter time than two months shall be void.



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The said Section also puts a maximum limit on the qualification that can be prescribed by the Articles of Association. Such maximum limit being shares with nominal value not exceeding Rs. 5,000 or in a case where the nominal value of one share exceeds Rs. 5,000 then the qualification share shall be maximum one share. Based on the provisions of Section 270 of the Companies Act, 1956 as explained above, the clause in the Articles of Association as given in the question is void since it stipulates the obtaining of the qualification shares within a period of 30 days which is shorter than two months. Moreover the clause also violates the maximum limit of share qualification by prescribing the same to be 1,000 shares of Rs.10 each totaling Rs.10,000 which is more than the limit of Rs. 5,000 as prescribed in the said Section. It is pertinent to note that as per Section 9 of the Companies Act, 1956, any clause in the Articles of Association of any company which is ultra virus the Act is void. Penalty (Section 272) Question 6 Mr. Busybody has been appointed as a Director of ACE Automobiles Limited on 2nd April, 2002. The articles of association of the company provide that the qualification of a director shall be holding of at least 10 shares in the company. Mr. Busybody applied for 10 equity shares of the company on 31st May, 2002. But the shares were allotted only at the Board meeting held on 19th August, 2002. Examine with reference to the relevant provisions of the Companies Act, 1956 whether Mr. Busybody has complied with the requirements relating to qualification shares. If not, what are the consequences? (May, 2003) Answer The Companies Act, 1956 does not provide for any share qualification of any director. But Regulation 66 of Table A provides that a Director must hold at least one share in the company. Usually the Articles of a company provides for holding qualification share by a Director. Where a share qualification has been prescribed in the Articles of a company which is a public company or a private company which is a subsidiary of a public company, the provisions of section 270 regarding holding of share qualification by a Director shall apply whereby such director must take his qualification share within 2 months after his appointment. If a person acts as a director without acquiring the qualification share in accordance with the provisions of section 270, he shall be punishable with fine which may extend to Rs.500/- for every day during which he continues to act as a director (Section 272). Moreover a director who fails to hold qualification shares is liable to vacate his office. (Section 283(i)(a). In this case, Mr. Busybody was appointed as Director of ACE Automobiles Ltd on 2nd April, 2002. He applied for shares of the company on 31st May, 2002 which was allotted only at the Board Meeting held on 19th August 2002. Unless the shares applied for by Mr. Busybody has



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been allotted in his favour it cannot be said that he held the shares before expiry of 2 months from the date of his appointment. Therefore Mr. Busybody must vacate his office of director. Question 7

The articles of association of DEF Ltd. mentioned in it that Mr. X and Mr. Y will act as directors of the company from the date of incorporation. The company was incorporated on 2nd January, 2007. The articles also provided that the directors will have to obtain qualification shares within one month from the date of appointment as director. Mr. X purchased the shares of the company on 28th February, 2007 and Mr. Y purchased on 28th March, 2007 thus violating the provisions contained in the articles. Having regard to the provisions of the companies Act. Examine the validity of the appointments of Mr. X and Mr. Y as directors. (November 2007) Answer Without prejudice to the restrictions imposed by section 266, it shall be the duty of every director who is required by the articles of the company to hold a specified share qualification and whom is not already qualified in that respect, to obtain his qualification within two months after his appointment as director [Section 270(1)] So it becomes incumbent on the part of every director to hold qualification share within the time specified and if he does not held the same at the time of his appointment as director he must acquire them within two months after his appointment as director. Any provision made in the articles of the company requiring a person proposed for directorship to hold qualification share either before appointment or within a shorter than two month after his appointment will be void. Here the provision in the articles of association to hold shares within one month shall be void. Keeping the above provision in consideration the appointment of Mr. X will be valid as he acquired the share before the expiry of two months. As far the appointment of Mr. Y is concerned he has failed to acquire the share within two-month period. As per section of 283(1)(a) the office of director shall become vacant if he fails to obtain the shares within the time specified in section 270(1) therefore Mr. Y shall have to vacate his office. Here the date of incorporation is taken as the date of appointment. Question 8

The Articles of Association of Sunrise Ltd. provide that the qualification of a director shall be holding of at least 10 shares in the company. Mr. Rao has been appointed as a director in the said meeting on 1st May, 2008. Mr. Rao applied for 10 equity shares of the company on 30th July, 2008. The said shares were allotted to him on 20th August, 2008 when the Board meeting was held.



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Discuss the relevant provisions of the Companies Act, 1956 in the matter of share qualification requirements and the consequences of non-compliance thereof. Also state whether Mr. Rao has complied with the requirements in this regard. (November 2008) Answer The Companies Act, 1956 does not provide for any share qualification of any director but Regulation 66 of Table ‘A’ provides that a director must hold at least one share in the company. Usually, the articles of the company provide for holding qualification shares by a director. Where a share qualification has been prescribed in the Articles of a company which is a public company or a private company which is a subsidiary of a public company, the provisions of Section 270 of the Companies Act, 1956 is applicable where under a director must take his qualification shares within 2 months after his appointment. Any provision in the articles of the company shall be void in so far as it requires a person to hold the qualification shares before his appointment as a director or to obtain them within a shorter time than two months after his appointment as such. The nominal value of the qualification shares shall not exceed Rs.5000/- or the nominal value of one share where it exceed Rs.5000/. A person acting as a director without acquiring qualification shares is punishable under Section 272 of the said Act. Moreover, a director who fails to hold qualification shares is also liable to vacate his office under Section 283 of the Companies Act, 1956. In the instant case Mr. Rao was appointed as Director of Sunrise Limited on 1st may 2008. He applied for shares of the company on 30th July 2008 which were allotted only at the Board meeting held on 20th August 2008. It can not therefore be said that he held the shares before expiry of 2 months from the date of his appointment. In view of this Mr. Rao must vacate his office as director as provided in Section 283(1)(a).


CHAPTER 8

DISQUALIFICATIONS OF DIRECTORS (SECTION 274)

Question 1 Whether the following persons can be appointed as a Director of a Public company:

(I) Mr. John, who has huge personal liabilities far in excess of his Assets and Properties, has applied to the court for adjudicating him as an insolvent and such application is pending.

(ii) Mr. Smith, who was caught red-handed in a shop lifting case two years ago, was convicted by a court and sentenced to imprisonment for a period of eight weeks.

(iii) Mr. Tom, a Former Bank Executive, was convicted by a court eight years ago for embezzlement of funds and sentenced to imprisonment for a period of one year.

(iv) Mr. Samuel is a Director of PQR Limited, which has not filed its Annual Returns pertaining to the Annual General Meetings held in the calendar years 2006, 2007 and 2008. Advice.

Answer All the cases stated above are based on the provisions of Section 274(1) of the Companies Act, 1956 dealing with disqualifications of directors. Based on the provisions of the said section, each case can be discussed as follows: (a) Section 274(1)(c) states that a person shall not be capable of being appointed as a

director of a company if he has applied to be adjudicated as an insolvent and his application is pending in the present case, Mr. John has applied to be adjudicated as an insolvent and his application is pending with the Court. Hence, he cannot be appointed as a Director of a Company – whether public or private.

(b) Section 274(1)(c) states that a person shall not be capable of being appointed as a director of a company if he has been convicted by a court of any offence involving moral turpitude and sentenced in respect thereof to imprisonment for not less than six months, and a period of five years has not elapsed from the date of expiry of the sentence. In the present case, although the sentence was only two years ago, but the period of sentence was only eight weeks, i.e., less than six months. Hence, Mr. Smith



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does not come under the prescribed disqualification and can be appointed as a director of a company.

(c) This case also falls within the provisions of section 274(1)(c). In this case the imprisonment was for a period of one year, i.e., for more than six months, but since more than five years have elapsed from the expiry of the sentence, Mr. Tom has come out of the prescribed disqualification and can be appointed as a director of a company.

(d) Section 274(1)(g) states that a person who is already a director of a public company which has not filed the annual accounts and annual returns for any continuous three years, then such a person shall not be eligible to be appointed as a director of another public company. In the present case, PQR Limited has failed to file only annual returns and not annual accounts. Hence, the disqualification for Mr. Samuel is not attracted and he can be appointed as a director.

Question 2 Mr. A is a director of ABC Limited failed to repay matured deposits from 1st April, 2001 onwards and the default continues. But ABC Limited is regular in filing annual accounts and annual returns. Mr. A is also a director of PQR Limited and XYZ Limited. Answer the following questions with reference to the relevant provisions of the Companies Act, 1956: (i) Whether Mr. A is disqualified under Section 274(1)(g) of the Companies Act, 1956 and

if so, whether he is required to vacate his office of director in PQR Limited and XYZ Limited.

(ii ) Is it possible for Board of Directors of DEF Limited to appoint Mr. A as an Additional Director at the board meeting to be held on 15th May, 2002? Would your answer be different if Mr. A ceased to be a Director of ABC Limited by resignation on 1st March, 2002?

State also the auditor’s responsibility with regard to reporting of disqualification under Section 274(1)(g). (May, 2002) Answer (1) A person who is already a director of a public company becomes disqualified for being

appointed as a director, if the concerned company has committed default on either of the two counts mentioned in sub-clauses (A) and (B) of section 274 (1) (g) of the Companies Act, 1956. In this case ABC Ltd., is regular in filing annual accounts and annual returns. But ABC Ltd failed to repay matured deposits from 1st April 2001 onwards and such failure continues for more than one year. Hence ABC Ltd committed default under section 274(1)(g)(B) and Mr. A, being a director of ABC Ltd is disqualified under Section 274(1)(g).


Disqualification of Directors (Section 274)

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This disqualification would come into operation only at the time of appointment or reappointment of Mr. A as a director in any other public company after the default has become effective. Hence Mr. A. need not vacate the office of director in PQR Ltd and XYZ Ltd as there is no such requirement either in section 274 or in section 283 which provides for vacation of office.

(2) According to proviso to section 274(1)(g), Mr. A is disqualified to act as director of any other public company for a period of 5 years from the date on which ABC Ltd. in which he is a director makes default under section 274(1)(g)(A) or 274(1)(g)(B). Hence, the Board of Directors of DEF Ltd cannot appoint Mr. A as additional director at the board meeting to be held on 15th May 2002.

The words ‘such a person is already a director of public company’ in section 274(1)(g) indicates that this disqualification would attach only if the two conditions are satisfied (i) either of the two defaults have taken place while the person was a director of the concerned public company and (ii) he holds that directorship at the time of his appointment/re-appointment in public company. The essential condition, therefore, is that a person should be a director of a public company at the relevant time when the default under sub-clause (B) takes place. The failure under sub-clause (B) takes place only when such failure continues for one year or more. If Mr. A ceased to be a director of ABC Ltd. by resignation on 1st March 2002, he would not attract disqualification for a period of 5 years from being eligible to be appointed as a director of any other public company. Hence Mr. A can be appointed as a director in DEF Ltd.

The auditor is required to state in his report whether any of the directors of the company, whether public or private are disqualified from being appointed as a director in terms of section 274(1)(g). [Section 227(3)(f)]. Section 274(1)(g) is applicable to appointment of directors both in public and private companies but the reporting will be limited to this directors of a company who are also directors of any public company.

Question 3 Mr. Ram is a Director of ABC Limited, XYZ Limited and PQR Limited. ABC Limited was regular in filing annual returns, but did not file annual accounts for the year ended 31st March, 2002. Further ABC Limited failed to pay interest on loans taken from a public financial institution from 1st January, 2002 onwards and also failed to repay the matured deposits on due date from 1st April, 2002 onwards.

Mr. Ram is proposed to be appointed as additional director of MN Limited on 1st June, 2003. MN Limited has sought a declaration from Mr. Ram to the effect that the disqualification specification Section 274(1) (g) of the Companies Act, 1956 is not applicable in his case. Mr. Ram seeks your advice on the following:



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(i) Whether it is in order for him to give the declaration sought by MN Limited in view of the defaults committed by ABC Limited.

(ii) Whether he can continue as a Director in XYZ Limited and PQR Limited and also seek reappointment when he retires by rotation at the annual general meetings of respective companies to be held in September, 2003.

Advise explaining the relevant provisions of the Companies Act, 1956. Would your answer be different, if Mr. Ram resigned his office of director in ABC Limited on 31st December, 2002? (May 2003) Answer According to Section 274 (1)(g) of the Companies Act, 1956, a person who is already a director of a public company becomes disqualified for being appointed as director; if the concerned company has committed default on either of the two counts mentioned below:- (i) The concerned public company has not filed the annual accounts and annual returns

for any continuous three financial years commencing on and after 1st April, 1999 or (ii) The concerned public company has failed to repay its deposit or interest on due date or

redeem its debentures on due date or pay dividends and such failure continues for one year or more.

Such a person is disqualified to act as a director of any other public company for a period of five years from the date on which the public company (in which he is a director) makes default as specified in the (A) or (B) above. Here Mr. Ram is a director of ABC Ltd. ABC Ltd was regular in filing annual returns but did not file annual accounts (i.e. Balance sheet and profit and loss accounts) for only one year i.e financial year ended 31st March 2002. The disqualification specified in 274(i)(g) (A) will not apply unless the company has committed defaults in respect of both the matters i.e annual returns and annual accounts for three consecutive financial years. Hence Section 274(i)(g)(s) is not attracted in this case. ABC Ltd. failed to pay interest on term loan taken from a public financial institution from 1.1.2002 onwards and also failed to repay matured deposits from 1.4.2002 onwards. The disqualification specified in sub-clause (B) will not apply unless the company has committed default in respect of loans from public financial institution is not covered under section 276(i) (g)(B). But as ABC Ltd has failed to repay its deposits on due date and the failure continues for more than one year, Mr. Ram is disqualified under section 274(1)(g)(B) and he cannot give the declaration sought by MN Ltd. In view of his disqualification u/s 274(I)(g)(B), Mr. Ram is not eligible to be appointed as additional director in MN Ltd. from 1st June 2003 onwards.



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The disqualification would come into operation only at the time of appointment or reappointment of Mr. Ram as director on any public company after the default has become effective. Till such time, Mr. Ram can continue to hold the office of director in all public companies in which he is a director. He need not vacate the office of director in XYZ Ltd and PQR Ltd. as there is no such requirement either in section 274(1)(g) or section 283(Section 283 stipulates the circumstances under which the office of a director shall become vacant). But Mr. Ram cannot seek reappointment on XYZ Ltd and PQR Ltd when he returns by rotation at the AGMs to be held in September, 2003. If Mr. Ram resigned his office of director in ABC Ltd. on 31st December 2002, he is not a director when the default u/s 274(i)(g)(B) becomes effective i.e. 31st March, 2003. Hence he can give the declaration sought by MN Ltd. He can also seek re-appointment as a director in XYZ Ltd. and PQR Ltd. when he retires by rotation. Question 4 State with reference to the relevant provisions of the Companies Act, 1956 whether the following persons can be appointed as a Director of a Public company:

(I) Mr. A, who has huge personal liabilities far in excess of his Assets and Properties, has applied to the court for adjudicating him as an insolvent and such application is pending.

(ii) Mr. B, who was caught red-handed in a shop lifting case two years ago, was convicted by a court and sentenced to imprisonment for a period of eight weeks.

(iii) Mr. C, a Former Bank Executive, was convicted by a court eight years ago for embezzlement of funds and sentenced to imprisonment for a period of one year.

(iv) Mr. D is a Director of DLT Limited, which has not filed its Annual Returns pertaining to the Annual General Meetings held in the calendar years 2001, 2002 and 2003. (May, 2004)

Answer All the cases stated in the question are based on the provisions of Section 274(1) of the Companies Act, 1956 dealing with disqualifications of directors. Based on the provisions of the said section, each case can be discussed as follows: (a) Section 274(1)(c) states that a person shall not be capable of being appointed as a

director of a company if he has applied to be adjudicated as an insolvent and his application is pending in the present case, Mr. A has applied to be adjudicated as an insolvent and his application is pending with the Court. Hence, he cannot be appointed as a Director of a Company – whether public or private.

(b) Section 274(1)(c) states that a person shall not be capable of being appointed as a director of a company if he has been convicted by a court of any offence involving



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moral turpitude and sentenced in respect thereof to imprisonment for not less than six months, and a period of five years has not elapsed from the date of expiry of the sentence. In the present case, although the sentence was only two years ago, but the period of sentence was only eight weeks, i.e., less than six months. Hence, Mr. B does not come under the prescribed disqualification and can be appointed as a director of a company.

(c) This case also falls within the provisions of section 274(1)(c). In this case the imprisonment was for a period of one year, i.e., for more than six months, but since more than five years have elapsed from the expiry of the sentence, Mr. C has come out of the prescribed disqualification and can be appointed as a director of a company.

(d) Section 274(1)(g) states that a person who is already a director of a public company which ahs not filed the annual accounts and annual returns for any continuous three years, then such a person shall not be eligible to be appointed as a director of another public company. In the present case, DLT Limited has failed to file only annual returns and not annual accounts. Hence, the disqualification for Mr. D is not attracted and he can be appointed as a director.

Question 5 Clever, a Director of ABC Ltd. Made default in filing of Annual Accounts and Annual Returns with the Registrar of Companies for a continuous period of three financial years ending 31st March, 2005. Referring to the provisions of the Companies Act, 1956 examine the validity of the following:

(i) Whether X can continue to be a Director of ABC Ltd. And also EF Ltd., where he is a Director. Also state whether he can be reappointed as a Director in ABC Ltd. as well as EF Ltd.

(ii) Would your answer be still the same in case X is a nominee Director of a Public Financial Institution?

(iii) What would be your answer in case the defaulting company (i.e. ABC Ltd.) is a Private Company? (May 2006)

Answer In accordance with the provisions of Section 274(1)(g) a person shall not be capable of being appointed as director of a company if such person is already a director of a public company, which – (A) has not filed the annual accounts and annual returns for any continuous three financial

years commencing on and after the first day of April, 1999; Provided that such person shall not be eligible to be appointed as a director of any

other public company for a period of 5 years from the date on which such public



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company, in which he is a director failed to file annual accounts and annual returns under this clause.

Applying the above provisions as contained in Section 274(1)(g), answers to the given questions are: 1. In the given case, Mr. Clever, the Director of ABC Ltd. is disqualified to be

appointed as Director of other public companies for a period of 5 years from the date on which default has been committed.

2. In the second case, Mr. Clever, as a nominee of the Public Financial Institution, shall not be disqualified to be appointed as Director for the reason that the Public Financial Institutions and are exempted from the provisions of Section 274(1)(g) of the Companies Act, 1956.

3. A director of a private company is not disqualified even if that company is a defaulter in filing return.

Mr. Clever does not cease to be a director in ABC Ltd. and EF Ltd. immediately because Section 283 which provides for ‘vacation of office’ has not been amended. He can continue as a director till his term ends. But he can be reappointed in the defaulting company ABC Ltd., but not in EF Ltd. as the disqualification applies only to ‘any other public company’.

Question 6 Mr. John is a director of MNC Ltd., which had accepted deposits from public. The Financial position of MNC Ltd. turned very bad and it failed to repay the deposits which fell due for payment on 10th April, 2007 and such repayment has not been made till 5th May, 2008. Another company JKL Ltd. wants to appoint the said Mr. John as its director at its annual general meeting to the held on 6th May, 2008. You are required to state with reference to the provisions of the Companies Act, 1956 whether Mr. John can be appointed as a director of JKL Ltd. (May 2008) Answer Section 274(1) (g) of the Companies Act, 1956 states that where a person is a director of a public company which has failed to repay its deposit on due date and such failure continues for one year or more, then such person shall not be eligible to be appointed as a director of any other public company for a period of five years from the date on which such public company, in which he is a director, failed to repay its deposit. In the instant case, MNC Ltd., has failed to repay its deposit on due dates and the default continues for more than one year. Hence, Mr. John will not be eligible to be appointed as a director of JKL Ltd. Question 7 Mr. Ramanathan is a Director of Fraudulent Ltd, Honest Ltd. and Regular Ltd. For the financial year ended on 31st March,2008 two irregularities were discovered against fraudulent



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Ltd. for the financial year ended on 31st March,2008 two irregularities were discovered against Fraudulent Ltd. Fraudulent Ltd. did not file its annual accounts for the year ended 31.3.2008 an failed to pay interest on loans taken from a financial institution for the last three years. On 1st June, 2009 Mr. Ramnathan is proposed to be appointed as additional director of Goodwill Ltd, which company has sought a declaration from Mr. Ramnathan and he also submitted the declaration stating that the disqualification specified in Section 274 of the Companies Act,1956 is not attracted in his case. Decide under the provisions of the Companies Act: (i) Whether the declaration submitted by Mr. Ramanthan to Goodwill Ltd. is in order? (ii) Whether Mr. Ramnathan can continue as a Director in Honest Ltd. and Regular Ltd.?

(June 2009) Answer According to section 274 (1) (g) of the Companies Act, 1956, a person who is already a Director of a public company becomes disqualified for being appointed as Director, if the concerned company has committed default on either of the two counts mentioned below:- (a) The concerned public company has not filed the annual accounts and annual return for

any continuous three yeas (financial) commencing on and after 1st April, 1999 or. (b) The concerned public company has failed to repay its deposits or interests on due date

or redeem its debentures on due date or pay dividend and such failure continues for one year or more.

Such a person is disqualified to act as a Director of any other public company for a period of five years from the date on which the public Company make default as specified above. Here Mr. Ramanthan is a Director of Fraudulent Limited. Fraudulent Limited was regular in filing Annual returns but did not file annual accounts for only one year i.e. financial year ended 31st March, 2008. The disqualification will not apply unless the company has committed defaults in respect of both the matters for three consecutive financial years. Hence the provision of section 274 is not attracted. The disqualification specified in sub-clause (b) is not applicable in matter of loans from public financial institutions. In view of this Mr. Ramnathan is eligible to be appointed as additional Director in Goodwills Limted and declaration submitted by him is in order The disqualification if any would come in to operation only at the time of appointment or reappointment Hence Mr. Ramnathan can continue as director of Honest Ltd and Regular Ltd. Question 8 Mr. Ravindranathan is holding the post of Director in three companies out of which Goodluck Colours Limited is one. For the financial year ended on 31st March, 2009, Goodluck Colours



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Limited failed to pay interest on loans taken from a financial institution and also failed to repay the matured deposits. On 1st June, 2009 Mr. Ravindranathan accepting the post of Additional Director in Soma Footwear Limited, submitted a declaration that the disqualification specified in Section 274 of the Companies Act, 1956 is not applicable in his case. Decide whether the declaration submitted by Mr. Ravindranathan to Soma Footwear Limited is in order. (CA Final, New Course, May 2010) Answer According to Section 274(1)(g) of the Companies Act, 1956 a person who is already a director of a public company becomes disqualified for being appointed as Director if the concerned public company has failed to repay its deposits or interest on due date o pay dividend and such failure continues for one year or more. The disqualification specified in Section 274(i) (g) of the Companies Act, 1956 is not applicable in matters of loan from public financial institutions. But Goodluck Colours Limited has failed to repay its deposits on due date and the said failure continues for more than one year, Mr. Ravindranathan is disqualified under the said section of the said Act. The declaration submitted by him is not in order and he is not eligible to the appointment as Additional Director in Soma Footwear Limited.


CHAPTER 9

RESTRICTIONS ON THE NUMBER OF DIRECTORSHIPS (SECTIONS 275 – 279)

No person to be a director of more than fifteen companies (Section 275) Question 1 Mr. Influential is already a director of 19 companies. He is being appointed as a director of another company named M/s Expensive Remedies Ltd. Advise Mr. Influential in regard to the following:

(i) Restrictions on the number of directorships to be held by an individual and whether he can accept the new appointment in view thereof.

(ii) What are the companies to be excluded for the purpose of calculating the ceiling on the appointment of directors? (November, 2001)

Answer (i) After the commencement of the Companies (Amendment) Act, 2000, (i.e, w.e.f.

14.12.2000), no person, shall save as otherwise provided in section 276, hold office at the same time as director in more than 15 companies (Section 275). Earlier the limit was 20 companies.

For calculating the limit certain companies are to be excluded as provided in section 278(1).

Any person holding office as Director in more than 15 companies immediately before the commencement of the Companies (Amendment) Act, 2000, has to make a choice of 15 companies in which he wishes to continue as Director. He has to make this choice within 2 months from the commencement of the Companies (Amendment) Act, 2000 (i.e. 12.2.2001) [Section 276(1)]. No such person shall act as a director in more than 15 companies after the expiry of 2 months from the commencement Companies (Amendment) Act, 2000 [Section 276 (3) (1)].

In view of the above, it is not possible for Mr. Influential to be a director in 19 companies after excluding the companies listed in section 278 (1). In the absence of information about companies, it is not possible to ascertain the exact number of directorship held by Mr. Influential for the purpose of section 275.



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There are two possibilities. Either Mr. Influential is a director in less than 15 companies (say 14 Companies) or 15 Companies. If he is a director in 14 Companies he can accept the directorship of M/s Expensive Remedies Limited. If he is already a director in 15 companies, he must within 15 days of his appointment as a director in M/s Expensive Remedies Ltd., relinquish any of his directorship. If he does not exercise the option within 15 days and does not vacate his directorship in any of the 15 companies, the appointment in M/s Expensive Remedies Ltd., shall become void immediately on the expiry of the 15 days [Section 277(1)].

(ii) For calculating the limit of 15 companies the following companies can be excluded: (i) a private company which is neither a subsidiary nor a holding company of a

public company. (ii) An unlimited company. (iii) An association not carrying on business for profit or which prohibits the payment

of a dividend. (iv) A company in which the person is only acting as alternate director.[Section 278(1)].

In making the above said calculation, any company referred to in (I), (ii) & (iii) above shall be excluded for a period of 33 months from the date on which the company ceases to fall within the purview of these clauses [Section 278(2)].

Question 2 Mr. PMC is Director in 14 Public Limited Companies as on 30th July, 2003. He continues to be so till 4th September, 2003. The following companies appoint Mr. PMC as a Director at their respective Annual General Meetings held on dates mentioned against their names.

(i) PQR Ltd. (AGM held on 29th September, 2003).

(ii ) BCD Private Ltd. (AGM held on 25th September, 2003).

(iii) City Traders Association (A company registered under Section 25 of the Companies Act, 1956- AGM held on 26th September, 2003).

(iv) TSP Ltd. (AGM held on 25th September, 2003).

You are required to state with reference to the relevant provisions of the Companies Act, 1956 the options available to Mr. PMC in respect of accepting or not accepting the appointment of Director of the above companies. (November, 2003) Answer Section 275 of the Companies Act, 1956 debars any person to hold office as a director of more than 15 companies simultaneously. As per provisions of Section 277(2) of the Companies Act, 1956 where a person holds directorship of 14 or less companies is


Restriction on the Number of Directorships (Sections 275 – 279)

9.3

appointed as a director of other companies and such appointments make the total number of his directorships more than 15, then the person concerned has to choose the directorships which he wishes to continue to hold or to accept so that the total number of directorships, old and new henceforth to be held by him does not exceed 15. The said section further provides that none of the new appointments shall be effective until such a choice is to be made and in case of failure of the person to make such a choice within 15 days of the day on which the last of the new appointments was made, all the new appointments shall become void. Section 278 of the Companies Act, 1956 states that for the purpose of section 275 and section 277 the number of companies of which a person maybe a director, following companies are not to be counted: (a) A private company unless it is a subsidiary of a public company. (b) An unlimited company. (c) An association not carrying on business for profit or which prohibits the payment of

dividend. (d) A company in which such a person is only an alternate director. In view of the above mentioned legal provisions, Mr. PMC who is already a director in 14 companies has to consider the following aspects: As per provisions of section 278 of the Companies Act, 1956, BCD Private Ltd. being a private company and City Traders Association being an association not carrying on business for profit and prohibiting payment of dividend by virtue of being a company registered under section 25 are not to be counted for the purpose of section 277 read with section 275. Thus, Mr. PMC can accept the appointment in BCD Private Ltd and City Traders Association without any obstacle. The appointment of Mr. PMC in the other two public companies along with the old directorships in 14 companies makes a total of 16, which is in excess of 15 prescribed by section 275. As per provisions of section 277, Mr. PMC has to decide within 15 days from 29th September, 2003, the date on which the last appointment was made, as to the directorships which he wishes to continue to hold or to accept so that the number of his total directorships does not exceed 15 and in case he fails to decide within the said 15 days, then his appointments as a director of PQR and TSP Ltd shall become void on the expiry of the said 15 days. Question 3

Mr. Raj is director in 14 public limited companies as on 30th July, 2007 and continues to be so till 26th September, 2007. The following companies appoint Mr. Raj as a director at their



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respective Annual General Meetings held on dates mentioned against their names:

(1) MLP Ltd. (AGM held on 27th September, 2007)

(2) PAT Private Ltd. (AGM held on 25th September, 2007)

(3) Retail Traders Association (a company registered under Section 25 of the Companies Act, 1956 (AGM held on 26th September, 2007)

(4) KMC Ltd. (AGM held on 29th September, 2007)

You are required to state with reference to the relevant provisions of the Companies Act, 1956 the options available to Mr. Raj in respect of accepting or not accepting the appointment of the above companies. (May 2008) Answer Section 275 of the Companies Act, 1956 debars any person to hold office as a director of more than 15 companies simultaneously. As per the provisions of Section 277(2) of the Companies Act, 1956 where a person holds directorship of 14 or less companies is appointed as a director of other companies and such appointments make the total number of his directorships more than 15, then the person concerned has to choose the directorships which he wishes to continue to hold or to accept so that the total number of directorships, old or new, henceforth to be held by him does not exceed 15. The said section further provides that none of the new appointments shall be effective until such a choice is to be made and in case of failure of the person to make such a choice within 15 days of the day on which the last of the new appointments was made, all the new appointments shall become void. Section 278 of the Companies Act, 1956 states that for the purpose of Section 275 and Section 277 the number of companies of which a person may be a director, following companies are not to be counted. (a) A private company unless it is a subsidiary of a public company (b) An unlimited company (c) An association not carrying on business for profit or which prohibits the payment of

dividend (d) A company in which such person is only an alternate director. In view of the abovementioned legal provisions, Mr. Raj who is already a director in 14 companies has to consider the following aspects.


Restriction on the Number of Directorships (Sections 275 – 279)

9.5

As per provisions of Section 278 of the Companies Act, 1956 PAT Private Ltd. being a private company and Retail Traders Association being an association not carrying on business for profit and prohibiting payment of dividend by virtue of being a company registered under section 25 are not to be counted for the purpose of Section 277 read with Section 275. Thus Mr. Raj can accept the appointment in PAT Private Ltd. and Retail Traders Association without any obstacle. The appointment of Mr. Raj in the other two public companies along with the old directorships in 14 companies makes a total of 16 which is excess of 15 prescribed by Section 275. As per provisions of Section 277, Mr. Raj has to decide within 15 days from 29th September, 2007, the date on which the last appointment was made, as to the directorships which he wishes to continue hold or to accept so that the number of his total directorships does not exceed 15 and in case he fails to be decide within the said 15 days then his appointments as a director of MLP Ltd. and KMC Ltd. shall become void on the expiry of the said 15 days. Note: A different view can also be taken to the extent that the appointment of Mr. Raj in MLP Ltd. on 26th September, 2007 will make the total number of directorships to 15 which is within the prescribed parameters. However, his appointment as Director of KMC Ltd. on 29th September, 2007 will make it 16 which is in excess of the permissible limit. Hence, the appointment in KMC Ltd. will become void and ineffective in case Mr. Raj does not decide about which of the two companies he should choose within 15 days.


CHAPTER 10

VACATION OF OFFICE BY DIRECTORS (SECTIONS 283 – 284)

Removal of Directors (Section 284) Question 1 Mr. Stubborn is a director of M/s Doubtful Industries Ltd. He along with other two directors has been running the Company for the past twenty years without declaring any dividends or giving any benefit to the shareholders. Frustrated by this, some shareholders are desirous of giving notice to pass a resolution with the support of other shareholders for his removal as a director in the Annual General Meeting of the Company to be held in the month of December of 2001. State the procedure to be followed for the removal of Mr. Stubborn as a director and the right of Mr. Stubborn to defend his position. (November, 2001) Answer Mr. Stubborn a director of M/s Doubtful Industries Ltd., can be removed by following the procedure laid down in Section 284 of the Companies Act, 1956. The procedure is as under: (i) An ordinary resolution is required to be passed at the general meeting of the company. (ii) A special notice, as provided in Section 190 of the Act is required to be given to the

company at least 14 days before the general meeting. (iii) On receipt of the notice, the company has to send a copy of the notice to Mr. Stubborn

and he is entitled to be heard on the resolution at the meeting. (iv) Mr. Stubborn is also entitled to make a representation in writing to the company and the

same has to be sent to all the members by the company. (v) In case the representation has reached or the same could not be sent to all the

members the same has to be read out at the meeting. (vi) Such a representation need not be sent to the members or read out at the meeting if on

the application of the company or any person aggrieved, the Company Law Board is satisfied that the rights conferred under this section are being abused to secure needless publicity for defamatory matter and passes an order to this effect.



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If at the general meeting the resolution is passed by a simple majority, Mr. Stubborn will have to step down from the office as director of the company. Question 2 (i) Mr. SDR, a shareholder in M/s JKP Ltd. holding ten equity shares of Rs. 10 each fully

paid up wants to give a special notice to the company for removal of Mr. EDM, a Director of M/s JKP Ltd. without stating any reason in the notice. You are required to state as per the provisions of the Companies Act, 1956 and/or any decided case law whether Mr. SDR is entitled to do so.

(ii) Would your answer be different, if Mr. EDM was a Director appointed by the Central Government under Section 408 of the Companies Act, 1956?

(iii) Explain briefly the provisions of the Companies Act, 1956 relating to removal of a Director in case of receipt of an appropriate special notice by the company for this purpose. (May, 2004)

Answer (i) The problem as stated in the question is governed by the provisions of section 284 of

the Companies Act, 1956. Sub-section (2) of the said section states that a special notice is required of any resolution to remove a director. The section does not put any condition in respect of the number of members or their shareholding and furnishing any reason therefore. Accordingly, the Karnataka High Court in the case of Karnataka Bank Ltd. Vs. A.B. Datar & Others reported at [1994] 79 Comp. Cases 417 held that there is no requirement with regard to the number of members or their shareholding and even one member is entitled to give special notice for removal of director. The court also held that there is no need to give any reason for removal of a director in the resolution proposed to be moved. Hence Mr. SDR holding only ten equity shares can alone give a special notice for removal of Mr. EDM from the office of director of M/s JKP Ltd.

(ii) According to section 284(1) of the Companies Act, 1956, the provisions relating to removal of directors are not applicable to the directors appointed by the Central Government under section 408 of the said Act. Hence, in case Mr. EDM was a director appointed by the Central Government under the said section 408, Mr. SDR would not be entitled to give any special notice under section 284 for removal of director.

(iii) On receipt of notice of a resolution to remove a director, the relevant provisions of the Companies Act, 1956 in this regard are as follows: (a) The company has to forward a copy of the notice to the concerned director.

[Section 284 (3)].


Vacation of Office by Directors (Sections 283 – 284)

10.3

(b) The concerned director, whether he is a member of the company or not, shall be entitled to be heard on the resolution at the meeting. [Section 284 (3)].

(c) In case the concerned director makes any representation in writing of reasonable length and requests the company to notify the same to the members of the company, the fact of receiving the representation should be stated in the notice of the meeting and a copy should be circulated to all the members of the company. [Section 284 (4)].

(d) In case the representation received by the company is too late for inclusion in the notice or if there is an omission of the part of the company, the same should be read out at the meeting [Section 284(4)].

(e) The company or the person who claims to be aggrieved may make an application to the Central Government seeking exemption from circulating or reading out the representation if the rights are sought to be abused to secure needless publicity for defamatory matter and the Central Government may pass an order granting such exemption. [Proviso to Section 284 (4)].

Question 3 Mr. Adam, a 15% shareholder of a company and other shareholders have lost confidence in the Managing Director (MD) of the company. He is a director not liable to retire by rotation and was re-appointed as Managing Director for 5 years w.e.f. 1.4.2005 in the last Annual General Meeting of the company.

Mr. Adam seeks your advise to remove the MD after following the procedure laid down under the Companies Act, 1956.

(i) Specify the steps to be taken by Mr. Adam and the Company in his behalf;

(ii) Draft a suitable resolution to be passed for removal of MD;

(iii) Is it necessary to state reasons to support the resolution for his removal? (May 2006) Answer (i) Under Section 284 of the Companies Act, 1956, a company may, by ordinary

resolution, remove a director before the expiry of his tenure. For the purpose, special notice from a shareholder (Mr. Adam in the present case) shall be required to be given to the company for moving a resolution to remove a director. On receipt of notice, the company shall forthwith send a copy thereof to the director concerned (MD in the present case) and he shall be entitled to be heard on the proposed resolution at the meeting. Copy of the representation, if any, made by the director be also sent to all members of the company to whom notice of the general meeting is normally sent. In case, the representation is received too late, the same shall be read at the meeting.



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The representation need not be sent if the Company Law Board is satisfied that it will cause needless publicity for defamatory matter.

Under Section 190, special notice of the intention to move the resolution shall be given not less than 14 days before the meeting.

In the present case, if the AGM is due to be held, Mr. Adam may send the special notice 14 days before the AGM. Otherwise, he may request the company to convent EGM under section 169 for consideration of the special notice and resolution for removal of MD. He already holds more than 10% shares in the company.

Once the ordinary resolution is passed in the general meeting, MD will cease to be a director of the company and consequently MD of the company.

(ii) Mr. Adam may give special notice of his intention to move the following resolution, as ordinary resolution: “RESOLVED THAT Mr. …………….., Managing Director of the Company be and is hereby removed as a director of the company under Section 284 of the Companies Act, 1956 with immediate effect.”

(iii) A statement of reasons is not necessary to support the resolution for removal of a director. LIC vs. Escorts Ltd. (1986) 59 Comp. Cases 548(SC)

Question 4 (i) Mr. SDR, a shareholder in M/s JKP Ltd. Holding ten equity shares of Rs. 10 each fully

paid up wants to give a special notice to the company for removal of a Mr. EDM, a director of M/s JKP Ltd. without stating any reasons in the notice. You are required to state as per the provisions of the Companies Act, 1956 and / or any decided case law whether Mr. SDR is entitled to do so?

(ii) Would your answer be different, if Mr. EDM was a director appointed by the Central Government under Section 408 of the Companies Act, 1956?

(iii) State the relevant provision of the Companies Act, 1956 in case of an appropriate special notice is received by the company for removal of any director. (May 2007)

Answer (i) The problems as stated in the question is governed by the provisions of section 284 of

the Companies Act, 1956. Sub-Section (2) of the said section stated that a special notice is required of any resolution to remove a director. The section states that a special notice is required of any resolution to remove a director. The section does not put any condition in respect of the number of members or their shareholding and furnishing any reason therefore. Accordingly the Karnataka High Court in the case of Karnataka Bank Ltd. Vs. A.B. Datar & Other reported at [1994] 79 Comp. Cases 417 held that here is no requirement with regard to the number of members of their


Vacation of Office by Directors (Sections 283 – 284)

10.5

shareholding and even one member is entitled to give special notice for removal of director, The Court also held that there is no need to give any reason for removal of a director in the resolution proposed to be moved. Hence Mr. SDR holding only ten equity shares can alone give a special notice for removal of Mr. EDM from the office of director of M/s. JK Ltd.

(ii) According to section 284 (1) of the Companies Act, 1956, the provisions relating to removal of directors are not applicable to the directors appointed by the Central Government under section 408 of the said Act. Hence, in case Mr. EDM was a director appointed by the Central Government under the said section 408, Mr. SDR would not be entitled to give any special notice under section 284 for removal of director.

(iii) On receipt of notice of a resolution to remove a director, the relevant provisions of the Companies Act, 1956 in this regard are as follows: (a) The Company has to forward a copy of the notice to the concerned director, [Sec

284(3)]. (b) The concerned director, whether he is a member of the company or not, shall be

entitled to be heard on the resolution at the meeting. [Sec 284(3)]. (c) In case the concerned director makes any representation in writing of

reasonable length and requests the company to notify the same to the members of the company, the fact of receiving the representation should be stated in the notice of the meeting and a copy should be circulated to all the members of the company. [Sec. 284 (4)]

(d) In case the representation received by the company is too late for inclusion in the notice or if there is an omission of the part of the company, the same should be read out at the meeting. [Sec 284 (4)]

(e) The company or the person who claims to be aggrieved may make an application to the Central Government seeking exemption from circulation or reading out the representation if the rights are sought to be abused to secure needless publicity for defamatory matter and the Central Government may pass an order granting such exemption. [Proviso to Sec 284 (4)].

(f) The Central Government may also order the company’s costs on the application to be paid in whole or in part by the director concerned not withstanding that he is not a party to it. [Proviso to Sec 284 (4)].

(g) The Board of Directors is not entitled to appoint a person as a Director if he has been removed from his office under the provision of section 284 of the Companies Act, 1956. [Proviso to Sec 284 (6)]


CHAPTER 11

MEETINGS OF BOARD (SECTIONS 285 – 290)

Board to meet at least once in every three calendar months (Section 285) Question 1 The Board of Directors of ABC Ltd. met thrice in the year 2004 and the 4th Meeting, though called, could not be held for want of quorum.

Examine with reference to the relevant provisions of the Companies Act, 1956, the following:

(i) Whether any provisions of the Companies Act, 1956 have been contravened?

(ii) Is a Director bound to attend the Board Meetings and when his frequent absence from the Board Meeting may be excused? (November 2005)

Answer (i) As per Section 285 of the Companies Act, 1956, a company must hold a meeting of its

Board of Directors at least once in every three calendar months and there should be at least four directors’ meeting every year. However, the Central Government may by notification in the official Gazette, direct these provisions will not apply in relation to any class of companies or will apply in relation thereto subject to such exceptions, modifications or conditions as may be specified in the notification. But in the terms of Section 288(2), a company shall not be deemed to have contravened the provisions of Section 285 where the meeting had been called but could not be held for want of a quorum.

(ii) Though a director is not so bound to attend the Board meetings, nonetheless, he will be guilty of breach of duty if he fails to attend the Board meetings with reasonable regularity without sufficient cause being shown for his non-attendance. Willful non-attendance on his part may give rise to his liability on ground of negligence if it is patently prejudicial either to the company or to the general body of shareholders. Fairly frequent absence from the Board meetings may, however, be excused if the entire control is exercised by a single director or if the Board is pretty large in number (Re Denhom & Co. D.25 ch. D. 752 Marquis of Bute’s Case (1892)2 Ch. 100). The fewer the directors, the more onerous is the duty to attend.

Question 2 What is the procedure to be followed, when a board meeting is adjourned for want of quorum?



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Answer (i) Section 288 of the Companies Act, 1956 provides: that if a Board meeting could not be

held for want of quorum, then, unless the articles otherwise provide, the meeting shall automatically stand adjourned till the same day in the next week, at the same time and place, or if that day is a public holiday, till the next succeeding day which is not a public holiday, at the same time and place. It is also provided that section 285 (i.e. frequency of Board meetings) shall not be deemed to have been contravened merely by reason of the fact that a meeting of the Board which had been called in compliance with the terms of that provision, could not be held for want of quorum.

(ii) Section 289 of the Companies Act, 1956 provides for passing a resolution by circulation, or what arc commonly known as circular resolutions. No such resolution shall be deemed to have been duly passed by the Board or a committee thereof, of a company, unless the following conditions are complied with, viz: (a) the draft resolution, together with supporting papers has been circulated, to all

the directors, or members of the Committee of the quorum for a Board meeting and

(b) to all directors of the Board or members of the Committee who are not in India, at their usual address in India, and

(c) the same has been approved by such of the directors then in India, or by a majority of them, who are entitled to vote on the resolution.

Question 3 PQR Limited held three board meetings till 31st December, 2008 during the financial year 2008-09. The next board meeting was due to be held on 27th March, 2009, but for want of quorum the meeting could not be held. A group of shareholders complained that the Company has violated the provisions of Section 285 of the Companies Act, 1956 in not holding the required board meeting. Further, Mr. P and Mr. Q who are the directors of the Company informed the Company their inability to attend the meeting because the notice of the meeting was not served on them. Discuss whether there is any default on the part of the Company and the consequences thereof. What will be the quorum in the given situation? (November 2009) Answer Section 285 of the Companies Act, 1956 requires Board of Directors to meet at least once in every three months, respective of whether it is the board of a public Company or a private Company and at least four such meetings must be held in every year. However, the Central Government may, by notification in the Official Gazette, direct that these provisions will not apply in relation to any class of Companies or will apply in relation thereto subject to such exceptions, modifications or conditions as may be specified in the notification


Meetings of Board (Sections 285 – 290)

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As per Section 288 of the Act, if a meeting of the board could not be held for want of quorum, then, unless the articles otherwise provide, the meeting shall automatically stand adjourned till the same day in the next week, at the same time and place, or if that day is a public holiday, till the next succeeding day which is not a public holiday, at the same time and place. The provisions of Section 285 shall not be deemed to have been contravened merely by reason of the fact that a meeting of the board which had been called in compliance with the terms of that Section could not be held for want of a quorum. As the meeting could not be held for want of quorum, it cannot be said that PQR Ltd has violated the provisions of Section 285 of the act. Notice of every meeting has to be served in writing on each director for the time being in India, and at his usual address in India to every other director(Section 286). Every officer of the Company whose duty is to serve the notice as aforesaid and who fails to do so shall be punishable with fine extending to Rs.1000 (Section 286). As no notice, was served on officer of the Company who is responsible for the default shall be punishable with fine to the extent of one thousand rupees. The Supreme Court, in case of Parmeshwari Prasad vs. Union of India.(1974) has held that the resolutions passed in the board meeting shall not be valid, since notice to all the Directors was not given in writing. Notice must be given to each Director in writing. Hence, even though the directors concerned knew about the meeting, the meeting shall not be valid and resolutions passed at the meeting also shall not be valid. In relation to board meeting quorum implies fully qualified and disinterested directors who must be present at the meeting, so as to enable the board of which they are the constituents to legally transact the business thereat. According to Section 287 the quorum of board meeting is one third of the total strength of board (any fraction contained in the said one third being rounded of as one) or two directors whichever is higher. The total strengths are to be derived after deducting the number of directors whose offices are vacant. Notice of meetings (Section 286) Question 4

A director goes abroad for a period of more than 3 months and an alternate director has been appointed in his place under Section 313(1). During the period of absence of the original director, a board meeting was called. In this connection, with reference to the provisions of the Companies Act, 1956, advice whom should the notice of Board meeting be given to the “original director” or to the “alternate director”? Answer Notice of every Board meeting has to be served in writing on each director for the time being in India, and at his usual address in India to every other director. Every officer of the company



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whose duty is to serve the notice as aforesaid and who fails to do so shall be punishable with fine extending to Rs. 100 (Section 286). It is usually the secretary of the company on whom it casts the duty to serve the notice as aforesaid. It should be noted that the company is not liable for the default in the service of the said notice; it is only the officer in default who is subject to the said penalty. Although there is no legal precedence in this regard, it would be a prudent practice on strictly construing Section 286 that the notice should be served to the alternate director as well as on the original director who is outside India for the time being. Question 5 The Board of Directors of M/s Infotech Consultants Limited, registered in Calcutta, proposes to hold the next board meeting in the month of May, 2000.They seek, your advice in respect of the following matters:

(i) Can the board meeting be held in Chennai, when all the directors of the company reside at Calcutta?

(ii ) Whether the board meeting can be called on a public holiday and that too after business hours as the majority of the directors of the company have gone to Chennai on vacation.

(iii) Is it necessary that the notice of the board meeting should specify the nature of business to be transacted?

Advise with reference to the relevant provisions of the Companies Act. (May, 2000) Answer (i) There is no difficulty at all in holding the board meeting at Chennai even if all the

directors of the company reside at Calcutta and the registered office is situated at Calcutta provided requirements regarding signing of register of contracts, etc. are complied with.

(ii) Under provisions of Section 166 of the Companies Act, 1956, the annual general meeting shall be held during business hours and on a day that is not a public holiday. There is no similar provision in the Act with regard to board meetings. Therefore, in the absence of any specific restrictive provision, the board meeting can be held even on a public holiday and out of the business hours. The term “public holiday” in this context should be understood. According to the proviso to Section 2 (38) no day declared by the Central Government to be a public holiday shall be deemed to be a public holiday unless the declaration was notified before the issue of the notice of the meeting. Suppose, the notice of a meeting was issued on April 1st where by it was to be held on May 3. If on April 2, the Central Government declares the 3rd day of May as a public holiday, there is no bar to the holding of the meeting on May 3 in spite of its being declared as a public holiday. If, however, the declaration is notified before the issue of



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the notice convening the meeting, say on 31st March, the meeting cannot be held on May 3.

(iii) If the articles of association of the company are silent, the notice of board meeting is not required to specify the nature of business to be transacted thereat [Compagnie de Mayville v. Whitley (1896) 1 Ch. 788 (CA)]. If, however, the articles provide otherwise, then the notice must specify the nature of business to be transacted. All said and done, a better course seems to be that the notice should specify the purpose of the meeting, if it is an extra-ordinary or special meeting.

Question 6 The Articles of Association of M/s ABC Ltd. provide that a meeting of the Board of Directors shall be held at 11.00 A.M. on the last day of every quarter ending on 31st March, 30th June, 30th September and 31st December. Relying on the said provision, the company did not send notices to the directors in respect of a board meeting held on 31.3.2002. Some of the directors have questioned the validity of the board meeting on the ground that individual notices have not been sent to directors. (May 2002) The Articles of Association of Big Limited provide that a meeting of the Board of Directors of the company shall be held at 11.00 A.M. on the last day of every quarter ending 31st March, 30th June, 30th September and 31st December. Relying on such a clause in the Articles, the company did not send notices to the directors in respect of the board meeting held on 30th September, 2008. Some of the directors have questioned the validity of the board meeting on the ground that individual notices have not been sent to the directors. Examine the validity of the following with reference to the relevant provisions of the Companies Act, 1956 and/or decided case laws. (CA Final, New Course, May 2009) Answer If the Articles of Association of Big Limited provides that a meeting of the board of directors shall be held on the last day of each quarter, it is not necessary that separate notices are required to be served on the directors. It was held in the case of Arunachalam Chettlar vs. Kaleswarar Mills Ltd. [(1956) 26 COMP. CAS. 431] that where articles of the company provide that there will be a meeting of the board of directors on the first Saturday of every month, there will be no necessity of service of notice to individual director and such clause in the articles of association is sufficient compliance of Section 286(1) of the Companies Act, 1956. In view of the said judgement the clause in the article is sufficient compliance of the requirement of sending the notice for a board meeting and the contention of some of the directors is not legally valid. However, as a good secretarial practice, notice for every board meeting should be sent to all the directors eligible to receive the notice.



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Question 7 XYZ Ltd. is a foreign collaborator in ABC Ltd incorporated in India under the Companies Act, 1956. The foreign collaborator holds 49% of the shareholding. The Board meetings of ABC Ltd are usually held in India and sometimes meetings of the Board are called at a very short notice for which there is a provision in the Articles of Association that during such situations notices of the meetings of the Board can be sent by e-mail. State in this connection whether such a provision in the Articles of Association of a foreign collaborated company is valid within the purview of the provisions of the Companies Act, 1956.

Answer In the post-Independence period, there is an upsurge of foreign consortia. Articles of foreign collaborations frequently provide that notice of Board meetings should be sent by Air Mail to foreign directors so that they may be able to attend the statutorily prescribed minimum number of meetings (i.e. 3 consecutive meeting without obtaining the leave of absence from the Board) so as to prevent the vacation of their office due to continuous non-attendance under Section 283(1) (g) of the Act. Now a vital question crops up as to whether such a provision in the articles of foreign collaborations is valid, because of the provisions of Section 286(1) which, as we have already stated earlier, requires the service of the said notice on a director out of India at his usual address in India. Such a question in not free from doubt. In England, such a notice is required to be given to a director abroad, only when he is within easy reach, else not. But a moot point arises whether a foreign director falls within the purview of the expression “a director other than a director for the time being in India.” On a scrutiny of the act we find that whereas Section 53 provides for service of documents like notices, etc. on members by a company there in no such or similar Section providing for services of notice on directors. Question 8 The Articles of the company provide that there will be a meeting on the first Saturday of every month, and no notice of the meeting will be given in this regard. State in this connection whether there will be any necessity of the service of the notice under provisions of the Companies Act, 1956 and whether the proceedings of the meeting will become invalid.

Answer It has been held in Arunachalam Chettiar vs. Kaleshwarar Mills Ltd. (1957) I.M.L.J.254-A.I.R. 1957 Mad. 309 that where articles of the company provide that there will be a meeting on the first Saturday of every month, there will not be no necessity of the service of the notice under Section 286(1) in as much as a provision in the articles is sufficient compliance of Section 286(1).



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Suppose, the above-mentioned notice, as required by Section 286(1) has not been served, in such a situation the proceedings at the meeting shall not become invalid provided (i) all the directors attend the meeting and do not raise any objection to the non-service of notice; or (ii) where the absent directors make no complaint about the want of notice, particularly when the proceedings are ratified at a subsequent meeting whereat the absentee directors are present [Re State of Wyoming Syndicate (1901) 2 Ch. 431]. Quorum for meetings (Section 287) Question 9 The Board meeting of MNO Ltd. was held on 10th May, 2008 at Chennai at 11a.m. At the time of starting the board meeting the number of directors present were 7.The total number of directors were 10. The board transacted ten items in the board meeting. At 12 noon after the completion of four items in the agenda 4 directors left the meeting. Examine the validity of these transactions explaining the relevant provisions of the Companies Act, 1956.

(CA Final, New Course, November, 2008) Answer Section 287 of the Companies Act, 1956 provides for the quorum for meeting. The quorum for a meeting of the Board of Directors of a company shall be one third of its total strength (any fraction contained in the said one third being rounded off as one), or two directors, whichever is higher. Where at any time the number of interested directors exceeds or it’s equal to two thirds of the total strength, the number of remaining directors, that is to say, the number of directors who are not interested present at the meeting being not less than two shall be the quorum during such time. In this case, the quorum is 4(i.e. 1/3rd of 10=3 1/3 rounded of as 4).Hence the quorum was present at the time of commencement of meeting. As a rule, in the case of a meeting of the Board of Directors, the meeting cannot transact any business, unless a quorum is present at the time of transacting the business. It is not enough that a quorum was present at the commencement of the business. The quorum of the Board is required at every stage of the meeting and unless a quorum is present at every stage, the business transacted is void. (Balakrishna vs. Balu Subudhi AIR 1949 Pat 184). In the given situation four items were transacted with the quorum and thus they are valid. Six items were transacted after 4 Directors left the meeting resulting in the reduction of quorum as only 3 Directors were present as against the required quorum of 4 Directors. Such six transactions are void. Question 10 ABC Ltd. has 12 directors on its Board and has the following clause in its Articles of Association:



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“The questions arising at any meeting of the Board of Directors or any Committee thereof shall be decided by a majority of votes, except in cases where the Companies Act, 1956 expressly provides otherwise.”

In one of the meetings of the Board of Directors of ABC Ltd., 8 directors were present. After completion of discussion on a matter, voting was done. 3 directors voted in favour of the motion, 2 directors voted against the motion while 3 directors abstained from voting.

You are required to state with reference to the provisions of the Companies Act, 1956 whether the motion was carried or not. It is clarified that the motion being voted upon was not concerning a matter which requires consent of all the directors present in the meeting. (CA Final, New Course, May 2009) Answer Regulation 74(1) of Table A of Schedule 1 to the Companies Act, 1956 provides that save as otherwise expressly provided in the Companies Act, 1956, questions arising at any meeting of the Board shall be decided by a majority of votes. In the problem given in the question, the similar article exists in the Articles of Association of ABC Ltd. In the given case, only 8 directors out of a total strength of 12 directors are present and out of those 8 directors present only 5 directors have exercised their votes. In such a case, only those directors who are present and vote on a motion are considered for determining whether the motion is carried or not. That means out of the 5 directors who voted on the motion are to be considered. Accordingly, since number of directors who voted in favour of the motion being 3, is higher than the number of directors who voted against the motion being 2, the motion is carried or is considered to be passed by majority. Question 11 The articles of Association of XYZ Computers Limited provide for a maximum of 15 Directors. But the company has only 10 Directors and for two of them representing Foreign Collaborators, alternate Directors have been appointed. Board Meeting held on 1st August, 2003 was attended by 4 Directors including 2 alternate Directors.

Examine with reference to the relevant provisions of the Companies Act, 1956 whether quorum was present at the Board Meeting held on 1st August, 2003.

Will your answer be different, if the articles provide for a Quorum of 6 Directors? (May, 2004) Answer Section 287 of the Companies Act, 1956 prescribes a quorum for meetings of Board of Directors of Companies. According to Section 287(2) quorum for a meeting of the Board of Directors of any company, public or private shall be one third of the total strength of the Board, or two directors, whichever is higher. According to Section 287(1), ‘total strength’



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means the total strength of the Board of Directors of a company as determined in pursuance of the Act, after deducting there from the number of directors, if any, whose place may be vacant at the time. Hence the total strength is 10 directors (excluding 2 alternate directors) even though the Articles provide for a maximum of 15. Section 287(2) provides that the quorum for a meeting of the Board of Directors of a company shall be one third of its total strength (any fraction contained in that one-third being rounded off as one), or two directors, whichever is higher. Hence, in this case 1/3 of 10 i.e. 3 1/3↓ the fraction being rounded off as one i.e. 4 is quorum. The alternate directors present at a meeting will be counted for quorum, if the original director is not present, the alternate directors present at a meeting will be counted for quorum. The Board meeting held on 1.8.2003 was attended by 4 directors including 2 alternate directors quorum was present at the meeting. Hence, it is a valid meeting. Section 287 only provides for a minimum quorum. It does not forbid a company to fix a higher quorum. A company in its articles cannot provide a quorum of lesser number of directors than what is provided in Section 287(2). However, it can provide for a higher number. Hence, if the articles provide 6 as quorum, the meeting held on 1.8.2003 is not valid as it was attended only by 4 directors. Question 12 ABC Ltd. has 12 directors on its Board and has the following clause in its Articles of Association:

“The questions arising at any meeting of the Board of Directors or any Committee thereof shall be decided by a majority of votes, except in cases where the Companies Act, 1956 expressly provides otherwise.”

In one of the meetings of the Board of Directors of ABC Ltd., 8 directors were present. After completion of discussion on a matter, voting was done. 3 directors voted in favour of the motion, 2 directors voted against the motion while 3 directors abstained from voting.

You are required to state with reference to the provisions of the Companies Act, 1956 whether the motion was carried or not. It is clarified that the motion being voted upon was not concerning a matter which requires consent of all the directors present in the meeting.

Answer Regulation 74(1) of Table A of Schedule 1 to the Companies Act, 1956 provides that save as otherwise expressly provided in the Companies Act, 1956, questions arising at any meeting of the Board shall be decided by a majority of votes. In the problem given in the question, the similar article exists in the Articles of Association of ABC Ltd. In the given case, only 8 directors out of a total strength of 12 directors are present



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and out of those 8 directors present only 5 directors have exercised their votes. In such a case, only those directors who are present and vote on a motion are considered for determining whether the motion is carried or not. That means out of the 5 directors who voted on the motion are to be considered. Accordingly, since number of directors who voted in favour of the motion being 3, is higher than the number of directors who voted against the motion being 2, the motion is carried or is considered to be passed by majority. Question 13 Analyse and Advise with reference to the provisions of the Companies Act, 1956, the following situations.

(a) The Articles of a company want to fix the quorum for the Board Meeting.

(b) There are 9 directors in a company and out of which 2 offices of the directors have fallen vacant. What will be the quorum for the Board Meeting?

(c) There are 15 directors in a company and during discussion of a particular item, 13 of the directors are said to be ‘interested’. What shall be quorum of the meeting?

(d) Continuing with above situation, what will be your advise, when all the 15 directors are said to be interested in the concerned resolution?

(e) What are the situations, when interested directors will be counted for the purpose of counting quorum for the meetings of the Board?

Answer (a) A quorum is the prescribed minimum number of qualified persons authorised to

transact the business at a meeting. In relation to a Board meeting quorum implies fully qualified and disinterested directors who must be present at the meeting so as to enable the Board of which they are the constituents to legally transact the business thereat. In view of Section 287 which has fixed the quorum of the Board meeting, the Articles of Association of the company cannot fix the quorum for the Board meeting.

(b) Accordingly such a quorum is one third of the total strength of Board (any fraction contained in the said one third being rounded of as one) or two directors whichever is higher. The total strength is to be derived after deducting the number of directors whose offices are vacant. Therefore, the Quorum = 1/3 (of the total strength vacancies). Where total number of directors are 9 and 2 offices of the directors have fallen vacant, we find: 1/3 of (9-2) = 1/3 of 7 = 21/3 directors. If the fraction of 3rd were to be rounded off as one then 3, i.e. 2+1 directors would constitute the quorum for the Board meetings. If at any time the number of the remaining directors exceeds or is equal to two thirds of the total strength, the number of the remaining



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directors who are non-interested but present at the meeting, not being less than two shall constitute the quorum.

(c) For example, there are in all 15 directors and the Board meeting commences with all the 15 directors. During the currency of the meeting, an item comes up for discussion in respect of which 13 happen to be “interested” directors. In this case, in spite of the excess of the interested directors being more than two-thirds, the prescribed minimum number of non-interested directors constituting the quorum, namely, 2 present at the meeting are to transact the particular item of business.

(d) If all the 15 directors cited in the above illustration are equally interested in that particular item of business and the time is so vital that but for a decision thereon, the business of the company will be greatly hampered. How to resolve this impasse? The Act has not made any direct provision to take with such a situation, but the Article 48 of Table A of Schedule 1 of the Act, provides a remedy. According to the said article, the Board may, whenever it thinks fit, call an extraordinary general meeting. By invoking this Article, the Board should get the aforesaid impasse resolved by the shareholders at the general meeting. Since according to Section 173(1) (b), all business in the case of any other meeting than the annual general meeting is to be deemed special, by virtue of sub-section (2) the notice of the extraordinary meeting must annex to it a statement setting out all the material facts concerning the item of business, including, in particular, the nature of the concern or interest there in of every director.

(e) The interested directors are excluded from the computation of the quorum under Section 300(1). However, in the terms of Section 300(2), the interested directors can be counted for the purpose of quorum in the following cases, namely – (a) where the company is a private company which is neither a subsidiary nor a holding company of a public company; (b) where the company is a private company which is a subsidiary of a public company, in respect of any contract or arrangement thereof; (c) where there is any contract of indemnity against any loss which the directors or any one or more of them may suffer by reason of becoming or being sureties or surety for the company; (d) in respect of any contract or arrangement entered or to be entered into with a public company, or a private company, which is a subsidiary of a public company in which the director’s interest consist solely (i) in his being a director holding shares of such number or value as to be just enough and not more than enough to qualify him for appointment as director, or (ii) in his being a member holding not more than 20% of the paid-up share capital of the company; (e) where it is a public company in respect of which the Central government has, through a notification in the official Gazette, waived the necessity to comply with the requirements of Section 300(1) on considerations of establishing or promoting any industry, business or trade in the public interest.



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Question 14 A Board meeting could not be held for want of quorum and therefore it was adjourned to next week, same time, place. At the adjourned meeting also, the requisite quorum was not present. What advise will you give with reference to the relevant provisions of the Companies Act, 1956? Answer Inability to hold a Board meeting for want of quorum results, as has already been stated in the automatic adjournment thereof under Section 288. According to Section 191, a resolution passed at an adjourned meeting is deemed as having been passed thereat itself; it does not date back to an earlier date, i.e., the date of the original meeting. It would be worthwhile to recapitulate here the provisions of Sections 174(2) to (5), which deal with adjournment of the general meeting for want of quorum so as to compare them with the provisions relating to adjournment of board meetings. Unless the article of a company whether public or private – provide otherwise, if the quorum is not present within half an hour from the time fixed for the general meeting, it shall stand dissolved in case the meeting has been convened, under Section 169, on the requisition of members; in regard to any other class of meeting, it shall stand adjourned to the same day in the next week at the same time and place of to such other day and at such other time and place as the board may determine. If again at the adjourned meeting the quorum is not present within half an hour of the scheduled time then the members present shall constitute the quorum. According to Article 53 of Table A of Schedule I to the Act, where a meeting is adjourned for 30 days or more, a fresh notice of the adjourned meeting has to be served. Section 288 does not throw any light on what happens if the quorum is not there at the adjourned meeting as well whether the Board meeting is to be adjourned over and over again till the quorum is procured. Secondly, for want of quorum, the Board meeting automatically stands adjourned to the same day in the next week and at the same time and place. But the Board has no power to fix any other day or place or time for such adjourned meeting: where as in the case of general meeting, the Board can adjourn it to any other day or other time and place. Thirdly Section 288 implies that a Board meeting can be called on a public holiday, though not the adjourned meeting. Under Section 166(2) annual general meeting cannot be held on a public holiday. But in the absence of any specific prohibitions by the Act, a statutory and an extraordinary meeting can be held on a public holiday. Procedure where meeting adjourned for want of quorum (Section 288) Question 15 Some urgent items are left over in the agenda of Board meeting which concluded and decision cannot be deferred till its next meeting Answer Items of business left unconsidered at the Board meeting and which cannot be deferred till the next Board meeting may be referred to the Directors for consideration by circulation in terms of Section 289. For the purpose, of passing a resolution by circulation, requirement is that the



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draft resolution should be circulated to all the directors in India, who are not below the quorum fixed for a board meeting and to all other directors at the usual address in India and the resolution should be approved by the directors in India or by a majority of them. Question 16 A meeting of the Board of ‘No Holiday Ltd’ was held on a public holiday. However due to lack of quorum, the proceedings of the meeting could not be held and therefore the Chairman of the meeting decided with the consent of the majority that the Board meeting be adjourned to next Monday. However, the date fixed for the adjourned meeting happened to be a ‘public holiday’. Advise and draw your analogy with reference to the provisions of the Companies Act, 1956, whether the adjourned meeting of the Board can be held on a day which is a public holiday.

Answer Whether or not the Board meeting can be held on a public holiday and out of business hours is a question open to conflict. Under Section 288, the adjourned Board meeting is to be held on a day which is not a holiday but no such restriction has been levied on the matter of holding the original Board meeting. On the basis of the provision of Section 288, one set of arguments may be that like the adjourned meeting, the holding of the original Board meeting is equally a normal and usual work of a company and that is why it should be held during usual business hours and on a day, which is not a public holiday. On this analogy, a similar inference may be drawn form the provision of Section 166(2) as well, because it prescribes only for each annual general meeting that it held on a day which is not a public holiday and during the business hours and also because annual general meeting is normal work of the company. Another set of arguments is that a meeting of the board can take place even on a public holiday and out of business hours because there is not such restriction as contemplated either by Section 166(2) or by Section 288. It would be prudent to subscribe to latter set of arguments. This is because if the Legislature could think of imposing similar restrictions twice-once at the time of drafting Section 166(2) in respect of only annual general meeting and the other at the time of drafting Section 288 in respect of adjourned Board meetings-it could rationally think of similar restrictions for the third time in respect of original Board meetings. If the human element of forgetfulness on the part of the draftsmen is to be given any consideration, even then it can be upheld on the first occasion when Section 166(2) was drafted. But definitely such forgetfulness is not tenable on second occasion when Section 288 was enacted especially in respect of adjourned Board meeting. Had it been the intention of the legislature, it could easily enact a provision and add it as a sub-section to Section 288. It, therefore, seems that the legislature did not deliberately think it necessary to provide for original board meeting to be held on a day other than a public holiday and during usual business hours. The law will take its course, however the course may sound irrational. Therefore, in the absence of



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any specific provisions in Act it seems that the original Board meeting can be held even on a holiday and out of the business hours. Question 17 Examine, with reference to the relevant provisions of the Companies Act, 1956, the validity/legality of the following:

A meeting of the Board of Directors of OPQ Co. Ltd. due to be held on 30.9.2001 did not take place for want of quorum. As a result, the Company did not hold any Board meeting for the quarter ended 30.9.2001 and there is a complaint that the Company has violated the provisions of the Act in this regard. (November, 2001) Answer Suppose a meeting of the Board has been convened within the prescribed period in strict conformity with the said Section but for want of quorum, the said meeting could not take place. In such a situation, the meeting automatically stands adjourned by virtue of Section 288(1) till the same day in the next week, at the same time and place. And if that “same day” is a public holiday, then the meeting stands adjourned till the next succeeding day, which is not a public holiday, at the same time and place. And because of this adjournment the meeting is obviously held after the period specified in Section 285. In terms of Section 288(2), which in not clearly couched, a company shall not be deemed to have contravened the provisions of Section 285 where the meeting does not take place for want of quorum. In view of these legal provisions, a pertinent question for our consideration comes up. For holding the next Board meeting, which date should we take into account for the purpose of calculating the statutory period of once in every three months. Whether the date of the original meeting, which was adjourned, for want of quorum or the adjourned date on which the meeting was actually held? A practical difficulty arises in this regard owing to the silence of the Act on this point. Our confusion gets worse confounded when we come across Section 191 which states that where a resolution is passed at an adjourned meeting inter alia, of the Board of Directors of a company, it must “for all purposes” be deemed to have been passed at the date of the adjourned meeting and not on an earlier (i.e., the original) meeting. For resolving our question indicated in italics above, should we take the indirect provisions of Section 191 and conclude, by correlating the phrase ‘for all purposes’ with the expression ‘be treated as having been passed on the date on which it was in fact passed, and shall not be deemed to have been passed on any earlier date’ appearing in Section 191, that for holding the next meeting for the Board, the statutory period should be calculated from the date at which the adjourned meeting was held? There is no judicial decision to warrant this conclusion.



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However, according to Buckely’s Companies Act, (p.339, 12th Edition), except as regards the meetings of the three classes referred to in Section 144 of the English Companies Act (corresponding to our Section 191 which is a verbatim copy of the English Section), the legal fiction of continuity of the original meeting and all adjournments or any legal consequence emanating therefrom remains unaffected by Section 144 of the English Act. This is so notwithstanding the phrase “for all purposes”, appearing in Section 144, in as much as our Section 191 is the verbatim copy of Section 144, we can rely on this treatise. And relying thereon, we may conclude that the continuity of the original meeting will remain unhampered and therefore for the purpose of holding the next Board meeting the statutory period of “every three months” should be computed from the date when the original meeting was adjourned for want of quorum. According to the provisions contained in Section 288(2) of the Companies Act, 1956, the provisions of Section 285 relating to the holding of at least one Board meeting in a quarter cannot be deemed to have been contravened merely by reason of the fact that a Board meeting which had been called in compliance with the terms of the said section could not be held for want of a quorum. Thus the allegation that the company has contravened the provisions of Section 285 in the matter of holding the Board meeting is not correct. Passing of Resolution by Circulation (Section 289) Question 18 In course of administration of the affairs of a limited company, Chairman of its Board of Directors came across a matter, which required the approval by say of a board resolution. In the prevailing circumstances, it is not possible to convent and hold a Board Meeting. The Chairman approaches you to advise him of the way and the relevant procedure to obtain such approval without holding the Board Meeting. You are required to advise him on the matter as per the provisions of the Companies Act, 1956. (May 2007) Chairman of Board of Directors of ABC Ltd. came across a matter, which required the approval by way of a board resolution. In the prevailing circumstances, it is not possible to convene and hold a Board Meeting. The Chairman approaches you to advise him of the way and the relevant procedure to obtain such approval without holding the Board Meeting. You are required to advise him on the matter as per the provisions of the Companies Act, 1956.

(CA Final,New Course, May 2009) Answer As per the provisions of the Companies Act, 1956, several Board Resolutions are required in course of carrying on the affairs of a limited company. But it may sometimes so happen that a Board Meeting can not be held. To meet such eventualities, the Companies Act, 1956 contains the solution in section 289. According to this section, the board resolution can be passed by



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way of circulation. It may however be noted that the matter listed in the provisions of section 292 and other sections requiring passing of resolution at the board meetings only can not passed by way of circulation and can be passed only at the Board Meeting. The Chairman of the company is advised that the approval in the form of a Board Resolution may be obtained by way passing the relevant resolution by circulation if the matter is not covered by the barring sections of the said Act. The procedure to be adopted for the purpose shall be as follows: (i) Send the draft of the resolution in duplicate together with the necessary papers, if any,

to all the directors then in India. It is to be ensured that the number of such directors is not less than the directors required to form the quorum for a Board meeting.

(ii) Send the draft of the resolution in duplicate together with the necessary papers, if any, to all other directors at their usual address in India.

(iii) Obtain one copy of the draft resolution duly signed by the directors, whether approving the resolution or disapproving the same. It may be noted that the resolution shall be deemed to be passed by the Board if all the directors then in India or majority of all directors as are entitled to vote on the matter approve the resolution by singing one copy and returning the same to the company.

(iv) The resolution passed by circulation shall be placed before the next Board Meeting for confirmation.

The resolution shall be recorded in the minutes of the next Board Meeting. Question 19 Proximo Limited has 9 Directors out of whom 3 Directors have gone abroad. The Chairman had an urgent matter to be approved by the Board of Directors which could not be postponed till the next Board meeting. The Company, therefore, circulated the resolution for approval of the Directors. 4 out of 6 Directors in India approved the resolution. The Company claimed that the resolution was passed. Examine with reference to the provisions of Section 289 of the Companies Act, 1956 the validity of the resolution. (CA Final, New Course, June 2009) Answer According to Section 289 of the Companies Act, 1956, a resolution by circulation shall not be deemed to have been passed, unless the resolution has been circulated in a draft, together with the necessary papers, if any to all the directors then in India (not less in number than the quorum fixed for a meeting of the Board) as the case may be, and all other directors at their usual addresses in India, and has been approved by such of the directors as are then in India or by majority of such of them, as are entitled to vote on the resolution. In this case, the resolution has been approved by 4 directors out of 6 in India; the majority of total number of



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directors who were entitled to vote was 5 as against 4 directors who approved the resolution. Thus both the alternate conditions were not fulfilled. The resolution cannot be deemed to have been passed. Validity of acts of directors (Section 290) Question 20 State whether the acts done by the Board meeting be invalid if it was found afterwards that there was some defect in the appointment of directors or any person acting as a director?

Answer All Acts done by the Board meeting by its committee meeting or by any person acting as a director shall be as valid as if every such director or such person had been duly appointed and was qualified to be a director. The validity of all such acts done is not affected even if it discovered later on that there was some defect in the appointment of any one or more of such directors or of any person acting as a director. The said acts will also remain unaffected even the directors are later on discovered to be disqualified (Article 80). This provision has been intended to prevent the validity of transactions from being questioned where there has been a slip in the appointment of a director. But the provision cannot be utilized to ignore or override the substantive provisions pertaining to such appointment. It is applicable only to acts of directors whose appointment or qualification is later on discovered to be faulty. Where, however, their appointments have not taken place at all but they merely choose to act on the company’s behalf, the protection prescribed by either Article 80 or Section 290 cannot be invoked [Morris vs. Danssen (1964) I, A.E.R. 586 (H, L.)] This is because the said subsequent discovery must be a discovery of the defect; it must not be discovery of facts which go to constitute the defect [British Asbestos Co. vs. Body (1903) 2 Ch. 439]. Suppose a regulation like Articles 80 is included in the Article of association of a company. What would be the possible impact of this? The impact has been summed up in Halsbury’s Laws of England (vide p. 277, 3rd Edition, Vol. VI) thus: “An Article validating the acts of persons acting as directors, though it is a afterwards discovered that there was a defect in their appointment or qualification, operates not only between the company and outsiders but also as between the company and its members; as where defecto directors make a call, summon meetings of the company, elect other directors or allot shares, A defecto director may be ordered to furnish a statement of affairs in winding up. Directors can not take advantage of any infirmity in their proceedings in which they have themselves participated; they are stopped as between themselves and the company; they are also stopped from saying they have been improperly appointed if, they have acted after appointment, persons dealing with them who know of the invalidity are likewise stopped.” It should also be noted that Section 290 applies to act of an individual director, whereas Article 80 covers Act of the Board and of its committee.



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Question 21 Mr. MTP was appointed as a director at the Annual General Meeting of a limited company held on 30th September, 2005 and he carried on his duties and functions as a director. In the month of August, 2006, it was found out that there were certain irregularities in his appointment and on 31st August, 2006, his appointment was declared invalid. But Mr. MTP continued to act as director even after 31st August, 2006. You are required to state, with reference to the provisions of the Companies Act, 1956, whether the acts done by Mr. MTP are valid and binding upon the company ? (May 2007) Answer In accordance with the provision of the Companies Act, 1956 as contained in section 290, acts done by a person as a director shall be valid, notwithstanding that it may afterwards be discovered that his appointment was invalid by reason of any defect or disqualification or had terminated by virtue of any provision contained in this Act or in the articles: The Proviso to section 290 further provide that nothing in this section shall be deemed to give validity to acts done by a director after his appointment has been shown to the company to be invalid or to have terminated. In view of the provision of section 290 of the Companies Act, 1956, the acts done by Mr. MTP prior to 31st August, 2006 are to be treated as valid and binding on the Company. However in view of the Proviso to the said section 290, the acts done by Mr. MTP after 31st August, 2006 shall be deemed to be invalid and not binding upon the Company. Minutes of Board Meeting Question 22 Accurate Arcs Ltd. maintains the Minutes Book of the Board Meetings in loose-leaf system and get them bound once in three months. Can it do so? Board meetings were held on 24th March, 2000 and 15th April, 2000. Mr. Rameshwar, who was the Chairman of these two Board Meetings died on 1.5.2000, without signing the Minutes. How should be the Minutes be signed and by whom? (November, 2000) Answer Ordinarily minutes cannot be kept in loose-leaf system. Section 193(1) of the Companies Act, 1956 enjoins the Minutes must be entered within 30 days of the conclusion of the relevant meeting. Ordinarily Minutes cannot be kept in loose-lead system. The Department of Company Affairs, however, has expressed that it would refrain from taking any action against a company which maintained its minutes in the loose-leaf form, provided that adequate safeguards are taken against falsification, and loose-leaves are bound in books at reasonable intervals, say six months.



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In this case, since the Minutes Book leaves are bound once in three months (January to March, 2000), and as such the same is in order. The minutes of the Board Meeting are required to be written within a period of 30 days from the date of the meeting held. [Section 193(1)]. But there cannot be any insistence that the same must be signed within a period of 30 days from the date of the Board Meeting. (Dept.’s circular No. 25/76 dated 1.9.1976). According to section 193(1A), the minutes of a Board Meeting may be signed by the Chairman of the said meeting or the Chairman of the next succeeding meeting. In this case, Mr. Rameshwar, who was the Chairman of the Board Meeting held on 24.3.2000 and 15.4.2000 died on 1.5.2000 without signing the minutes. The Chairman of the Board Meeting held after 15th April, 2000 for the first time may sign the minutes of Board Meeting, held on 15th April, 2000 in accordance with section 193(1A)(a). According to the provisions of section 193(1) read with section 193(1A) the minutes of Board Meeting held on 24th March, 2000 should have been signed by Mr. Rameshwar himself as he was the Chairman of the Board Meeting held on 24th March, 2000 as well as the Chairman of the next succeeding meeting. There is no specific provision in the Companies Act, 1956 as to the person who can sign the minutes of Board Meeting held on 24th March, 2000 in this case. Hence a board meeting may be convened and the Chairman of the said meeting may sign the minutes of Board Meeting held on 24th March, 2000.


CHAPTER 12

BOARD’S POWERS AND RESTRICTIONS THEREON (SECTIONS 291 – 293)

General Powers of the Board (Section 291) Question 1 M/s ABC Ltd. had power under its memorandum to sell its undertaking to another company having similar objects. The Articles of the company contained a provision by which directors were empowered to sell or otherwise deal with the property of the company. The Shareholders passed an ordinary resolution for the sale of its assets on certain terms and required the directors to carry out the sale. The Directors refused to comply with the wishes of the shareholders where upon it was contended on behalf o the shareholders that they were the principal and directors being their agents were bound to give effect to their decision. Based on the above facts, decide the following issues, having regard to the provisions of the Companies Act, 1956 and case laws.

(i) Whether the contention of shareholders against the non-compliance of their wishes by the directors is tenable.

(ii) Can shareholders usurp the powers which by the articles are vested in the directors by passing a resolution in the general meeting? (November 2007)

Answer General Powers vested in the Board of Directors: The provisions relating to the general powers which are vested are given under Section 291 of the Companies Act, 1956. As per this section, the Board of Directors of a company is entitled to exercise all such powers and to do all such acts and things as the company is authorized to exercise and do. This means the powers of the Board of Directors are co-extensive with those of the company. The proposition is, however subject to two conditions: Firstly, the Board shall not do any act which is to be done by the company in general meeting. Secondly, the Board shall exercise all such powers subject to the provisions contained in the Companies Act, 1956 or in the Memorandum or the Articles of the Company or in any regulations made by the Company in general meeting. But no regulation made by the company in general meeting shall invalidate any prior act of the Board which would have been valid if that regulation had not been made.



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It is the first and elementary principle of company law that when powers are vested in the Board of directors by the Articles of a company, they cannot be interfered with by the shareholders as such (Murarka etc. Works Ltd. vs. Mohal Lal AIR (1961) Col 251). In exercising their powers the directors do not act as agent for the majority members or even all the members. The members therefore cannot by resolution passed by a majority or even unanimously supersede the powers of directors or instruct them how they shall exercise their powers. The above problem is based on decision given by the Chancery Court in the case Automatic Self Cleansing Filter Syndicate Co. Ltd. Vs. Cunninghame (1906) 2ch 34 and this case also followed in India in MPLV Works vs Murarka AIR 1961 Col 251.

In view of above discussion, the contention of shareholders against the non-compliance of their wish by the directors is not tenable and shareholder cannot usurp the power which by articles vested in the directors by passing even a resolution of a numerical majority at the general meeting. The shareholders have, however, the power to alter the Articles of Association of the company in the manner they like subject to the provisions of the Companies Act, 1956. Certain powers to be exercised by Board only at meeting (Section 292) Question 2 Out of the powers exercisable by the Board under section 292, the board wants to delegate to the Managing Director of the company the power to borrow monies otherwise than on debentures. Advise whether such a delegation is possible? Would your answer be different, if the delegation is given to the manager or any other principal officer including a branch officer of the company?

Answer According to Section 292, the following powers can be exercised by the Board only by means of resolution passed at its meetings: (a) to make calls; (aa) to authorise the buy back of shares (b) to issue debentures; (c) to borrow money otherwise than on debentures; (d) to invest the funds of the company; (e) to make loans. The Board may, however, by resolution passed at meeting, delegate the last three powers mentioned above to the extent specified hereunder. Such a delegation can be made to any committee of directors, the managing director, the manager or any other principal officer of the company or in the case of a branch office of the company, a principal officer thereof. Every


Board’s Powers and Restrictions Thereon (Sections 291 – 293)

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resolution delegating the power referred to in (c), (d) and (e) above shall specify: (i) the total amount outstanding at any time up to which money may be borrowed by the delegate; (ii) the total amount up to which the funds may be invested as well as the nature of investment; and (iii) the total amount of loans and the purpose thereof up to which and for which loans may be raised respectively. It is to these extents that the delegate may exercise the aforesaid three powers. The company in general meeting may impose restrictions and conditions on the exercise by the Board of any of the five powers mentioned above. In connection with the power mentioned in (c) above, a question may arise whether borrowing on a promissory note is within the powers of the directors. It has been held in [P. Rangaswami Reddiar and Another vs. R. Krishnaswami Reddiar and another (1971) 43 Comp. Case 232] that where such a borrowing permissible under the company’s articles and moneys were borrowed on promissory notes, such transaction would come within the powers of the director. It has also been held in the same case that where a person was appointed as the managing director of the company by the Board’s resolution vested with full powers of the management of the affairs of the company and authorised to sign all the papers of the company, he would have full powers to borrow money on a promissory note even without a resolution of the Board as contemplated by Section 292(c) of the Act. Question 3 The Directors of X & Co. Ltd. desire to authorise the Managing Director to enter into the following transactions namely-

(a) invest from time to time surplus funds in the purchase of shares of other companies:

(b) borrow from banks money required for the purpose:

(c) give loans to persons, including firms in which directors or their relatives are partners and

(d) give donations to charitable trusts in which any of the directors may be interested as trustees.

State whether these delegated powers are within the purview of the relevant provisions of the Companies Act, 1956.

Answer (a) Although Section 292 empowers the Board of Directors of a company to delegate to the

Managing Directors the power to invest, in general terms, the funds of the company nevertheless because of the overriding provisions of Section 372(5) (which Section we shall discuss in detail in Study paper 3), the transaction in the instant case would be invalid. Section 372(5) provides that no investment in shares of a company can be made by the Board of Directors of an investing company in pursuance of sub-section



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(2), unless it is sanctioned by a resolution passed at a meeting of the Board with the consent of all the directors present at the meeting except those not entitled to vote thereat, and unless further notice of the resolution to be moved at the meeting has been given to every director in the manner specified in Section 286. Since Section 372 does not provide for delegation of the power, the proposed delegation to the Managing Director in question, notwithstanding the general provision of Section 292, cannot be made.

(b) In terms of Section 292 the Board of Directors may also delegate to the Managing Director the power to borrow money otherwise than debentures, which it can exercise only by means of resolutions passed at Board meetings. As per Explanation to Section 292(1), it is the arrangement for an overdraft or cash credit that constitutes the exercise of the borrowing power and not the actual utilisation of the arrangement. In other words, an arrangement for an overdraft or cash credit to the tune of say Rs.5 lakhs constitutes the exercise of the borrowing power and not the actual drawing of this amount on the basis of the overdraft or cash credit. Consequently, the transaction in the instant case shall be valid. But before implementation of the proposal, the Board must pass a resolution at its meeting authorising the Managing Directors to borrow from banks money required for the purpose of the company’s business. Also the resolution delegating this power shall specify the total amount outstanding at any one time up to which the delegate may borrow money.

If however, the moneys to be borrowed together with the money already borrowed by the company (apart from temporary loans obtained from the Company’s bankers in the ordinary course of business) will exceed the aggregate of the paid up capital of the company and its free reserves, [that is to say, reserves not set apart for any specific purpose] the Board of Directors of the company in question must obtain the consent of the company in its general meeting. Consequently, care should be taken to ensure that while delegating the power to the managing director the aforesaid provision has not been violated; also it should be ensured that the memorandum of association permits borrowing.

(c) Since according to Section 295(1), (which we shall discuss later) without obtaining prior approval of the Central Government in that behalf, a company can not directly or indirectly lend money to persons including firms, in which directors or their relatives are partners, the company in question must in the first instance seek the Central Government’s approval. Secondly since the power to make loans may be delegated under Section 292(1)(e), the Board of Directors of the company in question must pass a resolution therefore and every resolution delegating this power to the Managing Director shall specify the total amount up to which loans may be made by the delegate, the purpose for which loans may be made and the maximum amount of loans which



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may be made for each such purpose in individual cases. Thirdly, by virtue of Section 291(1), the Board must see with reference to the memorandum and articles whether the company is authorised to exercise the power.

