Academic Council 2021-2022 Commerce

III- B.COM COMPANY LAW 19ECM617

SEMESTER -VI (For the Students Admitted from the year 2019 HRS/WK –6
DSE – II (A) onwards) CREDIT -4

Course Outcomes
After completing this course, the student will be able to:
CO1: Learn the basic concepts of company and different kinds of companies.
CO2: Express the procedure of the Formation of a Company.
CO3: Study the various types of Share Capitals and Prospectus Company.
CO4: Acquire the Knowledge about the Management of Companies.
CO5: Explain the process of winding up of companies.

SEMESTER
VI COURSE CODE: 19ECM617 TITLE OF THE PAPER: HOURS: 6 CREDITS:4
PROGRAMME OUTCOMES(PO) COMPANY LAW
COURSE MEAN SCORE OF CO’S
PROGRAMME SPECIFIC OUTCOMES(PSO)
OUTCOMES
PO1 PO2 PO3 PO4 PO5 PSO1 PSO2 PSO3 PSO4 PSO5

CO1 5 5 5 5 5 5 5 5 5 5 5
CO2 4 4 5 4 5 4 5 4 5 3 4.3
CO3 4 4 4 4 3 4 3 4 4 3 3.7
CO4 3 4 3 3 4 2 4 3 4 3 3.3
CO5 3 3 4 3 4 3 4 3 3 4 3.4
Mean Overall Score 3.94

This Course is having HIGH association with Programme Outcome and Programme
Specific Outcome.

UNIT – I Introduction of a Company (15 Hrs.)

Company - Meaning and Definition - Kinds of Companies - Limited and Unlimited, Private
and Public, Government Companies, Statutory Companies – One Person Company
Corporate Social Responsibility u/s 35 of 2013.

UNIT – II Formation of a Company (15 Hrs.)

Formation of a Company - Promotion - Promoter, Functions of a Promoter - Incorporation
. Documents of Companies - Memorandum of Association - Definition, Clauses, Provisions
and Procedures for Alteration. Articles of Association - Definition, Contents, Provisions
and Procedures for Alteration, - Distinction between Memorandum and Articles of
Association.

St. Joseph’s College of Arts & Science (Autonomous), Cuddalore-1 Page | 46

Academic Council 2021-2022 Commerce

UNIT –III Prospectus and Share Capital (16 Hrs.)

Prospectus - Contents - Statements in Lieu of Prospectus. Share Capital - Types –
Provisions of Alteration, conversion - Buyback of Shares and Commencement of Business.

UNIT – IV Management of Companies (24 Hrs.)

Management of Companies -Directors –Independent Director – Women Directors -
Appointment, Qualification, Remuneration, Rights, Responsibilities and Liabilities -
Company secretary - definition - appointment - dismissal - qualification - duties &
liabilities - Meetings - Statutory, Annual, Extra ordinary and Board Meetings, Agenda -
Quorum - Proxy - Resolutions - Types - Minutes.

UNIT – V Winding Up (20 Hrs.)

Winding Up Companies - Meaning - Modes of Winding up - Winding Up by Court – Role of
Liquidators in Winding Up by Court - Voluntary Winding up - Liquidators in Voluntary
Winding up.

TEXT BOOKS
1. A text book of Company Law - P.P.S. Gogna, S. CHAND and Company Ltd, 7361, Ram Nagar,
New Delhi.
2. Prasanta K. Gosh and Balachandran, V. company Law and Pratice – II, Sultan chand &
sons, New Delhi.

REFERENCE BOOKS

1. Company Law - N.D. Kapoor, Sultan Chand & Sons, 23, Daryaganj, New Delhi - 110 002
2. Company Law - Ashok K. Bagrial, Vikash publishing, House PVT.LTD, 576, Masjid
Road, Jangpura, New Delhi - 110 014
3. Company Law - S. Kathiresan& Dr. V. Radha, Prasana Publisher, Old No:20,
Krishnappa street, (Near) Santhosh Mahal, Triplicane, Chennai -600 005

QUESTION PAPER PATTERN

Time: 3 Hours Marks: 75

Part - A = 10x2 =20 Marks – All the Questions are to be Answered.

Part – B = 5x5 = 25 Marks – Five Questions with Internal Choice.
Part – C = 3x10 = 30 Marks – Three Out of Five – Open Choice.

Note: Questions should be asked from all the units with equal weightage.

St. Joseph’s College of Arts & Science (Autonomous), Cuddalore-1 Page | 47

 UNIT-1
INTRODUCTION OF A COMPANY

INTRODUCTION AND NEW CONCEPTS

1.1. DEFINITION

The expression ‘Company Law’ may be defined as a branch of law governing the companies. It deals
with all aspects relating to companies, such as incorporation of companies, allotment of shares and
share capital, membership in companies, borrowings by companies, management and administration
of companies, winding up of companies. Thus, the company law is that branch of law which
exclusively deals with all matters relating to companies. The Company Law, in India, is codified, and
contained in THE COMPANIES ACT, 2013. This Act extends to the whole of India.

1.2. BEGINNING AND DEVELOPMENT OF COMPANY LAW

The development of the company law, in India, owes its origin to the law of companies, as it developed
in England. A brief discussion of the English system, and the developments of English Law, relating to
companies, becomes necessary in this regard.

During the eleventh to thirteenth centuries, the associations of merchants called the Merchant Guilds
were prevalent in England. In order to secure, for their members, a monopoly in respect of a particular
trade or commodity, the Merchant Guilds obtained a Charter from the Crown. Each member of the guild
traded on his own account, but subject to the rules and regulations of his guild. Gradually, the members
of the guild started trading on joint account subject to the rules and regulations of the guild. This joint
account trading was of two types, namely:

1. Commenda

2. Societas

In commenda, a trader lent money to another for trading, and got a share from the profit. And in case of
loss, the financier's (i.e., moneylender's) liability, was limited to the extent of money lent by him. The
moneylender was, somewhat, a sleeping partner with limited liability. In societas, all the members took
active part in the management of the trade and had unlimited liability. The commenda is still to be
found in continental countries, but the societas had now matured into partnership.

*It is a document issued by the sovereign (Crown/Queen) providing for the establishment of a corporate
body (i.e., company or corporation) and outlining the conditions under which such corporate body is
organized This being an ordinance for a particular purpose, only one corporate body is set up under one
charter.

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In the fourteenth century, the word 'Company' was adopted by certain merchants for trading overseas
i.e., with foreign countries. By Royal Charters, these merchants were give certain privileges in trading.
This was more or less an extension of the Merchant Guild in foreign trade. By sixteenth century, such
charters were commonly obtained by the merchants for forming the companies. The charter granted
monopoly of trade to members of the company. It also granted governmental power to the company
over the territory of its operation. These companies were called regulated companies. Originally, the
members of these companies were trading both, separately with their own funds or stock, and also
jointly with other members of the company. Gradually, the members gave up separate trading and
diverted their stock to joint trading. Thus, there became joint fund or joint stock with which the
members started trading on a joint account. The regulated companies thus became joint commercial
enterprises instead of trade protection associations. Thereafter, the joint trading started growing.

In 1600, East India Company was established in England by a Royal Charter. This company had
monopoly of trade in India. The members of the company could carry on trade individually, and also
had the option to subscribe to the 'joint fund' or 'joint stock' of the company.
Originally, the profits made by the company, together with subscriptions amount (i.e., joint fund), were
redivided among the members. Gradually, a permanent subscribed fund (i.e., the fund which was not to
be redivided) was introduced in the company. In this way, there came into existence a permanent joint
fund or joint stock of the East India Company. In 1692, private trading by the members of the company
was prohibited. At that time, the term 'joint stock company' was used in relation to such a company
whose members were prohibited from trading separately, to distinguish it from a 'regulated company'
whose members had the freedom to trade separately and had options to subscribe to the joint fund or
joint stock of the company.

During the seventeenth and eighteenth centuries, body corporate (i.e., company) could be brought in
existence either by a Royal Charter, or by a Special Act of Parliament. Both these methods were very
expensive and dilatory (i.e., inclined to cause delay). Consequently, to meet the growing commercial
needs of the nation, large unincorporated partnerships came into existence from the beginning of 19th
century trading, however, in corporate form. Such partnerships were formed by a deed of settlement.
The membership of each such partnership being very large, the management of the business was left to
a few trustees. This resulted in separation of ownership from management.

As the trade and commerce was expanding, the Trading Companies Act of 1834 was passed to meet the
needs of business community. This Act empowered the Crown to confer, by Letters Patent, all or any of
the privileges of incorporation except limited liability, without actually granting a Charter. In 1837, the
Trading Companies Act of 1834 was re- enacted by the Chartered Companies Act of 1837. But this Act
also provided that the personal liability of members might be expressly limited by the Letters Patent to
a specified amount per share.

In 1844, the Joint Stock Companies Act of 1844 was passed making the registration and incorporation
of large partnerships compulsory. It was the first legislative measure which provided incorporation by
registration, though the registration provided for was provisional.
However, the principle of unlimited liability was maintained i.e., the limited liability was not granted to
the members. The concept of limited liability, being the chief advantage of incorporation, was mooted
in the middle of nineteenth century. And ultimately, the right to trade with limited liability was granted
in 1855 by the Limited Liability Act of 1855.

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In 1856, the whole law relating to incorporation and registration of companies was consolidated
by the Joint Stock Companies Act of 1856. Important features of this Act were as under: .

1. It omitted the provisional registration, and allowed incorporation with limited liability

2. It omitted the deed of settlement required for registration, and introduced the memorandum and
articles of association. Any seven or more persons could register a memorandum of association.

3. It made provisions for winding up of companies.

Since then, the Acts relating to companies were considerably amended, enlarged and improved upon in
1857, 1862, 1908 and 1929. Finally, in 1948, the Companies Act of 1948 was passed consolidating the
entire law relating to companies. Thereafter, in 1967, 1976, 1980 and 1981 amendments were made.
The Acts of 1948 to 1981 now govern the company law in England.

The history of Indian Company Law began with the Joint Stock Companies Act of 1850, providing for
the registration of joint stock companies in India. During the early period of British Rule, a large
majority of companies operating in India were the companies incorporated in England, but having their
trade and other interest in India. However, due to the growth of trade and commerce in India, the
British Government felt i.e., realised the necessity of an enactment permitting the establishment of
companies in India.

In 1850, the Joint Stock Companies Act of 1850 was passed for the first time providing for the
registration of joint stock companies in India. This Act was passed in lines with the English Joint Stock
Companies Act of 1844. Under the Act of 1850, the Supreme Courts of Bombay, Calcutta and Madras
were authorised to order the registration of companies.
However, the privilege of limited liability of the shareholders was introduced in 1857 by the Joint
Stock Companies Act of 1857. But this benefit of limited liability was not extended to the banking and
insurance companies until the Act of 1860. A comprehensive Indian Companies Act was passed in
1866 consolidating and amending the laws relating to incorporation, regulation and winding up of
trading companies and other associations. This Act was recast in 1882 embodying the amendments
made in English Companies Act upto that time. This Act was amended and the law was consolidated
from time to time (i.e., in 1887, 1891, 1895, 1900, 1910) keeping pace with the English Companies
Acts.

In 1913, following the English Companies Act of 1908, the Indian Companies Act of 1913 was passed
consolidating and recasting the earlier Acts. This act was also amended and recast from time to time.

In view of mushroom growth of the companies and several malpractices noticed in the company
promotion and management, the Act of 1913, with subsequent amendments, proved to be inadequate. On
25th October 1950, the Government of India appointed a Company Law Committee, on the pattern of
Cohen Committee in England, under the chairmanship of Shri C.H. Bhabha to report on the working of
Companies Act of 1913 and to suggest suitable changes in the context of developing trade and commerce
in the country.
The committee made an extensive enquiry and submitted its report in 1952 recommending major
amendments in the company law. The government accepted its recommendation, and the Companies
Act, 1956 was passed incorporating provisions to meet the socio-economic needs of the country. The
Company Act, 1956 repealed all the earlier Acts, and consolidated the law relating to the companies.

3
Till now the law relating to companies was governed by the Companies Act, 1956 which had
subsequently been amended several times to suit the changing requirements of the companies and the
society.

Now the Companies Act, 1956 has been replaced by the new Companies Act, 2013.

1.3. OBJECTS OF COMPANY LAW

We have already discussed that the Company Law in India is codified and now contained in the

Companies Act, 2013. The objects of company law are those with which the Company Act, 2013 was

passed, and may be summarised as under:

1. To ensure that the activities of the companies are carried on not only in the interest of those directly
concerned with them but also in furtherance of the ultimate ends of our economic and social policy which
the country has accepted.

2. To fix up minimum standards of business integrity and conduct in the promotion and
management of companies' affair.

3. To protect the legitimate interest of the shareholders by ensuring effective participation and
control by them.

4. To prevent misconduct and malpractices on the part of company management and abuse of
power vested in them by the general body of shareholders.

5. To enforce proper performance of duties by persons responsible for the management of companies.

6. To require full and fair disclosure of all reasonable information relating to the affairs of the
companies.

7. To adjust the rights of the management vis-a-vis the shareholders and other concerned persons.

8. To empower the government to intervene and investigate into the affairs of the company where the
business of the company is being carried on in a manner prejudicial to the interest of the shareholders, the
company or the general public.

1.4. SUB-DIVISION OF COMPANY LAW

The subject of company law is very vast. But if we see it, from the syllabus point of view, we
find that the subject-matter can be sub- divided into the following important heads:

1. Incorporation of companies

2. Allotment of shares and share capital

3. Membership in companies

4
4. Borrowings by companies and registration of charge

5. Management and administration of companies

6. Winding up of companies

Now we shall discuss the above-mentioned sub-divisions of the subject in an extremely short form in this
chapter to have bird's eye view. However, we shall discuss them in detail in the appropriate chapters.

1.5. INCORPORATION OF COMPANIES

This part deals with the law relating to incorporation (i.e., formation) of companies, and may be studied
under the following sub-heads, which will be discussed in detail in separate chapters:

1. Nature and kinds of companies

2. Formation of a company

3. Memorandum of association

4. Articles of association

1. Nature and kinds of companies: This chapter deals with the legal definition of the
company', and its nature as revealed by special characteristics which a company possesses. The
different kinds of companies and the legal provisions relating thereto have also been discussed
in this chapter.

2. Formation of a company: This chapter deals with the stages in the formation of a company.
The steps required for the registration and incorporation of a company, and for the commencement
of business have also been discussed in this chapter.

3. Memorandum of association: This chapter deals with the legal provisions relating to
'memorandum of association'. It is the first important document to be filed with the Registrar of
Companies at the time of registration of the company. This document is of great importance, and
contains the fundamental conditions on which the company is to be incorporated (i.e., formed). The
provisions relating to alteration of various clauses of memorandum of association have also been
discussed in this chapter.

4. Articles of association: This chapter deals with the legal provisions relating to 'articles of
association'. It is the second important document to be filed with the Registrar of Companies at the time
of registration of the company. This document contains the rules, regulations, and byelaws for the
internal management of the company. The provisions relating to alteration of articles of association
have also been discussed in this chapter.

1.6. ALLOTMENT OF SHARES AND SHARE CAPITAL

This part deals with the law relating to the steps required for arranging finance by allotment of shares, the
share capital, and may be studied under the following sub-heads, which will be discussed in detail in
separate chapters:

1. Prospectus of a company
2. Shares of a company
3. Share capital

5
1. Prospectus of a company: This chapter deals with the legal provisions relating to the issue of
'prospectus'. A 'prospectus' is a document which is issued to the public inviting it to deposit money with
the company or to take shares or debentures of the company. The liability of the and other company for
mis-statement and omission of facts in the prospectus has also persons been discussed in this chapter.

2. Shares of a company: This chapter deals with the legal provisions relating to allotment, transfer,
transmission, forfeiture and surrender of shares. The different kinds of shares along with the legal
provisions relating thereto have also been discussed in this chapter.

3. Share capital: This chapter deals with the legal provisions relating to the alteration of the share
capital, increase in the share capital further issue of shares, and reduction of share capital. The
different types (i.e., categories) of share capital, and the purchase by the company of its own shares
have also been discussed in this chapter.

1.7. MEMBERSHIP IN COMPANIES

This part deals with the law relating to the acquisition and termination of membership in a company.
The capacity of members and their respective rights (including the voting rights), and liabilities have
also been discussed in this part. All these points have been put together in one chapter titled as
'Membership in a Company'.

1.8. BORROWINGS BY COMPANIES AND REGISTRATION OF CHARGE

This part deals with the law relating to the borrowing powers of the company, and the registration of
charge created on the assets of the company as security for the repayment of the money borrowed, and
may be studied under the following sub-heads, which will be discussed in detail in separate chapters:

1. Borrowing powers of a company

2. Debentures of a company

1. Borrowing powers of a company: This chapter deals with the legal provisions relating to the
borrowing powers of the company and the registration of charges created on the assets of the company as
security for the repayment of the money borrowed. The legal provisions relating to extent of borrowing
powers, authorised and unauthorised borrowings, creating of charge have also been discussed in this
chapter.

2. Debentures of a company: This chapter deals with the legal provisions relating to the issue of
debentures. A 'debenture' is a certificate of loan issued by the company which creates or acknowledges
an indebtedness of the company. The different kinds of debentures along with the legal provisions
relating thereto have also been discussed in this chapter.

1.9. MANAGEMENT AND ADMINISTRATION OF COMPANIES

This part deals with the law relating to the management and administration of company's affairs, and
may be studied under the following sub-heads, which will be discussed in detail in separate chapters:

1. Directors of a company

2. Managerial personnel of a company

3. Company secretary

4. Meetings and resolutions

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5. Dividends, accounts, audit and investigation

6. Supremacy of majority and protection of minority

7. Prevention of oppression and mismanagement

8. Organisational changes in a company

1. Directors of a company: This chapter deals with the legal provisions relating to the appointment,
qualifications, disqualifications, retirement and removal of directors. The powers of directors and
restrictions thereon, meetings of directors, their duties and liabilities along with their position and
remuneration payable to them have also been discussed in this chapter.

2. Managerial personnel of a company: This chapter deals with the legal provisions relating to the
appointment, disqualifications, terms of office and remunerations of managerial personnel such as
managing director, and manager. The legal provisions relating to other personnel such as whole-time
director, sole selling agent have also been discussed in this chapter.

3.Company Secretary: This chapter deals with the legal provisions relating to appointment, dismissal
and qualifications of a secretary. The duties and liabilities of a secretary along with his position have
also been discussed in this chapter.

4.Meetings and resolutions: This chapter deals with the legal provisions relating to the meetings of the
members, and the resolutions passed therein i.e., the decisions taken at the meetings. The different kinds
of meetings and resolutions along with the legal provisions relating thereto have also been discussed in
this chapter.

5.Dividends, accounts, audit and investigation: This chapter deals, with the legal provisions relating
to the declaration and payment of dividends, and maintenance of books of accounts and audit thereof
and investigation of company's affairs. The appointment of auditors, their qualifications and
disqualifications, their rights, duties and liabilities along with other provisions have also been
discussed in this chapter.

6.Supremacy of majority and protection of minority: This chapter deals with the legal provisions
relating to the rule of supremacy of majority. As the wide powers given to the majority shareholders
may be misused by them to exploit the minority shareholders, the Companies Act, 1956 contains
number of provisions for the protection of the interest of the minority shareholders. These provisions
have been discussed in this chapter.

7.Prevention of oppression and mismanagement: This chapter deals with the legal provisions relating
to the prevention of oppression and mismanagement. It is the special right given to the shareholders for
their protection. The instances of oppression and mismanagement, requisite numbers of members to
make the application, powers of the Company Law Board and Central Government have also been
discussed in this chapter.

8.Organisational changes in a company: This chapter deals with the legal provisions relating to the
schemes required for bringing certain internal organisational changes in the company. The schemes of
compromise and arrangement, and of reconstruction and amalgamation are recognised by the
Companies Act, and have been discussed in this chapter.

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1.10.WINDING UP OF COMPANIES

This part deals with the law relating to the winding up of companies, and may be studied under the
following sub-heads, which will be discussed in detail in separate chapters:

1. Winding up of a company
2. Conduct of winding up

1. Winding up of a company: This chapter deals with the legal provisions relating to the
procedure of winding up of companies. The modes of winding up, and kinds of winding up
along with the legal provisions relating thereto have also been discussed in this chapter.

2. Conduct of winding up: This chapter deals with the legal provisions relating to the conduct of
winding up. The object of winding up is to realise assets of the company and to satisfy its debts
and liabilities out of the amount so realised. And if there is any surplus, it is distributed among
the shareholders. All this work is conducted in accordance with certain uniform provisions as
contained in the Companies Act. These provisions have been discussed in this chapter.

1.11. NEW CONCEPTS IN THE COMPANIES ACT, 2013

Following are some of the important new concepts that have been included in the Companies Act,
2013, and which were not there in the earlier Companies Act, 1956: 1. One Person Company [Section
2(68)]

1. Small Company [Section 2(85)]

2. Dormant Company [Section 455]

3. Associate Company [Section 2(6)]

4. . Key Managerial Personnels [Section 2(51)]

5. Independent Director [Section 2(47); 149(6)]

6. Holding-Subsidiary Merger [Section 233]

7. Corporate Social Responsibility [Section 135]

8. Rotational Auditors [Section 139]

9. Class Action [Section 245]

All these concepts are discussed in detail in the following pages.

1.12. ONE PERSON COMPANY

The concept of one person company (OPC) has been introduced for the first time in the company law.

Now, under the Companies Act, 2013, a One Person Company can be validly formed, and such
company shall be formed as a private company.

1. Definition: It is defined in Section 2(6) of the Companies Act, 2013, as unde "One Person
Company" means a company which has only one person as a member.

2. Formation: A one person company can be formed by one person for any lawful purpose by
8
subscribing his name to a memorandum and complying with the requirements of the Companies Act,
2013 in respect of registration of the company [Section 3].

It is important to note that a one person company can only be formed as a private limited company
[Section 3].

3. Other important provisions: Following provisions are important to be noted in respect of one
person company:

(a) Only a natural person can be a member of a one person company.

(b) The memorandum of one person company (OPC) shall indicate the name of the other person who
shall become the member of the company in the event of death or incapacity of the single member
[Section 3(1), 1st proviso].

(c) The name of such other person can be included in the memorandum only with the prior written
consent of such other person.

(d) At the time of incorporation of one person company, the written consent of the other person,
whose name is indicated in the memorandum, shall also be filed with the Registrar alongwith its
memorandum and articles [Section 3(1)].

(e) The other person indicated in the memorandum may withdraw his consent in such manner as may
be prescribed. The member of one person company may also change the name of such other person at
any time by giving a notice in such manner as may be prescribed [Section 3(1), proviso].

() It shall be the duty of the member of OPC to intimate the Registrar any change in the name of person
nominated by him as already mentioned in the memorandum [Section 3(1), proviso].

(g) The words 'One Person Company' shall be mentioned in brackets below the name of the company
wherever its name is printed, affixed or engraved [Section 12(3), 2nd proviso].

(h) The minimum number of directors required for one person company is one [Section 149(1)].

(i) As regards first director, an individual member shall be deemed to be its first director [Section
153(1)].

(j) The concept of notice, quorum, passing of resolutions etc. as contained in Sections 98 and Section
100 to 111 are not applicable to one person company [Section 122]

(k) The provision relating to holding of annual general meeting is not mandatory for a one person
company [Section 96(1)].
(1) A one person company has to conduct at least one meeting of the Board of Directors in each half of
a calendar year, and the gap between two meetings should not be less than 90 days [Section 173(5)]..

(m) The requirement for quorum of Board meeting shall not apply to a one person company in which
there is only one director on its Board of Directors [Section 173(5), proviso].

1.13.SMALL COMPANY

It is a new definition which was not there in the earlier Companies Act, 1956. In case of a small
company, various relaxations in terms of reporting requirements, Board meetings and procedure for
merger/amalgamation have been introduced in the new Companies Act, 2013. The concept of small
company is discussed as under:
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1. Definition: The term 'small company' is defined in Section 2(85) of the Companies Act, 2013.
As per this section,

A 'small company' means a company other than a public company, and which has the following limits
with regard to paid-up share capital or turnover:

(a) The paid-up share capital of the company does not exceed 50 lakhs or such higher amount as may
be prescribed but the amount so prescribed shall not be more than 50 crores; or

(b) The turnover of the company, as per its last profit and loss account does not exceed * 2 crores or
such higher amount as may be prescribed, but the amount so prescribed shall not be more than 20 crore.

2. Exemption: The following companies shall not be regarded as a small company irrespective of
its share capital or turnover:

(a) A public company;

(b) A holding company or subsidiary company;

(c) A company incorporated for charitable purposes under Section 8;

(d) A company or a body corporate governed by any special Act.

1.14.DORMANT COMPANY

The concept of 'dormant company' is a new concept introduced in the Companies Act, 2013. It is a
welcome step and could be beneficial to the small trading community, which may set up companies but
may not be ready to carry on business, or may like a break for a while before they start again. By
having this class of companies, such companies could restart at a later stage easily, without actually
going through the difficult task of first closing the company and then restarting again.

In today's economic environment, a lot of companies are formed for the purpose of holding any assets
particularly real estate or any intellectual property, or for a future project. Such companies just keep on
complying with the legal requirements even if no actual business is being done or transacted. With the
concept of 'dormant company' being introduced in the Act, such company may obtain the status of a
dormant company, and enjoy various relaxations under the Companies Act.

The legal provisions in this regard are provided in Section 455 of the Companies Act, 2013 which has
been notified to be effective w.e.f.
1.4.2014 vide Ministry of Corporate Affairs Notification dated 26.3.2014, and are explained as under:

1. The companies that can obtain status of dormant company [Section 455(1): The following
companies may make an application to the Registrar for obtaining the status of a dormant company:

(a) A company formed and or to hold an asset or intellectual property, and has no significant
accounting transaction; or

(b) An inactive company

The concepts of 'significant accounting transaction' and 'inactive company' as used above are defined in
the Explanation to Section 455(1) as under:

(i) Significance Accounting Transaction: The "Significant Accounting Transaction" means any
transaction other than that of (a) payment of fees by a company to the Registrar, (b) payments made by it
to fulfill the requirements of this Act or any other law, (c) allotment of shares to fulfill the requirements
10
of this Act and (d) payments for maintenance of its office and records [Section 455(1), Explanation (ii)].

(ii) Inactive Company: An "Inactive Company" is defined as a company which has not been
carrying on any business or operation, or has not made any significant accounting transaction during the
last two financial years, or has not filed financial statements and annual returns during the last two
financial years [Section 455(1), Explanation (i)].

2. Authority to grant status of dormant company [Section 455(2)]: The authority to grant the
status of a dormant company is the Registrar. Any company stated above may make an application, in
the prescribed manner, to the Registrar for obtaining the status of a dormant company.

On consideration of such application, the Registrar may allow the status of a dormant company to the
applicant company, and issue a certificate as may be prescribed to that effect. [Section 455(2)].

It is important to note here that in case of a company which has not filed financial statements or annual
returns for 2 financial years consecutively, the Registrar may, on his own, issue a notice to such
company and enter its name in the register maintained for dormant companies [section 455(4)].

3. Register of dormant companies: The Registrar shall maintain a register of dormant companies in
such form as may be prescribed [Section 455(3)].

4. Dormant company to comply with prescribed compliances [Section 455(5)]: In order to retain
its dormant status, the dormant company shall have such number of minimum directors, file such
documents with the Registrar, and pay such annual fee to the Registrar as may be prescribed by rules
made by the Central Government.

5. Becoming an active company: The dormant company may again become an active company by
making an application to the Registrar in this regard. The application should be accompanied by such
documents and fee as may be prescribed [Section 455(5)].

Note: Where a dormant company has failed to comply with the requirements of this section for
becoming a dormant company, the Registrar shall strike the name of such company from the Register
of dormant companies [Section 455(6)].

1.15. ASSOCIATE COMPANY

The concept of 'associate company' is a new concept introduced under the Companies Act, 2013.

The 'associate company' is defined in Section 2(6) of the Companies Act, 2013 as under: "An associate
company', in relation to another company, means a company in which that other company has a
significant influence, but which is not a subsidiary company of the company having influence, and
includes a joint venture company"

The expression 'significant influence' used in the definition means the control of at least 20%
of total share capital or of business decisions under an agreement [Section 2(6), Explanation].

The analysis of the above provisions shows that an associate company is defined in relation to another
company, and a company is regarded as an associate company in the following circumstance:

(a) where another company has substantial influence in such a company, and

(b) such a company is not a subsidiary of the company having influence; or

(c) where another company is a joint venture company.

11
 Thus, to state simply, a company considered to be an associate company of the other, if the other
company has a significant influence over such company, or is a joint venture company. Note: Under the
Companies Act, 2013 many provisions have been made with regard to an associate company; some of
the important provisions are:

● A company is required to lay before annual general meeting, alongwith financial statements, the
consolidated financial statements of its subsidiaries and associate companies [Section 129].

• An associate company is considered as a 'related party' and if the directors are concerned or
interested in such associate company, such directors are not regarded as independent directors
[Section 2(76)].

• If an auditor is holding any security interest or is indebted to or has a business relation with the
associate company, he will not be eligible to be appointed as auditor of the company [Section 141].

• The auditors also cannot provide certain non-specified non-audit services to the associate
companies [Section 144].

1.16. KEY MANAGERIAL PERSONNEL

This is also a new concept introduced under the Companies Act, 2013.

The expression 'key managerial personnel' is defined in Section 2(51) of the Companies Act, 2013 as
under:
Key Managerial Personnel', in relation to a company, means the following:

 The Chief Executive Officer;

 . The managing director;

 . The manager;

 The company secretory

 . The whole-time director

 The Chief Financial Officer; and

 Such other officer as may be prescribed.

1.17. INDEPENDENT DIRECTOR

It is also a new concept and is defined in Section 2(47) of the Companies Act, 2013 as a director referred
to in Section 149(6).

As per section 149(6) an independent director, in relation to a company, means a director other than a
managing director or a whole-time director or a nominee director, and fulfills the following requirements:

(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise
and experience;

(b) (i) who is or was not a promotor of the company or its holding, subsidiary or associate
company;

12
(ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate
company.

(c) who has or had no pecuniary relationship with the company, its holding, subsidiary or associate
company, or their promotors, or directors, during the two immediately preceding financial years or
during the current financial year;

(d) none of whose relatives has or had pecuniary relationship or transaction with the n company, its
holding, subsidiary or associate company, or their promotors, or directors, a amounting to two per cent or
more of its gross turnover of total income or fifty lakh rupees or such higher amount as may be
prescribed, whichever is lower, during the two immediately preceding financial years or during the
current financial year;

(e) who, neither himself nor any of his relatives

(i) holds or has held the position of a key managerial personnel or is or has been employee of the
company or its holding, subsidiary or associate company in any of the three financial years immediately
preceding the financial year in which he is proposed to be appointed;
(ii) is or has been an employee or proprietor or a partner, in any of the three financial years
immediately preceding the financial year in which he is proposed to be appointed, of

a firm of auditors or company secretaries in practice or cost auditors of the company or its holding,
subsidiary or associate company; or

• any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary
or associate company amounting to ten per cent or more of the gross turnover of such firm;

(iii) holds together with his relatives two per cent or more of the total voting power of the company;

(iv) is a Chief Executive or director, by whatever name called, of any non-profit C organisation which
receives 25% or more of its receipts from the company.

(f)who possesses such other qualifications as may be prescribed.

1.18. HOLDING-SUBSIDIARY MERGER

The Companies Act, 2013 has introduced a new provision in Section 233 for making easier the merger of
holding and subsidiary companies.

It was always felt that in case of mergers of holding-subsidiary or companies where interest of third
party is not involved, the process should be simplified and a fast tract procedure should be provided.

The New Companies Act proposed a fast track simplified procedure for mergers and amalgamations of
certain class of companies such as holding- subsidiary, small size companies etc, which is a welcome
move. The previous Company Law required companies to follow the same cumbersome and time
consuming process for mergers and amalgamations even if it is between holding and subsidiary
companies or involves very small companies. The process included approval by the tribunal besides the
approval of shareholders, creditors, Regional Director and Official Liquidator.

In this backdrop, the Companies Act, 2013 has made a separate provision in Section 233 for merger
and amalgamations between holding and wholly- owned subsidiary, or two or more companies, small
companies or such other class of companies as the Central Government may prescribe.

The new provision gives these companies an option to adopt a fast track process where there is no
13
requirement of making application to the National Company Law Tribunal for affecting mergers.
However, as a safeguard in this kind of mergers and amalgamations, following provisions are made in
Section 233:
1. The advance notice of the proposed scheme of merger or amalgamation should be given to the
Registrar and Official Liquidator inviting their objections or suggestions within 30 days [Section
233(1)(a)].

2. The companies involved in the merger should file a declaration of solvency with the Registrar in
the prescribed form [Section 233(1)(c)].

3. The objections and suggestions received from Registrar and Official Liquidator should be
considered, and the scheme should be approved by majority representing 90% in value of each class
of shareholders and creditors [Section 233(1)(b)(d)].

4. The transferee company shall fill a copy of the scheme, so approved, with the Central
Government, Registrar and Official Liquidator [Section 233(2)].

5. On receipt of the scheme, the Central Government shall register the same and issue a
confirmation to the companies if the Registrar or Official Liquidator has no objections or suggestions
to the scheme [Section 233(3)].

1.19. CORPORATE SOCIAL RESPONSIBILITY

The concept of 'corporate social responsibility' (i.e., CSR) has been introduced in the company law, and
legal provisions in this regard are made in Section 135 of the Companies Act, 2013. This is a new
initiative of Ministry of Corporate Affairs to ask corporate to contribute towards society. It is a
paradigm shift (i.e., fundamental change in approach) in this area since earlier there were only
volumtary guidelines for CSR, and now there is a mandatory provision for CSR by some specified
companies which is expected to cover a huge number of companies in India. It may add sense of
responsibility and contribution among corporate. It is expected to be beneficial to different class of
people such as children, women, uneducated, unemployed etc towards which such CSR activities may
be focussed.

The legal provisions incorporated in Section 135 with regard to corporate social responsibility may be
stated as under:

1. Applicability to Companies [Section 135(1): The provisions of corporate social responsibility

shall be applicable to every company having the below mentioned net worth or turnover or net profits,
during any financial year:
(a) net worth of 500 crores or more; or
(b) turnover of 1,000 crores or more; or
(c) net profit of 5 crores or more.

2. Constitution of Corporate Social Responsibility Committee [Section 135(1)]: Every company

falling in the above category shall constitute a Corporate Social Responsibility Committee of the Board
of directors.

The committee shall consist of 3 or more directors, out of which atleast one director shall be an
independent director.
Note: The composition of the above CSR committee shall also be disclosed in the report of Board of
Directors attached to the financial statement of the company [Section 135(2)].

3. Functions of Corporate Social Responsibility Committee [Section 135(3)]: The

Corporate Social Responsibility Committee shall:

14
(a) formulate and recommend to the Board, a Corporate Social Responsibility Policy which shall
indicate the activity or activities to be undertaken by the Company as specified in Schedule VII;

(b) recommend the amount of expenditure to be incurred on the activities related to CSR; and

(c) monitor the Corporate Social Responsibility Policy of the company from time to time.

4. Responsibility of the Board of Company [Section 134(4)]: The responsibilities of

the board are as under:

(a) Approval of Policy: After taking into account the recommendations made by Corporate Social
Responsibility Committee, the Board shall approve the Corporate Social Responsibility Policy for the
company and disclose contents of such Policy in its report and also place it on the company's website,
if any, in such manner as be prescribed [Section 135(4)(a)]. may

Jus (b) Ensure compliance of policy: The Board shall ensure that the activities as included in the
Corporate Social Responsibility Policy of the company are undertaken by the company [Section
135(4)(b)].

(c) Ensure spending by the company: The Board shall make every endeavour to ensure that the company
spends, in every financial year, atleast two per cent of average net profits of the company made during
three immediately preceding financial years in pursuance of its Corporate Social Responsibility Policy.
If the company fails to spend such amount, the Board shall, in its report made under clause (o) of
subsection (3) 134, specify the reasons for not spending the amount [Section 135(5)]. 5. Activities
included in CSR Policy (Schedule VII]: The activities which shall be included by companies in their
Corporate Social Responsibility Policy are the activities relating to

( i) eradicating extreme hunger and poverty;

( ii) promotion of education;

( iii) promoting gender equality and empowering women;

( iv) reducing child mortality and improving maternal health;

( v) combating human immunodeficiency virus, acquired immune deficiency syndrome, malaria

and other diseases;

( vi) ensuring environmental sustainability;

( vii) employment enhancing vocational skills;

( viii) social business projects;

( ix) contribution to the Prime Minister's National Relief Fund or any other fund set up by the Central
Government or the State Governments for socio-economic development and relief and funds for
the welfare of the Scheduled Castes, the Scheduled Tribes, other backward classes, minorities
and women; and

( x) such other matters as may be prescribed.

1.20. ROTATION OF AUDITORS

The concept of 'rotation of auditors' has been introduced in the Companies Act, 2013 and the provisions
in this regard are made in Section 139 of the Act.
15
Under the earlier Companies Act, 1956, there was no provision for compulsory Rotation of Auditors. As
a result, an auditor in some companies continue for over 10-15 years and even more. To overcome this
hitch, the Companies Act, 2013 has provided for Rotation of Auditors after a specific time frame to
ensure independence of auditor and strengthen diligence in their role and conduct. Compulsory rotation
of audit partners is a global practice prevailing in developed countries also like USA.

The rotation of auditors has been made mandatory for listed and other specified class of companies. In
this regard Section 139(2) of the Companies Act, 2013 specifically states that no listed company or a
company belonging to such class of companies as may be prescribed, shall appointed or re-appoint

(a) an individual as Auditor for more than one term of 5 consecutive years; and

(b) an audit firm as Auditor for more than two terms of 5 consecutive years:

Thus, an individual auditor should be rotated after a term of 5 consecutive years; and an audit firm to be
rotated after two terms of 5 consecutive years. The manner of rotating the auditors may be prescribed
by the Central Government.

Following further provisions are important to note with regard to appointment and rotation of auditors.

1. An individual who has completed his term as aforesaid shall not be eligible for reappointment
as Auditor in the same company for 5 years from the completion of his term [Section 139(2),
proviso(i)].

2. An audit firm which has completed its term as aforesaid shall not be eligible for reappointment as
Auditor in the same company for 5 years from the completion of such term [Section 139(2),
proviso(ii)].

3. Subject to provisions of the Act, the members have the freedom to resolve that

(a) in the audit firm appointed by it, the auditing partner and his team shall be rotated at such
intervals as may be resolved by members, or
(b)the audit shall be conducted by more than one auditor.

4. The Central Government may, by rules, prescribe the manner in which the companies shall
rotate their auditors [Section 139(4)].

1.21. CLASS ACTION

A class action is the right of specified number of members or depositors to file an application before
the Tribunal for seeking relief on behalf of all the members or depositors.

The Companies Act, 2013 has given a statutory sanction to such class action proceedings by
incorporating provisions in this regard in Section
245 of the Act. The class action proceedings have been allowed keeping in mind the interest of the
shareholders or depositors and the situation where it may be prudent to allow such class action instead
of claims being raised by the affected parties individually. In this way, the Act now provides greater
variety of remedies to the affected parties to protect their interest.

Large provisions of Section 245, incorporating class action proceedings, may be stated under:

1. Application to Tribunal for relief [Section 245(1)]: If specified number of members or

depositors or any class of them (specified number as stated in point(2) below) are of the opinion that
the management or conduct of the affairs of the company are being conducted in a manner
prejudicial to the interests of the company or its members or depositors, then they may file an
16
 application before the Tribunal on behalf of the members or depositor for seeking all or any of the
following orders, namely:

(a) to restrain the company from committing an act which is ultra vires the Articles Memorandum
of the Company;

(b) to restrain the company from committing breach of any provision of the Company
Memorandum or Articles;

(c) to declare a resolution altering the Memorandum or Articles of the company as void if the
resolution was passed by suppression of material facts or obtained by misstatement to the members or
depositors;

(d) to restrain the company from doing an act which is contrary to the provisions of this Act or any
other law for the time being in force;

(e) to restrain the company and its director from acting on such resolution;

(f) to restrain the Company from taking an action contrary to any resolution passed by the members;

(g) to claim damages or compensation or demand any other suitable action from against

( i) The company or its directors for any fraudulent, unlawful act or omission or conduct or any
likely act or omission or conduct on its or their part;
( ii) To seek any other remedy as the Tribunal may deem fit

2. Requisite number of member to initiate class action [Section 245(2)]: The requisite
number of members/depositors who can file for class action suit shall be as under:

(i) In the case of a company having a share capital, the requisite number of members shall be

(a) not less than one 100 members of the company or not less than such percentage of the total
number of its members as may be prescribed, whichever is less, or

(b) any member or members holding not less than such percentage of the issued share capital of the
company as may be prescribed, subject to the condition that the applicant or applicants has or have paid
all calls and other sums due on his or their shares;

(ii) In the case of company not having a share capital, not less than 1/5 of the total number of its
members.

(iii) The requisite number of depositors shall be

(a) not be less than 100 depositors, or

(b) not less than such percentage of the total number of depositors as may be prescribed,
whichever is less, or

(c) any depositor or depositors to whom the company owes such percentage of total deposits of the
company as may be prescribed.

3. Other important provisions: These are as under:

(a) Tribunal order binding on all [Section 245(6)]: Any order passed by the Tribunal shall be
binding on the company and all its members, depositors and auditor including audit firm or expert

17
 consultant or advisor or any other person associated with the company.

(b)Penalty for non-compliance of order [Section 245(7)]: Any company which fails to comply with
an order passed by the Tribunal under this section shall be punishable with find which shall not be less
than five lakh rupees but which may extend to twenty-five lakh rupees and every officer of the
company who is in default shall be punishable with imprisonment for a term which may extend to three
years and with fine which shall not be less than twenty-five thousand rupees but which may extend to
one lakh rupees.

(c)Rejection of frivolous application [Section 245(8)]: Where any application filed before the
Tribunal is found to be frivolous or vexatious, it shall, for reasons to be recorded in writing, reject the
application and make an order that the applicant shall pay to the opposite party such cost, not
exceeding one lakh rupees, as may be specified in the order.

(d)Non-applicability to banking company [Section 245(9)]: Provision of Class Action suit are not
applicable to a banking company.

(e)Action by representative [Section 245(10)]: Subject to the compliance of this section, an application
may be filed or any other action may be taken under this section by any person, group of persons or any
association of persons representing the persons affected by any act or omission.

NATURE AND KINDS OF COMPANY:

2.1. INTRODUCTION

Nowadays, to start or carry on a business requires huge investments. It may not be possible for a single
person to fulfill all his financial requirements. Thus, the persons are generally desirous of carrying on
joint business enterprises. To such persons, the law offers a choice between a partnership and a company.
The partnership is suitable for small-scale business, in which the partners take personal interest and
work together with mutual trust and confidence. But sometimes, the persons like to start business on
large scale requiring huge investments which cannot be financed by the resources of a few persons. In
such cases, the formation of a company is the only choice. It may, however, be noted that even for a
small-scale business, a company offers certain privileges as compared to partnership, such as the limited
personal liability of the members. The law relating to companies is contained in THE COMPANIES
ACT, 2013, which has repealed the existing Companies Act, 1956. The new Companies Act, 2013
contains 470 sections and 7 Schedules. Initially, only 98 sections of the new Act were made effective
w.e.f. 12.9.2013 vide Notification F.No. 1/15/2013-CL. V dated 12.9.2013. Subsequently, majority of the
remaining sections and schedules have been made effective w.e.f. 1.4.2014 vide Ministry of Corporate
Affairs notification dated 26.3.2014. The entire text has been re-written keeping in view the new
provisions of the Companies Act, 2013 as amended by the Companies (Amendment) Act, 2015.

In this chapter, we shall discuss the legal meaning of the term 'company', its advantages and
disadvantages. Various kinds of companies along with the legal provisions relating thereto will also be
discussed in this chapter.

Note: In our discussion on the law relating to companies from Chapters 2 to 24, unless otherwise
stated, sections mentioned are those of the Companies Act, 2013.

2.2. DEFINITION OF A COMPANY

The term 'company' may be defined as a group of persons associated together to achieve some common
objective. This, however, is not the legal definition. In legal sense, a company means an association of
persons incorporated under the existing law of a country. The legal definition of a company has been
amended by the new Companies Act, 2013 and is given in Section 2(20) of this Act which reads as
under:
18
"Company means a company incorporated under this Act or under any previous company law".

Thus, in legal sense a company is one which is incorporated (i.e., formed) under the Companies Act,
2013 or under any previous company law'. The previous company law here means the Companies Act,
1956 and earlier Companies Acts. This definition, however, is not exhaustive. Strictly speaking, the
term 'company' is not defined in Section 2(20). It simply emphasises the formation and registration of
the company. The meaning and nature of the company becomes clear after looking into its
characteristics, as discussed in the next article. The legal meaning of the term 'company', as revealed by
these characteristics, may be summed up as under:

A company is a voluntary association of persons formed under the Company Law, to achieve
some common objectives, having a separate legal entity, independent and separate from its
members, with a perpetual succession and a common seal, if any, and with capital divisible into
transferable shares.

Following points are important to be noted with regard to the definition of a company:

1. Legally not every association of persons is a company; only such association of persons shall be
a company which is registered under the Companies Act, 2013 or under any previous
Companies Act.

