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APPLICABILITY OF SECTION 274(1)(g)

Thursday, April 29, 2010
posted by CS. T. Sandhya at 11:35 PM IST

APPLICABILITY OF 274(1)(g) TO A PRIVATE COMPANY WHICH IS SUBSIDIARY OF THE PUBLIC COMPANY

Whether 274(1)(g) is applicable to a Private Company which is subsidiary of the Public Company.

General Norm:

Under Companies Act, 1956, the Sections are drafted such a way that –

(a) they are applicable to all the companies – Public, Private and Private which is a subsidiary of a Public

(b) they are not specifically applicable to Private Companies which are not the subsidiary of a Public Company

(c) they are specifically applicable to the Public Companies and Private Company which is subsidiary of a Public

(d) they are applicable only to Public Companies

How to arrive at the applicability?

1) Where a provision is silent on applicability (or when it mentions the word “company”), it is applicable to all the Companies, i.e.,
a. Public,
b. Private and
c. Private which is a subsidiary of a Public.

2) Where a provision clearly specifies non-applicability to Private, it is applicable only to the Public Companies
Example: 70, 81,149, 165

3) Where a provision clearly specifies non-applicability to Private other than Private which is a subsidiary to Public, it is applicable to
a. Public and
b. Private which is a subsidiary of a Public
Example: 90, 257,264, 309, 372A

4) Where a provision clearly specifies the applicability to Public and Private which is subsidiary of Public, it is applicable to
a. Public and
b. Private which is subsidiary of public
Examples: 77, 170, 193, 255, 256, 259, 262, 263, 265, 269, 293, 310

Note: When a provision is applicable to a Private Company, it is also applicable to a Private Company which is a subsidiary of Public Company. But, when a provision is applicable only to a Public Company, it is not always applicable to a Private which is a subsidiary of a Public Company unless there is a specific mention of the same.

APPLICABILITY OF SECTION 274(1)(g)

Though 274(1) uses the generic word “Company”, 274(1)(g) [which was inserted by Amendment to the Act in 2000] uses specifically the words “Public Company”. It implies that all the provisions of Section 274 except for 274(1)(g) are applicable to all –
(a) Public
(b) Private
(c) Private which is a subsidiary of public

And 274(1)(g) is applicable to only to Public Companies.

To arrive at the conclusion that 274(1)(g) is not applicable to Private Company which is a Subsidiary of a Public company we need to prove that

(1) It is not applicable to Private Companies. Because if a provision is applicable to a Private Company it is also applicable to Private Company which is a subsidiary of Public Company.
(2) It is applicable only to Public Companies and not the Private Company which is a subsidiary of Public Company

(I) 274(1)(g) – Not applicable to Private Companies – How?

(a) 274(1) uses the generic word “company” hence provisions of 274 are applicable to Private Companies also.

(b) Further 274(3) say that a Private Company which is not subsidiary of public company can have additional disqualifications in Articles of Association. Implies, 274 is applicable to Private Company too.

(c) Coming to 274(1)(g):-

(i) Section Extract:

274 (1) A person shall not be capable of being appointed director of a company, if-
274 (1)(g) such person is already a director of a public company which,-
(A) has not filed the annual accounts and annual returns for any continuous three financial years commencing on and after the first date of April, 1999; or(B) has failed to repay its deposit or interest thereon on due date or redeem its debentures on done date or pay dividend and such failure continues for one year or more :
Provided that such person shall not be eligible to be appointed as a director of any other public company for a period of five years from the date on which such public company, in which he is a director, failed to file annual accounts and annual returns under sub-clause (a) or has failed to repay its deposit or interest or redeem its debentures on due date or pay dividend referred to in clause (b).

(ii) Basing on 274(1), assuming that 274(1)(g) is applicable to Private Companies, we will take an example as follows.

(iii) Example: Mr. X is a Director in ABC Private Ltd., LMN Ltd. and PQR Ltd. If PQR Ltd defaults as per 274(1)(g)(A) and 274(1)(g)(B), then Mr. X is not eligible for appointment or re-appointment in ABC Pvt. Ltd., LMN Ltd. And PQR Ltd.

(iv) What’s the period of ineligibility? Proviso to 274(1)(g) talk about the period of ineligibility for appointment in Public Companies. It is clear for Public Companies. But, there is no provision mentioning the period of ineligibility in case of appointment in Private Companies. It implies that a Director of a default public company is not eligible for appointment in a Private Company forever.

(v) When for Public Companies itself (where public interest is involved) restriction is only for five years from default, what’s the logic in restricting the appointment in Private Company forever. It makes no sense.

(vi) Hence applying 274(1)(g) to Private Companies has no meaning.

(vii) Further Companies (Disqualification of Directors under section 274(1)(g) of the Companies Act, 1956) Rules, 2003 are specifically applicable to Public Companies. If the intention of Law makers was to apply 274(1)(g) to Private Companies then the Rules would have been made applicable even to Private Companies. But the intention of Law makers is to apply 274(1)(g) only to Public Companies.

