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Substantial Issues in Defining “Substantially the Whole of the Undertaking”

Section 180(1)(a) of the Companies Act 2013 (“2013 Act”) requires a company to obtain prior approval by a special resolution to sell, lease or dispose of the whole or substantially the whole of the undertaking of the company or, when the company owns more than one undertaking, of the whole or substantially the whole of any of such  undertakings.

Recent amendments to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”), have introduced a ‘majority-of-minority’ approval requirement for alienation of undertakings by listed companies. This change has necessitated a renewed focus and understanding of thresholds and constructs prescribed under Section 180(1)(a) of the 2013 Act.

This blog delves into some of the less explored aspects of Section 180(1)(a), including the meaning of the expression “substantially the whole of the undertaking”.

Meaning of an “undertaking”

Section 293(1)(a) of the erstwhile Companies Act, 1956 (“1956 Act”), (which corresponds to Section 180(1)(a) of the 2013 Act)[1] neither defined the term “undertaking” nor prescribed any quantitative thresholds to determine what constitutes an undertaking.

The 2013 Act attempted to remove the ambiguity by specifying quantitative qualifiers, and accordingly defined an “undertaking” under Explanation (i) of Section 180(1)(a) to mean (a) an undertaking in which the investment of the company exceeds 20% of its net worth as per the audited balance sheet of the preceding financial year (FY);[2] or (b) an undertaking which generates 20% of the company’s total income duri ng the previous FY.[3]

Interestingly, while the 2013 Act prescribes the above quantitative thresholds, such thresholds are preceded by the expression “an undertaking in which…”, which still requires a qualitative analysis of what constitutes an undertaking before identifying if the quantitative tests bring such undertaking within the purview of Section 180(1)(a).

In the absence of any qualitative definition of “undertaking” under the 2013 Act or the 1956 Act, one needs to rely on case laws for determining the same (most of which are in respect of the 1956 Act).

In the landmark judgment of P.S. Offshore Inter Land Services Pvt. Ltd. v Bombay Offshore Suppliers & Services Ltd.,the Bombay High Court prescribed the following test for defining an “undertaking”, “If the question arises as to whether the major capital assets of the company constitute the undertaking of the company while examining the authority of the board to dispose of the same without the authority of the general body, the test to be applied would be to see whether the business of the company could be carried on effectively even after disposal of the assets in question or whether the mere husk of the undertaking would remain after the disposal of the assets? The test to be applied would be to see whether the capital assets to be disposed of constitute substantially the bulk of the assets so as to constitute the integral part of the undertaking itself in the practical sense of the term.” [4]

This principle aligns with the 11-judge bench judgement passed by the Supreme Court in R. C. Cooper v. Union of India, whereunderJustice AN Ray observed that the expression “undertaking” is a “going concern” and stated that “The undertaking is an amalgam of all ingredients of property and is not capable of being dismembered. That would destroy the essence and innate character of the undertaking. [5]

In Yellamma Cotton, Woollen and Silk Mills Co. Ltd. v Official Liquidator, the Mysore High Court distinguished an undertaking from the assets or properties belonging to the company and noted that an undertaking is analogous to business or commercial activity engaged in with a view to earn profit. Movable or immovable properties were described as tools of business or undertaking, which are used to keep the undertaking going or to assist the carrying on of the activities, leading to the earning of profit. [6] This judgment, passed by a single judge, was also approved by a Division Bench of the same High Court in International Cotton Corporation P. Ltd. v Bank of Maharashtra.[7]

Further, meaning of the term “undertaking” has also been explored in the context of definitions provided under the Income Tax Act, 1961, to determine whether sale of such undertaking constitutes a “slump sale”.[8]

Meaning of “substantially the whole of the undertaking”

Under Explanation (ii) of Section 180(1)(a), the expression “substantially the whole of the undertaking” has been defined to mean – in any FY, 20% or more of the value of the undertaking, as per the audited balance sheet of the preceding FY.   

Although judicial analysis over the years has shed light on the meaning of “undertaking”, the interpretation of “substantially the whole of the undertaking” has remained largely unexplored.

Basis the abovementioned case laws, while it can be reasonably argued that assets or properties in isolation would not constitute an undertaking, a key question that remains unanswered is whether such assets or properties can still fall within the ambit of Section 180(1)(a) of the 2013 Act by constituting “substantially the whole of the undertaking” if they meet the quantitative thresholds prescribed for the same under Explanation (ii) to Section 180(1)(a).

Relevant company law reports, including the Bhabha Committee Report (1952), which led to the introduction of the 1956 Act; the Irani Committee Report (2005), which led to the introduction of the 2013 Act; and the Company Law Committee Reports (2016, 2019 and 2022), provide no insight into the intended interpretation of “substantially the whole of the undertaking”. However, it is worth noting that the Irani Committee Report[9] had suggested that “whole or substantially whole” should mean “20% of the total assets of the company”, which is different from the definition that has been introduced under the 2013 Act.

