What is the legal framework and economic impact of ancillarisation?

Introduction

To establish a dynamic business environment, a sustainable ecosystem is essential for improving the overall efficiency and effectiveness of businesses and industries, which is closely tied to the concept of ancillarisation. Ancillarisation involves the establishment of small and medium enterprises (SMEs) to offer specialized services like providing goods and services in certain specific areas (for example; logistics, customer support, tech support) to larger enterprises or companies. These ancillary services enhance overall efficiency, effectiveness, and customer satisfaction in the functioning of business. This process creates a symbiotic relationship where ancillary units depend on the larger firm for business, while the larger firm benefits from the cost-effective and specialized products or services provided by SMEs.

Therefore, according to corporate law, the relationship between a primary company and its ancillary units is governed by various legal frameworks that regulate the formation and functioning of these businesses. The “Make in India” initiative encourages large firms to source components from local ancillary units, fostering a strong supply chain and supporting small businesses.

Meaning of Ancillarisation 

• Ancillarisation involves outsourcing or segregating non-essential tasks or services from a company’s main business operations. These tasks include logistics, tech support, administrative work and other non-core functions.
• The term ‘Ancillarisation’ is not specifically defined under any particular Indian statute. However, the concept is associated with the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006[1], which governs the classification and promotion of MSMEs but ancillary enterprises are indirectly addressed under this Act.
• Prior to the MSMED Act, 2006, ancillary units were more explicitly defined under the Industries (Development and Regulations) Act, 1951, but with the liberalization of the economy and the introduction of the MSMED Act, 2006, the specific focus on ancillary units was absorbed into the broader framework. Earlier ancillary units were defined as “enterprises that supply at least 50% of their production to one or more larger industrial units, typically as part of the supply chain for larger firms[2].”  
• Thus, the concept of ancillarisation itself does not have a specific definition under a single Act. It is generally understood as the process of fostering small-scale enterprises that supply goods or services to a larger company.

Purpose of Ancillarisation 

Ancillarisation fosters industrial collaboration and enables the growth of ancillary units as well as primary companies (large enterprises), boosting overall economic development. The purpose of ancillarisation includes the following:

• Economic Growth: To boost the local economy, create jobs, and stimulate the growth of SMEs. It enables smaller firms to succeed by having a stable demand from larger, established companies.
• Cost Efficiency: Larger firms can focus on their core competencies and streamline their operations by outsourcing specific functions to ancillary units, which may be more cost-effective due to specialization in their fields.
• Customer Retention: Ancillary services can increase customer loyalty by creating a more comprehensive solution that meets a wider range of needs.
• Market Differentiation: Providing a unique ancillary service can help a business stand out in a competitive market and meet specific customer needs.    

Key Legal Obligations of Ancillarisation

Ancillarisation typically refers to the process of supporting or supplementing a primary activity, often seen in contexts like business operations, finance, or a legal framework. Here some general legal obligations that may be relevant to ancillary services are the following:

• Contractual Agreements: The ancillary units and the larger firms enter into contracts that outline the terms of their business relationship. These contracts define aspects such as the scope of supply, pricing, timelines, quality standards, and penalties for non-performance. In some cases, ancillary units may be bound by exclusivity clauses, where they are restricted from supplying similar products or services to competitors of the larger firms.
• Liability of Ancillary Units: The ancillary units are typically independent legal entities, meaning that in most cases, the larger company is not liable for the debts or legal issues of the ancillary unit, unless specific joint liability exists. In some cases, larger firms could be held liable for actions of their ancillary units if they exert significant control over the operation of the ancillary units.
• Corporate Governance: The ancillary units may be privately owned or partially owned by a larger company. In cases of partly or full ownership, corporate governance rules apply to manage conflicts of interest, related party transactions, and transparency. The ancillary units may operate as subsidiaries or as affiliates, where they are connected to the larger firm without direct ownership control depending on their structure.
• Monopoly and Anti-Trust Regulations: In some jurisdictions, laws governing competition and anti-trust may scrutinize the relationship between large firms and their ancillary units to ensure that monopolistic practices or anti-competitive[3] behaviour do not arise. If large firms disproportionally control an ancillary market, it could lead to legal challenges. Larger companies cannot dictate prices unfairly for ancillary units or create anti-competitive practices that would limit the smaller company's ability to operate independently.
• Labour Laws and Compliances: The ancillary units must comply with labour laws[4] independent of the larger firm. However, in cases where there is a significant overlap in management or operation, labour law violations could implicate the larger firm under joint-employer theories. In some cases, the ancillary units may be required to provide the same level of wages and benefits as the larger firm to avoid disputes or imbalances within the labour force.
• Intellectual Property (IP) Rights: The ancillary units may use the intellectual property[5] of the larger firm under licensing agreements. Legal frameworks ensure that the use of trademarks, patents, and other IP is properly licensed and protected.

