Holding and subsidiary companies.

1. Introduction

Section 4 of the Companies Act, 1956 prescribes dual test and

conceptually defines the Holding-Subsidiary company relationship.
This is a special provision extending the provisions of the Act to
intra-company relationships. Section 4 of the Act states the
meaning of" holding company" and" subsidiary".
(1) For the purposes of this Act, a company shall, subject to the
provisions of sub- section (3), be deemed to be a subsidiary of
another if, but only if,--
(a) that other controls the composition of its Board of directors; or
(b) 2[ that other-
(i) where the first- mentioned company is an existing company in
respect of which the holders of preference shares issued before the
commencement of this Act have the same voting rights in all
respects as the holders of equity shares, exercises or controls more
than half of the total voting power of such company;
(ii) where the first- mentioned company is any other company,
holds more than half in nominal value of its equity share capital; or]
(c) the first- mentioned company is a subsidiary of any company
which is that other' s subsidiary.
1. Cl. (b) omitted by Act 62 of 1956, s. 2 and Sch (w. e. f. 1- 11-
1956).
2. Subs. by Act 65 of 1960, s. 3, for cl, (b),
Illustration Company B is a subsidiary of Company A, and
Company C is a subsidiary of Company B. Company C is a
subsidiary of Company A, by virtue of clause (c) above. It
 Holding and subsidiary companies.

Company D is a subsidiary of Company C, Company D will be a

subsidiary of Company B and consequently also of Company A, by
virtue of clause (c) above; and so on.
(2) For the purposes of sub- section (1), the composition of a
company' s Board of directors shall be deemed to be controlled by
another company if, but only if, that other company by the exercise
of some power exercisable by it at its discretion without the consent
or concurrence of any other person, can appoint or remove the
holders of all or a majority of the directorships; but for the purposes
of this provision that other company shall be deemed to have power
to appoint to a directorship with respect to which any of the
following conditions is satisfied, that is to say-
(a) that a person cannot be appointed thereto without the exercise in
his favour by that other company of such a power as aforesaid;
(b) that a person' s appointment thereto follows necessarily from his
appointment as director, managing agent, secretaries and treasurers,
or manager of, or to any other office or employment in, that other
company; or
(c) 1[ that the directorship is held by an individual nominated by
that other company or a subsidiary thereof;]
(3) In determining whether one company is a subsidiary of another-
(a) any shares hold or power exercisable by that other company in a
fiduciary capacity shall be treated as not held or exercisable by it;
(b) subject to the provisions of clauses (c) and (d), any shares held
or power exercisable-
(i) by any person as a nominee for that other company (except
where that other is concerned only in a fiduciary capacity); or
 Holding and subsidiary companies.

(ii) by, or by a nominee for, a subsidiary of that other company, not,

being a subsidiary which is concerned only in a fiduciary capacity;
shall be treated as held or exercisable by that other company;

Two significant factors which determine the relationships are

control and ownership. The business conduct of such companies
is regulated in certain respects and the effect of such regulations
will result in treating another company as a Subsidiary of the
Holding company. With the result, the provisions of the Act
applicable to a public company will also apply to the subsidiary
private company. However, the character of private remains
unchanged.

2. Board Control

The most common form of control in the case of bodies corporate is

controlling the composition of the Board without being a member
of the company. This may happen by direct control of the Board or
through one or more Subsidiaries. Be that as it may, the Board
occupies a pre-eminent position in the corporate hierarchy from the
point of the view of enormous power it exercises and control it
secures over the management of another company. It is not merely
an economic unit but a power house. Considering these and other
factors, the Act rightly recognizes the structure of the Board as a
manifestation of its inherent strength and standing in the corporate
structure.

3. Section 4 of the Act

 Holding and subsidiary companies.

The composition of Board of a company is deemed to have been

controlled, by another company if, but only if, that other company,
without the consent or concurrence of any other person, can appoint
or remove the holders of all or majority of the directors by virtue of
exercise of some power exercisable by it, at its discretion. Further,
the other company shall be deemed to have such a power of
appointment

a. if the person thereto cannot be appointed without the exercise

of the said power in his favor by the other company
b. that a person's appointment thereto follow necessarily from
his appointment as director or manager or to any other office
or employment in that other company or
c. that the director-ship is held by an individual nominated by
that other company or a Subsidiary thereof.

This is the sum and substance of sub-section (2) of section 4 of the

Act. If the conditions specified in the said sub-section are satisfied,
then the first mentioned company is deemed to be Subsidiary of the
other company by virtue of Board control.
 Holding and subsidiary companies.

4. Holding & Subsidiary Company Relationship

The manner of securing Board control is not envisaged as it is a

matter relating to business practice. However, this is possible if the
Articles of Subsidiary company specifically provide for a power to
the other company to nominate all or majority of directors on the
board of first mentioned company. The moot question is, can the
Articles provide for such a provision if the other company does not
hold all or majority of shares.

