Company Law to fix 'associate' definition; 'control' still hazy

Written by Ronojoy Banerjee | Ronojoy Banerjee | New Delhi | Updated: Aug 22 2011, 09:38am hrs
If one company has voting rights of 20% or above in another, the twosome will be defined as associates under the company law, as the government plans to make yet another bid to remove the veil over corporate relationships. Experts, however, warned that even this might not suffice to clarify whether one firm has control over the other.

The issue of control had agitated the mind of the country's top auditor when it found that Reliance Communications had major say in Swan Telecom, allegedly a beneficiary of the 2G spectrum scam, when the latter applied for licence. The control was allegedly exercised by RCom through preference shares, despite its equity in Swan being just 9.9%.

The corporate affairs ministry wants to address the problem of complex structures prospectively by clearly defining associate companies in the Companies Bill and thereby amplifying the term legally on the lines of existing everyday terms like joint ventures and subsidiaries. Though a similar definition is currently given in the Indian Accounting Standards (AS 18), it is subject to interpretation and rebuttal and by introducing the term associate company in the Companies Bill also, its legal status would be amplified.

We have decided to introduce the definition of an associate in the Companies Act. This would ensure alignment between the accounting standards and the Act, a government source told FE. According to him, the ministry of corporate affairs (MCA) had initially proposed a 26% voting share as defining an associate firm. That would have aligned the definition with the minimum requirement specified in the extant Act given for blocking a special resolution. However, paying heed to the Comptroller and Auditor General of India's recommendation for bringing about parity between the Accounting Standards and Companies Act, the ministry has opted for the 20% voting rights norm.

It may be recalled that the Central Bureau of Investigation had chargesheeted RCom for having substantial equity in Swan Telecom when the latter applied for 2G spectrum, which breached the cross-holding regulation. RCom denied that Swan was its associate company since its equity in the latter at the time of applying for licence was 9.9%.

But according to CAG, RCom had major say on the company by way of preference shares. In the case of Essar and Loop Telecom also, the CBI is investigating whether the two were associate companies. Company law experts termed the development as significant since the extant definition in AS-18 is vague and subject to interpretation. For instance, according to AS-18 guidelines, only if it can ascertained that an investing party has a significant influence in the affairs of another company would the two be considered associates of each other. Significant influence has been further defined as an investing party directly or indirectly holding 20% or more of the voting share rights. The definition of an associate in the accounting standards is very presumptive in nature and is subject to rebuttal, head (accounting advisory services) at KPMG Jamil Khatri said. Partner at Delhi-based Corporate Professionals Pavan K Vijay also said that once the Companies Act defines an associate it would be clear cut in nature. He said that the definition of an associate in the accounting standards is loose and very vague.

However, Khatri said that the 20% or more voting right share cap could still not be enough to address the issue of control. For instance, if an investing party holds only 19% stake in another company in which shareholding is widely dispersed making it the majority stakeholder, it could still wield a lot of influence despite not being an associate. The reverse is also equally possible. If a company holds 25% stake it another firm thereby clearly meeting the criteria for an associate, it would still not be able to block a special resolution for which a minimum cap required is 26%.

Khatri said the government should refrain from realigning the accounting standards and Companies Act since they have been drawn up for two separate purposes. He said that since an investor holding 26% stake in a company can block a special resolution the cap for an associate company should have been retained at 26% rather than reducing it to 20%.