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Inter-corporate Loans and
Sections 370 and 372 of
the Companies Act, 1956
relating to inter-corporate
loans and investments
had been replaced by
comprehensive Section
372A by the Companies
(Amendment) Act, 1999.
The scope and
applicability of the new
section and its modalities
have been explained here.
* Past President, The ICSI
Investments : An Appraisal
D. K. Prahlada Rao*, FCS, Advocate, Bangalore.
INTRODUCTION
One of the most important and much sought after provisions in the Companies Act,1956 (The
Act) relates to inter-corporate loans and Investments. This provision by providing a legal
framework for inter-corporate loans and investments has facilitated tremendous growth and
development of the Indian corporate sector, both in India and abroad and within and outside the
corporate groups. This is not to be construed as a mere legal framework but a potent weapon in
the hands of Industrialists and entrepreneurs to acquire, expand and consolidate their control
over other corporate organizations. Inter-corporate loans come in handy to help group companies
to tide over their financial problems at least temporarily and for deployment of surplus funds of
a company in a productive manner, investment is a potent weapon to acquire ownership or
management control of other companies. As the funds flow out of the company in the form of
loans and investment the shareholders should have a final word for exceeding the prescribed
monetary limit. In keeping with this principle, section 372A now reflects the changed profile of
regulations governing inter-corporate loans and investments. Needless to say, these corporate
actions build up business relationships between corporate organizations.
Till about October 1998, inter-corporate loans and investments were regulated by sections 370
and 372 of the Act separately with certain internal checks and balances built into the sections.
These provisions became inoperative with the introduction of section 372A.
The Companies (Amendment) Act,1999 brought about a radical change in bringing into
existence a combined provision in section 372A of the Act, effective from 31.10.1998. Section
372A has been enacted following the recommendation of the Working Group constituted by
the Govt. of India which opined that all over the developed world, corporate growth has been
predicated upon flow of funds from one company to another. Cash rich firms have invariably
used their free reserves to lend or to invest in other companies. The Govt. accepted the
recommendation of the Working Group. The new provision reflects the self operating
mechanism built into section 372A without Govt. intervention at any stage.
FOCUS OF SECTION 372A
The new provisions in section 372A provide for a combined limit of sixty percent of the paid
up share capital and free reserves (which term includes reserves free for distribution as dividend
including the amount in the securities premium account) or one hundred percent of free
reserves whichever is higher, for grant of loan (which term includes debentures) to any other
body corporate, giving of any guarantee or provision of security in respect of a loan to or by
any body corporate and acquisition of securities (which term includes shares, debentures,
bonds and other marketable securities, etc.) of any other body corporate by way of subscription,
purchase or otherwise. These powers are given to the board of a company by the statute .The
scope of section 372A is much larger than the erstwhile section 372. Needless to say that there
must a basic provision in the memorandum/articles of a company authorizing the board to
make inter-corporate loans and investments.
The aforesaid limit can be exceeded by the board by a previously authorized special resolution
of the shareholders of a company. The notice proposing such a resolution should indicate clearly
the specific limits, the particulars of body corporate in which investment is proposed to be made
or loan or security or guarantee to be given and the purposes thereof and the sources of funding.
However, in exceptional circumstances, the board may provide guarantee without the previous
authorization of shareholders, if the board passes a resolution in a meeting which prevent the
company from obtaining previous authorization for giving such guarantee. This is subject to the
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board obtaining confirmation in a general or AGM held after the
boards’ resolution aforesaid whichever is earlier. Needless to say
that this relaxation is applicable only to providing guarantee and
not for any other purposes like grant of loan or investment.
BUILT-IN CHECKS AND BALANCES
There are a number checks and balances built into section 372A
of the Act. They are : -
(a) No loan, provision of guarantee or security or investment
can be made unless the resolution sanctioning the same is
passed at a meeting of the board with the consent of all the
directors present at the meeting and with the prior approval
of the public financial institution where any term loan is
subsisting. However, prior approval of the financial
institution is not required, if the aggregate of the investments
made, loan granted, guarantees given or security provided
together with the proposals in this regard does not exceed
sixty percent of the limit referred to above, provided there is
no default in repayment of loan or interest thereon.