However, there can be an arrangement between the lender and

borrower companies as part of financing under which the lender
may nominate all or majority of directors with or without a specific
provision in the Articles for the purpose of ensuring proper
utilization of funds. This is possibly one of the reasons why section
4 provides for Board control as a means of creating Holding &
Subsidiary company relationship. The immediate effect of such an
arrangement is that lending company becomes a Holding company
by virtue of section 4 of the Act.
 Holding and subsidiary companies.

5. Examination of Section 4 in relation to Section 255

Another dimension relates to the validity of section 4 vis-a-vis

section 255 of the Act which deals with appointment and retirement
of directors by rotation. At least two-thirds of the total number of
directors of a Public Company or a Subsidiary Private Company
should be persons whose period of office is liable to retire by
rotation. However, Section 255(1)(b) saves the arrangement in
section 4 of the Act. With the result, prima facie, there is no
conflict between section 4 and section 255 of the Act.

While sub-section 255(1) (b) saves the arrangement envisaged in

section 4 by using the words "save as otherwise expressly provided
in this Act", section 255(1)(a) provides that not less that two-thirds
of total number of directors shall be persons whose period of office
are liable to retire by rotation. This is a mandatory provision.

6. Case law on the subject;

Oriental Industrial Investment Corporation of India vs Union of

India

(1981)51 Com Cases 487(Del)

The effect of section 4 in relation to sections 255,256 and 257 came

up for consideration.
 Holding and subsidiary companies.

Facts of the case

By an agreement dated August 19, 1975 between Oriental Limited

and Poonam Hotels, Oriental was given full and absolute power to
appoint five directors on the board of directors of Poonam Hotels.
This gave power to Oriental to appoint majority of directors on the
board of Poonam Hotels with power to remove such directors and
to appoint another in his place. Poonam also amended its Articles
suitably and Oriental appointed five of its directors on the board of
Poonam Hotels. This brought about holding and subsidiary
relationship in terms of section 4 of the Act. Thereafter Oriental
acquired 88% percent shares of Poonam Hotels in two tranches.
Oriental made an application to the DCA for extending the
financial year of its Subsidiary to bring it in line with its accounting
year for complying with section 212 of the Act. The Department
rejected the application on the ground that Article included by
Poonam conferring authority on Oriental to appoint majority of
directors is violative of sections 255,256 and 257of the Act and
treated it as void as per section 9 of the Act and consequently
Poonam cannot be treated as Subsidiary company. Request of
Oriental for reconsideration did not evoke positive response and the
Department reiterated its stand whereupon Oriental filed a writ in
the High Court of Delhi.
 Holding and subsidiary companies.

7. Decision of Delhi High Court

The High Court observed, inter alia, that the contention of the
counsel for the Union of India that "the control of Oriental over the
composition of the Board of Poonam Hotels which they exercise by
virtue of their agreement dated August, 1975 is in contravention of
the provisions of Sections 255,256 and 257 of the Act overlooks the
important fact that section 255 excludes from its purview cases
which have been otherwise expressly provided in the Act. The
words "save as otherwise expressly provided in this Act" used in
section 255(1)(b) are of commanding significance. Section 4(2) is
an express provision for the appointment of the directors on the
Board of Subsidiary. This provision is not hit by Section 255
because it is expressly excluded."

The High Court also observed that "there is no denying the fact that
the right of the members of a public company to appoint directors
of their choice at a general meeting is greatly abridged when there
comes into being a relationship of a Holding and Subsidiary
Company. But this restriction inheres in the definition of the
Holding Company. It is firmly embedded in section 4 of the Act.
The ability to control the conduct of the Subsidiary is the hall-mark
of the Holding Company. The Holding Company is the controlling
company. The controlled company is called a Subsidiary."
 Holding and subsidiary companies.

8. Revised clarification by DCA

Following the Judgment of the Delhi High Court, the Department

of Company Affairs (DCA) issued a clarification modifying their
earlier views on the above matter which is reproduced below;-

"Department views";- The Department has issued a circular 14\74

dated 28-8-1974 to the effect that the Articles of a company which
confer upon another company the right to make provisions for
appointment of director upon another company with a view to make
the company a subsidiary is invalid under section 9 of the
Companies Act. On a combined reading of the provisions of
sections 255, 256 and 257 and because section 257 is a mandatory
provision, this view does not seem to be well founded. The
appointments made pursuant to an arrangement whether by the
Articles or by an agreement is not invalid merely because any
shareholder may seek election at an annual general meeting.
Section 257 only deals with the right of a person other than a
retiring director to stand for election at the annual general meeting.
The agreement or Article of a company, in so far as it or they invest
a company with the status of holding company in relation to the
company of which the board is controlled cannot be said to be
inconsistent with section 257 which comes into operation only
when elections are to be held at the annual general meeting.

