Introduction

The investment manager (“IM”) of ABC InvIT proposes to appoint a statutory auditor for the InvIT. The proposed auditor has requested a tenure of three years. The IM, however, is of the view that Regulation 10(6) of the SEBI (Infrastructure Investment Trusts) Regulations, 2014 (“InvIT Regulations”) requires the auditor to be appointed for a five-year tenure

The question is whether Regulation 10(6) prescribes a maximum tenure, within which a shorter term may be fixed, or mandates the tenure specified in the provision. This article examines that question.

Regulatory framework

The provisions governing the appointment and tenure of an InvIT’s auditor are contained in Regulations 10(6) and 10(6A) of the InvIT Regulations. Before the 2023 amendment, Regulation 10(6) permitted the auditor to be appointed for a period not more then five consecutive years and to be reappointed for another period of five consecutive years, subject to the applicable conditions. The expression “not more then” indicated a ceiling. On that language, a shorter initial tenure was arguably permissible

The 2023 amendment

On 14 February 2023, Regulation 10(6) was substituted, with effect from 1 April 2023. The amended provision states that the auditor shall hold office from the conclusion of the annual meeting at which the auditor is appointed until the conclusion of the sixth annual meeting. Regulation 10(6A) was also inserted to govern reappointment and the maximum number of consecutive terms

Effect of the Amended Language

Following the amendment, Regulation 10(6) no longer uses language merely prescribing a maximum period. It fixes both the commencement and the expiry of the auditor’s term: from the conclusion of the annual meeting at which the appointment is made to the conclusion of the sixth annual meeting. The amended language therefore prescribes the tenure itself, rather than merely setting its outer limit.

Further the intentional removal of words “not more than” makes it clear that the term of 5 years is a fix term and cannot be less then that. Additionally, if we refer the language of reg 10(6), it is seen that the provision uses the word “shall hold office” while specifying the term. As per principles of interpretation of statutes, the use of word “shall” in the provision of a statute, indicates that the action followed by the word “shall” is mandatory. That means, if the provision states that auditor should be appointed for 5 years, then appointment has to be made for 5 years. The entity making the appointment does not have a choice with respect to the term in such case.

This interpretation is consistent with SEBI’s stated objective behind the amendment. In its December 2022 Board Meeting release, SEBI described the proposal as one intended to align the tenure of auditors of REITs and InvITs with that under Companies Act 2013 . The structure of amended Regulation 10(6) is also broadly aligned with Section 139(1) of the Companies Act, 2013, under which an auditor ordinarily holds office from the conclusion of the appointing annual general meeting until the conclusion of the sixth annual general meeting. The Companies Act framework therefore provides useful corroborative context, although the conclusion under the InvIT Regulations follows sprimarily from the language of Regulation 10(6) itself.

Conclusion.

The earlier provision allowed an auditor to be appointed for a period of up to five years. After the 2023 amendment, Regulation 10(6) prescribes a five-year term instead of merely fixing a maximum limit. So, to answer the question we saw at the beginning, the IM’s view is correct, and the auditor cannot be appointed at the outset for only three years. However, the auditor may leave office earlier due to resignation, removal, disqualification or any other legally permitted reason.

The article is written by

Rutuja Umadikar – Deputy Manager

This article is published on taxguru link below.

https://taxguru.in/sebi/invit-auditor-tenure-years-shorter-term.html

The post InvIT Auditor Tenure: Five Years or a Shorter Term? first appeared on MMJC.

Background

The concept of “material subsidiary” under the SEBI Listing Obligations and Disclosure Requirements Regulations, 2015 (“SEBI LODR”) is an important group governance requirement for listed entities.  A practical issue arises where:

1. the subsidiaries have negative net worth or
2. where the consolidated net worth of the listed entity and its subsidiaries itself is negative.

In such cases, the question is whether the subsidiary can still be identified as a material subsidiary and whether the turnover test can be applied independently?

Relevant provision under SEBI LODR

Regulation 16(1)(c) of SEBI LODR defines “material subsidiary” to mean a subsidiary whose turnover OR net worth exceeds 10% of the consolidated turnover or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year.

The definition therefore contains two independent parameters:

1. Turnover test; OR
2. Net worth test.

The use of the word “OR” is significant. It indicates that a subsidiary may qualify as a material subsidiary if it satisfies either the turnover test or the net worth test.

Further, Regulation 16(1)(c) also requires the listed entity to formulate a policy for determining material subsidiary. Therefore, the regulation gives a statutory threshold but also expects the listed entity to have a documented policy for identification of material subsidiary in case thresholds are not relevant to identify material subsidiary. The following four questions consequently arise.

Q1. If the net worth figure is negative as specified under regulation 16(1)(c ) of SEBI LODR, what shall be the criteria for determination of material subsidiary?

Where the networth of the subsidiary is negative but net worth of consolidated entity is positive then, the negative net worth of the subsidiary is  not comparable with a positive consolidated net worth. The net-worth test would, therefore, not be satisfied. In this case, the turnover test must be applied and ascertained whether subsidiary would be considered as material subsidiary or not? However, a subsidiary with a substantial negative net worth may create greater risk for the listed entity than a subsidiary with a positive net worth.   

Now looking at a situation where the consolidated net worth of the listed entity and its subsidiaries is negative or zero. In this situation ten per cent of a negative consolidated net worth would itself be negative. A mechanical comparison may consequently produce anomalous results for example, a subsidiary with a small positive net worth may technically “exceed” the negative threshold, while a subsidiary having a substantial negative net worth may not.

In order to tackle such situations, the material-subsidiary policy may, therefore, adopt a stricter criterion based on the absolute value of negative net worth, accumulated losses, guarantees, funding exposure or similar factors. Such an additional test would expand governance oversight rather than dilute the LODR threshold.

Q2. Can the listed entity follow only one of the two parameters?

