In a significant ruling delivered on April 27, 2026, the Bombay High Court slashed a ₹64 lakh penalty imposed by an Adjudicating Officer under the Companies Act, 2013, to ₹16 lakhs. The court’s message is unambiguous: a penalty imposed without genuine consideration of proportionality, and multiplied mechanically across every director on a board, is arbitrary and constitutionally unsound.

The Facts in Brief

NSJL Nidhi Ltd[i] uploaded sixteen returns of allotment in Form PAS-3 between February 2019 and January 2021. The company signed the main form, which contains an affirmation clause confirming the correctness of all attachments but did not separately certify the accompanying list of allottees as required under Rule 12(2) of the Companies (Prospectus and Allotment of Securities) Rules, 2014. The reason was purely practical: scanned, signed annexures were too large to upload to the MCA server.

An Adjudicating Officer treating this as a default under Section 39(5) of the Companies Act imposed a penalty of ₹1 lakh per return and then multiplied it by four (the company plus three directors), arriving at a total of ₹64 lakhs. Not a rupee less, not a factor considered.

Question of law

The court framed the case around two questions: first, whether any penalty was attracted at all; and second, whether the quantum was lawful. On the first question, the court held that the dual-certification requirement in Rule 12(2) is not a mere formality the same signatory who signs Form PAS-3 must also certify the attached list separately. The affirmation clause in the form, while constituting substantial compliance, does not erase the specific obligation in subordinate legislation. A default existed.

It was on the second question that the court’s analysis proves most consequential.

Proportionality Is Not Optional – It Is Constitutionally Mandated

The Adjudicating Officer had invoked Rule 3(12) of the Companies (Adjudication of Penalties) Rules, 2014 which lists seven factors that must be applied when assessing the quantum of penalty. These include the size of the company, the nature of its business, injury to public interest, nature and repetition of the default, disproportionate gain, and investor or creditor loss. The order then proceeded to apply none of them.

Instead, the AO simultaneously characterised Section 39(5) as both a fixed penalty provision (under Rule 3(13)) and a minimum penalty provision (under the proviso to Rule 3(12))- an internal contradiction the court did not hesitate to call out as absurd.

The court drew directly on the Supreme Court’s trilogy on Section 15-A of the SEBI Act, a provision worded identically to Section 39(5). In SEBI v. Bhavesh Pabari (2019) 5 SCC 90, a three-judge bench settled a longstanding debate: such provisions are neither fixed nor minimum penalty clauses. Aggravating and mitigating circumstances must always be weighed. Because Section 2(95) of the Companies Act designates the SEBI Act as cognate legislation, this ruling applies squarely to Section 39(5).

“The reading of Section 39(5) as a stipulation that does not permit the Adjudicating Officer to exercise adjudicatory discretion to examine the nature, the gravity, and the impact of the default is an unreasonable reading of the provision, which would render it unconstitutional.”

The Problem of Unreasonable Multiplication

AO imposed maximum penalty under section 39(5) separately on each director, treating Section 2(60)(iii) of the Companies Act as a licence to do so. That sub-clause provides that where no officer-in-default has been specifically designated and there are no key managerial personnel, all directors are treated as officers in default.

The court rejected the AO’s interpretation as unreasonable on three grounds:

• Section 2(60)(iii) speaks to who is liable – it says nothing about multiplying the quantum of penalty by the number of directors.
• Section 2(60)(vi) imposes a separate, more nuanced test for individual director liability: the director must have been aware of the contravention by virtue of Board proceedings and participated without objection or must have consented or connived in it. The order contained no analysis of this whatsoever.
• The correct approach is to make the company and its directors jointly and severally liable not to multiply the penalty additively per head. The distinction matters enormously: joint and several liability preserves the deterrent effect without creating a punitive multiplier that bears no relation to the gravity of the default.

The court illustrated the absurdity plainly: if the company had ten directors, the AO’s approach would have resulted in a penalty ten times the statutory ceiling for a single default. The penalty would scale with board size, not with culpability.

Penalty: before and after

What This Means in Practice

For adjudicating officers: Rule 3(12) is not a checklist to cite and set aside. Each of its seven factors must be genuinely examined and reflected in the order. An order that invokes the rule but applies none of its factors is vulnerable to being set aside.

The ‘whichever is less’ formulation in Section 39(5) does not create a mandatory minimum that forecloses discretion, it sets a ceiling, not a floor.

For company directors: Section 2(60)(iii) does not automatically expose every director to a full, separate penalty for every default. Individual liability under Section 2(60)(vi) requires specific findings of awareness and participation or consent. Directors should ensure that Board minutes and internal processes clearly document their involvement or lack thereof in matters that may later be characterised as defaults.

For companies: The Companies Act’s penalty framework, read correctly alongside the Bhavesh Pabari line of authority, demands proportionality. Where a default is genuine but minor, a tempered penalty not the ceiling multiplied across every board member is what the law contemplates.

“A disproportionate penalty on the wrong premise that the penalty provision entails a minimum penalty, and in the same breath also a fixed penalty; and then multiplying the penalty by the sheer number of directors who happen to occupy the Board of the Company, is wholly arbitrary.”

