Associate-adding objectivity in relationship of companies.
The 2G scam has created the substance for a proper definition of term ?associate? that has been widely under discussion for a long time now, for establishment of inter-corporate group relationships. The issue come up to limelight when the relation of Loop and Swan with Essar and Reliance Communication respectively have been inquired in the wake of the controversy over crossholding shares in telecom companies. While the Companies Act do not prescribe for any definition of the term ?associate? the relationship between entities, till date, may be established either by way of establishment of holding-subsidiary relationship or defining companies under same management. Due to lack of objectivity in such definition which does not at all take into account factors such as that control, funding and inter-company transactions before defining relationship amongst entities, the definition has faced serious abuse in the recent past. The new law now intends to curb all the shortcomings of previous definition and provide a more rational and objective- framework of associate relationship.
DEFINITION UNDER NEW LAW
Under the new law the term associate company has been defined which provides that an associate company ?in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.
Explanation.?For the purposes of this clause, ?significant influence? means control of at least twenty per cent. of total share capital, or of business decisions under an agreement;
RATIONALE BEHIND NEW LAW
Adding objectivity in establishment of relationship
While the former Companies Law provided for just shareholding as a base of establishment of inter-corporate relationship, there were several instances wherein though the nexus between entities was visible, however, due to absence of such defining criteria, it escaped the clutches of authorities as such relationship could not be established. Particularly the establishment of alter-ego relationships as between Loop-Essar and Swan-Reliance was a big hardship for the authorities, which are still trapped in different opinions in this matter.
Hence one of the rationales is to clearly establishment relationship amongst related entities, if some substantial interest is involved, which is targeted in the definition provided under new law.
Following are the clauses where in the term has been added, expanding its scope:
Insertion in the definition of ?related party? for the purpose of ascertaining related party transactions
Disclosure for the purposes of providing a true and fair view of annual return, financial statement and consolidation of accounts. Eligibility or non-eligibility of auditor or independent director to be appointed as such.
Requirement of inclusion of details regarding shares of directors and key managerial personnel in register maintained at registered office of company concerned.
Restrictions upon non-cash transactions and prohibitions on forward dealings in securities of company involving directors or key managerial personnel.
Cancellation of associate shareholding during Merger or Amalgamation of company.
DEFINITIONS UNDER OLD LAW
Under Companies Act, 1956
As per the Law Ministry opinion provided under the 2G case, associate relationship is established amongst the entities upon fulfilling of following:-
?For Company B to be treated as an associate of Company A, there must either be a holding and subsidiary relationship between the two companies, or there must be a more than50% shareholding in both companies by the common parent holding shares in either of the two companies. In the absence of these facts, one company cannot be said to be an associate of the other,"
Though no specific definition is provided under the provisions of law, definition used u/s 370(1B) was used as a base for establishment of such relationship. It states:-
Two bodies corpo¬rate shall be deemed to be under the same management
if the managing director or manager of the one body, is managing director or manager of the other body; or
if a majority of the directors of the one body constitute, or at any time within the six months immediately preceding constituted, a majority of the directors of the other body; or
if not less than one-third of the total voting power with respect to any matter relating to each of the two bodies corporate is exercised or controlled by the same individual or body corporate; or
if the holding company of the one body corporate is under the same management as the other body corporate within the meaning of clause (i), clause (ii) or clause (iii); or
if one or more directors of the one body corporate while holding, whether by themselves or together with their relatives, the majority of shares in that body corporate also hold, whether by themselves or together with their relatives, the majority of shares in the other body corporate.
Under AS-23 ? Accounting for Investment in Associates in Consolidated Financial Statements
?An associate is an enterprise in which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor.?
Significant influence is the power to participate in the financial and/or operating policy decisions of the investee but not control over those policies.
(a) the ownership, directly or indirectly through subsidiary(ies), of more than one-half of the voting power of an enterprise; or
(b) control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise so as to obtain economic benefits from its activities.
MISSING LINK UNDER NEW LAW
Under the new law, an ?Associate Company? is defined and not the term ?associate? as defined under Accounting Standard, implying that relationship with other form of entities with the Company would be excluded from the preview of Companies Act, which means at if at any time relationship is required to be established amongst different form of entities, there would again exist a question mark beyond that.
Further the definition of significant influence implies control of at least twenty per cent. of total share capital, or of business decisions under an agreement. This implies that contribution to other Company in other form, not being share capital i.e though other funding options, would again exclude the same out of preview of associate relationship. Further, only control of business decisions under an agreement is covered. In such circumstances deemed control without any oral or written agreement amongst the parties would be difficult to establish.
Objectivity provided to the definition of ?Associate Company? would make it easier to establish nexus between entities.
While insertion of this concept is a good move from the point of view of Corporate Governances, however, the concept and its adherence at several instances is going to be a burdensome exercise for the industry and is likely to face agitation as well. Some of the examples include:-
The provision of Consolidation of Financial Statement, besides providing for consolidation of subsidiary accounts also provides for consolidation of accounts of associate Company including Joint Venture. This not only is going to be a big exercise for the Company to perform but also very much likely to escalate and create duplicate figures in the economy with same associate companies being consolidated by different entities, unless proper rules are provided to such effect.
Another example could be the requirement with respect to auditor not to provide any other service in associate Company as well.
o Further the criteria of selecting independent director provides for such person not to have any predefined set of relationships even with associate entities, which would be very difficult for the companies to identify on a continuous basis.
Further since the definition is different from the definition provided under Accounting Standards, hence would again create ordeal for the companies to comply with both the aspects.