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Introduction:

According to sec. 3 (1) (ii) of the Companies Act, 1956 a company means a company formed and
registered under the Companies Act, 1956 or any of the preceding Acts. Thus, a Company comes into
existence only by registration under the Act. Registration of a company is called Incorporation.

Advantages of incorporation of a Company

Incorporation offers certain advantages to a company as compared with all other kinds of business
organizations. They are

1) Independent corporate existence- the outstanding feature of a company is its independent


corporate existence. By registration under the Companies Act, a company becomes a corporate
personality. The decision of the House of Lords in Salomon v. Salomon & Co. Ltd. is an authority on this
principle:

One S incorporated a company to take over his personal business of manufacturing shoes and boots.
The seven subscribers to the memorandum were all his family members, each taking only one share. The
Board of Directors composed of S as managing director and his four sons. The business was transferred
to the company at 40,000 pounds. S took 20,000 shares of 1 pound each n debentures worth 10,000
pounds. Within a year the company came to be wound up and the state if affairs was like this: Assets-
6,000 pounds; Liabilities- Debenture creditors-10,000 pounds, Unsecured creditors- 7,000 pounds.

It was argued on behalf of the unsecured creditors that, though the company was incorporated, it
never had an independent existence. It was Mr. ‘A’ himself trading under another name, but the House of
Lords held Salomon & Co. Ltd. must be regarded as a separate person from Mr. ‘A’

Company not a citizen- In State Trading Corporation of India v. CTO, the SC held that a company
though a legal person is not a citizen neither under the provisions of the Constitution nor under the
Citizenship Act.

2) Limited liability- limitation of liability is another major advantage of incorporation. If the


company fails then the members are not liable for the entire debt. The liability of members is limited by
their shares. They purchase the shares of the company with their investment and they are liable for up to
that limit only

3) Perpetual succession- An incorporated company never dies. Members may come and go, but
the company will go on forever.

4) Common seal- Since a company has no physical existence, it must act through its agents and
all such contracts entered into by such agents must be completed under the seal of the company. The
common seal acts as the official seal of the company.

5) Transferable shares- when joint stock companies were established then its object was that the
shares should be capable of being easily transferred. Sec 82 gives expression to this principle by
providing that “the shares or other interest of any member shall be movable property, transferable in the
manner provided by the articles of the company.”

6) Separate property- The company is capable of holding and enjoying property in its own name.
No members, not even all the members, can claim ownership of any asset of company’s assets.

7) Capacity for suits- A company can sue and be sued in its own name. The names of
managerial members need not be included.
8) Professional management- A company is capable of attracting professional managers. That it
why managerial class is called an executive class.

Disadvantages of incorporation

1) Corporate veil- though for all purposes of law a company is regarded as a separate entity and the
members and directors are not responsible for the acts of the company

a) For benefit of revenue- The separate existence of a company may be used for the
purpose of evasion of tax.

b) Fraud or improper conduct- When its principal shareholder was bound by a restraint
order and had incorporated a company only to escape the restraint.

c) Business run by defraud creditor- a defraud creditors may by making another company
run their business.

Types of Company

INTRODUCTION
The Companies Act, 2013 provides for the kinds of companies that can be promoted and registered
under the Act. The three basic types of companies which may be registered under the Act are:

 Private Companies;
 Public Companies; and
 One Person Company (to be formed as Private Limited).

Classification of Companies

Classification on the basis of Incorporation


There are three ways in which companies may be incorporated.
(a) Statutory Companies: These are constituted by a special Act of Parliament or State Legislature. The
provisions of the Companies Act, 2013 do not apply to them. Examples of these types of companies are
Reserve Bank of India, Life Insurance Corporation of India, etc.
(b) Registered Companies: The companies which are incorporated under the Companies Act, 2013

Classification on the basis of Liability


Under this category there are three types of companies:
(a) Unlimited Liability Companies: In this type of company, the members are liable for the company’s
debts in proportion to their respective interests in the company and their liability is unlimited.
(b) Companies limited by guarantee: A company that has the liability of its members limited to such
amount as the members may respectively undertake, by the memorandum

(c) Companies limited by shares: A company that has the liability of its members limited by the amount
of unpaid value of share. For example, a shareholder who has paid `75 on a share of face value ` 100 can
be called upon to pay the balance of `25 only. Companies limited by shares are by far the most common
and may be either public or private.