[i] N.S.J.L Nidhi Ltd v. Regional Director (Wr), Ministry of Corporate Affairs  |  WP No. 10782 of 2024  |  Somasekhar Sundaresan J.

The post When Penalties Must Be Proportionate: The Bombay High Court’s Criticize of Mechanical Adjudication first appeared on MMJC.

Background

The implementation of the labour codes in November 2025 has created a material financial impact for many companies, especially in relation to gratuity and leave encashment. In several cases, actuarial valuations have resulted in a one-time charge in the books, and a substantial portion of that charge relates not to the current year’s service, but to employee service rendered over earlier years.

This has raised a practical question under Section 198 of the Companies Act, 2013: While computing net profits for CSR and/ or managerial remuneration, should such a one-time charge be excluded to the extent it pertains to past periods?

At first glance, the question seems reasonable. If the liability relates to service already rendered in earlier years, should the entire expense really be considered while computing profits of the current year?

The answer, however, may lie less in the period to which the service relates and more in the nature of the liability itself.

Nature of the Liability

The first distinction that matters is between a hypothetical provision and a crystallised business obligation. Many disallowance issues arise in relation to doubtful debts, anticipated losses, or other provisions where the existence or quantum of the liability is uncertain. Those are estimates of possible future losses.

Gratuity and leave encashment are different. These liabilities arise from a definite statutory and contractual obligation owed by the employer to its employees. The obligation is not speculative. Employees have already rendered service, and the employer has already accrued the liability. The actuarial valuation only determines the present value and timing of its discharge.

So, even though the accounting entry is described as a “provision”, the substance is not hypothetical. It represents recognition of a real employee cost.

Effect of Labour Code Changes

This becomes even more relevant in the context of the labour code implementation. The one-time impact recognised during the year is not an amount created at management’s discretion, nor is it a prudential reserve. It arises because the legal framework governing employee benefits has changed, requiring companies to reassess and recognise obligations already embedded in the employment relationship.

In other words, the expense does not arise because the company chose to create a provision. It arises because the law altered the measurement of an existing obligation.

That is why excluding the amount merely because it relates to past service may not reflect the commercial reality of the transaction.

Section 198 Perspective

Section 198 permits deduction of “usual working charges” while arriving at net profits. Employee benefit costs, including gratuity and leave encashment, are part of the normal operating expenses of a business. The section does not distinguish between current service cost and past service cost, nor does it suggest that an expense should be ignored simply because it is recognised in one year due to a statutory change.

The trigger for recognition is also important. Although the underlying service may have been rendered over earlier years, the impact crystallises in the current year because of the implementation of the new law. The charge recognised in the books is therefore not a prior-period adjustment arising from error or omission, but a current-year recognition of an enhanced statutory obligation.

If a company is required during the year to recognise an increased employee benefit obligation because of a change in law, that expense assumes the character of an actual business charge incurred in that year, even if part of the underlying service relates to earlier periods.

Practical View

Viewed in this light, excluding such expense from Section 198 computation merely because it relates to past service may create an artificial divide between accounting recognition and legal obligation. More importantly, it would treat a genuine employee welfare cost as if it were a notional or contingent provision, which does not sit well with the nature of gratuity and leave encashment liabilities.

The better view, therefore, is that the one-time impact arising from the implementation of the labour codes should be allowable while computing net profits under Section 198, even where a substantial portion of the amount relates to past service periods as the expense represents a real statutory employee cost recognised pursuant to a change in law and forms part of the ordinary working charges of the company, rather than a hypothetical or contingent adjustment.

The discussion, therefore, is not merely about recognising an employee benefit expense, but about understanding how a statutory change in one area of law can influence outcomes under another. Companies would therefore be well advised to consider these implications while assessing the impact of the new labour code regime.

Since both managerial remuneration and CSR expenditure are determined on the basis of net profits computed under Section 198 of the Companies Act, 2013, any increase in employee benefit costs arising from the implementation of the labour codes would ordinarily have a corresponding impact on these computations. As a result, the one-time impact of the labour code changes is likely to reduce both the ceiling available for managerial remuneration and the amount required to be spent towards CSR.

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Wide Powers of the Tribunal

Section 241-242 of the Companies Act, 2013 gives the National Company Law Tribunal wide powers to provide reliefs in oppression and mismanagement matters. The provision is not confined to granting only the specific reliefs expressly listed in 241-242. Clause (m) of section 242(2) further expands the Tribunal’s scope by enabling it to provide for “any other matter” which, in its opinion, is just and equitable.

In addition to the statutory powers under Section 242, Rule 11 of the NCLT Rules, 2016 preserves the Tribunal’s inherent power to issue appropriate directions where necessary to meet the ends of justice or prevent abuse of process.

This language often gives parties the impression that Section 242 can operate as a complete remedial solution whenever a company is already before the Tribunal.

Although Sections 241-242 and Rule 11 reflect the Tribunal’s wide remedial jurisdiction, the relief sought cannot be viewed in isolation from the statutory framework governing that relief. For instance, when the relief concerns redemption of preference shares, the discussion must necessarily turn to Section 55, which sets out the conditions for such redemption.

Permissible Sources for Preference Share Redemption

Section 55 of the Companies Act, 2013 deals with the issue and redemption of preference shares. Its purpose is not merely to prescribe a redemption timeline, but also to protect the company’s capital structure.