It follows from the above that a public company is not required to

 Holding and subsidiary companies.

comply with the requirements of sections 255 to 257, if it is a

Holding Company having the right to appoint majority of directors
on the Board of the Subsidiary company pursuant to section 4 of
the Act.

9. Shareholding Control- Direct ;

This is the second method by which Holding & Subsidiary

company relationship can be established. This is possible if one
company holds more than half in nominal value of equity capital of
another company as per section 4(1)(b)(ii) of the Act. This is a case
of direct investment and indicates the financial interest and stake of
the Holding Company in its Subsidiary. This is however subject to
sub-section 4 (3) of the Act which seeks to exclude certain
shareholdings for the purpose of reckoning half the nominal value
of equity shares aforesaid.

They are;-

a. any shares held or power exercisable by that other company

in fiduciary capacity is considered as having not been held or
exercisable by it. What is referred to is the equity shares
carrying voting rights. Fiduciary capacity creates a
relationship under which one owes to another the duties of
good faith, trust and confidence. It is a company to company
relationship;
b. any shares held by a nominee of that company, except as a
fiduciary is considered as having been held by that company;
 Holding and subsidiary companies.

c. any shares held by a nominee for a Subsidiary of that

company, not being a Subsidiary connected as a fiduciary is
considered as having been held by that company;
d. any shares held or power exercisable by any person as
security for the debentures of the first mentioned company or
of a trust deed for securing any issue of debentures is to be
disregarded;
e. any shares held or power exercisable by or by a nominee for
that other or its Subsidiary shall be treated as not being held
or exercisable by that other ,if such holding or power is by
way of security only for the transaction of lending in the
ordinary course of business.

10. Indirect Control

This is envisaged in section 4(1)(c) of the Act as third type of

relationship applicable mainly in the case of group companies. A
Subsidiary of a Subsidiary becomes a Subsidiary o f the ultimate
Holding Company. This may be second or third generation
Subsidiary by virtue of management or shareholding control and
the linkage is endless.

Another distinctive feature can be seen in sub-section (5) of the

Act. For the purpose of section 4, the expression "company" is
defined to include any body corporate, whereas for other provisions
of the Act, "body corporate or corporation" includes a company
incorporated outside India as defined in section 2(7) of the Act.
 Holding and subsidiary companies.

11. Extension of the Principle of Control.

Sub-section (6) seeks to extend the principle of control in the case

of a body corporate incorporated in a country outside India, a
Subsidiary or Holding Company of such a company shall be
deemed as Subsidiary or Holding Company of the body corporate
within the meaning and for the purposes of Indian law, whether the
requirements of section 4 are fulfilled or not. In this case, the same
status is accorded under the Indian law to a body corporate as in the
country of its incorporation in relation to its Holding or Subsidiary
relationship. Here the shareholding control or management control
discussed above are not relevant.

12. An Indian Private Company as Subsidiary of foreign body

corporate

Sub-section (7) of section 4 provides for a deeming provision. The

intention is to place a Private Company registered in India which is
a Subsidiary of a foreign company on par with a Private Company
which is a Subsidiary of Public Company registered in India. To
achieve this purpose, sub-section (7) provides that a Private
Company which is a Subsidiary of the company incorporated
outside India, which if incorporated in India would be a Public
Company within the meaning of the Act shall be deemed as
Subsidiary of a Public company, provided that the entire share
capital in that Private Company is not held by the body corporate,
 Holding and subsidiary companies.

whether alone or together with one or more bodies corporate

incorporated outside India. This provision is based on the
recommendation o f the Joint Company Law Committee as it
considered unnecessary to treat an Indian Private Company, the
entire share capital of which is held by one or more bodies
corporate incorporated outside India as a Private Company which is
a Subsidiary of a Public Company for the purposes of the Act.

A close look at the provision indicates that the exemption is based

on a similar position as in the case of private company whose entire
share capital is held by one or more companies and none of them
hold 51% or more of share capital o f the private company. Even if
all these companies are public companies, the private company
continues to be a private company, particularly in the context of
deletion section 43A of the Act from the statute book.

Needless to say that a private company whose entire capital is held

by one or more bodies corporate, whether incorporated in India or
outside stands on a different footing, as such holding amounts to
indirect public holding. Such companies have to have greater
degree of accountability and transparency in their operations for the
benefit of their shareholders. It is therefore necessary that legal
framework to address this requirement should be in place.
 Holding and subsidiary companies.

13. Conclusion

What started as direct or indirect control, be it shareholding or

otherwise has inevitably resulted in having to rope in Subsidiary
Companies being increasingly set up by foreign companies. That
these companies should, no doubt, be brought within the regulatory
provisions as applicable to Indian companies but the matrix of
Holding-Subsidiary Company relationship has become more
complex and complicated. This appears to be inevitable in the
context of globalisation of Indian economy and increasing flow of
foreign exchange into our country through Foreign Direct
Investment (FDI) in joint ventures or Subsidiary companies.