This Article is written by- Shobhana Rathore, Course-B.A LL.B 4th year , College- Greater Noida College of Law, during her internship with the Le Droit India.
Abstract
Cross holding and promoter control are significant features of the Indian corporate landscape, often raising concerns about corporate opacity and governance challenges. While cross holding can be a strategic investment tool facilitating business synergies and operational flexibility, it also poses risks of fund diversion, conflicts of interest, and reduced transparency. This article explores the legal framework, practical implications, and judicial interpretations surrounding cross holding and promoter control in India, analyzing whether these mechanisms serve legitimate strategic purposes or contribute to corporate opacity.
Keywords
∙ Cross Holding
∙ Promoter Control
∙ Corporate Governance
∙ Related Party Transactions
∙ Corporate Opacity
∙ Strategic Investment
Introduction
Complex ownership patterns, such as cross holding and concentrated promoter control, are frequently used to describe the corporate structure in India. A network of interconnected ownership is created when two or more businesses own shares in one another. This is known as cross holding. Promoter control refers to the substantial influence that founding families or
promoters have over business choices, frequently through board control and ownership stakes.
There are two ways to interpret these phenomena. On the one hand, they may be calculated investments meant to promote business growth, risk mitigation, and operational synergy. However, they might also encourage corporate opacity, which would allow promoters to sway financial statements, syphon off funds, and erode the interests of minority shareholders. This article explores the subtleties of promoter control and cross holding, looking at their practical difficulties, legal regulation,
1. Understanding Cross Holding and Promoter Control
1.1 What is Cross Holding?
Cross holding occurs when two or more companies hold shares in each other. This can be direct or indirect and may involve subsidiaries, holding companies, or unrelated entities within a corporate group. Cross holding can be:
∙ Reciprocal cross holding: Two companies hold shares in each other. ∙ Circular cross holding: A chain of companies hold shares in one another in a circular manner.
Cross holding is often used to:
∙ Strengthen business alliances.
∙ Maintain control without direct majority ownership.
∙ Facilitate strategic investments and collaborations.
1.2 Promoter Control in Indian Companies
Promoters are individuals or groups who establish a company and hold significant ownership or influence. Promoter control is exercised through:
∙ Majority shareholding.
∙ Control over board composition.
∙ Influence on key management decisions.
In India, promoter dominance is prevalent, with many companies having concentrated ownership structures. This control can lead to conflicts of interest, especially when promoters prioritize personal gains over minority shareholders.
2. Legal and Regulatory Framework Governing Cross Holding and Promoter Control
2.1 Companies Act, 2013 Provisions
∙ Section 2(87) defines subsidiary companies and indirectly addresses control mechanisms.
∙ Section 186 regulates loans and investments by companies, including restrictions on inter-corporate investments to prevent misuse.
∙ Section 129 mandates consolidation of accounts for holding and subsidiary companies, ensuring transparency in financial reporting.
∙ Companies (Restriction on Number of Layers) Rules, 2017 limit the number of subsidiary layers to curb misuse of complex structures for fund diversion.
2.2 SEBI Regulations
∙ Listing Obligations and Disclosure Requirements (LODR) Regulations, 2015 impose governance standards on listed companies and their subsidiaries.
∙ Regulation 24 mandates independent directors on boards of material subsidiaries and restricts divestment without shareholder approval.
∙ Related Party Transactions (RPTs) provisions have been expanded to cover transactions involving subsidiaries and related parties, enhancing oversight. ∙ SEBI has introduced the concept of ‘controlling shareholders’ to replace the promoter label, aiming to better regulate influence and disclosures.
2.3 Judicial Interpretations
∙ In Vodafone International Holdings BV v. Union of India (2012), the Supreme Court emphasized the separate legal entity status of subsidiaries, rejecting the notion that subsidiaries are mere puppets of holding companies.
∙ The ‘India Nexus Test’ from Securities and Exchange Board of India v. Pan Asia Advisors Ltd. (2015) allows SEBI to exercise jurisdiction over extraterritorial transactions affecting Indian investors, relevant in cross-border cross holding cases.