Section 55(2) permits redemption only through recognised sources. Preference shares may be redeemed either out of profits of the company which would otherwise be available for dividend, or out of the proceeds of a fresh issue of shares made specifically for the purpose of redemption. Where redemption is made out of profits, an amount equal to the nominal value of the shares redeemed is required to be transferred to the Capital Redemption Reserve, thereby preserving the capital base of the company.

Status of Preference Shareholders when the preference shares are due for redemption

Preference share capital continues to form part of the company’s share capital until it is redeemed in accordance with law. Therefore, the maturity of preference shares may create an obligation on the company to redeem, but it does not by itself convert that obligation into an immediate debt payable from any available funds.

In Lalchand Surana v. Hyderabad Vanaspathy[1], the Court observed that where redeemable preference shares are issued but not honoured when they are ripe for redemption, the holder of those shares does not automatically assume the character of a creditor. This is because such shares can be redeemed only out of profits which would otherwise be available for dividend, or by a fresh issue of shares, which is a limitation not applicable to an ordinary creditor.

The Supreme Court, in EPC Constructions India Limited v. M/s Matix Fertilizers and Chemicals Limited[2], also clarified that holders of cumulative redeemable preference shares are investors and not creditors, more specifically not financial creditors, for the purpose of initiating insolvency proceedings under Section 7 of the IBC, since non-redemption of such shares does not qualify as a default under the Code.

This distinction becomes relevant when a holder of matured preference shares seeks immediate payment. Since the holder continues to remain a shareholder and not a creditor, the claim cannot be enforced like an ordinary debt claim from any available fund.

When Wide Powers meet a specific mechanism

Sections 241-242 and Rule 11 may enable the Tribunal to provide reliefs in appropriate cases, but they cannot be exercised in a manner that defeats an express statutory requirement by invoking just and equitable grounds.

In Haridas Krishnan Kutty v. Jatayupara Tourism Private Limited and Others[3], the preference shareholder sought redemption of his matured redeemable preference shares under Sections 241-242 proceedings. His case was that the shares had reached the redemption date, the company was under the supervision of an NCLT-appointed Administrator, and funds were available in a Tribunal-controlled escrow/common pool account. The preference shareholder therefore sought a direction for redemption by invoking the Tribunal’s wide powers, including its power to grant just and equitable relief.

The company, the Administrator and certain other respondents opposed the relief. They argued that the company had no distributable profits. Further, redemption through fresh issue proceeds was also not feasible because subsisting status quo orders restrained alteration of the company’s share capital. The escrow funds also could not be treated as profits of that company.

The Tribunal accepted that the shares had matured, but concluded that the wide powers under Sections 241-242 and the inherent powers under Rule 11 cannot be used to bypass or act contrary to express statutory provisions. Accordingly, it refused redemption in the present proceedings, while leaving the Applicant to pursue remedies in accordance with Section 55 and other applicable provisions.

Conclusion

Where the Act provides a dedicated mechanism for a subject, the Tribunal cannot use its powers to achieve indirectly what the statute does not permit directly. In the context of preference share redemption, Section 55 prescribes the permitted sources and manner of redemption. Therefore, even where the redemption date has arrived, a direction for redemption cannot be issued under Sections 241-242 or Rule 11 if it would contravene Section 55.

[1] Lalchand Surana v Hyderabad Vanaspathy Ltd (1990) 68 Comp Cas 415 (AP).

[2] EPC Constructions India Limited (Through its Liquidator) v. Matix Fertilizers and Chemicals Limited 2025 SCC OnLine SC 2293; [2025] 189 CLA 81.

[3] Haridas Krishnan Kutty v. Jatayupara Tourism Pvt. Ltd. and Ors., (2026) ibclaw.in 1474 NCLT

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1. Background

• We all know that section 43 of the Companies Act, 2013 (hereinafter referred to as “the Act”) states two kinds of capital (a) Equity share capital (b) Preference share capital.
  • These two kinds of shares capital have specific rights as stated in section 43 of the Act. It divides equity into two types
  • Equity share capital with voting rights or
  • Equity share capital with differential rights as to dividend, voting or otherwise in accordance with such rules as may be prescribed

• Preference share capital has some preferential right with respect to
  • Payment of dividend
  • Repayment in case of winding up or repayment of capital
  • Preferential right to the payment of any fixed premium or premium on any fixed scale specified in the memorandum or articles of the capital

• The basic two kinds of share capital when further dividend into different types are considered as “class” for the purpose of the Act. It can be seen from various sections viz 47, 48, 49.

• Sub-section (1) of section 48 states as follows:-
  • “Where a share capital of the company is divided into different classes of shares, the rights attached to the shares of any class may be varied with the consent in writing of the holders of not less than three-fourths of the issued shares of that class or by means of a special resolution passed at a separate meeting of the holders of the issued shares of that class,—
    • if provision with respect to such variation is contained in the memorandum or articles of the company; or
    • in the absence of any such provision in the memorandum or articles, if such variation is not prohibited by the terms of issue of the shares of that class:Provided that if variation by one class of shareholders affects the rights of any other class of shareholders, the consent of three-fourths of such other class of shareholders shall also be obtained and the provisions of this section shall apply to such variation.”

