Section 297 & 299 of the Companies Act, 1956

Section 297 & 299 of the Companies Act, 1956

The Directors occupy a fiduciary position in relation to a Company. They must act bona fide and in the interest of the Company. This duty of good faith which fiduciary relationship imposes is identical with those imposed on trustees. In this sense, it can also be concluded that the Directors are trustees.

 

Thus, if a Director makes contract with the Company and does not disclose his interest therein he will be committing breach of trust.

TYPE OF COMPANIES

Section 297 applies to all companies, public as well as private. However, it does not apply to the contracts where both the parties to the contract are public companies. The section would apply where one of the two companies (being parties to the contract) is a private company and the other is a public company, but in such a case, it will have to be complied with by the public company only.

BOARD’S CONSENT AND CENTRAL GOVERNMENT’S APPROVAL FOR CERTAIN CONTRACTS IN WHICH PARTICULAR DIRECTORS ARE INTERESTED [Sec. 297]

The object of the Section is that the Board should have knowledge of the extent of interest of a director in any contractual dealings with the company; or of any person connected with the director and accord their consent to such dealings.

 

The consent of Board of Directors of the Company is required for the contracts entered with the Company, except for the contracts which are exempted under Section 297 (2), as one of the party and other party being any of the following: -

1)    director of the Company; or

2)    any relative of any director of the Company; or

3)    any partnership firm in which any director of the Company is partner; or

4)    any partnership firm in which any relative of any director of the Company is partner; or

5)    any partner of the partnership firm in which any director of the Company is a partner; or

6)    any partner of the partnership firm in which any relative of any director of the Company is a partner; or

7)    any private company in which any director of the Company is a member; or

8)    any private company in which any director of the Company is a director.

The Contract to be entered can be for:

(a)  sale, purchase or supply of any goods or material;

(b)  sale, purchase or supply of any;

(c)  for underwriting the subscription of any shares in, or debentures of, the company.

Apart from the consent of the Board, previous approval of the Central Government is also required where the paid up capital of the Company is Rs. One Crore or more. (However, this power of giving approval has been delegated to the Regional Director at Kanpur, Bombay, Calcutta and Madras). The Application for approval shall be made to the concerned Regional Director in Form No. 24A prescribed under Companies (Central Government’s) General Rules & Forms, 1956 alongwith a certified copy of the contract and / or relevant papers and Demand Draft for the fees payable under the Companies (Fees on Applications Rules, 1968). Further, this provision does not has any impact on contacts entered into prior to the date of crossing of the limit of Rs. One Crore, and subsisting after that date. However, the Central Government’s approval is not required in respect of contracts entered into by the Government Company with any other Government Company.

CONSENT OF THE BOARD OF DIRECTORS

1. A consent of the Board of Directors to a contract attracting Section 297 may be given:

either before entering into a contract;

OR

after entering into a contract in circumstances of urgent necessity, but within three months of the date of which the contract was entered into.

2. Consent required to be given by the Board cannot be a general one; it must be specific with respect to the particular transaction.

3. Board must give its consent by a resolution passed at its meeting and not otherwise; it cannot be accorded by a circular resolution or in any other manner.

4. If consent is not accorded to any contract, then anything done in pursuance of the contract shall be voidable at the option of the Board.

EXEMPTED CONTRACTS

Any contract falling within the purview of any of the three exemptions as mentioned in clauses (a), (b) and (c) of sub-section (2) of Section shall neither require the consent of the Board of Directors of the Company nor the previous approval of the Central Government. Such contracts are as under:

(i)           The contract for the purchase of the goods and materials from the company; or the sale of goods and materials to the Company by any of the parties as mentioned earlier, for cash at prevailing market price.

Note:

Ø  A Cheque is to be treated as equivalent of cash payment

Ø  This clause is not applicable to contracts of service irrespective of any value involved.

Ø  The expression at prevailing market price suggests that the price charged ought to be the ruling market price of the seller and no extra favour vis-à-vis the other buyers should be shown as to the prices.

(ii)          The contract, between the company and any one of the parties as mentioned earlier, for sale, purchase or supply of any goods, materials or services, in which the company or the director / relative/ firm/ partner / private company regularly trades or does business and the value of such goods / materials or the  cost of the services does not exceed Rs. 5,000/- in aggregate in any year, materials or services;

(iii)        In the case of banking company or an insurance company, any transaction in the ordinary course of business of such company with any of the parties as mentioned earlier.

DUTY CAST BY SECTION 299

Section 299 casts upon directors of companies an onerous obligation. It is a statutory obligation violation of which may result in serious consequences. This Section applies to all companies and all directors. It also applies to directors nominated by Government on the Board of the Company.

The Object of Section 299 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 therefor. 

