[Harshit Anand is an Associate at Khaitan & Co, Kolkata, and deals with corporate and real estate matters. He may be reached at harshit.anand@khaitanco.com. Anwesa Paul is a student of law at National University of Study and Research in Law, Ranchi.]
The Companies Act, 2013 (Act) does not define the term "undertaking". However, the explanation to Section 180(1) contemplates a numerical definition of the term. The meaning of the expression "undertaking", for the purpose of Section 180(1)(a), refers to an enterprise in which the investment of the company is more than twenty percent of its net worth, as reflected in the audited balance sheet of the previous final year. It would also mean an enterprise which makes twenty percent of the total income made by the company during the previous financial year. Primarily, a transaction would be considered within the purview of the provision only if it relates to an undertaking, and is in respect of a lease or a disposal of such undertaking in any other manner.
The legal implication of the aforementioned would be that even where the asset(s) can be said to be an operating unit or segment, the asset(s) will have to qualify the numerical test given in the explanation to the section. Accordingly, in case of a sale of a leasehold estate by a company which is not used by the company in its ordinary course of business, the same shall not be considered to be a sale of an undertaking, the rationale being that in common legal parlance, a leasehold estate is a temporary right to hold such property in which the lessee or the tenant holds rights of real property by some form of title from the lessor, who is the owner of the property. Hence, the company only enjoys a beneficial ownership and not freehold ownership on the concerned property. It is also an affirmed legal principle that the business or undertaking(s) of the company must not be equated with the other properties belonging to the company. Because such a leasehold asset is neither owned by the company nor used for any business purpose of the company, it is not put to use in order to generate any productive income. Therefore, the leasehold property would not fall within the scope of the term undertaking. Considering this illustration, the concept of undertaking would mean an asset or a group of assets, where the sole ownership right(s) lie with the company planning to dispose of such asset(s) and which, when disposed of, can impact the working of the company and its profits.
Erstwhile position in the Companies Act, 1956
Section 293(1)(a) of the erstwhile Companies Act of 1956 is largely analogous to Section 180(1)(a) but does not furnish any explanation as to what an undertaking would mean with regard to any transaction concerning sale, lease or disposal of an undertaking. It is evident from a cursory reading of Section 180(1)(a) of the Act that it only puts forth a qualifying criterion on the basis of which an enterprise is classified as an undertaking, but does not actually define an undertaking in words. In the absence of any judgment clarifying the meaning of the term, this article would focus on some major pronouncements in which the courts have taken great pains to understand and explain the constituents of an undertaking so as to fill the existing void.
In Rustom Cavasjee Cooper v. Union of India, the Supreme Court provided an insight into what could constitute an "undertaking". Although the case did not pertain to an undertaking under Section 293(1)(a) of the Companies Act of 1956, it offers a detailed interpretation of the term. Quite intriguingly, the Supreme Court opined that the word "undertaking" refers to the entire organization. It went on to state that a company, whether it has a plant or it has an organization, is regarded as one whole unit and the entire business is embraced within the word undertaking. The Court also held that an undertaking would clearly connote a going concern with all its rights, liabilities and assets. Madras Gymkhana, on the other hand, looked at an undertaking as “any business or any work or project which one engages in or attempts as an enterprise analogous to business or trade.” The Karnataka High Court in International Cotton Corporation(P) Ltd. v. Bank of Maharashtra relied on Madras Gymkhana to infer that the business of the company or undertaking of the company must be distinguished from the other properties belonging to the company.
An English Understanding
In the case of In Re Vivian & Co. Ltd. Metropolitan Bank of England and Wales, Ltd. v. H. H. Vivian & Co. Ltd. [1900 H. 1662], the objects of a company comprised the carrying on of three distinct businesses which were supplemental to one another. The court refused, at the instance of debenture-holders having a floating charge on the whole undertaking, to restrain the sale of one business. The court thus ruled that there is a general charge upon the undertaking as a whole and not merely upon specific assets. The company is at liberty, so long as the undertaking is continued, to deal with all the assets not specifically charged in the ordinary and proper course of its business.
In the case of Doughty v. Lomagunda Reefs Ltd. [1902 D. 79.], the memorandum of association of a company contained powers to sell its undertaking for shares in another company and to distribute among its members in specie any of its property. Under a clause in the memorandum which provides for the sale of the undertaking of the company, one may sell the undertaking of the company although one does not contemplate having any subsequent undertaking at all. The sale may be made at a date when the corporation as a working concern is to come to an end. The company, in this case, had not gone into liquidation, but the agreement was for the sale of the undertaking and all the property of the company.
In the case of In Re Panama, New Zealand And Australian Royal Mail Company [(1870) 5 Ch App 318], the word "undertaking" was construed as an enterprise, which cannot include property unless the context requires such a construction. The company, in this case, had issued a mortgage debenture, which was, in substance, a bond, and a charge upon their property for the sum borrowed on bond. Having regard to the state of the particular company, the word undertaking had reference to all the property of the company- not only which existed at the date of the debenture, but which might afterwards become the property of the company. A necessary connotation of the word undertaking is that the company will go on, and that the debenture holder could not interfere until either the interest which was due was unpaid or the period for the payment of the principal had arrived and the same was unpaid. Under debentures, the holders have a charge upon all property of the company- past and future- by the term undertaking, and they stand in a superior position when compared to the general creditors, who can touch nothing until the debenture-holders are paid.
The case of In Re Borough of Portsmouth (Kimgston, Fratton and Southsea) Tramways Company [(1892) 2 Ch. 362, Ch D] brought to light that all a creditor could get from his security is the fruit of the undertaking as a going concern- he cannot pull the undertaking to pieces or break it up, so as to avail himself of the separate parts towards satisfaction of his debt. A debenture holder- whose debt is payable and who has exhausted all his remedies except for a winding-up petition without obtaining payment of his debt- should not be in a worse position than an ordinary creditor who has got no security upon his undertaking. The remedy given to him to enforce his security upon the undertaking as a going concern does not deprive him of his remedy as a creditor who has obtained a judgment for his debt but cannot obtain payment.
Another old case of Gardner v. London Chantham and Dover Railway Company [(1867) LR 2 Ch App 201] concerned itself with the effect of the word undertaking. In two public Acts, the Companies Clauses Act as well as the Lands Clauses Act, undertaking is defined as “undertaking or works by the special Act authorized to be executed,” and in the private Acts, the object appears to be not so much to describe what is included in the word undertaking as to divide by metes and bounds. The legislative intent makes the undertaking the subject of a mortgage, and whatever may be the liability to which any of the property or effects connected with it may be subjected by way of legal operation and consequences of a judgment recovered against it, the undertaking, so far as the contracts of mortgage are concerned, is made over as a thing complete or to be completed, as a going concern, with internal and Parliamentary powers of management not to be interfered with. The undertaking was loftily described as a fruit- bearing tree, the produce of which is the fund dedicated by the contract to secure and to pay the debt. The earnings of the undertaking must be made available to satisfy the mortgage.
Concluding Remarks
While the Act provides a quantitative classification for identifying the undertaking, one must refer to precedents laid down by courts in order to conceptualize a worded meaning of undertaking and accordingly ensure compliance under the Act. The "business" or "undertaking" of a company must always be distinguished from the "properties" belonging to the company, a position which has been maintained by Indian courts for a long time now.
The Karnataka High Court has stated in so many words that where only the properties belonging to the company have been taken care of by the board of directors under deeds of hypothecation and mortgage in favour of the bank, no part of the undertaking of the company can be considered to be disposed of in favour of the bank.
Note: All the English cases relied upon in this note can be accessed on Westlaw, an online legal research service.