Other Forms of Companies


(a) Associations not for profit (NGOs etc.) having a license under Section 8 of the Companies Act, 2013
or under any previous company law;
(b) Government Companies;
(c) Foreign Companies;
(d) Holding and Subsidiary Companies;
(e) Associate Companies/Joint Venture Companies
(f) Investment Companies

PRIVATE COMPANY
As per Section 2(68) of the Companies Act, 2013, “private company” means a company having a
minimum paid-up share capital of one lakh rupees or such higher paid-up share capital as may be
prescribed, and which by its articles,—

ONE PERSON COMPANY (OPC)


With the implementation of the Companies Act, 2013, a single person could constitute a Company, under
the One Person Company (OPC) concept.

Difference between a Sole Proprietorship and an OPC


The fundamental difference between a sole proprietorship and an OPC is the way liability is treated in the
latter.
A one-person company is different from a sole proprietorship because it is a separate legal entity that
distinguishes between the promoter and the company.
The promoter’s liability is limited in an OPC in the event of a default or legal issues. On the other hand, in
sole proprietorships, the liability is not restricted and extends to the individual.

Position of OPC in India under the Companies Act, 2013


The Companies Act, 2013 classifies companies on the basis of their number of members into One Person
Company, private company and public company. As stated above, a private company requires a
minimum of 2 members. In other words, a One Person Company is a kind of private company having only
one member.
One person company shall have a minimum of one director. Therefore, a One Person Company will be
registered as a private company with one member and one director.

Benefits of One Person Company


The concept of One person company is quite revolutionary. It gives the individual entrepreneurs all the
benefits of a company, which means they will get credit, bank loans, access to the market, limited liability,
and legal protection available to companies.

SMALL COMPANY
A small company is a new form of a private company under the Companies Act, 2013. A classification of
a private company into a small company is based on its size i.e. paid-up capital and turnover. In other
words, such companies are small sized private companies.
As per section 2(85) ‘‘small company’’ means a company, other than a public company,—
(i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be
prescribed which shall not be more than five crore rupees; or
(ii) turnover of which as per its last profit and loss account does not exceed two crore rupees or such
higher amount as may be prescribed which shall not be more than twenty crore rupees:

PUBLIC COMPANY
By virtue of Section 2(71), a public company means a company which:
(a) is not a private company;
(b) has a minimum paid-up share capital of five lakh rupees or such higher paid-up capital, as may be
prescribed.
As per section 3 (1) (a), a public company may be formed for any lawful purpose by seven or more
persons, by subscribing their names or his name to a memorandum and complying with the requirements
of this Act in respect of registration.

UNLIMITED COMPANY
As per section 2(92), “unlimited company” means a company not having any limit on the liability of its
members. Thus, the maximum liability of the member of such a company, in the event of its being wound
up, might stretch up to the full extent of their assets to meet the obligations of the company by
contributing to its assets.

GOVERNMENT COMPANIES
Section 2(45) defines a “Government Company” as any 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 State Government or
Governments, or partly by the Central Government and partly by one or more State Governments, and
includes a company which is a subsidiary company of such a Government company.
Notwithstanding all the pervasive control of the Government, the Government company is neither a
Government department nor a Government establishment [Hindustan Steel Works Construction Co. Ltd.
v. State of Kerala (1998)

FOREIGN COMPANIES
As per section 2(42), “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 or through electronic
mode; and
(b) conducts any business activity in India in any other manner

HOLDING, SUBSIDIARY COMPANIES AND ASSOCIATE COMPANIES


On the basis of control, companies can be classified into holding, subsidiary and associate companies.
Holding company
As per Section 2 (46), holding company is a company which has control over subsidiary companies.
Subsidiary company
Section 2 (87) provides that subsidiary company or subsidiary means a company in which the holding
company—
(i) controls the composition of the Board of Directors; or
(ii) exercises or controls more than one-half of the total share capital either at its own or together with one
or more of its subsidiary companies:

Associate company
As per Section 2(6), “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 such influence and includes a joint venture company.

INVESTMENT COMPANIES
As per explanation (a) to section 186, “investment company” means a company whose principal business
is the acquisition of shares, debentures or other securities.
An investment company is a company, the principal business of which consists in acquiring, holding and
dealing in shares and securities.

DORMANT COMPANIES
The Companies Act, 2013 has recognized a new set of companies called as dormant companies.
As per section 455 (1) where a company is formed and registered under this Act for a future project or to
hold an asset or intellectual property and has no significant accounting transaction, such a company or an
inactive company may make an application to the Registrar in such manner as may be prescribed for
obtaining the status of a dormant company.

Formation of a company

INTRODUCTION
 One of the first steps in the formation of a company is to prepare a document called the
memorandum of association (MoA).
 The MoA of the company contains the fundamental conditions upon which, the company has
been incorporated.
 In general the MoA regulates the company’s external affairs while the articles of association
(AoA) regulate its internal structure.
 The memorandum of association is also called the charter of the company as it is the company’s
principle document. Like explained before, no company can register without a memorandum of
association as it defines the right and objects of the company.
 the Memorandum of Association is a document of great importance in relation to the proposed
company. It contains the objects for which the company is formed.
Constituents of Memorandum of Association

Name Clause:
Since a company is an artificial person it can be identified only by its name. The promoters are free to
choose any name for the company.

