INTER-CORPORATE LOANS AND INVESTMENTS—UNNECESSARILY

COMPLEX LAW?*

S.D. BALSARA**

The importance of the subject

THE IMPORTANCE of the subject of inter-corporate loans and invest­
ments can be realised from the fact that inter-corporate holdings account for
a sizeable share in the ownership of equity shares in India and are the main
instrument for the control of companies. This is brought out by several inqui­
ries on the subject. L.C. Gupta, in his book The Changing Structure of Indus-
trial Finance in India, points out that in the sixty-three companies examined
by him, twenty-four per cent of the aggregate equity capital was held by com­
panies. R.K.Hazari found that in the 228 companies examined by him, thirty-
four per cent (including eight per cent of banks and general insurance compa­
nies which are now nationalised) of the equity capital was held by companies.
A survey of seventy companies made by the Reserve Bank of India shows
inter-corporate holdings to be as high as forty per cent. In 1957-58 companies
received thirty-four per cent of the total dividend income assessed to income-
tax, though it must be admitted that the small shareholder who receives divi­
dend but does not pay income-tax would not be included in this percentage.
The percentage of inter-corporate investment, would, therefore, be definitely
less than thirty-four per cent. From all these surveys, it is, perhaps, safe to
conclude that out of every four equity shares in India, one is owned by a
company. When it is realised that today five to ten per cent holding is regar­
ded as adequate for controlling a company, we can imagine how much the
companies control each other.
Why the control of the government is necessary in respect of inter-corpo­
rate loans will be clear from an instance mentioned in the Second Annual
Report on the Working and Administration of the Companies Act, 1956:

In a group of 13 sister companies, some companies had borrowed from

others and had, in their turn, lent to other companies in the group.
The company which had borrowed most heavily had invested the amount
so borrowed in fixed assets thereby blocking the funds of other
companies. The amount lent in one case was as high as 96% of the
total assets of the lending company and was in no case less than 3 3 % of

♦This article was written by the author before the passing of the Companies (Amend­
ment) Act, 1974. By the Amendment Act of 1974, no change has been made in sections
370 and 372—(Ed.)
**B.A., LL. M. (Bom.), LL, M. (Stanford), Professor of Law, Government Law
College, Churchgate, Bombay*

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200 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 17 :1

the assets of*the lending companies. This indirect method of capital

formation through loans from sister companies had resulted in an im­
balance in the capital structure of the borrowing company and further
the heavy burden imposed on it by way of interest charges prevented it
from making any profits. By following such a practice, it appears,
companies can sidetrack the provisions of the Capital Issues Control
Act. 1

The facts mentioned above would convince any one that inter-corporate
loans and investments are operations which require to be watched and
controlled carefully and closely to prevent malpractices that may shatter
public confidence in corporations and thereby hamper the commercial pros­
perity of the country. The question, however, is how much these operations
should be controlled by law and whether our law is needlessly becoming
more and more complex in the matter. In the humble opinion of the author
the Companies (Amendment) Bill, 1972 (hereinafter referred to as the Amend­
ment Bill) complicates the law on the subject still further when it is quite
possible to make it more simple.

Loans and guarantees to companies under the same management.

The following is a brief summary of the law regarding inter-corporate

loans and guarantees (section 370 of the Companies Act, 1956):
1. If the borrowing and lending companies are not under the same
management and the aggregate of the loans does not exceed ten per cent of
the aggregate of the subscribed capital plus free reserves of the lending
company, then no special formality is laid down by the Companies Act.
2. If the lending and the borrowing companies are under the same
management or the aggregate of the loans exceeds ten per cent of the aggre­
gate of the subscribed capital plus free reserves of the lending company, then
a prior special resolution of the lending company is necessary.
3. If the aggregate of the loans made to all companies by the lending
company exceeds thirty per cent of the aggregate of the subscribed capital
plus free reserves of the lending company and all such other companies are
not under the same management as the lending company, then a special
resolution of the lending company and the prior approval of the central
government are necessary.
4. If the aggregate of the loans made to all campanies exceeds twenty
per cent of the aggregate of the subscribed capital plus free reserves of
the lending campany, and all such other companies are under the same
management as the lending company, again a special resolution of the
lending company and the prior approval of the central government are
necessary.

