An Overview of Squeezing out of Minority under the Companies Act, 2013 Vis -À-Vis the Position in International Jurisdictions

Companies Act, 2013
Companies Act, 2013

Tanvi Kini

Squeeze outs demonstrate the power that majority shareholders in a company have to drive out the minority shareholders. It is a manifestation of the control of majority shareholders over the company. The minority shareholders are openly eliminated and are forced to accept the price determined by the majority for their shares. Although squeeze outs may enhance the value of the company at times, the interest of the minority shareholders is jeopardized. This open and legitimate method of forcefully removing shareholders from the company has posed several threats to minorities all around the world.

The Companies Act of 2013 which has provided for 4 methods of squeezing out, seems to be more defined and structured as opposed to the squeeze out provision(s) in the Companies Act of 1956. However, the questions that arise are, whether minority shareholders are adequately protected? What are the rights they exercise in a squeeze out process? Are the provisions of the 2013 Act really an improvement over the provisions of the 1956 Act? How different is the position in countries such as United Kingdom, United States, Australia and Canada?

The purpose of this article is first, to shed light on the squeeze out provision under the 1956 Act, second, to analyze the squeeze out provisions in the 2013 Act and third, to look into the position in foreign jurisdictions.


A ‘squeeze out’, also known as a ‘freeze out’ or ‘minority buy out’, is a transaction wherein the majority or controlling shareholders buy out the minority shareholders, in an attempt to gain complete control over the company, resulting in the total exclusion of the latter from the company.
The term ‘squeeze out’ is defined by Black’s Law Dictionary1 as,

“an action taken in an attempt to eliminate or reduce minority interest in a corporation.”
For example, a Company ‘B’ has 55% shareholding in Target Company ‘A’. If company ‘B’ which aims at eliminating the minorities, purchases the remaining 45% shares and compensates the minority shareholders in cash, it may be said that the minority shareholders have been squeezed out of Company ‘A’.
The methods of squeeze out under the Companies Act,2013 (“2013 Act”) may be categorized as: (i) Compulsory Acquisition or Acquisition of shares of dissenting shareholders2, (ii) Purchase of Minority Shareholding3, (iii) Scheme of Arrangement4(Section 230 to 234) and (iv) Reduction of Capital5. These provisions are not only in the interest of the majority shareholders, but do also afford some amount of protection to minority shareholders.
Legal Position in India

Under Section 395 of the 1956 Act, an acquirer company may make an offer to the shareholders of a target company under a scheme or contract involving the transfer of shares of the target company. In the event that the shareholders holding value of 90% of shares in the target company accept the aforementioned offer, the acquirer company has the right to give a notice to the dissenting shareholders to acquire their shares.6 The acquirer company shall be entitled and bound to acquire the shares of the dissenting shareholders, unless they make an application, objecting to the buy-out, to the Court within one month from receiving the notice.7 Further, under Section 395, if the acquirer company or its subsidiary holds more than 10% of the value of the shares of the target company, the offer is only valid if it is approved by holders of 90% of the shares of the target company, not including the shares held by the acquired. Such approving shareholders should constitute not less than three-fourths in number of the holders of those shares. This provision safeguards the interests of the minority only to the extent that they may approach the Court, however, it is important to note that this provision does not contain any guidelines for the valuation of offer price.
According to Section 235 of the 2013 Act, which is the corresponding provision to Section 395 of the 1956 Act, the acquirer company makes an offer to acquire the shares of the target company under a scheme or contract, which is required to be accepted by not less than shareholders holding 90% in value of shares of the target company. The acquirer must then serve a notice to the dissenting shareholders, who may in turn approach the National Company Law Tribunal (“NCLT”) to seek appropriate remedy. The sum or consideration received for the shares in the target company must be disbursed within 60 days from the date of receipt of such sum by the transferor company. The 1956 Act does not prescribe any such time period.
As per Section 236 of the 2013 Act, an acquirer entity or a person acting in concert with such acquirer which holds at least 90% of the issued equity share capital by way of an amalgamation, share exchange, conversion of securities or any other reason, may notify the company of their intention to buy the remaining equity shares. Section 236(2) provides for a pre-determined exit price which is reached at by a registered valuer as per the prescribed rules. The minority shareholders may also offer to the majority shareholders to purchase the minority equity shareholdings under Section 236(3). Further, in the absence of a physical delivery of shares by the shareholders within the time specified by the company, the share certificates shall be deemed to be cancelled, and the transferor company shall be authorised to issue shares in lieu of the cancelled shares and complete the transfer. Furthermore, when the majority shareholder fails to acquire full purchase of the shares of the minority equity shareholders, the provisions of section 236 will still apply to the residual minorities, although the shares of the company of the residual equity shareholders have been delisted and the period of one year or the period specified in the SEBI regulations have lapsed.