2. A company is, legally, regarded as a person, which has rights and duties at law. However, it is
not a natural person as human beings are. It is only a legal or artificial person, recognised by the
law. Since, the company is created by law i.e., by registration under the Companies Act, it is
known as a legal person, and as it has no body, no soul or conscience, no physical existence
except in the eyes of law, it is known as artificial person.

3. Though the company is a legal or artificial person, yet it really exists and is not a fictitious
person.

4. A company, being an artificial legal person, possesses similar rights and owes similar obligations
like natural persons. Thus, a company can do everything like a natural person except the acts
which are purely of personal nature, e.g., taking oath, seeking election, marriage or divorce.

Such as The Indian Companies Act, 1866; The Indian Companies Act, 1882; The Indian
Companies Act, 1913; The Registration of Transferred Companies Ordinance, 1942; The
Companies Act, 1956; The Registration of Companies (Sikkim) Act, 1961 [Refer to Section
2(67) of the Companies Act, 2013].

5. Though, the company is a person, the sentence of imprisonment cannot be imposed on a

company. Thus, where the violation of any provision of the Companies Act attracts penalty by
way of imprisonment only, the company cannot be punished for the violation of such a
provision.
[P.V. Pai v. R.L. Rinawama, (1993) 77 Comp. Cas. 179 (Kar.))² In M.V. Javali v. Mahajan
Borewell & Co., (1998) 91 Comp. Cas. 708 (SC), the Supreme Court has also held that a
company can be held liable for statutory violations like an individual, but it cannot be
imprisoned.

2.3. CHARACTERISTICS OF A COMPANY OR ADVANTAGES OF

INCORPORATION

19
We have discussed, in the last article, the legal definition of the term company. A company formed and
registered under the Companies Act has certain special characteristics, which reveal the nature of a
company. These characteristics are also called the advantages of a company because as compared with
other business organisations, these are in fact, beneficial for a company. Following are the special
characteristics of a company:

1. It has a separate legal entity: It is an important characteristic of a company that it has a separate
legal entity. It means that the existence of a company is independent and separate from its members.
In law, the company is regarded as an artificial legal person, which deals in its own name. Thus, a
member of a company cannot be held liable for the acts of a company even if he holds the substantial
part of company's share capital.

EXAMPLE 2.1. One Mr. Salomon was a shoe manufacturer and his business was in very sound
condition. He formed a company named 'Salomon & Co. Ltd.' This company was formed by him for the
purpose of taking over and carrying on his earlier business. The members of this new company were
Salomon himself, his wife, four sons and a daughter. And the members of the Board of Directors were
Salomon and his two sons. Salomon's earlier business was transferred to this company for £40,000. In
payment of this consideration, Salomon took 20,000 shares of £ 1 each, and debentures worth £ 10,000.
These debentures imply that the company owed £ 10,000 to Salomon, and for the repayment of this, a
charge was created in his favour on the assets of the company. One share was given to each remaining
member of Salomon's family. Owing to trade depression, the company went into liquidation within a
year, and it was wound up. On winding up, the assets of the company were £6,000, and the liabilities
amounted to £ 17,000 (out of which £10,000 were due to Salomon as secured creditor as he was having
charge over the assets of the company, and
£7,000 were due to other unsecured creditors). After paying the amount of Salomon as secured creditor,
nothing was left for unsecured creditors.
The unsecured creditors contended that the company never had separate existence. It was, in fact,
Salomon under another name, as such he could not owe money to himself. And thus, they should be
paid first their £ 7,000. But their contention was rejected by the House of Lords, and it was held that
'Salomon & Co. Ltd.', was a real company fulfilling all the requirements of the legislature, and it had a
separate legal entity independent from its members. Therefore, Salomon was entitled to be paid his
dues first as a secured creditor. [Salomon v. Salomon & Co. Ltd. (1897) AC 22]

In the above case, the following observations of the House of Lords are worth "When the memorandum is
duly signed and registered though there be only seven shares taken, the subscribers are a body corporate
forthwith of exercising all the functions of an incorporated company. It is difficult to understand how a
body corporate thus created by statute can lose its individuality by issuing the bulk of its capital to one
person. The company is at law a different person altogether from the subscribers of the memorandum, and
though it may be that after incorporation the business is precisely the same as before, the same persons are
managers, and the same hands receive the profits the company is not in law their agent noting:

See also Vijaya Commercial Credit Ltd. v. Sixth Income Tax Officer, (1988) 63 Comp. Cas. 581
(Kerala); Adding Machines India (P) Ltd. v. The State, (1988) 63 Comp. Cas. 588 (Calcutta).

or trustee..... There is nothing in the Act requiring that the subscribers to the memorandum should be
independent or unconnected, or that they or any of them should take a substantial interest in the
undertaking, or that they should have a mind or will of their own, or that there should be anything like a
balance of power in the constitution of company".

Thus, a company formed and registered under the Companies Act has a separate legal existence entirely
different and independent from its members. The principle of Salomon's cases (as discussed above) is
also applicable in India. As a matter of fact, this principle was recognised in India even earlier to
Salomon's case.

20
EXAMPLE 2.2. Certain persons formed a company and transferred their real tea estate to this
company. At the time of registration of this transfer, they claimed exemption and ad valorem (according
to value) stamp duty on the ground that they themselves were the shareholders in the company, and the
transfer of tea estate to the company was not a transfer of property in the real sense. It was merely a
transfer of their own property to themselves under another name. But the court rejected their contention
and held that the company was a separate person independent from the shareholders. The transfer of the
tea estate by the shareholders was, therefore, a transfer of property as if the shareholders had been
totally different persons.

EXAMPLE 2.3. A was employed as a peon in a company. A's wages were unpaid, and he filed a suit
against the secretary and managing director of the company for the recovery of his wages. But the
company itself was not sued. It was held that the suit for the recovery of wages due from a company
can be filed against the company only, and not against the members of directors of the company.

In connection with the separate legal entity of the company, the following observations Justice Kania³
are worthnoting:

Under the law, an incorporated company is a distinct entity, and although all the shares may be
practically controlled by one person, in law a company is a distinct entity and it is not permissible or
relevant to enquire whether the directors belonged to the same family or whether it is, as compendiously
described, a one-man company.

2. It has a perpetual succession: The term 'perpetual succession' may be defined as the continuous
existence. A company has a perpetual succession i.e., company never dies. The membership of a
company may change from time to time, but it does not affect the company's continuity. In other
words, the members may come and go, but the company can go on for ever. This, however, does not
mean that a company can never come to an end. As a company is created by the process of law, it can
also be brought to an end by the process of law. Thus, a company comes an end when it is wound up
according to the provisions of the Companies Act. It may, however, be noted that till a company is
wound up according to law, it continues to exist. Thus the death, insanity or insolvency of the members
does not affect the corporate existence of the company in any way. Moreover, the admission of
members also does not affect entity of new members. The company remains the same entity inspite of
the total change in membership.

EXAMPLE 2.4. A, B and C were the only members of a private limited company named Good Luck
Co. Pvt. Ltd. They held all the shares of the company. After some time, A died in an accident. In this
case, the company does not come to an end due to A's death. It continues to exist.

If A, B and C transfer all their shares to X, Y and Z, the new members, the original company will not
come to an end. It will remain in existence with the changed members.

It is to be kept in mind that a company does not come to an end, even if all its members die. On the death
of a member, his legal representatives (i.e., legal heirs) become entitled to the shares by way of
transmission. After the transmission of shares, to the legal representatives, they may get the shares
registered in their favour and become the members of the company. As per Section 12 of the new
Companies Act, 20134, every holder of securities (ie., shares or debentures) of a company may at any
time, nominate any person in whom his shares or debentures shall vest in the event of his death. Such
nominee may get the shares or debentures registered in his name and become the member or debenture
holder. The 'transmission of shares' and 'nomination of shares will be discussed in Chapter 7 in Art. 7.34,
and Art. 7.35.

EXAMPLE 2.5. A and his son B were the only members of a private limited company. While going on a
business trip, both of them died in an air crash. In this case, the company does not come to an end. It
continues to exist, as the company has a perpetual succession (i.e., continuous existence). Here, the legal
representatives of the deceased members shall become entitled to their shares by way of transmission of
21
 shares.

3. It has a separate property: We know that company is a legal person in the eyes of law. It can,
therefore, hold the property in its own name. All the property in the name of the company is its separate
property which is controlled, managed and disposed of by the company in its own name. Thus, the
company is the owner of its assets and capital. The members cannot claim to be the owner of the
company's property. It is to be noted that a member does not have even an insurable interest in the
property of the company i.e., he cannot insure company's property in his own name for his own benefit.

EXAMPLE 2.6. A was the shareholder of a timber company. He held all the shares except one. He
was also a substantial creditor of the company. A insured company's timber against fire, and took the
insurance policy in his own name. The timber was destroyed in fire, and A claimed the compensation
from the insurance company. It was held that the insurance company was not liable to A as he was
neither the owner of the property (timber) nor had any insurable interest in it.

Thus, the property of the company is not the property of the shareholders. It is the property of the
company. Although, company's capital and assets are contributed by its shareholders, they are not the
private and joint owners of its property. In Bacha F. Guzdar v. C.I.T. Bombay, AIR 1955 SC 74, the
Supreme Court has also emphasised this aspect in the following words:

"The company is the real person in which all its property is vested, and by which it is controlled,
managed and disposed of"

4. It has capacity to sue and being sued: We know that a company is a legal person and has
independent existence. Being a legal person, the company can file suits against others in its own
name. Similarly, the suits against the company can also be filed in company's name.

EXAMPLE 2.7. A, a company, was carrying on a cycle manufacturing business. It purchased certain
cycle parts from B, another company, and paid the price of the same. But B supplied the cycle parts of
substandard quality. In this case, A may file a suit against B for the recovery of the damages.

If, in the above example, B supplies the cycle parts of standard i.e., contracts quality but A fails to pay
the price, then B can file a suit against A for the recovery of the price of the cycle parts. Note: A
criminal complaint can be filed by the company in its own name but it must be represented by a natural
person. A complaint which is not represented by a natural person is liable to be dismissed in the same
way in which an individual complaint is liable to be dismissed in the absence of complainant.

5. It has a common seal: We know that a company is a legal person, but it is not, physically, in
existence. Thus, it cannot sign its name. It has a common seal which is used as a substitute for its
signature. The common seal is the official signature of a company. As a matter of fact, every company
must have a common seal with its name engraved on the same. The company being not physically in
existence, it acts through natural persons, who are the directors of the company.

Note: It is important to note that the requirement of having a 'common seal' by the company has been
made optional by the Companies (Amendment) Act, 2015. This Amendment Act has amended Section 9
of the Companies Act, 2015, and in view of the amended section, it is not obligatory for a company to
have a common seal.

6. Its members have limited liability: As a matter of fact, it is the principal advantage of carrying the
business under limited companies. A company may be limited by shares or by guarantee. In a company
limited by shares, the liability of a member is limited to the extent of nominal value of the shares held by
him. If the shares are partly paid, the liability of a member is limited to the extent of unpaid value of
shares held by him. And if the shares are fully paid, the liability of the member is nil.

EXAMPLE 2.8. A was a member of a company limited by shares, and held 100 shares of the face
22
value of 10 each. 8 on each share had already been paid by him. In this case, A's liability is limited to
the extent of 200 (the amount which is unpaid on the shares). In any circumstances, he cannot be asked
to contribute more than 200. This liability can be enforced during the existence of the company or
during the winding up of the company.

In a company limited by guarantee, the liability of a member is limited to such amount as the member
may undertake to contribute to the assets of the company in the event of the company being wound up. If
a company limited by guarantee has no share capital, the liability of the members arises only when the
company goes into liquidation i.e., when it is wound up.

EXAMPLE 2.9. A was a member of a company limited by guarantee. He guaranteed that in the event
of winding up of the company he would contribute 1,000 to the assets of the company. In this case, A's
liability is limited to the extent of 1,000 and no more. And this liability will arise only when the
company goes into liquidation.

Note: The companies limited by shares, and guarantee will be discussed in detail in Art. 2.13.

7. Its shares are freely transferable: The capital of a company is divided into parts, and each part is
called the share. The shares of a company are freely transferable and can be purchased and sold in share
market. This characteristic of a company is recognised by "Section 44 of the new Companies Act, 2013
which reads as under:

"The shares or debentures or other interest of any member in a company shall be movable property,
transferable in the manner provided by the articles of the company".

Thus, the shares of the company are transferable like a movable property. Every member is free to sell
his shares in the open market, and to get back his investment without having to withdraw the money
from the company. This provides liquidity to the investor (member) and stability to the company
because the company is in no way affected as the investments remain with the company.

EXAMPLE 2.10. A holds 100 fully paid shares of 20 each in a public limited company. He is in
immediate need of money. In this case, A may transfer (i.e., sell) his shares to another person say B,
and get the amount. On a valid transfer, B will become the shareholder of the company. In this transfer
of shares, the company is not affected as the amount is not withdrawn from the company.

It may, however, be noted that restrictions on transferability of shares are imposed in case of a private
limited company. In case of a private limited company, the shares can be transferred only according to
the conditions laid down in the Articles of Association of the company.

All the above discussed characteristics clearly explain the legal meaning of the term company

8. It has several other advantages: Apart from the above advantages available to a company, it
enjoys several other advantages also, such as
(a) a company has an autonomy and independence to form its own policies and implement them in
accordance with the provisions contained in its memorandum, articles of association and the
Companies Act. (b) a company attracts professional management, and thus helps in promotion of
professional management and efficiency (c) a company has the privilege of collecting interest free
money from the public, for its business, by making a public issue or through private placement of
shares and other securities (d) the restrictions, with certain exception, on the purchase of its own shares
by the company, provide permanence of capital collected and stability to the company and protection to
some extent to the creditors of the company.

Note: Section 68 of the new Companies Act, 2013 allows a company to buy- back its own shares. As
per this section, by following the prescribed procedure, company may purchase its own shares out of
(a) its free reserves, or (b) the securities premium account, (c) the proceeds of any shares or other

23
specified securities. This point will be discussed in detail in Chapter 8 on Share Capital. New Section
68 corresponds to Section 77-A of the Companies Act, 1956.

2.4. DISADVANTAGES OF INCORPORATION

We have discussed in the last article, the chief advantages (characteristics) of the company form of
organisations. However, there are also certain disadvantages of incorporation (i.e.. formation) of a
company, which may be summed up as under:

1. Company's formation requires many formalities and is expensive: The formation of a company
requires a number of formalities to be complied with, and is also an expensive affair. At the time of
registration, various documents such as memorandum and articles of association, along with certain
other documents, are to be filed with the Registrar of Companies for registration. This involves various
expenses such as, on drafting and printing of documents, stamp duty etc. After the incorporation also, the
management and administration of the company has to be carried on strictly in accordance with the
provisions of the Companies Act, as well as rules and regulations made thereunder, e.g., general meeting
must be held in time, many returns, such as annual return, must be filed with the Registrar in time, the
accounts must be prepared and audited according to rules and presented to the shareholders in general
meeting, copies of the accounts must be filed with the Registrar, registration of certain documents, and
resolutions etc. The non-compliance of various provisions attracts penalty also.

2. Company is not a citizen, and cannot have the benefit of fundamental rights: We know that a
company is a legal person and has the rights and obligations like a natural person. However, a company
is not a citizen either under the Constitution of India or the Citizenship Act. Thus, a company cannot
have the fundamental rights, which have been expressly given to the citizen only under the Constitution
of India. The Supreme Court has also emphasised that only the natural persons can be recognised as
citizens. Moreover, the right of citizenship can be conferred on the natural persons alone. Even if all the
members of a company are the citizens of India, the company does not become a citizen of India. The
company, being an independent and different identity from its members, has nothing to do with the
status of its members.

EXAMPLE 2.11. A and B, both Indian citizens, formed a company and got it registered in England as
per the law of that country. They also had their branch office in India. In this case, though both the
members are Indian citizens, the company cannot be treated as the citizen of India. In this example, the
company is a foreign company, as it has been incorporated outside India.

Although a company is not a citizen, but it is admittedly a person in the eyes of law. It can, therefore,
claim the protection of all such fundamental rights, which have been guaranteed to all persons whether or
not they are the citizens, e.g., right to equality guaranteed by Art. 14 of the Constitution of India. It may,
however, be noted that though a company cannot seek the protection of fundamental rights, which have
been guaranteed to the citizens only. But a citizen shareholder may, on behalf of the company, challenge
a law if it violates his company's Fundamental Rights.

It may also be noted that the fundamental rights of a citizen are not lost, only by the fact, that he is a
shareholder of a company. In this regard, the following observations of the Supreme Court", made in
Bannett Coleman Co. v. Union of India, (1972) 2 SCC 788, are worthnoting:

"It is now clear that the fundamental rights of citizens are not lost when they associate to form a
company. When their fundamental rights are impaired by State action, their rights as shareholders are
protected. The reason is that the shareholder's rights are equally and necessarily affected if the rights of
the company are affected".

It is to be noted that although a company is not a citizen, yet it has a residence, domicile and nationality.

The company's domicile is the place of its registration i.e., incorporation, and its nationality is the
24
nationality of the country in which it has been incorporated, e.g., a company registered and
incorporated in Germany will be a German company, even if all its members are Indian citizens. It may
be noted that company's domicile and nationality remains the same throughout its existence.

3. Company's social responsibility is greater: We know that the companies have enormous powers
and enjoy various advantages. Moreover, they also have their own impact on the society. Due to these
reasons, the companies are called upon to show greater social responsibility in their working as
compared to other forms of business organisations. Owing to greater social responsibility, the
companies are subjected to greater control and regulation.

4. Company's members cannot have effective control: The membership of companies is generally
large and the members are scattered at distant places. Consequently, the members of a company cannot
have effective control over its working and day to day affairs. The company, being a separate legal
entity, its members are neither the owners nor the agents of the company. A member of a company
cannot act for and on behalf of the company. Thus, the members of a company do not have active and
intimate control over its working as is possible in case of other forms of business organisations such as
sole proprietor or partnership. For the same reasons, the members cannot get full information about the
day to day administration, company's activities and administration.

5. Company's tax burden is heavy: The structure of tax legislation is such that in certain
circumstances the tax burden on a company is more as compared to other forms of organisations, e.g., the
company has to pay income tax on the whole of its income at a flat rate, whereas others are taxed on a
slab system. Also a company is liable to pay tax without any minimum taxable limit as is prescribed in
the case of registered firms.

Though the tax burden on a company is heavy in certain circumstances, but it should not be regarded as
an absolute disadvantage. Depending upon the size and category of the company, the tax rules are also
favourable to companies in certain cases. Thus, keeping in view the facts and circumstances of each
case, the tax rules may be regarded as disadvantages or advantages.

6. Company's separate entity can be ignored under the doctrine of 'lifting of corporate veil': We
know that the chief advantage of a company is its separate legal entity, and various other advantages,
which are available to a company are linked with this chief advantage. However, the separate legal
entity of the company can be ignored in certain circumstances. In such a case, some of company's
advantages disappear. The circumstances in which the separate entity is ignored is known doctrine of
lifting or piercing of corporate veil. This doctrine will be discussed in detail in the next article.

7. Company's winding up procedure is expensive and time-consuming: The company can be

wound up (i.e., put to an end) only by following the procedure prescribed in the Companies Act. This
procedure, being very elaborate and detailed, is expensive and time consuming. Thus, if any contingency
arises for putting an end to the company, it cannot be easily done as in case of other forms of business
organisations.

2.5. LIFTING OF CORPORATE VEIL

The term 'lifting of corporate veil' means ignoring the separate legal entity of the company, and looking
into the realities. It is an important doctrine in the company law according to which in certain
circumstances, the separate legal entity of the company is not taken into account. The company and its
members are treated as one person.

We know that the chief characteristic of a company is that it is a separate legal entity independent and
different from its members. And due to this characteristic, many other advantages are enjoyed by the
company. The fact is not denied that, by fiction of law, a company is a separate legal entity,
independent and different from its members. But in reality, it is an association of persons, who are in
fact the beneficial owners of all the corporate property (i.e., company's property). As a matter of fact,
25
the business of a company is carried on by some human beings who are the ultimate beneficiaries of
corporate advantages. Due to separate legal entity of the company, these real beneficiaries behind the
company are disregarded once they have formed a company and given to their association the status of
a legal entity.

Ordinarily, the separate legal entity of the company is to be respected. As a matter of fact, the whole law
of corporation is based on this principle of corporate personality (i.e., separate legal entity) of a
company. However, the statutory privilege of separate personality of the company must be used for
legitimate business purposes only. Sometimes, it becomes necessary to find out the real persons who
control the company e.g., in cases when this corporate personality (legal entity) of the company is
misused for fraudulent or improper conduct or for doing things against public policy. In such cases, the
courts ignore the separate entity. In other words, the corporate veil of the company is probed into and
lifted up. This, however, is the discretionary power of the court, and will depend upon the underlying
social, economic and moral factors as they operate in and through the company. When the corporate
personality of a company is used as a shield to cover its wrong doings, such as for evasion of tax, the
courts may lift the corporate veil.

[BSN (UK) Ltd. v. Janardan M. Rajan Pillai, (1996) 86 Comp. Cas. 371 (Bombay)] The cases in which
the corporate veil is lifted i.e., the separate legal entity of the company is ignored, may be discussed
under the two heads namely:

1. Judicial interpretations

2. Express statutory provisions

2.6. LIFTING OF CORPORATE VEIL UNDER JUDICIAL INTERPRETATIONS

Following are some of the judicially decided cases in which the corporate veil is lifted i.e.. the separate
legal entity of the company is ignored:

1. Determination of character of the company: Sometimes, it becomes necessary to determine

the character of a company e.g., to see whether it has assumed an enemy character. The doubts may
arise that the company is owned and controlled by the enemies of the country. In such cases, the court
may lift the corporate veil (i.e., ignore the separate entity of the company) and examine the character of
the persons who are in real control of the company affairs. As a matter of fact, the lifting of corporate
veil in such cases is necessary because trading with an enemy is against the public policy.

EXAMPLE 2.12. A company was incorporated in England for the purpose of selling tyres
manufactured in Germany by a German company. The bulk of the shares in English company were
held by the German company. And the remaining shares (except one) were held by the Germans
residing in Germany. Moreover, all the directors of the English company were also Germans residing in
Germany. Thus, in fact, the real control of the English company was in German hands. During the First
World War, the English company brought legal action to recover the trade debts. The question arose
whether the English company had become an enemy company and, therefore, should not be allowed to
proceed with the action. It was held that the company had assumed an enemy character, and was
debarred from maintaining the action i.e.. it was not allowed to proceed with the action.

In the above case, the following observations of the House of Lords are worthnoting: "Company is not
a natural person with mind or conscience. It can be neither loyal nor disloyal. It can be neither friend nor
enemy.
But it may assume an enemy character when persons in de facto control of its affairs, are residents in
any enemy country, or wherever resident, are acting under the control of enemies".

2. Protection of revenue: Sometimes, the lifting of corporate veil is necessary for the benefit of
revenue, e.g., where the separate entity of the company (i.e., corporate entity) is used for evasion of tax.

26
In such cases, the court may lift the corporate veil (i.e., ignore the separate entity of the company), and
the income of the company and its members may be taxed as that of one person.

EXAMPLE 2.13. A, an assessee, was a wealthy man receiving huge dividends and interest incomes. He
formed four companies and transferred his investments (from which he was receiving dividends and
interest income) to these companies. Thereafter, the income received from A's investments was credited
to the accounts of the companies, but the companies handed back the same to A as a pretended loan. In
this way, A divided his income into four parts, and reduced his tax liability. It was held that the
companies were formed by A purely and simply as a means of avoiding his tax liability, and the
companies were nothing more than the assessee himself. In this case, the companies were created as
legal entities simply, for the purpose of receiving dividends and interests from A's investments, and then
handing over the same to him
(A) as pretended loan.

It may, however, be noted that the members themselves are not allowed to claim that they should be
regarded as economically identical with the company, particularly when this is not in the interest of
justice.

EXAMPLE 2.14. A was a shareholder of tea company. Under the Income Tax Act then in force, the
income of a tea company was exempted from tax upto 60% as agricultural income, and 40% was taxed
as income from manufacture and sale of tea. A received certain amount as dividend in respect of the
shares held by him in the company. He claimed that this dividend income should be regarded as
agricultural income up to 60% and should be exempted from tax. It was held that although the income
in the hands of the company was partly agricultural, but the same when received by the shareholders
could not be regarded as agricultural income.

3. Protection of company's own justified interest: Sometimes, a company, itself, wants that its
separate entity should be ignored and treated alike with the members. In such cases, the court may lift
the corporate veil i.e., ignore the separate identity of the company if it is in company's own interest.
Thus, the corporate veil may be lifted for company's own benefit if the court thinks it to be justified.
The Honourable Supreme Court of India has taken this view in a case, which is illustrated below:

EXAMPLE 2.15. A firm of transporters was a tenant in the premises belonging to A, the landlord. After
some time, certain differences arose among the partners, and consequently the firm was split up into two
firms. Each firm agreed to operate in the area allocated to it, and a condition was attached that one firm
could not enter upon the area of the other. In the course of time, one of the firms floated a private limited
company. Both, the firm and the company had their offices in the same premises in which the original
firm was a tenant. The landlord of the premises filed an eviction petition (i.e., for vacation of the
premises) against the original firm on the ground that it had handed over (i.e., sublet or assigned) the
possession of the premises to a private limited company, which is a separate legal entity, without
obtaining his (landlord's) consent. And thus, there is violation of the provisions of the Rent Control Act.
The Supreme Court held that there was no sub-letting or assignment of the premises by the firm to the
company. The Supreme Court observed that the company, though a separate legal entity, was in fact a
creature of the partners of the firm and was the very image of the firm. The limited company and the
partnership firm were two only in name but one for practical purposes.There was substantial identity
between the limited company and the firm.

Thus, in this case, the court ignored the separate legal entity of the company. It, therefore, follows that
lifting of corporate veil is not always to the disadvantage of the company's promoters. In New Horizons
Ltd. v. Union of India, (1995) 1 SCC 478; (1997) 89 Comp. Cas. 849 (SC), the Supreme Court has again
upheld this view. In this case, the court lifted the veil and held that where the joint-venture sponsors of
the company were qualified for participating in a government tender, their company should also be
treated as a qualified tenderer.

27
4. Avoidance of legal obligations imposed by welfare legislation: Sometimes, it appears to the court
that the company is formed just to avoid the legal obligations imposed by a welfare legislation. In such
cases, the court may lift the corporate veil i.e., ignore the separate entity of the company, e.g., where in
order to reduce the liability to pay bonus to its workers, the company splits up its profits by creating
another company, the court may refuse to recognise the new company. In fact, the legislation requiring
the payment of bonus to workers is for the welfare of the workers, and the company should not be
allowed to escape liability imposed by such legislation. The avoidance of welfare legislation is as
common as avoidance of taxation, and the approach of the court in considering problems arising out of
such avoidance has necessarily to be the same as avoidance of taxation. This has been recognised by the
Supreme Court as is evident from the following example.

EXAMPLE 2.16. A company was earning handsome profits, and therefore its liability to pay bonus
was also high. In order to split up the profits into two hands and thereby to reduce its liability to pay
bonus to the workers, the company created another company as its subsidiary, and transferred some of
its investments and securities to the new company. The Supreme Court held that for the purpose of
working out the amount of bonus payable by the former company to its workers, the separate existence
of the new company would be disregarded.

5. Avoidance of contractual obligation: Sometimes, a company is formed simply to avoid the

obligations arising out of contracts. In such cases, the court may lift the corporate veil i.e., ignore the
separate entity and decide the case assuming that no company is in existence.

EXAMPLE 2.17. A and B were carrying on an auto parts business in partnership. They sold their
business to C and agreed not to start a competitive business for two years. Immediately thereafter, they
(i.e., A& B) wanted to start the similar business. In order to avoid the contractual obligation of not to start
a similar business for two years, they formed a private limited company, became the major shareholders
and directors, and started the similar business. In this case, the court may ignore the separate entity of
the company and restrain it from starting the similar business. Here, it is clear that the company has been
formed by A and B simply to avoid their contractual obligation with C.

6. Prevention of fraud or improper conduct: Sometimes, it appears to the court that the company
is formed for some fraudulent or improper purpose e.g., to defraud creditors, to avoid legal obligations,
or to defeat the provisions of law. In such cases, the court may lift the corporate veil i.e., ignore the
separate entity of the company. Thus, where the company is a mere sham i.e.. formed to deceive or
defraud, the court will lift the corporate veil and look into the ownership of the company.

A EXAMPLE 2.18. A borrowed a huge amount of money in his own name from B & Co., a finance
company. He formed three different companies, and invested the entire money borrowed from B & Co.
in these companies. The members of these companies were A and his son only. When the loan was not
repaid, & Co. filed a suit for the recovery of the loan amount, and also sought it to be recovered out of
the assets of the companies. It was held that the amount can be recovered out of the assets of the
companies as these were created only to deceive the creditor i.e., lending company.

EXAMPLE 2.19. A was appointed as a managing director of B & Co. A's appointment was on the
condition that "he shall not at any time while he shall hold the office of a managing director or
afterwards, solicit or entice away the customers of the company". His employment was terminated under
an agreement. After some time, he formed a company to carry on his own business. The company formed
by A started soliciting and enticing away the customers of B & Co. The company was formed by A
merely to avoid the breach of agreement with B & Co. under which he agreed not to entice away the
customers of B & Co., as he himself was not allowed to solicit the customers. It was held that the
company formed by A was a mere sham (or cloak) formed for the purpose of enabling him to solicit the
customers of B & Co. In fact, A's company was a mere channel used by him for the purpose of enabling,
for his own benefit, to obtain the advantages of customers of B & Co. In this case, A and his company
was restrained from carrying on the business.

28
EXAMPLE 2.20. A agreed to sell his certain land to B. But subsequently he changed his mind. In order
to avoid the specific performance of the agreement to sell land to B, A formed a company, and sold his
land to this company. B filed a suit against the company formed by A and also against A for the
specific performance of the agreement under which A had agreed to sell the land to B. The court looked
into the reality of the situation, and treated the company as a mere sham. The transfer (i.e., sale) of land
to the company was ignored and the land was ordered to be sold to B as already agreed between A and
B.

In a case before the Supreme Court, a company created a subsidiary company and transferred its
investment holdings to the subsidiary with a view to reduce its liability to pay bonus to its workers. In
this case, the Supreme Court ignored the separate existence of the subsidiary company.

7. Company acting as an agent of its members or of another company: Sometimes, a company acts
as an agent or trustee of its members or of another company. In such cases, the court may lift the
corporate veil (i.e., ignore the separate entity of the company), and the principal (i.e., for whom the
company acts) may be held liable for the acts of the company. Whether the company is acting as agent
or not is a question of fact, and generally the courts insist upon very strong evidence to prove this fact.
Thus, the relationship of agency should be substantively established to enable the court to lift the
corporate veil.

EXAMPLE 2.21. A, an American company, produced a film in the name of B, a British company, in
order to avoid certain technical difficulties. The British company (B) had a total capital of 100 shares
out of which 90 were held by an American director of the company. All the funds of the British
company for production of the film were provided by the American company. The film produced in the
name of British company was sought to be registered as an English Film. The Board of Trade of Films
refused to register the film as an English film. The court upheld the decision of the Board of Trade of
Films. In this case, the separate entity of the British company was ignored, and the court observed that
it acted merely as an agent and nominee of the American company for producing the film.

8.Holding and subsidiary company relationship: A holding company is one, which has control over
another company. And the company, over which the control is exercised, is called a subsidiary company.
Sometimes, the holding company completely controls and dominates the activities of its subsidiary
company in such a way that the latter becomes purely an agent of the holding company. In such cases, the
court may lift the corporate veil and consider the subsidiary company a part and parcel of the holding
company. Thus, where the facts and circumstances show that the holding as well as its subsidiary
company are in reality parts of one concern, the separate legal entity of the subsidiary company may be
ignored by the courts. In the following circumstance, the corporate veil may be lifted, and the holding
company and its subsidiary as a whole may be held liable for the debts and other liabilities of either or
both of such companies:

(a) Where business transactions, property, bank and other accounts, employees, management
etc., of both the holding company and its subsidiary are intermingled.

(b) Where the subsidiary is inadequately financed, as a separate business, so as to meet its
normal obligations.

(c) Where the businesses of both the companies are not held out to the public as separate.

(d) Where the holding company and the subsidiary company are operating portions (i.e., parts) of a
single business, and the financial and managerial control is entirely in the hands of holding company.

(e) Where the subsidiary is formed for some improper use or unfair advantages e.g., for dividing
profits, so as to reduce the tax or other liability of the holding company, to defraud creditors, to evade
the law or any other obligation.

29
Thus, in case of holding and subsidiary company relationship, the courts may lift the corporate veil,
whenever it is necessary to achieve a just and equitable result. Sometimes, the corporate veil may be
lifted even at the instance of the holding company for the protection of its own interest.

EXAMPLE 2.22. A, a company, acquired one partnership concern, and got it registered as a company
and then continued to carry it on as a subsidiary company. The company A held all the shares (except
few) of its subsidiary company, and treated the profits of subsidiary company as its own. In fact, the
effective control of the subsidiary company was in the hands of the parent company (A). Subsequently,
the business of subsidiary company was acquired by B a corporation. A claimed compensation from the
corporation in respect of acquisition of its business. It was held that A was entitled to receive
compensation from the corporation. The court observed that there was no distinction between the two
companies as the subsidiary company was not operative of its own behalf, but on behalf of the parent
company (A).

The lifting of corporate veil in cases of holding and subsidiary company relationship has also been
approved by the Supreme Court in a recently decided case of State of U.P. & Others v. Renusagar Power
Co. & Others, AIR 1988 SC 1737; (1991) 70 Comp. Cas. 127 (SC). The following example is based
upon the facts of this case.

EXAMPLE 2.23. A & Co. Ltd. was formed for the manufacture of aluminium. Another company, B &
Co. Ltd. was formed for generating electricity which was to be wholly supplied to A & Co. Ltd. to be
used in the manufacture of aluminium. B & Co. Ltd. was wholly owned subsidiary of A & Co. Ltd., and
was completely controlled by it (A & Co. Ltd.). Under the local laws of the State, the 'electricity duty'
was imposed on the electricity consumed by consumers. However, in case of electricity consumed from
one's own source the rate of electricity duty was less as compared to other cases. The Supreme Court
held that the corporate veil should be lifted and A & Co. Ltd. and B & Co. Ltd. should be treated as one
concern. And B & Co. Ltd's power plant must be treated as the 'own source of generation' of A & Co.
Ltd., and should be liable to electricity duty on that basis. The court also observed that the persons
generating and consuming the energy were the same, and thus the consumption of energy by A & Co.
Ltd. was clearly the consumption by it from its own source of generation'.

In Mehra (UK) v. Union of India, 1997 (88) Comp. Cas. 213 Delhi, the High Court has also held that a
parent company and its subsidiary are usually treated as one economic entity.

9. Dummy companies: Sometimes, a company formed by certain persons is not intended to be a

corporate body i.e., a separate legal entity. It is formed simply to carry on their own personal business. In
such cases, the court may lift the corporate veil, if it appears that the separate entity of the company is
being misused.

EXAMPLE 2.24. A was carrying on a jewellery business. He formed a company with himself and his
wife as the only members. No business was taken over by the company. Only a banking account was
opened in the name of the company in which A deposited a small amount. A was carrying on his
business exactly in the same manner in which he was doing prior to the formation of the company. The
company had practically no assets. B, a customer, entrusted some jewellery with A for ornamentation,
which was stolen from his custody. B filed a suit against A for the recovery of the value of the jewellery.
A contended that the jewellery was delivered to him in his capacity as a managing director of the
company, and thus he could not be held personally liable. The court ignored the separate entity of the
company formed by A, and he was held personally liable for the value of the jewellary entrusted to him.

10. Prevention of fraud upon public: Sometimes, a company commits a fraud upon the public and
the people suffer financial loss due to company's such fraudulent act. In such cases, the court can lift the
corporate veil so as to expose any person to liability who have committed a fraud upon the public from
their sheltered position.

30
EXAMPLE 2.25. A construction company advertised a scheme for booking of flats. Many people
deposited their hard earned money with the company under the scheme. The scheme was operated with
utter dishonesty and fraud, and no flat was given under the scheme. In this way, a large number of
persons were deceived by the company. Here, the persons playing such fraud, though in the name of a
company, can be held personally liable to the public.

In Ali Javed Ameerhasan Rizvi v. Indo French Biotech Enterprises Ltd., (1999) 95 Comp. Cas. 373
(Bombay), the Bombay High Court has also held that the corporate veil can be lifted where large
number of investors were being defrauded by persons in charge of the companies by employing the
corporate veil. In this case the promoters promised unattainable high return to the tune of 10.25% on
investments, and diverted the so collected funds to the firms of directors or their relatives. In this way
the promoters defrauded innocent investors by employing the corporate veil. The High Court lifted the
corporate veil to do justice to the investors.

11. Misuse of exemptions given by the government: Sometimes, certain exemptions are given by the
government to a particular sector such as to small scale industries, which are misused by forming a
company to carry on small scale industry. In such cases, the court may lift the corporate veil to know
whether or not such company is entitled to exemptions. Thus, where small scale industries were given
certain exemptions, and a company was owning a small scale industry, the court held that it was
permissible to lift the corporate veil in order to know whether or not such company was the subsidiary of
another company. Such a company would not be entitled to the proposed exemptions if it was shown that
it was a subsidiary of another company.

Thus, in appropriated cases, the courts may disregard the separate entity of the company and lift the
corporate veil i.e., look behind the legal person to know the actual position.

So far we have discussed some of the circumstances under which the corporate veil may be lifted i.e., the
separate legal entity of the company may be ignored. It may be noted that though the separate entity of
the company is ignored, but it does not mean that the company ceases to be an independent legal entity.
As a matter of fact, legal status of the company is not denied, it is only ignored where the company
attempts to misuse the same. As regards the true legal position of a company and the circumstances in
which its separate legal entity will be ignored, the following observations of the Supreme Court are
worthnoting:

1. "The true legal position in regard to the character of a corporation or a company, which ows its
incorporation to a statutory authority, is not in doubt or dispute. The corporation in law is equal to a
natural person and has a legal entity of its own. The entity of the corporation is entirely separate from
that of its shareholders; it bears its own name and has a seal of its own; its assets are separate and
distinct from those of its members; it can sue and be sued exclusively for its own purpose; its creditor
cannot obtain satisfaction from the assets of its members; the liability of the members or the
shareholders is limited to the capital invested by them; similarly the creditors or the members have no
right to the assets of the corporation. This position is well established ever since the decision in case of
Salomon v. Salomon & Co., 1897 AC 22 was pronounced in 1897 and indeed, it has always been the
well recognised principle of common law.
However, in course of time, the doctrine, that a corporation or company has legal and separate entity of
its own has been subjected to certain exceptions by the application of the fiction that the veil of the
corporation can be lifted and its face examined in substance. The doctrine of the lifting of the veil thus
marks a change in the attitude that law had orig nally adopted towards the concept of separate entity or
personality of the corporation. As a result of the impact of complexity of the economic factors, judicial
decisions have some time recognised, exceptions to the rule about juristic personality of the corporation".

2. "It is true that from the juristic point of view, the company is a
legal personality entirely distinct from its members, and the company is
capable of enjoying rights and being subjected to duties which are not the same as those enjoyed or
borne by its members. But in certain exceptional cases, the court is entitled to lift the veil of corporate
entity and to pay regard to the economic realities behind the legal facade
31
 2.7. LIFTING OF CORPORATE VEIL UNDER EXPRESS STATUTORY
PROVISIONS (LIABILITY OF DIRECTORS AND MEMBERS)

We have discussed, in the last article, that in certain cases the court may lift the corporate veil (i.e.,
ignore the separate entity of the company), and deal directly with the persons (members) behind it. The
Companies Act, itself, also provides certain cases in which the directors or members of the company are
held personally liable i.e., apart from the liability of the company, the persons behind it are also held
liable. It may, however, be noted that in these cases the separate entity of the company is not ignored
i.e., independent existence of the company is maintained. The only point is that the directors or members
are also held personally liable along with the company. Thus, the distinction between the lifting of
corporate veil under 'a judicial interpretation' and under 'express statutory provisions' is that, in the
former the separate entity of the company is ignored. But in the latter the separate entity of the company
is maintained with the exception that the persons behind it are also held personally liable. Following are
the main provisions, where the members are personally liable:

1. Fraudulent conduct of business: The members of the company are also personally liable for
fraudulent conduct of company's business [Section 339, Companies Act, 2013]. Sometimes, in the course
of winding up, it may appear that the business of the company has been carried on with the intention to
defraud creditors of the company or any other person, or for any fraudulent purpose. In such cases, the
Tribunal* may declare that the persons who were knowingly parties to such business shall be personally
responsible for such debts of the company as the Tribunal may direct. The Tribunal* may declare such
personal liability on the application made by the liquidator, or any creditor or contributory of the
company.

EXAMPLE 2.26. A was a furniture manufacturer and his business was in sound condition. He formed a
company and transferred his business to the company formed by him. The members of the newly formed
company were 4 and his other family members. A himself became the managing director of the
company. A's earlier business was transferred to this company for 1,00,000. In payment of this
consideration 4 took 4000 shares of 10 each, and debentures worth 30,000. These debentures imply that
the company owed 30,000 and for the repayment of this, a charge was created in A's favour on the
assets of the company. Due to trade depressions, the company was involved in financial difficulties, and
it was heavily indebted and was unable to pay its debts. Knowing this position of the company A
purchased, on credit, raw material (timber) worth 50,000 for the company. Soon thereafter, the company
went into liquidation. After paying the debts of A as secured creditor, nothing was left for the other
unsecured creditors. In this case, the separate legal entity of the company may be disregarded, and A
may be held liable for the debt of 50,000 which was incurred by him knowing the fact that the company
was already heavily indebted. The following judicial observations are worthnoting in this regard:

"If a company continues to carry on business and to incur debt at a time when there is to the knowledge
of its directors, no reasonable prospect of the creditors ever receiving payment of those debts, it is, in
general, a proper inference that the company is carrying on business with intent to defraud creditors".

Note: Earlier the corresponding provision was made in Section 542 of the Companies Act, 1956, which
stands repealed.

2. Mis-statement in the prospectus: A 'prospectus', is a document issued by the company inviting

offers from the public for the purchase of its shares or debentures, or to invest money with the company.
The prospectus must, therefore, represent to the public the true facts relating to the affairs of the
company. If the prospectus contains any mis-statement (i.e., untrue statement), then every director,
promoter of the company, and every person who authorised the issue of prospectus, shall be liable to pay
compensation to every person who has sustained any loss or damage by reason of any untrue statement
contained in the prospectus [Section 35, Companies Act, 2013]. Thus, the directors, promoters etc., incur
personal liability for the issue of false prospectus. Moreover, they are also liable for damages for deceit
under the law of torts (i.e., for civil wrong).
32
 EXAMPLE 2.27. The directors of a company issued a prospectus inviting subscriptions for debentures.
The prospectus stated that the objects of loan (i.e., issue of debentures) were to complete alterations in
the building of the company, to purchase horses and vans, and to develop the trade of the company. But
in fact, the real object of the loan was to enable the directors to pay off the old liabilities. Relying upon
the statement contained in the prospectus, A advanced some money to the company. Soon thereafter,
the company went into liquidation and A filed a suit against the directors for damages for fraud. It was
held that the directors were liable to pay damages. The court observed that "a man who lends money
reasonably wishes to know for what purpose it is borrowed, and he is more willing to advance if he
knows that it is not wanted to pay off the liabilities already taken". [Edgington v. Fitzmaurice, (1885)
29 Ch. D. 459]

Note: Earlier the corresponding provision was made in section 62 of the Companies Ac1956,

which stands repealed.

3. Failure to repay application money: The application money is that which is paid to the company
along with the application for the purchase of its shares. As a matter of fact, the persons desirous of
purchasing the shares of a company, submit their applications to the company along with the
application money.

The company can proceed to make allotment of shares, if the minimum amount stated in the prospects
has been paid and received by the company. If the amount of minimum subscription (not being less than
5% of the nominal value of shares) has not been subscribed and the sum payable on application is not
received within 30 days from the date of issue of prospectus, then the amount received as application
money shall be returned within such time and manner as may be prescribed [Section 39(3), Companies
Act, 2013].

If default is made in returning the amount as stated above, then the company and its officer in default shall
be liable to penalty upto 1000 for each day during which the default continues or one lakh, whichever is
less [Section 39(5)].

Note: Section 39 of the new Act of 2013 corresponds to Section 69 of the Companies Act, 1956.

4. Non-payment of income tax: Sometimes, a private company is wound up, and the income tax in
respect of its any income of any previous year is unpaid. In such cases, every person who was a director
of the company at any time during the relevant previous year, shall be personally liable for the payment
of the income tax. It may be noted that the unpaid tax may be assessed before the winding up, in the
course of winding up, or after the winding up of the company. The directors will remain liable for the
payment of the same in all such cases.

5. Liability for pre-incorporation contracts: A pre-incorporation contracts is one which is entered

into i.e., made, by the promoters before the formation of the company. Sometimes, after the formation of
the company, it does not adopt (accept) the pre-incorporation contracts. In such cases, the promoters are
personally liable for all such contracts which are not adopted by the after its formation. company

Note: Pre-incorporation contracts and promoters' liability for the same will be discussed in detail in
Chapter 3.

