Part II

Company Law

1 Introduction
1.1 General Modern business is characterized, inter alia, by the company from of business ownership. It happens to be the most popular means of carrying on a business activity though it may also be floated to promote art, science, sports or culture in the society. Formation, day-to-day governance and winding up of companies in India is regulated presently by the Companies Act !"#. For managers and other sta$eholders interested in a company, the $nowledge of its basic principles and provisions is of paramount importance. 1.2 Meaning and Features of Company %he word &company' is used generally to mean an association of persons having common ob(ectives. )very association, however, is not a company in the eyes of law. *egally, a company refers to an association which is &registered as a company' under the Companies Act, !"#. %he basic features of a company are listed below+ ,iIt is a voluntary association of persons. ,iiIt is a creation lf law. ,iii- It is incorporated for specific ob(ects only. ,iv- It has a separate legal entity. ,vIts members, generally, have limited liability. ,vi- Its capital, if any consists of transferable shares. ,vii- It has separationof ownership and management. and ,viii- It acts through a common seal. A brief description of the features of a company follows to enable us to appreciate its true nature. 12.1 Voluntary Association of Persons A company is a voluntary association of persons. %his implies that a person may become, and may cease to be, its member at his own volition or discretion. /owever, under the law, such discretion must be e0pressed in writing.

%he Companies Act, !"#, lays down the minimum number of person whose association is necessary to form a company. According to it, at least 1 person are re2uired to form a &public company' and minimum of 3 persons to form a &private company'. It also re2uires that the ma0imum number of members ,e0cluding past and present employes who are number also- in a private company shall not e0ceed "4. /owever, there is no such limit on the ma0imum number of members in a public company. 1.22 Creation of Law A company is brought into e0istence by a legal process called &incorporation' which clothes it with a personality. %he personality so conferred enables it to act li$e a natural person, e.g., it can enter into a contract, can buy and hold property, cau sue and be sued in court of law, etc. It, however, does not possess a physi2ue li$e a human being and is termed as an &artificial person' to distinguish it for him. 5eing an artifical person, it suffers from certain disabilities vis-6-vis natural person. For e0ample, it cannot marry, cannot appear in person, cannot be appointed as a secretary in another company, etc. It may be noted that, li$e its incorporation, a company ceases to e0ist also by a legal process called 7dissolution8. 1.2. Incorporation for !pecific "#$ects only

A company is formed for the purpose of attaining certain ob(ects. %hese ob(ects are re2uired to be stated e0pressly in its constitution which is $nown as &Memorandum of Association'. A company is granted incorporation to enable it to realize such ob(ects only. In other words, its personality e0ists only for the particular purposes of incorporation as defined in its memorandum of association. Conse2uently, a company can underta$e only those activities which are designed to achieve the specified ob(ects or are incidental thereto but nothing else. 9uch a restriction on the powers of a company, by confining corporate activites as aforesaid, provides protection : ,ito the shareholders by ensuring that the funds contributed by them shall not be employed in any unauthorized activity and, thus, their investment would not face an uncontemplated ris$. and ,iito the creditors by ensuring that the corporate funds, to which they ultimately loo$ for the repayment of their debts or loans, shall not be wasted away in unauthorized activities.

%he ob(ects of a company determine the sphere in which it shall operate, for it cannot underta$e any activity outside it. An act outside such sphere is $nown as an &ultra vires' act and is destitute of legal conse2uences, ie., is void. Conse2uently, it does not bind the company. Further, such an act cannot be validated even by the unanimous consent of all its members. 1.2% !eparate Leal &ntity As pointed out earlier, the incorporation of a company clothes it with a legal personality. %his personality of a company is in no way connected with the personalities of its members who constitute it. In short, a company has a separate legal entity. %he law considers and treats a company and its members as different personalities. %he attribute of separate legal entity of a company gives rise to many conse2uences. 9ome of these may be enumerated as under+ ,i%he ;ights and <uties of a company an its Members are <ifferent. It is so because the company and its members are different entities. =ne cannot be held liable for the acts of another. Conse2uently, a company, and not its members, can enforce its rights. =n similar grounds, it alone can be sued for its debts and obligations and its creditors en(oy no rights against it members. Contracts between company and its members are >ossible. It stems from the fact that a company and its members are separate entities. As a necessary conse2uence, they can be debtor and creditor of each other. %he magic of separate entities of company and each member enables them to be, master and servant at the same time. A Company )n(oys >erpetual )0istence ?ntil <issolved by *aw. Its life remains unaffected by the lunacy, insolvency or death of its members. 7<uring the ware all the members of a private company, while in general meeting, were $illed by a bomb. 5ut the company survived. not even a hydrogen bomb could have destroyed it8. %he members may come and go but the company can go on for ever. A Company, 5eing a *egal )ntity, Can 5uy and =wn >roperty in its =wn @ame. An, being a separate entity, such property belongs to it alone. Its members are not the (oint owners of the property even though it is purchased out of the funds contributed by them. Conse2uently, they do not have even an insurable interest in the property of the company.

