Overview
Investment in Associated Companies and Undertakings
Investment in associated companies and undertakings is one of the options available to companies for expanding their business and undertaking innovative projects. However, certain situations may arise in which the investment may not be as rewarding as estimated or expected. Further, they may have potentially damaging effects on overall profitability.
Sometimes, interested parties may manipulate the transaction for their own interests, putting the ordinary shareholders to a disadvantage. Therefore, to curb any such attempt and safeguard the interests of shareholders, the law provides certain restrictions and conditions for investment in associated companies and undertakings.
In Pakistan also, the law adequately addresses this matter—section 199 of the Companies Act 2017 (the 2017 Act). Section 199 of the 2017 Act and the Companies (Investment in Associated Companies or Associated Undertakings) Regulations, 2017 (the Regulations) [i] provide the relevant law, procedure, and disclosure requirements.
Definition of Associated Company or Undertaking
Before discussing the details of the procedure, it is imperative to know how associated companies and undertakings are defined. Section 2 (4) of the 2017 Act provides that if two or more companies or undertakings, or a company and an undertaking are interconnected in a particular way, they will be treated as associated companies and undertakings. In terms of the definition, the following scenarios will be treated as a relationship between associated companies and undertakings:
- Companies or undertakings are under common management or control;
- One company or undertaking is a subsidiary of the other;
- Modaraba (undertaking) is managed by the company;
- An owner, partner, director, or another person, directly or indirectly, holding or controlling shares (including shares held or controlled by the spouse or minor children of the person) with at least 20% voting power in a company or undertaking is also owner, partner, director or holding or controlling shares with at least 20% voting power in the other company or undertaking. (This relationship is shown in the figure below):
In addition, section 2 (4) also defines “associated persons” in the same manner as it defines relationship “d)” above- also illustrated in the figure above, but with the limit of 10% voting power. However, this term has not been used anywhere in the 2017 Act or regulations made thereunder.
After defining the relationship that determines the status of a company or an undertaking as associated companies and undertakings in clear terms, the law creates some exceptions (see Table 1) where relationships and shareholdings will not be counted for determining the status of a company, undertaking or person as an associated company, undertaking or person.
In order to provide the law and regulate investment in associated companies and undertakings, the 2017 Act specifies the activities that will be considered as investments. These activities include equity, loans, advances, and guarantees, by whatever name called. This means a loan given to associated companies will also be governed under section 199 and the Regulations.
However, if the amount due is normal trade credit, arising out of an arms-length trade transaction, and is in accordance with the trade policy of the company, such transactions shall not be treated as investment for the purpose of application of section 199. It is to be noted that “guarantees” were not treated as an investment in the repealed Companies Ordinance, 1984, and is an addition to the 2017 Act.
Law and Procedure for Investment Decision
Since it is clear how companies or undertakings are treated to be associated and what investment means, now let’s discuss the law on investment in associated companies and undertakings.
Since the ordinary shareholders/members do not have an active role in the day-to-day affairs of the company or undertaking. Therefore, safeguarding their interest requires that their money is not invested in any other company or undertaking with conflicting interests without their knowledge and permission. Any person, partner, or director may have interests in the investment which may affect the interest of the ordinary shareholders.
As a general principle, investment in an associated company or undertaking can only be made by a special resolution (75% of the shareholders/members present in person or through a proxy) so that shareholders/members’ money may not be used for the vested interests of anyone. It would not be out of place to mention that a special resolution passed by the company will have to be reported to SECP by filing Form 26 However, certain companies, keeping in view the nature of their business, have been exempted from to fulfill this requirement. The exempted companies[ii] are mentioned in Table 2.
As the law requires that any decision of investment in an associated company or undertaking would, where applicable, be taken by shareholders/members in general meetings, it was imperative to provide a mechanism for sufficient disclosure so that the shareholders/members can make an informed decision. Therefore, regulations have been issued that specify what necessary information should be provided to shareholders/members for seeking their approval, based on a complete picture of the investment proposal.
Disclosure Requirements related to investment in Associated Companies
The regulations made in terms of section 199 (3) (b) prescribe the information required to be provided to members which shall be attached with the notice of the meeting called for approval of members. The information shall include, general disclosure (Table 3), disclosure about the associated company or undertaking (Table 4), and disclosure for equity investment (Table 5) or for advances and loans (Table 6) as the case may be.
Further, information about the interest of the associated company or associated undertaking and its sponsors and directors in the investing company shall also be disclosed in the notice of general meeting if the associated company or associated undertaking or any of its sponsors or directors is also a member of the investing company.
Listed companies are required to dispatch a copy of the notice and the statement of material facts to the head office of the Securities and Exchange Commission of Pakistan, through fax or email and courier service on the same day it is dispatched to the members.
The directors of the investing company, while presenting the special resolution for making an investment in an associated company or associated undertaking are required to certify to their members that they have carried out necessary due diligence for the proposed investment before recommending it for members’ approval and that the financial health of the borrowing company is such that it has the ability to repay the loan as per the agreement.
It is pertinent to mention that the law requires that Investment by way of loans or advances can only be made in accordance with an agreement in writing which shall inter-alia include the terms and conditions specifying the nature, purpose, period of the loan, rate of return, fees or commission, repayment schedule for principal and return, penalty clause in case of default or late repayments and security, if any, for the loan in accordance with the approval of the members in the general meeting.