(d) Under Section 293(1) (e), the Board of Directors of a public company can contribute or donate to charitable and other funds not directly related to the business of the company or the welfare of its employees any amount the aggregate of which will not, in any financial year exceed Rs.50,000 or 5% of its average net profits during the three financial years preceding whichever is greater. If this power of the company is not ultra vires the memorandum of the company, then only the Board can act in pursuance of the above-mentioned resolution of the company and in so acting, it can authorise the Managing Director to exercise the power on behalf of the Board.

It may be noted that the power of the Board to donate to general charities is not conditional to the existence of any profits. In such case, they may contribute up to the limit given in Section 293(1)(e), even though the company may be working at a loss. Question 4 A Managing Director was authorized by the Board to borrow money on a Promissory Note. State in this connection whether borrowing on a promissory note is within the powers of the directors.

Answer It has been held in [P. Rangaswami Reddiar and Another vs. R. Krishnaswami Reddiar and another (1971) 43 Comp. Case 232] that where such a borrowing permissible under the company’s articles and moneys were borrowed on promissory notes, such transaction would come within the powers of the director, It has also been held in the same case that where a person was appointed as the managing director of the company by the Board’s resolution vested with full powers of the management of the affairs of the company and authorised to sign all the papers of the company, he would have full powers to borrow money on a promissory note even without a resolution of the Board as contemplated by Section 292(c) of the Act. Question 5 M/s Hurybury Builders Limited is contemplating to enter into a joint venture agreement with another construction company for the development of landed properties located at Bangalore. Since it is not possible to convene the Board Meeting immediately, as the directors are at different places in connection with various works, the Managing Director seeks your advice on the following matters:

(i) Whether the resolution pertaining to the joint venture agreement is required to be passed at the Board Meeting convened for this purpose or whether it can be passed by means of a circular resolution.



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(ii) What are the resolutions that are required to be passed only at the meetings of the Board of Directors?

(iii) The steps that are required to be taken to pass the Board resolution by circulation. Advise. (May, 2002)

Answer The directors of the company act together as a body and generally at the meeting of the Board duly convened, unless special powers are delegated to an individual director or the managing director. Where it is not possible to hold board meetings because the directors are busy elsewhere or the time for convening such a meeting is short, it is possible that the required resolution can be passed by way of circular resolution as provided in section 289 of the Companies Act, 1956. However, under section 292, certain powers can be exercised by the Board of directors only by means of a resolution passed at meeting convened for this purpose. They are (i) to make calls (ii) to issue debentures (iii) to borrow money otherwise than on debentures (iv) to invest the funds of the company and (v) to make loans. In view of the above, the Managing Director can go ahead and complete the joint venture agreement after obtaining the approval of the board by passing a circular resolution. For this purpose, the proposed resolution has to be circulated in draft along with the other necessary papers, if any, to all the directors in India at their usual residential addresses. The resolution will become valid if the same is approved by majority of the directors and who are entitled to vote on the resolution. There after the resolution as passed by way of circulation will be entered in the minutes book of the Board of Directors and is enough compliance of the provisions of Companies Act in this regard. Question 6 Advise the Board of Directors of a public company about their powers in respect of the following proposals explaining the relevant provisions of the Companies Act, 1956:

(i) Donation of Rs. 5,00,000 to a hospital established exclusively for the benefit of employees.

(ii) Buy-back of shares of the company for the first time upto 10% of the paid-up equity share capital.

(iii) Delegating to the managing director of the company the power to invest surplus funds of the company in the shares of some companies. (May, 2003)

Answer (i) Donation to a hospital run exclusively for the benefit of employees of the

company: The limit of 5% of average net profits during the last 3 financial years is applicable only to contributions to charitable and other funds not directly relating to the



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business of the company or the welfare of its employees [Section 293(1)(e), Companies Act, 1956]. Hence the Board is empowered to make the proposed donation to the hospital.

(ii) Section 292 has been amended by Companies (Amendment) Act 2001 to facilitate buy back of shares upto 10% of the total paid-up equity capital and free reserves [Section 292(i)(aa)]. Hence special resolution in general meeting of the company is not required. Hence the proposed buy back of shares is in order provided other conditions laid down on section 77A are fulfilled.

(iii) Section 292 of the Companies Act, 1956, empowers the Board of Directors to delegate to the M.D the power to invest in general terms. But Section 372A(2) provides that no investment shall be made, unless it is sanctioned by a resolution passed at a meeting of the Board with the consent of all the directors present Section 372A does not provide for delegation. Hence the proposed delegation of power to invest to the M.D. is not in order.

Question 7 Decide in the light of the provisions of the companies Act, 1956 the validity and extent of powers of Board of Directors and the procedure to be complied with in the following matters:

(i) Delegation of power of the Managing Director of the company to invest surplus funds of the company in the shares of some companies.

(ii) Donation of Rs.5 lakhs to a hospital established exclusively for the benefit of employees and a donation of Rs.5 lakhs to a charitable trust registered under Section 12A and exempted under Section 80G of the Income-tax Act, 1961.

(iii) Donation of Rs.5 Lakhs to a political party registered with the appropriate authority. (June 2009)

Answer (i) Section 292 of the Companies Act, 1956 empowers the Board of Directors to delegate

to the Managing Director the power to invest in general terms. But section 372A (2) of the said act provides that no investment shall be made, unless it is sanctioned by a resolution passed at a meeting of the Board with the consent of all the directors present. Section 372A does not provide for delegation. Hence the proposed delegation of power to the Managing Director to invest is not in order.

(ii) Donation to a hospital run exclusively for the benefit of employees of the company is in order. The limit of 5% of average net profits during the last three financial years is applicable only to contributions to charitable and other funds not directly relating to the business of the company or the welfare of its employees. Thus, under section 293 (1)



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(e) of the Companies Act, 1956, the Board is empowered to make the proposed donation to the hospital.

However the donation of Rs.5 Lakhs to a charitable trust is subject to the limit laid down in section 293(1) i.e. Rs.50,000 or 5% of the average net profits of the company during the last three financial years whichever is higher.

Thus to contribute Rs.5 lakhs the average net profits for last three financial years should be Rs.100 lakhs.

(iii) Donation of Rs.5 Lakhs to a political party can be made if the company is in existence for more than 3 years and the donation amount cannot exceed 5% of the average net profit for the preceeding three years. Further the procedure laid down in Section 293 A should also be complied with.

Question 8 Advise the Board of Director of Spectra Papers Ltd. regarding validity and extent of their powers, under the provisions of the Companies Act, 1956 in relation to the following matters:

(i) Buy-back of the shares of the Company, for the first time, upto 10% of the paid up equity share capital without passing a special resolution.

(ii) Delegation of Power to the Managing Director of the company to invest surplus funds of the company in the shares of some companies. (CA Final, New Course, May, 2010)

Answer (i) Section 292 (i) (aa) of the Companies Act, 1956 facilitates buy-back of shares upto 10 % of

the total paid up equity capital and free reserves. Hence, special resolution in general meeting of the company is not required. The proposed buy-back of shares is in order provided other conditions laid down in Section 77A of the Companies Act, 1956 are fulfilled.

(ii) Section 292 of the Companies Act, 1956 empowers the Board of Directors to delegate to the Managing Director the power to invest in general terms. But Section 372A (2) of the said Act provides that no investment shall be made unless it is sanctioned by a resolution passed at a meeting of the board with the consent of all Directors present. Section 372A does not provide for delegation. Hence the proposed delegation of power to the Managing Director to invest is not in order

Audit Committee (Section 292) Question 9 An Audit Committee of a Public Limited Company constituted under section 292A of the Companies Act, 1956 submitted its report of its recommendation to the Board. The Board, however, did not accept the recommendations. In the light of the situation, analyze whether:



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(a) The Board is empowered not to accept the recommendations of the Audit Committee.

(b) If so, what alternative course of action, would be Board resort to?

(c) As a Chairman of the Audit Committee, how would you respond to the situation?

Answer (i) As per Section 292A, a recommendations of the audit Committee on any matter relating

to financial management, including the audit report, shall be binding on the Board. (ii) If the Board does not accept the recommendations of the Audit Committee, it shall

record the reasons therefore and communicate such reasons to the shareholders. (iii) The Chairman of the Audit Committee shall attend the Annual General Meeting(s) of

the company to provide any clarifications on matters relating to Audit. Question 10 The paid-up capital of XYZ Limited has been increased from Rs.4 crores to Rs.6 crores. The Board of Directors of XYZ Limited purpose to constitute an ‘Audit Committee’. At present the board consists of 10 directors including a Managing Director. Draft a board resolution taking into account the requirements under the Companies Act relating to the constitution of the Audit Committee and the chairman of the audit Committee. XYZ Limited is not a listed public company. (May, 2002) Answer (1) As per section 292 A of Companies Act, 1956, every public company having paid up

capital of Rs. 5 cores or more must constitute a committee of Board as ‘Audit Committee’.

(2) The audit committee shall consist of minimum 3 directors. Out of the total members of committee, at least two-third shall be on executive directors, that is those who are not managing or whole time directors. The committee shall elect its own Chairman. Terms of reference will be specified in writing by the Board (Section 292A(2)).

(3) Draft Board resolution. Resolved that, pursuant to section 292A of the Companies Act, 1956 an Audit committee consisting of the following directors be and is hereby constituted 1. Shri________, Nomineee of IFCI 2. Shri________, Nomineee of IDBI 3. Shri________, 4. Shri________, 5. Shri________, Managing Director



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Further resolved that the Charmin of the Audit Committee shall be elected by its members from amongst themselves. Further resolved that the Audit Committee shall have the authority to investigate into any matter what may be prescribed under the said section 292 A and the following matters 1. ________________ 2. ________________ 3. ________________ 4. ________________ Question 11 A private company having a paid-up capital of Rs. 6 crores has been converted into a public company. The company proposes to constitute an Audit Committee.Draft a board resolution covering the following matters taking into account the provisions of the Companies Act, if any, in this regard: (i) Members of the audit committee (ii) Chairman of the audit committee (iii) Quorum for a meeting of the audit committee (iv) Any two main functions of the committee. (May, 2003) Answer Draft Board Resolution – Audit Committee Resolved that, pursuant to section 292 A of the Companies Act, 1956, an audit committee consisting of the following Directors be and is hereby constituted. 1. Shri __________, Nominee of IDBI 2. Shri __________, Nominee of ICICI 3. Shri __________, Nominee of State Bank of India 4. Shri __________, 5. Shri __________, Managing Director Further, resolved that the Chairman of the Audit Committee shall be elected by its members from amongst themselves. Further resolved that the quorum for a meeting of the Audit Committee shall be 1/3rd of the total number of members or two directors (other than the Managing Director) whichever is higher. Further resolved that the Audit Committee shall have the authority to investigate into any



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matter that may be prescribed under the said section 292 A and any other matter that may be referred to it by the Board from time to time. Further resolved that the Audit Committee shall conduct discussion with the auditors periodically about internal control systems, the scope of audit including the observation of auditors. Further resolved that the Audit Committee shall review the quarterly and annual financial statements and submit the same to the Board with its recommendations, if any Question 12 What do you understand by Corporate Governance? Explain, how the provisions of the Companies Act, 1956 relating to Audit Committee will help in achieving some of the objectives of Corporate Governance. (May 2005) Answer The vast amount of literature available on the subject ensures that there exist innumerable definitions of corporate governance. To get a fair view on the subject it would be prudent to give a narrow as well as a broad definition of corporate governance. In a narrow sense, corporate governance involves a set of relationships amongst the company’s management, its board of directors, its shareholders, its auditors and other stakeholders. These relationships, which involve various rules and incentives, provide the structure through which the objectives of the company are set, and the means of attaining these objectives as well as monitoring performance are determined. Thus, the key aspects of good corporate governance include transparency of corporate structures and operations, the accountability of managers and the boards to shareholders, and corporate responsibility towards stakeholders. In a broader sense, however, good corporate governance, the extent to which companies are run in an open and honest manner, is important for overall market confidence, the efficiency of capital allocation, the growth and development of countries’ industrial bases, and ultimately the nations’ overall wealth and welfare. AUDIT COMMITTEE For better corporate governance, the concept of Audit Committee for companies was introduced by section 292A of the Companies Act, 1956. Every public company having paid up capital of not less than Rs.5.00 Crores must have an Audit Committee. The auditors, the internal auditor, if any, and the director-in-charge of finance shall attend and participate at meetings of the Audit Committee [Section 292A(5)]. As per section 292A(6) of the said Act, the function of the Audit Committee includes the following:



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(a) The Audit Committee should discuss with the auditors periodically about internal control systems, the scope of audit including the observations of the auditors.

(b) The Audit Committee should review half yearly and annual financial statements before submission to the Board.

(c) The Audit Committee should ensure compliance of internal control systems. The Audit Committee shall have authority to investigate into any matter in relation to the items specified in this section or referred to it by the Board and for this purpose, shall have full access to information contained in the records of the company and external professional advice, if necessary. [Section 292A (7)]. The recommendations of the Audit Committee on any matter relating to financial management including the audit report, shall be binding on the Board and if the Board does not accept the recommendations of the Audit Committee, it shall record the reasons therefore and communicate such reasons to the shareholders. [Section 292 A (8) & (9)]. The above provisions of law relating to powers and functions of the Audit Committee relating to financial statements will help in achieving one of the objectives of corporate governance, i.e., accountability and avoidance of poor financial reporting. It also ensures that the companies are managed in clean and transparent manner. Question 13 MNC Ltd., a company, whose paid up capital was Rs. 4.00 Crores, has issued rights shares in the ratio of 1:1. The said company is listed with Mumbai Stock Exchange. Whether the company is required to appoint any Audit Committee and if yes, draft a suitable Board Resolution to appoint an Audit committee covering the aspects as provided in the Companies Act, 1956 and the listing Agreement with the Stock Exchange. In case the company is not required to appoint any Audit Committee, state the provisions of the Companies Act, 1956 in respect of appointment of Audit Committee by a Company. (May 2007) Answer As per provision of section 292A of the Companies Act, 1956, a public company having a paid up capital of Rs. 5.00 Crores or more is are required to have an Audit Committee. Since, after the rights issue by MNC Ltd. its paid up capital has increased to Rs. 8.00 Crores, it is required to appoint an Audit Committee. The relevant Board Resolution for appointment of an Audit Committee is as follows: “Resolved that pursuant to the provision contained in section 292A of the companies Act 1956 and clause 49 of Listing Agreement with the Mumbai Stock Exchange, an Audit Committee of the Company be and is hereby constituted as under: 1. Mr. A -- An Independent Director.



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2. Mr. B -- An Independent Director 3. Mr. C -- Director nominated by IDBI 4. Mr. D -- An Independent Director 5. Mr. FD -- Financial Executive 6. Mr. MD -- Managing Director Further resolved that the Chairman of the Committee, who shall be an independent Director, be elected by the members from amongst themselves. Further resolved that the quorum for a meeting of the Audit Committee shall be 1/3rd of the total number of members or two directors (other than the Managing Director), whichever is higher. Further resolved that the Audit Committee shall comply with the following: (1) The Audit Committee shall have meetings periodically as it may deem fit with at least

three meeting in a year, viz., one meeting before finalization of annual accounts and one every six months.

(2) The Audit Committee shall invite such of the executives (and particularly the head of the finance function) to be present at the meeting of the Committee whenever required by it.

(3) The finance Director, head of internal audit and the auditors of the company shall attend and participate at the meeting without right to vote.

Further resolved that the audit Committee shall have the authority to investigate into nay matter that may be prescribed under the said section 292A of the Companies Act, 1956 and the matters as mentioned in the Listing Agreements entered into between the Company and the Mumbai Stock Exchange and all the matters as may be referred to it by the Board from time to time and for this purpose the Audit Committee shall have full access to information contained in the records of the Company and external professional advice, if necessary. Further resolved that the Audit committee shall conduct discussions with the auditors periodically about internal control system, the scope of audit including the observations of the auditors. Further resolved that the Audit Committee shall review the quarterly and annual financial statements and submit the same to the Board with its recommendations, if any. Further resolved that the recommendations made by the Audit Committee on any matter relating to financial management including the audit report shall be binding on the Board. However, where such recommendations are not accepted by the Board, the reasons for the



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same shall be recorded in the minutes of the Board meeting or communicated to the shareholders. Further resolved that the Audit Committee have the minutes of its meetings drawn and approved by the Chairman of the Committee and the same be circulated to the members of the Board within thirty days from the date of such meeting. Further resolved that the Company Secretary of the Company shall be the Secretary to the Audit Committee. Further resolved that the Chairman of the Audit Committee shall attend the annual general meeting of the Company to provide any clarifications on matters relating to audit as may be required by the members of the company. Further resolved that the Board’s Report/Annual Report to the members of the Company shall include the particulars of the constitution of the Audit Committee.” Question 14

Supra Limited, a private company, has been converted into a public company and under the provision of the of the Companies Act, 1956. The company proposes to constitute an audit committee. Taking into account the provisions of the Companies Act, 1956 draft a board resolution covering the following matters:

(i) Member of the audit committee.

(ii) Chairman of the audit committee.

(iii) Quorum for meeting of the said committee.

(iv) Any two functions of the said committee. (November 2008) Answer AUDIT COMMITTEE – BOARD’S RESOLUTION: “Resolved that pursuant to Section 292A of the Companies Act, 1956 an Audit Committee consisting of the following Directors be and is hereby constituted. 1. Mr. ---- Nominee of IDBI 2. Mr. ---- Nominee of ICICI 3. Mr. ---- Nominee of the SBI. 4. Mr. --- 5. Mr. ----- Managing Director. Further resolved that the Chairman of the Audit Committee shall be elected by its members from amongst themselves.



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Further resolved that the quorum for a meeting of the Audit committee shall be 1/3rd of the total number of members or two directors (other than the Managing Director) whichever is higher. Further resolved that the Audit Committee shall have the authority to investigate into any matter that may be prescribed under Section 292A of the Companies Act, 1956 and any other matter that may be referred to it by the Board from time to time. Further resolved that the Audit committee shall conduct discussion with the auditors periodically about internal control systems, the scope of audit including the observation of auditors. Further resolved that the Audit Committee shall review the quarterly and annual financial statements and submit the same to the Board with its recommendations if any”. Question 15 Explain how the provisions of the Companies Act, 1956 relating to Audit Committee will help in achieving some of the objectives of Corporate Governance. (CA Final, New Course, May 2009) Answer For better corporate governance the concept of Audit committee for companies was introduced by section 292A of the Companies Act, 1956. Every public company having paid up capital of not less than Rs.5.00 crores must have an audit Committee. The auditors, the internal auditor, if any and the Director-In–Charge of finance shall attend and participate at meetings of the Audit Committee [Section 292A (5)] As per Section 292A(6) of the said Act, the functions of the Audit Committee includes the following: (a) The Audit Committee should discuss with the auditors periodically about internal control

systems, the scope of audit including the observations of the auditors. (b) The Audit Committee should review half yearly and annual financial statements before

submission to the Board. (c) The Audit Committee should ensure compliance of internal control systems. The Audit committee shall have authority to investigate into any matter in relation to the items specified in this Section or referred to it by the Board and for this purpose, shall have full access to information contained in the records of the company and external professional advice , if necessary. [Section 292A (7)]. The recommendations of the Audit Committee on any matter relating to financial management including the audit report shall be binding on the Board and if the Board does not accept the



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recommendations of the Audit Committee, it shall record the reasons therefore and communicate such reasons to the shareholders. (Section 292A (8) & (9)). The above provisions of law relating to powers and functions of the Audit committee relating to financial statements will help in achieving one of the objective of corporate governance i.e. accountability and avoidance of poor financial reporting. Restrictions on powers of Board (Section 293) Question 16 The Board of Directors of Stepping Stones Publications Ltd. at a meeting held on 15.1.2001 resolved to borrow a sum of Rs. 15 crores from a nationalized bank. Subsequently the said amount was received by the company. One of the Directors, who opposed the said borrowing as not in the interest of the company has raised an issue that the said borrowing is outside the powers of the Board of Directors. The Company seeks your advice and the following data is given for your information: (i) Share Capital Rs. 5 crores (ii) Reserves and Surplus Rs. 5 crores (iii) Secured Loans Rs. 15 crores (iv) Unsecured Loans Rs. 5 crores Advice the management of the company. (May, 2001) Answer According to the provisions of Section 293(1)(d) of the Companies Act, 1956 there are restrictions on the borrowing powers to be exercised by the Board of directors. According to that section, the borrowings should not exceed the aggregate of the paid up capital and free reserves. While calculating the limit, the temporary loans obtained by the company from its bankers in the ordinary course of business will be excluded. However, from the figures available in the present case the proposed borrowing of Rs. 15 crores will exceed the limit mentioned. Thus the borrowing will be beyond the powers of the Board of directors. However the share holders have the power to ratify the act of the Board of Directors, if it is not beyond the powers of the company as laid down in the memorandum of association. In that case the shareholders can ratify as it is intra vires the company even though it may be beyond the powers of the Board of Directors. Thus the management of Stepping Stone Publications Ltd., should take steps to convene the annual general meeting and pass a resolution by the members in the meeting as stated in Section 293(1)(d) of the Act. Then the borrowing will be valid and binding on the company and its members.



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Question 17 The last three years’ Balance Sheet of PTL Ltd., contains the following information and figures:

As at 31.03.2003 As at 31.03.2004 As at 31.03.2005 Rs. Rs. Rs. Paid up capital 50,00,000 50,00,000 75,00,000 General Reserve 40,00,000 42,50,000 50,00,000 Credit Balance in Profit & Loss Account

5,00,000 7,50,000 10,00,000

Debenture Redemption Reserve

15,00,000 20,00,000 25,00,000

Secured Loans 10,00,000 15,00,000 30,00,000 On going through other records of the Company, the following is also determined:

Net Profit for the year (as calculated in accordance with the provisions of Section 349 & 350 of the Companies Act, 1956

12,50,000 19,00,000 34,50,000

In the ensuing Board Meeting scheduled to be held on 5th November, 2005, among other items of agenda, following items are also appearing:

(i) To decide about borrowing from Financial institutions on long-term basis.

(ii) To decide about contributions to be made to Charitable funds.

Based on above information, you are required to find out as per the provisions of the Companies Act, 1956, the amount upto which the Board can borrow from Financial institution and the amount upto which the Board of Directors can contribute to Charitable funds during the financial year 2005-06 without seeking the approval in general meeting.

(November 2004, November 2005) Answer (i) Borrowing from Financial Institutions: As per Section 293(1)(d) of the Companies

Act, 1956, the Board of Directors of a public company or a private company which is a subsidiary of a public company, without obtaining the approval of shareholders in a general meeting, can borrow the funds including funds already borrowed upto an amount which does not exceed the aggregate of paid up capital of the company and its free reserves. Such borrowing shall not include temporary loans obtained from the company’s bankers in ordinary course of business. Here, free reserves do not include



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the reserves set apart for specific purpose. Since the decision to borrow is to be taken in a meeting to be held on 5th November,

2005, the figures relevant for this purpose are the figures as per the Balance Sheet as at 31.03.2005. According to the above provisions, the Board of Directors of PTL Ltd. can borrow, without obtaining approval of the shareholders in a general meeting, upto an amount calculated as follows:

Rs. Paid up Capital 7,500,000 General Reserve (being free reserve) 5,000,000 Credit Balance in Profit & Loss Account (to be treated as free reserve)

1,000,000

Debenture Redemption Reserve (This reserve is not to be considered since it is kept apart for specific purpose of debenture redemption)

----

Aggregate of paid up capital and free reserve 13,500,000 Total borrowing power of the Board of Directors of the company, i.e, 100% of the aggregate of paid up capital and free reserves

13,500,000

Less: Amount already borrowed as secured loans 3,000,000 Amount upto which the Board of Directors can further borrow without the approval of shareholders in a general meeting. 10,500,000

(ii) Contribution to Charitable Funds: As per Section 293(1)(e) of the Companies Act, 1956, the Board of Directors of a public company or a private company which is a subsidiary of a public company, without obtaining the approval of shareholders in a general meeting, can make contributions to charitable and other funds not directly related to the business of the company or the welfare of its employees upto an amount which, in a financial year, does not exceed Rs.50,000/- or five per cent of its average net profits as determined in accordance with the provisions of Sections 349 and 350 of the Companies Act, 1956 during the three financial years immediately preceding, whichever is greater.

According to the above provisions, the Board of Directors of the PTL Ltd. can make contributions to charitable funds, without obtaining approval of the shareholders in a general meeting, upto an amount calculated as follows:

Net Profit for the year (as calculated in accordance with the provisions of Sections 349 & 350 of the Companies Act, 1956:



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Rs. For the financial year ended 31.12.2003 12,50,000 For the financial year ended 31.12.2004 19.00,000 For the financial year ended 31.12.2005 34,50,000 TOTAL 66,00,000 Average of net profits during three preceding financial years 22,00,000Five per cent thereof 1,10,000

Since this amount is higher than Rs.50,000/-, the Board of Directors of PTL Ltd. can make contribution to charitable funds upto Rs.1,10,000/- during the financial year 2005-06 without obtaining the approval of shareholders in a general meeting.

Question 18 Examine the validity of the resolution passed at the Annual General Meeting of a public company for payment of dividend at a rate higher than that recommended by the board of directors. Is it possible for the board of directors of the company to revoke the dividend declared at the Annual General Meeting? The Board of Directors of XYZ Limited having paid-up share capital of Rs. 6 crores and free reserves of Rs.3 crores proposes to increase the sitting fee which is at present Rs.5,000. They seek your advice about the maximum amount upto which the sitting fee may be increased without seeking the approval of the Central Government. Advise explaining the relevant provisions of the Companies Act, 1956. (CA Final, New, November, 2008) Answer According to Regulation 85 of Table A of the Companies Act, 1956, a company in general meeting may declare dividends, but no dividend shall exceed the amount recommended by the Board of Directors of the company. The shareholders at an Annual General Meeting may reduce the amount of dividend recommended by the Board of Directors of the company, but they cannot increase it. Hence the resolution passed at the Annual General Meeting for payment of dividend at a rate higher than that recommended by the Board of Directors is not valid. Revocation of declared dividend Ordinarily, a dividend once declared at Annual General Meeting, cannot be revoked, except, with the consent of the shareholders, for a declaration of dividend creates a debt to the shareholders in whose favour it is declared. If a dividend is declared and the amount is paid or credited to the shareholders as dividend, the character of the credit or payment as dividend cannot be altered by a subsequent resolution (Kishanchand Chellaram VCIT (1962) 32 Company cases 1046,105C ( SC).



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But where a dividend has been illegally declared, or where, due to events intervening — after the declaration, such as fire destroying the company’s property, or the out break of a war, or the composition of new heavy tax burden or other causes diminishing the assets of the company makes it advisable to conserve the remaining assets, the Board of Directors will be justified in revoking the declaration of dividend. Sitting fees The company proposes to increase the Sitting fees payable to directors for attending Board meetings without seeking the approval of the Central Government for such increase. According to the first provision to Section 310 of the Companies Act, 1956, any increase in sitting fees up to prescribed limit will not require approval of the Central Government. As per rule 10b of Companies (Central Governments) General Rules & Forms, 1956 maximum sitting fees payable per meeting of Board of Directors or its committee is as follows- (a) Rs.20,000 per meeting if paid up capital plus free reserves are Rs.10 crore or more or

turnover is Rs.50 crore or more (since word used is “or”, it is so sufficient if one of the conditions is satisfied ).

(b) Rs. 10,000 per meeting in other cases (i.e. company whose paid up capital plus free reserves is less than Rs.10 crore and turnover is less than Rs.50 crore ).

The paid up capital plus free reserves of XYZ Ltd is less than Rs. 10 crore and information regarding turnover is not available. If the turnover of the company is also less than Rs.50 crore, the Sitting fees can be increased only up to Rs.10,000 per meeting ,without seeking approval of the Central Government. If the turnover is Rs.50 crore or above Sitting fees can be increased up to Rs.20,000 without approval of the Central Government. Question 19 Big Ben Ltd., a reputed public company, had advanced certain sum of money to one of its Directors, namely, Mr. Tanmay on certain terms and conditions and fixing the time limit for repayment thereof. Now, Mr. Tanmay has approached the Company with a request to extend the time limit for repayment of balance of loan amounting to Rs.12.00 lacs by another six months.

You are required to state with reference to the provisions of the Companies Act, 1956, the answer to the following: (i) Who is authorized to grant the extension as requested by Mr. Tanmay? (ii) Draft an appropriate notice for the meeting where such extension may be granted.

(CA Final, New Course, June 2009) Answer (i) As per provisions of Section 293(1)(b) of the Companies Act, 1956, the Board of

Directors of Big Ben Ltd., a public company can not give time for the repayment of any debt due by Mr. Tanmay, a director of the company except with the consent of the



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Company by way of an ordinary resolution passed in a General Meeting. In view of this provision of the law, the Company in a General Meeting is authorized to grant the extension as requested by Mr. Tanmay.

(ii) Notice for calling the General Meeting of the company: BIG BEN LIMITED

Registered Office:______________________________________

NOTICE FOR EXTRA ORDINARY GENERAL MEETING

NOTICE is hereby given that an Extra Ordinary General Meeting of the members of the company will be held at the Registered office of the Company on _________________, the _________ day of _______________, 2009 at 11.00 A.M. to transact the following business:

(1) To pass, with or without modification, the following resolution as an Ordinary Resolution:

“RESOLVED THAT pursuant to the provision of Section 293(1)(b) of the Companies Act, 1956, consent be and is hereby accorded to the company for extending the time for the repayment of the balance amount of Rs. 12.00 Lacs advanced to Mr. Tanmay, a Director of the company, by a further period of six months ending on ___________________, 2009.”

FOR & ON BEHALF OF THE BOARD

Dated._______________, 2009 ___________________________

Company Secretary

Notes: (1) A member entitled to attend and vote at the Meeting is entitled to appoint a proxy to

attend and vote instead of himself and such proxy need not be a member of the Company. Proxies in order to be valid must be deposited at least 48 hours prior to commencement of the Meeting.

(2) Explanatory Statement pursuant to Section 173(2) of the companies Act, 1956 is annexed hereto

Question 20 The Board of Directors of LM Limited propose to donate Rs.3,00,000 to a school established exclusively for the benefit of children of employees and also donate Rs.50,000 to a political party during the Financial year ending 31st March, 2010. The average net profits determined



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in accordance with the provisions of Sections 349 and 350 of Companies Act, 1956 during the three immediately preceding financial years is Rs.40,00,000. Examine with reference to the provisions of the Companies Act, 1956 whether the proposed donations are within the power of the Board of Directors of company. (CA Final, New Course, June 2009) Answer Donations: As per section 293(1) (e) of the Companies Act, 1956, the Board of Directors of a Company must obtain approval of the shareholder by way of resolution passed in their meeting for contributing in any year, to charitable and other funds not directly relating to the business of the company or the welfare of to employees any amount exceeding Rs.50,000 or 5% of its average net profits of the last 3 financial years, which ever higher. In the given case, the school is established exclusively for the benefit of the children of the employees of the company and hence the restriction under section 293 (1) (e) is not applicable and the Board is empowered to make the proposed donation. Donation to political parties: It is presumed that LM Ltd is not a Government Company. It has been in existence for more than 3 years. The proposed donation to a political party is only Rs.50,000 which is less than 5% of the average net profit for 3 immediately preceding financial years. Hence the Board of Directors is empowered to make a donation by passing a resolution at a Board meeting. The company is also required to make is proper disclosure in the profit and loss account. (Section 293 A).


CHAPTER 13

POLITICAL CONTRIBUTIONS (SECTIONS 293A – 293B)

Prohibitions and restrictions regarding political contributions (Section 293A) Question 1 The Board of Directors of Very Well Ltd., are contributing every year to a charitable organization a sum of Rs.60, 000/-. In a particular year, the company suffered losses and the directors are contemplating to contribute the said amount in spite of the losses. In this connection, state whether the directors can do so? Answer The power to donate to general charities is not conditional to existence of any profit. In such a case they may contribute up to the limit given in sec. 293(1) (e), even though the company may be working at a loss. Under the section the section a public company can contribute in any financial year not exceeding Rs 50,000 or 5% of its average net profits during the three preceding financial years whichever is greater. Question 2 M/s XYZ Ltd. was incorporated on 1st January, 2000. On 1st November, 2002 a political party approaches the company for a contribution of Rs. Ten lakhs for political purpose. Advise in respect of the following: (i) Is the company legally authorised to give this political contribution? (ii) Will it make any difference, if the company was in existence on 1st October, 1999? (iii) Can the company be penalised for defiance of Rules of this regard? Answer (i) No. prior to amendment of Section 293 A, by the Companies (Amendment) Act 1985,

there was a blanket ban on political Contributions by Companies. But the amended section seeks to continue the existing blanket ban against political contributions in case of government companies and companies which have been in existence for less than three financial years.

Since XYZ Co. has not completed three years of existence on 2nd November 2002, it is not eligible to give political contribution.



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(ii) Yes, because in that case, XYZ ñî. limited shall complete three financial years of its existence, therefore, will be eligible to give political contribution subject to the condition that such a political contribution should not exceed five percent of the average net profits and a resolution authorising such contribution is passed at a meeting of the Board of Directors.

(iii) The Amended Section 293A seeks to impose an obligation on every company to disclose in its profit and loss account contributions made by it to any political party or for any political purpose. Contravention of the provisions of this section will make a company liable to fine which may extend to three times the amount so contributed. Further every officer of the company in default would be liable to imprisonment for a term which may extend to three years and also to fine.


CHAPTER 14

APPOINTMENT OF SOLE SELLING AGENTS (SECTIONS 294 – 297)

Prohibition on payment of commission to role selling agents for loss of office in certain cases (Section 294 A) Question 1 Randhir was appointed as the sole selling agent of S Ltd. for a period of five years in a general meeting of the company. Exactly after 1-½ years, S. Ltd. was amalgamated with another company A. Ltd. Randhir was not appointed as the sole selling agent of A. Ltd. S Ltd. paid Randhir Rs. 6 lacs as selling agency commission during the said 1-½ years. Is Randhir entitled to any company and if yes what is the quantum. Answer Section 294A prohibits payment of compensation to the sold selling agent for the loss of his office in the following cases: (i) where the appointment of the sold selling agent ceases to be valid by virtue of section

294(2A). (ii) where he resigns his office as a result of reconstruction or amalgamation of the

company and is appointed as the sole selling agent of the reconstructed company or the body corporate resulting from the amalgamation.

(iii) where he resigns his office otherwise than in the circumstances envisaged in the foregoing clause (ii).

(iv) where he has been guilty of fraud or breach of trust in relation to, or of gross negligence in the conduct of his duty as the sole selling agent; and

(v) where he has instigated or taken part directly or indirectly in bringing about the termination of the sole selling agency.

In this case, Randhir has not been appointed as the sole selling agent of A Ltd. None of the other prohibitions also apply. Hence Randhir would be entitled to compensation. The amount of compensation payable for the loss of office must in non case exceed the remuneration which he would have earned, if he had been in office for the unexpired residue of his term, or for 3 years, whichever is shorter. The amount thereof is to be calculated on the basis of the average remuneration actually earned by him during a period of 3 years immediately proceeding the date on which he had ceased to be in office or his appointment



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was terminated. In case he had held his office for a period lesser than 3 years, the basis would be the average remuneration that he had earned during such shorter period. The average remuneration earned is 6/1.5 = 4 lakhs. The compensation payable would be 4×3 = Rs. 12 lakhs. Question 2 On 1st January, 2001 the Board of Directors of XL Co. Ltd. appointed Mr. Y as Sole Selling Agent of the Company for a period of five years. On 6th February, 2001 XL Co. Ltd. in its General Meeting disapproved the appointment of Mr. Y as Sole Selling Agent of the Company. Explain:

(a) Is Mr. Y entitled to payment of compensation for Loss of Office?

(b) Are there some other circumstances when compensation for loss of office is prohibited to a Sole Selling Agent? (November, 2002)

Answer (i) According to Section 294(2)of the Companies Act, 1956, the Board of Directors of XL

Ltd. "shall not appoint a sole selling agent for any area except subject to the condition that the appointment shall cease to be valid if it is not approved by the company in the first general meeting held after the date on which the appointment is made".

It has been held that the appointment of a sole selling agent must be made by the company in its general meeting and such clause must be inserted as a mandatory condition in all appointments of sole selling agents; an appointment without such a clause being inserted is void ab-intio (Arante manufacturing Corp. vs. Bright Bills Private Ltd. 1967 Comp/ Case 759 Shelagram Jhaigharia vs. National Co. Ltd. 1965 Comp. Cas. 706) If the company in the general meeting disapproves the appointment it shall become invalid form the date of the general meeting.

In the given case, assuming that the general meeting of XL Co. Ltd. held on February 6, 2001 was their first general meeting after January 1 , 2001 and the disapproval of the company, in this meeting will make the appointment of Mr. Y as sole selling agent invalid w.e.f. February 6, 2001.

(ii) Section 294(A) prohibits payment of compensation to the sole selling agent for the loss of his office in the following cases in addition to the one discussed in part (2) above : (a) Where the sole selling agent resigns his office as a result of reconstruction or

amalgamation of the company, and is appointed as the sole selling agent of the reconstructed company or the body corporate resulting from the amalgamation.

(b) Where the sole selling agent resigns his office otherwise than in the circumstances envisages in the foregoing clause (i)


Appointment of Sole Selling Agents (Sections 294 – 297)

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(c) Where a sole selling agent has been found to be guilty of fraud or breach of trust in relation to, or of gross negligence in the conduct of his duty as the sole selling agent.

(d) Where the sole selling agent has investigated or taken part directly or indirectly in bringing about the termination of the sole selling agency.

Question 3 Mr. BPK was appointed as the sole selling agent of M/s KMP Ltd. with effect from 1st January, 2002 for a period of five years. Mr. BPK earned his remuneration as follows during the years 2002 to 2004:

Year Amount of remuneration

2002 Rs.4,41,000

2003 Rs.6,32,000

2004 Rs.7,45,000

On and from 1st January, 2005, the sole selling agency agreement was terminated by M/s KMP Ltd. You are required to calculate the amount of compensation payable by the said company to Mr. BPK under the provisions of the Companies Act, 1956.

What would be your answer in a case where the said M/s KMP Ltd. was amalgamated with another company with effect from 1st January, 2005 and Mr. BPK refused to act as the sole selling agent of the amalgamated company after amalgamation. (May 2005) Answer As per provisions of section 294A(2) of the Companies Act, 1956, any compensation payable by a company to its sold selling agent for premature loss of office shall not exceed the remuneration which he would have earned if he would have been in office for the unexpired residue of his term, or for three years, which ever is shorter, calculated on the basis of the average remuneration actually earned by him during a period of three years immediately preceding the date on which his office ceased or was terminated, or where he held his office for a period lesser than three years, then average remuneration actually earned by him during such lesser period. Based on the above provision of the Companies Act, 1956, Mr. BPK is entitled to compensation for the unexpired residue of his term, i.e., for two years since it is shorter than three years. Such compensation shall be calculated on the basis of average remuneration received by him during the years 2002 to 2004. On the basis of figures given in the question, the amount of compensation shall be as follows:



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Year Amount of remuneration (Rs.) 2002 4,41,000/- 2003 6,32,000/- 2004 7,45,000/- Total Remuneration 18,18,000/- Average Remuneration per annum 6,06,000/- Compensation payable to Mr. BPK for two years 12,12,000/- As per provisions of section 294A(1) of the Companies Act, 1956, where the sole selling agent resigns his office in view of amalgamation with any other company and he is appointed as sole selling agent after such amalgamation, then he is not entitled to any compensation and the company is also prohibited from paying any compensation to the sole selling agent. Thus, in second case, Mr. BPK shall not be entitled to any compensation for premature loss of office since he himself has refused to act as the sole selling agent after amalgamation. Question 4 M/s FAB Electronics Ltd. (FEL) has appointed four private companies as its selling agents for sale of its white goods in the four regions of the country. A complaint has been made to the Registrar of Companies, new Delhi that the four selling agents are in fact functioning as sole selling agents and that the terms and conditions of their appointment are not in the interest of FEL. Advise FEL about the provisions of the Companies Act and the action that may be taken by the authorities under the Act. (November 2007) Answer According to Section 294(6) of the Companies Act, 1956 where a company has more selling agents than one, by whatever name called and it appears to the Central Government that it is necessary to obtain information about the terms and conditions and appointment of such agents for the purpose of determining whether any of those selling agents are in fact working as sole selling agents. The Central Government has the power to call for such information as may be necessary to find out the correct position. On the basis of the information obtained, the Central Government may by an order declare that selling agents be the sole selling agent for the area so related with effect from such date as may be specified in the order. From the date so specified in the order, the appointment of the sole selling agent shall be regulated by the terms and conditions as may be varied by the Central Government. It shall be the duty of the company to furnish all information and documents and refusal to do so will involve penalty which may extend upto Rs. 50,000/-. Thus it is imperative for the company to furnish all the information and documents in its possession to the Registrar of Companies or any authority making any enquiry in this regard that the selling agents are not functioning as sole selling agents.



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Question 5 On 24th January, 2010, the Board of Directors BUI Limited appointed Mr. A as the company's Sole Selling Agent for a period of 5 years. At the first general meeting of the company, held after the Board meeting, on April 10, 2010, the above appointment was disapproved. Referring to the provisions of the Companies Act, 1956.

(i) State the date from which the above appointment comes to an end.

(ii) What would be your answer in case a condition in the above appointment that "the appointment must be made by the company in General Meeting" was not attached thereto? (May, 2010)

Answer According to Section 294(2) of the Companies Act, 1956, the Board of Directors of BUI Ltd. shall not appoint a sole selling agent for any area except subject to the condition that the appointment shall cease to be valid if it is not approved by the company in the first general meeting held after the date on which the appointment is made. It has been held that the appointment of a sole selling agent must be made by the company in its general meeting and such clause must be inserted as a mandatory condition in all appointments of sole selling agents; an appointment without such a clause being inserted is void ab-intio (Arante manufacturing Corp. Vs. Bright Bills Private Ltd. 1967 Com/Case 769, Shelagram Jhaigharia Vs National Co. Ltd. 1965 Com. Cas. 706). If the company in the general meeting disapproves the appointment, it shall become invalid from the date of the general meeting. (i) Thus, appointment of Mr. A as the sole selling agent will come to an end on 10th

April 2010. Yes, as discussed above, in absence of the above clause, the appointment of Mr. A as the sole selling agent of the company will be void ab-initio. Question 6 Mr. Agent having ‘substantial interest’ in ABC Ltd is appointed as a Sole selling agent by the Board of Directors for a period of 5 years. The company’s paid-up share capital is Rs.49 crores. The Board did not place the matter in the AGM and communicated to Mr. Agent about his appointment, who in turn accepted the offer.

Examining the provisions of the Companies Act, 1956,

(a) Whether the appointment is in order?

(b) What course of action you would take as the Secretary of the company, in case Mr. Agent does not have substantial interest?



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Answer Appointment of Sole Selling Agent: Section 294 and 294AA of the Companies Act, 1956 regulate the appointment of sole selling agents. These sections provide that: 1. No company shall appoint a sole selling agent for any areas for a term exceeding 5

years at a time and the term may be extended for another period but not exceeding 5 years on each occasion. [Section 294(1)].

2. The Board of Directors may appoint a sole selling agent but only subject to the condition that the appointment shall cease to be valid if it is not approved by the company in the first general meeting held after the date on which the appointment is made. In case, the company in general meeting, as aforesaid, disapproved the appointment, it shall cease to be valid with effect from the date of that general meeting [Section 294(2) and (2A)].

3. Where the Central Government is of opinion that the demand for goods of any category, to be specified by that government is substantially in excess of the production or supply of such goods and the services of sole selling agents will not be necessary to create a market for such goods, the Central Government may be notification in the Official Gazette, declare that sole selling agents shall not be appointed by a company for the sale of such goods, for such period, as may be specified in the declaration.

4. No company shall appoint any individual firm or body corporate, who or which has a substantial interest in the company as sole selling agent of that company unless such appointment has been previously approved by the Central Government.

5. A company having a paid-up share capital ofRs.50 lakhs or more shall not appoint a sole selling agent except with the consent of the company accorded by a special resolution and the approval of the Central Government.

6. The Central Government may vary the terms and condition of appointment of a sole selling agent if those are found to be prejudicial to the interest of the company.

7. In case a company has more than one selling agents in any area, the Central Government may declare any one of such agents as the sole selling agent for such area after obtaining from the company and considering the terms and conditions of appointment of the selling agents.

Procedure for appointment of sole selling agents: 1. Call a meeting of the Board of Directors and determine the name of the sole selling

agent to be appointed. If the paid-up share capital of the company is less than Rs.50 lakhs a nd the appointee does not have a substantial interest in the company, the Board may also resolve to appoint him as sole selling agent subject to the approval of the general body meeting. Date for the general meeting may also be fixed by the Board in its meeting, appointing the sole selling agent.



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2. In case the appointee either has a substantial interest in the company, or the paid-up share capital of the company is Rs.50 lakhs or more, application for the approval of the Central Government should be made in Form 1 of the Companies (Appointment of Sole Agents) Rules, 1975.

3. See that the terms and conditions of appointment or reappointment do not contain the tenure exceeding 5 years, at a time.

4. Issue notices for holding the general meeting. Where the paid-up share capital of the company is Rs.50 lakhs or more, it shall r3equire passing a special res9olution; otherwise an ordinary resolution shall be sufficient.

5. Forward three copies of the notices and a copy of the proceedings of the general meeting to the Stock Exchange(s) with which the shares of the company are listed (if listed).

6. If the proposed sole selling agent is to be appointed in a foreign country, obtain the prior permission of the RBI.

Thus applying the above provisions (i) the appointment of J is not in order, as there have been a number of violation on the part of the company as per the Companies Act, 1956. Appointment without the approval of the general meeting and without the approval of the Central Government is not valid since the company’s paid-up share capital is more than Rs.50 lakhs in this case. Moreover, since J has substantial interest in the company, approval of Central Government in Form 1 is must. Thus, the appointment of J is not in order. In the second question (ii), the answer would not be different, as the capital (paid-up share capital) is more than 50 lakhs Rupees. In this case though the appointee (J) does not have substantial interest, but the company’s paid share capital is more than 50 lakhs, consent of the company in general meeting (special resolution) and the approval of the Central Government is required. Power of CG to prohibit the appointment of role selling agents in cartain cases (Section 294 AA) Question 7 The Board of Directors of ‘X Ltd. having a paid-up share capital of Rs. 40 lakhs appointed 'Y Ltd, as sole selling agent for a period of 5 years with effect from 1st January, 2003 and the said appointment was approved by the company in the Annual General Meeting held on 30th April, 2003. The Directors of 'Y Ltd. was holding fully paid-up shares of face value of Rs. 3 lakhs in Lid.’ Answer the following explaining the relevant provisions of the Companies Act: (i) Is the appointment of the sole selling agent in order? (ii) Would your answer be different if both are Private Companies or if the Directors of Y Ltd.

(acquired the aforesaid shares in 'X Ltd.) on 1st April, 2003?



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Answer (i) Sole Selling Agents: (i) According to Section 294AA(2) of the Companies Act, 1956 a

company shall not appoint any individual, firm or body corporate, who or which has a substantial interest in the company, as sole selling agent of that company unless such appointment has been previously approved by the Central Government.

Here a body corporate is appointed as sole selling agent. A body corporate can be said to have “substantial interest’ in the company, if such body corporate or one or more of its directors or any relative of such director, whether singly or taken together hold beneficial interest in the shares of the company, the aggregate amount paid-up on which exceeds Rs. 5 lakhs or 5% of the paid-up share capital the company, whichever is less. Here 5% of the paid-up share capital of X Ltd. works out to Rs. 2 lakhs. The directors of Y Ltd. were holding fully paid-up shares of face value of Rs. 3 lakhs in X Ltd.. and hence Y Ltd. can be said to have substantial interest in X Ltd. Therefore, the appointment of Y Ltd. as sole selling agent requires prior approval of the Central Government under Section 294AA(2). In this case the appointment has been made by the Board of Directors and approved by the company in general meeting. As the prior approval of the Central Government has not been obtained, the appointment is not in order and the company has contravened the provisions of Section 294AA(2).

(ii) Section 294AA is applicable to both private and public limited companies. So it is immaterial whether X Ltd. is a private in public company. Again the body corporate includes both private and public companies. Hence the provisions of Section 294AA(2) are attracted even if the sole selling agency company is a private company. Therefore even if both the companies are private companies, the appointment of sole selling agent without approval of the Central Government is not in order.

It has been clarified by the Department of Company Affairs that in case the provisions of Section 294AA(2) are not attracted to the appointment of sole selling agents the time of entering of agreement with them, it will not be obligatory on the companies to comply with the said provisions for the continuance of the said appointments for the remaining duration of their current tenure even if the provisions of Section 294AA(2) become applicable after the appointment due to the sole selling agents acquiring substantial interest as defined in the explanation under the Section. If the directors Ltd. were not holding shares in X Ltd. at the time of appointment but acquired the shares subsequently the appointment is in order and it does not violate the provisions of section 294AA(2).

Question 8 Randhir was appointed as the sole selling agent of S Ltd. for a period of five years in a general meeting of the company. Exactly after one and half years, S Ltd. was amalgamated



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with another company A Ltd. Randhir was not appointed as the sole selling agent of A Ltd. S Ltd. paid Randhir Rs.6 lacs as selling agency commission during the said one and half years. Is Randhir entitled to any compensation and if yes, what is the quantum? (November, 2000) Answer Section 294A prohibits payment of compensation to the sold selling agent for the loss of his office in the following cases: (i) Where the appointment of the sold selling agent ceases to be valid by virtue of section

294(2A). (ii) where he resigns his office as a result of reconstruction or amalgamation of the

company and is appointed as the sole selling agent of the reconstructed company or the body corporate resulting from the amalgamation.

(iii) where he resigns his office otherwise than in the circumstances envisaged in the foregoing clause

(iv) where he has been guilty of fraud or breach of trust in relation to, or of gross negligence in the conduct of his duty as the sole selling agent; and

(v) where he has instigated or taken part directly or indirectly in bringing about the termination of the sold selling agency.

In this case, Randhir has not been appointed as the sole selling agent of A Ltd. None of the other prohibitions also apply. Hence Randhir would be entitled to compensation. The amount of compensation payable for the loss of office must in no case exceed the remuneration which he would have earned, he had been in office for the unexpired resdue of his term, or for 3 years, whichever is shorter. The amount thereof is to be calculated on the basis of the average remuneration actually earned by him during a period of 3 years immediately proceeding the date on which he had ceased to be in office or his appointment was terminated. In case he had held his office for a period lesser than 3 years, the basis would be the average remuneration that he had earned during such shorter period. The average remuneration earned is 6/1.5=4 lacs. The compensation payable would be 4x3=Rs.12 lacs. Question 9 Ram and Co. Ltd. having paid up share capital of Rs. 40 lakhs appointed on 1st January, 1995 Lakshman and Co. Pvt. Ltd. as sole selling agent for a period of 5 years with effect from 1st January, 1995 with the approval of the company in general meeting. The directors of Lakshman and Co. Pvt. Ltd. were holding 40,000 equity shares of Rs. 10 each fully paid-up in Ram and Co. Ltd. since 1st December, 1994. State with reasons whether the appointment is valid. Will your answer be different, if Lakshman and Co. Pvt. Ltd. had acquired the aforesaid shares only on 1st December, 1995?

(May, 2003)



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Answer Under section 294AA. no company can except with the prior approval of the Central Government, appoint any individual, firm or body corporate, who or which has a substantial interest in the company as sole selling agent of that company. A person holding paid-up capital exceeding Rs.5 lakhs or 5% of the paid-up capital of the company whichever is less is deemed to have substantial interest in that body corporate [Explanation to Section 294AA]. Thus Ram & Co. should have obtained prior approval of the Central Government for appointing Lakshman & Co. Pvt Ltd as sole selling agents as the latter holds 10% of the paid-up capital of the former company. The appointment is accordingly not valid. The situation shall be different if shares were acquired by Lakshman & Co. on 1st December 1995. According to a clarification issued by the Department of Company Affairs, if the provisions of Section 294AA(2) are not attracted to the appointment of selling agents at the time of entering into the agreement with them, it will not be obligatory on the company to comply with the said provision for continuance of said appointment for the remaining duration of the current tenure, even if the provisions of section 294AA(2), became applicable after the appointment due to sole selling agents acquiring substantial interest. However Lakshman & Co. Ltd can continue as sole selling agents for period of 5 years i.e. upto 31st December, 1999, if it acquired the shares only on 1st December 1995 i.e after its appointment on 1st January 1995. Question 10

The Board of Directors of ACE Limited having a paid up share capital of Rs. 70 lakhs reappointed Bre Ltd. As sole selling agent for a period of 5 years W.E.F. 2 May, 2007. The Directors of BRE Ltd. were holding fully paid up shares of face value of Rs. 3 lakhs. In ACE Ltd. the reappointment was approved by the company in the next AGM held on 30th September, 2007 but Central Government approval was not obtained until 31st December, 2007. Give your opinion explaining the relevant provision of the Companies Act, 1956. (i) Is the reappointment of the sole selling agent in order? (ii) Will your opinion be different if the directors of BRE Ltd. do not hold any shares in ACE

Ltd? (iii) If the reappointment is valid. When will the reappointment take effect from?

(November 2008) Answer Section 294AA of the Companies Act, 1956 contains the powers of Central Government to prohibit the appointment of Sole Selling Agents in certain cases. The section further provides that no company shall appoint any individual, firm or body corporate, who or which has a substantial interest in the company, as Sole Selling Agent of that company unless such appointment has been previously approved by the Central Government (Section 294AA (2)).



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Also no company having a paid up share capital of rupees fifty lakhs or more shall appoint a Sole Selling Agent except with the consent of the company accorded by a Special Resolution and the approval of the Central Government (Section 294AA(3)). Section 294AA (7) provides that if the company in general meeting disapproves the appointment referred to in sub-section (3), such appointment shall, notwithstanding anything contained in sub-section (6), cease to have effect from the date of the general meeting. The explanation to this section provides that “appointment“ includes “re-appointment “ and “substantial interest “ in relation to a body corporate, means the beneficial interest held by such body corporate or one or more of its directors or any relative of such director, whether singly or taken together, in the shares of the company , the aggregate amount paid up on which exceeds five lakhs of rupees or five per cent of the paid up share capital of the company, whichever is the lesser. (i) So the reappointment of BRE Ltd. as sole selling agent is in order as general meeting

approval was obtained by way of special resolution. Further, ACE Ltd. has to obtain the approval of the Central Government as required under Section 294AA (3) and the same was also obtained by 31st December 2007.

(ii) No, even if BRE Ltd. does not hold any shares in ACE Ltd. the appointment shall remain valid as ACE Ltd has obtained the approval of the Central Government under Section 294AA(3).

(iii) Effective date of reappointment is the date from which he is re appointed by the company. As such the re-appointment shall be valid from 2nd May 2007.

Question 11 A company proposes to appoint a Sole Selling Agent for its products. State the cases in which such appointment requires approval of Central Government. Draft a Board Resolution to appoint a sole selling agent in a case where such appointment does not require approval of Central Government. (CA Final, New Course November, 2009) Answer Appointment of sole selling agents Under Section 294AA of the companies Act,1956, in following cases, appointment of sole selling agents will require approval of Central Government: (a) An individual firm or body corporate who has a substantial interest in the company

cannot be appointed as a sole selling agent without prior approval of Central Government [Section 294 AA(2)]. Substantial interest means shares of Rs.5. lakhs or 5% paid up capital of the company, whichever in less. The shareholding may be singly or together with relatives (in the case proposal Sole Selling Agent being an individual), partners and their relatives (in the case of a firm) directors and relatives of directors (in the case of a body corporate (Explanation (b) to Section 294AA).



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(b) Any company having paid up share capital of Rs.50 lakhs or more cannot appoint sole selling agent with approval in general meeting by a special resolution and also approval of Central Government [Section 294AA(3)]. These restrictions apply to all Companies is both Private and Public Companies.

Board Resolution Resolved that pursuant to the provisions of section 294 of the Companies Act, 1956, and subject to the approval of the Company at a general meeting by ordinary resolution, the Board approves the appointment of ‘X’ as the company’s sole selling agent for the sale of ….. in the territory of …. for a period of five years with effect from …… on the terms and conditions set out in the draft agreement produced to this meeting and initiated by the chairman for purposes of identification or with such modifications (not being less advantageous to the company) as may be mutually agreed by the Board and ‘X’ Loans to directors, etc (Section 295) Question 12 A director of a public company has taken a loan from the company without the approval of the Central Government. State in this connection

(i) is it possible to avoid prosecution by applying to the central Government for approval or by refunding the loan?

(ii) whether the offence is compoundable before or after institution of prosecution and the authority can compound the offence?

Answer (i) According to Section 295 of the Companies Act, no public company shall make any

loan to any of its directors either directly or indirectly without obtaining the previous approval of the Central Government. As the Act envisages prior approval, Central Government will not entertain any application from the company seeking approval for a loan already given to its director.

The company has, therefore, contravened the provisions of Section 295(1) and for this offence every person who is knowingly a party to this contravention including the person to whom the loan is made shall be punishable either with fine which may extend to Rs. 50,000 or with simple imprisonment for a term which may extend to six months [Section 255(4)]. Where any such loan has been repaid in full, no punishment by way of imprisonment shall be imposed and where the loan has been repaid in part, the maximum punishment, which may be imposed by way of imprisonment, shall be proportionately reduced. So, by refunding the loan in full, it is possible to avoid punishment in the form of imprisonment, but it is not possible to a avoid prosecution and punishment in the form of fine.



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(ii) All offences other than offences which are punishable under the Companies Act with imprisonment only or with imprisonment and also with fine are compoundable under Section 621A. As the offence under Section 295 is punishable with fine or imprisonment, it is compoundable but with the permission of the Court [Section 621A(2)]. The offence may be compounded either before or after the institution of prosecution. If the offence is compounded before the institution of any prosecution, no prosecution shall be instituted in relation to such offence, either by the Registrar or by any shareholder or by any person authorised by the Central Government. Where the composition of any offence is made after the institution of any prosecution, such composition shall be brought to the notice of the court by the Registrar in writing and on such notice of the composition of the offence being given, the company or its officer in relation to whom the offence is so compounded shall be discharged [Section 621A(4)].

The offence may be compounded by the Regional Director where the maximum amount of fine, which may impose for such offence, does not exceed Rs. 50,000 and in other cases by the company Law Board. In this case, Regional Director may compound the offence, as the maximum fine is only Rs. 50,000. On receipt of applications from the persons liable for penalty under Section 295(4) along with the comments of the Registrar, the Regional Director may specify the amount no exceeding the maximum fine which shall be paid to the Central Government for compounding of the offence. Question 13 A company is offering one of its flats on sale to one of its directors on the condition that 50% of the price to be paid in cash and the rest in equated instalments. Comment on the situation, whether this could be treated as a loan under Section 295 of the Companies Act, 1956. Answer (i) This transaction does not per se amount to a loan so as to violate Section 295 of

Companies Act, 1956. The burden of proving otherwise lies with the prosecution. (M.G. Electronics Components Ltd v. Asst. Registrar of Companies).

(ii) The deposit of the cost of purchase of property cannot be regarded as a loan or advance to the M.D. or book debt attracting the provisions of section 295 or section 296 of the Companies Act. It is no concern of the M.D. on what terms the company secures premises for residential accommodation for him.

(ii) In a petition in Dr. Fredie Ardeshir Mehta v. Union of India seeking quashing of a prosecution launched under Section 295, the Bombay High Court came to the conclusion that a company selling one of its flat to one of its directors on receiving half price in cash and agreeing to accept the balance in instalments does not give a loan to the director. It is accredit sale. It cannot continued be described even as an indirect loan. In view of this decision, the transaction in question does not amount to a loan to a director requiring approval of the Central Government.



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Question 14 A & Co. Ltd. wants to sell its products to its following customers: (a) A partnership firm in which two of the directors of the company are partners; (b) A private company in which one of the directors of the company is a member; (c) A public company in which one of the directors of the company is a director. In these three cases what steps are required to be taken by A & Co. Ltd.? Answer (a) & (b) According to Section 297, except with the consent of the Board of Directors of a company, firm in which the director or directors of the company is/are partners or a private company of which such director or directors is or are a member or members shall not enter into any contract with the company for the sale, purchase or supply of any goods, materials or services. Therefore, the public company in the instant two cases should obtain the consent of its Board of Directors. This consent shall have to be taken by a resolution passed at the Board meeting and not otherwise. The resolution according the consent must be passed before the contract to sell the product is entered into or within 5 months of the date on which it was entered into; otherwise consent shall not be deemed to have been given. If the consent is not accorded, anything done in pursuance of the contract shall be voidable at the option of the Board. Care should be taken to ensure that the interested directors do not vote on the motions and their presence is not counted for the purpose of quorum for the meeting. Also it is to be seen that such directors have disclosed their interests in the contract pursuant to Section 299 of the Companies Act unless any of them is enjoying the exemption under sub-section (6) of the above section. The consent contemplated above is not a general consent but consent referable to each particular or specific contract or contracts. Consent requires knowledge of the necessary facts and material, which lead to the consent and cannot be given in general or abstract manner (Watchand Nagar Industries Ltd. vs. Ratanchand, A.I.R. Bom. 256). Therefore, the Board of the public company should take appropriate steps in this regard. (c) The point of the case in question relates to disclosure of interest by directors.

According to Section 299(6), nothing in Section 299 shall apply to any contracts entered into or to be entered between two companies where one of the directors of the one company or two or more of them together holds or hold not more than 2% of the paid up share capital in the other company. This point is not clear from the facts in the problem. This is a contract to be entered into between two companies. And if the director of the first company holds 2% or less of the paid-up share capital in the second public company, the provisions of Section 299 will not apply to this case.

If, however, the said director holds more than the aforesaid 2% then the Board of Directors should see that the director, pursuant to Section 299, discloses his interest or concern at the meeting of the Board. This disclosure has to be made at the Board meeting at which the



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contract is considered. If the interest is acquired subsequent to the meeting then it is to be disclosed at the immediately next meeting. The Board of the first-mentioned public company should ascertain whether the interest of director aforesaid consists solely (i) in his being a director of such company and the holder of not more shares of such number and value therein as is requisite to qualify him for appointment as a director thereof, he having been nominated as such director by the company or (ii) in his being a member holding not more than 2% of its paid-up share capital. Also, there is no restriction on voting, etc. by an interested director if a notification had been issued by the Central Government under Section 300(3) exempting the company from the purview of Section 300. If, on such assertion, the interest is not found to be so consisting as aforesaid, the Board of the company should see that interested director does not participate in the discussion or vote on the contract and that his presence is excluded from the computation of quorum. Question 15 Mr. X is a director of M/s ABC Ltd. He has approached M/s Housing Finance Co. Ltd. for the purpose of obtaining a loan of Rs.50 lacs to be used for construction of building his residential house. The loan was sanctioned subject to the condition that M/s ABC Ltd. should provide the guarantee for repayment of loan instalments by Mr. X. Advise Mr. X. (November, 2001) Answer According to section 295 of the Companies Act, 1956, no company shall make a loan or give any guarantee, or provide any security in connection with a loan made by any other person to any director of the lending company unless the previous approval of the Central Government is obtained in this behalf. Thus, Mr. X has to approach his company ABC Ltd by stating the full details of the loan transaction and the stipulation of M/s Housing Finance Company Ltd. Thereafter M/s ABC Ltd has to make an application to the Central Government for approval under Section 295 along with the prescribed fees. Only on receipt of the approval M/s ABC Ltd can provide guarantee to M/s Housing Finance Co. Ltd. The company is also required to comply with the provisions of section 292 (i.e. Board Resolution) and section 372A (special resolution in a general meeting if required). Question 16 In the light of the conditions laid down by Section 295 of the Companies Act, 1956, examine if the following transactions can be considered as loans to Directors: (i) Advance payment of salary to the employee who is also the spouse of the Managing

Director of the Company. (ii) A sale of flat of the company at the Current Market Rate and Price. The Director pays

sixty per cent Cash immediately and contracts to pay the balance in ten monthly instalments.

(iii) A loan to a firm in which the Director of the company is a Partner. (November, 2002)



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Answer A company's power of lending money to its directors is strictly regulated by the Companies Act, 1956. The Act prohibits the company not only from directly lending money to its directors but also from giving any guarantee for a loan taken by a director from any other person, and providing any security for such loan. Section 295 deals with loans to Directors.

(i) This transaction does not per se amount to a loan so as to violate Section 295 of the Companies Act, 1956. The burden of proving otherwise lies with the prosecution. Thus in the absence of any evidence that there has been circumvention of the section by disguising the loan to the wife of the director, who is an employee, as salary advance, the court refused to accept the case for prosecution. M.R.Electronic Components Ltd. vs. Assistant Registrar of Companies (1987) 6 Comp. Case 8 (Mad).

(ii) In a petition, Dr. Fredie Ardeshir Mehta V. Union of India seeking quashing of a prosecution launched under section 295, the Bombay HIgh Court came to the conclusion that a company selling one of its flats to one of its directors on receiving more than half the price in cash and agreeing to accept the balance in installments does not amount to giving a loan to the directors. It is a credit sale. It can not even be described as indirect loan.

(iii) Through the loan given by the company to the firm may not be direct loan to the directors of the company, yet the provisions of Section 295 of the Companies Act, 1956 prohibit any loan to a firm in which one or more of the company directors are partners. Since one of the directors of the company is a partner of this firm, a loan to this firm is in contravention of the provisions of Section 619.

Question 17 Mr. X is a director of several companies. He has approached the following companies in which he is a director for financial help to start his own personal business.

(i) Expandable Industries Ltd.

(ii) Expensive Gadgets Private Ltd.

(iii) Easy Finance Ltd.

The first named company has agreed to grant a loan of Rs. 50 lakhs. The second company also offered another loan of Rs. 50 lakhs .The third company has agreed to provide guarantee for the repayment of a loan sanctioned to Mr. X by a Private Bank to the tune of Rs. One crore. Advise Mr. X about the legal provisions that should be complied with under the Companies Act, 1956 and the consequences if there is a non – compliance. (November 2008)



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Answer According to Section 295 of the Companies Act, 1956 no public company shall directly or indirectly make any loan to or give any guarantee or provide any security in connection with a loan made by any other person to a director of the company without obtaining the previous approval of the Central Government. Thus M/s. Expandable Industries Ltd, being a public company has to take approval of the Central Government before the loan amount of Rs. 50 lakhs is disbursed. However no approval of the Central Government is required in the case of Expensive Gadgets Private Ltd. being a Private Company. However, if the said Private Company is a subsidiary of a Public Company, the approval of Central Government is required. In the case of Easy Finance Ltd. the approval of Central Government is required and thereafter only the transaction can be entered into without committing violation of the provision of the Companies Act, 1956. If there is any violation, Mr. X the director will vacate his office as a director as provided in Section 283 (1) (h) of the Act. The said violations is however compoundable under Section 621A of the Act. Question 18 (i) Mr. KMP is director of XLS Ltd. He intends to construct a residential building for his

own use. The cost of construction is estimated at Rs.1.50 Crores, which Mr. KMP proposes to finance partly from his own sources to the tune of Rs.60 lacs and the balance Rs.90 lacs from housing loan to be obtained from a housing finance company. For the purpose of obtaining the loan, he has approached the housing finance company which has in principle agreed to grant the loan, but has put a condition. The condition put by the housing finance company is that the Company XLS Ltd. of which Mr. KMP is a director should provide the guarantee for repayment of the loan and interest as per the terms of the proposed agreement for granting the loan to Mr. KMP. You are required to advise Mr. KMP on the matter with reference to the provisions of the Companies Act, 1956.

(ii) Draft a Board Resolution of XLS Ltd. For providing guarantee for Rs. 90.00 lacs in respect of a Loan to be obtained by Mr. KMP, a director thereof from a Housing Finance Company for construction of a residential house for his own use.

(CA Final, New Course, June 2009) Answer (a) (i) According to the provisions of Section 295 of the Companies Act, 1956, no

company shall make any loan or give any guarantee or any security in connection with a loan made by any other person to any director of the lending company unless the previous approval of the Central Government is obtained in this respect.



14.18

In view of the above provisions of the law, Mr. KMP is required to approach XLS Ltd. intimating the company the full details of the loan transaction and the condition imposed by the housing finance company. The company XLS Ltd. is required to pass a Board Resolution as required by Section 292 of the Companies Act, 1956 and also a special resolution in terms of Section 372A if the facts of the case so require. Thereafter, the company is required to make an application to the Central Government for obtaining the approval under Section 295 of the Companies Act, 1956. On receipt of the approval of the Central Government, XLS Ltd. can provide the guarantee to housing finance company in respect of the loan proposed to be granted to Mr. KMP

(ii) RESOLUTION PASSED IN THE MEETING OF THE BOARD OF DIRECTORS OF XLS LTD. HELD ON____________________

“RESOLVED that, subject to the approval of the Central Government, sanction be and is hereby accorded to the proposal of furnishing the guarantee in respect of a loan of Rs.90.00 lacs to be obtained by Mr. KMP, a director of the Company , from M/s____________________, a housing finance company as per terms and conditions contained in the draft loan agreement to be entered into between the said housing finance company and Mr. KMP, a copy of which is placed before this meeting and initialed by the Chairman for the purpose of identification.

RESOLVED FURTHER that Mr. _____________, Secretary of the Company by and is hereby authorized to digitally sign the e-form 24AB, submit the application to the Ministry of Corporate Affairs and comply with all other formalities in this regard.”

Question 19 (a) X Ltd. whose paid up share capital to Rs.3 crores proposes to purchase raw material of

Rs.20 lakhs from Y Limited. It proposes to purchase raw material of Rs.10 lakhs on cash basis and the balance on 90 days credit. A who is the Managing Director of X Limited is also a director and shareholder of Y Limited. Advise the procedure.

(b) Z Limited has four directors and all of them are interested in a contract. Guide? Answer (a) The provisions of Section 297 are not applicable when the company from whom the

materials will be purchased is a public limited company. Mr. A has to comply with the provisions of Section 299 and disclose his interest at the Board Meeting and is not to participate in discussion at the meeting, when the above contract is put up for approval of the Board. Even if the shareholding of Mr. A in Y Ltd. together with the shareholding, if any,



14.19

of the directors is 2% or less in Y Ltd., disclosure of his interest as director in Y Ltd. shall be made.

(b) In terms of provision of Section 287 of the Companies Act, 1956, Quorum for meeting of Board of Directors of the Company shall be one third of its total strength or two Directors whichever if higher. Interested Directors presence shall not be considered for the purpose of quorum. In the present case, there will no quorum in the board meeting in respect of a contract as all the directors are interested therein. The remedy in such case seems to be to increase the strength of Board by appointing atleast two disinterested directors as additional directors who are not interested in said contract, if so authorised by Articles and if the said appointment shall be within the maximum number of directors as fixed by the Articles. If this is not found practicable it would be desirable to place the proposed contract before General Meeting for consent. [Department of Company Affairs Letter No. 816(l)61-P-R dated 9/5/81].

Board’s sanction to be required for certain contracts in which particular directors are interested (Section 297) Question 20 X Ltd., recently went in for public issue of shares and for this purpose it paid brokerage to a share broking firm in which one of the Directors of the company is a partner in that firm. State in this connection: (i) Whether the concerned interested director should disclose his interest in the firm to

the Company. If so, when? (ii) Should he still disclose, if the company already knew of this fact. (iii) What would be your answer, if the concerned director merely acted as a broker

between the firm and the company? Answer (i) According to Section 297, a director of the company or his relative, a firm in which such

a director or relative is a partner, any other partner in such a firm or a private company of which the director is a member or director, must not enter into contracts with company for the sale, purchase, or supply of goods, materials or services or for underwriting shares or debentures except with the consent of the Board of Directors. If the company is having a paid-up capital of Rs.1 crore or more no such contract shall be entered into except with the previous approval of the Central Government. The consent of the Board is deemed to have been given only if it is accorded by a resolution of the Board and not otherwise, either before or within three months of the date of entering into the contract. [sub-section (4)].

In view of the legal position as states above, the appropriate brokerage can be paid to the broking firm if the contract had been entered into with the consent of the Board of



14.20

Directors of X & Co. Ltd. the director in question is to disclose his concern or interest at the first meeting of the Board meeting held after the director becomes concerned or interested in the contract. A general notice given in this regard to the Board is deemed to be sufficient disclosure of his concern or interest, if either it is given at the meeting of the Board of Directors concerned or he takes reasonable steps to ensure that it is brought up and read at the first meeting of the board after it is given.

The condition under which the sanction of the Board of Directors in respect of contracts by directors or persons connected therewith would not be required [as contained in sub-section (2) of Section 297] have been liberalised. The restrictions do not apply to: (a) the purchase of goods and materials from, or sales thereof to, the company

for cash at prevailing market prices; (b) any contract or contracts between the company and directors or persons

connected therewith in respect of sale, purchase or supply of goods in which the parties to the contract regularly trade or do business in; provided they are in respect of goods and materials or services the value whereof or the cost of service would not exceed Rs.5,000 in aggregate in any year comprised in the period of the contract;

(c) the transactions by banking or insurance company entered into with any director, relative, firm, partner, etc. in the ordinary course of his business.

Section 297(3) provides that a director or persons connected with him may enter into a contract in the circumstances of urgent necessity without obtaining consent of the Board, even if the value of such a contract exceeds Rs. 5,000 in the aggregate, but in such a case the consent of the Board must be obtained at meeting within three months of the date of entering into the contract.

(ii) The term ‘disclosure’ means to make others aware of something, which they are not aware. The disclosure of interest by a director has been provided in Section 299 only with a view to know that the director occupies fiduciary position in the company should disclose his interest in any arrangement or contract either directly or indirectly so that the company is in a position to know whether he is acting in any way prejudicial to the interest of the company or for his own benefit. When board is aware of the fact of the interest of a director in a particular transaction, it would not be necessary for such a director to formerly disclose his interest. (Ramakrishna Rao vs. Bangalore Race Club, 40 Comp. Case 674 (Mysore). A. Sivasailam vs. Registrar of Companies {C.A. No. 11/621A/SRB/94 decided on 31.5.94 (CLB)}).

(iii) A contract to act as broker where the duty of the broker is merely to bring together the two contracting parties, namely, the company, on the one hand, and the purchaser of shares or debentures, on the other, does not seem to be covered either by clause (b) or by clause (a) of sub-section (1) of Section 297. It is not covered by clause (b) for two



14.21

reasons: First, clause (b) specifically refers to underwriting and importing into that clause the act of broking is not permissible. Secondly, there is a good deal of difference between underwriting and broking. In the case of the former, the obligation extends far beyond the mere bringing together the two contracting parties together, while in the case of latter, the broker earns his commission only when he succeeds in bringing the two parties together and not otherwise. To act as a broker is also not covered by clause (a) because commission earned as a broker is not earned by supplying services. The Madras High Court has rightly held that “rendering of services should consist of the doing of an act for the benefit of another which is more than the mere making of a contract and which goes beyond the performance of an obligation undertaken in the course of an ordinary commercial contract”. (Radhakrishna Rao vs. Province of Madras AIR 1952 Mad. 718)

Question 21

Examine whether the following contracts require previous approval of the Central Government keeping in view the effect of the proviso to Section 297(1) of the Companies Act, 1956.

(i)Contracts for purchase of goods from a public company having a paid-up share capital of more than ruppes one crore by a firm in which a director of the public company is a partner. The purchase is for cash at prevailing market prices.

(ii) Contracts attracting Section 297(1) to be entered into by a Public Company having a paid-up share capital of Rupees one crore in circumstances of urgent necessity. (May, 2004)

Answer

Section 297(3) provides that a contract attracting Section 297(1) may be entered into by the company without obtaining the consent of the Board in circumstances of urgent necessity. But the consent of the Board must be obtained within three months of the date on which the contract was entered into. While section 297(2) provides an exemption, Section 297(3) provides only relaxations that too only with one of the requirements i.e. consent of the Board. In the case under reference as the paid-up share capital of the company is Rs. 1 crore, both the consent of the Board as well as approval of the Central Government are required. Hence, the relaxation provided in Section 297(3) does not apply to a company which has a paid-up share capital of Rs.1 crore. The company must obtain approval of the Central Government before entering into contract even in circumstances of urgent necessity.

Question 22 X Ltd., recently went in for public issue of shares and for this purpose it paid brokerage to a share broking firm in which one of the Directors of the company is a partner in that firm. State in this connection:



14.22

(i) Whether the concerned interested director should disclose his interest in the firm to the company. If so, When?

(ii) Should he still disclose, if the company already knew of this fact. (iii) What would be your answer, if the concerned director merely acted as a broker

between the firm and the company? Answer (i) According to Section 297, a director of the company or his relative, a firm in which such

a director or relative is a partner, any other partner in such a firm or a private company of which the director is a member or director, must not enter into contracts with company for the sale, purchase, or supply of goods, materials or services or for underwriting shares or debentures except with the consent of the Board of Directors. If the company is having a paid-up capital of Rs.1 crore or more no such contract shall be entered into except with the previous approval of the Central Government. The consent of the Board is deemed to have been given only if it is accorded by a resolution of the Board and not otherwise, either before or within three months of the date of entering into the contract. [sub-section (4)].

In view of the legal position as states above, the appropriate brokerage can be paid to the broking firm if the contract had been entered into with the consent of the Board of Directors of X & Co. Ltd. the director in question is to disclose his concern or interest at the first meeting of the Board meeting held after the director becomes concerned or interested in the contract. A general notice given in this regard to the Board is deemed to be sufficient disclosure of his concern or interest, if either it is given at the meeting of the Board of Directors concerned or he takes reasonable steps to ensure that it is brought up and read at the first meeting of the board after it is given.

The condition under which the sanction of the Board of Directors in respect of contracts by directors or persons connected therewith would not be required [as contained in sub-section (2) of Section 297] has been liberalised. The restrictions do not apply to: (a) the purchase of goods and materials from, or sales thereof to, the company for

cash at prevailing market prices; (b) any contract or contracts between the company and directors or persons

connected therewith in respect of sale, purchase or supply of goods in which the parties to the contract regularly trade or do business in; provided they are in respect of goods and materials or services the value whereof or the cost of service would not exceed Rs.5,000 in aggregate in any year comprised in the period of the contract;

(c) the transactions by banking or insurance company entered into with any director, relative, firm, partner, etc. in the ordinary course of his business.



14.23

Section 297(3) provides that a director or persons connected with him may enter into a contract in the circumstances of urgent necessity without obtaining consent of the Board, even if the value of such a contract exceeds Rs. 5,000 in the aggregate, but in such a case the consent of the Board must be obtained at meeting within three months of the date of entering into the contract.

(ii) The term ‘disclosure’ means to make others aware of something, which they are not aware. The disclosure of interest by a director has been provided in Section 299 only with a view to know that the director occupies fiduciary position in the company should disclose his interest in any arrangement or contract either directly or indirectly so that the company is in a position to know whether he is acting in any way prejudicial to the interest of the company or for his own benefit. When board is aware of the fact of the interest of a director in a particular transaction, it would not be necessary for such a director to formerly disclose his interest. (Ramakrishna Rao vs. Bangalore Race Club, 40 Comp. Case 674 (Mysore). A. Sivasailam vs. Registrar of Companies {C.A. No. 11/621A/SRB/94 decided on 31.5.94 (CLB)}).

(iii) A contract to act as broker where the duty of the broker is merely to bring together the two contracting parties, namely, the company, on the one hand, and the purchaser of shares or debentures, on the other, does not seem to be covered either by clause (b) or by clause (a) of sub-section (1) of Section 297. It is not covered by clause (b) for two reasons: First, clause (b) specifically refers to underwriting and importing into that clause the act of broking is not permissible. Secondly, there is a good deal of difference between underwriting and broking. In the case of the former, the obligation extends far beyond the mere bringing together the two contracting parties together, while in the case of latter, the broker earns his commission only when he succeeds in bringing the two parties together and not otherwise. To act as a broker is also not covered by clause (a) because commission earned as a broker is not earned by supplying services. The Madras High Court has rightly held that “rendering of services should consist of the doing of an act for the benefit of another which is more than the mere making of a contract and which goes beyond the performance of an obligation undertaken in the course of an ordinary commercial contract”. (Radhakrishna Rao vs. Province of Madras AIR 1952 Mad. 718)

Question 23 LMB Ltd., Kolkata is a multiproduct manufacturing company having paid up capital of Rs.5.00 Crores. In order to increase the product portfolio, the said company intends to procure certain machines and equipments worth Rs.1.00 Crore from a partnership firm, namely, M/s MLPK, in which the son of managing director of LMB Ltd. is a partner. The contract for purchase of said machines and equipments is to be placed before the board of directors of the company for its consideration.



14.24

In view of above facts, you are required to explain briefly the procedure under the provisions of the Companies Act, 1956 to be followed by LMB Ltd. to enter into the said contract. (May 2005) Answer As per provisions of section 297 of the Companies Act, 1956, when a Company enters into a contract in which some of the directors are interested, then consent of the Board of Directors of the Company is required to be obtained. In the present case since the Managing Director of LMB is interested in the contract for the purchase of machines and equipments because of his son’s partnership in the supplier firm, the same should be approved by the board of directors of the company. Proviso to section 297(1) states that in the case of a company having a paid-up share capital of not less than rupees one crore, no such contract shall be entered into except with the previous approval of the Central Government. Since the paid up capital of LMB Ltd. is Rs.5.00 crores the company is required to take prior approval of the Central Government. For this purpose, following steps are required to be taken: (i) Hold a board meeting and place the terms of the contract for consideration. The

managing director should disclose the nature of his interest as required under section 299 of the Companies Act, 1956.

(ii) The managing director should not participate in discussion when in the board meeting; the matter in respect of the above mentioned contract is being discussed. He must not also vote on the relevant resolution. Moreover, his presence shall also not be counted for determining the quorum of the board meeting. [Section 300, Companies Act, 1956].

(iii) The consent of the board of directors must be accorded by way of a resolution and not otherwise.

(iv) An application to the Central Government (by delegation to Regional Director) should be made in prescribed form (Form No.24A). Following enclosures should be made with the said Form: (a) a certified true copy of the board resolution approving the contract. (b) a copy of the proposed agreement. (c) a copy of the Memorandum and Articles of Association of the company. (d) a copy of the latest audited annual accounts with directors’ and auditors’ reports

thereon. (e) Bank draft or treasury challan evidencing the payment of prescribed fees.

(v) Necessary entries are to be made in the Register of Contracts (Section 301).



14.25

On receiving the approval from the Central Government (Regional Director), the company can proceed to enter into the contract for supply of machines and equipments with the firm M/s MLPK in which the son of managing director is a partner. Question 24 Examine whether the following contracts require previous approval of the Central Government keeping in view the effect of the proviso to Section 297(1) of the Companies Act, 1956: Contracts for purchase of goods from a Public Company having a paid-up Share Capital of more than Rupees one crore by a firm in which a director of the Public Company is a partner. The purchase is for cash at prevailing market prices. (May 2004) Answer Section 297(a) of the Companies Act, 1956, provides that consent of the Board of Directors of a company shall be necessary for a contract for the sale, purchase or supply of any goods, material or services entered into by the company with a director of the company or his relative or a firm in which such a director or relative is a partner. The proviso to this sub-section requires that in the case of a company having paid up share capital of not less than Rs.1 crore (i.e. Rs.1 crore or more), no such contract shall be entered into except with the previous approval of the Central Government. Certain exemptions are provided in Sub-section (2) of Section 297. One such exemption is that noting contained in clause (a) sub-section (1) shall affect the purchase of goods and materials from the company by by any director, relative, firm stated in Section 297(1) for cash at prevailing market prices. As the contract referred to in the question qualifies for exemption under section 297(2)(a), approval of Central Government is not required. Question 25 PQR Machines Ltd. Entered into a contract with MN forgings, in which wife of P, a director of the company is a partner. The contract is for supply of certain components by the firm for a period of three years with effect from 1st September, 2005 on credit basis. The paid-up Share Capital was increased from Rs. 70 lakhs to Rs. 140 lakhs on 1st March, 2006. Explain the requirements under the Companies Act, 1956, which should have been complied with by PQR Machines Ltd. before entering into contract with MN Forgings. Whether there is any additional requirement which is required to be complied with by PQR Machines Ltd. in view of the increased paid-up Share Capital on 1st March, 2006. What would be your answer in case MN forgings is a Private Company in which P’s wife is holding substantial shares? (May 2006) Answer The contract for supply of components entered into between PQR Ltd. and MN Forgings, a partnership firm (on which wife of P, a director of the company is a partner) attracts Sections 297, 299, 300 and 301 of the Companies Act, 1956.



14.26

The contract cannot be entered into unless it is approved in the meeting of the Board of Directors of PQR Ltd. Specific Board resolution is required (Section 297). However, in case of urgent necessity such consent of the Board may be obtained within 3 months of the date on which the contract was entered into (Section 297(3)) P, the interested director must disclose his interest at the Board meeting at which the question of entering into the contract has been taken up for consideration (Section 299(1) & (2). P, the interested director should not have taken part in the discussion at the said board meeting and he should not have noted on the resolution in respect of that contract (Section 300) Prescribed particulars of the contract must be entered into the Registrar of Contract maintained under Section 301 within 7 working days of the Board meeting (Section 301). In the given case the contract was entered into on 1.9.2005 for supply of components for a period of 3 years. As the paid-up share capital was only Rs. 70 lakhs (i.e. less than Rs.1 crore) on 1.9.2005 proviso to Section 297(1) requiring prior approval of the Central Government is not attracted. Subsequent increase in the paid up share capital beyond Rs. 1 crore will not make it necessary to get the approval of the Central Government for continuation of the contract for the remaining period. Hence, there is no additional requirement. If MN Forgings is a private company the provisions of Section 297 are not attracted as the director of PQR Ltd. is a director or member of MN Forgings Private Ltd. Section 299 is also not attracted for the reasons given below: If the contract or arrangement is between companies, a director is deemed to be interested only if he singly or along with other directors hold 2% or more shares in other company (Section 299(6)). While calculating the 2% shares in other company, only investment of directors is considered. Here P, a director of PQR Ltd. is not holding any shares in MN forgings Pvt. Ltd. Shares held by P’s wife are not to be considered. Hence the provisions of Section 299 are not attracted. Sections 300 and 301 are also not applicable. Question 26

LMB Ltd., Kolkata is a multiproduct manufacturing company having paid up capital of Rs. 5.00 crores. In order to increase the product portfolio, the said company intends to procure certain machines and equipments worth Rs. 1.00 crore from a partnership firm, namely, M/s MLPK, in which the son of managing director of LMB Ltd. is a partner. The contract for purchase of said machines and equipments is to be placed before the board of directors of the company for its consideration.