Under Section 236, once the shares of the minority have been acquired, 75% of the minority shareholders may negotiate a higher price for the members and the additional compensation shall be shared with balance minority shareholders. On a thorough reading, several lapses in this provision unfold. There is no clarity as to whether minority shareholders are bound to accept the offer. If compulsory, there is no scope for opposition by the dissenting shareholders. There is no provision for holding a separate meeting of the minority shareholders to vote against the buy-out. Furthermore, there seems to be an overlap between Section 235 and Section 236.

Under Sections 230 to 234 of the 2013 Act, a scheme of arrangement may permit the acquirer to purchase shares held by the minority shareholders, thereby effecting a squeeze out. The company is required to make an application to High Court to convene meetings of the various classes of shareholders. The scheme is required to be approved by a majority in number representing 75% in value of each class of shareholders, present and voting, in each meeting of every class. On obtaining the approval of the shareholders, the company is required to approach the High Court for sanctioning of the scheme. The High Court on hearing representations made by interested parties, if satisfied, passes an order sanctioning the scheme. This form of squeeze out is more common than compulsory acquisition as it requires approval by 50% of the shareholders in number and 75% in value of shares, which is less onerous than the 90% required in the case of compulsory acquisition. The role of the Court and voting rights of the shareholders in a scheme of arrangement offer the minority a minimal standard of protection.

A company may, subject to confirmation by the NCLT and passing of special resolution by the shareholders, reduce the share capital by repurchasing some shares and consequently cancelling them under Section 66 of the 2013 Act. This is the most attractive and least onerous method of squeezing out minority shareholders because it requires a majority of 75% of votes by shareholders and not 75% of votes from each class as in the scheme of arrangement or consent of 90% of the shareholders as in compulsory acquisition.
Although Indian Courts have dealt with the issue of squeeze outs in limited cases, the following have left a significant mark. The Bombay High Court in In Re: Elpro International Ltd.,8 while dealing with a special resolution passed in favour of reduction of capital, held that a company can reduce the share capital of any shareholder in any way so long as the procedure is fair and gets the approval of the majority shareholders.

The legal position on squeezing out of minority shareholders through reduction of share capital was decided by the Bombay High Court in Sandvik Asia Limited v. Bharat Kumar Padamsi.9 The question before the court was whether a special resolution which proposed to wipe out a class of shareholders after paying them just compensation can be termed as unfair and inequitable? The Court held that,

“once it is established that non-promoter shareholders are being paid fair value of their shares, at no point of time it is even suggested by them that the amount that is being paid is any way less and that even overwhelming majority of the non-promoter shareholders having voted in favour of the resolution shows that the Court [lower] will not be justified in withholding its sanction to the resolution.”10

The abovementioned case laws lead us to the inference that minority shareholders can be squeezed out even without their consent.
Further, the Bombay High Court in the 2014 Cadbury India Limited, laid down the following guidelines to be pursued in matters of minority buy outs:
The Courts duty lies in ensuring that the scheme is not against the public interest, is fair and just and not unreasonable, does not unfairly discriminate against or prejudice a class of shareholders and draws a balance between the commercial wisdom of the shareholders expressed at properly convened meetings.
The term “prejudice” in relation to valuation of a scheme would mean something more than just receiving less than what a shareholder desires, being a concerted attempt to force a class of shareholders to divest themselves of their holdings at a rate far below what is reasonable, fair and just.

While there are several methods to squeeze out minority shareholders in India, the protection given to the same is lacking. Given this dearth, we examine the position in foreign jurisdictions, namely, United Kingdom, United States, Australia and Canada.

Legal Position in Foreign Jurisdictions

In English Law, under the Companies Act, 2006, the acquirer may squeeze out the minority shareholders using methods very similar to those used in India i.e. compulsory acquisition, scheme of arrangement and reduction of capital. While the thresholds and procedures are similar in both Indian and English laws, the judicial interpretation and rights afforded to minority shareholders are different. For instance, in Hellenic and General Trust Ltd.,11 the Court, while discussing the “majority of the minority” rule in a scheme of arrangement, held that a subsidiary of the acquirer had a distinct interest from the minorities and hence each must constitute a separate class. Such a view has not been taken in India yet. English courts have invalidated squeeze outs where they have been carried out in a manner that harms minorities’ interests. Further, under the scheme in English law, the notice that is to be sent to the minority shareholders explains the consequences and effect of the scheme of arrangement on the minority shareholders.12

