Meaning of ‘Control’ [Section 4(1)(a) of Companies Act, 1956]

Section 4 of the 195 Act was adopted from s. 154 of the English Act, 1948 but in adopting it an important change has been made in order apparently to make the definition wider. While the wording of clause (a)(i) of sub-section (1) of the English section is “that other is a member of it and control the composition of its Board of Directors” the words “is a member of it and” are omitted from the definition in the corresponding clause (a) of s. 4(1) of the 1956 Act.

The effect of this is that while under the English Act it is necessary for a company to be treated as having the legal status of a holding company of another, that it must both be a member of that other company and also control the composition of its Board of Directors, it is enough under the Indian Act to have control of the composition of the Board of Directors of the other company. That is to say, a company will be treated as holding company of a subsidiary company under the Indian Act even though it may not be a member of the subsidiary company and does not hold any shares in it.

Such will be the case where a holding company is in a position to control the Board of Directors of its immediate subsidiaries and through such control, controls also the subsidiaries of such subsidiaries without itself being a member of such sub-subsidiaries.

The various provisions of this Act dealing with holding companies and their subsidiaries maintain the distinction between the two as separate legal entities. An application to join the subsidiaries of the company as parties in a petition under s. 397 of the 1956 Act was dismissed on the ground that the affairs of the holding company do not necessarily include the affairs of its subsidiaries. The expression ‘control’ in relation to a company ordinary means the possession of the power by the exercise of voting rights to carry a resolution at a general meeting of a company.

The control can be said to exist only if the member company, i.e. the holding company, has independent power by exercising which either directly and/or through one or more subsidiaries it can appoint or remove the whole or a majority of the Board of directors. But control in relation to composition of Board may also be exercised, even without holding majority shares by way of shareholders or joint venture agreements. It can also be exercised indirectly as in the case of a company A holding shares in one or more subsidiaries B, C, D etc. and controlling the subsidiaries of B, C, D etc. ie. the sub-subsidiaries, by indirectly giving directions through B, C, D etc., A company may also be a holding company where a majority of shares in a company is held by it or its subsidiaries, and all of them along with or without the holding company, can, by acting together control that company, even though none of them by themselves hold a majority of shares in that company: Where a company is the holding company of the holding company of company A, it does not directly hold any shares in company A and, therefore, not a member of company A. That is to say, in the case of a subsidiary’s subsidiary, the ultimate holding company will not directly be a member, but will have ultimate control of the Board.

Controlling interest

The holding of a majority of voting power in a company is sufficient to constitute the power to control the composition of the Board; and it is not necessary to have such share-holding as would secure the passing of a special resolution for which special majority is required. In determining whether one company has a controlling interest in another company or whether directors have a controlling interest in a company, it is not necessary to consider whether the interest is a proprietary one and no distinction is to be drawn between direct and indirect interest. A relationship which brings about control in fact, by whatever machinery or means that result is affected is sufficient. The degree of control resulting from a 51 per cent holding is a control within the Act.

Control through nominee directors

 Where a company appointed additional directors as the nominees of another company and these nominees constituted the majority of the Board, the nominating company became the holding company within this clause notwithstanding that the nominees would hold office only up to the next annual general meeting. Where the Memorandum and Articles provided that its Board of directors was to be constituted only of the nominees of another company’s Board of directors, the former company would become the subsidiary of the later.

Controlling the Board without holding majority shares

 The possibility of controlling the Board of a company without holding majority shares has been all along recognized. It is observed in PENNINGTON, COMPANY LAW, 796 (5th Edn. 1985): “The other way by subsidiary is by the subsidiary’s memorandum and articles conferring the power or by a contract between the holding company and the subsidiary doing so.” A case of this kind was before the Kerala High Court in Velayudhan M. v. Registrar of Companies, (1980) 50 Com Cases 33 (Ker). A company entered into an agreement with another under which one company advanced money to the other. The agreement provided that the lending company would have power to nominate the majority of the number of directors, that the nominee directors would be treated in all respects as directors of the borrowing company and that they would be co-opted on its board and that the lending company would have the power to convert the loan into shares in installments or in lump sum. The lending company nominated its directors and they were immediately co-opted by the borrowing company on its Board. The Registrar launched proceedings against the lending company for violation of s. 372 (later omitted from the 1956 Act), namely, exceeding the limits of permissible investment. The lending company contended that they were a holding company and therefore enjoyed the exemption of sub-section (14) of s. 372 of the 1956 Act and were not liable to the penalty of s. 374 of the 1956 Act. The Registrar contended that they were a holding company at the most for a short period because they themselves had the power to recall the loans and their nominee directors would in any case rotate out at the next annual general meeting. Even so the court held that the lending company qualified itself as a holding company within the meaning of sub-section (1)(a) and sub- section (2) of s. 4 of the 1956 Act [corresponding to s. 2(87) of the 2013 Act].The court accepted the possibility of a temporary controlling power and therefore temporary relationship of holding and subsidiary because the Act nowhere prescribes the duration of the relationship. But the type of control envisaged by the Act has been further clarified in PENNINGTON’S COMPANY LAW, 796 (5th Edn., 1985): “Powers of appointment to andremoval from the putative subsidiary’s board which are exercisable by other subsidiaries of the holding company, or by nominees for its or such other subsidiary are deemed to be exercisable by the holding company, but powers held in a fiduciary capacity, or conferred by debentures issued by the subsidiary, or by a trust deed securing such debentures, or enjoyed in consequence of holding shares in the subsidiary as security for loans disregarded in the same way as shares in the subsidiary are disregarded when ascertaining whether the holding company holds more than half of the subsidiary’s equity share capital.”