In view of above facts, you are required to explain briefly the procedure under the provisions of the Companies Act, 1956 to be followed by the LMB Ltd., to enter into the said contract. (May 2008)



14.27

Answer As per provisions of section 297 of the Companies Act, 1956, when a Company enters into a contract in which some of the directors are interested, then consent of the Board of Directors of the Company is required to be obtained. In the present case since the Managing Director of LMB Ltd. is interested in the contract for the purchase of machines and equipments because of his son’s partnership in the supplier firm, the same should be approved by the board of directors of the company. Proviso to Section 297(1) states that in the case of a company having a paid-up capital of not less than rupees one crore, no such contract shall be entered into except with the previous approval of the Central Government. Since the paid up capital of LMB Ltd. is Rs. 5 crore, the company is required to take over prior approval of the Central Government. For this purpose, following steps are required to be taken: (i) Hold a board meeting and place the terms of the contract for consideration. The

managing director should disclose the nature of his interest as required under Section 299 of the Companies Act, 1956.

(ii) The managing director should not participate in discussion when in the board meeting, the matter in respect of the abovementioned contract is being discussed. He must not also vote on the relevant resolution. Moreover, his presence shall also not be counted for determining the quorum of the board meeting. [Section 300 of the Companies Act. 1956]

(iii) The consent of the board of directors must be accorded by way of a resolution and not otherwise.

(iv) An application to the Central Government (by delegation to Regional Director) should be made in prescribed form (Form No. 24A). Following enclosures should be made with the said form: (a) a certified true copy of the board resolution approving the contract (b) a copy of the proposed agreement (c) a copy of the Memorandum and Articles of Association of the company (d) a copy of latest audited annual accounts with directors’ and auditors’ reports

thereon. (e) bank draft or treasury challan evidencing the payment of prescribed fees.

(v) Necessary entries are to be made in the Register of Contracts (Section 301)

On receiving the approval from the Central Government (Regional Director), the company can proceed to enter into the contract for supply of machines and equipments with the firm M/s MLPK in which the son of Managing Director is a partner.



14.28

Question 27 A & Co. Ltd. wants to sell its products to its following customers: (a) A partnership firm in which two of the directors of the company are partners; (b) A private company in which one of the directors of the company is a member; (c) A public company in which one of the directors of the company is a director. In these three cases what steps are required to be taken by A & Co. Ltd.? Answer (a) & (b) According to Section 297, except with the consent of the Board of Directors of a

company, firm in which the director or directors of the company is/are partners or a private company of which such director or directors is or are a member or members shall not enter into any contract with the company for the sale, purchase or supply of any goods, materials or services. Therefore, the public company in the instant two cases should obtain the consent of its Board of Directors. This consent shall have to be taken by a resolution passed at the Board meeting and not otherwise. The resolution according the consent must be passed before the contract to sell the product is entered into or within 5 months of the date on which it was entered into; otherwise consent shall not be deemed to have been given. If the consent is not accorded, anything done in pursuance of the contract shall be voidable at the option of the Board. Care should be taken to ensure that the interested directors do not vote on the motions and their presence is not counted for the purpose of quorum for the meeting. Also it is to be seen that such directors have disclosed their interests in the contract pursuant to Section 299 of the Companies Act unless any of them is enjoying the exemption under sub-section (6) of the above section.

The consent contemplated above is not a general consent but consent referable to each particular or specific contract or contracts. Consent requires knowledge of the necessary facts and material, which lead to the consent and cannot be given in general or abstract manner (Watchand Nagar Industries Ltd. vs. Ratanchand, A.I.R. Bom. 256). Therefore, the Board of the public company should take appropriate steps in this regard.

(c) The point of the case in question relates to disclosure of interest by directors. According to Section 299(6), nothing in Section 299 shall apply to any contracts entered into or to be entered between two companies where one of the directors of the one company or two or more of them together holds or hold not more than 2% of the paid up share capital in the other company. This point is not clear from the facts in the problem. This is a contract to be entered into between two companies. And if the director of the first company holds 2% or less of the paid-up share capital in the second public company, the provisions of Section 299 will not apply to this case.



14.29

If, however, the said director holds more than the aforesaid 2% then the Board of Directors should see that the director, pursuant to Section 299, discloses his interest or concern at the meeting of the Board. This disclosure has to be made at the Board meeting at which the contract is considered. If the interest is acquired subsequent to the meeting then it is to be disclosed at the immediately next meeting. The Board of the first-mentioned public company should ascertain whether the interest of director aforesaid consists solely (i) in his being a director of such company and the holder of not more shares of such number and value therein as is requisite to qualify him for appointment as a director thereof, he having been nominated as such director by the company or (ii) in his being a member holding not more than 2% of its paid-up share capital. Also, there is no restriction on voting, etc. by an interested director if a notification had been issued by the Central Government under Section 300(3) exempting the company from the purview of Section 300. If, on such assertion, the interest is not found to be so consisting as aforesaid, the Board of the company should see that interested director does not participate in the discussion or vote on the contract and that his presence is excluded from the computation of quorum.


CHAPTER 15

PROCEDURE, ETC., WHERE DIRECTOR INTERESTED (SECTIONS 299 – 302)

Question 1

A Limited had four directors. At one of its convened Board meeting only two of them attended and they appointed two additional directors who were their relatives. Is the appointment of those additional directors valid?

Answer

Section 300 provides that a director shall not take part in the discussion of or vote on any contract or arrangement entered into or to be entered into by or on behalf of the company if he is in anyway whether directly or in directly concerned or interested in the contract or arrangement. The Department of Company Affairs has clarified that the word interested as used in the section should be given a restrictive interpretation and thus excludes a director who has no pecuniary interest. Accordingly, the relationship of the director with the contracting party will not per se make the director concerned or interested in the contract or arrangement.

The scope of the expression ‘contract’ or ‘arrangement’ was examined by the Madras High Court in Madras Tube Co. Ltd. vs. Hari Krishan Somani, (1985) I Comp LJ 195 (Mad). The question before the court was whether the appointment of an additional director would come within the scope of the word ‘contract’ or ‘arrangement’. The company had four directors. Only two of them attended the meeting. They appointed two additional directors who were related to them as brother and wife, respectively. The court came to the conclusion that although appointment as director does not come within the scope of the expression ‘contract’ because the position of a director may be conferred on a person by any method other than contract, became interested directors. Without them there was no independent quorum. Consequently the appointments were a nullity.

The Bombay High Court re-examined the matter in Shailesh Harilal Shah vs. Matushree Textiles Ltd., (1994) and after giving due consideration to the authorities which influenced the Madras decision nevertheless came to the conclusion that the appointment as an additional director of a person who is related to a director does not violate the requirement of Section 300(1) because the position of a director may be conferred on a person by any method other than contract buy that it would amount to an arrangement. The attending



15.2

directors, therefore, became interested directors. Without them there was no independent quorum. Consequently the appointments were nullity. Disclosure of interests by director (Section 299) Question 2 Company Y with a paid-up capital of Rs.50 lakhs entered into a contract with company Z in which a director of Y is holding equity shares of the nominal value of Rs.50,000. The director did not disclose his interest at the Board meeting under section 299 of the Companies Act, 1956. Is the director liable for his act? Answer As per Section 299, the disclosure of interest by directors do not apply to any contract or arrangement within two companies where any of the directors of one company or two or more of them together holds or hold not more than 2% of the paid up share capital in the other company. In the present case, if the holding is less than 2%, the director is not liable. Question 3 X Ltd. entered into a contract with M & Co. Ltd. for the purchase of raw materials for Rs. 2,50,000, at the prevailing market rate. The Director, of X Ltd. Mr. B was holding shares of the value of 1% of the paid up capital of M & Co. Ltd. Another Director, of X Ltd. Mr. C was holding shares of the value of 1.5% of the paid up capital of M & Co. Ltd. Mr. B at the beginning of the year, gave a general notice to X Ltd., that he was interested in M & Co. Ltd., but did not disclose the nature of interest. Mr. B claims that he had give notice to X :Ltd. as required under the Companies Act and that his holding being only 1% is within the limit prescribed under the Companies Act. (November, 2000) Answer In the problem given the contract was entered between two public companies for the purchase of raw materials for Rs.2,50,000 at the prevailing market rate. Therefore, transaction of this type, which too between two public limited companies will be hit by Section 299 and not by Section 297 as it may apparently appear to be. Though Section 299 to some extent overlaps Section 297, it is wider in scope and covers all kinds of contracts and arrangements as proposed in Section 297. In the problem given, contract between X Limited and M & Co. Limited was entered into wherein the concerned directors of X Ltd namely Mr. B (holding 1% of paid up capital of M & Co. Limited) and Mr. C (holding 1.5% of the paid up capital of M & Co. Limited) have given a general notice to X Limited but did not disclose the nature of their interest. The consequences of non-disclosure of interest are that it will cause vacation of the office of director under Section 283[1(i)] and will also subject to penalty under sub-section 4 of Section 299. However, in the opinion of the Department of Company affairs, (Company News & Notes dated 1.7.63) if a director has given a general notice in terms of sub-section 3 of Section 299, he will not be liable for prosecution provided the general notice covers the relevant contract in question. However, sub-section (6) of Section 299 provides


Procedure, Etc., Where Director Interested (Sections 299 – 302)

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that nothing contained in this section shall apply to any contract or arrangement entered into or to be entered into between two companies where any of the directors of the one company or two or more of them holds or hold not more that 2% of the paid up share capital in the other company. By necessary implications it also means that where a director or two or more or all the directors hold more than 2% of the paid up share capital of another company, any contract or arrangement with that other company (in the instant case X LTD) will come within the purview of Section 299. In keeping with the spirit of Section 299 and in view of their occupying fiduciary position in the company, the concerned directors (namely Mr. B & Mr. C) should disclose their interest even if their individual holding is less than 2% of the paid up capital of the M & Co. Ltd and they should take steps to see that the disclosure is made at the next meeting of the Board of Directors. Hence the argument of Mr. B is not valid. Question 4 Mr. Nanavati holding 3% shares in OPQ Ltd., became a director of this company on 1.5.2000. The company, prior to his appointment as director, had commenced transactions with A Ltd. In the next Board Meeting to be held on 10.5.2000, the Board proposes to discuss about price revisions sought for by A Ltd. Briefly explain: (i) Whether Mr. Nanavati should make a disclosure of his interest in A Ltd., assuming that

the company is going to have transactions with A Ltd. on a continuous basis; if yes, when and how? When should it be renewed?

(ii) Can he vote in the price revision resolution in the Board Meeting? You are informed that Mr. Nanavati holds 1.5% of the share capital of A Ltd and that his wife holds another 3% of the share capital of a Ltd. (November, 2000) Answer OPQ Ltd. entered into certain transactions (arrangement/contract) with A Ltd. in which Mr. Nanavati is interested before his appointment as a director in OPQ Ltd. The issue is whether Mr. Nanavati should disclose his interest in A Ltd. Section 299(2)(b) of the Companies Act, 1956 applies to a case of contract or arrangement in which a person was concerned or interested before he becomes a director and also to a case of a contract or arrangement in which he becomes concerned or interest after he becomes a director. The words ‘becomes concerned or interested’ occurring in the provision denotes a present state of thing. In the case of a person who was actually concerned or interested in the contract or arrangement, the liability for disclosure arises the moment he accepts office as director (M.O. Varghese v. Thomas Stephen & Co. Ltd. (1970) 40 CC 1131 Kerala). Further, in this case, the Board proposes to discuss in the Board meeting to be held on 10.5.2000 the price revision sought by A Ltd.



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In view of the above, Mr. Nanavati should make a disclosure of his interest in the first meeting to be held on 10.5.2000 after he became a director. Such disclosure may be made by a general notice under section 299(3) to the effect that he is a member or a director of a specified body corporate. Such notice is valid only for the financial year in which it is given and therefore, it should be renewed in the last month of every year, where necessary. Another issue is whether Mr. Nanavati can vote in the price revision resolution in the Board Meeting. As per section 300(1), no director of a company shall, as a director, take any part in the discussion of, or vote on, any contract or arrangement entered into, or to be entered into, by or on behalf of the company, if he is in any way, whether directly or indirectly, concerned or interested in the contract or arrangement. As per sub-section (2) the provision of sub-section (1) shall not apply to any contract or arrangement entered into or to be entered into with a public company, in which the interest of the director aforesaid consists solely in his being a member holding not more than two percent of its paid-up share capital. In the given case, Mr. Nanavati is holding 1.5% of the share capital of A Ltd., and his wife is holding another 3% in the share capital of A Ltd. and, therefore, it cannot be said he is interested only to the extent of less than 2% of the paid-up share capital of A Ltd. [The word ‘solely’ is used in section 300(2)(d)]. Hence Mr. Nanavati should not participate and vote in the Board Meeting to be held on 10.5.2000. Question 5 The Articles of Association of a company states that a director shall not vote in respect of a contract in which he is interested. In a resolution put up for approval of the shareholders, can a director exercise his voting right in favour of a contract in which he is interested? (November, 2001) Answer When a director exercises his voting right as a shareholder, he is free to vote in his own best interests like any other shareholder. A provision in the articles of association of a company stating that a director shall not vote in respect of a contract in which he is interested does not preclude him from voting thereon as a shareholder in the general meeting of the company. A shareholder may vote as he pleases even when his interests are different from or opposed to those of the company. Shareholders are not trustees for the company or for one another. However, in Cooks vs. Deeks, it was held that if directors use their position as directors to obtain for themselves the property of the company, as for example, by means of a beneficial contract, they cannot, by using their voting power as shareholders in general meeting, prevent the company from claiming the benefit of it. Further section 182 makes it clear that a public company or a private company which is subsidiary of a public company shall not put any restriction on voting right of members



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except the one specified in section 181 (i.e. restriction on exercise of voting right of members who have not paid calls). Hence the director can exercise his voting right at a general meeting in favour of a contract in which he is interested. Question 6 PQR Machines Ltd. Entered into a contract with MN forgings, in which wife of P, a director of the company is a partner. The contract is for supply of certain components by the firm for a period of three years with effect from 1st September, 2005 on credit basis. The paid-up Share Capital was increased from Rs. 70 lakhs to Rs. 140 lakhs on 1st March, 2006. Explain the requirements under the Companies Act, 1956, which should have been complied with by PQR Machines Ltd. before entering into contract with MN Forgings. Whether there is any additional requirement which is required to be complied with by PQR Machines Ltd. in view of the increased paid-up Share Capital on 1st March, 2006. What would be your answer in case MN forgings is a Private Company in which P’s wife is holding substantial shares? (May 2006) Answer The contract for supply of components entered into between PQR Ltd. and MN Forgings, a partnership firm (on which wife of P, a director of the company is a partner) attracts Sections 297, 299, 300 and 301 of the Companies Act, 1956. The contract cannot be entered into unless it is approved in the meeting of the Board of Directors of PQR Ltd. Specific Board resolution is required (Section 297). However, in case of urgent necessity such consent of the Board may be obtained within 3 months of the date on which the contract was entered into (Section 297(3)) P, the interested director must disclose his interest at the Board meeting at which the question of entering into the contract has been taken up for consideration (Section 299(1) & (2). P, the interested director should not have taken part in the discussion at the said board meeting and he should not have noted on the resolution in respect of that contract (Section 300) Prescribed particulars of the contract must be entered into the Registrar of Contract maintained under Section 301 within 7 working days of the Board meeting (Section 301). In the given case the contract was entered into on 1.9.2005 for supply of components for a period of 3 years. As the paid-up share capital was only Rs. 70 lakhs (i.e. less than Rs. 1 crore) on 1.9.2005 proviso to Section 297(1) requiring prior approval of the Central Government is not attracted. Subsequent increase in the paid up share capital beyond Rs. 1 crore will not make it necessary to get the approval of the Central Government for continuation of the contract for the remaining period. Hence, there is no additional requirement. If MN Forgings is a private company the provisions of Section 297 are not attracted as the director of PQR Ltd. is a director or member of MN Forgings Private Ltd.



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Section 299 is also not attracted for the reasons given below: If the contract or arrangement is between companies, a director is deemed to be interested only if he singly or along with other directors hold 2% or more shares in other company (Section 299(6)). While calculating the 2% shares in other company, only investment of directors is considered. Here P, a director of PQR Ltd. is not holding any shares in MN forgings Pvt. Ltd. Shares held by P’s wife are not to be considered. Hence the provisions of Section 299 are not attracted. Sections 300 and 301 are also not applicable. Question 7 P, son of A, who is the Managing Director of ABC Limited, proposes to give his flat on lease to the company .The paid-up share capital of ABC Limited is Rs.10 crores. Advise the company explaining the restrictions, if any, under the Companies Act, 1956.

(CA Final, New Course, November, 2008) Answer Lease of flat: Section 297 of the Companies Act, 1956 requires certain contracts on which the directors of a company are interested to be sanctioned by the Board of Directors of the Company and in certain cases (i.e. where the paid up share capital of the company is Rs.1 crore or more) it is also required to be approved with the previous approval of Central Government. Section 297 applies only to contracts of sale, purchase or supply of goods, materials and services or for underwriting the subscription of any shares in, or debentures of the company. Providing premises on a rental or lease basis by a director or his relative to company is not covered by Section 297. Since this Section does not apply to transactions in immovable properties, hence the proposed lease does not require either board resolution or approval of the Central Government. However it is an arrangement in which the Managing Director is interested and as such he is required to make a disclosure under Section 299 of the said act and he should not participate or vote in the Board’s proceedings (Section 300) and the lease arrangement must be entered in the Register of Contract maintained under Section 301 of the said Act. Question 8 M/s. Raman Limited having a paid up share capital of Rs. 5 crores owns an agency of Cement Corportion of India Ltd. and proposes to supply cement, on credit, to M/s. Raman Enterprises Private Limited. Mr. Raman is a common Director in both the companies. State the requirements of the Companies Act, 1956, if any, to be complied with by the company on the facts of this case. Will it make any difference, if - (i) M/s. Raman Enterprises Private Limited were a public company;

(ii) M/s. Raman Limited were carrying on real estate business and it proposes to sell a flat to M/s. Raman Enterprises Private Ltd. for Rs. 50 lakhs? (November 2006)



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Answer Under Section 297 of the Companies Act, 1956 except with the consent of the board of directors of a company, a director of the company or his relative; a firm in which such director or relative is a partner; or a private company of which the director is a member or director, shall not enter into any contract with the company for the sale, purchase or supply of any goods, materials or services. Where the paid up capital of the company is not less than Rs. 1 crore, it will also require previous approval of the Central Government. Exemption from the said provisions are available in the following circumstances - (i) the purchase of goods and materials from the company or sale of goods and materials

to the company is for cash at prevailing market prices; (ii) any contract for sale, purchase or supply of goods, materials and services in which the

company, or director etc. regularly trades the cost of which does not exceed Rs. 5,000 in any year.

In the present case, Mr. Raman is a common director in both the contractee companies. Accordingly, apart from the approval of the Board, previous approval of the Central Government (power delegated to Regional Director) is also required for entering into the proposed contract of supply of cement on credit. The provisions of Section 299 and 300 of the Companies Act, 1956 have also to be complied with and in the Board meeting Mr. Raman shall disclose his interest in the contract and shall not participate in the discussions on this item and shall not vote for the same. The particulars of the contract be also recorded in the Register of Contracts. (i) Section 297 does not apply to a contract where both the contractee companies are

public companies. If Ram Enterprises happens to be a public company, section 297 will have no applicability.

(ii) Section 297 does not apply to a contract relating to immovable properties being the sale of flat in case of Raman Ltd. is a real estate company. The expression ‘goods’ used in the section has been defined in the Sale of Goods Act, 1930 according to which its means every kind of movable property. Hence, sale of flat will not amount to sale of ‘goods’ for purposes of section 297 of the section.

Question 9 Premier Machineries Limited having a paid-up share capital of Rs.90 lakhs proposes to enter into a contract with the following parties for supply of components with effect from 1st January, 2008 for a period of 3 years:

(a) XYZ Metal Forging Private Limited in which Mr. John, a Director of Premier Machineries Limited, is a Director and member.



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(b) ABC Casting Limited in which Mr. Philips, a Director of Premier Machineries Limited, holds 30% of the paid-up share capital.

(c) The capital of Premier Machineries Limited was increased to Rs.1.50 crores on 1st January, 2009 by issue of further shares.

Briefly discuss the legal requirements to be complied with under the Companies Act, 1956 to give effect to the above proposals taking into account the increase in the paid-up share capital as on 1st January, 2009. (CA Final, New Course, November 2009) Answer Under section 297 of the Companies Act, 1956 as Mr. John, a director of Premier Machineries Ltd. Is interested is in XYZ metal Forging Private Ltd. as a director and a member of the Company, a resolution in the meeting of the Board of Directors is required to be passed before entering into a contract with XYZ Metal Forging Private Ltd. If due to urgency it is not possible to pass a Board resolution before entering into the contract, the requisite consent of the Board shall be obtained within three months of the date on which the contract was entered into under Section 299, Mr. John must disclose his interest to the Board and not participate in the said meeting/deliberations. Since the paid up capital of the Company is Rs.90. lakhs, approval of the Central Government is not necessary. In this case, the paid up capital was increased to Rs.1.50. crore subsequent to the date of entering the contract. No approval of the Central Government will be required as on the material date of entering into the contact, the paid up capital was less than Rs 1 crore. Section 297 does not cover cases of Public Limited Companies, hence aforesaid approvals will not be necessary. In both the cases the interested directors must make disclosure of interest as required under section 299 and also comply with section 300. Entries are also required to be made in the Register of Contract under section 301. Interested director not to participate or vote in Board’s proceedings (Section 300) Question 10

A Limited had four directors. At one of its convened Board meeting only two of them attended and they appointed two additional directors who were their relatives. Is the appointment of those additional directors valid?

Answer

Section 300 provides that a director shall not take part in the discussion of or vote on any contract or arrangement entered into or to be entered into by or on behalf of the company if he is in anyway whether directly or in directly concerned or interested in the contract or arrangement. The Department of Company Affairs has clarified that the word interested as used in the section should be given a restrictive interpretation and thus excludes a



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director who has no pecuniary interest. Accordingly, the relationship of the director with the contracting party will not per se make the director concerned or interested in the contract or arrangement.

The scope of the expression ‘contract’ or ‘arrangement’ was examined by the Madras High Court in Madras Tube Co. Ltd. vs. Hari Krishan Somani, (1985) I Comp LJ 195 (Mad). The question before the court was whether the appointment of an additional director would come within the scope of the word ‘contract’ or ‘arrangement’. The company had four directors. Only two of them attended the meeting. They appointed two additional directors who were related to them as brother and wife, respectively. The court came to the conclusion that although appointment as director does not come within the scope of the expression ‘contract’ because the position of a director may be conferred on a person by any method other than contract, became interested directors. Without them there was no independent quorum. Consequently the appointments were a nullity. The Bombay High Court re-examined the matter in Shailesh Harilal Shah vs. Matushree Textiles Ltd., (1994) and after giving due consideration to the authorities which influenced the Madras decision nevertheless came to the conclusion that the appointment as an additional director of a person who is related to a director does not violate the requirement of Section 300(1) because the position of a director may be conferred on a person by any method other than contract buy that it would amount to an arrangement. The attending directors, therefore, became interested directors. Without them there was no independent quorum. Consequently the appointments were nullity. The provisions mentioned above shall not apply to: (i) a private company, which is neither a subsidiary nor a holding company of a public

company (ii) a private company, which is a subsidiary of a public company in respect of a

contract or an arrangement, entered into by the private company with the holding company:

(iii) any contract of indemnity against any loss, which the director may suffer by reason of becoming surety for the company;

(iv) any contract or arrangement entered into (or proposed contract or arrangement) with a public company or a private company which is subsidiary of a public company in which the interest of the director consists a) in his being a director of such company and the holder of not more than the requisite qualification shares and he having been nominated as such director, or (b) in his being member holding of more than 2% of its paid up-share capital

(v) a public company or a private company which is subsidiary of a public company in



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respect of which the Central Government in the public interest issues a notification thereof having regard to the desirability of establishing or promoting any industry, business or trade. However, the Central Government may direct that the provision of Section 300(1) shall apply to these companies subject to such exceptions, modifications and conditions as it may specify in the notification in the foregoing circumstances. [Sections 300(2) and (3)].

According to Section 297, a director of the company or his relative, a firm in which such a director or relative is a partner, any other partner in such a firm or a private company of which the director is a member or director, must not enter into contracts with company for the sale, purchase, or supply of goods, materials or services or for underwriting shares or debentures except with the consent of the Board of Directors [sub-section (1)]. According to the provision to sub-section (1) in the case of a company having a paid-up capital of Rs.1 crore or more no such contract shall be entered into except with previous approval of the Central Governmentt. The consent of the Board is deemed to have been given only if it is accorded by a resolution of the Board and not otherwise, either before or within three months of the date of entering into the contract [sub-section (4)]. If the consent is not accorded to any contract under Section 297, anything done in pursuance of the contract shall be voidable at the option of the Board. [sub-section (5)]. Before we proceed on to discuss the other provisions contained in Sections 297(2) and (3) let us examine a situation. Question 11 With the knowledge of all the Directors of a Public Limited Company, a mortgage was created over the property of the company in respect of a loan given by the brother of one of the Directors of the company. But the interested Director neither disclosed his interest nor abstained from voting at the Board Meeting, when the loan transaction was approved. Examine with reference of the provisions of the Companies Act, 1956 whether there is any ban on such contracts and whether non-disclosure of interest and voting by the interested Director would make the contract void. (November, 2003) Answer Section 299 of the Companies Act, 1956 requires the disclosure of interest by a director while Section 300 prohibits an interested director to participate or vote on Boards' proceedings. But where a whole body of directors is aware of the facts relating to an interest of a director, a formal disclosure is not necessary. [Venkatachalapathy V.S. Guntur Collton Mills, AIR 1929 Mad. 353]. (i) The mere voting by an interested director will not render the contract void or voidable

unless with the absence of that vote, there would have been no quorum. The mere fact that voting under such situation is an offence punishable with fine under Section 299(4) and 300(4) of the Act, does not ipso facto render the contract void or violable. In this



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case, there is no allegation of earning secret profits. Thus the action of the company will fail as the contract of mortgage is fair and in the interest of the company.

(ii) Under Section 299 and 300 of the Act, there is no ban on a contract in which a director is interested. The only requirement is that the interest should be disclosed, bonafide and fair [P. Leslie & Co. vs. V.O. Wapshare AIR 1969 SC 843].

Even where the interest is not disclosed the transaction is only voidable against the interested director, and not void. [Narayan Das Shreeram Somani vs. Sangli Bank AIR 1966 SC 170]. Question 12 A Mortgage was created over the property of a public company. The loan was advanced by the son of the director. All the directors already knew this fact. Thus the director was interested in the transaction. But he has neither disclosed his interest nor abstained from voting while approving the said transaction. Later on a suit was filed for setting aside the mortgage on the ground that since the interested director voted on the matter, the contract was void. Advise with reasons. (i) Whether the contract became void due to non-disclosure of interest by the concerned

director? (ii) Is there any ban on such a contract under the Companies Act, 1956? (June 2009) Answer Section 299 of the Companies Act, 1956 requires the disclosure of interest by a director while section 300 prohibits an interested director to participate or vote in respect of that particular transaction at the Board meeting. Further his presence will not be counted for quorum also. But where a whole body of directors is aware of the facts relating to an interest of a director, a formal disclosure is not necessary. (Ramakrishna Rao vs. Bangalore Race Club). The mere voting by an interested director will not render the contract void or voidable unless with the absence of that vote, there would have been no quorum. The mere fact that voting under such situation is an offence punishable with fine under section 299(4) and 300(4) of the Act does not ipso facto render the contract void or voidable. In this case, there is no allegation of earning secret profits. Thus the action against the company will fail as the contract of mortgage is fair and in the interest of the company. Under section 299 and 300 of the Act,, there is no ban on contract in which a director is interested. The only requirement is that the interest should be disclosed, bonafide and fair. (P. Leslie & co. vs. Vo Wapshare)

Even where the interest is not disclosed the transaction is only voidable against the interested director, and not void. (Narayan Das Shreeram Somani vs Sangli Bank).


CHAPTER 16

REMUNERATION OF DIRECTORS (SECTIONS 309 – 311)

Remuneration of Directors (Section 309)

Question 1

Examine whether the payment of following remuneration to Non-executive Directors (Directors who are neither in the whole-time employment of the company nor Managing Director) is in accordance with the provisions of the Companies Act, 1956:

(i) Sitting fee payable to Directors is increased from Rs.3,000 to Rs.6,000 per meeting by amending the Articles of Association.

(ii) Commission payable to Non-executive Directors is calculated on the basis of book profits arrived at after providing for depreciation as per straight line method.

(iii) Guarantee commission has been paid to one of the Non-executive Directors for having guaranteed the term loans obtained from a Financial Institution. (November, 2003)

Answer Non-Executive Directors Remuneration Sitting Fees: Sitting fees are payable to directors at the rates prescribed in the Articles of Association of the company [Section 309(2) Companies Act, 1956]. No approval of the Central Government will be necessary for an increase in the amount of sitting fees so long as such increase is within the prescribed limits (Proviso 1 to Section 310) - The present prescribed limit is Rs.5,000 per meeting [Rule 10B of the Companies (Central Governments) General Rules and Forms 1956]. Since the sitting fee of Rs.6,000/- is above the prescribed limit, the amendment shall not have effect unless approved by the Central Government under Section 310. Depreciation: Section 350, as amended by the Companies (Amendment) Act, 2000 specifies the manner of ascertainment of depreciation. The amount of depreciation to be deducted is the amount of depreciation as appearing in the books i.e. as shown in the profit and loss account of the relevant financial year, at the rates specified on Schedule XIV to the Companies Act. Schedule-XIV specifies different rates of depreciation applicable to the two methods of depreciation, namely, written-down value method and straight-line method. Thus after the Companies (Amendment) Act, 2000, depreciation as per written-down value need not



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be recalculated where depreciation is charged in the books as per straight-line method. Hence, the computation of commission payable is in order. Guarantee Commission: Section 309(1) provides that the remuneration payable to any director shall be inclusive of the remuneration payable for services rendered by him in any other capacity. The question is whether the guarantee commission is a remuneration within the meaning of Section 309. It was held in Suessen Textile Bearings Ltd v. Union of India [(1984) 55 (Comp. Cases 492, 496, 497)] that the guarantee commission paid to directors for giving surety against loans or credit facilities taken by the company from financial institution is not a remuneration for any professional services within the meaning of section 309 and therefore, approval of the Central Government is not necessary. The director giving guarantee does not render manual, clerical, technical supervisory or administrative service. He gets the commission for the risk which he bears and that has nothing to do with his directorship. In view of this judgement, the Department of Company Affairs has withdrawn the earlier circular dated 16.12.1969, where the department has clarified that guarantee commission is 'remuneration' within the meaning of Section 309 (Circular No.3 dated 16.2.1994). Hence the payment of guarantee commission is in order. Question 2 Mr. Weldon was appointed as a Director of Esquire Engineering Ltd., with effect from 1st October, 2002. Since the Company, namely, Esquire Engineering Ltd. wanted to take full advantage of the wisdom and expertise of Mr. Weldon, it offered him remuneration payable on monthly basis and made an application to the Central Government for approval for payment of such remuneration. Anticipating the approval of the Central Government, Esquire Engineering Ltd. started paying such remuneration from the date of appointment and continued to do so till 31st March, 2003. The Central Government did not fully approve the remuneration proposed by the company and restricted the same to a lower amount. On scrutiny of the accounts, it was established that the company, till 31st March, 2003, has paid to Mr. Weldon a total sum of Rs.1.20 Lacs in excess of the remuneration sanctioned by the Central Government.

You are required to:

(i) State with reference to the provisions of the Companies Act, 1956 in respect of recovery and waiver of recovery of the excess remuneration so paid, whether Mr. Weldon can keep the excess remuneration so received and under what conditions.

(ii) Draft a resolution for waiver of recovery of the excess remuneration so paid by the Company. (November, 2004)

Answer (i) Mr. Weldon was appointed as a non-executive director. The services to be rendered by

him are not stated to be of a professional nature. Hence, the provisions of Section 309


Remuneration of Directors (Sections 309 – 311)

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(4) are attracted in this case. According to Section 309(4) of the Companies Act, 1956 a non-executive director may be paid remuneration by way of monthly, quarterly or annual payment basis with the approval of the Central Government.

Section 309(5A) of the Companies Act, 1956 states that if any director draws or receives, directly or indirectly, by way of remuneration any sum in excess of the limits prescribed by section 309 of the Companies Act, 1956 or without the prior approval of the Central Government, wherever required, then such director shall refund such excess remuneration to the company and until such refund is made, he shall hold such sum in trust for the company.

Section 309(5B) of the Companies Act, 1956 states that the company shall not waive the recover of any sum refundable under section 309(5A) of the Companies Act, 1956 unless permitted by the Central Government.

In light of the above mentioned provisions of the Companies Act, 1956, Mr. Weldon is under obligation to refund the excess remuneration of Rs.1.20 Lakhs received by him from the company and till the same is refunded, he shall hold the said sum in trust for the company. Similarly, the company is also not eligible to waive the recovery of such excess sum. However, the company can waive the recovery and Mr. Weldon can keep such excess sum, if the permission from the Central Government as envisaged in section 309(5B) of the Companies Act, 1956 is obtained.

(ii) Board Resolution for waiver of recovery of excess remuneration paid to a director: "RESOLVED that subject to the approval of the Central Government, the Board does

hereby decides to waive the recovery of a sum of Rs.1.20 Lacs paid to Mr. Weldon, a director of the company during the period from 1st October, 2002 to 31st March, 2003 in excess of the remuneration sanctioned by the Central Government in terms of section 309 of the Companies Act 1956."

“RESOLVED FURTHER that an appropriate application under section 309(5B) of the Companies Act, 1956 be made to the Central Government and that Mr ………., the Secretary of the company be and is hereby authorized to take necessary action in this regard."

Question 3 M/s Star Health Specialities Ltd. owns a Multi-specialty Hospital in Chennai. Dr. Hamilton, a practising Heart Surgeon, has been appointed by the company as its non-executive ordinary director and it wants to pay him fee, on case to case basis, for surgery performed on the patients at the hospital. A question has arisen whether payment of such fee to him would amount to payment of managerial remuneration to a director subject to any restriction under the Companies Act, 1956.



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Advise the company, which seeks to ensure that the same does not contravene any provision of the Companies Act, 1956 (November 2006) Answer Under the proviso to sub-section (1) or section 309 of the Companies Act, 1956, in case– (i) the services rendered are of a professional nature; and (ii) in the opinion of the Central Government, the director possesses the requisite

qualifications for the practice of the profession, the remuneration paid for these services shall be outside the scope of Section 309 of the Act and shall not be a part of managerial remuneration. It is then not open to the Central Government to put any restriction on the amount of remuneration payable to him for his approach work. The company is, accordingly, advised to approach the Ministry of Company Affairs to seek an affirmative expression of opinion that Dr. Hamilton who is a qualified surgeon, possesses the requisite qualification to practice the profession of surgery. Question 4 Mr. X appointed as the Managing Director of XYZ Ltd. w.e.f. 1st October, 2006. The company made an application to the Central Government for approval, as the remuneration proposed to be paid to Mr. X was beyond the limits laid down in schedule XIII to the Companies Act, 1956. The company started paying remuneration from the date of appointment and continued to do so till 31st March, 2007. The Central Government did not approve the remuneration as proposed by the company and restricted the same to a lower amount. On scrutiny of the accounts, it was noticed that the company till 31st March, 2007 has paid to Mr. X, a total sum of Rs. 1.20 lakhs in excess of the remuneration sanctioned by the Central Government. Explain with reference to the provisions of the Act whether Mr. X can keep the excess remuneration. Draft a resolution for waiver of recovery of the excess remuneration so paid by the company. (November 2007) Answer According to Section 309(5A) of the Companies Act, 1956, if any director draws any remuneration in excess of the remuneration sanctioned by the Central Government, he shall refund such excess remuneration to the company. The company shall not waive the recovery of any sum refundable to it unless permitted by the Central Government. In the present case Mr. X cannot keep remuneration drawn by him which is in excess of the remuneration sanctioned by the Central Government, the Central Government permit the waiver of recovery of excess remuneration, the company may waive the recover of excess remuneration, and then Mr. X will have a right to retain the excess remuneration drawn by him. Draft resolution for waiver of recovery of the excess remuneration:



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“Resolved that subject to the approval of the central Government, consent of the company be and is hereby given waiving the recovery of an amount of Rs. 120,000 paid to Mr. X the director of the company, during the period 1st October, 2006 to 31st March, 2007 being in excess of the remuneration sanctioned by the Central Government vide letter no. ………….. dated …………. Resolved further than an application be made to the Central Government and the company secretary be and is hereby authorized to take the necessary steps in this regard.” Provision for increase in remuneration to require Government sanction (Section 310) Question 5 An article of Association of a listed company has fixed payment of sitting fee for each Meeting of Directors subject to maximum of Rs. 10,000. In view of increased responsibilities of independent directors of listed companies, the company proposes to increase the sitting fee to Rs. 25,000 per meeting. Advise the company about the requirement under Companies Act, 1956 to give effect (May 2004, May 2007, November 2006, June 2007) Answer Under Section 310 of the Companies Act, 1956 approval of the Central Government shall not be required where sitting fee for each meeting of the Board of a Committee thereof does not exceed the prescribed sum under Rule 10-B of the Central Government’s (General Rules & Forms, 1956) as under:

1. Companies with paid up capital of Rs. 10 crores and above or turnover of Rs. 50 corres and above

Sitting fee not to exceed Rs. 20,000

2. Other companies Sitting fee not to exceed Rs. 10,000

Any increase in the sitting fee will require amendment of relevant provision of the Articles of Association. In the given case, the proposed sitting fee of Rs. 25,000 will require approval of the Central Government as the same exceeds the prescribed limits. The company can pay the sitting fee upto Rs. 20,000 depending upon the aforesaid parameters laid down in Rule 10-B. Question 6 A company wants to include the following clause in its Articles of Association:

“Each director shall be entitled to be paid out of the funds of the company for attending meetings of the Board or a Committee thereof including adjourned meeting such sum as sitting fees as shall be determined from time to time by the Directors but not exceeding a sum of Rs.30,000 for each such meeting to be attended by the Director.”

You are required to advise the company as to the validity of such a clause and the correct legal position under the provisions of the Companies Act, 1956.

(CA Final, New Course, June 2009)



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Answer The payment of sitting fee to a Director is governed by the provisions of Section 310 of the Companies Act, 1956 read with Rule 10B of the companies (Central Government’s) General Rules and Forms, 1956. According to the said provisions, a Company with a paid up share capital and free reserves of Rs.10 crores and above or a turnover of Rs.50 Crores and above can pay to its director by way of sitting fee for each meeting of the board of directors or a committee thereof an amount not exceeding Rs.20,000/- and in case of other companies, the limit has been set at Rs.10,000/-. In view of the above legal provisions, the company cannot have a clause in its Articles of Association which exceeds the limit prescribed by law. The company is advised to check whether the aggregate of its paid up capital and free reserves exceeds Rs. 10 crores or whether its turnover exceeds Rs. 50 crores and accordingly it can have a clause in its Articles of Association. In case the company keeps the clause as given in the question, it shall be ultra vires the Companies Act, 1956 as Section 9 states that any provision contained in Memorandum of Association, Articles of Association, Agreements or Resolutions to the extent it is repugnant to the provisions to the provisions of the Companies Act, 1956 shall be void. Question 7 Mr. X appointed as the Managing Director of XYZ Ltd. w.e.f. 1st October, 2006. The company made an application to the Central Government for approval, as the remuneration proposed to be paid to Mr. X was beyond the limits laid down in schedule XIII to the Companies Act, 1956. The company started paying remuneration from the date of appointment and continued to do so till 31st March, 2007. The Central Government did not approve the remuneration as proposed by the company and restricted the same to a lower amount. On scrutiny of the accounts, it was noticed that the company till 31st March, 2007 has paid to Mr. X, a total sum of Rs. 1.20 lakhs in excess of the remuneration sanctioned by the Central Government. Explain with reference to the provisions of the Act whether Mr. X can keep the excess remuneration. Draft a resolution for waiver of recovery of the excess remuneration so paid by the company. (November 2007) Answer According to Section 309(5A) of the Companies Act, 1956, if any director draws any remuneration in excess of the remuneration sanctioned by the Central Government, he shall refund such excess remuneration to the company. The company shall not waive the recovery of any sum refundable to it unless permitted by the Central Government. In the present case Mr. X cannot keep remuneration drawn by him which is in excess of the remuneration sanctioned by the Central Government, the Central Government permit the waiver of recovery of excess remuneration, the company may waive the recover of excess remuneration, and then Mr. X will have a right to retain the excess remuneration drawn by him.



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Draft resolution for waiver of recovery of the excess remuneration: “Resolved that subject to the approval of the central Government, consent of the company be and is hereby given waiving the recovery of an amount of Rs. 120,000 paid to Mr. X the director of the company, during the period 1st October, 2006 to 31st March, 2007 being in excess of the remuneration sanctioned by the Central Government vide letter no. ……… dated …………. Resolved further than an application be made to the Central Government and the company secretary be and is hereby authorized to take the necessary steps in this regard.” Question 8 Non-executive Directors of ABC Limited, who are neither in the whole time employment of the company nor Managing Directors have been given the following remuneration -- (i) Guarantee Commission has been paid to them for having guaranteed the term loans

obtained from a financial institution. (ii) Commission payable to them is calculated on the basis of book-profits arrived at after

providing for depreciation as per straight line method,

Examine the validity of these payments in the light of the provisions of the Companies Act, 1956. (CA, Final, New Course, May, 2010) Answer Remuneration to Non-Executive Directors: (i) Guarantee Commission: Section 309(i) of the Companies Act, 1956 provides that the

remuneration payable to any director shall be inclusive of the remuneration payable for services rendered by his in any other capacity. The question is whether guarantee commission is remuneration within the meaning of Section 309 of the said Act. In the case of Suesses Textile Bearings Ltd. Vs. Union of India (1984) it has been decided that the guarantee commission paid to the directors for giving surety against loan taken by the company from financial institutions is not a remuneration for any professional services within the meaning of Section 309 and therefore approval of the Central Government is not necessary.

(ii) Depreciation: Section 350 of the Companies Act, 1956 specifies the manner of ascertainment of depreciation. The amount of depreciation to be deducted is the amount of depreciation as appearing in the books i.e. as shown in the profit and loss account of the relevant financial year at the rates specified in Schedule XIV of the Companies Act, 1956. Thus, the payment of commission calculated on the basis of book profits arrived at after providing for depreciation as per straight-line method is not in order.



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Question 9 Mr. Weldon was appointed as a director of Esquire Engineering Ltd. with effect from 1st October,2008. Since the Company wanted to take full advantage of the wisdom and experience of Mr. Weldon, it offered him attractive remuneration payable on monthly basis and made an application to the Central Government for approval to pay such remuneration. Anticipating the approval of the Central Government. Esquire Engineering Ltd. started paying such remuneration from the date of appointment and continued to do so till 31st March, 2009. The Central Government did not fully approve the remuneration proposed by the Company and restricted the same to a lower amount. On scrutiny of accounts, the Company noticed that till 31st March, 2009 it has paid to Mr. Weldon a total sum of Rs.5.50 lakhs in excess of the remuneration sanctioned by the Central Government. Explain the relevant provisions of the Companies Act, 1956, in respect of recovery and waiver of recovery of the excess remuneration so paid. Draft a resolution for recovery/waiver of recovery of the excess remuneration paid by the Company. (November 2009) Answer (a) A director who is not a Managing Director or Whole Time Director can draw

remuneration by way of monthly, quarterly or annual payment only if so authorized by the Central Government (Section 309). The Central Government may while sanctioning the payment of remuneration under Section 309, fix remuneration at such amount as it may deem fit (Section 637AA). If any director draws any remuneration in excess of the remuneration sanctioned by the Central Government, he shall refund such excess remuneration to the Company. Until such excess remuneration is refunded he shall hold it in trust for the Company. The Company shall not waive the recovery of any sum refundable to it unless permitted by the Central Government.

(b) In the present case, Mr. Weldon cannot keep remuneration drawn by him which is in excess of the remuneration sanctioned by the Central Government. Accordingly he shall refund to the Company Rs.5.50 lakhs. Until such refund is made he shall hold the excess amount in trust for the Company. Further the Company cannot waive the recovery of excess remuneration.

However, if on an application made to the Central Government, the Central Government may permit, the waiver of recovery of excess remuneration. The Company can waive the recovery of excess remuneration and then Mr. Weldon shall have a right to retain the excess remuneration drawn by him. For recovery of the excess remuneration paid to Mr. Weldon, there is no need to pass any resolution. However, for waiver of recovery a resolution is required to be passed by the Company in a general meeting and approval of the Central Government in necessary.



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Resolution (c) “Resolved that subject to the approval of the Central Government, consent of the

Company be and is hereby given waiving the recovery of an amount of Rs.5.50 lakhs paid to Mr. Weldon, the director of the Company, during the period 1st October, 2008 to 31st march 2009 being in excess of the remuneration sanctioned by the Central Government vide letter no ………………… date …………………………….

(d) Resolved further that an application to be made to the Central Government and the Company Secretary be and is here by authorized to take the necessary steps in this regard.”

Question 10 Advise M/s Super Specialities Ltd. in respect of the following proposals under consideration of its Board of Directors:

(i) Appointment of Managing Director who is more than 70 years of age;

(ii) Payment of commission of 4% of the net profits per annum to the ordinary directors of the company;

(iii) Payment of remuneration to an ordinary director for rendering professional services; and

(iv) Payment of remuneration of Rs.40,000 per month to the whole time director of the company running in loss and having an effective capital of Rs.95.00 lacs. (May 2005)

Answer (i) Under Schedule XIII, Part I, Paragraph (c) of the Companies Act, 1956, a person shall

be eligible for appointment as Managing Director who has attained the age of 70 years where his appointment is approved by a Special resolution passed by the company in the general meeting. In that case, approval of the Central Government is not required.

(ii) Under Section 309(4)(b) of the Companies Act, 1956 ordinary directors may be paid commission if the company by special resolution authorise such payment not exceeding 1% of net profit, if the company has MD/WTD/Manager or upto 3% of the net profits in any other case. Further, under section 309(7) of the Act, Special resolution shall not remain in force for a period of more than 5 years at a time.

Second proviso to section 309(4) states that a company in general meeting may, with the approval of the Central Government, authorise the payment of such remuneration at a rate exceeding one per cent or, as the case may be, three per cent of its net profits.

Thus, in the present case, commission of 4% of net profits of the company per annum can only be paid to the ordinary directors with the approval of the Central Government



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(iii) Under proviso to section 309(1) of the Act, any remuneration for services rendered to any director in any other capacity shall not be so included if- (a) the services rendered are of a professional nature, and (b) in the opinion of the Central Government, the director possesses the requisite

qualification for the practice of the profession. In that case, approval of the Central Government will not be required for payment of

any remuneration to the concerned director. (iv) In terms of section II of Part II of Schedule XIII of the Act, approval of the Central

Government is not required for payment of monthly remuneration upto Rs.75,000/- in case of a company with effective capital of less than Rs.1 crore and having no profit or its profits are inadequate, to its managerial persons, provided - (1) the payment of remuneration is approved by the Remuneration Committee; (2) the company has not defaulted in repayment of its debts, including public

deposits or debentures or interest payable thereon for a continuous period of 30 days in the preceding year before the date of such appointment.

Thus, in the given case, the company may pay the remuneration of Rs.40,000 P.M. to its WTD without approval of the Central Government subject to the above restrictions.

Question 11 EF Chemicals Ltd. proposes to appoint one whole-time technical Director on a consolidated monthly remuneration of Rs. 30,000 and one whole-time Marketing Director on a consolidated salary of Rs. 25,000 per month for a period for three years with effect from 1st September, 2005. The company has got a Managing Director and he is getting Rs. 40,000 per month. Explain the requirements under the Companies Act to be complied with by the company in connection with the proposed appointment of whole-time Directors taking into account the following data collected from the Balance Sheet of the company as on 31st March, 2005:

Rs.

1. Paid-up Share Capital 80,00,000

2. Debentures redeemable after three years 90,00,000

3. Investments 20,00,000

4. Accumulated Loss 70,00,000

5. Preliminary Expenses not written off 15,00,000

(May 2006)



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Answer

Appointment of whole time directors: In the given case two whole time directors are proposed to be appointed with effect from 1st September, 2005. The remuneration payable to these directors depends on the effective capital of the company on the last day of the preceding financial year i.e. 31.3.2005. The effective capital is Rs. 65 lakhs (Rs. 80 lakhs + 90 lakhs − Rs. 20 lakhs − Rs. 70 lakhs − Rs. 15 lakhs) on 31.3.2005.

The ceiling on minimum remuneration has been prescribed in Part II of Schedule XIII of the Companies Act, 1956. Here the Managing Director is already getting a minimum monthly remuneration of Rs. 40,000. The proposed minimum remuneration to the whole-time technical director is Rs. 30,000 p.m. and to the whole time marketing director is Rs. 25,000 p.m. If a company has more than one managing director and / or whole-time director, the company may pay to each of them minimum remuneration within the prescribed ceiling. As the effective capital is less than Rs.1crore, the company may pay to each of the Managing Director/whole time director minimum remuneration upto Rs. 75,000 p.m. Hence the proposed minimum remuneration is within the prescribed limits.

The remuneration payable to the whole-time directors must be approved by Remuneration Committee of the Board of Directors, and thereafter the appointments of the Technical Director and Marketing Director shall be approved at a Board meeting.

Abstract of terms of appointment of whole-time directors must be sent to every member within 21 days as required under section 302(2). Nature of concern or interest of each director must be disclosed.

Copy of Board resolution, Form No. 32 must be filed with the Registrar of Companies.

Return in Form No. 25C must also be filed within 90 days from appointment as required under section 269(2). The return must contain a certificate from the auditor or the Secretary of the company or a Secretary in Whole-Time Practice that the requirements under Schedule XIII have been complied with Part III of Schedule XIII – Para 2)

The appointment and remuneration of the whole-time marketing and technical directors must be approved in next annual general meeting by ordinary resolution (Section 305(1) and part III of Schedule XIII).

The company has to comply with the above requirements under the Companies Act, 1956 with regard to the proposed appointment of two whole-time directors.


CHAPTER 17

MISCELLANEOUS PROVISIONS (SECTIONS 312 – 314)

Prohibition of assignment of office by director (Section 312)

Question 1

‘X’ was appointed as Managing Director for life by the Articles of Association of a private company incorporated on 1st June, 1970. The articles also empowered ‘X’ to appoint a successor. ‘X’ appointed by will ‘G’ to succeed him after his death. Examine in this connection

(a) Can ‘G’ succeed ‘X’ as Managing Director after the death of’ X’?

(b) Is it possible for the company in general meeting to remove ‘X’ from his office of directorship during his life time?

Answer (a) Section 312 prohibits assignment of his office by a director and such assignment shall be

void. It was held in Oriental Metal Pressing Works Private Ltd. vs. B.K. Thakoor (A.I.R.) 1960 Bom. 167 that the appointment of one as managing director by the will of one D was void in view of the provisions contained in Section 312, since, according to the High Court, the words ‘any assignment’ were comprehensive enough to include every assignment to transfer of a director or of the appointment by a director of a person to the office of a director in his place, whether by a deed inter vivos or by will. But this ruling has been reversed by the Supreme Court (vide A.I.R. 1961 S.C. 573). The Court considers that the word ‘assignment’ in Section 312 does not mean or include ‘appointment’. From its every nature transfer inevitably imports the passing of a thing from one person to another. A transfer without the passage of the thing, even when that is an office is inconceivable. On the other hand, an ‘appointment’ has nothing to do with passing from one person to another; it connotes the putting in of someone in a vacancy. So transfer and appointment are dissimilar. It would be an unusual statute, which by using a single word intended to prohibit at the same time, two wholly different acts. A construction leading to such a result cannot be permitted. The Court observed that ‘the section talks of assignment of his office by the director. The word ‘his’ would indicate that the office contemplated was one held by the director at the time of assignment. An appointment to an office can be made only if the office is vacant. It is legitimate, therefore it infer that by using the word ‘his’ the legislature



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indicated that an appointment by a director to the office which he previously held but did not hold at the date of appointment was not to be included ‘assignment’. In view of the Supreme Court decision, ‘x’ has not made any assignment of his office prohibited by section 312 and ‘G’ can succeed ‘X’ as Managing Director after the death of ‘X’.

(b) Section 284 empowers the company to remove a director, by ordinary resolution before the expiry of his period of office. This section applies to both public and private companies. It applies to permanent directors or life directors and directors appointed for a fixed term even though they might have been appointed by the Articles of Association or otherwise. But directors appointed by the Central Government under section 408 cannot be removed by the company under this section. Proviso 1 to sub-section (1) of section 408 exempts life directors who were holding offiein private companies on 1st April, 1952. As the private company in this case was incorporated on 1st June, 1970, it is not entitled to this exemption. Hence ’X’ can be removed as a director under section 284 even though he is a permanent director and once he is removed as a director, he also ceases to be a Managing Director.

Director, etc not to hold office or place of profit (Section 314) Question 2

Mr. X is serving in a company in the dual capacity of a director and an employee? Referring to the provisions of the Companies Act, 1956. State: (a) Whether there is any prohibition/restriction serving in the dual capacity? (b) If so whether a director serving as an employee would amount to holding an office or

place of profit? (c) Whether the remuneration drawn by the director as an employee of the company would

be governed by the provisions relating to managerial remuneration? (d) What would be your answer if the said director is rendering services of a professional

nature? Answer There is no prohibition is contained in the Companies Act for a director acting in the dual capacity of a director and an employee. However, Section 314 puts a restriction for a director while accepting office or place of profit in the company. For this purpose, the director appointment in the office or place of profit need to be approved by the shareholders in the general meeting. A director however, without recourse to Section 314 can render services to the company in his professional capacity on one time basis. Question 3 A is proposed to be appointed as a marketing executive on a monthly salary of Rs.60,000 in a company in which his father is a director.


Miscellaneous Provisions (Sections 312 – 314)

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Answer As per Section 314(1B) no relative of a director of a company shall hold any office or place of

profit which carries a total monthly remuneration of not less than such sum as may be prescribed except with the prior consent of the company by a special resolution and the approval of the Government. The limit of monthly remuneration prescribed by the Central Government presently is Rs.50,000/-, therefore, the company is required to pass a special resolution and get approved by Central Government before Mr. A is appointed. Question 4 Mr. Smart is a director of ABC Ltd., accepts the offer of employment as “Chief Executive-Technical Operations” of the same company on a monthly remuneration of Rs.15,000. Can he be an employee at the same time being the director of the company? In case his son is appointed to the same post, does it attract any provisions of the Companies Act? Answer

Ordinarily, the shareholders in general meeting elect a director, and once so elected, he enjoys well-defined rights and powers under the Act. An employee is appointed by the company under a contract of service is a servant of the company and the company can always direct his actions and interfere with his work. In Lee Behrens & Co. (Re [1932] 2 com cas. 588 it was observed that directors are elected representatives of the shareholders engaged in directing the affairs of the company on its behalf. However, there is nothing in law to prevent a director from accepting employment under the company under a special contract, which he may enter into with the company. (R.R. Kothandaraman vs. Commr. of I.Tax (1957). Section 314 provide for a director holding an office or place of profit under a company. Except with the consent of the company accorded by a special resolution no director shall hold any office or place of profit and no partner or relative of his, no firm in which he or his relative is a partner, no private company of which he is a director or member and no director or manager of such a private company shall hold any office or place of profit carrying a monthly remuneration of Rs. 10,000 or more. The special resolution may be passed before or a general meeting of the company held for the first time after the holding of such an office or profit. If it is done without the knowledge of the director, the consent of the company may be obtained either in the general meeting held for the first time after the holding of such an office or within 3 months from the date of appointment whichever is later. If a partner or a relative of a director or manager, a firm in which such director or manager or relative of either is a partner or a private company of which such a director or manager or relative of either is director or member can not hold any office or place of profit which carries a total monthly remuneration of Rs.20,000 or more except with the prior consent of the company by special resolution and the approval of the Central Government. Thus, in the instance case, Mr. Smart can accept the offer of employment as Chief Executive-Technical Operations. If his son is appointed to the said post, it requires the consent of the company.3



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Question 5 Mr. True is a director of a company and also a chartered accountant by profession and one of the partners in M/s True & Fair Co. The company appointed the said firm as chartered accountant of the company on a regular basis. Does Mr. True holds any office or place of profit in the company. Would your answer be different if his appointment is on a case-to-case basis? Answer Chartered Accountants appointed by a company on a regular basis are hit by a restrictive provisions of sub-sections I and I(b) of Section 314 if he is a director receiving remuneration over and above to which he is entitled. In case the office or place of profit is held by an individual other than a director or by any firm, private company or other body corporate, if it obtains from the company anything by way of remuneration whether as salary, fees, commission perquisite or otherwise, approval of the company is not required where the monthly remuneration is less than Rs. 10,000/-. Accordingly, if a director is holding the place of chartered accountants for the company he would be covered by Section 314(3) irrespective of the fact that office or place of profit carries a total monthly remuneration less than Rs.10,000/-. Question 6 Mr. V, a Chartered Accountant is a Director in PQR Limited. The company proposes to appoint/engage the firm V & Co. in which Mr. V is a partner in one or more of the following capacities:

(i) Consultants on regular retainer basis.

(ii) Authorised representatives to appear before tribunals.

Discuss whether the provisions of Section 314 of the Companies Act are attracted in the above situations. (May, 2000) Answer Apparently the prohibition under Sub-section (1) & (1B) of the Section 314 of the Companies Act, 1956 is not applicable to remuneration/compensation given to concerned persons (i.e. directors) for the services of a professional nature rendered by them to the company in their professional capacity such as advocate, chartered accountant, solicitor etc. However, prohibition will apply to them if they bind themselves on regular retainer ship basis. Therefore, (i) Chartered Accountants appointed by a company on a regular retainer basis as

advisers, consultants, internal auditors, etc., also hold the position or place of consultant or adviser and accordingly such appointments are hit by the restrictive provisions of Sub-sections (1) and (1B) of Section 314.



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(ii) Based on the above analogy as contained above the bare engagement of a Chartered Accountant in a particular case and the payment to him of his professional fees in that case would not attract the provisions of Sub-sections (1) and (1B) of Section 314 of the Companies Act. Engaging a person in his professional capacity for performing a particular function, say, for attending to a particular case or for undertaking a particular assignment of consultancy, or rendering advice on a specific matter, would not by itself constitute appointment to an office or place of profit in or under the company. But if the terms of engagement of a Chartered Accountant are that he should attend to all the tax cases or act as adviser in all connected matters, whether generally or in a particular city or town, then even though he may be paid on a case by case basis, it would amount to appointment to a “place of profit” under the company.

Question 7 Examine the validity of the following:

Mr. Q, a Director of PQR Limited proceeding on a long foreign tour, appointed Mr. Y as an alternate director to act for him during his absence. The articles of the company provide for appointment of alternate directors. Mr. Q claims that he has a right to appoint alternate director. (May, 2002) Answer Section 313 of the Companies Act, 1956 provides that the Board of Directors of a company may, if authorised by its articles or by resolution passed by the company in general meeting, appoint an alternate director to act for a director during his absence for a period of not less than 3 months from the State in which the meetings of the Board are ordinarily held. The alternate director can be appointed only by the Board of Directors and only in cases where the Board is authorised by Articles or by the company in general meeting. Hence Mr. Q, the director in question, is not competent to appoint alternate director and the appointment of Mr. Y as alternate director is not valid. Question 8 M/s Kith and Kin Consultants Private Limited seeks your legal advice regarding the following appointments relating to directors and their relatives:

(i) Mr. Nephew, who is a relative of one of the directors, is to be appointed as the Managing Director on a monthly salary of Rs.30,000 plus other perquisites as applicable to other executives of the company.

(ii) Miss Niece, a relative of a director, is to be appointed as Chief Executive Officer on a consolidated salary of Rs.25,000 per month.

Advise explaining the relevant provisions of the Companies Act, 1956. (May, 2002)



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Answer According to the provisions of section 314 of the Companies Act, 1956, except with the consent of the company accorded by a special resolution, no director of a company or relative shall hold any office or place of profit except that of Managing Director or manager of the company. Thus Mr. Nephew, if he is appointed as the Managing Director of the company, the provision of section 314 are not attracted, even through he is related to one of the directors of the company. This is because the appointment of Managing Director or manager is outside the purview of the provisions of Section 314. Further according to section 314 (1B) no relative of director can be appointed to any office or place of profit under the company which carries a monthly remuneration of not less than Rs.50,000/- (previously Rs. 20,000/-) except with the prior consent of the company by a special resolution and the approval of the central Government. Thus in the case of Mr. Wellconnected who is related to the managing director, his appointment requires not only the passing of a special resolution by the company but also the approval of the Central Government. The special resolution is required to be passed before the appointment. However in the case of Miss Niece, her appointment requires only prior passing of the special resolution and not the approval of Central Government because the remuneration proposed to be paid is less than Rs. 50,000/- per month. Question 9 Mr. A, an Advocate, is a Director of M/s ABC Limited and he is proposed to be engaged by the company as an Advocate to appear before the court in connection with a case, on a remuneration of Rs.10,000.

Will it amount to an ‘Office’ or Place of Profit’ attracting Section 314 of the Companies Act, 1956?

Will your answer be different, if he is proposed to be appointed on a regular retainer basis for rendering legal advice on a retainer fee of Rs.5,000 per month either by ABC Limited or its subsidiary?

State also whether the proposed appointments can be made by the Board of Directors of the Companies. (May, 2004) Answer Office or place of profit means in the case of a director, if the director obtains remuneration over and above the remuneration to which he is entitled as a director. Such remuneration may be as salary, fees, commission, perquisites, right to occupy any premises free of rent or in any other way [Section 314(3)(a)Companies Act, 1956]. An advocate who renders professional services as and when called upon to do so cannot be



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said to be holding an office or place of profit under the company or in the company. An advocate who cannot by reasons of his status at the Bar held any direct contractual relations with his clients in regard to the performance of his professional work and duties and he acts essentially as an officer of the court when he appears before the court. Hence A cannot be said to be holding an office or place of profit under Section 314 and the appointment can be made by the Board. But if Mr. A. is appointed on a regular retainer basis for rendering legal advice, other than appearance in courts, the provisions of Section 314(1) will be applicable. (DCA’s Circular No. 14 of 1975 dated 5th June, 1975) and A will be said to be holding an office or place of profit. For the same reason, A will be considered as holding an office or place of profit if he gets the retainer fee from the subsidiary of ABC Ltd. The exemption from Section 314(1) in respect of offices of profit carrying remuneration of less than Rs.10,000 per month applies only to the partners relatives, etc of a director and not to the director himself. In the case of a director, the section will hit any office of profit, however small the remuneration attached to it may be. Hence A cannot be appointed on a regular retainer basis on a retainer fee of Rs.5,000 per month without obtaining the consent of the company (ABC Ltd.) by a special resolution. If A receives retainer fee from the subsidiary of ABC Ltd., special resolution must be passed by both the holding company and the subsidiary company unless A remits the retainer fee received from the subsidiary company to the holding company. Question 10 Excellent Technical Consultants Ltd. has approached you seeking your opinion on the following appointments relating to directors and their relatives

(i) Appointment of Mr. Sonata (relative of one of the directors) as the Managing Director of the Company on a monthly remuneration of Rs.40,000 and other perquisites as are currently being allowed to other executives of the Company.

(ii) Appointment of Mr. Romesh (relative of one of the directors) as the General Manager – Marketing of the Company on a consolidated monthly remuneration of Rs.30,000.

(iii) Appointment of Mr. Kamal (relative of one of the directors) as an Accounts Manager of the Company on a consolidated monthly remuneration of Rs.18,000.

Express your opinion explaining the relevant provisions of the Companies Act, 1956? (November, 2004, November, 2006)

Answer As per provisions of section 314(1) of the Companies Act, 1956, except with the consent of the company accorded by way of a special resolution, no director or relative of a



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director shall hold any office or place of profit except that of Managing Director or Manager of the Company. Further, as per the provisions of Section 314(1B) of the Companies Act, 1956, no relative of a director can be appointed to any office or place of profit under the company which carries a monthly remuneration of not less than Rs.50,000/- (as per Notification vide 5th February, 2003) except with the prior consent of the company by way of a special resolution and the approval of the Central Government. In the light of above legal provisions the opinion on the appointments of various persons as stated in the question can be expressed as follows: Mr. Sonata is being appointed as the Managing Director of the Company, the provisions of section 314(1) are not attracted even though he is a relative of a director. This is because the appointment of Managing Director or Manager is outside the provisions of section 314 of the Companies Act, 1956. If Mr. Sonata is not already a director of the company, steps must be taken to appoint him first as an additional director/director. Thereafter he may be appointed as Managing Director by complying with the requirements under section 269 read with Schedule XIII to the Companies Act. The appointment can be made by the Board subject to the approval the company in general meeting as the proposed remuneration is within the limits laid down in Schedule XIII. Since the remuneration proposed to be paid to Mr. Romesh does exceed Rs.50,000/- per month, his appointment does not require the passing of special resolution by the company and also the approval of the Central Government is not required. However, as the proposed remuneration exceeds Rs.10,000/- his appointment shall require the passing of special resolution by the company. The special resolution is required to be passed at a general meeting of the company held for the first time after such appointment. In case of Mr. Kamal, since the remuneration proposed to be paid to him exceeds Rs.10,000/- but does not exceed Rs.50,000/- per month, his appointment shall require the passing of special resolution by the company only and the no approval of the Central Government is required. The special resolution according the consent may be passed at a general meeting of the members of the company held for the first time after such appointment. Question 11 Mr. Kamlesh, son of Managing Director of a Public Company, is proposed to be appointed as Chief Executive of the Company on a Monthly remuneration of Rs.75,000. State the provisions of the Companies Act, 1956 which are required to be complied with by the company in this regard?



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Will it make any difference if Mr. Kamlesh is appointed as Whole-Time Director on the same remuneration? (CA Final, New Course, November 2009) Answer Under Section 314(1B) of the Companies Act, 1956, in case relative of a Director holds office or place of profit under the Company on a monthly remuneration of Rs.50,000 or more, the Company is required to obtain prior consent of the company by special resolution and approval of Central Government. In the present case, the Company is accordingly required to pass a special resolution and obtain approval of the Central Government.

In case Mr. Kamlesh is appointed as Whole Time Director in the Company, Section 314 will not be attracted in view of sub-section (3) thereof, as he will be drawing remuneration in his capacity as a Director. He will be governed by the provisions of Section 269 read with Schedule XIII of the Act, according to which approval of Central Government is not required as the proposed remuneration of Rs.75,000. per month is within the ceiling provide in Part II of Schedule XIII provided the conditions prescribed in Part I of the Schedule have been complied with by the Company and the appointee. .


CHAPTER 18

COMPENSATION FOR LOSS OF OFFICE (SECTIONS 318 – 321)

Compensation for loss of office not permissible except to managing or whole-time directors or to directors who are manager (Section 318) Question 1 Can a company pay compensation to its directors for loss of office? Explain briefly the relevant provisions of the Companies Act, 1956 in this regard? (May, 2000) Answer A company can pay compensation to its directors for loss of office as provided in Sections 318 to 321 of the Companies Act 1956. Under Section 318, such compensation can be paid only to managing director, director holding the office of the manager and to a whole time director but not to others. The compensation payable shall be on the basis of average remuneration actually earned by such director for three years, or such shorter period as the case may be, immediately preceding the ceasing of holding of such office and shall be for the unexpired portion of his term or for three years whichever is shorter. No such payment can be made, if winding up of the company is commenced before or commences within 12 months after he ceases to hold office if the assets of the company on the winding up, after deducting expenses thereof, are not sufficient to repay to the shareholders the capital (including the premium, if any) contributed by them. However, no payment of compensation can be made in the following cases: (a) where a director resigns excepting on the ground of amalgamation or reconstruction

and holding the office of managing director or manager or other officer of such reconstructed or amalgamated company.

(b) where the director vacates office under section 203 or section 283(1). (c) where the winding up of the company is due to the negligence of the director

concerned. (d) where the director has been guilty of any fraud or breach of trust. (e) where the director has instigated or has taken part directly or indirectly in bringing

about, the termination of his office.



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Question 2 Mr. Doubtful was appointed as Managing Director of Carefree Industries Ltd. for a period of five years with effect from 1.4.2000 on a salary of Rs.12 lakhs per annum with other perquisites. The Board of Directors of the company on coming to know of certain questionable transactions, terminated the services of the Managing Director from 1.3.2003. Mr. Doubtful termed his removal as illegal and claimed compensation from the company. Meanwhile the company paid a sum of Rs.5 lakhs on ad hoc basis to Mr. Doubtful pending settlement of his dues. Discuss whether:

(i) The company is bound to pay compensation to Mr. Doubtful and, if so, how much.

(ii) The company can recover the amount of Rs. 5 lakhs paid on the ground that Mr. Doubtful is not entitled to any compensation, because he is guiding of corrupt practice. (November, 2004, November, 2007)

Answer According to Section 318 of the Companies Act, 1956, compensation can be paid only to a Managing or Whole-time Director. Amount of compensation cannot exceed the remuneration which he would have earned if he would have been in the office for the unexpired term of his office or for 3 years whichever is shorter. No compensation shall be paid, if the director has been found guilty of fraud or breach of trust or gross negligence in the conduct of the affairs of the company. In light of the above provisions of law, the company is not liable to pay any compensation to Mr. Doubtful, if he has been found guilty of fraud or breach of trust or gross negligence in the conduct of affairs of the company. But, it is not proper on the part of the company to withhold the payment of compensation on the basic of mere allegations. The compensation payable by the company to Mr. Doubtful would be Rs.25 Lacs calculated at the rate of Rs.12 Lacs per annum for unexpired term of 25 months. Regarding adhoc payment of Rs.5 Lacs, it will not be possible for the company to recover the amount from Mr. Doubtful in view of the decision in case of Bell vs. Lever Bros. (1932) AC 161 where it was observed that a director was not legally bound to disclose any breach of his fiduciary obligations so as to give the company an opportunity to dismiss him. In that case the Managing Director was initially removed by paying him compensation and later on it was discovered that he had been guilty of breaches of duty and corrupt practices and that he could have been removed without compensation. Question 3 A Managing Director was removed during the tenure of office and certain compensation was paid to him. It was later on found that during the tenure of his office that he was guilty of


Compensation for Loss of Office (Sections 318 – 321)

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corrupt practices and the company felt that no compensation should have paid to him and therefore wants to recover the compensation so paid to him. Can the company succeed?

Answer In Bell vs. Lever Brothers, (1932), Lever Brothers removed their managing director of a subsidiary by paying him compensation. It was afterwards discovered that during his tenure of office he had been guilty of so many breaches of duty and corrupt practices that he could have been removed without compensation. An action was then commenced to recover back the compensation money. It was held that Bell was not bound to refund the compensation money and to disclose any breach of his fiduciary obligation so as to give the company an opportunity to dismiss him.


CHAPTER 19

DIRECTORS WITH LIMITED LIABILITY (SECTIONS 322 – 323)

Special resolution of limited company making liability of directors, etc., unlimited (Section 323) Question 1 BHP Ltd. wants to make the liability to its directors unlimited. You are required to state with reference to the provisions of the Companies Act, 1956 whether this can be done.

Answer Section 323(1) of the Companies Act, 1956 states that a limited company may, if so authorized by its Articles of Association, by special resolution, alter is memorandum of association so as to render unlimited the liability of its directors or of any director or manager. Hence, by amending the Memorandum of Association of the company by way of passing a special resolution in a general meeting, BHP Ltd. can make the liability of directors unlimited.


CHAPTER 20

POWERS OF CG UNDER (SECTIONS 388B – 388E)

Powers of Central Government to remove managerial personnel from office on the recommendations of the Tribunal (Section 388B – 388E) Reference to Tribunal of cases against managerial personnel (Section 388B) Question 1 The Central Government came into possession of certain facts and documents, which indicated that some of the managerial personnel of a Company concerned with the management of the affairs thereof are acting in a manner, which is not desirable and if allowed to carry on, it is likely to cause serious injury to the interest of the trade, industry and business to which the company pertains. You are required to state the circumstances and manner in which the Central Government can initiate the process of removal of managerial personnel under the provisions of the Companies Act, 1956. (November 2005) Answer As per provisions of Section 388B of the Companies Act, 1956, if in the opinion of the Central Government, there are circumstances suggesting: (a) that any person concerned in the conduct and management of the affairs of a company

is or has been in connection therewith guilty of fraud, misfeasance, persistent negligence or default in carrying out his obligations and functions under the law, or breach of trust; or

(b) that the business of a company is not or has not been conducted and managed by such person in accordance with sound business principles or prudent commercial practices, or

(c) that a company is or has been conducted and managed by such person in a manner which is likely to cause or has caused, serious injury or damage to the interest of the trade, industry or business to which such company pertains; or



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(d) that the business of a company is or has been conducted and managed by such person with intent to defraud its creditors, members or any other persons or otherwise for a fraudulent or unlawful purpose or in a manner prejudicial to public interest.

Then, in any of the above circumstances the Central Government may state a case in the form of an application against the such person and refer the same to the Company Law Tribunal with a request that the Company Law Tribunal may enquire into the case and record a decision as to whether or not such person is a fit and proper person to hold the office of Director or any other office connected with the conduct and management of any company. The Company Law Tribunal is empowered to record its decision under the provisions of Section 388D of the Companies Act, 1956 and such decision shall be recorded by it after concluding the hearing of the case in which such person shall join as the respondent. Section 388E of the Companies Act, 1956 states that the Central Government shall, by order, remove from office any director or any other person concerned in the conduct and management of the affairs of a company, against whom a decision of the Company Law Tribunal under Section 388D has been recorded. NOTE: Powers of the Company Law Board has been transferred to the National Company Law Tribunal by the Companies (Second Amendment) Act, 2002 and assented by the President of India on 13.01.2003. This will take effect from the date of full enforcement. Till then, powers being currently exercised by the Company Law Board shall continue to be exercised. Power of CG to remove managerial personnel on the basis of Tribunal’s decision (Section 388E) Question 2 X Ltd. is being managed by Mr. Clever as the Managing Director. Serious allegations have been made by some shareholders and creditors of the company that the Managing Director has misused his position and caused enormous loss to the company. The said shareholders and creditors of the company make a complaint to the Central Government to intervene and provide relief to them. Their main prayer is that the Managing Director should be removed from the post. Explain the powers of the Central Government in this regard. (May, 2001) Answer On receipt of the complaint from some of the shareholders and creditors of X Ltd., that its managing director Mr. Clever has misused his office and thereby caused loss to the company, the Central Government, if satisfied with the contents of the complaint may make a reference to the Company Law Board with a request to inquire into the case and record a finding whether or not Mr. Clever is a fit and proper person to hold the office of Managing Director. The application made to CLB must contain a concise statement of the


Powers of CG Under (Sections 388B – 388E)

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circumstances and material as the central Government may consider necessary for the purpose of the enquiry. The Company Law Board will hear both the parties viz. (1) The Central Government and (2) The Respondent Mr. Clever as well as the company. The CLB has powers to pass any interim order to the effect that the respondent Mr. Clever shall not discharge any of the duties of his office until further orders and appoint a suitable person in place of the respondent. At the conclusion of the hearing the CLB will record its finding. If the finding of the CLB is against the respondent, the Central Government, by order, shall remove him from office, as provided in Section 388E(1) of the Companies Act, 1956. The person against whom such an order is passed is debarred from holding the post of director etc., for a period of 5 years from the date of order of removal. Also no compensation is payable to him for termination of office.


CHAPTER 21

ARBITRATION, COMPROMISES, ARRANGEMENTS AND RECONSTRUCTIONS

(SECTIONS 389 – 396 A)

Power to compromise or make arrangements with creditors and members (Section 391) Question 1 Alpha Ltd. and Beta Ltd. entered into a scheme of amalgamation by which Alpha Ltd. would transfer its entire undertaking to Beta Ltd. However, the Central Government raised an objection that unless the objects clause of the companies are similar, and memorandum empowers to do so, the scheme of amalgamation cannot be permitted. Is the contention of the Central Government correct?

Answer The power to amalgamate may flow from the memorandum or it may be acquired by resorting to the statute. Section 17 of the Companies Act, 1956 indicates that a company which desires to amalgamate with another company will take necessary steps to come before a court for alteration of its memorandum in aid of such amalgamation. The statute confers a right on a company to alter its memorandum in aid of amalgamation with another company. The provisions contained in sections 391 to 396 and 494, illustrate instances of statutory power of amalgamating a company with another company without any specific power in the memorandum. [Hari Krishna Lokia (v) Hoolungooree Tea Co. Ltd, 1996]. Section 391 is not only a complete code, but it is in the nature of a single window clearance system to ensure that parties are not put to avoidable, unnecessary and cumber some procedure for making repeated applications to court for various alterations and changes. What is to be seen is the over all fairness mid feasibility of scheme of amalgamation and there need not be any 'unison of objects of both transferor and the transferee company. [R Morarjee Goku/das spg. & wrg. Co., 1995]. To amalgamate with another company is the power of the company and not an object of the company. [Re. Hari Krishna Lohia, 1996]. Irrespective of the objects clause, the court is empowered to sanction scheme of amalgamation provided it does not prejudice the interest of the public. Therefore, based on the above judicial rulings, the contention of the central government is not correct. [Golkunda Engg. Enterprises Ltd (v) the G. V. Ltd, 1997J.



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Question 2 Overambitious Limited became sick. The shareholders and creditors of the company passed resolutions in meetings convened by the company approving a scheme of reconstruction of the company. The scheme provides for sale of vacant land and utilisation of the sale proceeds for payment of outstanding wages, sales tax dues and repayment of part of the loan taken from the bank. The unsecured creditors will have to forego 50% of their claims against the company and receive debentures for the balance amount. Advise the directors about the steps to be taken to give. effect to the proposed scheme inspite of objections raised by a few shareholders and creditors. (May, 2003) Answer Scheme of compromise or arrangement: The scheme provides for sacrifice on the part of creditors as they have to forego 50% of the amount due to them and accept debentures for the balance amount. The scheme also provides for sacrifice by members but the nature of sacrifice has not been stated in the problem. The company is sick and therefore it can be considered as a company liable to be wound up within the meaning of section 390(a) of the Companies Act, 1956. The proposed scheme involves as a compromise or arrangement with members and creditors and it attracts section 391. While the company or any creditor or member can make application to the court under section 391, it is usual for the company to make an application. On such application, the court may order that a meeting of creditors and/or members be called and held as per directions of the court (Section 391(1)). Company must arrange to send notice of meeting to every creditor/member containing a statement setting forth the terms of compromise or arrangement explaining its effect. Material interest of directors, M.D, or manager of the company in the scheme and the effect of scheme on their interest should be fully disclosed (Section 393(1)(a)). Advertisement issued by the company must comply with the requirements of Section 393(2). At the meetings convened as per directions of the court majority in number representing at least ¾ in value of creditors/members present and voting (either in person or proxy if allowed) must agree to compromise or arrangement. Thereafter the company must present a petition to the court for confirmation of the compromise or arrangement [Companies (Court) Rules-79]. The notice of application made by the company will be served on the Central Government and the Court will take into consideration representation, if, any made by the Central Government (Section 394A). The Court will sanction the scheme, if it is satisfied that the company has disclosed all material facts relating to the company e.g. latest financial position, auditor’s report on accounts of the company, pendancy of investigation of company, etc.


Arbitration, Compromises, Arrangements and Reconstructions (Sections 389 – 396A)

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Copy of Court order must be filed with the Registrar of Companies and then only the order will come into effect (Section 391(3)). Copy of court order must be annexed to every Memorandum of Association issued thereafter. (Section 391(4)). If the court sanctions the scheme, it will be binding on all members and creditors even those who were dissenting (Section 391(2)). (S.K. Gupta vs K.P. Jain A/R 1979 SC 374).

Question 3 A scheme of reconstruction of Southern Stone Company Limited was, approved by its shareholders and creditors in their meeting and resolutions to that effect were passed. Afterwards a few shareholders and creditors of the company raised objections against the said arrangements of reconstruction. The entire paid up capital of the company was wiped out by the accumulated losses. Advise the Directors of the said company about the steps to be taken, to give effect to the proposed scheme under the Companies Act, 1956.

(CA Final, New Course, May 2010) Answer Scheme of reconstruction: The Company is a sick company and therefore can be considered as a company liable to be wound up with the meaning of Section 390 of the companies Act, 1956. The proposed scheme involves a compromise or arrangement with members and creditors and attracts Section 391 of the said Act. An application be submitted before the High Court under Section 391 of the said Act. On such applicable the court may order that a meeting of creditors and/or members be called and held as per the directions of the court. The company must send notice of meeting to every creditor/member containing a statement setting forth the terms of compromise explaining its effects. At the meetings convened as per directions of the court majority in number representing atleast ¾ in value of creditors/members present and voting must agree in compromise or arrangements. Thereafter the company must present a petition to the court for confirmation of the compromise or arrangement. The notice of application made by the company will be served on the Central Government and the court will take into consideration representation, if any, made by the Central Government (Section 394A). The court will sanction the scheme, if satisfied, after consideration of all relevant matters. Copy of order issued by the court must be filed with the Registrar of Companies and then only the order will come into effect. Copy of the said order must be annexed to memorandum of Association issued thereafter. The scheme sanctioned by the court shall be binding on all members and creditors even on those who were dissenting. Provisions facilitating reconstruction and amalgamation of companies (Section 394) Question 4 HPC Ltd. for a number of years was in various types of business. In order to exit from its non core business, its management decided to hive off the business of Food Processing by



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demerging the said business with an associate company, namely, BCD Ltd. You are required to advise briefly, with reference to the provisions of the Companies Act, 1956, the steps the management should take to give effect to the proposed demerger (November 2005) Answer HPC Ltd. can demerge its food processing business with an associate company, BCD Ltd. By obtaining the approval of Company Law Tribunal (CLT earlier such power was vested in High Court and the High Court can continue to exercise such power till the CLT becomes fully functional) as provided in section 394 of the Companies Act, 1956 for this purpose, HPC Ltd. is required to take the following steps: (1) HPC Ltd., known as “Transferor Company” for this purpose, has to prepare a scheme

under which its properties and liabilities in respect of food processing business will be transferred to BCD Ltd., known as “Transferee Company” for this purpose. Such scheme must contain the consideration for transfer, known as “Exchange Ratio”.

(2) An application under Section 391(1) of the said Act must be made to CLT for an order convening meetings of creditors and/or members.

(3) Notice(s) of the meeting(s) must be sent to members/creditors as per the direction of CLT. Such notice must be accompanied by a statement under Section 393(1) of the said Act setting forth the terms of the compromise or arrangement and explaining its effect in general and in particular, the effect on the interests of Managerial Personnel.

(4) To hold the said meetings and pass necessary resolution approving the scheme subject to the confirmation of CLT. It may be noted that the resolution must be passed by a majority in number representing ¾ in value of the members/creditors as required under Section 391(2) of the said Act.

(5) Thereafter, HPC Ltd. is required to move to CLT jointly with BCD Ltd. for approval of the scheme disclosing all material facts relating to the Company. (Proviso to section 391(2). CLT as required under section 394A shall give notice to the Central Government and shall take into consideration any representation received from Central Government before passing any order on the application made to it for approval of the scheme.

(6) On receipt of CLT’s order, HPC Ltd. is required to file a certified copy of the order with the Registrar of Companies (ROC) for registration within 30 days after making of the order by CLT. [(Section 394(3)]. This is very important since the non-filing of the order with ROC would make the approval order ineffective.

(7) Lastly, to proceed to give effect to the scheme as approved by CLT in the manner as directed by it.



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Question 5 Answer the following with reference to a scheme of amalgamation of companies explaining the relevant provisions of the Companies Act, 1956:

(i) Whether companies being amalgamated must be companies registered in India.

(ii) What is the majority required for approving the scheme of amalgamation in a meeting of members of a company called as per directions of the court? Is the scheme to be approved by preference shareholders?

(iii) When will the court order dissolution of the transferor company? (May, 2000) Answer (i) A scheme of compromise or arrangement may provide for amalgamation of companies

under Section 394 of the Companies Act, 1956. Section 394(4)(b) defines the ‘transferee’ and ‘transferor’ companies. While the ‘transferee company’ does not include any company other than a company within the meaning of the Companies Act, 1956 the transferor company includes any body corporate whether a company within the meaning of the Companies Act or not. Hence the scheme of amalgamation may provide for transfer of foreign companies to Indian companies.

(ii) Majority in number representing three-fourths in value of members or class of members, as the case may be, present and voting either in person or by proxy, where proxies are allowed under the rules made under Section 643 must approve the scheme or arrangement providing for amalgamation of companies [Section 391(2)]. Any member who though present at the meeting, does not vote for or against, but remains neutral, is not to be taken into consideration.

As the expression used is ‘member’, not only holders of equity shares but also preference shareholders will have to be taken into account and the value of their shares be included or, if the meeting of holders of preference shares and equity shares are ordered by the court to be held separately, the three-fourths majority of each class will have to be ascertained separately.

(iii) The scheme may provide for the dissolution, without winding up, of any transferor company [Section 394(1)]. The Court shall not order dissolution of any transferor company unless the official liquidator has, on scrutiny of the books and papers of the company, made a report to the court that the affairs of the company have not been conducted in a manner prejudicial to the interests of its members or to public interest [Second proviso to Section 394(2)].

Question 6 M/s Over-ambitions Consultants Ltd. had, in course of its operations over the years, acquired various other ventures like plantations and tourism businesses. With a view to consolidate its



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core business activities, the management decided to hive off its non-core activities by demerging them with an associate company. Advise briefly the steps the management should take to achieve the purpose of demerger. (November, 2001) Answer M/s Over Ambitions Constructions Ltd. can achieve its purpose of hiving off its plantations and tourism business activity by demerger process by obtaining the approval of the High Court as provided in Section 394 of the Companies Act, 1956. The following steps are to be taken by M/s Over Ambitions Consultants Ltd., (1) Prepare a draft scheme under which the properties and liabilities of the company

comprising of plantations and tourism will be transferred to the associate company known as the transferee company. The consideration for the transfer must be stated in the scheme. (exchange ratio).

(2) An application under section 391(1) must be made to the Court for an order convening meetings of creditors and/or members.

(3) Notice of the meeting must be sent to members/creditors as per the court’s directions, The notice must be accompanies by a statement under section 393(1) setting forth the terms of the compromise or arrangement and explaining its effects etc.