No. The word “OR” makes turnover / net worth alternative and independently sufficient tests. It does not give the listed entity an option to select whichever parameter it prefers. Accordingly, both materiality criteria needs to be checked with turnover and net worth respectively. It may happen that in a particular situation one of the criteria for determining materiality is not relevant. In such scenario that criteria may not be relevant and hence policy for determining materiality of subsidiaries would come into play.

Where one parameter becomes arithmetically distorted because the denominator is zero or negative, the other parameter continues to operate independently, but the difficulty concerning the affected parameter must be addressed through a reasoned and documented process that may be provided under the policy for determining of material subsidiary

Q3. Why is a policy required for determination of material subsidiary when SEBI LODR already prescribe the criteria expressly for determination of material subsidiary?

Reg. 30(4) of SEBI LODR prescribes criteria for determination of materiality for the purpose of disclosure of events or information to stock exchange. It provides for three criteria for determination of materiality for the purpose of disclosure of events or information as per Sch III, Para B of SEBI LODR viz. 2% of net worth, 2% of turnover or 5% avg of absolute value of profit after tax for last three financial years. In addition to this reg. 30(4) provides for determination of other criteria for determination of material events or information that may form part of the policy on determination of materiality. Further Reg 23(1) of SEBI LODR provides for framing of policy on determination of material related party transactions. Reg. 23 provides that transactions with related party would be material once they cross threshold specified under Sch XIII of LODR.

It can be seen that when it comes to determination of materiality, SEBI has in LODR not only prescribed the threshold for determining materiality but has empowered the listed entity to frame policy.

It is seen that when it comes to assessment of materiality, SEBI has provided for framing policy for determination of materiality in addition to prescribing threshold for ascertainment of materiality, in order to ensure that the determination of materiality is always holistic in nature. Policy for determining materiality of subsidiary or otherwise is always prescribed in order to further the purpose of identification of material subsidiary.

Hence the policy requirement is not redundant but has to be applied for where the identification of subsidiary as material subsidiary only on the basis of turnover or net worth would not be correct in the context of the compliances that are made applicable to material subsidiary under LODR.

The policy for determination of material subsidiary may address matters such as:

• the financial statements and accounting figures to be used;
• treatment of foreign, step-down and newly acquired subsidiaries;
• treatment of negative or zero net worth;

• responsibility for preparing and verifying the calculations;
• monitoring of subsidiaries approaching the threshold;
• treatment of mergers, demergers or changes in the group structure;
• cover subsidiaries having significant borrowings, guarantees or funding exposure;
• identify strategically or operationally critical subsidiaries; or
• additional qualitative or quantitative criteria requiring enhanced oversight.

Q4. What is the role of the board in identifying and overseeing material subsidiaries?

Its role is to ensure that the criteria for determination of material subsidiary is applied across all subsidiaries uniformly and check whether it is relevant to determine subsidiary as per the criteria laid down in SEBI LODR.

Where it is not relevant to identify material subsidiary as per the criteria laid down in SEBI LODR then ensuring that the policy for determination of material subsidiary has all the relevant criteria for same.

The board cannot override the statutory formula merely because it considers a subsidiary to be immaterial.

The board should ensure that:

1. The policy for identification of material subsidiary is appropriately framed, approved and periodically reviewed and identification of material subsidiary is done accordingly;

The board’s oversight is not confined only to material subsidiaries. Regulations 24(2), 24(3) and 24(4) refer to unlisted subsidiaries, rather than only unlisted material subsidiaries. Consequently, the audit committee must review the financial statements and investments of unlisted subsidiaries, while their board minutes and significant transactions must be brought before the board of the listed entity.

Conclusion

A holistic assessment of materiality does not permit the listed entity to depart from the statutory thresholds. It requires the company to apply both prescribed parameters, recognize the limitations of a purely arithmetic exercise and supplement the statutory tests with stricter and consistently applied policy criteria. The policy may expand the universe of subsidiaries receiving enhanced oversight, but it cannot narrow the scope prescribed by the LODR Regulations. The board must ultimately ensure that the identification process is annual, reasoned, documented and aligned with the governance consequences flowing from Regulations 24, 24A, identification of designated persons under Reg. 9 of PIT and 30. It is advisable for the listed entity to initiate tracking for material subsidiary classification as soon as a subsidiary’s turnover or net worth attains 8% to 9% of the consolidated turnover or net worth of the listed entity.

The article is written by

Vallabh Joshi  – Associate Director

This article is published on taxguru link below.

https://www.taxmann.com/research/company-and-sebi/top-story/105010000000028925/identification-of-material-subsidiary-where-the-consolidated-net-worth-of-listed-entity-and-its-subsidiaries-is-negative-opinion

The post Identification of Material Subsidiary where Subsidiaries / Consolidated Net Worth is Negative first appeared on MMJC.

Background

The Companies Act, 2013 (herein referred to as “the Act/Act”) has introduced several provisions regulating borrowings and private placements by companies. Subsequently, the Ministry of Corporate Affairs (MCA) granted various exemptions to private companies through notifications. One such exemption has given rise to an apparent inconsistency when read alongside the provisions governing private placement of Non-Convertible Debentures (NCDs).

This article examines the chronology of the relevant provisions and analyses whether a private company can simultaneously claim the exemption from passing a special resolution under Section 180(1)(c) and the exemption under Section 42 for issuance of NCDs.

Chronology of Relevant Provisions

• Notification of Section 180

Section 180 of the Companies Act, 2013 was notified with effect from 12 September 2013 which provides certain conditions for borrowings for any COMPANY registered under the Act :

“the Board of Directors shall exercise the power to borrow money, where the money to be borrowed together with the money already borrowed exceeds the aggregate of the company’s paid-up share capital, free reserves and securities premium, only with the consent of the members by way of a special resolution”

• MCA Notification dated 5 June 2015

The Ministry of Corporate Affairs, vide Notification G.S.R. 464(E) dated 5 June 2015, granted exemptions to PRIVATE companies out of which One of the significant exemptions provides that:

“Section 180 shall not apply to a PRIVATE company”

Accordingly, a private company is no longer required to obtain shareholders’ approval by way of a special resolution under Section 180(1)(c), irrespective of the amount of its borrowings.