(d) A question may arise that if we go by 274(3) then all the clauses of 274 are applicable to Private Companies also. But here, we should note one point that 274(1)(g) was inserted in 2000 and a specific mention of public was done to avoid the confusion

(e) Hence, if we go by the true intention of the Law makers and logic behind not applying it to Private Companies, 274(1)(g) is applicable only to Public Companies.

(II) 274(1)(g) – Applicable to only Public Companies and not the Private Company which is a subsidiary of a Public Company

As mentioned earlier, the general norm in the Companies Act, 1956 is to make a specific mention of applicability of any provision to a Private Company which is a subsidiary of a Public Company, in that provision itself. If there is no specific mention, then that provision is not applicable to Private Company which is a subsidiary of a Public Company.

For example, if we take the sections 70, 81,149, 165. These are the sections which are applicable exclusively to the Public Limited Companies and here there is no specific mention of the applicability to “Private Company which is a subsidiary of a Public Company”. They are not applicable to Private Company which is a subsidiary of a Public Company.

Even in case of Section 274(1)(g) there is mention of applicability to Public companies and no specific mention of “and Private company which is a subsidiary of a public company” (unlike sections 77, 170, 193, 255, 256, 259, 262, 263, 265, 269, 293, 310).

Hence, 274(1)(g) is not applicable to a Private Company which is a subsidiary of a Public Company.



CONCLUSION:





Section 274(1)(g) is applicable only to Public Companies. It is not applicable to a purely Private Company and a Private Company which is a subsidiary of Public Company.

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13 comments


Comments:


good article
 

Good One. Thorough analysis and conclusion.
 

I wish to know can a Director of a Private Limited Company which has not filed the Annual Reports and Returns for a consecutive period of 11 Years become a Director in a Public Limited Company or a Company formed Under Section 25
 

Yes, such Director can become a Director in a Public Company or a Company under section 25 of Companies Act, 1956.
Section 274(1)(g) clearly specifies that defaulting company to be a public company. In the instant case, Private company has made default and hence 274(1)(g) does not apply. There are no other restrictions as such under Companies Act, 1956.

However, we have to consider the conditions of Sch. XIII, if such director is to be appointed as a MD and in case the RoC has prosecuted and convicted such Director for default in the Private Company.
 

If it is not applicable to a private company then why does the auditors report about the disqualification of directors in his audit report as per the provision of section 227(3)(f) of the Companies Act, 1956 which is mandatory to all companies ie. both public and private ???????????????????
 

Let me put it clearly - Section 227 is applicable for the auditors of both the Public & Private Limited Companies. 227(3) talks about what the auditors report should state, wherein as per sub-clause (f) Auditor in his report has to state whether a director is disqualified u/s 274(1)(g).

If the Auditor is reporting for a public limited companies he shall state whether the directors of such company are disqualified u/s 274(1)(g) or not; and if the Auditor is reporting for a Private Limited Company he shall simply state that it is not applicable to the Company. If an Auditor wants to go a step ahead and report on what is not applicable to the Company, he may do so at his expense, but because an auditor has reported on a point which is not applicable, it will not make the provision mandatory.

Section 227(3) only states on what an Auditor has to report and for each item of 227(3), he has to go to the respective section. Similar is the case with 227(3)(f), to report on 227 (3)(f) he has to refer to section 274(1)(g). If 274(1)(g) is applicable he shall report on it and if it is not applicable, he shall state as not applicable.

Coming to your question - why most auditors report on it even for private companies - my only answer is either the provision is mis-interpreted or intention is to go beyond the provision. But only for a reason that because a auditor is reporting on a provision which is not applicable will not make the provision mandatory.

I again repeat 274(1)(g) is not applicable to Private Companies. Hope its sufficient to clarify your doubt. Even if not, please do come again with your query and shall reply to it.
 

Please clarify the following with reference to your post on 12-10-2010 ::-

1) How will the auditor know about the directorship of the director untill he get a declaration under this section??????

2) As per your explanation this section may be used as a grey area by a director of a public company to become a director of a private company if he is so disqualified???????

3) By not reporting about the said section 274(1)(G) as required under 227(3) is it not a violation of section 227(3)(F) ?????

4) The section 227(3)(f) reads as ::::: " The auditor's report shall also state-

(f) whether any director is disqualified from being appointed as director under clause (g) of sub-section (1) of section 274.].

They word used here in the section is "SHALL" and not "MAY" ??? if it were MAY then the reporting was optional????

You have given a straight statement and a conclusion in your note!! How?? Law is to be read as it is and not interprited???

5) You mean that it was the fault of the person who had drafted the section in the Law???

