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Published : April 28, 2010 | Author : ASIFBASHA.A
Category : Banking and Finance laws | Total Views : 4471 | Rating :

A student of NALSAR, pursuing LL.M. in Corporate Law and Governance.I would like to mention a special thanks to my parents and dedicate this article to them without whom nothing is possible in my life.

Latest Financial Statement & Its Relevance Under The Scheme

In the initial days of corporation the business entities were guided by the moral principles and ethics but with the emergence of industrialization and globalization, the trend changed. The competition increased and man was in the verge of making money and nothing else. It was during this time man was ready to do anything to mint money. Thus he used to do mergers, amalgamations, etc without disclosing the ills and evils in his company to the creditors, shareholders, etc. Goodwill as a term was originally used to reflect the fact that an ongoing business had some prudent value beyond its assets, such as the reputation of the firm enjoyed with its clients. But this wasn’t to be long lasting, good will diminished and capital will dominate, it is during this regime the disclosing of material facts of the company plays a very vital factor in determining the motive behind the business entities entering in to the scheme with other companies. One of the vital material facts is latest financial statement, which helps to know the ins and outs of the scheme.

Financial Statement, Meaning:
Financial Statement is a written document which shows the financial flows and levels of the concerned entity. These are formal records of financial activities of on organization. The financial statement largely consists of balance sheet, income statement, statement of cash flows and statement of retained earnings. It is only these four which helps in getting a clear picture of the financial status of the company. Let us look at these four concepts in brief; balance sheet describes a company’s assets and liabilities which the company possesses. The income statement helps in describing a company’s income and the expenditures incurred by the company. Statement of cash flows portrays the skills of corporate operating of the company, where all the company has made its investments and lets one know how the financial activities have affected the company’s cash position. Lastly, the statement of retained earnings, which describes changes to shareholders equity that is for example a payment of dividend, etc. Since, the above statements are often complex, an extensive set of notes to the financial statements and management discussion and analysis is usually included. The notes will typically describe each item on the balance sheet and income statement in further detail. In many cases notes are much longer than the financial statements, they are elucidating. All the financial statements provided should fulfill the accounting standard as provided under section 211 of the Act.

Provisions in the Companies Act regarding latest financial statement:
Section 391 (2), states that no order sanctioning any compromise or arrangement shall be made by the [tribunal][1 unless the [tribunal][2 is satisfied that the company or any other person by whom an application has been made under sub-section (1) has disclosed to the [tribunal][3, by affidavit or otherwise, all material facts relating to the company, such as the latest financial position of the company, the latest auditors on the accounts of the company, the pendency of any investigation proceedings in relation to the company under sections 235 to 251, and the like.[4 This is the only provision in the Act which deals with the submission of latest financial statement to the court, in cases where a scheme is to take place.

Scheme, Meaning:
Scheme is a tool used by the Companies for various purposes, some of them being rescheduling debt, for takeovers and for returns of capital. A scheme which is dealt under section 391 of the Companies Act, 1956 is a comprehensive code used by the business entities to do each and every thing which they wish to, in reorganizing the financial structure of the company, with a few exceptions such as reduction of capital, winding up of the company. Scheme of arrangement is defined under section 390 (b) of the Act, which says the “arrangement” includes a reorganization of the share capital of the company by the consolidation of shares of different classes, or by the division of shares into shares of different classes or, by both these methods.

Essential of the Scheme:
A scheme of arrangement includes reorganization of the capital structure of the company, which is done through compromising on the creditor and shareholders rights. That is why every scheme has to get the nod of the court. Court gives the nod only after the fulfillment of essentials for the scheme. The essentials or procedure to be followed in getting the nod of the court is:

a. Application to the court for grant of scheme;
b. Meeting of the creditors or members as required;
c. Passing of the proposal through voting done by the majority;
d. Declaring all the material facts relating to company through affidavit, which includes:-

(1). Latest financial position of the company,
(2). Latest auditor’s report with regards to the financial status,
(3). Details of any investigation proceedings which are instituted against the company under the code.

Section 391, covers within its ambit all forms of arrangement like merger, demerger, and amalgamation, apart from dealing with schemes to compromises between a company and its creditors, likewise between accompany an its members. A company which wants to fulfill the above said aims need to go through all the essentials mentioned above, one among them being latest financial statement.

Importance of latest financial statements and its relevance under the scheme:
Financial statements are historically historical documents. This always plays a pivotal role to the future generations in deciding ‘do’s and don’ts’ in administering the company as also to the company in which it is going for a scheme. It helps in knowing the financial performance of the company. It helps both the insiders and outsiders. Insiders get to know the information of their concern, which eventually helps them in planning ahead and setting goals for the upcoming periods. It also helps in comparing their concern with other concerns in the market which would be suitable for them in getting into a scheme. It helps the outsider that is the creditors and members, in a way that creditors and investors get a clear picture of the financial health of the company. Submission of latest financial statement plays a crucial role under the scheme; it is because it helps the courts in knowing the status of creditors of the company, and what sort of impact it will have on the creditor if it allowed for the scheme. It helps the courts in ascertaining whether the so called other creditors where actually shareholders but also for finding the current net annual profits and how far the past losses had been wipe off.[5 Latest financial statement also helps the court in determining whether the petitioner is malafide or bonafide in bringing the scheme. That is it helps the court in knowing whether the petitioner has moved the petition with the primary intention of defeating the creditors dues or otherwise. The distinct and homogeneous class of creditors and members should be properly drawn up while giving direction for convening meetings as per section 391 and it would be impossible to do so in the absence of disclosures about latest financial statement of the company.

