Tuesday, October 18, 2011

Transactions under Section 297 of the Companies Act, 1956: A Brief Analysis


Transactions under Section 297 of the Companies Act, 1956: A Brief Analysis

By this article I attempted to elaborate and interpretation Section 297 of the Companies Act, 1956, which deals with ‘Board’s sanction to be required for certain contracts in which particular directors are interested’.

What section 297 says (bare act):

(1)   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 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, shall not enter into any contract with the company-

(a)    for the sale, purchase or supply of any goods, material or services; or

(b)    after the commencement of this Act, for underwriting the subscription of any shares in, or debentures of, the company:

[Provided 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.]

(2)   Nothing contained in clause (a) of sub-section (1) shall affect-

(a)    the purchase of goods and materials from the company, or the sale of goods and materials to the company, by any director, relative, firm, partner or private company as aforesaid for cash at prevailing market prices; or

(b)    any contract or contracts between the company on one side and any such director, relative, firm, partner or private company on the other for sale, purchase or -supply of any goods, materials and services in which either the company or the director, relative, firm, partner or private company, as the case may be, regularly trades or does business.

Provided that such contract or contracts do not relate to goods and materials the value of which, or services the cost of which, exceeds five thousand rupees in the aggregate in any year comprised in the period of the contract or contracts; or

(c)    in the case of a banking or insurance company any transaction in the ordinary course of business of such company with any director, relative, firm, partner or private company as aforesaid.

(3)   Notwithstanding anything contained in sub-sections (1) and (2) a director, relative, firm, partner or private company as aforesaid may, in circumstances of urgent necessity, enter, without obtaining the consent of the Board, into any contract with the company for the sale, purchase or supply of any goods, materials or services even if the value of such goods or cost of such services exceeds five thousand rupees in the aggregate in any year comprised in the period of the contract; but in such a case, the consent of the Board shall be obtained at a meeting within three months of the date on which the contract was entered into.

(4)   Every consent of the Board required under this section shall be accorded by a resolution passed at a meeting of the Board and not otherwise; and the consent of the Board required under sub-section (1) shall not be deemed to have been given within the meaning of that sub-section unless the consent is accorded before the contract is entered into or within three months of the date on which it was entered into.

(5)   If consent is not accorded to any contract under this section, anything done in pursuance of the contract shall be voidable at the option of the Board.

(6)   Nothing in this section shall apply to any case where the consent has been accorded to the contract before the commencement of the Companies (Amendment) Act, 1960.

Sub-Section wise Analysis:

Sub-Section
Deals with
     297 (1)

Charging / Fixing responsibility to obtain consent of board for entering into contract
     297 (2)

Exemptions / Gateways


     297 (3) & (4)


Modus operandi for obtaining consent

     297 (5)

Consequences of not obtaining consent


It is now clear that Section 297 states about obtaining consent of the board of directors, for entering into certain contracts in which particular directors are interested. Thus, not every contract requires consent of the board, only those contracts in which directors are interested require the consent of board. It is to be noted that usually a contract is entered into with the approval of the board, or even with the authority of the Managing Director/CEO/VP, or with the sanction of the Management Committee. But, here the only way of getting sanction for the contracts (in which directors are interested) is board’s sanction.

Section 297 (1):

Board’s sanction is required if:
        i.            a director;

      ii.            or his relative;

    iii.            a firm in which such a director or relative is a partner;

    iv.            any other partner in such a firm ( ie; a firm as stated in (iii) above);

      v.            a private company of which the director is a member or director;

enters into a contract with the company (a) for the sale, purchase or supply of any goods, materials or services; or (b) for underwriting the subscription of any shares in, or debentures of the company.

Further, the board’s sanction to be supported by the PREVIOUS approval of the Central Government, if the company’s paid-up capital is not less than Rs.1 Crore.

Section 297 (2):

Exemption to board’s sanction - to the  contract for the sale, purchase or supply of goods, materials or services, ie: Section 297 (1) (a) doest not apply, to the following:

§  purchase / sale for cash at prevailing market prices; or

§  regular trade / business between the company and party (director etc.), up to Rs.5,000/- per annum for the contract period;

§  any transaction in the ordinary course of business (exemption only for banking / insurance company)

Section 297 (3) & (4):

The board should accord its sanction only through a resolution passed at a board meeting (ie; it should not be a circular resolution) before the contract is entered into or within three months of the date on which the contract was entered into (three months allowed only in the case of urgent necessity – sub-section (3)

If the board’s sanction is not obtained, either before the contract date or within three months (in urgent cases), it will be deemed that the board’s sanction is not obtained, under Section 297.

