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Since A Subsidiary Is Not An Undertaking…

Published on Tue, Feb 25,2014 | 22:36, Updated at Tue, Feb 25 at 22:48Source : Moneycontrol.com 

By: Menaka Doshi, Executive Editor, CNBC TV18

This is material news for India Inc. – especially those companies looking to sell non-core businesses held via subsidiaries. SEBI in its new corporate governance guidelines has imposed a new safeguard for such sales.  SEBI has announced a NEW CLAUSE 49, that contains new corporate governance requirements that companies will have to adhere to starting 1st October this year. Many of these new developments are to align the existing Clause 49 to the Companies Act, 2013 – for instance, all material, related party transactions require approval from the majority of minority shareholders. Then there are some SEBI changes that go beyond the Companies Act, 2013 – for instance, the Companies Act, 2013 permits independent directors to hold a maximum of 2 terms of five years each (after which there has to be a 3 year cooling-off) and this is prospective. But SEBI has applied the tenure restriction with partial retroactivity and said if an independent director has already served 5 years or more on a board than he is eligible for only one five year term, before the 3 year cooling-off.

Now finally – let’s get to the news I want to talk about today – SEBI says in case of a divestment of shares in a ‘material subsidiary’, the company will have to seek shareholder approval by a special resolution.

SEBI defines a subsidiary as material ‘if the investment of the company in the subsidiary exceeds twenty per cent of its consolidated net worth as per the audited balance sheet of the previous financial year or if the subsidiary has  generated twenty per cent of the consolidated income of the company during the previous financial year’.

WHY HAS SEBI IMPOSED THIS NEW RESTRICTION?

Well, the Companies Act, 1956  says the sale, lease or disposal of an undertaking requires shareholder approval (simple majority)

Companies Act, 1956 Section 293

(1) The Board of directors of a public company, or of a private company which is a subsidiary of a public company, shall not, except with the consent of such public company or subsidiary in general meeting,-

(a) sell, lease or otherwise dispose of the whole, or substantially the whole, of the undertaking of the company, or where the company owns more than one undertaking, of the whole, or substantially the whole, of any such undertaking…

This often led to the sale of material businesses without shareholder approval, which is odd when you consider that any big investment in a new business requires shareholder approval. Worse still, some promoter led companies were found selling such subsidiaries to companies they owned directly or indirectly.  

So the Companies Act, 2013 built in more safeguards by  requiring that a company get shareholder approval via special resolution (75% approval) to sell, lease or dispose 20% or more of an undertaking of the company. Undertaking is defined as ‘in which the investment of the company exceeds twenty per cent. of its net worth as per the audited balance sheet of the preceding financial year or an undertaking which generates twenty per cent. of the total income of the company during the previous financial year.’

Companies Act, 2013

(a) to sell, lease or otherwise dispose of the whole or substantially the whole of the undertaking of the company or where the company owns more than one undertaking,

of the whole or substantially the whole of any of such undertakings.

(i) “undertaking” shall mean an undertaking in which the investment of the company exceeds twenty per cent. of its net worth as per the audited balance sheet of the preceding financial year or an undertaking which generates twenty per cent. of the total income of the company during the previous financial year;

(ii) the expression “substantially the whole of the undertaking” in any financial year shall mean twenty per cent. or more of the value of the undertakingas per the audited balance sheet of the preceding financial year;

Ofcourse, for material related party transactions, there is another layer of scrutiny – they need approval from the majority of minority shareholders. And thereby the Companies Act, 2013 has attempted to block further abuse by the majority shareholder.

But lawyers tell me an ‘undertaking’ does not include a subsidiary that gap has often led to abuse. SEBI too refers to this abuse in its Consultation Paper on Corporate Governance released in January 2013.

SEBI CONSULTATIVE PAPER (JANUARY 2013) ABUSIVE RPTs

Divestment of major subsidiaries does not require shareholder’s approval as per the existing law. There have been instances where ownership of major subsidiaries was transferred to controlling shareholders, without taking the approval of other shareholders. Section 292 of the Companies Act, 1956 mentions that the powers for investing funds of the company have to be exercised by the board only in its meeting by means of resolutions passed at meeting (i.e. it cannot be passed through circulation). Section 293 (1) (a) of the Companies Act, 1956 requires shareholder’s approval for selling off whole or substantial part of an undertaking.

However, there is no specific requirement regarding selling up of the shares in subsidiary (i.e. divesting) in the Companies Act. This has led to abuse by controlling shareholders by divesting the major subsidiaries without proper valuation to the companies indirectly owned by them. This lacuna is left uncorrected in the Companies Bill. As SEBI have powers under SEBI Act, 1992 to prescribe listing conditions, which may be in addition to but not in derogation of the provisions of the Companies Act, we may require the listed companies to obtain shareholder’s approval, in case of divestment of shares in subsidiaries through inserting a provision in listing agreement.

INDIA INC NEEDS SHAREHOLDER APPROVAL BEFORE SELLING SHARES OF 'MATERIAL' SUBSIDIARY!

And so in its final decision on new corporate governance standards (NEW CLAUSE 49) , approved by the SEBI board in February, the market regulator has decided to impose a new standard for the sale of a subsidiary. This applies to all listed companies, starting 1st October, 2014. Here is the exact provision as laid out in the SEBI Board Agenda papers

Review of Corporate Governance Norms in India for Listed Companies SEBI BOARD MEETING: 13th February, 2014

6.29 Approval by shareholders for divestment of major subsidiaries

Proposal in the Consultative Paper- To mandate the listed companies to obtain shareholders’ approval, in case of divestment of shares in major subsidiaries.

Comments received – Most of the comments received are in agreement with the proposal. The details of the comments received for and against the proposal are as under:

Proposal                                             For         Against

Approval by shareholders for              17           7

divestment of major

subsidiaries

Recommendation of PMAC - PMAC recommended that listed companies shall obtain shareholders' approval through special resolution for divestment in ‘material’ subsidiaries.

Recommendation of SEBI - In line with the PMAC recommendation, it is proposed to mandate the following:

i) All listed companies shall have a policy for determining ‘material’ subsidiaries and such policy shall be disclosed to Stock Exchanges upon approval or subsequent modification(s) and also in the Annual Report;

ii) Notwithstanding anything contained in (i) above, a subsidiary shall be considered as ‘material’ if the investment of the company in the subsidiary exceeds twenty per cent of its consolidated net worth as per the audited balance sheet of the previous financial year or if the subsidiary has generated twenty per cent of the consolidated income of the company during the previous financial year;

iii) Divestment of shares in all ‘material’ subsidiaries shall require prior approval of shareholders of the company by way of special resolution

I suppose the question swirling in your mind is – what does SEBI mean by ‘divestment of shares’ – will a sale of 5% or 10% or 15% shareholding in the subsidiary, constitute divestment and hence  need shareholder approval?

Well I understand that SEBI intends divestment to mean a sale that recharacterises the subsidiary – so for instance, if it’s a sale of 51% stake in a 100% subsidiary, then yes it would need shareholder approval, via special resolution.

We’ll know the full details when the final draft of Clause 49 is made public. But till then let this serve as an alert to companies looking to sell subsidiaries…first ask your shareholders for permission!

 
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