India: Legal Sustainability Of Share Transfer Restrictions In Indian Private Companies Which Are Subsidiaries Of Indian Public Companies

More often than not in equity investment transactions, restricting the transferability of shares in the relevant company is a fundamental aspiration of the parties. Under the Indian Companies Act, 1956 ("Act"), private companies' articles of association are required to restrict the right of shareholders to transfer shares.1 However, the shares of public companies are required to be freely transferable.2 While there is clarity on the feasibility (or the infeasibility, as the case may be) of restricting share transfers in private companies and public companies, there are competing views on the feasibility of placing such restrictions in private companies which are subsidiaries of public companies. By way of background, the Companies (Amendment) Act, 2000 ("Amendment Act of 2000") expanded the definition of public company in Section 3(1)(iv)3 of the Act to include a "a private company which is a subsidiary of a company which is not a private company".

In Hillcrest Realty v. Hotel Queen Road4, the Company Law Board ("CLB") observed that the basic characteristics of a private company do not get altered post the Amendment Act of 2000, even if it is a subsidiary of a public company. According to the CLB, such a company could continue to retain in its articles of association ("Articles") provisions with respect to the attributes of a private company set forth in Section 3(1)(iii) of the Act (i.e., restriction on raising funds from the public, restriction on transfer of shares, etc.), although it would become a public company for all other purposes. However, in Jerr Rutton Kavasmanek v. Gharda Chemicals 5, the Bombay High Court stated that all attributes and characteristics of a public company get attached to a private company which is the subsidiary of a public company. In neither of these cases, observations regarding the appropriateness of placing transfer restrictions on the shares of private companies which are subsidiaries of public companies were the ratio of the decision. Further, both these cases are now in appeal. Therefore, it is worthwhile to examine if transfer restrictions can be imposed on the shares of private companies which are subsidiaries of public companies.

Logically, all references to "public company" in the Act would cover all types of companies which are covered by the definition of public companies (including private companies which are subsidiaries of public companies). But as Section 3(1)(iv)(c) uses the term "a "private company" which is the subsidiary of a public company", it is also tempting to argue that the basic characteristics of a private company (including requirement for share transfer restrictions) can (and should) be retained by these companies. If this were the correct position, companies covered under Section 3(1)(iv)(c) would be private companies and public companies at the same time.

Is it possible for a company to be a private company and a public company at the same time?

On a plain reading the definitions of public company and private company do not appear to be mutually exclusive. For a company to be a private company it must satisfy all the attributes under Section 3(1)(iii). In contrast, the definition of public company is worded such that to become a public company, a company must satisfy either of two independent conditions. That is a company can be a public company if it is not a private company or a company can be a public company if it a private company which is the subsidiary of a public company. Compliance with the conditions in Section 3(1)(iii) does not appear to adversely impact a company's ability to comply with the conditions under Section 3(1)(iv).This suggests that a company can be a public company by virtue of being a subsidiary of a public company and at the same time be a private company by virtue of satisfying all the conditions of Section 3(1)(iii). If so, the provisions of the Act would apply to such a company as if it is a private company and a public company. However, this is not seen to be the case. There are certain sections in the Act which mandate two separate (and mutually exclusive) regimes for private companies and public companies. For instance, the Act requires that a public company shall have "Limited" as the last word of its name, and a private company shall have the words "Private Limited" as the last words of its name. This would show that it is not viable for a company to be a private company and a public company at the same time.

An analysis of the scheme of the Amendment Act of 2000 also supports the above position. A key change ushered in by the Amendment Act of 2000 was to make Section 43A of the Act inoperative. Under Section 43A, deemed public companies were permitted to include in their Articles provisions related to attributes of private companies specified in Section 3(1)(iii). The regime created by Section 43A, therefore, also led to the creation of a category of companies which had the attributes of both private companies and public companies. The Amendment Act of 2000, along with removing the Section 43A regime from the Act, also removed the category of companies created by Section 43A. Thus it appears that the most appropriate interpretation of Section 3(1)(iv)(c) is that a private company which is the subsidiary of a public company becomes a public company for all purposes under the Act. As a natural consequence, the shares of such a company must be freely transferable.

What type companies do multiple references in the Act to "private companies which are subsidiaries of public companies" apply to?

Several sections in the Act make specific references to a "private company which is a subsidiary of a public company".6 These references place a private company which is the subsidiary of a public company in the same position as a public company for the applicability of certain sections of the Act. On a standalone reading of provisions containing these references, it is tempting to argue that only those provisions apply to private companies which are subsidiaries of public companies. However, this reading is seen to render the amendment of the definition of public companies (by adding Section 3(1)(iv)(c)) ineffective. Prior to the amendment of the definition of public companies, private companies which were subsidiaries of public companies were treated at par with public companies in the following ways: (a) through the fiction created by Section 43A (where private companies of which ownership beyond a threshold was held by corporate bodies including public companies were covered), and (b) private companies which were subsidiaries of public companies, but did not get covered by Section 43A7, were treated as public companies only for the purposes of the provisions which through specific references were made applicable to private companies which were subsidiaries of private companies. If the intent of the Amendment Act of 2000 was that private companies which were subsidiaries of public companies are treated as public companies only vis-à-vis provisions which are expressly made applicable to such companies, it could have been accomplished by removing Section 43A from the Act. However, the legislature went further and introduced changes to the definition of public companies. This should be seen as an indication of the intent to create a regime which is different from what would have been created if the definition of public companies was not amended.

It is therefore important to examine whether equating private companies which are subsidiaries of public companies to public companies would make the specific references to a "private company which is a subsidiary of a public company" redundant if all provisions applicable to public companies would be applicable to private companies which are subsidiaries of public companies. It is submitted that these references apply to companies falling under Section 4(7) of the Act and are therefore not redundant.