Section 297 (5):

This sub-section states the consequence of not obtaining board’ sanction, as stipulated under section 297. As per 297 (5), if the consent is not accorded to any contract, anything done in pursuance of the contract shall be VOIDABLE AT THE OPTION OF THE BOARD.


CRITICAL INTERPRETATION:

Now, we will go into few critical interpretation of Section 297.

Aspect
Interpretation
Consent of Board


Consent of board means ‘a consent throughresolution at a duly convened board meeting, and not by mere circular resolution.

Contract between a company and director / interested director / relative / firm / private company.


The, the section does not apply to a contract between two public limited companies, because the word used is ‘private company’. If the word used is ‘company’, then it may be interpreted as any type of company (public / private). Thus, the two parties of the contract must be 1st party -  any type of company, and 2nd party -  director / relatives / firm / private company. 

Any other partner in such a firm.


Section is attracted to the contract entered into by the company and any other partners, of the firm of in that the director / his relative are a partner.

Sale or purchase of any goods, materials or services.


Section does not apply to a contract of immovable property (eg: purchase of land, building etc.), because the terms used is goods, materials or services – all are movables.  Thus contract for movables only get attracted by the section, immovable properties contracts are excluded.

Exemptions under sub-section (2)


Exemptions are independent provisions, because the words “or” is used to separate the provisions.

Exemption to transactions in the ordinary course of business.


Exemption applies only to banking and insurance companies, and not for all companies.

Rs.5000/- Exemption limit.


Calculated on Annual Basis, only for the period of contract.

Effect on not obtaining consent of board.


Contract voidable at the option of the board, and not void (invalid). The contract is voidable ie; can be ratified by the board.


Wednesday, October 5, 2011

Legal Provisions and Procedure for External Commercial Borrowings under Automatic Route


Legal Provisions and Procedure for External Commercial Borrowings under Automatic Route
(Guidelines, Procedure and Provisions)

External Commercial Borrowings (“ECB”) and Trade  Credits availed of by residents are  governed by clause (d) of sub-section 3 of section 6 of the  Foreign Exchange  Management Act, 1999 read with Notification No. FEMA 3/ 2000-RB viz. Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000, dated May 3, 2000, as amended from time to time.

The Reserve Bank of India issues a Master Circular every year consolidating all the circulars / notifications, and the existing instructions on the subject of "External Commercial Borrowings and Trade Credits" at one place.

The present information in the article is based on the Master Circular No.9 /2011-12 issued by RBI dated July 2011, FDI Policy via CIRCULAR 2 OF 2011 dated 30th September 2011, RBI Circular No.  RBI/2011-12/201, A.P. (DIR Series) Circular No.27 dated 23 september 2011 and Companies Act 1956 as amended upto 4th September, 2011 which may change from time to time and the provisions shall be changed accordingly.

The External Commercial Borrowing (“ECB”) can be accessed under two routes, viz., Automatic Route and Approval Route. ECB under Automatic Route do not require Reserve Bank / Government of India approval. In case of doubt as regards eligibility to access the Automatic Route, applicants may take recourse to the Approval Route.


Fund Raising Activities on which ECB Policy applies (i.e. such funds must be raised in compliance with ECB Policy)

The following fund raising activities required to be in compliance with the ECB Policy.

  1. Commercial Borrowing from outside India (i.e. External Commercial Borrowings): refer to commercial loans in the form of bank loans, buyers’ credit, suppliers’ credit; securitized instruments (e.g. floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially convertible preference shares) availed of from non-resident lenders with a minimum average maturity of 3 years.  

