- Are professional services not within the purview of section 297?
Saturday, 28 April 2012
Section 297 of the Companies Act 1956
Section 297 is applicable to all companies whether public or private.
2. Scope of section 297
Section 297 of the Act embodies the principles of good faith and fiduciary relationship of a director and enjoins upon him certain statutory obligations. Section 297(1) states that “a Company cannot enter into contracts with the specified persons without the consent of the Board. These types of contracts are:—
(a) sale, purchase or supply of any goods or materials or services;
(b) underwriting the subscription of any shares in or debentures of the company.”
3. Non-applicability of section 297
Section 297 does not apply in the following cases:—
(1) Contracts between two public limited companies.
(2) Contracts between a company registered under the Companies Act and a company incorporated outside India (Foreign Company)
(3) Unless the contractee company is a private company. [Albert Judan v Rampada Gupta (1960) 30 Comp Cas 582 (Cal)] 'Private company' does not include a foreign company.
(4) Contract between company and a private company of which the relative of a director is a member or a director.
(5) Contracts for sale, purchase or lease of immovable property. A contract with a person who deals in or is engaged in the business of providing services relating to immovable properties may be hit by the section as one of 'supply of services'.
(6) Contract for employment of a director as managing director or whole-time director. [Circular No. 13 of 75, dated 5 June, 1975]
(7) Transaction of a loan made to a director by the company, since it is not a sale or purchase of goods or a contract to render services.
(8) The Central Government's approval under the proviso is not applicable to a Government company in respect of contracts with another Government company. [Notification No. GSR 233, dated 31 January, 1978]
(9) Professional services rendered by solicitors/advocates or by firms of solicitors and advocates. [Circular No. 13, dated 5 June, 1975]
(10) Contracts entered into by the company with a dealer on a 'principal to principal' basis, provided the dealer does not acquire the same on agency basis. [Circular No. F.M. 8/297/56-PR, dated 2 August, 1956]
4. Persons covered under section 297
The following are the persons with whom a company cannot enter into contracts without the consent of the Board of directors and prior approval of the Central Government is required in case if the paid up capital of a company is not less than Rupees One Crore:—
(i) director of the company; (ii) relative of such director;
(iii) a firm in which such director is a partner;
(iv) a firm in which relative of such director is a partner;
(v) any other partner of such firm in which such director is a partner;
(vi) any other partner of such firm in which relative of such director is a partner;
(vii) a private company in which such director is a member or director.
The consent contemplated in the section is not a general consent but consent referable to each specific contract. [Walchand Nagar Industries Ltd v Rattanchand AIR 1953 Bom 285]
5. Exemptions under section 297(2) in certain cases
The prior consent of the Board or Central Government will not be required in the following circumstances:—
(i) Contract for purchase of goods from the company or sale of goods to the company, which are for cash at prevailing market prices.
(ii) Contract for sale or purchase of goods and services in which the company or other party regularly does business but upto Rs. 5,000 in a year during the period of the contract.
(iii) Any transaction of a Banking/Insurance Company in the ordinary course of business of such company with the specified persons.
6. Approval of contracts by the Board
Before the company enters into a contract of the nature stated above with any of its directors or with any other specified persons mentioned above, it must be approved by the Board in the form of a resolution at a Board meeting. — sub-section (4).
The object of this section is that the Board of Directors should be made aware of all contracts and arrangements in which any director has an interest, whether direct or indirect, so that the Board may be in a position to satisfy itself as to the fairness and reasonableness of the contract from the point of view of the company and then accord its consent to it. [Vinod Kumar Jain v Registrar of Companies (1987) 2 Comp LJ 188 (Del)]
However, in such contracts where a director may be deemed to be interested may be entered into in the circumstances of urgent necessity even for value exceeding Rs. 5,000 in a year without taking, prior consent of Board but such consent shall be obtained within three months of entering into the contract.
7. Non-participation of interested director in proceedings of the Board Meeting – Section - 300
Section 300 of the Companies Act provides that no interested director can take part in the proceedings of the Board or vote on the resolution on that matter.
Even if the interested director votes on the resolution the contract will not be void if the contract would have been carried through without taking into account the vote of the interested director. [Sundararaja Pillai v Sakthi Talkies Ltd. (1967) 37 Comp Cas 463 (Mad)(DB)] It is immaterial whether the conflicting interest belongs to him beneficially or as a trustee for others. [TR Pratt (Bombay) Ltd. v MT Ltd. AIR 1938 PC 150]
Directors cannot issue debentures to themselves as security for money advanced. [Cox v Dublin City Distillery 2 (1915) 1 IR 345] A general scheme might be passed at a meeting of the Board of directors under which the directors could subsequently enter into contracts with the company like any other member. [Mohanlal v Grain Chamber Ltd 1 LR (1959) All 276]
But in a private company an interested director is under no such disability. Further, this restriction is not applicable in respect of a contract which a private company subsidiary of a holding company enters with the holding company nor to a contract which may be entered into by a public company in which the interest of the director consists in his holding the qualification shares or in his holding not more than 2% of the paid-up share capital.