In the United States, it is the Delaware State laws (which are highly relied on for mergers) which provide squeeze out methods:13 (1) long-form merger, wherein the acquirer is unable to purchase at least 90% or more of the targets shares and thereby calls for a special meeting to obtain the requisite shareholder’s votes and (2) short form merger, wherein the acquirer is able to purchase at least 90% of the targets shares and obtaining the votes of the target’s shareholders is not required. Minority shareholders have two remedies against squeeze out: (1) Appraisal Rights and (2) Fiduciary Duty Class Actions. The appraisal rights under state corporate law statutes entitle dissenting shareholders in a squeeze out merger to compel the acquirer to pay them a court-determined fair value for their shares. Further, the Delaware Fiduciary Duty Class Action (FDCA) has evolved over the years. The FDCA is available regardless of the transactional structure or consideration used and places the burden to show that the transaction is entirely fair, on the acquirer.
In Canada, under the Canada Business Corporations Act (“CBCA”), squeeze outs may be effected by (i) compulsory acquisition or (ii) shareholder-appr oved transaction (which is generally an amalgamation squeeze out). Under the CBCA, the threshold for minority buy out is 90% of the shares of the target company, however, the minority shareholders have the right to demand for payment of fair value when they believe that the consideration being offered does not represent fair value of target company’s shares. This fair value is determined by the Court.14 To implement an amalgamation, squeeze out, a meeting of the shareholders of the target company must be held and at least 66 2/3% of the shares of the target company voting at the meeting must approve the amalgamation. The unique right of demanding payment of fair value by the minority shareholders is exercisable in the amalgamation method as well.
In Australia, under the Corporations Act, 2001 there are two methods of squeeze out: (1) compulsory acquisition following a takeover bid or (2) compulsory acquisition in other circumstances. In both these methods, the minority shareholders have the right to object to the acquisition of their securities by signing an objection form (which accompanies the notice served to them) and return it to the shareholders (90%) who approved the acquisition. The 90% shareholders lodge the objection with the Australian Securities & Investments Commission (“ASIC”) along with a list of shareholders who objected.15 Once the minority objection is cleared, the compulsory acquisition proceeds provided that the shareholders in each class who have objected to the acquisition together hold less than 10% of the shares or the Court has approved the acquisition on the basis of fair value for the securities offered.
To summarize, the key problem globally, is the inadequate protection of minority shareholder interest. While in the above mentioned foreign jurisdictions, the protection afforded to minority shareholders are still insufficient, they are certainly more well defined than the current position in India. It is important for minorities to understand the implications of the squeeze out provisions in the 2013 Act and be aware of the rights that they have as owners of the company i.e. the right to vote, fair valuation, and oversight of the Court. There is an urgent need to establish a balance between the interests of minority and majority.
1 Blacks Law Dictionary, The Law Dictionary (2nd Ed.), available at: http://thelawdic eze-out/
2 Section 235 of the Companies Act, 2013.
3 Section 236 of the Companies Act, 2013.
4 Section 230 to 234 of the Companies Act, 2013.
5 Section 66 of the Companies Act, 2013.
6 Section 395(1) of the Companies Act, 2013.
7 Ibid.
8 [2008] 86 SCL 47 (Bom).
9 (2009) 3 BomCR 57.
10 Sandvik Asia Limited v. Bharat Kumar Padamsi, (2009) 3 BomCR 57.
11 [1976] 1 WLR 123
12 IBA Corporate and M&A Committee 2014, Squeeze-Out Guide, United Kingdom. (2016).
13 IBA Corporate and M&A Committee 2014, Squeeze-Out Guide, United States of America (2016).
14 Christopher C. Nicholls, Lock-ups, Squeeze-outs, and Canadian Takeover Bid Law: A Curious Interplay of Public and Private Interests, MCGill Law Journal, 2006.
15 IBA Corporate and M&A Committee 2014, Squeeze-Out Guide, Australia (2016)

Proposed Changes to the Companies Act

The Companies Act, 2013 (“Companies Act”), while beneficial, has also been perceived as overzealous over regulation in part. With a view to facilitating the ease of doing business in India, addressing stringent compliance requirements, harmonising company law with other regulations, the Companies-Act-Amendment(“Bill”)was introduced in the Lok Sabha in March 2016 and is currently under review by the Parliamentary Committee on Finance. We present below, a brief summary of a few pertinent amendments proposed by the Bill.

Generic Objects Clause: The Bill proposes to dispense with the listing of specific objects in the Memorandum of Association and permits a universal objects clause i.e. “to engage in any lawful act, activity or business”. Only if the company prefers to restrict its activity or objects, will specific object(s) be required in the MOA. This is seen as a positive change in keeping with today’s fast changing business landscape.

CSR: Currently CSR compliance in the current year is required where the net worth, turnover or net profit exceed the thresholds in any financial year. The Bill clarifies that CSR compliance will be mandatory only where the thresholds are met in the immediately preceding financial year. Further, unlisted private companies only require two or more directors to constitute their CSR committee, and will not require an independent director. Unfortunately, the Bill also allows for certain sums to be excluded in the computation of ‘net profit’. This may be a cause for concern as it may significantly increase the actual amount to be spent on CSR activities.