• Notification and Amendment of Section 42

Section 42 read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014, (herein refereed to as “Rule 14” ) to Private Placement was also brought into force on 12 September 2013. Thereafter, the provision underwent substantial amendments through the Companies (Amendment) Act, 2017, effective 7 August 2018 in which specific exemption is given for those COMPANIES who are issuing NCD’s which exceeds the limits of Section 180 (1) (c ) to not comply with sub-reg 14(1) i.e. passing of special resolution for issuance of NCD’s via private placement in case a prior approval under section 180 (1) (c) exists. The extract of the second and third proviso to rule 14 has been provided below:

“Provided further that this sub-rule shall not apply in case of offer or invitation for. non-convertible debentures, where the proposed amount to be raised through such offer or invitation does not exceed the limit as specified in clause (c) of sub section (1) of section 180 and in such cases relevant Board resolution under clause (c) of subsection (3) of section 179 would be adequate”

“Provided also that in case of offer or invitation for non-convertible debentures, where the proposed amount to be raised through such offer or invitation exceeds the limit as specified in clause (c) of sub-section (1) of section 180, it shall be sufficient if the company passes a previous special resolution only once in a year for all the offers or invitations for such debentures during the year”

A tabular representation  has been given below to simply the anomaly:

The Apparent Anomaly Since Section 180 does not apply to a private company, the question arises whether a private company can issue NCDs of any quantum solely via a Board resolution under Section 179(3)(c), or whether it must still pass a special resolution under Rule 14.

Two Schools of Thought

School 1: The Blanket Exemption Approach Section 180 is not applicable to a private limited company by virtue of the MCA exemption notification Consequently, pursuant to the second proviso to Rule 14(1) of the Companies (Prospectus and Allotment of Securities) Rules, 2014 (PAS Rules), a Board resolution passed under Section 179(3)(c) constitutes sufficient compliance for the issuance of Non-Convertible Debentures (NCDs) via private placement under Section 42 of the Companies Act, 2013.

Thus, requiring a private company to pass a special resolution under Section 42 for every offer of non-convertible debentures (NCDs) on the premise that Section 180 does not apply indirectly reintroduces a compliance burden from which the Ministry of Corporate Affairs (MCA) expressly exempted private companies via its official notification.”

Accordingly, under the first approach the interpretation can be that since there is no limit for borrowings under section 180 for private limited companies, a board resolution passed under section 179 shall be a sufficient compliance under section 42 of Companies Act, 2013 and thus it can be said that the inability to satisfy this condition under Rule 14 is a consequence of a statutory exemption and not of any non-compliance and therefore private companies should not be denied the benefit intended under Rule 14 of the Act.

However, will this approach actually sever the intention of Section 42 read with Rule 14 of the Act? Will it not render the second proviso redundent?

Harmonious Interpretation: Treating Section 180(1)(c) as a Mathematical Benchmark

The exemption provided under Rule 14 for issuance of NCD’s is principally to avoid duplication of approvals taken to the shareholders of the Company and thus once the shareholders have approved the overall borrowing capacity under section 180 (1) (c ) of the Act, the issuance of non-convertible debentures ordinarily represents only the mode or instrument through which that borrowing authority is exercised via Section 42 read with Rule 14 of the Act.

Now, while analysing this from the lense of a private Company, basis to the exemption received via MCA Notification; section 180 has been exempted to private companies and thus, any amount of borrowings can be done by a private company via Board resolution under Section 179 of the Act without taking the matter to the shareholders of the Company.

Thus an alternative view may be that the exemption granted to private companies from Section 180 cannot be extended so as to dilute the independent approval requirement prescribed under Section 42 read with Rule 14. The MCA Notification dated 5 June 2015 only exempts private companies from the restrictions on the borrowing powers of the Board under Section 180. It does not expressly exempt them from the private placement framework under Section 42 or from the requirement of obtaining shareholders’ approval for an offer or invitation of non-convertible debentures.

Treating a Board resolution under Section 179(3)(c) as a substitute for a special resolution under Section 42 lacks statutory backing and risks rendering the third proviso to Rule 14(1) redundant.

Applying the rule of harmonious construction which requires apparently conflicting provisions to be interpreted in a manner that preserves the operation and purpose of each provision, the reference in Rule 14(1) to the “limit as specified in clause (c) of sub-section (1) of section 180” must be construed as a numerical benchmark (aggregate of paid-up share capital, free reserves, and securities premium) rather than a condition precedent regarding the operative applicability of Section 180 itself. This interpretation reconciles both provisions effectively: it preserves the Board’s unrestricted general borrowing power under Section 180 for private companies while retaining shareholder oversight under Section 42 read with Rule 14 whenever NCD issuances breach the statutory financial threshold.

Conclusion

The interplay between the exemption granted to private companies under the MCA Notification dated 5 June 2015 and the exemption available under Section 42 read with Rule 14 presents a genuine interpretative issue under the Companies Act, 2013.

While one line of reasoning, based on the rule of harmonious construction, suggests that a private company should not be denied the benefit of Rule 14 merely because it is statutorily exempt from Section 180, an equally plausible interpretation is that the relaxation under Rule 14 is predicated upon prior shareholder approval of the company’s borrowing capacity under Section 180(1)(c). Since a private company does not obtain such shareholder approval, the very foundation for dispensing with a separate special resolution under Section 42 may be absent.