• From this is it clear that section 43 of the Act states two kinds of capital and section 48 of the Act makes it clear that there can be classes in each kind of capital.

• Sub-section (2) of Section 47 of the Act also mentions about classes in second proviso as follows
  • “Provided further that where the dividend in respect of a class of preference shares has not been paid for a period of two years or more, such class of preference shareholders shall have a right to vote on all the resolutions placed before the company.”

• Section 49 of the Act states as under:-
  • “Where any calls for further share capital are made on the shares of a class, such calls shall be made on a uniform basis on all shares falling under that class.
  • Explanation.—For the purposes of this section, shares of the same nominal value on which different amounts have been paid-up shall not be deemed to fall under the same class.”
• It is clear from section 43, 47, 48 and 49 that there are only two kinds of share capital i.e equity and preference. In each kind there can be different classes of share capital.

2 The question which this article deals with :-

• Whether the use of word “class” is restricted to “shares” or it extends to “shareholders” as well? In other words, whether the rights not attached to shares, but individual shareholder can be considered as “class” under section 48 of the Act and can it be varied?

• Consider a situation where particular rights are given to a shareholder viz.. right of pre-emption over other shareholders, right to prior consent on some matters, right to appoint director, right in case of unissued shares etc.   The rights are given to specific investor or shareholder in the articles of the company. The Company had not issued any shares having these rights. But by virtue of the articles one shareholder enjoys these rights.

• In above situation, whether we will consider him as a “class” or since the shares when issued not having these terms and conditions as part of issue and allotment, will it be considered as “class”

3 We need to analyse following to arrive at the conclusion for above questions

• Whether the title of the section gives any hint?
  
• Whether the section itself is clear about it?
  
• Whether any precedent available for addressing the question raised?
  

4 Lets analyse it one by one:-The first one is whether the title of the section is giving any hint?

• The title of section 48 is “variation of shareholders rights”  

• Heading in particular section lends, though not normally a part of the statutory provision, assistance in interpreting the statutory intent since the ‘heading’ always serves as a guide to depict the intention. It also makes it clear that the marginal note to a section cannot be referred to for the purpose of construing the section, but it can certainly be relied upon as indicating the drift of the section. It also shows that the heading/marginal notes prima facie furnish some clue as to the meaning and purpose of the section. [1]

• The title of a statute is an important part which may be referred to for the purpose of ascertaining its general scope and depicting its construction, although it cannot override the clear meaning of the enactment.[2]

• One cannot resort to the title of a Statute for the purpose of construing its provisions. Still, the title of an Act of parliament is no part of the law, but it may tend to show the object of the legislature.[3]

• The title of a statute does not traverse much in construing it; but it is not to be absolutely disregarded.[4]

• In our case, the title states that it is variation of shareholders rights. The title shows the object of the legislature, then here it is in indicating that the rights of shareholders too.

5 The Second aspect which we should analyse – Whether the section itself is clear about it?

• Sub-section (1) of section 48 of the Act uses both the terms “rights attached to the shares of any class” and “variation by one class of shareholders affects the rights of any other class of shareholders”

• Since sub-section (1) of section 48 of the Act states that rights attached to shares of any class may be varied with the consent in writing of the holders of not less than three-fourth of the issued shares of that class or by means of special resolution passed at a separate meeting of the holders of the issued shares of that class ….. … “variation by one class of shareholders affects the rights of any other class of shareholders”

• It is understood from the section that there can be two scenarios
  • One is where at the time of issuance of shares the company has created different classes of shares and now there is a situation to vary those terms and conditions
  • The other possibility mentioned in the proviso which is -variation of rights of one class of shareholders affecting other class of shareholders
  • The first rule of interpretation is literal interpretation. If we apply the simple meaning to the words used in the section then what it indicates to us. Why literal interpretation to be applied first? We can refer to the Hon’ble Supreme Court’s classic observation on ‘literal rule’ in Kanailal Sur V Paramnidhi Sadhu Khan, AIR 1957 SC 907, Gajendragadkar J., had explained the rule in these words:
  • “The first and primary rule of construction is that the intention of the legislature must be found in the words used y the legislature itself. If the words used are capable of one construction only then it would not be open to the Courts to adopt any other hypothetical construction on the ground that such construction is more consistent with the alleged object and policy of the Act. The words used in the material provisions of the statute must be interpreted in their plain grammatical meaning and it is only when such words are capable of two constructions one of which is likely to defeat or impair the policy of the Act whilst other construction is likely to assist the achievement of the said policy, then the Courts would prefer to adopt the latter constructions. It is only in such cases that it becomes relevant to consider the mischief and defect which the Act purports to remedy and correct.Maxwell in his book on the subject of statutory interpretation – ;the first and most elementary rule of construction the words of a statute must prima facie be given their ordinary meaning. Ordinary words must be given their ordinary meanings and technical words their technical meanings, unless absurdity would result. This is the golden rule
  • If we apply literal rule of interpretation, then the words in sub-section (1) of section 48 of the Act shall be given their ordinary meaning. Hence, the two terms used in section 48 covers both rights attached to the shares of any class and variation of one class of shareholders.