Sweat Equity to be issued anytime: It is proposed to permit issuance of sweat any time post incorporation of a company without the earlier mandatory waiting period of one year post incorporation. Start-ups and small companies will find this a useful tool to acquire and retain senior talent.

AGM of Unlisted companies can be anywhere in India: Currently AGMs are to be held in the same city, town or village as the registered office of the company. The Bill proposes to permit unlisted companies to hold their AGM anywhere in India,if consented to by all members.

Shareholder meetings can be outside India: Extraordinary General Meetings (EGMs) are currently required to be held only within India. The Bill, proposes to permit EGMs of an Indian company which is a wholly owned subsidiary of a foreign company, to be held anywhere in the world. Unfortunately, AGMs of such companies still need to be held within India even where all the shareholders are outside India.

Voting through Postal Ballot and electronic voting: This amendment will enable items of business currently required under the law to be transacted only by postal ballot to also be transacted through electronic voting at general meetings.

Video Conference meetings:Currently, the Board may conduct meetings via video conference except on prohibited matters which require a physical meeting. The Bill now clarifies that if the minimum quorum is physically present, the remaining directors may attend via video conference even on these restricted matters.

If Shareholder numbers fall below minimum: The Bill proposes a six month period to cure any shortfall in the minimum number of shareholders (i.e. two for a Private Company and seven for a Public Company). Beyond such six month period, the remaining shareholders who were aware of such shortfall in minimum shareholders shall be severally liable to bear all the debts of the company contracted during such period.

Relief from Registration of Charges:Currently companies need to register all charges created on their assets or undertakings. The Bill proposes to grant relief by way of rules exempting certain charges from registration. It remains to be seen however, which charges will be exempted by the rules. The earlier companies act (1956) did not require the registration of pledges. Nomination and Remuneration Committees and Audit

Committees only for listed public companies: Currently all listed companies (even private companies with debt listing) are required to constitute N&R Committees and Audit Committees. The Bill proposes this only apply to listed public companies, not to private companies. Management remuneration exceeding 11%:It is proposed to delete the requirement for a public company to obtain central government approval prior to payment of management remuneration exceeding 11% of net profit.

Independent Director can have limited pecuniary interest in Company: The Companies Act currently prohibits an Independent Director having any pecuniary relationship with the company. The Bill proposes to permit an independent director to have a pecuniary interest in the Company of up to 10% of his total income, without being liable to disqualification as an independent director. Disqualified Director to vacate office in all other companies:The Bill proposes that any director of a company that has not filed its financial statements or annual returns for a continuous period of three financial years or failed to file its financial statement or annual returns, failed to repay deposits, redeem debentures or pay dividend etc., will immediately be disqualified from directorship in all other companies in which he is a director, other than the contravening company. This may act as a serious deterrent.

Deletion of restriction on investment through not more than two layers of investment companies: Post the amendment, companies will be able to invest through any number of layers of investment companies. Given that companies will need to maintain a beneficial ownership register as set out below, concerns about declaration of ultimate beneficial ownership stand addressed.

Register of Significant Beneficial Ownership: The Bill has created the concept of ‘significant beneficial ownership’ (i.e. alone or with others holds beneficial interest of 25% or more in the shares or significant influence or control). Persons holding /acquiring such significant beneficial interest are required to declare such interest/change to the company and the company is to maintain a register accordingly.

Changes on Related Party Transactions: Currently, companies are prohibited from entering into certain related party transactions except with a special resolution and members who are related parties are not permitted to vote on such resolutions. The Bill proposes to do away with the restriction on voting by relatives for companies in which 90% or more members, in number, are related parties.

Deletion of Forward Dealing and Insider Trading provisions: The prohibitions on Forward Dealing in Securities and Insider Trading are proposed to be deleted and will be inapplicable to private companies. Public / listed companies will need to comply with the relevant SEBI regulations in this regard.

No consolidation: The current requirement of consolidating accounts of joint ventures is proposed to be omitted.

Conclusion:The Parliamentary Committee continues to receive recommendations on the Bill and the question remains whether the above changes will in fact see the light of day as law. It is hoped that the Bill once passed, eases the conduct of business in India.

By Ms. Hufriz Wadia (Partner, Kochhar & Co.) with Mr. Sandeep Thomas (Intern) and Mr. Nikhil Gupta (Intern).”

Section 185 of the Companies Act and its impact on lending transactions

Section 185, effective from September 12, 2013 and Section 186, effective from April 1, 2014 are two provisions of the company act(“Act”) which have created much anxiety among the business community because of its direct impact on capability of the businesses to raise finance.