Thus, from a legal-risk and governance perspective, obtaining a special resolution under Section 42 read with Rule 14 for the private placement of non-convertible debentures by a private company, particularly where the proposed borrowings exceed the thresholds referred to in Section 180(1)(c), appears to be the more prudent and defensible course. Such an approach mitigates potential compliance risk without materially prejudicing the company’s ability to raise funds.

The article is written by

Krishna  Shah – Senior Manager

This article is published on taxguru link below.

https://www.taxmann.com/research/company-and-sebi/top-story/105010000000028916/issuance-of-ncds-by-private-companies-a-compliance-anomaly-under-the-companies-act-2013-opinion

The post Issuance of NCDs by Private Companies: A Compliance Anomaly under the Companies Act, 2013 first appeared on MMJC.

Introduction.

As a students of English language, we have been learning various punctuation marks and their different uses at different places, since our school days. However, now is the time to understand one of the crucial functions of punctuation, which is, aiding the Courts in interpreting the statutes in the most unambiguous manner possible.

Both Indian and international, Courts have time and again clarified that punctuation marks can be used to clear confusion and understand the exact meaning of statutes. In this article, we shall make an effort to understand how one of such punctuation marks, “the oxford comma”, helps the Courts in clearing the ambiguity around the meaning of any provision of law.

Concept of oxford comma

Before understanding how an oxford comma helps in interpreting statutes, let us first understand, what exactly is meant by oxford comma and how does it help in interpretation of statutes.

Meaning of oxford comma

An oxford comma, also known as the serial comma, is a comma placed before a conjunction used before the last item of any list. For example, Apples, Oranges, and Mangos. The comma placed after Oranges and before and is the oxford comma. It can also be used after conjunction “or”. There is no fixed rule for use of this type of comma. its use is optional and depends upon writer’s own style of writing. However, it is recommended to use the oxford comma before conjunction and last item of the list wherever there is a possibility that the last 2 items of the list may be read as one combined category.

Function of oxford comma

The function of an Oxford comma is to make the meaning of a sentence clearer by showing that each item in a list is separate and independent. It reduces the chances of the last two items being read as a single group, thereby avoiding ambiguity. This comma acts as an aid to interpretation by helping the Courts understand how the law maker intended the words to be grouped. Although courts do not decide cases based on punctuation alone, the presence or absence of an Oxford comma may help in adopting an appropriate interpretation, especially when there can be more than one reasonable interpretation of same provision.

Let us try to understand this with the help of a general example.

Suppose the sentence reads as, “we met the directors, Mr. ABC, and Mr. XYZ.” Here, the comma present after Mr. ABC and before conjunction “and”, makes it clear that we met 2 separate persons named ABC and XYZ who are different from directors.

However, if the sentence reads as, “we met directors, Mr. ABC and Mr. XYZ.” There are 2 possible interpretations.

1. We met the directors and 2 different persons other then the directors whose names were ABC and XYZ. And
2. We met 2 directors whose names were ABC and XYZ.

The presence of oxford comma helps eliminate multiple interpretations of the same provision and reach the one correct interpretation which the law maker intended to have.

Judicial pronouncement illustrating the use of oxford comma

While discussing the role of oxford comma in the interpretation of statutes, reference has to be made to an American judgment in the matter of O’Connor v. Oakhurst Dairy. This judgment was passed by the American first circuit Court in March 2017. In this case, the Court was required to determine, whether or not, the dairy delivery drivers were exempt from the state laws with respect to overtime.

As per the facts of the case, the dairy delivery drivers demanded an overtime pay for their job. But the state laws exempted some workers belonging to food and agriculture industry from requirement of being paid overtime. The state laws stated that wage and hour laws do not apply to “canning, processing, preserving, freezing, drying, marketing, storing, packing for shipment or distribution”.

Before going forword, a point worth noting here is that, there is no oxford comma present before the conjunction “or” and the last list item, that is, distribution.

The delivery drivers argued that they were not exempt from the overtime laws, since “packing for shipment or distribution” meant packing for shipment and packing for distribution. The actual distribution wasn’t exempted. Whereas, the dairy argued that, packing and distribution were separate items in the exemption list and both were exempt.

Referring to the missing Oxford comma, the First Circuit Court observed that, “For want of a comma, we have this case.” The absence of the Oxford comma made the statutory provision ambiguous, allowing both parties to offer different but reasonable interpretations. As the ambiguity could not be resolved through ordinary rules of interpretation, the court applied the rule of purposive interpretation and interpreted the provision in favour of the employees. The case highlights the importance of the Oxford comma in interpretation of statutes.

Even though this is a foreign judgment, The practical importance of the Oxford comma can also be seen in Indian regulatory drafting. The following definition under the SEBI (InvIT) Regulations illustrates how a single comma helps avoid ambiguity.

Example of oxford comma under SEBI INVIT regulations 2014

The convenience caused due to presence of oxford comma can be understood by referring to the definition of “senior management” in clause (zxb) of regulation 2(1) of SEBI Infrastructure Investment Trust regulations 2014 (INVIT regulations). The definition reads as under.

(zxb)] “Senior Management” means the officers and personnel of the investment manager who are members of its core management team, excluding the Board of Directors, and shall also comprise all members of the management, one level below the Chief Executive Officer or Managing Director or Whole Time Director or manager (including Chief Executive Officer and manager, in case they are not part of the Board of Directors) and shall specifically include the Compliance Officer and Chief Financial Officer;]

The definition provides list of persons who may be included in the category of senior management. The first part being that of the core management team excluding the board of directors and the second part being that of all members of the management one level below the Chief Executive Officer, Managing Director, Whole-Time Director, or Manager. Both these parts are separated by an oxford comma placed before the words “and shall also comprise”.

The comma before “and shall also comprise” plays an important role in understanding this provision. It clearly indicates that the qualifying phrase relating to first category, “excluding the Board of Directors”, has come to an end and that the definition is now introducing an additional category of persons.