1. Government of India, The Second Annual Report on the Working and Administra*
Hon of the Companies Act, 1956, 23-24 (1959).
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1915] INTER-CORPORATE LOANS AND INVESTMENTS 201

If a special resolution, generally authorising the making of loans up to

the limit of thirty per cent or twenty per cent, as the case may be, is passed,
then no further special resolution is necessary for the making of any loans
within such limits.

The above provisions also apply:

(a) When a company gives any gurantee or provides any security in

connection with a loan made by any other person to, or to any other
person by, any company, and

(b) to a loan made, guarantee given or security provided to a firm in

which a partner is a company under the same management as the
lending company.

Besides penal liability there is joint and several liability for repayment of
the loan on all the persons who are parties to a lending transaction contrary
to the provisions of section 370 of the Companies Act (section 371).
Clause (a) of the second proviso to sub-section (1) of section 370 of the
Companies Act requires the sanction of the central government where the
loans to "all such other bodies corporate...under the same management as
the lending company" exceed thirty per cent of the aggregate of the subscribed
capital of the lending company and its free reserves. Does the expression put
in quotes mean "where none of such other companies are under the same
management" or "where some of such other companies are under the same
management"? Again clause (b) of the second proviso to sub-section (1) of
section 370 lays down the limit of twenty per cent "where all such other
bodies corporate are under the same management as the lending company".
If clause (a) means that the thirty per cent limit applies only where all the
other companies are under the same management, then what is the limit
applicable to cases where some are under the same management and some are
not ? It is unfortunate that even in 1972 Amendment Bill no effort is made
to rectify this ambiguity.
The Second Annual Report on the Working and Administration of the
Companies Act 1956, points out the guideliness followed by the government
in sanctioning loans. It says:

With regard to the lending company, important points, e.g., whether (a)
it has surplus funds to lend, (b) the loan is secured or not, (c) the rate of
interest offered on the loan is reasonable, (d) the loan is for a definite
period and (e) the general financial position of the lending company is
satisfactory are considered. In regard to the borrowing company, points
such as whether the borrowing company is fully solevent and has a good
profit record are investigated before the sanction of the Government
is conveyed to the parties concerned.2

2. W. at 23,
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202 JOURNAL OF THE INDIAN LA W INSTITUTE [Vol. 17: 2

Suggestion
It must be considered whether companies, other than purely investment
companies, should at all be allowed to give loans to other companies except
in the usual course of business. Today the banks give about seven per cent in­
terest on monies deposited with them and charge about eleven per cent in­
terest on monies lent by them on reasonable security. So if two companies
do borrowing and lending directly between themselves instead of through the
medium of a bank they do so for this difference of about four per cent
interest only. For this benefit of four per cent in interest rate, should com­
panies be allowed to do direct borrowing and lending business, which more
often than not, leads to malpractices? If a company gets from another com­
pany more than eleven per cent interest then the lending company is definitely
running some risk, because no company which is in a sound position would
borrow money at a rate higher than eleven per cent from another company
instead of from a bank from whom the loan is available at eleven per cent. A
company, other than a purely investment company, should not be allowed to
take such risk with shareholders' monies. Lending is a business which requires
expertise; ordinary companies cannot normally be expected to have on their
staff experts who can wisely decide what risk can be taken by the company
with advantage. Under the present law as stated above, the government in
sanctioning loans is required to consider whether the lending company has
sufficient surplus funds, whether the loan is for a definite period, whether the
rate of interest is reasonable, whether the borrowing company is fully solvent,
whether it has a good profit record, etc., etc. Why should the government
take all this trouble when the banks are there to consider all these points for
just a nominal charge?
It is a different matter if two companies are having business transactions
and in the course of business, one gives credit facilities to the other. Here a
reasonable limit may be laid down, say, the giving of credit to the other com­
pany to the extent of fifty per cent of the business transaction.
Again, it is a different matter if the lending campany is an investment
company. Under the present law also, sections 370 and 372 of the Companies
Act do not apply to companies established with the object of financing indus­
trial enterprise. Such a company can be expected to have the expertise to
decide what risk may be taken by the company with advantage. A distinc­
tion, however, should be made between a purely investment company and a
company which has lending businees as one of its objectives, because the law
can otherwise be easily evaded by providing lending as one of the objects of
the company in the memorandum.
The present law may, therefore, be simplified by laying down that no
company, except a purely investment company, otherwise than in the usual
course of business, shall give a loan to other companies exceeding ten per cent
(the limit may be raised to fifteen per cent or so if considered proper) of the
aggregate of the subscribed captial plus free reserves of the lending com­
pany*