A bare reading of Section 185 of the Act, suggests that advancing of loans or giving of corporate guarantee or providing any security by any company (for the purposes of this article, the “Lending Company”) to a firm and/or body corporate with common management with such Lending Company is completely proscribed. Also prohibited are transactions where the Lending Company is advancing loans, providing security or guarantee to body corporate, the management of which is accustomed to act in accordance with the direction or instructions of the board of directors/or any director of such Lending Company. No guidance has been provided as to what constitutes “acting in accordance with the direction or instructions of the board of directors/or any director”. Furthermore, this provision has been made applicable both to the public and private companies and even the provision of undertaking such transactions with the approval of the Central Government (as under Section 295 of the Companies Act, 1956) has been omitted under the new Act.

The compliance of Section 185 of the Act has been ensured by putting in stringent punishments for contravention, the fine being as high as Rs.5,00,000 (Rupees Five Lakhs) extendible to Rs. 25,00,000 (Rupees Twenty Five Lakhs) for the Lending Company. The director or any other person to whom the loan is advanced or guarantee or security is given or provided in connection with any loan taken by him or the person shall be punishable with imprisonment which may extend to six (6) months along with a fine which shall not be less than Rs.5,00,000 (Rupees Five Lakhs) but may extend to Rs.25,00,000 (Rupees Twenty Five Lakhs) or both. The stakes being this high for both the Lending Company and the persons receiving such loan and/or the benefit of the guarantee/security, makes it very important to understand the nuances of this provision.

The following transactions are permitted under Section 185 of the Act:

  1. Any loan provided by a holding company to its wholly owned subsidiary company for its principle business activities.
  2. Any guarantee given or security provided by a holding company in respect of any loan for funding the principle business activities of its wholly owned subsidiary company;
  3. Any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company for its principle business activities;Even though ‘principal business activity’ has not been defined under the Act, generally the activities provided under the main objects of the memorandum of association should qualify as a principal business activity of that company.
  4. Any loan advanced or guarantee/security provided by a company, which in its ordinary course of business provides loans or gives guarantees or securities for repayment of any loan, provided that such loans shall not be provided at an interest rate less than the bank rate declared by the Reserve Bank of India. No loan may be given by the Lending Company at an interest rate lower than the prevailing yield of one year, three year, five year or ten year government security closest to the tenor of the loan.The phrase ‘ordinary course of business’ has also not been defined under the Act. This is because there can be no universal meaning ascribed to it. What is ordinary for one entity or one type of business or one sector or even one region may not be so for another. However, based on judicial precedents and keeping in view the intent and purpose of the provision, a transaction can be said to be in ‘ordinary course of business’, if:
  1. The Lending Company has in the past provided loans/guarantees/securities to such entities as a matter of routine.[1] The frequency of such transactions[2] and a certain amount of continuity is imperative as ‘business’ itself implies carrying on a particular trade or vocation as a ‘continuous’ activity by application of labour, skill and money to earn the income. [3] Also, important is that such transactions have been appropriately disclosed in the financial statements of the Lending Company for the past years.[4] The disclosure of such transactions in the financial statement indicate that such activities were being carried on normally in the usual course of business, specifically inclusion of the amounts involved as ‘business income’ gives further credence to the fact.
  2. The memorandum of association of the Lending Company allows for such transactions i.e. the providing of loans/guarantees/security to other entities should be part of atleast the incidental or ancillary objects of the memorandum of association. The Courts have not been uniform in their ruling with respect to the significance of the objects clause of the memorandum of association in making this assessment. The Courts also differ on whether an activity is in ‘ordinary course’ only if is part of the main objects or whether an activity ancillary to the main objects may also be considered so.[5]
  • The Lending Company has passed a board resolution, specifically, categorising the transaction as being in ‘ordinary course of business’. Also, the board should have examined the transaction from the perspective of Section 185 and should have resolved to undertake the same. The consent of all the directors present at the meeting should have been obtained in accordance with Section 186 (5) of the Act. Whether a transaction is in the ‘ordinary course of business’ is a question of fact and a board resolution is important in making this assessment.[6]