Now imagine the same provision without this comma. The sentence would read: “…excluding the Board of Directors and shall also comprise all members…” such drafting may have left scope for multiple possible interpretations. One possible argument could be that the exclusion with respect to board of directors, and the words “and shall also comprise” form one continuous expression, while another argument could be that the provision contains two distinct categories. The court would then have to examine the language, context, and purpose of the regulation to determine which interpretation was intended. The comma helps avoid such unnecessary interpretative debates by clearly signalling where one idea ends and the next begins.

Not all commas after conjunction are oxford commas

While the previous example makes it clear that an oxford comma is one which appears after conjunction in a list of items and indicates that last item in the list is an independent item, it is necessary to keep in mind that not all commas appearing before a conjunction are oxford commas. Let’s understand this statement with the help of an example.

Take note of comma before the conjunction “and” in the following sentence.

“She agreed to attend and, despite her busy schedule, arrived on time.”

In this sentence, neither there is any list, nor the comma before “and” separates any list item. Therefore, in this sentence, the comma after “and” is not an Oxford comma. The words “despite her busy schedule” form an interrupting or parenthetical phrase. The two commas mark the beginning and end of that phrase, and give further information about her arrival on time.

Now let’s understand the same situation in context of a legal provision. The SEBI INVIT regulations define the term “INVIT assets” as follows,

(zb) “InvIT assets” means assets owned by the InvIT, whether directly or through a  [holdco and/ or] SPV, and includes all rights, interests and benefits arising from and incidental to ownership of such assets;

Since placed before a conjunction, at first glance, the comma before “and includes” may appear to be an Oxford comma. However, as discussed in the above example, it does not separate the last item in a list. Instead, it marks the end of the qualifying phrase—“whether directly or through a HoldCo and/or SPV”—and indicates that the definition is now moving to a separate and independent part. In other words, the comma tells the reader that the qualification regarding the manner of ownership has ended, and that the words “and includes” introduce an additional aspect of the definition. Thus, the comma performs a structural function by separating two distinct legal ideas, rather than an Oxford comma’s function of separating the final item in a series.

One way to understand this is to think of commas as brackets in mathematics. Consider the expressions 2 × (3 + 4) and (2 × 3) + 4. They contain the same numbers, yet the brackets group them differently and produce different results. Commas perform a similar function in legal drafting. They help the reader identify which words or phrases belong together and where one idea ends and another begins. In this definition, the comma makes it clear that the qualifying phrase has ended and that the drafter is introducing a new and independent part of the definition.

Conclusion.

The Oxford comma may appear to be a small punctuation mark, but its presence or absence can affect how a legal provision is understood. A comma is treated as an Oxford comma only where the following conditions are fulfilled.

1. There is a list of three or more items,
2. the comma appears before the final conjunction such as “and” or “or”, and
3. It separates the last item from the other items in the list.

However, every comma appearing before or after a conjunction is not an Oxford comma. Such a comma may merely separate two parts of a sentence, mark the end of a qualifying or parenthetical phrase, or indicate that one legal idea has ended and another has begun. Therefore, whether a comma is an Oxford comma depends upon the function it performs in the sentence and not merely upon its placement near the conjunctions, generally “and” or “or”.

Ultimately, courts do not decide cases on the basis of punctuation alone. They always consider the language, context, and purpose of the provision. However, where the wording is capable of more than one reasonable interpretation, punctuation, including the Oxford comma, may provide valuable guidance in understanding the intention of the law maker. Therefore, careful use of punctuation is not merely a matter of good drafting, it is also an important aid to legal interpretation.

The article is written by

Rutuja Umadikar – Deputy Manager

This article is published on taxguru link below.

https://taxguru.in/corporate-law/oxford-comma-small-punctuation-mark-big-legal-consequences.html

The post The Oxford Comma: A Small Punctuation Mark with Big Legal Consequences first appeared on MMJC.

Corporate groups often adopt multi-tier structures for operational efficiency, regulatory compliance, business segregation, investment management, risk isolation, and geographical expansion. While such structures may serve legitimate commercial objectives, excessive layering of subsidiaries can also result in opaque ownership patterns, reduced transparency, difficulty in regulatory supervision, and challenges in tracing the movement of funds within a corporate group.

Recognising these concerns, the legislature introduced restrictions on the number of subsidiary layers that a company may maintain. The framework seeks to strike a balance between legitimate business requirements and the need for transparency in corporate governance.

The Companies (Restriction on Number of Layers) Rules, 2017, notified under the Companies Act, 2013, impose a limitation on the number of subsidiary layers that may be maintained by a company. However, the Rules also contain a specific relaxation in respect of wholly owned subsidiary structures. This relaxation has given rise to an important interpretational question:

Does the law permit exclusion of every layer comprising wholly owned subsidiaries, or is the exemption restricted to only one such layer?

A careful examination of the statutory language, legislative intent, and accepted principles of interpretation suggests that the exemption is intended to be available only in respect of a single layer and cannot be repeatedly availed for multiple downstream layers.

This article seeks to analyse the provision in detail and provide clarity on the scope and limitations of the wholly owned subsidiary exemption.

Legislative Framework

Section 2(87) of the Companies Act, 2013

Section 2(87) defines a “subsidiary company” and, through its proviso, empowers the Central Government to prescribe the number of layers of subsidiaries that may be maintained by certain classes of companies.

Pursuant to such authority, the Central Government notified the Companies (Restriction on Number of Layers) Rules, 2017.

Rule 2(1) – The Principal Restriction

Rule 2(1) provides that:

“No company, other than a company belonging to a class specified in sub-rule (2), shall have more than two layers of subsidiaries.”

The Rule therefore establishes a general prohibition against maintaining more than two layers of subsidiaries.

The Rule contains two important provisos:

First Proviso

The restriction does not affect acquisition of a foreign company having subsidiaries beyond two layers where such layering is permitted under the laws of the country in which the foreign company is incorporated.