The consent of all the directors present at the meeting as
aforesaid is a unique provision in the Act as all other
decisions of the board are taken by simple majority or by
consensus. This means that the board cannot make any
investment, grant loan or provide guarantee or security
even if one director present at the meeting does not consent
to the proposal. This is presumably for the reason that there
is out flow of funds from the company or the company may
incur certain liability and such an action deserves the
unanimous consent of all the directors present at the
meeting. There is one other provision in the Act in section
386 which requires unanimous consent of all directors
present at the meeting for the purpose of appointing a person
as manager of a company who is already a manager or
managing director of another company.
Section 386 is a bit more rigorous as it requires specific
notice of the resolution to be moved at the Board meeting
to be given to all the directors in India. A similar provision
was there in section 372(5) of the Act but the same has not
been enacted as part of section 372A.
(aa) Under the erstwhile provision of section 372 the investment
limit was applied to the company along with its subsidiaries.
This is not the provision in section 372A.This means both
holding and subsidiary companies can independently
operate section 372A.
(b) No loan can be given to any body corporate at a rate of
interest lower than the prevailing bank rate, being the
standard rate made public under section 49 of the Reserve
Bank of India Act, 1934. This is a new provision when
compared to the erstwhile provision in section 370 of the
Act. The need for such a provision is clear in the context of
a specific provision in the Companies (Auditors’ Report)
Order, 2003 which requires an auditor to state in his report,
inter alia, whether the rate of interest and other terms and
conditions of loans given or taken by the company are prima
facie prejudicial to the interest of the company.
(c) If a company has defaulted in the matter of public deposits
under section 58A of the Act, such a company is prohibited
Inter-corporate Loans and Investments : An Appraisal
from availing of the provision in section 372A of the Act.
This is a temporary restriction, as the prohibition does not
apply when the default under section 58A is made good.
COMPARISON OF SECTION 372A WITH
SECTIONS 370 AND 372
The changes introduced by section 372A can be better understood
by comparing section 372A with the erstwhile provisions of
sections 370 and 372 of the Act. They are ;
(a) Under section 370 no loan could be given to a body corporate
in the same management except with the previous
authorization of shareholders by a special resolution.
However, no such approval was needed for grant of loan to
other bodies corporate not under the same management.
The financial limit in both cases is thirty percent of the
aggregate of the subscribed capital of the lending company
and its free reserves. The limit under section 372A is a
combined limit as already discussed and there is no such
distinction as aforesaid.
(b) There could be separate limit for providing guarantees, as
the provisos to section 370(1) refers to loan only, read with
Explanation 2 thereunder.
(c) Approval of the Central Govt. was needed for exceeding
the aforesaid limit.
(d) There are certain exceptions which are comparable to the
exceptions envisioned under section 372A.
(e) As regards investments are concerned, the financial limit
under section 372 is thirty percent of the subscribed equity
capital or the aggregate of the paid up equity capital and
preference capital of such other body corporate, (i.e., investee
company) whichever is less. However the aggregate of all
investments made, both in the group and outside the group,
could not exceed thirty percent of the subscribed capital and
free reserves of the investing company.
(f) The investing company may at any time invest in the right
shares offered to it under section 81(1)(a) of the Act irrespective
of the aforesaid percentages. However, while making further
investments other than rights shares, all existing investments,
including investment in right shares shall be included for
calculating the percentage limits. This is not required under
section 372A,as rights issue is wholly exempt.
(g) No investment could be made in excess of the aforesaid
limits except with the sanction of the shareholders and unless
previously approved by the Central Govt. under section
372. However, under section 372A while approval of the
Central Govt. has been dispensed with, approval of
shareholders for exceeding the financial limit is retained
with the addition of approval of the financial institution(in
case borrowing),when the proposal involves exceeding the
limit of 60% or 100% as the case may be and further there is
no default in repayment of loan.
SCHEDULE VI REQUIREMENT
Schedule VI to the Companies Act requires disclosure of
information regarding investments and loans in the Balance sheet
in the manner following : -
(a) nature of investment together with the basis of valuation,
 Inter-corporate Loans and Investments : An Appraisal
i.e., cost or market value of investments and distinguishing
between investment in Government securities, shares,
debentures or bonds, and showing separately fully paid or
partly paid securities and distinguishing different classes
of shares, etc.
(b) aggregate amount of company’s quoted investments and
unquoted investments are also to be given. Quoted
investments relate to the securities quoted on a stock exchange.