Registered Office Clause:


The Memorandum of Association registered with the RoC (Registrar of Company) must contain the
location of the company. Every registered company must have a registered office which establishes its
address at which notices and other communications can be sent. The notice of the exact situation of the
company has to be submitted to the RoC within 30 days of incorporation.

Objects Clause:
The Memorandum of Association of a company should state the objects of the company. The object
should be lawful. Pursuing any other object is said to be ultra vires (against the law) of the company.
Capital Clause:
A company has share capital and a company limited by shares must write in its memorandum the total
amount of share capital the company can have and how the shares have been divided. The clause also
writes about the limit beyond which the company cannot issue shares. If it wants to issue more shares
than its limit, then company has to change the memorandum.

ALTERATION OF MEMORANDUM
As a matter of course Memorandum of Association is not alterable. In fact the words of the Memorandum
cannot be changed that easily. It is said that “Memorandum of Association is an unalterable document
alterable only in accordance with the provisions of the law”

The alteration of object clause involves:

(a) Special Resolution:


In the first place, the company has to call a general meeting of its members and pass a special resolution
and file a certified copy of the resolution with the central government.

(b) Ratification by the central government:


After this, the application for proposed alteration is filed with the central government. The application shall
be scrutinized by the government before confirming the alteration.

(c) Registration of alteration:


A certified copy of the order of the central government shall be filed by the company with the RoC along
with the printed copy of the altered memorandum within three months from the date of the order.

Doctrine of Ultra Vires

It is the function of the Memorandum of Association to write everything in plain and clear manner so that
the reader can easily understand the object and function of the company for which it has been
incorporated. If the company does an act or activity which for which it has not been formed (for example
company formed to sell cold drinks starts selling medicines) , then it is called ultra vires.

The doctrine has been affirmed by the Supreme Court in India in the case of Lakshmanaswami Mudaliar
v. Life Insurance Corporation of India. In this case directors of the company donated some money for
charitable purpose for public good. Payment made towards the same was held by the court as ultra vires.
The court said that the directors could not spend the company’s money on any charitable institutions for
general object. They could spend for the promotion of only such charitable objects as would be useful for
the attainment of the company’s own objects.

Article of Association (AoA)


 Articles of Association, the second important document of a company, contains rules, regulations
and bye-laws for the internal administration of the company.

 The articles given in the AoA regulate the internal management of the company.

 Articles define the powers of the directors and other officers of the company.
 Section 2(2) of the Companies Act defines articles of association as follows:
“Articles mean the articles of association as originally framed or as altered from time to time in
pursuance of any previous company’s law or of this Act.”

According to section 26 of the Companies Act, the following companies must file their own articles along
with the Memorandum of Association for registration:

(i) Private limited Companies

(ii) Companies limited by Guarantee

(iii) Unlimited Companies.

 Articles of association can be thought of as a user's manual for a company, defining its purpose
and outlining the methodology for accomplishing necessary day-to-day tasks.

Company Name
Purpose of the Company
The reason for the creation of the company must also be stated in the articles of association.

Share Capital
The number and type of shares that comprise a company's capital are listed in the articles of association.

Organization of the Company


The legal organization of the company, including its address, the number of directors and officers, and the
identity of the founders and original shareholders, are found in this section.

Shareholder Meetings
The provisions for the first general meeting of shareholders and the rules that will govern
subsequent annual shareholder meetings, such as notices, resolutions and votes are laid out in detail in
this section.

4 Binding Effects of Memorandum and Articles of Association

“Subject to the provisions of this Act, the Memorandum and Articles shall, when registered, bind the
company and the members
Thus, the Articles bind the company to its members, the members to the company and the members to
each other. They constitute a contract between a company and its members in respect of their rights and
liabilities as members. A member may sue the company, just as the company may sue the members to
enforce and restrain any breach of the articles.

1. Binding the company to its members:


The company is bound to the members to observe and follow the articles. In case the company commits
a breach of the articles, members can restrain the company from doing so, by bringing an injunction
against the company.

Members may also sue the company for the enforcement of their personal right under the Articles, e.g.,
right to receive divided which has been declared.

2. Binding on members in their relations to the company:


An article of Association is a ‘contract of the most sacred character’ between the company and each
member, binding the members to the company under a statutory covenant.

3. Binding between members:


The contractual force given to the articles is limited to the matters arising out of company’s relationship of
the members as members and does not extend beyond the company relationship. The articles constitute
a contract between each member and the company.