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1975] INTER-CORPORATE LOANS AND INVESTMENTS 203

Purchase by a company of shares and debentures of other companies (sec­

tion 372 of the Companies Act)
The following is a brief summary of the law regarding inter-corporate
investments :
1. {a) If the investment of a company in shares of another company
exceeds ten per cent of the subscribed captial of such other company, or
(b) If the investments of a company in shares of other companies
exceed thirty per cent of the subscribed capital of the investing company
(this provision does not apply to investment companies), or
(c) If the aggregate of the investments made in shares or debentures
of all others companies under the same management exceeds twenty per cent
of the subscribed capital of the investing company, then the investment must
be:
(/) sanctioned by a resolution of the investing company in general meet­
ing, and
(it) approved by the central government.
Exception: No such sanction and approval are necessary to investment up to
any amount in right shares offered to the investing company under section 81
of the Companies Act; but in computing the percentage of investments in
subsequent cases, the investment made in right shares must also be taken into
consideration.
2. In all other cases of investment in other companies it is only neces­
sary to obtain the consent of all the dire:tors present at the Board meeting
provided that prior notice of the resolution to be moved has been given.(This
provision does not apply to investment companies." Again "consent of ali the
directors" would mean that they all must support the resolution. (Abstain­
ing from voting does not amount to "consent").
It may be of interest to note that from 1956 to 1971, the government
approved of inter-corporate investment applications to the tune of about
eighty-two crores of rupees. During the same period, the applications rejected
or withdrawn amounted to about rupees nineteen crores.
Under the same management
The Amendment Bill proposes to make a redical change in the defini­
tion of "same management". Therefore, the present section and the proposed
amendment are given side by side for comparison.
For the purposes of sub-section (1) and (1-A), two bodies corporate shall
be deemed to be under the same management—
Present Section 370 (1-B) Provisions of the Companies
(Amendment) Bill 1972, (clause
4B)
(i) If the managing director or man- (i) If the managing director or mana-
ager of the one body is (a) mana- ger of the one is the managing
ging director or manager of the director or manager of the other
other body, or (4B*l-tf) or,
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204 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 17: 2

