Framework to define 'ordinary course of business': IiAS Report

The Companies Act 2013 mandates companies to seek approval from its board of directors and shareholders for related-party transactions, unless these are in the 'ordinary course of business'. The term 'ordinary course of business' has, however, not been defined in the Act and the government also has ruled out defining the term which is used in the Companies Act, 2013 several times. So, boards are left to their different interpretations of the term, thus creating confusion.

Related-party transaction not in the 'ordinary course of business' must be approved by the board/audit committee of the company and requirements become more stringent if the transactions crosses certain pre-determined 'materiality' thresholds. In such cases, the company will require the consent of 75 per cent of the minority (non-related) shareholders (Consent requirements will go down to 50 per cent once the pending amendment gets cleared).

Institutional Investor Advisory Services (IiAS), a leading proxy advisory firm has come up with a report listing guidelines for companies to define the 'ordinary course of business'. "Given this backdrop, having a framework to decide what constitutes 'ordinary course of business' is important, especially for listed companies which tend to have a large and diverse set of activities." the report said.

The report also points out that out of the 30 companies listed on the S&P BSE Sensex, 21 companies have no defined framework for identifying 'ordinary course of business'.

Thus, the lack of definition or framework leaves a lot to the discretion of the board and the audit committee in particular. "Given the sensitivity and potential conflict of interest in related-party transactions, you need have a guiding pillar around which the board can take the decision to add fairness and neutrality to the decisions," says Hetal Dalal, Chief Operating Officer, IiAS.

IiAS came out with a list of factors which should be taken into consideration in order to define 'ordinary course of business' for a company.

 

• Objects clause - Activities which features in the 'Main Objects' clause of the company's Memorandum of Association.
• Nature of Business and Industry - On occasions, the nature of the business carried out and industry practice helps determining the if any activity is an '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.
• Precedence - If an activity is being conducted for the first time, it is likely not part of the 'ordinary course of business'.
• Periodicity - 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.
• Uniformity - 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 a 'Negative List' which in general must never be considered as a part of 'ordinary course of business'. This includes corporate restructurings and schemes of arrangement between related entities, 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 and providing capital support to group entities (other than wholly-owned subsidiaries).  

 "One size will clearly not fit all. Before taking a judgment call, the board must review the above factors in unison: each factor by itself may not be definitive," the report added.