6. Ultra vires acts: The ultra vires acts are those which are not the authorised acts i.e., which are beyond
powers. The directors of a company are personally liable for all the ultra vires acts even if they are done on
behalf of the company. The ultra vires acts may be grouped into two categories, namely:

(a) Acts ultra vires the company.

33
(b) Acts ultra vires the directors.

The directors are also personally liable for the acts which are in the nature of tort (i.e., civil wrong).

Note: The ultra vires acts will be discussed in detail in Chapter 4 in Art. 4.17.

2.8. REFUSAL TO LIFT THE CORPORATE VEIL

We have already discussed, in Art. 2.5, the cases in which the corporate veil is lifted i.e., the separate
entity of the company is ignored by the courts. As a matter of fact, the purpose of lifting the veil, in those
cases, is to prevent the misuse of corporate entity by the companies. It is to be noted that the lifting of the
corporate veil may also be refused by the courts where the lifting of the veil itself is sought to be
misused. For example, where the lifting of veil would not be in the interest of Government revenue or
national interest etc. Thus, in these cases, the separate entity of the company is generally maintained by
the courts even if it is sought to be ignored. Following are the judicially recognised cases in which the
courts have refused to lift the corporate veil i.e.. the separate entity of the company maintained:

1. Protection of revenue: Sometimes, the separate entity is sought to be ignored for the purpose of
escaping i.e., avoiding the liability to pay the tax, such as property tax, income tax etc. In such cases, the
court may refuse to lift the corporate veil, and separate entity of the company may be maintained.

EXAMPLE 2.28. The entire capital of a company was held by the Government of India. Under the law
then in force, the buildings and lands owned by or vested in the Union of India were exempted from
property tax. On this ground, the company sought the exemption from the payment of property tax and
contended that the land and building of the company was the property of the Government as entire share
capital of the company was held by the Government of India. The court refused to accept the contention
of the company and held that the company was a separate legal entity and that the land and building
owned by the company were the property of the company itself and not of the Government of India.
Thus, the company was held hable to pay the property tax.

Thus, for the protection of revenue, the court may refuse to lift the corporate veil even if asked by the
company itself. The decision of Supreme Court in the case of Bacha F. Guzdar discussed in Example
2.14 is also relevant on the point.

2. National interest: Sometimes, the maintenance of separate legal entity of a company is necessary in
the interest of the nation. In such cases, the court may refuse to lift the corporate veil, and the separate
entity of the company may be maintained. Thus, where the lifting of the corporate veil will go against
some national policy, the courts will not do so.

EXAMPLE 2.29. A group of 13 companies, incorporated abroad, separately applied for permission
under the Foreign Exchange Regulation Act, 1973 (FERA) for purchase of the shares of an Indian
company. The FERA encouraged the flow of such investments from non-resident Indians and from the
companies belonging to them. However, the Act also imposed a ceiling on such investment so that this
privilege may not be used to destabilise the Indian companies. It was prayed before the Supreme Court
that all the 13 companies belonged to one family trust which was operated by a single person, and the
purchase of shares in the name of 13 persons was in fact by a single person, and, therefore, ceiling
imposed by FERA was violated. The Supreme Court did not accept this argument, and refused to lift the
corporate veil i.e., all the 13 companies were considered separate and independent for the purpose of
purchasing share of the Indian company. It was observed by the court that the policy and purpose of
FERA is to attract investment by nonresident Indians. The lifting of corporate veil would go against that
policy and the national interest because it would discourage the flow of investment by the non-resident
Indians.

3. Government companies: A government company is one in which majority of the shares are held by
the Central Government or the State Government or by both of them. In case of such companies where

34
almost all the shares are held by the Government, the courts generally refuse to lift the corporate veil
i.e., the company is treated as a separate legal entity and not the part of the Government itself.

EXAMPLE 2.30. A government company contended that it cannot be subjected to development tax, as
it is not a separate entity but a part of the Government itself. The court refused to lift the corporate veil
as requested by the company, and regarded the Government company to be a separate entity for the
purpose of enabling the Development Authority to impose a development tax on the company.

Similarly, where transport services were provided by a company all of whose shares were owned by the
Transport Commission, the court refused to lift the corporate veil and held that the transport services
were provided by the company itself and not by the Government (i.e., Transport Commission)¹2. Thus,
a Government company is not regarded as the Government itself or its agent. It can be regarded as an
agent of the Government only when it is performing in substance governmental or sovereign function,
and not merely commercial functions ¹³.

2.9. KINDS OF COMPANIES

Though there are many kinds of companies, yet the following are important from the subject point of
view:

1. Chartered companies. 2. Statutory companies. 3. Registered companies.

4. Private companies. 5. Public companies. 6. One person companies. 7. Holding and subsidiary
companies. 8. Government companies. 9. Foreign companies.

2.10. CHARTERED COMPANIES

A chartered company is one which is incorporated (formed) under a Special Charter granted by the King
or Queen of England in the exercise of prerogative powers e.g., East India Company, Bank of England,
Standard Chartered Bank. The chartered companies are governed by the provisions of the Special
Charter, under which they are formed. The charter defines the nature and power of such companies. It
may be noted that after independence, the chartered companies are rarely found in India.
Moreover, the Companies Act, 1956 does not apply to such companies.

2.11. STATUTORY COMPANIES OR CORPORATIONS

A statutory company is one which is incorporated by a Special Act of the Legislature (i.e., by the Act of
Parliament or State Legislature). It may be noted that an Act is specially passed to create a statutory
company e.g., the Life Insurance Corporation of India was created by the Life Insurance Corporation
Act, the Food Corporation of India was created by the Food Corporation of India Act. The statutory
companies are also known as 'corporations'. Such companies are, generally, created for the public utility
services, and their main object is not to earn profits, but to serve the general public. The nature and
powers of such companies are defined by the Special Act, under which they are created. However, the
provisions of the Companies Act are also applicable to them in so far as they are consistent with the
provisions of the Special Act.

A statutory company resembles with the company created under the Companies Act as it has a separate
legal entity, and the liability of its members it also limited. However, it may not be required to use the
word 'Limited' after its name. Moreover, it is also not required to have 'memorandum' and 'articles of
association'. Following are some of the important provisions relating to the statutory companies:

1. A change in the structure of a statutory company is possible only by amending the Special Act
under which it is created.

2. The audit of a statutory company is conducted under the control and supervision of Auditor
General of India.
35
3. The annual report of working of a statutory company is required to be placed before the Parliament
or State Legislature, as the case may be.

It may be noted that statutory companies or corporations are considered 'State' for the purpose of
Article 12 of the Constitution of India, and thus are required to observe principles of equality in their
contractual dealings ¹4. In a case before the Supreme Court, the Regional Engineering College,
Srinagar was considered to be 'State' and was held bound by the principles of equality in the matter of
selection of students for admission.

Note: Though a corporation is regarded as state, but protection by way of sanction under Section 197
of the Code of Criminal Procedure (Cr.P.C.) is not available to the officers of the corporation. As per
Section 197 of Cr.P.C. when a public servant is accused of any offence, an action against him can be
taken with the previous sanction of the Central Government or the State Government. But if any officer
of a corporation is to be removed due to his being guilty of an offence, such sanction is not required.

2.12. REGISTERED COMPANIES

A registered company is one which is formed and registered under the Companies Act, 2013. It also
includes an existing company, which was formed and registered under the earlier Companies Acts. It
may be noted that a registered company comes into existence when it is registered (i.e., its name is
entered in the register meant for this purpose) under the Companies Act, and a certificate of
incorporation is granted to it by the Registrar of Companies. The registered companies are governed by
the provisions of the Companies Act, 2013, and by the rules and regulations laid down in the
'memorandum' and 'articles' of association of the companies. These are the commonly found
companies in India, and are the subject of our discussion of the Company Law. The registered
companies may be of two kinds, namely:

1. Limited companies

2. Unlimited companies

2.13. LIMITED COMPANIES

A limited company is one in which the liability of the members is limited i.e., the members are liable
upto a limited amount, and beyond that limit they cannot be asked to contribute anything towards the
payment of
company's liabilities. Thus, if in the event of winding up of a company, the assets of the company are not
sufficient to pay its liabilities, then the private property of the members cannot be utilised for the
payment of company's liabilities. It may be noted that a limited company is required to add the word
'Limited' after its name. The limited companies may be of two kinds, namely (a) companies limited by
shares, and (b) companies limited by guarantee.

1. Companies limited by shares: A company limited by shares is one in which the liability of the
members is limited to the extent of nominal value of shares held by them. If the shares are fully paid i.e.,
all the amount of share has already been paid, then the liability of the members is nil. And if the shares
are partly paid, then the liability of the members is limited to the extent of the amount which remains
unpaid, e.g., if a member has purchased 100 shares of a company of the face value of 10 each, and has
already paid 5 per share. In this case, the maximum liability of the members is * 5 per share i.e., 500 in
total. It may be noted that the liability of the members can be enforced during the continuation (i.e.,
existence) of the company, or during its winding up. Thus, the members can be asked to pay the unpaid
amount on their shares at any time. This is the most common kind of companies. The companies limited
by shares may be either 'private' or 'public' companies. The private and public companies will be
discussed in Arts. 2.15 and 2.16 respectively.

36
2. Companies limited by guarantee: A company limited by guarantee is one in which the liability of
the members is limited to such amount as he undertakes to contribute to the assets of the company in the
event of its being wound up. The amount of guarantee is fixed in the 'memorandum of association' of the
company. The guaranteed amount may differ from member to member. It may be noted that the liability
of the member can be enforced only at the time of winding up of the company. Thus, the members
cannot be asked to pay the guaranteed amount during the continuation of the company. A company,
limited by guarantee, may or may not have the share capital. If the company has the share capital, then
the members are also liable to pay the unpaid amount on their shares. However, the amount of guarantee
can be called only at the time of winding up of the company.
It may be noted that the companies limited by guarantee are generally non-trading companies, and they
are not formed for the purpose of earning profits, e.g., companies carrying charitable activities,
companies formed for the promotion of art, sports, science and culture etc. The companies limited by
guarantee may also be either 'private' or 'public' companies.

The important features of a company limited by guarantee may, therefore, be summed up as under.

(a) The memorandum of a guarantee company must contain a clause stating that the members shall
contribute a fixed sum of money towards the assets of the company in the event of its winding up.

(b) The amount of guarantee must be stated in the memorandum

(c) The guarantee company must have articles.

(d) The liability of the members to pay the guaranteed amount arises only when the company goes into
liquidation and not when it is a going concern.

Note: The words 'Limited' or 'Private Limited' are to be used by the public' or 'private companies as the
last words of their name only if the company is incorporated (ie, formed) with limited liability If any
person or persons use these words in their name without being incorporated with limited liability, each
of such persons shall be punishable with a minimum fine of 500 but may entend to 2000 for every day
for which such names have been used in the name of their business concern (Section 453, the
Companies Act, 20131

2.14. UNLIMITED COMPANIES

An unlimited company is one in which the liability of the members is unlimited i.e. the members are also
personally liable for the payment of companies' liabilities. Thus, if in the event of winding up of a
company, the assets of the company are not sufficient to pay its liabilities, then the private property of
the members can also be utilised for the payment of company's liabilities It may, however, be noted that
due to separate legal entity of the company, its creditors cannot file a suit against the members directly.
The members can be asked to contribute their property at the time of winding up of the company if its
assets are not sufficient to pay its liabilities. As a matter of fact, the liability of members of such
companies is unlimited as that of partners of a partnership firm. It may be noted that the articles of
association of an unlimited company should state the number of members with which the company is to
be registered. And if the company has share capital, the articles should also state the amount of shares
with which it is to be registered. The unlimited companies may also be either 'private' or 'public'
companies.

It may be noted that a company registered as an unlimited company may subsequently convert itself
into a limited company. However, it can be so converted subject to the provision that any debts,
liabilities, obligations or contracts incurred or made by or on behalf of the unlimited company before
such conversion are not affected by the conversion [Sections 18 and 65, Companies Act, 2013].

Note: The unlimited companies are rarely found in these days.

2.15. PRIVATE COMPANIES

37
 This point is discussed under the following sub-heads.

2.15.1. Definition of a Private Company

A private company is defined in Section 2(68) of the new Companies Act, 2013, which correspond to
Section 3(1)(iii) of the Companies Act, 1956, and section 2(68) has been amended by the Companies
(Amendment) Act, 2015 w.e.f. 29-5-2015. Which has removed the minimum paid up share capital
requirement of rupees one lakh for the formation of a private company.

As per amended Section 2(68), a private company is one which has a minimum paid up share capital of
such sum as may be prescribed, and by its articles of association, puts the following restrictions on
itself:

1. Restricts the right to transfer its shares, if any.

2. Limits the maximum number of its members to 200 (excluding the present or past employees of
the company).

3. Prohibits any invitation to the public to subscribe for any shares or debentures, of the company
i.e., it should not make public issue of its securities.

Thus, in case of a private company, its articles must expressly contain the three restrictions, namely (a)
members' right to transfer shares should be restricted, however not totally prohibited, (b) the maximum
number of members should be 200 (and minimum two), and there should be no invitation to the public to
subscribe for its shares or debentures i.e., the issue of prospectus should be prohibited.

• Under section 631 of the Companies Act, 1956, the maximum limit of fine
was upto 500 only.

Note: The requirement of minimum paid up share capital of rupees one lakh for the formation of a
private company has been removed by the Companies (Amendment) Act, 2015 w.e.f. 29-5-2015. This
step has been initiated by the government to promote the easy formation of companies and the
establishment of business units under various schemes of the government.

The removal of minimum capital limit may have positive effect if there will be control and survelliance
over the working of companies.

Now the government may, by rules, prescribe the paid up capital requirements for the formation of a
company.

2.15.2. The Manner of Restrictions on Members' Right to Transfer Shares

The object of restricting the members' right to transfer their shares is probably to enable the company to
keep the number of its members within the prescribed limit of 200. It is to be noted that the Companies
Act does not specify the manner in which the members' right to transfer the shares is to be restricted.
However, it has been held by the courts that the restriction upon transfer of shares means any restriction
which will give some control to the company over transferability. Generally, the restrictions on
members' right to transfer their shares take the following two common forms:

1. Right of pre-emption: The 'right of pre-emption' means existing members' preferential right to
purchase the shares of other members as and when sold. The articles of association of the company
may contain a clause that when a member wishes to sell some or all of his shares, he shall first offer
them to the other existing members at a price to be determined in the manner set out in the articles. It
may, however, be noted that under the pre-emption clause, a member is not bound to sell his shares to
38
 other members unless they (other members) or some of them agree to buy all the shares which he
offers for sale¹5.

2. Directors' powers to refuse to register transfer of shares: The articles of association of the
company may contain a clause giving powers to the directors to refuse to register the transfer of shares.
However, this power must be exercised by the directors in good faith and for the benefit of the company.
Thus, we see that in case of a private company, the members' right to transfer their share is restricted. It
may, however, be noted that the 'restrictions' does not mean prohibitory restrictions. As a matter of
fact, there cannot be absolute prohibition on members' right to transfer shares. The reason for the same
is that the transferability of shares is one of the characteristics of a company, which has been
recognised by Section 44 of the Companies Act, 2013.

In case a private company is a limited company, then it must add the words "private limited' at the end
of its name. Generally, the membership of a private company is confined, more or less to friends or
relatives.
The private companies enjoy certain advantages (privileges) over the other companies, which will be
discussed in Art. 2.21.

2.15.3. Important Points Relating to Private Companies

Following important points may be noted in connection with a private company:

1. A private company must have a minimum paid up capital of such amount as may be prescribed by the
government by rules.

2. In computing the number of members, the joint holders of shares shall be counted as one person
i.e., two or more persons holding the shares jointly shall be treated as one single member.

3. In case, a private company is limited company, then it must add the words Private Limited at the
end of its name.

4. A private company need not necessarily be a company having share capital. Thus, in case of a
private company having no share capital, there is no question of restrictions on members' right to
transfer their shares. However, the articles of such a company must contain the other statutory
restrictions.

5. The legal position (i.e., status) of a private company is similar to that of a public company i.e., it
is a separate legal entity.

6. In case of private companies, it is only the number of members that is limited to 200. and not the
number of debenture-holders. Thus, a private company may issue debentures to any number of persons.
However, the debentures can be issued privately i.e.. without inviting the public to subscribe for the
same. This is so because the invitation to the public to subscribe for any shares or debentures of the
company is prohibited by its articles.

Notes: 1. In case of private companies, certain restrictions are imposed by its articles of association.
It, therefore, follows that a private company must have its own articles of association

2. The private companies were, for the first time,

introduced in the Indian Company Law by the Companies Act of 1913. Until 1913, all the registered
companies were known as the public companies.

39
 Changes brought in by the Companies Act, 2013

1. The maximum limit of number of members has been increased to 200 from
50 prescribed under the earlier Compani Act, 1956.

2. The private company can also be formed with one member only, as the concept of 'One
Person Company' has been introduced in the new Companies Act, 2013.

3. The requirement of minimum paid up share capital of rupees one lakh for the formation of a
private company has now been removed by the Companies (Amendment) Act, 2015 w.e.f.
29.5.2015.

2.16. PUBLIC COMPANIES

This point is discussed under the following sub-heads.

2.16.1. Definition of a Public Company

A public company is defined in Section 2(71) of the new Companies Act, 2013, which correspond to
Section 3(1)(iv) of the Companies Act, 1956. The new section 2(71) has recently been amended by the
Companies (Amendment) Act, 2015 w.e.f. 29-5-2015 which has removed the minimum paid up share
capital requirement of 5 lakhs for the formation of a public company.

A per amended Section 2(71), a public company means a company, which

(a) is not a private company;

(b) has minimum paid-up capital of such amount as may be prescribed.

Thus a public company may be defined as an association of persons consisting of not less than seven
members, which is registered under the Companies Act with a minimum paid up capital of the prescribed
amount and which is not a private company within the meaning of this Act.

It may, however, be noted that the 'articles of association' of a public company may, sometimes contain
restriction on the issue of or transfer of shares. But despite such restrictions, if any, the company
remains public company as the other statutory restrictions are not there. It may be noted that generally
a company is considered as a public company, unless it is clear from its constitution that it is a private
company.

2.16.2. Important Points Relating to Public Companies

Following points are important to note in connection with a public company

1. A public company must have such paid up capital as may be prescribed by the government by
rules.
2. A private company which is subsidiary of a public company will be treated as a public company
even where such subsidiary company continues to be a private company as per its articles [Section
2(71), proviso].
3. In case of public companies, there are no restrictions in its articles, (a) on transfer of shares, (b) on
maximum number of members (though minimum must be 7), and (c) on the invitation to general
public to subscribe for its shares.

40
4. The requirement of minimum paid up share capital of 5 lakhs for the formation of public company
has been removed by the Companies (Amendment) Act, 2015. Now a public company can be
formed with such minimum paid up share capital as may be prescribed by the government by rules.

This step has been initiated by the government to promote the easy formation of companies the
establishment of business units under various schemes of the government. The removal minimum capital
limit may have positive effect if there will be control and survelliance over working of companies.

Changes brought in by the Companies Act, 2013

The definition of a public company as given in Section 2(71) of the new Companies Act, 2013 is
substantially on the same lines as given in the earlier Act.

1. The new definition has, however, removed the ambiguity surrounding the status of a private
company which is a subsidiary of a public company.

2. It is clarified in the definition itself that any private company which is subsidiary of a public
company shall be deemed to be a public company even where such subsidiary company
continues to be a private company as per its articles of association.

3. The definition given in the earlier Companies Act, 1956 did not provide as to whether such
subsidiary company will have the articles of a public company or a private company.

4. The requirement of minimum paid up share capital of 5 lakhs for the formation of a public
company has now been removed by the Companies (Amendment) Act, 2015 w.e.f. 29.5.2015.

2.17. ONE PERSON COMPANY

The concept of 'one person company' is a new concept and has been introduced in the company law for
the first time.

It is defined in Section 2(68) of the Companies Act, 2013 as under:

"One person company means a company which has only one person as a member".

Thus, a one person company can legally be formed under the Companies Act, 2013. Following points are
important in this regard:

1. Only a natural person can be a member of a one person company.

2. One person company can only be formed as a private limited company [Section 3].

3. The words 'One Person Company' shall be mentioned in brackets below the name of the
company wherever its name is printed, affixed or engraved [Section 12(3)].

4. The memorandum of one person company shall indicate the name of other person who shall become
member of the company in the event of death or incapacity of the single member [Section 3(1), first
proviso].

Note: The concept of 'one person company' has, already been discussed in chapter 1 in Article on 'New
Concepts'.
41
2.18. HOLDING AND SUBSIDIARY COMPANIES

We know that a holding company is one which has control over another company. And the company,
over which the control is exercised, is called the subsidiary company. It may be Loted that the 'holding'
and 'subsidiary' companies are relative terms. A company is a holding company of another if the other is
its subsidiary. The circumstances in which such type of control is exercised (i.e., in which one company
becomes the holding and the other a subsidiary) are contained in Section 2(87) of the new Companies
Act, 2013 which have been made effective from 12.9.2013.
Earlier these circumstances were contained in Section 4 of the Companies Act, 1956.

As per new provisions of section 2(87), one company shall become a subsidiary of another company
(i.e., holding company) in the following circumstances.

1. Control over the composition of Board of Directors Section 2(87)(i)]: Where, one company
controls the composition of the Board of Directors of another company, then the former becomes the
holding company, and the latter a subsidiary company (i.e., subsidiary of the holding company). A
company shall be deemed (i.e., considered) to have control over the composition of the Board of
Directors of another company, if it has the powers, of its own, to appoint or remove all or majority of the
directors of the other company [Section 2(87), Explanation (b)].

EXAMPLE 2.31. The Board of Directors of company A consists of 10 directors. Another company B
is formed, which has 5 directors, out of which 4 have been appointed by the company A. In fact, the
company A has full powers to appoint 4 directors of company B. In this case, company A is the
holding company, and the company B its subsidiary as the former has full powers to appoint majority
of the directors of the latter.

Notes: 1. The fact that the majority of directors, over which the control is exercised by the holding
company, will remain on the Board only upto the next annual meeting is not material. In such a case, the
relationship of holding and subsidiary company is established at least for the time being.

2. The holding company need not be a member of the subsidiary company. The holding company may
control the composition of Board of Directors of the subsidiary company without holding the majority of
shares in the subsidiary. The ways, by which the holding company may have
powers to appoint or remove directors of the subsidiary company, may be as under:

(a) The 'memorandum' or 'articles' of the subsidiary company may confer such powers upon the
holding company.

(b) There may be contract between the holding and subsidiary company conferring such powers
upon the former.

This note is based on the observations made in Pennington, Company Law, 796 (5th Edn. 1985).

2. Holding of majority of shares [Section 2(87)(ii)]: Where, one company holds the 'majority of
shares' in another company, then the former becomes the holding company. And the latter a subsidiary
company. The term 'majority of shares' means more than half (50%) of the total share capital of the
company. Thus, a company becomes a holding company if it holds more than 50% of the total shares
of another company.

Here, the total share capital means the aggregate of

(a) equity share capital; and

(b) convertible preference share capital.

42
Note: Under section 4 of the earlier Companies Act, 1956, the requirement was holding of more than
50% of the total equity capital only. The new provisions includes both kinds of share capital namely,
equity as well as convertible preference.

EXAMPLE 2.32. A is a company registered under the Companies Act having share capital of 5 lacs
divided into 5000 equity shares of 100 each. Out of the total shares, 2600 shares are held by B another
company. In this case, B is the holding company and A, the subsidiary company. Here, more than half
of the nominal value of the total share capital of company A is held by company B.

It may be noted that to fulfil the requirement of this clause, the majority of shares in the subsidiary
company may be held by the holding company itself of its own or together with one or more of its
subsidiary companies.

Notes: 1. Under this clause, the holding company will also be the member of a subsidiary company
where it directly holds the shares in the subsidiary company.
2. A holding company cannot, directly or indirectly purchase its own shares through its subsidiary
company [Section 70 of the new Companies Act, 2013].

3. Subsidiary of another subsidiary company [Section 2(87), Explanation (a)]: Where, one
company is the subsidiary of another company, which itself is a subsidiary company of some other
company, then the first mentioned company shall also become the subsidiary of the last mentioned
company.

EXAMPLE 2.33. Company A is a subsidiary of company B and the company B is the subsidiary of
another company C. In this, the company A will also become the subsidiary of company C. Now suppose
another company D is also the subsidiary of company A. In that case, the company D will become the
subsidiary of company B, and consequently also the subsidiary of company C.

Under this clause also, the holding company need not be the member of a subsidiary company. In the
above example, company C is the holding company of the company A, but it (C) is not directly the
member of the subsidiary company (4).

Thus, a company is the holding company of another (i.e., subsidiary company) if it exercises any one of
the above types of control over the other company.

Notes: 1. It is to be kept in mind that both, the holding company and its subsidiary company, are the
separate legal entities.

2. A subsidiary company is prohibited from holding shares in its holding company, except as a trustee
or legal representative of a deceased member. And the holding company shall not allot or transfer any
of its shares to its subsidiary company, any such allotment or transfer of shares shall be void [Section
19 of the Companies Act, 2013 w.e.f. 12.9.2013]

3. The definition contained in the Indian section is wider than that of Section 154 of the English
Companies Act, 1948. Under the English section, for a company to be a holding company of another
company, both the following requirements must be fulfilled: (a) It must be a member of the other
company, and

(b) It must also control the composition of the Board of Directors of that other company. However,
under the Indian section, it is enough for a company to have control over the composition of the Board of
Directors of the other company.

4. As the holding company need not be a member of the subsidiary company, the relationship of

43
holding and subsidiary company may also exist where there is no share capital.

Changes brought in by the Companies Act, 2013

1. Now the requirement for becoming a holding company is the holding of more than 50% of the total
share capital (i.e. equity as well as convertible preference share capital) in another company as against
only equity share capital under Section 4 of the Companies Act, 1956.

2. Now the Central Government may prescribe such class of holding companies which shall not have
layers of subsidiaries beyond such numbers as may be prescribed [Section 2(87), proviso]. The layer in
relation to a holding company means its subsidiary or subsidiaries.

2.19. GOVERNMENT COMPANIES

The definition of a government company' is contained in Section 2(45) of the Companies Act, 2013
which is almost similar to the definition contained in Section 617 of the Companies Act, 1956.

The new section has been made effective with effect from 12.9.2013, and the definition given below is
as per new Section 2(45).

A Government company is one in which 51% or more of the paid up share capital is held by the
Central Government, or by any one or more State Governments, or partly by Central Government or
partly by one or more State Governments. The required percentage of share capital, to be held by the
Central Government and/or by the State Government, may be either of equity share capital or of
preference share capital or of both. Even if the holding by the Central or State Government consists of
only preference shares carrying no voting rights, the company will still be a Government company. A
subsidiary of a Government company is also a Government company.

EXAMPLE 2.34. A & Co. Ltd. is a public company having paid up share capital of 20 lacs (₹ 10 lacs
equity share capital + 10 lacs preference share capital). Out of the total paid up share capital, 7 6 lacs of
equity share capital are held by the Central Government, and 5 lacs of preference share capital are held
by Punjab Government. In this case, A & Co. Ltd. will be a Government company as more than 51% of
its total paid up share capital is held by the Central and State Governments jointly.
Here, A & Co. Ltd. will also be a Government company, even if the required percentage of share
capital is held by the Central Government alone, or by the State Government alone.

It may be noted that the takeover, by the Government, of the management of a company under some
legislative Act does not make it a Government company. In a case before the Delhi High Court, the
management of the company was taken over by the Government under the provisions of the Industrial
Development Regulation Act, 1951, and after takeover company was not held to be the Government
company.

The important provisions relating to the Government companies may be summed up as under.
1. The auditor of a Government company is appointed by the Comptroller and Auditor General of
India. The appointment of the auditor in respect of a financial year shall be made by the Comptroller
and Auditor General within a period of 180 days from the commencement of the financial year. The
auditor so appointed shall hold office till the conclusion of the annual general meeting [Section 139(5),
the Companies Act, 2013]

2. In those cases, where the Central Government is a member of a Government company, it is the duty
of the Central Government to cause to be prepared (i.e., got prepared) an annual report on the working
and affairs of the company. Such report must be got prepared within three months of the annual general
44
meeting before which the audit report of the company is placed. The report, so prepared, is to be laid
before the both houses of Parliament together with a copy of the audit report and the comments, if any,
of the Comptroller and Auditor General of India.

3. In those cases where in addition to the Central Government, any State Government is also a member
of a Government company, the report as stated
above, shall also be laid before the State Legislature. But where the Central Government is not a
member then the State Government which is the member of the Government company shall cause to be
prepared the annual report within the same time as stated above, and thereafter as soon as may be, lay
it before the State Legislature.

Notes: 1. The above two provisions relating to the annual report are contained in Section 394 of the
Companies Act, 2013. The provisions of this section shall also apply to a Government company in
liquidation Section 394 has been made effective w.e.f. 12.9.2013, as they apply to any other
Government company'

2. A Government company is a separate legal entity independent from its shareholders, who may be
Central Government and/or State Governments.

3. Ordinarily, a Government company will be presumed not to be a servant or agent of the State. Bu
inference may be drawn that such company is an agent of the Government, if in substance, it also
perform the governmental function [Heavy Engg. Mazdoor Union v State of Bihar, (1969)
39 Comp. Cases 905 (SC)

4. If the Government company or other statutory corporate body is an instrumentality or agency of the
Government (i.e., State), it would be an 'authority', and therefore 'state' within the meaning of Article 12
the Constitution of India, and will be subject to the same constitutional limitations as the Government
and a writ will lie against it. [Som Prakash Rekhi v. Union of India, (1981) 51 Company Cases (SC);
Central Inland Water Transport Corpn. Ltd. v. Brojo Nath Ganguly, (1986) 60 Company Cases 797
(SC)]. For the purpose of invoking writ jurisdiction of the court, a nationalised bank has also bee equated
with a Government company. [State of Gujrat v. Central Bank of India, (1988) 63 Company Cases 598
(Gujarat) (DB)].

2.20. FOREIGN COMPANIES

This point is discussed under the following sub-heads.

2.20.1. Definition of a Foreign Company

In simple words, a foreign company is one which is incorporated (i.e., formed) outside India Legally, it
has now been defined in Section 2(42) of the Companies Act, 2013. As per Section 2(42), a foreign
company means any company or body corporate incorporated outside India, which -

(a) has a place of business in India whether by itself or through an agent, physically a through
electronic mode, and

(b) conducts any business activity in India in any other manner.

Thus, a 'foreign company' is one which is incorporated outside India and which apart from having a place
of business in India also conducts any business activity in India. It is to be noted that having or
establishing a place of business indicates something more than an occasional connection. A company
will have an established place of business in India, if it has a specified or identifiable place at which it
carries on business, such as an office, store house, godown a other premises which indicates that the
company has a concrete connection with such particular premises¹7. Thus, there must be some specific
45
location readily identifiable with the company where some substantial business activity of the company
is being carried on. A place of business is not considered to be established in India where a foreign
company has merely posted a representative in India only for the purposes of seeking orders.

2.20.2. Foreign Company and Foreign Controlled Company

The expression foreign company' is to be distinguished from a foreign controlled company' 'foreign
controlled company' means a company (Foreign or Indian) in which majority shareholders and voting
power is in the hands of foreign individual and/or foreign bodies corporates.

Whereas a 'foreign company' is one which is incorporated outside India and has a place of business in
India and also conducts any business activity in India.

2.20.3. Important Provisions Relating to Foreign Companies

The important provisions relating to foreign companies may be summed up as under:

1. Furnishing of particulars with the Registrar: The foreign company has to furnish to the Registrar
of Companies, for registration, the following documents/particulars within 30 days from the
establishment of place of business in India:

(a) A certified copy of the charter or statutes under which the company is incorporated, or the
memorandum and articles of the company, or any other document containing the constitution of the
company. If the document is not in English language, then a certified translation of the same.

(b) A list of directors and secretary of the company giving such particulars as may be
prescribed such as name, residential address, nationality, business, occupation, if any.

(c) The name and address of one or more person resident in India who is authorised to accept, on
behalf of the company, the service of legal process and any notice or document required to be served
on the company.

(d) The full address of the company's registered or principal office outside India.

(e) The full address of the company's principal place of business in India.

(f) The particulars of opening and closing of a place of business in India on earlier occasion or
occasions.

(g) The declaration that none of the directors of the company or authorised representative in India
has ever been convicted or debarred from formation of companies and management in India or
abroad.

(h) Any other information as may be prescribed.

All the above documents are required to be furnished to the Registrar of two places, namely (a) the
Registrar at New Delhi, and (b) the Registrar of the State in which the company's principal place of
business is situated.

Notes: (1) All the above stated documents/particulars are required to be furnished under Section 380 of
the new Companies Act, 2013 which were earlier required under section 592 of the Companies Act,
1956. There is no significant change in the new section except the three particulars mentioned in points
(f), (g) and (h) above which have been inserted by the new Act of 2013.
46
(2) When any change occurs in any of the above particulars, return of the same must also be filed with
the Registrar of Companies, for registration [Section 380(3), the Companies Act, 2013].

2. Display of names etc., of foreign company: The foreign company shall visibly exhibit on the
outside of every office or place of business in India, its name and the country in which it is incorporated.
It shall be so exhibited in English language and also in the local language of the place of business in
India. The company's name and the country in which it is incorporated shall also be stated in all its
business letters, bill-heads, letter papers and in all notices and other official publications. This is,
however, required to be stated in English language only. If the liability of the members of the company is
limited, it must be exhibited and stated outside every office or place of business, and in all official
publication of the company as aforesaid.

Note: This provision is made Section 382 of the Companies Act, 2013, which was earlier made in
Section 595 of the Companies Act, 1956.

3. Filing of accounts with the Registrar: The foreign company shall file with the Registrar of
Companies every year the copies of its 'balance sheet', and 'profit and loss account' and other
documents as required under the Companies Act. If such documents are not in English language, then a
certified translation of the same must be annexed to the copies of documents These documents must be
accompanied with three copies of a list, in the prescribed form, of all places of business established by
the company in India However the Central Government may exempt a foreign company from the
requirement of th clause

This provision is contained in Section 381 of the Companies Act, 2013 which is almog similar to
earlier provision contained in Section 594 of the Companies Act, 1956.

Note: The failure to comply with any of the above provisions does not affect the validity of any contract
made by the foreign company. However, the foreign company shall not be entitled to bring any suit or
legal proceeding in respect of any such contract until it has complied with the provisio of the Companies
Act relating to foreign companies (Section 393, the Companies Act, 2013),

3. Winding up of a foreign company: The foreign company may be wound up an unregistered

company if it ceases to carry on business in India [Section 376, the Companies Act, 2013].

It may, however, be noted that where 50% or more of the paid up share capital (equity or preference) of
a foreign company is held by one or more Indian citizens, or by one or more Indian companies or
corporations, then it shall have to comply with such of the provisions of the Companies Act as may be
prescribed as if it were an Indian company [Section 379, the Companies Act, 2013]¹*.

Notes: 1. As regards the status of a foreign company, the law of the place of incorporation of the
company applies. And as regards the contractual and other obligations, the law of the place of business
wil govern the same [National Bank of Greece & Athens S.A. v. Metliss, (1957)
2 All ER 1, Affirmed in (1957) 3 All ER 608 (HL)].

2. Under the Companies Act, no formality is required for a foreign company establishing a place of
business in India except the filing of documents as stated in point 1 above. However, under Section 29 of
the Foreign Exchange Regulation Act, 1973, a foreign company is required to obtain the general or
special permission of the Reserve Bank of India for carrying on any activity of a trading, commercial or
industrial nature. The object of this provision is to know the possible effects of the foreign company's
business on the country's economy and foreign exchange position.

2.21. SPECIAL PRIVILEGES OR ADVANTAGES OF A PRIVATE COMPANY

47
A private company enjoys certain special privileges (or advantages) as compared to other companies
(i.e., public companies). As a matter of fact, the private companies are very suitable for carrying on
family business. The reason for the same is that the requirement of minimum number of members,
which is two only, can be easily fulfilled by family members or close relatives Moreover, a private
company is also exempted from certain statutory provisions of the Companies Act. These exemptions
in fact, are the special privileges or advantages of a private company. The special privileges and
exemptions available to a private companies may be stated as under:

1. Its formation is easy: A private company can be easily formed as it requires only two minimum
members. This also helps in smooth functioning of the company [Section 12(1)].

2. It is exempted from the issue of prospectus: We know that a private company is prohibited from
inviting offers from general public for the purchase of its shares or debentures Thus, it is not required to
issue a prospectus which is meant for this very purpose. A private company is, therefore, exempted
from all the legal requirements relating to the preparation and issue of prospectus.

3. It is exempted from the requirement of minimum subscription for allotment of shares: The
minimum subscription is the amount which must have been collected by a company before any allotment
of shares is made. But a private company can proceed to allot shares without waiting for the minimum
subscription. The reason for the same is that a private company is not required to offer shares to the
public, and thus no question of minimum subscription from the public arises [Section 39].

4. It need not have more than two directors: A private company is not required to have more than
two directors. However, this is also the minimum requirement for a private company. That is to say, a
private company must have at least two directors [Section 149]. Whereas, a public company must have
at least three directors.

5. It is exempted from certain provisions regarding proceedings at the company meeting: An

independent private company enjoys certain exemptions (privileges) in respect of the proceedings at its
meeting. The important of them may be summed up as under:

(a) Only two members, who are personally present at the meeting, are sufficient to
form the quorum. However, the articles of the company may provide for quorum of
higher number [Section 103(1)(b)].

(b) The requirement of 21 days' notice for calling a general meeting is not
applicable to such a company. It may, by its articles, provide for a shorter or longer
period of notice for calling such meeting [Section 101].

(c) The contents of the notice for calling a meeting, the manner of its service and
the person on whom it is to be served may be regulated by such a company by its own
articles [Section 101].

6. It is exempted from certain restrictions regarding directors: We have already discussed in the
last article that a private company, including a subsidiary of a public company, may have only two
directors. However, an independent private company enjoys certain more exemptions (privileges) in
respect of appointment, retirement, increase in numbers etc., of the directors, and may be grouped as
under:

(a) All the directors can be appointed as permanent life directors. The requirement
of directors' retirement by rotation does not apply [Section 152].

(b) The casual vacancy of a director may be filled in a manner prescribed in such
company's articles. And it need not necessarily be filled by the Board of Directors at the
meeting of the Board. The duration of the period of office of such directors may also be
48
 fixed by the company itself [Section 161(4)].

(c) Special grounds may also be provided by the company, in its articles, for the
vacation of the office of a director [Section 167(4)].

7. It is exempted from restrictions regarding managerial remuneration: An independent private

company also enjoys certain exemptions in respect of the fixation or increase of the remunerations
payable to managerial personnel (such as directors, manager etc).

8. It is exempted from certain restrictions regarding financial assistance for the purchase of its
own shares: An independent private company enjoys certain exemptions in respect of giving financial
assistance to the persons for the purchase of its own shares. It can give any financial assistance to the
persons for the purchase of its own shares", and there is no restriction in this regard.

2.22. DISADVANTAGES OF A PRIVATE COMPANY

We know that certain restrictions are imposed on a private company by its articles of association. These
restrictions may be treated as disadvantages of a private company as compared to a public company.
How these restrictions are disadvantageous may be discussed as under:

1. Restrictions on members: The maximum number of a private company is limited to 200 only.
Thus, it cannot enjoy more financial facilities as can be enjoyed by having more members.

2. Restrictions on transferability of shares: The members of a private company cannot transfer their
shares. Thus, if they are in immediate need of money, they cannot sell their shares as in case of public
companies.

3. Restrictions on issue of prospectus: A private company cannot invite offer from the general
public for the sale of its shares or debentures. Thus, it may not have the advantages of sound investors
and cannot have the benefit of public money.

2.23. CONVERSION OF A PRIVATE COMPANY INTO A PUBLIC COMPANY

A company originally formed as a private company may choose to become a public company. It may
so become by altering its articles of association by special resolution. Legal provisions in this regard
are provided in Section 14(1) of the Companies Act, 2013, which were earlier provided in Section
44(1) of Companies Act, 1956.

The provisions of Section 14 have been made effective w.e.f. 1.4.2014 vide Ministry of Corporate
Affairs Notification dated 26.3.2014, and may be discussed as under:

2.23.1. Procedure for Conversion

A private company may become a public company by complying with the following procedure
requirements:

Alteration of articles by special resolution: The company should alter its articles of association by
passing a special resolution. The alteration made should have the effect of conversion of a private
company into a public company i.e., the articles should be altered so as to delete the statutory
restrictions/conditions essential for a private company. On alteration of articles, as stated above, the
company shall cease to be a private company from the date of such alteration [Section 14(1)].

Note: No approval of Tribunal is required for such conversion.

49
1. Filing of alteration and altered articles: The company shall file the following with the Registrar,
in the prescribed manner, within 15 days:

(a) a copy of alterations; and

(b) a printed copy of altered articles.

On receipt of these documents, the Registrar shall register the same [Section 14(2)]. The altered articles
so registered shall be valid as if it were originally so made [Section 14(3)] Note: A copy of special
resolution altering the articles should also be filed with the Registrar within 30 days of passing. It is
necessary because all special resolutions are required to be so filed with the Registrar [Section 117].

2. Compliance of other procedural requirements: The following procedural requirements should

also be complied with:

i. Increase the number of members to 7, if it is below this statutory limit.

ii. Increase the number of directors to 3, if it is below this statutory limit.
iii. Increase the paid-up share capital to 5 lakh, if it is below the statutory limit.
iv. Change the name clause of the memorandum so as to delete the word 'Private'
from the name of the company by passing a special resolution.

2.23.2. Steps Required for Conversion of a Private Company into a Public Company

The steps required in this regard may be stated as under:

1. Board Meeting: The Board meeting should be held to discuss and vote the proposal regarding
conversion of a private company into a public company. The Board should pass a resolution by majority
approving conversion, and the general meeting of the company should be called for alteration
of articles accordingly.

2. General Meeting: The general meeting of the company should be held as per Board directions and
special resolution should be passed to alter the articles so as to delete the statutory restrictions/conditions
of Section 2(68) included in the articles which constitute the company to be a private company. Special
resolution should also be passed for the following purposes:

(a) To alter the name clause of memorandum 'so as to delete the word' Private'
from company's name. Approval of Central Government is not required for such a
change in the name [Section 13(2), proviso].

(b) To alter such provisions of articles which are inconsistent with provisions
applicable to public companies.

3. Filing of documents: The following documents should be filed with the Registrar within 15 days in
such manner as may be prescribed:

(a) a copy of alteration; and

(b) a printed copy of altered articles.

On receipt of these documents, the Registrar shall register the same. And the alteration shall be valid as if
it were originally in the articles [Section 14(3)]. Act, 1956, the time limit for filing these documents

Note: Earlier under Section 31 of the Companies with the Registrar was one month instead of 15 days
50
as under the new Act of 2013.

4. Compliance of other procedural requirements: The following procedural requirements should

also be complied with:

(a) Obtain a fresh certificate of incorporation from Registrar with new name of
the company [Section 13(3)].

(b) Increase the number of members to 7, if it is below this statutory limit. (c)
Increase the number of director to 3, if it is below this statutory limit. (d) Increase the
paid-up share capital to 5 lakh or higher limits as prescribed, if it is below this
statutory limit.

5. Date of conversion: The company shall be converted into a public company from the date of passing
special resolution altering articles and memorandum.

Changes brought in by the Companies Act, 2013

1. The copy of alterations alongwith a printed copy of altered articles shall be filed with the Registrar
within 15 day, earlier under Section 31 of the Companies Act, 1956, it was to be filed within one month.

2. There shall be no requirement of filing any statement in lieu of prospectus at the time of
conversion from private company to public company, which was required earlier.

2.24. CONVERSION BY CHOICE

We have discussed above, the circumstances in which a private company becomes a public company
without any choice of the company itself. A private company may also become a puble company by its
own choice. It may do so by passing a special resolution deleting, from its article of association, the
statutory restrictions which are essential for a private company. If it does so, becomes a public company
from the date of the alteration in the articles of association' [Section 44]. Thereafter, all the provisions
of the Companies Act shall apply to the company as if it we a public company. On conversion of a
private company into a public company, by its own choice it must comply with the following
formalities:

• A prospectus or a 'statement in lieu of prospectus' must be filed with the Registrar Companies within
30 days from the date of alteration of the articles of association.

Note: On the conversion of a private limited company into a public limited company, apart from th
change in its name, the constitution and the legal entity of the company is not affected in any other
manne Thus, the legal proceedings instituted by its former name may be continued by its name.

2.25.CONVERSION OF A PUBLIC COMPANY INTO PRIVATE COMPANY

We have already discussed the conversion of a private company into a public company Similarly a public
company may also be converted into a private company. A public company may become a private
company by making necessary alteration in its articles of association by passing a special resolution, so
as to include in it the statutory restrictions which are necessary for a private company i.e., restrictions on
transfer of shares, on the maximum numbers of members, and on the issue of prospectus.

Legal provisions in this regard are provided in Section 14 of the Companies Act, 2013, which correspond
to Section 31 of the Companies Act, 1956.
51
Section 14 has been made effective w.e.f. 1.4.2014 vide Ministry of Corporate Affairs notification at
26.3.2014, and its provisions may be discussed as under.

