What is the Meaning of “Undertaking” and “Substantially the Whole Undertaking” under the Companies Act?

An analysis of the meaning of “undertaking” and “substantially the whole of the undertaking” under Section 180 of the Companies Act, 2013, examining judicial interpretations, shareholder approval requirements, the 20% threshold, and the application of the concept to modern business models.

“Undertaking shall mean an undertaking in which the investment of the company exceeds …..” is the Explanation¹ in the Companies Act, 2013. This is the classic style of the legislature, where the lawmaker does not define the core term [in this case, the Explanation does not explain the meaning of the term “undertaking”]. Probably, the lawmaker assumes that readers know the meaning of “undertaking”, or the lawmaker chooses to remain non-prescriptive about the core concept and merely prescribes that the said undertaking will be treated as an undertaking for the purposes of this provision if the investment of the company in such undertaking exceeds the threshold explained in that Explanation. However, the core question that has kept haunting stakeholders is: what is an undertaking?

There have been multiple pronouncements dealing with questions such as: what is an undertaking? What is the whole or substantially the whole of an undertaking? What is disposal of an undertaking? Whether a closed unit is an undertaking? Whether an asset is an undertaking? However, the core issue that first needs to be understood is what constitutes an undertaking, followed by the meaning of “substantially the whole of an undertaking”.

What is undertaking?

The erstwhile Companies Act, 1956 had no definition or even an Explanation of what constitutes an undertaking. However, this subject came before the judiciary on multiple occasions for interpretation. Depending upon the background of each case, the judiciary gave its verdict on whether the thing being sold or disposed of was an undertaking. This concept was initially discussed in the context of the Industrial Disputes Act, 1947². From this context, the issues that arise for deliberation are:

1. Whether the Board is disposing of asset or undertaking?

2. If what is proposed to be disposed of is some assets, whether it is disposal of whole or substantially the whole of the undertaking or not?

Landmark judicial view

There are many pronouncements on what is treated as an undertaking. Some landmark judicial views are set out below:

Rustom Cavasjee Cooper (Banks Nationalisation) v. Union of India³, the learned Judge observed that the undertaking meant the entire organisation. It was observed by the learned Judge, at page 417, that the undertaking was an amalgam of all ingredients of property and was not capable of being dismembered. It was further held on this aspect as under:

“In reality the undertaking is a complete and complex weft and the various types of business and assets are threads which cannot be taken apart from the weft.”

Yallamma case

“Undertaking was not, in its real meaning, anything which may be described as a tangible piece of property like land, machinery, or the equipment; it is in actual effect an activity of man which in commercial or business parlance means an activity engaged in with a view to earn profit. Property, movable or immovable, used in the course of or for the purpose of such business can more accurately be described as the tools of business or undertaking, i.e., things or articles which are necessarily to be used to keep the undertaking going or to assist the carrying on of the activities leading to the earning of profits.⁴

P.S. Offshore case

18. In my judgment, the expression “undertaking” used in this section is liable to be interpreted to mean “the unit”, the business as a going concern, the activity of the company duly integrated with all its components in the form of assets and not merely some asset of the undertaking. Having regard to the object of the provision, it can, at the most, embrace within it all the assets of the business as a unit or practically all such constituents.

If the question arises as to whether the major capital assets of the company constitute the undertaking of the company while examining the authority of the Board to dispose of the same without the authority of the general body, the test to be applied would be to see whether the business of the company could be carried on effectively even after disposal of the assets in question or whether the mere husk of the undertaking would remain after disposal of the assets? The test to be applied would be to see whether the capital assets to be disposed of constitute substantially the bulk of the assets so as to constitute the integral part of the undertaking itself in the practical sense of the term.⁵

Companies law, in all its versions, has had a very clear-cut bifurcation of powers between the Board and shareholders. The power to sell, lease or dispose of an undertaking, either wholly or substantially as a whole, required prior consent of the shareholders of the company. The law was, and is, very clear that for selling or leasing assets, the Board does not need the consent of shareholders; it is within its powers. However, for selling, leasing or disposing of an undertaking, the Board needs the prior consent of the shareholders.

Litmus test

Though the Companies Act does not expressly define and differentiate the terms “asset” and “undertaking”, it can be inferred from the usage of these expressions in the Companies Act, together with judicial pronouncements, that there is a legislative intent to give different meanings to both terms.

While “asset” would generally mean a property of the company whether movable or immovable and may or may not be used to generate revenue, an “undertaking” of a company could be referred to as something that would constitute an integral part of a company and would be used as a tool for business purpose thereby contributing to the company’s generation of revenue and/or earning of profits.