(4) To hold the general meeting and pass that resolution approving the draft scheme of amalgamation subject to confirmation of the high court. Resolution must be passed by a majority in number representing 3/4th in value of the members as required under section 391.

(5) To move the High Court jointly with transferee company for approval of the scheme and for the purpose to supply it with material facts [proviso to section 391(2)]. The court shall give notice of the application to the Central Government and shall take into consideration the representation, if any, made by the Government before passing any order. (Section 394A).

(6) On receipt of the court’s order, file the certified copy of the order, with the Registrar of Companies within 30 days after the making of the order [Section 394(3)]. Otherwise, it would not be effective.

(7) To proceed to effect the scheme as per the scheme of amalgamation approved and the directions given by the High Court.

Question 7 M/s FMCG Ltd. proposes to acquire the majority shares of M/s Slow Industries Ltd. by way of Amalgamation. Briefly enumerate the steps that should be taken by the Transferee Company to achieve the objective under the Companies Act, 1956. (November, 2002)



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Answer FMCG LTD., the transferee company should take the following steps to achieve the objective of acquiring the majority shares of Show Industries Ltd. They are: (i) to check up whether the memorandum of association of the transferee company

contains the power of amalgamation. If not, to take steps to alter the objects clauses suitably to acquire the said power.

(ii) to prepare the draft scheme of amalgamation including the exchange ratio and get it approved by a meeting of the Board of Directors.

(iii) to apply to the High Court for direction to convene the general meeting by way of Judges' summons as provided in Companies (Court ) Rules 1959.

(iv) to send notice of general meeting to every member alongwith the details of the scheme of amalgamation.

(v) to hold the general meeting and to pass the resolution approving the draft scheme of amalgamation subject to the confirmation of the High Court. The resolution is to be passed by a majority in number representing 3/4th in value of the members as required by Section 391.

(vi) to move the High Court for approval of the scheme. (vii) on receipt of the court order, to file the certified copy thereof to the Registrar of

Companies within 30 days after making the order. [Section 394(3)]. (viii) A copy of the order of the court to be annexed to every copy of the memorandum

issued after the certified copy of the order has been filed with the Registrar. (ix) To effect the scheme of amalgamation as per the scheme approved and the directions

given by the High Court and to allot shares of the transferee company to the shareholders of transferor company i.e., Slow Industries Ltd.

Question 8 ABC Company Limited was amalgamated with and merged in XYZ Company Limited. Some workers of ABC Company Limited refuse to join as workers of XYZ Company Limited and claim compensation for premature termination of service. XYZ Company Limited resists the claim on the ground that their services are transferred to XYZ Company Limited by the order of amalgamation and merger and, therefore, the workers must join service of XYZ Company Limited and cannot claim any compensation. Examine whether the workers' contention is correct. (November, 2003) Answer An order under Section 394 of the Companies Act, 1956 transferring the property, rights and liabilities of one company to another does not automatically transfer contracts of



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personal service, which are in their nature, incapable of being transferred and no contract of service is thereby created between an employee of the transferor company on the one hand and the transferee company on the other. In Nokes vs. Doucaster Amalgamated Collieries Ltd. [(1940) 3All 2k 549], the House of Lords categorically stated that the workers are not furniture and their services can not be transferred without their consent. Therefore, the workers of ABC Co. Ltd will succeed against XYZ Co. Ltd. Question 9 Examine with reference to the provisions of the Companies Act, 1956 the validity of the following:

(i) A scheme provides for Amalgamation of a ‘Foreign Company’ with a Company Registered under the Companies Act, 1956.

(ii) The statement forwarded with the notice convening a meeting of its members pursuant to Court’s Direction Under Section 391 contains only ‘Exchange Ratio’ without details of its calculation.

(iii) At the time of filing of the petition for Amalgamation, the object clause of both the transferor and Transferee Companies does not contain power to Amalgamate. (May, 2004)

Answer Amalgamation of a foreign company with a company registered under the Companies Act According to Section 394(4)(b), ‘transferor company’ does not include any company, other than a company within the meaning of this Act. But transferor company includes any body corporate whether a company within the meaning of this Act or not. According to the definition of ‘body corporate’ in Section 2(7), it includes a company incorporated outside India. Further, as per Section 390(a), for purposes of Section 391, ‘Company’ means ‘any company liable to be wound up’. A foreign company having a place of business in India (i.e. a ‘foreign company’ within the meaning of Section 591) can be wound up as an ‘unregistered company’ under Section 582(b) read with Section 583 and 584. Hence, a scheme providing for amalgamation of a foreign company as a transferor company can be sanctioned by the court (NCLT). Statement under section 393: Every notice sent to members or creditors to convene a meeting pursuant to High Court’s (NCLT) directions under Section 391 must be accompanied by a statement setting forth the terms of compromise or arrangement and explaning its effects and material interests of directors and effect thereof on the scheme (Section 393(1). But the statement required under Section 393 is different from one required.



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The ‘statement’ required under Section 393 is different from the ‘explanatory statement’ required under Section 173. The former does not ordain disclosure of all material facts [Re. Tata Gil Mills Co. Ltd (1994) 14 CLA 13 (Bom.)]. The statement should contain the exchange ratio. But it is not necessary to give details thereof, nor is it necessary to circulate the valuation report to shareholders (Hindustan Lever Employees’ Union v. Hindustan Lever Ltd (1995) 83 Comp. Cas. 30(SC). Hence the statement containing only exchange ratio without giving details of calculation of exchange ratio is valid. Paper to amalgamate: It has been held in various cases that where there is a statutory provision dealing with the amalgamation of companies, no special power in the object clause of the memorandum of association of a company is necessary for its amalgamating with its company [Hari Krishna Lohia v. Hoolungoree Tea Company (1970) 47 Comp. Cases 458]. Hence the objects in the memorandum of association of the transferor company or transferee company need not contain power to amalgamate. Question 10 Answer the following explaining the relevant provisions of the Companies Act, 1956: (1) Whether the Companies being amalgamated must be Companies registered under the

Companies Act, 1956. (2) Whether the Companies seeking sanction of the court for a scheme of amalgamation must

have specific power to amalgamate in the object clause of their Memorandum of Association. (CA Final, New Course, November 2009)

Answer Amalgamation: A scheme of compromise or arrangement may provide for amalgamation of companies under section 394 of the Companies Act, 1956. Section 394(4)(b) defines the ‘transferor’ and ‘transferee’ companies. While the ‘transferee’ company does not include any company other than a company within the meaning of the Companies Act, 1956, the transferor company includes any body corporate, whether a company within the meaning of the Companies Act or not. ‘Body Corporate’ includes a company incorporated outside India [(section 2(7)]. Hence transferor company may be a company incorporated outside India, but transferee company must be a company incorporated under the Companies Act, 1956. Usually the Memorandum of Association of a company contains in its object clause the power to amalgamate. But, in a number of cases it has been held that it is not necessary to have in the memorandum of association a specific power to amalgamate with another company. The provisions of Section 391/394 of the Companies Act, 1956 indicate the scope of the statutory power for amalgamating a company with another company despite the absence of any specific enabling provision in their memoranda. (Aimco Pesticides Ltd, Feedback Reach Consultancy Pvt Ltd., Sir Matturdas Vissaiji Foundation in re). Hence even companies not having specific power to amalgamate in their Memoranda can seek sanction of the Court for a scheme of amalgamation.



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Question 11 The shareholders and creditors of Wagonbound Company Limited, in meeting convened for approval of a scheme of reconstruction of the company, passed resolutions. The scheme of reconstruction provided for the following:

(i) Sale of vacant land and appropriation of proceeds for payment of outstanding wages, tax dues and repayment of loan.

(ii) Unsecured creditors to forego 40% of their claims against the company and receive debentures for the balance amount.

A few share holders and creditors raised objections against the said arrangements. Advise the directors about the steps to be taken to give effect to the proposed scheme under the Companies Act, 1956. (May 2009) Answer

RECONSTRUCTION SCHEME OF COMPANY: The provisions contained in sections 391 to 394 of the Companies Act, 1956 are applicable to Wagonbound Company Limited as it can be considered as a company liable to be wound up within the meaning of Section 390 of the Companies Act, 1956. The proposed scheme involves a compromise or arrangement with members and creditors and it attracts section 391 of the said Act. While the company or any creditor or member can make application to the Court/Tribunal under Section 391, it is usual for the company to make an application. On such application the Court/Tribunal may order that a meeting of creditors and/or members be called and held as per the directions of the Court/Tribunal. The company must send notice of meeting to every creditor/member containing a statement setting forth the terms of compromise or arrangement explaining its effect. Material interest of directors, Managing Director or manager of the company in the scheme and the effect of scheme on their interest should be fully disclosed (Section 393). At the meetings convened as per directions of the Court/Tribunal majority in number representing at least ¾ in value of creditors/members present and voting must agree to compromise or arrangement. Thereafter the company must present a petition to the Court/Tribunal for confirmation of the compromise or arrangement. The notice of application made by the company will be served on the Central Government and the Tribunal will take into consideration representation, if any, made by the Central Government (Section 394A). The Court/Tribunal will sanction the scheme, if satisfied, after considering all relevant matters. Copy of order issued by the Court/Tribunal must be filed with the Registrar of Companies and then only the order will come into effect. Copy of the said order must be annexed to every



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Memorandum of Association issued thereafter. The scheme sanctioned by the Court/Tribunal shall be binding on all members and creditors even those who were dissenting. Note: The power under the scheme of reconstruction etc. is still with the High Courts pending constitution of the National Company Law Tribunal. Question 12

Sunrise Company Limited was merged with Moonlight Company Limited on account of amalgamation. Some workers of sunrise Company Limited refused to join as workers of Moonlight Company Limited and claimed compensation on the ground of premature termination of their services. Moonlight Company Limited resists the claim of the workers on the ground that their services have been transferred to Moonlight Company Limited in view of the order of amalgamation and merger and hence the workers must join the service of Moonlight Company Limited and cannot claim any compensation.

State the powers of the court about the matters that would be considered while sanctioning the scheme of amalgamation under the provisions of the Companies Act, 1956. Decide whether the contention of the workers is justified. (November 2008) Answer While sanctioning the scheme of amalgamation, the Court under Section 394 of the Companies Act, 1956 may make provision for all or any of the following matters: (i) The transfer to the transferee company of the whole or any part of the undertaking,

property or liabilities of the transferor company. (ii) The allotment by the transferee company of any shares, debenture etc, in that company

which under the scheme are to be allotted by that company to any person. (iii) The continuation of any legal proceedings by or against any transferor and transferee

company. (iv) The dissolution, without winding up of any transferor company. (v) The provisions to be made for any persons who within such time and in such manner

as the court directs, dissent from the scheme of amalgamation. (vi) Such incidental matters as are necessary to secure that the amalgamation shall be fully

and effectively carried out. An order under Section 394 of the Companies Act, 1956 transferring the property, rights and liabilities of one company to another does not automatically transfer contracts of personal service which are in their nature incapable of being transferred and no contract of service is thereby created between an employee of the transferor company on the one hand and the transferee company on the other.



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In Nokes vs. Doucaster Amalgamated collieries Ltd. (1940 (3) all 2k 549) the House of Lords clearly stated that the workers are not furniture and their services can not be transferred without their consent. Thus the contention of the workers of Sunrise Company Limited against the Moonlight Company Limited is correct and justified. Question 13 HPC Ltd. for a number of years was in various types of business. In order to exit from its non-core business, its management decided to hive off the business of food processing by demerging the said business with an associate company, namely BCD Ltd. You are required to advise briefly, with reference to the provisions of the Companies Act, 1956, the steps the management should take to give effect to the proposed demerger. (May 2008) Answer HPC Ltd. can demerge its food processing business with an associate company, BCD Ltd. by obtaining the approval of National Company Law Tribunal (NCLT) [earlier such power was vested in High Court and the High Court can continue to exercise such power till the CLT becomes fully functional] as provided in Section 394 of the Companies Act, 1956. For this purpose, HPC Ltd. is required to take the following steps: 1. HPC Ltd., known as “transferor Company” for this purpose, has to prepare a scheme

under which its properties and liabilities in respect of food processing business will be transferred to BCD Ltd., known as “Transferee Company” for this purpose. Such scheme must contain the consideration for transfer, known as “Exchange Ratio”.

2. An application under Section 391(1) of the said Act must be made to NCLT / High Court for an order convening meetings of creditors and / or members.

3. Notice(s) of the meeting(s) must be sent to members/creditors as per the direction of NCLT/ High Court. Such notice must be accompanied by a statement under Section 393(1) of the said Act setting forth the terms of the compromise or arrangement and explaining its effect in general and in particular, the effect on the interests of Managerial Personnel.

4. To hold the said meetings and pass necessary resolution approving the scheme subject to the conformation of NCLT/ High Court. It may be noted that the resolution must be passed by a majority in number representing 3/4th in value of the members / creditors as required under Section 391(2) of the said Act.

5. Thereafter, HPC Ltd. is required to move to NCLT / High Court jointly with BCD Ltd. for approval of the scheme disclosing all material facts relating to the Company. [Proviso to Section 391(2)], the High Court as required under Section 394A shall give notice to the Central Government and shall take into consideration any representation received from Central Government before passing any order on the application made to it for approval of the scheme.



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6. On receipt of NCLT’s / High Court’s order, HPC Ltd. is required to file a certified copy of the order with the Registrar of Companies (ROC) for registration within 30 days after making of the order by NCLT / High Court [Section 394(3)]. This is very important since the non- filing of the order with ROC would make the approval order ineffective.

7. Lastly, to proceed to give effect to the scheme as approved by NCLT / High Court in the manner as directed by it.

Notice to be given to Central Government for application under section 391 and 394 (Section 394A) Question 14 A scheme of amalgamation was approved by overwhelming majority of members of both the merging companies. The exchange ratio was fixed by a firm of reputed Chartered Accountants. When the scheme of amalgamation was awaiting sanction of the court, a small group of members of one of the merging companies raised objection on the ground that the exchange ratio was unfair. Examine with reference to decided case law whether the objection is likely to be sustained. What would be your answer in case similar objection was raised by the Central Government? (CA Final, New Course, November, 2008) Answer Exchange Ratio: Courts leave the aspect of share valuation to expert valuers and shareholders. Unless the person who challenges the valuation satisfies the court that the valuation is grossly unfair, the court will not disturb the scheme (Piramal Spg Vs Weaving Mills Ltd). In this case the valuation is confirmed to be fair by eminent firm of auditors and is also confirmed by majority of members. The objection of the some by small group of shareholders cannot be sustained as held in Hindustan Lever Employees. Union Vs Hindustan Lever Ltd. Section 394A of the Companies Act, 1956 requires the Court (Tribunal) to give notice of every application made to it under Section 391 or 394 to the Central Government. The Court (tribunal) should take into consideration the representations if any made to it by that Government before passing any order. The role played by the Central Government is that of an impartial observer who acts in public interest and advises the Court (tribunal) whether it is or it is not feasible for the two companies to amalgamate (Ucal Fuel Systems Ltd Sure). But the court is not bound to accept the views of the Central Government. Thus objection of the Central Government as regards valuation of shares was rejected by the Court (Tribunal), in the face of views expressed by two independent chartered accountants (M.G Investments & Industrial Co. Ltd Vs New Shorrock spinning & Mgf Co. Ltd). Hence even in the case of representation bay Central Government, unless that Government establishes that the exchange ratio was unfair and not in public interest, the court will refuse to interfere.



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Power of Central Government to provide for amalgamation of companies in national interest (Section 396) Question 15 With a view to boost the share values, the Central Government wants to amalgamate two Public Limited Companies into a single company. The Government and Public Financial Institutions have substantial interest in both the companies. The two companies are in the business of tourism and running several hotels which are not making good profits and consequently the share prices are depressed. Examine the powers of the Central Government to amalgamate the two companies in public interest. (May, 2002) Answer According to section 396 (1) of the Companies Act, 1956 where the Central Government is satisfied that it is essential in public interest that the two public limited companies should amalgamate the said Government may be order notified in the Official Gazette, provide for the amalgamation of the said two companies into a single company with such constitution; with such property, powers, rights interest, authorities and privileges and with such liabilities duties and obligations as may be specified in the order. This power of Central Government is notwithstanding anything contained in sections 394 and 395 of the Act that deal with amalgamation and reconstruction of companies. The Central Government has also the power to pass and provide for any consequential incidental and supplementary provisions in connection with the amalgamation including the confirmation by or against the transferee company of any legal proceedings pending by or against any transferor company. Any member or creditor who is aggrieved by the order of the amalgamation resulting in any financial loss is entitled to compensation which will be assessed by such authority as may be prescribed. Any person aggrieved by the order of compensation can file an appeal to the Company Law Board within 30 days of the publication of the order of compensation. Any order passed by the Central Government under this section can be made only where the draft copy thereof is sent to both the companies who have right to make an appeal and the same has been either disposed of or no appeal has been filed within the time provided thereof. The Central Government has duty to make such modifications in the light of any suggestions and objections received. All copies of the orders made under this section shall be laid before both the Houses of Parliament as soon as the same has been made. Question 16

X Ltd. and Y Ltd. are two listed companies engaged in the business of telecommunication. The companies are not making profits and as such their share’s market prices have gone down. A substantial portion of their share capital is held by Central Government as well as some Public Financial Corporations. In order to increase the share value, the Central Government wants to amalgamate the aforesaid two companies into a single company.



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Examine the powers of Central Government to amalgamate the two companies in public interest as per the provisions of the Companies Act, 1956. (May 2007) Answer According to section 396 (1) of the Companies Act 1956 where the Central Government is satisfied that it is essential in public interest that two public limited companies should amalgamate the said Government may, by order notified in the Official Gazette, provide for the amalgamation of the said two companies into a single company with such constitution, with such property, powers, rights, interests, authorities and privileges and with such liabilities, duties and obligations as may be specified in the order. This power of Central Government is notwithstanding anything contained in section 394 and 395 of the Act that deal with amalgamation and reconstruction of companies. The Central Government has also the power to pass and provide for any consequential, incidental and supplementary provisions in connection with the amalgamation including the continuation by or against the transferee company of any legal proceedings pending by or against the transferor company. Any member or creditor who is aggrieve by the order of the amalgamation resulting in any financial loss is entitled to compensation, which will be assessed by such authority as, may be prescribed. Any person aggrieved by the order of compensation can file an appeal to the Company Law Board (now tribunal) within 30 days of the publication of the order of compensation. Any order passed by the central government under this section can be made only where the draft copy thereof is sent to both the companies who have right to make an appeal and the same has been either disposed of or no appeal has been filed within the time provided thereof . The Central Government has duty to make such modifications In the light of any suggestions and objections received. All copies of the orders made under this section shall be laid before both the houses of parliament as soon as the same has been made. ABC Ltd has made an offer to acquire all the equity shares of XYZ Ltd at a certain price. Members of the company who hold 90% of the shares of XYZ Ltd have accepted the offer. The remaining shares are held by 2 persons who do not agree to the deal. Explain the procedure to finalize the deal. State the steps to be taken to acquire the shares of dissenting shareholders? Also, state whether ABC Ltd can acquire all the shares in XYZ Ltd? Question 17 ABC Ltd has made an offer to acquire all the equity shares of XYZ Ltd at a certain price. Members of the company who hold 90% of the shares of XYZ Ltd have accepted the offer. The remaining shares are held by 2 persons who do not agree to the deal. Explain the procedure to finalize the deal. State the steps to be taken to acquire the shares of dissenting shareholders? Also, state whether ABC Ltd can acquire all the shares in XYZ Ltd? Answer

Applying the provisions of section 395 of the Companies Act, 1956, ABC Ltd., can acquire all the shares of XYZ Ltd. including those held by 2 persons. It can acquire the shares held by 2



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persons if no application is made to the court for avoiding the sale of their shares or if the court refused it accordingly. In Bombay Gas Company (P) Ltd., vs. Central Government (1997) (CC) 89, the Bombay High Court held that Section 394(4)(b) provides for amalgamation of a foreign country with the Indian company. The transferee company, however, cannot be a foreign country. The expression member is not only holders of equity shares but also preference shareholders who had to be taken into account and value of their shares be included. The scheme may provide for the dissolution without winding up of any transferor company [Section 394(i)]. Question 18 A scheme of merger of DJA Company Limited with MRN Company Limited with approved by the shareholders at an extraordinary general meeting and the exchange ratio of 3 shares of MRN Company Limited for 20 shares in DJA Company Limited was approved. The proposal was also okayed by a lending financial institution which held 45% shares in DJA Company Limited. The valuation was carried out by one of the directors of DJA Company Limited, who was also a senior member of the Institute of Chartered Accountants of India. The valuation was affirmed by three independent valuers nominated by the shareholders in general meeting. However, certain leasehold properties, under license, which were not transferable, were not taken into accent in the valuation While the scheme was awaiting the Court’s sanction, it was challenged by certain shareholders on the ground that the exclusion of leasehold assets in the valuation, made the scheme Unfair' Decide giving reasons :

(i) Whether the contention of the shareholders is tenable ?

(ii) What factors would the court take into account in approving the exchange ratio?

Answer Merger And Scheme of Valuation: (i) The contention of the shareholders in this case shall not be tenable. The court is not to

disturb a scheme unless the person who challenges the valuation satisfies the court that the valuation arrived at was grossly unfair. Valuation in this case was approved by the shareholders and also okayed by the lending institution(s) which are usually well-informed and scrutinize the scheme with expert’s eye and which are also presumed to act bonafide. In the similar case of Tata Oil Mills Ltd. Re (1994), the court held that the presumption of fairness was writ large on the face of the Scheme. The Court did not attach importance to the fact that certain leasehold assets and properties held under license were excluded from valuation. Such assets, the court said, were neither transferable nor heritable. They are in the nature of a personal privilege. The Supreme Court affirmed this decision in Hindustan Lever Employees Union v, Hindustan Lever Ltd,, (1994) and accepted the exchange ratio proposed. The Supreme Court found no objection to the valuation being done by one of the directors of TOMCO (DJA Co. in this case). His report did not show any prejudice and was



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also affirmed by the independent valuers. Supreme Court also enumerated all the possible methods of valuation such as, market price, book value and yield basis and pointed out that a combination of all or some of the methods, may have to be adopted in circumstances of a particular case. Thus based on the above explanation and the decisions given by the Supreme Court, it can be concluded that the contention of the shareholders that the exclusion of certain leasehold assets in the valuation has made the scheme unfair, shall not be tenable.

(ii) The court would take into account the following factors in determining the final share exchange ratio: 1. The stock exchange prices of the shares of the two companies before the

commencement of negotiations or the announcement of the bid. 2. The dividends presently paid on the shares of the two companies. 3. The relative growth prospects of the two companies. 4. The cover for the present dividends of the two companies. 5. The relative gearing of the shares of the two companies. 6. The values of the net assets of the two companies. 7. The voting strength in the merged enterprise of the shareholders of the two

companies. 8. The past history of the prices of the shares of the companies.


CHAPTER 22

PREVENTION OF OPPRESSION AND MISMANAGEMENT (SECTIONS 397 – 407)

Application to Tribunal for relief in cases of oppression (Section 397) Question 1 The group of requisite shareholders under Section 399 filed a petition before the Company Law Board for relief against oppression. Meanwhile, a secured creditor filed a civil suit for winding up for non-payment of his debt. The shareholders contended that winding up proceeding should not be heard as the Company Law Board is seized of the petition under Section 397. Is there contention tenable?

What would be your answer, if in the said situation a composite petition (petition praying for relief against oppression as well petition for winding up) is filed in the Court of Law?

Answer In A.K. Puri vs. Devi Dass Gopal Kishan Ltd., (995) 17CLA, the J&K High Court held that there was no conflict of jurisdiction with respect to Sections 397, 398 and Section 433. The court observed that there is no statutory provisions in the Companies Act which provides for stay of the winding up proceedings under Section 433 when the CLB was seized of a petition between the same parties under Section 397/398. In other words, there is neither explicit nor implicit to carry on the winding up proceedings even when the CLB was seized of the matter. The question whether shareholders can file a writ petition for relief against oppression and mismanagement during pendency of proceedings before the CLB, the Supreme Court in World-wide Agencies Pvt. Ltd., vs. Mrs. M.T. Desor (1990) 67 CC. 607 held against such filing as a shareholder cannot be allowed to bypass the express provisions of the Companies Act. Winding up petition as a creditor on ground of inability to pay debts is not a bar to admission of a composite petition under Section 397 and 398 by the same party in the capacity of a member. [MMTC Ltd. vs. Indo French Biotech Enterprise Ltd (2000)] 23 SCL 192 (CLB).

Question 2

What is meant by oppression’? State whether the aggrieved party would succeed in obtaining relief from Company Law Board on the ground of oppression in the following cases:



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(i) The majority of the Board of Directors override the minority directors and the minority directors apply to Company Law Board complaining oppression by majority directors.

(ii) A petition by majority shareholders complaining oppression by minority shareholders.

Answer

Oppression: The term oppression’ is not defined in the Companies Act. Oppression, according to the Dictionary meaning of the word, is any act exercised in a manner burdensome, harsh and wrongful. The meaning of the term ‘oppression’ was explained by Lord Cooper in the Scottish case of Elder v. Elder and Watson Ltd, as given below:

“The conduct complained of should be at the lowest involve or visible departure from the standards of fair dealing and a violation of the conditions of fair play or which every shareholder who entrusts his money to a company is entitled to rely.

(i) Oppression of a member as a director: The oppression dealt with by section 397 is only oppression of members in their character as such; and it is only in that character they can involve section 397. The harsh treatment, for instance, of a member who is a director or other officer or employee, by the Board of Directors or management does not come within (section 397). It has been held in Re. Bellador Silk Ltd. that if the majority of the Board of Directors override the minority directors the latter cannot resort to section 397 and hence the minority directors will not succeed in getting relief from CLB on the ground of oppression.

(ii) Right not confined to minority: According to section 399, the right to apply for relief under section 397/398 is given to 100 members or 1/10th of the total number of members or any member or members holding not less than 1/10th of the issued share capital of the company. There is nothing in this section which suggests even indirectly that unless the application is made by minority shareholders it is not maintainable. The right to apply is, therefore, not confined to oppressed minority of the shareholders alone. It was held by Calcutta High Court in Re. Sindhri Iron Foundry (P) Ltd. that the oppressed majority also might apply for relief under section 397. Therefore, the petitioners are likely to succeed in getting relief provided the other condition laid down in section 397 (i.e. that to wind up the company would unfairly prejudice such members, but that otherwise the facts would justify the making of a winding-up order on just and equitable ground) is satisfied, even though the Delhi High Court held a contrary view in Suresh Kumar Sanghi v. Supreme Motors Ltd,

Question 3 Messrs Ahimsa Private Limited was incorporated in the year 2001 under the Companies Act, 1956 by 3 brothers, namely, Amit, Anil and Akhlesh. All the three were Promoter-directors named in the Articles of Association and subscribed for 100 shares each in the company


Prevention of Oppression and Mismanagement (Sections 397 – 407)

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through Memorandum of Association. Thereafter, from time to time, further shares were allotted in proportion of one-third to each of them and in due course, the company started earning substantial profits. Due to greed of money, the two brothers, namely, Amit and Anil, joined hands together to assume complete control of the company, leaving their brother, Akhlesh in lurch. Both the brothers got further shares allotted to themselves, thereby their joint shareholding increased from 66 2/3% to 90%, while the shareholding of Akhelesh got reduced from the erstwhile 33�% to 10%. No notice of any Board Meeting was sent to Akhlesh, who was sidelined and was also removed as a Director.

Aggrieved by the decisions taken by; his two brothers at his back, Akhlesh seeks your advice for taking out appropriate proceedings before the court or judicial authority of competent jurisdiction. Also suggest the nature of reliefs he may claim while filing his case. (November 2006) Answer Under Section 397 of the Companies Act, 1956 on an application by any member of a company, the Company Law Board (Tribunal as per amended provision which has not come into force) is of the opinion that – (i) the company’s affairs are being conducted in a manner which is prejudicial to public

interest or in a manner oppressive to any member(s); and (ii) to wind up the company would unfairly prejudice such member(s), but that otherwise

the facts justify winding up of the company on just and equitable ground, The CLB may, with a view to bringing to and end the mattes complained of, make such order as it thinks fit. As per section 399, a member holding 10% shares is entitled to file such a petition. In the present case, Mr. Akhlesh was holding 33�% shares in the company which is nothing but a quasi partnership and was participating in the management. By further allotment of shares in a clandestine manner and without the consent of Mr. Akhilesh, his shareholding was reduced to 10% while the shareholding of his brothers stood at 90%. This is a serious act of oppression of Akhlesh, a minority shareholder. On similar facts, it was held by Supreme Court in Dale & Carrington Invt. Private Ltd. Vs. P.K. Prathpan, (2004) 122 Comp cases 175(SC) that assuming meetings of board of directors did take place, the manner in which the shares were issued in favour of R without informing other shareholders about it and without offering them to any other shareholder, was totally mala fide and the sole object of R in this was to gain control of the company by becoming a majority shareholder. This was clearly an act of oppression on the part of R. The only relief that has to be granted in the present case was to undo the advantage gained by R through his manipulation and fraud. The allotment of all the additional shares in favour of R had to be set aside.



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Section 397 protects the rights of shareholders and not as a director. It has, however, been held by CLB in a number of cases that in a family company like the present one, removal of the promoter–director is also an act of oppression. In the facts and circumstances of this case, Akhlesh is advised to file a petition under Section 397 of the Act. Being a 10% shareholder he is entitled to file the petition, before the Principal Bench of Company Law Board at New Delhi. He may seek the following reliefs: (i) the alleged allotment of further shares be declared null and void and set aside; (ii) the alleged removal of the petitioner, Mr. Akhlesh be declared as null and void and set

aside; (iii) The Board of Directors be re-constituted with the petitioner and his two brothers and an

independent person, as the Chairman of the board of directors to be appointed by the Company Law Board with casting vote;

(iv) the petitioner may be appointed as Managing director of the company having substantial powers of management.

Question 4 State the conditions which must be satisfied before filing a petition under Section 397 of the Companies Act, 1956 for prevention of oppression. (CA Final, New Course, May, 2009) Answer The conditions which are required to be satisfied before filing a petition under Section 397 of the Companies Act, 1956 can be enumerated as follows: (i) An application under the said Section 397 can be made only by the members. In the

case of a company having share capital minimum one hundred members or one-tenth of total number of member of the company, whichever is less; or a member or members holding not less than 10% of the paid up capital of the company can file such petition . In case of a company not having share capital, minimum one-fifth of the total number of members of the company is required for the purpose. However, Central Government may authorise any lesser number of members to file such petition.

(ii) It must be established that the affairs of the company are being conducted in a manner (a) oppressive to any member/members of the company or (b) prejudicial to public interest.

(iii) The oppression complained of must affect a person in his capacity as a member of the company. Rights and interests as a member of a company can only be agitated and not in relation to any commercial relation that a member has with the company as was decided by the Company Law Board in the case of Anil Gupta vs. Mirai Auto Industores Ltd. [(2003)113 COMP. CAS.63].



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(iv) The acts complained of must be continuing acts of oppression. The acts constituting oppression must continue till the date of making the application.

(v) The applicant must make out a prima facie case that the degree of oppression is so severe that there is just and equitable ground for winding up of the company. But at the same time, it must also be established that the winding up of the company would not unfairly prejudice the applicant.

(vi) It may be noted that expression “issued share capital” in section 399(1) includes both the preference and equity share capital.

Question 5 The profits of MJR Company Limited for the financial year 2009-2010 fell considerably due to recession. The Board of Directors of the company, therefore, bonafide did not recommend any dividend for the year. At the Annual General Meeting of the company, a group of shareholders/members objected to the Board's decision and wanted the Board to make recommendation for dividend. On refusal by the Board, the members, who feel oppressed by the Board's decision to skip the dividend, move to the Company Law Board/Tribunal and complain against the Board on the ground of oppression and mismanagement. Examining the provisions of the Companies Act, 1956, decide: (1) Whether the members contention shall be tenable? (2) Whether the act of Board of Directors not to recommend any dividend shall amount to

oppression and mismanagement? (May, 2010) Question 6 60% shares of Indo-French Ltd. are held by French Group and balance by an Indian Group. As per articles of association of the company both groups had equal managerial powers. The relationship between the two groups soured and the operations of the company reached a deadlock. The Indian Group approached the Company Law Tribunal (Company Law Board till Company Law Tribunal becomes functional, referred to as CLB hereinafter) for action against the French Group for oppression. Based on these facts, you are required to decide, with reference to the provisions of the Companies Act, 1956 and/or the decided case laws, the following issues: (i) Whether the contention of oppression against the French Group by the Indian Group is

tenable? (ii) What are the powers of the CLB in this regard? (May 2007) Answer (i) Section 397 of the Companies Act, 1956 deals with the remedy in a situation when the

affairs of the company are being conducted in a manner oppressive to a shareholder or



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shareholders. This means that some of the shareholders must be in such a position that they can be oppressed by other shareholders or the management. In the present case as given in the question, both the Indian Group and the French Group are equally strong and none is able to oppress the other. The situation stated in the question is a deadlock but it can not be termed as oppression. Since it is not a case of winding up of the company, the relief under the said section 397 is not available to the Indian Group. [Gnanasambandam v. Tamilnad Transporters (Coimbators) p. Ltd. (1971) 41 Comp. Cas. 26] In view of the position discussed, the contention of the Indian Group is not tenable.

(ii) The powers of the Company Law Tribunal (Company Law Board till National Company Law Tribunal becomes functional) referred to as CLB hereinafter) under the provisions of section 397 of the Companies Act 1956, are discretionary in character. Apart from the general powers envisaged therein, the CLB under section 402 (b) of the said Act, may order the purchase of the shares of one group by the other group. In the case of Yashovardhan Saboo Vs. Groz Beckert Saboo Ltd. 1933 1 Comp. L.J. 20, the presiding officer ordered the foreign group to buy out the shares of the minority group at the fair price with deadlock and the matters are not sorted out by any other means, an order for winding up of the company may also be made under the jest and equitable clause, [Kishan Kumar Ahuja Vs. Suresh Kumar Ahuja]. Thus, if the Indian Group of the French Group fail to buy out the shares of the other group, the CLB may order the winding up of the company.

Right to apply under sections 397 and 398 (Section 399) Question 7 (i) ABC Private Limited is a company in which there are eight shareholders. Can a

member holding less than one-tenth of the share capital of the company apply to the Company Law Board for relief against oppression and mismanagement?

(ii) It is alleged by said member that the Directors of the Company have misused their position in making certain inter-corporate deposits which are against the interests of the company. Will the Company Law Board entertain application containing such allegation in the case of a private company? (May, 2000)

Answer (i) Under Section 399(1)(a) of the Companies Act, 1956, in the case of a company having

share capital, the following member(s) have the right to apply to the Company Law Board under Section 397 or 398: (i) Not less than 100 members of the company or not less than one-tenth of the

total number of members, whichever is less; or



22.7

(ii) Any member or members holding not less than one-tenth of the issued share capital of the company provided the applicant(s) have paid all the calls and other sums due on the shares.

In the given case, since there are eight shareholders. As per (i) above, 10% of 8 i.e. 1 satisfies the condition. Therefore a single member can present a petition to the Company Law Board (CLB), regardless of the fact that he holds less then one-tenth of the company’s share capital.

(ii) As regards the proprietary rights in inter-corporate loans by a private company, they are not closely regulated by Company Law as in the case of public companies. Though the Board of Directors are the best to judge and to take a commercial decision in this regard, if it is mala fide, it should be looked into. Therefore the CLB can look into the allegation lodged by the member.

Question 8 A group of shareholders of Deceptive Duplicating Machines Ltd. filed an application before the Company Law Board alleging various acts of fraud and mismanagement by Mr. Unscrupulous, the Managing Director, and his associates. During the course of hearings before the CLB, it was contended on behalf of the company that the alleged transactions had taken place long ago and that the Managing Director, who was responsible for such actions had already been removed and that there is no case before the CLB to interfere in the working of the company. The contention of the Applicants on the other hand is that though the fraudulent nature of the transactions is a thing of the past and though the Managing Director had been removed, yet the management of the company is still controlled by the henchmen of Mr. Unscrupulous. Discuss the powers of the Company Law Board in support of your answer. (May, 2001) Answer The power available to the shareholders to seek relief or remedy from the acts of oppression and mismanagement as stated in Sections 397 and 398 of the Companies Act, 1956 can be invoked only when the affairs of the company are being conducted in a manner oppressive to shareholders or prejudicial to the interest of the company. Thus at the time of making an application, there must be a continuing course or conduct of the affairs of the company, which is oppressive to any shareholder or shareholders or prejudicial to the interest of the company. It is this course of oppressive or prejudicial conduct which can be made the subject matter of a complaint in the application to CLB. The forgoing provisions of law (Section 397 & 398) do not confer any power on the Company Law Board to set aside or interfere with past and concluded transactions between the company and the shareholders or third parties which are no longer continuing wrongs or to award a compensation in respect of such concluded transactions. (Seth Ganpatram Vs. Shri Satyaji Jubilee Cotton and Jute Mills Company Ltd. (1964) 34 comp. Case 777). However, there are two exceptions to the above said general rule. The first one is



22.8

provided in Section 402(f) which enables CLB to set at naught transactions amounting to fraudulent preference effected within 3 months before the date of application under Sections 397 and 398, even though they are no long continuing wrongs. The second one is provided in Section 406 which enables the CLB, on an application under Sections 397 and 398, to book delinquent directors, managers and other office bearers of the company and to enforce the company’s claim against them if they have misapplied or retained the company’s money or have committed any misfeasance or breach of trust in relation to the company. It is necessary for the petitioners to establish that the matter complained falls under either of these exceptions and mere statement that the management of the Company still controlled by the Hechmen of Mr. Unscrupulous is not enough. Question 9

M/s Continuous Conflicts Ltd. is a company controlled by two family groups. The first family group has four directors, namely, Mr. A, Mr. B, Mr. C and Mr. D on the board of directors. The second family group has two representatives Mr. X and Mr. Y on the board. Because of internal family troubles, the first group, by virtue of its majority shareholding removed both Mr. X and Mr. Y as the directors of the company. Aggrieved by this action the second group is planning to move an application before the Company Law Board. You have been approached for advice. Advise as to the eligibility restrictions regarding filing the application and the chances of getting relief from the Company Law Board, assuming that there is no other material on record in support of oppression of the minority group (May, 2002)

Answer

The management of any company registered under the Companies Act, 1956 is based on the principle of majority rule and the voting power of every member depends upon the number of shares held by them. Thus one single individual holding the majority shares can overrule the views of the other members who may be more in numerical numbers but not in voting power. However, certain rights have been given to minority shareholders who complain that the affairs of the company are being conducted in a manner oppressive to any member or members. In such an event, the minority shareholders can apply to the Company Law Board for relief against oppression and mismanagement. The eligibility restriction for filing an application to the Company Law Board is contained in Section 399 of the Companies Act. According to the said section, the application to CLB can be made in the case of a company having share capital, by not less than one hundred members or not less than one-tenth of the total number of members whichever is less or members holding not less than one-tenth of the issued share capital provided, the applicants have paid all calls and other dues on their respective shares. In the case of a company not having the share capital, the application can be filed by members holding not less than one-fifth of the total number of members.



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In the present case the majority group have removed the minority directors from the board. The election and removal of directors is the prerogative of the members and such an act cannot be per se treated as oppressive to the minority shareholders, unless there is an allegation of mismanagement to the detriment of the shareholders. The application under section 397/398 requires to prove oppressive conduct to their members in their capacity as members. Thus the minority group consisting of two directors Mr. X and Mr.Y will not be able to successfully prosecute the case against the majority directors in the absence of any material or record in support of oppression and mismanagement of the minority group. Question 10 There are eight shareholders in M/s Supra Private Ltd. Mr. Shyam who is holding less than one-tenth of the Share Capital of the company seeks your advice whether he can apply to the Company Law Board for relief against oppression and Mismanagement. Advise. (November, 2002) Answer Petition to Company Law Board Under Section 399 (1) (a) of the Companies Act, 1956, in the case of a company having share capital, the following members have right to apply to the Company Law Board under Section 397 or 398. (a) Not less than 100 members of the company or less than one-tenth of the total number

of members, whichever is less; or (b) Any number of members holding not less than one-tenth of the issued share capital of

the company provided that the applicants have paid all calls and other sums due on their respective shares.

In the instant case, since there are eight share holders, as per (b) above, 10% of 8, i.e. 1 satisfies the condition laid down in section 399 mentioned above. In view of this Mr. Shyam can present a petition to the Company Law Board, regardless of the fact that he hold less than one-tenth of the Company's share capital. Further, a single member can present a petition to the Company Law Board under section 401 of the Act, if authorised by the Central Government. Question 11 A group of shareholders of Badwill Machineries Ltd. filed an application before the Company Law Board (CLB) alleging various acts of fraud and mismanagement by Mr. Bigfish, the Managing Director of his associates. During the course of hearing before the CLB, the authorised representative of the said company contended that the alleged transactions had taken place several years ago and the company has already removed the Managing Director, who was responsible for such transactions and hence there is no case before the CLB to interfere in the working of the company. Against the submissions on behalf of the company,



22.10

the applicants submitted that although the fraudulent transactions were done in past and the Managing Director has been removed, but the company is still controlled by the persons, who are in league with the erstwhile Managing Director and are working as his henchmen. State the merits of the applicants’ arguments and the powers of the CLB. (November, 2003) Answer The power available to the shareholder to seek relief or remedy from acts of oppression and mismanagement as stated in section 397 and 398 of the Companies Act, 1956 can be invoked only when the affairs of the company are being conducted in a manner oppressive to the shareholders or prejudicial to the interest of the company. Thus at the time of making an application, there must be a continuing course or conduct of the affairs of the company, which is oppressive to the shareholders or prejudicial to the interest of the company. It is this course of oppressive or prejudicial conduct which can be made subject matter of a complaint in the application to the Company Law Board (CLB). The provisions of sections 397 and 398 of the Companies Act, 1956 do not confer any power on the CLB to set aside or interfere with the past and concluded transactions between the Company and the shareholders or third parties which are no longer continuing wrongs or to award a compensation in respect of such concluded transactions [Seth Ganpatram vs. Shri Satyaji Jubilee Cotton and Jute Mills Co. Ltd. (1964) 34 Company Cases 777]. However, the above mentioned general rule is subject to following exceptions: (i) As per clause (f) of section 402 of the Companies Act, 1956, the CLB can set aside any

transfer, delivery of goods, payment, execution or other act relating to property made or done by or against the company within three months before the date of the application under sections 397 and 398 of the said Act, even though they are no longer continuing wrongs.

(ii) As per provisions of section 406 read with Schedule XI to the Companies Act, 1956, the CLB, on an application made to it under sections 397 and 398 of the said Act, has power to book the delinquent directors, managers and other office bearers of the company and to enforce the company's claim against them if they have misplaced or retained the company's money or have committed any misfeasance or breach of trust in relation to the company.

In the light of the above legal position, it is necessary for the petitioning shareholders to establish that the subject matter of the complaint falls within the scope of any of the above mentioned exceptions and a mere allegation that the affairs of the company is still controlled by the persons who are in league with the erstwhile Managing Director and are working as his henchmen is not sufficient.



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Question 12 Messrs Ahimsa Private Limited was incorporated in the year 2001 under the Companies Act, 1956 by 3 brothers, namely, Amit, Anil and Akhlesh. All the three were Promoter-directors named in the Articles of Association and subscribed for 100 shares each in the company through Memorandum of Association. Thereafter, from time to time, further shares were allotted in proportion of one-third to each of them and in due course, the company started earning substantial profits. Due to greed of money, the two brothers, namely, Amit and Anil, joined hands together to assume complete control of the company, leaving their brother, Akhlesh in lurch. Both the brothers got further shares allotted to themselves, thereby their joint shareholding increased from 66 2/3% to 90%, while the shareholding of Akhelesh got reduced from the erstwhile 33�% to 10%. No notice of any Board Meeting was sent to Akhlesh, who was sidelined and was also removed as a Director.

Aggrieved by the decisions taken by; his two brothers at his back, Akhlesh seeks your advice for taking out appropriate proceedings before the court or judicial authority of competent jurisdiction. Also suggest the nature of reliefs he may claim while filing his case. (November, 2006) Answer Under Section 397 of the Companies Act, 1956 on an application by any member of a company, the Company Law Board (Tribunal as per amended provision which has not come into force) is of the opinion that – (i) the company’s affairs are being conducted in a manner which is prejudicial to public

interest or in a manner oppressive to any member(s); and (ii) to wind up the company would unfairly prejudice such member(s), but that otherwise

the facts justify winding up of the company on just and equitable ground, The CLB may, with a view to bringing to and end the mattes complained of, make such order as it thinks fit. As per section 399, a member holding 10% shares is entitled to file such a petition. In the present case, Mr. Akhlesh was holding 33�% shares in the company which is nothing but a quasi partnership and was participating in the management. By further allotment of shares in a clandestine manner and without the consent of Mr. Akhilesh, his shareholding was reduced to 10% while the shareholding of his brothers stood at 90%. This is a serious act of oppression of Akhlesh, a minority shareholder. On similar facts, it was held by Supreme Court in Dale & Carrington Invt. Private Ltd. Vs. P.K. Prathpan, (2004) 122 Comp cases 175(SC) that assuming meetings of board of directors did take place, the manner in which the shares were issued in favour of R without informing other shareholders about it and without offering them to any other shareholder, was totally mala fide and the sole object of R in this was to



22.12

gain control of the company by becoming a majority shareholder. This was clearly an act of oppression on the part of R. The only relief that has to be granted in the present case was to undo the advantage gained by R through his manipulation and fraud. The allotment of all the additional shares in favour of R had to be set aside. Section 397 protects the rights of shareholders and not as a director. It has, however, been held by CLB in a number of cases that in a family company like the present one, removal of the promoter–director is also an act of oppression. In the facts and circumstances of this case, Akhlesh is advised to file a petition under Section 397 of the Act. Being a 10% shareholder he is entitled to file the petition, before the Principal Bench of Company Law Board at New Delhi. He may seek the following reliefs: (i) the alleged allotment of further shares be declared null and void and set aside; (ii) the alleged removal of the petitioner, Mr. Akhlesh be declared as null and void and set

aside; (iii) The Board of Directors be re-constituted with the petitioner and his two brothers and an

independent person, as the Chairman of the board of directors to be appointed by the Company Law Board with casting vote;

(iv) the petitioner may be appointed as Managing director of the company having substantial powers of management.

Question 13 M/s. City Hospital Private Ltd. has two groups of Directors. A dispute arose between the two groups out of which one group controlled the majority of shares. A very serious situation arose in the administration of the company’s affairs when the minority group ousted the lawful Board of Directors from the possession and control of the management of the company’s factory and workshop. Books of account and statutory records were held by the minority group and consequently the annual accounts could not be prepared for two years. The majority group applied to the company law board for relief under sections 397 and 398 of the Companies Act. You are required to decide with reference to the provisions of the said Act, the following issues:

(i) Can majority of shareholders apply to the Company Law Board for relief against the oppression by the minority shareholders?

(ii) Whether Company Law Board can grant relief in such circumstances. (November 2007) Answer (i) The case started in the question relates to the provisions of sections 397 and 398 of

the companies Act, 1956 with regard to remedy available to majority shareholders.



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Where the majority is prevented from protecting itself by controlling the directors at general body meetings, the majority becomes an artificial minority entitled to claim protection under Section 397 and 398 (V. Sebastean, Dr V City Hospital (Pvt.) ltd. (1985) 57 Comp. case 453 (Ker)] Thus the remedy under Section 397 and 398 is confined not to an oppressed minority of the shareholders alone; an oppressed majority may also apply to the Company Law Board against their oppression from the side minority shareholders. In Sindhri Iron Foundry (Pvt.) Ltd. Re (1963) 78 E. to N. 118, issue and allotment of a number of shares in a company whereby an admitted majority of shareholders was reduced to a minority was struck down. While granting relief to a majority group, Mitra J observed in their case;

“If the Court (now the Company Law Board) finds that the company’s interest is being seriously prejudiced by the activities of one or the other group of shareholders, that two different registered offices at two different addresses have been set up, that tow rival boards are holding meetings, that the company’s business property and assets have passed into hands of unauthorized persons who have taken wrongful possession and who claim to be the shareholders and directors, there is no reason why the Court (now the company Law Board) should not make appropriate orders to put an end to such matters”.

(ii) Relief by the Company Law Board: The Company Law Board may give relief if its is of opinion: 1. that the company’s affairs are being conducted (a) in a manner prejudicial to public

interest, or (b) in a manner oppressive to any member or members; 2. that the facts justify the compulsory winding up order on the ground that it is just and

equitable that the company should be wound up; 3. that to wind up the company would unfairly prejudice the applicants.

On being satisfied about the above requirements, the Company Law Board may pass such order as it thinks fit with a view to bring an end to the matters complained of this provision would help salvage an otherwise sound concern which would have been, but for this principle, forced to into winding up. Question 14 The issued, subscribed and paid-up share capital of ABC Company Limited is Rs.10 lakhs consisting of 90,000 equity shares of Rs.10 each fully paid up and 10,000 preference shares of Rs.10 each fully paid up. Out of the members of company, 400 members holding one preference share each and 50 members holding 500 equity shares applied for relief under Sections 397 and 398 of the Companies Act, 1956. As on the date of petition, the company had 600 equity shareholders and 5,000 preference shareholders.



22.14

State with details whether the above petition under Section 397 and 398 is maintainable. Will your answer be different, if preference shareholders have subsequently withdrawn their consent? (May, 2004, May 2009)

Answer

As per section 399 of the Companies Act, 1956, in the case of a company having a share capital, members eligible to apply for oppression and mismanagement shall be lowest of the following:

100 members; or

1/10th of the total number of members; or

Members (including equity shareholder as well as preference shareholder) holding not less than 1/10th of the issued share capital of the company.

The consent to be given by shareholder is reckoned at the beginning of the proceedings. The withdrawal of consent by shareholder during the course of proceedings does not affect the maintainability of the application.

In the question above, the shareholding pattern of the company is as follows:

Rs. 9,00,000 equity share capital held by 600 members.

Rs. 1,00,000 preference share capital held by 5,000 members.

Rs. 10,00,000 total share capital held by 5,600 members.

The application alleging oppression and mismanagement has been made by the members as follows:

(a) Number of members making the application:

• Preference shareholders 400

• Equity shareholders 50

• Total members 450

(b) Amount of share capital held by members making the application:

• Preference share capital Rs. 4,000 (400 preference shares of Rs.10 each)

• Equity share capital Rs. 5,000 (500 equity shares of Rs.10 each)

• Total capital Rs. 9,000

The application shall be valid if it has been made by the lowest of the following: 100 members



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560 members (being 1/10th of 5,600) Members holding Rs.1,00,000 share capital (being 1/10th of Rs.10,00,000) As it is evident, the application made by 450 members meets the eligibility criteria specified u/s 399; therefore, the application is maintainable. Such application shall remain valid despite the fact that some of the applicants have withdrawn their consent. Question 15 A group of members of XYZ Limited has filed a petition before the Company Law Board alleging various acts of oppression and mismanagement by the majority shareholders of the Company. The Petitioner group holds 12% of the issued share capital of the Company. During the pendancy of the petition, some of the petitioner group holding about 5% of the issued share capital of the Company wish to disassociate themselves from the petition and they along with the other majority shareholders have submitted before the Company Law Board that the petition may be dismissed on the ground of non-maintainability. Examine their contention having regard to the provisions of the Companies Act, 1956. (November, 2009) Answer The argument of the majority share holders that the petition may be dismissed on the ground of non-maintability is not correct.The proceedings shall continue irrespective of withdrawl of consent by some petitionrers. It has been held by the Supreme Court in Rajmundhry Electric Corporation vs. V. Nageswar Rao, AIR (1956) SC 213 that if some of the consenting members have subsequent to the presentation of the petition withdraw their consent, it would not affect the right of the applicant to proceed with the petition. Thus, the validity of the petition must be judged on the facts as they were at the time of presentation. Neither the right of the applicants to proceed with the petition nor the jurisdiction of Company Law Board to dispose it of on its merits can be affected by events happening subsequent to the presentation of the petition. Oppression & Mismanagement: Under Sections 397 and 398 of the Companies Act, 1956, members may apply to the Company Law Board/Tribunal in cases of oppression and mismanagement. However, bona fide decisions consistent with the company’s memorandum and articles are not to be equated with mismanagement even if they turn out to be wrong in the circumstances or these cause temporary losses. The Court will not permit the machinery created by the sections to be used by the minority for compelling the majority to come to terms, where the company is honestly managed. Directors’ bona fide decision not to declare dividend and to accumulate available profits into reserves is not mismanagement. (Thomas Vettom (V.J.) vs. Kuttanad Rubber Co. Ltd. (1984) 56 Com. Cases 284 (Ker). Thus in the given case, the group of shareholders/members who complain to CLB/Tribunal against the decision of the Board not to declare any dividend and to



22.16

accumulate available profits into reserves, would not succeed, as the act of directors does not amount to mismanagement. Furthermore, the shareholders cannot compel the Board to recommend a dividend. The Board’s recommendations are placed in the general meeting. The general meeting can reduce the dividend, but cannot even increase the dividend as recommended by the Board. Therefore, the shareholders/members cannot compel the company to declare dividend and cannot charge the directors with oppression or mismanagement.

Applying the above, answers to the question shall be as under:

(1) The contention of shareholders/members shall not be tenable.

(2) The act of the Board of Directors who acted bona fide, not to recommend any dividend shall not amount to oppression or mismanagement.

Question 16

A group of shareholders holding more than 15% of the issued capital of M/S Defraud Ltd. have filed a petition before the Company Law Board alleging various acts of illegal, invalid and irregular transactions entered into in the name of the Company. Examine the merits of the petition in the light of the judicial pronouncements made in this regard. (November 2009)

Answer

A group of shareholders of M/s Defraud Ltd. must hold more than 15% of the issued share capital of the Company or satisfy other requirements under Section 399(1) of the Companies Act,1956 .Since the group holds 15% of the issue capital they are entitled to file a petition before the Company Law Board under sections 397 and 398 of the Companies Act,1956 by alleging that the affairs of the Company are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member or members of the Company. There are however, several judicial pronouncements according to which mere illegal, invalid or irregular acts by themselves do not constitute a ground for invoking the provisions of Section 397 unless it is proved that they are oppressive to any shareholder or prejudicial to the interest of the Company or to the public interest. [Sheth Mohanlal Ganpatram vs Shri Savaji Jubilee Cotton and Jute Mills Company Ltd.] Thus in the present case, the petition filed by the group of shareholders will fail unless they can prove to the satisfaction of the Company Law Board that the acts Complained of in the petition are oppressive and prejudicial to the interest of the Company and the public interest. And that to wind up the Company would unfairly prejudice such member or members, but that otherwise those facts would justify the making of a winding up order on the ground that it was just and equitable that the Company should be wound up.

Question 17 A group of shareholders consisting of 25 members decide to file a petition before the Company Law Board for relief against oppression and mismanagement by the Board of



22.17

Directors of M/s Fly By Night Operators Ltd. The company has a total of 300 members and the group of 25 members holds one –tenth of the total paid –up share capital accounting for one-fifteenth of the issued share capital. The main grievance of the group is the due to mismanagement by the board of directors, the company is incurring losses and the company has no declared any dividends even when profits were available in the past years for declaration of dividend. Advise the group of shareholders regarding the success of (i) getting the petition admitted and (II) obtaining relief from the Company Law Board. Answer Section 399 of the Companies Act, 1956 provides the right to apply to the Company Law Board for relief against oppression and mis-management. This right is available only when the petitioners hold the prescribed limit of shares as indicated below: (i) In the case of company having a share capital, not less than 100 members of the

Company or not less than one tenth of the total number of its members whichever is less or any member or members holding not less than one tenth of the issued share capital of the company, provided that the applicant(s) have paid all calls and other dues on the shares.

(ii) In the case of company not having share capital not less than one-fifth of the total number of its members.

Since the group of shareholders do not number 100 or hold 1/10th of the issued share capital or constitute 1/10th of the total number of members, they have no right to approach the CLB for relief. However, the Central Government, if it is of the view that circumstances exist which make it just and equitable so to do, may authorize any member(s) to apply to the CLB (Section 399(4)]. So, members any approach Central Government to authorize them to approach CLB in spite of deficiency in numbers. As regards obtaining relief from CLB, continuous losses cannot, by itself, be regarded as Oppression (Ashok Betelnut Co. P. Ltd. vs. M.K. Chandrakanth).

Similarly, failure to declare dividends or payment of low dividends also does not amount to oppression. (Thomas Veddon V.J. (v) Kuttanad Robber Co. Ltd). Thus the shareholders may not succeed in getting any relief from CLB.


CHAPTER 23

MISCELLANEOUS PROVISIONS (SECTIONS 416 – 424)

Employees’ securities and provident funds (417 – 419) Employees’ securities to be deposited in post office savings bank or Scheduled Bank (Section 417) Question 1 M/s Flyover Constructions Ltd. has to recruit 2,000 Civil Engineers on contract basis for a period of 5 years. The company entered into an agreement with the employees that each employee will have to deposit Rs. 50,000 as security which sum will be returned on completion of 3 years of contract of service. The company wants to utilize the fund so collected in their business. Advise the company with reference to Companies Act in the matter of collection and utilization of money received from employees as security deposit. (November 2007) Answer Section 417 of the Companies Act, 1956 provides that (1) any money or security deposited with a company by any of its employee in pursuance

of his contract of service with the company shall be kept or deposited by the company within fifteen days from the date of deposit. (i) in a post office savings bank account, or (ii) in a special account to be opened by the company for the purpose in the state

bank of India or in a scheduled bank, or (iii) where the company itself is a scheduled bank, in a special account to be opened

by the company for the purpose either in itself or in the state bank of India or in any other scheduled bank.

(2) No portion of such moneys or securities shall be utilized by the company except for the purposes agreed to in the contracts of service.

(3) A receipt for moneys deposited with a company by its employee shall not be deemed to be security within the meaning of this section; and the moneys themselves shall accordingly be deposited as provided in sub-section (1).



23.2

So the company cannot utilize the money so collected. It will have to deposit the money in the special accounts as referred in the section. Provisions applicable to provident funds of employees (Section 418) Question 2

As per the terms of the agreement of service between NOC Ltd. and its employees, an amount equal to 12.5% of the salary shall be transferred to the recognized Provident Fund and shall be payable to the employee either on retirement or termination, as the case may be. An amount equal to 12.5% of the salary shall be contributed by the company to the recognized provident fund.

Mr. A earning Rs. 3000 p.m. has been working with the company since the last four years. Due to some personal reasons Mr. A is in need of Rs. 100,000 and wants to obtain as advance the amount standing to the credit in the fund. With reference to the provisions of the Companies Act, 1956. advice as regards the following: (i) When and where should the money so collected by the company be deposited? (ii) Can Mr. A obtain the advance from his accumulated contribution to recognized

Provident Fund? (November 2008) Answer Section 418 of the Companies Act, 1956 dealing with the provident fund of the employees provides that: (1) Where a provident fund has been constituted by a company for its employees or any

class of its employees, all moneys contributed to such fund (whether by the company or by the employees) or received or accruing by way of interest or otherwise to such fund shall, within fifteen days from the date of contribution, receipt or accrual, as the case may be either- (a) be deposited-

(i) in a post office saving bank account, or (ii) in a special account to be opened by the company for the purpose in the

State Bank of India or in a Scheduled Bank, or (iii) Where the company itself is a Scheduled Bank, in a special account to be

opened by the company for the purpose either in itself or in the State Bank of India or in any other Scheduled Bank; or

(b) be invested in the securities mentioned or referred to in clauses (a) to (e) of Section 20 of the Indian Trusts Act, 1882 (2 of 1882).

(2) Notwithstanding anything to the contrary in the rules of any provident fund to which sub-section (1) applies or in any contract between a company and its employees, no



23.3

employee shall be entitled to receive, in respect of such portion of the amount to is credit in such fund as is invested in accordance with the provisions of sub-section (1), interest at a rate exceeding the rate of interest yielded by such investment.

(3) Nothing in sub-section (1) shall affect any rights of an employee under the rules of a provident fund to obtain advances from or to withdraw money standing to his credit in the fund, where the fund is a recognized provident fund. (i) So the money collected by NOC Ltd. from its employees will have to be

deposited in any of the following:

(a) in a post office saving bank account, or

(b) in a special account to be opened by the company for the purpose in the State Bank of India or in a Scheduled Bank, or

(c) be invested in securities mentioned or referred to in clauses (a) to (e) of Section 20 of the Indian Trusts Act, 1882 (2 of 1882 ).

(ii) As per the provision of Section 418 (3), Mr. A can obtain advances from or withdraw money standing to his credit in the fund provided the fund is a recognized provident fund.


CHAPTER 24

WINDING-UP (SECTIONS 425 – 560)

Contributories Liability as contributories of present and past members (Section 426) Question 1 By an order of the Court M/s ABC Limited was wound up with effect from 15.3.2002. Mr. Gupta, who ceased to be a member of the Company from 1.6.2001 received a notice from the liquidator to deposit a sum of Rs.15,000 as his contribution towards the liability on the shares previously held by him. Mr. Gupta seeks your opinion about his liability. (November, 2002) Answer Liability of Contributory ‘Contributory’ is a term used in the case of winding up of a company. A Contributory can be past or present member and is liable to contribute to the assets of the company in the event of winding up. In the instant case, Mr. Gupta ceased to be a member of the Company when it went into liquidation from 15.3.2002. Thus, Mr. Gupta will be treated as a past member. He will not be required to contribute to the assets of the company if the following conditions are fulfilled: (1) If Mr. Gupta had ceased to be a member of the company for a period of one year or

upwards before the commencement of the winding up. In this case, since one year has not elapsed, Mr. Gupta will be liable to contribute to the assets of the company.

(2) If the debt or liability of the company was contracted or incurred after he ceased to be a member.

(3) If the present members are able to satisfy the contributions required to be made by them under the Act.

In any case, the liability of the past or present member cannot exceed the unpaid amount on the shares and if the shares are fully paid up, no contribution is required to be made by the members past or present. Question 2 M/s XYZ Limited was wound up with effect from 15.3.2000 by an order of the court. Mr.A, who ceases to be a member of the company from 1.6.1999, has received a notice from the



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liquidator that he should deposit a sum of Rs. 5,000 as his contribution towards the liability on the shares previously held by him. In this context explain whether Mr. A can be called a contributory and whether he can be made liable and whether there is any limitation on his liability. (May, 2000) Answer Contributory is a term used in the case of winding up of a company. A contributory can be a past or present member and is liable to contribute to the assets of the company in the event of winding up. In the present case Mr. A ceased to be a member of the company when it went into liquidation from 15.3.2000. Thus Mr. A will be treated as a past member. He will not be required to contribute to the assets of the company if the following conditions are fulfilled: (a) If Mr. A had ceased to be a member of the company for a period of one year or

upwards before the commencement of the winding up. In this case since one year has not elapsed, Mr. A will liable to contribute to the assets of the company.

(b) If the debt or liability of the company was contracted or incurred after he ceased to be a member.

(c) If the present members are able to satisfy the contributions required to be made by them under the Act.

In any case, the liability of the past or present member cannot exceed the unpaid amount on the shares and if the shares are full paid up no contribution is required to be made by the members past or present [Section 426 of Companies Act, 1956]. Question 3 X Ltd. had gone into liquidation and a liquidator was appointed to administer the assets and liabilities of the Company. The liquidator of the Company finds that the assets of the Company are not sufficient to meet out the liabilities. He therefore, calls on the contributories including the part members as per List B to contribute towards the assets. The past members object to the liquidator’s act on the ground that since they are no more members of the Company, they are not liable to contribute. Referring to the provisions of the Companies Act, 1956 decide:

(i) Whether the contention of the past member is tenable and can they be exempted from the liability to contribute?

(ii) What would be your answer in case the members in question are the present members? (November 2009)

Answer In accordance with the provisions of the Companies Act, 1956, as contained in Section. 426, in the event of a Company being wound up every present and past member shall be liable to contribute to the assets of the Company to an amount sufficient -


Winding-Up (Sections 425 – 560)

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(a) for payment of (i) its debts and liabilities, and (ii) costs, charges and expenses of the winding up, and

(b) for the adjustment of the rights of the contributories among themselves. The liability of the present member i.e. as per List A shall be limited (i) in case of a Company limited by shares , to the amount remaining unpaid on the

shares; and (ii) in case of a Company limited by guarantee, to the amount undertaken to be contributed

by him to the assets of the Company in the event of its being wound up. However, in the winding up of a Company limited guarantee, which has a share capital, every member of the Company shall be liable, to contribute not only the amount undertaken to be contributed by him in the event of winding up but also to contribute to the extent of any sum unpaid on any shares held by him as if the company were a company limited by shares. Liability of Past Members: (List B) A past member shall not be liable to contribute: (i) if he has ceased to be a member for 1 year or more before the commencement of the

winding up; (ii) in respect of any debt or liability of the Company contracted after he ceased to be a

member; (iii) if it appears to the Court that the present members will be able to satisfy the contributions

required to be made by them. The past members can be called upon only after the Court has called upon the contributories in List A to pay and their contributions are found insufficient. In the case of a Company limited by shares a past member shall not be liable to contribute more than the amount unpaid on the shares in respect of which he is liable as such member: Thus examining the above provisions, answer to the given questions shall be: 1. The past members’ contention shall be tenable only:

(i) Whey they have ceased to be a member for 1 year or more before the commencement of the winding up of the Company.

(ii) If the liability of the Company was contracted after he ceased to be a member. (iii) If it appears to the court that the present members will be able to satisfy the

contributions required to made by them. 2. In the second case, the present members shall be liable to the extent of the amount

remaining unpaid on the shares in case of a Company limited by shares. In case of a Company limited by guarantee, to the amount undertaken to be contributed by him to the assets of the Company.



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Winding-Up by Tribunal (Cases in which companies may be wound up by the Tribunal) Circumstances in which company may be wound up by Tribunal (Section 433) Question 4 XYZ Co. Limited has its subsidiary company PRM Ltd, which is formed to carry out some of the objectives of XYZ Co. Limited. XYZ Ltd suspends one of its several businesses, by passing a resolution at the company‘s extraordinary general meeting, with effect from Ist January 2006. The business so suspended continues to be suspended until March 2006. On Ist April 2006, a group of shareholders of XYX Ltd file a petition in the court for winding of the company on the ground of suspension of business by the company.

Referring to the provisions of the Companies Act, 1956, decide:

(1) Whether the shareholders’ contention shall be tenable?

(2) What would be your answer in case XYZ Ltd suspends all its business?

(3) Can shareholders of PRM Ltd. File a petition in the court for winding up of their company (PRM Ltd) on the ground that the holding company viz., XYZ Ltd has suspended its entire business, though PRM Ltd. has not suspended business?

Answer The problem relates to suspension of business by a company. Section 433 provides that if a company does not commence its business within a year from its incorporation or suspends its business for a whole year, it may be wound up by the court .The contention of the shareholders of XYX Ltd that the company is liable to be wound up in the ground so suspensions so business, is not tenable for the following reasons: (a) A company may be wound up by court if a company suspends its business for a whole

year. Here the business was suspended only on 1. 1.97 . Hence on 1st April, 1997 the business has not been suspended for the whole year to attract Section 433(c)

(b) Where a company having much business discontinues on of them, it cannot be said to have suspended business within the meaning of Section 433(c).

(c) Where a company ceases to do any business but is a holding company of subsidiaries engaged in the pursuit of the business, which it was previously doing, it cannot be said that the company has suspended its business (Ref; Eastern Telegraph Company Ltd).

Question 5 RM Limited went for a public issue of Equity Shares (Rs. 10 Crores) of Rs.10 each. The shares were subscribed to an extent of 95% of the total issue. The shares of the company were accepted for listing by Bombay Stock Exchange but subsequently the permission was



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cancelled on certain grounds. On an appeal to the Central Government by the company, the decision of the Stock Exchange was held to be valid. As a result, the application money had become refundable to the allottees. The company, had no prospects of doing any business and there was a complete deadlock among the Directors. Looking at the circumstances, certain creditors filed a petition in the court for winding up of the company on the ground that the company had become commercially insolvent. The shareholders of the company object to the petition of the creditors. Decide giving reasons :

(a) Whether the objections of the shareholders will sustain and the court can dismiss the petition of creditors for winding up of the company?

(b) State the provisions of the Companies Act, 1956 in this regard.

Answer (a) Commercial Insolvency of RM Ltd.: In this case three facts are given i.e.:

1. RM Limited went for a public issue and subsequently it was required to refund the amount received on application.

2. As a result, the company has no prospects of doing any business. 3. There was a complete dead lock among the directors.

These three circumstances may be construed as indicators of commercial insolvency of the company.

Section 433 (e) read together with Section 434 provides that a Court may order for winding up of a company if it is unable to pay its debts or deemed to be unable to pay its debts and it is proved to the satisfaction of the Court after taking into account all the liabilities including the contingent and prospective liabilities of the company. Moreover, Section 439 gives powers to the creditors for filing an application for its petition for winding up. There are no chances for the sustainment of shareholder’s objection. Deccan Farms & Distilleries Ltd. vs. Velabai Laxmidas Bhaiji (1979). The Court has got wide discretionary powers regarding winding up. It may or may not dismiss the petition of creditors for winding up. Even if a winding up petition is a proper remedy against a company which is unable to pay its debts, the Court may in its discretion refuse to put an end to the life of the company [Jugalkishore Banarsidas v. South India Saw Mills P. Ltd. (1975)].

(b) The Provisions of the Companies Act, 1956, which will apply in this case, are: (a) A company may be wound up by the Court, if the company is unable to pay its

debts. [Section 433(e)].



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(b) A company shall be deemed to be unable to pay its debts, if it is proved to the satisfaction of the Court that the company is unable to pay its debts, and in determining whether a company is unable to pay its debts, the Court shall take into account the contingent and prospective liabilities of the company. [Section 434 (c)].

(c) An application to the Court for the winding up of a company shall be by petition presented, subject to the provisions of this section, by any creditor or creditors, including any contingent or prospective creditor or creditors. [Section 439 (b)].

Question 6 Mr. X is an unsecured creditor and has to recover a sum of Rs. 7 lakhs from Global Footwear Company Limited. The said company has become financially insolvent and hence unable to pay its debts. With the object of recovery of the said amount Mr. X is willing to proceed for compulsory winding up of the company. Advise the steps and procedure in this relation under the provisions of the Companies Act, 1956 (CA, Final, New Course, May, 2010) Answer Procedure in case of Compulsory Winding-Up: Mr. X has to take the following steps to put the company into compulsory winding up: 1. A petitions for winding up of the company is to be filed in the high court, where the

registered office of the company is located under section 439(I)(b) read with section 433(e) and (f) of the Companies Act, 1956. A copy of the petition should be served on the company.

2. The petition should be filled along with an affidavit showing sufficient ground for the appointment of a provisional liquidator till an order is passed by the High Court appointing an official liquidator (Rule 106 of the Companies (Court) Rules 1959).

3. After obtaining the winding up order from the high court the same should be advertised within 14 days in a newspaper in English language and in the regional language of the state where the company is registered (Rule 113 of the Companies (Court) Rules, 1959).

4. A certified copy of the winding up order passed by the court should be filed with the concerned Registrar of companies along with the prescribed fees within 30 days from the date of the winding upto order (Section 445(i)).

5. The winding up proceedings will be carried out by the official liquidator till dissolution of the company.

Petition for winding up Provisions as to applications for winding up (Section 530) Question 7 High Value Builder Ltd. is financially insolvent and is unable to pay its debts. Mr. X an unsecured creditor has to recover a sum of Rs.5 lakhs from the company. Advise Mr. X about the steps and



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the procedure to be followed to put the company into compulsory winding up, as an alternative for the recovery of his dues. (May 2009) Answer Mr. X has to take the following steps to put High Value Builders Ltd. into compulsory winding up: (i) A petition for winding up of the company is to be filed in the High Court where the

registered office of the company is located under Section 439(1) (b) read with Section 433(e) and (f) of the Companies Act, 1956. A copy of the petition should also be served on the company.

(ii) The petition should be filed along with an affidavit showing sufficient ground for the appointment of a provisional liquidator till an order is passed by the High Court appointing an official liquidator..

(iii) After obtaining the winding up order from the High Court the same should be advertised within 14 days in a newspaper in English language and in the regional language of the state where the company is registered.

(iv) A Certified copy of the winding up order passed by the court should by filed with the concerned Registrar of Companies along with the prescribed fees within 30 days from the date of the winding up order.

(v) If the shares of the company are listed in a stock exchange, copy of the petition along with the order may be filed with the stock exchange concerned.

(vi) The winding up proceedings will be carried out by the official liquidator till dissolution of the company.

Winding Up by Tribunal Official Liquidators (Section 448 – 463) Question 8 A listed Public Company was ordered to be wound up by the order of the Bombay High Court. While ordering the winding up, the Court ordered the Official Liquidator to submit a preliminary report to the Court as per the provisions contained in the Companies Act. State briefly the details to be given in the preliminary report of the Official Liquidator. (November, 2001) Answer As soon as the winding up order is received by the official Liquidator, a preliminary report is required to be submitted to the court. This report should be submitted as soon as the Liquidator receives the Statement of Affairs from the persons who were directors of the company at the time of winding up. There is a time limit of six months within which the official Liquidator is required to submit his preliminary report to the court.



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The preliminary report should contain the following details:

(i) The amount of capital issued, subscribed and paid up.

(ii) The estimated amount of assets and liabilities giving separately (a) cash and negotiable securities; (b) debts due from contributories; (c) debts due to the company and securities, if any, available in respect thereof; (d) moveable and immovable properties belonging to the company; (e) unpaid calls.

(iii) If the company has failed, the causes of the failure. (iv) The opinion of the Liquidator as to whether any further enquiry is desirable as to any

matter relating to promotion, formation or failure of the company or the conduct of the business thereof.

The Official Liquidator has also the power to make a further report if in his opinion the company was formed with a view to commit a fraud or a fraud has been committed in respect of any matter which in his opinion is desirable to bring to the notice of the court. Voluntary Winding-Up Declaration of Solvency Declaration of solvency in case of proposal to wind up voluntarily (Section 488) Question 9 The Directors of M/s HIJ Company Ltd. desire to proceed for voluntary winding up of the company and hence they are required to File ‘Declaration of Solvency’. Your advice is sought about the procedure to be followed for the said purpose. (November, 2002) Answer Declaration of Solvency Chapter III of part VII of the Companies Act, 1956 deals with "Voluntary winding up" of companies and in this relation section 488 of the said Act provides for filing of "declaration of solvency" on the part of the directors of the company when there is proposal for voluntary winding up of the company. The analysis of Section 488 of the Companies Act, 1956 discloses that a declaration of solvency contains the following features - 1. It is declaration duly supported by an affidavit, verified by a competent authority. 2. The declaration is made by the directors or where there are more than two directors, by

the majority of the directors. 3. A meeting of Board of Directors is required for the purpose.



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4. There is recital on the part of the Directors that they have made full inquiry into the affairs of the company and

5. That they have formed opinion that the company has no debts or that if it will be able to pay its debt in full within a period not exceeding three years from the date of commencement of winding up as may be specified in the said declaration.

In order that the above declaration in valid, it should be made within five weeks immediately preceding the date of passing the resolution for winding up of the company and must be delivered to the Registrar before that date. Further, the said declaration should be accompanied by a copy of the auditors report on the profit and loss account of the company for the period commencing from the date of the last audited accounts upto a date practicable immediately before the date of the declaration and a balance sheet on the last mentioned date and also a statement of company's assets and liabilities as on the date of the declaration made out in accordance with the requirements laid down by clause (2) of section 488 of the Companies Act, 1956. A false declaration of a solvency makes the directors, liable under clause (3) and (4) of section 488 of the Companies Act, 1956.

Provisions applicable to a members’ voluntary winding up (Section 489 – 498)

Question 10

What are the steps to be taken for up in a case, where the company is solvent, but the business for which it was formed has been completed. (November, 2000)

Answer

In this case the company is proposed to be wound up as the business for which it was formed has been complied. As the company is solvent, the voluntary winding up can be member’s voluntary winding up and for this purpose the following steps is to be taken:

(1) All the directors or atleast majority of directors have to make declaration at the meeting of Board of Directors that they have made full enquiry into the affairs of the company and they are of the opinion that the company has no debts at all or it will be able to pay all its debts within three years from the date of commencement of winding up proceedings [section 488(1) Companies Act, 1956]. Such declaration should be made within five weeks preceding the date of general meeting where winding up petition is proposed to be passed.

(2) The declaration should be filed with Registrar of Companies before the date of general meeting. The declaration should be accompanied by report of auditors of the company giving profit and loss account for the period commencing from date upto which last accounts were prepared and ending with latest practicable date before the making of declaration. A balance sheet on that date should also be prepared. [Section 488(2)].



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(3) Next, the company has to pass at its general meeting a resolution called ‘resolution for voluntary winding up’. Ordinary resolution will do in this case, if the articles provide that the company is to be dissolved on completion of the business (section 484). Otherwise, special resolution is required.

(4) At this meeting or any meeting subsequent thereto, one or more liquidators are to be appointed and their remuneration should be fixed. (Section 490).

(5) After the resolution is passed, company must give notice of such resolution by advertisement within 14 days in Official Gazette and also in some newspaper circulating in the District where the registered office is situated. (Section 485).

(6) Under section 494, the company has to give notice of appointment of the liquidator to the Registrar of Companies.

(7) The voluntary winding up commences at the time when the resolution for voluntary winding up is passed. (Section 486).

Official Liquidators Audit of liquidators’ accounts (Section 462) Question 11

The High Court at Mumbai appointed the Official Liquidator as the Liquidator of Imprudent Engineering Company Ltd. Some of the creditors have brought to the notice of the Liquidator that though the company is in liquidation for the past several years, nothing worthwhile has been done to speed up the winding up and no documents have been filed to indicate the progress of Liquidation. Examine in this connection the nature and periodicity of returns required to be field by the Liquidator in terms of the provisions contained in the Companies Act. (May, 2001) Answer According to Section 462(1) of the Companies Act, 1956 read with Rule 298 of the companies (Court) Rules the Official Liquidator is required to fill the accounts of M/s Imprudent Engineering Company Ltd., with the Court twice a year, one made upto 31st March and the second upto 30th September, within 3 months of closing the accounts. The accounts should be drawn up in Form No. 144 of the Rules. Further according to Rule 302, the accounts should be audited by a Chartered Accountant appointed by the Court or if the Court so directs by the Examiner of the Local Fund Accounts of the State concerned. A copy of the accounts so filed by the Official Liquidator with the court is open to inspection by any creditor, contributory or any person interested. Where the winding up is not concluded within one year after commencement, the official liquidator is required within 2 months after the expiry of the year and thereafter until the winding up is concluded, once every year to file his statement in the prescribed form No. 148 (Rule 311) in Court. A copy thereof shall also be filed with the Registrar (Rule 511).



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Provisions applicable to every voluntary winding up Arrangement when binding on company and creditors (Section 517) Question 12 Reckless Constructions Ltd. has gone into liquidation, because of the inability of the company to pay its debts. During the course of winding up a proposal was put forward by the previous management to revive the working of the company through a scheme of arrangement between the company and its creditors. As per the scheme, all the creditors have to forego fifty per cent of their dues. The company approaches you for advice. Discuss the steps that have to be taken by the company in this regard. (May, 2001) Answer As per the provisions contained in Section 517 of the Companies Act, 1956 M/s Reckless construction Ltd. can enter into a scheme of arrangement with the creditors, even though the company is in liquidation. According to the said section, the scheme of arrangement will be binding on the company and its creditors provided it has been approved by a special resolution of the company and agreed to by three fourths in number and value of the creditors. Any creditor or contributory may, however, within three weeks from the completion of the arrangement appeal to the court and the court may amend., vary, confirm or set aside the arrangement. The company should take the following steps in this regard: (i) to get the draft scheme of arrangement approved by the Board of Directors. (ii) to apply to the Court for directions to convene the meetings of the members/ creditors. (iii) to hold the general meeting and pass the required special resolution. (iv) to move the High Court for approval of the scheme. (v) on receipt of the court’s order, to file the certified copy of the order with the Registrar of

Companies. Question 13 Worthless Ltd. has gone into liquidation because of the inability of the company to ay its debts. During the course of winding up, a proposal was put forward by the previous management to receive the working of the company through a scheme of arrangement between the company and its creditors. As per the scheme, all the creditors have to forego fifty percent of their dues. Some of the creditors have voiced their opposition to the said scheme. The company approaches you for advice. State the steps that have to be taken by the company in this regard. (November 2007) Answer As per Section 517 (1) any arrangement entered into between a company about to be, or in the course of

being would up and its creditors shall, subject to the right to appeal under this section,



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be binding on the company and on the creditors if it is sanctioned by a special resolution of the company and acceded to by three-fourths in number and value of the creditors.

(2) any creditor or contributory may, within three weeks from the completion of the arrangement, appeal to the court (now Tribunal) against it and the (now tribunal) may thereupon, as it thinks just, amend, vary, confirm or set aside the arrangement.

Thus, the company may enter into a scheme of arrangement with the creditors by the procedure given below: The draft scheme of arrangement shall be considered and approved by the board of director. The company shall apply to the court for directions to convene the meetings of the members and creditors A general meeting of the company shall be held and the special resolution approving the scheme of arrangement shall be passed. A meeting of creditors shall be held whereat the scheme shall be agreed to by ¾ in number and value of the creditors. The company shall approach the court (Tribunal) for approval of the scheme. On receipt of the courts (Tribunal) order, the company shall file a certified copy of the courts (Tribunal) order with the registrar. Provisions applicable to every mode of winding up Proof and ranking of claims Question 14 The value of the security of a secured creditor of a company is Rs. 1,00,000. The total amount of the workmen’s dues is Rs. 1,00,000. The amount of the debts due from the company to its secured creditors is Rs. 3,00,000. The aggregate of the amount of workmen’s dues and of the amounts of debts due to secured creditors is Rs. 4,00,000.

With reference to the provisions of the Companies Act, 1956, what is the workmen’s portion of the security?

If the liquidator incurs Rs. 10,000 for the preservation of the security before it is realised by the secured creditor, what is the portion of Rs. 10,000 that should be borne by the secured creditors?

Answer (i) The workmen portion of the security is therefore 1/4th of the value of the security, i.e.

25,000, [Sub-section (3) added to Section 529 by the Companies (Amendment) Act, 1985].



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(ii) If he liquidators incur Rs. 10,000 for the preservation It is equal to the following equation:

Whole of expenses – Whole of expenses ×security the of Valueportion s' Workmen

= Rs. 10,000 × 000,00,1

000,25000,10 ×

= Rs. 10,000 – 2,500 = Rs. 7,500. This is the amount to be borne by the secured creditors. Overriding preferential payments (Section 529A) Question 15

OGC Ltd. was a supplier of Raw Materials to SAM Ltd.,which could not make payment to OGC Ltd. owing to huge losses and financial constraints. Ultimately, SAM Ltd, went into liquidation and Official Liquidator was appointed. OGC Ltd. filed a suit for recovery of its dues. The Court awarded a decree in favour of OGC Ltd. Armed with the Court’s decree, OGC Ltd. approached the Official Liquidator to pay the amount to it in preference over dues of the workmen. The workmen protested the demand of OGC Ltd. and contended that their dues rank pari passu with the Secured Creditors and will override all other claims of other creditors even where a decree has been passed.

You are required to ascertain the validity of the argument of the workmen in the light of the provisions of the Companies Act, 1956 and the decide cases on the subject. (May 2008) Answer The problem given in the question is covered by the provisions of Section 529A of Companies Act, 1956 read with Sections 529 and 530 of the said Act. The effect of combined reading of these sections is that the workmen of the company become secured creditors by operation of law to the extent of the workmen’s dues and are entitled to proportional payment along with other secured creditors. If there is no secured creditor then the workmen of the company become unsecured preferential creditors under the said Section 529A to the extent of workmen’s dues. The purpose of the said section 529A is to ensure that the workmen should not be deprived of their legitimate claims on the event of the liquidation of the company and the assets of the company would remain charged for the payment of workmen’s dues and such charge will be pari passu with the charge of other secured creditors. There is no other statutory provision overriding the claim of the secured creditors except the said Section 529A. Thus under the said Section 529A, the dues of the workmen and debt due to the secured creditors are to be treated pari passu and have to be treated as prior to all other dues. Thus, the law is very much clear in this respect and the Hon’ble Supreme Court of India held



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in the case of UCO Bank [(1994) 81 Comp. Case 780] that the provisions of Section 529A of the Companies Act, 1956 will override all other claims of the creditors even where a decree has been passed by a court. In view of the above stated legal position, the contention of the workmen of SAM Ltd. is valid and the Official Liquidator will have to pay their dues as provided in Section 529A of the Act. Preferential Payments (Section 530) Question 16 MIs XYZ Limited is being wound up by the Court. The official liquidator after realisation of the assets has an amount of Rs. 56,00,000 at his disposal towards payment of creditors of the company. Details of creditors are as under:

Rs. (i) Dues to secured creditors 40,00,000 (ii) Dues to workers 30,00,000 (iii) Taxes and duties payable to Government authorities 4,00,000 (iv) Unsecured creditors 80,00,000 Since the available amount is insufficient to meet the claims of all the creditors, explain the procedure to be followed for payment of dues as provided in the Companies Act, 1956, assuming that the company has created a charge on all the assets of the company in favour of the secured creditors. Answer Section 530 of the Companies Act, 1956 lays down the procedure for payment of debts out of available funds with the Official Liquidator. However, Section 529A provides for overriding of the preferential payments as mentioned in Section 530. According to Section 529A, not withstanding anything contained in other provisions of this Act or any other law for the time being in force, in the winding up of a company , (a) workmen’s dues; and (b) debts due to secured creditors, shall be paid in priority to all other debts. The above debts have to be paid in full unless the assets are insufficient to meet them, in which case they shall abate in equal proportions. In this light of the legal provisions explained, the funds available with the Official Liquidator are not even sufficient to meet fully the dues payable to secured creditors and workers. Thus, tax dues to the tune of Rs.4,00,000 payable to Government authorities will not get any payment even though they are to be considered as preferential payments as per section 530 of the Act. The secured creditors dues and workmen dues will get abated equally and they get Rs. 32 lakhs and Rs.24 lakhs respectively. The other creditors will get nothing.



