A Company incorporated under the statute has an identity of its own, which is different from its members and shareholders, etc. A subsidiary company is an incorporated entity which has an identity of its own, which shall be separate from its holding company
Let us understand how we can determine whether a particular company is a subsidiary or not.
DEFINITION OF SUBSIDIARY COMPANY: (Section 2(87) of Companies Act 2013)
Unless the context requires otherwise, the term ‘subsidiary company’ or ‘subsidiary’ wherever appearing in the Companies Act, 2013 shall have the following meaning:
“Subsidiary company” or “Subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding company –
- (i) controls the composition of the Board of Directors; or
- (ii) exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.
Explanation – For the purposes of this clause, –
- (a) a company shall be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
- (b) the composition of a company’s Board of Directors shall be deemed to be controlled by another company if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors;
- (c) the expression “company” includes any body corporate;
- (d) “layer” in relation to a holding company means its subsidiary or subsidiaries;
In Short ,Subsidiary As per the 2013 Act, a ‘subsidiary’ is as an entity of which the holding company controls more than one-half of the total share capital (either directly or indirectly) or controls composition of the board of directors.
A.CONTROLS COMPOSITION OF BOARD OF DIRECTORS.
What do we understand about “Controls the composition of Board of Directors?
v The composition of a company’s Board of Directors shall be deemed to be controlled by another company, even if the same is not actually so controlled, if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors [explanation (b)].
v Sometimes companies enter into an agreement or an understanding with other companies to procure/receive some financial/technical/marketing/copyright/royalty /other sorts of assistance, in return of some powers to exercise their discretions in their Financial/Economic/Commercial decision processing. It means they allow other companies to play a strategic role in their management as they were provided with some sort of assistance, which is very important in running the business.
DEFINITION OF CONTROL:
The term ‘control’ is defined u/s.2(27) as under:
‘Control’ shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
Where more than one-half of the total share capital of a company (including body corporate), S Ltd., is controlled by another company (holding company), H Ltd., either directly (on its own) or together with is one or more subsidiaries, then such company (or body corporate), S Ltd., is said to be subsidiary of the other company, H Ltd. Such control can be through any one or more subsidiary / subsidiaries of the holding company [explanation (a)].
Let’s put it in simple words to understand about “Controls the Composition of Board of Directors”
ABC Ltd company can appoint a director when ABC Ltd is favored by the exercise of power by XYZ Ltd .Otherwise ABC ltd cannot appoint its director.ABC Ltd needs an approval from XYZ Ltd to appoint its director. It is clear that ABC Ltd cannot appoint a director of its choice.
B.TOTAL SHARE CAPITAL
The term ‘total share capital’ is not defined under the Companies Act, 2013.However, the term ‘share’ is defined u/s.2(84) to mean a share in share capital of a company and includes stock. U/s. 43 share capital can be of two kinds, equity share capital and preference share capital.
Some companies have allotted Preference Shares and the same has been more that of Equity share capital.
For example, the Company “ S” Ltd paid up share capital is Rs.5 crore ,Equity share capital Rs.2 crore ( out of which 40% is held by one of the group company) Preference Share capital Rs.3 crores ( entire shares held by the same group company where it hold Equity shares as mentioned above).
As per the Companies Act, 1956, the above company is an Associate company not a subsidiary company .Now Present Companies Act 2013, we need to understand the implication of the same. As per the definition of Subsidiary company provides that sub clause (ii) exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies:
The above sub clause denotes total share capital either at its own or together with one or more of its subsidiary companies. Share capital is both Equity and Preference Share capital.
Please note that here is small interpretation about determining subsidiary . The above sub clause, it has been mentioned as Total Share capital. We need to understand what is the total share capital and how to see its classification.
The term ‘total share capital’ is defined under the Rules1 as:
In these rules, unless the context otherwise requires, “Total Share Capital”, for the purposes of sub-sections (6) and (87) of section 2, means aggregate of the:-
- (a) paid-up equity share capital- and
- (b) convertible preference share capital.