6 Now the last one is -Whether any precedent available for addressing the question raised?

• We can refer the judgement given in “Cumbrian Newspapers Group Ltd V Cumberland & Westmorland Herald Newspaper & Printing Co. Ltd [1986] BCLC 286 (Ch) 
• The Plaintiff, Cumbrain Newspapers Group Ltd and defendant Cumberland & Westmorland Herald Newspaper & Printing Co Ltd.
• The plaintiff and defendant were both publishers of newspapers. They negotiated a transaction whereby the defendant would acquire inter alia one of the plaintiff’s newspapers and the benefit of certain advertising arrangements and the plaintiff would acquire inter alia 10 per cent of the defendants share capital. The defendant duly issued 10 percent shareholding to the plaintiff and as part of the agreement under which the shares were issued amended its articles to grant to the plaintiff rights of pre-emption over other ordinary shares, rights in respect of unissued shares and the right to appoint a director. The purpose of such rights was to enable plaintiff, in its capacity as shareholder, to be in a position to be able to prevent a take-over of the defendant. After the arrangements so embarked on hd continued for several years the directors of the dependent proposed to convene an extraordinary general meeting and to pass a special resolution to cancel the articles which gave such special rights to the plaintiff. Plaintiff objected it stating that (a) the rights were class rights which could not be abrogated without its consent and (b) an injunction restraining the defendant from convening or holding the extraordinary general meeting. 
• In this case, the plaintiff contends that the special rights which it enjoys under the articles in question are “class rights” which cannot be varied or abrogated without is consent. Alternatively, the plaintiff contends that it is entitled to enjoy those special rights pursuant to an agreement made between itself and the defendant in 1968, and that it is , in consequence, entitled either to restrain the defendant from conveying the proposed general meeting , or at least to restrain the defendant from acting on any special resolution abrogating or varying the plaintiff’s special rights.
• The defendant on the other hand, denies the contractual entitlement of the plaintiff to enjoy those rights, and asserts that it is entitled to alter its articles in the manner prescribed by law.   
• We will focus on the discussion w.r.t. section 125 of the Companies Act, 1985 (UK) (Section 48 in our case). The judgement states that the rights and benefits which may be contained in articles can be divided into three categories:-
  • There are rights or benefits which are annexed to particular shares. Classic examples of rights of this character are dividend rights, rights to participate in surplus assets on a winding up.
  • Second category of rights or benefits which may be contained in articles, would cover rights or benefits conferred on individuals not in the capacity of members or shareholders of the company bit , for ulterior reasons connected with the administration of the company’s affairs or the conduct of its business.
  • The third category, the rights or benefits that, although not attached to any particular shares, were nonetheless conferred on the beneficiary in the capacity of member or shareholder of the company.
• The first category is very clear to us. When the rights are attached to shares at the time of issue it falls under Section 48 of the Act. The second category is not relevant for us.  The judgement elaborated the third category where the rights and benefits are not attached to any particular shares but conferred on the beneficiary in the capacity of member or shareholder of the company.
• The judgement also refers, Bushell V Faith , 1970 A.A. 1099 there were two classes of shareholders in the company. There were shareholders who were not for the time being directors, and shareholders who were for the time being directors. The former had rights against latter which the latter did not enjoy against the former. The two classes were identifiable not by reference to their respective ownership of particular shares, but by reference to the office held by the latter. But the rights of the former, and the obligations of the latter, required their respective ownership of shares in the company. Accordingly, as a matter of classification, the rights in question fall in third category.
• In Cumbrain case, it was the question for decision whether rights in this third category are within the meaning of the phrase in section 125 of the Companies Act, 1985 and in article 4 of table A. (in our case section 48 of the Act and article 6 of Table F)
• In this case defendant argued that third category of rights are not rights attached to a class of shares, for the purposes of section 125, it must follow that articles containing such rights can be altered by special resolution pursuant to section 9 of the Act of 1985 (Special resolution for alteration of articles of association).
• The judge stated it would, in my opinion, be surprising and unsatisfactory of class rights contained in articles were to be at the mercy of a special resolution majority in general meeting.
• This is very important paragraph from the said judgement “A number of considerations lead me to the conclusion that the purpose of sections 125 to 127 of the Act of 1985, and section 32 of the Act of 1980, was to deal comprehensively with the manner in which class rights in companies having a share capital could be varied or abrogated.
  • They are these : first, chapter II of Part V of the Act (Which includes section 125 to 129) is headed “class rights”. The side note to section 125 reads “Variation of class rights”. The language seems to treat “Class rights” as synonymous with “rights attached to any class of shares” at any rate so far as companies with a share capital are concerned.
  • Second, the use in section 17(2)(b) of the Act of 1985 of the expression rights of any class of members in connects both with companies having share capital and with companies having no share capital, underlines the point that the expression “rights attached to any class of shares” in section 125, must have been regarded by the legislature as synonymous with the former phase, so far as companies with a share capital were concerned.
  • Third, the evident intention of the legislature to protect rights attached to any class of shares against variation or abrogation by the mere alteration of articles, would if coupled with an intention to provide no such protection against variation or abrogation of class rights of the third category , be anomalous and arbitrary,
  • Fourth, if the variation or abrogation of third category right are not dealt with by section 123 the conclusion would see to follow that if the rights were contained in the memorandum, the rights could not be varied or abrogated at all. The enabling provisions of section 124 of the Act, of 1985 would obviously not apply, or would the enabling provisions of section 17 of the Act of 1985. The term of section 17, to my mind, strongly suggest a legislative belief that section 125 would deal with the variation or abrogation of any “special rights of any class of member” contained in the memorandum.
  • Fifth, the combination of considerations thirdly and fourthly above-mentioned leads to a further point. What sense could be there be in a result under which third category rights contained in articles were more freely alterable than rights attached to any class of shares contained therein, but under which third category rights contained in the memorandum were less freely alterable than rights attached to any class of shares contained in the memorandum ? the distinction would not be merely anomalous; it would, to my mind, be perverse.
  • The question, whether section 125 covers even rights conferred by articles to a specific member holding shares of the company was concluded in favour of plaintiff. The conclusion was as follows:“In my judgment, a company which, by its articles, confers special rights on one or more of its members in the capacity of member or shareholder thereby constitutes the shares for the time being held by that member or members, a class of shares for the purposes of section 125. The rights are class rights.”