4. No binding in relation to the outsiders:


The memorandum and articles do not constitute a contract between the company and the third party.
Neither the company nor the members of the company is bound to the outsiders to give effect to the
provisions of the memorandum and the articles. For example:

Doctrine of Constructive Notice

Section 399 allows any person to electronically inspect make a record, or get a copy of any document of any
company which the Registrar maintains. There is a fee applicable for the same. The documents include the
certificate of incorporation of the company.

By now we know that the Memorandum and Articles of Association are public documents. This section
confers the right of inspection to all.
Before any person deals with a company he must inspect its documents and establish conformity with the
provisions. However, even if a person fails to read them, the law assumes that he is aware of the contents of
the documents. Such an implied or presumed notice is called Constructive Notice.

Doctrine of Indoor Management

The doctrine of indoor management is an exception to the earlier doctrine of constructive notice. It is
important to note that the doctrine of Indoor Management does not allow outsiders to have notice of the
internal affairs of the company.

Hence, if an act is authorized by the Memorandum or Articles of Association, then the outsider can assume
that all detailed formalities are observed in doing the act. This is the Doctrine of Indoor Management or the
Turquand Rule. This is based on the landmark case between The Royal British Bank and Turquand. In
simple words, the doctrine of indoor management means that a company’s indoor affairs are the company’s
problem.

Therefore, this rule of indoor management is important to people dealing with a company through its directors
or other persons. They can assume that the members of the company are performing their acts within the
scope of their apparent authority.

Most Important Differences between Doctrine of Indoor Management and Doctrine of Constructive
Notice

Most Important Differences between Doctrine of Indoor Management and Doctrine of Constructive Notice
are mentioned below:

The Doctrine of Indoor Management:


1. It protects outsider against the company.
2. It is confined to the internal position and affairs of the company.
3. The internal affairs need not be registered
They are not open to public and third parties.

4. Third persons, who have no notice to any irregularity or want of authority, will be protected on the
principle called the ‘Turquand Rule’.
5. It mitigates the effects of the “Doctrine of Constrictive Notice”.
6. It is based on positive concept.
The Doctrine of Constructive Notice:
1. It protects the company against the outsider.
2. It is confined to the external position and affairs of the company.
3. The memorandum and articles of association of the company are public documents. They must be
registered with the Registrar of Companies. These are open to public and third parties to access.
4. Third persons, who have no notice of an irregularity or want of authority, if they try they could know
about that irregularity or want of authority, will not be protected on the principle of ‘constructive notice’
5. It operates as an estoppel against the outsider.
6. It is based on negative concept.

Definition of Company Promoter

According to section 2(69) of the Companies Act, 2013 the term ‘Promoter’ can be defined as the
following:

1. A person who invests in the company


2. A person who has been named as such in a prospectus or is identified by the company in
the annual return; or
3. A person who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or otherwise; or
4. A person, according to whose directions or instructions the Board of Directors of the company
acts.

Functions of Company Promoter

 who settles the name of the company thus determine the name will be acceptable by the
registered official of the office;
 who decides the content or details as to the Articles of the companies; (here, articles refers to
Articles of association & Memorandum of association);
 who proposes the directors, bankers, auditors and etc.;
 who decides the place where registered office or head office has to be situated;
 Who prepares the Memorandum of Association, Prospectus and other essential documents and
file them for the reason of incorporation.

Theory of Corporate Personality

Corporate Personality is the creation of law. Legal personality of corporation is recognized both in English
and Indian law. A corporation is an artificial person enjoying in law capacity to have rights and duties and
holding property.

It has the legal personality of its own and it can sue and can be sued in its own name. It does not come to
end with the death of its individual members and therefore, has a perpetual existence.

Corporations are of two kinds :

1. Corporation Aggregate : Is an association of human beings united for the purpose of forwarding their
certain interest. A limited Company is one of the best example. Such a company is formed by a number
of persons who as shareholders of the company contribute or promise to contribute to the capital of the
company for the furtherance of a common object. Their liability is limited to the extent of their share-
holding in the company. of a company was recognized in the case of Saloman v. Saloman & Co[5].

2. Corporation Sole :. It consists of a single person who is personified and regarded by law as a legal
person. A corporation sole is perpetual. Post – Master- General, Public Trustee, Comptroller and auditor
general of India, the Crown in England etc are some examples of a corporation sole. Generally,
corporation sole are the holders of a public office which are recognized by law as a corporation

Lifting The Corporate Veil

Editor’s Note: The principle of veil of incorporation is a legal concept that separates the personality of a
corporation from the personalities of its shareholders and protects them from being personally liable for
the company’s debts and other obligations. While a company is a separate legal entity, the fact that it can
only act through human agents that compose it, cannot be neglected. Since an artificial person is not
capable of doing anything illegal or fraudulent, the façade of corporate personality might have to be
removed to identify the persons who are really guilty. This is known as lifting of the corporate veil.

