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INTRODUCTION

One of the most important and much sought after provisions in the Companies Act,1956 (The Act) relates to inter-corporate loans and Investments. This provision by providing a legal framework for inter-corporate loans and investments has facilitated tremendous growth and development of the Indian corporate sector, both in India and abroad and within and outside the corporate groups. This is not to be construed as a mere legal framework but a potent weapon in the hands of Industrialists and entrepreneurs to acquire, expand and consolidate their control over other corporate organizations. Intercorporate loans come in handy to help group companies to tide over their financial problems at least temporarily and for deployment of surplus funds of a company in a productive manner, investment is a potent weapon to acquire ownership or management control of other companies. As the funds flow out of the company in the form of loans and investment the shareholders should have a final word for exceeding the prescribed monetary limit. In keeping with this principle, section 372A now reflects the changed profile of regulations governing inter-corporate loans and investments. Needless to say, these corporate actions build up business relationships between corporate organizations. Till about October 1998, inter-corporate loans and investments were regulated by sections 370 and 372 of the Act separately with certain internal checks and balances built into the sections. These provisions became inoperative with the introduction of section 372A. The Companies (Amendment) Act,1999 brought about a radical change in bringing into existence a combined provision in section 372A of the Act, effective from 31.10.1998. Section 372A has been enacted following the recommendation of the Working Group constituted by the Govt. of India which opined that all over the developed world, corporate growth has been predicated upon flow of funds from one company to another. Cash rich firms have invariably used their free reserves to lend or to invest in other companies. The Govt. accepted the recommendation of the Working Group. The new provision reflects the self operating mechanism built into section 372A without Govt. intervention at any stage.

COMPARISON OF SECTION 372A WITH SECTIONS 370 AND 372


The changes introduced by section 372A can be better understood by comparing section 372A with the erstwhile provisions of sections 370 and 372 of the Act. They are ; (a) Under section 370 no loan could be given to a body corporate in the same management except with the previous authorization of shareholders by a special resolution. However, no such approval was needed for grant of loan to other bodies corporate not under the same management. The financial limit in both cases is thirty percent of the aggregate of the subscribed capital of the lending company and its free reserves. The limit under section 372A is a combined limit as already discussed and there is no such distinction as aforesaid. (b) There could be separate limit for providing guarantees, as the provisos to section 370(1) refers to loan only, read with Explanation 2 there under. (c) Approval of the Central Govt. was needed for exceeding the aforesaid limit. (d) There are certain exceptions which are comparable to the exceptions envisioned under section 372A. (e) As regards investments are concerned, the financial limit under section 372 is thirty percent of the subscribed equity capital or the aggregate of the paid up equity capital and preference capital of such other body corporate, (i.e., investee company) whichever is less. However the aggregate of all investments made, both in the group and outside the group, could not exceed thirty percent of the subscribed capital and free reserves of the investing company. (f) The investing company may at any time invest in the right shares offered to it under section 81(1)(a) of the Act irrespective of the aforesaid percentages. However, while making further investments other than rights shares, all existing investments, including investment in right shares shall be included for calculating the percentage limits. This is not required under section 372A,as rights issue is wholly exempt. (g) No investment could be made in excess of the aforesaid limits except with the sanction of the shareholders and unless previously approved by the Central Govt. under section 372. However, under section 372A while approval of the Central Govt. has been dispensed with, approval of shareholders for exceeding the financial limit is retained with

the addition of approval of the financial institution (in case borrowing),when the proposal involves exceeding the limit of 60% or 100% as the case may be and further there is no default in repayment of loan.

CHAPTER 1 SCOPE AND IMPLICATIONS OF SECTION 372A OF THE COMPANIES ACT, 1956
Section 327A talks about the Inter corporate borrowings. This section can be understood in the following ways:

Meanings:
Loans: It includes debentures or any deposit of money made by one company with another company, not being a banking company Free Reserves: means those reserves which, as per the latest audited balance sheet of the company, are free for distribution as dividend and shall include balance to the credit of the securities premium account but shall not include share application money. Paid Up Capital: Paid-up capital is essentially the portion of authorized share capital that the company has issued and received payment for.