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Question 17 Mars India Limited, a company incorporated under the Companies Act, 1956 is being wound

up by the court. After realization of the assets of the company, the official liquidator has an amount or Rs. 70,00,000 at his disposal towards payment of creditors of the said company. The details of creditors are as follows:

(i) Unsecured creditors 50,00,000

(ii) Taxes and duties payable to Government 5,00,000

(iii) Dues to workers 30,00,000

(iv) Dues to secured creditors 40,00,000

The available amount with the liquidator, obviously, is not sufficient to meet the claims of all the creditors. Moreover, the company had already created a charge on all the assets of the company in favour of the secured creditors. Explain the procedure to be followed by the liquidator for payment of dues as provided in the Companies Act, 1956. (November 2008) Answer WINDING UP (PAYMENT OF CREDITORS): Section 530 of the Companies Act, 1956 lays down the procedure for payment of debts out of available funds with the official liquidator. However Section 529A of the said Act provides for overriding of the preferential payments as mentioned in Section 530. According to Section 529A of the Companies Act, 1956 notwithstanding anything contained in other provisions of this Act or any other law for the time being in force, in the winding up of a company – (1) Workmen’s dues and (2) debts due to secured creditors, shall be paid in priority to all other debts. Further these debts have to be paid in full unless the assets are insufficient to meet them, in which case they shall abate in equal proportion. In the light of the above mentioned provisions, the funds available with the official liquidator are not sufficient to meet fully the dues payable to all the creditors. Thus, tax dues to the tune of Rs. 5,00,000 payable to government authorities will not get any payment even though they are to be considered as preferential payments as per Section 530 of the Act. Thus the secured creditors will get Rs. 40,00,000 and the remaining amount of Rs. 30,00,000 shall be paid towards workers dues. The other creditors will get nothing. Effect of winding up on antecedent and other transactions Fraudulent preference (Section 531) Question 18 M/s. Info-tech Overtrading Ltd. was ordered to be wound up compulsory by an order dated 15th October, 2007 of the Delhi High Court. The official liquidator who has taken control for the assets and other records of the company has noticed the following:



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(i) The Managing Director of the company has sold certain properties belonging to the company to a private company in which his son was interested causing loss to the company to the extent of Rs. 50 lakhs. The sale took place on 0th May, 2007.

(ii) The company created a floating charge on 1st January, 2007 in favour of a private bank for the overdraft facility to the extent of Rs. 5 crores, by hypothecating the current assets viz., stocks and book debts.

Examine what action the official liquidator can take in this matter. Having regard to the provisions of the Companies Act, 1956. (November 2007)

Answer

The official liquidator can invoke the provisions contained in Section 531 of the companies Act, 1956 to recover the sale of assets of the company. According to Section 581, any transfer of property, movable or immovable made within 6 months before the commencement of winding up will be deemed to be a fraudulent preference and hence invalid in the eyes of laws. Since in the present case, the sale of immovable property took place on 10th May, 2007 and the company went into liquidation on 15th October, 2007 i.e., within 6 months before the winding up of the company and since the sale has resulted in a loss of Rs. 50 lakhs to the company. The official liquidator will be able to succeed in proving the case under Section 531 by way of fraudulent preference as the property was sold to a private company in which the son of the ex-managing was interested.

According to Section 534 of the Companies Act, any floating charge created within 12 months of the commencement of the winding up will be treated s invalid unless it is proved that the company immediately after the creation of charge was solvent. In the present case it may be difficult for the Bank, the charge holder to prove that the company was solvent after the creation of the floating charge. The charge holder i.e., the Bank is however, entitled to recover from the company. The amount advanced along with 5% interest. Further preferential debts under Section 530 will have priority over debts secured by a floating charge. The official liquidated may thus prove that the floating charge created by the company is invalid.

Effect of winding up on antecedent and other transactions

Effect of floating charge (Section 534)

Question 19

A Company created a floating charge of its Current Assets in favour of a Bank to secure a Current Account, which was in debit of Rs.5 lakhs and also to secure further Working Capital facilities provided by the bank. The charge created on 1st January, 2003 was duly registered with the registrar of Companies. The bank advanced Rs.10 lakhs subsequent to the creation of charge. The company has gone into voluntary liquidation pursuant to a resolution passed on 1st September, 2003. Examine the validity of the floating charge in case it is a creditors’



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voluntary winding up, but there is no fraudulent preference. Would your answer be different, if it was a member’s voluntary winding up? (May, 2004)

Answer Effect of floating charge in Winding-up Section 534 of the Companies Act, 1956 deals with effect of floating charge. Where a company is being wound up, a floating charge created on the assets of the company within 12 months prior to the commencement of winding up will be valid only to the extent of money advanced at the time of creating charge or subsequent to creating charge, plus interest at 5% or such other rate notified by the Central Government in this behalf. In other words, floating charge created for pre-existing debt will be invalid. This section does not, however, affect companies which can prove that after the creating of the floating charge, they were in quiet solvent condition. The voluntary winding up commences at the time when the resolution for voluntary winding up is passed by the company (Section 486). Members’ voluntary winding up is permissible only when the company is solvent and declaration of solvency is made (Section 488). If declaration of solvency is not made, the winding up would be termed as creditors’ voluntary winding up. In this case, the floating charge was created within 12 months preceding the commencement of winding up and hence the provisions of Section 534 are attracted. In the question, there is no fraudulent preference and hence it is not necessary to examine the applicability of Section 531. In the case of creditors’ voluntary winding up, the company cannot be considered as solvent. In view of the position explained above the floating charge is valid only to the extent of advances made subsequent to the creation of charge i.e. Rs.10 lakhs plus interest at 5%. In the case of members’ voluntary winding up, the position is different. As the company is solvent, the floating charge is valid for the entire debt of Rs.15 lakhs including the pre-existing debt of Rs.5 lakh (at the time of creation of charge). Offences antecedent to or in course of winding up Power if Tribunal to assess damages against delinquent directors etc (Section 543) Question 20 The official liquidator of ABC Limited (in liquidation) instituted misfeasance proceedings under section 543 of the Companies Act, 1956 against ‘A’, a director of the company in liquidation. During the pendancy of misfeasance proceedings ‘A’ died.

What is meant by Misfeasance? Is it possible for the official liquidator to impede the legal representatives or ‘A’ and continue the proceeding against them? (November 2006)



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Answer Misfeasance The term ‘misfeasance’ has not been defined in the Companies Act, 1956. It can be considered as an act or omission in the nature of breach of trust in relation to the company which causes losses or injuring to the company. Although loss to the company has not been expressely stated in Section 543 nevertheless such ‘loss’ has to be implied in case of misapplication or retainer. Only such an act of misfeasance as results in the loss to the company will fall within the ambit of section 543. As regards the second question (ii) in case of death of the directors, the Supreme Court held that the proceedings commenced against the delinquent director of a company liquidation under section 543 can be continued after his death against his legal representatives and the amount declared to be due in such misfeasance proceeding can be realized from the estate of the deceased on the hands of his legal representatives. The Court further held that the legal representatives would not, however, be liable for any sum beyond the value of the estate of the deceased in their hands (Official Liquidator, Supreme Bank Ltd. V.P.A. Tendolkar (1973) 43 Comp. (Case 382) (Official Liquidator vs. Parthasarthy Sinha (1983) 53. Comp. Case (SC) (3c)). Hence the misfeasance proceeding can be continued against the legal representatives of A. Question 21 M/s Raman Ltd. was wound up by the Court. The official liquidator invited claims from its creditors which stood as under:

Income tax dues Rs.11 lakhs

Sales tax dues Rs. 5 lakhs

Dues of workers Rs.25 lakhs

Unsecured loans payable to directors Rs.25 lakhs

Trade creditors who supplied raw material Rs.15 lakhs

Secured creditor being the bankers of the company Rs.75 lakhs

Rs. 156 lakhs

Official Liquidator could realize only Rs.80 lakhs by sale of assets and realizations made from the company’s debtors, which is not sufficient to pay to all the creditors. Please decide the order of priority for payment to creditors explaining the relevant provisions of the Companies Act, 1956.

Answer Under section 529A of the Companies Act, 1956, (i) workmen’s dues, and (ii) debts due to secured creditor shall be paid in priority of all debts, and shall be paid in full, unless the assets are



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insufficient to meet them, in which case they shall abate in equal proportions. Income tax dues and sales tax dues are preferential creditors under section 530 of the Act, and subject to the provisions of section 529A, the same may be paid in priority to the claims of unsecured creditors. In the present case, the available funds are only to the extent of Rs.80 lakhs which will be distributed amongst the secured creditor and workmen in proportion to their dues, as follows: Workmen

(1/4th of Rs.80 lakhs) : Rs.20 lakhs Secured creditor

(3/4th of Rs.80 lakhs) : Rs. 60 lakhs As such, the dues of preferential creditors (namely, Income tax and sales tax dues) and unsecured creditors (unsecured loan and trade debtors) cannot be paid any amount. Provisions as to dissolution (Section 560) Question 22 Ganesh Textiles Private Limited has discontinued its Business since 2006. Negligible assets are available with the company, but also some liabilities. The company has been regular in filing Annual Returns and Balance Sheets. The Director of the Company proposes to apply to the Registrar of Companies for striking the name of the company on the ground that it is a defunct company. Advise, as to what steps can be taken to get the name of the company struck off under the provisions of the Companies Act, 1956. (CA Final, New Course, May 2010) Answer Striking off defunct company: In the given case Ganesh Textiles Private Ltd. is required to follow the established procedure to enable the Registrar to remove the name of the company under Section 560 of the Companies Act, 1956. For this purpose, an application accompanied with the following documents be submitted to the Registrar of Companies – 1. An affidavit of at least two directors including that of the Managing Director or whole time

Director to the effect that the company has no assets or liabilities as on date and the company has not been carrying on any business during the last one year or more.

2. Latest audited balance sheet and profit and loss account of the company. 3. An indemnity bond from the aforesaid directors to the effect that the liabilities of the

company if any will be met by them even after the name of the company is struck off. In view of the above, Ganesh Textiles Private Limited must first take steps to realize all the assets and pay all the liabilities and make it nil. Thereafter the company may apply to the Registrar of Companies along with “nil” balance sheet, affidavit and indemnity bond. After making necessary inquiry, the Registrar will publish notice in the official Gazette that the name of the company has



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been struck off. Under Section 560(5) of the said Act, the company shall stand dissolved from the date of publication of notice in the Official Gazette. Question 23 Super Chemicals Private Limited has discontinued its business since 1992. Its entire capital has been lost. It has some liabilities, but negligible assets. The company has been regular in filing annual Returns and Balance Sheets. The Directors propose to apply to the Registrar of Companies for striking the name of the company under Section 560 of the Companies Act, 1956 on the ground that it is a defunct company.

State the circumstances under which the name of the company can be struck off under Section 560 of the Act and the steps to be taken by the Directors of the Company to get the name of the company struck off. (November, 2003)

Answer

Striking off defunct company

Where the Registrar of companies has reasonable cause to believe that a company is not carrying on business or in operation, he shall send to the company by post a letter inquiring whether the company is carrying on business or in operation (Section 560(1). If no reply is received from the company within one month, Registrar will send another letter to the company by registered post [Section 560(2)].

If the Registrar either receives an answer from the company to the effect that it is not carrying on business or in operation or does not receive any reply from the company after second letter, the Registrar will publish a notice in official Gazette that the name of the company will be struck off and company dissolved, unless cause is shown to the contrary within 3 months from the date of notice. [Section 560(2) and (3)].

If no reply is received or no cause is shown within 3 months, Registrar will publish notice in Official Gazette that the company's name has been struck off. Company shall stand dissolved from the date of publication of Official Gazette [Section 560(5)].

This power can be exercised by Registrar even in the case of company being wound up, if he has reasons to believe that no liquidator is acting or the company is completely wound up or any returns required to be made to Registrar have not been made for 6 months [Section 560(4)].

Hence a defunct company can be struck off from the Register of Companies by the Registrar by following the procedure laid down in Section 560.

However, the company in this case, which is admittedly not carrying on any business since 1992 must follow the procedure laid down by Department's Circular No. 9/7/83-CL III dated 17.2.1987 to enable the Registrar of Companies to remove the name of the company under Section 560.



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The company should make an application to the Registrar accompanied by the following documents: (1) An affidavit of at least 2 directors including that of the managing director or whole time

director to the effect that the company has no assets or liabilities as on date and the company has not been carrying on any business during the last one year or more.

(2) Latest audited balance sheet and profit and loss account of the company. (3) An indemnity bond from the aforesaid directors to the effect that the liabilities of the

company, if any will be met by them even after the name of the company is struck off from the Register under Section 560.

The Department of Company Affairs simplified the procedure for removal of defunct companies vide Circular letter No. 17/78/2001-CLV dated 25.3.2003. This simplified procedure was in operation till 30.09.2005. But the essential condition that the assets and liabilities of the company should be zero must be fulfilled [Dept's Clarification No. 17/78/2001 - CLV dated 17.4.2003]. Hence the company must first take steps to realise all the assets and pay all the liabilities and make it 'Nil'. Thereafter, the company may apply to Registrar of Companies along with 'Nil' balance sheet, affidavit and indemnity bond.


CHAPTER 25

PRODUCER COMPANIES (SECTIONS 581A – 581ZT)

Appointment of Directors (Section 581P) Question 1 XYZ Producer Company Limited was incorporated on 1st April, 2003. At present it has got 200 members and its board consists of 10 Directors. The Board of Directors of the company seeks your advice on the following proposals:

(i) Appointment of one expert Director and one Additional Director by the Board for a period of four years.

(ii) Loan of Rs.10,000 to Mr. X, a Director of the company repayable within a period of six months.

(iii) Donation of Rs.10,000 to a Political Party.

Advise the Board of Directors explaining the relevant provisions of the Companies Act, 1956. (May, 2004)

Answer Producer Company Appointment of expert director or additional director: Section 581P(6), Companies Act, 1956 empowers the Board of Directors of a producer company to cooperate one or more expert directors or an additional director not exceeding one fifth of the total number of directors for such period as the Board may deem of it. But the maximum period shall not exceed the period specified in the Articles of the company (Proviso 2 to Section 581P(6). The number of directors proposed to be co-opted is only 2 and it does not exceed one-fifth of the total number of directors. They can hold office for the period specified by the Board provided it does not exceed the period specified in the Articles (Section 260 stipulating that the additional director can hold office only upto the date of the next annual general meeting is not applicable to a producer company). Hence the proposed appointment of one expert director and one additional director is in order. Loan to a director: Section 581ZK empowers the Board of Directors to provide financial assistance to the members of the producer company subject to the provisions made in articles



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and also subject to certain conditions laid down in 581ZK(b). But any loan or advance to any director or his relative shall be granted only after the approval by the members in general meeting. (Proviso to Section 581ZK). In view of the above, the directors must convene the general meeting and get the approval of the members before granting the proposed loan of Rs.10,000 to X, a director of the company (According to Section 581C(5)a producer company is a private limited company and there is no limit to the number of its members. Hence, Section 295 is not applicable to a producer company).

Donation to a Political Party: Producer company shall not make directly or indirectly to any political party or for any political purpose to any person any contribution or subscription or make available any facilities including personnel or material (Second proviso to Section 581ZK). As the donation to a political party is prohibited, the company cannot donate Rs.10,000 to a political party.

Option to inter-State cooperative societies to become producer companies (Section 581J)

Question 2

(i) The existing Inter-state Cooperative Society seeks your advice regarding the papers to be submitted to the Registrar of Companies for its registration as a Producer Company under the provisions of the Companies Act, 1956. You are required to prepare a list of such papers.

(ii) A group of individuals eligible to form a Producer Company within the meaning of the Companies Act, 1956 has entrusted you with the job of preparing the Memorandum of Association of the proposed Producer Company. You are required to state the matters, which are required to be included in such Memorandum of Association. (November 2005)

Answer

(i) As per Section 581J of the Companies Act, 1956, any Inter-State Co-operative Society with objects not confined to one State may make an application to the Registrar of Companies for registration as Producer Company.

The application for registration as a producer Company is to be submitted along with the following:

(a) a copy of the special resolution, of not less than two-third of total members of Inter-State Co-operative Society, for its incorporation as a Producer Company under the Companies Act:


Producer Companies (Sections 581A – 581ZT)

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(b) a statement showing:

(i) Names and addresses or the occupation of the directors and Chief Executive, if any, by whatever name called, of such inter-State Co-operative Society, and

(ii) list of members of such Inter-State Co-operative Society;

(c) a statement indicating that the Inter-State Co-operative Society is engaged in any one or more of the objects specified in Section 581B of the Companies Act, 1956;

(d) a declaration by two or more directors of the Inter-state co-operative society certifying that particulars given in the above statements are correct.

(ii) As per Section 581F of the Companies Act, 1956, the Memorandum of Association of a Producer Company has to state the following: (a) the name of the company with “Producer Company Limited” as the last words of

the name of such Company; (b) the State in which the registered office of the Producer Company is to situate; (c) the main objects of the Producer Company confirming to the objects specified in

Section 581B of the Companies Act, 1956; (d) the names and addresses of the persons who have subscribed to the

memorandum of Association; (e) the amount of share capital with which the Producer Company is to be registered

and division thereof into shares of a fixed amount; (f) the names, addresses and occupations of the subscribers being producers, who

shall act as the first directors in accordance with section 581J(2) of the Companies Act, 1956;

(g) that the liability of its members is limited; (h) opposite to the subscriber’s name the number of shares each subscriber takes

(Each subscriber must take at least one share); (i) in case the objects of the Producer Company are not confined to one State, the

States to whose territories the objects extend. Number of Directors (Section 581O) Question 3 (i) An Interstate Cooperative Society has been incorporated on 1st May, 2004 as a

Producer Company under the provisions of the Companies Act, 1956. Give your



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comments on its proposal to have 18 directors on its Board after incorporation as a Producer Company.

(ii) A Producer Company wants to issue bonus shares. You are required to state the relevant provisions of the Companies Act, 1956 in this regard.

(iii) What are the modes of investment, from and out of its general reserves, available to a Producer Company formed and registered under Section 581C of the Companies Act, 1956? (November, 2004)

Answer

(i) As per provisions of section 581-O of the Companies Act, 1956, any Producer Company can not have more than fifteen directors. However, by way of a proviso, the said section further provides that in the case of an inter-State co-operative society which is incorporated as a Producer Company, may have more than fifteen directors for a period of one year from the date of its incorporation as a Producer Company.

In view of the above provisions of the Companies Act, 1956 the proposal to have 18 directors by the Producer Company after its incorporation as such, is a valid proposition, but since it is incorporated on 1st May, 2004, it can have more than 15 directors for one year only from the date of its incorporation

(ii) As per provisions of section 581ZJ of the Companies act 1956, any Producer Company may, upon recommendation of the Board and passing of resolution in the general meeting, issue bonus shares by capitalisation of amounts from general reserves referred to in section 581ZI in proportion to the shares held by the Members on the date of the issue of such shares.

(iii) As per Producer Companies (General Reserves) Rules. 2003 issued by the Department of Company Affairs, Ministry of Finance, Government of India on 7th August, 2003 a producer company formed and registered under section 581C of the Companies Act, 1956, shall make investments from and out of its general reserves in the following manner, namely:-

(a) in approved securities, fixed deposits, units and bonds issued by the Central or State Governments or cooperative societies or scheduled bank; or

(b) in a co-operative bank, state co-operative bank, co-operative land development bank or central co-operative bank; or

(c) with any other scheduled bank; or

(d) in any of the securities specified in section 20 of the Indian Trusts Act, 1882; or

(e) in the shares or securities of any other multi-state co-operative society or any co-operative society; or



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(f) in the shares, securities or assets of a public financial institutions specified under section 4A of the Companies Act, 1956.

Donation or subscription to Producer Companies (Section 581 ZH)

Question 4

(i) A two year old Producer Company registered under Section 581C of the Companies Act, 1956 wants to donate some amount. The Chief Executive of the Producer Company has approached you to advise him as to how and for what purposes the donation can be made by such company. Also state the monetary restrictions, if any, laid down in the Companies Act, 1956 on making donations by a Producer Company. You are informed that as per the Profit & Loss account of the Producer Company for its last accounting year, net profit was Rs.20.00 lacs.

(ii) Is it obligatory for every producer company to appoint a whole time secretary under the provisions of the Companies Act, 1956? (May, 2005)

Answer

(i) As per provisions of section 581 ZH of the Companies Act, 1956, a Producer Company may, by special resolution, make donation or subscription to any institution or individual for the following purposes:-

(a) For promoting the social and economic welfare of Producer Members or Producers or general public; or

(b) For promoting the mutual assistance principles. Thus as per the above stated provisions of the Companies Act, 1956, a Producer

Company may make a donation by passing a special resolution and for the above mentioned purposes.

The 1st Proviso to the said section 581ZH lays down the monetary limit for making the donation by a Producer Company. According to the said proviso the aggregate amount of all such donation and subscription in any financial year shall not exceed three per cent of the net profit of the Producer Company in the financial year immediately preceding the financial year in which the donation or subscription was made.

Since the net profit of the Producer Company as per its last profit & loss account was Rs.20.00 lacs, it can make a total donation of Rs.60,000/- in this year being three percent thereof.

(ii) Under section 581X of the Companies Act, 1956 every Producer Company having an average turnover exceeding Rs.5 crores in each of three consecutive financial years shall have a whole time secretary who is a member of ICSI.



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Incorporation of Producer Companies and other matters (Section 581B to 581N) Option to inter-State co-operative societies to become Producer Companies (Section 581J) Question 5 The Executive Committee of an Inter-state Co-operative society decides to convert the society into a ‘Producer Company’ under the provisions of the Companies Act, 1956. You being a practicing Chartered Accountant are approached by the society for advice. Advise the society on the following matters:

(i) The steps to be taken for conversion of the society into a ‘Producer Company’.

(ii) Manner in which voting rights of members of Producer company after conversion may be exercised. (May 2006)

Answer Conversion of inter state cooperative society into producer company steps to be taken and manner in which voting rights of members after conversion to be exercised. [Section 581J and 581D The Companies (Amendment) Act, 2002.] As a practicing Chartered Accountant the following advise can be given to the inter-state society which wants to get converted into a ‘Producer company’ under the provisions of Companies (Amendment) Act, 2002. 1. Steps to be taken for conversion (Section 58IJ): Any inter-state cooperative society having objects for multiplicity for states may make

an application to the Registrar for registration as producer company. Such application should be accompanied by – (a) A copy of the special resolution, of not less than 2/3rd of total member of Inter-

State Cooperative Society, for its incorporation as a producer company. (b) A Statement showing : (i) names and address or the occupation of the directors

and Chief Executive, if any, by whatever name called, of such inter-state cooperative society; and (ii) list of members of such inter-state cooperative society.

(c) A statement indicating that the inter-state cooperative society is engaged in any one or more of the objects specified in Section 581B.

(d) A declaration by two or more directors of the inter-state cooperative society certifying that particulars given in clauses (a) to (c) given above are correct.



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The word “Producer Company Ltd.” should form part of its name to show its identity. On compliance with the requirements of the Act, the Registrar shall, within a period of 30 days of the receipt of application, certify under his hand that the society applying for registration is registered and thereby incorporated as a producer company.

Upon registration as a producer company, the Registrar of Companies who registers the company is required to intimate the Registrar with whom the erstwhile inter-State cooperative society was earlier registered for appropriate deletion of the society from its register.

2. Manner in which voting rights of members can be exercised (Section 581Z): Section 581Z of the Companies Act, 1956 states that subject to the provisions of sub-

sections (1) and (3) of Section 581D, every member shall have one vote and in the case of equality of votes, the chairman or the person presiding shall have a casting vote except in the case of election of the chairman. As regards the voting rights it may be noted that: 1. Where individual is a member of the producer company, he has one vote

irrespective of the size of his holding. 2. Where both individuals and producer institutions are members – single vote for

every member. 3. Where membership is confined to producer institutions only, in the first year of

registration of the company, the voting rights shall be based on the size of the shareholding of the member institution and in the following years it will be based on participation by the respective institutions in the business of the producer company in the previous year (as may be specified in the Articles),

4. A producer company, may, if authorized by the Articles, restrict the voting rights to active members of the producer company, and

5. Casting vote can be cast by the presiding member (Chairman) in case of equality of votes on any resolution (except for election of the Chairman).

Appointment of Directors (Section 581P) Question 6

Mr. Z an expert in modern agriculture practices is willing to lend his services as a director of M/s. Lord Krishna Cotton Producer Company Ltd. registered under Section 581C of the Companies Act, 1956. Advise Mr. Z as to how he can be appointed as a director including (1) The total number of directors that can be appointed (2) The tenure of the directors (3) The time limit within which the appointment should be made (4) the co-option of directors and (5) the voting powers of such co-opted directors (November 2007)



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Answer According to Section 581P of the Companies Act, 1956 the members who sign the memorandum and the articles and designated as first directors and shall given the affairs of the company until the directors are appointed at the Annual General Meeting. According to Section 581-0 every producer company shall have at least five and not more than fifteen directors. The election of directors shall be conducted within 90 days from the date of registration of the producer company. In the case of Inter-state co-operative society the election shall be held within a period of 360 days. The period of office of director shall be not less than one year and not exceeding 5 years as may be specified in the articles. The directors are normally elected and appointed by the members in the Annual General Meeting. The Board may also co-opt one or more expert directors as an additional directors. Such directors cannot exceed 1/5th of the total number of directors. The expert directors shall not have the right to vote in the election of Chairman but shall be eligible to be elected as Chairman if it is provided by the articles. The maximum period for which such experts are appointed as directors will be as provided in the articles of association and it cannot exceed 5 years. Thus Mr. Z can be appointed as expert director but he will not have any voting right in the election of chairman of the Board of Directors. Him tenure of office can be between one to five years. Question 7 (i) An inter-state co-operative society has been incorporated on 1st May, 2008 as a

Producer Company under the provisions of the Companies Act,, 1956. Give your comments on its proposal to have 18 directors on its Board after incorporation as a Producer Company.

(ii) Mr. Zameen, a member of a Producer Company, wants to transfer his shares. You are required to state as to how he can transfer his shares under the provisions of the Companies Act, 1956.

(iii) A Producer Company wants to issue bonus shares. You are required to state the relevant provisions of the Companies Act, 1956 in this regard.

(iv) What are the modes of investment, from and out of its general reserves, available to a Producer Company formed and registered under Section 581C of the Companies Act, 1956? (May 2008)

Answer (i) As per provisions of Section 581-O of the Companies Act, 1956, any producer

Company can not have more than fifteen directors. However, by way of a proviso, the said section further provides that in the case of an inter-state cooperative society which is incorporated as a Producer Company, may have more than fifteen directors for a period of one year from the date of its incorporation as a Producer Company.



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In view of the above provisions of the Companies Act, 1956 the proposal to have 18 directors by the Producer Company after its incorporation as such, is a valid proposition, but since it is incorporated on 1st May, 2008, it can have more than 15 directors for one year only from the date of its incorporation.

(ii) According to the provisions of Section 581ZD(1) and (2) of the Companies Act, 1956, the shares of a member of a Producer Company shall not be transferable but a member of a Producer Company may after obtaining the previous approval of the Board, transfer the whole or part of his shares along with any special rights, to an active member at par value.

Based on the above provisions relating to the transfer of shares of a member in a Producer Company, Mr. Zameen has to obtain prior approval of the Board and then transfer his shares to an active member of the Producer Company at par value.

(iii) As per provisions of Section 581ZJ of the Companies Act, 1956, any Producer Company may, upon recommendation of the Board and passing of resolution in the general meeting, issue bonus shares by capitalization of amounts from general reserves referred to in Section 581ZI in proportion to the shares held by the Members on the date of the issue of such shares.

(iv) As per Producer Companies (General Reserves) Rules, 2003 issued by the Department of Company Affairs, Ministry of Finance, Government of India on 7th August, 2003, a producer company formed and registered under Section 581C of the Companies Act, 1956, shall make investments from and out of its general reserves in the following manner namely: (a) in approved securities, fixed deposits, units and bonds issued by the Central or

State governments of cooperative societies or scheduled banks; or (b) in a co-operative bank, State co-operative Bank, co-operative land development

bank or Central co-operative bank; or (c) with any other schedule bank; or (d) in any of the securities specified in Section 20 of the Indian Trusts Act, 1882; or (e) in the shares or securities of any other multi-State Co-operative society or any

co-operative society; or (f) in the shares, securities or assets of a public financial institutions specified

under Section 4A of the Companies Act, 1956 specified. Further, Section 581ZL of the Act provides that the general reserves of any producer

company shall be invested to secure the highest returns available from approved securities. A producer company may, for promotion of its objectives acquire the shares



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of another producer company. Again a producer company, either by itself or together with its subsidiaries may invest in the shares of any other company, other than a producer company for an amount not exceeding thirty per cent of the aggregate of its paid up capital and free reserves. Provided that a producer company may, by special resolution passed in its general meeting and with prior approval of the Central Government, invest in excess of the limits specified in the section. All investments by a producer company may be made if such investments are consistent with the objects of the producer company.

Question 8 A Producer Company wants to issue bonus shares. You are required to state the relevant provisions of the Companies Act, 1956 in this regard (CA Final, New Course, May 2009) Answer As per provisions of Section 581ZJ of the Companies Act, 1956, any Producer Company may, upon recommendation of the Board and passing of resolution in the general meeting, issue bonus shares by capitalization of amounts from general reserves referred to in Section 581ZI in proportion to the shares held by the Members on the date of the issue of such shares. Question 9 A Producer Company has received applications from Mr.Ramanathan, a Director of the Company, and Mr.Prem, a member of the Company, for grant of loan of Rs.2,00,000 and Rs.25,000 respectively. Discuss the relevant provision of the Companies Act, 1956 as to how the applications for grant of loan will be disposed of by the Company. (November 2009) Answer Under Section 581ZK of the Companies Act, 1956, the Board of the Producer Company may, subject to the provision in the Articles of Association, provide financial assistance by way of loan and advances against such security as may be specified in its Articles of Association to any member repayable within a period exceeding three months but not exceeding seven years from the date of disbursement of such loan or advances. In the instant case, member has applied for loan of Rs.25.000. The period is not specified in the question. The Company may grant the member a loan of Rs.25,000 against such security and at such rate of interest as may be specified in the Articles. However, in the case of a director, loan of Rs.2 lakh can be granted only after its approval by the members in general meetin


CHAPTER 26

COMPANIES INCORPORATED OUTSIDE INDIA (SECTIONS 591–608)

Provisions as to establishment of places of business in India Applications of sections 592 to 602 to foreign companies (Section 591) Question 1 Examine with reference to the provisions of the Companies Act, 1956 whether the following companies can be treated as foreign companies:

(i) A company incorporated outside India having a share registration office at Mumbai.

(ii) Indian citizens incorporated a company in Singapore for the purpose of carrying on business there. (May, 2003)

Answer “Foreign company” as per Section 591 of the Companies Act 1956, means a company incorporated outside India but having a place of business in India. Accordingly, to qualify as ‘foreign company’ a company must have both the following features: (a) it should be a company incorporated outside India; and (b) it should have a place of business in India. As to what amount to having a place of business in India, Section 602 (e) provides that the expression ‘place of business’ includes a share transfer or share registration office. Thus a company incorporated outside India having a share registration office at Mumbai is a foreign company. But, the company incorporated in Singapore for the purpose of carrying on business in Singapore is not a foreign Company. Its incorporation by Indian citizen is immaterial. In order to be a foreign company it has to have a place of business in India. Question 2 (i) As per provisions of the Companies Act, 1956, what is the status of XYZ Ltd., a

Company incorporated in London, U.K., which has a Share Transfer Office at Mumbai?

(ii) ABC Ltd., a foreign company having its Indian principal place of business at Kolkata, West Bengal is required to deliver various documents to Registrar of Companies under



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the provisions of the Companies Act, 1956. You are required to state, where the said company should deliver such documents.

(iii) In case, a foreign company does not deliver its documents to the Registrar of Companies as required under Section 597 of the Companies Act, 1956, state the penalty prescribed under the said Act, which can be levied. (November, 2004)

Answer (i) According to section 591 of the Companies Act, 1956, a company incorporated outside

India and having a place of business in India is treated as a "Foreign Company". As per clause (c) of section 602 of the said Act, the expression 'place of business' includes a Share Transfer office. Thus, according to the provisions of the Companies Act, 1956, the status of XYZ Ltd. incorporated in London, U.K., which has a Share Transfer office in Mumbai, shall be that of a 'Foreign Company'.

According to section 597 of the Companies Act, 1956, any document which a foreign company is required to deliver to the Registrar of Companies shall be delivered to the Registrar having jurisdiction over New Delhi and also to the Registrar of the State in which the principal place of business of the foreign company is situate.

In light of the above provisions of the Companies Act, 1956, ABC Ltd. is required to deliver the requisite documents to the Registrar of Companies having jurisdiction over New Delhi and also to the Registrar of Companies, West Bengal.

Section 598 of the Companies Act, 1956 prescribes the penalty for non-compliance of the provisions of section 597 of the said Act. According to the provisions of the said section 598, the foreign company and its every officer or agent, who is in default, shall be punishable with a fine upto Rs.10,000/- and in case of continuing offence, additional fine upto Rs.1,000/- per day for the period during which the default continues.

Question 3 M/s Joel Ltd. was incorporated in London with a paid up capital of 10 million pounds. Mr. Y an

Indian citizen holds 25% of the paid up capital. M/s. X Ltd. a company registered in India holds 30% of the paid up capital of Joel ltd. M/s. Joel Ltd. has recently established a share transfer office at New Delhi. The company seeks your advice as to what formalities it should observe as a foreign company under Companies Act, 1956. State briefly the requirements relating to filing of accounts with the Registrar of Companies by the foreign company in respect of its global business as well as Indian business. (November 2007) Answer As per section 591 companies falling under the following two classes shall be known as foreign companies namely:


Companies Incorporated Outside India

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(i) companies incorporated outside India which, after the commencement of this act, establish a place of business within India, and

(ii) companies incorporated outside India which have, before the commencement of this act, established a place of business within India and continue to have an established place of business within India at the commencement of this act.

(2) notwithstanding anything contained in sub-section (1), where not less than fifty percent of the paid up share capital (whether equity or preference or partly equity and partly preference) of a company incorporated outside Indian and having an established place of business in India, is held by one or more citizens of Indian or by one or more bodies corporate incorporated in India, or by one or more citizens of Indian and one or more bodies corporate incorporated in India, whether singly or in the aggregate, such company shall comply with such of the provisions of this act as may be prescribed with regard to the business carried on by it in India, as if it were a company incorporated in India. Here as more than 50% of the paid-up capital is held by Indian citizen and Indian company M/s Joel Ltd. shall be treated as Indian company. It shall have to comply with such provision of the act as may be prescribed as if it were a company incorporated in India. Jeet Ltd. has to submit the following document with the registrar of companies with 30 days of establishment of business in India. (a) a certified copy of the charter, statues, or memorandum and articles, of the company or

other instrument constituting or defining the constitution of the company; and, if the instrument is not in the English language, a certified translation thereof.

(b) the full address of the registered or principal office of the company; (c) a list of the directors and secretary of the company, containing the particulars

mentioned in sub-section (2). (d) the name and address or the names and addresses of the some one or more persons

resident in India, authorized to accept on behalf of the company service of process and any notices or other documents required to be served on the company; and

(e) the full address of the office of the company in India which is t be deemed its principal place of business in India.

Question 4 Ashes Ltd is a company incorporated outside India. 50% of its preference share capital and

20% of its equity share capital is held by companies incorporated in India. It issued prospectus inviting subscriptions in India for its shares but did not state the country in which it is incorporated.



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Examine

(i) Is the prospectus of the company valid?

(ii) What is none of the shares (preference and equity) were held by Companies Incorporated in India?

(iii) What other disclosures and required to be made by a Foreign Company?

(November 2008) Answer Section 591(2) of the Companies Act, 1956, provides that where not less than fifty per cent of the paid up share capital (whether equity or preference or partly equity and partly preference) of a company incorporated outside India and having an established place of business in India, is held by one or more citizens of India or by one or more bodies corporate incorporated in India, or by one or more citizens of India and one or more bodies corporate incorporated in India, whether singly or in the aggregate, such company shall comply with such of the provisions of this Act as may be prescribed with regard to the business carried on by it in India, as if it were a company incorporated in India. (i) As 50% of the preference share capital and 20% of the equity share capital of Ashes

Ltd. is held by companies incorporated in India, it shall be treated as if it were a company incorporated in India. As such it is not necessary for Ashes Ltd. to comply with the provisions relating to foreign companies. So the prospectus of the company shall be valid.

(ii) If none of the shares (preference and equity) were held by companies incorporated in India, Ashes Ltd. would be a foreign company within the meaning of Section 591 of the Act. Section 595 of the Act provides that every foreign company shall in every prospectus inviting subscriptions in India for its shares or debentures, state the country in which the company in incorporated. As Ashes Ltd. did not mention the name of the country in which it is incorporated, the prospectus shall not be valid.

(iii) Section 595 of the Act provides for the following additional disclosures to be made by a foreign company: (a) conspicuously exhibit on the outside of every office or place where it carries on

business in India, the name of the company and the country in which it is incorporated, in letters easily legible in English characters, and also in the characters of the language or one of the languages in general use in the locality in which the office or place is situated;

(b) cause the name of the company and of the country in which the company is incorporated, to be stated in legible English characters in all business letters, bill



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heads and letter paper, and in all notices, and other official publications of the company; and

(c) If the liability of the members of the company is limited, cause notice of the fact- ● to be stated in every such prospectus as aforesaid and in all business

letters, bill heads, letter paper, notices, advertisements and other official publications of the company, in legible English characters; and

● to be conspicuously exhibited on the outside of every office or place where it carries on business in India, in legible English characters and also in legible characters of the languages or one of the language in general use in the locality in which the office or place is situated.

Documents, etc to be delivered to Registrar by for eign companies carrying on business in India (Section 592) Question 5 A company incorporated in Singapore has established its place of business at Chennai. State the documents which are required to be furnished on such establishment of business in India under the Companies Act, 1956 and the authorities to whom such documents are to be furnished. (CA Final, New Course, May, 2009) Answer Foreign Company: A foreign company has to furnish to the Registrar of Companies the following documents within 30 days of the establishment of the place of business in India (Section 592 of the Companies Act, 1956). (i) Certified copy of charter, statute or memorandum and articles of the company or other

instruments deferring the constitution of the company. If it is not in English Language its certified translation should be submitted.

(ii) Full address of the registered or principal office of the company. (iii) List of directors and Secretary giving details like present and former name and

surname, his usual residential address, nationality, business occupation etc. (iv) The names and address of one or more persons resident in India authorized to accept

on behalf of the company, service of process and any notices or other documents required to be served on the company.

(v) The full address of the office of the company in India which is deemed to be its principal place of business in India.

The aforesaid documents shall be required to be filed at two places first with the Registrar of the state where principal place of business (Chennai) is situated i.e. Registrar of Tamil Nadu in this case and second with the Registrar of New Delhi (Section 597).



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Misscellaneous Question 6 Considering the provisions of the Companies Act, 1956, advise a foreign company on filing of World Accounts’ and the ‘Indian Business Accounts’ with the Registrar of Companies in India? Answer Filing of World Accounts and Indian Business Accounts with the Registrar of Companies: World Accounts: Three copies of balance-sheet and profit and loss account, including documents relating to every subsidiary of the foreign company, in such form, containing such particulars and including such documents as required under the provisions of the Companies Act, 1956, are required to be filed with the Registrar of Companies. However, the Central Govt., may exempt any foreign company from this requirement by notification in the official gazette. The World accounts shall be delivered to the Registrars within a period of 9 months from the close of the financial year of the foreign company. The Registrar at New Delhi may extend the said period by 3 months, vide Rule ISA of Companies (Central Government’s) General Rules and Forms, 1957. Indian Business Accounts: Three copies of balance-sheet and profit and loss accounts of Indian business accounts of a foreign company duly audited by a practising Chartered Accountant in India, in the form prescribed in Schedule VI (as modified in terms of Notification, dated 4-10-1957 and 6-1-1959) shall be filed with the Registrar within 9 months of the close of the financial year. The Registrar at New Delhi may extend this period by 3 months. The accounts shall be audited by such person and in such manner as provided in Section 226 and 227 (as modified in terms of the notifications cited above). The aforesaid accounts have to be filed with the Principal Registrar (i.e., Registrar of Companies, New Delhi) and the concerned Registrar having jurisdiction over the principal place of business of the foreign company (Section 597). It may be pointed out that the Indian accounts have to be drawn up in Indian rupees as per the requirements of Schedule VI. The profit and loss account of the Indian business in respect of a foreign company which, if not incorporated under this Act would be deemed to be a private company, shall not be open for inspection by any person other than a member of the company. Section 594 provides for the requirements of accounts of foreign company. As per this section (1) Every foreign company shall, in every calendar year –

(a) make out a balance sheet and profit and loss account I such form containing such particulars and including or having annexed or attached thereto such documents (including, in particular documents relating to every subsidiary of the foreign company) as under the provisions of this act it would, if it had been a



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company within the meaning of this act, have been required to make out land lay before the company in general meeting; and

(b) deliver three copies of those documents to the registrar; Provided that the Central Government may, by notification in the official gazette, direct

that, in the case of any foreign company or class of foreign companies the requirements of clause (a) shall not apply, or shall apply subject to such exceptions and modifications as may be specified in the notification.

(2) If any such document as is mentioned in sub-section (1) is not in the English language, there shall be annexed to it a certified translation thereof.

(3) Every foreign company shall send to the registrar with the documents required to be delivered to him under sub-section (1), three copies of a list in the prescribed form of all places of business established by the company in India as at the date with reference to which the balance sheet referred to in sub-section (1) is made out.

Prospectuses Dating of prospectus and particulars to be contained therein (Section 603) Question 7 Under Section 603 of the Companies Act, 1956, what are particulars required for incorporating a prospectus to be issued by an existing foreign company? Answer Under Section 603, (Companies Act, 1956), the prospectus to be issued by an existing or intended Foreign Company in India must be dated and contain the following particulars:

(a) the instrument constituting or defining the constitution of the company; (b) the enactment’s or provisions under which the company was incorporated; (c) the address of the place in India where the said instrument, enactments etc.

translation thereof in English if they are in some other foreign language, can be inspected;

(d) the date on which and the country in which the company was incorporated; and (e) whether there is a place of business in India and if so, the address of its

principal office. The provision contained in (a), (b) and (c) above, shall not be applicable if the prospectus is issued more than 2 years after the company had become entitled to commence business. The prospectus of Foreign Company must contain the matters laid down in Part-I of the Schedule II and set out the report specified in Part II of the Schedule subject always to the provisions of Part-III of the Schedule.


CHAPTER 27

LEGAL PROCEEDINGS (SECTIONS 632 – 635AA)

Power of Court to grant relief in certain cases (Section 633) Question 1 Gulmohar Ltd., a company registered under Indian law owns a factory’ in Calcutta, wherein it manufactures jute products. By a notification of the State Government, issued during October, 2002, due to a strike and lock-out, it was declared a relief undertaking. After four months, in February, 2003, the lock-out was lifted. However, during the said period the company’s directors defaulted in payment of Provident Fund (PF) and other ancillary dues. During the month of December, 2002, the Regional PF Commissioner initiated criminal proceedings against the company and its directors under the Employees PF and Miscellaneous Provisions Act, 1952, for default and delay in payment of PF dues.

Immediately the directors of the company applied to the High Court for relief under Section 633 of the Companies Act, 1956, praying for relief from liable under the PF law. 77th petition is now pending before a single judge. The company desire to know from you, as to the tenability of their claim for relief at the High Court, and as to whether they would be excused and exonerated by the High Court, in respect of the contraventions committed under the PF law.

Briefly discuss the law on the subject and state whether the petition filed by the directors would be admitted or not under the Companies Act.

Answer The crux of the matter involved in the above case, is whether the words “any proceeding” against an officer of a company, would mean only a proceeding under the Companies Act or any Criminal proceeding under any other law. The provisions of the Companies Act, define “officer” and “officer in default” but there is no definition for the word “proceeding”. In the present case, the proceeding has not resulted from or has not been brought about as a consequence of default, refusal, contravention, non-compliance or failure under the Companies Act, 1956, but has come about as a result of certain acts and omissions committed by the directors of the company Gulmohar Ltd., under the Employees PF and Misc. Provisions Act, 1952. The Court has powers under Section 633 to grant relief only to a director/officer of a company, and not to the company. But the significance of the words “in any proceeding” employed in Section 633(1) require to be understood.



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The facts of the case, bear resemblance to those which came up before their Lordships of the Supreme court in Rabindra Chamaria and Others Vs Registrar of Companies, West Bengal and others, 1992 (73) Comp. Cas. 257 (SC). Going by the tenor of section 633 of the Companies Act, 1956 and the Supreme Court ruling the directors of Gulmohar Ltd., cannot avail of relief under Section 633 of the Companies Act, 1956 and their Petition is not likely to succeed. It is liable to be dismissed.


CHAPTER 28

APPLICATION OF SECRETARIAL PROCEDURES AND PRACTICES

Question 1 Explain the procedure for passing the resolution by Circulation under Section 289 of the Companies Act, 1956. (November, 2000) Answer The procedure for passing resolution by circulation as under section 269 of the Companies Act, 1956 are as follows: (a) Circulate the draft of the resolution in duplicate with all necessary papers if any, to all

the directors then in India not being less in number than the quorum for a board meeting and to all other directors at their usual addresses in India for approval by signing one copy of the resolution and send it back to the company.

(b) If all are majority of the above directors as are entitled to vote on the resolution approve the resolution, the resolution shall deemed to have been duly passed by the Board.

(c) Record the resolution having been passed by circulation in the minutes of the immediate next Board meeting.

(d) See that the resolution do not pertain to the matters which cannot be passed by the Board by circulation (i.e. Sections 262(1), 292, 297, 299, 307 etc.

(e) Enclose a copy of the circular resolution to the Agenda of the ensuing immediately next Board meeting.

Question 2 Under Section 603 of the Companies Act, 1956, what are the particulars required for incorporating in a prospectus to be issued by an exiting Foreign Company? (November 2000) Answer Under Section 603, Companies Act, 1956, the prospectus to be issued by an existing or intended Foreign Company in India must be dated and contain the following particulars: (a) the instrument constituting or defining the constitution of the company; (b) the enactment’s or provisions under which the company was incorporated;



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(c) the address of the place in India where the said instrument, enactments etc translation thereof in English if they are in some other Foreign language, can be inspected;

(d) the date on which and the country in which the company was incorporated; and (e) whether there is a place of business in India and if so, the address of its principal office. The provision contained in (a), (b) and (c) above, shall not be applicable if the prospectus is issued more than 2 years after the company had become entitled to commence business. The prospectus of Foreign company must contain the matters laid down in specified in part-II of the schedule subject always to the provisions of Part-III of the schedule. Question 3 Explain briefly the salient points to be taken into account while drafting the minutes of the Board of Directors. Draft a specimen Board resolution regarding the appointment of Mr. Sincere as the Managing Director of Full Cure Pharma Ltd. (May, 2001) Answer While drafting the minutes of the Board of directors, the following points have to be kept in mind. (i) The minutes may be drafted in a tabular form or in the form of a series of paragraphs

numbered consecutively and with relevant headings. (ii) The place, date and time of the meeting should be stated. (iii) The names of the persons present at the meeting should be stated. (iv) Contents of the meeting giving serial number of the minute, brief subject heading, full

terms of the resolutions adopted including the statistical details etc. (v) Names of directors dissenting or not concurring with any resolution passed. (vi) Reference about interested directors abstaining from voting is necessary. (vii) Chairman’s signature and date of verification of minutes as correct. Specimen board resolution: “Resolved that Shri Sincere who fulfills the conditions specified in Parts I and II of schedule XIII to the Companies Act, 1956 be and is hereby appointed as the Managing Director of the company for a period of 5 years effective from 1.4.2001 and that he may be paid remuneration by way of salary, commission and perquisites in accordance with Part II of Schedule XIII of the Act.

Resolved further that the Secretary of the company be and is hereby directed to file the necessary returns with the Registrar of Companies and to do all acts and things as may be necessary in this connection.”


Application of Secretarial Procedures And Practices

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Question 4 Some of the small shareholders of M/s Progressive Industries Ltd. approach you for advice regarding appointment of one of them as a director of the company. Explain the meaning of a small shareholder and the legal position regarding appointment of a director by such small shareholders. (November 2001) Answer According to Section 252 of the Companies Act, 1956 as amended, every public company having a paid up capital of Rs.5 cores or more and 1000 or more small shareholders may have a director elected by such small shareholders in the manner as may be prescribed. For this purpose, a small shareholder means a shareholder holding shares of nominal value of Rs.20,000 or less in a public company. If the paid up capital of M/s Progressive Industries Ltd., is more than Rs.5 crores and the Company has 1000 or more small share holders, then the small share holders can proceed to elect their nominee as a director. The appointment is to be made in accordance with Companies (Appointment of small shareholders-Director) Rules, 2001. Question 5 M/s A to Z Technologies Ltd. has been wound up and the official liquidator has been asked to take charge of the company. Briefly explain the relevant provisions regarding filing of statement of affairs in relation to the company in liquidation. (May, 2002) Answer According to section 454 of the Companies Act, 1956 where the Court has made a winding up order or the Official Liquidator has been appointed a provisional liquidator, a statement as regards the affairs of the company in the prescribed Form No. 57 shall be filed with the Official Liquidator. The said statement should be verified by an affidavit and contain particulars of (i) the assets of the company stating separately the cash balance in hand and at bank (ii) its debts and liabilities (ii) the details of creditors including their names, residence, occupations and amounts due to them as secured and unsecured (iv) the details of debtors including the particulars of securities and their values, the names and particulars of debtors (with estimated amount to be realised) and (v) such further or other information as may be prescribed or required by the Official Liquidator. The said statement is required to be verified by one or more directors at the time of passing the winding up order by the court. Further the said statement is required to be submitted within 21 days of the winding up order or within such extended time not exceeding three months as may be fixed by the Official Liquidator or the court for special reasons. Question 6 The Board Meeting of M/s ABC Company Ltd. was adjourned for want of Quorum. Advise the



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procedure now to be followed and also whether a resolution can be passed by circulation. If so, how? (November 2002) Answer Quorum and Resolution by circulation: For the conduct of business in the Board Meeting quorum is required. The Board Meeting of M/s. ABC Company Ltd. is adjourned for want of quorum. Section 288 of the Companies Act, 1956 provides the procedure when a Board Meeting is adjourned for want of quorum. Thus, under section 288 of the Act, following procedure is applicable: 1. If a Board Meeting could not be held for want of quorum, then, unless the articles

otherwise provide, the meeting shall automatically stand adjourned till the same day in the next week, at the same time and place, or if that day, is a public holiday, till the next succeeding day which is not a public holiday, at the same time and place.

2. The provisions of Section 285 shall not be deemed to have been contravened merely by reason of the fact that a meeting of the Board which had been called in compliance with the terms of that provision, could not be held for want of quorum.

When the question of passing resolution by circulation arises, the provisions of section 289 of the Companies Act, 1956 are applicable. For the passing of the circular resolution following conditions must be complied with: 1. The draft resolution, together with supporting papers has been circulated, to all the

directors or members of the committee of the board thereof, then in India, not being less in number than the quorum fixed for a meeting of the Board or Committee, as the case may be.

2. to all the directors of the Board or member of the committee who are not in India, at their usual address in India, and

3. the same has been approved by such of the directors then in India, or by a majority of them, who are entitled to vote on the resolution.

Question 7 Explain the circumstances under which a Director retiring at an annual general meeting shall be deemed to have been re-appointed even though no such appointment has been made.

(May, 2003) Answer Section 256 of the Companies Act, 1956 deals with deemed re-appointment of a retiring director. The vacancies caused by the retirement of a director by rotation should be filled up at the same meeting or at an adjourned meeting. If it is not so done, the retiring director shall be deemed to have been re-appointed at such adjourned meeting except in the following cases:-



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1. at any previous meeting, a resolution for his re-appointment was put to vote but was lost, or

2. the retiring director has, in writing expressed his unwillingness to continue or 3. he is not qualified or is disqualified for appointment, or 4. a special or ordinary resolution is necessary for his appointment by virtue of any

provisions of the Companies Act; or 5. it is resolved to appoint two or more directors by a single resolution {Section 263(2)

Proviso]; or 6. it is resolved not to fill the vacancy. Question 8 Examine whether the following transactions are permissible under Foreign Exchange Management Act, 1999:

(i) Payment of remuneration to foreign technician.

(ii) Remittance of dividend to non-residents.

State also the procedure to be followed with regard to payment of dividend to non-residents. (November 2003)

Answer Foreign Technician: Salary payable to a foreign technician is a current account transaction. According to Section 5 of Foreign Exchange Management Act, 1999, any person can sell or draw foreign exchange to or from authorised person if such sale or drawal is a current account transaction and reasonable restrictions on current account transaction can be imposed by the Central Government in public interest, in consultation with RBI. Hence, basically all current account transactions are free, unless specifically restricted by the Central Government. Hiring of foreign nationals as technician is permissible without any restrictions. There is no ceiling on salary, which can be paid as per contract. Their salary can be remitted abroad, after tax deducted at source. Remittance of dividend: Since remittances of dividend on investment are current account transactions, these are permitted without restrictions, if the shares were issued as per guidelines/regulations/permission. Dividend is restricted only when permission for issue of shares to non-residents was granted with condition for dividend balancing. Procedure for remittance of dividend to non-residents: The procedure involved is briefly as follows: 1. Application in Form A2 - Application should be submitted in Form A2 to authorised

dealers. It should be accompanied by (a) List of non-resident shareholders (b) dividend



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to be remitted - the amount will be payable in Indian Rupees and payment will be made to payee in foreign exchange at current exchange rate.

2. Supporting documents: Application should be accompanied by copies of supporting documents to establish that the issue of shares was permissible as per regulations/specific approval was obtained as required. Copy of resolution in general meeting/Board meeting approving dividend/interim dividend should be submitted.

3. Certificates: Certificate from Chartered Accountant, practicing Company Secretary in respect of amount payable and details of calculation should be submitted. A certificate from Chartered Accountant that tax has been properly deducted at source should be submitted.

Remittance of dividend:- The dividend may be remitted through normal banking channels. If shareholder has issued instructions, the amount can be credited to NRE/FCNR account of NRI. Question 9 An existing society seeks your advice as to its eligibility to be registered as a 'Producer Company' under the Companies Act, 1956 and the procedure to be followed for such registration. Advise explaining the relevant provisions of the Companies Act, 1956.

(November 2003) Answer Producer Company: Any existing inter-state co-operative society with objects not confined to one State may make an application to the Registrar of Companies for registration as 'Producer Company under the Companies Act, 1956. The conversion is purely optional (Section 581J(1)]. 'Inter-State Co-operative Society' means a 'Multi-State Co-operative Society' within the meaning of Multi-State Co-operative Societies Act, 2002 and includes any co-operative society registered under any other law for the time being in force which has, subsequent to its formation, excluded any of its objects to more than one State by enlisting the participation of persons or by extending any of its activities outside the State, whether directly or indirectly through an institution of which it is a constituent [Section 581A(e)]. Hence a co-operative society registered under Multi-state Co-operative Societies Act, 2002 or any other State Act with objects not confined to one State may opt for conversion into a 'producer company' under Companies Act, 1956. The application to the Registrar of companies must be accompanied by the following:



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(1) A copy of the special resolution of not less than two-third of total members of inter-state co-operative society, for its incorporation as a producer company under the Companies Act.

(2) A statement showing the names and addresses or the occupation of the directors and Chief Executive.

(3) A statement showing the list of members. (4) A statement indicating that the Inter-State Co-operative Society is engaged in one or

more of the objectives specified in Section 581B. (5) A declaration by two or more directors of the Inter-State Co-operative Society

(certifying that the particulars given in the above statements are correct. [Section 581J(2)].

When an Inter-State Co-operative Society is registered as a 'producer company', the words 'Producer Company Limited' shall form part of its name with any word or expression to show its identity preceding it [Section 581J(3)]. On completion of all formalities, the Registrar of Companies shall register and incorporate such society to be a 'Producer Company' under Part IXA of the Companies Act, 1956 (Section 581J (4)]. Upon registration as a Producer Company, the Registrar of Companies shall forthwith intimate the Registrar with whom the erstwhile Inter-State Co-operative Society was earlier registered for appropriate deletion from its register [Section 581J(7)]. Question 10 Draft a resolution proposed to be passed at a General Meeting of a Public Company giving consent to the Board of Directors for borrowing upto a specified amount in excess of the limits laid down under Section 293(1)(d) of the Companies Act, 1956 and also state the borrowings, which are to be excluded from the said limits. (May, 2004) Answer Draft of ordinary resolution under Section 293(1)(d) Resolved that the company hereby consents to the Board of Directors borrowing monies not exceeding Rs……(Rupees………………..) in excess of the aggregate of the paid-up capital of the company and its free reserves, that is to say reserves not set apart for any specific purpose, as provided in Section 293(1)(d) of the Companies Act, 1956, and in addition to any temporary loans obtained from the company’s bankers in the ordinary course of business. Borrowings Section 293(1)(d) does not apply to the borrowing by a company by way of temporary loans



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obtained from the company’s bankers in the ordinary course of business. Therefore, in calculating the limits stipulated in this provision, temporary loans obtained from the company’s bankers in the ordinary course of business shall be excluded. The expression ‘temporary loans’ in i.e. (d) means loans repayable and demand or within six months from the date of the loan such as short term cash credit arrangements, the discounting of bills and the issue of other short terms loans of a seasonal character, but does not include loans raised for the purpose of financing expenditure of capital nature [Explanation II to Section 293(1)]. Question 11 ABC Engineering Limited proposes to invest Rs.20 lakhs in the Equity shares of PQR Trading Limited. The proposed investment together with the investments in securities of companies and loans to body corporates already made exceed 60 per cent of the paid-up share capital and also 100 per cent of free reserves of the company. The company has taken term loans from IDBI.

Explain the procedure to be followed by ABC Engineering Limited to give effect to the proposed investment. (May, 2004) Answer Investment in Shares: The proposed investment together with the investments, loans already made exceed 60% of the paid-up share capital of the company and also 100% of the free reserves. Hence, the proposed investment must be approved by a special resolution passed in a general meeting [Proviso to Section 372A (i)]. The Board of Directors must convene a general meeting for the purpose of passing a specific special resolution authorizing the proposed investment. The special resolution should specify: (a) The limit upto which Board is to be authorized to make investment; (b) Particulars of the body corporate in which the investment is proposed to be made; (c) The purpose of the proposed investment; (d) The source of funds to be invested; and (e) Other relevant details (3rd proviso to Section 372A(1). The special resolution passed at the general meeting will be filed with the Registrar of Companies. As the total amount of inter-corporate investments, loans, etc. exceeds 60% of the paid-up share capital prior approval of public financial institution i.e. IDBI must be taken [Section 372A(2)].



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Board meeting must be convened and the proposed investment must be sanctioned by a resolution passed with the consent of all the directors present at the Board meeting (Section 372A(2)]. The following particulars must be entered in the ‘Register of Investments, Loans, Guarantees and Securities pursuant to Section 372A: (a) Name of the body corporate on which the investment is made. (b) Amount invested. (c) Type and nature of securities in which investment is made. (d) Main terms of the issue of the securities. (e) The date on which the investment is made. Particulars must be entered in the register in respect of each investment chronologically within 7 days of the making of the investment. [Section 372A(5)]. The register must be kept at the registered office of the company. Any member of the company can inspect the register. [Section 372A(6)]. Question 12 Answer any one of the following:

(i) Board of Directors of DBM Limited held a board meeting on 2nd May, 2008 at its registered office. You are required to state the salient points to be taken into account while drafting the minutes of the said board meeting.

(ii) Draft a board resolution for appointment of Mr. Paul as the managing director for 5 years with effect from 1st June, 2008 of DBM Limited passed in the above stated board meeting. (May 2008)

Answer (i) While drafting the minutes of a board meeting following salient points should be kept in

mind: (a) the minutes may be drafted in a tabular form or they may be drafted in the form

of a series of paragraphs, numbered consecutively and with relevant headings. (b) the place, date and time of the meeting should be stated. (c) the minutes should contain the constitution of the meeting, i.e., persons present

and the capacity in which present, e.g. name of the person chairing the meeting, names of the directors and secretary, identifying them as director or secretary, names of persons in attendance like auditor, internal auditor etc. The minutes



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should also contain the subject of leave of absence granted, if any, to any of the board members.

(d) content of the meeting giving serial number of the minute, brief subject heading, full terms of the resolution adopted including the statistical details, if any.

(e) names of the directors dissenting or not concurring with any resolution passed at the board meeting.

(f) reference about interested directors abstaining from voting is also required to be stated in the minutes.

(g) Chairman’s signature and date of verification of minutes as correct. (ii) Resolution passed at the meeting of board of directors of DBM Limited held at its

registered office situated at ……………………… on 2nd May, 2008 at ………… AM. “RESOLVED that subject to the approval by the shareholders in a general meeting and pursuant to provisions of Sections 198, 309, 310, Schedule XIII and other applicable provisions of the Companies Act, 1956, Mr. Paul be and is hereby appointed as the Managing Director of the Company with effect from 1st June, 2008 for a period of five years on a remuneration approved by the Remuneration Committee as enumerated below: (1) Salary: Rs. ……………………… per month (2) Perquisites, Benefits and Facilities ……………………………. “RESOLVED FURTHER that Mr. Paul, so long as the functions as the Managing Director of the Company shall not be entitled to any sitting fee for attending any meeting of the board of directors or any committee thereof and that he shall not be liable to retire by rotation.” “RESOLVED FURTHER that Mr. Paul till he holds the office of Managing Director of the Company shall not become interested or concerned in any selling agency directly or through his wife or minor children in future without prior approval of the Central Government.” “RESOLVED FURTHER that Mr. Paul, the Chairman, as well as the Company shall have right to terminate the appointment by giving 3 (three) months’ notice in writing.” “RESOLVED FURTHER that the Secretary of the company be and is hereby directed and authorized to file necessary returns with the Registrar of Companies and to do all other necessary things required under the provisions of the Companies Act, 1956.” Question 13 Mr. Shrikant is working as Chief accountant in Black marbles Limited. The Board of Directors of the said company propose to charge him with the duty of ensuring compliance with the provisions of the Companies Act, 1956 so that books of account can be properly maintained and Balance sheet and Profit and loss Account can be prepared as per the provisions of law.



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Draft a “Board Resolution” for the said purpose.

Also point out the consequences in case of default, when such a resolution is passed. (June 2009)

Answer DRAFT BOARD RESOLUTION: “Resolved that pursuant to Sections 209 (7) and 211 (8) of the Companies Act,1956 Mr. Shrikant, Chief Accountant of the company be and is hereby charged with the duty of seeing that the requirements of Sections 209 and 211 of the Companies Act, 1956 are duly and fully complied with. Resolved further that Mr. Shrikant is hereby entrusted with the authority to do such acts, things and deeds as may be necessary or expedient for the purpose of compliance with the requirements of the said sections 209 and 211 of the said Act.” Consequences in case of default According to Section 209 (6) of the companies Act, 1956 the following persons are responsible to ensure that the company duly complies with the provisions of section 209: 1. The managing Director or manager of the company, if any; 2. All officers and other employees of the company or. 3. If the company has no managing director, every director of the company. Penalty for default is imprisonment up to six months or fine up to Rs.10,000/- if the persons mentioned above fail to take all reasonable steps to ensure that the provisions of Section 209 are duly complied with by the company or default has been committed by their own willful act. The punishment by way of imprisonment shall not be imposed unless the default was committed willfully [Section 209(5)]. In any penal proceedings, it shall be a defence to prove that a competent and reliable person was charged with the duty of seeing that these requirements are complied with and that he was in a position to discharge that duty. Thus, the above Board resolution makes the chief accountant responsible for compliance with the provisions of sections 209 and 211 of the Companies Act, 1956. Question 14 Draft a board resolution for appointment of Mr. Paul as the Managing Director for 5 years with effect from 1st July, 2009 of DBM Limited passed in the board meeting of the said company held on 6th June, 2009. (CA Final, New Course, June 2009)



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Answer Resolution passed at the meeting of Board of Directors of DBM Limited held at its registered office at ………………………………………. on 6th June, 2009 at ………………………… A.M. “Resolved that subject to the approval by the shareholders in a general meeting and pursuant to provisions of Sections 198, 309, 310, schedule XIII and other applicable provisions of the Companies Act, 1956, Mr. Paul be and is hereby appointed as the Managing Director of the Company with effect from 1st July, 2009 for a period of five years on a remuneration approved by the Remuneration committee as enumerated below: 1. Salary: Rs____________per month. 2. Perquistes, Benefits & Facilities: ……………….. Resolved Further that Mr. Paul, so long as he functions as the Managing Director of the Company, shall not be entitled to any sitting free for attending any meeting of the Board of Directors or any Committee thereof and that he shall not be liable to retire by rotation. Resolved Further that Mr. Paul, till he holds the office of Managing Director of the Company, shall not become interested or concerned in any selling agency directly or through his wife or minor children in future without prior approval of the Central Government. Resolved Further that Mr. Paul, the Chairman, as well as the company shall have right to terminate the appointment by giving 3 (three) months’ notice in writing. Resolved Further that the Secretary of the company be and is hereby directed and authorized to electronically file necessary returns with the Registrar of Companies by putting his digital signature and to do all other necessary things required under the provisions of the Companies Act, 1956” Question 15 Draft a board resolution for appointment of Mr. Paul as the Managing Director for 5 years with effect from 1st July, 2009 of DBM Limited passed in the board meeting of the said company held on 6th June, 2009. (CA Final, New Course, June 2009) Answer Resolution passed at the meeting of Board of Directors of DBM Limited held at its registered office at ………………………………………. on 6th June, 2009 at ………………………… A.M. “RESOLVED that subject to the approval by the shareholders in a general meeting and pursuant to provisions of Sections 198, 309, 310, schedule XIII and other applicable provisions of the Companies Act, 1956, Mr. Paul be and is hereby appointed as the Managing Director of the Company with effect from 1st July, 2009 for a period of five years on a remuneration approved by the Remuneration committee as enumerated below: 1. Salary: Rs____________per month.



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2. Perquistes, Benefits & Facilities: ……………….. RESOLVED FURTHER that Mr. Paul, so long as he functions as the Managing Director of the Company, shall not be entitled to any sitting free for attending any meeting of the Board of Directors or any Committee thereof and that he shall not be liable to retire by rotation. RESOLVED FURTHER that Mr. Paul, till he holds the office of Managing Director of the Company, shall not become interested or concerned in any selling agency directly or through his wife or minor children in future without prior approval of the Central Government. RESOLVED FURTHER that Mr. Paul, the Chairman, as well as the company shall have right to terminate the appointment by giving 3 (three) months’ notice in writing. RESOLVED FURTHER that the Secretary of the company be and is hereby directed and authorized to electronically file necessary returns with the Registrar of Companies by putting his digital signature and to do all other necessary things required under the provisions of the Companies Act, 1956.” Question 16 DVJ Limited decide to appoint Mr. A, as its Managing Director for a period of 5 years with effect from 1st May, 2010. A, fulfils all the conditions as specified in Part I and Part II of Schedule XIII of the Companies Act, 1956.

The terms of appointment are as under:

(i) Salary Rs. 1 lac per month.

(ii) Commission, as may be decided by the Board of Directors of the Company.

(iii) Perquisites :

Free Housing

Medical reimbursement upto Rs. 10,000 per month.

Leave Travel concession for the family.

Club Membership Fee.

Personal Accident Insurance Rs. 10 lacs.

Gratuity; and

Provident Fund as per company's policy.

You, being the Secretary of the company, are required to draft a resolution to give effect to the above, assuming that A is already the Managing Director of a public limited company. (May, 2010)



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Answer I. “Resolved that Mr. A who fullfills the conditions specified in Parts I and Part II of

Schedule XIII to the Companies Act, 1956 be and is hereby appointed as the Managing Director/Whole-time Director/Manager of the company for a period of five years effective from …….. and that he may be paid remuneration by way of salary, commission and perquisites in accordance with Part II of Schedule XIII of the Act, subject to approval of the Central Government.

Resolved further that in the event of loss or inadequacy of profits the salary payable to him shall be subject to the limits specified in Schedule XIII”.

II. “Resolved that Mr. A be and is hereby appointed as Managing Director/Whole-time Director/Manager of the company subject to the approval of the Central Government for a period of five years effective from …………. And that he may be paid remuneration as follows: (i) Salary (ii) Commission (iii) Perquisites: Housing, Medical reimbursement, Leave Travel Concession,

Club fee, Personal Accident Insurance, Gratuity, Provident Fund etc. Resolved further that the Secretary of the company be and is hereby authorized to make an application to the Central Government seeking their approval to the above appointment. Sd/ Board of Directors DVJ Ltd.


SECTION B


CHAPTER 1

THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992

UNIT I (Questions based on the SEBI Act, 1992)

Purpose of the Act & Establishment of SEBI Question 1 Explain briefly the purpose of establishing SEBI. (May 2002)

The purpose of the SEBI Act is to provide for the establishment of a Board called Securities and Exchange Board of India (SEBI). The Preamble to the Act provides for the establishment of a Board to: (i) Protect the interests of investors in securities, (ii) Promote the development of the securities market, (iii) To regulate the securities market, and (iv) For matters connected therewith or incidental thereto. The Securities and Exchange Board of India was set up to achieve the following objectives: (i) To promote fair dealings by the issuers of securities and ensure a market place where

they can raise funds at a relatively low cost. (ii) To provide' a degree of protection to the investors and safeguard their rights and

interests so that there is a steady flow of savings into the market. (iii) To regulate and develop a code of conduct and fair practices by intermediaries like brokers,

merchant bankers, etc., with a view to making them competitive and professional. Board to regulate or prohibit issue of prospectus, offer document or advertisement soliciting money for issue of securities – Section 11 Question 2 State the circumstances under which Securities and Exchange Board of India may prohibit a company from issuing prospectus, any offer document or advertisement soliciting money from public for issue of securities. (November, 2006)



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Point out the circumstances where under the following powers may be exercised by the Securities and Exchange Board of India:

(a) Prohibiting a company from issuing or publishing any document or advertisement soliciting money from public for issue of securities.

(b) Pass cease and desist order in relation to any listed company.

What remedies are available to the companies against such orders under the SEBI Act, 1992? (June, 2009) Answer Without prejudice to the provisions of the Companies Act, 1956, the Board may, for the protection of investors specify, by regulations (a) (i) the matters relating to issue of capital, transfer of securities and other matters

incidental thereto; and (ii) the manner in which such matters shall be disclosed by the companies; and

(b) by general or special orders (i) prohibit any company from issuing prospectus, any offer document, or advertisement soliciting money from the public for the issue of securities; (ii) specify the conditions subject to which the prospectus, such offer document or advertisement, if not prohibited, may be issued. The Board may specify the requirements for listing and transfer of securities and other matters incidental thereto. without prejudice to the provisions of section 21 of the Securities Contracts (Regulation) Act, 1956.

Seizure of records of a Stock Broker by SEBI Question 3 Explain briefly the powers of SEBI under Securities and Exchange Board of India Act, 1992 to seize the records of a Stock broker or other Intermediaries associated with Securities Market.

(May, 2004) Answer Section 11C was inserted by SEBI (Amendment) Act, 2002. Where SEBI has reasonable grounds to believe that (a) transactions in securities are being dealt with in a manner detrimental to the investors or securities market or (b) any intermediary or any person associated with securities has violated provisions of SEBI Act, rules, regulations or directions issued by SEBI, it can appoint an investigating Authority to investigate the affairs of such intermediary/person and report matter thereon to the Board [Section 11C (1)].


The Securities and Exchange Board of India Act, 1992

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If Investigating Authority is of the opinion that the records are likely to be destroyed or mutilated or secreted or altered, he can make application to Judicial Magistrate of First Class for an order of seizure of such books, registers, other documents and record [Section 11C(8). The Magistrate can authorize Investigating Authority to enter premises search and seize records. But Magistrate will authorize seizure of records of a listed company or company intending to be listed only if it is indulging in insider trading or market manipulation [11C (9)]. The seized records will be kept by Investigating Authority till conclusion of investigation and then return it to person concerned after placing identification marks on them [11C(10)]. Price Manipulation by brokers – Action by SEBI Question 4 SEBI received complaints from some investors alleging that ABC Ltd. And some brokers are indulging in price manipulation in the shares of ABC Ltd. Explain the powers that can be exercised by SEBI under the Securities and Exchange Board of India Act, 1992 in case the allegations are found to be correct. (May, 2006) Answer Price manipulation in the shares of ABC Ltd. can be considered as fraudulent and unfair trade practices relating to securities market. In this case SEBI may exercise the following powers under Section 11(4) of securities and Exchange Board of India Act, 1992. (i) Suspend the trading of any security (in this case the securities of ABC Ltd.) in a

recognized stock exchange. (ii) Restrain persons (in this case ABC Ltd.) from accessing the securities market. It can

also prohibit any person associated with securities market (i.e. brokers who have indulged in price manipulation) to buy, sale or deal in securities market.

SEBI may issue the above orders for reasons to be recorded in writing. SEBI shall, either before or after passing such orders give an opportunity of hearing to company and brokers concerned (proviso 2 to Section 11(4)) SEBI may also appoint an adjudicating officer who may levy penalty under Section 15 HA after holding an enquiry in the prescribed manner. According to Section 15HA if any person indulges in fraudulent and unfair trade practices relating to securities, he shall be leviable to a penalty of Rs. 25 crores or 3 times the amount of profits made out of such practices, whichever is higher. Prohibition on manipulation and deceptive practices: Further according to Section 12A, no person shall directly or indirectly indulge in following (i.e.) (a) using in manipulative or deceptive device in connection with purchase, sale or securities listed (b) Employ any scheme or device to defraud in connection with dealing in securities which are listed (c) engage in an act which would operate as fraud on deceit upon any person in connection with dealing in



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securities which are listed. SEBI may impose penalty upto Rs. 1 crore on any person who fails to comply with any provisions of SEBI Act (Section 15 HB). Penalties Question 5 Mr. Clever who is registered as an Intermediary fails to enter into an agreement with his client and hence penalised by SEBI under Section 15B of the SEBI Act. Advise Mr. Clever as to what remedies are available to him against the order of SEBI. (May, 2002) Answer Remedies against SEBI order: Section 15B of the Securities and Exchange Board of India Act, 1992 lays down that if any person, who is registered as an intermediary and is required under this Act or any rules or regulations made there under, to enter into an agreement with his client, fails to enter into such agreement, he shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore rupees, whichever is less. Mr. Clever has been penalised under the above mentioned provision. Two remedies are available to Mr. Clever in this matter:- (i) Appeal to the Securities Appellate Tribunal : Section 15 T of the SEBI Act, 1992 provides that any person aggrieved by an order of

the Board made, on and after the commencement of the Security Laws (Second Amendment) Act, 1999, under this Act or the rules or regulations made there under may prefer an appeal to a Securities Appellate Tribunal having jurisdiction in the matter.

Such appeal shall be filed within a period of 45 days from the date on which a copy of the order made by the Board is received and it shall be in such form and be accompanied by such fee as may be prescribed. However, the Tribunal may entertain an appeal after satisfied that there was sufficient cause for not filing it within the said period. The Tribunal may, after giving the parties an opportunity of being heard, pass such orders as it thinks fit, confirming, modifying or setting aside the order appealed against.

(ii) Appeal to the High Court Section 15 Z of the SEBI Act, 1992 provides that any person aggrieved by any decision

or order of the Securities Appellate Tribunal may file an appeal to the High Court within 60 days from the date of communication of the decision or order to him on any question or fact or law arising out of such order. The High Court may, if it is satisfied that the appellant was prevented by sufficient cause from filing the appeal with in the said period, allow it to be filed within a further period not exceeding 60 days.



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Failure to redress investor grievances (Section 15C) Question 6 Mr. DB is a member of RPA Ltd. He obtains an order against the company for redressal of his grievances against the company. But the company fails to redress the grievances of DB within the time fixed by the SEBI. The Board thereafter imposed penalty upon the company U/s 15C of the SEBI Act. RPL Ltd. seeks your advice whether it has any remedy against the order of SEBI. Advise. (November 2008) Answer Section 15C of Securities Exchange Board of India Act, 1992 lays down that if any listed company or any person who is registered as an intermediary, after having been called upon by the board in writing, to redress the grievances of investors, fails to redress such grievances within the time specified by the board, such company or intermediary shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore rupees, whichever is less. RPA limited was penalized under the provisions of above-mentioned section. Now two remedies are available to RPA limited in this matter: (i) Appeal to the Securities Appellate Tribunal: Section 15T of the SEBI Act, 1992

provides that any person aggrieved by an order of the Board made, on and after the commencement of the security laws (second amendment) act 1999, under this act or the rules or regulations made there under may prefer an appeal to a Securities Appellate Tribunal having jurisdiction in the matter.

Such appeal shall be filed within a period of 45 days from the date on which a copy of the order made by the Board is received and it shall be in such form and be accompanied by such fee as may be prescribed. However the Tribunal may entertain an appeal after the expiry of the said period of forty-five days if it is satisfied that there was sufficient cause for not filing it within the said period.

The Tribunal may, after giving the parties an opportunity of being heard, pass such orders as it thinks fit, confirming, modifying or setting aside the order appealed against.

(ii) Appeal to the Supreme Court: Section 15Z of the SEBI Act, 1992 provides that any person aggrieved by any decision or an order of the Securities Appellate Tribunal may file an appeal to the Supreme Court within 60 days from the date of communication of the decision or an order to him on any question of law arising out of such order. The Supreme Court may, if it is satisfied that the appellant was prevented by sufficient cause from filing the appeal within the said period, allow it to be filed within a further period not exceeding 60 days.



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Penalty for failure in case of stock brokers – (Section 15F) Question 7 What are the default for which a stock-broker may be penalized under the provisions of Securities and Exchange Board of India Act, 1992 in respect of his dealings with the investors? State the factors that must be taken into account by the adjudicating officer while determining the quantum of penalty in such cases. (May, 2000) SEBI received a complaint from an investor that he has not received the payment due to him from a registered stock broker. Explain the action that can be taken by SEBI against the stock broker under the provisions of Securities and Exchange Board of India Act, 1992 and the factors that will be taken into account while taking such action. (May, 2003) Answer Penalty for default in case of stock brokers: Section 15F of Securities and Exchange Board of India Act, 1992 provides for penalty for default in case of stock brokers. If any person who, is registered, as a stock broker under this Act: (a) fails to issue contract notes in the form and in the manner specified by the stock

exchange of which such broker is a member, he shall be liable to a penalty not exceeding five times the amount for which the contract note was required to be issued by that broker.

(b) fails to deliver any security or fails to make payment of the amount due to the investor in the manner or within the period specified in the regulations, he shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore rupees, whichever is less.

(c) charges an amount of brokerage which is on excess of the brokerage specified in the regulations, he shall be liable to a penalty of one lakh rupees or five times the amount of brokerage charged in excess of the specified brokerage, whichever is higher.

Factors for taking into account while action While adjudging quantum of penalty under section 15J, the adjudicating officer shall have due regard to the following factors: (a) the amount of disproportionate gain or unfair advantage, wherever quantifiable, made

as a result of the defaults. (b) the amount of loss to an investor or group of investors as a result of the default. (c) the repetitive nature of the default. Taking into consideration the above factors, the adjudicating officer may levy a maximum penalty as prescribed in Section 15F for default by the concern stock broker in making the payment to the investor.



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Question 8 A group of investors are upset with the functioning of two leading stock brokers of Calcutta Stock Exchange and want to make a complaint to SEBI for intervention and redressal of their grievances. Explain briefly the purpose of establishing SEBI and what type of defaults by the stock brokers come within the purview of SEBI Act, 1992. (May, 2002) Answer The Securities and Exchange Board of India (SEBI) was established primarily for the purpose of 1. to protect the interests of investors in securities 2. to promote the development of securities market 3. to regulate the securities market and (iv) for matters connected therewith and

incidental thereto. The following defaults by stock brokers come within the purview of SEBI Act: (a) Any failure on the part of the stock broker to issue contract notes in the form and in the

manner specified by the Stock Exchange. (b) Any failure on the part of the broker to deliver any security or to make payment of the

amount due to the investor in the manner or within the period specified in the regulations.

(c) Any collection of charges by way of brokerage in excess of the brokerage as specified in the regulations. (Section 15 F, SEBI Act, 1992)

Question 9 Mr. Raman, an investor is not satisfied with the dealings of his stock broker who is registered with Delhi Stock Exchange. Mr. Raman approaches you to guide him regarding the avenues available to him for making a complaint against the stock broker under Securities and Exchange Board of India Act, 1992 and also the grounds on which such complaint can be made. You are required to briefly explain the answer to his queries. (November, 2003) Answer Securities and Exchange Board of India (SEBI) was established for regulating the various aspects of stock market. One of its functions is to register and regulate the stock brokers. In the light of this, Mr. Raman is advised that the complaint against the erring stock broker may be submitted to SEBI. The grounds on which or the defaults for which complaints may be made to SEBI are as follows:



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(a) Any failure on the part of the stock broker to issue contract notes in the form and manner specified by the stock exchange of which the stock broker is a member.

(b) Any failure to deliver any security or any failure to make payment of the amount due to the investor in the manner within the period specified in the regulations.

(c) Any collection of charges by way of brokerage which is in excess of the brokerage specified in the regulations.

Penalty for insider trading – Section 15G Question 10 On the complaint of Mr. Kamlesh Gupta, after enquiry SEBI finds that Mr. P. Mehta a Chief Executive Officer of the Company, on the basis of unpublished price sensitive information, has indulged in the trading of the securities of that company. Explain, on the basis of the said finding, what action SEBI can take against Mr. P. Mehra under the Securities and Exchange Board of India Act, 1992. (May, 2002) Answer Section 15G of the Securities and Exchange Board of India (SEBI) Act, 1992 deals with penalty for Insider Trading. According to this, if any insider (i) either on his own behalf or on behalf of any other person, deals in securities of a body

corporate on any stock exchange on the basis of any unpublished price sensitive information; or

(ii) communicates any unpublished price sensitive information to any person, with or without his request for such information except as required in the ordinary cause of business or under any law, or

(iii) counsels or procures for, any other person to deal in any securities of any body corporate on the basis of unpublished price sensitive information,

shall be liable to a penalty of twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher. As such SEBI can, after following the prescribed procedure, impose a penalty on Mr. P.Mehra. The maximum penalty that SEBI can impose is Rupees twenty-five crores or three times the amount of profits made out of insider trading, whichever is higher. Question 11 What provision has been made under Section 15G of the SEBI Act, 1992, in connection with penalty for insider trading? (November, 2000) Answer If any insider who:



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(i) either on his own behalf or on behalf of any other person, deals in securities of a body corporate on any stock exchang e on the basis of any unpublished price sensitive information; or

(ii) communicates any unpublished price sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law; or

(iii) counsels, or procures for, any other person to deal in any securities of any body corporate on the basis of unpublished price sensitive information,

shall be liable to a penalty of twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher. [Section 15, SEBI Act, 1992].



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UNIT – II Questions based on

SECURITIES AND EXCHANGE BOARD OF INDIA (ISSUE OF CAPITAL AND DISCLOSURE REQUIREMENTS) REGULATIONS, 2009

Earlier known as SEBI (Disclosure for Investor Protection) Guidelines, 2000 Book-Building Process Question 12 What is the specific advantage of Book-building process in connection with issue of securities by a company? (May, 2000) Answer Book building is a process of price discovery. The issuer discloses a price band or floor price before opening of the issue of the securities offered. On the basis of the demands received at various price levels within the price band specified by the issuer, Book Running Lead Manager (BRLM) in close consultation with the issuer arrives at a price at which the security offered by the issuer, can be issued. When the price of an issue is discovered on the basis of demand received from the prospective investors at various price levels, it is called “Book Built Issue”. According to Regulation 2(f) of SEBI (ICDR) Regulation 2009 “book building” means a process undertaken to elicit demand and to assess the price for determination of the quantum or value of specified securities or Indian Depository Receipts, as the case may be, in accordance with these regulations. The specific advantage of the book-building process is: (a) It is a process which helps the issuer company and the lead merchant banker to

discover the price through the demand received. (b) Cut-off option is available for the investors. i.e investors who are applying for securities

worth up to Rs 1,00,000/- only. Such investors are required to tick the cut off option which indicates their willingness to subscribe to shares at any price discovered within the price band. Unlike price bids (where a specific price is indicated) which can be invalid, if price indicated by applicant is lower than the price discovered, the cut�off bids always remain valid for the purpose of allotment.

(c) Investors can change/revise/before the date of closure of the issue and also cancel the bid anytime before the finalization of the basis of allotment by approaching/ writing/ making an application to the registrar to the issue.

Common Conditions for Public Issues and Rights Issues (Regulation 4)



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Question 13 What are the Common restrictions for issuers in case of public and rights issues? Answer No issuer shall make a public issue or rights issue of specified securities: (a) if the issuer, any of its promoters, promoter group or directors or persons in control of

the issuer are debarred from accessing the capital market by the Board; (b) if any of the promoters, directors or persons in control of the issuer was or also is a

promoter, director or person in control of any other company which is debarred from accessing the capital market under any order or directions made by the Board;

(c) if the issuer of convertible debt instruments is in the list of wilful defaulters published by the Reserve Bank of India or it is in default of payment of interest or repayment of principal amount in respect of debt instruments issued by it to the public, if any, for a period of more than six months;

(d) unless it has made an application to one or more recognised stock exchanges for listing of specified securities on such stock exchanges and has chosen one of them as the designated stock exchange:

Provided that in case of an initial public offer, the issuer shall make an application for listing of the specified securities in at least one recognised stock exchange having

nationwide trading terminals; (e) unless it has entered into an agreement with a depository for dematerialisation of

specified securities already issued or proposed to be issued; (f) unless all existing partly paid-up equity shares of the issuer have either been fully paid

up or forfeited; (g) unless firm arrangements of finance through verifiable means towards seventy five per

cent. of the stated means of finance, excluding the amount to be raised through the proposed public issue or rights issue or through existing identifiable internal accruals, have been made.

Eligibility Requirements in case of Public Issues (Chapter III - Regulation 26) Question 14 M/s Herbal Pharma Limited, a listed company, decides to make a public issue of equity shares. Explain briefly the eligibility norms prescribed by SEBI guidelines to be complied with by the company. (May, 2002) or

AVD Limited was incorporated on 1st April,2006. The Company got its shares listed at Bombay Stock Exchange on 30th September, 2007. The Company at an Extra-Ordinary General Meeting



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held on 31st October,2009, decided to go for public issue of equity shares to an extent of Rs.300 crores. The net worth of the Company as per the audited Balance sheets in the financial years 2007-08 and 2008-09 was Rs.50 crores and 60 crores respectively. During the financial year 2008-09 the Company had already issued equity shares amounting to Rs.20 crores. There is no change in the name of the Company or its business activities during the financial year 2008-09. Referring to the guidelines issued by Securities and Exchange Board of India, advise the Company on the following: (i) Whether the Company can go ahead with the public issue of equity shares as stated above. (ii) What would by your advice in case the net worth of the Company as per audited balance

sheets in the financial years 2007-08 and 2008-09 was Rs.20 crores and 30 crores respectively?