When deemed to control composition [Section 4()(a) and (2) of Companies Act, 1956]

As provided in sub-section (2) of s. 4 of the 1956 Act, the Board of directors of company will be deemed to be controlled by another if, and only if, that other, at its own discretion and without depending upon any other person’s consent or concurrence, has power to appoint or remove the whole or a majority of the directors of the first-mentioned company.

‘Consent or concurrence’ of any other person cannot be taken to include the consent or concurrence of the person appointed. For, as under s. 264 of the 1956 Act the consent of the person appointed as director is a necessary condition for his acting as director in all cases, it will not be possible in any case for any company to satisfy the requirement of sub-section (2) of s. 4 of the 1956 Act. If the provision is to be construed so as to have efficacy, the expression ‘without the consent or concurrence of any other person’ will have to exclude from its scope the person appointed as director.

Again, the expression ‘any other person cannot also include the subsidiary company itself. For, if the consent or concurrence of the subsidiary company is required, it cannot be said that the appointment or removal of any of its directors is made at the holding company’s own discretion ‘without the consent or concurrence of any other person’. ‘Further, where the holding company exercises control, it will be meaningless to say that the subsidiary’s consent or concurrence is required for exercising such control consent is required, then there can be no control at all nor can it be said that the power of appointing and removing the subsidiary company’s directors is exercised or exercisable at the holding company’s own discretion.

The following commentary under the 1956 Act stands amended in view of the definition of “total share capital” in Rule 2(1)(r) referred above. The 1956 Act considered only equity share holding while holding in equity as well as convertible preference will now be considered under the 2013 Act to define total share capital.

“Holds more than half in nominal value of its equity share capital… [Section 41)(b)(ii) of Companies Act, 1956]

The expression ‘nominal value’ is used to denote the paid-up value of the equity shares  so as to distinguish it from their market value’. What the phrase holds more than half in nominal value of its equity share capital’ means is that where one company holds equity shares, in another company and the paid-up value i.e. the amount paid in respect of such shares is more than half of the total paid-up value or amount on the entire equity share capital issued and allotted by that other company, the first-mentioned company becomes the holding company and the other its subsidiary. The meaning will be clear when we read this provision along with s. 87(1)(b) of the 1956 Act which provides that in the case of a member holding equity shares in a company his voting right in respect of such shares shall be in proportion to his share of the total paid-up equity capital of the company.

The words ‘holds more than half in nominal value of its equity share capital’, obviously mean ‘holds more than half in nominal value of its paid-up equity share capital’ and not of its authorized equity share capital. In the English Act of 1948 this is made clear by defining the expression ‘equity share capital’ as meaning ‘its issued share capital excluding any part thereof which neither as respects dividends nor as respects capital carries any right to participate beyond a specified amount in a distribution’. As the present section is adopted from the English Act, it may be presumed that the meaning of the expression ‘equity share capital’ is the same here also. The omission of the word issued’ would seem to be inadvertent. Thus, where both fully paid and partly paid equity shares have been issued and allotted by a company, it is more than half of the total of equity shares held, and not the holding of more than half of the total paid-up equity share capital that will make the company holding such shares, the holding company of the company issuing and allotting the shares. Thus, in a given case a holding company may not be in a position to exercise majority of voting power in respect of any resolution at any general meeting of the subsidiary company, having regard to the provisions of sub-section (1)(b) of s. 87 of the 1956 Act (which provides that in case of member holding equity shares in a company, his voting rights in respect of such shares shall be in proportion to his share of the total paid-up equity capital of the company). The power to control by exercise of majority voting rights is thus not the decisive factor in determining the holding-subsidiary relationship

This indeed is an anomalous situation as a holding company should be one which controls the majority voting power in the subsidiary.

The interpretation by way of clarification given by the Department of Company Affairs in their publication entitled CLARIFICATIONS AND CIRCULARS ON COMPANY LAW’ at page 4 as regards the expression nominal value of equity share capital, to the effect that the nominal value of equity share capital is “unrelated to the amount paid up on the equity shares” and “may be interpreted to mean the face value of the equity capital which has been subscribed” is vague and un-understandable. The expression “nominal value of equity share capital” used in this section has no affinity whatever with the expression nominal share capital’ occurring in Schedule X in connection with the levying of fees for the registration of companies, where it clearly means the authorized capital for purposes of registration as required by s. 13(4) of the 1956 Act. The use of the word ‘value’ after the word ‘nominal’ in this section clearly indicates that what is meant here is ‘paid-up’ equity capital as used in s. 87(1)(b) of the 1956 Act.

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