When the Board is disposing of certain assets of the company, the test to be applied is whether the business of the company could be carried on effectively even after disposal of the assets in question, or whether only the mere husk of the undertaking would remain after disposal of those assets.

Closed unit versus Running unit

In Pramod Kumar Mittal v. Andhra Steel Corpn. Ltd.⁶ and in P.S. Offshore Inter Land Services (P) Ltd. v. Bombay Offshore Suppliers and Services Ltd., one common question was whether a closed factory, or an undertaking not deployed for running the business, is treated as an undertaking under the Companies Act, 2013. After reading both judgments, it emerges that the answer depends on the context and facts of the case. For example, in the P.S. Offshore case, the company had three ships, and one ship was newly purchased but, due to the business situation, was not deployed in the business. Whether disposal of a newly acquired ship not put to use in the business would require shareholder approval was the question. The Court clearly held that whether the undertaking is generating revenue or not is not determinative. The logic in the P.S. Offshore case appears to be that even if the newly acquired ship was not put to use, it could have been put to use at any time; therefore, whether the business is being carried on today should not be the parameter. However, in the Pramod Kumar Mittal case, the Court held that since the factory proposed to be disposed of was a closed unit, it did not require shareholder approval. The context in that case, however, was different. The petition was related to oppression and mismanagement, and the High Court supplanted the Board with a court-appointed Committee of Management, which subsequently sold a company unit to settle creditor dues. The Court held that Section 293 does not apply to such a sale, as the statutory requirement for shareholder approval governs voluntary actions by a Board, not decisions executed by a court-appointed committee. Therefore, it emerges that if the underlying assets, taken together, constitute an undertaking, whether it is currently running as a business and the proximity and probability of restarting that business by an acquirer would be subjective parameters to be evaluated on a case-by-case basis to decide whether shareholder consent is required in a particular matter.

Meaning of substantially the whole [before 2013]

In the P.S. Offshore case, one more subject came for discussion — whether disposal of one ship out of three ships would be considered as disposal of substantially the whole of the undertaking or not? To that court opined that—

22. … If the question arises as to whether the major capital assets of the company constitute the undertaking of the company while examining the authority of the Board to dispose of the same without the authority of the general body, the test to be applied would be to see whether the business of the company could be carried on effectively even after disposal of the assets in question or whether the mere husk of the undertaking would remain after disposal of the assets?⁷

Here, the word “substantial” was also interpreted by the court with similar parameters like those applied for treating something as undertaking, i.e. whether after disposal of this part of undertaking, the rest of the undertaking is becoming husk. Since after disposing off one ship still company had other two ships, disposal of one ship does not fall under the term “substantially the whole” was the view taken by the Bombay High Court.

J.J. Irani Committee Recommendation

Probably, this and similar cases contributed to the deliberations of the J.J. Irani Committee⁸, constituted in 2004 to overhaul the Companies Act, 2013. The Irani Committee felt that:

Section 293 of the present Act “should be reviewed and it should be provided that the consent of the shareholders should be through a special resolution for certain items such as those presently mentioned in Section 293(1)(a)(c) and (d) of the present Act. Shareholders’ approval should be required for sale of whole or substantially whole of the undertaking in that financial year. ‘whole or substantially whole’ should mean 20 per cent of the total assets of the company”.

The J.J. Irani Committee did not change the meaning of the term “undertaking”. It merely recommended defining “whole or substantially whole” as 20 per cent of the total assets of the company.

So, Committee’s recommendation was simple. While adopting the Explanation, it was split into two parts. What is whole undertaking and what is substantially the whole undertaking, which reads as follows:

Explanation.—For the purposes of this clause,—

(i) “undertaking” shall mean an undertaking in which the investment of the company exceeds twenty per cent of its net worth as per the audited balance sheet of the preceding financial year or an undertaking which generates twenty per cent of the total income of the company during the previous financial year;

(ii) the expression “substantially the whole of the undertaking” in any financial year shall mean twenty per cent, or more of the value of the undertaking as per the audited balance sheet of the preceding financial year;⁹

This Explanation does not define what is undertaking but clarifies that undertaking in which investment of the company exceeds 20 per cent of its net worth or which generates more than 20 per cent of the total income will require compliance of Section 180(1)(a).

And substantially the whole undertaking would mean “20% or more of the value of undertaking as per audited balance sheet of preceding financial year”. This was a significant departure from P.S. Offshore case.