As per Section 299, every Director of a company must disclose to its Board of Directors at a meeting of the Board the nature of his / her interest: -

if he / she is any way, whether directly or indirectly, concerned or interested in any contract or arrangement or proposed contract or arrangement entered into or proposed to be enter into, by or on behalf of the company.

GENERAL NOTICE OF INTERST [SECTION 299 (3)]

Where general notice is given to the Board as regards the interest of a director in any contract or arrangement, it is not effective, unless the director concerned either gives it at a meeting of the Board or takes reasonable steps to secure that it is brought up and read at the next meeting of the Board after it is given. The Notice then gets entered in the minutes of the Board Meeting at which it is given or read. The Notice in Form No. 24AA as prescribed under Companies (Central Government’s) General Rules & Forms, 1956, is also required to be given afresh year after year, so that new directors who may be coming into the Board may be aware of the interest of that particular director. Once a director has give general notice of interest, it is not necessary for him to once again disclose his interest when the matter comes up before the Board. 

Nothing in Section 299 is applicable to any contract or arrangement between two companies, if any one or more of the directors of the one company together holds / hold 2% or less of the paid–up share capital in the other company. [Section 299 (6)].

This limit of 2% has to be taken either as an individual director’s holding or the aggregate holding of two or more directors. It is, therefore necessary for the company to ascertain the aggregate holding of Directors even if every director has given in the general notice his individual holding. The point of time with reference to which the fact whether or not the holding exceeds 2% limit laid down in sub-section (6) should be verified is the date on which the contract is entered into.

SECTION 25 COMPANIES

Section 299 does not apply to companies incorporated under Section 25 of the Companies Act, 1956, in respect of the cases to which sub-sections (1) and (3) of the Section 297 applies.

SECTION 299 VIS-À-VIS SECTION 297

Section 299 applies to any contract or arrangement to which a company is party and in which a director is interested. This Section is wider in scope than Section 297, which refers to certain direct contracts only. Thus, the contracts falling within the purview of Section 297 necessarily attract Section 299, although the converse may not be true. A contravention of section 297 would also result in contravention of Section 299, hence its consequences would also follow.

COMPANIES (AUDITOR’S REPORT) ORDER, 2003 IN RELATION TO SECTION 297 & 299OF THE COMPANIES ACT, 1956

The order shall come into force on 1st July 2003. Since MAOCARO, 1998 has been replaced by COMPANIES (AUDITOR’S REPORT) ORDER, 2003 {CARO, 2003} w.e.f. 1st July, 2003 it follows that all Auditor’s Report signed after 1st July, 2003 should be in the new format introduced by CARO, 2003. However, under Clause 4 of the CARO, 2003, it is stated that the said order shall apply only in respect of financial years commencing on or after CARO, 2003 comes into operation.

According to the circular, the companies to whom the order is applicable should make serious efforts to comply with the new order from the effective date. In case of non-compliance for accounts pertaining to financial year which closes on 31st December 2003 or earlier, Government would take a lenient view provided the accounts at least carry MAOCARO Report, if required. The circular, however, provides that accounts in respect of financial years ending on 1st January, 2004 or thereafter, will have to strictly follow the CARO, 2003.

The requirement of the Order apply in relation to full financial year irrespective of the fact that a part of such year may fall prior to the date of coming into force of the Order. However, in case of non-compliance of CARO, 2003, for the period prior to 1st July 2003, because such requirements were not part of erstwhile MAOCARO, 1988, it is advisable that in such situations, the auditor should also clearly mention the fact of non-maintenance of such record or non-existence of system and procedures while making comments under the relevant clauses.

Under COMPANIES (AUDITOR’S REPORT) ORDER, 2003, the Auditors of every company are required to include in their report a statement on “Whether the transactions of purchase of goods and materials and sale of goods, materials and services, made in pursuance of contracts, arrangements entered in the register(s) maintained under Section 301(1) of the Companies Act, 1956 and aggregating during the year to Rs. 5,00,000 (Rupees Five Lacs) or more in respect of each party have been made at prices which are reasonable having regard to prevailing market prices for such goods, material, or services or the prices at which the transactions for similar goods or services have been made with other parties.”

The auditors’ role would seem to be limited to those transactions or contract and arrangements, which have been entered in the register. They cannot go beyond the register and make enquiry as to whether all the contracts falling under Section 297 or 299 have been entered or not, or whether in respect of such contracts compliance with Section 297 or 299 has been done or not.

CONCLUSION

 

Thus, when a director is interested in a contract or arrangement, the other directors must have knowledge of it; they should be enabled to take an unbiased decision which would be in the best interest of the Company and the terms of the contract and arrangement should be fair and reasonable and not solely beneficial to the interested director.

 

A Company is entitled to the collective wisdom of its directors and if all or any of them are interested in a contract with the Company, the Company loses the benefit of unbiased judgement.

Thus keeping in mind the interest of the Company and for the best interest of the Shareholders of the Company, the provisions of Section297 & 299 shall be duly complied with.