  1. Foreign Currency Convertible Bonds (FCCBs): It means a bond issued by an Indian company expressed in foreign currency, and the principal and interest in  respect of which is payable in foreign currency. Further, the bonds are required to  be issued in accordance with the scheme viz., "Issue of Foreign Currency  Convertible Bonds and Ordinary Shares (Through Depositary Receipt  Mechanism) Scheme, 1993”, and subscribed by a non-resident in foreign  currency and convertible into ordinary shares of the issuing company in any  manner, either in whole, or in part, on the basis  of any equity related warrants  attached to debt instruments. The ECB policy is applicable to FCCBs. The issue  of FCCBs is also required to adhere to the provisions of Notification FEMA No. 120/RB-2004 dated July 7, 2004, as amended from time to time.

  1. Preference shares (i.e. non-convertible, optionally convertible or partially convertible):  for issue of which, funds have been received on or after May 1, 2007 would be considered as debt and should conform to the ECB policy. Accordingly, all the norms applicable for ECBs, viz. eligible borrowers, recognised lenders, amount and maturity, end use stipulations, etc. shall apply. Since these instruments would be denominated in Rupees, the rupee interest rate will be based on the swap equivalent of LIBOR plus the spread as permissible for ECBs of corresponding maturity

  1. Foreign Currency Exchangeable Bond (FCEB): means a bond expressed in foreign currency, the principal and interest in respect of which is payable in foreign currency, issued by an Issuing Company and subscribed to by a person who is a resident outside India, in foreign currency and exchangeable into equity share of another company, to be called  the Offered Company, in any manner, either wholly, or partly or on the basis of any equity related warrants attached to debt instruments. The FCEB must comply with the “Issue of Foreign Currency exchangeable Bonds (FCEB) Scheme, 2008”, notified by the Government of India, Ministry of Finance, Department of Economic Affairs vide Notification G.S.R.89(E) dated February 15, 2008. The guidelines, rules, etc governing ECBs are also applicable to FCEBs.

Who can Raise ECB/ Eligible Borrowers under Automatic Route

The ECB facility is available to the following kind of entities:

1.     Automatic route is available to the Companies Registered under the Companies Act 1956 carrying business in the following sectors:
Ø  Real Sector,  Industrial Sector, Infrastructure Sector
Ø  Service Sectors Companies viz. hotel, hospital, software sectors

  Ø     Infrastructure Finance Companies except financial intermediaries, e.g.   banks,  financial  institutions (FIs), Housing Finance Companies (HFCs) and Non-Banking  Financial Companies (NBFCs) 

2.      Infrastructure Finance Companies except financial intermediaries, e.g. banks, financial  institutions (FIs), Housing Finance Companies (HFCs) and Non-Banking  Financial Companies (NBFCs)

3.      Units in Special Economic Zones (SEZ) can raise ECB for their own requirement. However, they cannot transfer or on-lend ECB funds to sister concerns or any  unit in the Domestic Tariff Area

4.      Non-Government Organizations (NGOs) engaged in micro finance activities provided such NGO’s should have a satisfactory borrowing relationship for at least 3 years with a scheduled commercial bank authorized to deal in foreign exchange in India and they have acquired a certificate of due diligence on `fit and proper’ status of the Board/ Committee of management of the borrowing entity from the designated AD bank.

From whom ECB (Loan) can be raised/ Recognized Lenders under Automatic Route:

The eligible borrowers can raise loan under ECB policy from any internationally recognized financial sources. The following may be the sources:
(i)                 International banks,
(ii)              International capital markets,
(iii)            Multilateral financial institutions (such as IFC, ADB, CDC, etc.) / regional financial institutions and Government owned development financial institutions,
(iv)            Export credit agencies, S
(v)               Suppliers of equipments,
(vi)            Foreign collaborators and
(vii)          Foreign equity holders (other than erstwhile Overseas Corporate Bodies OCBs).
Note:

  1. Foreign equity holder is eligible to be recognized lender only if he satisfies the following criteria.

He must hold the minimum paid up equity share capital in the company to which he is lending as set out below:

For ECB up to USD 5 million - minimum paid-up equity of 25 per cent held directly by the lender,

For ECB more than USD 5 million - minimum paid-up equity of 25 per cent held directly by the lender and debt-equity ratio not exceeding 4:1 (i.e. the  proposed ECB not exceeding four times the direct foreign equity holding)

Amount of ECB and Maturity Time under Automatic Route:

The followings are the provisions in this regard:

  1. The maximum amount of ECB which can be raised by an Eligible borrowers in real sector-industrial sector-infrastructure sector is USD 750 (increase from USD 500 million to USD 750 million via Circular RBI/2011-12/201, A.P. (DIR Series) Circular No.27 dated 23 september 2011) million or equivalent per financial year under the automatic.