(c) A statement of investments, whether shown under
investment or under current assets as stock-in-trade,
classifying separately trade investments and other
investments should be annexed to the Balance sheet and
showing the names of bodies corporate (indicating bodies
corporate in the same management) in whose shares or
debentures investment has been made.
(d) In the case of an investment company, that is to say, a company
whose principal business is the acquisition of shares, stock,
debentures or other securities, it shall be sufficient if the
statement shows only the investments existing on the date as
at which the balance sheet has been made.
(e) In the case of investment in the capital of partnership firms,
the names of the firm with the names of all the partners,
total capital and the shares of each partner shall be given in
the statement.
(f) In the case of loans and advances, advances and loans to
subsidiaries and loans to partnership firms in which the
company or any of its subsidiaries is a partner are to be
given separately.
(g) The board is also required to state whether in its opinion
any of the current assets, loans and advances have a value
on realization in the ordinary course of business at least
equal to the amount at which they are stated and, the fact
that the board is of that opinion should be stated.
(h) As regards loans and advances, the amounts due from other
companies under the same management within the meaning
of section 370(1B) of the Act ,the maximum amount due
from every one of them at any point of time during the year
must be shown.
REPORTING REQUIREMENT BY THE
STATUTORY AUDITOR
The Auditor is required to enquire in compliance of section 227
of the Act, whether the company is not an investment company
within the meaning of section 372 (now section 372A) or a banking
company, whether so much of the assets of the company as consist
of shares, debentures and other securities have been sold at a
price less than that at which they were purchased by the company
and whether loans and advances made by the company have
been shown as deposits.
In compliance of Companies (Auditor’s) Report (Amendment)
Order, 2004, the Auditor is required to state in his report whether
the company has either granted or taken any loans, secured or
unsecured to from companies, firms or other parties covered in
the register maintained under section 301 of the Act. If so he has
to mention the number of the parties and the amount involved
in such transactions. The Auditor is also required to state whether
payment of the principal amount and interest are also regular.
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INVESTMENT OF SURPLUS FUNDS
Section 292(1)(d) and (e) provides for boards’ power to invest the
funds of the company and the power to make loans. Prima facie,
this provision seems to conflict with the provisions of section
372A, as it also provides for investment of funds of the company
and grant of loans. However, a closer examination reveals that
section 292 is a general provision, whereas section 372A is an
exclusive provision applicable only for inter-corporate loans and
investments. There is, therefore, no conflict between the two
provisions discussed above.
Schedule VI also requires classification of investments as trade
and non-trade investments. Needless to say that trade investments
are those relating to the business of the company in which it is
engaged. Such an investment may be in upstream or downstream
industries. These investments are intended to secure for the
company the benefit of lower prices in the matter of procuring
raw materials and components which are needed for the
manufacturing activity and such an arrangement provides the
much needed support to the company to remain competitive in
the market and secure an edge over the competitors. This may
take the form of investment in subsidiaries, both in India and
outside India and group companies which manufacture and
supply inter plant deliveries in the form of intermediate product
or final product as the case may be.
The explanation to section 372A defines loan as including
debentures or any deposit of money made by one company with
another company ,not being a banking company. While deposit
regulations describe inter company loans as not deposits, such
loans have to be reckoned within the over-all limit envisioned
in section 372A of the Act.
GUIDING PRINCIPLES FOR APPROVAL OF
INVESTMENTS
Under section 372, Govt. approval was required for making
investment in excess of the threshold limit. For granting such
approvals, the Govt. had formulated certain guiding principles.
They are :
(a) although industrial and trading companies are not
investment companies and it is not their primary business
to give financial accommodation to or make investments
in the shares and debentures of other companies, they may
be allowed to make trade investments in other companies,
viz., investments which are likely to create conditions
conducive to the interest of the investing company as well
as to the other companies more economic working and
betterment of production. An example in point would be
an investment by a sugar company in a company which
produces sugarcane supplying to the sugar company ;
(b) a company may be allowed to make investment only if it
has adequate liquid resources for making the investment
and the depletion of the working capital which would result
from the blocking up of funds of the company in the form
of investments would not adversely affect the company’s
own working.
(c) a company that has borrowed, for its own requirements or
intends to finance its investments by borrowing should not
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be permitted to make the investments, except in the case of
trade investments if the terms of borrowing are
commensurate with the return expected both directly in terms
of dividend and indirectly through creation of conditions
conducive to the interests of the investing company.