(iii) What would be the position in case the Company in question changed its name to AJD Limited during the year 2008-09, three months before filing the offer document and the revenue due to change of business activity suggested by the new name during the financial year 2008-09 was 40% less than the total revenue for the financial year 2007-08 reckoned from the date of filing the offer document? (November, 2009)

Answer As per the SEBI (ICDR) Regulations 2009, vide Regulation 26 (d) & (e), a listed Company shall be eligible to make a public issue of equity shares or any other security which may be converted into or exchanged with equity shares at a later date provided (d) the aggregate of the proposed issue and all previous issues made in the same financial

year in terms of issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year;

(e) if it has changed its name within the last one year, at least fifty per cent. of the revenue for the preceding one full year has been earned by it from the activity indicated by the

new name. Applying the above Regulations, the questions as asked in the problem can be answered as under: 1. There are two conditions in the guidelines as stated above viz.i) that the aggregate issue

i.e. proposed + all the previous issues made in the same financial year should not exceed 5 times the net worth of the Company; ii) there is no change in the name of the issuer Company within the last 1 year. In the question the proposed issue of Rs.300 crores + Previous issue in the same financial year is Rs.20 crores, making an aggregate of Rs.320. Since the aggregate of the issue is more than 5 times of Net Worth, i.e. more than Rs.300 crores , the proposed offer is not within the limit, Company cannot proceed ahead with in the proposed issue of Rs.300 crores.



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2. In the second case the net worth is only Rs.30 crores. 5 times of the net worth comes to Rs.150 crores only. Since the aggregate of the proposed issue and the previous issue during the same financial year is Rs.320 crores, which is exceeding the limits of Rs.150 crores, as calculated above, the Company cannot proceed with the public issue of shares as proposed in the second case.

3. In the third case the offer cannot be made since the current year revenue is less than 50% of the total revenue of the previous year.

Question 15 Following information is available from the Records of Star Chemicals & Engineering Ltd.: (i) The company is a closely held unlisted company. (ii) The paid up share capital of the company since 1st April, 1999 is Rs.3.00 crores and its

net worth as at 31st March,2008 was Rs.5.00 crores as per audited Balance Sheet. (iii) The Net Tangible Assets of the company as per last 3(three) audited Balance Sheets

as at 31st March, 2005, 2006 and 2007 were Rs.4.00 crores, 4.50 crores and 5.00 crores respectively, out of which monetary assets were less than Rs. 50 lacs in each of the three years.

(iv) The company was incorporated in 1996 and commenced its business on 1st April, 1996 and since then it has earned good profits and it has not incurred any loss in any year in past.

(v) The company has not declared any dividend so far, but according to the profits earned so far, the management could have declared the dividend in each of the last five years.

(vi) The name of the company was changed from Star Engineering Ltd. to its present name with effect from 1st January, 2007

(vii) The company’s turnover in the years ended 31st March, 2006, 2007 and 2008 was Rs.20 crores, 30 crores and 35 crores respectively.

The company wants to make a public issue of shares to raise Rs. 20.00 crores by issuing equity shares at premium. For the purpose of including the information in the prospectus, the Company has prepared its accounts for 12 months ended 31st December, 2007 showing segment wise revenue which reveals that revenue from chemical segment is more than the revenue from Engineering segment. You are required to state the relevant guidelines issued by SEBI and your conclusion whether the Company can make the desired issue of equity shares based on the facts stated above.

(November, 2005) Question 16 M/s Earth Chemicals and Engineering Ltd. is a closely held unlisted company with a paid up share capital of Rs. 3.00 crores, since 1st April, 2001 and its net worth as on 31st March, 2007 was Rs.



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5.00 crores. The net tangible assets of the company as per last three audited balance sheets as at 31st March, 2005, 2006 and 2007 were Rs. 4.00 crores, 4.50 crores and 5.00 crores respectively out of which momentary assets were less than Rs. 50 lakhs in each of the three years. The company was incorporated in 1998 and commenced its business on 1st April, 1998 and since then it was earned good profits and it has not incurred any loss in any year in the past. The company has not declared any dividend so far. But according to the profits earned so far, the management could have declared dividends in each of the last five years. The name of the company was changed from Earth Engineering ltd. to its present name effective from 1st October, 2006. The company wants to make a public issue of shares to raise Rs. 20.00 crores by issuing equity shares at premium. For the purpose of including the information in the prospectus. The company has prepared its accounts for 12 months ended 30th September, 2007 showing segment wise revenue, which reveals that revenue from chemical segment was more than the revenue from engineering segment. Keeping the relevant guidelines issued by SEBI into account, examine whether the company can make the desired issue of equity shares based on the facts stated above.

(November 2007) Answer Regulation 26 of the SEBI (ICDR) Regulations, 2009 prescribes the conditions to be fulfilled for issue of shares. As per the said Regulation, an issuer may make an initial public offer, if: (a) it has net tangible assets of at least three crore rupees in each of the preceding

three full years (of twelve months each), of which not more than fifty per cent. are held in monetary assets. Further that if more than fifty per cent of the net tangible assets are held in monetary assets, the issuer has made firm commitments to utilise such excess monetary assets in its business or project.

(b) it has a track record of distributable profits in terms of section 205 of the Companies Act, 1956, for at least three out of the immediately preceding five years. The extraordinary items shall not be considered for calculating distributable profits.

(c) it has a net worth of at least one crore rupees in each of the preceding three full years (of twelve months each).

(d) the aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year.

(e) if it has changed its name within the last one year, at least fifty per cent. of the revenue for the preceding one full year has been earned by it from the activity indicated by the new name.

In the given case, (a) The net tangible assets of the company as per the last three audited balance sheets as

on 31sat March, 2005, 2006 and 2007 were Rs. 4.00 crores, Rs. 4.50 crores, and Rs.



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5.00 crores respectively. It satisfies the requirements of clause (a) as above as during each of the preceding three full years, it has net tangible assets, more than Rs.3 crores and out of which the monetary assets are not more than 50 % of the net tangible assets. (In this case it has monetary assets less than Rs 50 lacs).

(b) The company has good track record of distributable profits in terms of section 205 of the Companies Act, 1956. In other words, it has not incurred any loss in any year in the past.

(c) The net worth of the company during the three preceding years was at least Rs. 1 crore in the preceding three full years. (paid-up capital since 1st April, 1999 is Rs 3 crores and net worth as at 31st March, 2005 was Rs. 5.00 crores.

(d) The aggregate of the proposed issue and all previous issues made in the same financial years does not exceed 5 times its pre-issue net worth. (Rs. 20 crores is the proposed issue and pre-issue net worth is Rs. 5 crores as on 31st March, 2007.

(e) It is stated in the problem that the revenue earned by the company under its activity (chemical) the new name is more than from the old activity (engineering, it satisfied the condition (e) as stated above.

Hence Star Chemicals & Engineering Ltd can proceed to make a public issue of shares to raise Rs. 20.00 crores by issuing equity shares at premium. Question 17 The Annual Accounts of CALM Ltd., a listed company from for the year ended 31st March, 2003 were finalized on 31st May, 2004. The Company had a paid up capital of Rs.50.00 Lacs and free reserves of Rs.100.00 Lacs. The Company did not have any accumulated losses. The Board of Directors of the Company wishes to make a public issue of Equity Shares amounting to Rs. 10.00 Crores comprising of offer to public through offer document, firm allotment and promoters contribution. State, how this can be done under SEBI Guidelines.

What would be your answer in the following cases?

(a) If CALM Ltd. was a Private Sector Bank known as CALM Bank Ltd.

(b) If the issue of above mentioned Rs.10.00 Crores was a right issue (November, 2004) Answer To determine, whether CALM Ltd can proceed with the public issue of equity shares amounting to Rs.10.00 crores, one has to find out whether the company satisfied Regulation 26 of the SEBI (ICDR) Regulations, 2009 applying clause (c) of the said Regulation, the aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue size does not exceed five times its pre-issue net worth as per the audited



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balance sheet of the preceding financial year. In this case, it exceeds 5 times the net worth as on 31st March, 2004. (Proposed issue is Rs.10 crores and net worth as at 31st March, 2003 is Rs. 1.5 crores). Since the company does not satisfy the above stated condition, it has to satisfy any of the alternate conditions specified in Clause 2(a)(b), which states that, the issue is made through the book building process and the issuer undertakes to allot at least fifty per cent. of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make allotment to the qualified institutional buyers ; or at least fifteen per cent. of the cost of the project is contributed by scheduled commercial banks or public financial institutions, of which not less than ten per cent. shall come from the appraisers and the issuer undertakes to allot at least ten per cent. of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make the allotment to the qualified institutional buyers; a. (i) the minimum post-issue face value capital of the issuer is ten crore rupees; or (ii) the issuer undertakes to provide market-making for at least two years from the

date of listing of the specified securities, subject to the following: (A) the market makers offer buy and sell quotes for a minimum depth of three

hundred specified securities and ensure that the bid-ask spread for their quotes does not, at any time, exceed ten per cent.;

(B) the inventory of the market makers, as on the date of allotment of the specified securities, shall be at least five per cent. of the proposed issue.

Pricing in Public Issue (Regulation 28) Question 18 State the guidelines issued by SEBI in this regard in respect of the following matters: (i) Determination of issue price and that of successful bidders. (ii) Reservation for individual investors who have not participated in the bidding process

and basis of allotment to such investors. (May, 2000) Answer Determination of issue price: (Regulation 28, read with Schedule XI) (a) The issuer shall, in consultation with lead book runner, determine the issue price based

on the bids received. (b) On determination of the price, the number of specified securities to be offered shall be

determined (i.e. issue size divided by the price to be determined). (c) Once the final price (cut-off price) is determined, all those bidders whose bids have been

found to be successful (i.e. at and above the final price or cut-off price) shall be entitled



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for allotment of specified securities. (d) Retail individual investors may bid at "cut off" price instead of their writing the specific bid

price in the bid forms. (e) The lead book runner may reject a bid placed by a qualified institutional buyer for reasons

to be recorded in writing provided that such rejection shall be made at the time of acceptance of the bid and the reasons therefor shall be disclosed to the bidders. Necessary disclosures in this regard shall also be made in the red herring prospectus.

Allotment procedure and basis of allotment. (Regulation 50) 1. The allotment of specified securities to applicants other than anchor investors shall be

on proportionate basis within the specified investor categories and the number of securities allotted shall be rounded off to the nearest integer, subject to minimum allotment being equal to the minimum application size as determined and disclosed by the issuer: Provided that value of specified securities allotted to any person in pursuance of reservation made under clause (a) of sub-regulation (1) or clause (a) of sub-regulation (2) of regulation 42, shall not exceed one lakh rupees.]

2. The executive director or managing director of the designated stock exchange along with the post issue lead merchant bankers and registrars to the issue shall ensure that the basis of allotment is finalised in a fair and proper manner in accordance with the allotment procedure as specified in Schedule XV.

Manner of Allotment/ Allocation. (a) Allotment to retail individual investors, non-institutional investors and qualified

institutional buyers other than anchor investors shall be made proportionately as illustrated in this Schedule.

(b) In case of under subscription in any category, the undersubscribed portion in that category shall be allocated to the bidders as per disclosures made in the red herring prospectus; Provided that the unsubscribed portion in qualified institutional buyer category shall not be available for subscription to other categories, in case the book building process is undertaken for the purpose of compliance of eligibility conditions for public issue.

(c) On receipt of the sum payable on application for the amount towards minimum subscription, the issuer shall allot the specified securities to the applicants as per these regulations.

(d) Definition of CAN to be modified to state that it is for ‘allocation of shares’ and not ‘confirmation of shares

Question 19 M/s Ambitious Financiers Ltd., an existing unlisted Public Company, is planning to issue to the



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public five lakhs fully convertible debentures of Rs. 100 each. Explain the eligibility norms to be fulfilled by the company as per SEBI guidelines before making the issue. (May, 2001) Answer Conditions for initial public offer (Regulation 26) (1) An issuer may make an initial public offer, if:

(a) it has net tangible assets of at least three crore rupees in each of the preceding three full years (of twelve months each), of which not more than fifty per cent. are held in monetary assets: Provided that if more than fifty per cent. of the net tangible assets are held in monetary assets, the issuer has made firm commitments to utilise such excess monetary assets in its business or project;

(b) it has a track record of distributable profits in terms of section 205 of the Companies Act, 1956, for at least three out of the immediately preceding five years: Provided that extraordinary items shall not be considered for calculating distributable profits;

(c) it has a net worth of at least one crore rupees in each of the preceding three full years (of twelve months each);

(d) the aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year;


(2) An issuer not satisfying any of the conditions stipulated in sub-regulation (1) may make an initial public offer if:

(a) (i) the issue is made through the book building process and the issuer undertakes to allot at least fifty per cent. of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make allotment to the qualified institutional buyers;

Or (ii) at least fifteen per cent. of the cost of the project is contributed by

scheduled commercial banks or public financial institutions, of which not less than ten per cent. shall come from the appraisers and the issuer undertakes to allot at least ten per cent. of the net offer to public to qualified institutional buyers and to refund full subscription monies if it fails to make the allotment to the qualified institutional buyers;



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(b) (i) the minimum post-issue face value capital of the issuer is ten crore rupees; Or

(ii) the issuer undertakes to provide market-making for at least two years from the date of listing of the specified securities, subject to the following: (A) the market makers offer buy and sell quotes for a minimum depth of

three hundred specified securities and ensure that the bid-ask spread for their quotes does not, at any time, exceed ten per cent.;

(B) the inventory of the market makers, as on the date of allotment of the specified securities, shall be at least five per cent. of the proposed issue.

(3) An issuer may make an initial public offer of convertible debt instruments without making a prior public issue of its equity shares and listing thereof.

(4) An issuer shall not make an allotment pursuant to a public issue if the number of prospective allottees is less than one thousand.

(5) No issuer shall make an initial public offer if there are any outstanding convertible securities or any other right which would entitle any person any option to receive equity shares after the initial public offer: Provided that the provisions of this sub-regulation shall not apply to: (a) a public issue made during the currency of convertible debt instruments which

were issued through an earlier initial public offer, if the conversion price of such convertible debt instruments was determined and disclosed in the prospectus of the earlier issue of convertible debt instruments;

(b) outstanding options granted to employees pursuant to an employee stock option scheme framed in accordance with the relevant Guidance Note or Accounting Standards, if any, issued by the Institute of Chartered Accountants of India in this regard.

(6) Subject to provisions of the Companies Act, 1956 and these regulations, equity shares may be offered for sale to public if such equity shares have been held by the sellers for a period of at least one year prior to the filing of draft offer document with the Board in accordance with sub- regulation (1) of regulation 6: Provided that in case equity shares received on conversion or exchange of fully paid-up compulsorily convertible securities including depository receipts are being offered for sale, the holding period of such convertible securities as well as that of resultant equity shares together shall be considered for the purpose of calculation of one year period referred in this sub-regulation: Provided further that the requirement of holding equity shares for a period of one year shall not apply:



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(a) in case of an offer for sale of specified securities of a government company or statutory authority or corporation or any special purpose vehicle set up and controlled by any one or more of them, which is engaged in infrastructure sector;

(b) if the specified securities offered for sale were acquired pursuant to any scheme approved by a High Court under sections 391-394 of the Companies Act, 1956, in lieu of business and invested capital which had been in existence for a period of more than one year prior to such approval.

(7) No issuer shall make an initial public offer, unless as on the date of registering prospectus or red herring prospectus with the Registrar of Companies, the issuer has obtained grading for the initial public offer from at least one credit rating agency registered with the Board.

Explanation: For the purposes of this regulation: (I) “net tangible assets” mean the sum of all net assets of the issuer, excluding intangible

assets as defined in Accounting Standard 26 (AS 26) issued by the Institute of Chartered Accountants of India;

(II) “project” means the object for which monies are proposed to be raised to cover the objects of the issue;

(III) In case of an issuer which had been a partnership firm, the track record of distributable profits of the partnership firm shall be considered only if the financial statements of the partnership business for the period during which the issuer was a partnership firm, conform to and are revised in the format prescribed for companies under the Companies Act, 1956 and also comply with the following: (a) adequate disclosures are made in the financial statements as required to be

made by the issuer as per Schedule VI of the Companies Act, 1956; (b) the financial statements are duly certified by a Chartered Accountant stating

that: (i) the accounts and the disclosures made are in accordance with the

provisions of Schedule VI of the Companies Act, 1956; (ii) the accounting standards of the Institute of Chartered Accountants of India

have been followed; (iii) the financial statements present a true and fair view of the firm’s accounts; (IV) In case of an issuer formed out of a division of an existing company, the track record of

distributable profits of the division spun-off shall be considered only if the requirements regarding financial statements as provided for partnership firms in Explanation III are complied with;



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(V) “bid-ask spread” means the difference between quotations for sale and purchase; (VI) The term “infrastructure sector” includes the facilities or services as specified in

Schedule X. Conditions for further public offer (Regulation 27) An issuer may make a further public offer if it satisfies the conditions specified in clauses (d) and (e) of sub-regulation (1) of regulation 26 and if it does not satisfy those conditions, it may make a further public offer if it satisfies the conditions specified in sub-regulation (2) of regulation 26. Question 20 Super Chemicals Limited, a closely held unlisted company, is in need of about Rs. 20 crores for financing its expansion programme. The company has not declared any dividend so far though it has made good profits from the commencement of commercial operations on 1st January, 1995. The paid-up capital of the company was increased to Rs. 3.5 crores on 1st April, 1998. The net worth of the company as per latest audited Balance Sheet as at 31st March, 2002 is Rs. 5 crores. The company seeks your advice as to its eligibility to raise Rs. 20 crores through public issue of equity shares at a premium. Advise with reference to relevant guidelines issued by SEBI. (May, 2003) Answer Super Chemicals Ltd, a closely held company is eligible to raise Rs.20 croes through public issue of equity shares at a premium provided it satisfies the Conditions for initial public offer contained in Regulation 26 of the SEBI (ICDR) Regulations 2009. (a) it has net tangible assets of at least three crore rupees in each of the preceding three

full years (of twelve months each), of which not more than fifty per cent. are held in monetary assets: Provided that if more than fifty per cent. of the net tangible assets are held in monetary assets, the issuer has made firm commitments to utilise such excess monetary assets in its business or project;

(b) it has a track record of distributable profits in terms of section 205 of the Companies Act, 1956, for at least three out of the immediately preceding five years: Provided that extraordinary items shall not be considered for calculating distributable profits;

(c) it has a net worth of at least one crore rupees in each of the preceding three full years (of twelve months each);

(d) the aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year;



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Question 21 What are the SEBI’s important guidelines regarding pricing of first issue of Equity shares of new companies? (November, 2000)

A company proposes to make a public issue of equity shares for financing its project through book building process. It proposes to fix the floor price of the share at Rs.500 for a share of Rs. 10. Answer the following with reference to SEBI (Disclosure and Investor Protection) guidelines: What is the price band that may be indicated in the red herring prospectus?

If the company wants to lower the floor price during the bidding period in order to increase the response to the issue, state the conditions subject to which such revision can be made.

(CA Final, New Course, November, 2008) Answer Pricing of public issue of equity shares are contained in SEBI (ICDR) Regulations, 2009 - Regulations 28 to 31, Part II of Chapter III Pricing 28. (1) An issuer may determine the price of specified securities in consultation with the

lead merchant banker or through the book building process. (2) An issuer may determine the coupon rate and conversion price of convertible

debt instruments in consultation with the lead merchant banker or through the book building process.

(3) The issuer shall undertake the book building process in a manner specified in Schedule XI.

Differential pricing 29. An issuer may offer specified securities at different prices, subject to the following:

(a) retail individual investors or retail individual shareholders 1[or employees of the issuer entitled for reservation made under regulation 42 making an application for specified securities of value not more than one lakh rupees,] may be offered specified securities at a price lower than the price at which net offer is made to other categories of applicants:

1 Inserted by SEBI (Issue of Capital and Disclosure Requirements) (Amendment) Regulations, 2009, w.e.f. 11.12.09.



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Provided that such difference shall not be more than ten per cent. of the price at which specified securities are offered to other categories of applicants;

(b) in case of a book built issue, the price of the specified securities offered to an anchor investor shall not be lower than the price offered to other applicants;

(c) in case of a composite issue, the price of the specified securities offered in the public issue may be different from the price offered in rights issue and justification for such price difference shall be given in the offer document.

(d) In case the issuer opts for the alternate method of book building in terms of Part D of Schedule XI, the issuer may offer specified securities to its employees at a price lower than the floor price:

Provided that the difference between the floor price and the price at which specified securities are offered to employees shall not be more than ten per cent. of the floor price.]

Price and price band 30. (1) The issuer may mention a price or price band in the draft prospectus (in case of

a fixed price issue) and floor price or price band in the red herring prospectus (in case of a book built issue) and determine the price at a later date before registering the prospectus with the Registrar of Companies: Provided that the prospectus registered with the Registrar of Companies shall contain only one price or the specific coupon rate, as the case may be.

(2) If the floor price or price band is not mentioned in the red herring prospectus, the issuer shall announce the floor price or price band at least two working days before the opening of the bid (in case of an initial public offer) and at least one working day before the opening of the bid (in case of a further public offer), in all the newspapers in which the pre issue advertisement was released.

(3) The announcement referred to in sub-regulation (2) shall contain relevant financial ratios computed for both upper and lower end of the price band and also a statement drawing attention of the investors to the section titled “basis of issue price” in the prospectus.

(4) The cap on the price band shall be less than or equal to one hundred and twenty per cent. of the floor price.

(5) The floor price or the final price shall not be less than the face value of the specified securities. Explanation: For the purposes of sub-regulation (4), the “cap on the price band” includes cap on the coupon rate in case of convertible debt instruments.



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Face value of equity shares. 31. (1) Subject to the provisions of the Companies Act, 1956, the Act and these

regulations, an issuer making an initial public offer may determine the face value of the equity shares in the following manner: (a) if the issue price per equity share is five hundred rupees or more, the

issuer shall have the option to determine the face value at less than ten rupees per equity share: Provided that the face value shall not be less than one rupee per equity share;

(b) if the issue price per equity share is less than five hundred rupees, the face value of the equity shares shall be ten rupees per equity share:

Provided that nothing contained in this sub-regulation shall apply to initial public offer made by any government company, statutory authority or corporation or any special purpose vehicle set up by any of them, which is engaged in infrastructure sector.

(2) The disclosure about the face value of equity shares (including the statement about the issue price being “X” times of the face value) shall be made in the advertisements, offer documents and application forms in identical font size as that of issue price or price band.

Explanation: For the purposes of this regulation, the term “infrastructure sector” includes the facilities or services as specified in Schedule X.

Question 22 An Unlisted Public Company, having a paid-up equity share capital of Rs.5 Crores consisting of 50,00,000 equity shares of Rs.10 each fully paid-up, proposes to reduce the denomination of equity shares to less than Rs.10 Per share and make an initial public offer of equity shares at a premium. Examine whether it is possible for the company to issue shares at a denomination of les than Rs.10 and, if so, state the minimum issue price and other conditions to be fulfilled under the SEBI (Disclosure and Investor Protection) Guidelines, 2000. (November, 2009) Answer Denomination of shares for public issue An eligible company shall be free to make a public or right issue of equity shares in any denomination determined by it by complying with section 13(4) of the Companies Act, 1956 and also SEBI Guidelines. According to SEBI guidelines, in case of initial public offer by an unlisted company.



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(a) if the issue price is Rs.500 or more, the issuer company shall have a discretion to fix the face value below Rs.10 per share subject shall in no case be less than Re.1 per share and also it shall not be is decimal of a rupee.

(b) If issue price is less than Rs.500 per share the face value shall be Re.10 per share. Here the issue price has not been given in the question. It is possible for the company to issue shares having a face value of less than Rs.10 per share only if the issue price is Rs.500 or more (para 3.7.1) However, at any one time, shares shall be only of one denomination. Hence the denomination of existing shares can be altered by changing memorandum and articles by passing special resolution disclosure and accounting norms specified by the SEBI from time to time ( para 3.7.). The face value shall be disclosed in the advertisement offer documents and is application fauses, in the same font size as that of issue price or price band . Promoters’ Contribution and Lock in period (Regulations 32) Question 23 An unlisted Company, having paid-up Share Capital of Rs.3 crores consisting of 30,00,000 Equity Shares of Rs. 10 each fully paid-up, proposes to make an initial Public offer of 90,000 Equity Shares of Rs.10 each at a premium of Rs.5 per share, in July, 2004. The promoters acquired 10,00,000 shares on 1st January, 2000 and another 10,00,000 shares on 1st January, 2004 at face value:

(i) What should be the minimum contribution that should be made by the promoters of the above company in order to comply with the guidelines issued by SEBI?

(ii) State also the period for which the promoters are required to hold these shares and also the shares, if any acquired by the promoters in excess of the required minimum contribution. (May, 2004)

Answer (i) The minimum contribution that should be made by the promoters should be in

accordance with the Regulation 32 (1) of the SEBI (ICDR) Regulations, 2009. According to the said regulations the promoters of the issuer shall contribute in the public issue in case of an initial public offer, not less than twenty per cent. of the post issue capital. In the above case, pre-issued capital is Rs. 3 crores and proposed issue is Rs. 9 crores (90,000 equity shares of Rs. 10 each). Of the total post issue capital ie. Rs. 12 crores (Rs. 3 crores + Rs. 9 crores), the promoters have to contribute minimum of Rs. 2.4 crores (20% of Rs. 12 crores). For the purpose of promoters’ contribution, the following securities shall be considered as ineligible as per Regulation 33 (b) (i)



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Specified securities acquired by promoters during the preceding one year at a price lower than the price at which specified securities are being offered to public in the initial public offer: Provided that nothing contained in this clause shall apply: if promoters pay to the issuer, the difference between the price at which specified securities are offered in the initial public offer and the price at which the specified securities had been acquired.

In the above case, shares acquired by the promoters on 1st January, 2004 shall not be taken into account for the computation of promoter’s contribution, as the allotment was made in the preceding one year. However, shares acquired during the 1st January, 2000 shall be taken into account for promoter’s contribution. Further, it is to be noted that there is a difference in price (shares which were earlier acquired at Rs.10 each as on 1st January, 2000 and the issue price in July, 2004 (Rs 15 per share). In view of the proviso in the said Regulation, the difference in price ( Rs. 15 including premium of Rs. 5 per share for issue in July, 2004 and acquisition @ Rs.10 per share = Rs. 5 per share for 10 lakh equity shares ( Rs 50 lakhs) acquired in 1st January, 2004 need to be brought in by the promoters. In view of the proviso to the said Regulation, the acquisition of shares in July, 2004 of 10 lakh shares will also be taken into consideration for calculating promoters’ contribution. Of the total Rs.2.4 crores issue of shares, if Rs. 2 crores issue already acquired by the promoters are taken into account, then the promoters are eligible to subscribe only for the balance of 4 lakh shares (ie. 2.4 crores – 2 crores = 0.4 crores or 44 lakh equity shares).

(ii) Lock-in of specified securities held by promoters: As per Regulation 36 of the SEBI (ICDR) Regulations, 2009, In a public issue, the specified securities held by promoters hall be locked-in for the period stipulated hereunder: (a) minimum promoters’ contribution shall be locked-in for a period of three years

from the date of commencement of commercial production or date of allotment in the public issue, whichever is later;

(b) promoters’ holding in excess of minimum promoters’ contribution shall be locked-in for a period of one year: Provided that excess promoters’ contribution as provided in proviso to clause (b) of regulation 34 shall not be subject to lock-in.

Explanation: For the purposes of this clause, the expression "date of commencement of commercial production" means the last date of the month in which commercial production in a manufacturing company is expected to commence as stated in the offer document. Accordingly, in the above case, promoters are required to hold the shares for a lock-in-period of 3 years. However, any excess of minimum promoter’s contribution shall be locked in for a period of 1 year. Green Shoe Option (Regulation 45)



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Explain clearly the meaning of the term “Green shoe option” in relation to a public company going for public offer of equity shares. What disclosures is such a company required to make in the draft red herring prospectus in accordance with SEBI (Disclosure and Investor Protection) Guidelines? (November, 2008) “Green Shoe Option” means an option of allotting equity shares in excess of the equity shares offered in the public issue as a post-listing price stabilizing mechanism; (Regulation 2(o) Price stabilisation through green shoe option. (1) An issuer making a public issue of specified securities may provide green shoe option

for stabilising the post listing price of its specified securities, subject to the following: (a) the issuer has been authorized, by a resolution passed in the general meeting of

shareholders approving the public issue, to allot specified securities to the stabilising agent, if required, on the expiry of the stabilisation period;

(b) the issuer has appointed a merchant banker or book runner, as the case may be, from amongst the merchant bankers appointed by the issuer as a stabilising agent, who shall be responsible for the price stabilisation process;

(c) prior to filing the draft offer document with the Board, the issuer and the stabilising agent have entered into an agreement, stating all the terms and conditions relating to the green shoe option including fees charged and expenses to be incurred by the stabilising agent for discharging his responsibilities;

(d) prior to filing the offer document with the Board, the stabilising agent has entered into an agreement with the promoters or pre-issue shareholders or both for borrowing specified securities from them in accordance with clause (g) of this sub-regulation, specifying therein the maximum number of specified securities that may be borrowed for the purpose of allotment or allocation of specified securities in excess of the issue size (hereinafter referred to as the “over- allotment”), which shall not be in excess of fifteen per cent. of the issue size;

(e) subject to clause (d), the lead merchant banker or lead book runner, in consultation with the stabilising agent, shall determine the amount of specified securities to be over-allotted in the public issue;

(f) the draft and final offer documents shall contain all material disclosures about the green shoe option specified in this regard in Part A of Schedule VIII;

(g) in case of an initial public offer pre-issue shareholders and promoters and in case of a further public offer pre-issue shareholders holding more than five per



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cent. specified securities and promoters, may lend specified securities to the extent of the proposed over- allotment;

(h) the specified securities borrowed shall be in dematerialised form and allocation of these securities shall be made pro-rata to all successful applicants.

(2) For the purpose of stabilisation of post-listing price of the specified securities, the stabilising agent shall determine the relevant aspects including the timing of buying such securities, quantity to be bought and the price at which such securities are to be bought from the market.

(3) The stabilisation process shall be available for a period not exceeding thirty days from the date on which trading permission is given by the recognised stock exchanges in respect of the specified securities allotted in the public issue.

(4) The stabilising agent shall open a special account, distinct from the issue account, with a bank for crediting the monies received from the applicants against the over-allotment and a special account with a depository participant for crediting specified securities to be bought from the market during the stabilisation period out of the monies credited in the special bank account.

(5) The specified securities bought from the market and credited in the special account with the depository participant shall be returned to the promoters or pre-issue shareholders immediately, in any case not later than two working days after the end of the stabilization period.

(6) On expiry of the stabilisation period, if the stabilising agent has not been able to buy specified securities from the market to the extent of such securities over-allotted, the issuer shall allot specified securities at issue price in dematerialised form to the extent of the shortfall to the special account with the depository participant, within five days of the closure of the stabilisation period and such specified securities shall be returned to the promoters or pre-issue shareholders by the stabilising agent in lieu of the specified securities borrowed from them and the account with the depository participant shall be closed thereafter.

(7) The issuer shall make a listing application in respect of the further specified securities allotted under sub-regulation (6), to all the recognised stock exchanges where the specified securities allotted in the public issue are listed and the provisions of Chapter VII shall not be applicable to such allotment.

(8) The stabilising agent shall remit the monies with respect to the specified securities allotted under sub-regulation (6) to the issuer from the special bank account.

(9) Any monies left in the special bank account after remittance of monies to the issuer under sub- regulation (8) and deduction of expenses incurred by the stabilising agent



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for the stabilisation process shall be transferred to the Investor Protection and Education Fund established by the Board and the special bank account shall be closed soon thereafter.

(10) The stabilising agent shall submit a report to the stock exchange on a daily basis during the stabilisation period and a final report to the Board in the format specified in Schedule XII.

(11) The stabilising agent shall maintain a register for a period of at least three years from the date of the end of the stabilisation period and such register shall contain the following particulars: (a) The names of the promoters or pre-issue shareholders from whom the specified

securities were borrowed and the number of specified securities borrowed from each of them;

(b) The price, date and time in respect of each transaction effected in the course of the stabilisation process; and

(c) The details of allotment made by the issuer on expiry of the stabilisation process.

Preferential Issue (Chapter VII – Regulation 76) Question 24 MGR Ltd. wants to issue certain shares on preferential basis and has sought your advice in respect of pricing the shares for such issue. You are required to state the guidelines issued by the Securities and Exchange Board of India in respect of pricing of the issue of shares on a preferential basis. (May, 2008) Answer The Regulations relating to pricing of the issue of shares on a preferential basis is contained in Regulation 76 in Chapter VII of the SEBI (ICDR) Regulations, 2009. Pricing of equity shares. (1) If the equity shares of the issuer have been listed on a recognised stock exchange for a

period of six months or more as on the relevant date, the equity shares shall be allotted at a price not less than higher of the following: (a) The average of the weekly high and low of the closing prices of the related

equity shares quoted on the recognised stock exchange during the six months preceding the relevant date; or

(b) The average of the weekly high and low of the closing prices of the related equity shares quoted on a recognised stock exchange during the two weeks preceding the relevant date.



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(2) If the equity shares of the issuer have been listed on a recognised stock exchange for a period of less than six months as on the relevant date, the equity shares shall be allotted at a price not less than the higher of the following: (a) the price at which equity shares were issued by the issuer in its initial public

offer or the value per share arrived at in a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956, pursuant to which the equity shares of the issuer were listed, as the case may be;

Or (b) the average of the weekly high and low of the closing prices of the related equity

shares quoted on the recognised stock exchange during the period shares have been listed preceding the relevant date; or

(c) the average of the weekly high and low of the closing prices of the related equity shares quoted on a recognised stock exchange during the two weeks preceding the relevant date.

(3) Where the price of the equity shares is determined in terms of sub-regulation (2), such price shall be recomputed by the issuer on completion of six months from the date of listing on a recognised stock exchange with reference to the average of the weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during these six months and if such recomputed price is higher than the price paid on allotment, the difference shall be paid by the allottees to the issuer.

(4) Any preferential issue of specified securities, to qualified institutional buyers not exceeding five in number, shall be made at a price not less than the average of the weekly high and low of the closing prices of the related equity shares quoted on a recognised stock exchange during the two weeks preceding the relevant date.

Explanation: For the purpose of this regulation, ‘stock exchange’ means any of the recognised stock exchanges in which the equity shares are listed and in which the highest trading volume in respect of the equity shares of the issuer has been recorded during the preceding six months prior to the relevant date. Question 25 Excel Ltd., a public limited company listed with The Stock Exchange, Mumbai, wants to make issue of equity shares on preferential basis pursuant to a scheme approved under Corporate Debt Restructuring framework specified by Reserve Bank of India to various persons as may be selected by the Board of Director of the Company. Following information relevant to the preferential issue is available:

(i) Total No. of equity shares to be issued: 50 Lac equity shares of Rs.10 each out of which 30 lac equity shares will be allotted on 30th June, 2005 as fully paid up and



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balance 20 lac equity shares shall be allotted on the same date but paid up to Rs.5 each and balance Rs.5 shall be called upon at a later date and shall be paid up on 30th November, 2005.

(ii) Out of the proposed allottees some persons are holding their shares in Excel Ltd. in physical form and not in dematerialed form and some persons had sold their entire shareholding in Excel Ltd. in January, 2005.

(iii) The meeting of general body of shareholders for approving the preferential issue was held on 15th March, 2005.

Based on the above information you are required to answer the following queries with reference to the SEBI (Disclosure and Investor Protection Guidelines, 2000:

(i) What would be the lock-in period for the shares allotted on preferential basis?

(ii) Who are the persons not entitled for allotment of shares on preferential basis? (May, 2005, May 2008)

Answer (i) Lock-in period for the shares allotted on preferential basis: Regulation 76(4), SEBI,

(ICDR) Regulations, 2009. As per the aforesaid regulation, the equity shares issued on preferential basis pursuant to a scheme of corporate debt restructuring as per the Corporate Debt Restructuring framework specified by the Reserve Bank of India shall be locked-in for a period of one year from the date of allotment: Provided that partly paid up equity shares, if any, shall be locked-in from the date of allotment and the lock-in shall end on the expiry of one year from the date when such equity shares become fully paid up. Accordingly, the first lot of 30 lac full paid equity shares issued on 30th June, 2005 will have a lock-in period of 1 year from the date of allotment. ie. till 30th June, 2006. In respect of the second lot, of partly paid 20 lac equity shares, the lock in period will be till 30th November, 2006 being the date on which the calls shall be paid up on 30th November, 2005. (ii) Persons not entitled for allotment of shares on preferential basis (Regulation 72) (1) A listed issuer may make a preferential issue of specified securities, if:

(a) a special resolution has been passed by its shareholders; (b) all the equity shares, if any, held by the proposed allottees in the issuer

are in dematerialised form; (c) the issuer is in compliance with the conditions for continuous listing of

equity shares as specified in the listing agreement with the recognised stock exchange where the equity shares of the issuer are listed;



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(d) the issuer has obtained the Permanent Account Number of the proposed allottees.

(2) The issuer shall not make preferential issue of specified securities to any person who has sold any equity shares of the issuer during the six months preceding the relevant date: Provided that in respect of the preferential issue of equity shares and compulsorily convertible debt instruments, whether fully or partly, the Board may grant relaxation from the requirements of this sub-regulation, if the Board has granted relaxation in terms of regulation 29A of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 to such preferential allotment.

Accordingly, as given in the problem, persons are holding their shares in Excel Ltd. in physical form and not in dematerialised form and persons had sold their entire shareholding in Excel Ltd. in January, 2005 shall not be eligible for preferential allotment of shares.

Issue of Bonus Shares - Chapter IX – Regulations 92 - 95 Question 26 The Balance Sheet of M/s Get Rich Quick Ltd. as at 31.3.2001 disclosed the following details:

(i) Share Capital Rs. 150 crores

(ii) Reserves and Surplus Rs. 750 crores

The company has issued in the year 1996, fully convertible debentures of Rs.100 crores, which are due for conversion in the year 2001. The company proposes to issue bonus shares in the ratio of 1: 1. Explain briefly the SEBI guidelines to be followed by the company.

(May, 2001) or

Following information and figures are noticed from the Annual Accounts for the year ended 31st March, 2003 of MNP Limited, a listed company:

(i) Authorised Shares Capital Rs.10 crores comprising of one crore Equity shares of Rs.10 each.

(ii) Paid-up Share Capital of Rs.4.5 crores comprising of 40,00,000 Equity shares of Rs.10 each fully paid-up and 10,00,000 Equity shares of Rs.10 each called and paid-up to Rs.5 each. The total paid-up capital is paid up in cash.

(iii) Securities Premium Account Rs.10 crores.



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(iv) 2,50,000 fully convertible debentures of Rs.100 each. These debentures are due for conversion on 30th June, 2003 in full into fully paid Equity shares of Rs.10 each in the ratio of two equity shares for one debenture.

(v) General Reserve Rs.15 crores.

(vi) Fixed asset revaluation reserves Rs.2.5 crores.

It was further ascertained that the partly paid shares were made fully paid by 30th June, 2003.

The Directors of MNP Limited propose to issue bonus shares in the ratio of 1:1.

Advise the Directors on the matter with reference to the guidelines issued by SEBI on bonus issue. What will be your advice, if the company has defaulted in the matter of payment of interest on fixed deposits? (November, 2003) Answer Chapter IX of the SEBI (ICDR) Regulations, 2009 deal with the issue of Bonus Shares. They are contained in Regulations 92 to 95 of the said Regulations. Applying the said Regulations, the above stated problem can be solved as follows: 1. Conditions for Bonus Issue Subject to the provisions of the Companies Act, 1956 or any other applicable law for the time being in force, a listed issuer may issue bonus shares to its members if: (a) it is authorised by its articles of association for issue of bonus shares, capitalisation of

reserves, etc.. If there is no such provision in the articles of association, the issuer shall pass a resolution at its general body meeting making provisions in the articles of associations for capitalisation of reserve.

(b) it has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;

(c) it has sufficient reason to believe that it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity and bonus;

(d) the partly paid shares, if any outstanding on the date of allotment, are made fully paid up.

In the above stated problem, MNP Ltd, authorized capital is Rs.10 crores and proposes to issue bonus shares in the ratio of 1:1, which means the authorized capital after bonus issue is to increase the company has to pass a special resolution for increase of its authorized capital because of bonus issue. In the said problem, MNP Ltd has –



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Fully paid up share capital Rs 4.0 crores 40,00,000 shares of Rs. 10 each)

Partly paid-up capital (to be made fully paid-up before bonus issue)

Rs.1 crore 10,00,000 shares of Rs. 10 each, Rs. 5 paid-up

2,50,000 convertible debentures of Rs. 100 each convertible into full paid up shares of Rs. 10 each in the ratio of 2 equity shares for every 1 debenture

Rs. 5 crores 5,00,000 shares of Rs. 10 each.

Total capital after conversion Rs.5.5 crores 5,50,000 shares of Rs. 10 each

In all the company will be having 40,00,000 + 10,00,000 + 5,00,000 shares of Rs. 10 each amounting to Rs. 5.5 crores of paid-up capital. If the company propose to issue bonus shares in the ratio of 1:1, then post-issue capital will be Rs.11 crores (5.5 crores + 5.5 crores), bringing the authorized capital to Rs. 11 crores (post bonus issue) and since its present authorized capital is Rs. 10crores, it has to pass a special resolution for increasing to Rs. 11 crores. Bonus shares only against reserves, etc. if capitalised in cash. (Regulation 94) (1) The bonus issue shall be made out of free reserves built out of the genuine profits or

securities premium collected in cash only and reserves created by revaluation of fixed assets shall not be capitalised for the purpose of issuing bonus shares.

(2) Without prejudice to the provisions of sub-regulation (1), the bonus share shall not be issued in lieu of dividend.

Applying the above regulations, MNP Ltd, currently has Rs. 25 crores (general reserve of Rs 15 crores and Rs. 10 crores as securities premium amount) which can be utilsied for the purpose of bonus issue amounting to Rs. 5.5 crores. Completion of bonus issue (Regulation 95) (1) An issuer, announcing a bonus issue after the approval of its board of directors and not

requiring shareholders’ approval for capitalisation of profits or reserves for making the bonus issue, shall implement the bonus issue within fifteen days from the date of approval of the issue by its board of directors. Provided that where the issuer is required to seek shareholders’ approval for capitalisation of profits or reserves for making the bonus issue, the bonus issue shall be implemented within two months from the date of the meeting of its board of directors wherein the decision to announce the bonus issue was taken subject to shareholders’ approval.



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(2) Once the decision to make a bonus issue is announced, the issue can not be withdrawn.

Question 27 (a) As on 31st December, 2004, following information and figures are noticed from the

Annual Accounts for the year ended 31st March, 2004 of SKP Ltd., a Company listed with The Stock Exchange, Mumbai:

(i) Authorised Share Capital Rs.20.00 Crores comprising of 2 Crore Equity Shares of Rs.10 each.

(ii) Paid up Share Capital Rs.9.00 Crores comprising of 80 lac Equity Shares of Rs.10 each fully paid up and 20 lac Equity Shares of Rs.10 each called and paid up to Rs.5 each. The total paid up capital is paid up in cash.

(iii) Securities Premium Account Rs.20.00 Crores.

(iv) 5 lac Fully Convertible Debentures of Rs.100 each. These debentures are due for conversion on 31st March, 2005 in full into fully paid Equity Shares of Rs.10 each in the ratio of one Debenture: two Equity Shares.

(v) General Reserve Rs.30.00 Crores.

(vi) Fixed Assets Revaluation Reserve Rs.10.00 Crores.

(vii) Outstanding Liabilities in respect of Bonus to Employees and Workers Rs.25.00 lacs.

(viii) Outstanding Liabilities in respect of Interest payable on Public Deposits comprising of Fixed Deposits from general public Rs.15.00 lacs.

Following other information is gathered from the books of account and other records of the said Company for the period upto 31st December, 2004: (a) The partly paid shares were made fully paid prior to 30th September, 2004. (b) Bonus to employees and workers was paid on 15th September, 2004. (c) Interest on Public Deposits was outstanding on 31st December, 2004. The Directors of SKP Ltd. wants to issue Bonus Shares on or after 1st April, 2005 in the ratio of 1:1. Advise the Directors on the matter with reference to the guidelines issued by Securities and Exchange Board of India on Bonus Issue. (May, 2005, May, 2007) Answer Chapter IX of the SEBI (ICDR) Regulations, 2009 deal with the issue of Bonus Shares. They are contained in Regulations 92 to 95 of the said Regulations. Applying the said Regulations, the above stated problem can be solved as follows:



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Whether there is any need for increase of authorized capital because of bonus issue?

Fully Paid up share capital 80,00,000 x Rs. 10 Rs 8 crores Partly paid-up capital (Rs 5 each) converted into fully paid-up of Rs. 10 each

20,00,000 x Rs 10 Rs. 2 crores

Total paid up capital after conversion partly paid up are converted into fully paid-up

1,00,00,000 x Rs. 10 Rs 10 crores

5 lac Fully Convertible Debentures of Rs.100 each. (These debentures are due for conversion on 31st March, 2005 in full into fully paid Equity Shares of Rs.10 each in the ratio of one Debenture: two Equity Shares)

10,00,000 x Rs 10 Rs 1crore

Capital before bonus issue Rs 11 crores Bonus issue 1:1 Rs/ 11 crores Capital after bonus issue Rs. 22 crores Current authorized capital Rs 20 crores

In view of the increase in authorized capital because of bonus issue, the company has to pass a special resolution. Bonus shares only against reserves, etc. if capitalised in cash As per Regulation 94 (1), the bonus issue shall be made out of free reserves built out of the genuine profits or securities premium collected in cash only and reserves created by revaluation of fixed assets shall not be capitalised for the purpose of issuing bonus shares. In the given case, the bonus issue amounts to Rs. 11 crores which can be paid out of Securities premium account (Rs. 20 crores) and General Reserves (Rs. 30 crores). As per the Conditions for bonus issue stated in Regulation 92, bonus issue cannot be made if the company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it; it has sufficient reason to believe that it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity and bonus and the partly paid shares, if any outstanding on the date of allotment, are made fully paid up. In the present case, SKP Ltd, proposed date of bonus issue is on or after 1st April, 2005 and since partly paid-up shares were made fully paid-up prior to 30th June, 2004, bonus to employees and workers were paid on 15th September, 2004 and interest on public deposits was still outstanding on 31st December, 2004, it is advised that the company shall make good the interest on public deposits before proceeding for its bonus issue. Question 28 The Balance Sheet of Get Well soon Ltd as at 31.3.2009 disclosed the following details:



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(i) Authorised share capital Rs.400 crores (ii) Paid up share capital Rs.150 crores (iii) Reserves and surplus Rs.750 crores

The company has issued in the year 2004, Fully Convertible Debentures of Rs.100 crores which are due for conversion in the year 2009. The company proposes, after conversion of Debentures to issue Bonus shares in the ratio of 1:1. Explain briefly the requirements of the Companies Act, 1956 and the Securities and Exchange Board of India (SEBI) guidelines to be followed by the company in this regard. (May 2009) Answer Chapter IX of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 contains the Regulations (Regulations 92 to 95) for issue of bonus shares, following which M/s Get well soon Ltd. can make a bonus issue in the ratio of 1:1 as follows: 1. The articles of M/s Get well Soon Ltd. must authorize it to issue the bonus shares. If

there is no provision in the articles authorizing the company to issue bonus shares, firstly, the articles shall be amended by passing a special resolution.

2. Steps for determining whether any increase in authorised share capital is required. (a) Paid up share capital as on 31st March, 2009 Rs.150 crores. (b) Paid up capital (after conversion of Rs.100 crores fully convertible debentures,

assuming that these debentures shall be converted into share capital Rs.100 crores) Rs.250 crores.

(c) Proposed bonus issue – 1 share for every held. (d) Post bonus issue capital. Rs.500 crores.

Since the anthorised share capital of the company is only Rs.400 crores, it has to take steps to increase the amount to Rs.500 crores or beyond by complying with the provisions laid down in section 94 and 97 of the Companies Act,1956.

3. Sources of bonus shares. Reserves and surplus (since free reserves built out of the genuine profits can be used

for issue of bonus issue). Rs. 750 Crores Since the source of issue of bonus shares (Rs.750 crores) is sufficient to issue bonus

shares (Rs.250 crores), the proposed issue can be made. 4. Other legal requirements for issue of bonus shares are as under.

(a) A resolution shall be passed by the board in a duly convened board meeting. (b) The bonus issue shall be made within 6 months of passing the board resolution.



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5. The bonus issue can be made if there is no default in payment of interest or principal in respect of fixed deposits and interest on existing debentures or principal on redemption there of; and Payment of statutory dues of the employees such as contribution to provident fund, gratuity, bonus, etc.

Pricing under Book-Building Process Question 29 XYZ Automobiles Ltd. intends to make a public issue of 2,00,00,000 equity shares of Rs. 10 each through the 100% book building process indicating a price band. You are required to answer the following with reference to the SEBI (Disclosure and Investor Protection) Guidelines:

(i) What is the price band that can be indicated in the red herring prospectus, if the floor price is proposed to be fixed at Rs. 300 per equity share?

(ii) What are the restrictions, if the company wants to revise the price band during the bidding period?

(iii) How the shares are to be allocated to different categories of investors like Qualified institutional buyers, Retail individual investors, etc.? (November 2006)

Answer Schedule XI of the SEBI (ICDR) Regulations, 2009 contains provisions relating to Book-Building process. Clause 8 (b) deals with the Floor Price and Price Band. According to the said clause where the issuer decides to opt for price band instead of floor price, the issuer shall also ensure compliance with the following conditions: 1. The cap of the price band should not be more than 20% of the floor of the band; i.e

cap of the price band shall be less than or equal to 120% of the floor of the price band.

2. The price band can be revised during the bidding period in which case the maximum revision on either side shall not exceed 20% i.e floor of price band can move up or down to the extent of 20% of floor of the price band disclosed in the red herring prospectus and the cap of the revised price band will be fixed in accordance with clause (i) above.

3. Any revision in the price band shall be widely disseminated by informing the stock exchanges, by issuing press release and also indicating the change on the relevant website and the terminals of the syndicate members.

4. In case the price band is revised, the bidding period shall be extended as per provisions of sub–regulation (2) of regulation 46.



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5. The manner in which the shortfall, if any, in the project financing, arising on account of lowering of price band to the extent of 20% will be met shall be disclosed in the red herring prospectus. It shal l a lso be disclosed that the allotment shall not be made unless the financing is tied up.

Accordingly, in the given problem (i) The price band that can be indicated in the red herring prospectus, if the floor

price is to be fixed at Rs. 300 per share will be 20% of the floor price ie. Rs.300 + 20% = Rs. 360 per share.

(ii) If the company wants to revise the price band during the bidding period, the maximum revision on either side shall not exceed 20% i.e floor of price band can move up or down to the extent of 20% of floor of the price and the cap of the revised price band shall not be more than 20% of the revised floor price band. In other words, on the lower side it can be down by Rs. 240 (300 – 20% = Rs. 260) and 360 being the revised price band – 20% = Rs. 288) and on the upper side, it can be Rs. 360 (Rs. 300 + 20%) and Rs. 432 (360 + 20%).

(iii) Any revision in the price band shall be widely disseminated by informing the stock exchanges, by issuing press release and also indicating the change on the relevant website and the terminals of the syndicate members. Regarding the period of subscription, Regulation 46 provides that a public issue shall be kept open for at least three working days but not more than ten working days including the days for which the issue is kept open in case of revision in price band. In case the price band in a public issue made through the book building process is revised, the bidding (issue) period disclosed in the red herring prospectus shall be extended for a minimum period of three working days, provided that the total bidding period shall not exceed ten working days.

(iv) As per Regulation 42, if an issue is made through book building process, the allocation to different categories of investors will be as follows:

o Not less than 35% to retail individual investors

o Not less than 15% to non-institutional investors

o Not less than 50% to qualified institutional buyers, five per cent. of which shall be allocated to mutual funds:

Question 30

A company proposes to make a public issue of equity shares for financing its project through book building process. It proposes to fix the floor price of the share at Rs.500 for a share of Rs. 10. Answer the following with reference to SEBI (Disclosure and Investor Protection) guidelines:



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What is the price band that may be indicated in the red herring prospectus? If the company wants to lower the floor price during the bidding period in order to increase the response to the issue, state the conditions subject to which such revision can be made.

(November, 2008) Answer The price band is the range within which the price can move. The cap of the price band shall not be more than 20% of the floor price. If the floor price is Rs.500 the cap of the price shall be Rs.600 and the company may indicate a price band of Rs.500 to 600 in the red herring prospectus (Schedule XI, Clause 8(b) SEBI (ICDR) Regulations, 2009.. The price band can be revised during the bidding period in which case the maximum revision on either side shall not exceed 20% i.e. floor of the price band can move up or down to the extent of 20% of the floor price. Hence the revised price band may be Rs. 400 ( Rs. 500 less 20%) to 480 (120% of Rs.400). Any revision in the price band shall be widely disseminated by informing the stock exchange, by issuing press releases and also indicating the change on the relevant website and terminals of syndicate members. The bidding period shall be extended for a further period of 3 days subject to the total bidding period not exceeding 10 days. The manner in which the shortfall, if any in the project financing arising on account of lowering of price band will be met shall be disclosed in the red- herring prospectus. It shall also be disclosed that the allotment shall not be made unless the financing is tied up. These are the conditions subject to which the price the price band may be lowered )


CHAPTER 2

THE SECURITIES CONTRACTS (REGULATION) ACT, 1956

Question 1 (a) (i) Delhi Stock Exchange wants to establish additional Trading Floor. Explain briefly

the meaning of and procedure for establishing additional Trading Floor.

(ii) Complaints of unethical practices have been received against members of the Governing Body of a Recognized Stock Exchange. Examine whether the Government has any power to take action against the Governing Body of the said exchange.

(b) The application filed by M/s XYZ Ltd. for the listing of its securities has been rejected by the Mumbai Stock Exchange. Advise the company regarding the steps it can take against the rejection. (November, 2002)

Answer (a) (i) According to Section 13 A of Securities Contracts (Regulation) Act 1956, a Stock

Exchange may establish additional trading floor with the prior approval of the Securities Exchange Board of India in accordance with the terms and conditions stipulated by the said Board.

For the purpose of this section 'Additional Trading Floor' means a trading ring or trading facility offered by a recognized stock exchange outside its area of operation to enable the investor to buy and sell securities through such trading floor under the regulatory frame work of that Stock Exchange.

(ii) Section 11, of the Securities Contracts (Regulation) Act, 1956 deals with the powers of the Central Government to supersede the Governing body of a recognized Stock Exchange. The Central Government may serve on a governing body a written notice specifying the reasons and after giving an opportunity to the governing body to be heard, may, by notification in the Official Gazette, declare the governing body as superseded. The Central Government after superseding the governing body may appoint any person or persons to exercise and perform all the powers and duties of governing body. It may also appoint one of such nominees as Chairman.



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(b) Yes XYZ Ltd. can appeal against refusal of stock exchange to list the securities. Section 22 of Securities Contracts (Regulation) Act 1956 deals with this. According to section:

where a recognized stock exchange refuses listing to a company, it has to furnish reasons for refusal to the company. Section 73(1) of the Companies Act, 1956 specifies the time period within which stock exchange has to grant listing permission. If exchange fails to do so within the time limit or refuses to list, the company may with in 15 days make an appeal to the Central Government. The Central Government may after hearing the Stock Exchange vary or set aside the decision of the Stock Exchange, or grant permission for listing.

However, no appeal under this section shall be allowed after the commencement of Securities Laws (Second Amendment) Act 1999 since appeal before Securities Appellate Tribunal is permitted under Section 22A.

Where a Stock Exchange refuses listing or is unable to grant listing within time frame prescribed, company is entitled to appeal to Securities Appellate Tribunal (SAT). SAT may, after hearing the exchange vary or set aside exchange's order or grant or refuse. (Section 22A).

Question 2 (a) M/s AB & Company, a member of a recognised stock exchange propose to buy and sell

shares of a particular company on behalf of investors as well as on their own account. They seek your advice as to restrictions, if any, under Securities Contracts (Regulation) Act, 1956 for dealing in securities on their own account. Advise.

(b) Rampur Stock Exchange wants to get itself recognize. Explain':

(i) Who enjoys the power to recognize stock exchange?

(ii) What information will have to be provided with the application for recognition? (May, 2003)

Answer (a) Members not to act as principals in certain circumstances: Members of stock exchange normally carry out transactions on behalf of investors and

hence principal agent relationship exists. A Member can enter into transaction as principal with another member of the Exchange only. If he desires to enter into contract as principal with a non-member, then he has to get written consent from such person to act as principal. Contract note should indicate that he is acting as principal [Section 15, Securities Contract (Regulation) Act, 1956].


The Securities Contracts (Regulation) Act, 1956

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Where the member has secured the consent of such person other wise than on writing he shall secure written confirmation by such person or such consent within three days from the date of the contract [Proviso to Section 15].

Spot delivery contracts are outside the preview of section 15 (Section 18). A & Co, stock broker must bear in mind the above restrictions while entering into any

transaction as principal with a non member. (b) (i) Power to recognize Stock Exchange vests with Central Government. However,

Central Government has delegated the powers to SEBI vide its notification No.F.No.1/57/SE/93 dated 13.9.94. (Section 3 of Securities Contracts (Regulation) Act, 1956).

(ii) Application for recognition must be accompanied with Bye-Laws, Rules, Regulations which must contain specific details on: 1. Constitution, powers of management and manner of transacting business

by the Governing Body of the Stock Exchange. 2. Powers and duties of the offer bearers of Stock Exchange. 3. Various classes of Members, qualification of membership and the

exclusion, suspension, expulsion and re-admission of members. 4. The procedure for registration of Partnerships as members to stock

exchange and rules of nomination of anthorised representatives. Membership provisions, composition of Board Powers of Governing Board are defined

in the Articles of the Exchange. Rules governing Listing Trading and Settlement, Penalties and Prohibitions, Disciplinary Actions and Defaults are defined in Bye-Laws of the Exchange.

Question 3 (a) Mr. Patel has transferred his shares of a listed company registered in his name to Mr.

Mehta. Mr. Mehta has failed to get the shares registered in his name before the company declared and paid the dividend on the shares. Examine with reference to the provisions of Securities Contracts (Regulation) Act, 1956 whether Mr. Patel is entitled to retain the dividend even though he has transferred the shares before declaration of dividend.

(b) SEBI is of the opinion that in the interest of investors it is desirable to amend the rules of XYZ Stock Exchange prohibiting the appointment of the broker-member as President of the stock exchange. Explain with reference to the provisions of the Securities Contracts (Regulation) Act, 1956 whether it is possible for SEBI to amend the rules of the Stock Exchange, if the rules are not amended by the stock exchange.

(November, 2003)



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Answer (a) Title to dividends: Section 27(1) of Securities Contracts (Regulation) Act, 1956

provides that a holder of security can legally receive and retain any dividend declared by the company even if he has transferred the security for valuable consideration. However, he (i.e. holder of security who is a transferor) cannot receive or retain the dividend if the transfer deed with all other documents required for transfer are lodged with the company within 15 days of the date on which the dividend became due.

The period of 15 days shall be extended as follows: - (1) In case of death of the transferee by the actual period taken by his legal representative to establish his claim to the dividend. (2) In case of loss of the transfer deed by theft or any other cause beyond the control of the transferee, by the actual period taken for the replacement thereof and (3) In case of delay in the lodging of any security and other documents relating to the transfer due to causes connected with the post, by the actual period of delay (Explanation to Section 27(1) of SCRA).

In view of the above, Mr. Patel is entitled to retain the dividend received by him if the transferee, Mr. Mehta has not lodged the transfer deed with the company within 15 days of the date on which the dividend became due or the extended period as per explanation to Section 27(1).

However, Section 27(1) will not affect the right of the transferee to enforce his rights, if any against the transferor or any other person, if the company refuses to register the transfer of security in the name of the transferee.

(b) Power of Central Government/SEBI to direct rules to be made or to make rules: Central Government is empowered under Section 8 of the Securities Contracts (Regulation) Act, 1956 to issue written order directing all or any of the recognized stock exchanges to make any rules or to amend any rules already made within 2 months from the date of the order in respect of matters specified in Section 3(2). One of the matters specified in Section 3(2) is the governing body of stock exchange, its constitution and powers of management and the manner in which its business is to be transacted. Hence, the Central Government is empowered to direct the Stock Exchange in respect of prohibition of broker-member being appointed as president of the stock exchange. According to the notification issued by the Central Government under Section 29A, this power is also exercisable by SEBI.

If any recognized stock exchange fails or neglects to comply with any order made by SEBI within 2 months, SEBI may itself make the rules made, either in the form prepared in the order or with such modifications thereof as may be agreed to between the stock exchange and SEBI. The amended rules should be published in the Gazette of India and also in the Official Gazette of the State in which the principal office of the



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recognized stock exchange is situate. After such publication, the rules will be valid, as if they had been made or amended by the stock exchange itself.

Hence SEBI can issue directions to the recognized stock exchange to amend the rules and if the said stock exchange does not take steps for amending the rules, SEBI may amend the rules on its own by following the procedure laid down in Section 8.

Question 4 (a) Securities and Exchange Board of India received serious complaints against the Affairs

of a Member of a Stock Exchange. Explain the powers of SEBI under Securities Contracts (Regulation) Act, 1956 to make enquiries and to take action, if necessary, against the member of a Stock Exchange.

(b) The governing body of City Stock Exchange Association Ltd. is desirous of putting various restrictions on voting rights of its members to be exercised in a meeting and on their right to appoint a proxy. You are required to state whether the same is permissible. Also state the role of Central Government in this respect. (May, 2004)

Answer (a) Disciplinary action against members of Stock Exchange: SEBI can exercise the

following powers under Securities Contracts (Regulation) Act, 1956 on receipt of serious complaints against the affairs of a member of a stock exchange. (i) SEBI may, if it is satisfied that it is in the interest of the trade or in the public

interest, by order in writing call upon the member of the stock exchange to furnish in writing information or explanation in respect of the matter under inquiry [Section 6(3)(a)].

(ii) SEBI instead of calling for information, may either appoint one or more persons to make an enquiry or direct the governing body of stock exchange to make inquiry and submit its report to SEBI [Section 6(3)(b)].

In case of adverse fundings, SEBI can direct stock exchange to take disciplinary action against the member such as fine, expulsion from membership, suspension from membership for a specified period and any other penalty of a like nature not involving the payment of money. Bye-laws of the stock exchange usually provide for such punishment [Section 9(3)(b)]. Stock exchange is under obligation to take the action as directed.

(b) As per Section 7A(1) of the Securities Contracts (Regulation) Act, 1956 a recognized stock exchange may make rules or amend any rules made by it in respect of voting rights of its members and also on appointment of proxy. The restrictions can be put in respect of the following matters:



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(a) The restriction of voting rights to the members only in respect of any matter placed before the stock exchange at any meeting.

(b) The regulation of any voting rights in respect of any matter placed before the stock exchange at any meeting so that each member may be entitled to have one vote only, irrespective of his share of the paid up equity capital of the stock exchange.

(c) The restriction on the right of a member to appoint another person as his proxy to attend and vote at a meeting of the stock exchange.

(d) Such incidental, consequential and supplementary matters as may be necessary to give effect to the matters as stated in (a), (b) and /or (c) above.

As per section 7(A)(2) of the said Act, the role of the Central Government in respect of the restriction placed by the stock exchange as stated above is as follows: (i) Approval of the proposed changes by the stock exchange. (ii) Publishing the same in the Official Gazette. (iii) To make such modification in the proposed changes as it deems fit.

Question 5 The Rural Electrification Corporation, New Delhi issued 6 years bonds to public directly and not through any Stock Exchange. Whether the Rural Electrification Corporation can do so? Is it not a violation of Securities Contracts (Regulation) Act, 1956? (November, 2004) Answer In order to prevent undesirable transactions in securities and to promote healthy stock market, the Securities Contract (Regulation) Act, 1956 was enacted. Stock Exchanges are recognized under the Act. Section 73 of the Companies Act, 1956 lays down that offer of shares or debentures to public for subscription shall be only after the permission of the Stock Exchange. Section 28 of the Securities Contract (Regulation) Act, 1956 says that the provisions of the Act shall not apply to the Government, the Reserve Bank of India, any local authority or any corporation set-up by a special law or any person who has effected any transaction with or through the agency of any such authority as stated above. The Rural Electrification Corporation is a corporation established under a special statute enacted by the Parliament. Therefore, the Corporation need not require permission of any Stock Exchange. It is exempted. There is no violation of the provisions of the Act of 1956 because according to section 28 provisions are not applicable to this corporation. Question 6 Working of City Stock Exchange Association Ltd., is not being carried on by its Governing Board in public interest. On receipt of representations from various Investors and Investors’



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Association, the Central Government is thinking to withdraw the recognition granted to the said Stock Exchange. You are required to state the circumstances and procedure for withdrawal of such recognition as per the provisions of Securities Contracts (Regulation) Act, 1956 in this regard. Also state the effect of such withdrawal on the contracts outstanding on the date of withdrawal. (May 2005) Answer Section 5 of the Securities Contracts (Regulation) Act, 1956 empowers the Central government to withdraw the recognition granted to a Stock Exchange. The circumstances and procedure to be followed for withdrawal of such recognition is stated below: (i) If, considering the interest of the trade or the public interest, the Central Government is

of the opinion that the recognition granted to a stock exchange should be withdrawn, the Central Government shall serve a written notice of the governing body of the stock exchange.

(ii) The said notice shall specify the reasons for the proposed withdrawal of the recognition.

(iii) The governing body of the stock exchange shall be afforded an opportunity of being heard by the Central Government.

(iv) Even after hearing the governing body, the Central Government is satisfied that the recognition granted to the stock exchange should be withdrawn, the Central Government may, by way of a notification in the Official Gazette, withdraw the recognition granted to the stock exchange.

The proviso to the said section 5 states that no such withdrawal shall affect the validity of any contract entered into or made prior to the date of notification withdrawing the recognition and the Central Government may, after consultation with the stock exchange, make such provision as it deems fit in the notification of withdrawal or in any subsequent notification for the due performance of any contracts outstanding on that date. Question 7 Delhi Stock Exchange has refused to grant listing of the shares of ABC Limited but the Exchange has not disclosed any reason therefore. The company wants to challenge the decision of the Stock Exchange in the Civil Court. Advise the company pursuant to relevant provisions of the Securities Contracts (Regulation) Act, 1956. (May 2005) Answer Under section 22A of the Securities Contracts (Regulation) Act, 1956 where a recognised Stock Exchange refuses to list the securities of any public company, the company shall be entitled to be furnished with reasons for such refusal. If aggrieved, the company may appeal to the Securities Appellate Tribunal:



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(i) within 15 days from the date on which the reasons for such refusal are furnished to it, or

(ii) where the Stock Exchange has omitted or failed to dispose of within the time specified in section 73(1A) of the Companies Act, 1956 (i.e., before the expiry of ten weeks from the date of closing of the subscription list as per prospectus) within 15 days from the expiry of the specified time or within such further period not exceeding one month as Securities Appellate Tribunal may allow.

In terms of section 22E of the Act, Civil Court has no jurisdiction to entertain any suit in respect of this matter.

The company may be advised accordingly. Question 8 Describe the provisions of the Securities Contracts (Regulation) Act, 1956 regarding the powers of the Central Government to supersede the Governing Body of a recognized Stock Exchange and the consequences of such supersession. (November 2005) Answer According to the provisions of section 11 of the Securities Contracts (Regulation) Act, 1956, where the Central Government is of opinion that the governing body of any recognized stock exchange should be superseded, then notwithstanding any thing contained in any other law for the time being in force, the Central Government may serve on the governing body a written notice that the Central Government is considering the supersession of the governing body for the reasons specified in the notice. After giving an opportunity to the governing body of such Stock Exchange to be heard in the matter, the Central Government may, by notification in the Official Gazette, declare the governing body of such Stock Exchange to be superseded. The Central Government may appoint any person or persons to exercise and perform all the powers and duties of the governing body. If more than one person is so appointed, one of them may be the Chairman and another as the Vice-Chairman. Such person or persons shall hold office for such period as may be specified in the Notification and the Central Government may vary such period by way of another Notification. On the publication of the notification in the Official Gazette, following are the consequences: (i) The members of the governing body of such Stock Exchange ceases to hold office as

such members on and from the date of notification. (ii) The person or persons appointed by the Central Government may exercise and perform

all the powers and duties of the governing body which has been so superseded.



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(iii) The property of the Stock Exchange as deemed necessary and so specified in writing by such person or persons to carry on the business of the Stock Exchange shall vest in such person or persons.

Question 9 (i) Delhi Stock Exchange wants to establish additional trading floor. Advise.

(ii) Complaints of unethical practices have been received against members of a recognized Stock Exchange by the Government. Examine whether the government has any power to suspend the business of such a recognized Stock Exchange. (November 2005)

Answer (i) According to Section 13A of Securities Contracts (Regulation) Act, 1956, a Stock

Exchange may establish additional trading floor with the prior approval of the Securities Exchange Board of India with the terms and conditions stipulated by the said Board. ‘Additional Trading Floor’ means a trading facility offered by a recognized stock exchange outside its area of operation to enable the investors to buy and sell securities through such trading floor under the regulatory frame work of that Stock-Exchange.

(ii) Section 12 of the Securities Contracts (Regulation) Act, 1956 deals with the powers of the Central Government to suspend business of recognized Stock Exchange. Central Government, if it deems fit, is vested with power to suspend business for a period not exceeding 7 days by notification in Gazette. Central Government also have power to extend this period by a like notification. However, such power can be exercised by the Central Government, if it is of opinion that an emergency has arisen and it is expedient so to do.

Question 10 On 31st March, 2006 D holds certain securities issued under ‘Collective Investment Scheme.’ His name appears in the books of the scheme. He has transferred these securities to another person for a consideration. The transferee lodged the instrument of transfer with the authorities one month after the date on which the income on these securities became due. Examining the provisions of the Securities Contracts (Regulation) Act, 1956 state:

(i) Whether D is entitled to receive and retain the income on these securities for the financial year ended 31st March, 2006 in the given case?

(ii) Would your answer be still the same in case the transferee lodged the instrument of transfer with the authorities 14 days after the date on which the income on these securities became due? (May 2006)



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Answer Transfer of securities under Collective Investment Scheme under the Securities Contracts (Regulation) Act, 1956 (Section 27A) Problem as asked in the question is based on the provisions of Section 27A of the Securities Contracts (Regulation) Act, 1956, wherein it shall be lawful for the holder of any securities, being units or the other instruments issued by collective investment scheme, whose name appears on the books of the scheme, issuing the said security to receive and retain any income in respect of units issued by the scheme in respect thereof for any year, notwithstanding that the said security, being units issued by the scheme, has already been transferred by him for consideration, unless the transferee who claims the income in respect of units issued by the scheme from the transferor has lodged the security and all other documents relating to the transfer which may be required by the scheme with the scheme for being registered in his name within 15 days of the date on which the income in respect of units or other instruments issued under the scheme became due. The period of 15 days can be extended in certain contingencies as stated in Explanation to Section 27A(1). Applying the above provisions in the given case: (i) the holder of securities (i.e. D, the transferor) has right to receive or retain the income

on these securities for the financial year ended 31st March, 2006, since the instrument for transfer was lodged one month after the date on which the income became due.

(ii) The answer in the second case would differ. The holder (i.e. D, the transferor) cannot receive and retain the income since the instruments for transfer was lodged with the company within the statutory period of 15 days by the transferee.

Question 11 The Executive Committee of a recognized Stock Exchange desires to transfer certain duties and functions of a clearing house to a recently set up Clearing Corporation, incorporated as a company under the Companies Act, 1956. Examining the provisions of the Securities Contracts (Regulation) Act, 1956: (i) State the purpose for which such transfer of duties and functions can be made to

Clearing Corporation. (ii) What is the procedure to be adopted for such transfer of duties and functions?

(May 2006) Answer Transfer of certain duties and functions of a clearing house by a stock exchange to clearing corporation under the Securities Contracts (Regulation) Act, 1956 (Section 8A)



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Purposes: A recognized stock exchange may, with the prior approval of the Securities and Exchange Board of India, transfer the duties and functions of a clearing house to a clearing corporation, being a company incorporated under the Companies Act, 1956 for the purpose of: (i) the periodical settlement of contracts and differences thereunder, (ii) the delivery of, and payments for, securities; (iii) any other matter incidental to, or connected with, such transfer. Procedure: 1. Every clearing corporation shall for the purpose of transfer of the duties and functions

of a clearing house to clearing corporation make bye-laws and submit the same to the SEBI for approval.

2. The SEBI may, on being satisfied that it is in the interest of the trade and also in the public interest to transfer the duties and functions of a clearing house to a clearing corporation, grant approval to the bye-laws submitted to it under sub-section (2) and approve transfer of the duties and functions of a clearing house to a clearing corporation.

3. The provisions of Sections 4 to 12 shall, as far as may be, apply to a clearing corporation as they apply in relation to a recognized stock exchange.

Question 12 The shares of MLM Ltd. were listed in Cochin Stock Exchange. The stock exchange delists the shares of the company. The aggrieved company approaches you to know the remedy available to the company. Give your suggestion to the company keeping in view the provision of the Securities Contracts (Regulation) Act, 1956. (November 2006) Answer Section 21A of Securities Contracts (Regulation) Act, 1956 contains the provision relating to delisting of securities. As per this section (1) A recognized Stock Exchange may delist the securities after recording reasons therefor

from any recognized stock exchange on any ground or grounds as may be prescribed under this Act.

(2) The Securities of a company shall not be delisted unless the company concerned has been given a reasonable opportunity of being heard.

(3) A listed company may file an appeal before the Securities Appellate Tribunal (SAT) against the decision of the recognized stock exchange delisting the securities within



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fifteen days from the date of the decision of recognized stock exchange delisting the securities.

(4) Securities Appellate Tribunal may, if it is satisfied that the company was prevented by sufficient cause from filing the appeal within the said period, allow it to be filed within a further period of not exceeding one month.

So here, the company may make an appeal to the Securities Appellate Tribunal against the delisting within fifteen days or such extended period not exceeding one month after showing sufficient cause of not filing within fifteen days. Question 13 Explain the powers, which can be exercised by the Securities and Exchange Board of India under the Securities Contracts (Regulation) Act, 1956, while approving the schemes for corporatisation and demutualization submitted by recognized stock exchanges, so that there is segregation of ownership and management from the trading rights of members of such stock exchanges. (November 2006) Answer Corporatisation and Demutalisation – Power of SEBI under SCRA, 1956 SEBI has been empowered under sub-section (2) of Section 4B of Securities Contracts (Regulation) Act, 1956 to approve the scheme of corporatisation and demutalisation with or without modification. SEBI can reject the proposed scheme if it is satisfied that it would not be in the interest of the trade and also in the public interest to approve the scheme. Besides these general powers, SEBI has got certain specific powers under Section 4B(6). SEBI, while approving the scheme, may, by an order in writing restrict (a) the voting rights of the shareholders who are also stock-brokers of the recognized stock

exchange. (b) the right of shareholders in a stockbroker of the recognized stock exchange to appoint

the representatives on the governing board of the stock exchange. (c) the maximum number of representatives of the stock-broker of the recognized stock

exchange to be appointed on the governing board of the stock exchange shall not exceed one-forth of the total strength of the governing body.

On receipt of approval of scheme, stock exchange will issue shares to public within 12 months so that at least 51% equity shares are with public other than shareholders having trading rights. SEBI can extend the period upto another 12 months [Section 4B(8)]. Question 14 Describe the provisions of the Securities Contracts (Regulation) Act, 1956 regarding the powers of the Central Government to supersede the Governing Body of a recognized Stock Exchange and the consequences of such supersession. (May 2007)



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Answer In accordance with the provisions of Section 11 of the Securities Contracts (Regulation) Act, 1956, where the Central Government is of opinion that the governing body of any recognized stock exchange should be superseded, then notwithstanding anything contained in any other law for the time being in force, the Central Government may serve on the governing body a written notice that the Central Government is considering the supersession of the governing body for the reasons specified in the notice. After giving an opportunity to the governing body of such Stock Exchange to be heard in the matter, the Central Government may, by notification in the Official Gazette, declared the governing body of such Stock Exchange to be superseded. The Central Government may appoint any person or persons to exercise and perform all the powers and duties of the governing body. If more than one person is so appointed, one of them may be the Chairman and another as the Vice-chairman. Such person shall hold office for such period as may be specified in the Notification and the Central Government may vary such period by way of another Notification. On the publication of the notification in the Official Gazette, following are the consequences: (i) the members of the governing body of such Stock Exchange ceases to hold office as

such members on and from the date of notification. (ii) The person or persons appointed by the Central Government may exercise and perform

all the powers and duties of the governing body which has been so superseded. (iii) The property of the Stock Exchange as deemed necessary and so specified in writing

by such person or persons to carry on the business of Stock Exchange shall vest in such person or persons.

Question 15 SEBI is of the opinion that in the interest of investors, it is desirable to amend the rules of RSP Stock Exchange prohibiting the appointment of the broker-member as President of the Stock Exchange. Explain briefly with reference to the provisions of Securities Contracts (Regulation) Act, 1956, whether it is possible for SEBI to amend the rules of the Stock Exchange, if the Stock Exchange does not change the rules. (May 2007) Answer In accordance with the provisions of section 8 of Securities Contracts (Regulation) Act, 1956, The Central Government is empowered to issue written order directing all or any of the recognized stock exchange to make any rules or to amend any rules already made within two months from the date of the order in respect of matters specified in section 3(2) of the said Act. One of the matters specified in the said section 3(2) is the governing body of stock



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exchange, its constitution and powers of management and the manner in which its business is to be transacted. Hence, the Central Government is empowered to direct the stock exchange in respect of prohibition on broker-member being appointed as President of the stock exchange. According to notification issued by Central Government under section 29A of the said Act, this power is also exercisable by SEBI. If any recognized stock exchange fails or neglects to comply with any order made by SEBI with in two months, SEBI may itself make the rules or amend the rules made by stock exchange either in the form proposed in the order or with such modification thereof as may be agreed to between SEBI and the stock exchange. The amended rules are required to be notified in the Gazette of India and in the Gazette of the State where the principal office of the stock exchange is situated. After such publication, the rules shall be valid as if the same were made or amended by the recognized stock exchange itself. Accordingly of the above provisions of Securities Contracts (Regulation) Act, 1956, SEBI can issue directions to RSP Stock Exchange to amend the rules and if the said stock exchange does not comply with the above, SEBI can amend the rules on its own. Question 16

PQR Ltd. is holding 33% of the paid up equity capital of Koya Stock Exchange. The company appoints MNL Ltd. as its proxy who is not a member of the Koya Stock Exchange, to attend the vote at the meeting of the stock exchange. Examine whether the Koya Stock Exchange can restrict the appointment of MNL ltd. as proxy for PQR Ltd. and further restrict, the voting rights of PQR Ltd. in the Koya Stock Exchange. (November 2007) Answer Section 7(a) of the Securities (Contracts) Regulation Act, 1956 provides that a recognised stock exchange is empowered to amend rules to provide for all or any of the following matters: (a) Restriction of voting right to members only. (b) Regulation of voting rights by specifying that each member is entitled to one vote only

irrespective of number of shares held. (c) Restriction on right of members to appoint proxy. As such Koya Stock Exchange can restrict the appointment of MNL Ltd., as proxy, if rules of the exchange so provide. If it is not so provided, rules may be amended and after getting approval of the Central Government regarding amendment, it can restrict appointment of proxies. Koya Stock Exchange can also restrict the voting rights of PQR Ltd. as proxy if rules of the exchange so provide. If it is not so provided, rules maybe amended and after getting approval of Central Government regarding amendment, it can restrict appointment of proxies. Koya Stock Exchange can also restrict the voting rights of PQR Ltd.



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Question 17 Working of City Stock Exchange Association Ltd., is not being carried on by its governing Board in public interest. On receipt of representations from various investors and Investors’ Association, the Central government is thinking to withdraw the recognition granted to the said Stock Exchange. You are required to state the circumstances the procedure for withdrawal of such recognition as per the provisions of Securities Contracts (Regulation) Act, 1956 in this regard. Also state the effect of such withdrawal on the contracts outstanding on the date of withdrawal. (May 2008) Answer Section 5 of the Securities Contracts (Regulation) Act, 1956 empowers the Central Government to withdraw the recognition granted to a stock exchange. The circumstances and procedure to be followed for withdrawal of such recognition is stated below (i) if considering the interest of the trade or the public interest, the Central government is

of the opinion that the recognition granted to a stock exchange should be withdrawn, the Central Government shall serve a written notice on the governing body of the stock exchange.

(ii) The said notice shall specify the reasons for the proposed withdrawal of the recognition.

(iii) The governing body of the stock exchange shall be afforded an opportunity of being heard by the Central Government.

(iv) Even after hearing the governing body, the Central Government is satisfied that the recognition granted to the stock exchange should be withdrawn; the Central Government may, by way of a notification in the Official Gazette, withdraw the recognition granted to the stock exchange.

The proviso to the said section 5 states that no such withdrawal shall affect the validity of any contract entered into or made prior to the date of notification withdrawing the recognition and the Central Government may, after consultation with the stock exchange, make such provision as it deems fit in the notification of withdrawal or in any subsequent notification for the due performance of any contracts outstanding on that date. Question 18 The Executive Committee of a recognized stock exchange desires to transfer certain duties and functions of a clearing house to a recently set up clearing corporation, incorporated as a company under the companies Act,1956, examining the provisions of The Securities Contract (Regulation) Act, 1956. State the purposes for which such transfer of duties and functions can be made to clearing corporation. What is the procedure to be adopted for such transfer of duties and functions?

(November 2008)



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Answer A recognized stock exchange may, with the prior approval of the Securities Exchange Board of India, transfer the duties and functions of a clearing house to a clearing corporation, being a company incorporated under the Companies Act, 1956 for the purpose of: (a) The periodical settlement of contracts and differences there under (b) The delivery of, and payment for, securities; (c) Any other matter incidental to, or connected with, such transfer PROCEDURE Every clearing corporation shall for the purpose of transfer of the duties and functions of a clearing house to clearing corporation, make byelaws and submit the same to the SEBI for approval. The SEBI may, on being satisfied that it is in the interest of the trade and also in the public interest to transfer the duties and functions of the clearing house to a clearing corporation, grant approval to the byelaws submitted to it under sub-section (2) of Section 8A of the Securities Contracts (Regulation) Act, 1956 and approve transfer of the duties and function of a clearing house to a clearing corporation. The provision of Sections 4 to 12 of the said act shall as far as may be apply to a clearing corporation as they apply in relation to a recognized stock exchange. Question 19 Mr. Bansal holds certain securities on 31st March, 2008, issued in his favour under the “Collective Investment Scheme.” For a consideration, Mr. Bansal transferred the said securities in favour of another person. One month after the date on which the income on these securities became due, the transferee lodged the instrument of transfer. Decide in the light of the provisions of the Securities Contracts (Regulation) Act, 1956.

(i) Whether in the given case Mr. Bansal is entitled to receive and retain the income on these securities for the financial year ended 31st March, 2008?

(ii) What would be your answer in case the transferee lodged the instrument of transfer 10 days after the date on which the income on these securities became due?

(November 2008) Answer TRANSFER OF SECURITIES: The problem as asked in the question is based on the provisions of Section 27A of the Securities contracts (Regulation ) Act, 1956, wherein it shall be lawful for the holder of any securities, being units or the other instruments issued by collective investment scheme, whose



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name appears on the books of the scheme, issuing the said security to receive and retain any income in respect of units issued by the scheme in respect thereof for any year, notwithstanding that the said security, being units issued by the scheme, has already been transferred by him for consideration, unless the transferee who claims the income in respect of units issued by the scheme from the transferor has lodged the security and all other documents relating to the transfer which may be required by the scheme with the scheme for being registered in his name within 15 days of the date on which the income in respect of units or other instruments issued under the scheme become due. The period of 15 day can be extended in certain contingencies as stated in explanation to Section 27A (1) of the said Act. Thus, (i) the holder of the securities i.e Mr. Bansal, the transferor has right to receive or retain

the income of the said securities for the financial year ended 31st March 2008, since the instrument for transfer was lodged one month after the date on which the income became due.

(ii) the answer in the second case would differ. The holder i.e. Mr. Bansal, the transferor can not receive and retain the income since the instrument for transfer was lodged with the company within the statutory period of 15 days by the transferee. Accordingly the transferee would be entitled to receive the income on these securities.

Question 20 M/s Goyanka & Company, which is a member of a recognised stock exchange desire to buy and sell shares of Crossroads Company Limited on their own count as well as on behalf of investors. Advise M/s Goyanka & Company whether there are any restrictions for dealing in securities on their own count under the provisions of the Securities Contracts (Regulation) Act, 1956. (May 2009) Answer SHARE TRANSACTIONS BY MEMBERS OF STOCK EXCHANGE AS PRINCIPALS: Members of stock exchange normally carry out transactions on behalf of investors and hence principal and agent relationship exists between them. A member can enter into transaction as principal with another member of the exchange only. If a member of stock exchange desires to enter into contract as principal with a non member then he has to get written consent from such person to act as principal. The contract note should indicate that he is acting as principal. (Section 15 of the Securities Contracts (Regulation) Act, 1956). Where the member has obtained the consent of such person otherwise than in writing he shall secure written confirmation by such person or such consent within three days from the date of such contract.



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However, such written consent of such person is not necessary for closing outstanding contract entered into by such person in accordance with the bye-laws, if the member discloses in the note, memorandum or agreement of sale or purchase in respect of such closing out that he is acting as principal. Spot delivery contracts are not within the purview of section 15 of the said Act. (Section 18). Thus M/s Goyanka & Company working as stock broker must bear in mind the above restrictions while entering into any transaction as principal with a non – member Question 21 The Mewar Rural Financial Corporation, Udaipur, established under a special statute issued 5 years bonds to public directly and not through any Stock Exchange. Decide whether the said act of the Mewar Rural Financial Corporation is in violation of the provisions of the Securities Contracts (Regulation) Act, 1956. (May 2009) Answer DIRECT ISSUE OF BONDS BY CORPORATION: In order to prevent undesirable transactions in securities and to promote healthy stock market, the Securities Contracts (Regulation) Act, 1956 was enacted. Stock Exchanges are recognised under the Act. Section 73 of the Companies Act, 1956 lays down that offer of shares and debentures to public for subscription shall only be made after obtaining the permission of the stock exchange. Section 28 of the Securities Contracts (Regulation) Act, 1956 lays down that the provisions of the Act shall not apply to the Government, Reserve Bank of India, any local authority or any corporation set up by a special law or any person who has effected any transaction with or through the agency of any such authority as stated above. As given in the question, the Mewar Rural Financial Corporation is a corporation established under a special statute enacted by competent legislature. Therefore, the said corporation need not require to seek permission of any stock Exchange for the said purpose because it is exempted from the requirement given in the legislation. There is no violation of the provisions of the Securities Contracts (Regulation) Act, 1956 because the provisions of Section 28 of the said act are not applicable to the said corporation. Question 22 Industrial Finance Corporation of India, established under the Industrial Finance Corporation Act, 1948 having its registered office at Mumbai issued 8% Redeemable Bonds redeemable after 7 years. These bonds were issued directly to the members of the public and not through mechanism of Stock exchanges.