7 Summary

• The title of section 48 of the Act is “variation of shareholders Rights” which though not forming part of law but does indicate the intent or objective behind the section. It indicates that the section contains the provisions relating to variation of shareholders rights too.

• Sub-section (1) of section 48 of the Act uses the terms “rights attached to the shares of any class and proviso to sub-section (1) of section 48 “variation by one class of shareholders affects the rights of any other class of shareholders…” It seems that the words “rights attached to class of shares” and “rights of any class of shareholders” are used interchangeably. Section 48 covers both the types of rights.

• As per the judgement citied in para 6, we could see that the it is in favour of view that section 48 also includes the rights of class of shareholders.

• It is very interesting to study the case laws on selective reduction of capital or reduction of capital where minority is wiped out. Whether such type of shareholders will be considered as “Class of shareholders”? if yes, whether consent of three-fourth shareholders will be required as per Section 48 of the Act?

8 Conclusion :-

As per the title which indicates variation of shareholders rights, section having used both the terms interchangeably and based on the judgement discussed above, it seems that a view can be taken that section 48 shall apply even in cases where there is variation of rights of shareholders too.  It will be Interesting to study minority as “class” under section 48 of the Act.

[1] Brihan Mumbai Electric Supply Transport Undertaking & Another V Laqshya Media P. Ltd 2009 AIR SCW 7528.

[2] Ashwini Kumar V Arabinda Bose AIR 1952 SC 369, Popatlal Shah AIR 1953 SC 274; Manoharlal AIR 1961 SC 918

[3] Per Wightman, J.. in Johnson V Upham (1859) 2 EcE 250, 263

[4] Kenrick & Co V Lawrence & Co (1890) 25 QBD 99, 104; Sunderaraman AIR 1958 SC 468, 485

_________________________________________________________________________________________

This Article written by

CS Kumudini Paranjape Bhalerao,

Founder Partner, Makarand M. Joshi & Co

_________________________________________________________________________________________

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Whether recommendation of Senior Management is role of NRC?

A. Background:-

1. The Companies Act, 2013 (hereinafter referred to as “the Act”) and the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (hereinafter referred to as “SEBI LODR”) as amended from time to time contains provisions for constitution, role and responsibilities of Nomination and Remuneration Committee. In addition to identification of directors, it also plays important role in appointment of Key managerial personnel.

B. The questions which this article is trying to analyse:-

1. Whether it is the role of the ‘Nomination and Remuneration Committee’ to even recommend appointment and removal of senior management personnel? Or
2. Whether it is the role of the ‘Nomination and Remuneration Committee’ to recommend appointment and removal of senior management personnel who can be qualified as directors?

C. The provision dealing with above question:-

1. For identification of directors etc, the exact wording of the provision in the Act and SEBI LODR is as follows:-

1. Sub-section (2) of section 178 of the Act :-

“(2) The Nomination and Remuneration Committee shall identify persons who are qualified to become Directors and who may be appointed in senior management in accordance with the criteria laid down, recommend to the Board their appointment and removal and ⁵[shall specify the manner for effective evaluation of performance of Board, its committees and individual Directors to be carried out either by the Board, by the Nomination and Remuneration Committee or by an independent external agency and review its implementation and compliance.

b.Schedule II – Part D-of SEBI LODR:-

A. Role of NRC

(4) identifying persons who are qualified to become directors and who may be appointed in senior management in accordance with the criteria laid down, and recommend to the board of directors their appointment and removal.

D. To find out appropriate view of the questions, we can analyse following :-

1. Background behind insertion of provision relating to identification by NRC
2. Applying principles of interpretation
3. Any order by regulators addressing the issue.

E. Summary of the background behind insertion of section 178 under the Act and SEBI LODR:-

1. Section 198 of the Companies Act, 1956 read with Schedule XIII was having a requirement of approval of Remuneration Committee for remuneration of managerial personnel.

2. Kumar Mangalam Birla Committee on Corporate Governance -1999 recommended certain disclosures in corporate governance report relating to remuneration of managerial personnel.

3. Narayan Murthy Report 2003 also had similar recommendations wr.t. disclosures in Corporate Governance Report.

4. J.J Irani Committee Report 2005 recommended Independent directors in the Committee and Chairman should be independent director.