  1. The loan documents/security documents executed for the purpose of the loan/security/guarantee provided by the Lending Company should contain a clause stating that the transaction contemplated therein is in ‘ordinary course of business’.
  2. The transaction should be conducted at arms’ length basis and appropriate disclosures should be made with respect to the interest of any management of the Lending Company in the entity receiving the loan, guarantee or security. Ultimately the aim of Section 185 is to prohibit related party transactions where the Lending Company provides undue advantage or gain to any other entity related to the management of the Lending Company and to avoid conflict of interest scenarios for directors of such Lending Company.
  3. The Lending Company (not if it is a banking company or an insurance company or a housing finance company providing the loan/security/guarantee in ordinary course of business or company engaged in business of financing of companies or of providing infrastructural facilities[7]) should have complied/should comply with the following conditions under Section 186 of the Act:
  1. The loan or the guarantee/security to be provided should be within the limits prescribed under Section 186 of the Act i.e. it should not exceed the higher of 60% (sixty percent) of the paid up share capital, free reserves and securities premium account or 100% (one hundred percent) of its free reserves and securities premium account. Alternatively, if the giving of loan, security or guarantee is beyond the prescribed limits the Lending Company should have obtained special resolution of its shareholders in the general meeting.
  2. The Lending Company should disclose to its members in the financial statement the full particulars of the transaction, including the purpose for which the loan or guarantee or security is proposed to be utilised.
  3. The prior approval of each of the public financial institution from which the Lending Company has availed any term loan should be obtained in case: (1) the loan or the guarantee/security to be provided by the Lending Company is beyond the limits prescribed under Section 186 of the Act; and/or (2) the Lending Company has defaulted in repayment of loan instalments or payment of interest as per the terms and conditions of the term loan availed from the public financial institution.
  4. The Lending Company should not be in default of repayment of any deposits or payment of interest.
  5. The Lending Company shall have maintained a register in Form MBP 2 as per Companies (Meetings of Board and its Powers) Rules, 2014 and enter therein the particulars of loans and guarantees given, securities provided by it.
  1. The borrowing company shall have obtained requisite special resolutions under Section 180 (1)(a) and Section 180 (1)(c) of Act, if applicable.

Popular Views in the Market

One view in the market is that as Section 185 of the Act begins with ‘Save as otherwise provided in this Act’, it should be subject to Section 186 of the Act, implying that any transaction permitted under Section 186 should be permitted under Section 185 of the Act. However, this view makes the very existence of Section 185 redundant which could not have been the intent of the legislature. Such an interpretation of Section 185 should be avoided.

A popular method being used by financers/investors and creditors to comply with Section 185 is to make the Lending Company providing the security or guarantee a co-borrower to the lending transaction. This works well for some transactions but in other cases group companies are found reluctant to undertake such responsibilities.

Also, financers/investors/creditors have been seeking organisational restructuring of holding and subsidiary companies including eliminating common directors and other senior management to avoid falling within the purview of Section 185. For further comfort, certificates of non applicability of Section 185 from the company secretary or a director of the Lending Company is being insisted upon as pre-condition to such lending transactions.


One must look at Section 185 of the Act in the right spirit in which it was modified from its predecessor provision under the Companies Act, 1956. The objective was not to hinder business and financing of businesses but was to discourage related party lending transactions which bred favouritism and nepotism. Any transaction should be tested on the anvil of Section 185 of the Act while keeping this in mind.

Aastha Suman

[1] Dillip Kumar Swain v. Executive Officer, Cuttack  1997 I OLR 202

[2] Ibid

[3] A.R.Enterprises v. Assistant Commissioner of Income Tax [2007]14SOT13(Chennai), (2006)99TTJ(Chennai)85

[4] Poysha Oxygen (P) Limited v. Assistant Commissioner of Income Tax [2008] 19 SOT 711 (Delhi); Matrix Logistics Limited v. The Commissioner of Income Tax-II [2010] 22 ITD 228 (Ahd)

[5] Poysha Oxygen (P) Limited v. Assistant Commissioner of Income Tax [2008] 19 SOT 711 (Delhi); Commissioner of Income-Tax v. City Motor Service Limited 1966 61 ITR 418 Mad; Matrix Logistics Limited v. The Commissioner of Income Tax-II [2010] 22 ITD 228 (Ahd); A.R.Enterprises v. Assistant Commissioner of Income Tax [2007]14SOT13(Chennai), (2006)99TTJ(Chennai)85

[6] In Matrix Logistics Limited v. CIT (2010)122ITD 228 (Ahd)

[7]The expression “business of financing of companies” shall include with regard to a Non-Banking Financial Company registered with the Reserve Bank of India, the “business of giving of any loan to a person or providing any guaranty or security for due repayment of any loan availed by any person in the ordinary course of its business”.

A Critical essay on compounding of offenses under Companies Act, 2013


An ‘offence’ is defined as ‘any act or omission made punishable by any law for the time being in force’ under Section 3(38) of the General Clauses Act, 1897. Section 2(n) of Criminal Procedure Code 1973 (‘CrPC’) alsCompanies Acto defines ‘offence’ in the same way. A person guilty of committing an offence is liable to be prosecuted under the relevant provisions of law. Compounding of an offense in the context of law means an amicable settlement for the purpose of averting prosecution for an offense.

As per the Black’s Law Dictionary, to “Compound” means “to settle a matter by a money payment, in lieu of other liability.” This definition thoughtfully presents the concept of Compounding as a settlement mechanism that affords the offender an opportunity to avoid prosecution in exchange of him undertaking a liability that is pecuniary in character or otherwise. The landmark decision of the Calcutta High Court in Murray vs. The Queen-Empress lends the gist of this concept as one which “ signifies that the person against whom the offence has been committed has received some gratification, not necessarily of a pecuniary character, to act as an inducement of his desiring to abstain from a prosecution”.