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You are required to state with reference to the provisions of Securities Contracts (Regulation) Act, 1956, whether such direct issue of bonds by the Industrial Finance Corporation of India is not violating the provisions of the said Act. (CA Final, New Course, (May 2009) Answer In order to prevent undesirable transactions in securities and to promote healthy stock market, the Securities Contracts (Regulation) Act, 1956 was enacted and all the Stock Exchanges in the country are registered under this Act. Section 73 of the Companies Act, 1956 states that offer of shares or debentures to public for subscription shall be made only after the permission of a Stock exchange. Section 28(1) of the Securities Contracts (Regulation) Act, 1956 states that the provisions of this Act shall not apply to the Government, the Reserve Bank of India, any local authority, or corporation set up by a special law or any person who has effected any transaction with or through the agency of any such authority as stated earlier. As stated in the question Industrial Finance Corporation of India is a corporation set up under the Industrial Finance Corporation Act, 1948. i.e. under a special statue enacted by the Parliament Therefore, this Corporation does not need any permission from a Stock Exchange to issue any Bond or other securities. Accordingly, it has not violated the provisions of the Securities Contracts (Regulation) Act, 1956. The nature and tenure of the Bonds are immaterial. Question 23 (a) A stock exchange desirous of taking over another stock exchange, seeks your advice on

corporatisation. Examining the provisions of the Securities Contracts (Regulation) Act, 1956 and the meaning of the terms ‘corporatisaton’ and ‘demutualisation’, advise the stock exchange about the steps to be taken to give effect to the scheme of corporatisation.

(b) Mr. Veer a newly entered investor in the field of securities business seeks your advice on the investments to be made in securities of large Companies for long term purposes. With this object in view, he wants to know the meaning of the following terms commonly used in any stock exchange. (i) Derivative (ii) Option in securities (iii) Spot delivery contract. Advise suitably. (November, 2009)

Answer (a) CORPORATISATION & DEMUTUALISATION OF STOCK EXCHANGES Corporatisation’ means the succession of a recognized stock exchange, being a body of individuals or a society registered under the Societies Registration Act, 1860, by another stock exchange,



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being a Company incorporated for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities carried on by such individuals or society ‘Demutualisation’ means the segregation of ownership and management from the trading rights of the members of a recognized stock exchange in accordance with a scheme approved by the SEBI. Steps for Corporatisation and Demutualization [Section 4B - Securities Contracts (Regulations) Act, 1956] In accordance with the provisions of the Securities Contracts (Regulation) Act, 1956, as contained in Section 4B: 1. All recognized stock exchanges referred to in Section .4A shall, within such time as may be

specified by the SEBI submit a scheme for corporatisation and demutualization for its approval.

2. On receipt of the scheme, the SEBI may, after making such enquiry as may be necessary in this behalf and obtaining such further information, if any, as it may require and if it is satisfied that it would be in the interest of the trade and also in the public interest, approve the scheme with or without modification.

3. No scheme shall be approved by the SEBI if the issue of shares for a lawful consideration or provision of trading rights in lieu of membership card of the members of a recognized stock exchange or payment of dividends to members have been proposed out of any reserves or assets of that stock exchange.

4. Where the scheme is approved, the scheme so approved shall be published immediately by- (a) The SEBI in the Official Gazette (b) The recoginised Stock Exchange in such two daily newspapers circulating in India,

as may be specified by the SEBI, and upon such publication, notwithstanding anything to the contrary contained in this Act or any other law for the time being in force or any agreement, award, judgment, decree or other instrument for the time being in force, the scheme shall have effect and be binding on all persons and authorities including all members, creditors, depositors and employees of the recognized stock exchange and on all persons having any contract, right, power, obligation or liability with, against, over, to, or in connection with, the recognized stock exchange or its members.

5. Where the SEBI is satisfied that it would not be in the interest of the trade and also in the public interest to approve the scheme, it may, by an order, reject the scheme and such order of rejection shall be published by it in the Official Gazette. SEBI shall give a reasonable opportunity of being heard to all the persons concerned and the recognized stock exchange concerned before passing an order rejecting the scheme.



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6. SEBI may, while approving the scheme by an order in writing, restrict - (a) the voting rights of the shareholders who are stock brokers of the recognized stock

exchange. (b) the right of shareholders or a stock broker of the recognized stock exchange to

appoint the representatives on the governing board or the stock exchange. 7. The order made by SEBI shall be published in the Official Gazette and on the publication

thereof, the order, notwithstanding anything to the contrary contained in the Companies Act,1956. or any other law for the time being in force, have full effect.

8. Every recognized stock exchange, in respect of which the scheme for corporatisation or demutualization has been approved shall either by fresh issue of equity shares to the public or in any other manner as may be specified by the regulations made by SEBI, ensure that at least 51% of its equity share capital is held, within 12 months from the date of publication of the order by the public other than shareholders having trading rights. The SEBI may, on sufficient cause being shown to it and in the public interest, extend the said period by another 12 months. (a) Mr. Veer, a new investor, desirous of entering investments business in any Stock

Exchange, can be advised on different terms commonly used in any Stock Exchange.

(i) DERIVATIVE: Derivative includes –

(a) a security derived from a debt instrument, share, loan whether secured or unsecured risk instrument or contract for differences or any other form of security.

(b) a contract, which derives its value from the prices or index of prices, of underlying securities.

(ii) OPTION IN SECURITIES: Option in Securities means a contract for the purchase or sale of a right to buy or sell or a

right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call securities.

(iii) SPOT DELIVERY CONTRACT Spot delivery contract means a contract which provides for:

(i) actual delivery of securities and the payment of a price therefore either on the same day as the date of the contract or on the next day, the actual period taken for the dispatch of the securities or the remittance of money therefore through the post



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being excluded from the computation of the period aforesaid if the parties to the contract do not reside in the same town or locality.

(ii) transfer of the securities by the depository from the account of a beneficial owner to the account of another beneficial owner when such securities are dealt with by a depository.

Question 24 (a) MNC Limited whose shares are listed on a recognized Stock Exchange, are delisted by

the Stock Exchange. The company seeks your advise on the remedies available to the company against the order of the Stock Exchange. Referring to the provisions of the Securities Contracts (Regulation) Act, 1956, advise the company.

(b) Referring to the provisions of the Securities Contracts (Regulation) Act, 1956:

(i) Examine the extent to which the Central Government is empowered to suspend business of a recognized Stock Exchange.

(ii) The Central Government has granted recognition to a Stock Exchange. To what conditions may such a recognition be subject to? (May, 2010)

Answer (a) Section 21A of the Securities Contracts (Regulation) Act, 1956 describes the provisions

regarding delisting of securities by a recognised stock exchange. (1) A recognized stock exchange may delist the securities, after recording the

reasons therefore, from any recognized stock exchange on any of the ground or grounds as may be prescribed under this Act: Provided that the securities of a company shall not be delisted unless the company concerned has been given a reasonable opportunity of being heard.

(2) A listed company or an aggrieved investor may file an appeal before the Securities Appellate Tribunal against the decision of the recognized stock exchange delisting the securities within fifteen days from the date of the decision of the recognized stock exchange delisting the securities and the provisions of sections 22B to 22E of this Act shall apply, as far as may be, to such appeals; Provided that the Securities Appellate Tribunal may, if it is satisfied that the company was prevented by sufficient cause from filing the appeal within the said period, allow it to be filed within a further period not exceeding one month. MNC Ltd. may be advised accordingly.

(b) (i) Power of the Central Government to suspend business at a Stock Exchange: Section 12, Securities Contracts (Regulations) Act, 1956. If in the opinion of the Central Government an emergency has arisen and for the



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purpose of meeting of the emergency the Central Government considers it expedient so to do, it may, by Notification in the Official Gazette, for reasons to be set out therein, direct a recognized stock exchange to suspend such of its business for such period not exceeding 7 days and subject to such conditions as may be specified in the notification, and if in the opinion of the Central Government the interest of the trade or the public interest requires that the period should be extended, may, by like notification extend the said period from time to time. Provided that where the period of suspension is to be extended beyond the first period, no notification extending the period of suspension shall be issued unless the Governing Body of the recognized Stock Exchange has been given an opportunity of being head in the matter.

(ii) Grant of recognition to stock exchanges - Conditions: Section 4(2), SCR, Act, 1956 The conditions may include, condition relating to: (1) qualification for Membership of the Stock Exchange. (2) manner in which contracts shall be entered into and enforced as between

members. (3) representation of the Central Government. on the Stock Exchange (not

exceeding 3 nominated by the Central Government.) (4) maintenance of Accounts of members and their audit by Chartered

Accountants wherever audit is required by the Central Government.


CHAPTER 3

THE FOREIGN EXCHANGE MANAGEMENT ACT, 1999

Question 1 Explain the meaning of the term “Current Account Transaction” and the right of a citizen to obtain Foreign Exchange under the Foreign Exchange Management Act, 1999. (May, 2001) Answer The term “current account transaction” is defined in Section 2(j) of Foreign Exchange Management Act, 1999. It means a transaction other than a capital account transaction and includes: (i) payments due in connection with foreign trade in the ordinary course of business. (ii) payments due as interest on loans and as net income from investments. (iii) remittances for living expenses of parents, spouse and children residing abroad and (iv) expenses in connection with foreign travel education and medical care of parents,

spouse and children. According to Section 5 of FEMA, 1999 any citizen may sell or draw foreign exchange to or from an authorised person if such sale or drawl is a current account transaction. Provided that the Central Government may in public interest and in consultation with the Reserve Bank, impose such reasonable restrictions for current account transactions as may be prescribed. Further, any person may sell or draw foreign exchange to or from an authorised person for a capital account transaction subject to the provisions of section 6(2). Question 2 Mr. X, an Indian national has failed to realise and repatriate foreign exchange worth more than Rs.2 crores. Mr. X having realised that he had committed a contravention of the provisions of the Foreign Exchange Management Act, 1999, desires to compound the said offence. Advise Mr. X. (November, 2001) Answer Because of his failure to realise and repatriate foreign exchange, Mr. X has contravened the provisions of section 8 of FEMA and he is liable to the penalties leviable under Section 13,



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followed by adjudication proceedings. Section 15 of FEMA permits the offending party to compound the contravention within 180 days from the date of receipt of application by the Director of Enforcement or such other officers of the Directorate of Enforcement and officers of the Reserve Bank of India as may be authorised in this behalf by the Central Government in such manner as may be prescribed. No contravention shall be compounded unless the amount involved in such contravention is quantifiable. Where a contravention has been compounded, no proceeding can continue or be initiated against the person in respect of the contravention so compounded. Question 3 Mr. G., an Indian national desires to obtain Foreign Exchange on current account transactions for the following purposes:

(i) Payment of commission on exports made towards equity investment in wholly owned subsidiary abroad of an Indian Company.

(ii) Remittance of hiring charges of transponder.

(iii) Remittance for use of trade mark in India.

Advise G whether he can obtain Foreign Exchange and, if so, under what conditions? (November, 2001)

Answer

Under Section 5 of Foreign Exchange Management Act, 1999, certain rules have been framed for drawal of foreign exchange on current account. According to the said rules, drawal of foreign exchange for certain transactions are prohibited. In respect of certain transactions drawal of foreign exchange is permissible with the prior approval of Central Government. In respect of some of the transaction, prior permission of RBI is sufficient for drawal of foreign exchange.

(i) In respect of item No.1 i.e. Payment of Commission on exports made towards equity investment in wholly owned subsidiary abroad of an Indian company is prohibited.

(ii) Drawal of foreign exchange for remittance of hiring charges of transponder, can be made with the prior approval of the Central Government.

(iii) So far as remittance for use of Trade Mark in India is concerned, the necessary foreign exchange can be obtained with the prior permission of the Reserve Bank of India.

In the case of (ii) & (iii) above, approval of concerned authority is not required if the payment is made out of funds held in Resident Foreign Currency (RFC) Account or Exchange Earner’s Foreign Currency (EEFC) Account of the remitter. Further foreign Exchange can be drawn only from an authorised person.


The Foreign Exchange Management Act, 1999

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Question 4 (a) According to Foreign Exchange Management Act, 1999, a person resident in India shall

take all reasonable steps to repatriate to India any amount of foreign exchange earned and accrued to him. What is meant by the expression ‘Repatriate to India’? State the cases where foreign exchange can be held or need not be repatriated to India by a resident in India.

(b) Explain the meaning of the term “Adjudicating Authority” under the Foreign Exchange Management Act, 1999, the powers available with the said authority to pass orders imposing penalty and enforce the same in relation to violation of any provision of FEMA by Mr. Dubious, a resident in India.

(c) (i) How will you determine whether a particular business unit like a factory or office is a ‘person resident in India’ under Foreign Exchange Management Act, 1999?

(ii) ‘Printex Computer’ is a Singapore based company having several business units all over the world. It has a unit for manufacturing computer printers with its Headquarters in Pune. It has a Branch in Dubai which is controlled by the Headquarters in Pune. What would be the residential status under FEMA, 1999 of printer units in Pune and that of Dubai branch? (May, 2002)

Answer (a) The word “repatriate to India” is defined in section 2(y) of the FEMA, Act 1999.

‘Repatriate to India’ means the realized foreign exchange should be sold to an authorised person in India in exchange for rupees. It also includes the holding of realised amount in an account with an authorised person in India to the extent notified by the Reserve Bank and includes use of the realised amount for discharge of a debts or liability denominated in foreign exchange.

Exemption from holding/repatriation.

Section 4 of the FEMA, 1999 prohibits holding of foreign exchange by a resident in India. Section 8 requires that foreign exchange earned by a resident in India is realised and repatriated to India. However, in the following cases, the foreign exchange can be held or need not be repatriated to India:- 1. Possession of foreign currency – possession of foreign currency or foreign coins

upto limit prescribed by RBI is permitted (section 9(a)) 2. Foreign currency account – Foreign currency account can be held and operated

by such persons and within such limits as specified by RBI (Section 9(b))



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3 Foreign currency acquired before July 1947 – Foreign exchange acquired or received before 8th July 1947 or income arising or accruing thereon can be held outside India (section 9(c))

4. Gift or inheritance – If such foreign exchange is acquired as a gift or inheritance, that exchange and income arising therefrom can be held as foreign exchange in India or held abroad and need not be repatriated (Section 9(d)).

5. Foreign exchange acquired abroad – Foreign exchange acquired from employment, business, trade, vocation, services honorarium, gifts, inheritance, or any other legitimate means can be held as foreign exchange in India or it need not be repatriated to India subject to limits specified by RBI (Section 9(e))

6. Any other receipts specified by RBI (Section 9(f)) (b) Adjudicating authority According to Section 2(a) of FEMA, 1999, ‘Adjudicating Authority’ means an officer

authorised under section 16(i) Power of adjudicating authority: Persons committing an offence under FEMA are liable

to penalty. An adjudicating authority appointed by the Central Government under FEMA can impose any penalty for violation of any provision of FEMA or contravention of any rule, regulation, directions or orders issued under the powers conferred by the Act. Their jurisdiction will be prescribed by the Central Government (section 16(1) & (2)). The Adjudicating Authority can hold inquiry only on receiving a complaint form an authorised officer (Section 16(3)). They have to follow principles of natural justice by giving opportunity to Mr. Dubious of making representation. The adjudicating authority should endeavor to dispose off the complaint within one year (Section 16(6)) The adjudicating authority can impose penalty upto thrice the sum involved in such contravention where the amount is quantifiable. If the amount is not quantifiable, penalty upto Rs. 2 lakhs can be imposed. If contravention is of continuing nature, further penalty upto Rs 5,000 per day during which the default continues can be imposed [Section 13(i)].

The Adjudicating Authority adjudicating the contravention can also order confiscation of any currency, security or any other money or property in respect of which the contravention has taken place. He can also direct that foreign exchange holdings of any person committing the contravention shall be brought back to India or retained outside as per directions (Section 13(2)).



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Enforcement of orders of adjudicating authority. Person on whom penalty is imposed is required to make payment within 90 days of

receipt of notice. If such payment is not made, he is liable to civil imprisonment (Section 14(i)). Such civil imprisonment can be upto 6 months, if demand is for less than Rs. 1 crore. If demand exceeds Rs. 1 crore, civil imprisonment can be upto 3 years. If he pays the amount, he shall be released. Order for arrest and detention cannot be made unless a show cause notice is issued to the defaulter. However, arrest can be made without show cause notice, if adjudicating authority is satisfied (a) that the defaulter has dishonesty transferred, concealed or removed his property or he is refusing or neglecting to pay even if he has means to pay [Section 14(2) (b)] and (b) he is likely to abscond the local limits [Section14(3)].

If a person to whom show cause notice is issued does not appear before Adjudicating authority, warrant of arrest can be issued [Section 14 (4)].

(c) (i) Person resident in India Section 2 of FEMA,1999 defines the term “person resident in India”. According

to Section 2 (iii), all business units in India will be “resident in India” even though these units are owned or controlled by a person resident outside India.

Similarly all business units outside India will be ‘resident in India’ provided the business units are either owned or controlled by a person resident in India [Section 2(v) (iv)]. It is necessary to determine the residential status of the person who owns or controls the business unit.

(ii) Printex Computer being a Singapore based company would be person resident outside India [(Section 2(w)] Section 2 (u) defines ‘person’ under clause (viii) thereof, as person would include any agency, office or branch owned or controlled by such person. The term such person appears to refer to a person who is included in clause (i) to (vi). Accordingly printex unit in Pune, being a branch of a company would be a ‘person’.

Section 2(v) defines a person resident in India. Under clause (iii) thereof person resident in India would include an office, branch or agency in India owned or controlled by a person resident outside India. Printex unit in Pune is owned or controlled by a person resident outside India, and hence it, would be a ‘person resident in India.’

However, Dubai Branch though not owned is controlled by Print unit in Pune which is a person resident in India. Hence prima facie, it may be possible to hold a view that the Dubai Branch is a person resident in India.



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Question 5 (a) Mr. Ram had resided in India during the Financial Year 1999-2000 for less than 183

days. He again came to India on 1st May, 2000 for Higher studies and business and stayed upto 15th July, 2001. State under the Foreign Exchange Management Act, 1999.

(i) If Mr. Ram can be considered ‘person Resident in India’ during the Financial year 2000-2001 and

(ii) Is citizenship relevant for determining such a status?

(b) Mr. Ramesh of Nagpur wants to travel to Nepal and for this purpose proposes to draw Foreign Exchange. Specify.

(i) Can Mr. Ramesh draw any Foreign Exchange for his journey?

(ii) What are the purposes for which Foreign Exchange drawal is not allowed for Current Account Transaction? (November, 2002)

Answer (a) (i) No. Mr. Ram cannot be considered 'Person resident in India' during the financial

year 2000-2001 notwithstanding the purpose or duration of his stay in India during 2000-2001. An individual has to be present in India for more than 182 days in the preceding financial year. Mr. Ram does not satisfy this condition for the financial year 2000-2001.

(ii) No. Citizenship is no more relevant for determining the status. (b) (i) No. According to the rules, drawl of foreign exchange is not allowed for travel to

Nepal or Bhutan. (ii) Following are the transactions (current account) for which drawl of foreign

exchange is prohibited. 1. Remittance of interest income on funds held in Nonresident Special Rupee (NRSR)

Account Scheme. 2. Transactions with a person resident in Nepal or Bhutan (unless specifically exempted

by RBI by general/special order). 3. Remittance out of lottery winnings. 4. Remittance of income from racing/ riding etc. or any other hobby. 5. Remittance for purchase of lottery tickets, banned/ prescribed magazines, football,

pools etc. 6. Payment of commission on exports made towards equity investment in joint

ventures/wholly owned subsidiaries aboard of Indian Companies.



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7. Remittance of dividend by any company to which the requirement of dividend balancing is applicable.

8. Payment of commission on export under Rupee State Credit Route. 9. Payment related to 'Call Back Services' of telephones. Question 6 (a) Examine whether the following branches can be considered as a 'Person resident in

India' under Foreign Exchange Management Act, 1999:

(i) ABC Limited, a company incorporated in India established a branch at London on 1st January, 2003.

(ii) M/s XYZ, a foreign company, established a branch at New Delhi on 1st January, 2003. The branch at New Delhi controls a branch at Colombo.

(b) Mr. Ramesh is an exporter of goods and services. Explain briefly his duties under Foreign Exchange Management Act, 1999 with regard to the following:

(i) Furnishing of information relating to such exports.

(ii) Realisation and repatriation of foreign exchange on such exports. (May, 2003) Answer (a) Person resident in India (Foreign Exchange Management Act, 1999):

(i) Any person or body corporate registered or incorporated body in India is a resident in India [section 2(v)(ii)]. ‘Person’ includes a company [section 2(u)]. An office, branches or agency outside India owned or controlled by a person resident in India is a person resident in India. [Section 2(v)(iv)].

In view of the above provisions in FEMA, 1999 London branch established by ABC Ltd, a company incorporated in India, is a ‘person resident in India’ under the Act from the date of establishment i.e. 1st January, 2003.

(ii) According to Section 2(v)(iii) of FEMA, 1999 an office, branch or agency in India owned or controlled by a person resident outside India is a person resident in India’. Only a body corporate registered or incorporated in India is a ’person resident in India’. According to section 2(w), ‘person resident outside India’ means a person who is not resident in India. Hence M/s XYZ, foreign company is a ‘resident outside India. But the branch at New Delhi owned by M/s XYZ is a ‘resident in India’ within the meaning of section 2(v) (iii) from the date of establishment i.e. 1st January, 2003. The branch at Colombo controlled by the branch at New Delhi referred to in the question is a person ‘resident in India’ within the meaning of section 2(v)(iii) read with section 2(v)(iv).



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(b) Duty of every exporter of goods and services under FEMA, 1999:

(i) Furnishing of Information:- Every exporter of goods is required the furnish to RBI or other prescribed authority a declaration containing true and correct material particulars, including the amount representing full export value. If full exportable value is not ascertainable at the time of export due to prevailing market conditions, the exporter shall indicate the amount he expects to share indicate the amount he expects to receive on sale of goods in a market outside India. The exporter of goods shall also furnish to RBI such other information as may be required by RBI for the purpose of ensuring realization of export proceeds by such exporter [section 7(i)].

RBI can direct any exporter to comply with prescribed requirements to ensure that full export value of the goods or such reduced value of the goods as RBI determines, is received without delay [section 7(2)]. Every exporter of services shall furnish to RBI or other prescribed authority a declaration containing true and correct material particulars in relation to payment of such services [section 7(3)].

(ii) Realisation and repatriation of foreign exchange: Where any amount of foreign exchange is due or has accrued to any resident in India, such person shall take all reasonable steps to realize and repatriate to India the foreign exchange within such period and in such manner as may be specified by RBI (section 8). Mr. Ramesh as an exporter of goods and services must comply with the requirements of section 7 and 8 of FEMA, 1999 and also with the requirements under Foreign Exchange Management (Export of Goods and Services) Regulations, 2000.

Question 7

Mr. Ram, citizen of India, left India for employment in U.S.A. on 1st June, 2002. Mr. Ram purchased a flat at New Delhi for Rs.15 lakhs in September, 2003. His brother, Mr. Gopal employed in New Delhi, also purchased a flat in the same building in September, 2003 for Rs.15 lakhs. Mr. Gopal's flat was financed by a loan from a Housing Finance Company and the loan was guaranteed by Mr. Ram.

Examine with reference to the provisions of Foreign Exchange Management Act, 1999 whether purchase of flat and guarantee by Mr. Ram are Capital Account transactions and whether these transactions are permissible. (November, 2003)



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Answer Section 2(e) of Foreign Exchange Management Act, 1999 states that 'capital account transactions' means (a) a transaction which alters the assets or liabilities, including contingent liabilities, outside India of person's resident in India (b) a transaction which alters assets or liabilities in India of persons resident outside India and includes transactions referred to in Section 6(3). According to the said definition, a transaction which alters the contingent liability will be considered as capital account transaction in the case of person resident in India, but it is not so in the case of person resident outside India. Purchase of immovable property by Mr. Ram in India is a capital account transaction. It has also been specifically provided in Section 6(3)(i) as a capital account transaction. Guarantee will be considered as a capital account transaction in the following cases: (1) Guarantee in respect of any debt, obligation or other liability incurred by a person

resident in India and owed to a person resident outside India. (2) Guarantee in respect of any liability, debt or other obligation incurred by a person

resident outside India. In this case, Mr. Ram, a resident outside India gives a guarantee in respect of a debt

incurred by a person resident in India and owed to a person resident in India. Hence, it would appear that guarantee by Mr. Ram cannot be considered as a capital account transaction within the meaning of Section 2(e), particularly because it is a contingent liability.

All capital account transactions are prohibited unless specifically permitted. RBI is empowered to issue regulations in this regard [Section 6(3)]. Permissible capital account transactions by persons resident outside India are given in Schedule II to Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000. According to the said regulations both the purchase of immovable property by Mr. Ram and guarantee by Mr. Ram are permissible.

Question 8 (a) Mr. Sane, an Indian National desires to obtain Foreign Exchange for the following

purposes:

(i) Remittance of US Dollar 50,000 out of winnings on a lottery ticket.

(ii) US Dollar 1,00,000 for sending a cultural troupe on a tour of U.S.A.

(iii) US Dollar 50,000 for meeting the expenses of his business tour to Europe.

Advise him whether he can get Foreign Exchange and if so, under what conditions?



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(b) Explain the restrictions, if any, under Foreign Exchange Management Act, 1999 in respect of the following issue and transfer of shares:

(i) Issue of Equity Shares of Rs.1 crore at face value accounting for 45 percent of post-issue capital to non-resident Indians in U.S.A. on non-repatriation basis. The shares are issued by M/s ABC Knitwear Limited to finance the modernization of its plant.

(ii) A Non-resident Indian, who is holding Equity shares in M/s DEF Textiles Limited, proposes to sell some shares to another Non-resident Indian for a consideration of Rs.50 lakhs and also transfer shares of face value of Rs.25 lakhs to a person resident in India by way of Gift. (May, 2004)

Answer (a) Under provisions of section 5 of the Foreign Exchange Management Act, 1999 certain

Rules have been made for drawal of Foreign Exchange for Current Account transactions. As per these Rules, Foreign Exchange for some of the Current Account transactions is prohibited. As regards some other Current Account transactions, Foreign Exchange can be drawn with prior permission of the Central Government while in case of some Current Account transactions, prior permission of Reserve Bank of India is required. (i) In respect of item No.(i), i.e., remittance out of lottery winnings, such remittance

is prohibited and the same is included in First Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000. Hence Mr. Sane can not withdraw Foreign Exchange for this purpose.

(ii) Foreign Exchange for meeting expenses of cultural tour can be withdrawn by any person after obtaining permission from Government of India, Ministry of Human Resources Development, (Department of Education and Culture) as prescribed in Second Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000. Hence, in respect of item (ii), Mr. Sane can withdraw the Foreign Exchange after obtaining such permission.

(iii) The type of payment as envisaged in Item No.(iii) is covered under third Schedule to the Foreign Exchange Management (Current Account Transactions)

In all the cases, where remittance of Foreign Exchange is allowed, either by general or specific permission, the remitter has to obtain the Foreign Exchange from an Authorised Person as defined in Section 2(c) read with section 10 of the to the Foreign Exchange Management Act, 1999.

(b) Issue of equity shares to NRI’s and transfer of shares by NRIs are capital account transactions.



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RBI may in consultation with the Central Government specify any class or classes of transactions which are permissible (Section 6(2)(a).

According to Regulation 3(1) of the Foreign Exchange Management (Permissible capital Account Transactions) Regulations, 2000 issued by RBI Investment in India by a person resident outside India is a permissible capital account transactions (Schedule II).

Further RBI is empowered under Section 6(3)(b) to prohibit, restrict or regulate, by regulations, transfer or issue of any security by a person resident outside India. In exercise of these powers RBI issued Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations 2000.

According to Regulation 5(3)(ii) of the said regulations a NRI may purchase shares of an Indian Company which is not engaged in Print Media Sector on non-repatriation basis without any limit (para 2 of Schedule 4). The shares may be issued by the company either by public issue or private placement. The only condition is that the amount of consideration for purchase of shares shall be paid by way of inward remittance through normal banking channels from abroad or out of funds held in NRE/FCNR/NRO/NRSR/N&NR account maintained with an authorized dealer or as the case may be with an authorised bank in India (Para 3 of Schedule 4).

Transfer of shares of an Indian Company by a person resident outside India. Regulation 9(2)(ii) of Foreign Exchange Management (Transfer or issue of security by a

person resident outside India) Regulations, 2000 permits NRI to transfer by way of sale the shares held by him to another NRI. Further according to Regulation 9(2)(iii) a person resident outside India may transfer any security held by him, to a person resident in India by way of gift. There are no restrictions in this regard.

Hence the proposed sale of shares to NRI and transfer to a persons resident in India by way of gift are permissible under FEMA.

Indian company can issue the above shares and record in its books the above transfer (Regulation 4).

Question 9 (a) (i) Tomco Ltd., a vehicles manufacturing company in India has received an order

from a transport company in Italy for supply of 100 Trucks on lease. You are required to state, how the said Tomco Ltd. can accept such an order.

(ii) Forex Dealers Ltd. is an Authorised Person within the meaning of Foreign Exchange Management Act, 1999. Reserve Bank of India issued certain directions to the said Authorised Person to file certain returns, which it failed to



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file. You are required to state the penal provisions to which the said Authorised Person has exposed itself.

(b) (i) Mr. Sekhar resided for a period of 150 days in India during the Financial year 2003-2004 and thereafter went abroad. He came back to India on 1st April, 2004 as an employee of a business organization. What would be his residential status during the financial year 2004-2005?

(ii) Mr. Atul, an Indian National desires to obtain Foreign Exchange for the following purposes:

(a) Remittance of US Dollar 10,000 for payment for goods purchased from a party situated in Nepal.

(b) US Dollar 10,000 for remitting as commission to his agent in U.S.A. for sale of commercial plot situated near Bangalore, consideration in respect of which was received by Mr. Atul by way of foreign currency inward remittance amounting to US Dollar 1,00,000.

Advise him, if he can get the Foreign Exchange and under what conditions. (November, 2004)

Answer (a) (i) “Export,” means the taking out of India to a place outside India any goods

(Section 2(1) of Foreign Exchange Management Act, 1999). Hence sending 100 trucks on lease to Italy is an ‘export’ within the meaning of Section 2(1).

Under provisions of section 7 of the Foreign Exchange Management Act, 1999 rules have been made governing export of goods and services. Regulation 14-A of the Foreign Exchange Management (Export of Goods and Services) Regulations, 2000 prescribes that no person shall, except with prior permission of the Reserve Bank of India, take or send out by land, sea or air any goods from India to any place outside India on lease or hire or under any arrangement or in any other manner other than sale or disposal of such goods.

Based on the above provisions, it can be concluded that if the company, namely, Tomco Ltd. wants to accept the order for despatching 100 trucks to Italy on lease, it has to take prior permission of the Reserve Bank of India.

(ii) Section 11(3) of the Foreign Exchange Management Act, 1999 stated that where any Authorised person contravenes any direction given by the Reserve Bank of India under the said Act or fails to file any return as directed by the Reserve Bank of India, the Reserve Bank of India may, after giving reasonable opportunity of being heard, impose on Authorised Person a penalty which may



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extend to ten thousand rupees and in the case of continuing contraventions with an additional penalty which may extend to two thousand rupees for every day during which such contravention continues.

Since as per the facts given in the question, the Authorised person, namely, Forex Dealers Ltd., has failed to file the returns as directed by the Reserve Bank of India. According to the above provisions, it has exposed itself to a penalty which may extend to ten thousand rupees and in the case of continuing contraventions in the nature of failure to file the returns, with an additional penalty which may extend to two thousand rupees for every day during which such contravention continues.

(b) (i) According to the provisions of section 2(v) of the Foreign Exchange Management Act, 1999, a person in order to qualify for the purpose of being treated as a "Person Resident in India" in any financial year, must reside in India for a period of more than 182 days during the preceding financial year. In the given case, Mr. Sekhar has resided in India for a period of only 150 days, i.e., less than 182 days, during the financial year 2003-2004. Hence he cannot be considered as a "Person Resident in India" during the financial year 2004-2005 irrespective of the purpose or duration of his stay.

(ii) Under provisions of section 5 of the Foreign Exchange Management Act, 1999 certain Rules have been made for drawal of Foreign Exchange for Current Account transactions. As per these Rules, drawal of Foreign Exchange for some of the Current Account transactions is prohibited. As regards some other Current Account transactions, Foreign Exchange can be drawn with prior permission of the Central Government while in case of some Current Account transactions prior permission of Reserve Bank of India is required.

In respect of item (a), i.e. remittance to Nepal, such remittance is prohibited and the same is included in First Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000. Hence Mr. Atul cannot withdraw Foreign Exchange for this purpose.

The type of payment as envisaged in item (b) is covered under Third Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000 and for withdrawing foreign Exchange exceeding 5% (five percent) of the inward remittance as commission to agent abroad for sale of commercial plot in India Mr. Atul will require the prior permission of the Reserve Bank of India.

Current Account Transactions have been liberalized by RBI, Foreign Exchange Department with effect from 24.02.2004 vide A.P. (DIR Series) Circular No.76 dated 24.02.2004. Now authorized persons (authorized dealers) are authorized



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to allow freely such remittances ((i.e.) commission to agents abroad for sale of commercial plots) up to USD 25000 or 5 per cent of inward remittance per transaction, whichever is higher. As the amount to be remitted is only USD 10,000, authorized person (authorized dealer) may be approached for permission.

Question 10 (i) MKP Limited, an Indian company having its Registered Office at Mumbai, India

established a branch at New York U.S.A. on 1st April, 2004.

(ii) WIP Ltd., a company incorporated and registered in London established a branch at Chandigarh in India on 1st April, 2004.

(iii) WIP Ltd.’s Singapore branch which is controlled by its Chandigarh branch. (May 2005) Answer (i) As per provisions of section 2(v)(ii) of the Foreign Exchange Management Act, 1999

(FEMA) any person or body corporate registered or incorporated in India is a “Person resident in India”. As per section 2(v) of the said Act the term “person” includes a company. Section 2(v)(iv) of the said Act states that an office, branch or agency outside India owned or controlled by a person resident in India is a “Person resident in India”.

In the light of the above provisions of FEMA, the residential status of the New York branch of MKP Ltd is that of a “Person resident in India” from the date of its establishment since it is owned by a person, i.e., a company, resident in India.

(ii) As per provisions of section 2(v)(iii) of the Foreign Exchange Management Act, 1999 (FEMA) an office, branch or agency in India owned or controlled by a person resident outside India is a “Person resident in India”. Section 2(w) of the said Act states that a person who is not resident in India is a “Person resident outside India”.

On application of the above provisions of FEMA, it can be concluded that WIP Ltd. is a “Person resident outside India” and since it owns a branch in Chandigarh, India, the residential status of the said Chandigarh branch is that of a “Person resident in India” from the date of its establishment.

(iii) As per provisions of section 2(v)(iv) of the Foreign Exchange Management Act, 1999 (FEMA) an office, branch or agency outside India owned or controlled by a person resident in India is a “Person resident in India”. Here, the Singapore branch of WIP Ltd. is controlled by its Chandigarh branch which is a “Person resident in India”. Therefore, the residential status of the Singapore branch of WIP Ltd. shall be that of a “Person resident in India”.



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Question 11 Mr. F, an Indian National desires to obtain foreign exchange for the following purposes:

(i) Payment of US $10,000 as commission on exports under Rupee State Credit Route.

(ii) US $ 30,000 for a business trip to U.K.

(iii) Remittance of US $ 2,00,000 for payment as prize money to the winning team in a Hockey Tournament to be held in Australia.

Advise him, if he can get the Foreign Exchange and under what condition (May 2005) Answer Under provisions of section 5 of the Foreign Exchange Management Act, 1999 certain Rules have been made for drawal of Foreign Exchange for Current Account transactions. As per these Rules, Foreign Exchange for some of the Current Account transactions in prohibited. As regards some other Current Account transactions, Foreign Exchange can be drawn with prior permission of the Central Government while in case of some Current Account transactions, prior permission of Reserve Bank of India is required: (i) In respect of item No. (i), i.e., payment of commission on exports under Rupee State

Credit Route, such payment is prohibited and the same is included in First Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000.

(ii) Foreign Exchange for business trip upto US$ 25,000 can be obtained by any person. If a person wants to exceed this limit, then prior permission of Reserve Bank of India is required as per Third Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000. In respect of item (ii), since the amount involved is more than US $ 25,000, Mr. F can obtain the foreign exchange after getting the permission of Reserve Bank of India.

(iii) The type of payment as envisaged in item No.(iii) is covered under Second Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000 and for remitting of prize money exceeding US$ 1,00,000 for sports activity abroad other than International, National or State level body will require the prior permission of the Central Government. (Ministry of Human Resource Development – Department of Youth Affairs and Sports). Since the amount involved in item No. (iii) of the question is more than US$ 1,00,000 and Mr. F is not an International, National or State level body, he has to obtain the permission of the Central Government before remitting the prize money of US$ 2,00,000.

In all the cases, where remittance of Foreign Exchange is allowed, either by general or specific permission, the remitter has to obtain the Foreign Exchange from an Authorised Person as defined in Section 2(c) read with section 10 of the to the Foreign Exchange Management Act, 1999.



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Question 12 (a) Explain the meaning of “Capital Account Transaction” under the Foreign Exchange

Management Act, 1999. State whether there are any restrictions in respect of the following transactions:

(i) Drawal of Foreign Exchange for payments due on account of amortisation of loans in ordinary course of business.

(ii) Purchase by a person resident outside India of shares of a company in India engaged in plantation activities.

(b) TKM Exporters of New Delhi are engaged in Export Business. It made certain exports, but failed to realize and repatriate to India the foreign exchange due on its exports. The Adjudicating Authority imposed a penalty under the provisions of Foreign Exchange Management Act, 1999 (FEMA). Being aggrieved by this penalty, the said exporter seeks your advice as to the authority to which appeal can be made and the time limit for making such appeals. You are required to advise on the matter. (November 2005)

Answer (a) As per provisions of section 2(e) of the Foreign Exchange Management Act, 1999

(FEMA) “Capital Account Transaction” means a transaction which alters (a) the assets and liabilities, including the contingent liabilities, outside India of persons resident in India or (b) the assets and liabilities in India of persons resident outside India.

It also includes the following as stated in section 6(3) of FEMA: (i) Transfer or issue of any foreign security by a person resident in India. (ii) Transfer or issue of any security by a person resident outside India. (iii) Transfer or issue of any security or foreign security by any branch, office or

agency in India of a person resident outside India. (iv) Any borrowing or lending in foreign exchange in whatever form or by whatever

name called. (v) Any borrowing or lending in India rupees in whatever form or by whatever name

called between a person resident in India and a person resident outside India. (vi) Deposits between persons resident in India and persons resident outside India. (vii) Export, import or holding of currency or currency notes. (viii) Transfer of immovable property outside India, other than a lease not exceeding

five years, by a person resident in India. (ix) Acquisition or transfer of immovable property in India, other than a lease not

exceeding five years, by a person resident outside India.



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(x) Giving a guarantee or surely in respect of any debt, obligation or other liability incurred (a) by a person resident in India and owed to a person resident outside India or (b) by a person resident outside India.

(i) Amortisation of Loans:

Under provisions of FEMA, 1999 subject to Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000 as amended by Foreign Exchange Management (Permissible Capital Account Transactions) (Amendment) Regulations, 2004 all capital account transactions are prohibited unless permitted by proviso to section 6(2) of FEMA. The proviso specifically permits drawal of foreign exchange for payments due on account of amortisation of loans in ordinary course of business. Hence, there is no restriction in FEMA in this regard.

(ii) Purchase of Shares of Company engaged in Plantation activities:

According to Section 6(2) of FEMA, 1999 the Reserve Bank of India is empowered to specify in consultation with the Central Government, the classes of capital account transactions which are permissible and the limits upto which the foreign exchange shall be admissible for such transactions. Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000 completely prohibits certain capital account transactions. One such transaction is foreign investment in India in any company, firm or proprietary concern engaged in or proposed to be engaged in agriculture or plantation activities. Hence, purchase by a person resident outside India of shares of a company in India engaged in plantation activities in not permissible.

(b) Sections 17 and 19 of FEMA, 1999 provide for appeals against orders of Adjudicating Authority. If Adjudicating Authority is Assistant Director of the Enforcement or Deputy Director of Enforcement, appeal will lie to Special Director (Appeals). Further appeal shall lie with Appellate Tribunal for Foreign Exchange. However, if the Adjudicating Authority is senior to the Assistant Director of Enforcement or Deputy Director of Enforcement, then the appeal shall lie directly to the Appellate Tribunal.

Appeal to Special Director (Appeals)

Appeal against order of Assistant Director of Enforcement or Deputy Director of Enforcement can be filed with Special Director (Appeals) under Section 17 within 45 days from the date on which the copy of the order made by the Adjudicating Authority is received by the aggrieved person. The Special Director (Appeals) can condone the delay in filing the appeal if he is satisfied that there was sufficient cause for not filing the appeal within the stipulated time.



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Special Director (Appeals) will hear the parties and then pass his order. Copy of the order shall be sent to the concerned parties and the Adjudicating Authority.

Appeal to Appellate Tribunal

Appeal against the order of Adjudicating Authority being senior to Assistant Director of Enforcement or Deputy Director of Enforcement or against the order of Special Director (Appeals) can be made to the Appellate Tribunal for Foreign Exchange under section 19 of FEMA within 45 days from the date on which the copy of the order made by such Adjudicating Authority or Special Director (Appeals) is received by the aggrieved person. In this case also, the delay can be condoned by the Appellate Tribunal. In case of an appeal against the order imposing penalty, the appellant has to deposit the amount of such penalty with the authority prescribed by the Central Government. However, the Appellate Tribunal may waive such deposit to mitigate the likely hardship that may be caused to the appellant. After hearing of the appeal, the Appellate Tribunal shall pass a reasoned order.

It may be noted that the Tribunal is the final fact finding authority and no appeal lies against the facts determined by the Tribunal.

Question 13

(a) State which kind of approval is required for the following transactions under the Foreign Exchange Management Act, 1999:

(i) X, a Film Star, wants to perform alongwith associates in New York on the occasion of Diwali for Indians residing at New York. Foreign Exchange drawal to the extent of US dollars 20,000 is required for this purpose.

(ii) F International Ltd. has purchased the trade mark from a Foreign Company to establish retail business chain in India as a joint venture at a consolidated price of US dollars 500,000 which is to be paid in Foreign currency of that country.

(iii) R wants to get his heart surgery done at UK. Up to what limit Foreign Exchange can be drawn by him and what are the approvals required?

(iv) L wants to pursue a course in Fashion design in Paris. The Foreign Exchange drawal is US dollars 20,000 towards tuition fees and US dollars 30,000 for incidental and stay expenses for studying abroad.

(b) A French Manufacturing Company desirous of setting up its branch office at Pune seeks your advice on the objects for which the company may be allowed to set up the desired branch office. Advise the company about the procedure as required under the Foreign Exchange Management Act, 1999 to be followed in this regards (May 2006)



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Answer (a) Approval to the following transactions under FEMA, 1999:

(i) Foreign Exchange drawals for cultural tours require prior permission/approval of the Government of India irrespective of the amount of foreign exchange required. Therefore, in the given case X, the Film Star is required to seek permission of the Government of India.

(ii) In this case prior permission/approval of RBI is required for purchasing trade mark from a foreign company where purchase consideration is to be paid in foreign currency. Therefore, F International Ltd. needs prior permission of RBI.

(iii) Remittance in foreign exchange for medical treatment abroad requires prior permission/approval of RBI when the expenditure in foreign currency exceeds the estimate of hospital/doctor abroad or estimate from doctor in India in that field of treatment. Therefore, R can draw foreign exchange up to the estimate of hospital/doctor abroad or estimate from doctor in India in that field of treatment and prior permission/approval of RBI is required.

(iv) Release of foreign exchange for education abroad is permitted up to US$ 1,00,000 on self declaration basis. Therefore, L can draw foreign exchange on self declaration basis for pursuing a course in fashion design in Paris.

(b) Setting up a branch office at Pune by a French company – Objects and the procedure under the FEMA, 1999:

Since setting up a branch office by a foreign company in India involves foreign exchange, permission of RBI is required. Following are the objects for which RBI permits companies engaged in manufacturing and trading activities abroad to set up Branch Office in India: 1. To represent the parent company/other foreign companies in various matters in

India e.g. acting as buying/selling agents in India. 2. To conduct research work in the area in which the parent company is engaged. 3. To undertake export and import trading activities. 4. To promote possible technical and financial collaborations between the Indian

companies and overseas companies. 5. Rendering professional or consultancy services. 6. Rendering services in information technology and development of software in

India. 7. Rendering technical support to the products supplied by the partner/group

companies.



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Steps / procedure: 1. Foreign company can set up Branch Offices in India after obtaining approval from RBI. 2. The office can act as a channel of communication between Head Office abroad and

parties in India. It is not allowed to undertake any business activity in India and cannot earn any income in India. Expenses of such offices are to be met entirely through inward remittances of foreign exchange from the Head Office abroad.

3. Permission to set up such office is initially granted for a period of 3 years and this may be extended from time to time by the Regional Office in whose jurisdiction the office is set up.

4. The representative office will have to file an annual activity certificate etc. from a Chartered Accountant to the concerned Regional Office of the RBI.

5. Application is required to be made in Form FNC-1. Question 14 Mr. Loma, an Indian National desires to obtain foreign exchange for the followin purposes:

(a) Payment to be made for securing insurance for health from a company abroad.

(b) Payment of commission on exports under Rupee State Credit Route.

(c) Gift remittance exceeding US Dollars 10,000.

Advise him whether he can get foreign exchange and if so, under what condition? (November 2006)

Answer Under provision of Section 5 of FEMA 1999, certain Rules have been made for drawl of foreign exchange for current account transitions. As per these rules, foreign exchange for some of the current account transaction is prohibited. As regards some other current account transaction foreign exchange can be drawn with prior permission of the Central Government while in case of some other current account transaction, the prior permission of Reserve Bank of India is required. 1. The payment required to be made for securing insurance for health from a company

abroad as referred in item 1 can be made after obtaining permission from Central Government of India, as prescribed in Second Schedule to Foreign Exchange Management (Current Account Transaction) Rules 2000. Hence Mr. LOMA can draw foreign exchange after obtaining such permission.

2. As regards item no. 2 i.e., the payment of commission on export under Rupee State Credit Route, such payment is prohibited as referred in First Schedule to Foreign



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Exchange Management (Current Account Transaction) Rules 2000. Hence Mr. LOMA cannot withdraw for the said purpose.

3. The item referred here is covered by Third Schedule to Foreign Exchange Management (Current Account Transaction) Rules 2000. As per this schedule, gift remittance exceeding USD 5,000 per beneficiary per annum requires permission of RBI. Since the amount involved here is more than USD 5000, Mr. LOMA can draw foreign exchange after permission from RBI.

In all the cases, where remittance of foreign exchange is allowed either by general or specific permission, the remitter has to obtain the foreign exchange from an authorized person as defined in Section 2(c) read with section 10 of FEMA, 1999.

Question 15 Mrs. Kamala, a resident in India is likely to inherit an immovable property in U.S.A. from her father, who is a resident outside India. Advise Mrs. Kamla about the restrictions, if any, in this regard under the Foreign Exchange Management Act, 1999 explaining the relevant provisions of the Act. Will your answer be different, if she is likely to inherit foreign securities? (November 2006) Answer (i) As per section 15 of Competition Act 2002 any act or proceeding of the Commission

shall not be invalidated merely on the ground of: (a) any vacancy in, or any defect in the constitution of the Commission; or (b) any defect in the appointment of a person acting as a Chairperson or as a

member; or (c) any irregularity in the procedure of the Commission not affecting the merits of

the case. Here in this case Mr. ZPM should have professional qualification of not less than

15 years as per section 8 of the Act but this disqualification will not invalidate the proceeding of the Commission.

(ii) Section 2(i) of Competition Act, 2002 defines ‘goods’ as follows: ‘Goods’ means goods as defined the Sale of Goods Act, 1930 and includes –

(a) products manufactured, processed or mined; (b) debentures, stock and shares after allotment (c) in relation to goods supplied, distributed or controlled in India, goods imported

into India.



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Hence, debentures and shares can be considered as ‘goods’ within the meaning of section 2(i) of Competition Act, 2002 only after allotment and not before allotment.

Question 16 (i) Tomco Ltd. a vehicles manufacturing company situate at Pune, Maharastra has

received an order from a transport company in Italy for supply of 100 Trucks on lease. You are required to state, how the said Tomco Ltd. can accept such an order.

(ii) Forex Dealers Ltd. Is an Authorised Person within the meaning of Foreign Exchange Management Act, 1999. Reserve Bank of India issued certain directions to the said Authorised person to file certain returns which it failed to file. You are required to state the penal provisions to which the said Authorised Person has exposed itself.

(May 2007) Answer (i) Under provisions of section 7 of the Foreign Exchange Management Act, 199 certain

rules have been made governing export of goods and services. Regulation 14-A of the Foreign Exchange Management (Export of Goods and Services) Regulations, 2000 prescribes that no person shall, except with prior permission of the Reserve Bank of India, take or send out by land, sea or air any goods from India to any place outside India on lease or hire or under any arrangement or in any other manner other than sale or disposal of such goods.

Accordingly if Tomco Ltd. wants to accept the order for dispatching 100 trucks to Italy on lease, it has to take prior permission of the Reserve Bank of India.

(ii) In accordance with the provisions of the Foreign Exchange Management Act, 1999 as contained in section 11(3), stated that where any authorized person contravenes any direction given by the Reserve Bank of India under the said Act or fails to file any return as directed by the Reserve Bank of India, the Reserve Bank of India may, after giving reasonable opportunity of being heard, impose on Authorised Person a penalty which may extend to ten thousand rupees and in the case of continuing contraventions with an additional penalty which may extend to two thousand rupees for every day during which such contravention continues.

Since as per the facts given in the question, the Authorized person, namely, Forex Dealers Ltd., has failed to file the return as directed by the Reserve Bank of India, according to the above provisions if has exposed itself to a penalty which may extend to Rs. 10,000 and in the case of continuing contraventions in the nature of failure to file the return, with an additional penalty which may extend to Rs. 2,000 for every day during which such contravention continues.



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Question 17 (i) Mr. Sekhar resided in India for a period of 150 days in India during the financial year

2006-07 and thereafter went abroad. He came back to India on 1st April, 2007 as an employee of a business organization. What would be his residential status during the financial year 2007-2008?

(ii) Mr. Atul, an Indian National desires to obtain foreign exchange for the following purposes:

(a) Remittance of US Dollar 10,000 for payment for goods purchased from a party situated in Nepal.

(b) US Dollar 10,000 for remitting as commission to his agent in USA for sale of commercial plot situated near Bangalore, consideration in respect of which was received by Mr. Atul by way of foreign currency inward remittance amounting to US Dollar 1,00,000.

Advise him, if he can get the Foreign Exchange and under what conditions. (May 2007)

Answer (i) In accordance with the provisions of Section 2(v) of the Foreign Exchange Management

Act, 1999, as contained in section 2(v) a person in order to qualify for the purpose of being treated as a “Person Resident in India” in any financial year, must reside in India for a period of ore than 182 days during the preceding financial year. In the given case, Mr. Sekhar has resided in India for a period of only 150 days, i.e., less than 182 days, during the financial year 2006-2007. Hence he cannot be considered as a “Person Resident in India” during the financial year 2007-2008 irrespective of the purpose or duration of his stay.

(ii) In accordance with the provisions the Foreign Exchange Management Act, 1999 as contained in Section 5, certain Rules have been made for drawal of Foreign Exchange for Current Account transactions. As per these Rules, drawal Foreign Exchange for some of the Current Account transactions is prohibited. As regards some other Current account transactions, Foreign Exchange can be drawn with prior permission of the Central government while in case of some Current Account transactions, prior permission of Reserve Bank of India is required. (a) In respect of item (a), i.e., remittance to Nepal, such remittance is prohibited and

the same is included in First Schedule to be Foreign Exchange Management (Current Account Transactions) Rules, 2000. Hence, Mr. Atul cannot withdraw Foreign Exchange for this purpose.



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(b) The type of payment as envisaged in item (b) is covered under Third Schedule to the Foreign Exchange Management (Current Account Transactions) Rules 2000 and for withdrawing foreign Exchange exceeding 5% (five percent) of the inward remittance as commission to agent abroad for sale of commercial plot in India, Mr. Atul will require the prior permission of the Reserve Bank of India.

Question 18 Examine with reference to the provisions of the Foreign Exchange Management Act, 1999, the residential status of the branches mentioned below:

(i) NNM Ltd. an Indian Company having its registered office at Mumbai, India established a branch at New York USA on 1st April, 2005.

(ii) DDI Ltd. a company incorporated and registered in London established a branch at Kanpur in India on 1st April 2005.

(iii) DDI Ltd. has a branch office at Singapore which is controlled by its Kanpur branch. (November 2007)

Answer As per Section 2(u) of the Foreign Exchange Management Act, 1999, ‘person’ includes the following: • A Company • Any agency, office or branch owned by a ‘person’ • Section 2(v) defines a ‘person resident in India as to include: • Any person or body corporate registered or incorporated in India • An office, branch or agency in India owned or controlled by a person resident outside India • An office, branch or agency in India owned or controlled by a person resident in India. • Considering the provisions of the two section, the residential status is as follows: NNM Ltd. as well as the New York branch of NNM Ltd. is a ‘person’. Therefore, the residential status under FEMA shall be determined for each of them separately. NNM ltd. is incorporated in India. Therefore, it is a ‘person resident in India’. NNM ltd. (a person resident in India) has established a branch outside India. Therefore, the New York branch of NNM ltd. falls under the clause ‘an office’, branch or agency outside India owned or controlled by a person resident in India and so the New York branch is a ‘person resident in India’. (a) DDI Ltd. (a foreign company) does not fall under any of the clauses of the definition of a

‘person resident in India’. Therefore, DDI Ltd. is a ‘person resident outside India’.



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(b) The Kanpur branch of DDI Ltd. is a person resident in India’ since it falls under the clause ‘an office, branch or agency in India owned or controlled by a person resident outside India’. (111) the Singapore branch of DDI Ltd., though not owned, is controlled by the

Kanpur branch. The Singapore branch is a ‘person resident in India’ since it falls under the clause ‘an office, branch or agency outside India owned or controlled by a person resident in India.

Question 19 Explain the meaning of “Capital Account Transactions” under the Foreign Exchange Management Act, 1999. State its categories and also examine whether the following transactions are permissible or not under the above act as Capital Account transactions:

(i) Investment by person resident in India in Foreign Securities.

(ii) Foreign currency loans raised in India and abroad by a person resident in India.

(iii) Export, import and holding of currency / currency notes.

(iv) Investment in a Nidhi Company. (November 2007) Answer Meaning of Capital Account Transaction It means a transaction which alters the assets or liabilities including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of a person resident outside India, and includes transactions referred to in sub-section (3) of Section 6 of FEMA Act, 1999. The Reserve Bank of India has formed Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000. The provisions of these regulations are as under Categories of Capital Account Transactions: As per these regulations, capital account transactions may be classified under the following heads. (1) Permissible capital account transaction of persons resident in India (schedule 1) (2) Permissible Capital transactions of persons resident outside India (schedule II). (3) Prohibited capital account transactions. A person resident in India may enter into any of the following capital account transactions provided the regulations specified by the Reserve Bank of India in respect of such capital account transactions are complied with. In view of the above provisions: among five capital account transaction of question first three i.e. (i), (ii) and (iii) are permissible capital account transactions and rest two i.e., (iv) and v are prohibited capital transactions.



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Question 20 TKM Exporter of New Delhi are engaged in Export Business. It made certain exports but failed to realise and repatriate to India the foreign exchange due on its exports. The Adjudicating Authority imposed a penalty under the provisions of Foreign Exchange Management Act, 1999 (FEMA). Being aggrieved by this penalty, the said exporter seeks your advice as to the authority to which appeal can be made and the time limit for making such appeals. You are required to advise on the matter. (May 2008) Answer Sections 17 and 19 of Foreign Exchange Management Act 1999 provide for appeals against orders of Adjudicating Authority. If the Adjudicating Authority is Assistant Director of Enforcement or Deputy Director of Enforcement, appeal will lie to Special Director (Appeals). Further appeal shall lie with Appellate Tribunal for foreign Exchange. However, the Adjudicating Authority is senior to the Assistant Director of Enforcement or Deputy Director of Enforcement, then the appeal shall lie directly to the Appellate Tribunal. Appeal to Special Director (Appeals) Appeal against order of Assistant Director of Enforcement or Deputy Director of Enforcement can be filed with Special Director (Appeals) under Section 17 of the said act within 45 days from the date on which the copy of the order made by the Adjudication Authority is received by the aggrieved person. The Special Director (Appeals) can condone the delay in filing the appeal if he is satisfied that there were sufficient cause for not filing the appeal within the stipulated time. Special Director (Appeals) will hear the parties and then pass his order. Copy of the order shall be sent to the concerned parties and the Adjudicating Authority. Appeal to Appellate Tribunal Appeal against the order of Adjudicating Authority being senior to Assistant Director of Enforcement or Deputy Director of Enforcement or against the order of Special Director (Appeals) can be made to the Appellate Tribunal for Foreign Exchange under Section 19 of Foreign Exchange Management Act, 1999 within 45 days from the date on which the copy of the order made by such Adjudicating Authority or Special Director (Appeals) is received by the aggrieved person. In this case also, the delay can be condoned by the Appellate Tribunal. In case of an appeal against the order imposing penalty, the appellant has to deposit the amount of such penalty with the authority prescribed by the Central Government. However, the Appellate Tribunal may waive such deposit to mitigate the likely hardship that may be caused to the appellant. After hearing of the appeal, the Appellate Tribunal shall pass a reasoned order. It may be noted that the Tribunal is the final fact finding authority and no appeal lies against the facts determined by the Tribunal.



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Question 21 Mr. Kale, an Indian National desires to obtain foreign exchange for the following purposes:

(i) Remittance of US Dollar 50,000 out of winnings on a lottery ticket.

(ii) US Dollar 100,000 for sending a tour of a cultural group to USA.

(iii) US Dollar 50,000 for meeting the expenses of his business tour to Europe.

Advise him, if he can get the Foreign Exchange and under what conditions. (May 2008) Answer Under provisions of Section 5 of the Foreign Exchange Management Act, 1999 certain rules have been made for drawal of Foreign Exchange for Current Account transactions. As per these Rules, Foreign Exchange for some of the Current Account transactions is prohibited. As regards some other Current Account transactions, Foreign Exchange can be drawn with prior permission of the Central government or Reserve Bank of India. (i) Remittance out of lottery winnings, is prohibited and the same is included in First

Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000. Hence Mr. Kale cannot withdraw Foreign Exchange for this purpose.

(ii) Foreign Exchange or meeting expenses of cultural tour can be withdrawn by any person after obtaining permission from Government of India, Ministry of Human Resources Development, (Department of Education and culture) as prescribed in Second Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000. Hence, in respect of item (ii), Mr. Kale can withdraw the Foreign Exchange after obtaining such permission.

(iii) The type of payment as envisaged is covered under Third Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000 and for withdrawing foreign Exchange exceeding US Dollar 25,000 for a business tour irrespective of period of stay Mr. Kale will require the prior permission of the Reserve Bank of India.

In all the cases, where remittance of Foreign Exchange is allowed, either by general or specific permission, the remitter has to obtain the Foreign Exchange from an Authorised Person as defined in Section 2(c) read with Section 10 of the Foreign Exchange Management Act, 1999. Question 22 Mr. Guilt an Indian National realizes that a penalty may be imposed upon him for violation of the provisions of the Foreign Exchange Management Act, 1999. He therefore desires to compound his offences. Advise Mr. Guilt about the process and procedure of compounding of the offence. (November 2008)



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Answer Sections 15 of Foreign Exchange Management Act, 1999 (FEMA) authorizes the Reserve Bank of India and Enforcement Directorate to compound contravention on an application made by any person who has committed contravention. The process and procedure of compounding is as under: • An application for compounding of a contravention under the FEMA may be submitted

to the compounding authority either on being advised of a contravention or either through a memorandum or suo moto on being made or becoming aware of the contravention. The application should be as per format in the Foreign Exchange (Compounding proceeding) Rules.

• Application for compounding in prescribed form together with a copy of the memorandum wherever applicable with the prescribed fee has to be submitted with relevant facts and supporting documents to the compounding authority.

• The compounding authority may call for any information/record or any other documents relevant to the compounding proceedings.

• Where additional information/documents are called for, such information shall be submitted within thirty days or such additional period as may be given by the compounding authority from the date of the said letter. In case the contravener fails to submit additional information/document called for within the specified period, the application for compounding will be liable for rejection.

• On receipt of the application for compounding, the proceeding would be concluded and the order issued by the compounding authority within 180 days from the date of the receipt of the application for compounding.

• The sum for which contravention has been compounded shall be paid within 15 days from the date of order of compounding.

• The payment towards application fee and the sum for which contravention has been compounded shall be paid by demand draft in favour of compounding authority.

Thus Mr. Guilt will have to follow the above procedure for compounding his offences. Question 23 Mr. Amit, a citizen of India, left India for employment in Australia on 1st June, 2007. Mr. Amit purchased a flat at New Delhi for Rs.15 lakhs in September, 2008. His brother, Mr. Sumit employed in New Delhi, also purchased a flat in the same building in September, 2008 for Rs. 15 lakhs. Mr. Sumit ‘s flat was financed by a loan from a housing finance company and the loan was guaranteed by Mr. Amit. Examine with reference to the provisions of Foreign



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Exchange Management Act, 1999, whether purchase of flat and guarantee by Mr. Amit are capital account transactions and whether these transactions are permissible.

(November 2008) Answer A “capital account transaction” means a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of persons resident outside India. It also includes following transactions referred to in sub-section (3) of Section 6 of Foreign Exchange Management Act 1999: (a) Acquisition or transfer of immovable property in India, other than a lease not exceeding

five years, by a person resident outside India; (b) Giving of a guarantee or surety in respect of any debt, obligation or other liability

incurred- Thus purchase of flat at New Delhi and giving of guarantee would be considered as capital account transactions. A capital account transaction is not permissible, unless otherwise provided in the Act, Rules or Regulations made there under, or with the general or special permission of Reserve Bank of India. In the case referred, Mr. Amit left India for employment in Australia on 1st June 2007. Therefore, he becomes a person resident outside India from June 2007. The purchase of flat by Mr. Amit is a capital account transaction. This is permissible in accordance with the regulation framed in this behalf i.e. The Foreign Exchange Management (Acquisition and Transfer of Immovable Property In India) Regulation, 2000. The Foreign Exchange Management (Acquisition and Transfer of Immovable property In India) Regulation, 2000 imposes restrictions on a person resident outside India from acquiring immovable property in India provided he fulfills both the following conditions: (a) the person resident outside India is citizen of India and (b) the immovable property acquired in India is not agricultural/plantation or farmhouse. Therefore the purchase of flat by Mr. Amit is permissible under FEMA. Guarantee involves a long term commitment which alters the assets and liabilities of a person and therefore it is considered as a “capital account transaction’ and thus restricted under FEMA. Accordingly Mr. Amit can give a guarantee to the housing finance company in respect of purchase of flat by Mr. Sumit with the permission of Reserve Bank of India. Question 24 Mr. Basu desires to draw foreign exchange for the following purposes: (i) Payment related to “Call back services” of telephones



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(ii) USD 1,20,000 for studies abroad on the basis of estimates given by the foreign university.

(iii) USD 25,000 for sending a cultural troupe on a tour of Europe. Advise him, whether he can get foreign exchange and, if so, under what conditions

(CA, Final, New Course, November, 2008) Answer Current Account Transactions: The Central Government in consultation with RBI framed regulation known as Foreign Exchange Management (Current Account Transaction) Regulation, 2000. Under these Regulations certain transactions are prohibited, certain transactions require Central Government approval and certain transactions require RBI approval. (i) Payment related to ‘call back services’ of telephone is totally prohibited under Schedule

I of Foreign Exchange Management (Current Account Transaction) regulations. (ii) Remittance of Foreign Exchange for studies abroad: This is a Schedule III transaction. Foreign Exchange may be released for studies

abroad up to a limit of USD 1,00,000 or the estimates from the institution abroad, whichever is higher. Above this limit RBI’s approval is required. In this case USD 1,20,000 is required on the basis of estimates of the institution abroad. Hence no permission from RBI is required.

(iii) Cultural troupe: This is a Schedule II transaction. Irrespective of the amount involved prior approval of

Central Government, Ministry of HRD (Dept. of Education and Culture) is required. However no permission is required in case of remittance out 0f Resident Foreign Currency (RFC) Account or (Exchange Earner’s Foreign Currency) EEFC Account.

Question 25 Answer any two of the following:

(a) State the kind of approval required for the following transaction under the Foreign Exchange Management Act, 1999:

(i) L, a famous playback singer of India wants to perform a musical night in Paris for Indians residing there. Foreign exchange to the extent of US D 20,000 is required for this purpose.

(ii) M requires US D 5,000 to make payment related to ‘ call back services’ of telephone.



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(iii) N wants to pursue a course in business management in New York.. He wants to draw US D 50,000 towards expenses for studying abroad.

(iv) R wants to draw US D 20,000 to make donation to a charitable trust situated in South Korea.

(b) Mr. Raman is a software engineer of Armtek Ltd. The company sent him to Japan to develop a software programme there on deputation for 2 years. He earned a sum of US $ 3,000 as a honorarium there. On his return to India he wants to hold this foreign currency with him. Whether Mr. Raman will be allowed to keep the foreign currency with him. (May 2009)

Answer (a) (i) Foreign exchange drawals for cultural tours require prior permission/approval of

the Government of India irrespective of amount of foreign exchange required. Therefore, in the given case L, the singer is required to seek permission of the Government of India.

(ii) Drawal of foreign exchange for payment related to ‘call back services’ of telephones is prohibited. Therefore ‘M’ can not draw foreign exchange.

(iii) Release of foreign exchange for education abroad is permitted up to USD 100,000 on self declaration basis. Therefore ‘N’ can draw foreign exchange on self declaration basis for pursuing a course in business management in New York.

(iv) Making donation exceeding USD 10000 per annum per beneficiary require Reserve Bank of India’s prior approval. Therefore ‘R’ can draw USD 20000 to make donation after taking prior approval from Reserve Bank of India.

(b) As per Section 8 of Foreign Exchange Management Act, 1999 where any amount of foreign exchange is due or has accrued to any person resident in India, such person shall take all reasonable steps to realize and repatriate to India such foreign exchange within such period and in such manner as may be specified by Reserve Bank of India.

But as per section 9(e) of the said Act, this provision shall not apply to foreign exchange acquired from employment, business trade, vocation, service honorarium, gifts, inheritance or any other legitimate means up to such limit as the Reserve Bank of India may specify.

The Reserve Bank of India has specified the following persons with the limits for possession and retention of foreign currency by a person resident in India:

Any person may possess foreign coins without any restriction to the amount.



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Any person resident in India is permitted to retain in aggregate foreign currency not exceeding USD 2,000 or its equivalent in the form of currency notes/bank notes or travelers cheques acquired by him;

Any person resident in India but not permanently resident therein is permitted to hold the foreign currency without limit, if the foreign currency was acquired when he was resident outside India and was brought into India and declared to the custom authorities.

In the given case as Mr. Raman earned a sum of USD 3000 as a honorarium when he was in employment in Japan. But in view of the restrictions under FEMA and the aforesaid regulation he can retain foreign exchange up to USD 2000 only and not more than that.

Question 26

(i) Mr. Sekhar resided in India for a period of 150 days during the financial year 2007-2008 and thereafter went abroad. He came back to India on 1st April, 2008 as an employee of a business organization. What would be his residential status under Foreign Exchange Management Act, 1999 during the financial year 2008-2009?

(ii) Mr. Atul, an Indian National desire to obtain Foreign Exchange for the Following purpose:

(a) Remittance of US Dollars 10,000 for payment for goods purchased from a party situated in Nepal.

(b) US Dollars 10,000 for remitting as commission to his agent in U.S.A for sale of Commercial plot situated near Bangalore, consideration in respect of which was received by Mr. Atul by way of foreign currency inward remittance amounting to US Dollars 1,00,000.

Advise him, if he can get the Foreign Exchange and under what conditions for making the above remittances. (CA, Final, New Course, May 2009)

Answer

(i) According to the provisions of Section 2(v) of the Foreign Exchange Management Act, 1999, a person in order to qualify for the purpose of being treated as a “Person Resident in India” in any financial year, must reside in India for a period of more than 182 days during the preceding financial year. In the given case, Mr. Sekhar has resided in India for a period of only 150 days, i.e. less than 182 days, during the financial year 2007-2008. Hence he cannot be considered as a “Person Resident in India” during the financial year 2008-2009 irrespective of the purpose or duration of his stay.



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(ii) Under provisions of Section 5 of the Foreign Exchange Management Act, 1999 certain Rules have been made for drawal of Foreign Exchange for Current Account transactions. As per these Rules, drawal of Foreign Exchange for some of the Current Account transactions is prohibited. As regards some other Current Account Transactions, Foreign Exchange can be drawn with prior permission of the Central Government while in case of some Current Account transactions, prior permission of Reserve Bank of India is required. (a) In respect of item (a), i.e. remittance to Nepal, such remittance is prohibited and

the same is included in First Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000. Hence Mr. Atul can not withdraw foreign Exchange for this purpose.

(b) The type of payment as envisaged in item (b) is covered under Third Schedule to the Foreign Exchange Management (Current Account Transactions) Rules, 2000 and for withdrawing foreign Exchange exceeding 5% (five percent) of the inward remittance as commission to agent abroad for sale of commercial plot in India Mr. Atul will require the prior permission of the Reserve Bank of India.

Question 27 (a) (i) Mr. Ruchi resided for a period of 170 days in India during the financial year 2008 -

09 and thereafter went abroad. He came back to India on 1st April, 2009 as an employee of a business organization. What would be his residential status during financial year 2009-10 under the Foreign Exchange Management Act, 1999?

(ii) Pamtop is a London based Company having several business units all over the world. It has manufacturing unit called Laptop with headquarters in Bengaluru. It has a branch in Seoul, South Korea which is controlled by the headquarters in Bengaluru. What would be the residential status under the FEMA, 1999 of Laptop in Bengaluru and that of Seoul branch?

(b) Referring to the provisions of the Foreign Exchange Management Act, 1999, examine whether V, an exporter is bound to make declaration of the following goods exported from India to United Kingdom: (i) Exports software valuing Rs.50,000. (ii) V gifts certain items of jewellery valued at Rs.20,000 to his friend in Australia. (iii) V exports certain goods valuing US $ 5,000 to Myanmar under Barter Trade

Agreement. Answer (a) (i) Residential status of an individual for a particular financial year is determined with

reference to his residence in India in the immediately preceding financial year. In the



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given problem Mr. Ruchi resided in India for less than 183 days in the financial year 2008-09. Therefore for the financial year 2009-10 he is a person resident out side India. Unless a person resides in India for more than 182 days in the preceding financial year, he can in no case be termed as a person resident in India.

(ii) Pamptop being a London based Company would be a person resident out side India .Section 2 (u) defines ‘person’ Under clause (vii) thereof ‘person’ would include any agency office or branch owned or controlled by such person. The term ‘such person’ appears to refer to person who is included in clauses (i) to (vi). Accordingly, a laptop unit in Bengaluru, being a branch of a Company, would be a ‘person.’

Section 2(v) defines person ‘resident in India’, under clause (iii) thereof person ‘resident in India’, would include an office, branch or agency in India owned or controlled by a person resident outside India. Laptop unit in Bengaluru is owned or controlled by a person ‘resident outside India’ Hence, it would be a person ‘resident in India’.

However Seoul branch ‘though not owned’ is controlled by Laptop unit in Bengaluru which is a person resident in India. Hence, prima-facie, it may be possible to hold a view that the Seoul branch is also a ‘person resident in India’.

(b) In accordance with provisions of the FEMA, 1999 as contained in Section 7read with Section 8, it imposes on an exporter to make appropriate declaration of the value of the goods being exported and he is also required to repatriate the foreign exchange due to India in respect of such exports to India in the manner within the time as may be prescribed. Under Section 8, the exporter is under an obligation to realise and repatriate to India such foreign. However, if there is an delay in the receipt of export, it will not be a violation which shall be punishable. Section 8 applies to a resident who shall take all the reasonable steps, depending upon the individual case.

There are certain categories of export for which declaration need not be made. These are: (a) Export of goods/software no exceeding Rs.25,000 in value. (b) Export by way of gift not exceeding Rs.1 lac in value. (c) Export of goods not under exceeding US $ 1000 or its equivalent per transaction to

Myanmar under Barter Trade Agreement. Taking into consideration the above, answer to the question are: 1. In the first case since the value is exceeding Rs.25,000 in value, therefore, declaration has

to be completed. 2. In the second case since the value of gift of jewellery to V’s friend in Australia is less than

Rs.1 lac in value, the gift does not need any declaration to be completed.



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3. In the third case since the value is more than U.S.$ 1,000,therefore, the declaration has to be completed.

Question 28 A Company incorporated in United Kingdom established a branch at Chennai. What is the residential status of the Chennai branch? The Chennai branch proposes the purchase some immovable property at Chennai for the purpose of its business. Is it a ‘Capital Account Transaction’ within the meaning of Section 2(e) of the Foreign Exchange Management Act, 1999? Are there any restrictions under the Foreign Exchange Management Act, 1999 in respect of such acquisition? (CA, Final, New Course, November, 2009) Answer According to section 2(v)(iii) of FEMA, 1999, person resident in India inter alia means an office, branch, or agency in India owned or controlled by a person resident outside India. The company incorporated in U.K is a person resident outside India [Section 2(v)(ii) read with section 2(w) of the FEMA] as it is not a body corporate registered or incorporate in India. As the Chennai branch is branch in India is owned and controlled by the U.K Company is resident outside India, the Chennai branch is resident is India under section 2(v) (iii) stated above. Capital account transaction. In the case of a resident in India, capital account transaction means a transaction which alters the assets or liabilities outsides India. The Chennai branch (is resident in India) acquires immovable properly at Chennai (is in India). Hence this acquisition is not a capital account transition within the meaning of Section (2(e) of FEMA. Section 6(3) empowers RBI to restrict or regulate the acquisition of immovable property in India by a person resident outside India. Hence there is no restriction in acquisition of immovable property in India by Chennai branch. Question 29 (a) The Reserve Bank of India receives a complaint that an authorized person has

submitted incorrect statements and information to the Reserve Bank of India in respect of receipt and utilization of Foreign Exchange. Explain the powers of the Reserve Bank of India with regard to inspection of records of the above authorized person in respect of the above complaint.

Referring to the provisions of Foreign Exchange Management Act, 1999, state the duties of the above authorized person.

(b) Referring to the provisions of the Foreign Exchange Management Act, 1999, state the kind of approval required for the following transactions:

(i) M requires U.S. $ 5,000 for remittance towards hire charges of transponders.

(ii) D requires U.S. $ 14,000 per annum for donation to Mr. White in U.S.A.



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(iii) P requires U.S. $ 2,000 for payment related to call back services of telephones.

(iv) XYZ Limited, a company incorporated in India under the Companies Act, 1956, wants to withdraw U.S. $ 5,00,000, for short-term credit to its overseas office situated in Australia. (May, 2010)

Answer (a) As per Section 12 of the Foreign Exchange Management Act, 1999

(1) The Reserve Bank may, at any time, cause an inspection to be made by any officer of the Reserve Bank specially authorized in writing by the Reserve Bank in this behalf, of the business of any authorized person as may appear to it to be necessary or expedient for the purpose of: (a) verifying the correctness of any statement, information or particulars

furnished to the Reserve Bank; (b) obtaining any information or particulars which such authorized person has

failed to furnish on being called upon to do so; (c) securing compliance with the provisions of this Act or of any rules,

regulations, directions or orders made thereunder. (2) It shall be the duty of every authorized person, and where such person is a

company or a firm, every director, partner or other officer of such company or firm, as the case may be, to produce to any officer making an inspection under section 12 (1) such books, accounts and other documents in his custody or power and to furnish any statement or information relating to the affairs of such persons, company or firm as the said officer may require within such time and in such manner as the said officer may direct.

(b) Under section 5 of the Foreign Exchange Management Act, 1999, and Rules relating thereto, some current account transactions require prior approval of the Central Government, some others require the prior approval of the Reserve Bank of India, some are free transactions and some others are prohibited transactions. Accordingly, (i) It is a current account transaction, where M is required to take approval of the

Central Government for drawal of foreign exchange for remittance of hire charges of transponders.

(ii) It is a current account transaction, which requires RBI’s prior approval for donating US $ 14,000 per annum to Mr. White in U.S.A., as the donation amount exceeds the ceiling of US $ 10,000 per annum per beneficiary.



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(iii) Withdrawal of foreign exchange for payment related to call back services of telephone is a prohibited transaction. Hence, Mr. P will not succeed in acquiring US $ 2,000 for the said purpose.

(iii) Here, XYZ Limited has to take prior approval of the RBI for withdrawing US $ 5,00,000 for short-term credit to its overseas office situated in Australia.

Question 30 (i) The Reserve Bank of India issued certain directions to Dream Construction Limited, an

authorised person under the Foreign Exchange Management Act, 1999 to file certain returns. The Company failed to file the said returns. Decide, as to what penal provisions are applicable against the said authorised person under the said Act.

(ii) Examine under the Foreign Exchange Management Act, 1999 whether "Payment of remuneration to foreign technicians" is a permissible transaction under the provisions of the said Act. (CA, Final, New Course, May, 2010)

Answer (i) Penal provisions: Section 11(3) of the Foreign Exchange Management Act, 1999 states

that where any authorized person contravenes any direction given by the Reserve Bank of India under the said Act or fails to file any return as directed by the Reserve Bank of India, the Reserve Bank of India may, after giving reasonable opportunity of being heard impose a penalty which may extend to Rs. 10,000/- and in the case continuing contraventions with an additional penalty which may extend to Rs. 2,000/- for every day during which such contravention continues.

(ii) Foreign Technician: Salary payable to a foreign technician is a current account transaction. According to Section 5 of the Foreign Exchange Management Act, 1999 any person can sell or draw foreign exchange to or from authorized person if such sale or drawal is a current account transaction. Reasonable restrictions on current account transactions can be imposed by the Central Government. Basically all current account transactions are free unless specifically restricted by the Central Government. Hiring of foreign nations as technicians is permissible without restriction. There is not ceiling on salary which can be paid as per contract. Their salary can be remitted abroad after tax deducted at source.


CHAPTER 4

THE COMPETITION ACT, 2002

Question 1 How will the Chairperson and other members of the Competition Commission of India be appointed? State whether the Chairperson shall be only a person, who has been or is qualified to be, a Judge of a High Court. (November, 2003) Answer Competition Commission of India The Competition Commission of India shall consist of a Chairperson and not less than two and not more than six other members to be appointed by the Central Government (Section 8) while the appointment is made by the Central Government, the Chairperson and other members shall be selected in the manner as may be prescribed (Section 9). The Chairperson and every other member shall be a person of ability, integrity and standing and who has special knowledge of, and such professional experience of not less than 15 years in international trade, economics, business, commerce, law, finance accountancy, management, industry, public affairs or competition metters including competition law and policy and which, in the opinion of the Central Government may be useful to the commission [Section 8(2)]. As the qualification prescribed in the Act is the same for chairperson and other members, chairperson of commission may or may not be a judicial person. Question 2 An understanding has been reached among the manufacturers of cement to control the price of cement, but the understanding is not in writing and it is also not intended to be enforced by legal proceedings.

Examine whether the above understanding can be considered as an ‘Agreement’ with the meaning of Section 2(b) of the Competition Act, 2002. (May, 2004) Answer Agreement ‘Agreement’ includes any arrangement or understanding or action in concert: (i) Whether or not, such arrangement, understanding or action is formal or in writing or



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(ii) Whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings. [Section 2(b)].

In view of the above definition of ‘agreement’, an understanding reached by the cement manufacturers to control the price of cement will be an ‘agreement’ within the meaning of Section 2(b) of the Competition Act, 2002 even though the understanding is not in writing and it is not intended to be enforceable by legal proceedings.

Question 3 Poly Ltd., (hereinafter referred to as “Seller”), manufacturer of footwears entered into an agreement with City Traders (hereinafter referred to as “purchaser”), for sale of its products. The agreement includes, among others, the following clauses:

(i) That the Purchaser shall not deal with goods, products, articles, by whatever name called, manufactured by any person other than the Seller.

(ii) That the Purchaser shall not sale the goods manufactured by the Seller outside the municipal limits of the city of Secunderabad.

(iii) That the Purchaser shall sale the goods manufactured by the Seller at the price as embossed on the price label of the footwear. However, the purchaser is allowed to sale the footwear at prices lower than those embossed on the price label.

You are required to examine with relevant provisions of the Competition Act 2002, the validity of the above clauses. (November, 2004)

Answer Provisions of section 3(1) of the Competition Act, 2002 prohibits any agreement for goods and/or services that may have an appreciable adverse effect on competition in India. Provisions of section 3(2) of the said Act states that any agreement entered into in contravention of provision of section 3(1) of the said Act shall be void. Sections 3(3) and 3(4) of the said Act enumerates the types of the agreements which are to be treated as contravening the provisions of the said section 3(1). According to section 3(4) of the said Act, any agreement among enterprises or persons at different stages of the production chain in different markets, in respect of production, supply, distribution, storage, sale or price of, or trade in goods or provision of services including the following shall be treated as agreements in contravention of the said section 3(1): (a) tie-in-arrangement ; (b) exclusive supply agreement ; (c) exclusive distribution agreement ; (d) refusal to deal


The Competition Act, 2002

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(e) re-sale price maintenance The clauses of the agreement given in the question are covered by above mentioned provisions Clause at Sr. No.(i) comes under exclusive supply agreement; Clause at Sr. No.(ii) comes under exclusive distribution agreement and Clause at Sr. No.(iii) is covered by re-sale price maintenance. Explanations to said section 3(4) explains the above terms. According to Explanation (b), exclusive supply agreement includes any agreement restricting in any manner, the purchaser in the course of his trade from acquiring or otherwise dealing in any goods other than those of the seller or any other person. According to Explanation (c), exclusive distribution agreement includes any agreement to limit, restrict or withhold the output or supply of any goods or allocate any area or market for the disposal or sale of the goods. According to Explanation (e), "resale price maintenance" includes any agreement to sell goods on condition that the prices to be charged on the resale by the purchaser shall be the price stipulated by the seller unless it is clearly stated that prices lower than those prices may be charged. In view of the above provisions of the Competition Act, 2002, validity of the clauses of the agreement as given in the question can be determined as follows: Clause (i) restricts the purchaser to deal in the goods of manufacturers other than the seller. Hence this is in contravention of the provisions of section 3(1) of the said Act. Clause (ii) restricts the purchaser to sell the goods within a specified area. Hence this is in contravention of the provisions of section 3(1) of the said Act Clause (iii) stipulates the resale price, but it allows the purchaser to sell the goods at lower prices than the stipulated prices. Hence this is a valid clause. But, the law states that any such agreement containing any of the prohibited clause shall be void. Therefore, even if the agreement contains some valid clauses, it shall still be termed as void if it contains even one prohibited clause. Question 4 Mr. MKP was a member of the Competition Commission of India. He ceased to be such member on 31st March, 2005. Thereafter, he was offered the post of Executive Director with appropriate remuneration and perquisites in the following organisations to join his duties on and from 1st July, 2005:



4.4

(i) HLL Ltd., a private sector public limited company, whose case was disposed off by the Competition Commission under the provisions of the Competition Act, 2005 in the month of February, 2005.

(ii) Life Insurance Corporation of India.

You are required to state with relevant provisions of the Competition Act, 2002 the option available to Mr. MKP in respect of accepting the above offers. (May 2005) Answer The Chairperson and other Members shall not, for a period of two years from the date on which they cease to hold office, accept any employment in, or connected with the management or administration of, any enterprise which has been a party to a proceeding before the Commission under this Act. (Section 12 of the Competition Act, 2002) Provided that nothing contained in this section shall apply to any employment under the Central Government or a State Government or local authority or in any statutory authority or any corporation established by or under any Central, State or Provincial Act or a Government company as defined in section 617 of the Companies Act, 1956 (1 of 1956). Based on the above provisions of the Competition Act, 2002, Mr. MKP will not be able to accept the offer of HLL Ltd. for two years from the date of his cessation as a member of the Competition Commission since the said company was a party to the proceedings before the Commission. However, since Life Insurance Corporation of India is a Corporation established under the Central Act, the above restriction does not apply and Mr. MKP can accept the offer to join as the Executive Director of the said corporation with effect from 1st July, 2005. Question 5 (i) In a proceeding before the Competition Commission of India involving two

pharmaceutical companies, the plaintiff requested the presiding officer to call upon the services of experts from the pharmaceutical sector to determine the truth of the allegations leveled by it against the respondent. The respondent opposed the request on the ground that such action can not be taken by the Competition Commission. You are required to state with reference to the provisions of the Competition Act, 2002, whether the contention of the respondent is tenable.

(ii) The Central Government has formed an opinion that Mr. CBM (a member of the Competition Commission of India) has acquired such financial interest that it may affect prejudicially his functions as a member of the Competition Commission and it wants to remove him from his office. You are required to state with reference to the provisions of



4.5

the Competition Act, 2002, whether the Central Government can do so and if yes, how? (November 2005)

Answer (i) As per provisions of Section 36(3) of the Competition Act, 2002, the Competition

Commission may call upon such experts from the fields of economics, commerce, accountancy, international trade or other disciplines as it deems necessary, to assist the Commission in the conduct of any enquiry or proceeding before it. As per Regulation 54 of the Competition Commission (General) Regulations, 2004 made by the Commission under Section 64 of the Competition Act, 2002, it may draw up a panel of such experts.