Section 4(7) of the Act provides that a private company which is a subsidiary of a non-Indian body corporate, which if incorporated in India would have been a public company under the Act, would be deemed to be a "subsidiary of a public company"8 ("Section 4(7) Companies"). To assess whether the specific references to a "private company which is a subsidiary of a public company" are applicable to Section 4(7) Companies, it needs to be examined whether Section 4(7) Companies would be covered by Section 3(1)(iv)(c) of the Act.

The Act defines "company" as a company formed and registered under the Act. The words "subsidiary of a company which is not a private company" in Section 3(1)(iv)(c) suggests that for a private company to become a public company, its holding company must be a company formed and registered under the Act. However, Section 4(7) treats a private company which is the subsidiary of a certain type of non-Indian corporate entity as a "subsidiary of a public company". The question therefore is: can the legal fiction under Section 4(7) be extended to include Section 4(7) Companies in definition of public company (under Section 3(1)(iv)(c)).

A deeming provision should be confined only for the purpose it is meant, and should not be extended by importing another fiction.9 Section 4(7) was introduced in the Act through the Amendment Act of 1960 to ensure same treatment for a private company which is a subsidiary of a public company incorporated in India and a private company which is the subsidiary of a 'public company' incorporated outside India.10 The Amendment Act of 1960 also introduced Section 43A (under which certain types of private companies were deemed to be public companies) in the Act.11 After the Amendment Act of 1960, thanks to Section 43A, private companies which were subsidiaries of an Indian public company or certain type of foreign body corporate by virtue of such Indian public company or foreign body corporate holding a majority of the equity share capital of the private company were deemed public companies. On the other hand, private companies which were subsidiaries of an Indian public company or a foreign body corporate due to the public company or the relevant type of foreign body corporate controlling the composition of the Board of Directors of the private company were not deemed public companies. Such private companies, continued with their private company status, and were only subject to higher regulatory compliance in instances where the Act specifically provided so by making references to a "private company which was the subsidiary of a public company". However, in the Companies (Amendment) Act, 1988 ("Amendment Act of 1988"), Indian private companies which were subsidiaries of foreign bodies corporate, were excluded from the coverage of Section 43A(1), thereby resulting in Indian private companies which were subsidiaries of Indian public companies being treated differently from Indian private companies which were subsidiaries of non-Indian bodies corporate. The former type of companies continued to be deemed public companies, while the latter type of companies were no longer deemed public companies (under Section 43A) and became only "subsidiaries of public companies" as per Section 4(7). They were subject to higher regulatory compliance only in instances where the Act made specific reference to subsidiaries of public companies.

It follows that, since the objective of creating parity between private companies which are subsidiaries of Indian public companies and private companies which are subsidiaries of certain types of foreign bodies corporate was abandoned with the Amendment Act of 1988, after the Amendment Act of 2000, the legislature would have intended to continue treating Section 4(7) companies differently. If the intention was to the contrary, the legislature should have expressly indicated such intention. In the absence of such express indication, there does not appear to be sound grounds to treat private companies which are subsidiaries of a foreign body corporate as public companies for all purposes.

Thus post Amendment Act of 2000, it appears that while Section 4(7) Companies are deemed to be subsidiaries of public companies by virtue of Section 4(7), they are not covered by Section 3(1)(iv)(c). The specific references in the Act to "private companies which are subsidiaries of public companies" would continue to apply to Section 4(7) Companies.

CONCLUSION

As seen from the foregoing discussion, there are more arguments which favour the view that private companies which are subsidiaries of public companies, after the commencement of the Amendment Act of 2000 have attained all the characteristics of public companies, than arguments which favour the view that such companies can retain the basic characteristics of private companies. However, it is acknowledged that until there is a judicial decision or legislative clarification satisfactorily addressing whether companies covered under Section 3(1)(iv)(c) can retain characteristics of private companies, some amount of uncertainty would remain.

Footnotes

1.Section 3(1)(iii) of the Act: "private company" means a company which has a minimum paid-up capital of one lakh rupees or such higher paid-up capital as may be prescribed, and by its articles, 

a.restricts the right to transfer its shares, if any;

b.limits the number of its members to fifty not including-

i.persons who are in the employment of the company, and

ii.persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased; and

c.prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company;

d prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives. (Emphasis supplied)

3.Section 111A.

4.Section 3(1)(iv) of the Act: "public company" means a company which-

a.is not a private company; 

b.has a minimum paid-up capital of five lakh rupees or such higher paid-up capital, as may be prescribed; 

c.is a private company which is a subsidiary of a company which is not a private company.

4. [2006] 71 SCL 4 1 (CLB).

5.2011 (113) BomLR 2487.

6.These references appear in, inter alia, Sections 77(2), 90, 108A, 111(11), 166(2), 170, 176(3), 182, 300, etc.

7.A private company could become a public company's subsidiary if (a) a majority of the voting power was held by the public company; or (b) if the public company had the right to appoint a majority of the board of directors of the private company. Only subsidiaries which were majority owned by public companies were covered under Section 43A.

8.An exception to this rule is that if the entire share capital of a private company is held by one or more foreign bodies corporate, that private company would not be considered to be the subsidiary of a public company.

9.GP Singh, Principles of Statutory Interpretation (12th edn., 2010).

10.See notes on clauses, Companies (Amendment) Bill, 1959.

11.In the relevant portion, Section 43A(1) provided that if 25% or more of the paid-up capital of a private company was held by 'bodies corporate' , such private company would be deemed to be a public company. It may be noted that Act defines 'bodies corporate' to include companies incorporated outside India.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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