Section 19: Subsidiary Companies Not to Hold Shares in Its Holding Company

Introduction

Section 19 of Companies Act, 2013, part of chapter II, lays down the provision which states that subsidiary companies cannot hold shares in its holding company. Companies Act, 2013 defines in relation to one of more other companies, a holding company to be a company of which such companies are subsidiary companies [1]. A subsidiary company is defined in relation to any other company/ holding company in which the holding company (i) has control over the composition of the board of directors in the subsidiary company (ii) has control over  more than one-half of the total share capital of the subsidiary company, either by way of its own or together with one or more of its subsidiary companies. The holding company has control over the working of a subsidiary and thus they are not allowed to hold shares in holding company as this could be misused by the holding company. This analysis will provide more information on this section.

Purpose of Section 19

This section in brief is as follows:

• Similar to the provisions of the 1956 Act, this section prohibits subsidiary companies from holding shares in its holding company. It prohibits holding companies to allot or transfer its shares to any of its subsidiary companies. Any such allotment or transfer of shares of a company to its subsidiary company will be void according to this section.
• Certain exception to the rule of this section is provided in this section itself as follows: (a) the subsidiary company holds shares in the holding company as the legal representative (b) the subsidiary company holds shares as a trustee (c) where the subsidiary company is a shareholder even before it became a subsidiary company of the holding company.
• Subsidiary companies who are an exception under this section have a right to vote at a meeting of the holding company, but this right only extends in respect of the shares held by it as a legal representative or as a trust. However, under the third exception, where the subsidiary company is a shareholder even before it became a subsidiary company of the holding company, right to vote will not be extended to the subsidiary company at the meeting of the holding company.
• It may be noted that debentures are not shares and, therefore, a subsidiary can hold debentures in a holding company. However, in the case of convertible debentures, the section is not attracted when the debentures are allotted, but this section becomes applicable when the debentures get converted into shares.

Situation Before Enactment of Section 19

This section corresponds to section 42 (Membership of holding company) of the 1956 Act. The replication of this section has no substantial change in the new act. The concept of “body corporate” as used in section 42 of the old act, 1956, which corresponds to the extant provision has been removed.

Application of Section 19

This section basically comes into application whenever a subsidiary company wants to hold shares in its holding company.

Cases at a Glance

• Himachal Telematics Futuristic case [2]: In this case the court held that a subsidiary company could buy shares in its holding company where such buying is part of a scheme of amalgamation sanctioned by the court.
• Mr. Anil Nanda v. state and Ors [3]: The petitioner filed the present petition under section 482 of CRPC for quashing a criminal complaint against him for violation of section 42 of companies’ act 1956. The petitioner claimed that any allotment by way of statutory legal fiction of shares by a holding company to its subsidiary will be void ab initio, as there cannot be said to be any contravention of any provision of law and thus the said complaint discloses no commission of offence and is liable to be quashed and the petitioner cannot be held liable under this section. The respondent contends that violation of Section 42 of the act, 2013 is a continuing offence and as such the complaint is not barred by limitation. Here the court rejected the view of petitioner that no offence is committed under section 42. It stated an offence would be committed, even though the action would be considered void ab initio and thus the criminal complaint is filed on the right basis and will not be quashed if filed within the limitation period.
• In Re: Asian Investments Ltd. and Others [4]: This is a case, where the company in question passed an amalgamation scheme. The case discusses the nitty gritties of the same and touches briefly section 42 of the act, 1956. It states that the object of section 42 is to maintain the separate operational identity of a holding company and its subsidiaries and thereby preserves the respective shareholders’ control over them.
• In Re: New Vision Laser Centers (Rajkot) (P.) Ltd [5]: In this case the liquidator challenged the amalgamation scheme of the company, whereby the subsidiary company will then hold shares in the holding company. The liquidator contended that this is invalid as this scheme violates section 42. The company contended that the provisions of Sections 391 to 394 constitute a complete code relating to amalgamation and merger and that the provisions of Sections 42 and 77 are not applicable in case of amalgamation or merger. The court held that this scheme is in public interest and in the interest of the shareholder and that the provisions of Sections 42 and 77 do not control the provisions of Sections 391 to 394.

Concluding Summary

This is a very important section laying down a requirement that needs to be followed by every holding and subsidiary company. Holding company controls its subsidiary and if subsidiary can hold shares of its holding company, the holding company could use this to its advantage putting the shareholders and the company at risk. This is done to make sure that no undue advantage is taken by holding company of its controlling interest in its subsidiary and there is separation of power, to protect the interest of the shareholder.

References:

[1] Companies Act, 2013, No. 18, Acts of Parliament, § 2(46) (2013).

[2] Himachal Telematics Futuristic (1996) 22 CLA 314 (Delhi).

[3] Mr. Anil Nanda v. state and Ors Crl. M.C. No. 1279 of 2008, High Court of Delhi.

[4] In Re: Asian Investments Ltd. and Others (1992) 73 CompCas 517(Mad).

[5] In Re: New Vision Laser Centers (Rajkot) (P.) Ltd. (1982) 84 BOM LR 587.