In view of the above stated specific powers given to the Competition Commission, it can call upon the services of an expert from the pharmaceutical sector to determine the truth of the allegations levelled by the plaintiff against the respondent. Hence, the contention of the respondent is not tenable.

(ii) Section 11(2) of the Competition Act, 2002 empower the Central Government to remove, by an order, a member of the Competition Commission of India from his office if such member has acquired such financial interest as is likely to affect prejudicially his functions as a Member of the Competition Commission. However, provisions of Section 11(3) of the said Act puts some restrictions on such powers of the Central Government. According to this section, in case as stated in the question, the Central Government wants to remove a member of the Competition Commission from his office on the above ground it has to make a reference to the Supreme Court. The Supreme Court shall hold an enquiry in accordance with the procedure formulated by it and then report that the member in question ought to be removed from his office on such ground.

Thus, the Central Government can remove a member of Competition from his office by following the above procedure.

Question 6 Examine with reference to the relevant provisions of the Competition Act, 2002 the following:

(i) Whether a Government Department supplying water for irrigation to the Agriculturists after levying charges for water supplied (and not a water tax) can be considered as an ‘Enterprise’.

(ii) Whether a person purchasing goods not for personal use, but for resale can be considered as a ‘consumer.’ (May 2006)

Answer Enterprise: The term ‘enterprise’ is defined in Section 2(h) of Competition Act, 2002. Accordingly ‘enterprise’ means a person or a department of the Government, who or which is engaged in any activity, relating to the production, storage, supply, distribution, acquisition or



4.6

control of articles or goods, or the provision of services of any kind. But the term does not include any activity of the Government relatable to sovereign functions of the Government including all activities carried on by the departments of the Central Government dealing with atomic energy, currency, defence and space. Certain specific activities of Government departments like dealing with atomic energy, etc,. and sovereign functions of the Government (like police, defence, etc.) are excluded from the purview of the said terms. Hence, a Government department engaged in the activity of providing service in the form of supply of water for irrigation to the agriculturists after levying charges can be considered as an ‘enterprise’ within the meaning of Section 2(h) of Competition Act, 2002. Consumer: The term ‘consumer’ is defined in Section 2(f) of Competition Act, 2002. Accordingly ‘consumer’ means any person who buys any goods for a consideration, which has been paid or promised or partly paid and partly promised, whether such purchase of goods is for resale or for any commercial purpose or for personal use. Hence, it is not necessary that a person must purchase the goods for personal use in order to be considered as a ‘consumer’ under Competition Act, 2002. Even a person purchasing goods for resale or for any commercial purpose will also be considered as a ‘Consumer’ within the meaning of Section 2(f) of Competition Act, 2002. Question 7 (i) Mr. ZPM was appointed as a Member of the Competition Commission of India by

Central Government. He has a professional experience in international business for a period of 12 years, which is not a proper qualification for appointment of a person as member. Pointing out this defect in the Constitution of Commission, Mr. YKJ, against whom the commission gave a decision, wants to invalidate the proceedings of the commission. Examine with reference to the provisions of the Competition Act, 2002 whether Mr. YKJ will succeed.

(ii) ABC Ltd. made an initial public offer of certain number of equity shares. Examine whether these shares can be considered as ‘Goods’ under the Competition Act, 2002 before allotment. (November 2006)

Answer (i) As per section 15 of Competition Act 2002 any act or proceeding of the Commission

shall not be invalidated merely on the ground of: (a) any vacancy in, or any defect in the constitution of the Commission; or (b) any defect in the appointment of a person acting as a Chairperson or as a

member; or



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(c) any irregularity in the procedure of the Commission not affecting the merits of the case.

Here in this case Mr. ZPM should have professional qualification of not less than 15 years as per section 8 of the Act but this disqualification will not invalidate the proceeding of the Commission.

(ii) Section 2(i) of Competition Act, 2002 defines ‘goods’ as follows: ‘Goods’ means goods as defined the Sale of Goods Act, 1930 and includes –

(a) products manufactured, processed or mined; (b) debentures, stock and shares after allotment (c) in relation to goods supplied, distributed or controlled in India, goods imported

into India. Hence, debentures and shares can be considered as ‘goods’ within the meaning of

section 2(i) of Competition Act, 2002 only after allotment and not before allotment. Question 8 (i) Hon’ble Justice Mr. HCJ, a retired High Court Judge, attained the Age 61 years on 31st

December, 2004. The Central Government appointed him as the Chairperson of the Competition Commission of India with effect from 1st January, 2005. You are required to state, with reference to the provisions of the Competition Act, 2002, the term for which he may be appointed as Chairperson of the Competition Commission of India. Whether he can be reappointed as such and till when he can remain as Chairperson of the Competition Commission of India ?

(ii) After ceasing to be a member of the Competition Commission of India with effect from 31st March, 2007, Mr. MKP was offered the post of Executive Director with appropriate remuneration and perquisites in the following organizations with effect from 1st April, 2007: (a) HLL Ltd. a private sector public limited company, whose case was disposed off

by the Competition Commission under the provisions of the Competition Act, 2002 in the month of February, 2007.

(b) Life Insurance Corporation of India. You are required to state with relevant provisions of the Competition Act, 2002, the

option available to Mr. MKP in respect of accepting the offers. (May 2007) Answer (i) According to Section 10(1) of the Competition Act, 2002, the Chairperson and every

other Member shall hold office as such for a term of five years from the date on which he enters upon his office and shall be eligible for re-appointment.



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Provided that no Chairperson or other Member shall hold office as such after he has attained the age of sixty five years.

Based on the above provisions of the Competition Act, 2002, it can be concluded that Hon’ble retired Justice Mr. HCJ can be appointed as the Chairperson of the Competition Commission of India by the Central Government initially for a period of five years and he can also be re-appointed after his initial term of five years is over. But since he shall be attaining the age of 65 years as on 31st August, 2008, he will have to step down from the post on his attaining the age of 65 years.

(ii) In accordance with the provisions of the Competition Act, 2002 as contained in Section 12, the Chairperson and other Members shall not, for a period of two years from the date on which they ceased to hold office, accept any employment in, or connected with the management or administration of, any enterprise which has been a party to a proceeding before the Commission under this Act:

Provided that nothing contained in this section shall apply to any employment under the Central Government or a State Government or local authority or in any statutory authority or any corporation established by or under any Central, State or Provincial Act or a Government company as declined in section 617 of the Companies Act, 1956 (1 of 1956).

Based on the above provisions of the Competition Act, 2002, Mr. MKP will not be able to accept the offer of HLL Ltd. for two years from the date of his cessation as a member of the Competition Commission since in a case of the said company, it was a party to the proceedings before the Commission.

However, since Life Insurance Corporation of India is a Corporation established under the Central Act, the above restriction does not apply and Mr. MKP can accept the offer to join as the Executive Director of the said corporation with effect from 1st April, 2007.

Question 9 (i) An arrangement has been made among the Cotton producers that the cotton produced

by them will not be sold to mills below a certain price. The arrangement was in writing but it was not intended to be enforced by legal proceeding. Examine whether the above arrangement can be considered as an agreement within the meaning of Section 2(b) of the Competition Act, 2002.

(ii) The Central Government has formed the opinion that Mr. CBM (A member of the Competition Commission of India) has abused his position which may be prejudicial to public interest as a member of the commission. Examine the powers of the Central Government in this regard (November 2007)



4.9

Answer (i) As per Section 2(b) of Competition Act, 2002 an ‘agreement’ includes any arrangement

or understanding or action in concert, - • Whether or not, such a arrangement or understanding or action is formal or in

writing; or • Whether or not, such a arrangement or understanding or action is intended to be

enforceable by legal proceedings. In the given case the understanding reached among the cotton produces not to sell below a certain price shall amount to an agreement as defined under Section 2(b) notwithstanding the fact that arrangement is writing but no intended to enforce by legal proceeding.

(ii) Section 11(2) (e) of the Competition Act, 2002 empowers the Central Government to remove by an order, a member of the Competition Commission of India from his office if such member has abused his position as to render his continuance in office prejudicial as a member of competition commission. However provision of Section 11(3) of the said act puts some restrictions on such powers of the Central Government. According to this section, in case as stated in the question, Central Government wants to remove a member or the Competition Commission from his office on the above ground, it has to make a reference to the Supreme Court. The Supreme Court shall hold an enquiry in accordance with the procedure formulated by it and then report that the member in question ought to be removed form his office on such ground. Thus the Central Government can remove a member of Competition Commission from his office by following the above procedure.

Question 10 (i) In a proceeding before the Competition Commission of India involving two

Pharmaceutical companies, the plaintiff requested the presiding officer to call upon the services of experts from the pharmaceutical sector to determine the truth of the allegations leveled by it against the respondent. The respondent opposed the request on the ground that such action cannot be taken by the Competition Commission. You are required to state with reference to the provisions of the Competition Act, 2002, whether the contention of the respondent is tenable.

(ii) The Central Government has formed as opinion that Mr. CBM (a member of the Competition Commission of India) has acquired such financial interest that it may affect prejudicially his functions as a member of the Competition Commission and it wants to remove him from his office. You are required to state with reference to the provisions of the Competition Act, 2002, whether the Central Government can do so and if yes, how?



4.10

(May 2008) Answer (i) As per provisions of Section 36(4) of the Competition Act, 2002 the Competition

Commission may call upon such experts from the fields of economics, commerce, accountancy, international trade or other disciplines as it deems necessary, to assist the Commission in the conduct of any enquiry or proceeding before it. As per Regulation 54 of the Competition Commission (General) Regulations, 2004 made by the Commission under Section 64 of the Competition Act, 2002, it may draw up a panel of such experts.

In view of the above stated specific powers given to the Competition Commission, it can call upon the services of an expert from the pharmaceutical sector to determine the truth of the allegations leveled by the plaintiff against the respondent. Hence, the contention of the respondent is not tenable.

(ii) Provisions of Section 11(2) of the Competition Act, 2002 empower the Central Government to remove, by an order, a member of the Competition Commission of India from his office if such member has acquired such financial interest as is likely to affect prejudicially his functions as a Member of the Competition Commission. However, provisions of Section 11(3) of the said Act put some restrictions on such powers of the Central Government. According to this section, in case as stated in the question, the Central Government wants to remove a member of the Competition Commission from his office, it has to make a reference to the Supreme Court. The Supreme Court shall hold an enquiry in accordance with the procedure formulated by it and then report that the member in question ought to be removed from his office.

Thus, the Central Government can remove a member of Competition Commission from his office by following the above procedure.

Question 11 The Competition Commission of India has received a complaint that M/s. XYZ company has been abusing its dominant position in the food processing industry. Explain briefly the factors that will be considered by the commission to ascertain whether M/s. XYZ company enjoys a dominant position in the industry. (November 2008) Answer The Competition Commission while inquiring whether the enterprise XYZ Company enjoys a dominant position or not under Section 4 of the Competition Act, 2002 will take the following factors into account: (a) market share of the enterprise



4.11

(b) size and resources of the enterprise (c) size and importance of the competitors (d) economic power of the enterprise including commercial advantages over competitors. (e) vertical integration of the enterprises or sale or service net work of such enterprises. (f) dependence of consumers on the enterprise. (g) monopoly or dominant position whether acquired as result of any statute or by virtue of

being a Government company or a public sector undertaking or otherwise. (h) entry barriers including barriers such as regulatory barriers, financial risk , high capital

cost of entry, marketing entry barriers, technical entry barriers, economies of scale, high cost of substitutable goods or services for consumers.

(i) countervailing buying power. (j) market structure and size of market . (k) social obligations and size of market. (l) relative advantage, by way of contribution to the economic development, by the

enterprise enjoying a dominant position having or likely to have an appreciable adverse effect on competition.

(m) any other factor which the commission may consider relevant for the inquiry. Question 12 The Central Government on the recommendation of selection committee appoints Mr. RKP aged 56 years as Member of the Competition Commission of India to be effective from 1st January, 2009. State with reference to the provisions of Competition Act, 2002 the term for which he will be appointed and whether he can be reappointed as such and also if he resigns after two years whether the vacancy can be filled up by the Chairman of the commission.

You are further required to mention the composition of the selection committee on whose recommendation the central Government appoints chairman and other members of the Competition Commission of India. (May, 2009) Answer Term of office of chairperson and other members are contained in Section 10 of the Competition Act, 2002 : As per this section the chairperson and every other member shall hold office as such for a term of five years from the date on which he enters upon his office and shall be eligible for re-appointment. They shall not hold office as such after attaining the age of sixty-five years. [Section 10(1)]



4.12

A vacancy caused by the resignation or removal of the chairperson or any other member by death or otherwise shall be filled by fresh appointment in accordance with the provisions of Sections 8 and 9 of the Act. [Section 10(2)] Keeping the above provision in mind Mr. RKP can be appointed as member of the commission for a term of 5 years as he is aged 56 years on 1-1-09. He can also be reappointed but his reappointment will be only up to the age of 65 years. If Mr. RKP resigns as member after working for two years the resulting vacancy can be filled up by fresh appointment approved by the Selection Committee and the Chairman has no power to fill up the vacancy on his own. Selection committee for chairperson and members of commission The chairperson and other members of the commission shall be appointed by the Central Government from a panel of names recommended by a selection committee. Selection committee shall consisting of – (a) The chief justice of India or his nominee ------------------ as chairperson; (b) The secretary in the ministry of corporate affairs ---------- as member; (c) The secretary in the ministry of law and justice --------------- as member; (d) Two experts of repute who have special knowledge of, and professional experience in

international trade, economics, business, commerce, law, finance, accountancy, management, industry, public affairs or competition matters including competition law and policy as members. (Section 9)

Question 13 (i) An arrangement has been made among the cotton producers that the cotton produced by

them will not be sold to mills below a certain price. The arrangement is in writing but it is not intended to be enforced by legal proceeding. Examine whether the said arrangement can be considered as an agreement within the meaning of Section 2(b) of the Competition Act,2002.

(ii) The orange producers of Nagpur have formed an association to control the production of oranges. Examine whether it will be considered as a cartel within the meaning of Section 2(c)of the Competition Act,2002. (November, 2009)

Answer (i) As per Section 2(b) of the Competition Act, 2002 an Agreement includes any arrangement

or understanding or action in concert:- (i) whether or not, such arrangement, understanding or action is formal or in writing; or (ii) whether or not, such arrangement, or understanding or action is intended to be

enforceable by legal proceedings.



4.13

In the given case the understanding reached among the cotton producers not to sell below a certain price shall amount to an agreement as defined under Section 2(b) notwithstanding the fact that through the arrangement is in writing but not intended to be enforced by legal proceeding.

(ii) As per Section 2(c) of the Competition Act, 2002 the term “cartel” includes an association of producers, sellers, distributors, traders or service providers who, by agreement amongst themselves, limit, control, or attempt to control the production, distribution, sale or price of, or, trade in goods or provision of services.

The term “cartel” has an inclusive meaning. Thus an association formed to control the production of oranges is within the aforesaid definition of a cartel. Hence the association of orange producers of Nagpur will be considered as a cartel under the provisions of the Act.

Question 14 Mr.Raj Behari retired as a Member of Competition Commission of India (CCI) on 31st October, 2008. He was offered the post of Chief Executive in M/s. LSD Ltd. which was earlier a party in the proceedings before CCI. Can he join the Company with effect from 1st November, 2009?

What will be the position if Mr. Raj Behari joins Oil & Natural Gas Commission Ltd. a Government Company with effect from 1st April, 2009? ONGC was also earlier a party in the proceedings before CCI. (November, 2009) Answer Under Section 12 of the Competition Act, 2002, a Member of CCI shall not, for a period of two years from the date on which he ceased to hold office, accept any employment in any enterprise, which has been a party to a proceeding before the Commission. However, these provisions will not apply to any employment in a Government Company or Government or local authority or any Corporation established under any Central or state Act. In view of the aforesaid, Mr. Raj Behari cannot join M/s LSD Ltd on 1-11-2009 as only one year has expired from the date of his retirement. However, there is no bar for him to join ONGC on 1-4-2009 even earlier than two years of his retirement as it is a Government Company. Question 15 The Competition Commission of India(CCI) has received a complaint from a State Government alleging that X Limited and Y Limited have entered into an informal agreement, not enforceable at law, to limit or control production, supply and market, to determine the sale price of their products. Such an action of these companies has an appreciable effect on competition. Examining the provisions of the Competition Act, 2002: (A) Decide whether the above agreement has appreciable effect on competition.



4.14

(B) What factors shall the Competition Commission if India consider while taking the above decision?

(C) What orders can the Competition Commission of India pass on completion of the inquiry? (May, 2010)

Answer (A) The term ‘agreement’ as defined in Section 2 (b) of the Competition Act, 2002, includes

any arrangement or understanding or action in concert. (i) whether or not such arrangement, understanding or action is formal or in writing, or (ii) whether or not such arrangement, understanding or action is intended to be

enforceable by legal proceedings. Thus agreement between X Ltd and Y Ltd satisfies the above ingredients of an

agreement as per Section 2 (e) of the Act.. (B) Factors to be considered:

(1) creation of barriers to new entrants in the market. (2) driving existing competitors out of the market. (3) foreclosure of competition by hindering entry into the market. (4) accrual of benefits to consumers. (5) improvements in production or distribution of goods or provision of services

(C) Orders of CCI: If after enquiry by the Director General, the Commission funds the agreement entered

into by X Ltd. and Y Ltd. are in contravention of section 3, it may pass all or any of the following orders: (1) direct X Ltd. and Y Ltd. to discontinue and not to reenter such agreement. (2) impose such penalty as it may deem fit which shall not be more than 10% of the

average other turnover for the last 3 preceding financial years, upon each of such person or enterprises which are parties to such agreement or abuse;

(3) direct that agreement shall stand modified to the extend and in the manner as may be specified in order by the commission

(4) direct X Ltd and Y Ltd. to abide by such other orders as the commission may pass and comply with the directions including payment of cost, if any.

(5) pass such other orders or issue such directions as it may deem fit. Question 16 P Ltd. and Q Ltd. both dealing in chemicals and fertilizers have entered into an agreement to jointly promote the sale of their products. A complaint has been received by the Competition Commission



4.15

of India (CCI) starting that the agreement between the two is anti-competitive and against the interests of others in the trade. Examine with reference to the Provisions of the Competition Act, 2002, what are factors the CCI will take into account to determine whether the agreement in question will have any appreciable adverse effect on competition in the market. (CA Final, New Course, ( May, 2010) Answer Factors determining appreciable adverse effect on competition: The Competition Commission of India (CCI), while determining whether an agreement is anti-competitive under Section 3 of the competition Act, 2002, will take into account the following factors. (a) creation of barriers to new entrants in the market (b) driving existing completions out of the market. (c) foreclosure of competition by hindering entry into the market. (d) accrual of benefits to consumers. (e) improvements in production or distribution of goods or provision of services and (f) promotion of technical, scientific and economic development by means of production or

distribution of goods or provision of services.


CHAPTER 5

OVERVIEW OF BANKING REGULATION ACT, 1949, THE INSURANCE ACT, 1938, THE

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY ACT, 1999, THE SECURITISATION

AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST

ACT, 2002

THE BANKING REGULATION ACT, 1949 Question 1 In what way does the Reserve Bank of India regulate the determination of loans and advances which can be made by Banking Company under the Banking Regulation Act, 1949? Explain. CA Final New Course. (November, 2008) Answer POWERS OF RBI TO REGULATE DETERMINATION OF LOANS AND ADVANCES BY BANKING COMPANIES: By virtue of provisions of Banking Regulations Act, 1949, as contained in Section 21 the RBI is empowered to issue directives to a banking company to determine the policy in relation to loans and advances. Such directions may relate to: (1) Purpose for which loan may or may not be made. (2) Margin stipulation. (3) Maximum amount of advances to any company, firm individual or association of persons (at

present 15% for individual borrower without infrastructure project, if infrastructure project go by additional 10%, 40% for group borrower and for infrastructure project of group borrower it



5.2

may be up to 50% of bank’s capital and reserve (presently tier-I and tier-II capital from capital adequacy point of view).

(4) Maximum amount of guarantee liability on behalf of any individual firm /company. (5) The rate of interest and other terms and conditions on which such advances are made or

guarantee given. It may further be mentioned that in accordance with the provisions of Section 21A, rate of interest charged by banking company on the basis of loan contract between the bank and debtor is not to be subject to scrutiny by the court. Question 2 Enumerate the obligations of banking companies under the Prevention of Money Laundering Act, 2002. (6 Marks) Answer Section 12 of Prevention of Money Laundering Act, 2002 provides for the obligation of Banking Companies, Financial Institutions and Intermediaries of securities market. Every banking company, financial institution and intermediary shall: (a) Maintain a record of all transactions, the nature and value of which may be prescribed,

whether such transactions comprise of a single transaction or a series of transactions integrally connected to each other, and where such series of transactions take place within a month. Such records shall be maintained for a period of ten years from the date of cessation of the transactions between the clients and the banking company or financial institution or intermediary, as the case may be:

(b) Furnish information of the above transactions to the Director appointed for the purpose of this Act within the prescribed time;

(c) Verify and maintain the records of the identity of all its clients, in the prescribed manner. If the principal officer of a banking company or financial institution or intermediary has reason to believe that a single transaction or series of transactions integrally connected to each other have been valued below the prescribed value so as to defeat the provisions of this section, such officer shall furnish information in respect of such transactions to the Director within the prescribed time. Question 3 XLR Bank Limited is not managing its affairs properly. Employees as well as depositors of the bank have complained to the Central Government from time to time about such mismanagement and requested the Central Government to acquire the undertaking of the Banking Company. Explain the powers of the Central Government in this regard under the Banking Regulation Act, 1949.

(November, 2009)


Overview of Banking Regulation Act, 1949

5.3

Answer Under Section 36AE of the Banking Regulation Act, 1949, if the Central Government is of the opinion that a Banking company has failed to comply with the direction given by RBI relating to policy matters under section 21 and 35A and or the affairs of the Bank are being managed in a manner detrimental to the interest of depositors or that of the banking policy or for better provision of credit generally or of credit to any particular section of the community or in any particular area; it is necessary to the Government may after consultation with RBI, by notified order, acquire the undertaking of a Banking Company. In such a case, on the date specified in the notification, the undertaking of the Banking Company and its assets and liabilities shall stand transferred to and vest in Central Government. Before acquiring the undertaking, the Central Government shall give a reasonable opportunity of hearing to the Banking Company. Question 4 The promoters of a company to be registered under the Companies Act, 1956 having its main object of carrying on the business as manufacturers and stockists of Iron and Steel proposes that the name of the company is to be “ABC Steel Bank Limited”. You are required to state with reference to the provisions of the Banking Regulation Act, 1949 whether the said company with the proposed name can be registered. (June 2009) Answer As per provisions of Section 7 of the Banking Regulation Act, 1949 no company other than a banking company can use, as part of its name, the word “Bank” unless it is a banking company as defined in Section 5(c) of the said Act. In view of such a legal provision, the promoters of the company having the main object of carrying on the business as manufacturers and stockists of iron & steel can not keep the name of the company as “ABC Steel Bank Limited”. Question 5 Union Bank of India, a National Bank acquired on 1st January, 2002 a building, fully occupied by various tenants, from Mr. Rahul, the owner of the building , in discharge of a term loan advanced to Mr. Rahul, who had mortgaged the said building as security with the said Bank and failed to repay the loan. The said bank wants to keep the building permanently with it and earn the rent from tenants. You are required to state with reference to the provisions of the Banking Regulation Act, 1949 whether the said bank can do so. (June 09) Answer Union Bank of India being a nationalized bank is a banking company within the meaning of the Banking Regulation Act, 1949. As per provisions of Section 9 thereof, no banking company shall hold any immovable property, howsoever acquired, for a period exceeding seven years except: (i) If such property is required for banking company’s own use.



5.4

(ii) If the Reserve Bank of India extends the said period of seven years by up to another five years on the ground that such extension would be in the interest of the depositors of the banking company.

Accordingly, Union Bank of India in this case would normally be required to dispose off the building acquired from Mr. Rahul before 1st January, 2009. However, if the Reserve Bank of India on above stated ground grants the extension, then also the said Bank will have to dispose off the same before 1st January, 2014. But in no case, Union Bank of India can hold it permanently because the building is not for bank’s own use. Question 6 In what way does the Reserve Bank of India regulate the determination of loans and advances which can be made by a Banking Company under the Banking Regulation Act, 1949? Explain. (November, 2008) Answer Powers of RBI to regulate determination of loans and advances by banking companies: By virtue of provisions of Banking Regulations Act, 1949, as contained in Section 21 the RBI is empowered to issue directives to a banking company to determine the policy in relation to loans and advances. Such directions may relate to: (1) Purpose for which loan may or may not be made. (2) Margin stipulation. (3) Maximum amount of advances to any company, firm individual or association of

persons (at present 15% for individual borrower without infrastructure project, if infrastructure project go by additional 10%, 40% for group borrower and for infrastructure project of group borrower it may be up to 50% of bank’s capital and reserve (presently tier-I and tier-II capital from capital adequacy point of view).

(4) Maximum amount of guarantee liability on behalf of any individual firm /company. (5) The rate of interest and other terms and conditions on which such advances are made

or guarantee given. It may further be mentioned that in accordance with the provisions of Section 21A, rate of interest charged by banking company on the basis of loan contract between the bank and debtor is not to be subject to scrutiny by the court. Question 7 Explain the provision relation to Reserve Fund under the Banking Regulation Act, 1949.

Answer



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(Section 17) – Every Banking Company incorporated in India must create a Reserve Fund and transfer a sum equal to not less than 20 % of its net profits. However, Central Govt. is empowered to exempt from this requirement on the recommendation of the RBI. Such exemption will be allowed only:- _ when the amounts in the reserve fund and the share premium account are equal to the

paid-up capital of the banking company _ when the Central Govt. feel that its paid-up capital and reserves are adequate to safe

guard the interest of the depositors If a banking company appropriates any sum from the Reseve fund or the share premium account, it must be reported to RBI within 21 days explaining the circumstances leading to such appropriation Question 8 What are the powers of RBI’s to control loans & advances granted by banking company?

Answer RBI is empowered to issue directives to a banking company to determine the policy in relation to loans and advances. Such direction may relate to: (i) Purpose for which loan may or may not be made (ii) Margin stipulation (iii) Maximum amount of advances to any company, firm, individual or association of

persons( popularly known as exposure norms which is at present 15 % for individual borrower without infrastructure project, if infrastructure project it may go by additional 10%, 40% for group borrower and for infrastructure project of group borrower it may be upto 50 % of bank’s capital and reserve (presently tier-I & Tier-II capital from capital adequacy point of view)

(iv) Maximum amount of guarantee liability on behalf of any individual/ firm/ company (above exposure norm includes non-fund facilities like bank guarantee/ letter of credit etc)

(v) The rate of interest and other terms and condition on which such advances are made or guarantee given

(It may be noted that at present, in this deregulated interest rate regime RBI gives directives on for loans and advances with sanctioned limit upto Rs. 2.00 lakhs where rate of interest should not exceed individual bank’s Benchmark Prime Lending Rate(BPLR), BPLR is fixed by Bank’s Board, Rate of interest for advances with sanctioned limit above Rs. 2 lakhs is determined according to credit rating exercise done by bank,



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{RBI’s stipulation on this score is rate of interest should not exceed BPLR+4) RBI exercise its power through its selective credit control though under selective credit control list, at present no item except sugar for buffer stock is kept. More} [Moreover, with credit policy measures of RBI Cash Reserve Ratio, Bank Rate and Repo & Reverse Rate is announced on which Bank’s BPLR is somehow depended] Section 21A:- Rate of interest charged by banking company on the basis of loan contract between the bank and debtor is not to be subject to scrutiny by the court Question 9 Explain the provision relating to audit of banking companies under the Banking Regulation Act, 1949. Answer Balance sheet & profit & loss account as prepared in terms of sec 29 are subject to audit by a person duly qualified under any law for the time being in force to be an auditor for auditing such balance sheet and profit & loss accounts. (These Auditors are known as Statutory Auditors for the said purpose and appointment /reappointment or removal is subject to prior approval of the RBI. Under these Statutory Auditors there are numbers of External Auditors who conduct audit operation of the branch accounts) Further Reserve Bank can for special Audit of Banking Company, if it is of the opinion that it is in the public interest or in the interest of the depositors. The auditors shall comply with the directions given by the RBI and shall submit a report of the audit to RBI and also to the bank. The auditor shall have the powers and exercise the functions as specified in section 227 of the Indian Companies Act, 1956. Apart from the above, the auditor is required to state in his report: • Whether or not the information and explanation required by him have been found to

be satisfactory • The transactions of the bank which have come to his notice have been within the

powers of the bank or not • The return received from branch offices have been found adequate for the purpose

of his audit • Whether the profit and loss account shows a true balance of profit or loss for the

period covered by such account • Any other matter which he considers should be brought to the notice of the share

holders of the company {In addition to what have been stated here-in-above auditors are also required to audit and certify the statement of advances as prepared in terms of prudential accounting norms, required to certify



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some other returns viz. Friday figure of 12 odd dates, utilization of govt. subsidies, payment of premium of deposit insurance& credit guarantee scheme, Long Form Audit Report , 3CB &3CD Return as applicable and many others} Section 31:- Submission of Balance Sheet & P&L :- Three copies of such returns along with auditors report shall be published in prescribed manner and submit to RBI within three months from the end of the period which they refer. The RBI may extend the period by a further of not exceeding three months. Section 32:- Three copies of such accounts and balance sheet along with auditor’s report shall be sent by the banking company to the ROC, at the same time while sending the same to RBI. Section 35:- Power of RBI to inspect banks:- RBI is empowered to conduct inspection of any bank and to give them direction as it deems fit. All banks are bound to comply with such directions. Every directors or other officer of the bank shall produce all such books, documents as required by the inspector. The inspector may examine on oath any director or other officers RBI shall supply the bank a copy of such inspection. RBI submits report to Central Govt. and the latter, on scrutiny , if is of the opinion that the affairs of the bank are being conducted detrimental to the interest of its depositors, it may, after giving an opportunity of being heard, to the bank, may order in writing prohibiting the bank from receiving fresh deposits, direct the RBI to apply section 38 for winding up of the bank Apart from inspection under section 35 RBI is empowered to undertake inspection of a bank in terms/ for the purposes of the following sections:-

Section 11 Requirement as to maintaining paid-up capital & reserve

Section 22 Licensing of banks

Section 23 Restrictions on opening new and transfer of existing places of business

Section 37 Suspension of business

Section 38 Winding up by High Court

Section 44 Power of High Court in voluntary winding-up

Section 44A Procedure for Amalgamation of banking companies

Section 45 Power of RBI to apply to Central Govt. for suspension of business by a bank and prepare scheme of reconstitution or amalgamation



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Question 10 Mr. Gopal is a director in a Bank. The Reserve Bank of India terminates him on the ground that his conduct is detrimental to the interest of the depositors. Decide, whether the Reserve Bank of India can do so under the Banking Regulation Act, 1949. Can the Reserve Bank of India appoint additional Director in a Bank under the said Act? (New, May, 2010) Answer Appointment of Additional Director in a Bank by the RBI: Under Section 36AA of the Banking Regulation Act, 1949, RBI can terminate any Chairman, Director, Chief Executive, other officials or any employee of the bank where it considers desirable to do so particularly when RBI is of the opinion that conduct of such persons is detrimental to the interest of the depositors or for securing proper management of the banking company. Before such termination concerned person should be given opportunity to be heard of. Such terminated officials can make appeal to the Central Govt. within 30 days from the date of communication of such termination order. The decision of the Central Government cannot be called into question. In case an order is issued pursuant to this section the concerned person shall cease to hold his office for a period of not exceeding 5 years as may be specified in the order. Contravention of the above provision shall be punishable with a fine, which may extent to Rs. 250 per day. Any such order shall be valid for a period not exceeding three years or such further periods of not exceeding three years at a time as RBI may specify. Under section 36AB: RBI is empowered to appoint additional Directors for the banking company with effect from the date to be specified in the order, in the interest of the bank or that of depositors. Such additional directors shall hold office for a period not exceeding three years or such further periods not exceeding three years at a time.

THE INSURANCE ACT, 1938 Question 1 With reference the provisions of Insurance Act, 1938, what do you mean by “Life Insurance Business”? (June 2009) Answer As per Section 2(11) of the Insurance Act, 1938, Life Insurance Business means the business of effecting contracts of insurance upon human life, including any contract whereby the payment of money is assured on death (except death by accident only) or the happening of any contingency dependent on human life, and any contract which is subject to payment of premiums for a term dependent on human life and shall be deemed to include: (a) The granting of disability and double or triple indemnity accident benefits, if so provided

in the contract of insurance. (b) The granting of annuities upon human life; and



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(c) The granting of superannuation allowances and annuities payable out of any fund applicable solely to the relief and maintenance of persons engaged or who have been engaged in any particular profession, trade or employment or of the dependents of such persons.

Question 2 What are the provisions in the Insurance Act, 1938 regarding nomination by of Life Insurance Policy holder? Whether a minor can be a nominee in a Life Insurance Policy? (June 09) Answer As per Section 39 of the Insurance Act, 1938, the holder of a policy of life insurance on his own life may nominate a person or persons to whom the money secured by the life insurance policy shall be paid in the event of his death. Such nomination can be made either at the time of taking the policy or at any time before the maturity of the policy. Such nomination is either incorporated in the text of the policy or is stated as an endorsement on the policy document. The nomination can be cancelled or altered by the policyholder at anytime before the maturity of the policy. The insurer is required to communicate to the policyholder that it has recorded the nomination, its cancellation or alteration as the case may be. In case the policyholder survives the full term of policy, the insurer shall pay the maturity amount to him only and the nomination becomes redundant. In a case where the nominee dies before the maturity of the policy and if no new nomination is made, the maturity proceeds of the policy shall be paid to the policy holder and if dies before the maturity, to the legal heirs of the policy holders. Minor as a nominee: A minor can be nominated as a nominee in life insurance policy by its holder. The only other requirement as per proviso to Section 39(1) of the said Act is that the policyholder is to appoint, in the prescribed manner, an adult person to receive the money secured by the policy on behalf of the minor in the event of death of the policyholder during the minority of the nominee.

THE INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY ACT, 1999

Insurance Regulatory and Development AUTHORITY: (Sections 3-12) The Central Government by notification appoint such ‘Authority’ in the nature of body corporate enjoying all the characteristics of such entity along with contractual powers. The Head Office of such ‘Authority’ is to be decided by the Central Government.



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The members of such ‘Authority appointed by the Central Government depending upon their expertise and experience in the field of Insurance, Law, Economic Accountancy, etc. The member consists of: (a) Chairman. (b) Five Whole Time members (maximum) (c) Four Part – Time members (maximum) One of these members should have knowledge in Life Insurance, General Insurance and Actuarial Science. The Chairperson shall hold office for a term of five years until he reaches sixty five years. And he is eligible for re – appointment. A whole time member however can hold office for up to sixty-two years. Moreover a member can relinquish his membership by giving three month prior notice to the Central Government or he can be removed from office under provision of Sec – 6. A member may be removed from office if he became insolvent or insane or convicted for offence involving moral turpitude or illegally established financial interest in the ‘Authority’ or acting contrary to public interest. The remuneration for each member shall be as per prescribed Law. The chairperson and the Whole – time member shall within two years from the date of appointment, cannot hold office under Central Government or State Government or any Insurance Sector. All decisions regarding administrative matters are taken by the Chairperson. The procedural aspect of the meetings of the ‘Authority’ may be determined by regulations, Resolutions are passed by simple majority and chairperson may use casting vote in case of a tie. In case, chairperson unable to attend any meeting then members attending may appoint chairperson among themselves. Any act of the ‘Authority’ cannot be invalidated simply because of any defect in appointing a member or procedural irregularity. From time to time, authority may appoint employees and officers for efficiency in their work. Transfer of Assets, liabilities, etc. of Indian Insurance Regulatory Authority (IIRA) to Insurance Regulatory Development Authority (IRDA) (Section 13) On any appointed day, all assets and liabilities shall stand transferred from IIRA to IRDA. Here, the assets may be movable or immovable. Along with it also includes attached



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rights and powers. Before this, books of accounts, documents and other papers are also included. All contractual obligations entered by IIRA with third parties till before the appointed day shall automatically transferred to IRDA. Similarly all debts owed to IIRA also stands transferred to IRDA. Also, legal proceedings including suits whether instituted by or against IIRA shall stand transferred to IRDA.

THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF

SECURITY INTEREST ACT, 2002 Question 1 What do you understand by asset reconstruction under the SARFAESI Act, 2002?

Answer "asset reconstruction" means acquisition by any securitisation company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of realization of such financial assistance. [Section 2(b)] Question 2 What are financial assets?

Answer "financial asset" means debt or receivables and includes- (i). a claim to any debt or receivables or part thereof, whether secured or unsecured; or (ii). any debt or receivables secured by, mortgage of, or charge on, immovable

property; or (iii). a mortgage, charge, hypothecation or pledge of movable property; or (iv). any right or interest in the security, whether full or part underlying such debt or

receivables; or (v). any beneficial interest in property, whether movable or immovable, or in such debt,

receivables, whether such interest is existing, future, accruing, conditional or contingent; or

(vi). any financial assistance [Section 2(l)]



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The use of the word ‘future’ in clause (v) of Section 2(l) means that the term financial asset includes a future debt also. It must be noted that a future debt does not refer to debt payable in future. In case of a debt repayable in future, the debt exists today but is payable in future, for example a loan given by the lender to the borrower. But in case of a future debt, the debt does not exist today. It seems difficult to imagine as to how one can transfer a future debt (which does not exist today). This becomes easy when we understand the principle used in the case of Bharat Nidhi Limited v. Takhatmal (1969) AIR SC 313. In case of a future debt, what exists today is an agreement to transfer and it will be possible to transfer the future debt when it actually arises, for example sales that will occur in future. In case of conditional receivable, the receivable is transformed into a financial asset after the fulfillment of the relevant conditions. Clause (vi) of Section 2(l) mentions ‘any financial assistance’. The term financial assistance has already been defined in Section 2(k) supra. Question 3 What are non-performing asset?

Answer "non-performing asset" means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or under guidelines relating to asset classifications issued by the Reserve Bank [Section 2(o)] Question 4 How are rights or interest in financial assets acquired under the SARFAESI Act, 2002?

Answer Section 5 : Notwithstanding anything contained in any agreement or any other law for the time being in force, any securitisation company or reconstruction company may acquire financial assets of any bank or financial institution- (a.) by issuing a debenture or bond or any other security in the nature of debenture, for

consideration agreed upon between such company and the bank or financial institution, incorporating therein such terms and conditions as may be agreed upon between hem; or

(b.) by entering into an agreement with such bank or financial institution for the transfer of such financial assets to such company on such terms and conditions as may be agreed upon between them.



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Debenture is we commonly know, is an acknowledgement of debt. Bond also refers to the same nature of instrument as a debenture. Both of them acknowledge a debt and hence an obligation to pay. In case the bank or financial institution is a lender in relation to any financial assets acquired by the securitisation company or the reconstruction company, then such securitisation company or reconstruction company shall, on such acquisition, be deemed to be the lender and all the rights of such bank or financial institution shall vest in such company in relation to the subject financial assets. Unless otherwise expressly provided by this Act, all contracts, deeds, bonds, agreements, powers-of-attorney, grants of legal representation, permissions, approvals, consents or no-objections under any law or otherwise and other instruments of whatever nature which relate to the said financial asset and which are subsisting or having effect immediately before the acquisition of financial asset and to which the concerned bank or financial institution is a party or which are in favour of such bank or financial institution shall, after the acquisition of the financial assets, be of as full force and effect against or in favour of the securitisation company or reconstruction company, as the case may be, and may be enforced or acted upon as fully and effectually as if, in the place of the said bank or financial institution, securitisation company or reconstruction company, as the case may be, had been a party thereto or as if they had been issued in favour of securitisation company o reconstruction company, as the case may be. If, on the date of acquisition of financial asset, any suit, appeal or other proceeding of whatever nature relating to the said financial asset is pending by or against the bank or financial institution, save as provided in the third proviso to sub-section (1) of section 15 of the Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986) the same shall not abate, or be discontinued or be, in any way, prejudicially affected by reason of the acquisition of financial ass t by the securitisation company or reconstruction company, as the case may be, but the suit, appeal or other proceeding may be continued, prosecuted and enforced by or against the securitisation company or reconstruction company, as the case may be. Question 5 How disputes are resolved under the SARFAESI Act, 2002?

Answer Where any dispute relating to securitisation or reconstruction or non-payment of any amount due including interest arises amongst any of the parties, namely, the bank, or financial institution, or securitisation company or reconstruction company or qualified institutional buyer, such dispute shall be settled by conciliation or arbitration as provided in the Arbitration and Conciliation Act, 1996, as if the parties to the dispute have



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consented in writing for determination of such dispute by conciliation or arbitration and the provisions of that Act shall apply accordingly. Question 6 Explain briefly the procedure relating to Enforcement of security interest

Answer (Section 13) Notwithstanding anything contained in section 69 or section 69A of the Transfer of Property Act, 1882 (4 of 1882), any security interest created in favour of any secured creditor may be enforced, without the intervention of the court or tribunal, by such creditor in accordance with the provisions of this Act. Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any installment thereof, and his account in respect of such debt is classified by the secured creditor as on-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under sub-section (4) of Section 13. This notice shall give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in the event of non-payment of secured debts by the borrower. The procedure for the service of the notice is prescribed in the Security Interests (Enforcement) Rules. Sub-section (4) of Section 13 provides that if the borrower fails to discharge his liability in full within the above specified period, the secured creditor may take recourse to one or more of the following measures to recover his secured debt:- (a) take possession of the secured assets of the borrower including the right to transfer

by way of lease, assignment or sale for realising the secured asset; (b) take over the management of the secured assets of the borrower including the right

to transfer by way of lease, assignment or sale and realise the secured asset; (c) appoint any person (hereafter referred to as the manager), to manage the secured

assets the possession of which has been taken over by the secured creditor; (d) require at any time by notice in writing, any person who has acquired any of the

secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt.

Question 7 Explain Manner and effect of take over of management.



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Answer (Section 15): When the management of business of a borrower is taken over by a secured creditor, the secured creditor may, by publishing a notice in a newspaper published in English language and in a newspaper published in an Indian language in circulation in the place where the principal office of the borrower is situated, appoint as many persons as it thinks fit- (a) in a case in which the borrower is a company under the Companies Act, 1956, to be

the directors of that borrower in accordance with the provisions of that Act; or (b) in any other case, to be the administrator of the business of the borrower. On publication of the above notice, all persons holding office as directors of the company (if the borrower is a company) and in any other case, all persons holding any office having power of superintendence, direction and control of the business of the borrower immediately before the publication of the above notice, shall be deemed to have vacated their offices. Any contract of management between the borrower and any director or manager thereof holding office as such immediately before publication of the above notice, shall be deemed to be terminated. The directors or the administrators appointed under this section shall take such steps as may be necessary to take into their custody or under their control all the property, effects and actionable claims to which the business of the borrower is, or appears to be, entitled and all the property and effects of the business of the borrower shall be deemed to be in the custody of the directors or administrators, as the case may be, as from the date of the publication of the above notice. All directors appointed in accordance with the above notice shall, for all purposes, be the directors of the company of the borrower and such directors or the administrators (if the borrower is other than a company) appointed under section 15, shall only be entitled to exercise all the powers of the directors or as the case may be, of the persons exercising powers of superintendence, direction and control, of the business of the borrower whether such powers are derived from the memorandum or articles of association of the company of the borrower or from any other source. Where the management of the business of a borrower, being a company as defined in the Companies Act, 1956, is taken over by the secured creditor, then, notwithstanding anything contained, such borrower in the said Act or in the memorandum or articles of association of such company - (a) it shall not be lawful for the shareholders of such company or any other person to

nominate or appoint any person to be a director of the company; (b) no resolution passed at any meeting of the shareholders of such company shall be

given effect to unless approved by the secured creditor;



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(c) no proceeding for the winding up of such company or for the appointment of a receiver in respect thereof shall lie in any court, except with the consent of the secured creditor.

The secured creditor is under an obligation to restore the management of the business of the borrower, on realisation of his debt in full, in case of take over of the management of the business of a borrower by such secured creditor.


CHAPTER 6

PREVENTION OF MONEY LAUNDERING ACT, 2002

DEFINITIONS Major Definitions Question 1 What is Money – Laundering? Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projecting it as untainted property shall be guilty of offence of money laundering.

Question 2 What are Proceeds of crime? Section 2(1)(u) defines "proceeds of crime" as any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or the value of any such property. Question 3 What is Payment System? (As introduced by the Amendment Act, 2009) In terms of clause (rb) of section 2 "payment system" means a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them. It includes the systems enabling credit card operations, debit card operations, smart card operations, money transfer operations or similar operations;

Question 4 What is the punishment for the offence of money laundering? Chapter II comprises of Sections 3 and 4. Section 3 deals with the office of money laundering which has been discussed in the definition part above. Section 4 provides for the punishment for Money-Laundering. Whoever commits the offence of money-laundering shall be punishable with rigorous imprisonment for a term which shall not be less than three years but which may extend to seven years and shall also be liable to fine which may extend to five lakh rupees. But where the proceeds of crime involved in money-laundering relates to any offence specified



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under paragraph 2 of Part A of the Schedule, the maximum punishment may extend to ten years instead of seven years.

Question 5 Enumerate the obligations of banking companies under the Prevention of Money Laundering Act, 2002. (Nov 08) Answer Section 12 of Prevention of Money Laundering Act, 2002 provides for the obligation of Banking Companies, Financial Institutions and Intermediaries of securities market. Every banking company, financial institution and intermediary shall: (a) Maintain a record of all transactions, the nature and value of which may be prescribed,

whether such transactions comprise of a single transaction or a series of transactions integrally connected to each other, and where such series of transactions take place within a month. Such records shall be maintained for a period of ten years from the date of cessation of the transactions between the clients and the banking company or financial institution or intermediary, as the case may be:

(b) Furnish information of the above transactions to the Director appointed for the purpose of this Act within the prescribed time;

(c) Verify and maintain the records of the identity of all its clients, in the prescribed manner.

If the principal officer of a banking company or financial institution or intermediary has reason to believe that a single transaction or series of transactions integrally connected to each other have been valued below the prescribed value so as to defeat the provisions of this section, such officer shall furnish information in respect of such transactions to the Director within the prescribed time.

Question 6 How the trials under PMLA are conducted in special courts? Is the offence under PMLA are bailable? Sections 43 – 47 deals with provision relating to Special Courts. Section 43 empowers the Central Government (in consultation with the Chief Justice of the High Court) for trial of offence of money laundering, to notify one or more Courts of Sessions as Special Court of Special Courts for such area or areas or for such cases as may be prescribed in the notification to this effect. Section 44 clearly provides for the offences triable by Special Courts. It overrides the provisions of the Code of Criminal Procedure, 1973 and provides that –

(i) the schedule offence and the offence punishable under section 4 shall be triable only by the Special Court constituted for the area in which the offence has been committed;


Prevention of Money Laundering Act, 2002

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(ii) a Special Court may, upon a complaint made by an authority authorised in this behalf under this Act take cognizance of the offence for which the accused is committed to it for trial. The requirement of police report of the facts which constitute an offence under this Act is no more applicable.

Answer The provisions of Section 44 shall not be deemed to affect the special powers of the High Court regarding bail under section 439 of the Code of Criminal Procedure, 1973 and the High Court may exercise such powers including the power under clause (b) of sub-section (1) of that section as if the reference to "Magistrate" in that section includes also a reference to a "Special Court" designated under section 43. Section 45 provides that the offences under the Act shall be cognizable and non-bailable. Notwithstanding anything contained in the Code of Criminal Procedure, 1973, no person accused of an offence punishable for a term of imprisonment of more than three years under Part A of the Schedule shall be released on bail or on his own bond unless- (i) The Public Prosecutor has been given an opportunity to oppose the application for such

release and (ii) Where the Public Prosecutor opposes the application, the court is satisfied that there

are reasonable grounds for believing that he is not guilty of such offence and that he is not likely to commit any offence while on bail.

In case of any person who is under the age of 16 years or in case of a woman or in case of a sick or infirm person, the Special Court can direct the release of such person on bail.

The Special Court cannot take cognizance of any offence under the Act, unless a complaint in writing is made by:- (a) The Director or (b) Any officer of the Central Government or a State Government, authorised in

writing in this behalf by the Central Government by a general or special order made in this behalf by that Government.

Notwithstanding anything contained in the Code of Criminal Procedure, 1973, or any other provision of this Act, no police officer shall investigate into an offence under this Act unless specifically authorised, by the Central Government by a general or special order, and, subject to such conditions as may be prescribed. Section 45 has been amended by the Amendment Act of 2005 and it is interesting to observe, how the law grants the right of bail to the accused but avoids the misuse of this right by providing for adequate safeguards in the Section. The suo motto authority of the police officer



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in investigating an offence under the Act has been done away with. An authority from the Central Government by a general or special order, and fulfillment of the prescribed conditions has been introduced by the Amendment Act - is in right spirit. There is always a fear of such powerful legislation being misused unless adequate safeguards are provided as in the instant case. Section 46 provides that the provisions of the code of Criminal Procedure, 1973 (including the provisions as to bails or bonds) shall apply to the proceedings before a Special Court and the Special Court shall be deemed to be a Court of Session and the persons conducting the prosecution before the Special Court, shall be deemed to be a Public Prosecutor. Section 47 empowers the High Court to exercise (so far as applicable) all the powers granted by Chapter XXIX or Chapter XXX of the Code of Criminal Procedure 1973 on Special Court within its jurisdiction


CHAPTER 7

RULES AND INTERPRETATION OF STATUTES DEEDS AND DOCUMENTS

Question 1 Explain the rule of ‘beneficial construction’ while interpreting the statutes quoting an example

(May, 2000) Answer Where the language used in a statute is capable of more than one interpretation, the most firmly established rule for construction is the principle laid down in the Heydon’s case. This rule enable, consideration of four matters in constituting an act: (1) what was the law before making of the Act, (2) what was the mischief or defect for which the law did not provide, (3) what is the remedy that the Act has provided, and (4) what is the reason for the remedy. The rule then directs that the courts must adopt that construction which ‘shall suppress the mischief and advance the remedy’. Therefore even in a case where the usual meaning of the language used falls short of the whole object of the legislature, a more extended meaning may be attributed to the words, provided they are fairly susceptible of it. If the object of any enactment is public safety, then its working must be interpreted widely to give effect to that object. Thus in the case of Workmen’s Compensation Act, 1923 the main object being provision of compensation to workmen, it was held that the Act ought to be so construed, as far as possible, so as to give effect to its primary provisions. However, it has been emphasized by the Supreme Court that the rule in Heydon’s case is applicable only when the words used are ambiguous and are reasonably capable of more than one meaning [CIT v. Sodra Devi (1957) 32 ITR 615 (SC)]. Question 2 What is meant by ‘disclaimer of onerous property’ and how the same is exercised during winding up”. Explain the circumstances under which such a disclaimer is not allowed.

(May, 2000)



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Answer The provisions relating to disclaimer of onerous property will arise during the winding up of the company. The liquidator, may, with the leave of the court disclaim any onerous property within 12 months of the commencement of the winding up. If the existence of any disclaimable property does not come to the knowledge of the liquidator, within one month after the commencement of the winding up, he can disclaim at any time within 12 months after he has become aware of it. The Court has, however, the power to extend the time. An onerous property may consist of (a) land of any tenure burdened with onerous covenants (b) shares or stocks in companies (c) any other property which is unsaleable or not readily saleable (d) unprofitable contracts. The liquidator’s right to disclaim is lost if within 28 days or such extended period as may be allowed by the court, of receiving a demand from any interest person to make his decision, he does not give notice that he intends to apply to the court for leave to disclaim [Section 535(4)]. Question 3 How far are (i) title, (ii) preamble and (iii) marginal notes in an enactment helpful in interpreting any of the parts of an enactment? (May, 2001) Answer (i) Title: An enactment would have what is known as ‘Short Title’ and also a ‘Long Title’.

The short title merely identifies the enactment and is chosen merely for convenience. The ‘Long title’ describes the enactment and does not merely identify it.

The Long title is a part of the Act and, therefore, can be referred to for ascertaining the object and scope of the Act.

(ii) Preamble: It expresses the scope and object of the Act more comprehensively than the long title. The preamble may recite the ground and the cause for making a statute and or the evil which is sought to the remedied by it. The preamble like the Long title can legitimately be used for construing it. However, the preamble cannot over ride the provisions of the Act. Only if the wording of the Act gives rise to doubts as to its proper construction (e.g., where the words or a phrase has more than the one meaning and doubts arises as to which of the two meanings is intended in the Act) the preamble can and ought to be referred to the arrive at the proper construction.

(iii) Marginal notes: As held in CIT Ahmed Bhai Umar Bhai Company HJR 1950, SC (134, 141) marginal notes applied to the section cannot be used for construing the section.

However, marginal notes appended to the Articles of the Constitution have been held to be part of the constitution and therefore, have been made use of in construing the articles.


Rules and Interpretation of Statutes Deeds and Documents

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Question 4 Explain the principles of grammatical interpretation vis-à-vis logical interpretation especially in the context that the duty of the Court is to administer the law as it stands and not to find out whether the law is just or reasonable. (November, 2001) Answer Interpretation may be either grammatical or logical. Grammatical interpretation concerns itself exclusively with the verbal expression of law. It does not go beyond the letter of the law. Logical interpretation on the other hand, seeks more satisfactory evidence of the true intention of the legislature. In all ordinary cases, the grammatical interpretation is the sole form allowable. The court cannot take from or add to modify the letter of the law. However, where the letter of the law is logically defective on account of ambiguity, inconsistency or incompleteness, the court is under a duty to travel beyond the letter of law so as to determine from the other sources, the true intentions of the legislature. Further a statute is enforceable at law, however, unreasonable it may be. The duty of the court is to administer the law as it stands. It is not within its jurisdictions to see whether the law is just or unreasonable. However, if there are two possible constructions of a clause, one a mere mechanical construction based on the rules of grammar and the other which emerges from the setting in which the clause appears and the circumstances in which it came to be enacted and also the words used therein, the courts may prefer the second construction which though may not be literal may be a better one. (Arora vs. State of U.P.) Question 5 Explain the significance of the definition clause in a Statute. The definition of a word may be either restrictive or extensive. Elaborate this with particular reference to the following definition of ‘Book and Paper’ as contained in the Companies Act, 1956: “Book and Paper” include accounts, deeds, vouchers, writings, and documents. (May, 2002) Answer When a word is defined as having a particular meaning in the enactment, it is that meaning alone which must be given to it in interpreting the said section of Act unless there be anything repugnant in the context. When a word is defined to “mean” such and such, the definition is prima facie restrictive and exhaustive and it restricts the meaning of the word to that given in the definition section. But where the word is defined to “include” such and such the definition is prima facie extensive. Again when the word is defined as “means” and includes such and such, the definition would be exhaustive. ‘Book and paper’ It is an inclusive definition and as such the definition is prima facie extensive i.e. the word defined is not restricted to the meaning assigned to it but has extensive meaning which also



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includes the meaning assigned to it in the definition section. It includes all registers, book and other papers maintained by the company and as such the directors who are entitled to inspect the books of accounts and other books and papers can have access to all the registers and other documents maintained by the company. Question 6 Explain the meaning of the word “Statute” and discuss the need for interpretation of any statute citing an example in the case of holding the annual general meeting of a company where more than one prescribed time is given in the Companies Act, 1956. (May, 2002) Answer The word ‘Statute’ generally means the laws and regulations of every sort without considering from which source they emanate. It has been defined as the written will of the legislature solemnly expressed according to the forms necessary to constitute it the law of the State. Normally, the term denotes an Act enacted by the legislative authority (e.g. Parliament of India). Even though the Laws are drafted by legal experts, yet they are expressed in language and no language is so perfect as to leave no ambiguities. Since a statute is an edict of the legislature, many a time the intent of the legislature has to be gathered not only from the language but the surrounding circumstances that prevailed when the law was enacted. Further if any provision is open to two interpretations, the Court has to choose that interpretation which represents the time intention of the legislature. In the case of holding an annual general meeting of a company three different periods have been given as stated. (a) The meeting should be held in every calendar year (section 166(i)) (b) The gap between the two meetings should not be more than 15 months (Section 166(i)) (c) The meeting should be held with 6 month from the close of the financial year of the

company (section 210(3)) The above said three requirements are cumulative and separate. Failure to comply with any of them constitutes an offence. Therefore to give effect to all the provisions, they are to be interpreted harmoniously. Question 7 Explain the rules relating to interpretation of the terms 'subject to' and 'notwithstanding' used in the provisions of an Act. State the effect of the term 'notwithstanding anything contained in this Act' used in Section 408 of the Companies Act empowering the Central Government to prevent oppression or mismanagement. (May, 2003)



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Answer Interpretation of the terms ‘notwithstanding’ and ‘subject to’ The word ‘notwithstanding anything contained’ characterise the non obstante clause. It is generally included to give an overriding effect to the clause over the other. If there is any inconsistency or departure between the non obstante clause and another provision, it is the non obstante clause which will prevail (K. Parasuramaiah v. Pakari Lakshman, A/R 1965 AP 220).

But the word ‘subject to’ conveys the idea of a provision yielding place to another provision or provisions to which it is made ‘subject to’. Hence the effect of non obstante clause (i.e. notwithstanding) is the opposite of a provision which states ‘subject to’. Section 408 of the Companies Act, 1956 opens with the words ‘notwithstanding anything contained in this Act. This is a non obstante clause which vests overriding powers in the Government to nominate directors to prevent mismanagement or oppression (Oriental Industrial Investment Corporation Ltd vs. Union of India (1981) 52 Com cases 487, 493 (Del)). This expression indicates that the appointment of directors under this section is not to be controlled by the maximum number or other proportion, if any, fixed by any provisions of the Act. Further, they cannot be removed by the company at general meeting under section 284 of the Companies Act. Question 8 Explain the usefulness of 'Heading and Title of a chapter in an Act and marginal notes of a Section' as internal aids in interpreting the provisions of a Statute. (November, 2003) Answer Heading and Marginal Notes: A number of sections in an Act applicable to any particular object are grouped together, sometimes in the form of chapters, pre-fixed by Heading and/or Titles. Marginal notes means titles to the section. In Uttam Das Chela Sunder Das v. SGPC AIR 1996 SC 2133, it was observed that 'Marginal notes or captions undoubtedly, part and parcel of legislative exercise and the language employed therein provides the key to the legislative intent. The words employed are not mere surplusage'. Marginal note is legislative and not editorial exercise C Bhagirath v. Delhi Admn. AIR, 1985 SC 1050. It gives an indication as to what was exactly the mischief that was intended to be remembered and throws light on the intention of legislature. It is relevant factor to be taken into consideration in construing the ambit of the section. Shree Sajjan Mills Ltd. (v) CIT (1985) 156 ITR 585(SC). Heading, title and marginal notes can be referred to if the words are ambiguous. If there is any doubt in the interpretation of words in a section, the headings help to resolve the doubt. But they cannot control the plain words of a statute.



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To sum up, heading, title and marginal notes can be used to understand the legislative intent, but cannot limit or restrict the clear word used in a section. Question 9 Explain the effects of a proviso to a section in a statute. (May, 2004) Answer Proviso: Some times a section in a statute contains a proviso. The normal function of a proviso is to except something out of the enactment to qualify something stated in the enactment which would be within its purview of the proviso were not there. The effect of the proviso is to qualify the preceeding enactment which is expressed in terms which are too general. As a general rule, a proviso is added to an enactment to qualify or create an exception to what is in the enactment. Ordinarily a proviso is not interpreted as stating a general rule. It is a cardinal rule of interpretation that a proviso to a particular provision of a statute embraces only the field which is covered by the main provision. It carries out an exception to the main provision to which it has been enacted as a proviso and to no other (Ram Narain Sons Ltd v. Asst. Commissioner of Sales Tax AIR 1955 Sc. 765).

Question 10 Explain briefly the distinction between “Mandatory” and “Directory” provisions in a statute. How the Court deals with them differently? (November, 2004) Answer The distinction between a provision which is mandatory and one which is 'directory' is that when it 'mandatory', it must be strictly complied with, when it is 'directory', it would be sufficient that it substantially complied with. Non-observance of mandatory provisions involves the consequences invalidating. But non-observance of directory provision does not entail the consequence of invalidating, whatever other consequences may occur. No general rule can be laid down for deciding whether any particular provision on a statue is mandatory or directory. In each case the court has to consider not only the actual word used, but has to decide the legislatures intent. For ascertaining the real intention of the legislature, the court may consider, amongst other things, the following 1. The nature and design of the statute. 2. The consequence, which would flow from construing one-way or the other. 3. The impact of other provisions by resorting to which the necessity of complying with the

provision in question can be avoided.



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4. Whether or not the statute provides any penalty if the provision in question is not complied with

5. If the provision in question is not complied with, whether the consequences would be trivial or serious.

6. Most important of all, whether the object of the legislation will be defeated or furthered. Where a specific penalty is provided in a statute itself for non-compliance with the particular provision of the Act no discretion is left to the court to determine whether such provision is directory or mandatory - it has to be taken as mandatory. Question 11 (i) Explain the rule of ‘ejusdem generis’ with regard to interpretation of statutes. (4 Marks)

(ii) Sunrise Industries Ltd. has paid Rs.1,00,000 to a political party as its contribution to fight elections. Can it do so under the provisions of the Companies Act, 1956? (4 Marks)

Will it make any difference if the company has advertised its products in the monthly magazine published by the political party? (May 2005) Answer (i) the term ‘ejusdem generis’ means ‘of the same kind or species’. This rule can be

explained as follows: (a) Where any Act enumerates different subjects, general words following specific

words are to be construed with reference to the words that precede them. Those genera words are to be taken as applying to things of the same kind as the specific words previously mentioned, unless there is something to show that a wider sense was intended. Thus, this rule means that where specific words are used and after them some general words are used the general words would take their colour from the specific words used earlier.

Where there was prohibition on importation of arms, ammunition or gun -powder or any other goods’, the words’ any other goods’ will be construed as referring to goods similar to ‘arms, ammunition or gun powder – A.G. Brown (1920)/KB. 773.

(b) If the particular words used exhaust the whole genus (category), then the general words are to be construed as covering a larger genus.

(c) This rule applies only where the specific words are of the same nature. When they are of different categories than the meaning of the general words following these specific words remains unaffected. The general words then would not take colour from the earlier specific words.



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Courts have discretion whether to apply this rule in a particular case or not. For example, the ‘just and equitable’ clause under Section 433 of the Companies Act is held to be not restricted by the first five situations in which the court may wind up a company.

(ii) Under section 293A of the Companies Act, 1956, a company may contribute any amount not exceeding 5% of its average net profits during 3 immediately preceding financial years, to any political party or for any political purpose. For the purpose, Board may pass a resolution in this behalf and the amount contributed and the name of the party be disclosed in the Profit and Loss Account of the company. However, a Government company is prohibited to make any such political contribution.

Sunrise Industries Ltd. may contribute the amount of Rs.1 lakh subject to the above restrictions provided it has been in existence for more than three years. As per section 293A(3)(b) of the Act, the amount of expenditure incurred on advertisement in any publication (being a publication in the nature of a souvenir, brochure, tract, pamphlet or the like) by a political party shall also be deemed to be a contribution to a political party. Publication of advertisement of the products of the company in the monthly magazine of the political party will be covered by the general words ‘or the like and will also be deemed to be a contribution to the political party for the purposes of section 293A of the Act. Question 12 (i) Explain the rules relating to interpretation of Statutes, when the terms “notwithstanding”

and “Subject to” are used in any provision of an Act. (ii) State the effect of the words “notwithstanding anything contained in this Act” used in

Section 408 of the Companies Act, 1956, which vests certain powers in the Central Government to prevent oppression or mismanagement (November 2005)

Answer (i) The term “notwithstanding” used along with the words “anything contained” in an Act

characterises the non obstante clause. It is used in a provision of an Act when the intention of the legislature is to give an over-riding effect to that provision over other provisions of that Act and/or over provisions of other Acts as may be specified later in such provision. If there is any inconsistency or departure between the non obstante clause and other provisions, then the provisions as contained in the non obstante clause shall prevail. [K. Parasuramaiah Vs. Pakari Lakshman AIR (1965) AP 220].

As against the above non obstante clause, the term “subject to” is used in a provision of an Act to convey the intention of the legislature that the particular provision is yielding place to another provision or provisions to which is made “subject to”. Thus, it



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can be concluded that the effect of non obstante clause (i.e., not withstanding”) is the opposite to a provision or provisions which includes the term “subject to”.

(ii) Section 408 of the Companies Act, 1956 starts with the words “notwithstanding anything contained in this Act”. This is a non obstante clause which vests over-riding powers in the Central Government to nominate directors to prevent mismanagement or oppression. [Oriental Industrial Investment Corporation Ltd. Vs. Union of India (1981) 52 Comp. Cas. 487, 493]. This expression indicates that the appointment of the directors under this section is not to be controlled by other provisions of the Companies Act, 1956 such as maximum number or other proportion, if any fixed by the said Act. Further, the directors so appointed are also not liable to be removed by the company at general meeting under the provisions of section 284 of the Companies Act, 1956.

Question 13 What are the Internal and External aids to interpretation of statutes? Give five examples each of Internal and External aids. (May 2006) Answer Internal aids to interpretation / construction are those which are found within the text of the statutes. On the other hand external aids of interpretation are those factors which are external to the text of the statute but are of great help. Examples of internal aids to interpretation: 1. Definitional sections and clauses 2. Illustrations 3. Provisos 4. Long title and short title 5. Preambles 6. Heading and title of chapter 7. Marginal notes 8. Explanations 9. Schedules 10. Reading the statute as a whole Examples of external aids to interpretation: 1. Historical setting (Background) 2. Consolidating statute & Previous law



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3. Usage 4. Earlier & later analogous acts 5. Earlier acts explained by the later act 6. Reference to repealed acts 7. Dictionary definition 8. Use of foreign decisions Question 14 There is an apparent difference between section 292 of the Companies Act, 1956, which permits the board to delegate its power to make loans and section 372A of the Companies Act, which requires approval of loan by a resolution passed at a board meeting with the consent of all the directors present at the meeting. How would you interpret these two provisions applying the rule of harmonious construction? (November 2006) Answer Rule of Harmonious Construction Where there are in an enactment two or more provisions which cannot be reconciled with each other, they should be so interpreted, wherever possible, as to give effect to all of them. This is what is known as the Rule of Harmonious Construction. Importance should not be attached to a single clause in one section overlooking the provisions of another section. If it is impossible to avoid inconsistency, the provision which was evaluated or amended later in point of time must prevail. The rule of Harmonious Construction is applicable only where there is real and not merely apparent conflict between the provisions of an Act, and one of them has not been made subject to the other. Every loan falling within the purview of Section 372 A of the Companies Act, 1956 must be sanctioned by a resolution of the Board of Directors passed at its meeting (Section 372 A(2). Every such resolution must be passed with the consent of all the directors present at the Board meeting, that is no one dissenting or unanimously. Every loan covered by Section 372 A falls within the purview of Section 292 (i)(e). That section permits delegation by the Board of its power of making loans vide proviso to Section 292 (i), subject to the conditions stipulated in Section 292(3). The condition that the resolution delegating the power must specify the total amount upto which loans may be made by the delegate, the purposes for which the loans may be made and the maximum amount of loans which may be made for each purpose in individual cases. However, by harmonious interpretation of both the provisions of Section 292 and 372A and in absence of specific prohibition in Section 372A against delegations, the Boards



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power under Section 372A may be delegated in accordance with the provisions of Section 292 by passing unanimous resolution of the Board. Any other interpretation will make provisions of Section 292 redundant. Question 15 (i) What is the effect of proviso ? Does it qualify the main provisions of an Enactment? (ii) Does an explanation added to a section widen the ambit of a section ? Support your

answer with an example from the Companies Act, 1956. (iii) What do you understand by the term ‘Preamble” and how does it help in

interpretation of a statute ? (May 2007) Answer (i) Normally a Proviso is added to a section of an Act to except something or qualify

something stated in that particular section to which it is added. A proviso should not be, ordinarily, interpreted as a general rule. A proviso to a particular section carves out an exception to the main provision to which it has been enacted as a Proviso and to no other provision. [Ram Narian Sons Ltd. Vs. Commissioner of Sales Tax AIR (1955) S.C. 765]

(ii) Sometimes an explanation is added to a section of an Act for the purpose of explaining the main provisions contained in that section. If there is some ambiguity in the provisions of the main section, the explanation is inserted to harmonise and clear up and ambiguity in the main section. Something may added to or something may be excluded from the main provision by insertion of an explanation. But the explanation should not be construed to widen the ambit of the section.

For example, Section 294AA of the Companies Act, 1956 gives power to the Central Government to prohibit the appointment of Sole Selling Agents of a company in certain cases. An explanation has been added to that section which states that an “appointment” includes “re-appointment”. By inclusion of this explanation, the legislature has only clarified the main provisions of that section and has not widened the ambit of the powers of the Central Government.

(iii) The “Preamble” expresses the scope, object and purpose of the Act. It may recite the ground and the cause making a statue and the evil, which is sought to be remedied by it. It is a part of the statute and can legitimately be used for construing it. However, it does not over-ride the plain provisions of the Act, but if the wording of the statute gives rise to the doubts as to its proper construction, e.g., where the words or phrase have more than one meaning and a doubt arises as to which of the two meanings is intended in the Act, then the Preamble can and ought to be referred to in order to arrive at the proper construction.



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Question 16 “When two or more provisions of the same statue are repugnant to each other, the court will try to construe the provisions in such a manner, if possible, as to give effect to all”. Examine the statement with reference to the provisions of sections 166 and 210 of the Companies Act, 1956 which appear to be seemingly contradictory to each other for compliance. (November 2007)

Answer The statement in question is relates to an important rule of interpretation that is ‘Rule of Harmonious Construction of a statute. According to this rule when there is doubt about the meaning of the words of a statute, these should be understood in the sense in which they harmonise with the subject of the enactment and the object which the legislature had in view their meaning is found not so much in strictly grammatical or etymological propriety of language, nor even its popular use, as in the subject or in the occasion on which they are used and the object to be attained. Where there are in an enactment two or more provisions which cannot be reconciled with each other, they should be so interpreted whichever possible as to give effect to all of them. This is what is known as the Rule of Harmonious Construction. Let us take an example: according to Section 166(i) of the Companies Act, 1956 there must be not more than fifteen months between tow consecutive annual general meetings of a Company. Section 210 requires the Board of Directors to lay at every annual general meeting of a company a profit and loss account, which must cover the period since the preceding account and must be made up to date not earlier than the date of the meeting by more than six months. The account is required to be accompanied by a balance sheet as at the date to which the profit and loss account is made up. For some special reasons, however, the Registrar may give an extension for not more than 3 months to hold the meeting. In such a case, the accounts must relate to a period not earlier than the date of the meeting by more than six months plus the extension period. From this, we can easily make out that except the first annual general meeting which is subject to different rules on annual general meeting is to be held subject to the following rules: (i) The meeting must be held in each year (ii) It must be held not later than 15 months (18 months if extension is granted) from the date of

the previous general meeting. (iii) Further, it must be held later than six months (or six months + extension) of the date of

balance sheet.



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These three requirements are cumulative and separate; failure to comply with any of them constitutes an offence. We would note that even where a company may hold its annual general meeting within the time limit of 15 moths (or 18 months, if extension is granted) it may still be guilty of contravention of Section 210. Therefore, to give effect to both the sections, they are to be interpreted harmoniously and in fixing the date of the annual general meeting Section 166 as well as 210 are to be taken into account. The following illustration will make things clear – the financial year of a company ends on 31st March each year, presumption that the annual general meeting to adopt the accounts etc. relating to the year ended on 31st March, 2006 was hold on 30th September, 2006 under Section 166 (i) the next general meeting need not be held till 31st December, 2007. But the relevant accounts would be those of the year ended on 31st March, 2007 which would be more than six months before the date of meeting. Therefore, the last date for holding that meeting would be 31st September, 2007. Question 17 (i) Explain the rules relating to interpretation of statues when the terms “notwithstanding”

and “Subject to” are used in any provision of an Act.

(ii) State the effect of the words “notwithstanding anything contained in this Act” used in Section 408 of the Companies Act, 1956 which vests certain powers in the Central Government to prevent oppression or mismanagement. (May 2008)

Answer (i) The term ‘notwithstanding’ used along with the words ‘anything contained’ in an Act

characterises the non obstante clause. It is used in a provision of an Act when the intention of the legislature is to give an over-riding effect to that provision over other provisions of that Act and/or over provisions of other Acts as may be specified later in such provision. If there is any inconsistency or departure between the non-obstante clause and other provisions, then the provisions as contained in the non-obstante clause shall prevail. [K Parsuramaiah Vs. pakari Lakshman AIR (1965) AP 220].

As against the above non obstante clause, the term ‘subject to’ is used in a provision of an Act to convey the intention of the legislature that the particular provision is yielding place to another provision or provisions to which is made ‘subject to’. Thus, it can be concluded that the effect of non obstante clause (i.e., not withstanding) is the opposite to a provision or provisions which includes the term “subject to”.

(ii) Section 408 of the Companies Act, 1956 starts with the words “notwithstanding anything contained in this Act”. This is a non obstante clause which vests over-riding powers in the Central Government to nominate directors to prevent mismanagement or oppression. [Oriental industrial Investment Corporation Ltd. Vs. Union of India (1981) 52 Comp. Cas. 487, 493]. This expression indicates that the appointment of the directors under this section is not to be controlled by other provisions of the Companies



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Act, 1956 such as maximum number or other proportion, if any, fixed by the said Act. Further, the directors so appointed are also not liable to be removed by the company at general meeting under the provisions of Section 284 of the Companies Act, 1956.

Question 18 The analysis of the language of Section 292 and Section 372A of the Companies Act, 1956 apparently discloses a conflict because the former provision permits the Board of Directors to delegate its powers to make loans whereas the latter provision requires approval of loan by resolution passed at a board meeting with the consent of all the directors present at the said meeting. To what extent the rule of “Harmonious construction” can be applied for the purpose of interpreting these two provisions of the companies Act, 1956. (November 2008) Answer HARMONIOUS CONSTRUCTION: Where there are in an enactment two or more provisions which can not be reconciled with each other, they should be so interpreted, wherever possible so as to give effect to all of them. This is what is known as the rule of Harmonious Construction. Importance should not be attached to a single clause in one section overlooking the provision of another section. If it is impossible to avoid inconsistency the provision which was enacted or amended later in point of time must prevail .The Rule of Harmonious Construction is applicable only when there is a real and not merely apparent conflict between the provisions of an Act and one of them has not been subject to the other. Every loan falling within the preview of Section 372A of the Companies Act, 1956, must be sanctioned by a resolution of the Board of Directors passed at its meeting. Every such resolution must be passed with the consent of all the directors present at the Board meets unanimously so that there is no one dissenting. Every loan covered by Section 372A falls within the preview of Section 292(1)(e). The Section permits delegation by the Board of Directors of its powers of making loans vide proviso to Section 292(I), subject to the conditions stipulated in Section 292(3). The condition is that the resolution delegating the power must specify the total amount up to which loans may made by the delegate, the purpose for which the loans may be made and the maximum amount of loans which may be made for each purpose in individual cases. However by harmonious interpretation of both the provisions of Section 292 and Section 372A and in the absence of specific prohibition in Section 372A against delegation, the Board’s power under Section 372A may be delegated in accordance with the provisions of Section 292 by passing unanimous resolution of the Board. Any other interpretation will make provisions of Section 292 redundant.



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Question 19 The word “May” doesn’t mean “Shall”. Yet the word ‘May’ under certain circumstances means “Shall”. Discuss the statement in the context of interpretation of statutes and the importance of distinction between mandatory and directory provisions. (May 09) Answer The use of the word ‘may’ in a statutory provision will not by itself show that the provision is directory in nature. In some cases the legislature may use the word ‘may’ as a matter of pure conventional courtesy and yet intend a mandatory force. Therefore, in order to interpret the legal import of the word ‘may’ we have to consider various factors, e.g. the object and the scheme of the Act, the context or background against which the words have been used, the purpose and advantages of the Act sought to be achieved by use of this word and the like. Coming to the word ‘shall’ the use of the word ‘shall’ would not of itself make a provision of the Act mandatory. It has to be construed with reference to the context in which it is used. Thus, as against the government the word ‘shall’ when used in a statute is to be construed as ‘may’ unless a contrary intention is manifest. Hence, a provision in a criminal statue that the offender shall be punished as prescribed in the statute is not necessary to be taken as against the government to direct prosecution under that provision rather under some other applicable statute. The distinction between a provision which is mandatory and one which is directory is that when it is mandatory, it must be strictly complied with; when it is ‘directory’, it would be sufficient that it is substantially complied with. Non-observance of mandatory provision involves the consequences of invalidity. But non-observance of directory provisions does not entail the consequence of invalidity, whatever other consequences may occur. No general rule can be laid down for deciding whether any particular provision in a statute is mandatory or directory. In each case the court has to consider not only the actual words used, but has to decide the legislative intent. For ascertaining the real intention of the legislature, the court may consider, amongst other things, the following: (i) The nature and design of the statute. (ii) The consequence which would flow from construing from one way or the other. (iii) The impact of other provisions by resorting to which the necessity of complying with the

provisions in question can be avoided. (iv) Whether or not the statute provides any penalty if the provision in question is not

complied with. (v) If the provision in question is not complied with, whether the consequences would be

trivial or serious.



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(vi) Most important of all, whether the object of the legislation will be defeated or furthered. Where a specific penalty is provided in a statute itself for non-compliance with the particular provision of the act, no discretion is left to the court to determine whether such provision is directory or mandatory – it has to be taken as mandatory. Question 20 Explain the principles of “Rule of Beneficial Interpretation”.

Answer While framing the language of a statute, generally, the care is taken to make it in such a manner that there does not remain any confusion in its interpretation. But sometimes, the language of the statue may be capable of more than one interpretation. In such cases the most firmly established rule of construction is the principle laid down in the Heydon’s case. This rule is also called the “mischief rule”. This rule enables construction of four matters in construing an Act as stated below: (i) What was the law before the making of the Act. (ii) What was the mischief or defect for which the law did not provide; (iii) What is the remedy that the Act has provided; and (iv) What is the reason for the remedy. The rule then directs that the courts must adopt that construction which ‘shall suppress the mischief and advance the remedy’. Therefore, even in a case where the usual meaning of the language used falls short of the whole object of the legislature, a more extended meaning may be attributed to the words, provided they are fairly susceptible of it. If however, the circumstances show that the phraseology in the Act is used in a larger sense than its ordinary meaning then that sense may be given to it. If the object of a statute is public safely then its working must be interpreted widely to give effect to that object. Thus the legislature having intended, while passing the Workmen’s Compensation Act, the main object being provision of compensation to workman, it was decided that the act ought to be so construed, as far as possible, so as to give effect to its primary provisions. It has been emphasized by the Supreme Court that the rule in Heydon’s case is applicable only when the works used are reasonably capable of more than one meaning. This rule does not normally apply to a fiscal statue like Income tax Act,. While construing a fiscal statute the words of the statue are give three plain meaning. If a tax payer is within the plain meaning of the terms of an exemption, he cannot be denied the benefit by resorting to any supposed intention of the exempting authority. This was held by the Supreme Court in the case of Hemraj Gordhandas vs. H.H. Dave.



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Question 21 (i) Many a time a proviso is added to a Section of the enactment. Explain the function of such

a proviso while carrying out the interpretation?

Discuss the rules of interpretation of deeds and documents (Nov 09) Answer (i) The normal function of a provisio is to except something out of the enactment or to qualify

something stated in the enactment which would be within its purview if the proviso were not there. The effect of the proviso is to qualify the preceding enactment which is expressed in terms which are too general. As a general rule, a proviso is added to an enactment to qualify or create an exception to what is in the enactment Ordinarily a proviso is not interpreted as it stating a general rule.

It is a cardinal rule of interpretation that a proviso to a particular provision of a statute only embraces the field which is covered by the main provision. It carves out an exception to the provision to which it has been enacted as a proviso and not to the other. (Ram Narain Sons Ltd. Vs. Assistant Commissioner of Sales Tax.,A.I.R,1995 Sc 765)

An explanation is at times appended to a Section to explain the meaning of the text of the section. An explanation may be added to include something within the Section or to exclude something from it. An explanation should normally be so read as to harmonise with and clear up any ambiguity in the main section. It should not be so construed as to widen the ambit of the section.

(ii) The rules regarding interpretation of deeds and documents are as follows: First and the foremost point that has to be borne in mind is that one has to find out what a

reasonable man, who has taken care to inform himself of the surrounding circumstances of a deed or a document, and of its scope and intendments, would understand by the words used in that deed or document.

It is inexpedient to construe the terms of one deed by reference to the terms of another. Further, it is well established that the same word cannot have two different meanings in the same document, unless the context compels the adoption of such a rule.

The Golden Rule is to ascertain the intention of the parties to the instrument after considering all the words in the document/deed concerned in their ordinary natural sense. For this purpose, the relevant portions of the document have to be considered as a whole. The circumstances in which the particular words have been used have also to be taken into account. Very often, the status and training of the parties using the words have also to be taken into account as the same words may be used by a ordinary person in one sense and by a trained person or a specialist in quite another sense and a special sense. It has also to



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be considered that very many words are used in more than one sense. It may happen that the same word understood in one sense will give effect to all the clauses in the deed while taken in another sense might render one or more of the clauses ineffective. In such a case the word should be understood in the former and not in the latter sense.

It may also happen that there is conflict between two or more clauses of the same document. An effort must be made to resolve the conflict by interpreting the clauses so that all the clauses are given effect to. If, however, it is not possible to give effect to all of them,then it is the earlier clause that will over ride the latter one.

Similarly, if one part of the document is in conflict with another part, an attempt should always be made to read the two parts of the documents harmoniously, if possible. If that is not possible, then the earlier part will prevail over the latter one which, therefore, be disregarded.

Question 22 Briefly discuss the Rule of ‘ejusdem generis’ as applied in the interpretation of statute. (6 Marks)

Answer When particular words pertaining to a class or genus are followed by general words, the general words are construed as limited to things of the same kind as those specified. This rule which is known as Rule of ejusdem generis reflects an attempt ‘to reconcile incompatibility between the specie and general words in view of the other rules of interpretation that all words in the statute are given effect if possible, that a statute is to be construed as a whole and that no words are presumed to be superfluous. For instance, where an Act permits keeping of dogs, cats, cows, buffaloes and other animals the expression ‘Other animals’ would not include animals like lions and tigers, but would mean, only domesticated animals like horses etc. The rule applied when (i) the statute contains an enumeration of specific words: (ii) the subjects of enumeration constitute a class or category: (iii) that class or category is no exhausted by the enumeration; (iv) the general terms follow the enumeration; and (v) there is no indication of a different legislative intent. If the subjects of enumeration belong to a broad based genus as also to narrower genus, there is no principle that the general words should be confined to the narrower genus. The rule is applied extensively in interpreting the various statutes. The rule of ejusdem generis has to be applied with care and caution. It is not an inviolable rule of law, but only permissible reference in the absence of an indication, to the contrary, and where the context and the object and mischief of the enactment do not require restricted meaning to be attached to word of general import, it becomes the duty of the courts to give/words their plain and ordinary meaning. The rule of ejusdem generis has no inverse application. General words preceding the enumeration of specific instances are not governed by this rule and their import cannot be limited by such words.



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Question 23 (i) Explain the rules relating to interpretation of the terms ‘Subject to’ and ‘Not

withstanding’ as used in the different provisions of the Acts. What is the effect of the term ‘Not withstanding anything contained in this Act’ used in Section 408 of the Companies Act, 1956 empowering the Central Government to prevent oppression and mismanagement ?

(ii) In what way are the following terms considered as ‘internal aid’ in the interpretation of statutes? (A) Illustrations (B) Explanation. (May, 2010)

Answer The word ‘notwithstanding anything contained’ characterize the non obstante clause. It is generally included to give an overriding effect to the clause over the other. If there is any inconstancy or departure between the non obstante clause and another provision, it is the non obstante clause which will prevail (K. Parasuramaiah Vs. Pakari Lakshman, A/R 1965 AP 220). But the word ‘subject to’ conveys the idea of a provision yielding place to another provision or provisions to which it is made ‘subject to’. Hence the effect of non obstante clause (i.e notwithstanding) is the opposite of a provision which states ‘subject to’. Section 408 of the Companies Act, 1956 opens with the words ‘notwithstanding anything contained in this Act. This is a non obstante clause which vests overriding powers in the Government to nominate directors to prevent mismanagement or oppression (Oriental Industrial Investment Corporation Ltd. vs. Union of India (1981) 52 Com Cases 487, 493(Del). This expression indicates that the appointment of directors under this section is not to be controlled by the maximum number or other proportion, if any, fixed by any provisions of the Act. Further, they cannot be removed by the company at general meeting under section 284 of the Companies Act, 1956. (ii) (A) Illustrations: Illustrations form a part of the statute and considered to be of

relevance and value in construing the text of the section. However, illustration can not have the effect of modifying the language of the section and can neither curtail nor expand the ambit of the section.

(B) Explanation: An Explanation may be added to include something or to exclude something from it. Explanation should normally be read as to harmonise with and clear up any ambiguity in the main section. It should be construed as to widen the ambit of the section

Question 24 Gaurav Textile Company Limited has entered into a contract with a Company. You are invited to read and interpret the document of contract. What rules of interpretation of deeds and documents would you apply while doing so? (New, May, 2010)



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Answer The rules regarding interpretation of deeds and documents are as follows: First and the foremost point that has to be borne in mind is that one has to find out what reasonable man, who has taken care to inform himself of the surrounding circumstances of a deed or a document, and of its scope and intendments, would understand by the words used in that deed or document. It is inexpedient to construe the terms of one deed by reference to the terms of another. Further, it is well established that the same word cannot have two different meanings in the same documents, unless the context compels the adoption of such a rule. The Golden Rule is to ascertain the intention of the parties of the instrument after considering all the words in the documents/deed concerned in their ordinary, natural sense. For this purpose, the relevant portions of the document have to be considered as a whole. The circumstances in which the particular words have been used have also to be taken into account. Very often, the status and training of the parties using the words have also to be taken into account as the same words maybe used by a ordinary person in one sense and by a trained person or a specialist in quite another sense and a special sense. It has also to be considered that very many words are used in more than one sense. It may happen that the same word understood in one sense will give effect to all the clauses in the deed while taken in another sense might render one or more of the clauses ineffective. In such a case the word should be understood in the former and not in the latter sense. It may also happen that there is a conflict between two or more clauses of the same documents. An effect must be made to resolve the conflict by interpreting the clauses so that all the clauses are given effect. If, however, it is not possible to give effect of all of them, then it is the earlier clause that will over ride the latter one.


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