As per the new Explanation, if the proposed disposal amounts to 20% or more of the value of the undertaking as per the audited balance sheet of the preceding financial year, it will be treated as a sale, lease, or disposal of substantially the whole of the undertaking, requiring shareholder approval. This seems to be a rule-based Explanation, and the principle-based view taken in P.S. Offshore may not be relevant here onwards. If P.S. Offshore were to arise today, since the company was in the shipping business, and if the value of the third ship was more than 20 per cent of the value of the undertaking, it would require compliance with Section 180.

Madhukar Anantrao Pathak v. MPTA Ltd.

In this context, there is recent National Company Law Tribunal (NCLT)/National Company Law Appellate Tribunal (NCLAT) pronouncement where company was in business of advisory and coaching and it had a bungalow as a property. The company was trying to dispose of said bungalow, and question was whether this will require shareholder approval or not, to which NCLAT said that bungalow is not an undertaking, and it will not require approval of shareholders. It is not clear whether company had any business/undertaking and whether bungalow was part of that business/undertaking or not? If there is no business unit/undertaking in the company or if bungalow is not part of the business unit, then undertaking compliance of Section 180 would not be required. However, had the appellant proved that there was an undertaking and bungalow was part of the undertaking which is constituting more than 20 per cent of value of undertaking probable, the conclusion could have been different. There are many old companies who have huge land parcel, and they have business unit separately functioning and the courts often take a view that asset which is being disposed of is not part of undertaking and therefore will not require compliance of new framework prescribed under Section 180. This view looks perfectly fine.¹⁰

What if company is in service or investment or lending business

Most of the pronouncements discussed above, apart from P.S. Offshore and Madhukar Pathak¹¹, relate to manufacturing companies. For a service company, a trading company, or a lending or investment company, the meaning of a business unit needs to be looked at differently. As observed in all landmark pronouncements, it is not about a factory or a unit alone; an undertaking is a business unit.

What is a business unit for the service industry? Is it the office, staff, customer contracts, IT infrastructure, intellectual property, or a business vertical? A business vertical can be an undertaking, and even intellectual property can constitute substantially the whole of an undertaking.

What is business unit for investment company? because their business is to invest in other companies or properties and their earnings is either from its dividend/interest or in the form of profit on sell. Whether disposing off investment will be a sale of substantially whole of the undertaking? We have seen in Brooke Bond India Ltd. v. U.B. Ltd.¹² and Gujarat NRE Mineral Resources Ltd. v. SEBI¹³ the court or adjudicating authorities have taken a view that investment in other company is not an undertaking. However, both these companies were operating- cum-investment companies, i.e. a dual-purpose entity that actively runs its own core commercial business operations while simultaneously holding and managing a portfolio of investments in other companies. It generates revenue both from its direct business activities and from investment returns like dividends, interest, or capital gains. Had this case been of pure investment holding company [sole or primary business is to hold, manage, and trade financial assets and investments (such as shares, bonds, or mutual funds) for capital appreciation and income] probably answer can be different particularly when value of investment which is getting sold is more than 20 per cent of its net worth!

If the business is e-commerce, what is the business unit? Is it the platform? or is it the dark stores? If the company is not selling its platform but is selling only its dark stores to subsidiaries, is it a sale of a substantial undertaking if the value exceeds the threshold? Since the whole undertaking is not being sold, but what is being transferred or disposed of exceeds 20 per cent of the value of the undertaking, it would still require shareholder approval.

Similarly, for a non-banking finance company engaged in the lending business, disposing of a loan portfolio may be treated as disposing of a substantial part of an undertaking. The meaning of “undertaking”, which originated from the Industrial Disputes Act and was adopted into the Companies Act without being restricted to the meaning attributed to it under the Industrial Disputes Act, continues to have significance. This concept will remain dynamic and will have to be adapted as times change.

Conclusion

Though the term “undertaking” emerged from the Industrial Disputes Act, judicial pronouncements have made it contemporary even in the modern business world, where different forms of businesses have emerged.

Explanation of undertaking starts with the word “Undertaking shall mean an undertaking in which investment of the company exceeds 20%”, and therefore this Explanation adopts the meaning of undertaking which emerged from judicial pronouncements, it just adds some threshold in case company has multiple business units.

Though an Explanation was added for “substantially the whole of the undertaking”, it is still to be tested judicially. The Bombay High Court took the view that “substantially the whole of an undertaking” means a significant part of the undertaking without which the residual undertaking becomes a husk. However, pursuant to the J.J. Irani Committee recommendation and the Explanation added to Section 180, the meaning of “substantially the whole” has become rule-based, and corporates need to be mindful of it.