Besides the statutory provisions for lifting the corporate veil, courts also do lift the corporate veil to see
the real state of affairs. However, even though the legislature and the courts have in many cases now
allowed the corporate veil to be lifted, it should be noted that the principle of veil of incorporation is still the
rule and the instances of lifting or piercing the veil are the exceptions to this rule.

INTRODUCTION

Before dealing with the lifting of corporate veil it is pertinent to define what the meaning of a company is.
Strictly, a company has no particular definition but section 3(1) (i) of the Companies Act attempts to
provide the meaning of the word in context of the provisions and for the use of this act. It states: ‘a
company means a company formed and registered under this Act or an existing company as defined in
section 3 (1) (ii).’ The company must be registered under the Companies Act for it to become an
incorporated association. If it is not registered it becomes an illegal association. This paper would deal
with the lifting of corporate veil and its aspects with the judicial decisions. Let us first discuss the exact
meaning of corporate veil and lifting of corporate veil with limited liability concept.

Corporate veil:

A legal concept that separates the personality of a corporation from the personalities of its shareholders,
and protects them from being personally liable for the company’s debts and other obligations.

Lifting of Corporate veil:

At times it may happen that the corporate personality of the company is used to commit frauds and
improper or illegal acts. Since an artificial person is not capable of doing anything illegal or fraudulent, the
façade of corporate personality might have to be removed to identify the persons who are really guilty.
This is known as ‘lifting of corporate veil’.

It refers to the situation where a shareholder is held liable for its corporation’s debts despite the rule of
limited liability and/of separate personality. The veil doctrine is invoked when shareholders blur the
distinction between the corporation and the shareholders. A company or corporation can only act through
human agents that compose it. As a result, there are two main ways through which a company becomes
liable in company or corporate law: firstly through direct liability (for direct infringement) and secondly
through secondary liability (for acts of its human agents acting in the course of their employment).

There are two existing theories for the lifting of the corporate veil. The first is the “alter-ego” or other self
theory, and the other is the “instrumentality” theory.

The alter-ego theory considers if there is in distinctive nature of the boundaries between the corporation
and its shareholders.
The instrumentality theory on the other hand examines the use of a corporation by its owners in ways that
benefit the owner rather than the corporation. It is up to the court to decide on which theory to apply or
make a combination of the two doctrines.

Concept of limited liability:

One of the main motives for forming a corporation or company is the limited liability that it offers to its
shareholders. By this doctrine, a shareholder can only lose what he or she has contributed as shares to
the corporate entity and nothing more. This concept is in serious conflict with the doctrine of lifting the veil
as both these do not co-exist which is discussed by us in the paper in detail.

DEVELOPMENT OF THE CONCEPT OF “LIFTING THE CORPORATE VEIL”

One of the main characteristic features of a company is that the company is a separate legal entity
distinct from its members. The most illustrative case in this regard is the case decided by House of Lords-
Salomon v. A Salomon & Co. Ltd[i].

In this case, Mr. Solomon had the business of shoe and boots manufacture. ‘A Salomon & Co. Ltd.’ was
incorporated by Solomon with seven subscribers-Himself, his wife, a daughter and four sons. All
shareholders held shares of UK pound 1 each. The company purchased the business of Salomon for
39000 pounds, the purchase consideration was paid in terms of 10000 pounds debentures conferring
charge on the company’s assets, 20000 pounds in fully paid 1 pound share each and the balance in cash.

The company in less than one year ran into difficulties and liquidation proceedings commenced. The
assets of the company were not even sufficient to discharge the debentures (held entirely by Salomon
itself) and nothing was left to the insured creditors. The House of Lords unanimously held that the
company had been validly constituted, since the Act only required seven members holding at least one
share each and that Salomon is separate from Salomon & Co. Ltd.

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 distinct and separate from those of its members; it can sue and be
sued exclusively for its purpose; liability of the members are limited to the capital invested by them.[ii]

Further in Lee v. Lee’s Air Farming Ltd.[iii], it was held that there was a valid contract of service
between Lee and the Company, and Lee was therefore a worker within the meaning of the Act. It was a
logical consequence of the decision in Salomon’s case that one person may function in the dual capacity
both as director and employee of the same company.

In The King v Portus; ex parte Federated Clerks Union of Australia[iv], where Latham CJ while
deciding whether or not employees of a company owned by the Federal Government were not employed
by the Federal Government ruled that the company is a distinct person from its shareholders. The
shareholders are not liable to creditors for the debts of the company. The shareholders do not own the
property of the company.