Non- Compliance of latest financial statement:
The court can send back an application for scheme if the applicant or petitioner has not placed before the court its authenticated latest financial position.[6 It is an important case in the history of latest financial statement, since it brings out the relevance of latest financial statement. Latest financial statement brings a ‘condition precedent’ for the petitioner to follow, the scheme could be sent back to the applicants company by the court on non- compliance by the petitioner. In another recent case the court said that it is mandatory to submit an affidavit by the petitioner company, which had to contain details with regards to the latest financial statement.[7 Thus, submission of latest financial statement is a mandatory one without which the sanctioning of scheme is inevitable.

Latest Financial Statement, When does it become due:

Section 391 (2) of the Companies Act, 1956 only talks about the disclosing of latest financial statement to the court, but it doesn’t mention the particular time when it becomes due. This has led to contradictory views with in the minds of practitioners and entrepreneurs, who like to use this provision according to their whims and fancies. Certain literal interpretation followers take the view that it becomes due only during the time of filing the petition. But logical interpreters differ from this and take a divergent view. They state that if suppose the time of filing the petition and the time when the court takes up the petition for grant of scheme has a long gap between them, then the latest financial position should be filed at the time when the petition becomes due for sanction. The contradictory views were settled by the courts. The Delhi High Court held that latest financial statement under proviso to section 391 (2) is the one up to the stage when the petition becomes due for sanction.[8 It was upheld by the Supreme Court in Miheer H. Mafatlal vs. Mafatlal Industries Ltd. [1996] 87 Comp Cas. 792. This view was taken by the courts, it is because if there is a long gap of many years between the time when the petition was filed and when it becomes due for sanction, then the company could indulge in a number of untoward activities whereby the condition of creditors get degraded, then the entire objective behind the submission of latest financial statement becomes meaningless.

But the literal interpreters where not satisfied with the above conclusion as to the timing where latest financial statement becomes due. Thus, in a comparatively recent case it was held that the relevant point of time for disclosing the latest financial position would be as at the time of filing of the petition. But if there is a long gap between the filing of the latest balance sheet etc., and the time when the court considers the scheme for sanction that the court, may require latest financial position, otherwise it has been clearly held that the latest financial position should be disclosed as at the time of moving/ filing of the petition.[9 Thus, if there is a delay in court considering the petition, latest financial statement has to be filed during the sanction and not otherwise. But the time period which is considered to be a long gap is not precise and is left to the discretion of the court to decide on it.

Production of latest financial statement, on will or demand:
Normally, it would appear that as the law stands today, during the time of filing the petition and when there is a long gap between the filing of the petition and its hearing the concerned company should itself produce the latest financial position, at the appropriate time, which may be available before the court. But, if the same has not been produced by the company, then the court should call for it, and give an opportunity to the company to produce the relevant record and examine the same, instead of dismissing the petition on this technical ground. It also appears that this requirement of furnishing the latest financial position is to be examined in the light of objections about any such drastic change in the financial position as would make the sanction to the scheme undesirable.[10

Latest Financial Statement under Companies Bill 2009:
Under this bill, the provisions regarding latest financial statement is dealt under clause 201, which is an exact replica of the existing Act. This bill also does not try to try to elaborate the provisions of latest financial statement.

Since it could decide a number of factors relating to scheme as mentioned above, utmost emphasis has to be laid on the latest financial statements by the court, investor, company and the society at large. It is high time that legislators make a specific and enhanced provision in the Companies Act, which would deal in a detailed manner about the latest financial statement and all its connected provisions. This would clear the doubts in the minds of entrepreneurs and prevent them from entering into schemes with malafide intention, which would serve the society at large.
[1 Substituted for “court” by the Companies (Second Amendment) Act, 2002, w.e.f. a date yet to be notified.
[2 Ibid.
[3 Ibid.
[4 Inserted by the Companies (Amendment) Act, 1965, w.e.f. 15.10.1965.
[5 Bhagwan Singh and Sons Pvt. Ltd. V. Kalawati, Satyawati and Pramod Kumar, (1986) 60 Comp Cas. 94.
[6 Bharat Synthetics Ltd. V. Bank of India (1995) 82 Comp Cas. 437.
[7 Mekaster Valves and Engineering Services Private Ltd, (2009) 149 Comp Cas. 593.
[8 Bhagwan Singh and Sons (P) Ltd. V.
[9 Blue Star Ltd., In re. (2001) 104 Comp Cas. 371.
[10 In Re: Jaypee Cement Limited; In Re: Jaiprakash Industries Limited,(2004) 122 Comp Cas. 854.

Authors contact info - articles The  author can be reached at: ASIFBASHA.A@legalserviceindia.com

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Posted by ARCHANA on July 17, 2010
this is an article which has a very good flow and analysis of a very rare topic.

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