(d) inter-company investments should not be permitted where
there is a reasonable suspicion that they are prompted by a
desire to gain control over the management of companies
or are for speculative or for other mala fide purposes, unless
such investment will result in subsidiary relationship.
(e) whether having regard to the considerations set out below,
the proposed investment may be regarded as sound ;
(i) the company in which the investment is proposed to
be made should be in a sound financial position and in
particular, the depreciation provisions made should
be adequate ;
(ii) the financial structure of the company in which
investment is proposed to be made, after taking into
account the proposed investment, should be a balanced
one as otherwise idle capital or heavy interest charges
would act as an economic drag in the working of the
company.
(iii) the company in which investment proposed to be made
should have earned profits and declared dividends in
the past or should at least clearly be capable of making
profit and declaring dividends within a reasonable
period of time.
(iv) the purchase price should be reasonable and neither
too high nor too low, taking into account the net worth,
prevailing market prices and future expectations of
profitability.
(v) the proposed investment should provide an expected
return on capital at least equal to the return on gilt
edged securities ; and
(vi) except in the case of trade investments, the shares or
debentures proposed to be acquired should preferably
be readily marketable.
Section 372A(7) of the Act enables for the Central Government to
issue guidelines for the purpose of inter-corporate loans and
investments. No such guidelines have been issued so far.
However as and when the guiding principles are issued, some of
the guidelines discussed above will find a place.
INVESTMENT IN JOINT VENTURES AND
WHOLLY OWNED SUBSIDIARIES
Under FEMA resident corporates are allowed to invest overseas
upto 100% of their net worth in an overseas joint venture(JV) or
wholly owned subsidiaries. The acquisition of foreign equity
may be financed, under the refinance scheme of Export Import
Bank of India, and the banks may sanction term loan on merits to
eligible Indian companies for acquisition of equity in overseas
JVs and wholly owned subsidiaries., as strategic investment.
Section 372A is not an hindrance for making such investments, as
it has no application to wholly owned subsidiary by an Indian
holding company. Even where there is no adequate limit with
reference to sub-section (1) of section 372A,approval of
shareholders by special resolution may be obtained.
Inter-corporate Loans and Investments : An Appraisal
SEBI (SUBSTANTIAL ACQUISITION OF
SHARES AND TAKEOVERS) REGULATIONS
Listed Indian companies have additional reporting requirements
in terms of aforesaid regulations. Certain acquisition of shares
or voting rights like allotment of shares in a public offer, rights
issue, allotment to underwriters, inter se transfers within the
group, acquisition by way of transmission etc., are exempt from
the requirement of the above regulations. However, other
secondary market acquisitions which entitles the acquirer to more
than 5% or 10% or 14% or 54% or 74% shares or voting rights
require disclosure to the target company and to the stock
exchanges where the acquired securities are listed. However,
acquisition of shares which entitles the acquirer 15% or more of
the voting rights in a listed company calls for such acquirer
making a public announcement to acquire shares of such company
in accordance with the regulations.
EXCEPTIONS
The regulatory provisions of section 372A are not applicable in
the following cases : -
(a) to any loan made, any guarantee given or any security
provided or any investment made by a banking or
insurance company or a housing finance company in the
ordinary course of their business or to a company
established with the object of financing industrial
enterprises or of providing infrastructural facilities ;
(b) to a company whose principal business is the acquisition
of shares, stock, debentures or other securities ;
(c) to a private company unless it is a subsidiary of a public
company ;
(d) to any investment made in rights issue ;
(e) to any loan made, any guarantee given or security provided
to or acquisition of shares by a holding company in its
wholly owned subsidiary.
CONCLUSION
Corporate actions envisaged in section 372A can be invoked
only by profit making companies as these actions result in out
flow of funds from the company. This provision is meant for
companies which can spare funds for investment outside its
business. In these days of globalisation of business and
tremendous business opportunities open world wide,
companies cannot remain isolated. In the final analysis it is a
balancing act which every company has to decide to understand
what it serves best. In reality companies have invoked this
provision in expanding business empire and acquiring new
companies. The provision regarding grant of loans has been
effectively used to support group companies. While there is
nothing wrong in this approach, the productivity of capital
invested and the return on investment holds the key to future
growth and development. It is worthwhile undertaking
corporate research into the pattern of investment by the
corporate organizations and whether the chosen investments
by the corporates have or have not resulted in promoting
competition in the market place. ‰