In course of time, the doctrine that a company has a separate and legal 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.

Thus when “Tata Company” or “German Company” or “Government Company” is referred to, we look
behind the smoke-screen of the company and find the individual who can be identified with the company.
This phenomenon which is applied by the courts and which is also provided now in many statutes is
called “lifting of the corporate veil”. As a consequence of the lifting of the corporate veil, the company as a
separate legal entity is disregarded and the people behind the act are identified irrespective of the
personality of the company. So, this principle is also called “disregarding the corporate entity”.
LIFTING THE CORPORATE VEIL
Meaning of the doctrine:

Lifting the corporate refers to the possibility of looking behind the company’s framework (or behind the
company’s separate personality) to make the members liable, as an exception to the rule that they are
normally shielded by the corporate shell (i.e. they are normally not liable to outsiders at all either as
principles or as agents or in any other guise, and are already normally liable to pay the company what
they agreed to pay by way of share purchase price or guarantee, nothing more).[v]

When the true legal position of a company and the circumstances under which its entity as a corporate
body will be ignored and the corporate veil is lifted, the individual shareholder may be treated as liable for
its acts.

The corporate veil may be lifted where the statute itself contemplates lifting the veil or fraud or improper
conduct is intended to be prevented.

“It is neither necessary nor desirable to enumerate the classes of cases where lifting the veil is
permissible, since that must necessarily depend on the relevant statutory or other provisions, the object
sought to be achieved, the impugned conduct, the involvement of the element of public interest, the effect
on parties who may be affected, etc.”. This was iterated by the Supreme Court in Life Insurance
Corporation of India v. Escorts Ltd.[vi]

The circumstances under which corporate veil may be lifted can be categorized broadly into two following
heads:

1. Statutory Provisions
2. Judicial interpretation

STATUTORY PROVISIONS

Section 5 of the Companies Act defines the individual person committing a wrong or an illegal act to be
held liable in respect of offenses as ‘officer who is in default’. This section gives a list of officers who shall
be liable to punishment or penalty under the expression ‘officer who is in default’ which includes a
managing director or a whole-time director.

Director of a Company
Procedure of Appointment of Company Directors in India (Companies Act 1956)

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Only individual who has been allotted a Director Identity Number (DIN) under section 266B.

The appointment of directors is made in the following manner:

1. Appointment of Directors by Promoters:


The first directors of the company are usually appointed by the promoters in the manner laid down by the
company’s articles. Their names are usually given in the company’s articles. Where the articles do not
provide for the appointment of first directors, the signatories to the memorandum, who are individual, shall
be deemed to be the first directors of the company subject to the regulations of the company’s articles
(Sec. 254) .

ADVERTISEMENTS:

The first directors can hold office only till the first annual general meeting of the company when they will
be replaced by directors appointed by the company at this meeting.

2. Appointment of Directors by Members:


The subsequent directors, in the case of a public company, are appointed by the members of the
company in the general meeting. Section 255 provides that at least 2/3 of the total number of directors
shall be appointed by the members of the company in general meeting. They shall be rotational directors
i.e. subject to retirement by rotations.

The remaining directors in the case of any such company and the directors of a private company may be
appointed in accordance with the provisions of the company’s articles. In the absence of any such
provision in the articles or in case of default in so appointing directors, these directors shall also be
appointed by the company in general meeting (Sec. 255).

ADVERTISEMENTS:

Retirement of directors by rotation:


In case of a public company, out of the two third directors liable to retire by rotation, one-third (or the
nearest number to one-third) shall retire at every subsequent annual general meeting of the company.
The turn for retirement shall be determined by the length of office of each director. Those who have been
longest in office shall retire first. As between persons who become directors on the same day, retirement
may be decided by lot, or mutual agreement.

Re-appointment of directors:
ADVERTISEMENTS:

The vacancies caused by the retirement of directors should be filled up at the same meeting. Retiring
directors are eligible for re-election and may be re-appointed again.

A person, other than the retiring director can also contest election for directorship only if he or any other
member who intends to propose him has given at least 14 days’ nomination notice before the date of the
meeting, in writing, to the company along with a deposit of Rs. 500. The deposit amount will be refunded
on election of such person as director [Sec. 257 (1)].

On receipt of such a notice the company is required to inform all the members at least 7 days before the
meeting about the candidature. However, individual notices to members will not be necessary if the
company advertises such candidature or intention not less than 7 days before the meeting in at least two
newspapers circulating in the place where registered office of the company is located, of which one is
published in English language and the other in regional language of that place [Sec. 257 (1-A)].