5. the Companies Bill 2009 first time included that “the Nomination and Remuneration Committee shall identify individuals qualified to become board members consistent with the criteria laid down, recommend to the board the appointment and removal of directors and of senior management and shall carry out evaluation of individual director‘s performance.”

6. The Companies Bill 2011 recommended that instead of two committees there can be only one committee for Nomination and Remuneration.

7. There is no discussion on the insertion of word “Senior management” in the objects of the Bill in 2009 and 2011.

8. Hence, this is not helping us for taking appropriate view for question which this article deals with.

F. Principles of interpretation: –

1. Lets look at the language of the relevant sub-section / schedule. Sub-section (2) of section 178 of the Act and Point 4 of Schedule II-Part D of the SEBI LODR has same provision as under:- “Identifying persons who are qualified to become directors and who may be appointed in senior management in accordance with the criteria laid down…”
2. Now here “and” is creating confusion – Whether it means..
   • Identifying persons who are qualified to become directors,
   • Identifying persons who may be appointed in senior management

Or

Whether it means

a. Identifying persons who are qualified to become directors and who may be appointed in senior management ?

3. We need to understand the meaning of the sentences when the word “and” is used to connect two sentences.

4. Use of word “and” whether it is used as conjunction?

As stated in the Maxwell’s Interpretation of Statutes, in ordinary usage, ‘and’ is conjunctive (that connects words, phrases and clauses in a sentence) and ‘or’ is disjunctive (that separates words, phrases and clauses in a sentence). Thus, ‘and’ connects two or more items and makes a cumulative group of them whereas ‘or’ separates two or more items and makes them alterative to one another. Normally the word “and” should be given its ordinary meaning and should be understood in a conjunctive sense.

The word “and” is always used as a conjunction between the first part of a sentence and the second part of a sentence, and how word “or” is used to denote an alternative in a series of exclusive arrangements.[1]

The expression ‘and’ has generally a cumulative effect, requiring the fulfilment of all the conditions that it joins together and it is the antithesis of ‘or’.[2]

5. If we apply that “and” is acting as conjunction between “Identifying persons who are qualified to become directors” and “who may be appointed in senior management” then fulfilment of both the conditions is necessary. It means only those persons who are qualified to become directors only, NRC recommendation needed for appointment of SMP. If “and” is used as conjunction here, it is giving absurd meaning. If NRC wants to screen for directorship level why it will recommend someone for SMP level and vice versa.

6. It has been held in series of judgements that the word and should be given its ordinary meaning and should be understood in a conjunctive sense, unless it would lead to an absurd situation or an unintelligible result.[3]

7. To carry out the intention of the legislature it may be necessary to read “and” in place of the conjunction “or”, and vice versa”[4]. It is settled law that expression “and” may be read as “or” in order to further the object of the statute and /or to avoid an anomalous situation.[5]

8. If we apply that and is acting as conjunction between “Identifying persons who are qualified to become directors” and “who may be appointed in senior management it is leading to absurdity. Hence we need to read “and” here as “or”, then it is giving correct meaning.

9. One more angle to this statement if “comma” could have been used to separate these two statements as independent. Though punctuation is a minor aid to interpretation, if a “comma” was used before the word “and” it could have separated two sentences. B.K.Mukherjea J,. in Aswini Kumar Ghose V Arabinda Bose AIR 1952 SC 369,p 383 :1953 SCR1.” But it would appear, at any rate, with respect to modern statues, that if the statute in question is found to be carefully punctuated, punctuation, through a minor element, may be resorted to for purposes of construction.

10. These two sentences actually are independent..(a) to identify persons who are qualified to become director (b) to identify person who may be appointed in senior management.

11. Following table shows the correct way of reading sub-section(2) of section 178 of the Act.

12. Too many compliances inserted in sub-section (2) of section 178 of the Act. It also contains the provision to specify manner of evaluation of performance of Board, its committees and individual director. This could have been elaborated in separate sub-sections under section 178 of the Act.

G. Lets see if regulator had passed any order clarifying role of NRC in case of SMP appointment.

• Final Order against Ms.Chitra Ramkrishna and others  WTM/AB/MRD/DSA/21/2021-22 (National Stock Exchange of India Limited)
• In this case, Mr. Anand Subramanian was appointed as consultant directly by Managing Director Ms. Chitra Ramkrishna without following HR, NRC processes.
• His compensation was more than the KMPs in the Company.
• He got increments which are of highest ratings without following the processes and without any documentation.
• His appointment itself as consultant to MD was questioned by SEBI looking at his background and experience.
• Mr. Anand Subramanian was having substantial executive powers akin to Managing Director, he used to attend board meetings and the various heads of departments reporting to him, it was deemed that Mr. Anand Subramanian was not merely a consultant.
• It was employment in substance.
• The order indirectly depicts the role of NRC that it cannot act as passive committee. It must look at independently for appointment of SMPs, KMPs advisors with executive powers and highly compensated executives.
• NRC should have screened it from following lenses:-

1. Why was this person selected?
   1. Was there a comparative evaluation?
   1. Was the candidate suitably qualified ?
   1. Was the designation structured to bypass governance controls?