(ii) if a majority of the directors of (ii) if one or more directors of one

the one body constitute, or at
any time within six months imme­
diately preceding constituted, a
majority of the directors of the
other body, or
(iii) if not less than one-third of the (iii) if not less than one-third of the
total voting power with respect
to any matter relating to each
of the two bodies corporate is
excercised or controlled by the
same individual or body corpor­
ate, or
(iv) if the holding company of the
one body corporate is under the
same management as the other
body corporate within the mean­
ing of clause (0 or clause (iii),
or
(v) if one or more directors of the (v) if the same individual or indivi­
one body corporate while hold­
ing, whether by themselves or
together with their relatives, the together with their relatives not
majority of shares in that body
corporate also hold, whether by
themselves or together with
their relatives the majority of
shares in the other body corpor­
ate.3 [Section 370 (4): For the
body corporate constitute, or any
time within a period of six months
immediately preceding constituted
(whether independently or together
with relatives) one-third of the
directors of the other (4B.1-/V), or
total voting power with respect to
any matter relating to each of the
two bodies corporate is exercised
or controlled by the same indivi­
dual, whether independently or to­
gether with relatives, or by the
same body corporate whether in­
dependently or together with its
subsidiaries (4B.1-V/Y), or
duals belonging to a group while
holding, whether by themselves or
less than one-third of the shares
(whethere equity or preference or
partly equity and partly preference)
in one body corporate also hold,
whether by themselves or together
with their relatives not less than

A Ramaiya has commented on sub-section KB of section 370 as follows :

In many cases the test applied by this sub-section will prove illusory. As the
number of directors of one body corporate may not be the same as the number of the
other bcdy, in very mary cases, the majority of the Board of Directors may not be
the same in both. If in company A the total number of directors is three and in
company B, seven, even if all the three directors of the company A are directors
of company By the majority of the company A ate not the majority of the direc­
tors of company B. What Parliament apparently intended was that both the com­
panies should not be under the control of the same directors. But the language of
the clause does not give effect to such intention of Parliament.
A. Ramaiya, A Guide to the Companies Act 543 (6th ed., 1971).

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1075] INTER-CORPORATE LOANS AND INVESTMENTS 205

purposes of this section, any per­
son in accordance with whose
directions or instructions the
Board of Directors of a com­
pany is accustomed to act shall
be deemed to be a director of
the company].
(vi) If one exercises control over the
(v/i) if one holds not less than one-
(viii) if the same body corporate or
one-third of the shares (...) in the
other (4B I-v), or
if the directors of the one are
accustomed to act in accordance
with the directions or instructions
of the directors of the other or if
the directors of both the bodies
corporate are accustomed to act
in accordance with the directions
or instructions of any individual,
whether belonging to a group or
not (4B.l-/x).
The additional provisions of
clause 4-B of the Amendment Bill
are:
other or both are under the con­
trol of the same group or any of
the constituents of the same
group4 (4B. 1-i), or
third of the shares (whether equity
or preference or partly equity and
partly preference) in the other or
controls the composition of not
less than one-third of the total
membership of the Board of Direc­
tors of the other (4B. l-z/7), or
bodies corporate belonging to a
group holding not less than one-
third of the shares (whether equity
or preference or partly equity and
partly preference) in one body
corporate also hold not less than
one-third of the shares .... in the
other (4B. 1-vi), or

4. "Group" means a group of two or more individuals, associations, firms or bodies

corporate, or any combination thereof, which exercises, or has the object of exercising,
control over any body corporate, firm or trust (clause 2-/).
The term "control" has not been defined under the Companies Act. In England,
in Revenue Commissioners v. Harton Coal Co. Ltd., [ 43 I.T.R. 541(1961) ], the court held
that "control" in relation to a company ordinarily means the possession of a power, by
the exercise of voting rights, to carry a resolution at a general meeting of a company.

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206 JOURNAL OF THE INDIAN LA W INSTITUTE [Vol. 17 : 2

(ix) if not less than one-third of the

total voting power with respect
to any matter relating to each of
the two bodies corporate is excer-
cised or controlled by the same
individuals belonging to a group
or by the same bodies corporate
belonging to a group, or jointly
by such individual or individuals
and one or more of such bodies
corporate (4B. l-viii), or
(x) if a group excercises control over
a body corporate, that body cor­
porate and every other body cor­
porate, which is a constituent of,
or controlled by, the group shall
be deemed to be under the same
management (4 B. 2), or
(xi) if two or more bodies corporate
under the management hold, in
the aggregate, not less than one-
third of share capital (whether
equity or preference or partly
equity and partly preference) in
any other body corporate, such
other body corporate shall be
deemed to be under the same
management as the first mentio­
ned bodies corporate (4B. 3).