3. Cross Holding: Strategic Investment or Corporate Opacity?
3.1 Strategic Investment Perspective
Cross holding can be a legitimate strategic tool for:
∙ Business Synergy: Facilitating collaboration between companies to leverage complementary strengths.
∙ Risk Diversification: Spreading investments across related entities to manage financial risks.
∙ Operational Flexibility: Allowing companies to maintain influence without direct majority ownership.
∙ Capital Structure Optimization: Enhancing financial stability through inter company investments.
Illustration:
A manufacturing company holds shares in a logistics firm, which in turn holds shares in the manufacturing company. This cross holding enables coordinated supply chain management, reducing costs and improving efficiency.
3.2 Corporate Opacity and Governance Risks
However, cross holding can also lead to:
∙ Fund Diversion: Promoters may route funds through subsidiaries and cross holdings to obscure transactions.
∙ Conflict of Interest: Related party transactions may be used to benefit promoters at the expense of minority shareholders.
∙ Reduced Transparency: Complex ownership structures make it difficult for investors and regulators to track financial flows.
∙ Weak Board Oversight: Promoter-controlled boards may lack independence, enabling governance failures.
Illustration:
In several Indian corporate scandals, funds were diverted from parent companies to subsidiaries and then to promoter-controlled entities, evading regulatory scrutiny and harming investors.
4 Promoter Control and Its Impact on Corporate Governance 4.1 Concentrated Ownership and Board Dominance
Promoter control often results in:
∙ Dominance over board appointments.
∙ Suppression of independent directors’ roles.
∙ Decisions favoring promoters over other stakeholders.
4.2 Challenges to Minority Shareholders
∙ Limited influence in decision-making.
∙ Exposure to related party transactions without adequate disclosure. ∙ Risk of financial misreporting and fraud.
4.3 Regulatory Responses
∙ Mandatory inclusion of independent directors.
∙ Enhanced disclosure norms for related party transactions.
∙ Whistleblower mechanisms to detect internal fraud.
∙ Shareholder approval requirements for significant transactions involving promoters.
5. Case Studies and Examples
∙ Gensol Engineering: Promoters allegedly misused funds meant for electric vehicle projects to purchase luxury residences, illustrating fund diversion risks. ∙ BluSmart: Capital was diverted through promoter-controlled shell companies, violating disclosure norms.
∙ GoMechanic: Admitted to inflating revenue figures, highlighting falsified financial reporting.
∙ Satyam Scandal: A large-scale example of promoter-driven financial fraud and governance failure.
These cases underscore the risks associated with promoter control and opaque cross holding structures.
6. Measures to Enhance Transparency and Governance
6.1 Strengthening Board Independence
∙ Empower independent directors with real authority.
∙ Regular performance evaluations of board members.
6.2 Tiered Financial Controls
∙ Escalation protocols for high-value or strategic transactions.
∙ Robust internal compliance systems for real-time monitoring.
6.3 Enhanced Regulatory Oversight
∙ SEBI’s expanded jurisdiction over related party transactions involving subsidiaries. ∙ Stricter enforcement of Companies Act provisions on inter-corporate investments.
6.4 Promoting Ethical Corporate Culture
∙ Ethics as a core strategic element, not just compliance.
∙ Transparent disclosures and accountability to all stakeholders.
Conclusion
Cross holding and promoter control in Indian companies present a complex interplay between strategic investment and corporate opacity. While these mechanisms can facilitate business growth and operational efficiency, they also pose significant governance challenges, including fund diversion, conflicts of interest, and reduced transparency. The existing legal and regulatory framework, including the Companies Act and SEBI regulations, provides tools to address these issues but requires stringent enforcement and cultural change within corporations.
For India Inc. to foster sustainable growth and regain investor confidence, it is imperative to strengthen subsidiary governance, enhance board independence, and promote transparency. A balanced approach recognizing the legitimate strategic uses of cross holding while curbing its misuse will be key to improving corporate governance standards in India.
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