Scope of Section 372A


When a company makes a loan to any other body corporate When a company acquires the securities of any other body corporate When a company gives any guarantee or provides any security to (i) Any person who gives a loan to any body corporate or (ii) A body corporate, which gives a loan to any other person.

Consequences of Non-Compliance
1. The Company and every Officer in default a) Imprisonment up to 2 years, or b) With fine up to Rs.50, 000. 2. All persons who are knowingly parties to any contravention shall be liable jointly

and severally to the Company for:

a. Repayment of the loan, or b. Making good the sum which the Company may have been called upon to pay on account of the guarantee given or the securities provided by such Company. 3. Transaction in violation of Sec.372 is void and ineffective.

The provisions of Section 372A


Approval of the Board:

Approval in all cases Prior approval Resolution passed at a Board meeting Power to make inter corporate loans and investments cannot be delegated Unanimous approval

Approval by special resolution: Ceiling limit. The ceiling limit on making loan, investment, guarantee, or security is higher of the following: 60% of the aggregate of paid-up share capital and free reserves of the company. 100% of free reserves of the company. Paid up capital shall include paid up equity share capital as well as paid up Preference share capital.

Where the ceiling limit is exceeded: Previous authorization by a special resolution is required. Time of passing special resolution: Special resolution is required prior to making any inter corporate loan, investment, guarantee or security. Manner of passing special resolution: Whether annual general meeting or extraordinary general meeting However, the special resolution shall be passed by postal ballot, if the following 2 conditions are satisfied:

- The company is a listed company. - The proposed business relates to making of any inter corporate loan, guarantee, or security. Disclosure requirements in notice of special resolution The specific limits The particulars of other body corporate in which investment is proposed to be made or loan, guarantee, or security is proposed to be given. Purpose of making loan, investment, guarantee, or security. Specific sources of funding. Other relevant details.

No blanket permission to be given by the shareholders

Approval of Public Financial Institution: The Company shall obtain the prior approval of the Public Financial Institution from which it has taken a term loan. The prior approval is required even if the loan agreement does not specify any such condition. The expression 'Public Financial Institution' has been defined under Sec.4A and includes ICICI, IFCI, IDBI, LIC and UTI.

Minimum rate of interest: Prevailing bank rate. Bank rate' means the rate at which RBI lends money to commercial banks.

CHAPTER 2 GUARANTEE Legal Definition - Guarantee


In law, a contract under which one person agrees to pay a debt or perform a duty if the other person who is bound to pay the debt or perform the duty fails to do so1.

Inter-corporate guaranties
Inter-corporate guaranties are a common business practice that benefit both the borrower and lender. Within an affiliated corporate group, some entities constitute better credit risks than others. The entities that are weaker may either be unable to obtain financing or be able to obtain credit facilities only upon unfavorable terms. When a corporate borrowing group includes multiple businesses, it is common for lenders to look to guaranties of corporate affiliates to support the credit facility. The contingent obligation of an affiliated company supports the credit, and the guarantee is often secured by assets of the corporate guarantor, thereby securing the aggregated debt with a larger pool of assets. The current financial environment requires that these guaranties receive close evaluation and scrutiny. In seeking to enforce an inter-corporate guarantee, there is a risk that it may be avoided due to lack of consideration or due to a determination that the guarantee constituted a fraudulent conveyance in the event the guarantor fi les bankruptcy.

What Is an Inter-corporate Guarantee?