Section 300 applies to existing contracts and arrangements and not to prospective contracts and arrangements. [Seth Mohanlal v Grain Chambers Ltd. (1968) 38 Comp Cas 543: AIR 1968 SC 772]
8. Director should not participate and vote when his near relative is proposed to be appointed as director
The question whether, under the provisions contained in sections 299 and 300, a director can vote on a Board resolution purporting to appoint a relative of such a director as director or additional director of a company has been examined by the Company Law Board and their opinion stands as under:—
"Two different views have been expressed on the question at issue. One view is that the appointment of a director is an arrangement entered into by company and the director whose relative is appointed as a director or additional director is interested in such appointments and, as such, is prevented from voting on resolutions purporting to appoint such relative as a director. The other view held in some quarters is that the word 'arrangement' used in the section is intended primarily to cover transactions in which a director acquires some right or incurs some liability as a result of it and not supposed to cover anything that is likely to have a bearing on the company's affairs. Only a restrictive interpretation should, therefore, be placed on the word "interested" used in the section thus excluding a
director who has no pecuniary interest. Where, however, there is a pecuniary advantage, it must be regarded as an "interest" within the meaning of the section. The language of the section contemplates a pecuniary interest, direct or indirect, of the director in the contract or arrangement. Accordingly the relationship of the director with the contracting party will not per se make the director concerned or interested in the contract or arrangement.
The Company Law Board has carefully considered both the above-mentioned viewpoints. It is of the opinion that whatever may be the strictly legal position in this regard; the matter is essentially one to be viewed from the point of view of the development of sound and healthy company practice. It should, therefore, be held to be a clearly unsound company practice if a director, whose near relative is proposed to be appointed to the Board, were to participate in the discussions at the Board meeting and vote on the proposal for such appointment." [Source: Circular Letter No. 8/46/(300)/64-PR, dated 27 January, 1965]
9. Specific consent by the Board at a meeting
The consent under section 297 is a specific, a particular consent and not a general one. This consent should be separately obtained in relation to different contracts. (Appendix 1) No consent can, therefore, be accorded by a circular resolution or in any other manner except by a resolution passed at a meeting of the Board. [Mahesh Co. v Oil Mills Ltd AIR 1955 NUC 3576 (All)]
10. Consequences and penalty where consent is not taken
If a contract, which requires consent in advance or subsequently, is entered into without taking the consent, the contract is voidable at the option of the Board.
A contract affected by a director without the consent of the other directors is not illegal. The prohibition is against the director and there is a penalty for any violation of the section. This does not mean that the contract is void. [Albert Judah v Ramapada Gupta (1960) 30 Comp Cas 582 (Cal): AIR 1959 Cal 715]
The section does not provide any penalty for non-compliance. The penalty would therefore, be as per the provisions of section 629A. (Section 629A indicates penalty for such sections of the Companies Act, 1956 for which no penalty has been specifically provided)
Accordingly, the company and every officer of the company who is in default or such other person shall be punishable with fine which may extend up to Rs. 500 for every day after the first day during which the contravention continues.
11. Offence under section 297 is compoundable
The offence committed under this section is compoundable in accordance with the provisions of section 621A of the Companies Act, 1956.
CLARIFICATIONS IN RESPECT OF SECTION 297
(a) Section 297 (1) does not apply to the employment as managing director/whole-time director: The Department (now MCA) has clarified vide Circular No. 13 of 1975, dated 5-6-1975 that 'supply of service' is not the same as 'rendering of service' as managing/whole-time director and that there are specific provisions regarding the matter. Hence the proviso to section 297(1) does not apply to the above appointments.
(b) Appointment of additional directors: Appointment of a relative of a sitting director on the post of additional director does not violate the requirements of section 300(1) because such appointment does not amount to any "contract or arrangement".
(c) Transactions in respect of immovable property: The Department (MCA) has vide Letter No. 9/41/90-CL.X, dated 27-3-1990 stated that in view of the fact that the proposal of the subject company related to taking office premises on rental (in which a director of the company was interested), the section is not attracted as the contract is in respect of immovable property.