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12.' Limited Lia#ility of Mem#ers

%he liability of the members of a Company is generally limited, although it can be unlimited also. %he Companies Act, !"#, re2uires every company to state the e0tent of liability of its members in its memorandum of association under the &*iability Clause'. %he said clause reveals whether the liability is limited, or unlimited and further, whether it is limited by shares or by guarantee. Ahere the liability of members in a company is limited by shares, each member underta$es to pay an amount not e0ceeding the nominal value of shares held by him. Ahere such liability is limited by guarantee each member promises to pay an amount not e0ceeding the amount guaranteed by him in the event of its winding up. %he liability of a member in a company limited by guarantee and having a share capital is e2ual to the nominal value of shares held by him and the amount guaranteed by him. It may be noted that, in all these cases, the liability of a member does not e0ceed a certain sum, that is, the nominal value of shares held by him orBand the amount guaranteed by him. %hus their liability is limited. In certain cases, the liability of the member of a company may be unlimited that is, may not be limited to a certain sum. /owever, such companies are rarely formed because the unlimited liability may have disastrous conse2uences for the members in case of loss. 12.( Capital consists of )ransfera#le !*ares %he capital of a company is divided into parts and each part is $nown as a share. )ach shares has a nominal or face value which is e0pressed in terms of money and it represents the ma0imum amount which its holder may be as$ed to pay. %he shares in a company are transferable in the manner provided in its articles. Accordingly, a shareholder in need of money may sell his shares in the open mar$et and thus satisfy his need without disturbing the financial position of the company. %he characteristic of transferability of shares provides li2uidity to the investor and financial stability to the company. It may be noted that a private company puts restrictions on the transfer of shares through its articles. /owever, it does not ta$e away the right to transfer shares absolutely. 12.+ !eparation of "wners*ip and Management %here is separation of ownership and management in a company which implies that it is not managed by all those who own it in the

ultimate analysis, i.e., its members. As the number of members in a company, generally, is large, it is neither practicable nor feasible to entrust its management to all of them in view of the obvious difficulties involved. %herefore, it isentrusted to their elected representatives who are $nows as directors. /owever, the ultimate control of a company rests with its members, for they are empowered to remove any director and replace him by a new director, to amend the memorandum or articles of the company etc. In addition to it the directors cannot act without their approval or permission in certain cases. 12., Common !eal As a company is devoid of physi2ue, it cannot act in person li$e a human being. Alternatively, it employes natural persons to act on its behalf. %o identify the acts done by such people as agents, a sal e0hibiting the name of the company is affi0ed over the relevant documents. %he seal, $nows as &Common 9eal', is ta$en, at law, to be e2uivalent to the signatures of the company. It, however, must be affi0ed in the presence of and must be signed by, at least 3 directors and the secretary or such other persons as the 5oard may authorize for this purpose. 1. Lifting of Corporate -eil

%he law courts, in general, respect the principle of separate entity of a company and treat the company and its members as different personalities. It contemplates a distinction between company and members and this is $nows as &corporate veil'. /owever, whenever fraudulent use is made of the principle of separate entity or corporate veil, it would be imprudent to allow the defaulters to ta$e shelter behind the corporate faCade. %he courts, in such cases, try to ascertain the reality by ignoring the rule of separate entity and treats the company and its members as one. %his is $nown as &piercing of lifting the corporate veil'. %he circumstances when the corporate veil may be lifted includes the following+ ,i,ii,iiiAhen it is desired to ascertain the character of the company, e.g., to find out whether it belongs to an alien enemy. Ahen it is desired to prevent the evasion of ta0es. Ahen it is desired to chec$ fraud or improper conduct, e.g., where a company has been formed to defraud creditors or avoid legal obligations. Ahere the number of members in company is reduced below 1 ,in case of public company- or 3 ,in case of a private company- and the company carries on business for more than

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# months with reduced members, every member, who is cognizant of this fact, shall be personally liable for the repayment of debts contracted during period after the said # months. Ahere a person enters into any contract, accepts a bill of e0change or orders for goods on behalf of the company but without disclosing the name of the company fully and the fact of his agency, he would be personally liable for his acts unless the liability contracted is paid off by the company. Ahere during the course of winding up of company, it appears that any business of the company has been carried with intent to defraud creditors of the company, any other person or any fraudulent purpose, those responsible for such conduct of business may be held liable for the debts of the company.