The criteria laid down by the proposed clause 4B for determining whe­
ther the two companies are under the same management can be conveniently
divided under the following three heads :
(A) Direct management.
(B) Control of the Board of Directors.
(C) Holding of shares.
Sub-clauses (1) and (2) of clause 4B of the proposed Amendment Bill
are couched in general terms and their application would be very wide. Again,
sub-clause (3) would mean that if two or more companies under the same
management hold in aggregate one-third share capital in another company,
such other company shall also be deemed under the same management. For
example, if A, B and C companies are under the same management and if
they hold in aggregate one-third share capital of D company, then D com­
pany will also be deemed to be under the same management.

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1975] INTER-CORP0R4TE LOANS AND INVESTMENTS 207

By the proposed clause 4B, the scope of inter-connection has been con­
siderably enlarged and most companies wiU fall in its net. Its consequences
as regards application of sections 370 and 372 will be far-reaching and dras­
tic.
If the holding of the financial institutions is counted with the holdings of
the other companies, for the purposes of considering one-third holding of
the voting power, then very soon almost all of the companies in India would
be under the same management!

Suggestions

(/') The biggest headache under this section is to determine which com­
panies are under the same management 1 and which are not under the same
management. Just to enable companies to invest ten per cent more without
the sanction of the central government, a distinction is made between compa­
nies under the same management and those not under the same management.
The author is sure that the companies would readily agree to an investment
up to a lower limit, say, twenty-five per cent instead of the present thirty per
cent, if thereby they are not required to decide whether the companies in
which they are investing are to be treated as under the same management.
Whatever may be the advantage of the definition of companies under the same
management in the Monopolies and Restrictive Trade Practices Act, the de­
finition is unnecessarily introduced as regards inter-corporate investments.
Nothing would be lost if the distinction between the companies under the
same management and those not under the same management is abolished
and a flat limit of twenty-five per cent on inter-corporate investments is laid
down.
(ii) Further, except in the case of a purely investment company, a limit
of twenty-five per cent of the subscribed capital of the investment company is
quite on the high side and a company will be able to make trade investments,
i.e., investments which are likely to create conditions conducive to the interest
of the investing company as well as to the other company's more economic
working and betterment of production. For example, a sugar company would
like to invest in a company which runs a sugarcane-farm and supplies sugar­
cane to it. So investments up to twenty-five per cent should be permitted.
However, a company should not be allowed to invest more than twenty-five
per cent of its subscribed capital in other companies except when the latter
are its subsidiary companies. This exception is there under the persent law
also [section 372, clause 14(d)]. Having regard to the evils of the inter corpo­
rate investments, this absolute limit of twenty-five per cent would be
quite fair so that a company may not digress from its main business and frit­
ter away shareholders' monies by investing in other companies when the
monies have been given by the shareholders not for the purpose of invest­
ments in other companies but for some other purposes. Again, the practical
effect of such a prohibition is not likely to be far-reaching, because as stated

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208 JOURNAL OF THE INDIAN LA W INSTITUTE [Vol. 17 : 2

above, during 1956 to 1971, a period of fifteen years, such applications to the
government have been only to the tune of one hundred crores of rupees.
Companies exempted from sections 370 and 372
Sections 370 and 372 of the Companies Act do not apply —
(a) to a banking or an insurance company ;
(b) to a private company, unless it is a subsidiary of a public com­
pany ;
(c) to investments and loans made, or guarantee given, by a holding
company, in, or in respect of, its subsidiary;
(d) to a company established with the object of financing industrial enter­
prise (in case of investments under section 372, the enterprise must
be in India and the central government must have made to the com­
pany a special advance for the purpose or must have guaranteed the
payment of monies borrowed by the company from any institution
outside India).