H. Conclusion

1. If we read “and” used in sub-section (2) of section 178 of the Act and Schedule II -Para D (4) of SEBI LODR as conjunction, it is giving absurd meaning.
2. If we read “and” as “or” and apply purposive interpretation it is giving us the proper meaning of the provision. The comma before the word “and” could have made it clearer.  
3. The order passed by SEBI in case of NSE as stated in paragraph F above, makes the role of the NRC clear even to screen, evaluate, identify persons for the core positions included in the definition of SMP.

[1] Indian Medical Association V Union of India 2011 AIR SCW 3469

[2] M. Satyanarayana V State of Karnataka (1986) 2 SCC 512; AIR 1986 SC 1162

[3] Chintalpati Srinivas Raju V Securities and Exchange Board of India AIR 2018 SC 2411

[4] Maxwell on Interpretation of Statutes, 12^th edn, page 232

[5] Mobilox Innovations Pvt Ltd V Kirusa Software Pvt Ltd AIR 2017 SC 4532

This article is published on taxmann link below.

https://www.taxmann.com/research/company-and-sebi/top-story/105010000000028470/whether-recommendation-of-senior-management-is-role-of-nrc-opinion

The post Whether recommendation of Senior Management is role of NRC? first appeared on MMJC.

The Companies Act, 2013 offers two distinct exemptions that, when combined, create a legal paradox for intermediate holding companies. Specifically, if an intermediate holding company avails exemption from preparing Consolidated Financial Statements (CFS), does it inadvertently lose exemption from shareholders’ approval for Related Party Transactions provided under fourth proviso of Section 188(1)?

This article examines whether this literal interpretation, which creates an irreconcilable hurdle, can be reconciled through a purposive reading of the statutory framework.

Exemption From Consolidation

As per Section 129(3) of the Companies Act, 2013 r/w Rule 6 of the Companies (Accounts) Rules, 2014 (Accounts Rules), preparation of consolidated financial statements by a company is exempt if it meets the following conditions:

1. If Company is Wholly Owned Subsidiary or is a partially-owned subsidiary of another company and all its other members, including those not otherwise entitled to vote, having been intimated in writing for not objecting for consolidation and proof of the same is maintained by the Company;

2. No securities of Company are Listed or Proposed to be listed on any stock exchange, whether in India or outside India; and

3. its ultimate or any intermediate holding company files consolidated financial statements with the Registrar.

Exemption from Shareholders approval u/s 188

The fourth proviso to Section 188(1) exempts transactions between a holding company and its WOS from the requirement of shareholders’ approval. However, this relief is strictly conditional:

“…whose accounts are consolidated with such holding company and placed before the shareholders…”

Literal Rule V. Purposive Interpretation

The phrase “such holding company” in Section 188 indicates that for claiming said exemption, the consolidation must happen at the level of the company entering the transaction.

If we apply Literal Rule, the scenarios can be as follows:

· The Ultimate Parent (A Ltd): Since A Ltd prepares the CFS, any transaction between A Ltd and its step-down WOS (C Ltd) is exempt from shareholder approval. The accounts are consolidated at this level.

· The Intermediate Parent (B Ltd): If B Ltd enters into a transaction with its direct WOS (C Ltd), it faces a hurdle. Because B Ltd chose not to prepare CFS (relying on Rule 6), it cannot satisfy the condition that the accounts are “consolidated with such holding company” (B Ltd).

Purposive Interpretation

The purposive interpretation of the fourth proviso to Section 188(1) suggests that the legislative intent is to ensure transparency. If the ultimate parent consolidates the entire group, the underlying financial position of every subsidiary is already disclosed to the stakeholders who hold the actual economic interest.

Unlike Section 177, which protects creditors through Audit Committee oversight, Section 188 is purely shareholder centric. In a vertical structure, the ultimate shareholders already have “informed oversight” through the ultimate consolidation. Therefore, requiring an additional shareholder vote at the intermediate level offers no extra protection to shareholders. It therefore appears that intermediate holding companies can claim the exemption under the fourth proviso to Section 188(1)

Conclusion

The fourth proviso to Section 188(1) is not an independent requirement, but a consequential trigger. One may take a view that it does not exist to create a new obligation for consolidation; rather, it built upon the obligation created by Section 129 i.e. when consolidation is mandatory as per section 129.

The proviso uses the phrase “whose accounts are consolidated.” This refers to the financial statements that a company is legally mandated to prepare under the Accounting Rules1. If the law (Rule 6) provides a specific exemption from preparing CFS, then the legal “mandatory” requirement for consolidation at that level ceases to exist. If the obligation to consolidate is extinguished by an exemption, the subsequent condition (“and placed before shareholders”) loses its subject matter.

If the proviso were interpreted as an absolute factual requirement, then any company exempt under Rule 6 would be effectively disqualified from the RPT exemption. This would create a legislative absurdity. However, to ensure absolute certainty and avoid the risk of transactions being deemed voidable, an MCA clarification to this effect remains necessary.

By Abhishek Gupta and Vrushali Bhave Athavale

This article is published on taxguru link below.

https://taxguru.in/company-law/saving-consolidation-cost-rpt-approval.html

The post Does Saving on Consolidation Cost You an RPT Approval? first appeared on MMJC.