'Inter-corporate guarantees ', means guarantees provided by a company in connection with loans given:a) By any persons to bodies corporate; or b) To bodies corporate by any persons. The Indian Contract Act defines the expression "contract of guarantee" as a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the "surety"; the person in respect of whose
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default the guarantee is given is called the "principal debtor"; and the person to whom the guarantee is given is called the "creditor". A guarantee may be either oral or written. A guaranty is a contingent obligation by a third party to perform anothers financial undertaking. The three implicated parties are the primary obligor, the creditor and the guarantor. Inter-corporate guaranties are routine in commercial transactions. They enable a corporate group to secure borrowing as a single unit, even though under applicable corporate law each member is a separate legal entity

Guaranties facilitate the availability of financing in situations when a single corporate borrower is unable to borrow on desirable terms. In many instances, a lender may be willing to provide financing to a corporate borrower only if an affiliate agrees to guarantee the loan. As a result, the guarantee provides the lender with additional assets to secure repayment of the loan. Moreover, the collective borrowing base may upgrade the corporate groups credit, allowing the group to obtain less restrictive financing, at a lower cost, than each member could obtain independently.

sections 370 and 372 have been made inoperative w.e.f. 31.10.1998 by the Companies (Amendment) Act, 1999. Instead section 372A has been introduced under which, provisions of section 370 and 372 relating to inter-corporate loans and investments etc. have been merged and a combined ceiling of 60 per cent of the aggregate of paid up share capital and free reserves or 100 per cent of the free reserves, whichever is higher, has been introduced, for exercise of powers by the Board of directors of a company.

Prescribed ceiling limit of 60% as above, also includes the amounts of corporate guarantees and securities provided under section 372A.

- No company shall make loans or investments or provide guarantee or security, if it has defaulted in complying with the provisions of Section 58A [ Section 372A(4)].

A private company which is not a subsidiary of a public company and other companies specified in sub-section (8) of section 372A are exempted from the provisions of this section.

Procedure and Documentation:


Case 1 Where the aggregate of loans/investments/guarantees/securities is up to 60% of the company's paid up share capital and free reserves or 100% of its free reserves, whichever is higher: 1. A Board meeting shall be convened to approve the loan, investment, guarantee by passing a Board Resolution. It must be noted that unanimous consent of the Board is required for sanctioning the aforesaid resolution [Section 372A(2)] 2. If the company has taken any term loan from any of the financial institutions referred to in Section 4A , then prior approval of that financial institution shall be taken, provided the following conditions are fulfilled : a) That term loan is subsisting, and b) The company has defaulted in repayment of loan instalment or payment of interest to financial institution. However, prior approval of financial institution will not be required if the company has not defaulted in repayment of loan instalment or payment of interest to financial institution.

Case II Where the aggregate of loans/investments/guarantees/securities exceeds 60% of the company's paid up share capital and free reserves or 100% of its free reserves, whichever is higher 1. A Board meeting shall be convened to approve the loan, guarantee, security and investment and also to approve the draft notice of the general meeting to be convened in this regard. 2. In case of a listed company, send three copies of the notice of general meeting to the stock exchange. ( Clause 31 (c) of listing agreement)

3. Notice of the general meeting shall be issued to the eligible members at least 21 clear days before the date of the meeting. 4. The General Meeting shall be held to pass the special resolution for inter corporate loans and investments. The aforesaid special resolution shall clearly specify the following (third proviso to Section 372A(1):) Specific limits, Particulars of the body corporate in which the investment is proposed to be made or loan or security or guarantee to be given. The purpose of the investment, loan or security or guarantee. Specific sources of funding Other details.

5. In case of a listed company, send a copy of the proceedings of the general meeting to the stock exchange. (Clause 31 (d) of listing agreement) 6. Form No. 23 of Companies General Rules and Forms shall be filed with the Registrar of Companies along with special resolution within 30 days of passing of the resolution along with requisite fee. 7. Take the approval from public financial institution where any term loan is subsisting with that financial institution. 8. Necessary entries shall be made in the register of intercorporate loans and investments within seven days of the making of such investments or loan or the giving of such guarantees or the provision of such securities :

Case III

1. The Board of directors may, in exceptional circumstances, give corporate guarantee without the authorisation of special resolution and in such a case : a) A Board meeting shall be convened to pass a resolution authorising the giving of such guarantee and

c) The said Board resolution shall be confirmed within 12 months in an extraordinary or Annual General Meeting held after passing the Board resolution, whichever is earlier. [Second proviso to Section 372A(1)]