1.% Company person #ut not citi.en %he law confers personality on a company for limited purposes, e.g., to enable it to enter into contracts to accomplish corporate goals. /ence, many of the rights, privileges and abilities of a natural person are not en(oyed by it. %he constitution of India as also the Citizenship Act, !"", do not bestow it with citizenship. It can, en(oy those fundamental rights as are available to all persons but not the ones which are available to citizens only. 1.' /ationality and 0omicile of Company A company, being a person, has a place of domicile or residence which is determined with reference to the place of its registered office. A company having registered office in <elhi would be a resident of the place. Further, the domicile determines the nationality of a company. In nutshell, a company has a nationality depending upon its place of residence. 1.( )ypes of Companies %he companies which can be formed and registered under the Companies Act, !"#, may be of the following two types+ ,i>ublic, and ,ii>rivate. 1.(.1 Pu#lic and Pri-ate Companies A public company means a company which is not private and a private company means a company which, by its ArticlesD ,irestricts the right to transfer its shares, if any.

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limits the number of its members to "4 ,e0cluding those members who are or were in the employment of the company-. and prohibits any invitation to the public to subscribe to its shares or debentures.

>rivate companies are generally family concern and are formed to carry on business on a small scale. ?nli$e a public company, its activities are financed by the funds contributed by its members and not by the general public. 9ince such companies do not employ public funds, the need to control their activities is less as compared to public companies. %herefore, they are e0empted from the operation of several sections of the Companies Act, !"#, and en(oy certain privileges. 9ome of these are as follows+ ,i%he formation of a private company re2uires only two persons. ,iiIt may allot shares without issuing a prospectus of filing a statement in lieu of prospectus. ,iii- It can commence business immediately on its incorporation and is not re2uired to obtain the certificate to commence business for this purpose. ,iv- It may allot its new shares to the outsiders without offering them first to the e0isting members. ,vIt is not re2uired to hold a statutory meeting or to deliver a statutory report to the ;egistrar. ,vi- At its meetings, only two members can demand a poll. ,vii- It may have only two directors and en(oy the following e0emptions as regards the appointment of directors+ ,aall its directors may be appointed as directors for life or as permanent directors. ,bthey are not re2uired to retire by rotation. ,cthey can be appointed en bloc by single resolution. and ,dthey can be appointed without signing and filing with the ;egistrar the consent in writing to act as such. ,viii- %he annual accounts and balance sheet of a private company filed with the ;egistrar are not open for inspection to the general public. 1.+ Con-ersion of Pri-ate company into pu#lic company A private company may be converted into a public company in the following ways+ ,iConversion by default

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Conversion by operation of law Conversion by choice

1.+.1 Con-ersion #y 0efault A private company en(oys various e0emptions under the Companies Act only so long as it complies with restrictions contained in its Articles that ma$e it private. If it defaults in complying with any of them, the provisions of the Companies Act become applicable to it as if it were a public company. 1.+.2 Con-ersion #y "peration of Law %hese are instances where a private company is &deemed to be public' or becomes a 9ection EF-A company. ,discussed earlier in 9ection .#1.+. Con-ersion #y C*oice

A private company may convert itself into a public company by passing a special resolution altering thereby its Articles of Association and deleting the relevant restrictions contained therein. Aithin F4 days of passing the resolution, the company shall file with the ;egistrar of Companies, a prospectus of statement in lieu of prospectus. It shall also raise the number of its members to the statutory minimum 1 and that of its directors to a statutory minimum F, if re2uired. It will, after the conversion, follow the provisions of the Companies Act as are applicable to a public company. 1., Con-ersion of pu#lic company into pri-ate company A public company can be converted into a private company by ta$ing the following steps+ ,i%he Articles of the company should be altered so as to+ ,arestrict the right of its members to transfer shares, if any. ,blimit the number of its members ,e0cluding past and present employees of the company who are its members also- to "4. ,cprohibit invitations to the public to subscribe to its shares and debentures. and ,dto delete any other provision contained therein which the Articles of a private company should not contain, e.g., power to issue share warrants.