2.25.1. Procedure for Conversion

A public company may become a private company by complying with the following procedure
requirements:

1. Alteration of articles by special resolution: The company shall pass a special resolution to alter its
articles. The alteration should have the effect of conversion of a public company into a private company
i.e., the articles should be altered so as to include it the statutory restrictions/conditions essential for a
private company as specified Section 2(68).

2. Approval of Tribunal: The company should obtain the approval of Tribunal for conversion
of a public company into a private company.

It is to be noted that the conversion shall not take effect unless it is approved by the Tribunal [Section
14(1), second proviso].

3. Filing with the Registrar: The company should file the following documents with
Registrar within 15 days in such manner as may be prescribed:

i. a copy of alterations;
ii. a copy of order of Tribunal approving the alteration;
iii. a printed copy of altered articles.

On receipt of these documents, the Registrar shall register the some [Section 14(2)] The altered articles
so registered shall be valid as if it were originally so made (Section 14(3)) Note: A copy of special
resolution altering the articles of association should also be filed with the Registrar within 30 days of
passing the resolution. This is required because every special resolution should be so filed with the
Registrar within 30 days after passing [Section 117]

4. Compliance of other procedural requirements: The following procedural requirements should

also be complied with:

(a) Change the name of the company so as to add the word 'Private' to the name of
the company.

(b) Maximum number of members should be limited to 200, which is the

statutory maximum limit for a private company.

5. Date of conversion: The company shall become a private company from the date of order of
Tribunal approving the conversion of the company from public to private.

2.25.2. Steps Required for Conversion

The steps required for conversion of a public company into a private company may be stated as under:

1. Board Meeting: The Board meeting should be held to discuss and vote the proposal for
conversion of a public company into a private company.

The Board should pass a resolution by majority approving conversion, and the general meeting of the
company should be called for alteration of articles accordingly.
52
2. General Meeting: The general meeting of the company should be held as per Board directions, and
special resolution should be passed to alter the articles so as to include in it the statutory restrictions, as
specified in Section 2(68) necessary for a private company, such as (a) restrictions on transfer of shares,
(b) restrictions on maximum number of members, and (c) restrictions on public issue.

The special resolution should also be passed for the following purposes:

(a) To alter the name clause of 'memorandum' so as to add the word' Private' to company
name.

Approval of Central Government is required for such a change in the name [Section 13(2), proviso].

(b) To alter such provisions of the articles which are inconsistent with provisions applicable to
private companies.

3. Application for approval: The company shall make an application to the Tribunal for obtaining its
approval for conversion of the company from public to private. It is to be noted that the conversion of a
public company into a private company shall not take effect except with the approval of Tribunal
[Section 14(1), second proviso].

4. Filing of documents: The following filing requirements should be complied with:

(i) The following documents should be filed with the Registrar within 15 days in such
manner as may be prescribed:

 a copy of alteration; and

 a copy of Tribunal order approving alteration;

 a printed copy of altered articles.

(ii) The following copies of resolutions should also be filed with the Registrar within 30 days of passing
the resolution:

(a) a copy of special resolution altering the articles;

(b) a copy of special resolution altering name clause of memorandum. It is

necessary because every special resolution is required to be filed with the Registrar
within 30 days after passing [Section 117].

5. Compliance of other procedural requirements: The following procedural requirements should

also be complied with:

(a) Obtain a fresh certificate of incorporation from the Registrar with new name of the company
[Section 13(3)].

(b) Limit the maximum number of members to 200.

53
 Changes brought in by the Companies Act, 2013

1. Now, a copy of alteration alongwith a copy of Tribunal order and printed copy of altered articles
should be filed with the Registrar within 15 days, earlier under Section 31 of the Companies Act,
1956, it was required to be filed within one month.

2. Now, the approval of Tribunal is required for conversion of a public company into a private
company. Earlier the approval of Central Government was required for this purpose.

Note: The conversion of a company from private to public or from public to private does not affect
legal identity of the company i.e., it remains the same. As a matter of fact, no new company comes into
existence by conversion. Only an already existing company is converted from private to public or vice
versa All India Reporter v. Ram Chandra, AIR 1961 Bom.292; Hindustan Lever v. Bombay Soda
Factory, AIR 1964 Mysore 173].

2.26. COMPARISON BETWEEN A PRIVATE COMPANY AND A PUBLIC

COMPANY

The following table gives the comparison between a private company and a public company:
Private Company Public Company

S.NO. PRIVATE COMPANY PUBLIC COMPANY

1 It is formed and registered under the It is also formed and registered under the
Companies Act, and is also a separate legal Companies Act, and is a separate legal
entity. entity.
2 In this case, the minimum number of persons In this case, the minimum number of
required to form a company is persons required to form a company is
seven.
two.
3 In this case, the maximum number of members In this case, there is no such restriction on
must not exceed 200 the maximum number of members.
4 In this case, the right of members to transfer In this case, the right of members to
their shares is restricted i.e., the shares are not transfer their shares is not restricted i.e.,
freely transferable. the shares are freely transferable.

5 It is prohibited from issuing a prospectus i.e., It is not prohibited from issuing a prospectus
it cannot invite offers from the general i.e., it can invite offers from the general
public to subscribe for its shares or public to subscribe for its shares or
debentures. debentures.
6 It must have minimum of two directors. It must have minimum of three directors.
7 Its conversion to a public company does Its conversion to a private company requires
not require approval of the Tribunal.
approval of the Tribunal.

8 In this case, the quorum required for In this case, the quorum required for
holding a meeting is of two members i.e., holding a meeting shall depend upon the
there must be at least two members number of members of the company.
personally present for holding the company
meetings.
9 It enjoys certain special privileges. It does not enjoy any special privileges.

54
2.26. COMPARISON BETWEEN A COMPANY AND JOINT HINDU FAMILY BUSINESS
The following table gives the comparison between a company and a Joint Hindu Family
Business:

S.NO. COMPANY JOINT HINDU FAMILY BUSINESS

1 It is formed by registration under the It is not formed by registration under the
Companies Act Companies Act. No registration is required
for a joint Hindu family to carry on the
business.
2 In this case, the minimum number of In this case, there is no statutory
members must be two in case of a private requirement regarding the minimum
company, and seven in case of a public numbers.
company.
3 In this case, a person does not become a In this case, a person becomes a member in
member merely by birth the joint family business merely by virtue of
his birth.
4 In this case, the members need not be family In this case, the members are necessarily
members. Generally they are outsiders the family member.
5 . In this case, the business is carried on as per In this case, the business is carried on by
the provisions of the Companies Act. the Karta. He has the sole authority to
contract debts for the purpose of joint
family business.

Notes: 1. Company distinguished from a club: The points of difference between the two are (a) a
company is a trading association, and a club is a non-trading association, (b) the registration of a
company is compulsory, but the registration of a club is not compulsory.

2. A society, registered under the Societies Registration Act can be treated as a 'person' having separate
legal entity apart from its members, and thus capable of becoming a member of a company. However,
it is not a 'body corporate' for the purposes of various provisions of the Companies Act [Ayurvedic &
Unani Tibbia College, Delhi v. State of Delhi, AIR 1962 SC 458].

2.27. COMPARISON BETWEEN A PRIVATE COMPANY AND A PARTNERSHIP

The following table gives the comparison between a private company and a partnership:

S.NO. PRIVATE COMPANY PARTNERSHIP

1 It is created by registration under the It is created by mutual agreement of the
Companies Act i.e., it comes into existence partners i.e., it comes into existence by
by operation of law. agreement and not law by operation of
law.
2 It must be registered with the Registrar of It may or may not be registered with the
Companies. As a matter of fact, a company Registrar of Firms. As a matter of fact,
cannot come into existence without its the registration of partnership is not
registration. compulsory, and it comes into existence
even without its registration.
3 It is a legal entity separate from its members. It is not a legal entity separate from its
members (i.e., partners). The firm and its
partners are one and the same thing in the
eyes of law.
4 In this case, the minimum number of persons It this case also, the minimum number of
required to form a company is two. persons required to form a firm is two.
5 In this case, the maximum number of In this case, the maximum number of
55
 members must not exceed 200 [Section members must not exceed 100 [Section
2(68)]. 464].
6 In this case, the right of a member to transfer In this case, a member (partner) has no right
his shares is restricted by its articles of to transfer his share without the consent of
association. all other partners. If he does so, the
partnership may be dissolved.
7 In this case, the members are not personally In this case, the members (partners) are
liable for the debts of the company. Their personally liable for the debts of the firm.
liability is limited to the value of shares held Their liability is unlimited.
by them.
8 In this case, the general powers of the In this case, the general powers of the firm
company are governed by its memorandum, are governed by the mutual agreement
and articles of association. The alteration in between the partners. The alteration in this
these documents is not easy as these can be agreement is comparatively easy as it can
altered only by following the procedure be altered with the consent of the partners.
prescribed in the Companies Act.
9 In this case, there is no agency relationship In this case there is an agency
either between the company and its relationship between the firm and its
members or between the members members (partners) and also between
themselves. Thus, a member is not an agent the partners themselves. This, in
of the company or of other members. fact, is an essential characteristic of a
partnership firm.

10 It must keep proper books of accounts, and In this case, there is no such statutory
the annual accounts must be audited by a provision in this regard.
chartered accountant.
11 It has a perpetual succession i.e., its
existence is continuous. It does not come to It does not have a perpetual (i.e.,
an end by the death or insolvency of its dissolved) by the death or insolvency of its
members. It can be wound up only ording to members, unless there is an
the provisions of the Companies Act. agreement to the contrary.

12 It is governed by the provisions of the It is governed by the provisions of the Indian

Companies Act, 2013. Partnership Act, 1932.

2.28. FAMILY COMPANY

The term 'one-man company' may be defined as a company in which one person holds the substantial
number of shares, and has the controlling power over the company. In a family company practically
whole of the shares of the company are held by a single member. The other members are included only
to comply with the statutory requirement of minimum number of members. Generally, the other members
are his friends or near relatives who hold only one or two shares. A family company is perfectly valid.
The reason for the same is that there is nothing in the Companies Act which suggests that the members
should be independent or unconnected, or that they should hold substantial number of shares. One share
is sufficient to make a person the member in the company. Thus, a single person can hold practically all
the shares and give each to his relatives or family members. And in this way he can enjoy the control
over the company, and also enjoy the profits of the company with the benefit of limited personal
liability.

EXAMPLE 2.35. A and his wife B formed a private company. The company is registered with a share
capital of 4 lacs divided into 4,000 share of 100 each. Out of the total shares, 3,999 shares are held by A
himself, and one share is held by his wife B. In this case, the company formed by A and B is a
separate legal entity and can be termed as a one-man company.

It is important to note that such a company is a separate legal entity independent from its members.
56
This has already been discussed in detail in Example 2.1 (Salomon's case). As regards the separate
legal entity of such companies, the following observations of Bombay High Court are also
worthnoting in this regard:

"Under the law, an incorporated company is a distinct entity, and although all the shares may be
practically controlled by one person, in law a company is a distinct company and it is not permissible or
relevant to enquire whether the directors belonged to the same family or whether it is, as compediously
described a 'one-man company" [Justice Kania in
T.R. Pratt (Bombay) Ltd. v. E.D. Sasson & Co. Ltd, AIR (1936) Bombay 62]

2.29. NON-PROFIT EARNING ASSOCIATIONS OR LICENSED COMPANIES

Legal provisions relating to the registration of 'non-profit earning association are provided in Section 8
of the Companies Act, 2013, which correspond to Section 25 of the Companies Act, 1956. The
provisions of new Section 8 have been made effective we.f. 1.4.2014 vide Ministry of Corporate
Affairs notification dated 26.3.2014.

This point may be discussed under the following sub-articles/topics:

2.29.1. Definition of Non-profit Earning Association

An 'association' is combination of persons formed for achieving some common objects. And a 'non-profit
association' is an association which is formed not for earning profits, but for promotion of commerce, art,
science, sports, education, research, social welfare, religion, charity, protection of environment or any
such other object.

Following points to be noted with regard to 'non-profit earning associations":

1. It is not of commercial nature as its main object is not to earn profits. It applies its profits, if any, or
other income in promoting its objects.
2. It prohibits the payment of any dividends to its members.

3. It may or may not be registered as a company under the Companies Act.

4. It may be registered as a limited company without adding the word 'Limited' or 'Private
Limited' to its name, by getting a license from Central Government for exemption from using these
words.

2.29.2. Legal Provisions Relating to Grant of Licence

The legal provisions relating to grant of licence and registration of 'non-profit associations' are
provided Section 8 of the Companies Act, 2013.

The Central Government may grant a license to a 'non-profit association' to be registered as company
without the word 'Limited' or 'Private Limited' if conditions/requirements of Section are complied with.
The provisions of this section are as under:

1. Licence by Central Government: Legal provisions in this regard are:

(a) Licence to a proposed company: The Central Government may grant a licence to a non-profit
association which proposes to be registered as a limited company under Section 8 without words
'Limited' or 'Private Limited' [Section 8(1)].

(b) Licence to an existing company: The Central Government may also grant a licence to an existing
limited company to omit the word 'Limited' or 'Private Limited' from its name if it satisfies the conditions

57
 of Section 8 [Section 8(5)].

2. Conditions for obtaining licence: The Central Government may grant a licence to a proposed
company or an existing company from exemption from the use of words 'Limited' or 'Private Limited' if
the following conditions specified in Section 8(1) are satisfied:

(a) The objects of the company are to promote commerce, art, science, sports, education,
research, social welfare, religion, charity, protection of environment or any other such objects.

(b) The company shall apply its profits, if any, or other income in promoting its objects, (c) The
company shall prohibit the payment of any dividends to its members. On the fulfilment of all the above
requirements, the Central Government may gram a licence directing that the association may be
registered as a company with limited liability without adding the words 'Limited' or 'Private Limited' to
its name. This licence may be granted on such terms and conditions as the Central Government thinks
fit.

3. Registration by the Registrar: On grant of licence by the Central Government and on receipt of
application in the prescribed manner, the Registrar shall register the association as a company under
Section 8 of the Act [Section 8(1)(5)].

4. Effect of grant of licence and registration under Section 8: The legal effects are a under:

(a) The company is not required to use the words Limited or Private Limited at the end of its
name.

(b) The company enjoys all the privileges of a limited company, and is also subject to all the
obligations of such a company [Section 8(2)].

(c) The company cannot alter the provisions of its 'memorandum' or 'articles' excep with the
previous approval of Central Government [Section 8(4)(1)].

(d) The company may convert itself into a company of any other kind. However, i can get itself
so converted only after complying with such conditions as may be prescribed [Section 8(4) (ii)].

(e) A from may become a member of such a company [Section 8(3)].

5. Revocation of Licence: The licence granted to the company under Section 8 may also be revoked
by the Central Government in the following cases [Section 8(6)]:

(a) If the company contravenes any of the requirements of Section 8, such as alter its objects without
approval of Central Government; or

(b) If the company contravenes any of the conditions subject to which licence is granted by the
Central Government; or

(c) If the affairs of the company are conducted fraudulently or in a manner violative of the objects
of the company or prejudicial to public interest.

On the revocation of the licence, the association loses the exemption granted by such licence.
Thereafter, the association must publish its name with the words 'Limited' or 'Private Limited' as the
case may be. And the Registrar of Companies shall enter the word 'Limited' at the end of the
association's name in the register maintained by him.

6. Advantages of Incorporation Under Section 8: The main advantage of incorporation of such an

58
association and obtaining a licence for dispensing with the word 'limited' or 'private limited' is that it can
adopt a more suitable name without using the word company. Thus, the names such as 'association',
'chamber', 'club', 'guild' etc., may be used so as to suit their objectives. In this way, it gains public
estimation, status and credit. By virtue of its becoming a registered company, the following advantages
follow automatically: (a) It becomes a body corporate with perpetual succession. (b) It can have a
common seal.

(c) Its members are no more personally liable.

(d) It can hold property in its own name, and can also enter into contract in its own name.

(e) It can institute and defend legal proceedings in its own name.

Changes brought in by the Companies Act, 2013

1. The activities like sports, education, research, protection of environment and social welfare
have been specifically added in the scope of the objects for which a non-profit association may
be formed. Earlier, under Section 25 of the Companies Act, 1956, these activities were
covered under the general clause t.e., any other useful objects.

2. Now the memorandum' or articles of such a company can be altered only with the
previous approval of Central Government. Earlier, approval of Central Government was
required only for alteration of objects.

3. A company registered under Section 8 can be amalgamated only with another company
registered under this section and having similar objects [Section 8(10)].

4. The punishment for non-compliance has been increased.

2.30. ILLEGAL ASSOCIATIONS

The term ‘illegal association' may be defined as an association which is not formed according to the
provisions of any law, and in which the maximum number of members exceeds the statutory limit.
Section 464 of the Companies Act, 2013 provides the maximum statutory limit of members which
must not be exceeded unless the association is registered as a company, or is formed according to the
provisions of some other Indian Law.

The provisions of new Section 464, which correspond to Section 11 of the Companies Act, 1956, have
been made effective w.e.f. 1.4.2014 vide MCA Notification dated 26.3.2014, and may be stated as
under:

1. Prescribed limit of maximum number of members [Section 464(1)]: This section makes the
following provision:

(a) Without registration as a company or without being formed under any other law, the maximum
number of persons of an association or partnership must not exceed such numbers as may be prescribed
by rules.

(b) The maximum number of members which may be prescribed by rules must not exceed 100.

(c) The above provisions make it clear that in any case the maximum number of persons must
not exceed 100.
59
2. Conditions to term an association as an illegal one: If the membership of an association exceeds
this statutory limit, then it must be either registered as a company under the Companies Act, or formed
under the provisions of some other Indian Law. If it is not so registered or formed, then it becomes an
illegal association which has no legal existence. Thus, an unincorporated company, association or
partnership consisting of large number of persons than prescribed above has been declared as an illegal
association. An association becomes an illegal association if the following conditions are satisfied:

1. The association must have been formed for the purpose of carrying on some business. 2. The
association must have been formed with the object of acquiring profits for itself or for its members.

3. The association must not have been either registered as a company under the Companies Act, or
formed according to the provisions of some other Indian Law.

4. The number of members of the association must be more than the limit prescribed by rules or
100.

EXAMPLE 2.36. A & Co. and B & Co. are two partnership firms carrying on spare parts business
separately. The firm A & Co. consists of 50 members, and the firm B & Co. 52 members. Both the
firms join together and the business jointly as partners under the name and style of AB & Co. In this
case, the partnership of AB is illegal as the same is not registered under the Companies Act, and the
number of its members exceeds the statutory limit (ie, 100) prescribed under Section 464.

3. Exemptions [Section 464(2)]: The following shall not become illegal associations even if the
number of members exceeds the maximum prescribed limit:

(a) A Hindu undivided family carrying on any business; or

(b) An association or partnership if it is formed by professionals who are governed by Special Acts
such as advocates, chartered accountants etc.

4. Other important points: Following points are important to note:

(a) The restrictions as to the statutory limit of members laid down in Section 464 apply not only to the
first formation of the association, but also if the limit is exceeded afterwards during the continuance of
the association. Thus, where an association is legal at the time of its formation (i.e., the number of its
members is within the statutory limit), it will become illegal if the number of its members subsequently
exceeds the statutory limit.

(b) Once an association becomes illegal, it remains illegal until it is registered under the Companies
Act or formed according to some other Indian Law. The illegality of the association cannot be cured
by subsequent reduction in the number of its members.

EXAMPLE 2.37. A & Co. consisting of 95 members is an unregistered association carrying on steel
furniture business. After some time 6 more members join the association, and it continues its business
without being registered under the Companies Act. In this case, the association will become illegal as
the number of its members exceeds the statutory limit (i.e., 100). This association will remain illegal even
if the number of its members is subsequently reduced below 100.

(c) An association formed for promotion of commerce, art, science, religion and charity etc. does
not become illegal even if the number of its members exceeds the statutory limit and it is not
registered or formed as required by Section 464 of the Companies Act. The reason for the same is
that such associations are not required to be compulsory registered as companies.

60
 Notes: 1. An illegal association, as discussed above, is not an association for illegal purpose. Section
464 makes only the association illegal. But that does not imply that the business of the association is
illegal. 2. The object of Section 464 is firstly, to prevent the mischief which may arise from large trading
business being carried on by a fluctuating body. Because, the persons dealing with such associations
may not know with whom they are contracting, and, therefore, they might be put to great difficulty and
expense. And secondly, to avoid confusion and uncertainty as regards the rights and liabilities of the
members among themselves.
Changes brought in by the Companies Act, 2013

1. No distinction between banking and other business: Under Section 464 of the new Act, the
distinction between an association carrying on banking business and other associations has been
dispensed with.

2. Maximum number of members: Under new provision, an association or partnership carrying on

any business with the object of acquisition of gains cannot be formed if the number of its members
exceeds 100. Earlier, under Section 11, the maximum limit in case of banking business was 10 persons,
and in other cases the limit was 20 persons.

3. Exemption to professionals: An association or partnership if it is formed by professionals who are

governed by Special Acts is exempted from the provisions of Section 464. Now the professionals can
form large associations or partnerships without being registered as a company. Earlier, there was no
such exemption.

4. Enhanced penalty: The penalty for contravention of this provision may extend to rupees one
lakh, and the members shall also be personally liable. Earlier, the maximum limit of penalty was Rs.
10,000.

2.31. CONSEQUENCES OF AN ILLEGAL

ASSOCIATION Following are the consequences of an illegal association:

1. It has no legal existence i.e., in the eyes of law, it is no more in existence. 2. It cannot enter into any
binding contract. If it enters into a contract, its members cannot maintain any legal action in respect of
such contract.

3. It cannot bring any legal action against its members or outsiders. Moreover, its members or
outsiders can also not bring any legal action against the association.

4. It cannot be wound up (i.e., dissolved) under the provisions of Companies Act, even under the
provisions relating to the winding up of unregistered companies. 5. Every member of such association is
personally liable for the debts and liabilities incurred by the association. Moreover, every member is
also liable to be punishable with fine which may extend to one lakh*.
Thus, neither the association nor its members can maintain any legal action in a Court of Law. There can
also be no suit between the members for the partition of the existing assets of such association or for
taking its accounts. It, therefore, follows that a member of such association is not entitled to file a suit in
a Court of Law for the partition of the association or for its dissolution. This view point has also been
approved by the Supreme Court of India in Badri Prasad v. Nagarmal, AIR 1959 SC 559 where it held
that in case of an illegal association, no relief can be granted either to the association or to any of its
members as the courts cannot adjudicate (i.e., decide) in respect of contracts which the law declares to be
illegal. The Supreme Court also held in this case that when the association is itself illegal, the court
cannot assist its members in getting accounts made so that they may recover their share of profits made
by the illegal association.

61
 UNIT-2

FORMATION OF A COMPANY

3.1. INTRODUCTION

We know that a company is a separate legal entity which is formed and registered under the Companies
Act. It may be noted that before a company is actually formed (i.e., formed and registered under the
Companies Act), certain persons, who wish to form a company, come together with a view to carry on
some business for the purpose of earning profits. Such persons have to decide various questions such as
(a) which business they should start, (b) whether they should form a new company or take over the
business of some existing company, (c) if new company is to be started, whether they should start a
private company or public company, (d) what should be the capital of the company etc. After deciding
about the formation of the company, the desirous persons take necessary steps, and the company is
actually formed. Thereafter, they start their business.
Thus, there are various stages in the formation of a company from thinking of starting a business to the
actual starting of the business. In this chapter, we shall discuss these stages along with the legal
provisions relating to them.

3.2. STAGES IN FORMATION OF A COMPANY

Following are the three stages in the formation of a company:

1. Promotion of a company.
2. Registration and incorporation of a company.
3. Commencement of business.

3.3. PROMOTION OF A COMPANY

It is the first stage in the formation of a company. We have discussed in Art. 3.1 that before a company is
actually formed, certain persons plan about the starting of some business, and after arriving at the
decision about the formation of a company, they take necessary steps in this regard. The promotion of a
company refers to all those steps which are taken from the time of having an idea of starting a company
to the time of the actual starting of the company business. Thus, 'formation of a company' means
originating the idea of forming a company, and taking necessary steps in this regard. The persons who
think of forming a company and take necessary steps in its formation are known as 'promoters' or
'company promoters'. The legal meaning of the term 'promoters', their legal status (position), functions,
duties and obligations, liabilities, and the remuneration payable to them will be discussed in Arts. 3.8 to
3.13.

3.4. REGISTRATION AND INCORPORATION OF A COMPANY

This point is discussed under the following sub-heads:

3.4.1. Formation of the Company

It is the second stage in the formation of a company, and the company comes into existence when it is
registered under the Companies Act, 2013. The persons associated for any lawful purpose may form the
same by getting it registered with the Registrar of Companies. These persons may decide to form any
of the following type of company [Section 3(1)]:

(a) Public company: 7 or more persons may form the company by getting it registered with the
Registrar;

(b) Private company: 2 or more persons (not exceeding 200) may form the company by getting it
registered with the Registrar.

(c) One person company: One person may also form a company by getting it registered with the
Registrar. It would always be a private company only.
The company so formed, whether public or private, may be of the following two types, namely [Section
3(2)]:
1. Limited company (limited by shares or limited by guarantee).
2. Unlimited company.

Note: Section 3 of the new Companies Act, 2013 corresponds to Section 12 of the Companies Act, 1956.
There is no change in the provision with regard to above discussion. The additional point made in new
section 3 discussed above, is with regard to formation of a 'one person company'.

3.4.2. Procedure for Registration and Incorporation

The procedure for registration and incorporation of the company involves the following steps:

1. Application to the Registrar for availability of name: An application for availability of proposed
name should be made to the Registrar in the prescribed form. The Registrar shall then inform about the
availability of proposed name. Thereafter, the company is got registered by filing an application with
the Registrar of Companies of the area in which registered office of the company is to be situated.
Such an application is filed by the promoters, and must be accompanied by requisite fees and documents.

2. Filing of documents and information with Registrar [Section 71: After getting the approval of
name, the application for registration of the company should be filed with the Registrar alongwith the
following documents and particulars:

(a) The 'memorandum of association': It is the document which describes the scope of company
activities It must be signed by the required number of persons which are necessary for the formation
of company, and who come forward to form it (i.e., seven in case of public, and two in case of private
company) [Section 7(1)(a)].

(b) The 'articles of association': It is the document which contains the rules and regulations of the
company. It must also be signed by all the persons who sign the memorandum of association [Section
7(1)(a)].

(c) Prescribed declaration: A declaration in the prescribed form stating that all the requirements of
the Companies Act, 2013 and rules made thereunder in respect of registration have been complied with.
Such a declaration should be given by [Section 7(1)(b)]:

(i) an advocate, a chartered accountant, cost accountant or a company secretary in practice who is
engaged in the formation of the company; and

(ii) a person named in the articles as a director, manager or secretary of the

(d) Affidavit of subscribers and first directors: An affidavit from each of subscribers to
memorandum, and from first directors named in 'articles' to the effect that they are not convicted and
have not been found guilty of any fraud, misfeasance or breach of duty under this Act or under any
previous company law during the last 5 years and all the documents filed with the Registrar are correct
and complete [Section 7 (1)(c)]:

(e) Correspondence address: The address for correspondence till the registered office of the company
is established [Section 7(1)(d)].

(f)Particulars of subscribers: The complete particulars of name including surname or family name,
residential address, nationality and prescribed particulars of every subscriber to the memorandum
including their proof of identity [Section 7(1)(e)].

(g) Particulars of first directors: The complete particulars of name, as stated above, including proof
of identity of persons named in Articles as first directors. The particulars of Director Identification
Number (DIN) should also be given [Section 7(1)(e)].
(h) Consent to act as directors and particulars of interest: The consent to act as directors, and
particulars of interest of first directors mentioned in company's articles of association [Section 7(1)(g)].

3. Registration by the Registrar: When the application for registration of the company alongwith the
requisite fee and above documents is presented to the Registrar for registration, the Registrar shall satisfy
himself regarding compliance of legal formalities, such as(a) The company is proposed to be formed for
lawful object.

(b) The 'memorandum of association' has been signed by the requisite number of persons (i.e.,
seven in case of public, and two in case of private company).

(c) The 'memorandum of association' and the 'articles of association' are prepared according to the
provisions of the Companies Act i.e., they do not go against the Companies Act.

(d) The prescribed declaration, affidavits and particulars have been duly signed and filed. (e) The
name of the company is acceptable i.e., the name is neither prohibited nor is similar to the name of any
existing company.

On being satisfied with all the above points, the Registrar will registrar the company and all documents,
and place the name of the company in a registrar known as the 'Register of Companies' [Section 7(2)].

4. Issue of certificate of incorporation: After the registration, the Registrar issues a 'certificate of
incorporation' (i.e., a certificate of the formation of company) in the prescribed form to the effect that the
proposed company is incorporated. In this way, the company is formed and comes into existence
[Section 7(2)].

Following points are important to note in this regard:

(a) Corporate Identity Number (CIN): On and from the date mentioned in the certificate of
incorporation, the Registrar shall allot CIN to the company. The CIN shall be a distinct entity for the
company. It shall also be included in the certificate of incorporation [Section 7(3)].

(b) Maintenance and preservation of documents: The company shall maintain and pressure, at its
registered office, the copies of all documents and information as originally filed with the Registrar for
registration, till its dissolution [Section 7(4)].
Changes brought in by the Companies Act, 2013

1. Increase in number of documents to be filed: The number of documents to be filed at the time of
registration of company have been increased as compared to lesser number of documents required
under the Companies Act, 1956. In this regard, new provisions are:

(a) Affidavits of subscribers and first directors as stated in point 2(d) above.

(b) An address for correspondence until registered office is established, as stated in point 2(e)
above.

(c) Proof of identity of subscribers and first directs, as stated in point 2(f) and 2(g) above. (d)
Particulars of interest of first directors as stated in point 2(h) above.

2. Corporate identity number: The Registrar shall allot a CIN to the company on registration.
It is a new provision. See point 4(a) above.

3. Preservation of documents till dissolution: It is also a new provision. See point 4(b) above.

4. 4. Increase in penalty: The penalty for furnishing false particulars at the time of registration of
company, has been increased as compared to earlier penalty.
3.5. CERTIFICATE OF INCORPORATION

A certificate of incorporation is one which certifies that the company is incorporated (i.e., formed). It is
issued by the Registrar of Companies. It contains the name of the company, Corporate Identity Number
(CIN), the date of its issue, and the signature of the Registrar with his seal. This certificate brings the
company into existence. The legal effects of the certificate of incorporation may be stated as under
[Section 9]:

1. The company comes into existence and it becomes a legal entity independent from its
members.

2. The subscribers to the memorandum become members of the company. 3. The company's life
starts from the date of the certificate of incorporation. 4. The company acquires a perpetual
succession i.e., it

remains in existence for ever unless

wound up according to the provisions of the Companies Act. In other words, the death, retirement,
admission etc., of the members of the company does not affect its existence. 5. The 'memorandum' and
'articles of association' become binding upon the company and all its members.

6. The liability of the members of the limited company becomes limited. Thus, on the issue of
certificate of incorporation, the company comes into existence with all the characteristics. ***

Note: In the Companies Act, 2013, the provisions relating to the certificate of incorporation are provided
in Sections 7(2) and 9 which correspond to the provisions made in earlier section 34 of the Companies
Act, 1956. Section 7(2) relates to registration of the company and issue of certificate of registration by
the Registrar, and Section 9 relates to the effect of registration (ie, incorporation). There is no change in
the new provisions.

3.6. CHALLENGE OF VALIDITY OF CERTIFICATE OF INCORPORATION

The validity of certificate of incorporation may be challenged by any person by making an application to
the Tribunal.

The legal provision in this regard is made in Section 7(7) of the Companies Act, 2013 which is a new
provision and has been made effective
w.e.f. 1.4.2014 vide Ministry of Corporate Affairs notification dated 26.3.2014.

The provisions of Section 7(7) may be stated as under:

1. Grounds of challenging validity: Any person may challenge the validity of certificate of
incorporation by making an application to the Tribunal when a company has been got incorporated

(a) by furnishing any false or incorrect information or representation; or

(b) by suppressing any material fact or information in any document or declaration or declaration
filed at the time of incorporation; or

(c) by any fraudulent act.

2. Order of Tribunal: On receipt of such application and on being satisfied that the situation
so warrants, the Tribunal may make the following orders

(a) Regulation of company: The Tribunal may pass such order as it may think fit for regulation of
the management of the company. The Tribunal may also order any change in company's memorandum
and articles which is necessary in public interest or in the interest of the company and its members or
directors [Section 7(7)(a)]; or
(b) Unlimited liability: The Tribunal may direct that the liability of the members of the company
shall be unlimited [Section 7(7)(b)]; or

(c) Removal of name: The Tribunal may direct the removal of company's name from the
Register of Companies [Section 7(7)(c)]; or

(d) Winding up of company: The Tribunal may pass an order for winding up of the company
[Section 7(7)(d)]; or

(e) Any other order: The Tribunal may pass such other order as it may deem fit [Section
7(7)(e)].

3. Consideration for making order: Before making any order as stated above, the following
provisions shall apply [Section 7(7), proviso]:

(a) The company shall be given a reasonable opportunity of being heard; and (b) The Tribunal shall
take into consideration the transaction entered into by the company, including the obligation, if any,
contracted; or payment of any liability.
Changes brought in by the Companies Act, 2013
1. The provision of Section 7(7), stated above, is a new provision, and there was no such
provision in the earlier Companies Act, 1956.

2. Earlier under Section 35 of the Companies Act, 1956, the certificate of incorporation was
considered to be conclusive evidence of registration of the company i.e., the certificate was
considered decisive and final with regard to registration of the company. Under the new
Companies Act, 2013 no provision with regard to conclusiveness of the certificate has been made.

3.7. COMMENCEMENT OF BUSINESS

We know that a company comes into existence when it is registered and a certificate of incorporation is
issued by the Registrar of Companies.
Thereafter, the company becomes entitled to commence its business.

It is important to role that the provisions relating to the commencement of business by the companies
were contained in section 11 of the companies Act, 2013 which imposed certain restrictions on
companies (public and private) to commence business. Now, this section 11 has been omitted by the
companies (Amendment) Act, 2015 w.e.f. 29.5.2015.

Thus, now a company (public or private) commence its business on obtaining certificate of
incorporation from the Registrar of companies.

Legal provisions of the omitted section 11 are explained in brief in the note hereunder for references of
the students.

Note: The legal provision of omitted section 11 in respect of commencement of business by the
companies were as under:

1. Legal requirements to commence business [Section 11(1)]: A company having share capital,
including a private company, can commence business or exercise borrowing powers only on the filing of
the following declaration and verification with the Registrar:
(a) Filing of prescribed declaration: A declaration, in such form and verified in such manner as
may be prescribed, is to be filed with the Registrar by the director stating
(i) that every subscriber to the memorandum has paid the value of shares agreed to be taken by him,
and

(ii) that on the date of making the declaration, the paid-up share capital of the company is not less
than 5 lakhs in case of a public company, and not less than one lakh in case of a private company
[Section 11(1)(a)].

(b) Filing of verification of registered office: The company has filed with the Registrar a verification
of its registered office in such manner as may be prescribed [Section 11(1)(b)].

2. Penalty for non-compliance [Section 11(2)]: In case of default of non-compliance of above

provisions, the penalty is as under:

(a) The company shall be liable to penalty which may extend to 5,000; and

(b) Every officer in default shall be punishable with fine upto 1,000 for each day during which the
default continues.

Thus, if the company commences its business or exercises borrowing powers without filing the above
declaration and verification, then the company and its officers in default are liable as stated above.

3. Consequences of non-filing of declaration within 180 days [Section 11(3)]: Where a declaration as
stated above in point 1(a), has not been filed with the Registrar within a period of 180 days of
incorporation. then the Registrar may initiate action for removal of company's name from the Register of
companies. The Registrar may initiate such action if he has reasonable cause to believe that the company
is not carrying on any business or operation.

3.8. PROMOTER OR COMPANY PROMOTER

This point is discussed under the following sub-heads:

3.8.1. General Definition of a Promotor

The term 'promoter' or 'company promoter' may be defined as a person who thinks of forming a
company, and actually brings it into existence. This term is used in many company matters. The
Companies Act itself uses it in various Sections and imposes liability on the promoters. Following are
some of the important definitions:

1. "A person who originates a scheme for the formation of the company, has the Memorandum and
Articles prepared, executed and registered, and finds the first directors, settles the terms of preliminary
contracts and prospectus (if any), and makes arrangements for advertising and circulating the prospectus
and placing the capital, is a promoter".

-Palmer.

2. "A promoter is one who undertakes to form a company with reference to a given project and to set it
going, and who takes the necessary steps to accomplish that purpose". Twycross v. Grant (1877) 2 CPD
469, 541.

-Cockbourn CJ in

3. "The term promoter is a term not of law but of business usually summing up in a single word a
number of business operations familiar to the commercial world by which a company is generally
brought into existence".

-Bowen CJ in Whaley Printing Co. v. Green (1880) 5 Q.B.D. 109.

4. "A promoter is a person who brings about the incorporation and organisation of a corporation. He
brings together the persons who become interested in the enterprise, aids in procuring subscriptions, and
sets in motion the machinery which leads to the formation itself".
-Bosher v. Richmond Land Co. 89 Va 455 (16) SE 360.
Thus, the promoter is a person who originates the idea of starting a business, plans the formation of a
company, and actually brings it into existence. He is the person who does the necessary preliminary work
incidental to the company. In simple words, a promoter is a person who brings a company into existence.
Whether a person is a promoter or not is a question of fact in each case. Much depends upon the nature
of the role played by him in the promotion of the company.

3.8.2. Legal Definition of Promotor

The term promoter was not defined in the earlier Companies Act, 1956 but it has now been legally
defined in Section 2(69) of the Companies Act, 2013 as under: A 'promoter' means a person

(a) Who has been named as such in a prospectus or is identified by the company in the annual
return referred to in Section 92; or

(b) Who has control over the affairs of the company, directly or indirectly whether as
shareholder, director or otherwise; or

(c) In accordance with whose advice, directions or instructions the Board of Directors of the company
is accustomed to act. However, nothing in this clause shall apply to a person who is acting merely in a
professional capacity.

3.9. LEGAL STATUS (POSITION) OF PROMOTERS

We know that the promoters are responsible for the formation of a company i.e., they bring the
company into existence. As such, the promoters occupy important position, and have very
wide powers relating to the formation of the company. It will, however, be interesting to know that so
far as the legal status (position) of a promoter (i.e., his relationship with the proposed company) is
concerned, he is neither an agent nor a trustee of the proposed company. He is not the agent because
there is no principal in existence. And he is not the trustee because there is no tru in existence. However,
it does not mean that the promoter does not have any legal relationship with proposed company. He
stands in a fiduciary relationship towards the company which he brings into existence. The position and
powers of the promoter becomes clear from the following observations:

"The promoters stand undoubtedly in a fiduciary position. They have, in their hand, the creation and
moulding of the company. They have the powers of defining how and when, and in what shape and
under what supervision the company shall start into existence and begin to act as trading corporation."

This fiduciary relationship imposes an obligation on the promoter to disclose fully all material facts
relating to the formation of the company. Moreover, his dealings with the proposed company must be
open and fair.

3.10. FUNCTIONS OF PROMOTERS

Following are the main functions of promoters:

1. To originate an idea of starting a business and forming a company.

2. To investigate the idea and know whether the formation of the company is possible and profitable.

3. To collect the requisite number of persons necessary for the formation of the company, and to find
out the first directors.

4. To settle the name of the company.

5. To settle the details of the 'memorandum' and 'articles of association of the company, and to get
these documents drafted and printed, and to arrange for the registration of the company.

6. To arrange for the preparation of the 'prospectus' and its issue.

7. To enter into preliminary contracts.

8. To pay preliminary expenses.

9. To arrange for the loan etc., from various financial institutions.

10. To perform such other functions as are necessary for the formation of the company.

11. 11. To conduct the negotiations for the purchase of business where it is intended to purchase an
existing business.

3.11. DUTIES AND OBLIGATIONS OF PROMOTERS

We have discussed in Art. 3.10 that the promoter stands in a fiduciary relationship towards the company
which he brings into existence. He, therefore, becomes bound to perform all such duties and obligations
which are imposed by this relationship. The duties of a promoter arising out of this relationship may be
summed up as under:

1. The promoters must not make, directly or indirectly, any secret profits at the expense of the
company which they are promoting. If they do so, the company may recover the same.

2. The promoters must disclose fully all the material facts regarding the formation of the company.

3. The promoters must faithfully disclose all the facts relating to the property which they want to sell
to the company. They should also disclose their interest in such property. Such disclosure of facts and
interest may be made in any one of the following ways:

(a) To an independent and competent board of directors.

(b) To the whole body of persons who are invited to become the shareholders of the
company.

(c) In the prospectus of the company.

(d) In the articles of association of the company.

If the promoters make any secret profits without disclosing the full facts, then the company may rescind
(put an end to) the contract made by the promoters. If the rescission of contract is not possible (e.g.,
where the company is not in a position to return the property), then the company can recover the secret
profits from the promoters.

4. The promoters must not make an unfair use of their position, and they must disclose to the
company their true position.

Thus, the promoters must act honestly. The following examples highlight the duties of promoters.

EXAMPLE 3.1. A group of persons headed by A, purchased an island for 2,50,000, containing the
phosphate mines. Thereafter, a company was formed to purchase this island and to work the mines. A
named five persons as directors of the company. The contract for the purchase of the island was then
entered into between the company and A. But at the time of this contract, two directors of the company
were abroad, two of the remaining three were under the complete control of A. These three directors
purchased the island for *5,00,000. The purchase of the island was adopted by the shareholders at their
first meeting, but the details of the sale were not disclosed to them i.e., the profits made by the
promoters and their influence over directors was not disclosed. After some time the company failed i.e.,
went into liquidation, and the liquidator filed a suit against the promoters (A and his group) to recover
the secret profits made by them on account of sale of their island to the company. It was held that the
promoters were liable for the secret profits as the promoters failed to disclose the full facts relating to
the sale.

EXAMPLE 3.2. A Syndicate (i.e, a group of persons) consisting of three persons A, B and C purchased
the great number of debentures of a company called 'Olempia & Co.' at heavy discount. These debentures
were secured by a charge over the property of 'Olempia & Co.' Subsequently, they (ie., A, B
& C) purchased the property of the 'Olempia & Co.' for £ 1,40,000, and resold the same to a new
company promoted by them for £ 1,80,000. Out of the £ 1,40,000 realised by 'Olempia & Co.', the
debentures held by A, B and C were paid in full, which resulted in profit of £ 20,000 to the debenture-
holders (ie, A, B and C). A, B and C became the first directors of the new company which they
promoted. They issued a prospectus inviting applications for the purchase of the shares of their new
company. In the prospectus, they disclosed the profit of £40,000 earned on the purchase of property,
but did not disclose the profit of £ 20,000 earned due to receipt of full amount of debentures. It was
held that there was not a sufficient disclosure of the secret profits made by the promoters, and they
must pay the secret (ie.. undisclosed) profit of £20,000 to the company.

It may, however, be noted that it is not the profit made by the promoters which the law forbids, but the
non-disclosure of such profits. Thus, the promoters are not prohibited from making profits by selling
their own property to the proposed company. The law only requires that the promoters must make the
full disclosure of all the material facts and profits made by them. It is also important to note that if the
persons making secret profits are not promoters at the time of making such profits, they are not bound to
disclose the same to the company of which they subsequently become the directors.

EXAMPLE 3.3. On 15th July 1999, three persons A, B and C purchased a mine for 5 lacs. After one
year i.e., on 14th July 1999, they entered into a provisional contract with one T, a trustee of a proposed
company for the sale of that mine for 7.5 lacs. Subsequently, when the company was registered, A and
B were appointed as the directors of the company. The company adopted the contract for the purchase
of mine from the sellers (i.e., A, B and C) for 7.5 lacs. However, A and B did not disclose the profit
made by them on the sale of their mine to the company. On coming to know of these profits, the
company filed a suit against the sellers (A, B and C) for the recovery of profit of 2.5 lacs. In this case,
the company cannot succeed in its action as the sellers were not the promoters of the company when
they entered into a contract for the sale of their mine to the company, and they were therefore not
bound to disclose this fact to the company

3.12. LIABILITIES OF PROMOTERS

The liabilities of the promoters are contained in various sections of the Companies Act, 2013, the
important of which may be summed up as under:

1. The prospectus issued by the promoters must state the matters and reports as specified in Section 26
of the Companies Act, 2013. If the promoters do not comply with this provision, then they may be held
liable for the same [Section 26, the Companies Act, 2013].

2. The prospectus of the company should contain the true statements. If it contains any untrue or
misleading statement or any omission of any matter then, the promoters are liable to the persons who
subscribe any shares or debentures on the faith of the prospectus. The liability of the promoters for
untrue statement in the prospectus is as under:

(a) They are liable to pay compensation to the subscribers for damages suffered by them due to
untrue statement [Section 35, the Companies Act, 2013].

They are also criminally liable, e.g., punishable with imprisonment for a term which may extend from
minimum 6 months to 10 years and shall also be liable to fine which shall not be less than the amount
of involved in fraud and may extend to three times the amount involved in the fraud [Sections 34, 447,
the Companies Act, 2013].