CHAPTER 3 APPLICATION
The following types of guarantees will attract the provisions of section 372A:a. Guarantee given in respect of an intercorporate deposit; a. Counter-guarantees in respect of loans obtained by any body corporate; b. Guarantee given by the company to HDFC or any other Housing Finance company or other body c. Corporate in connection with loans given by it to the company's employees. Any guarantee not involving the transaction of lending and borrowing of money between a body corporate and any other party would not attract the provisions of this section, viz. : a. Performance guarantees; b. Guarantees against advance received in respect of a contract for supply of goods or a project, do not come under this section; c. Guarantees on behalf of or in favour of a person not being a body corporate. The provisions of Section 372A, so far as guarantees are concerned, applies to every public companies, private companies which are subsidiaries of public companies, Section 25 company and deemed public companies, but the following corporate entities are exempted from this provision:a. A banking company in the ordinary course of its business; b. An insurance company in the ordinary course of its business; c. A housing finance company in the ordinary course of its business; d. A company established with the object of financing industrial enterprises; e. A company established with the object of providing infrastructural facilities; f. A company whose principal business is the acquisition of shares, stock, debentures or other securities; and g. a private company which is not a subsidiary of a public company. While passing the resolution in the Board meeting, the Directors must also take into account:a. Total cost of investments in securities of all bodies corporate made till date; b. Total amount of outstanding loans given to other bodies corporate till date;

c. Total amount of guarantees given in respect of loans given to/by other bodies corporate and valid till date; and d. Total amount of securities provided in respect of loans given to/by other bodies corporate and valid till date. Any guarantee provided by the holding company to its wholly-owned subsidiary is exempted from the prescribed limit, but other provisions of section 372A must be

The Board must also obtain the prior approval of every public financial institution(s) from which the company has taken any term loan, and wherein the said loan is outstanding, if a. The total amount of inter-corporate investments, loans, guarantees and securities exceeds 60% of the paid-up share capital and free reserves; or b. There is default (at the time of making such loan) in payment of an installment of the term loan or interest thereon as per the terms thereof.

Such approval may be a general approval and it need not be a specific approval in each case of security. A financial institution may give approval subject to certain limit and such conditions as it may think fit.

If the Board of Directors wishes to provide a guarantee to any body corporate/other person in excess of the limit mentioned above, it must then obtain a prior approval of the company by a special resolution passed at a general meeting. In spite of the requirement of prior specific approval of shareholders to every proposal of giving guarantee in excess of the prescribed limits, the Board of Directors may, in cases of urgent necessity, provide a guarantee without the such approval, if the following conditions are satisfied:a. Obtaining of shareholders' previous approval by special resolution is prevented by exceptional circumstances; b. A resolution authorising to provide the guarantee is passed in the meeting of the c. Board in accordance with the provisions of section 372A; and d. Such Board resolution is confirmed at a general meeting within twelve months from the date of the Board meeting.

There is no limit on the amount upto which guarantee can be provided with the approval of the company by special resolution, beyond the limit of 60% or 100% as the case may be. However, a specific special resolution must be passed for every inter-corporate guarantee in excess of the aforesaid limit. No general resolution (Authorizing the Board to make loans up to the specified limit from time to time) can be passed. Convene the general meeting for passing a special resolution specifying therein : The limit up to which Board is to be authorised to provide guarantee; Particulars of the body corporate or other party to which and the loan in respect of which the guarantee is proposed to be provided; The purpose of the proposed guarantee; and Other relevant details.

A company, who is in default in complying with the provisions of section 58A of the Act, is prohibited from providing any inter-corporate guarantee, till the default is made good.