%he aforesaid amendments can be made by passing special resolutions. A copy of each such resolution must be filed with the ;egistrar within F4 days of passing it. ,iii%he name clause in the Memorandum of Association of the company shall also be changed by passing a special resolution as the new name of the company shall end with the words &>rivate *imited'. A copy of such a resolution is also re2uired to be filed with the ;egistrar within F4 days of its passing. %he company should obtain approval of the Central Government to the alteration of Articles which has the effect of converting it into a private company. From the date of approval by the Central Government the company ceases to be public company and becomes a private company. A printed copy of the altered Articles must be filed with the ;egistrar within one month of the date of the receipt of the order of approval passed by the Central Government. *astly, the company should ta$e steps to follow the provisions as are applicable to a private company. For e0ample, it should ta$e steps to reduce the number of members and limit it to "4. 9imilarly, it should convert its share warrants into share certificates, and so on.

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1.1 2olding Company and !u#sidiary Company A company is termed as a holding company only if it has a subsidiary. A company shall be deemed to be a subsidiary of another if+ ,ithat other controls the composition of its 5oard of <irectors. ,iithat other e0ercises or controls more than half of the total voting powr or more than half in nominal value of its e2uity share capital. or ,iii- It is subsidiary of any company which is that other's subsidiary. It maybe noted that ,i- the composition of company's 5oard of <irectors shall be deemed to be controlled by another company if, but only if, that other company by the e0ercise of some power e0ercisable by it at its discretion, without the consent or concurrence of any other person, can appoint or remove the holders of all or a ma(ority of the directorshis. ,ii- that other company shall be deemed to have power to appoint to a directorsshp with respect to which any of the following conditions is satisfied, that is to say +

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that a person cannot be appointed thereto without the e0ercise in his favour by that other company of such a power as aforesaid. that a person's appointment theeto follows necessarily from his appointment as director ,managing agent, secretaries and treasures- or manager of, or to any other office of employment in that other company. or that the directorship is held by an individual nominated by that other company or a subsidiary thereof.

1.13 Go-ernment Company Government company means a company in which not less than fifty-one per cent of the paid-up share capital is held by the Central Government, or by any 9tate Government or Governments, or partly by the Central Government and partly by one or more 9tate Governments and includes a company which is a subsidiary of a Government company as thus defined. 1.11 Pro*i#ition of Association e4ceeding twenty persons @o company, association or partnership consisting of more than 34 persons shall be formed for carrying on any business ,more than 4 in case of ban$ing business- for profit unless it is &registered as a company' under the companies Act, !"# or is formed in pursuance of some other Indian *aw. %he aforesaid rules do not apply to a (oint family or /indu ?ndivided Family. Ahere two or more (oint families carry on a business together, the said rules apply but in computing the number of persons, minor members of such families shall be e0cluded. )very member of a company, association or partnership carrying on business in violation of the above rules shall be personally liable for all liabilities incurred in such business and shall also be punishable with fine which may e0tend to one thousand rupees. 1.12 Incorporation of Company A company is brought into e0istence by a legal process called incorporation. %his process, broadly spea$ing, entails+ ,ipromotional activities, and ,iifiling of documents 1.12.1 Promotional Acti-ities

%hese include ma$ing decisions and performing acts that lead to incorporation, such as, the nature of business, the members who would constitute the company, the type of company to be floatedD public or private, size business and capital, plae of registered office, the first directors of company, etc. %he people wo underta$e these promotional activities are $nows as &promoters'. %hey, with the help of professionals li$e advocates, chartered accountants, engineers, company secretaries, etc., formulate pro(ect report on business to be carried on and get the legal documents drafted. In particular, they should arrange for approval of ;egistrar of Companies to the proposed name of the company. In addition, they should $eep in mind the following re2uirements. ,iAny seven or more persons ,or where the company to be formed will be a private company, any two or more personsassociated for any lawful purpose may form an incorporated company, with or without limited liability. For this purpose, they need to subscribe their names to the memorandum of association and also have to comply with the other re2uirements in respect of registration. ,ii9uch a company may be either. ,aa company having the liability of its members limited by the memorandum to the amount, if any, unpaid on the shares respectively held by them ,termed 7a company limited by shares8-. ,ba company having the liability of its members limited by the memorandum to such amount as the members may respectively underta$e by the memorandum to contribute to the assets of the company in the event of its being would up ,termed 7a company limited by guarantee8-. or ,ca company not having any limit on the liability of its members ,in this Act termed 7an unlimited company8-. 1.12.2 Filing of 0ocuments %he following documents, duly stamped, are re2uired to be filed with the ;egistrar of Companies having (urisdiction over the state in which the registered office of the company shall situate+ ,i%he Memorandum of Association duly signed by 1 subscribers in case of a public company and by 3 subscribers in case of a private company. ,ii%he Articles of Association signed by the subscribers to the Memorandum of Association. A public company limited by shares may, if it so desires and does not file its own Articles,

