Overview
Companies Act, 2013 does not define what is ordinary for a company and what is not. It let the companies decide what is ordinary and what is extra-ordinary/ special kind of business for them. Generally, for most companies, it’s an easy task to identify what is ordinary course of business, however, in cases where it is not so obvious, it will always be a subjective matter and require analysis and judgement.
Meaning of “ordinary course of business”
In common parlance the term “ordinary course of business” is used to mean usual transactions, customs and practices as a part of doing regular business including the things which usually happen. Black’s Law Dictionary (8th edition) defines ‘ordinary course of business’ as “the normal routine in managing a trade or business” and calls it as ‘regular course of business’, ‘ordinary course’, ‘regular course’.
Usage of “ordinary course of business” in Companies Act, 2013
There is no requirement of any special approval for the transactions which are in ordinary course of business. These transactions appear as an exemption under the Companies Act, 2013 (“Act”). Below are certain crucial provisions of the Act in which exemption from approvals has been given to transactions in the ordinary course of business.
Section 180: Restrictions on Powers of Board
Section 180(1)(c) of the Act requires special resolution to borrow money (including money already borrowed) in excess of aggregate of paid-up share capital, free reserves and securities premium.
However, it provides exemption to – temporary loans obtained from the company’s bankers in the ordinary course of business from being included in the aggregate of paid-up share capital and free reserves and securities premium.
Here the emphasis is on two terms “temporary loans” and “ordinary course of business”. “Temporary loans” is clearly defined in the said section to mean loans repayable on demand or within six months from the date of the loan such as short-term, cash credit arrangements, the discounting of bills and the issue of other short-term loans of a seasonal character, but does not include loans raised for the purpose of financial expenditure of a capital nature. Now, this loan must be obtained to fulfil financial need of ordinary business transaction. Therefore, while excluding any temporary loan from the above aggregate, care should be taken in identifying which loan has been taken in ordinary course.
Section 185: Loan to directors
Section 185(3)(b) allows companies to provide loans/ guarantees/ securities to its directors or persons in whom director is interested. However, such loan must be granted in the ordinary course of business of such company. For example, personal loan to a director by a company engaged in granting loans for Export and import does not qualify as ordinary course of business. The reason is that the company is engaged in granting of specialized loans and not commercial loans. More such instances are provided in article – Loan to Directors – Basic concept with examples.
Section 188: Related Party Transactions
Fourth proviso to Section 188(1) provides exemption from Board approval to related party transactions in the ordinary course of business and at arm’s length price. To identify whether the transaction is in ordinary course, ICSI in its guidance note on related party transaction has specified following factors to be considered:
- Whether the activity is covered in the objects clause of the Memorandum of Association
- Whether the activity is in furtherance of the business
- Whether the activity is normal or otherwise routine for the particular business (i.e., activities like advertising, staff training, etc.)
- Whether the activity is repetitive/frequent
- Whether the income, if any, earned from such activity/transaction is treated as business income in the company’s books of account
- Whether the transactions are common in the particular industry
- Whether there is any historical practice to conduct such activities
- The financial scale of activity with regard to the operations of the business.
- Revenue generated by the activity
- Resources committed to the activity
It is pertinent to note that financial transactions are not covered under Section 188 and therefore the above criteria is not required to be applied on granting of loan, guarantee etc. when the company is not in financial services business.
Further, in case of related party transactions, most companies generally define their Ordinary Course of Business in the policy along with a negative/ exemption list.
Case laws:
- Advance of money:
Facts: Main activity of the company was the business of telecom services. It was also engaged in the business of lending money through inter-corporate deposits in the course of such business which generated substantial interest during the assessment years. Certain amounts could not be recovered and were treated as bad debt. The Company wrote off the unrecoverable amount and claimed it to be treated as bad debt.
Basis of Decision: Memorandum and Articles of Association are not conclusive on the question, but it shows sufficiently the intention of the company to pursue certain main objects. The frequency of the activity is sought to be highlighted. It should be a continuous and organized activity.
Decision: Since the business of the company was not that of money lending, it cannot be said that the sum in question represents money lent in the ordinary course of the business of money lending
- Commission free corporate guarantee:
Facts: The company is an investment company and gave guarantee without charging commission. It became a bad debt subsequently and the company made zero efforts in realizing the same.
Basis of Decision: It is the general accepted practice that MOA of the companies are drafted so as to include a broad spectrum of objects and activities in the object clause even if no such activities are actually intended to be carried out by the company. In the instant case, no business of giving guarantees for repayment of loans etc. has been carried out by the company and in fact, no guarantee has been given to any party for repayment of loan. The impugned guarantee transaction is the solitary transaction which has been entered into without charging of any commission.
Decision: Giving of guarantee was not a commercial decision and in the ordinary course of company’s business because it could not be company’s business to guarantee the payment of bad and irrecoverable amounts.
[Source: Malbros Investments Ltd. vs Dcit on 11 March, 2004]
- Granting of loan:
[A] Facts: The company is engaged in manufacture and sale of sugar and advanced a loan to a firm.
Basis of Decision: Every act which is intra vires of the company (allowed in the MOA) is not necessarily done in the ordinary course of the business of the company. It must be found as to whether the particular act has any connection with the normal business that the company is carrying on and whether it is so related to the business of the company that it can be considered to be performed in the ordinary course of the business of that company.
Decision: moneys lent by the company were not in the ordinary course of business, and that transaction did not constitute part of the business of the company.
[Source: Seksaria Biswan Sugar Factory vs Commissioner Of Income-Tax, AIR 1950 Bom 200]
[B] For companies which are engaged in financial services: When a commercial bank grants a business loan it is absolutely in ordinary course. But when a housing finance company grants a business loan it’s clearly not in ordinary course if the same is not a recurring transaction.
Conclusion
The question whether a transaction is in the ordinary course of business of a company or not will vary depending upon the facts and circumstances of each case. There cannot be a specific guideline or thumb rule for all the companies because it is a relative aspect and every organization has its own complex operations and diversified sectors. A company might end up being non-compliant just because of a slight misinterpretation. That’s why it is extremely important to analyze it conscientiously. The Board of directors must unequivocally come to a conclusion for the respective matter after considering potential conflict of interest and sensitivity of the transaction.
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