- Section 188 of The Companies Act 2013 requires companies to seek approval from its board of directors and shareholders for related-party transactions, unless these are in the ‘ordinary course of business’.
- WHAT CONSTITUTES ORDINARY COURSE OF BUSINESS IS THE BIG QUESTION?
- The term ‘ordinary course of business’ has, not been defined in the Act.
- It is generally understood as; the ordinary course of business will cover the usual transactions, customs and practices of a business and of a company.
- Institutional Investor Advisory Services (IiAS), a leading proxy advisory firm has come up with guidelines for companies to define the ‘ordinary course of business’.
- These guidelines is especially for Listed entities as they tend to have diverse set of activities
As Per IiAS, The following list of factors which should be taken into consideration in order to define ‘ordinary course of business’ for a company.
- An activity is more likely to be considered in the ordinary course of business, if it features in the ‘Main Objects’ clause of the company’s Memorandum of Association.
- This will not include activities which are incidental or ancillary to the main objects.
Nature of Business and Industry:-
- On occasions, the nature of the business carried out and industry practice helps in determining whether the activity is in ‘ordinary course of business’ or not.
- For example, a software company building residential colonies for their employees would not fall into ‘ordinary course of business’ for them.
- If an activity is being conducted for the first time, it is likely not part of the ‘ordinary course of business’.
- Transactions which are infrequent and occur only once in a while are not to be classified as ‘ordinary’.
- IiAS has assumed periodicity as a gap of 18 months, though companies can determine this gap as per their nature of business.
- To constitute uniformity two test will be taken into account:
i. Predictability: Activities whose nature is predictable
ii. Consistency: Activities where the quantum of transactions are consistent with past history.
- For example, in an automobile company, any acquisition of auto ancillaries will be ordinary course of business. But if the quantum of transactions is hiked threefold in a particular year, without a commensurate increase in production, it will cease to be classified as an ordinary activity.
IiAS also listed few activities under the ‘Negative List’ which shall not be construed as ‘ordinary course of business’.
- Corporate Restructurings and Schemes of Arrangement between related entities
- Slump Sales or Hive-Offs to related entities
- Purchase of securities of related entities (other than for pure investment companies)
- Royalty fees paid or received from related entities
- Providing capital support to group entities (other than wholly-owned subsidiaries)