If the vacancy caused by the retirement of a director by rotation is not filled up at the same general
meeting, the meeting shall be deemed to have been adjourned to the next week. If at the adjourned
meeting also the vacancies are not filled up, the retiring director shall be deemed to have been re-
appointed automatically except in the following cases:

(a) A resolution for his re-appointment was put before the meeting, but was lost; or

(b) When such person has declined re-appointment in writing; or

(c) When he has been disqualified; or

(d) A resolution, whether special or ordinary, is required for his appointment or reappointment by virtue of
any provisions of this Act; or

(e) When it is resolved not to fill up the vacancy (Sec. 256).


It is to be noted that failure on the part of the company to call the annual general meeting on the due date,
does not entitle a director to continue in office. He will be treated as having vacated his office on the last
day on which the annual general meeting could and should have been held as per section 166 (including
the period of extension).

3. Appointment of Directors by the Board:


The Board of Directors may make the following appointments:

(i) Additional or co-opted directors:


It authorised by the Articles, Board of Directors may appoint additional directors within the maximum
strength of the board fixed by the Articles of Association. Such additional directors shall hold office only
up to the commencement of the next annual general meeting (Sec. 260).

(ii) Casual vacancy:


A casual vacancy occurring amongst the directors ( on account of death, resignation or otherwise) may
be filled up by the Board of Directors unless the Articles provide a different procedure. The person so
appointed shall hold office only up to the time his predecessor would have continued (Sec. 262).

(iii) Alternate directors:


The Board of Directors may, if so authorised by the Articles of Association or by a resolution passed by
the company in the general meeting, appoint an alternate director, to act for a director during his absence
for a period of not less than 3 months from the State in which meetings of the Board are ordinarily held.
Such a director will vacate office immediately on the return of the original director to the State. Such an
alternate director will automatically vacate office on the expiry of the term of the original director even if
the latter has not returned (Sec. 313).

4. Appointment of Directors by Third Parties:


A company may give, by its articles, power to debenture-holders, a banking company or a financial
institution who has advanced loans to the company to appoint their nominees on the Board. The number
of such directors should not exceed one-third of the total strength of the Board. These directors are not
required to retire by rotation.

5. Appointment of Directors by the Central Government (Sec. 408):


Central Government may appoint such number of directors as the Company Law Board (Tribunal w.e.f.
the date to be notified) may, by order in writing specify to prevent oppression and mismanagement in a
company. Such appointment shall be made for a period of not more than 3 years on any one occasion.
The Company Law Board (the Tribunal) may issue such an order on a petition made to it by the Central
Government or on the application of at least 100 members of the company or the member(s) holding at
least 10% of the voting rights in the company.

The ground of such petition is conduct of the affairs of the company in a manner oppressive to any
member of the company or in a manner prejudicial to the interests of the company or public interest.

A person appointed as a director by the Central Government in pursuance of the above provisions shall
not be:

(i) Required to hold qualification shares;

(ii) Required to retire by rotation;

(iii) Considered for the purpose of reckoning two-thirds or any other proportion of the total number of
directors of the company.

The Central Government has the right to remove any such director from his office at any time and appoint
another person to hold office in his place.

These provisions are applicable to both public and private companies.

6. Appointment of Directors by Proportional Representation:


Directors in a company may be appointed either by

(a) A system of straight majority of votes or

(b) A system of proportional representation.

In a system of straight majority of votes, those who get the largest number of votes are declared elected.
Further, voting for each director is done individually through single resolution for each of the director to be
elected (Sec. 263).

Under this system, a shareholder or group of shareholders holding 51% or more shareholding is able to
monopolise all the directorships with the result that even a sizeable minority of the shareholders is
powerless to get even one of their representatives into the directorate.
The alternative system is the system of proportional representation by a single transferable vote or
cumulative voting. In this system the minority shareholders may also be in a position to get representation
on the board of directors.

Section 265 of the Indian Companies Act gives option to the companies to adopt system of proportional
representation for the appointment of directors. Appointment of directors in such a case is to be made
once in 3 years. If the terms of the directors are staggered so that one or a few are elected each year, a
minority may not be able to elect any director on the board.

The system of proportional representation works either by cumulative voting or single transferable voting.
In cumulative voting system, every shareholder has votes equal to the number of directors to be elected
multiplied by the number of shares held. The directors to be elected are voted for at the same time.

Thus, a minority is allowed to secure representation on the Board of Directors. In single transferable
voting system each voter has only one vote. The names of all the candidates for election are entered in
the ballot paper. The voter is required to indicate his first, second, third preferences and so on against
each candidate.

These preferences are equal to the number of candidates to be elected. In the first instance, only the first
preference is counted and any candidate who receives the number of votes called quota is declared
elected.

