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Interested Contracts Under Section 297 And Course Of Action

March 24, 2011

Introduction

The Directors of a Company act as agents of the Company and enter into contracts and arrangements on behalf of the Company. Sometimes, in the course of such transactions, the Directors may have some personal interest  in the transactions to be entered into by the Company. Since they occupy such a key position requiring trust and utmost good faith, they must act bona fide and in the interest(s) of the Company.

The Companies Act, 1956 has laid down extensive provisions to prevent any misuse of rights and powers by the Directors. The main purpose of one of such provisions (i.e., Section 297 which is applicable to both Private & Public Companies) is to bring to the knowledge of the Board of Directors, the extent of the interest of a Director, in any contract entered or proposed to be entered with the Company by the Director or any of his specified associates.

This article tries to throw light on what are the contracts in which Directors may have personal interest and what should be their course of action when entering into such contracts.

Interested Contracts

The Contracts with following features are Interested Contracts:

(1) Purpose of Contracts

(a) for the sale, purchase or supply of any goods, materials or services; or

(b) for underwriting the subscription of any shares in, or debentures of, the company.

(2) Parties to the Contracts

The Company is one party and any of the following should be the second party:

1. any director of company;

2. any relative of any director of the company;

3. any partnership firm in which any director of the company is a partner;

4. any partnership firm in which any relative of any director of the company  is a partner

5. any partner of the partnership firm in which any director of the company  is a partner

6. any partner of the partnership firm in which any relative of any director of the company is a partner

7.  any private company in which any director of the company is a member;

8. any private company in which any director of the company is a director;

However all the contracts with above mentioned features might not fall under the purview of provisions of Section 297 of the Companies Act, 1956.  There are certain exceptions to it as mentioned below:

Exceptions provided in the provision

1. Purchase of goods & materials from the company / Sale of goods & materials to the company for cash at prevailing market prices.

“Cash & at prevailing market price”

A cheque is to be treated as the equivalent of a cash payment for the purpose of this provision. To avail this exemption, the payment should be on the spot or against delivery. In other words, purchase or sale should not be on credit. Payment for the goods purchased must be made on the day of the delivery of goods, lest the transaction will turn to be one of credit.

“Prevailing market price”

The price charged should be the ruling market price of the seller and no favour should be offered to other buyers in respect of the purchases. Any extra commercial consideration for entering into the deal would distort the price and dis-entitle the company to this exemption.

2.  Contracts for sale / purchase or supply of goods / services / materials in which the company or the director/ relative/partner/private company or a firm  regularly trades or does business.

Such contracts should cost less than Rs. 5000/-in total in any year comprised in the period of that contract.

“Regularly trades or does business”

If it is not the regular business activity of the party concerned to deal, trade or do business in the goods, materials, or to provide services, in question, then the exemption would not be available.

3. Transaction in the ordinary course of business of banking / insurance company with any director/ relative/partner/private company or a firm.

“Banking & Insurance Company”

Any banking or insurance service provided by a banking company or an insurance company shall not require consent of the Board of Directors or approval of the C.G.

4. Contracts between two public companies.

(Ex- If the contract is for the provision of services and the recipient of the services is a public company, sec 297 will have no application even if a private company has been employed as a conduit to provide the services on behalf of the public company.)

5.   Transaction of loan made by a director to the company

6.   A lease simplicitor of Plant & Machinery

7. Contract for sale for immovable Property.

8. Rendering of services. (Ex- Supply of services given by firms of solicitors and advocates.)

9. Contracts for professional services, personal services, or to employment contracts and to the services of managing or whole time director.

10. Bodies Corporate, Government Companies & Foreign Companies.

Approval from the Board: The Company has to obtain the consent of the Board of Directors before entering the above mentioned interested contracts.  In a situation where the Board does not have a quorum of disinterested directors, the contract shall be approved by the shareholders in General Meeting.

Exception: In cases of urgent necessity, prior approval of the Board is not required but the consent should be obtained within three months by a resolution passed in the board meeting

Consent must be specific: The word consent means agreement or permission. The consent can't be a general one,  that means it must be with respect to particular transaction.

Consent must imply knowledge of the necessary facts and materials which leads to the consent.

Manner of according consent: Every consent of the Board must be accorded by a resolution passed at a meeting of the Board. It can't be through circular resolution. The directors must apply their minds to the facts of the contract and consider them having regard to the interest of the company. Full particulars & facts with respect to the contract must be placed before the Board. A statement recorded in the minutes is the evidence of the proceedings of the meeting.

Approval from the Central Government: If the Company's  paid-up capital is Rs.1Crore or more, prior approval of Central Government (i.e., Regional Director) is required.

Consequence of Non-compliance: Failure to obtain the Board’s consent  or prior approval of the Central Government will make a contract voidable at the option of Board of Directors.

Responsibility of  Directors: If a director makes a profit on a transaction entered into on behalf of Company, profit belongs to company and not to the Director/Agent.  If a director takes from another person a commission on a transaction or contract entered into on behalf of the company, he commits a breach of duty and amount so received belongs to the company.

1. Directors should ensure that any of the interested Contract is brought to the notice of Board of Directors

2. A director cannot enter into a contract which may conflict with interests of company

3. The disclosure of interest can be specific to the Contract proposed to be

4.  entered or entered or it can be a General disclosure each year, listing all the entities wherein the director is interested.

5. Such General Disclosure should be made in Form 24AA in the last month of the Financial Year.

6. If the Company's paid-up capital is Rs.1 Crore or more,  Directors should ensure prior approval of Central Government under appropriate legal guidance.

7. It is right of the Board to make any interested contract void in the best interests of the Company.

Issues to be relooked: An issue that needs consideration is the capital limit specified in the proviso to sub-section (1). As mentioned earlier, this proviso with the limit came on the statute with effect from 1975 and at that time an amount of rupees one crore was a very large sum. It is obvious that the intention of the lawmakers was to mainly regulate the large companies through government control. As a result only a few large companies attracted the provisions of the section.

However, the passage of resulted in a very large number of companies with a paid up capital of rupees one crore or more. It indicates that by keeping the threshold amount unchanged the number of companies required to comply with this provision has multiplied manifold without really serving the underlying objective of the Law makers.

Conclusion: The interested Director should enable the Board to take a unbiased decision which would be in the best interest of the Company and the terms of the contract and arrangement should be fair and reasonable and not solely beneficial to the interested director.

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