Thus, where more than one-half of the aggregate of
- (i) paid-up equity share capital, and
- (ii) convertible preference share capital
of a company (including body corporate) is exercised or controlled by another company, the former company becomes subsidiary company.
The Central Government (Ministry of Corporate Affairs or MCA) have authority to limit number of layers of subsidiary companies that certain kinds of companies can have. MCA to specify number of subsidiary companies that a subsidiary of certain kinds of companies can have. [explanation (d)].
Going by the Total share capital definition, if the company is having the convertible preference share capital , then only it will have taken into consideration for Total share capital .Now we need to see how the companies issued Preference Share Capital.
Many companies issued Preference Share Capital as Redeemable Preference Share Capital , which means they need to maintain as an Associate company irrespective of Preference shares issued to their Group company or holding company.
To conclude, The companies which have issued convertible Preference Share capital will come under the subsidiary status.
SUBSIDIARY COMPANY AS PER COMPANIES ACT 1956
CORRESPONDING PROVISIONS OF THE COMPANIES ACT, 1956:SECTION 2(47) AND SECTION 4.
As per Section 4(1)(b)(ii) of the companies act 1956,if a company holds more than half in the nominal value of equity share capital of another company,than such another company is a subsdiary of first mentioned company .The wording of section i. more than half clearly says that it is more than 50% & not exactly 50% even.
There is an interesting case on the above subject. In the case of Oriental Industrial Investment Corporation of India vs Union of India (1981)51 Com Cases 487(Del), the effect of section 4 in relation to sections 255,256 and 257 came up for consideration.
In this case The High Court observed, inter alia, that the contention of the counsel for the Union of India that "the control of Oriental over the composition of the Board of Poonam Hotels which they exercise by virtue of their agreement dated August, 1975 is in contravention of the provisions of Sections 255,256 and 257 of the Act overlooks the important fact that section 255 excludes from its purview cases which have been otherwise expressly provided in the Act. The words "save as otherwise expressly provided in this Act" used in section 255(1)(b) are of commanding significance. Section 4(2) is an express provision for the appointment of the directors on the Board of Subsidiary. This provision is not hit by Section 255 because it is expressly excluded."
The High Court also observed that "there is no denying the fact that the right of the members of a public company to appoint directors of their choice at a general meeting is greatly abridged when there comes into being a relationship of a Holding and Subsidiary Company. But this restriction inheres in the definition of the Holding Company. It is firmly embedded in section 4 of the Act. The ability to control the conduct of the Subsidiary is the hall-mark of the Holding Company. The Holding Company is the controlling company. The controlled company is called a Subsidiary."
Revised clarification by DCA
Following the Judgment of the Delhi High Court, the Department of Company Affairs (DCA) issued a clarification modifying their earlier views on the above matter which is reproduced below;-
"Department views";- The Department has issued a circular 14\74 dated 28-8-1974 to the effect that the Articles of a company which confer upon another company the right to make provisions for appointment of director upon another company with a view to make the company a subsidiary is invalid under section 9 of the Companies Act. On a combined reading of the provisions of sections 255, 256 and 257 and because section 257 is a mandatory provision, this view does not seem to be well founded. The appointments made pursuant to an arrangement whether by the Articles or by an agreement is not invalid merely because any shareholder may seek election at an annual general meeting. Section 257 only deals with the right of a person other than a retiring director to stand for election at the annual general meeting. The agreement or Article of a company, in so far as it or they invest a company with the status of holding company in relation to the company of which the board is controlled cannot be said to be inconsistent with section 257 which comes into operation only when elections are to be held at the annual general meeting.
It follows from the above that a public company is not required to comply with the requirements of sections 255 to 257, if it is a Holding Company having the right to appoint majority of directors on the Board of the Subsidiary company pursuant to section 4 of the Act.
SIMPLE ILLUSTRATION TO UNDERSTAND THE CONCEPT OF SUBSIDIARY COMPANIES ACT 1956 AND 2013
In this scenario, D Ltd. Is a subsidiary of A Ltd under old Companies Act, 1956, however under New Companies Act, 2013, D Ltd will be subsidiary of C Ltd.
A.Rengarajan (Practising Company Secretary) Chennai Mobile 93810 11200