Section 370, with regard to inter-corporate loans, does not apply to a

book debt unless the transaction represented by the book debt was from its
inception in the nature of a loan or advance.

Suggestions

The way in which exemptions from sections 370 and 372 of the
Companies Act are given to banking and insurance companies gives rise to
some interesting questions. Can a bank or an insurance company give
a loan to company A with full knowledge that the company wishes
to utilise the loan for lending it to company B in violation of sec­
tion 370? Or can a bank or an insurance company give guarantee in respect
of a loan given by company A to company B in violation of section 370?
Or can a bank or an insurance company give a loan to company A to
invest in shares of company B in violation of section 372? It seems that a
bank or an insurance company can do ali these things without invoking the
penal consequences. The danger of flouting the sections with impunity may
not be there with regard to insurance companies, because the insurance
business is now fully nationalised, but it is definitely there in the case of
banks many of which are still in the private sector. The desirability of
plugging the loop-holes in these cases so that banks may not assist in violation
of the intentions of legislature may be considered.

Register of loans, gurantees and investments

Every lending campany and every investing company shall keep regis­
ters in which particulars of loans, guarantees and securities shall be entered
within three days and particulars of investments must be entered within seven
days. Such particulars should include the names of all the companies under

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1975J INTER-CORPORATE LOANS AND INVESTMENTS 209

the same management or in the same group respectively as the lending

or the investing company.
Default regarding maintenance of the registers will make the company
and every officer who is in default punishable with fine.
The register must be kept at the registered office of the company and
the members shall have the right to inspect and make copies in the same
manner as in the case of register of members.
Further, every investing company shall annex to each balance sheet, a
statement showing:
(a) The companies in the shares of which investments have been made
by it;
(b) investments, whether existing or not, made subsequent to the date
as at which the previous balance sheet was made out (in the case of
an investment company, that is a company whose principal busi­
ness is the acquisition of shares and securities, the statement need
show only existing investment); and
(c) the nature and extent of the investments made in each com­
pany.
Regulation of acquisition and transfer of shares5
The government noticed a "striking unhealthy phenomenon in recent
times" in the trend towards take-over of trie well-established companies by
individuals, groups or combines. Such take-overs are apt to be unfair to,
and adversely affect the interest of, the non-controlling shareholders, parti­
cularly public financing institutions which are kept in the dark while secret
negotiations are entered into with those having control of the company. The
government also felt that the provisions of section 372 of the Companies Act
were not adequate to regulate the take over of the companies. The new sec­
tion, section 108A, is intended to meet the cases of take-over bids by groups
or combines. It provides for governmental approval before completion of any
take-over either in one transaction, or in a series of transactions, resulting
in acquisition of shareholdings in the aggregate of over twenty-five per cent
by an individual, a group or a combine having the common intention of
acquiring control over the company concerned. The proposed restriction
will apply in respect of companies having total paid-up capital of not less
than twenty-five lacs of rupees and private companies which are subsidiaries
of such public companies.
The proposed new section, 108B, provides that every company or compa­
nies under the same management holding whether singly or in the aggregate,
ten per cent or more of the nominal share capital of any other company, shall
intimate to the government any proposal to transfer such shares. On receiv-

5. Proposed sections 10SA and 10SB of the Companies Act.

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210 JOURNAL OF THE INDIAN I,AW INSTITUTE [Vol. 17 :2

ing such intimation, the central government can issue directions regulating
the transfer of such shares. In respect of companies operating in the fields
covered by industries (covered by the Industrial Policy Resolution of the cen­
tral febverriment an# enumerated in schedule 13, the central government may
direct the shares to be* transferred to it or a corporation owned or con­
trolled by it,
The government alsb proposes to regulate the terms for acquiring the
shares so directed to be transferred. Anv disagreement shall be settled by
the court
The proposed new section 108D, will empower the cemral government
to direct companies not to give effect to any transfer of shares, if as a result
of such transfer, a change in the controlling interest of the concern, prejudicial
to the interests of the company or to public interest, is likely to take place.
The power will extend to a restoration of the status quo ante.
Though the object of the sections may be laudable, the wording of the
sections has generated a lot of criticism; for example from the wording of
section 108B it would appear that the restrictions will operate even in case
of a transfer of one share out of the total holding of ten per cent.