3. The promoters may also be liable to be examined publicly like any other director or officer of the
company. They can be so examined if, after the winding up order, the liquidator states in his report that a
fraud has been committed in the promotion or formation of the company and the Tribunal makes an
order for such examination [Section 300, the Companies Act, 2013].

4. The promoters are also liable to the company for deceit or breach of duty where they have
misappropriated or retained any property of the company, or are guilty of misfeasance or breach of
trust in relation to the company [Section 340, the Companies Act, 2013].

3.13. REMUNERATION OF PROMOTERS

It will be interesting to know that the promoters cannot claim remunerations from the company as a
matter of right. They can get remunerations for their services in promoting the company only if there is
a contract to that effect. If there is no such contract, the promoters cannot even recover the payments
made by them in connection with the formation of the company.

EXAMPLE 3.4. A syndicate (i.e., group of persons) promoted a company, and incurred certain expenses
in respect of fees, stamp duty etc., for the formation of the company. However, there was no contract
entitling the promoters to recover their remunerations etc., from the company. Later on, the company
failed and went into liquidation. The promoters sought to recover their expenses from the liquidator. It
was held that the promoters were not entitled to recover the expenses incurred by them.

Thus, a contract must be there entitling the promoters to receive remuneration from the company. When
the company is registered, it usually pays or agrees to pay some remuneration for the services rendered
by promoters. Their remuneration may be given in cash or by allotment of shares, or partly in cash and
partly in shares. The usual ways of paying remuneration to a promoter for his services, are as under:

1. He may be paid a certain lump sum.

2. He may be given shares of the company.

3. He may be given commission on the shares sold by the company.

4. He may be given an option to buy the shares of the company at par when their market price is
higher.
5. He may be paid the commission on the purchase price of the business or property acquired by the
company through him.
6. He may sell his own property to the company at a higher price and earn profits. However, the profits
in this way can be earned by him after making the full disclosure of facts.

3.14. PRE-INCORPORATION CONTRACTS

The 'pre-incorporation contracts' are those which are entered by the promoters on behalf of the
company before its incorporation (i.e., formation). Before the incorporation of the company, the
promoters usually enter into certain contracts for the purchase of assets on company's behalf.
Regarding the legal obligations of the company with regard to pre-incorporation contracts, the
following points are to be noted:

1. Not binding on the company: Ordinarily pre-incorporation contracts are not binding on the company
even after its incorporation. The reason for the same is that before incorporation, the company is not
competent to enter into contract in its own name as it has no legal entity. Thus, a company cannot be
sued for the pre-incorporation contracts.

EXAMPLE 3.5. The promoters of a proposed company engaged a solicitor to prepare the 'memorandum'
and 'articles of association' of the company and get it registered. Accordingly, the solicitor prepared these
documents, paid the registration fees, and got the company registered. The solicitor filed a suit against
the company for the recovery of his service charges and expenses incurred by him. It was held that the
company is not liable to pay for the services and expenses incurred by the solicitor. The court observed
that the company could not be sued in law for those expenses, in as much as it was not in existence at the
time when the expenses were incurred. [Re English & Colonial Product Co. (1906) 2 Ch. 435]. In CIT v.
City Mills Distilleries (P) Ltd. (1996) 2 SCC 375, the Supreme Court has also held that a company has
no status prior to its incorporation. It can have no income before incorporation for tax purposes.

Similarly, the company is also not entitled to sue on pre-incorporation contracts. As a matter of fact, the
company cannot take the benefit of a contract made on its behalf before its incorporation.
EXAMPLE 3.6. A entered into a contract with B, who acted on behalf of a syndicate (a proposed
company). Under the contract, A was to give to the syndicate the lease of coal mining rights. The
syndicate was then registered as B & Co. On registration, it asked for the agreed mining rights, which
4 refused to give. B & Co. filed a suit against A claiming that he (4) should be ordered to give lease of
mining rights to B & Co. It was held that the legal action by B & Co. is not maintainable as it was not
in existence when the contract between A and the syndicate was signed.

Thus, the company can neither be made liable for the pre-incorporation contracts nor it can take
benefit of these contracts.
2. Adoption (i.e., ratification) of contract by the company: The above stated principle that the
company is not bound by pre-incorporation contracts, is subject to the provisions of the Specific Relief
Act, 1963. The effect of this Act is that the pre-incorporation contracts can be enforced by or against the
company in certain circumstances. The relevant provisions of this Act may be summed up as under:

(a) Sometimes, the promoters of a public company have made a contract, before its incorporation, for
the purposes of the company. In such cases, the company may enforce the contract if it is 'warranted by
the terms of incorporation. The words 'warranted by the terms of incorporation' means within the scope
of the company's objects as stated in its memorandum of association. Moreover, the contract must also
be for the purposes of the company i.e., for the working of the company [Section 15]. (b) The other
party may also enforce the contract against the company, if the company has adopted the contract after
incorporation and it is within the terms of incorporation [Section 19].

Thus if the pre-incorporation contract is for the purposes of the company and within the company's
objects, it can be enforced by or against the company if the company adopts the same after
incorporation.

EXAMPLE 3.7. The promoters of a proposed ice manufacturing company entered into a contract with
A for the purchase of ice manufacturing machinery for the company. After the formation, the company
adopted the contract and sent the communication of acceptance to A. In this case, the contract is for the
purposes of the company, and therefore is enforceable by or against the company. [Imperial Ice
Manufacturing Co v. Manchershaw,
13 Bombay 415)

3.15. LIABILITY OF PROMOTERS FOR PRE-INCORPORATION CONTRACTS

We have discussed, in the last article, that the pre-incorporation contracts can be enforced by or against
the company if they are for the purpose of company and within the scope of company's objects, and the
company adopts them after incorporation. It may be noted that any contracts which do not fall within the
above provisions, can be enforced against the promoters personally i.e., the promoters are personally
liable for such contracts. However, the liability of the promoters depends upon the facts and
circumstances of the case and the construction of the contract. The principle on which the promoters are
held personally liable is that "where a contract is made on behalf of a principal known to both the
parties to be non-existent, the contract is deemed to have been entered into personally by the actual
maker". Thus, the promoter is personally liable if he purports to act as an agent, and the non- existence
of the company is known to both the parties.

EXAMPLE 3.8. A, a promoter and prospective director of a proposed company, entered into a contract
with B for the purchase of some stocks. A contracted on behalf of the company signing his name by
adding purchased by was consumed by the the words "for and on behalf of 4 & Co. Ltd." The stock
into liquidation. B filed a suit against 4 for the But before paying the price of the stock, the company
went recovery of the price of the stock. It was held that A was personally liable as he had contracted on
behalf of a principal (ie, company) which was not in existence at that time.

However, the promoters may avoid i.e., escape their liability by inserting the following clauses in the
original contract made by them:

1. If after incorporation, the company adopts the contract, the promoters shall be discharged from all
liabilities.
2. If after incorporation, the company does not adopt the contract within a specified or reasonable time,
either party (i.e.. the promoter or third party) may rescind (ie., put an end to) the contract.

Note: The company may adopt the contract by entering into a contract with the third parties on the same
terms as were embodied in the previous contract made by the promoters.

3.16. PROVISIONAL CONTRACTS

The provisional contracts are those which are entered by a company after its incorporation but before
the company becomes entitled to commence business. We have already discussed that a company,
having a share capital, becomes entitled to commence business only after filing a declaration and
verification of registered office with the Registrar. The contracts made by a company before filing these
documents are provisional.

Such contracts shall not be binding on the company until these declaration and verification are filed
with the Registrar.

MEMORANDUM OF ASSOCIATION

4.1. INTRODUCTION

The 'memorandum of association' briefly called the memorandum is the first importan document to be
filed with the Registrar at the time of formation of the company. The legal definition, meaning and
purpose of 'memorandum' is given here under:

1. Legal definition: The 'memorandum' is legally defined in Section 2(56) of the Companies Act,
2013, as under:

'Memorandum' means memorandum of association of a company as originally formed or as altered from

time to time in pursuance of any previous company laws or of this Act.

Thus, legally a memorandum means

(a) a memorandum as originally formed by the company, or

(b) a memorandum as altered by the company from time to time.

2. Meaning of memorandum: The memorandum is a document which lays down the powers and
objects of the company, and the scope of operations of the company beyond which its activities cannot
go.

It may rightly be called as a charter of the company as it contains the fundamental conditions upon which
the company is incorporated. It regulates the relationship of the company with the outside word.
The memorandum of company is a public document and every person who deals with the company is
presumed to have the sufficient knowledge of its contents.

3. Purpose of memorandum: The main purpose of the memorandum of association is to enable

shareholders, creditors and all those persons who deal with the company to know what are its powers,
and what is the range of its activities. Thus, the shareholders will come to know for what purpose their
investment is going to be utilised. They will also know the risk involved in the investment. The other
persons dealing with the company shall also know whether their dealings are in relation to the matters
within the objects of the company.

Note: The provisions with regard to memorandum of association have been modified and are provided
in Section 4 of the Companies Act, 2013. The new section makes a departure from the Companies Act,
1956 in the following respects:

(a) Now only Main Object Clause is required in the memorandum of association and there is no
provision of having Other Objects Clause. The requirement of approval of shareholders for pursuing
other objects have been done away with.
(b) The requirements with regard to the name of the company have been made part of the Act and
stated in Section 4 itself. Earlier these were prescribed in naming guidelines.

(c) The provisions pertaining to liability of a member in a company limited by shares have been
modified. Now the liability of the members of such a company is limited to the amount unpaid, if any,
on the shares held by them, including premium if any. Under the Companies Act, 1956, the liability
was limited to the amount unpaid on the face value of the shares.

4.2. FORM OF MEMORANDUM OF ASSOCIATION

Following legal provisions have been made in this regard:

1. The forms of memorandum of association are given in Tables A, B, C, D and E in Schedule I of the
Companies Act, 2013. The memorandum of a company must be in one of such forms as may be
applicable to the company, or in a form as near to these tables as the circumstances admit [Section 4(6)].

2. The memorandum of association must be printed, and divided into paragraphs which
should be consecutively (serially) numbered.

3. The memorandum should be signed by the required number of subscribers (seven in case of public
company and two in case of a private company).

4. The subscribers must sign in the presence of at least one witness, who shall attest the signatures of
each subscriber. Every subscriber must also add his address, description and occupation, if any. The
witness shall also write his address, description and occupation accordingly.

5. Only a person Sui juris i.e., who is capable of entering into a contract on his own, can subscribe to
the memorandum of association.

Notes: 1. An artificial legal person such as a company or body corporate is competent to subscribe to the
memorandum.

2. The memorandum of association must be stamped according to the provisions of the Stamp Act. The
stamp duty is paid as prevalent in the State in which the registered office of the company is to be situated.

4.3. CLAUSES (CONTENTS) OF MEMORANDUM OF ASSOCIATION

The memorandum of association of every company must have the following clauses: 1. Name Clause. 2.
Registered Office Clause. 3. Objects Clause.
4. Liability Clause. 5. Capital Clause. 6. Association or Subscription Clause.

4.4. NAME CLAUSE

This clause of 'memorandum of association' contains the name of the proposed company. The company
being a legal person, must have a name to establish its identity. As a matter of fact, the name is the
symbol of personal existence of the company. A company may choose any suitable name it likes. This
point may be discussed under the following sub-articles:

4.4.1. Legal Rules Relating to Selection of Name

The following rules as contained in Section 4 of the Companies Act, 2013, must be observed while
selecting a name of the company:

1. The name should not be undesirable: The name of the company should not be undesirable in the
opinion of the Central Government. If it is so, the company cannot be registered with such a name
[Section 4 (2)(b)]. This provision enables the Central Government to reject a name withou giving any
reason.
 2. The name should not be identical with another company's name: The name of the company
should not be identical with the name of an already existing company. It should also not too closely
resemble the name of another existing company [Section 4(2)(a)]. The purpose of prohibiting the use of
such names is that the company must not create an impression that it is carrying on the business of
another well established company. If the company gets registered with such a name, the other company
with whom the name resembles can also apply to the court for an order that the new company be
restrained from having an identical name.

EXAMPLE 4.1. A was carrying on a business under the name of 'Buttercup Dairy Company'. After
some time, a new company was incorporated under the name of "Buttercup Margarine Company Ltd. A
brought a legal action against the new company and sought an order that it should be restrained from
using the name of A's company. A contended that the name used by the new company created the
impression th the two companies were closely connected. The court passed the order restraining the new
company from using that name. [Ewing v Buttercup Margarine Company Ltd. (1917) 2 Ch: 1 However,
in order to obtain in injunction from the court, the resemblance between the two names must be such as
to be 'calculated to deceive' the customers. The name is said to be 'calculated to deceive' when it
suggests that a company adopting it is in some way connected or associated with the existing company.
If the name does not create such impression, the courts may refuse to grant injunction.

EXAMPLE 4.2. A company was registered under the name of "The Society of Motor Manufacturing
and Traders Ltd." Subsequently, another company was registered under the name of "Motor
Manufacturing and Traders Mutual Insurance Ltd." The first company brought an action to restrain the
use of this name. I was held that the name of the new company could not be regarded as one 'calculated
to deceive'. The court observed that "Anyone who took the trouble to think about the matter, would see
that the defendant company was an insurance company, and that the plaintiff society was a trade
protection society, and I do not think that the defendant company is liable to have its business stopped
unless it changes its name simply because a thoughtless person might unwarrantedly jump to the
conclusion that it is connected with the plaintiff society In this case, the name is not 'calculated to
deceive' because the names do not suggest that the companies are connected or associated with each
other. Because the first company is a trading company whereas the other is an insurance company. A
man of mind can distinguish between the two.

3. The name should not constitute an offence under law: The name of the company should not
constitute an offence under any law for the time being in force [Section 4(2)(b)]
Note: It is a new provision which was not there under the earlier Companies Act, 1956.

4. The name should not be a prohibited one: The name of the company should not prohibited by the
Emblems and Names (Prevention of Improper Use) Act, 1950. This Act prohibits the use of the name
and emblems of (a) U.N.O. and World Health Organisation, (b) Indian National Flag, (c) The official
Seal and Emblem of Central and State Government, (d) The name and pictorial representation of
Mahatma Gandhi, and Prime Minister of India.

5. The name should end with words Limited or Private Limited: The public company with
limited liability must add the word 'Limited' at the end of its name, and the private company the word
'Private Limited' [Section 4(1)(a)). The purpose of adding these words is that all persons dealing with
the company should have a clear notice that the liability of the members is limited. It may be noted that
in case of companies in which the liabilities of members are limited, the company's name is incorrect
without the use of the words 'Limited' or 'Private Limited as the case may be. If any contract is made on
behalf of the company by misdescription of its name i.e., by using incorrect name, then the officers of
the company who made the contract will be personally liable. However, the word 'Limited' need not be
used in full. The abbreviation "Lid." may be used for this word.

EXAMPLE 4.3. A was the director of AB & Co. Ltd. He accepted a bill of exchange on behalf of the
company and signed his name as director of AB & Co. In this case, as the word 'Limited' is omitted
from the name of the company. A is personally liable to pay the amount of the bill of exchange.

[Basudeo Lal v. Madan Lal AIR 1969 Orissa 107; Atkins & Co. v. Wardle (1889) Sometimes, the word
'Limited' is accidentally omitted from the name of the company, e.g., where the impression of the rubber
stamp is not complete on the paper, or where the stamp is longer than the paper itself etc. In such cases,
the persons signing the documents on behalf of the company cannot be personally held liable.

EXAMPLE 4.4. A and B were the two directors of AB & Co. Ltd. A bill of exchange drawn on the
company in its proper name was accepted by A and B on behalf of the company. But the rubber stamp
containing the name of the company was longer than the paper of the bill of exchange, and the word
"Ltd." was missed while affixing the stamp. In this case, A and B are not personally liable for the
amount of the bill of exchange as the omission of the word 'Ltd'. was accidental. Here, the company will
be liable to pay the amount of the bill of exchange.

Note: The companies formed for the promotion of commerce, art, science, religion, charity etc, may not
use the word 'Limited' at the end of their names if they get a licence from the Tribunal to that effect
[Section 4(1)(a), proviso]. This has already been discussed in detail in Chapter 2 in Art. 2.30.

6. Certain names to be used only with permission of Central Government: The company name
containing the following words or expressions can be used by the company only with the previous
approval of the Central Government [Section 4(3)]:

(a) any word or expression which is likely to give an impression that the company is in any way
connected with or having patronage of the Central Government, any State Government or any local
authority, corporation or body constituted by the Central or Statement Government; or

b) any word or expression as may be prescribed by the rules.

Note: It is a new provision which was not there under the earlier Companies Act, 1956.

4.4.2. Reservation of Name

Legal rules in this regard are made in Section 4(4), (5) of the Companies Act, 2013 which are as under:

1. Application to Registrar [Section 4(4)]: Any person may make an application, in the prescribed
manner accompanied by prescribed fee, to the Registrar for reservation of (a) the name of the proposed
company; or

(b) the name to which the company proposes to change its name.

2. Reservation by Registrar [Section 4(5)]: On receipt of the application, the Registrar may reserve
the name for 60 days from the date of application. While doing so, the Registrar shall take into
consideration the information and documents furnished alongwith the application.

3. Consequences of reservation of name by false information [Section 4(5)(ii)]: Where, after

reservation of name, it is found that the name was applied by furnishing wrong and incorrect
information, then the following consequences would follow:

(a) If the company has not been incorporated, then the reserved name shall be cancelled, and the
person making the application shall be liable to a penalty which may extend to Rs. one lakh.

(b) If the company has been incorporated, then the Registrar may, after giving an opportunity of
being heard to the company, proceed as under:

(i) direct the company to change its name within a period of 3 months, after passing an ordinary
resolution; or

(ii) take action for striking off the name of the company from the Register of companies; or

(iii) make a petition for winding up of the company.

4.4.3. Display of Name

The name of the company with which it is registered must be made known to the public. In this regard,
the following steps are required to be taken by the company [Section 12(3)]¹: (a) The name of the
company must be painted on the outside of every place where the business of the company is carried
on.

(b) The name of the company together with the address of its Registered Office must be engraved
on its seal.

(c) The name of the company together with the address of its Registered Office must also be
mentioned in all business letters, negotiable instruments, orders, receipts, notices and all other official
publications.

Notes: 1. The word 'Company' or 'Co.' or any other similar word need not form part of the name of the
company. Thus, the names such as 'AB Traders Ltd.' or 'AB Traders (Pvt.) Ltd.' are proper names even if
the word 'company' is not used.

2. Abbreviated names are not allowed at the first instance. An established company may change its
name into an abbreviated form by showing that it has become well-known in its field under it
abbreviation [DCA Circular No. 4/93, Dated 31-3-1993].

4.5. REGISTERED OFFICE CLAUSE

This clause of 'memorandum of association' contains the name of the State in which the Registered
Office of the company is to be situated [Section 4(1)(b)]. Following provisions are to be noted relating to
the registered office of the company:

1. Establishment of registered office: The registered office of the company must be in existence (i.e.,
established) on and from the 15th day of incorporation of the company. and at all times thereafter
[Section 12(1)].

2. Verification to be filed with the Registrar: The verification of the situation of the registered
office must be given to the Registrar of Companies within 30 days of the incorporation of the
company [Section 12(2)].

3. Importance of registered office: Its importance becomes clear from the following points:

(a) The situation of company's registered office determines the domicile of the company. The domicile
is important to determine the jurisdiction of the courts in which the legal actions are to be brought by or
against the company.

(b) All the important documents and books of the company such as Annual Returns, Minutes Books,
Register of Members, etc., are kept in the registered office. Moreover, all important communications,
notices, circulars, process of court and other correspondence relating to the company are also addressed
to its registered office.

Note: The expressions 'registered office' and 'head office' are not the same. The 'registered office' is one
with which the company is to be registered and to which all communications and notices may be
addressed. And the 'head office' is one where the substantial business of the company is carried on and
its negotiations are conducted. Usually, the 'registered office' and the 'head office' are at the same place,
but it need not be so. The 'head office' (or principal office) may be located elsewhere than the
'registered office'. The law requires that the notice of situation of the 'registered office' must be given to
the Registrar of Companies. But there is no such requirement in respect of 'head office'.
 Changes brought in by the Companies Act, 2013
1. The requirement of having registered office by the company is now necessitated on and from
the 15th day of its incorporation instead of 30th day of incorporation [Section 12(1)].

The verification of registered office is required to be furnished by the company to the Registrar

2. within a period of 30 days of its incorporation. There is no change on this point [Section 12(2)]. 3.
The penalty for non-compliance of provisions of section 12 has been increased from 500 per day of
default to 1000 per day but not exceeding rupees one lakh [Section 12(8)].

4.6. OBJECTS CLAUSE

This clause of 'memorandum of association' contains the objects for which the proposed company is to be
formed [Section 4(1)(c)]. It is the most important clause of the memorandum, and should be drafted very
carefully. The objects of the company must state in clear and definite terms:

(i) The objects for which the company is proposed to be incorporated; and
.

(ii) Any matter considered necessary in furtherance of the stated objects

The choice of objects rests with the subscribers to the memorandum. They are free to choose any
lawful objects for their company. This is, however, subject to the following restrictions:

(a) The objects should not be illegal or against the public policy, e.g., formation of a company for
conducting lotteries, trading with enemy, etc.

(b) The objects should not be against the provisions of the Companies Act. (c) The objects should
not be against the general law of the land, e.g., the law prohibits gambling. No company can be
formed for that purpose.

Thus, the company must be formed for lawful objects which should not be against the provisions of the
Companies Act, or any other Indian Law for the time being in force in the country.

Note: The Companies Act, 2013 makes a departure from the Companies Act, 1956 with regard to object
clause. Now only the main object clause required in the memorandum of association, and there is no
provision for other objects clause [Section 4].

4.7. PURPOSE OF OBJECTS CLAUSE

The purpose of requiring the company to state its objects in clear and definite terms may be summed up
as under:

1. It informs the members (i.e., the shareholders), the kind of business in which their mone may be
used. No doubt that the company is the owner of its capital. But in reality capital has been contributed
by the shareholders. Therefore, the shareholders must know the purpose for which their money will be
utilised.

2. It informs the persons dealing with the company, the powers of the company. In this it provides a
certain degree of protection to the creditors who can ascertain the power of the company. When they
know that the company is formed for sound objects, it give them a feeling of security.

3. It also serves the public interest, as the activities of the company are confined to a defined field
and the company cannot go beyond these activities.

Once the company is registered with the objects defined in the memorandum, it can exercise the powers
as are necessary for the attainment of its objects. However, a company cannot do anything which is
outside the scope of its stated objects. If it does any such act, is ultra vires and is void. Such act cannot
be ratified by the company even if the whole body of shareholders agrees to it. (The doctrine of ultra-
vires will be discussed later in this chapter).

Though the activities of the company should be confined to the objects specified in memorandum of
association, but the object clause is not to be construed i.e., interpreted strictly for the purpose of
company's activities. The company may, therefore, do such acts which are fairly incidental to the
objects/powers stated in the memorandum of association.

EXAMPLE 4.5. A company acquired a piece of land for the purpose of its railways. The company
constructed arches on this land, and the railroad (i.e., railway line) of the railway company was carried
over these arches. The company let out the arches as workshops. The running of workshops in the
arches was objected by certain persons, and it was claimed that the letting out the arches for this
purpose is ultra vires the company. It was held that the letting out of the arches was fairly incidental to
the powers of the company and thus was valid. The court observed that to hold otherwise, would be
like contending that the railway companies are not entitled to sell the hay which grows on their banks
so as to make something out of it
However, the acts which are not reasonably incidental to the objects of the company will be void and
inoperative on the ground of ultra-vires.

EXAMPLE 4.6. The memorandum of association of a company authorised it to acquire gold mines in
'Mysore and elsewhere'. The company wanted to acquire mines in another country Ghana. The compart
supported its action on the ground that the word 'elsewhere' authorised the company to acquire mine
another country also. It was held that the company could not do so as the word 'elsewhere' could not be
taken to mean any other place outside India.

More discussion and examples on the above point relating to the objects of the company wit be given in
Art. 4.17.

4.8. LIABILITY CLAUSE

This clause of 'memorandum of association' contains the nature of liability of the members the company.
This clause is necessary for those companies in which the liability of the member is limited. The
memorandum of such companies must state that the liability of the members limited.
The proposed company may be limited by shares, or by guarantee. In these cases, t liability clause
should state as under:

1. In case of companies limited by shares: The liability clause must state that the liability of the
members shall be limited to the amount unpaid, if any, on shares held by him Section 4(1)(d)(i)]. If the
shares are fully paid (i.e., all the amount has been paid), the the liability of the members is nil.

2. In case of companies limited by guarantee: The liability clause must state that the liability of the
members shall be limited by guarantee. In such cases, the liability clause will also state the amount
which every member undertakes to contribute to the assets of the company in the event of its winding
up [Sections 4(1)(d)(ii)). This means that if at the time of winding up of the company, the assets of the
company fall short to pay its debts and liabilities, then members shall contribute to the assets of the
company, the amount which they have undertaken to pay. It may be noted that a member cannot be
asked to pay anything before the company goes into liquidation.

4.9. CAPITAL CLAUSE

This clause of ‘memorandum of association' contains the amount of share capital with which the
company is to be registered. This clause should also state the number and value of shares into which the
capital of the company is divided. [Section 4 (1) (e)]. The capital with which the company is registered
is called the registered', 'nominal' or 'authorised' capital. The effect of this clause is that the company
cannot issue more shares than are authorised by its memorandum of association, except by altering the
memorandum as provided by Section 94.

The usual way to state the capital in the memorandum of association is as under: "The capital of the
company is 50,00,000 divided into 5,00,000 equity shares of 10 each".

4.10. ASSOCIATION OR SUBSCRIPTION CLAUSE

This clause of 'memorandum of association' contains the names of the persons who sign the
memorandum and states that they are willing to form themselves into a company. These persons are
called subscribers. In this clause, the subscribers must make a declaration reading as under "We, the
several persons whose names and addresses are subscribed, are desirous of being formed into a company
in pursuance of this memorandum of association, and we respectively agree to take the number of shares
in the capital of the company set opposite our respective names”2.

This declaration must be signed by each subscriber in the presence of at least one witness who must
attest the signatures. Moreover, every subscriber must also write his name, address, description and
occupation, if any, and the number of shares which he takes. It may be noted that every subscriber must
take at least one share. In case of a public company, the memorandum must be signed by at least seven
subscribers, and in case of a private company by at least two subscribers. After the memorandum is
actually registered, no subscriber can withdraw his name on any ground whatsoever. The memorandum
of association concludes with the subscription clause This being the concluding clause, it need not be
numbered.

4.11. ALTERATION OF MEMORANDUM OF ASSOCIATION

The provisions relating to alteration of memorandum are provided in Section 13 of the Companies Act,
2013, which correspond to Sections 16, 17, 18, 19, 21 and 23 of the Companies Act, 1956.

The new Section 13 has been made effective w.e.f. 1.4.2014 vide Ministry of Corporate Affairs
Notification dated 26.3.2014, and the discussion below is as per new section.

The memorandum of association is a very important document of a company. It cannot be altered by

the sweet will of the members of the company. It can be altered only by following the procedure as
prescribed in the Companies Act. It may be noted that the right of the company to alter its
memorandum is strictly limited to the provisions of the Companies Act. The procedure of alteration of
memorandum as prescribed in Section 13 is as under: resolution; and

(a) By passing special

(b) By complying with procedure specified in this section.

It is important to note that now special resolution has been prescribed for all changes in the
memorandum unlike for different resolutions for different clauses prescribed under the earlier
Companies Act, 1956 the alteration of memorandum is discussed under the following heads:

1. Alteration of name clause.

2. Alteration of registered office clause.

3. Alteration of objects clause.

4. Alteration of liability clause.

5. Alteration of capital clause.

These clauses are also known as conditions of memorandum and can be altered in accordance
with the legal provisions as discussed in the following pages.

4.12. ALTERATION OF NAME CLAUSE

This point may be discussed under the following sub-articles/topics:

4.12.1. Alteration of Name by the Company on its Own [Section 13]

Legal provisions in this regard are provided in Section 13 of the Companies Act, 2013, which correspond
to Section 21 of the Companies Act, 1956. Section 13 has been made effective wel 1.4.2014 vide MCA
Notification dated 26.3.2014, and its provisions may be stated as under:

1. b A company may alter (i.e., change) its name at any time. The only requirement is that the change
must be made by adopting the following procedure prescribed under Section 13:

(a) By passing a special resolution; and

(b) By obtaining the approval of Central Government in writing.

However, the approval of Central Government is not required when the change involves the addition or
deletion of the word 'Private' on the conversion of a public company into a private company or vice versa
[Section 13(2), proviso]. 2. Filing with the Registrar [Section 13(6)]: The company shall file the
following with the Registrar:

(a) Special resolution altering the name; and

(b) Approval of Central Government obtained for change of name. The special resolution should be
filed with the Registrar within 30 day of passing as under Section 117 every special resolution is
required to be filed with the Registrar within 30 days after passing.

3. Registration of alteration (Section 13(9)(10)]: The Registrar shall register the alteration and
certify the registration within 30 days from the date of filing the special resolution with him [Section
13(9)].

No alteration shall have any effect until it has been so registered by the Registrar [Section 13(10)].

4. Issue of fresh certificate of incorporation [Section 13(3)]: When any change in the name of the
company is made, then

(a) the Registrar shall enter the new name in the Register in place of the old name and issue a fresh
certificate of incorporation with new name;
(b) the change in the name shall be complete and effective only on the issue of fresh certificate.

4.12.2. Rectification of Name on Central Government Directions [Section 16]

Legal provisions in this regard are provided in Section 16 of the Companies Act, 2013, which correspond
to Section 22 of the Companies Act, 1956, which has been made effective w.e.f. 1.4.2014 vide MCA
Notification Dt. 26.3.2014.

As per Section 16, the company is bound to change its name on Central Government directions.
However, the company can change the name in this case by passing an ordinary resolution. The
provisions of Section 16 may be stated as under:

1. Where the name is identical or resembles the name of an existing company Section 16(1)(a)]:
Where on its own, the Central Government is of the opinion that the registered name of the company is
identical or too nearly resembles with the name of an existing company, then the Central Government
may suo moto (i.e., on its own) direct the company to change its name.

• One such directions the company shall change its name within 3 months
from the issue of such directions.

• The company can change its name by adopting an ordinary resolution for this purpose.

2. Where the name is identical or resembles to a registered trade mark (Section 16(1) (b)]:
Where on an application by the proprietor of a registered trade mark the Central Government is of the
opinion that the registered name of the company is identical with or too nearly resembles with an
existing trade mark, then the Central Government may direct the company to change its name.

● On such directions, the company shall change its name within 6 month
from the issue of such directions.

• The company can change its name by passing on ordinary resolution for this purpose. • The
application by the proprietor of a registered trade mark must be made within 3 years of registration of
the name of the company.

Notes: 1. The time limit of rectification of name under this clause has been increased to 6 months as
against 3 months under earlier section 22 of the Companies Act, 1956.

2. The time limit for making application to the Central Government by the proprietor of registered
trade mark has now been reduced to 3 years from
5 years prescribed under earlier Section 22 of the Companies Act, 1956.

3. Notice of change to the Registrar [Section 16(2)]: Where the company changes its name as
stated in points (1) and (2) above, then

(a) the company shall give a notice of change to the Registrar within 15 days of change alongwith the
order of Central Government; and

(b) on receipt of such notice of change, the Registrar shall carry out necessary changes in (i) the
certificate of incorporation, and (ii) memorandum of association. Note: The time period of filing notice
of change with the Registrar has been reduced to 15 days as against 30 days prescribed under Section
22 of the Companies Act, 1956.

4. Penalty for non-compliance of directions (Section 16(4)]: If the company fails to comply
with the directions of Central Government for change of name, then the penalty shall be as under:

(a) the company shall be punishable with fine of Rs. 1000 for every day during which the default
continues; and

(b) every officer of company who is in default shall be punishable with minimum fine of Rs. 5,000
which may extend to Rs. one lakh.

5. Right, obligations and legal proceedings not affected by change: The change of name does affect
the rights and obligations of the company. It also does not affect pending legal proceedings by or against
the company. Such legal proceedings may be continued by its new name.

After the change of name has been effected and registered in the register of companies, the legal
proceedings, if any, should be commenced by the company in its new name. The legal proceedings
commenced by the company in its old name may not be held competent by the court.

EXAMPLE 4.7. A tea company had changed its name from Malhati Tea Syndicate Ltd.' to 'Malhati
Tea and Industries Ltd.' The company filed a writ petition in the High Court in its former name. It was
held that the writ petition filed by the company was not competent. The court observed that after the
new name has been registered, the company is not authorised to commence a legal proceeding in its
former name. [Malhati Tea Syndicate Ltd. v.
Revenue Officer, AIR 1973 Calcutta 78]

However, where, after the change of name, any legal proceeding is commenced against the company in
its old name, it is a case of mere misdescription of name³. Such a defect can be cured by substituting the
new name with the permission of the court.

Note. A change of name does not bring into existence a new company. The company remains the same
entity as it was before. Only the name of the company changes. No doubt, a new certificate of
incorporation has to be issued, but that does not incorporate a new company. Thus, on the change of
name, neither a company is dissolved nor does any new company come into existence.

Changes brought in by the Companies Act, 2013

1. In case of company name identical with registered trade mark, time limit for change of name by
the company has been increased from 3 to 6 months [Section 16(1)(b)], Refer to Art 4.12.2.
(point 2).

2. In case of name identical with registered trade mark, time limit for making application to Central
Government for directions of change of name has been reduced from 5 years to 3 years [Section
16(1)(b)]. Refer to Art

3. In case of change on Central Government directions, the period filing the notice of change with
the Registrar has been reduced from 30 to 15 days [Section 16(2)].

4.13. ALTERATION OF REGISTERED OFFICE CLAUSE

Legal provisions with regard to alteration of registered office clause are provided in Sections 12 and 13
of the Companies Act, 2013, which were earlier contained in Sections 17, 18 and 146 of the Companies
Act, 1956.

The provisions of Sections 12 and 13 have been made effective w.e.f. 1.4.2014 vide MCA Notification
dated 26.3.2014, and may be discussed as under:

4.13.1. Change of Registered Office within the Local Limits of the City

The company can shift its registered office from one place to another within the local limits of the city,
town or village in which the registered office is situated by complying with following requirements:

1. Board Resolution: The company shall pass a Board resolution to that effect; and

2. Notice of change: The company shall give a notice of change of situation of registered office to the
Register within 15 days of the change [Section 12(4)]. On receipt of notice of change, the Registrar
shall record the same. Strictly speaking this change does not involve alteration of memorandum. Note:
The time limit of giving notice of change in situation to Registrar has been reduced to 15 days as
against 30 days prescribed under Section 146(2) of the Companies Act, 1956.

4.13.2. Change of Registered Office from One City to Another within Same State

This change also does not involve the alteration of memorandum. Legal provisions/steps required for
such a change are:

1. Procedure of change [Section 12(5)]: The company can shift its registered office outside the local
limits i.e., from one city to another by passing a special resolution to that effect. 2. Notice of change
[Section 12(4)]: On shifting the registered office, the company shall give a notice of change of situation
of registered office to the Registrar within 15 days of the change.

3. Filing of special resolution [Section 117]: The company shall file the special resolution, bringing
change in situation of registered office, with the Registrar within 30 day of passing the resolution.

Note: The time limit of giving notice of change of situation of registered office has been reduced to 15
days as against 30 days prescribed under Section 146(2) of the Companies Act, 1956.

4.13.3. Change from Jurisdiction of One Registrar to another Registrar within Same State

Legal provisions/steps required for such a change are:

1. Procedure of change [Section 12(5), proviso]: The company can shift its registered office from
jurisdiction of one Registrar to the jurisdiction of another Registrar by adopting the following
procedure:

(a) By passing special resolution to that effect; and

(b) By obtaining confirmation from Regional Director to the shifting of office. The special
resolution passed by the company shall be filed by the company with the Registrar within 30 days of
passing [Section 117].

2. Confirmation by Regional Director [Section 12(5), proviso]: A company shall not change the
place of its registered office from jurisdiction of one Registrar to that of another unless such change is
confirmed by the Regional Director. Legal provisions in this regard are:

(a) Application to Regional Director: The company shall make application for confirmation to the
Regional Director in the prescribed manner.

(b) Communication of confirmation by the Regional Directors: On receipt of application, the

Regional Director shall communicate the confirmation to the company within 30 days from the date of
receipt of application [Section 12(6)].

(c) Filing of confirmation by the company: The company shall file the confirmation with the
Registrar within 60 days of date of confirmation [Section 12(6)].

(d) Registration and certificate of confirmation: On receipt of confirmation, the Registrar shall
register the same and issue certificate of registration of change within 30 days from the date of
filing such confirmation [Section 12(6)].

3. Certificate of registration of change [Section 12(7)]: The certificate of registration of change

issued by the Registrar, as stated in point(d) above, shall be a conclusive evidence that all the
requirement of the Companies Act, 2013 with respect to change of registered office have been complied
with.

4. Effective date of change [Section 12(7)]: The change of registered office shall take effect from the
date of certificate of registration of change of registered office as stated above,

5. Notice of change [Section 12(4)]: On shifting the registered office, the company shall give a notice
of change of situation of registered office to the Registrar within 15 days of change.

Note: This time limit was 30 days under Section 146(2) of the Companies Act, 1956.

4.13.4. Change of Registered Office from One State of Another

Such a change in the registered office requires alteration of memorandum, and legal provisions in this
regard may be stated as under:

1. Procedure of change [Section 13(1) (4)]: The company can shift its registered office from one
State to another by adopting the following procedure. a special resolution, and

(a) By passing

(b) By obtaining the approval of the Central Government.

Thus, the first step for such a change is to pass a special resolution and the second step is to apply to the
Central Government for its sanction. It may be noted that the alteration of registered office from one
State to another shall not take effect unless it is confirmed by the Central Government on a petition
[Section 13(4)].
2. Procedure of obtaining approval of Central Government [Section 13(4)(5)]: Legal provisions
for obtaining approval of Central Government are:

(a) The company shall make an application for approval to the Central Government such form
and manner as may be prescribed [Section 13(4)].

(b) The Central Government shall satisfy itself about the following before passing its order
[Section 13(5)]:

(i) that the alteration has the consent of creditors, debenture - holders and other persons concerned
with the company; or

(ii) that sufficient provision (or security) has been made by the company for due discharge of all its
debts and obligations.

(c) The Central Government shall dispose of (i.e., decide) the application within 60
days.

Note: Under the earlier Companies Act, 1956, no time limit was prescribed for the Central Government
to dispose of the application as stated in point(c) above.

3. Filing requirements by the company [Section 13(6)(7)]: These are as under:

(a) Special resolution: The special resolution altering the registered office clause shall be filed by the
company with the Registrar of the State in which registered office is situated [Section 13(6)].

The special resolution should be filled with the Registrar within 30 days of passing as under Section
117 every special resolution is required to be filed with the Registrar within this period of 30 days.

(b) Certified copy of Central Government order of approval: Legal requirements of filing this
certified copy by the company are as under Section 13(7)]:

• It shall be filed with the Registrar of each State, who shall register it
• It shall be filed in such time and in such manner as may be prescribed.
• The Registrar of new State (Le.. where office is being shifted) shall issue a fresh
certificate of incorporation indicating alteration.

4. Registration of alteration (Section 139(10): The Registrar shall register the alteration of shifting of
registered office to another State, and shall certify the registration within 30 days from date of filing
special resolution within (Section 13(9)). No alteration of memorandum shall have any effect until it is
so registered with the Registrar [Section 13(10)]

5. Notice of change of situation (Section 12(4): On shifting the registered office, the company shall
give a notice of change of situation of registered office to the Registrar within 15 days of change.

Note: This time limit was of 30 days under earlier Section 146(2) of the Companies Act, 1956. 6. New
certificate of incorporation (Section 13(7): The Registrar of State where registered office is being
shifted shall issue a fresh certificate of incorporation indicating the alterations.

Notes: 1. The State's objection to the shifting of registered office out of State on the ground of loss of
revenue or adverse effect on employment opportunities, is not a relevant consideration

2. Where the shifting of company's registered office from one State to another is refused once, it is not a
bar to ordering change subsequently if the circumstances are so altered so as to make the shifting of
registered office necessary in the interest of the company. Thus, the shifting of registered office from one
State to another cannot be refused by the Central Government on the ground that the change in
company's registered office has already been refused once. (See Promode Kumar Minal v. v. Southern
Steele Ltd. (1980) 50 Company C y Cases $55 (Calcutta))
 Changes brought in by the Companies Act, 2013

1. Earlier, under the Companies Act, 1956, the shifting of registered office from one State t another
State was allowed only if it was necessary for the purposes specified in Section 17 of that Act. Now there
is no provision corresponding to Section 17, as such so specified purpose is required to be shown for such
shifting of registered office from one State to another However, there has to be some justification for such
shifting

2. Now the application of approval of shifting of registered office out of State should be dispose of by
the Central Government within 60 days. Earlier, there was no such time limit fixed for disposal of
application.
4.14. ALTERATION OF OBJECTS CLAUSE

The legal provisions in this regard are provided in Section 13 of the Companies Act, 2013, which were
earlier contained in Sections 17 and 18 of the Companies Act, 1956. The provisions of Section 13 (ie,
steps required for alteration of objects) may be stated as under

1. Procedure for change (Section 13(1)(8): The procedure for change of objects clause may be
discussed as under:

(a) Procedure in general (Section 13(1)]: The company can change the object clause of its
memorandum by passing a special resolution to that effect.

(b) Procedure where company has unutilised money raised for its objects [Section 13(8)]: A
company which has raised money from public (through prospectus) for its objects and still has unutilised
money, cannot change its objects for which money is so raised unless:

i. a special resolution is passed by the company; and

ii. the justification for change is indicated by publishing prescribed particulars of

the special resolution in newspaper and placing the details on company
website, if any.

iii. an opportunity to exit is given to the dissenting shareholders.

2. Filing of special resolution [Section 13(6)(a)): The company shall file with the Registrar the
special resolution altering the objects clause.

The special resolution should be filed with the Registrar within 30 days of passing as under Section 117
every special resolution is required to be filed with the Registrar within 30 days of passing.

3. Registration of alteration (Section 13 (9)(10)]: The Registrar shall register the alteration and
certify the registration within 30 days from the date of filing the special resolution with him.

No alteration of memorandum shall have any effect until it has been so registered with the Registrar
[Section 13(10)].

Changes brought in by the Companies Act, 2013

1. Earlier, under the Companies Act, 1956, the alteration of object clause was allowed only if it was
necessary for the purposes specified in Section 17 of that Act.
Now, in the Companies Act, 2013, there is no provision corresponding to Section 17, as such no
specified purpose is required to be shown for change of objects clause. However, there has to be
justification for alteration of object clause.

2.Where company has unutilised money raised for the objects, then additional compliance is required
as stated in point (1)(b) above. Earlier, there was no such provision under the Companies Act, 1956.
4.15. ALTERATION OF LIABILITY CLAUSE

We know that an important characteristic and advantage of a company is the limited liability of
members (shareholders). As a matter of fact, it is the main attraction for persons to invest their money
in the company. Generally, the company cannot alter the liability clause of its memorandum so as to
increase the liability of the members. The liability of members can be increased only if the concerned
member agrees in writing.

4.16. ALTERATION OF CAPITAL CLAUSE

The company may alter the capital clause of its memorandum by adopting the procedure prescribed in
the Companies Act. It may, however, be noted that the company can alter (change) its capital only if it is
so authorised by its 'articles of association'. Certain alterations in the capital clause may be made by
passing an ordinary resolution, and certain by a special resolution. Following types of alterations can be
made simply by passing an ordinary resolution:

1. Increase of share capital by issue of new shares.

2. Consolidation or sub-division of existing shares into shares of larger or smaller amount.

3. Conversion of fully paid shares into stock, and conversion of stock into fully paid shares.

4. Cancellation of unissued shares.

However, if the alteration is by way of 'reduction of share capital', it can be made only by passing a
special resolution and obtaining the confirmation from the Tribunal. The alteration of the capital clause
will be discussed in detail in Chapter 8.

4.17. DOCTRINE OF ULTRA-VIRES

The term 'ultra' means beyond, and the term 'vires' means powers. Thus term 'ultra-vires' means doing an
act beyond the powers. The law relating to the doctrine of ultra-vires may be discussed as under:

4.17.1. Categories of Ultra-vires Acts

The ultra-vires acts may be categorised as under:

1. An act ultra-vires the directors: It is an act which is beyond the powers of the directors.
2. An act ultra-vires the articles of association: It is an act which is beyond the powers given by the
articles of association.
3. An act ultra-vires the company (or memorandum of association): It is an act which is beyond the
powers given by the memorandum of association. As a matter of fact, such act is beyond the legal powers
of the company, and is also known as 'ultra-vires the company'.

4.17.2. Legality of Ultra-vires Acts

The legality (or validity) of ultra-vires acts is as under:

1. An act of the company which is ultra-vires the directors, is not altogether void and inoperative. It
can be ratified by the general body of shareholders. When the act is so ratified, the company becomes
bound by the same.