Second Proviso

The second proviso states:

“For computing the number of layers under this rule, one layer which consists of one or more wholly owned subsidiary or subsidiaries shall not be taken into account.”

It is this proviso that forms the subject matter of the present discussion.

Understanding the Concept of “Layer”

Before analysing the exemption, it is necessary to understand what constitutes a layer.

Consider the following structure:

Holding Company (H)
↓
Subsidiary A
↓
Subsidiary B
↓
Subsidiary C

In the above structure:

• Subsidiary A represents the first layer;
• Subsidiary B represents the second layer; and
• Subsidiary C represents the third layer.

Ordinarily, such a structure would exceed the permissible limit prescribed under Rule 2(1).

The second proviso permits exclusion of one qualifying layer consisting of wholly owned subsidiaries while computing the number of layers.

The Objective Behind Restricting Layers:

The Rules were introduced as part of a broader regulatory effort to promote transparency and accountability within corporate groups.

Historically, excessively layered structures have often been associated with:

• difficulty in identifying ultimate ownership;
• diversion or routing of funds through multiple entities;
• reduced transparency in financial reporting;
• challenges in regulatory monitoring; and
• creation of unnecessarily complex corporate arrangements.

The legislative objective therefore was not merely numerical restriction but enhancement of corporate governance standards.

Any interpretation of the exemption must consequently be consistent with this overarching objective.

Why Was an Exemption Provided for Wholly Owned Subsidiaries?

Corporate groups frequently utilise wholly owned subsidiaries for legitimate business reasons.

Some common examples include:

• segregation of business verticals;
• separating business risks and liabilities;
• holding investments through dedicated entities;
• regulatory requirements in specific sectors;
• ease of management and administration;
• geographical expansion and overseas operations.

Recognising these commercial realities, the legislature provided a limited relaxation by allowing one layer consisting entirely of wholly owned subsidiaries to be disregarded while computing the total number of layers.

The exemption therefore represents a practical accommodation of genuine business needs rather than an unrestricted permission to create complex structures.

The Critical Phrase: “One Layer”

The answer to the interpretational issue lies in the precise wording adopted by the legislature.

The proviso states that:

“one layer which consists of one or more wholly owned subsidiary or subsidiaries shall not be taken into account.”

The significance of the expression “one layer” cannot be overstated.

Had the legislative intent been to exclude all wholly owned subsidiary layers, the Rule could have employed phrases such as:

• every layer;
• any layer;
• all layers; or
• each layer consisting of wholly owned subsidiaries.

Instead, the legislature consciously chose the expression “one layer”.

Under settled principles of statutory interpretation, every word used in a statute must be given meaning and effect. An interpretation that renders a particular word redundant or meaningless must generally be avoided.

Accordingly, the expression “one layer” cannot be expanded to mean “multiple layers” or “all layers”.

The language itself indicates a limited exemption.

• Applying the Literal Rule of Interpretation

The literal rule requires that where statutory language is clear and unambiguous, effect must be given to the words used by the legislature.

The language employed in the proviso is straightforward.

The legislature has granted exemption to:

“one layer”

and not to:

“one or more layers”.

Therefore, applying the literal rule alone leads to the conclusion that only a single layer qualifies for exclusion.

Any interpretation permitting exclusion of multiple wholly owned subsidiary layers would amount to rewriting the provision rather than interpreting it.

• Applying the Mischief Rule

The mischief rule requires identification of:

1. the defect or mischief sought to be remedied;
2. the legislative solution introduced; and
3. the interpretation that best advances such solution.

The mischief sought to be addressed by the Rules was excessive and opaque corporate layering.

The solution adopted by the legislature was:

• restriction of subsidiary layers to two; and
• limited relaxation for one wholly owned subsidiary layer.

If every wholly owned subsidiary layer were allowed to be ignored, a company could theoretically create an endless chain of wholly owned subsidiaries without violating the Rule.

Such an interpretation would revive the very mischief that the legislation sought to eliminate.

Consequently, the mischief rule strongly supports a restrictive reading of the exemption.

• Applying Purposive Construction

A purposive interpretation seeks to advance the legislative intent behind a provision.

The purpose of the proviso appears to be:

• accommodating legitimate commercial structures; and
• avoiding hardship in cases where a wholly owned subsidiary is maintained for genuine business reasons.

The purpose does not appear to be granting unrestricted freedom to create unlimited subsidiary chains.

Accordingly, the interpretation that best aligns with legislative intent is one that permits exclusion of only a single qualifying layer.

Can Every Wholly Owned Subsidiary Layer Be Ignored?

The practical implications of this question may be understood through an illustration.

Illustration 1

Holding Company (H)
↓ 100%
WOS A
↓
Subsidiary B
↓
Subsidiary C

If WOS A is excluded from computation:

• B becomes first counted layer;
• C becomes second counted layer.

Result:

The structure remains within the permissible limit.

Illustration 2

Holding Company (H)
↓ 100%
WOS A
↓ 100%
WOS B
↓ 100%
WOS C
↓
Subsidiary D

Suppose all wholly owned subsidiary layers are ignored.

Then:

• WOS A ignored;
• WOS B ignored;
• WOS C ignored.

Only D would remain for computation.

This would mean that a company could establish an unlimited chain of wholly owned subsidiaries and still claim compliance.

Such an outcome would completely defeat the purpose of Rule 2.

Therefore, the proviso cannot reasonably be interpreted as permitting exclusion of every wholly owned subsidiary layer.

Is the Exemption Available More Than Once?

This is perhaps the most important compliance takeaway.

The proviso grants a computational benefit in respect of one qualifying layer.

It does not create a recurring exemption capable of being availed at every stage of the subsidiary chain.

Once a qualifying wholly owned subsidiary layer has been disregarded for computation purposes, subsequent layers continue to be counted in the ordinary manner.