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give a declaration that it has adopted %able A in 9chedule I to the Companies Act, !"#, either fully or partially. %he agreement, if any, which the company proposes to enter into with any individual for appointment as its managing or whole time director or manger. %he written consent of the people who have agreed to act as first directors. ?nderta$ing by first directors to ta$e up and pay for 2ualification shares, if any It may be noted that re2uirements stated as point number ,iiiand ,iv- above are not applicable to a private company. A statutory declaration that all the re2uirements of the Companies Act, !"#, pertaining to registration of the company have been complied with. %he declaration shall be signed by any one of the following+ ,aan advocate of the 9upreme Court or of a /igh Court. ,bAn attorney or a pleader entitled to appear before a /igh Court. ,cA practicing secretary or a chartered accountant who is engaged in the formation of the company. ,dA person named in the Articles as a director, manager or secretary, of the Company. Fee for registration should also be paid. Award of Certificate of Incorporation and its &ffect

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If the ;egistrar is satisfied that all the re2uirements aforesaid have been complied with by the company and that it is authorized to be registered under this Act, he shall retain and register the memorandum, the articles, if any, and the agreement relating to appointment of managerial personnel, if any. =n the registration of the memorandum of a company, the ;egistrar shall certify under his hand that the company is incorporated and, in the case of a limited company, that the company is limited. From the date of incorporation mentioned in the certificate of incorporation, such of the subscribers of the memorandum and other persons, as may from time to time be members of the company, shall be a body corporate by the name contained in the memorandum, capable forthwith of e0ercising all the functions of an incorporated company, and having perpetual succession and a common seal, but with such liability on the part of the members to contribute to the assets of the company in the event of its being wound up.

1.12.% Conclusi-eness of Certificate of Incorporation A certificate of incorporation given be the ;esistrar in respect of any association shall be conclusive evidence that all the re2uirements of this Act have been complied with in respect of registration and matters precedent and incidental thereto, and that the association is a company authorized to be registered and duly registered under this Act. 1.1 Pre5Incorporation Contracts

%he law stipulates that at least two persons are essential to form a contract. 9ince a company, before incorporation, does not e0ist, no contract can be made by it or by an agent on its behalf. Accordingly, pre-incorporation contracts are nullity and cannot be enforced either by or against a company. %he board effects of such contracts are as under+ ,iA company is not bound by pre-incorporation contracts. ,iiIt cannot enforce a pre-incorporation contract against the other parties. ,iii- %he promoters are personally liable on such pre-incorporation contracts since the Indian Contract Act ma$es an agent personally liable for contracts entered into on behalf of a principal not in e0istence. %he promoters, however, can avoid their liability by disclosing to the other party the fact of non-e0istence of company at that point of time and by providing in the contract that they would be absolved of their liability. ,aif the company, after incorporation, enters into a fresh contract with the other party on terms and conditions as contained in pre-incorporation contract. ,bIf the company does not enter into a fresh contract as stated in ,i- above, either of the parties may rescind the contract. ,iv%he specific performance of a contract may be obtained by any party when the promoters of a company have, before its incorporation, entered into it for the purposes of the company and such contract is warranted by the terms of its incorporation provided that the company has accepted the same and has communicated such acceptance to the other party to the contract. 1.1% Certificate to commence #usiness

A private company can commence business immediately on grant of certificate of incorporation. 5ut, a public company can do so only after it has obtained another certificate which is $nows as the &certificate to commence business' or the &trading certificate'. It is granted after a public company has completed specified procedure and submitted certain specified documents and fee for the purpose.