2. An act which is ultra-vires the articles of association, is also not altogether void and inoperative. It
can also be ratified by the company by making necessary alterations in the articles of association by
passing a special resolution. Thereafter, the company becomes bound by such act. It may, however, be
noted that such an act can only be ratified if it is intra-vires the company i.e., within the powers of the
company.
3. The acts which are 'ultra-vires the company' are wholly void and inoperative as they are beyond the
legal powers of the company. The company is not bound by such acts. It may be noted that such acts
cannot be ratified even by the whole body of shareholders. The doctrine of ultra-vires is generally
meant for this category of ultra-vires acts. We know that a company is formed only for the objects
stated in its memorandum of association. The company, therefore, has the powers to do the following
acts:

(a) Which are essential for the attainment of the objects stated in memorandum of association'.

(b) Which are reasonably and fairly incidential to the attainment of its objects.

(c) Which are otherwise authorised by the Companies Act. If the company does any other act which is
not covered by the above powers, that will be ultra vires the memorandum (or company), and shall be
wholly void and inoperative. The company is not bound by the acts which are ultra-vires the
'memorandum of association' i.e., beyond the legal powers of the company. However, if the acts are
within the powers of the company, any irregularity in doing the acts may be cured with the consent of all
the shareholders. The purpose of this doctrine is to protect the interest of the investors and creditors. The
interest of investors is protected in a way that they know the purpose for which their money is going to
be used, and due to this doctrine the company cannot depart from its objects. Similarly, the interest of
creditors is also protected as they feel assured that company's assets will not be risked in unauthorised
business activities.

4.17.3. Application of the Doctrine of Ultra-vires

The application of the doctrine of ultra-vires is clear from the following examples based decided cases.

EXAMPLE 4.8. The 'memorandum of association' of a company defined its objects as "to make and
sell, or to lend on hire, railway carriages and wagons, and to carry on the business of mechanical
engineers and general contractors". The company entered into a contract with another firm of railway
contractors, to finance the construction of railway line in Belgium. This contract was, however, ratified
by the special resolution of the company. Later on, the company repudiated the contract as an ultra-
vires. The firm of railway contractors brought an action against the company for damages for breach of
contract. The firm contended that the contract is well within the world 'general contractors' as used in
the objects clause, and secondly that the contract was also ratified by the majority of shareholders. The
company defended the action on the ground of ultra-vires. It was held that the contract was ultra-vires the
company, and therefore, null and void, and could not be validated even by the unanimous consent of all
the shareholders. In this case, the House of Lords observed as under:

"The term 'general contractors' must be taken to indicate the making generally of such contracts as are
connected with the business of mechanical engineers. If the term general contractors' is not so
interpretted, it would authorise the making of contracts of any and every description, such as, for
instance, of fire and marine insurance, and the memorandum in place of specifying the particular kind of
business would virtually point to the carrying on the business of any kind whatever and would,
therefore, be altogether unmeaningful. Hence, the contract was entirely beyond the objects in the
'memorandum of association....... it is not a question whether the contract ever was ratified or not
ratified. If it was a contract void at its beginning it was void because the company could not make the
contract".
EXAMPLE 4.9. The 'memorandum of association' of a company stated that, "it was formed for
working a German patent which would be granted for manufacturing coffee from dates; for obtaining
other patents for improvements and extensions of the said invention; and to acquire and purchase any
other invention for similar purposes". The company could not get the intended German patent. But the
company purchased a Swedish patent and started making and selling coffee from dates. The petition for
winding up was presented by the two shareholders of the company. It was held that the main object for
which the company was formed had become impossible, therefore, it would be just and equitable to
wind up the company. In this case, the main object of the company was to manufacture coffee under a
German patent.

EXAMPLE 4.10. The directors of a company were authorised by its memorandum of association, to
make payments towards any charitable or any benevolent object, or for any general public, or useful
objects Exercising this power, the directors paid rupees two lacs to a trust formed for the purpose of
promoting technical and business knowledge. The payment was held to be ultra-vires. The Supreme
Court observed that the directors could not spend the company's money on any charitable or general
object which they might choose. They could spend for the promotion of only such charitable objects as
would be useful for the attainment of company's own object. The company's business having been taken
over by the Life Insurance Corporation, it had no business of its own to promote.

Whether a particular act on the part of the company is within its powers is a question of fact, and is to be
decided on the construction of the terms of its 'memorandum'. However, the doctrine of ultra-vires
should not be understood and applied unreasonably. The acts which are reasonably fair and incidental
to the objects of the company, should not be regarded as ultra-vires unless they are expressly prohibited.
The Companies Act itself requires that the incidental objects should be stated in the objects clause.
Even if they are not stated, they should be allowed by the principle of reasonable construction.

EXAMPLE 4.11. A railway company was authorised to keep steam boats for the purpose of a ferry
(1.e., to carry the persons across in a boat). It used the boats for excursion trips (ie, pleasure trips) to the
sea when the boats were otherwise unemployed. It was held that the act of company was not ultra-
vires.

EXAMPLE 4.12. A gas company was authorised by its memorandum of association (a) to make and
supply gas, (b) to manufacture and sell residuals arising from gas making, and (c) to provide such
apparatus and materials as it deemed requisite for those purposes. For the purpose of converting a
particular residual into a marketable product, caustic soda was required which the company used to
purchase from market. After purchasing caustic soda for a number of years it decided to manufacture its
own caustic soda. It was held that this act was not ultra vires the company. In this case, the fact of
manufacturing caustic soda was essential and incidental to the fulfilment of company's main objects.

It may, however, be noted that a company cannot carry on the activities which are neither essential
nor incidental to the fulfilment of its objects.

EXAMPLE 4.13. A company was authorised, by its memorandum of association, to pay pension to
former employees, their widows and children. One of the former directors of the company died, and five
years after his death the company decided to pay a fixed amount to his widow as pension. It was held
that the payment of pension was ultra-vires as it was neither for the benefit of the company nor it was
incidental to the business of the company. In this case, there was no power in the memorandum to make
such a payment. The memorandum authorised the company to make the payment of pension to the
former employees, their widows and children. But the directors are not employees

Sometimes, company's main object comes to an end, or the company abandons its main object. In such
cases, the company cannot continue to pursue its subsidiary objects.

EXAMPLE 4.14. A company was authorised, by its memorandum of association, to act as a bank, and
further to invest the money in securities and land. After some time, the company abandoned its banking
business and confined itself to the subsidiary object i.e., to make investment in securities, etc. It was
held that the company was not entitled to do so. [Crown Bank, Re (1890) 44 Ch. D. 634)

The legal position of the ultra-vires acts may be summarised as under:

1. An act which is ultra-vires the director i.e., beyond the powers of the directors, is not altogether void
and inoperative. It can be ratified by the general body of shareholders if it is within the powers of the
company.

2. An act which is ultra-vires the articles of association Le.. beyond the powers given by the
articles is also not altogether void and inoperative. It can be ratified by the company by making
necessary alteration in its articles by passing a special resolution.

3. An act which is ultra-vires the memorandum i.e., beyond the powers given by the memorandum, is
wholly void and inoperative. It cannot be ratified even by the whole body of shareholders. As a matter of
fact, an act ultra-vires the memorandum is in fact ultra-vires the company itself.
4.18. EFFECTS OR CONSEQUENCES OF ULTRA-VIRES ACTS

The effects of ultra-vires acts may be discussed under the following heads:

1. Injunction against the company: In case any ultra-vires act has been done or is about to be
done, any member of the company can obtain an injunction from the court i.e., he may obtain a court
order restraining the company from proceeding with the ultra-vires acts.

2. Personal liability of directors to the company: The directors of the company are personally liable
to the company for the ultra-vires acts. It is the duty of the directors to see that company's capital is used
for the legitimate objects of the company. If company's money is used for any purpose which is in no
way connected with the company's objects, the directors will be personally liable for the same i.e., they
can be compelled to restore such funds to the company.

EXAMPLE 4.15. The directors of a company paid dividends on shares out of capital. In this case, the
directors were held liable to refund the money, so paid, to the company. The reason for the same is that
the dividend can be paid out of profits only. The payment of dividend out of capital is ultra-vires.

Similarly, where the directors apply company's money on unauthorised objects, they are liable to make
good the company's loss.

Sometimes, the persons receiving the money know that the payment to them is ultra- vires. In such
cases, the directors can recover the money from such persons.

3. Personal liability of directors to third party: The directors of the company are also personally
liable to the third party as they exceed their authority by doing ultra-vires acts. It is the duty of an agent
to act within the scope of his authority. If he exceeds his authority he will be personally liable to the
third party. The directors are the agents of the company, therefore, they should not go beyond their
authority. If they induce any outsider (third party), to contract with the company in a matter in which
the company has no power to act, they will be personally liable for any loss suffered by the outsiders.

EXAMPLE 4.16. A railway company was authorised by its memorandum of association, to borrow
money to the extent of 5 lacs by issuing debentures. The company, by an advertisement, invited proposal
for a loan on debentures. At the time of the publication of this advertisement, the company had fully
exhausted its borrowing powers. A offered a loan of 10,000 on the footing of this advertisement. The
directors accepted this amount of loan, and issued debentures of the company to A. It was held that the
loan accepted by the company was ultra vires as the company had already exhausted its borrowing
power. Further, the directors were held personally liable to repay this amount of loan to A. In this case,
the directors, by an advertisement, had made the persons to believe that they had the power to borrow
which in fact they did not possess. [Week v.
Propert (1873) LR 8 CP 427]

4. Ultra-vires contracts are void: A contract which is ultra-vires the company i.e., beyond
company's powers, is void and without any legal effect. This is so because the company is not at all
competent to enter into such contracts. It may be noted that the ultra-vires contracts cannot become
intra-vires by subsequent ratification.

Though the ultra-vires acts are void, but the company is entitled to bring a legal action for the
protection of its property even if acquired by unauthorised acts or expenditure.

EXAMPLE 4.17. A telephone company was authorised by its memorandum of association, to put up
telephone wires in certain areas. The company acquired some telephone wires and put up the same in
an area which was not mentioned in the memorandum. Certain person cut down the telephone wires in
the area where the company was not authorised to put on the wire. The company filed a suit against
these persons for claiming damages. It was held that the company was entitled to recover damages
from these persons.

4.19. EXCEPTIONS TO THE DOCTRINE OF ULTRA-VIRES

We have already the doctrine of ultra-vires according to which the ultra- vires acts i.e., the acts which
are beyond the powers of the company, are void and inoperative. However, in the following exceptional
circumstances, the ultra-vires acts are not absolutely inoperative:

1. If the company acquires some property by ultra-vires expenditure, the company's right over the
property will be protected. The reason for the same is that such property though acquired by making
unauthorised expenditure, represents the company's property.

2. If the company acquires some property under an ultra-vires contract, the same can be recovered
from the company if it exists and is traceable in the hands of the company.

3. If the company takes an ultra-vires loan and uses it to pay of its own debts, then the money-lender
gets the rights of that creditor whose loan has been paid by the company, and can recover his money
from the company.

4. If any person borrows money from the company under an ultra-vires contract, the company has
the right to sue and recover the money from him.

5. If a director of a company makes payment of certain money, which is ultra-vires the company, he
can be compelled by the company to refund it. However, the director may claim indemnity (i.e.,
compensation) from the person who received the money knowing that it is ultra-vires.

6. The company may be held liable for the ultra-vires torts (ie, civil wrongs) of its employees.
However, the company will be liable only if the following points are proved, that:

(a) The tort was committed in the course of an activity which falls within the scope of
company's memorandum, and

(b) The employee committed the tort within the course of his employment.

4.20. DOCTRINE OF ULTRA-VIRES AN ILLUSORY PROTECTION

We know that the purpose of the doctrine of ultra-vires is to protect the interest of the shareholders and
creditors of the company. But it has been criticised by the Bhabha Committee on Company Law
Reforms which has observed that "this doctrine is an illusory protection to the shareholders, and a
pitfall for third parties dealing with the company". The reason for such criticism of this doctrine is that it
has not been proved effective in protecting the interest of the shareholders and creditors. This criticism
of the doctrine is due to the following reasons:

1. The 'memorandums of association' are so widely drafted that all probable acts are covered in the
objects clause. It is then possible for the company to extend its operations at any time and, therefore,
the doctrine becomes ineffective.

2. The directors generally consider that all their activities are within the powers until they are
challenged in the Courts of Law. The shareholders may not go to courts all the time. And thus they may
not be actually protected by the doctrine of ultra-vires.

Thus, certain complications are there in the application of the doctrine of ultra-vires. The English
Company Law Revision Commission (known as the Cohen Committee, 1945) recommended the
abolition of the doctrine of ultra-vires. It was further suggested that the memorandum should make a
contract only between the shareholders and company. Every contract made on behalf of the company
whether within or beyond its powers should be made valid". Thus, some efforts are necessary to protect
the interest of shareholders and the third parties dealing with the company.

4.21. FORMS OF MEMORANDUM OF ASSOCIATION AS GIVEN IN TABLES A, B, C,

D AND E OF SCHEDULE 1
The Tables A, B, C, D and E of Schedule 1 of the Companies Act, 2013 contain the forms of
'memorandum of association' of various types of companies. The type of company and the
corresponding Table containing the form of memorandum is as under:

S.NO. TYPE OF COMPANY MEMORANDUM FORM

1. Company Limited by Shares Table- A

2. Company Limited by Guarantee Table B

and Not Having Share Capital

3. Company Limited by Guarantee Table C

and Having Share Capital

Unlimited Company and Not Table D

4. Having Share Capital

5. Unlimited Company and Having Table-E

Share Capital

ARTICLES OF ASSOCIATION

5.1. INTRODUCTION

The 'articles of association', briefly called 'articles', is the second important document which has to be
filed with the Registrar at the time of registration of the company.

The legal definition and meaning of 'articles of association' is given hereunder:

1. Legal definition: The 'articles of association' is legally defined in Section 2 (5) of the Companies
Act, 2013 as under:

"Articles' means articles of association of a company as originally framed or altered from time to time
or applied in pursuance of any previous company or of this Act."

Thus, legally the articles means

(a) The articles as originally framed; or

(b) The articles altered or applied by the company from time to time.
2. Meaning of articles: The 'articles of association is a document containing the rules and regulations
framed by the company for its own governance. In other words, (these are the rules, regulations and
bye-laws for the internal management of the company. Following points are important to note with
regard to articles

(i) The 'articles of association' is subordinate to and controlled by the 'memorandum of association'.
The 'memorandum of association' lays down the objects and powers of the company, and the 'articles of
association' lays down the modes in which the objects of the company are to be carried out by the
members.

(ii) As this document is subordinate to the 'memorandum of association' therefore framing the rules
and regulations it must be kept in view that they do not exceed the
powers of the company given by the 'memorandum of association'. Moreover, these rules and regulations
must not be contrary to the provisions of the Companies Act.

5.2. IMPORTANCE OF ARTICLES OF ASSOCIATION

The articles of association' of a company play a very important role in the management of the affairs of a
company. The Companies Act contains many provisions under which the company can act only if it is
authorised by its articles. Following are some of the important provisions wherein the company can act
only if so authorised by its articles:

1. To issue redeemable preference shares [Section 55].

2. To accept calls in advance from shareholders [Section 50].

3. To increase share capital [Section 61 (1) (a)].

4. To consolidate and divide its share capital into shares of larger amount than existing shares
[Section 61 (1) (b)].

5. To convert its fully paid-up shares into stock, and to reconvert that stock into fully paidup shares
[Section 61 (1) (c)].

6. To sub-divide its shares into shares of smaller amount than is fixed by the memorandum [Section
61 (1) (d)].

5.3. FORM OF ARTICLES OF ASSOCIATION

The forms of 'articles of association' are given in Tables F, G, H, I and J in Schedule I of the Companies
Act, 2013. The articles of association of a company must be in one of such model forms as may be
applicable to the company [Section 5 (6)].

A company may adopt all or any of the regulations contained in these model articles applicable to such
company [Section 5(7)].
The articles of association must be printed and divided into paragraphs which should be consecutively
(serially) numbered. Generally, each paragraph should contain one regulation. This document should be
signed by the subscribers to the 'memorandum of association' [Section 7). They must also write their
address, description and occupation, if any. The subscribers should sign in presence of at least one
witness who shall attest the signature of each subscriber. The witness shall also write his address,
description, occupation accordingly.

5.4. CONTENTS OF ARTICLES OF ASSOCIATION

Legal provision in this regard are provided in Section 5 of the Companies Act, 2013, which were earlier
contained in Section 26, 27, 28 and 29 of the Companies Act, 1956.

Section 5 has been made effective w.e.f. 01.4.2014 vide MCA Notification dated 26.3.2014, and as per
this section the articles of a company shall contain the following contents:
1. Regulations for management of company [Section 5 (1)]: The 'articles of association' of a
company contains the rules and regulations which are framed for the internal management of the
company. Thus, such rules and regulations are contained in it which are necessary to carry out the
objects of the company.
Usually, the 'articles of association' of a company contain the rules and regulations on the following
matters.
1. Definition of important terms and phrases. 2. Adoption or execution of pre-incorporation contracts. 3.
Share capital and the rights of the shareholders. 4. Allotment of shares.
5. Procedure as to making of calls on shares. 6. Procedure as to forfeiture of shares. 7. Transfer of shares.
8. Lien on shares. 9. Share certificate and share warrants. 10. Alteration of share capital. 11. Conversion
of shares into stocks. 12. Dividend, reserves and capitalisation of profits. 13. Appointment of managerial
personnel e.g., directors etc. 14. Meetings. 15. Borrowing powers. 16. Accounts and audit. 17. Common
seal of the company. 18. Voting rights and proxies. 19. Winding up of the company.
2. Matters as may be prescribed by rules [Section 5 (2)]: The articles of company shall also contain
such matters as may be prescribed by rules made by Central Government.

3. Additional matters [Section 5 (2), proviso]: The articles of a company may also contain such
additional matters as may be considered necessary for management of the company.
 The subscribers may frame rules and regulations on any matter which is necessary for internal
management of the company. But these provisions must not conflict with the provisions of the
Companies Act. Moreover, these should also not go beyond the powers of the company as contained in
its 'memorandum of association'. Any provision of the articles of association which is contrary to the
provisions of the Companies Act or beyond the powers of the company shall be void and inoperative
[Section 6] e.g., Section 123 of the Companies Act declares that no dividend shall be paid by the
company except out of profits. If any provision is made in the articles which is contrary to this section
shall be void. Thus, the articles cannot sanction something which is forbidden by the Companies Act.

EXAMPLE 5.1. The articles of association' of a company contained a provision that a petition for
winding up of the company can be filed in the court only if the following conditions are satisfied:
(a) minimum two directors consented to writing for filing such petition.

(b) a resolution to wind up the company was passed at a general meeting.

(c) the applicant held minimum one-fifth of the issued capital.

A petition for winding up of the company was filed in the court on the grounds specified in the
Companies Act. However, none of the above conditions was fulfilled at the time of filing the petition for
winding up. The company contended that the winding up petition is not maintainable as the conditions
laid down in articles had not been complied with. The court held that the winding up petition is
maintainable as the conditions laid down in the articles were contrary to the provisions of the Companies
Act.

The articles of association of a private company must also contain the three statutory restrictions which
make the company a private one, under Section 2 (68).

4. Provisions for entrenchment [Section 5 (3), (4), (5)]: The articles may contain provisions for
entrenchment (i.e., additional safeguards for alternation) stating that certain specified provision of articles
may be altered only if more restrictive conditions or procedure is complied with. In simple words, the
articles may now contain such provisions which provide very difficult procedure (than special resolution)
for alteration of certain specified provisions of articles.

It is a new provision in the Companies Act, 2013 and it would provide additional layer of protection to
the investors. Other important provision in this regard are:

(i) These provisions shall only be made either, (a) on formation of the company, of (b) by an
amendment in articles agreed to by all the members of the company in case of a private company and
by special resolution in the case of a public company [Section 5 (4)].

(ii) Where the articles contain such provisions for entrenchment, whether on formation or by
amendment, the company shall give notice of such provision to the Registrar in such form and manner as
may be prescribed [Section 5 (5)]. Note: The provisions of entrenchment as stated above, are new
which were not there under the earlier Companies Act, 1956.

5.5. ALTERATION OF ARTICLES OF ASSOCIATION

The provisions relating to alteration of 'articles' of a company are provided in Section 14 of the Companies
Act, 2013, which were earlier contained in Section 31 of the Companies Act, 1956. Section 14 has been
made effective w.e.f. 1.4.2014 vide MCA notification dated 26.3.2014, and its provisions are discussed as
under:

1. Procedure for alteration Section 14 (1)]: This sub-section makes the following provisions:

(a) Alteration in general: The company alter its articles of association at any time by passing a
special resolution.

(b) Alteration having the effect of conversion of a public company into a private company: The
 alteration of articles which has the effect of conversion of a public company into a private company can
be made by the company as under [Section 14 (1), second proviso]:

 by passing a special resolution; and

 by obtaining approval of Tribunal.
Note: No such approval of Tribunal is requited for conversion of a private company into a public
company.

2. Filing requirements by the company: These requirements are as under:

(a) Filing of special resolution: The special resolution altering the articles shall be filed by the
company with the Registrar within 30 days of passing [Section 117, under this section every special
resolution is required to be so filed].

(b) Filing of copy of Tribunal order and altered articles: The company shall file the alterations,
copy of Tribunal order of approval and a printed copy of altered articles with the Registrar within 15
days in the prescribed manner [Section 14 (2)]. On receipt of these documents, the Registrar shall
register the same. Note: The time limit of filing of the Tribunal order and altered articles with the
Registrar has been reduced to 15 days as against one month under earlier Section 31 of the Companies
a c t 1956.

3. Statutory right of alteration: A company can alter its articles of association as a matter of right.
Section 14 gives a clear and statutory power to the company to alter its articles of association. It is to be
noted that this power of the company cannot be taken away in any manner. Thus, if there is a clause in
the articles of association providing that the company will not alter its articles, the clause will be invalid
on the ground that it is contrary of the Companies Act. Similarly, a company cannot deprive itself of
this statutory power by entering into a contract with any one. The altered articles shall be binding on the
members in the same way as original articles [Section 14 (3)].

4. Important points: Following points are important to note with regard to alteration of articles:

(a) When an alteration is made in company's articles, every copy of articles issued after the date of
alteration shall be in accordance with the alteration. On default, the company and every officer in default
shall be punishable with fine which may extend to 1000 for each copy so issued. [Section 40]

(b) The articles of association can be altered only by passing a special resolution. Even a clerical
mistake in the articles of a company can be rectified by passing a special resolution. It cannot be set
right by application to the court.

(c) The mere passing of special resolution inconsistent with existing articles is enough unless it
expressly alters the articles concerned [Halsbuy's Law of England 4th Edn. Vol. 7 para 454, page
257).

Changes brought in by the Companies Act, 2013

1. The approval of the Tribunal is required for alteration which has the effect of converting public company into
a private company. In the earlier Companies Act, 1956, the approval of Central Government was required.

2. Every alteration alongwith the printed copy of altered articles is required to be filed with the Registrar within
15 days of passing special resolution as against one month required under Section 31 of the earlier Companies
Act, 1956.

5.6. LIMITATIONS OR RESTRICTIONS ON ALTERATION OF ARTICLES OF

ASSOCIATION

We have discussed, in the last article, that the company can alter its articles of association at any time by
passing a special resolution.
However, the basic requirements is that the power alteration must be exercised in good faith in the
interest of the company and also fairly as betwee different classes of shareholders. The company may,
therefore, exercise its power of alteratio subject to the following limitations or restrictions:

1. The alteration must not be inconsistent with the provisions of the Companies Act: The
alteration of articles which is inconsistent or contrary to the provisions of the Company Acti inoperative
and without any legal effect. Thus, the alteration should not add any provision which is forbidden by the
Companies Act.

EXAMPLE 5.2. The Companies Act, 2013 (Section 123) provides that no dividend shall be paid by th
company except out of profits. The company, by a special resolution, altered its articles and added to
class providing for the payment of dividends out of capital in case the profits are not sufficient. In this
case, t alteration is invalid as it is contrary to the provisions of the Companies Act.

EXAMPLE 5.3. The Companies Act, 2013 (Section 56) provides that the shares of a company can
transferred only by executing a proper instrument i.e., document of transfer, and without such instrume of
transfer, the company shall not register any transfer of its shares. A company by a special resolution
altered its articles and added a clause providing for the expulsion of a member, and authorising directors
to register the transfer of the shares of an expelled member without any instrument of tramle In this case,
the alteration is invalid as it is contrary to the provisions of the Companies Act.

2. The alteration must not be inconsistent with the memorandum of association: The alteration of
articles which is inconsistent or contrary to the provisions of memorandum of association is inoperative
and without any legal effect. Thus, the alteration should not go beyond the power given by the
memorandum. However, if the alteration sanctions an act which is otherwise legal a is not clearly
prohibited by the memorandum, the alteration will be valid and operative.

EXAMPLE 5.4. The 'memorandum of association of a company provided that the nominal cap of the
company was 10 lacs divided into 10,000 equity shares of 100 each. The company wanted t issue
preference shares. But there was no express provision either in the 'memorandum' or in the article
regarding the issue of preference shares. The company, by a special resolution, altered its articles and add
a clause authorising the directors to issue preference shares. Thereafter, the preference shares were issu
It was held that the alteration and issue of preference shares was valid. In this case, the issue of preferens
shares was not expressly forbidden by the memorandum.

Note. However, if the company is expressly forbidden by its then such an alteration in articles would be
invalid.

3. The alteration must not sanction anything which is illegat: The alteration of articles which
sanctions any illegal act, is inoperative and without any legal effect. Thus, the alteration should not
add provision which is illegal Le, unlawful or forbidden by the law of the country

EXAMPLE 5.5. The gambling is forbidden by the law of the country. A company, by special resolution,
articles and added a clause authorising the directors to allow gambling in the office building after
working hours, and to eam commission thereon. In this case, the alteration is invalid as in sanctions an a
which is illegal.

4. The alteration must not constitute a fraud on the minority shareholders: The alteration of
articles which constitutes a fraud on minority shareholders, is inoperative and without any legal effect.
Thus, an alteration should not add any provision which discriminates between the majority
shareholders and minority shareholders, and gives some advantage to the majority of which the minority
is deprived. As a matter of fact, the articles cannot be so altered as to deprive the minority shareholders
of their rights.

EXAMPLE 5.6. A company was in financial difficulties, and thus, was in great need of further capital
The majority shareholders representing 98% of the shares were willing to provide the required capital if
the emaining shareholders, amounting to 2%, would sell their shares to them (mayority) However, the
minority shareholders refused to sell their shares to majority. The majority then passed a special
resolution altering the articles which enabled them (majority) to purchase the minority shares
compulsorilty on certain terms The minority shareholders refused to surrender their shares, and brought
 an action in court to restrain the majority from acting in terms of the altered articles. The alteration was
held to be void and inoperative, as a constiruted a fraud on minority and was not for the benefit of the
company as a whole

Note. The majority powers and minority rights will be discussed in detail in separate chapters 17 and
18.

5. The alteration must not increase the liability of existing shareholders: The alteration of articles
which increases the liability of existing shareholders is insperative and without any legal effect. Thus,
by alteration of articles, the shareholders cannot be asked to pay more than their hability unless they
agree in writing. The liability of the shareholders cannot be increased in any way Le, neither they can be
asked to make more contribution towards share capital, nor otherwise to pay money to the company.

EXAMPLE 5.7. A was the holder of 500 shares of 100 each of a public limited company. On these
shares, 4 had already paid ₹ 80 per share to the company. In this company, was also the holder of 100
fally paid-up shares. The company was in financial difficulties, and is needed further funds. The
company, by special resolution, altered its articles and added a clause providing that the holder of fully
paid-up shares would be liable to pay 10 more on each share, and those holding shares on which ?
80 and been paid would be liable to pay 30 more on each share. The shareholders did not give their
consent to this alteration. In this case, the alteration is invalid as it increases the liability of shareholders
without their

6. The alteration must not cause (ie, operate as) a breach of contract. The alteration of articles
which enables the company to commit a breach of contract with a third party is not justified, and the
company may be held liable to pay damages. Thus, where the company has entered into an independent
contract with an outsider which is subsequently repudiated (ie, cancelled) by it by changing articles, the
company will be liable to pay damages for the breach of contract. As a matter of fact, the company
cannot justify the breach of an independent contract by altering its articles. The expression independent
contract here means a separate contract apart from articles of association.

EXAMPLE 5.8. A was the director of a company A & Co Ltd. The company entered into a contract
with A by which he was appointed as a managing director of the company for a period of 10 years.
After two years A & Co. Ltd. Amalgamated with another company B & Co. Ltd. and nearly all the
shares of A& Co Ltd. were acquired by B & Co. Ltd. After amalgamation, the articles of association of
A & Co. Ltd. were adopted by B & Co. Ltd. after making certain alterations. The new articles provided
that a person would cease to be a managing director if he ceased to be the director. The articles also
gave power to the company to dismiss any of the directors. Under these articles, A was removed from
the office of director, and thus he ceased to be the managing director of the company. A filed a suit
against the company for wrongful repudiation (cancellation) of the contract of his employment. It was
held that it was an implied term of the contract that A & Co. Ltd. would not remove A from the office
of director during the contracted term of 10 years, and thus the company was held liable to pay damages
to A for breach of contract.
Sometimes, it is expressly provided in an independent contract, with a third party that the company shall
not alter its articles so as to cause a breach of contract. In such cases, the court may restrain the
company from committing a breach of contract by changing its articles if the breach is likely to cause a
damage which cannot be adequately compensated in terms of money.

EXAMPLE 5.9. A entered into a contract with a company which provided that so long as A held 5,000
shares in the company, A should have the right of nominating two directors on the board of the company
This right of nomination was also contained in the clause of company's articles. The contract between A
and the company also provided that the clause in articles authorising A to nominate directors should not
be company, altered by the company. As per the terms of contract, A nominated two persons as
directors of the but the company refused to accept them. A insisted upon having his nominees on the
board of directors. The company tried to prevent this by altering its articles and depriving A of his right
to nominate directors. A applied to the court for restraining the company from doing so. Accordingly, the
court passed an order restraining the company from changing its articles to this effect.

Thus, the company cannot justify the breach of an independent contract by altering its articles of
association. The company may be held liable to pay damages for the breach of a contract. And where
 the compensation would not be an adequate remedy for breach, the court may pass an order restraining
the company from changing its articles.

But sometimes, the contract is wholly dependent (i.e., based) upon the provisions of the articles of
association, and there is no independent (i.e., separate) contract with an outsider. In such cases, the
alteration would be valid and operative even if it causes (i.e., operatives as) a breach of contract with an
outsider'. The reason for the same is that any one dealing with the company purely on the terms of the
articles, takes the risk of articles being altered e.g., a person who accepts an appointment purely on the
terms of the articles, is bound by those terms even if they are altered subsequently.

EXAMPLE 5.10. The articles of association of a company contained a clause providing that the
remuneration of the company's secretary would be 1,250 per month. A accepted the post of company
secretary on the basis of the terms contained in the articles. Subsequently, the company altered its
articles and reduced the secretary's remuneration to 1,000 per month. It was held that the alteration was
valida operative. In this case A's appointment as company secretary was not on the basis of a separate
contract, but on the basis of company's articles.

From the above discussion, the legal position regarding the validity of alteration which operatives as a
breach of contract with an outsider may be summed up as under:

(a) If the alteration of articles operatives as a breach of an independent contract, the alteration is not
justified and the company is liable to pay damages to the other party. In such cases, the company may
also be restrained by court order from altering its articles.

(b) If the alteration of articles operates as a breach of contract which is purely based upon the terms
of the articles, the alteration is justified and the company is not liable to other party.

7.The alteration must be made in good faith and . for the benefit of the company as a whole:
The alteration of articles which is not made in good faith and for the benefit of the company as a
whole' is inoperative and without any legal effect. But the alteration which is made in good faith and for
the benefit of the company as a whole' shall be valid and operative even if it is likely to affect aversly the
interest of some of the shareholders.

EXAMPLE 5.11. The articles of association of a company contained a clause which gave power to the
company to exercise lien on all shares 'not fully paid-up', for calls due to the company 4 was the only
shareholder holding fully paid up shares. He also owed money to the company for call due on other
shares A died, and the amount of calls on his other shares (ie, which were not fully paid) was still due.
For the unpaid amount of call on these shares, the company wanted to exercise lien on all his shares,
including those fully paid. The company altered the articles so as to give itself the power to exercise lien
on all shares (1 on not fully paid-up, and also on 'fully paid-up'). It was held that the alteration was valid
and operative as it was made in good faith, and for the benefit of the company as a whole.

Note. The exoression 'lien' means the right of a person to retain the properly of another until the
amount due to the former by the latter is paid by him (latter).

EXAMPLE 5.12. The majority of shares in a company were held by directors, and the minority of them
by A, another person, A was also carrying on his own business in competition with the company. The
company altered its articles of association so as to give power to the directors to require any
shareholder who competed with company's business to transfer his shares to the nominees of the
directors, at their fall value. A challenged this alteration in a Court of Law. It was held that the
alteration was valid and operative as it was made in good faith and for the benefit of the company as a
whole. The court observed that it was very much for the benefit of the company to get rid of the
members who were in competing business, as such members have the unique opportunity of exploiting
the company's business secret against its very interest."

In M.V. Shekaran v. Joint Registrar of Coop Societies, (1995) All HC 2798 ker, an alteration to enable
the company to recover its dues was held to be for the benefit of the company and, therefore, valid.
5.7. BINDING FORCE OF MEMORANDUM AND ARTICLES OF ASSOCIATION

On registration, the memorandum and articles of association bind the company and its members to the
same extent as if they had been signed by the company and each member respectively. Ja fact, they
contain the agreements by the company and by each member to observe all the provisions of
memorandum and articles of association (Section 10). Thus, the memorandum and articles of
association constitutes a binding contract between the company and its each member. The legal effects
(Le., binding force) of these documents may be discussed under the following heads:

1. These are binding on members in their relation to the company: The members of a company are
bound to the company by provision of memorandum and articles of association. A company can sue its
members for the enforcement of the provisions of these documents. The members may also be
restrained through court, from commisting the breach of the provisions of these documents.

EXAMPLE 5.13. The articles of association of a company contained a provision that on the bankruptcy
(insolvency) of a member, his shares will be sold to a person at a price fixed by the directors. A, a
shareholder was declared bankrupt. A's trustee in bankruptcy claimed that he was not bound by this
provision and should be at liberty to sell A's shares at their true value. It was held that the provision
contained in the articles was binding on the shareholders as it constituted a binding contract between
the members and the company.

EXAMPLE 5.14. The articles of association' of a company contained a provision that for any deb due
from a member to the company, the company will have a first charge on his shares. A, a member who
owned money to the company, also borrowed some money from a bank on the security of shares. The
bank claimed priority over A's shares. It was held that the company has priority over A's shares for its
own debts and the bank's charge is secondary. [Bradform Banking Co. v. Briggs (1886) 12 A.C. 291

2. These are binding on the company in its relation to the members: The company is also bound to the
members by the provisions of memorandum and articles of association. Every member may sue the
company for the enforcement of the provisions of the documents. The company may also be restrained
from committing the breach of the provisions of these document. Thus, the company can exercise its
rights against the members only in accordance with the provisions contained in the memorandum and
articles of association.

EXAMPLE 5.15. The articles of association of a company contained a provision that "the directors may,
with the sanction of the company at a general meeting, declare a dividend to be paid to the members
Instead of paying the dividend in cash to the shareholders, the company passed a resolution to give
'debenture bonds' to the shareholders. A member brought an action for restraining the directors from
acting on the resolution. It was held that 'to be paid' means 'to be paid in each'. The debenture bonds
proposed to be issued are not payment in each. The directors were restrained from acting on the
resolution.

Similarly, where the articles of association confer a right on the shareholder to record his vote
at a company meeting, the chairman of the meeting cannot deprive a member of this voting right.

3. These are impliedly binding on the members in their relation to one another.
The members of the company, among themselves, are also bound by the provisions of memorandum
and articles of association. It may, however, be noted that the memorandum and articles of association
do not create any express contract between the members of the company. The members are bound
between themselves only on the basis of an implied contract.

EXAMPLE 5.16. The articles of association of a company contained a provision that a member
wishing to transfer his shares must inform the directors of his intention to transfer his shares. And the
directors must take shares equally between them at a fair value. According to this provisions, a member
informed the directors. But the directors refused to take his shares. They contended that they were not
bound to take shares, and the articles of association could not impose such obligation upon them in
their capacity a members. The court held that the directors were bound to take the shares. The articles
of association imposed an obligation on the directors as members of the company. [Rayfield v. Hands
and Others (1958) 2 WLR 851; (1960) Ch. Note. The binding force of memorandum and articles,
between the members themselves, is not yet finally decided because the Companies Act does not settle
the rights and liabilities of members inter se (ie, among themselves).

4. These are not binding on the company and members in their relation to outsiders: The company or
members are not bound to the outsiders (i.e., third person who are not members) by the provisions of
memorandum and articles of association. The articles of association create no contract between the
company and outsiders. An outsider, therefore, cannot take advantage of the provisions contained in
company's articles of association. This is based on the general rule of law that a stranger (i.e., who is
not a party) to a contract cannot bring an action upon a contract.

EXAMPLE 5.17. The articles of association of a company contained a provision that one A should be a
director of the company. His term of service was also fixed by the articles. However, he was removed
before the expiration of his term as fixed by the articles. He brought an action to restrain the company
from removing him from service. It was held that there was no such contract between A and the
company. The court observed that an outsider cannot enforce the provisions of the articles against the
company even if he is given certain rights.

EXAMPLE 5.18. The articles of association of a company contained a provision that one A should be
the solicitor of the company for life, and should not be removed except for misconduct. A was also a
member of the company. He acted as solicitor for some time but ultimately the company discontinued his
services without any charge of misconduct. A brought an action against the company for damages for
breach of contract in removing him contrary to the provision of articles. His action was dismissed. It
was held that the articles did not constitute any contract between the company and an outsider. In this
case, A was enforcing his right as a solicitor of the company and not in the capacity of a member i.e.,
shareholders.

Thus, an outsider cannot hold the company liable on the basis of articles of association. He must prove a
special contract outside and independent of the articles of association if he wants to hold the company
liable.

5.8. ARTICLES OF ASSOCIATION IN THEIR RELATION TO OUTSIDERS

We have discussed in point 4 of last articles that the articles of association' of a company does not
create any contract between the company and outsiders. And thus, an outsider cannot enforce his rights
based on the basis of company's articles of association. However, this rule proved to be harsh, and later
on, some of the courts have taken a lenient view in applying this rule. The courts have recognised the
actions of the outsiders on the ground that "sometimes the articles may create an implied contract
between the company, and outsiders". The following example illustrates this approach of the courts:

EXAMPLE 5.19. The articles of association of a company contained a provision that a director should
receive a specified amount per year by way of remuneration. The company, by special resolution,
altered its articles of association so as to reduce the remuneration payable to the directors with
retrospective effect from the end of the last year. A was the director of the company. He resigned and
filed a suit against the company for the recovery of his remuneration upto the date of his resignation, at
the rate originally specified in company's articles. The court held that he was entitled to recover
remuneration on the rate specified in the articles. The court observed that there was an implied contract
that the remuneration would be paid to the directors as originally provided in the articles.

Regarding enforcement of an outsiders' right on the basis of implied contract, the following extracts
from a decided case is worthnoting:

"Where in pursuance of certain articles acted upon by the company, a member was appointed a
managing director and acted for eleven years in that capacity, the articles constitute an implied contract
between the member and the company If the company removes him from office, he would be entitled
to damages for breach"

Thus, an outsider may enforce his rights against the company where the circumstances show that the
articles constituted an implied contract between the company and the outsiders. It is submitted that, it
may not be taken that the articles create an implied contract between the company and a third party i.e.,
outsider in all cases. It is to be decided on the fact and circumstance of each particular case whether or
not there is an implied contract between the company and a third party.

5.9. CONSTRUCTIVE NOTICE OF MEMORANDUM AND ARTICLES OF ASSOCIATION

The term 'constructive notice' means the presumption of notice in certain circumstances. We
know that the memorandum' and 'articles' of association of a company are registered with the Registrar
of Companies. The office of the Registrar is a public office. Therefore, registration, these documents
become the 'public documents'. They are open for public inspection in Registrar's office. It is, therefore,
the duty of every person dealing with the company to inspec these documents, and make sure that his
contract with the company is in accordance with the provisions of these documents. He will be
presumed to have read the documents and to know their contents. This kind of presumed knowledge of
these documents is called the constructive notice' of memorandum and articles of association. If any
person enters into a contract with the company which is contrary to the provisions of memorandum and
articles of association, he will not get any right under such contract.

EXAMPLE 5.20. The 'articles of association' of a company contained a provision that all deeds other
important documents should be signed by three officers of the company namely, the managing director
the secretary, and working director. A accepted a deed of mortgage executed by the secretary and working
director only. It was held that A could not claim any right under this deed as it was invalid. The coun
observed that had he (4) consulted the articles of association, he would have known that such deed wa
required to be executed by three specified officers of the company.

It is to be noted that a person dealing with the company is not only presumed to have read these
documents but also to have understood them according to their proper meaning [Pamers Company Law,
20th Edn. by Schmitthoff and Curry, (1959) p. 243]

5.10. DOCTRINE OF 'INDOOR MANAGEMENT'

We have discussed, in the last article, that every person dealing with the company is presumed to have
read and understood the contents of company's memorandum and articles of association. And if he enters
into a contract with the company which is contrary to the provisions of memorandum and articles of
association, then he will not get any right under such contract In other words, the company will not be
bound by such contracts. This rule seeks to protect the company against the outsiders. There is one
exception to this general rule, popularly known as 'doctrine of indoor management'. According to this
doctrine, a person dealing with the compan is not presumed to have the knowledge of internal
proceedings of the company i.e., there a no constructive notice as to how the company's internal
machinery is handled by its officers Thus, every person dealing with the company is entitled to assume
that everything has been done regularly so far as the internal proceedings of the company are concerned.
In other words, outsider may assume that the things have been done according to the provisions and
procedure laid down in the memorandum and articles of association. This doctrine seeks to protect the
outsiders against the company. As a matter of fact, a person dealing with the company is not bound to
know the internal procedure of the company such as constitution of the board, quorum, voting internal
resolutions, and regulations etc. It is the duty of the officers of the company to observe the internal
procedure. If the transaction, when compared with the memorandum and articles of association, appears
to be proper, then the company cannot escape liability by showing that there was some irregularity in
internal procedure relating to the company. In other words, if the interna formalities have not been
complied with, the contract will be binding on the company and it will be liable to the outsiders. The
reason for the same is that the details of internal procedure of the company are not open for public
inspection. Moreover, an outsider is not required to investigate into the proceedings and procedure of
internal management. A person can be presumed to know the constitution of the company, but not what
may or may not have taken place within the doors that are closed to him'. The following observations of
Justice Bray are worthnoting in this regard
"The wheels of commerce would not go round smoothly if persons dealing with Companies
were compelled to investigating thoroughly the internal machinery of a company to see if something
is wrong".
This doctrine is also known as 'TURQUAND'S RULE, because it has its origin in an English case of
'Royal British Bank v. Turquand', (1865) 119 ER 886, as discussed in the following example.

EXAMPLE 5.21. The articles of association' of a company contained a provision that the directors had
powers to borrow money on bonds if authorised by a resolution passed at the general meeting of the
company. The directors borrowed money from A, and issued bonds to him without passing the
required resolution. The shareholders contended that the loan was taken without authority, therefore, A
cannot recover it from the company. It was held that A could recover the loan from the company, as he
was entitled to assume that the necessary resolution must have been passed.

The doctrine of indoor management is of great practical utility, and may be summed up as under:

"If the directors have power and authority to bind the company, but certain preliminaries are required to
be gone through on the part of the company before that power can be duly exercised, then the person
contracting with the directors is not bound to see that all these preliminaries have been observed. He is
entitled to presume that the directors are acting lawfully in what they do".

5.11. EXCEPTIONS TO THE DOCTRINE OF INDOOR MANAGEMENT

We have discussed, in the last articles, the doctrine of indoor management according to which the
company is bound by its acts even if there is some irregularity in its internal proceedings. However, in
the following exceptional circumstances, a person dealing with the company cannot take the benefit of
this doctrine:

1. Knowledge of irregularities: Sometimes, a person dealing with the company has the knowledge of
irregularities regarding the internal management. In such cases, he cannot take the benefit of the doctrine
of indoor management i.e., he cannot hold the company liable for his dealings with the company. The
reason for the same is that any contract made with the company is void if it is made with the knowledge
of irregularity in the internal procedure of the company. The knowledge of irregularities may be actual
or constructive. A person who himself is a part of the internal machinery is presumed to have
constructive knowledge of irregularities.

EXAMPLE 5.22. The articles of association of a company contained a provision that on behalf of the
company, the directors have power to borrow money upto 10,000 without any resolution. And for the
amount exceeding 10,000 the consent of the shareholders was necessary by way of resolution. The
directors themselves lent to the company an amount exceeding the borrowing powers of the company.
(ie, 10,000). But no resolution was passed to authorise such borrowing. It was held that the company
was liable to the extent of 10,000. The directors were not entitled to recover the excess amount of their
loan as they had the knowledge of the irregularity (i.e., limit on company's borrowing powers).