The exemption is therefore best understood as:

A One-Time Exclusion

and not

A Repetitive Exclusion

This interpretation preserves both:

• the language of the proviso; and
• the purpose of the Rules.

Whether the Exempt Layer Must Necessarily Be the First Layer?

An interesting interpretational issue arising from the second proviso to Rule 2(1) is whether the layer consisting of wholly owned subsidiaries, which is permitted to be excluded for computation purposes, must necessarily be the first layer immediately below the holding company.

A careful reading of the provision reveals that the Rule does not expressly use the words “first layer”, “immediate layer” or any similar expression indicating the position at which the exemption must be applied. Instead, the proviso simply provides that, for the purpose of computing the number of layers, one layer consisting of one or more wholly owned subsidiaries shall not be taken into account.

The significance of this drafting is noteworthy. While the legislature consciously restricted the benefit to one layer, it did not prescribe the exact location of such layer within the subsidiary chain. Had the intention been to confine the exemption exclusively to the first layer beneath the holding company, the Rule could have expressly incorporated such a condition.

Accordingly, from a purely textual standpoint, the provision does not mandate that the exempted layer must always be the first layer. What is clear, however, is that the benefit can be availed only once in the entire structure.

Practical Compliance Considerations:

Before implementing group restructuring exercises, companies should carefully examine:

• existing subsidiary structures;
• number of downstream entities;
• identification of the qualifying wholly owned subsidiary layer;
• overall layer count after exclusion; and
• future expansion plans.

Compliance teams should avoid assuming that every wholly owned subsidiary automatically falls outside the scope of the Rules.

Such assumptions may inadvertently result in non-compliant structures.

A conservative and legally sustainable approach would be to treat the exemption as available only once while evaluating the layer count.

Key Takeaways:

• Rule 2(1) of the Companies (Restriction on Number of Layers) Rules, 2017 restricts companies from having more than two layers of subsidiaries, subject to specified exemptions.
• One layer consisting of one or more wholly owned subsidiaries is excluded while computing the number of layers.
• The expression used by the legislature is “one layer” and not “every layer” or “all layers”.
• The exemption is therefore a limited computational benefit and not a blanket exclusion for all wholly owned subsidiary layers.
• Permitting exclusion of multiple WOS layers would defeat the very objective of the Rules and render the restriction largely ineffective.
• While the Rule does not expressly state that the exempted layer must be the first layer, it clearly contemplates exclusion of only one qualifying layer in the entire structure.

Conclusion:

The restriction on layers of subsidiaries constitutes an important corporate governance measure designed to enhance transparency and discourage unnecessarily complex group structures.

While the legislature recognised legitimate business needs by providing a relaxation for wholly owned subsidiary structures, the relaxation is carefully worded and intentionally limited.

The use of the expression “one layer” demonstrates a clear legislative intent to grant only a narrow computational benefit rather than a blanket exclusion for all wholly owned subsidiary layers.

A combined application of the literal rule, mischief rule, and purposive interpretation leads to a consistent conclusion: the proviso permits exclusion of only one qualifying layer consisting of wholly owned subsidiaries and does not allow repeated exclusion of multiple downstream wholly owned subsidiary layers.

Any contrary interpretation would dilute the effectiveness of the Rules, defeat their regulatory purpose, and render the statutory restriction largely ineffective.

Accordingly, for purposes of compliance and corporate structuring, the more legally sound view is that the exemption is available only once and only in respect of a single qualifying wholly owned subsidiary layer, after which all remaining layers must be counted while determining compliance with the prescribed limit.

The wholly owned subsidiary exemption is therefore an exception to the rule—not an avenue to circumvent it.

The article is written by Ms. Devika Anghe – Deputy Manager.

The post Restriction on Layers of Subsidiaries: Wholly Owned, Not Wholly Exempt first appeared on MMJC.

Introduction:

The Corporate Laws (Amendment) Bill, 2026 proposes an important change to Section 185 of the Companies Act, 2013 by bringing Limited Liability Partnerships (“LLPs”) within the specific prohibition relating to loans, guarantees and securities.

At first glance, the proposed amendment may appear straightforward. However, a more nuanced question arises when the LLP itself does not have the concerned directors as its partners, but has body corporates as its partners, with individuals nominated by those body corporates acting as designated partners of the LLP.

The question that arises in the above structure is:

“Whether an advance of a loan by a company to a Limited Liability Partnership (LLP) is prohibited or restricted under Section 185 of the Companies Act, 2013, where the partners of the LLP are exclusively bodies corporate, and the individuals nominated by such bodies corporate to act as Designated Partners are also directors of the lending company?

The answer requires a careful examination of the Companies Act, the LLP Act and, importantly, the language employed in the proposed amendment.

The distinction between a “partner” and a  designated partners who are nominees of” body corporate” therefore becomes central to this analysis. While the LLP Act recognises an individual nominated by a body corporate to act as a designated partner, the underlying partnership interest may continue to vest with the body corporate itself.

This gives rise to an important question of statutory interpretation: should the expression “partner” in Section 185 be given its ordinary statutory meaning, or should it be expanded to include an individual who acts as a nominee/designated partner on behalf of a body corporate?

This article examines these aspects and evaluates the interpretative principles that may be applied in determining whether such a loan would fall within the proposed prohibition.

In order to understand the above we need to the comprehend some provisions of Companies Act, 2013 and LLP Act, 2009

Section 185 of Companies Act, 2013

Prior to the proposed amendment, Section 185(1)(b) of the Companies Act, 2013, prohibited a company from advancing loans, or providing guarantees or securities, to “any firm in which any such director or relative is a partner.”

Because an LLP is a body corporate with a separate legal personality distinct from a traditional partnership firm, the narrow statutory use of the word “firm” created an interpretational loophole. Companies could circumvent the absolute prohibition under Section 185(1) by routing loans to LLPs in which their directors were partners, arguing that LLPs fell outside the ambit of “firms”.