The definition of “substantially the whole of the undertaking” entails various inherent challenges, such as:

  • The term “value”, as used under Explanation (ii), is not defined under the 2013 Act, which only refers to value as determined as per the audited financial statements of the previous FY. Notably, even the terms “investment” and “income”, used for quantitative determination of “undertaking” under Explanation (i), are not defined under the 2013 Act. In the absence of such definitions, there is ambiguity related to how such numerical thresholds should be calculated if a company does not have segmented reporting in its financial statements for multiple undertakings and thus the numbers required for the above calculations under Section 180(1)(a) may not be available.
  • Absence of more nuanced guidance on the interpretation and definition of the terms used in under Explanation (i) and (ii), can lead to an anomalous situation wherein the transfer of a smaller, less significant segment of the business undertaking may trigger more stringent approval requirements than a transfer involving a much larger, integral segment of the business undertaking, in particular, and also of the company, in general.

For example, consider a company with two undertakings, A (which contributes 75% of the total income of the company) and B (which contributes 25% of the total income of the company).

For the purposes of this analysis, assuming that the value of the undertakings is directly proportionate to the income generated by them, transfer of 20% of the value of B, would require shareholders’ approval even while constituting only 5% of the total income of the company.  

In contrast, a transfer of just under 20% of the value of A, would not necessitate such approval despite contributing much more to the total income of the company as compared to undertaking B.

  • In case a company has an unused property, which does not generate any income; will the transfer of such property require prior shareholder approval if its value exceeds 20% of the value of the sole undertaking of the company? It can be argued that while the property itself is valuable, it should not form part of an “undertaking” and therefore cannot form a part of “substantially the whole of the undertaking”. But such a literal interpretation would mean that such significant value erosion of the company can happen without shareholder approval.  
  • Lastly, since Section 180(1)(a) refers to both the defined term undertaking, i.e., an undertaking which meets the prescribed quantitative thresholds, and the undefined term undertaking, i.e. an undertaking whose meaning is derived basis case laws, it is important to determine which “undertaking” Explanation (ii) refers to for defining “substantially the whole of the undertaking”.

If Explanation (ii) refers to the undefined term “undertaking”, then for a company with multiple undertakings, 20% of the value of such undertaking, which would otherwise not meet the quantitative thresholds under Explanation (i) to Section 180(1)(a), may still require shareholder approval. It is likely that the intent may not have been to expand the meaning of Explanation (ii) beyond Explanation (i), however, some ambiguity remains.

Concluding Remarks

The above discussed gaps in the interpretation of expressions “undertaking” and “substantially the whole of the undertaking” as used under Section 180(1)(a) of the 2013 Act, highlight the need for a more comprehensive understanding of the legal framework governing such significant corporate actions. Considering that SEBI has now linked the stringent requirement of obtaining approval of minority shareholders to the requirements under Section 180(1)(a), interpretation of this provision will become crucial for many listed companies. 

To protect the interests of shareholders without impeding upon the commercial activity of companies, legislators must consider issuing further clarifications for the definitions/ expressions under Section 180(1)(a), to remove any/ all ambiguities. It would be beneficial for public companies if the ambiguities highlighted above in the potential interpretations of the provision are demystified by the regulators as they consider shaping the next round of amendments to the 2013 Act.

[1] Section 293 of the 1956 Act provided that the alienation of the whole or substantially the whole of the undertaking of a public company or subsidiary of a public company cannot be done without the approval of a general meeting.

[2] Section 2(57) of the 2013 Act defines ‘net worth’ as “the aggregate value of the paid-up share capital and all reserves created out of the profits, securities premium account and debit or credit balance of profit and loss account, after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off, as per the audited balance sheet, but does not include reserves created out of revaluation of assets, write-back of depreciation and amalgamation.”

[3] Vide Ministry of Corporate Affairs notification dated June 5, 2015, Section 180 of the 2013 Act does not apply to private companies.

[4] (1994) 2 CompLJ 407 (Bom), see paragraph 23

[5] (1970) 1 SCC 248, see paragraph 183, 184, 185. Note that while Justice A.N. Ray has given a dissenting judgment, the judgment is not dissenting on the meaning of the term “undertaking”.

[6] (1970) 40 Comp Cas 466b (Kar), see paragraph 56, 61

[7] (1971) 41 Comp Cas 226 (Kar), see paragraph 7, 9

[8] Explanation 1 to Section 2(19AA) of the IT Act defines “undertaking” for the purpose of inter alia a slump sale as “any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity”. Additionally, Section 2(42C) of the IT Act defines a “slump sale” as “the transfer of one or more undertaking, by any means, for a lump sum consideration without values being assigned to the individual assets and liabilities in such transfer.”

[9] Report of the Expert Committee on Company Law, chaired by Dr. Jamshed J. Irani, May 31, 2005, at Paragraph 28 of the said report.