Suspicion of irregularities: Sometimes, a person dealing with the company has some suspicion of
irregularity regarding the internal management. In such cases also, he cannot take the benefit of the
doctrine of indoor management. Sometimes, the circumstances surrounding the contract are suspicious
which invite some enquiry. In such cases, the person dealing with the company should make proper
enquiry. If he enters into contract without making any enquiry to remove his suspicion, then the
company will not be bound by the contract if some required formality is not complied with e.g., where it
appears that an officer of the company is acting beyond his authority, then the person dealing with the
company should make proper enquiries in order to know his authority.

EXAMPLE 5.23. A an accountant of a company, agreed to transfer some property of the company to B.
A and B accepted this transfer of company's property. The transfer was held to be void, as such a transfer
of company's property was apparently beyond the scope of an accountant's authority. B should have seen
the 'power of attorney' authorising A to transfer company's property.

3. Forgery: Sometimes, a person dealing with the company relies upon a document which is forged by
the officer of the company. In such cases, he cannot take the benefit of doctrine of indoor management.
The company may not be held liable for the complete forgeries committed by its officer. As a matter of
fact, for the application of the doctrine of indoor management, the transaction should be a genuine one,
and the irregularity should be regarding the internal procedure only.

EXAMPLE 5.24. A a secretary of a company, forged a share certificate and issued it to B in return of
money advanced by B. The certificate was issued under the seal of the company on which the signature
of the directors were forged by A. The company refused to register B as the shareholder of shares. B
relied upon the doctrine of indoor management, and claimed damages from the company for not
registering him as the shareholder. It was held that B had no right under the share certificate. The court
observed that the doctrine of indoor management is not applicable to such cases of complete forgeries.

It may, however, be noted that in certain circumstances, a person may be allowed to rely upon the forged
documents, e.g., where a company represents that a forged document is genuine, afterwards the company
may not be allowed to deny its genuineness as against a person who has relied upon the representation
of the company. The company may also give the impression that a forger has the authority to execute a
particular document, in such a case also the company may be held bound by the document even if it
turns out to be forged."

4. No knowledge of articles of association: Sometimes, the person dealing with the company has not in
fact consulted the company's memorandum and articles of association, and at the time of making the
contract he is not aware of the contents of these documents. In such cases, he cannot take the benefit of
this doctrine. The reason for the same is that a person cannot rely upon something about which he is
completely ignorant. It may, however, be noted that this exception is applicable in a case where the
knowledge of the documents was essential.

EXAMPLE 5.25. The 'articles of association' of a company contained a provision that the directors may
delegate any of their powers, other than the power to borrow and make calls on shares, to committees
consisting of such members of their body as they think fit". One A was the active director of the
company He purporting to act on behalf of the company, entered into a contract with B & Co, another
company under which A took a cheque from this company. In fact no such power was delegated to A by
the Board of Directors'. B & Co. had not inspected the articles of A's company, and therefore, it did not
know about the existence of Board's power to delegate. It was held that A's company was not bound by
the contract. Is this case, the knowledge of the articles of association was essential. As B & Co. had no
knowledge of the articles, it cannot bind A's company. It could have relied upon the power of
delegation only if it knew that the power existed, and had acted on the belief that it must have been
duly exercised.

It may be noted that this exception deals with the controversial and confusing aspect of company's
powers. This is subject to great criticism. It is observed by jurists that, what is relevant for the application
of this exception is not the person's knowledge of company's articles, but whether the act in question is
within the apparent authority of the officers through whom he contracted with the company. The rule,
therefore, may be stated that once it is shown that the contract in question is within the apparent authority
of the officers through whom it was made, the company cannot escape liability unless it can show that
under its memorandum or articles of association it had no capacity either to enter into a contract of that
kind or to delegate the authority in the matter to its officer.

5. Acts outside apparent authority: Sometimes, a person enters into a contract with the company
through its officer who has no authority to act on behalf of the company. In such cases, he cannot take
the benefit of this doctrine i.e., his contract with the company will be void.

EXAMPLE 5.26. The articles of association' of a company contained a provision that the directors may
authorise any person to draw, sign, accept, etc., the bills of exchange on behalf of the company. A branch
manager of the company, drew and endorsed some bills of exchange on behalf of the company.
However, he was not authorised by the company. It was held that the company was not liable on these
bills of exchange. In this case, the drawing (i.e., making) of the bills of exchange was not within the real
or apparent authority of the branch manager. Moreover, he was also not authorised by the company.

The Anand Bihari's case discussed in Example 5.23 is also relevant here.
 5.12. RELATION BETWEEN MEMORANDUM AND ARTICLES OF ASSOCIATION

The relation between the memorandum and articles of association of a company is that the articles of
association is subordinate to the memorandum of association. This relation between these two documents
is evident from the following points:

1. The articles of association cannot give to the company which are not given by the memorandum
of association. If they are inconsistent on any point, then the memorandum of association shall prevail.

2. The articles of association cannot alter the provisions of memorandum of association. The articles,
therefore, must not contain anything which is contrary to the provisions of memorandum of association.

3. The articles of association may explain or supplement the memorandum of association, but cannot
extend its scope. However, if there is no ambiguity in the memorandum of association, its terms
cannot even be controlled or modified by the articles of association.

5.13. COMPARISON BETWEEN MEMORANDUM AND ARTICLES OF ASSOCIATION

Following table gives the comparison between the memorandum and articles of association:

S.NO. MEMORANDUM OF ASSOCIATION ARTICLES OF ASSOCIATION

1 It defines the objects and powers of the It contains the rules and regulations of the
company. company which are formed for the purpose of
carrying out the objects as laid down in the
memorandum of association.
2 It is the supreme document as it defines It is subordinate to the memorandum of
the constitution of the company. As a association. In case of any conflict between the
matter of fact, it is the charter of the two, the memorandum shall prevail.
company
3 It regulates the relationship of the It regulates the internal management of
company the with the outsiders, as the company, as the rules and regulations contained
objects and powers of the company are in it describe the internal procedure to be
made known to the outsiders through this followed by the company.
document.
4 It cannot be easily altered. The It can be easily altered as compared to
company has to follow strict procedure
for the alteration of its registered office memorandum of association.
clause for shifting the registered office
from one state to another.
5 Any act which is ultra vires (i.e., beyond Any act which is ultra vires the articles of
powers) the memorandum, is wholly association may be ratified by the
void and cannot be ratified even by the shareholders. Acts ultra vires the articles of
whole body of shareholders. As a association are merely irregular and not void.
matter of fact, the company cannot go However, such act can be ratified only if it is
beyond the scope of its memorandum within the scope of memorandum of
of association. association.

5.14. FORMS OF ARTICLES OF ASSOCIATION AS GIVEN IN TABLES F, G, H, I AND J

OF SCHEDULE I

The Tables F, G, H, I and J of Schedule I of the Companies Act, 2013 contain the forms of 'articles of
association' of various types of companies.

The type of company and the corresponding table containing the form of articles of association is as
under:
S.NO. TYPE OF COMPANY ARTICLE FORM
1 Company Limited by Shares Table-F
2 Company Limited Guarantee and Having Table-G
a share capital
3 Company Limited Guarantee and not Table-H
Having a share capital
4 Unlimited Company and Having a Share Table-I
Capital
5 Unlimited Company and not Having a Table-J
Share Capital

\
\

.
 UNIT- 3

PROSPECTUS OF A COMPANY

6.1. INTRODUCTION

After formation, the company needs the necessary amount of money to finance its busines activities.
The necessary money for this purpose may either be raised (or collected) from the general public, or be
obtained through private contracts. However, the required money is generally raised from the public, as
the private money may not be sufficient for the needs of the company. As a matter of fact, it is the great
advantage of forming a public¹ company. The money from the general public is raised by inviting
deposits from the public, or by inviting offers to purchase the shares or debentures of the company.
Such deposits or offers may be invited from the public by issuing a document known as 'prospectus'. In
this chapter we shall discuss the definition of prospectus and other legal provisions relating to
prospectus.

6.2. DEFINITION OF PROSPECTUS

The term prospectus is defined in Section 2 (70) of the Companies Act, 2013, which reads a under:

"A prospectus means any document described or issued as prospectus and includes(a) a
shelf prospectus referred in Section 31; or

(b) a red-herring prospectus referred in Section 32: or

(c) any notice or circular, advertisement or other document inviting offers

from the public

for the subscription or purchase of any securities of, a body corporate". or In other words, a prospectus
means any invitation issued to the public inviting it to take shares debentures of the company. Such
invitation may be in the form of (a) a shelf prospectus; or (b) red-herring prospectus; or (c) a document
or a notice, circular, advertisement, etc. The only requirement is that the invitation must be made (or
issued) to the public.

EXAMPLE 6.1. An advertisement in a newspaper stated that "some shares are still available for sale
according to the terms of the company which may be obtained on application". It was held that the
advertisement was a prospectus as it invited the public to purchase shares.

The above definition reveals the following ingredients of a prospectus:

(a) There must be an invitation to the public.

(b) The invitation must be to subscribe or purchase shares or debentures of the company.

(c) The invitation must be made by or on behalf of the company or in relation to a proposed company.

It may be noted that a public company must issue a prospectus if it wishes to raise public money by
issue of shares. However, a private company is not required to issue a prospectus at all, because it is
prohibited from inviting the public to subscribe for its shares or debentures.

Note: Shelf prospectus, and Red-hearing prospectus will be discussed later in this chapter.

6.3. PUBLIC ISSUE OF PROSPECTUS OR ISSUE OF PROSPECTUS TO THE PUBLIC

We have discussed, in the last article, that a prospectus must be 'issued to the public'. The word 'public'
here does not mean 'public at large'.
It means 'any section of the public' howsoever selected. In fact, it is used here as opposed to 'private
communications'. Thus, where an invitation is made to the friends or relatives of the directors, it will
not be an invitation to the public, and, therefore, not a prospectus.

EXAMPLE 6.2. The managing director of a company prepared a document which was in the form of a
prospectus. The document was marked as 'strictly private and confidential'. But the document did not
contain all material facts required to be disclosed by the Companies Act. It was circulated among the
directors and their friends. A an outsider, received this document through some friend of a director. On
the basis of this document, A applied for the shares of the company. It was held that the document
received by A was not a prospectus as it was merely a 'private communication' between the directors
and their friends.

As a matter of fact, the requirement of 'public issue' is that the invitation must be open to anyone who
wishes to invest his money in the company. If this requirement is fulfilled, the invitation will be a
prospectus even if it is made to limited section of the 'public' e.g., an advertisement among a group or
class of persons only.

EXAMPLE 6.3. A company prepared some document in the form of a prospectus. The copies of this
document were sent and distributed only among the members of certain 'gas companies'. It was held to
be an offer of shares to the public', although the officer was not to the public at large.

6.4. PUBLIC OFFER AND PRIVATE PLACEMENT

Legal provision in this regard are contained in Section 23 of the Companies Act, 2013 which is a new
provision, and has been made effective w.e.f. 1.4.2014 vide Notification dated 26.3.2014.

Section 23 is a new section which clearly provides the manner in which the securities can be issued by
the public as well as private companies. The provisions of this section are as under:

1. Issue of Securities by a Public Company [Section 23(1)]: A public company may issue securities
only in the following manner:

(a) to public through prospectus (herein referred to as “public offer") after complying with Part 1 of
this Chapter III, or

(b) through private placement after complying with Part II of this Chapter III, or

(c) by way of rights issue or bonus issue in accordance with the provisions of this Act and in case of a
listed company, according to SEBI regulation; or

Here, the term "public offer" includes initial offer or further offer of securities to the public
by a company, or an offer for sale of securities to the public by an existing shareholder,
through issue of a prospectus [Section 23, Explanation].

2. Issue of Securities by a Private Company [Section 23(2)]: A private company may issue securities
only in the following manner:

(a) through private placement after complying with Part II of this Chapter III; or
b) by way of rights issue or bonus issue in accordance with the provisions of this Act.

6.5. PUBLIC OFFER OF SECURITIES TO BE IN DEMATERIALISED FORM

Legal provisions in this regard are provided in Section 29 of the

Companies Act, 2013, which correspond to Section 68-B of the Companies
Act, 1956, which has been made effective w.e.f. 12.9.2013 vide Notification F.No. 1/15/2013 CL.V
dated 12.9.2013.

The provisions of new Section 29 are as under:

1. Every company making public offer of securities shall issue the securities only in dematerialised
form by complying with the provisions of the Depositories Act, 1996 and the regulations made
thereunder [Section 29(1)(a)].

2. Other class or classes of companies as may be prescribed by the ruler made under the Act, shall
also issue securities only in dematerialised form [Section 29(1)(b)].

3. Any company, other than the company stated in points (1) and (2) above, may proceed as
under [Section 29(2)]:

(a) may convert its securities into dematerialised form; or

(b) may issue its securities in accordance with the provisions of this Act, or

(c) may issue its securities in dematerialised form in accordance with the
provisions of the Depositories Act, 1996.
Changes brought in by the Companies Act, 2013

Dematerialised form irrespective of initial offer and size of issue: Earlier under Section 68-B,
only a company making initial offer of any security for a sum of 10 crores or more was required
to issue the securities in dematerialised form. Now (a) every company making public offer, and
(b) the prescribed companies are required to issue securities in dematerialised form.

6.6. REQUIREMENTS FOR ADVERTISEMENTS OF PROSPECTUS

Legal provisions in this regard are provided in Section 30 of the Companies Act, 2013, which correspond
to Section 66 of the Companies Act, 1956, which has been notified (te, made effective) w.e.f. 12.9.2013.

Section 30 states that where an advertisement of any prospectus of a company is published in any
manner, then it shall be necessary to specify in the advertisement

1. The contents of memorandum as regards

(a) the objects of the company,

(b) the liability of members of the company

(c) the amount of share capital of the company.

2. The names of signatories to the memorandum and the number of shares subscribed by them.

3. The capital structure of the company.

Changes brought in by the Companies Act, 2013

Relaxation withdrawn: Under earlier Section 66 of the Companies Act, 1956, the company
was not required to specify in the advertisement, (a) the contents of memorandum (b) the
signatories to the memorandum and (c) the number of shares subscribed by signatories.
Now the provision providing this relaxation has been dispensed with i.e., dropped.

6.7. LEGAL RULES RELATING TO THE ISSUE OF PROSPECTUS

Legal rules/provisions relating to the issue of prospectus are provided in Section 26 of the Companies
Act, 2013, which were earlier contained in Section 55, 56, 57, 58 and 60 of the Companies Act, 1956.

Section 26 has been notified (i.e., made effective) w.e.f. 1.4.2014 vide MCA Notification dated
26.3.2014, and the rules/provisions relating to the issue of prospectus, as provided in this section, are as
under:

Following are the legal rules and provisions relating to the issue of prospectus:

1. The signing of prospectus: Every prospectus issued by the company must be signed by every
person who is named in it as director or a proposed director or by his duly authorised attorney [Section
26(1)(4)].

2. The date of prospectus: The prospectus of a company must be dated. The date of prospectus is
considered to be the date of its publication [Section 26(1), (3) Explanation].

3. The consent of an expert (Section 26(5)]: Generally, a statement, relating to the company,
purporting to be made by an expert cannot be included in the prospectus. However, the statement of an
expert may be included in the prospectus if the concerned expert is not engaged in or interested in the
formation, promotion or management of the company. The following conditions must also be satisfied
for inclusion of expert's statement in the prospectus [Section 26(5)]:

(a) The expert must have given his written consent to the issue of prospectus;
(b) The expert must not have withdrawn his consent before delivery of prospectus for
registration.

(c) The fact that the expert has given his written consent and has not withdrawn the same must
be stated in the prospectus.

Note: 'Expert' includes an engineer, a valuer, a chartered accountant, a company secretary, a accountant
and any other person who has the power or authority to issue a certificate in pursu of any law for the
time being in force [Section 2(38), the Companies Act, 2013]

4. The registration of prospectus: A copy of prospectus must be filed with the Regist of
Companies for registration before the prospectus is issued to the public. The copy prospectus sent for
registration must be signed by every director or proposed director the company [Section 26(4)].

The prospectus so filed must also be accompanied by written consent of all the person named in
prospectus [Section 26(7)].

On compliance of these requirements, the Registrar shall register the prospectus.

5. Time for issue of prospectus [Section 26(8)]: The prospectus must be issued by company within 90
days after the date of delivery of copy of prospectus to the Registra for registration.

The prospectus shall not be valid if it is not issued within this period of 90 days.

6. Disclosures on the issued prospectus [Section 26(6)]: Every prospectus issued by the company
shall, on the face of it

(a) state that a copy of prospectus has been delivered to the Registrar for
registration, and also

(b) specify the documents attached to the copy so delivered.

7. The terms of contracts not to be varied: After the registration of the prospectus, the terms of any
contract stated in the prospectus cannot be varied except with the approval of members in the general
meeting.

8. Issue of application form for share or debentures: When the company issues a application
form for the purchase of its shares or debentures, then the form must be accompanied by an abridged
form of prospectus². However, in anyone of the following cases, the abridged form of prospectus is
not required to be issued:
 (a) Where the shares or debentures are not offered to the public [Section 33 (1)].

(b) Where the invitation is made inviting person to enter into an underwriting agreemen with
respect to the shares or debentures [Section 33 (1)].

These provisions were earlier contained in Section 56(3) of the Companies Act, 1956, which are now
incorporated in Section 33 of the new Companies Act, 2013. Section 33 has been made effective w.e.f.
12.9.2013.

The purpose of allowing the issue of abridged prospectus is to reduce the expenses a public issue.
However, the full prospectus has to be maintained in the office of the company.

6.8. CONTENTS OF PROSPECTUS

We know that a prospectus is issued to the public to purchase the shares or debentures of the company.
Every person wants to invest his money in some sound undertaking. The soundness of a company can
be judged from the prospectus of a company. Thus, the prospectus must disclose the true nature of
company's activities which enable the public to decide whether or not to invest money in the company.

The provisions relating to the contents of prospectus are provided in Section 26 of the Companies Act,
2013, which were earlier contained in Section 56 and Schedule - II of the Companies Act, 1956.

Now, the contents of prospectus are listed out in Section 26 itself as against in the Schedule under the
earlier Companies Act, 1956.

The contents of prospectus, as listed in Section 26, may be stated as under:

1. General Information [Section 26(1)(a)]: Every prospectus issued by the company shall state the
following information, namely:

(1) names and addresses of the registered office of the company, com any secretary. Chief
Financial Officer, auditors, legal advisers, bankers, trustees, if a y, underwriters and such other
persons as may be prescribed.

(ii) dates of the opening and closing of the issue, and declaration about the issue of allotment
letters and refunds within the prescribed time;

(iii) a statement by the Board of Directors about the separate bank account where all monies
received out of the issue are to be transferred and disclosure of details of all monies including
utilised monies out of the previous issue in the prescribed manner; (iv) details about underwriting
of the issue;

(v) consent of the directors, auditors, bankers to the issue, expert's opinion, if of such
other persons, as may be prescribed; any, and

(vi) the authority for the issue and the details of the resolution passed therefor; (vii) procedure
and time schedule for allotment and issue of securities;

(viii) capital structure of the company in the prescribed manner;

(ix) main objects of public offer, terms of the present issue and such other particulars as
may be prescribed;

(x) main objects and present business of the company and its location, schedule of
implementation of the project;

(xi) particulars relating to

(a) management perception of risk factors specific to the project;

 (b) gestation period of the project;

(c) extent of progress in the project;

(d) deadlines for completion of the project; and

(e) any litigation or legal action pending or taken by a Government Department or a statutory
body during the last five years immediately preceding the year of the of the company; issue of
prospectus against the promotor of the company

(xii) minimum subscription, amount payable by way of premium, issue of shares otherwise than
on cash;

(xiii) details of directors including their appointments and remuneration, and such particulars
of the nature and extent of their interests in the company as may be prescribed; and

(xiv) disclosures in such manner as may be prescribed about sources of promoter's contribution;

2. Reports of Financial Information Section 26(1)(b)]: Every prospectus issued by company shall set
out the following reports for the purposes of the financial information namely:

(1) reports by the auditors of the company with respect to its profits and losses a assets
and liabilities and such other matters as may be prescribed.

(2) reports relating to profits and losses for each of the five financial years immediately preceding
the financial year of the issue of prospectus including such reports of subsidiaries and in such
manner as may be prescribed:

Provided that in case of a company with respect to which a period of five yea has not elapsed
from the date of incorporation, the prospectus shall set out in su manner as may be prescribed,
the reports relating to profits and losses for each of the financial years immediately preceding
the financial year of the issue of prospects including such reports of its subsidiaries;

(iii) reports made in the prescribed manner by the auditors upon the profits and losses of the
business of the company for each of the five financial years immediately preceding issue and
assets and liabilities of its business on the last date to which the accounts of the business were
made up, being a date not more than one hundred and eighty days before the issue of the
prospectus:

Provided that in case of a company with respect to which a period of five yea has not elapsed
from the date of incorporation, the prospectus shall set out in the prescribed manner, the reports
made by the auditors upon the profits and losses of the business of the company for all financial
years from the date f its incorporation, and assets and liabilities of its business on the last date
before the issue of prospectus, and

(iv) reports about the business or transaction to which the proceeds of the securities are to
be applied directly or indirectly;

Declaration of Compliance [Section 26(1)(c)]: The prospectus issued by the company shall make a
declaration about the compliance of the provisions of this Act and a statement to the effect that nothing in
the prospectus is contrary to the provisions of this Act, the Securities Contracts (Regulation) Act, 1956
and the Securities and Exchange Board of India Act, 1992 and the rules and regulations made
thereunder;

4. Matters and Reports as Prescribed [Section 26(1)(d)]: The prospectus issued by the company shall
also state such other matters and set out such other reports as may be prescribed by rules made by the
Central Government. Note: Exceptions (Section 26(2)]
The provisions of Section 26(1) relating to contents of prospectus, as stated in above three points shall
not apply in the following cases:

(a) to the issue of prospectus to the existing members or debenture- holders of a company
whether or not the applicant has a right to renounce the shares in favour of any other person
under Section 62(1)(a)(ii); or

(b) to the issue of prospectus relating to the shares or debentures which are, in all respect,
uniform with the shares or debentures previously issued and for the time being dealt or quoted on
recognised stock exchange.

6.9. GOLDEN RULE AS TO FRAMING OF PROSPECTUS

We know that a prospectus is a document which induces the public to invest their money in the shares or
debentures of the company. The public invest the money in the company on the basis of the information
disclosed in the prospectus of the company. Therefore, the prospectus must present before the public, the
whole picture of the company. All the material facts relating to the nature of the company must be truly,
honestly and accurately disclosed in the prospectus. It should neither contain any mis-statement (i.e.,
untrue or misleading statement) nor omit to disclose any material fact. This is known as the golden rule
as to the framing of prospectus. This golden rule was laid down by KINGDERSELY VC in New
Brunswick Co. v. Muggeridge (1860) 3 LT 651; 30 LJ Ch. 242, which may briefly be stated as under:

Those who issue a prospectus hold out to the public great advantages which will accrue to the persons
who will take shares in the proposed undertaking. The public is invited to take shares on the faith of the
representations contained in the prospectus, and it is at the mercy of company promoters. Therefore
everything must be stated with strict and scrupulous accuracy. Nothing should be stated as a fact which
is not so, and no fact should be omitted the existence of which might, in any degree, affect the nature
or quality of the privileges and advantages which the prospectus holds out as inducement to take shares.
In simple words, the ‘golden rule' is that the true nature of company's activities and business should be
disclosed in the prospectus. And the prospectus as a whole must not give a misleading impression.

6.10. LIABILITY FOR MISLEADING STATEMENTS AND OMISSION OF FACTS IN

THE PROSPECTUS

We have discussed, in the last articles, that a prospectus should disclose the whole picture of the
company. It should neither contain any mis-statement, i.e., untrue or misleading statement nor omit to
disclose any material fact. If there is any mis-statement or omission of material facts, then the
directors, promoters, the persons responsible for the issue of the prospectus, and the company incur a
liability for the same, which may be discussed under the following heads:

1. Civil liability for mis-statement in prospectus [Section 35].

2. Criminal liability for mis-statement in prospectus [Section 34]. 3. Liability of

the company.

6.11. CIVIL LIABILITY FOR MIS-STATEMENT IN PROSPECTUS

The civil liability means the liability to pay damages or compensation. The civil liability for the issue of
false or misleading statement is now provided in Section 35 of the Companies Act, 2013 which was
earlier contained in Section 62 of the Companies Act, 1956. The new section has been made effective
w.e.f. 12.9.2013 and its provisions may be discussed as under:

1. Persons liable for mis-statement: When a false or misleading prospectus is issued by the company,
then the following persons are liable to pay compensation to every person who has suffered any loss or
damage by purchasing shares or debentures of the company relying upon the faith of the prospectus:

(a) The company;

(b) Every person who is director of the company at the time of issue of prospectus;
(c) Every person who has authorised himself to be named as a director in the prospectus;
(d) Every person who has agreed to become, a director of the company.

(e) Every person who is a promoter of the company;

(f) Every person who has authorised the issue of prospectus;

(g) Every person who is an expert.

Note: Now the civil liability has been expressly extended to experts. Earlier, there was no such clause.

2. Liability for compensation: In case of mis-statement in a prospectus, the persons, stated above, are
liable to pay compensation to every person who has suffered any loss damage by subscribing the shares,
debentures or any other securities relying upon the faith of prospectus issued by the company. The
liability of these persons may be discussed under the following heads:

(a) Liability for compensation (or damages) for mis-statement.

(b) Liability for damages under the general law.

Note: The persons who are entitled to bring a legal action on the basis of misleading prospectus will be
discussed later in this chapter.

6.12. LIABILITY FOR COMPENSATION FOR MIS-STATEMENT

When, a prospectus issued by the company

(a) includes any misleading statement; or

(b) includes or omits any matter which is misleading,

then the company, the directors, promoters and other persons as stated in last article, are liable to
compensate any investor for any loss sustained by him by reason of any such statement in the
prospectus upon which he had relied for the purchase of shares or debentures [Section 35(1)].

EXAMPLE 6.4. A company was formed for manufacturing leather tyred wheels for trollyes. The
company issued a prospectus stating that "orders have already been received from the House of
Commons, to be followed by large orders later...wheels for trolleys in the House of Commons have
been ordered and are now in use". In fact no single order had been obtained for supply of wheels. All
orders received were for trial and by way of experiment. It was held that the prospectus contained an
untrue and misleading statement.

The following legal provisions are important in this regard:

1. Exemption from liability: In the following circumstances no person (i.e., director, promoter, etc.)
shall be liable for any misleading statement in the prospectus [Section 35(2)]:

(a) When he proves that before the issue of the prospectus, he had withdrawn his consent to act as a
director.

(b) When he proves that the prospectus was issued without his knowledge or consent, and on becoming
aware of the issue of prospectus, he immediately gave a public notice to the effect that the prospectus
was issued without his knowledge or consent. Thus, the directors, promoters etc. can put up the above
mentioned defences to escape liability for damages for mis-statement in the prospectus.

Note: The measure of damages, to be recovered by the aggrieved shareholder, is the loss suffered by
reason of untrue statement, omission of facts, etc., in the prospectus. Thus, in such cases, a shareholder is
entitled to recover the difference between what he paid for the shares and what they were worth (i.e.,
their true value) when they were allotted to him.
2. Unlimited liability in case of intent to defraud: Where it is proved that a prospectus has been
issued with intent to defraud the applicants for securities (shares or debentures etc.) of the company,
then the directors, promoters, etc., shall be personally liable, without any limitation of liability, for all
the losses or damages suffered by any person who has subscribed to the securities on the basis of such
prospectus [Section 35(3)]. Here, the liability is without any limitation which means that the directors,
promoters etc. cannot escape liability even by putting up defences stated in above point. This clause
aims at imposing strict punishment and thereby ensures fairness and transparency in the dealings
between an investor and the company.

Changes brought in by the Companies Act, 2013

1. Section 35 is applicable to all types of securities not only shares or debentures.

2. Civil liability has been expressly extended to experts, which was not so under the
earlier Companies Act, 1956.

3. The clause of personal liability without any limitation as discussed in point 2 above,
is a newly introduced clause which was not there in Section 62 of the Companies Act,
1956.

6.13. LIABILITY FOR DAMAGES UNDER THE GENERAL LAW

We have discussed, above, the liability of the persons (directors, promoters, etc.) responsible for the issue
of the prospectus. The persons responsible for the issue of false prospectus may also be held liable for
the payment of damages under the general law. Thus, a person who has been induced to invest money in
a company by fraudulent statement in a prospectus can recover damages for fraud (or deceit) under the
Indian Contract Act', or the 'Law of Torts'.

The term 'fraud' may be defined as the mis-statement of facts made with an intention to deceive a
person. If the statement is made without any intention to deceive and the person making the statement
believes the same to be true, then the person making the statement will not be liable for damages for
fraud.

EXAMPLE 6.5. The prospectus of a company contained a statement that the company had been
authorised by Special Act of Parliament to use steam or mechanical power for running the trains. In
fact, the authority to use the steam was subject to the approval of the Board of Trade'. But this fact was
not mentioned in the prospectus. A purchased certain shares of the company on the faith of the
statement made in the prospectus. However, the Board of Trade did not approve the use of steam, and
consequently the company was wound up. A filed a suit against the directors for damages for fraud. But
the court held that the directors were not liable for fraud. In this case, the directors were not guilty of
fraud as they honestly believed that once the Parliament had authorised the use of steam, the consent of
the Board of Trade was practically concluded. In this case, Lord Herschel observer that-

"Fraud is proved when it is shown that false representation has been made

(a) knowingly, or

(b) without belief in its truth, or

(c) recklessly, carelessly whether it be false or true".

Thus, a person making a false statement is not guilty of fraud, if he honestly believes that the statement
made by him is true. The damages for fraud can, therefore, be recovered from the company only if the
following conditions are satisfied and proved by the investor:

1. The mis-statement in the prospectus must be fraudulent i.e., must be made knowingly and with
the intention to deceive. In other words, there must exist the elements of fraud.

2. The fraudulent mis-statement must relate to some existing facts which are material to the contract
of purchasing shares or debentures, and the investor must be induced to purchase the shares or
debentures in the company

3. The investor must have taken the shares directly from the company. A person who purchases
shares in the open market has no remedy against the company or directors, etc even if he bought the
shares on the faith of representation contained in the prospectus

EXAMPLE 6.6. A company issued a prospectus inviting subscriptions for debentures. The prospectus
contained a statement that "the objects of the issue of debentures are (a) to complete alterations in the
buildings of the company, (b) to purchase horses and vans, and (c) to develop the trade of the company
However, the real object of money raised by debentures was to pay off pressing liabilities. Relying upon
the statement in the prospectus, A advanced money to the company and purchased its debentures. The
company became insolvent, and A filed a suit against the directors for fraud. It was held that the directors
were liable for fraud. In this case, the statement made was of existing fact as the directors had
misrepresented their of mind, and the statement made in the prospectus was material to the contract of
purchasing debentures The court further observed as under:

"All man who lends money reasonably wishes to know for what purpose it is borrowed, and he is
more willing to advance if he knows that it is not wanted to pay off liabilities already incurred."

It may be noted that if the investor claims damages under the provisions of Company Act he is not
required to prove the above points. In those cases, he has simply to show that the prospectus contains a
false statement or omits to disclose some material particulars as required by the Companies Act.

6.13. CRIMINAL LIABILITY FOR MIS-STATEMENT IN PROSPECTS

The criminal liability means the liability which impose punishment of imprisonment or fine or both.
We have already discussed the civil liability of persons who have authorised the issue of the prospectus.
These persons are also criminally liable, under the Companies Act, for the issue of false prospectus.

The criminal liability for the issue of untrue or misleading prospectus is now provided in Section 34 of
the Companies Act, 2013 which was earlier contained in Section 63 of the Companies Act, 1956. The
new section has been made effective w.e.f. 12.9.2013, and its provisions may be stated as under:

1. Liability for imprisonment and fine: If a prospectus issued, circulated or distributed by the
company contains any untrue or misleading statement, or contains or omits any matter which is likely
to mislead, then every person who authorises the issue of such prospects shall be liable to punishment
and fine as provided in Section 447, which is as under:

(a) imprisonment for 6 months which may extend to 10 years, and

(b) fine which shall not be less than the amount involved in fraud, but which may extend to three
times the amount involved in fraud.

It is to be noted that where the fraud in question involves public interest, then the term of imprisonment
shall not be less than 3 years.

2. Exemption from liability: The person authorising the issue of prospectus shall not be
criminally liable if he proves that:
 (a)The untrue statement was immaterial; or

(b)He had reasonable grounds to believe that the statement was true, and upto the issue of the
prospectus he actually believed the statement to be true.

EXAMPLE 6.7. The prospectus of a company stated that the company had the experience of two half
decades in its line of business. In fact, the experience was not of the company itself but that of the
partners of a firm which had been taken over by the company. In this case, the management was held
not liable for the untrue statement. It was held that there was no malafide intention behind the
statement. The statement was not so materially false as to make the directors criminally liable.
Notes 1. Any person who fraudulently induces or attempts to induce another person to enter into an
agreement relating to an investment in shares or debentures, shall be liable to same punishment as
stated above [Section 36, the Companies Act, 2013]. Fearing liability under this provision, the
promoters may not make any untrue and misleading statement in the prospectus with a view to
obtaining capital from public.

2. Any person who has purchased shares in a fictitious name or who has induced company to allot
shares in a fictitious name, is punishable with same punishment as stated above [Section 38, the
Companies Act, 2013].

6.14. LIABILITY OF THE COMPANY

We have already discussed that the persons who have authorised the issue of false prospectus are liable to
the persons who invest money in the company on the belief of such prospectus. It will be interesting to
know that the company is also liable to pay damages for mis-statement in the prospectus. Thus, any
person who has been induced to invest money in the company by fraudulent statement in the prospectus,
may recover damages for fraud either from the directors, etc. or from the company. However, the
company can be made liable if it is proved that the false prospectus was issued by the directors within the
scope of their authority. It may, however, be noted that the liability of the company is only for those
mis-statements which amount to 'fraud'. Thus, the damages can be recovered from the company only if
following conditions are satisfied and proved by the investor:

1. The mis-statement in the prospectus must be fraudulent i.e., it must be made with the
intention to deceive.

2. The fraudulent mis-statement must relate to some existing material facts.

3. The fraudulent mis-statement must have induced the investor to purchase the shares or
debentures in the company, and he actually acted upon the mis-statement and suffered damages.

It may, however, be noted that before an investor can bring an action for damages, he must first
surrender the shares to the company³. One cannot remain in the company as shareholder, and also sue it
for damages suffered by the purchase of shares. In actual practice, the suits for recovery of damages
are rarely filed against the company. The usual claim against the company is for rescission of contract
as discussed in the next article.

Note: The English Misrepresentation Act, 1976 now entitles the court to award damages in lieu of
rescission. It means that a rescission (i.e., termination) of contract is no longer necessary as pre-
requisite for liability of the company.

6.15. INVESTOR'S RIGHT OF RESCISSION OF CONTRACT

The 'rescission of contract' means the 'termination of or putting and end to the contract'. Any person who
has been induced to purchase the shares or debentures in a company by misrepresentation of material
facts in the prospectus, can rescind (i.e., put an end to) the contract to purchase shares or debentures.
This is because of the reason that if the consent of a party is obtained by misrepresentation, then the
contract is viodable at the option of such party who may rescind the same. An investor can rescind the
contract to purchase shares or debentures by filing a suit against the company for the rescission of the
contract. When the court passes an order of of recession of the contract, then the investor can get back his
money with interest. The shares debentures will be returned to the company, and his name shall be
removed from the register shareholders, or debenture holders, as the case may be.

6.16. CONDITIONS FOR RESCISSION OF CONTRACT

The investor can rescind the contract to purchase shares or debentures only if the following conditions
are satisfied:

1. There must be false representation of facts in the prospectus: The term 'fal representation' means
mis-statement of facts, or concealment of material facts. However, the representation need not be
fraudulent i.e., intention to deceive is not required.

EXAMPLE 6.8. A prospectus of a company contained a table showing that between the years 1911
1927 the company has paid dividends every year. This statement created the impression that the
company was in sound financial position. In fact, the truth was that during these years the company had
sustained substantial losses and the dividend could be paid only out of the funds accumulated in
previous years. But this fact was not disclosed in the prospectus. It was held that the prospectus was
false. In this case, there was false representation as the prospectus did not disclose the material fact.and
Similarly, the following statements in the prospectus have been held to be misleading, the investors
could rescind the contract on this ground:

(a) A prospectus contained a statement stating that "more than half the shares have already been sold".
But the fact was that only one promoter of the company had applied for more than half the shares, and
had not paid any money and ultimately took only a few number of shares. The statement was held to be
misleading and rescission of contract was allowed. [Ross v. Estates Investment Co. (1968) Ch. App.
682)

(b) A prospectus contained a statement stating that "the directors and their friends have subscribed to
the large portion of the capital and they now offer to the public the remaining shares". But the fact was
that the directors had subscribed ten shares each. The statement was held to be misleading, and the
rescission of contract was allowed. [Henderson v. La Con (1857) 17 LT 527)

(c) A prospectus contained a statement stating that "the contracts which the company had entered into
were considerably within the capital it proposed to raise. But the fact wa that the fulfilment of those
contracts would not leave sufficient capital with the company to carry out the under taking for which it
was formed. The statement was held to be misleading, and the rescission of contract was allowed.

The false representation must be of some facts which are material to the contract of purchasing shares or
debentures: The materiality of facts is a question of fact in each case. Generally, a fact is said to be
material when it induces an average person to take a decision regarding the purchase of shares or
debentures.

EXAMPLE 6.9. The prospectus of a company contained a statement that two leading businessmen of
repute have agreed to become directors of the company. In fact, the truth was that they had only
expressed their willingness to help the company. It was held that the prospectus contained a misleading
statement of material fact.).

A statement of fact should be distinguished from a statement of mere opinion or expectation eg., a
statement that the profits of the company are expected to reach a certain figure, is only a statement of
opinion or expectation, and a contract cannot be rescinded on such statements. It may also be noted
that the misrepresentation must be of facts and not of law e.g. a statement, in a prospectus, that
company's fully paid shares will be issued at half of their nominal value, is a misrepresentation of law as
the Companies Act prohibits the issue of shares a so much discount. An investor deceived by the
misrepresentation of law has no remedy against the company

3. The false representation (ie, statement) must have induced the investor to purchase the
shares or debentures in the company: The investor must have been induced by the false statement
to purchase the shares or debentures in the company. If any person purchases the shares or
 debentures without relying upon the prospectus, he has no remedy against the comp Whether or not
the false statement has induced a person to purchase the shares or debentures is a question of fact
depending upon the circumstances of each case. Generally, a statement is considered to influence the
investor if it induces a reasonable (Le, average) man to purchase the shares or debentures in the
company. If an investor's acts show that he did not rely on the statement in the prospectus, he is not
entitled to put an end to the contract

EXAMPLE 6.10. The prospectus of a mining company contained a statement about the capacity of
company's mine But in this statement, the capacity of the mine was inaccurately described. A. an
intending investor, inspected the mine himself, and purchased the shares in the company Subsequently.
A wanted to rescind (re, cancel) the contract for the purchase of shares on the ground that the capacity of
the company's mine was inaccurately described in the prospectus. It was held, that A was not entitled to
rescind the contract as he had inspected the mine himself, and therefore, must have relied on his own
observations and not on the statement contained in the prospectus

As a matter of fact, an investor cannot rescind the contract to purchase the shares or debentures in the
company, if he knows the statement to be false. The reason for the same is that in such a case he cannot
be considered to have been induced by the false statement

Note: Sometimes, a prospectus indicates the means by which the accuracy of the vament may be
verified. In such cases, the investor is not considered to have the knowledge of the false statement in the
prospectus unless he had actually inspected the prospectus and verified the accuracy of the statement

4. The investor must have relied upon the false representation Le statement) in the prospectus:
The investor must have purchased the shares or debentures in the company relying upon the statement in
the prospectus. Thus, where a person purchases shares in open market and not directly from the
company, he cannot rescind (Le, put and end to) the contract on the ground of false statement in the
prospectus.

EXAMPLE 6.11. The prospectus issued by a company contained certain false statement. Relying upon
the statements in the prospectus, 4 purchased shares of the company. Later on A sold these shares to B.
another person. After some time, the company went into liquidation (Le, wound up), and B being the
shareholder of the company, had to contribute a large sum towards the company's assets for the payment
of company's habilities. B wanted to recover indemnity (e. compensation) for his loss from the persons
who were directors at the time of issue of the prospectus. It was held that the directors were not liable
(Peek v. Gurney (1873) LR. 6 HL 377: (1873) 43 LJ Ch. 19 The above rule is based upon the principle
that the function of the prospectus is to invite the persons to purchase the shares or debentures in the
company. And as soon as the allotment of all shares or debentures offered by the prospectus is complete,
the function of the prospectus is exhausted. After the completion of this function, the directors cannot
be made liable for subsequent dealings which may take place with regard to those shares or debentures
in the open market.
Sometimes, a statement is true at the time of issue of prospectus, but becomes false at the time of
allotment of shares. This may happen when the circumstances change between the interval the issue of
prospectus and the allotment of shares. It will be interesting to know that in also investor can rescind
the contract if the statement was false when purchased the shares such debentures.

EXAMPLE 6.12. A person applied for the shares in a company on the basis of a prospectus containing
the names of the directors. Before the allotment took place, there was change in the Board of Directors
some directors had retired. It was held that the applicant may revoke i.e., cancel) his application.

However, if a statement is true at the time of allotment, the shareholder cannot rescind contract even if
the statement was false at the time of issue of prospectus. This is so because the statement relied upon
by the shareholder became true at the time of allotment. proper

5. The prospectus must have been issued by or on behalf of the company: A company i responsible
for the false statement in the prospectus only when the prospectus is issued by the company or by
someone with the authority of the company. The Board of Directors is the authority to issue prospectus
on behalf of the company. Thus, an investor can rescind the contract only when it is shown that the
false prospectus was issued by the Board of Directors or by some one with the authority of the Board
of Directors.

Sometimes, a person is induced to invest money in the company by the representation of person who
has no authority to make such representation. In such cases also, the investor canny rescind the
contract.

EXAMPLE 6.13. A, the secretary of a company, made a false representation to B about the position of
the company, and induced him (B) to purchase shares of the company. Relying upon the representation B
purchased certain shares. On becoming aware about company's true position, B wanted to rescind
contract for the purchase of shares. The court refused to grant the relief to B, and observed that a
secretary of the company had no general authority to make such representation.

6. The investor must take action for rescission of contract within a reasonable time: The expression
reasonable time' is a question of fact depending upon the circumstances of each particular case. However,
an investor should start the legal proceedings as soon as he comes b know of the false statement in the
prospectus. If he does not take any action for an unreasonable time, he loses his right to rescind the
contract.

EXAMPLE 6.14. A purchased certain shares in a company relying upon the statements in the prospects
Subsequently, 4 came to know that representations made in the prospectus were false. However, he did
n take any action for five months. Thereafter, he wanted to rescind the contract, and took steps to have
i name removed from the register of members. The court refused to grant the relief to A. It was held that
is unexplained delay of five months precluded him from obtaining the relief.

It may also be noted that the proceedings for rescission must, in all cases, be started bef the company
goes into liquidation.

Note: When an investor decides to put an end to the contract on the ground of false representation the
prospectus, a mere notice to the company to this effect is not enough. He must take effective steps the
rectification of register of members and removal of his name from the register.

6.17. LOSS OF RIGHT OF RESCISSION

The investor's right to rescind the contract to purchase shares or debentures in the company lost in the
following circumstances:

1. When he expressly or impliedly affirms or adopts the contract, e.g., when with the full knowledge of
misrepresentation, the shareholder attends meetings of the company, receives dividends, attempts to sell
the shares, pays the calls, then he cannot afterwards rescind the contract.

2. When he purchases the shares in the open market and not directly from the company. In such cases he
cannot be said to rely upon the prospectus. However, if the company does something to induce him to
purchase shares in the market, he may rescind the contract. 3 When there is unreasonable delay in
rescinding the contract, eg, when he does not take any action for a long time after becoming aware of the
false statement.

When the winding up proceedings are started against the company. The object of this provision is to
protect the general body of creditors who might have formed their own opinion as to the persons who
constitute the shareholders of the company, and expect contribution from them However, if the
shareholder has started the rescission proceedings before winding up, then the passing of winding up
order during the pendency of rescission proceedings will not prevent him from getting the relief.

6.19 PERSONS ENTITLED TO REMEDIES FOR MISLEADING PROSPECTUS

We have already discussed the ability of directors, promoters and the company for a misleading (re),
false) statements in the prospectus. It may be noted that the right to bring an action on the basis of
misleading prospectus is available to a person who is affected by the
Newely added Section 37 of the Companies Act, 2013 makes a specific provision with regard to the
persons who can bring a legal action on the basis of a misleading prospectus. This is a new section and
has been made effective wef. 12.9.2013.

According to Section 37, a suit may be filed or any other action may be taken by any person, group of
persons, or any association of persons who is affected by any misleading statement or the inclusion or
omission of any matter in the prospectus

In simple words, the following persons who have subscribed the securities of the company and are
thereby affected by the misleading prospectus, are entitled to bring an action against the company for
damages or loss sustained due to misleading statement in the prospectus:

(a) Any person

(b) the group of persons,

(c) any association of persons.

This section paves the way for class action suits by members/depositors affected by misleading
statements in the prospectus.