Suggestions
It may be of interest to ftote that this type $f provisions were
considered even when the Companies Act, 1956 was drafted. D.L. Mazum-
dat, Who was intimately connected With the drailirig and early working of
the Companies Act, writes in his interesting book, Towards a PhihSphy of We
Modern Corporation:

Conceptually, it should be possible to envisage proposals Which would

have the effect of preventing the tranfcfe* of significant' blocks of shares
eiceptwith the appfoVarof some appropriate authority. Indeed, this
suggestion was specifically considered in 1953-55 in connection with the
increasing* tendency noticeable? ^aboutt that time on the Jiart of many
leading business houses iii Ndrth India and alko to a lister extent in the
South to acquire controlling interest in tea and other plantations at what
was then considered to be unduly inflated prices.6

The proposal was,* however, dropped for several reasons. First of all,
it was doubted whether su^h proposals would be intra vires the Constitution
(as it then was), unless elaborate and complicated provisions relating to com­
pensation were made. Further, action in individual crises would infringe a
citizen's fundamental rigljt to acquire, hold and dispose of property^ To
aypida* charge of discriminatioa in,, particular cases, the general principles
or tests which the administration $Jwd4 follow ir^ arriving at its assessment
in individual cases, would have had to be laid down with sufficient precision.

6. D.L. Mazumdar, Towards ^Philosophy of the Modern Corporation 100 (l£67).

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1975] INTER-CORPORATE LOANS AND INVESTMENTS 211

Lastly, formidable operational difficulties in enforcing the contemplated

wider powers for direct control and regulation of sheare transfers were
visualized, because of the difficulty in determining any particular case when
the critical point in the change of ownership of shares had been reached.
With the lapse of time and the recent changes in the Consitution regarding
property rights, perhaps the government now feels the need to widen the
protective hedges essential for the defence of the legitimate interests of honest
and efficient managements against the depredations of unscrupulous business­
men who desire quick profit at the expence of indifferent shareholders.
Upstream investments prohibited
Under section 42 of the Companies Act, a company cannot be a member
of another company which is its holding company and any allotment or trans­
fer of shares in a company to its subsidiaries is void. This prohibition is
subject to a couple of exceptions.
The Company Law Committee, while recommending this new section in
the Companies Act, rightly stated:
These salutary provisions constitute an attempt to maintain the separate
operational identity of a holding company and its subsidiary and
thereby to preserve the respective shareholders' control over them. In
the absence of any such provision, the affairs of a holding company
and its subsidiary may, in the hands of unscrupulous company managers,
become in extricably involved and confused to the seriqus detriment of
shareholders.7
Conclusion
To summerise the suggestions in this brief article:
(a) Except in the case of banks and lending institutions or when
credit facility is given by one company to another in the usual course
of business, companies should not be allowed to g\VQ loans to each
other.
(b) The distinction between companies under the same management
and those not under the same management may be done away with
and a flat limit of twenty-five per cent of the subscribed capital plus
free reserves of the investing company may be laid down on inter­
corporate loans and investments.
(c) Instead of giving absolute exemption to banks from sections 370
and 372, the exemption should be restricted so that banks may not
abate the violation of the sections by companies in inter-corporate
loans and investments.
(d) The proposed new sections, sections 108A to 108D, which deal
with the regulation of acquisition and transfer of shares, need a
lot of trimming up so that unnecessary irritants may be removed.

7. Government of India, Report of the Company Law Committee, p,32(1952).

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