The concept of compounding of offenses was incorporated as a measure to avoid the long drawn process of prosecution, which would save both cost and time in exchange of payment of a penalty to the aggrieved. In criminal law, the power to compound the offence is at the discretion of the victim. The perpetrator cannot demand for compounding of the offence. But in corporate law, compounding is at the discretion of the offender/offending company.

Through this Article, the Author endeavours to shed light on the scope and limitations of compounding under C-ompanies Act, 2013 in light of Section 24(1) of Companies Act, 2013 and the Supreme Court ruling in SEBI vs. Sahara India Real Estate Corporation Ltd. & Ors.


The meaning of word ‘Compounding’ is not defined under Companies Act, 2013 or in the erstwhile Companies Act, 1956. However its substance can be deciphered from a thorough reading of Section 441 under the Companies Act, 2013. In the context of the framework, compounding of an offence is a process by which a corporate entity may come forward suo-moto or on receipt of notice of default/initiation of prosecution by making an application before the Tribunal, admitting to the commission of the offense and praying for condonation of the same.

The compounding provision in the Act was inserted by the Companies Amendment Act, 1988 on the recommendation of the Sachar Committee. It was felt that leniency is required in the administration of the provisions of the Act particularly penalty provisions because a large number of defaults are of technical nature and arise out of ignorance on account of bewildering complexity of the provisions.

A careful reading of section 441, will unfold that all the offences under the Companies Act are compoundable save those offences which attract imprisonment as a mandatory part of the prescribed punishment. In other words, only the following offences that can be compounded under the Companies Act, 2013:
1. Offences punishable with fine only;
2. Offences punishable with fine or imprisonment;
3. Offences punishable with fine or imprisonment or both.

As per the said provision, the Central Government and the Tribunal shall be responsible for compounding of the offenses under the Act, based on their respective pecuniary jurisdiction prescribed under the same. Where the offence to be compounded is punishable with a fine not exceeding Rs.5,00,000/-, it shall be compounded by the Regional Director or any other officer authorised by the Central Government. The Tribunal shall compound all those offences under the Act where the fine imposed exceeds Rs.5,00,000. Furthermore, in case the offence committed by a corporation or its officer has been compounded earlier, such a corporate entity shall not be eligible for compounding of a similar offence for a period of 3 years from the date of compounding the first offence.


Since the nature compounding of an offense involves a trade-off between admission of guilt and absolution of guilt for the offender, it invites a lot of repercussions. This Author believes a sentient effort has been taken to draft Section 441 of the Act with reasonable circumspection of such repercussion by laying down sensible limitations on the exercise of the power to Compound. However, every piece of legislation has its limitation and fallibility and this Section is no exception.

A plain reading of the section gives us a crystallized understanding that the jurisdiction to compound any offense under the Companies Act lies with the Tribunal/Central Government as the case maybe. The words of the section denote a mandatory obligation on the part of the Tribunal/Central Government to compound any offense punishable under this Act. Also, this Section provides no parameters to determine if the offender has come before the Tribunal/Central Government with clean hands and bona fide intentions. It predicts a very black and white state of events that will surround the process compounding under the Act. As a result, it removes any scope of discretion at the hands of the Tribunal/Central Government to determine whether the offender merits such a compounding of the offenses that were committed.

Given that the object with which the compounding provision was inserted in the Companies Act is to avoid cumbersome litigation on technical grounds, it is surprising that the section allows all offences under the Companies Act, save those that attract mandatory imprisonment, to be compounded. Without any strictures laid down in the provision to gauge which of the offences were an act of inadvertence and which ones were not, the concept of compounding runs the risk of being abused by the wrongdoers.

One other grey area of compounding under the Company Law is the limitation in its application in respect of the provisions relating to transfer and issue securities under chapter III and IV of the Companies Act, 2013. For the purpose of illuminating these inconsistencies within the provision, it is vital to bring to attention Section 24 (1) in chapter IV of the Companies act, 2013 which is produced below verbatim :

24. (1) The provisions contained in this Chapter, Chapter IV and in section 127 shall,—
(a) in so far as they relate to —
(i) issue and transfer of securities; and
(ii) non-payment of dividend,
by listed companies or those companies which intend to get their securities listed on any recognized stock exchange in India, except as provided under this Act, be administered by the Securities and Exchange Board by making regulations in this behalf;
(b) in any other case, be administered by the Central Government

The above-mentioned section articulates that the jurisdiction insofar as matters relating to transfer and issue securities in Chapter III and IV of the Act with respect to listed companies and companies with the intention to list itself in a recognized stock exchange, lies with the Securities and Exchange Board of India (SEBI).

Owing to notorious OFCD racket of Sahara, the Supreme Court found it necessary to interpret the meaning of “those companies which intend to get their securities listed” found in Section 24(1) of the Companies Act, 2013 or the erstwhile section 55A of the Companies Act, 1956 to include unlisted companies in certain circumstances. It was held that “Section 55A can never be constructed or interpreted to mean that SEBI has no power in relation to the prospectus and the issue of securities by an unlisted public company, if the securities are offered to more than forty nine persons” .