In Kisan Mehta & Others v. Universal Luggage Mfg Co. Ltd., (1988) 63 Company Cases 39%
(Bombay), the Bombay High Court has held that any person who is not at all interested in the company
in any way, is not entitled to sue the company for misleading prospectus. In this case, a suat was field
against the company, by uninterested persons ie, who have not invested any money in the company, for
an order restraining the company from issuing shares and debentures on the bases of misleading
statement. The court refused the order and held that the persons not interested in the company at all are
not entitled to bring an action against the company. The following example is based upon the facts of
this case.

EXAMPLE 6.15. A company issued a prospectus showing various items of profits. In fact, these items
in were liabilities as certain accounting adjustments were not made while calculating the items of
profits. A & Others, a group of public interest litigants, filed a suit against the company, and sought an
injunction order restraining the company from issuing any shares and debentures on the basis of
misleading and false prospectus. The suit was filed by A & Others on the ground that the prospectus
was false and misleading as it did not give a true and fair picture of the company. They also contended
that the statements contained the prospectus might mislead the public and result in public injury. The
court dismissed the suit and refused to grant the injunction order. The court observed that a person who
is not interested in the company at all cannot come forward and say that the statements contained in the
prospectus are false. The court further observed that the plaintiffs i.e., A & Others themselves were not
cheated, nor was there any compulsion the public to accept the offer of the company on misleading

Thus, the affected persons are entitled to bring an action on the basis of a prospectus. A stranger i.e.,
person who has not invested any money in the company has no right to start a public interest litigation
against the company on the ground that it has published a misleading prospectus.

6.20. SHELF PROSPECTUS

The legal provisions relating to 'shelf prospectus' are now contained in Section 31 of the Companies Act,
2013, which were earlier contained in Section 60A of the Companies Act, 1956 Section 31 of the new
Act has been made effective w.e.f. 12.9.2013 and the following discussion is based on the new Section
31.

A 'shelf prospectus' means a prospectus in respect of which the securities or class of securities included
therein are issued for subscription in one or more issues over a certain period without the issue of
further prospectus [Section 31, Explanation].

This prospectus is like information contained in a file lying on a shelf. The legal provisions in this regard,
as contained in Section 31, may be discussed as under:

1. Issue of shelf prospectus by the companies specified by SEBI (Section 31(1)]: The shelf
prospectus may be issued by the companies specified by the Securities and Exchange Board of India
(SEBI).

The SEBI may by regulation, provide that any class of companies as specified by it, may issue a shelf
prospectus. Such specified companies may file a shelf prospectus with the Registrar of companies at the
stage of first offer of securities to the public.

2. Validity of the shelf prospectus [Section 31(1)]: The shelf prospectus shall remain valid for a
period of one year from the date of opening of the first offer of securities under the prospectus. It is to
be noted that in respect of second or subsequent offer of securities, included in the shelf prospectus,
issued during the validity period of one year, no further prospectus is required.

3. Advantage of filing shelf prospectus: A company filing a 'shelf prospectus' with the Registrar
shall not be required to file prospectus afresh every time it issues securities within the period of
validity of such prospectus [Section 31(1)].

4. Filing of information memorandum: A company filing the shelf prospectus is, however. required to
file with the Registrar, an 'information memorandum' on all material facts relating to the following,
namely [Section 31(2)]:

(a) new charges created.

(b) changes occurring in financial position between the first offer of securities, previous offer of
securities and succeeding offer of securities, and

(c) such other changes as may be prescribed.

The information memorandum' is to be filed with the Registrar within prescribed time, prior to the issue
of a second or subsequent offer of securities under the shelf prospectus.

5. Deemed prospectus: An information memorandum together with the shelf prospectus shall be
deemed to be a prospectus [Section 31(3)).

Note: Under the Companies Act, 1956, only financial institutions or banks could issue shelf
prospectus. areas under the new Companies Act, 2013 any class or class of companies as prescribed by
the SEBI may e shelf prospectus with the Registrar of Companies

6.21 RED-HERRING PROSPECTUS

We know that a public company is required to issue a prospectus to the public when it wants to raise
money by issue fie, allotment) of shares or debentures

A company may also make an offer of securities (ie. shares, etc.) by issuing a red herring prospectus
prior to the issue of prospects

The legal provisions relating to red herring prospectus are contained in Section 32 of Companies Act
2013 which have been made effective wef 12.9.2013 and the following 15based on the new section.

1. Meaning of red herring prospectus: A red herring prospectus' means a prospectus which does not
include complete particulars of the (a) quantum of securities, or (b) price of securities included therein
(Section 32, Explanation].

2. Time of issuing red herring prospectus: A company proposing to make an offer of securities may
issue a red herring prospectus prior to the issue of prospectus [Section 32(1)].
3. Filing of red herring prospectus: A company which proposes to offer securities by issuing a red
herring prospectus is bound to file the same with the Registrar at least 3 days prior to the opening of the
subscription list and the offer [Section 32(2)}.

4. Obligations and variations in red herring prospectus: In this regard, the legal provisions

(a). The information memorandum and red-herring prospectus carry the same obligations as are
applicable in case of a conventional prospectus [Section 32(3)].

(b) The issuing company has to highlight any variation between the red herring prospectus and a
prospectus (Section 32(3)

5. Filing of final prospectus: On completion of allotment and closing of the offer of securities, a
final prospectus shall be prepared completing the information which was missing in the red-herring
prospectus, namely,
(a) the amount of capital raised whether by way of debt or share capital,
(b) the closing price of securities, and (c) any other details which was not complete in the red-herring
prospectus (Section 32(4)]. The final prospectus shall be filed by the company with the Securities and
Exchanges Board of India (SEBI), and the Registrar of Companies (Section 32(4)).

Note: Under the earlier Companies Act, 1956, there was requirement of individually intimating the
highlighted variations, if any, between the red-herring prospectus and prospectus to the persons invited to
subscribe to the issue of securities Now this provision has been dispensed with be dropped.

6.22. PROSPECTUS BY IMPLICATION OR DEEMED PROSPECTUS

We have discussed that the provisions relating to the preparation and the filing of the prospectus at very
stringent, and shall be observed strictly. If these are not observed then there is civil and mal ability of
the company and of the persons who have authorised the issue of prospectus. is under to avoid these
tough requirements, the companies used to allot the whole of their capital intermediary, known as
Issung House The Issuing House' may be a company, or a firm The intermediary then offered the
shares to the public by means of a document or advertisement of its own. The requirements of the
Companies Act relating to the prospectus were evaded in this way. But after the enactment of
Companies Act, every such document or advertisement is known as an 'offer for sale', and is
considered to be a prospectus issued by the company.

Legal provisions in this regard are contained in Section 25 of the Companies Act, 2013, which
correspond to Section 64 of the Companies Act, 1956. Section 25 has been notified (i.e., made effective)
w.c.f.12.9.2013, and its provision may be stated as under:

1. Meaning of deemed prospectus [Section 25(1)]: Any document by which the company offers any
securities for sale to the public shall, for all purposes, be deemed to be prospectus issued by the
company.

2. Application of provision Section 25(1)]: All provisions as to the (a) contents prospectus, (b) liability in
respect of mi-statement in prospects, or (c) otherwise relating to prospectus, shall apply as if the securities
had been offered to the public for subscription The persons making the offer shall be considered to be the
directors of the company.

3. Evidence of offer of securities to public [Section 25(2)]: In the following cases, it would be an
evidence to show that the securities were offered to the public for sale, and the document containing such
offer would be treated as a prospectus:

(a) Offer within 6 months of allotment: If it is shown that the offer of securities for sale to the
public was made within 6 months after the allotment or agreement to allot,

(b) Whole consideration not received: If it is shown that at the date of making offer the whole
consideration to be received by the company in respect of securities had not been received by it.
 4. Signing of offer document [Section 25(4)]: The offer document deemed to be a prospects issued
on behalf of the company should be signed by two directors of the company. And in case of such
document issued by a firm, it should be signed by not less than one ha of the partners of the firm.

Note: Earlier, under Selection 64 of the Companies Act, 1956, the agent of the director or of the partner
authorised in writing could also validly sign the offer document. Now, under new Section 25, the
authorised agents are not entitled to sign the offer document.

5. Additional information [Section 25(3)]: The following additional information is require to

be there in a deemed prospectus:

(a) The net amount of consideration received or to be received by the company respect of the shares or
debentures to which the 'offer for sale' relates.

(b) The time and place at which the contracts relating to the allotment of shares debentures may be
inspected.

6.23. MINIMUM SUBSCRIPTION

The minimum subscription' is the minimum amount stated in the prospectus which is requi for certain
specified purposes, namely:

1. For the payment of purchase price of the property.

2. For the payment of preliminary expenses including any commission payable for the s of
company's share (e.g., underwriting commission).

3. For the repayment of any money borrowed by the company for the above, two purpo 4. For
working capital.

4. For any other necessary expenditure.

The amount of minimum subscription is fixed by the directors or signatories to the memorandum after
making due inquiry about the purposes for which it is required. This amount is raised by the company by
the issue of shares.

Note: The allotment of shares for the first time cannot be made by the public company unless the amount
of minimum subscription has been subscribed. In other words, the applications for the purchase of shares
upto the amount of minimum subscription must have been received by the company before making the
first allotment [Section 39 (1)].

6.24. UNDERWRITING COMMISSION

The expression 'underwriting' literally means the giving of a guarantee. It is a well-known business term
and is commonly used in company matters. In this connection, it may be defined as the entering into a
contract with a company by which a person (known as 'underwriters*) agrees that if the shares or
debentures offered by the company to the public for subscription are not taken up by the public, he will
himself take up the shares and pay for them. As a matter of fact, an underwriter guarantees the purchase of
company's shares or debentures by the public. The amount payable to the underwriters for giving such
undertaking (i.e., guarantee) is known as the underwriting commission'. The 'underwriting commission' is
paid to the underwriters whether or not they are called upon to take up any of the shares or debentures. In
fact, the commission is paid to the underwriters not for the shares or debentures taken by them, but for the
risk to which they are exposed in placing the shares or debentures before the public. Thus, the
underwriting commission is paid on all the shares offered to the public for which the underwriting
agreement is made i.e., on all the shares specified in the underwriting agreement.
We know that a public company cannot proceed to allot shares to the public unless the shares have been
subscribed upto the amount of 'minimum subscription' [Section 69]. Moreover, a public company which
has issued a prospectus, cannot commence its business unless the shares upto the amount of 'minimum
subscription' have been allotted [Section 149]. Thus, a public company which invites the public to
subscribe for its shares or debentures must ensure that the shares of the value upto the amount of minimum
subscription are taken up by the public. It is, therefore, usual for the public companies to make an
underwriting agreement with some financial institutions (i.e., underwriters) for the shares upto the amount
of minimum subscription. The underwriting is in the nature of insurance which covers the risk against the
shortfall in pubic response to purchase the shares or debentures offered by a company.

As a matter of fact, when the shares are offered to the public, the company would like to assure success of
its issue. In order to prevent the failure of an issue, the companies generally make underwriting agreement
with financial institutions (i.e., underwriters) who in consideration of their commission, agree to take up
the shares to the extent to which they are not taken up by the public. Even if the company is sure that all
the shares or debentures will be taken up by the public, it is advisable for the company to get the shares or
debentures underwritten in order to avoid any risk arising from certain unforseen contingencies which may
endanger the success of the issue.

Following points may be noted with regard to underwriting commission: (a) The underwriting commission
is payable on all shares or debentures offered to the public, and not on those which are taken up by the
underwriters.

The underwriting commission may be paid both out of profits as well as capital

Notes: The company may pay commission to any person any person in connection with subscription to its
securities subject to such conditions as may be prescribed [Section 40(6), the Companies Act, 2013.

6.25. BORKERAGE

The term 'brokerage' may be defined as the commission payable to a 'broker' on the transaction
negotiated by him. A 'broker' is a person who acts as a middleman and brings the parties together and
assist them in negotiating a contract or deal. The brokers are generally, professional person dealing in
securities (i.e., shares, debentures, etc.) by whose mediation the customers are induced to purchase the
shares of the companies. It may be noted that the brokers do not undertake to t up the shares or
debentures which are not taken by the public. They simply induce the customers to purchase the shares
or debentures of the company. As a matter of fact, the brokers render services of bringing buyer and
seller together. And the remuneration paid for these services known as 'brokerage'.

The legal provisions relating to the payment of brokerage may be summed up as under.

1. The brokerage must be paid to a person carrying on the business as a broker and not a private
person. In other words, the brokerage is payable to a broker for his service as a broker, and not to a
person who had casually introduced some one to purchase t shares or debentures of the company.
2. The brokerage is paid only on those shares or debentures for which subscription procurred i.e.,
which are subscribed through brokers, and not on the entire issue.

3. The maximum rate of brokerage to be paid to the brokers has not been prescribed in the
Companies Act. However, it should be reasonable.

6.26. COMPARISON BETWEEN UNDERWRITING COMMISSION AND BROKERAGE

The following table gives the comparison between under-writing commission and brokerage
S.NO. UNDERWRITING COMMISION BROKERAGE
1 It is paid to those who give an undertaking It is paid to those who induce customers to
to take the shares or debenture of the purchase the shares or debentures of the
company if they are not taken up by the company. Such person do not given any
public undertaking to take company’s shares or
debentures
2 It is paid on entire issue i.e., on all shares or It is paid only on those shares or debentures for
debentures offered to the public whether or which subscription is procured i.e., which are
not they are taken by the underwriters subscribed through brokers. It is not paid on the
entire issue.
3 It is paid at the rate as may be prescribed by It is paid at such rate which is reasonable
rules
4 It is paid on those shares or debentures It is paid on those shares or debentures for
which are offered he public for which subscription is procured through brokers
subscription. Thus, it is not paid on shares even if they are not offered to the public
on debentures which are not offered to the
public
5 It is a sort of insurance premium paid to the It is a sort of remuneration paid to the brokers
underwriter to cover the risk of under for their service of introducing purchase for the
subscription shares or debentures.

SHARE CAPITAL

8.1. INTRODUCTION

We have discussed, in the last chapter, that the amount required by the company for its business activities
is raised by the issue of shares. The amount so raised is called the share capital (or capital) of the
company. The share capital of a company may be of two kinds, namely:

1. Preference share capital.

2. Equity share capital".

The preference share capital is the sum total of the preference shares of the company. And the equity
share capital is the sum total of the equity shares of the company. The 'preference' and equity' shares have
already been discussed in details in the previous chapter on 'shares of a company'.

It is important to note that the shares capital is not an essential clause for the formation of a company
under the Companies Act, 2013. A company may be registered with or without the share capital. The
companies limited by guarantee or unlimited companies need not have any share capital. But where the
'memorandum of association' of a company provision for share capital, then the memorandum must state
the amount of share capital and its division into various types, and also the number and value of
shares.

8.2. TYPES OR CATEGORIES OF SHARE CAPITAL

The term 'capital' in connection with a company is used in different senses. Keeping this aspect in view,
the capital of the company may be categorised as under:

1. Authorised capital: It mean such capital as is authorised by the memorandum of a to be the

maximum amount of share capital of the company [Section 2(8), the Companies Au 2013]. In simple
words, it is the maximum amount of capital stated in company's memorandum of association with
which the company intends to be registered. It is also called the 'nominal 'registered' capital. In fact, it is
the maximum amount of share capital which can be issued by a company during its life time. The
authorised capital is divided into shares of fixed amount. The authorised capital may be increased or
reduced by the company by passing an ordinary resolution

Issued capital: It means such capital as the company issues from time to time for subscription [Section
2(50), the Companies Act, 2013]. In simple words, it is that part of the authorised (nominal) capital
which is actually offered (issued) to the public for subscription. It indicates the amount which is open
 for public subscription. It is not obligatory for the company to issue whole of its authorised capital.
The company may issue whole or any part of it, and keep the balance for future requirements.
However, the issued capital cannot exceed the authorised capital.

Note: The part of the authorised capital which is not issued to the public, is known as the 'unissued
capital'.

3. Subscribed capital: It means such part of the capital which is for the time being subscribed by the
members of a company [Section 2(86), the Companies Act, 2013]. In simple words, it is that part of the
issued capital which is actually subscribed (i.e., taken up) by the public. i.e., for which the applications
are received from the public and the shares have been allotted to the public. The subscribed capital
depends upon the response from the investing public which is received the basis of issued capital. on

4. Called-up capital: It means such part of the capital, which has been called for payment Section 2(15),
the Companies Act, 2013]. In simple words, it is that part of the subscribed capital which is actually
demanded by the company to be paid. The company may not be in need of the entire amount of the
capital subscribed by the public. The company may call such amount from the subscribers as is required
by it.

Note: The part of the subscribed capital which is not called by the company is known as the 'uncalled
capital'. It may be called according to requirements subject to the terms of issue of shares, and the
provisions of 'articles of association'.

5. Paid-up capital: It is that part of called-up capital which has been actually paid by the members
(subscribers). In other words, the total money received on shares is known as the paid-up capital
[Section 2(64), the Companies Act, 2013].

6. Reserve capital: It is that part of the uncalled capital which cannot be called by the company except
in the event of its winding up. The company may, by a special resolution, declare that a portion or whole
of the uncalled capital shall not be called except in the event of its winding up

EXAMPLE 8.1. A company mentioned in its memorandum of association 10 lakhs as its capital divided
into 10,000 shares of 100 each. The company was registered with this amount as its capital. In this case,
this amount of 10 lakhs is the authorised (or nominal) capital of the company.

Now suppose that the company offers 8,000 shares to the public. It represents the issued capital of the
company which is 8 lakhs (8,000 x 100). The balance of 2 lakhs is the 'unissued capital'. O of these
8,000 shares offered to the public, the company receives only 5,000 applications for the purchase of its
shares. It represents the subscribed capital of the company which is 5 lakhs (5,000 100). The balance of
3 lakhs (8-5) is the unsubscribed capital. If the company requires, it can call entire amoun from the
subscribers. However, the company calls 30 (
10 on application, 10 on allotment and 10 on first call) on each share subscribed by the public. It
represents the called-up capital of the company which is 1,50,000 (5,000 x 30). The balance of 3.5
lakhs (5,000
70) is the uncalled capital Now suppose that a member to whom 100 shares were allotted, does not pay
the first call of 10 m his shares. The 'paid- up capital' of the company will be 1,49,000 (1,50,000 1,000).
The amount 1,000 is known as 'calls in arrears', and is still the part of uncalled capital.

8.3. PUBLICATION OF AUTHORISED, SUBSCRIBED AND PAID-UP CAPITAL

Legal provisions in this regard are made in Section 60 of the Companies Act, 2013, which correspond
to Section 148 of the Companies Act, 1956.

Section 60 has been notified (i.e.. made effective) w.e.f. 12.9.2013, and it seeks to provide the mandatory
publication of subscribed capital and paid-up capital in case of publication of authorised capital.

This section makes the following legal provisions:

 1. Mandatory publication of subscribed and paid-up capital alongwith authorised capital Section
60(1)]: Where any notice, advertisement or other official publication, or any business letter, bill heads, or
letter paper of a company contains a statement of the amount of the authorised capital of the company,
then such notice advertisement etc. shall also contain a statement of the amount of subscribed and paid-
up capital.

1. Penalty of default Section 60(2): The penalty for default in complying with the above requirements is
as under

(a) The company shall be liable to pay a penalty of Rs. 10,000 for each default; and
(b) Company's every officer in default shall be liable to pay a penalty of Rs. 5,000 for each default

Note: Under earlier section 148 of the Companies Act, 1956, the penalty was of fine extending upto
Rs 10,000 There was to provision with regard to the penalty by fine for each default, as is now the
case.

8.4. ALTERATION OF SHARE CAPITAL

We know that the capital of the company is mentioned in the capital clause of its memorandum of
association. The company may alter its share capital by altering the capital clause of its memorandum
of association. However, the company may do so only if it is authorised by its articles of association.
The company may alter its share capital in anyone of the following ways (Section 61(1)

1. Increase its authorised share capital by issuing new shares.

2. Consolidate and divide the whole or any part of its share capital into shares of larger amount, eg.
consolidation of 1,000 shares of? 10 each into 500 shares of 20 each.

However, where such consolidation and division of share capital results in change in the voting
percentage of shareholder, then it can be done only with the prior approval of the Tribunal (Section
61(1)(b), proviso). It is a new proviso, which was not there in earlier Section 94 of the Companies Act,
1956.

3. Sub-divide the whole or any part of its share capital into shares of smaller amount e.g.,
subdivision of 1,000 shares of 10 each into 2,000 shares of 5 each.

4. Convert all or any of its fully paid-up shares into stock, or reconvert the stock into fully
paid up shares of any denomination.

5. Cancel those shares which have not been taken up by any person and thereby diminish the
amount of its share capital accordingly. Such cancellation of shares does not amount to reduction of
capital as only such shares are cancelled which were not taken by any person.

The alteration of share capital as stated above may by made be the company by passing an undmary
resolution at a general meeting. Such alteration does not require any confirmation of the Tribunal
However, within 30 days of the alteration (e. passing of the resolution of alteration), the company must
give notice, of such alteration, to the Registrar of Companies. On receipt of the notice, the Registrar
shall record the same and make necessary alteration in company's memorandum or articles of
association [Section 64].

To sum up, the legal requirements for the alteration of share capital of the company, may be stated as
under:

(a) The articles of association' of the company must contain a clause authorising the company to
alter its share capital. If the articles contain no such clause, then the articles must first be amended by
a special resolution before the power to alter share capital is

exercised by the company [Re Patent Invert Sugar Co., (1885) 31 Ch. D. 166].
(b) The company should pass an ordinary resolution at its general meeting to alter the share capital.

(c) The power to alter share capital should be exercised in a bona fide manner and in the interest of
the company as a whole and not for the benefit of any particular group.

8.5. INCREASE IN SHARE CAPITAL

The company may increase its share capital in two ways, namely:

1. By further issue of shares.

2. By conversion of debentures or loan into shares.

8.6. FURTHER ISSUE OF SHARES

We have already discussed that a company limited by shares may increase its share capital by issuing
new shares. Generally, the companies do not issue the whole of its authorised capital at once. Only a
portion of it is offered to the public, and the further shares are offered as and when the amount is
required. It may, however, be noted that the directors cannot offer these new shares at their discretion. If
they are allowed to issue the shares at their discretion, they would naturally offer the new shares to
their nominees and increase their own majority. Thus, certain restrictions are imposed by the Companies
Act on the further issue of the shares [Section 62]. And, these restrictions apply as and when the
company proposes to increase its subscribed capital (within the limit of authorised capital) by allotment
of further shares.

Legal provisions in this regard are made in Section 62 of the Companies Act, 2013, which correspond
to Section 81 of the Companies Act, 1956.

Section 62 has been made effective w.e.f. 1.4.2014, and its provisions may be discussed under the
following heads:

1. Offer of shares to existing shareholders [Section 62(1)(a)].

2. Offer of shares to employees [Section 62(1)(b)].

3. Offer of shares to outsiders [Section 62(1)(c)].

8.6.1. Offer of Shares to Existing Shareholders

When, at any time, a company having a share capital proposes to increase its subscribed capital by issue
of further shares, then the new shares must be offered to the existing equity shareholders in proportion to
the paid up capital on the shares held by them on that date of the offer [Section 62(1)(a)]. The shares
issued to the existing shareholders are called the right shares, and the issue of such shares is called the
right issue'. The shareholder's right to receive these shares is called as the 'pre-emptive right of the
shareholders. The object of this rule is that there should be an equitable distribution of shares, and the
holding of shares by each shareholder should not be affected by the issue of new shares.

Legal requirements to be complied in this case are as under:

1. Offer by giving notice: The offer to the existing shareholders must be made by giving notice to
them. The notice must specify the number of shares offered, and the time within which the offer is to be
accepted. And such time should not be less than 15 days and not exceeding 30 days from the date of the
offer [Section 62(1)(c)(i)].

Following points are to be noted with regard to the notice of offer:

(a) The notice must inform the shareholders that if the offer is not accepted within the specified
time, it shall be deemed to be declined.
(b) The notice must also inform the shareholders that they have the right to renounce all or any of the
shares, offered to them, in favour of their nominees.

(c) The notice must be despatched to all existing shareholders atleast 3 days before the opening of
the issue.

2. Directors discretion to dispose of the shares: If the offer is declined or is not accepted by the
shareholders within the specified time, then the board of directors may dispose of such shares according
to their discretion. However, they must exercise their discretion in such
manner which is not dis-advantageous to the shareholders and the company. Similarly, if some shares are
left after the proportionate allotment to the existing shareholders, they may also be disposed of by the
directors in the same manner [Section 62(1)(a)(iii)].

8.6.2. Offer of Shares to Employees

Apart from existing shareholders, the offer of new shares can also be made to the employees under a
scheme of employees' stock option [Section 62(1)(b)].

'Employees' stock option' means the option given to directors, officers or employees of a company
which gives such directors, officers or employees the benefit or right to purchase or to subscribe for the
shares of the company at a future date at a pre-determined price [Section 2(37)].

The offer of new shares to the employees can be made only after complying with the following legal
requirements:

1. Approval by special resolution: The company should seek the approval of shareholders by
passing a special resolution; and

2. Compliance of prescribed conditions: The company should comply with such conditions as
may be prescribed by rules made by the Central Government.

8.6.3. Offer of Shares to Outsiders

The new shares may also be offered to the outsiders to the total exclusion of the existing shareholders
or employees [Section 62(1)(c)].

The shares can be so offered if the following conditions are satisfied:

1. If the company passes a special resolution in the general meeting deciding to offer new
shares to the outsiders, and

2. If the price of such shares is determined by valuation of report of a registered valuer subject to
such conditions as may be prescribed.

Thus after complying with the requirements of Section 62, as discussed above, the company may
proceed to issue further shares.
 Changes brought in by the Companies Act, 2013
1. Applicability to private companies: The application of new provisions has been extended to
private companies also as against earlier Section 81 which applied to public companies only.

2. Applicability to every further issue: The new provision shall be applicable to the company
whenever it plans to increase subscribed capital by further issue. Earlier, the provisions of Section
81 were applicable only (a) to further issue after 2 years from the formation of the company, or (b)
to issue made after expiry of one year after first allotment, whichever is earlier.

3. 3.Time limit for acceptance of offer by existing shareholders: The maximum time of offer as
stated in Art. 8.6.1 (point 1) above has been fixed at 30 days as against no such limit in the earlier
Section 81.

2. 4.Offer to employees: Now, the fresh shares may also be offered to employees as stated in
Art. 8.6.2 above. Earlier there was no such provision in Section 81.

8.7. CONVERSION OF DEBENTURES OR LOAN INTO SHARES

Sometimes, the company has raised a loan by issuing debentures to government, or has otherwise taken
loan from the government. In such cases, the Central Government has the power to direct the company
that such debentures or loan shall be converted into the shares of the company [Section 62 (4) to (6)].
Further legal provisions in this regard are as under:

1. Increase in authorised capital: Where the conversion has the effect of increasing the authorised
capital of the company, then on such conversion of debentures or loan into shares, the authorised capital
of the company will stand increased by an amount equal to the value of such shares [Section 62(6)].

2. Conversion in public interest: The Central Government may order the conversion debentures or
loan into shares if it appears to the government that such conversion is necessary in the public interest.
Such conversion may be ordered by the Central Government even if the terms of the issue of debentures
or loan do not contain any provision for conversion. The Central Government shall order conversion on
such terms and conditions as appear to it to be reasonable [Section 62(4)].

3. Considerations for making order: In determining the terms and conditions of

conversion, the Central Government must taken into consideration the following factors
[Section 62(5)].

(1) The financial position of the company.

(ii) The original terms of the issue of debentures or the terms of the loan.

(iii) The rate of interest payable on debentures or loan.

(iv) Such other matters as government may consider necessary.

Notes 1. The company is required to send copy of the conversion order to the Registrar within 30 days
so that he may effect necessary alterations in company's memorandum [Section 64(1)],

2. The company may prefer an appeal to the Tribunal within 60 days of communication of order if it is
not satisfied with the terms and conditions of conversion [Section 62(4), proviso)

8.8. REDUCTION OF SHARES CAPITAL

As a matter of fact, the reduction of share capital is unlawful except when it is confirmed by the
Tribunal. The share capital of a company is the only security on which the creditors rely The reduction
of capital reduces the funds out of which the creditors are to be paid. Due to this reason, the power of
the company to reduce its share capital is closely guarded by Section 66 of the Companies Act, 2013*.
Thus, the company can reduce its capital only by adopting prescribed procedure as discussed in the next
 article.

It may be noted that by adopting the prescribed procedure, the company limited by shares or a
company limited by guarantee and having a share capital may reduce its share capital in any of the
following ways:

1. Extinguishing may extinguish or reducing liability on unpaid capital [Section 66(1)(a)]: The
company or reduce the liability on any of its shares in respect of the unpaid share capital not paid-up. In
other words, the company may reduce the liability of its members for the unpaid amount of the shares.

EXAMPLE 8.2. A company has issued 1000 shares of 100 each. And 80 are paid on each share. In this
case, the company may extinguish the further liability of 20 per share by reducing the share of 100 to
80 as fully paid up share. In this way the company's capital will be reduced by 20,
000 (1000 × 20).
2. Cancellation of lost paid-up capital [Section 66(1)(b)(i)]: The company may cancel and paid up
share capital which is lost or is unrepresented by any available assets.

EXAMPLE 8.3. A company has a share capital of 10 lakhs divided into

10.000 shares of 100 each. The shares are fully paid up. The company has lost ₹ 2 lakhs in its business,
and the worth of company's assets is reduced by this amount of 2 lakhs. After this loss, the company
has the assets worth 8 lakhs which represent the share capital of 10 lakhs. In this case, the company
may write off the unrepresented amount, and make each share of 80 fully paid up. Or in the alternative,
the company may make the share of 100 as one on which 80 have been paid up, and the balance as
unpaid. In this way, the company's capital will be reduced by 2 lakhs (10,000 20).

3. Paying off excess paid-up capital [Section 66(1)(b)(ii)]: The Company may pay off any paid-up
share capital which is in excess of the requirements of the company.

EXAMPLE 8.4. A company has a share capital of 5 lakhs divided into 50,000 shares of 10 each. The
shares are fully paid up. But the company's requirement is only of 4 lakhs. In this case the company may
return * 2 per share to the shareholders and make the shares of 8 each as fully paid up. In this way, the
company's capital will be reduced by rupees one lakhs.

8.9. PROCEDURE FOR REDUCTION OF SHARE CAPITAL

The procedure (or steps required) for reduction of share capital are provided in Section 66 of the
Companies Act, 2013, and are as under:

1.Authorisation in articles: A company can reduce its share capital only if it is authorised by its
'articles of association' to reduce the capital. If the articles of association do not contain any provision
for the reduction of capital, the articles must first be altered so as to authorise the company to reduce
its capital.

2.Procedure for reduction: Where the company is authorised by its articles of association, it may
reduce its share capital by adopting the following procedure [Section 66(1)]:
(a) By passing a special resolution for the reduction of the capital, and
(b) By obtaining confirmation of the Tribunal.

3. Confirmation of Tribunal: The confirmation of Tribunal is obligatory for reduction of share

capital. The confirmation of Tribunal is obtained by the company by making an application to the
Tribunal. On receipt of such application by the Tribunal, the following provisions shall apply:

(a) Notice of application: The Tribunal shall give notice of every application of confirmation to the
following [Section 66(2)]:

• to the Registrar,
• to the Central Government;
• to the creditors of the company
• to the Securities and Exchange Board of India (SEBI), in case of lasted companies
 Note: It is a new provision which was not there under the earlier Companies Ac. 1956
(b) Consideration of objections: The Tribunal shall take into consideration representations, if any, made
to it by the government. Registrar, credinors or the within 3 months from the date of receipt of notice
[Section 66/2)]
Where no such representation is received by the Tribunal within this penol y months, then it shall be
presumed that they have no objection to the reduction 66(2), proviso].

Note: It is also a new provision which was not there under the earlier Companies Act,

(c) Order of confirmation: On taking into consideration the objections, if any, and being satisfied about
the interest of the creditors, the Tribunal may make an one confirming the reduction of share capital on
such terms and conditions, as it deem fit The Tribunal shall make an order of confirmation if it is satisfied
about the following namely [Section 66(3):

(1) that the debt or claim of every creditor has been discharged or determined or
(2) that the debt or claim of every creditor has been secured; or
(3) that the consent of every creditor has been obtained.
Note: No application for share capital shall be sanctioned by the Tribunal unless app treatment,
proposed by the company for such reduction, is in conformity with accom standards (as specified in
Section
133 or any other provision of this Act), and a certificate t effect by company's auditor has been filed
with the Tribunal [Section 66(3), provisoj, It a new provision.

4. Publication of Tribunal order: The order of Tribunal confirming the reduction of shee
capital shall be published by the company in such manner as the Tribunal may dire is the
mandatory requirement [Section 66(4)).
If the company fails to comply iwth this requirement, it shall be punishable with minimu fine of Rs. 5
lakh which may extend to Rs. 25 lakhs (Section 66(11)

5. Filing requirements by company: These are as under

(i) Filing of special resolution: The special resolution passed by the company reduction of
share capital shall be filed by the company with the Registrar witn days of passing as under Section
117, every special resolution is required to be filed.

(ii) Filing of certified copy of Tribunal order: The certified copy of the order of Tribus
shall be delivered by the company to the Registrar within 30 days of receipt of one On receipt
of the same, the Registrar shall register the same and issue a certificates that effect [Section
66(5)]. A copy of minute approved by the Tribunal showing t following shall also be so filed:

(a) amount of share capital.

(b) number of shares into which it is to be divided,

(c) amount of each share, and

(d) amount, if any, at the date of registration deemed to be paid-up on each share

6. Other important provisions: Following provisions are important to note with regards reduction of
share capital:

(i) No reduction of share capital is allowed if the company is in arrears in the repayme of any deposits
accepted by it or the interest payable thereon (Section 66(1), It is a new provision which was not there in
the earlier Companies Act, 1956.

(ii) The provisions of Section 66 relating to reduction of share capital shall not apply to buy-back by
the company of its own shares under Section 68 [Section 66(6)].
 Changes brought in by the Companies Act, 2013

The changes in the new provisions are in the following respects:

1.The reduction of share capital is not allowed if the company is in arrears in the repayment of any
deposits accepted by it [Section 66(1), proviso].

2.The Tribunal is now required to give the notice of every application of confirmation to the Central
Government, Registrar and Securities and Exchange Board of India, and creditors for their objection, if
any, to the reduction [Section 66(2).

8.10. LIABILITY OF MEMBERS AFTER REDUCTION OF SHARE CAPITAL

After reduction of the share capital, the liability of members becomes as reduced by the company and as
ordered by the Tribunal [Section 66(7)]. A member shall be liable to pay the amount which is deemed to
have been unpaid on his shares. His liability is limited to the difference between the amount of share as
reduced by the company and the amount paid on the share e.g., if ₹ 100 share is reduced to 80 per share
and 50 is already paid on the share. The liability of the member is to pay 30 on each share.

However, in one case, the members remain liable to pay the original nominal value of the shares even if
there is a reduction of capital. Such case arises when a creditor entitled to object to reduction is left out
of the list of the creditors, and subsequently the company is unable to pay his claims. In such cases, in
order to meet the claim of such creditor, the members shall be liable to pay that amount on their shares
which they would have been liable to pay before the reduction of capital (Section 66(8)).

Note: If any officer of the company knowingly conceals the name of any creditor entitled to object the
reduction, or knowingly misrepresents the nature or amount of debt of any creditor, then he is liable to
be punished for fraud under Section 447

8.11. RESTRICTIONS ON PURCHASE BY COMPANY OF ITS OWN SHARES

Legal provisions in this regard are made in Section 67 of the Companies Act, 2013 which has been
notified (1.e., made effective) w.e.f. 1.4.2014 vide MCA Notification dated 26.3.2014.

As per Section 67(1), no company limited by shares or by guarantee and having a share capital shall
have the power to buy its own shares unless the consequent reduction of share capital is effected under
the provisions of this Act.

In simple words, a company can purchase its shares only by following the procedure for reduction of
share capital as discussed earlier in the chapter.

The reason for restricting company's right to purchase its own shares is that the creditors give credit to
the company on the faith that the capital shall be applied only for the purpose of the business. And,
therefore, they have the right to say that the company shall retain its capital and not return it to the
shareholders. However, in the following cases the company is not taken to have purchased its shares,
when it has:

(a) redeemed its redeemable preference shares.

(b) forfeited its shares for non-payment of calls, or

(c) accepted a valid surrender of shares.

These points have already been discussed in detail in the previous chapter.
Note: Under the Companies Act, 1956, restriction on companies for purchase of its own shares were
provided in Section 77 of the Act.
8.12. LOAN BY THE COMPANY FOR THE PURCHASE OF ITS OWN SHARES

A public company cannot give loan or any sort of financial assistance to any person to enable him to
purchase company's own shares or shares of its holding company [Section 67 (2)]. Thus, an agreement
by the company to give loan for the purchase of company's own shares is void. A guarantee given by
the company for the performance of such agreement is also void. However, this restriction does not
apply in the following cases [Section 67(3)]:

1. Where the loan is given by a banking company in the ordinary course of its business
. 2. Where according to a scheme, a provision of money is made to enable the trustees to purchase fully
paid shares in the company or its holding company to be held for the benefit of the employees of the
company.

3. Where the loan is given by the company to its employees (other than the directors, or key managerial
personnel) to enable them to purchase shares in the company to be held by them as beneficial owners.
However, the amount of loan cannot exceed the employees' salary for a period of six months.

8.13. BUY-BACK OF SHARES

The buy-back means the purchase by the company of its own shares. This facility enables the company
to go back to the holders of its own shares and make an offer to purchase such shares from them.

The legal provisions relating to buy-back of shares are provided in Sections 68, 69 and 70 of the
Companies Act, 2013 which correspond to Section 77A, 77-AA and 77-B of the Companies Act, 1956,
are discussed as under:

1. Sources (funds) for the buy-back [Section 68(1)]: A company can purchase its own
shares out of:

(a) its free reserves; or

(b) security premium account; or

(c) proceeds of the earlier issue of shares.

However, the proceeds of an earlier issue of a kind of shares cannot be used to buy-back the same kind
of shares.

Note: Where a company purchases its own shares out of free reasons or security premium account, then a
sum equal to the nominal value of shares purchased has to be transferred to the Capital Redemption
Reserve Account and its details should be disclosed in the Balance Sheet (Section 69(1)].

2. Persons from whom to buy-back [Section 68(5): The buy-back of shares by the company may
be

(a) from existing shareholders on a proportionate basis;

(b) from open market;

(c) by purchasing the securities issued to company's employees pursuant to scheme of stock option
or sweat equity.

3. Conditions of buy-back [Section 68(2)]: A company cannot purchase its own-shares unless it
complies with the following conditions:

(a) Authorisation by articles: A company can purchase its own shares only if buy-back is authorised
by company's articles of association [Section 68(2)(a)].

(b) Passing of special resolution: A company can purchase its own shares only by passing a special
 resolution in the general meeting of the company authorising the buy-back. However, in the following
cases, the passing of special resolution is not required and the buy-back can be made by Board
resolution only [Section 68(2)(b)]:

(1) where the buy-back is 10% or less of the total paid-up equity capital and free resources of the
company, and

(ii) such buy-back has been authorised by the Board by means of Board resolution passed at its
meeting.

Note: Before making buy-back in view of special resolution or Board resolution, the company must file a
declaration of solvency with the Registrar and SEBI. This declaration should state that the company is
capable of meeting all its liabilities and will not be rendered insolvent within one year of the date of
declaration. It should be signed by at least 2 directors one of whom should be a managing director, if any.
However, no such declaration is required to be filed with SEBI by a company whose shares are not
listed on any recognised stock exchange [Section 68(6)].

(c) Amount of buy back: The amount involved in the buy-back must not be more than 25% of
company's paid-up capital and free reserves. However, the buy-back of equity shares in any financial
year should not exceed 25% of company's total paidup equity capital in that financial year [Section
68(2)(c)].

(d) Debt equity ratio: The debt equity ratio after the buy-back should not be more than 2:1 unless a
higher ratio is prescribed by the Central Government for certain class of companies [Section 68(2)(d)].

It means that after the buy-back, the ratio of debt (secured and unsecured) owed by the company is not
more than twice the paid-up capital and free reserves.
(e) Shares to be fully paid-up: The buyback of shares by the company can be of fully paid-up shares
only [Section 68(2)(e)].

(f)Buy-back of listed and unlisted shares: Legal provisions in this regard are as under:
● The buy-back of shares listed on any recognised stock exchange should be in accordance with the
regulations made by the Securities and Exchange Board of India [Section 68(2)(f)].

• The buy-back of other shares not listed on any stock exchange should be in accordance with such
guidelines as may be prescribed in this regard [Section 68(2)(g)].

4. Gap between offers of two buy-backs [Section 68(2), proviso]: No offer of buy-back shall be
made by the company within a period of one year reckoned from the date of the closure of the preceding
offer of buy-back, if any. It means that the gap between two offers of buy-back must be at least of one
year.

5. Completion of buy-back [Section 68(4)]: Every buy-back by the company must be completed
within a period of one year from the date of passing a special resolution or Board resolution, as the case
may be, for the buy- back of shares.

6. Extinction of bought-back shares (Section 68(7)]: The shares bought back by the company must
be extinguished and physically destroyed by the company within 7 days of the last date of completion
of buy-back.

7. Register of bought-back shares (Section 68(9): The company shall maintain the register of
bought-back shares stating (a) consideration paid for the shares bought-back, (b) date of
cancellation of shares bought-back, (c) date of extinguishing and physically destroying the shares,
(d) such other particulars as may be prescribed.

Filing of return (Section 68(10)]: After the completion of the buy- back, the company should file a
return with the Registrar of companies and the Securities and Exchange Board of India (SEBI) within
30 days of completion of buy-back. The return should contain the prescribed particulars.
 However, no such return is required to be filed with the SEBI by a company whose share are not listed
on any recognised stock exchange.

9.No further issue of same kind after buy-back [Section 68(8)]: After the completion buy-back of
shares, the company cannot make a further issue of the same kind of share within a period of 6
months from completion of buy-back.

However, the issue of bonus shares and the conversion of preference shares or debentures into equity
shares is allowed.

10.Penalty for non-compliance [Section 68(11)]: If the company makes default in complying with
the above discussed provisions of Section 68, the penalty is as under:
(a) company is punishable with minimum fine of rs .one lakh which may extend toRs.3 lakh;and
(a)
(b) company
company'sisevery
punishable
officerwith minimum
in default fine of Rs.asone
is punishable lakh which may
under:

 with imprisonment upto 3 years; or

 with minimum fine of Rs. one lakh which may extend to Rs. 3 lakhs; or
 with both.

11. Transfer of amount to capital redemption reserve account [Section 69]: This Section 69 makes
the following provisions in this regard:

(a) Transfer of amount: Where the company purchases its own shares out of free reserves or
securities premium account, then a sum equal to the nominal value of shares purchased should be
transferred to the Capital Redemption Reserve Account, and its details should be disclosed in the
balance sheet [Section 69(1)].

(b) Application of amount: The Capital Redemption Reserve Account may be applied by the
company in paying up unissued shares of the company to be issued to be members of the company as
fully paid bonus shares [Section 69(2)].

12. Prohibition of Buy-Back of Shares [Section 70]: The buy-back is prohibited in certain
circumstances as provided in Section 70. This section prohibits the buy-back through the medium of
other companies, and provides that

(a) A company cannot purchase its own shares through any subsidiary company including its
own subsidiary company.

(b) A company cannot purchase its own shares through any investment company.

(c) A company cannot purchase its own shares if it is in default in the repayment of deposit or interest on
it, redemption of debentures or preference shares, or repayment of a term loan or interest thereon to any
financial institution or a bank, or the payment of dividend to any shareholder.

However, the buy-back is not prohibited if the above sated default is remedied, and a period of 3 years
has lapsed after such default ceased to exist.
Note: A company can also not purchase its own shares, directly or indirectly, if the company has not
complied with the provisions of (a) Section 92, relating to annual return, (b) Section 123, relating to
declaration of dividend. (c) Section 127, relating to default in distributing dividend, and Section 129,
relating to financial statements.
 Changes brought in by the Companies Act, 2013

1. No buy-back within one year of earlier buy-back: Now, as stated in point (4) above, no offer of buy-
back shall be made within a period of one year from the date of close of the preceding buy-back offer, if any.
Earlier under Section 77A, such a restriction was only in respect of offer of buy back made in pursuant to
Board resolution, and not in pursuant to special resolution of company.

2. Enhanced penalty: Earlier the punishment under Section 77-A(11) was imprisonment upto 2 years; or
fine upto Rs. 50,000; or both. Now it is increased as stated in point (10) above.

3. Buy-back in smaller lots: Earlier under Section 77-A, buy-back was allowed from odd lots i e.,
smaller lots than the marketable lot specified by a stock exchange. Now, this provision has been dispensed
with.

4. Application of Capital Redemption Reserve Account: Earlier there was not provision in Section 77-
A for application of Capital Redemption Reserve Account. Now, a specific provision in made in Section
69(2) in this regard as stated in point (11) above.

5. Buy-back in case of certain defaults: Now, a company can make buy-back of shares if the defaults, as
stated in point (12) above, is remedied and a period of 3 years has lapsed thereafter. Earlier there was no such
provision under Section 77-A.