6) As per the Companies (Disqualification of Directors under section 274(1)(g) of the Companies Act, 1956) Rules, 2003 it is provided in rule 4 that:—

(a) it shall be the duty of the statutory auditor of the appointing company as well as the disqualifying company, as required under section 227(3)(f), to report to the members of
the company whether any director is disqualified from being appointed or re-appointed as director under section 274(1)(g) and to furnish each year as to whether on the basis of his examination of the books and records of the company, any director of the company is disqualified for appointment or reappointment as a director or not.

(b) it shall be the duty of the statutory auditors of the disqualifying company as required in section 227(3)(f) to report to the members of the company whether any director in
the company has been disqualified during the year from being appointed or reappointed as director in another company under section 274(1)(g) of the Act.

COMMENT !!!!

7)It was held in the case of Pawan Jain v Hindustan Club Ltd.(2005) that from a careful perusal of section 227, which provides for the power and duties of the auditors, it appears that the auditor cannot submit a report on the basis of the statement supplied by the company alone. He has to examine and even he has to make an independent enquiry about the collected materials from other sources to submit a report regarding clause (f) of sub-section (3) about the disqualification of the directors under section 274(1)(g).

Before reporting a particular person as being disqualified, an auditor must seek for the views and/or representations of the director concerned or any person as to whether he was a director of the defaulting company as mentioned in section 274. Auditor's report really affects a particular persons right as his civil rights or status is necessarily declared
in a negative way by the auditor by his fact finding. The rules of natural justice demand that before a person's right is affected, he/she should be given opportunity to explain
his or her position.

COMMENT ON THIS CASE LAW !!!!

8)The Department has issued a Press Note No. 7/99, dated 23-7-1999 which states that the provisions of section 227 of the Companies Act, 1956 have been amended with effect from 31-10-1998, with an obligation on the part of the auditors of the companies to include a para in their report under section 227 of the Act to the members of the Company.

COMMENT ON THIS PRESS NOTE !!!!!

9) Is violation of the provisions of Section 227(3) of the Companies Act, Compoundable under the Act ?????? Comment on the violation of this provision???? Will the Auditor loose his membership / pay hefty fine for such violation????

10) Section 274(1)(g) is not a compoundable section under 621A of the Companies Act ?? Then how will it be made good if there is default????

Hope to receive answers to my quaries from you at the earliest!!
 

It sounds interesting to see so many queries at a time. I'll try my best to clarify you point wise.

1) Yes. An auditor might not know about the directorships of the director until a declaration is received from such director.

2) Section 274(1)(g) restricts only appointment or re-appointment in Public companies (the proviso is very clear about this). Hence there is no grey area as such. A Director disqualified under section 274(1)(g) has no restrictions for being appointed as a Director in a Private Limited Company, under the Companies Act, 1956.

3)Yes, if reporting is not as per 227(3) its a violation.

4)Yes, 227(3) is mandatory and not optional. Auditor has to report on all the clauses of 227(3). Similar is the case with 227(3)(f) for Private Companies, Auditor will report as "Not Applicable".

5)No, I do not mean that. I do not find any fault in the section.

6)Yes, even as per said rules Auditor has to report on 274(1)(g) and rules are applicable only to PUBLIC COMPANIES.

7)Yes. an Auditor has to examine and even he has to make an independent enquiry about the collected materials from other sources to submit a report regarding clause (f) of sub-section (3) about the disqualification of the directors under section 274(1)(g).

8)What should I comment on. Its very correct and proven fact that Auditor is under an obligation to include a para in their report u/s 227

9) & 10) You are welcome to obtain the advice whether the violation u/s 227(3) and 274(1)(g) are compoundable or not. You may approach our office during the office hours and we shall advice you.

Auditor has to report on 227(3)(f) saying that it is not applicable, he need not violate the provisions.
 

Sandhya, Its a very interesting article. But one small point to add, what if the directors do not make a declaration in a private company under Sec 274(1)(g). Is the private Company responsible to provide the same to auditors? Also can that lead to qualifying the audit report for violation of sec 274(1) (g)?

I feel as this section is not applicable for private companies, the same should not be considered as violation.
 

Yes. Sec.274(1)(g) is not applicable to Private companies and if declarations are not given as per the respective rules, by the directors of a Private company, there is no violation as those rules are applicable only to public companies.

No, even the private company is not responsible to provide with the declarations if Auditors desire to report on the same. Here the Auditor may report as "Not Applicable", but still if the Auditor wants to go beyond the provision and comment on the qualification of auditors u/s 274(1)(g), he may do so on the information secured by him either from the company or directors or elsewhere. However, there is no mandatory requirement on such pvt. co. or its directors to provide with the declarations to the Auditor. Further, if Auditor is reporting on this point for a pvt. ltd. company it implies that his report is not for such company, but he is reporting on a specific director, which is not the intention of 227(3)(f).
 

very nice artcile Madam.
 

very clear and in depth article.thanx.Khusboo Agarwal
 

Thanks MAM for value addition
 

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