This clarification on the intention and meaning of Section 24(1) by the Supreme Court has led to further uncertainty in the application of compounding to the provisions relating to transfer and issue securities contained within chapter III and IV of the Companies Act.

In view of the above-mentioned judgment, a conundrum would now present itself when a compounding application under Section 441 is made by an unlisted company to compound an offence under Chapter III or IV of the Act in relation to the issue of securities to more than 49 persons, as the jurisdiction in such a matter would fall within the purview of SEBI’s governance considering section 24(1), but at the same time, it would also be within the jurisdiction of the Tribunal/Central Government in light of Section 441.

What further complicates the issue is that both pieces of legislation viz., SEBI Act and Companies Act, have provisions for compounding offences under its respective legislations. As a result, there is severe ambiguity as to who between the Central Government and SEBI has the jurisdiction in respect of the compounding of offenses committed under the provisions of Chapter III and IV of the Act.

When the legislation does not adequately address a particular issue or is ambiguous in its nature, the judiciary takes it upon itself to rectify the deficiencies by astute and sagacious interpretations of the law keeping in mind the legislative intent. However, a definitive solution to the above-mentioned predicament is yet to be arrived at as there have not been many precedents set to make clear the issues cited above by this author.

When the jurisdiction in matters relating to issue and transfer of securities under Chapter III and IV of the Companies Act 2013 by an unlisted company falls within the ambit of SEBI’s governance, compounding it under Companies Act will defeat the purpose of section 24(1). Therefore the offences under Chapter III and IV relating to issue and transfer of securities must be compounded under Section 24A of the SEBI Act, 1992.

It was further held by the Supreme Court in the SEBI vs. Sahara India Real Estate Corporation Ltd. & Ors. that:
“From a collective perusal of sections 11, 11A, 11B and 11C of the SEBI Act, the conclusions drawn by the SAT, that on the subject of regulating the securities market and protecting interest of investors in securities, the SEBI Act is a standalone enactment, and the SEBI’s powers there under are not fettered by any other law including the Companies Act, is fully justified. In fact the aforesaid justification was rendered absolute, by the addition of section 55A in the Companies Act, whereby, administrative authority on the subjects relating to “issue and transfer of securities and non payment of dividend” which was earlier vested in the Central Government (Tribunal or Registrar of Companies) came to be exclusively transferred to the SEBI.”

The above-mentioned judgment makes amply clear that in the matters of regulating the securities market, SEBI’s jurisdiction will override all other laws including Companies Act, 2013. Hence, the Compounding provision under Section 441 will have no application in matters that shall fall within the ambit of SEBI in light of Section 24(1) of Companies Act, 2013.

This judgment brings the much needed clarity on the question of which authority has the jurisdiction in respect of the offences relating to issue and transfer of securities under Chapter III and IV of the Companies Act. However, it is not specific to the issue of compounding. Therefore, it would also be reasonable to interpret that the power of SEBI under Section 24(1) and the Central Government’s power to compound offenses under section 441 of the Companies Act, are parallel in nature and are independent of one another. This would mean that the compounding of the offences under Companies Act by the Central Government would not affect the proceedings under the SEBI Act.
This view was upheld by SEBI in Vibgyor Allied Infrastructure Ltd matter wherein it was held that:
“In this regard, I note that under section 621A of the Companies Act, the Central Government can compound any offence punishable with imprisonment only, or with imprisonment and also with fine under the Companies Act either before or after the institution of any prosecution. Such compounding bars only institution of prosecution for the offence under the Companies Act which has been compounded. Such compounding does not apply with regard to an offence under the SEBI Act and the regulations and it does not bar or preclude the civil proceedings under the Companies Act or the SEBI Act or the regulations made there under.

Conversely, this judgment does not address how SEBI can independently compound the offences committed by an unlisted company under the relevant SEBI regulations as a consequence of making a public offer under the Companies Act. Since the definition of what constitutes a ‘public offer’ is only found under Companies Act, the compounding of violations committed under the relevant SEBI regulations is dependent upon not compounding the offense of public offer and other related offenses under Companies Act. If at all the offense of public offer and other related offenses under the Companies Act are compounded under Section 441, it would lead to the offender’s acquittal from all the other contravention under the relevant SEBI regulations by way of concomitancy along with the offense committed under Companies Act.

These ambiguities in the compounding provision are likely to lead to an increase in litigation, challenging SEBI’s powers to initiate prosecution against the offenders in these circumstances. The issue is also likely to increase the friction between SEBI and the Department of Company Affairs. The Central Government needs to bring clarity in the compounding provision in this respect so that it benefits all concerned.