(d) Services of a legal practitioner: The Department (MCA) has clarified that services of a legal practitioner are not obtained on the basis of say, lowest tender, but on account of his professional expertise irrespective of the cost involved. Such services cannot be bracketed with a contract for supply of goods or materials. The Department's view is that these services fall outside the scope of section 297 of the Act and the scope of the section does not extend to supply of professional services of the nature given by firms of solicitors and advocates. (Circular No. 13 of 1975, dated 5-6-1975)
(e) Contract for services vis-a-vis contract of personal services: Section 297 applies to contracts for services but not to contract of personal services.
(i) Contract for services
Contract of services includes contract for supply of services. Further, contract for supply of services may also include supply of one's own services or supplying the services of some other person.
However, contract of service is quite different from contract for services. The latter attracts the provisions of section 297 whereas the former has been exempted vide Department (MCA) Circular No. 13/75, dated 5-6-1975, which is dealt separately, hereunder. And in a case where such a person is appointed at a place of profit, it will not only require the compliance of the provisions of section 314 but also the requirements of the proviso to sub-section (1) of section 297 have to be complied with in every such matter because no exemption is provided in this section unlike section 314 in which monthly remuneration of Rs. 10,000 has been prescribed under section 314 (l)(b).
(ii) Contract of personal services
The Department's (MCA) views in this connection are contained in Circular No. 13/75, dated 5-6-1975 that "section 297(1) provides that consent of the Board of directors of a company shall be necessary for a contract for the sale, purchase or supply of any goods, materials or services entered into by the company with a director of the company or his relative or a firm in which such a director or relative is a partner, etc. The proviso to this sub-section requires that in the case of a company having paid-up share capital of not less than rupees one crore, no such contract shall be entered into except with the previous approval of the Central Government."
(f) Contracts on principal to principal basis: The Department (MCA) has expressed its views vide Circular No. F.M. 8/Z97/56-PR, dated 2-8-1956 that the provisions of section 297 would not become applicable to contracts entered into by the company with a dealer on a principal to principal basis, unless the contract is in respect of goods which the dealer sells or supplies on an agency basis.
(g) Sale or purchase for cash: Whether includes for cheque also?
The Department (MCA) has expressed its views vide Circular No. 8/2(Misc)/75- CL.V., dated 6 June, 1975 that a cheque may be treated as the equivalent of a cash payment for the purpose of this section.
The term "cash" must be interpreted in a reasonable manner. It would include not only payment in legal tender but also other modes of payment, which are recognised by law or by customary practice as amounting to payment in cash. For example, payment by cheque or through a bill or hundi which is payable on demand would tantamount to payment in cash.
(h) Approval of the Central Government in case of multiple requirements of section 297(1), 314(1B),
294AA or 269 of the Act: The Department (MCA) vide its Circular No. 18 of 1976, dated 29 June, 1976 has expressed the following views:
"I am directed to say that instances have come to notice in which applications were made simultaneously for seeking approval of the Central Government under the proviso to section 297(1) of the Companies Act, 1956 as well as under other provisions viz, section 269 or section 294AA or section 314(1B) of the Act in respect of same contracts/transactions. The need for according approval under both the sections of the Act has been examined in the Department. It is felt that the provisions of section 297 are of general nature and those of sections 269, 294AA and section 314(1B) are of special nature. In view of this, it has been decided in the interest of administrative convenience and also to avoid multiplicity of applications that where facts and circumstances of a case require approval of the Central Government under section 269 or section 314(1B) or section 294AA and also under section 297 approval under section 269, section 314 (1B) or section 294AA of the Act would be enough and no separate approval under section 297 of the Act is necessary."
In Bhagwati Developers v Peerless General Finance & Investment Co. (2005) (5) Comp LJ 377 (SC), the Supreme Court has remarked that the circulars issued by the DCA (now MCA) do not have any mandatory effect; these circulars are merely advisory in character, as a matter of fact, these circulars are read, followed and applied (many times by deriving a general principle of universal nature from the language used or illustrations given in the circular) by millions of people of this country as interpretation of the law, something similar to court rulings.
Accordingly the effect of the above circular is that many companies and professional exclude all types of professional services from the purview of section 297, whether legal or those given by chartered accountants, tax consultants, company secretaries, coat accountants, engineers, architects, etc.
13. Secretarial checklist
Check whether exempting provisions contained in section 297(2) of the Companies Act, 1956 were not applicable? If not, check that:—
1. Consent of the Board of directors was obtained by a resolution passed at a meeting for entering into contracts in which directors were interested.
2. Prior approval of the Central Government (Regional Director) has been obtained, if the paid up share capital of the company is not less than Rs. One Crore.
3. The particulars of the contract were entered in the Register of contracts, in accordance with the provisions of section 301.
4. The requisite resolutions were recorded in the minutes of Board meetings.