CHAPTER 4 CONSIDERATION ANALYSIS OF INTER-CORPORATE GUARANTIES


Like other contracts, inter-corporate guaranties must be supported by consideration. Any consideration that suffices to support contracts generally may be relied upon as consideration sustaining the promise of a guarantor. Consideration moving directly to the guarantor is not essential, and the consideration need not move only between the lender and the guarantor2. Instead, a benefit to the borrower or a detriment to the lender suffices as consideration to support a guarantee. Accordingly, the mere lack of any personal consideration fl owing directly to a guarantor, standing alone, is not a legal defense to a guarantors liability. For most commercial loan arrangements, consideration is simply not a problem. The consideration fl owing between a lender and a borrower is obvious. With contingent obligations such as guaranties, however, the consideration may not be as apparent. In a downstream guarantee the consideration is clear: The value of the parent corporations stock in the subsidiary is increased by the credit infusion.

Inter-corporate Guaranties: A Checklist for Lenders


In the current climate, the issue of affiliated entities requires a heightened awareness. In contemplating a loan transaction supported by inter-corporate guaranties,

A lender must be aware of the reality that these guaranties can be avoided. To guard against the risk that a guarantor will avoid its obligation, the lender should implement the following precautions:

It is preferable that the guarantor enter into the guarantee at the same time the loan transaction is consummated.

Avery Wiener Katz, An Economic Analysis of the Guaranty Contract, 66 U. CHI. L. REV. 47 (1999), at 5961 (1999).

If the guarantee cannot be executed with the loan documents, the lender should document that the loan was made in anticipation of the guarantors guarantee.

Appraisals of the guarantors assets should be reviewed with an awareness of whether the guarantor is insolvent or undercapitalized at the time of the loan or whether the guarantor would be rendered insolvent or undercapitalized as a result of incurring the guarantee.

When more than one guarantor is involved in the transaction, the guarantee agreements should be structured so that each guarantor guarantees only as much of the debt as it can reasonably afford.

The lender should obtain satisfactory assurances that the guarantor is solvent and possesses sufficient capital and an opinion letter from counsel that the guarantee is valid and enforceable.

CHAPTER 5 EXCEPTIONS TO SEC 372A


The regulatory provisions of section 372A are not applicable in the following cases: (a) To any loan made, any guarantee given or any security provided or any investment made by a banking or insurance company or a housing finance company in the ordinary course of their business or to a company established with the object of financing industrial enterprises or of providing infrastructural facilities ; (b) To a company whose principal business is the acquisition of shares, stock, debentures or other securities. (c) To a private company unless it is a subsidiary of a public company ; (d) To any investment made in rights issue; (e) To any loan made, any guarantee given or security provided to or acquisition of shares by a holding company in its wholly owned subsidiary.

What are the relaxations in conditions?

No special resolution for guarantee: The Board may give guarantee in excess of the ceiling limit without passing a special resolution if the following three conditions are satisfied:

A unanimous resolution is passed in a Board meeting for giving guarantee. There exist exceptional circumstances which prevent the company from passing a special resolution. The resolution of the Board is confirmed within 12 months: In the general meeting of the company; or In the annual general meeting held immediately after passing of the Board's resolution; Whichever is earlier.

No approval of Public Financial Institution: Loans, investments, guarantee, or security does not exceed 60% of the aggregate of paid up share capital and free reserves. There is no default in repayment of loan installments or interest to Public Financial Institution.

CHAPTER 6 CONCLUSION
Corporate actions envisaged in section 372A can be invoked only by profit making companies as these actions result in out flow of funds from the company. This provision is meant for companies which can spare funds for investment outside its business. In these days of globalisation of business and tremendous business opportunities open world wide, companies cannot remain isolated. In the final analysis it is a balancing act which every company has to decide to understand what it serves best. In reality companies have invoked this provision in expanding business empire and acquiring new companies. The provision regarding grant of loans has been effectively used to support group companies. While there is nothing wrong in this approach, the productivity of capital invested and the return on investment holds the key to future growth and development. It is worthwhile undertaking corporate research into the pattern of investment by the corporate organizations and whether the chosen investments by the corporates have or have not resulted in promoting competition in the market place. Inter-corporate Loans and Investments : An Appraisal