Provisions regarding Ancillarisation under the Companies Act, 2013 

The Companies Act, 2013 does not specifically use the term ‘ancillarisation,’ but it provides several provisions and frameworks that indirectly help the concept by facilitating the growth of small and medium-sized enterprises (SMEs), including ancillary units. The ancillary units typically operate as subsidiaries, associates, or joint ventures of larger companies, and their functions are governed by the general principles of the Companies Act, 2013, along with other relevant policies related to MSMEs. Here are some provisions under this Act that could apply to the operation of ancillary units:

• Incorporation and Registration: Section 2(85) defines a ‘small company’,[6] which may include an ancillary unit. Small companies enjoy certain benefits, such as fewer compliance requirements, reduced penalties, and exemptions from certain reporting obligations. The ancillary units must comply with general provisions regarding the incorporation of companies, registration, and related statutory requirements.
• Provisions of Subsidiary and Holding Company: According to Section 2(87) of the Companies Act, 2013, an ancillary unit may operate as a subsidiary of a larger company, especially if the larger firm holds a controlling interest, and Section 129[7] of this Act requires companies to prepare consolidated financial statements if they have subsidiaries, including ancillary units, and to disclose the financial relationships between holding and subsidiary companies.
• Related Party Transactions: According to Section 188, if an ancillary unit is closely connected to a larger company through shareholding or business operations, it may fall under the scope of related party transactions[8] and these transactions must be conducted at arm's length with proper disclosure to ensure transparency and fairness when the larger company deals with an ancillary unit.
• Fast Track Mergers of Small Companies: Section 233 allows for fast track mergers between small companies or between a holding and its wholly-owned subsidiary, simplifying the process. This provision may facilitate the recognition or consolidation of ancillary units with their parent companies or other ancillary businesses.

Conclusion 

The concept of ancillarisation plays a crucial role in fostering a dynamic and sustainable ecosystem that enhances the efficiency and effectiveness of businesses, particularly in the context of small and medium enterprises (SMEs). By establishing a network of ancillary units that specialize in providing goods and services to larger firms, ancillarisation creates a symbiotic relationship that benefits both parties. Larger companies gain access to cost-effective and specialized services, allowing them to focus on their core competencies, while SMEs benefit from stable demand and the opportunity to grow within the supply chain.

The provisions within the Companies Act, 2013 further facilitate the operation of ancillary units by allowing for their incorporation as subsidiaries or joint ventures, outlining the necessary regulations for related party transactions, and enabling fast-track mergers. By promoting collaboration between large firms and SMEs, ancillarisation ultimately drives economic development and supports the broader goals of initiatives like "Make in India."

Ancillarisation is, therefore, an essential strategy for nurturing small businesses while simultaneously strengthening the capabilities of larger enterprises. It fosters an environment conducive to innovation and efficiency, ultimately contributing to sustainable economic growth. Understanding the legal frameworks surrounding this concept is vital for ensuring that both ancillary units and larger firms can thrive in a mutually beneficial relationship.

[1]  ICSI, Setting Up of Business, Industrial & Labour Laws 116.

[2]  ICSI, Setting Up of Business, Industrial & Labour Laws 458.

[3]  ICSI, Economic, Commercial & Intellectual Property Laws 311.

[4]  ICSI, Setting Up of Business, Industrial & Labour Laws 584.

[5]  ICSI, Economic, Commercial & Intellectual Property Laws 461.

[6]  ICSI, Company Law & Practices 65.

[7]  ICSI, Company Law & Practices 71.

[8]  ICSI, Company Law & Practices 688.