  1. Corporates in the services sector viz. hotels, hospitals and software sector are allowed to avail of ECB up to USD 200 million or its equivalent (increase from USD 100 million to USD 200 million via Circular RBI/2011-12/201, A.P. (DIR Series) Circular No.27 dated 23 september 2011) in a financial year for meeting foreign currency and/ or Rupee capital expenditure for permissible end-uses.  The proceeds of the ECBs should not be used for acquisition of land.

  1. ECB up to USD 20 million or its equivalent in a financial year with minimum average maturity of three years. 

  1. ECB above USD 20 million or equivalent and up to USD 750 million or its equivalent with a minimum average maturity of five years. 

  1. NGOs engaged in micro finance activities can raise ECB up to USD 5 million or its equivalent during a financial year. Designated AD bank has to ensure that at the time of drawdown the forex exposure of the borrower is fully hedged.

  1. ECB up to USD 20 million or equivalent can have call/put option provided the minimum average maturity of three years is complied with before exercising call/put option. 

All-in-cost ceilings

There is a limit that the total cost of raising shall no go beyond a certain limit. The ECB All-in-cost includes the following:

                                i.            Rate of interest,

                             ii.            Other fees and expenses in foreign currency except commitment fee, pre-payment fee, and fees payable in Indian Rupees. 

Note: The payment of withholding tax in Indian Rupees is excluded for calculating the all-in-cost.  

Presently the following ceilings are valid until reviewed:

Average Maturity Period                        All-in-cost Ceilings over 6 month LIBOR

Three years and up to five years               300 basis points

More than five years                                    500 basis points


End Use of ECB Raised Under Automatic Route:

The amount raised through the ECB under automatic route is subject to regulations. It can be used for some specific purposes and certain use is not permitted also.

Permitted End Use: the followings are the permitted end use of ECB

Ø      ECB can be raised for investment [such as import of capital goods (as classified by DGFT in the Foreign Trade Policy), new projects, modernization/expansion of existing production units] in real sector - industrial sector including small  and medium enterprises (SME), infrastructure sector and specified service sectors namely hotel, hospital, software in India.

Note: Infrastructure sector is defined as (i) power, (ii) telecommunication, (iii) railways, (iv) roads including bridges, (v) sea port and airport, (vi) industrial parks, (vii) urban infrastructure (water supply, sanitation and sewage projects), (viii) mining, exploration and refining and (ix) cold storage or cold room facility, including for farm level pre-cooling, for preservation or storage of agricultural and allied produce, marine products and meat. 

Ø    Overseas direct investment in Joint Ventures (JV)/ Wholly Owned Subsidiaries (WOS) subject to the existing guidelines on Indian Direct Investment in JV/ WOS abroad.

Ø      Utilization of ECB proceeds is permitted for first stage acquisition of shares in the disinvestment process and also in the mandatory second stage offer to the public under the Government’s disinvestment programme of PSU shares.

Ø    For lending to self-help groups or for micro-credit or for bonafide micro finance activity including capacity building by NGOs engaged in micro finance activities.

Ø      Payment for Spectrum Allocation.

Ø   Infrastructure Finance Companies  (IFCs) i.e. Non Banking Financial Companies (NBFCs) categorized as IFCs by the Reserve Bank, are permitted to avail of ECBs, including the outstanding ECBs, up to 50 percent of their owned funds, for on-lending  to the infrastructure sector as defined under the ECB policy, subject to their complying with the following conditions:

i)   Compliance with the norms prescribed in the DNBS Circular DNBS.PD.CCNo.168 / 03.02.089 / 2009-10 dated February 12, 2010

ii)          Hedging of the currency risk in full. Designated Authorised Dealer should ensure compliance with the extant norms while certifying the ECB application.

End Use Not Permitted: the followings are the not permitted end use of ECB

Ø      For on-lending or investment in capital market or acquiring a company (or a part thereof) in India by a corporate [investment in Special Purpose Vehicles (SPVs), Money Market Mutual Funds (MMMFs), etc., are also considered as investment in capital markets).