To suppress this mischief and advance the legislative intent of curbing improper siphoning of corporate funds to director-controlled entities, the Corporate Laws (Amendment) Bill proposes to insert the words “or limited liability partnership” after “any firm” in Section 185(1)(b).

While the proposed amendment seeks to suppress the mischief of routing funds through LLPs by bringing them within the threshold of Section 185(1)(b), it gives rise to a fresh interpretational conundrum. The fundamental objective of Section 185 is to prevent the siphoning of corporate funds to entities where directors exert personal or proprietary influence. However, under Section 7 of the Limited Liability Partnership Act, 2008, where all partners in an LLP are bodies corporate, individual nominees must be appointed as Designated Partners.

This creates a critical question of statutory interpretation:

Where a company advances a loan to an LLP whose partners are exclusively bodies corporate, and the individuals nominated by those corporate partners to act as Designated Partners are also directors of the lending company, does such a transaction fall within the absolute prohibition of the amended Section 185(1)(b), or does it remain outside Section 185(1) on the ground that the directors are merely representative nominees and not ‘partners’ in their individual capacity?”

Let’s Analyses the definition of partner / designated partner under Limited Liability Act, 2009 to understand the above distinction between a designated  partner and a Designated partner as a Nominee .

Section 2(q) of the LLP Act defines

a “partner” in relation to an LLP as a person who becomes a partner in accordance with the LLP agreement.

Separately, Section 2(j) defines

a “designated partner” as a partner designated as such under Section 7.

Section 7(1) of the LLP Act say’s that

“Every limited liability partnership shall have at least two designated partners who are individuals and at least one of them shall be a resident in India:

Provided that in case of a limited liability partnership in which all the partners are bodies corporate or in which one or more partners are individuals and bodies corporate, at least two individuals who are partners of such limited liability partnership or nominees of such bodies corporate shall act as designated partners”

Thus, basis to the above reading of the provisions of LLP Act we can say that there is a visible distinction reflected in the LLP Rules, which separately capture:

• Individual partner
• the body corporate;
• its nominee;
• the designation of the individual; and
• the authority under which the nominee acts.

The Fillip form framework also specifically refers to a “Name of Nominee in case of body corporate” demonstrating that the nominee and the body corporate are not simply treated as the same person.

And thus, basis to the above analysis it can be said that where the body corporate is the actual partner and the individual merely acts as its authorized nominee/designated partner, the individual cannot be considered as a person/designated partner as the owner of the LLP.

Now let’s analyses the application of Section 185 after the Proposed Amendment

First Approach – Literal Rule of Interpretation

The amended provision uses the expression “limited liability partnership in which any such director or relative is a partner” and does not expressly carve out or exclude a director who acts as a designated partner on behalf of a body corporate.

Basis to the literal rule of interpretation, statutory words are ordinarily required to be given their plain, natural and grammatical meaning where the legislature is clear and unambiguous.

Accordingly, it may be argued that, once an individual is recognised and functions as a designated partner of the LLP, the absence of any specific exclusion for a nominee designated partner could bring such an individual within the expression “partner” for the purposes of Section 185.

On this interpretation, where a director of the lending company acts as a designated partner of the borrowing LLP, the transaction may fall within the prohibition under Section 185 and, consequently, the company may not be permitted to advance a loan, guarantee or security to such LLP.

However, if this interpretation if applied it may seem to not be in line with the separate distinction recognised under the LLP Act between the body corporate which is the actual partner and the individual who merely acts as its  designated partner and also with the actual purpose of section 185 of Companies Act, 2013.

Now, let’s analyse the above basis to the above discussion:

Second Approach- Purposive and Harmonious Interpretation

The purpose underlying Section 185 is essentially to prevent directors, who occupy a fiduciary position, from using or facilitating the use of company funds for their own benefit or for entities in which they have the kind of interest or connection contemplated by the section.

Accordingly, if we analyse with the Lense of purposive rule, its guides us to look beyond the bare words to identify the object for which the provision was intended to address and read two statutory provisions in a manner which gives effect to both rather than creating an inconsistency between them where two provisions operate in the same field.

Against this background merely treating a director as a “partner” of an LLP because he or she acts as the designated partner of a body corporate partner may extend Section 185(1)(b) beyond both the statutory distinction created by the LLP Act.

As a nominee designated partner does not, merely by virtue of such nomination,

1. acquire a partnership interest,
2. profit-sharing entitlement or
3. economic ownership in the LLP;

the partnership interest continues to vest in the body corporate represented by such nominee.

Further the nominee acts in a representative capacity on behalf of the body corporate partner, although he or she continues to be subject to the statutory duties and responsibilities attached to the office of designated partner.

Therefore, where a director of the lending company is only a designated partner of the borrowing LLP and is not independently a partner in that LLP, there is a strong basis to contend that the LLP should not fall within the expression “limited liability partnership in which any such director or relative is a partner” proposed to be inserted in Section 185(1)(b).

Accordingly, the loan, guarantee or security should not be regarded as absolutely prohibited under Section 185(1)(b) merely because of such nominee position, subject, of course, to examining whether the transaction is otherwise covered by any other limb of Section 185 of Companies Act, 2013.  

Conclusion:

Accordingly, a combined reading of the LLP Act and Section 185, supported by purposive , provides a reasonable basis to contend that a nominee designated partner should not automatically be treated as a “partner” for the purposes of Section 185(1)(b). Therefore, a loan, guarantee or security to such LLP should not be regarded as prohibited merely because a director of the lending company acts as its nominee designated partner, provided the director does not independently hold a partnership interest and the transaction is not otherwise covered by any other restriction under Section 185.

The Article is written by Ms. Krishna Shah – Senior Manager.

The post Section 185 and Loans to LLPs: Can a Company Lend to an LLP Where Its Directors Act as Nominee Designated Partners? first appeared on MMJC.