Ø      For real estate sector.

Ø   for working capital, general corporate purpose and repayment of existing Rupee loans.

Security to be Provided to the Lender and Creation of Charge over Immoveable Assets and Financial Securities

  1. The borrower of can offer any security of his choice against ECB raised.  But creation of charge over immoveable assets and financial securities, such as shares, in favour of the overseas lender is subject to Regulation 8 of Notification No. FEMA 21/RB-2000 dated May 3, 2000 and Regulation 3 of Notification No. FEMA 20/RB-2000 dated May 3, 2000, respectively, as amended from time to time ans can be offered only after a “No Objection” certificate given by AD Category I Bank in this regard.

  1. AD Category - I banks have been delegated powers to convey ‘no objection’ under the Foreign Exchange Management Act (FEMA), 1999 for creation of charge on immovable assets, financial securities and issue of corporate or personal guarantees in favour of overseas lender / security trustee, to secure the ECB to be raised by the borrower. 

Parking of ECB Proceeds under Automatic Route:

Borrowers are permitted to either keep ECB proceeds abroad or to remit these funds to India, pending utilization for permissible end-uses.  ECB proceeds parked overseas can be invested in the following liquid assets

(a) Deposits or Certificate of Deposit or other products offered by banks rated not less than AA (-) by Standard and Poor/Fitch IBCA or Aa3 by Moody’s

(b) Treasury bills and other monetary instruments of one year maturity having minimum rating as indicated above, and

(c) Deposits with overseas branches / subsidiaries of Indian banks abroad. The funds should be invested in such a way that the investments can be liquidated as and when funds are required by the borrower in India.   

ECB funds may also be repatriated to India for credit to the borrowers’ Rupee accounts with AD Category I banks in India, pending utilization for permissible end-uses.


Repayment of ECB Raised under Automatic Route:

Prepayment of ECB up to USD 500 million may be allowed by AD banks without prior approval of Reserve Bank subject to compliance with the stipulated minimum average maturity period as applicable to the loan.

Refinancing of an existing ECB

The existing ECB may be refinanced by raising a fresh ECB subject to the condition that the fresh ECB is raised at a lower all-in-cost and the outstanding maturity of the original ECB is maintained.
Procedure of Raising ECB

Step-1

The first step is to get the loan sanctioned in the Board or general meeting of the Company as applicable and authorized any person to do the required fthings with regard to issue of ECB.

Step-2

As under automatic route no prior permission of Government of India /RBI is required permission the Borrower may enter into loan agreement with the recognized lender complying with the ECB guidelines for raising ECB under Automatic Route.

Step-3

Apply for the Loan Registration Number (LRN) from the Reserve Bank  of India before drawing down the ECB. For allotment of Loan Registration Number (LRN), borrowers are required to submit Form 83, in duplicate, certified by the Company Secretary (CS) or Chartered Accountant (CA) to the designated AD bank. One copy is to be forwarded by the designated AD bank to the Director, Balance of Payments Statistics Division, Department of Statistics and Information Systems (DSIM), Reserve Bank of India, Bandra-Kurla Complex, Mumbai The borrower can draw-down the loan only after obtaining the LRN from DSIM, Reserve Bank

Non Compliance of ECB Guidelines and Penalties

The primary responsibility to ensure that ECB raised / utilised are in conformity with the ECB guidelines and the Reserve Bank  regulations / directions is that of the borrower concerned and any contravention of the ECB guidelines will be viewed seriously and will invite penal action under FEMA 1999 (cf. A. P. (DIR Series) Circular No. 31 dated February 1, 2005).  The designated AD bank is also required to ensure that raising / utilisation of ECB is in compliance with ECB guidelines at the time of certification

Companies Act 1956 and External Commercial Borrowings:

A public and private limited company can take loan from other company and body corporate in and outside India and the same would be covered under section 372A as an inter corporate loan. The above is exempt from the deposit rules, 1975.

A public and private company can also take loan from Banks/PFIs under the same section 372A as inter corporate loan.

Further provisions of section 124 to 145 related to creation, modification and satisfaction of charges will also be attracted in ECB.