The surplus first preference votes of the candidate elected are transferred to other candidates in the order
of preference. This process is continued till the requisite candidates are elected.

What is the Qualification Required to become a Company Director in India?

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The Companies Act does not prescribe any qualification for a person to become director in a company.
However, director of a company may be required by the Articles to hold certain shares in the company to
be eligible to become director in the company (Sec. 2 70). These shares are called qualification shares.
The nominal value of these qualification shares must not exceed Rs. 5,000 or the nominal value of one
share where it exceeds Rs. 5,000. A director may purchase these qualification shares within 2 months of
his appointment.
A person cannot be asked to obtain qualification shares before his appointment as a director or within a
period shorter than 2 months of his appointment. The bearer of a share warrant shall not be deemed
holder of shares for the purposes of qualification shares.

ADVERTISEMENTS:

But unless the articles provide otherwise, if the joint holders hold the qualification shares in their joint
name, one of them is entitled to be appointed as director. Similarly, a pledge of shares by the shareholder
will not disqualify a person to be a director of the company on this basis unless the articles require holding
of unencumbered shares.

A person who acts as a director of a company without holding qualification shares after the expiry of the
period of two months from the date of his appointment shall have to vacate his office as a director and
shall be punishable with a fine extending to f 500 for every day from the date of expiry of the period of two
months till the date he continues to act as a director (Sec. 272).

Directors not required holding the Qualification Shares:


ADVERTISEMENTS:

(i) Directors appointed by the Central Government to prevent oppression or mismanagement of


companies.

(ii) Directors appointed by the Public Financial Institutions (i.e. nominee directors), (in) Small
Shareholders’ directors.

(iv) Directors exempted by the Articles of Association of the company.

(v) Directors of private companies.

ADVERTISEMENTS:

Directors of government companies are, however, not exempted from the requirement as to the holding of
qualification shares.

Provision for the Removal of Company Directors – (Companies Act, 1956)

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A director can be removed from his office by:
(i) The shareholders under section 284;

(ii) The Central Government under sections 388-B to 388-E; and

ADVERTISEMENTS:

(iii) The Company Law Board under section 402.

(i) Removal by the Shareholders:


According to section 284, “A company may, by ordinary resolution, remove a director before the expiry of
his period of office.” Special notice of at least 14 days is required to be given for moving a resolution to
remove a director.

On receipt of notice of a resolution to remove a director, the company shall forthwith send a copy thereof
to the director concerned. The director shall be entitled to be heard on the resolution for his removal at
the meeting.

ADVERTISEMENTS:

On request of the director, the company shall send a copy of any representation made by the director in
writing thereon to each of its members. In case the copies of the representation could not be sent to the
members because it was received too late, the director concerned may require it to be read out at the
meeting.

However, Central Government may not allow the representation to be sent out or read to the members if
on an application of the company or any member, the Government is satisfied that the rights conferred by
law shall be abused by the director concerned in securing needless publicity for the defamatory matter.

The vacancy caused by the removal of a director may be filled at the same meeting in which the removal
takes place provided an earlier special notice to this effect has been given to the members together with
the removal notice.

The person so appointed will hold office up to the date to which his predecessor would have held it, had
he not been removed. If the vacancy is not filled at the meeting, it may be filled by the Board as a casual
vacancy.

ADVERTISEMENTS:
However, the shareholders cannot remove the following directors:

(i) A director appointed by the Central Government under section 408 for the prevention of oppression
and mismanagement.

(ii) A director holding office for life on the 1st day of April 1952, in the case of private company.

(iii) A director appointed under the system of proportional representation adopted by the company under
section 265.

(iv) A director appointed by the Financial Institution.

(ii) Removal by the Central Government:


Central Government has the power (under Sec. 388B, 388C, 388D, and 388E) to remove directors of a
company from office on the recommendations of the Company Law Board (Tribunal w.e.f. its constitution).

The case of any director or other managerial personnel may be referred by the Central Government to the
Company Law Board (Tribunal) for enquiry, where the Central Government is convinced of the existence
of any of the following circumstances:

(a) Such person is or has been guilty of fraud, misfeasance, persistent negligence or default in carrying
out his obligation and functions under the law, or breach of trust; or

(b) The business of the company is not or has not been conducted and managed by such person in
accordance with sound business principles or prudent commercial practices; or

(c) The company is or has been conducted and managed by such person in a manner which is likely to
cause, or has caused serious injury or damage to the interest of the trade, industry or business to which
such company pertains; or

(d) The business of the company is or has been conducted and managed by such person with intent to
defraud its creditors, members or any other persons or otherwise for a fraudulent or unlawful purpose or
in a manner prejudicial to public interest.

After the hearing of the case, the Company Law Board (Tribunal) shall record its findings and forward it to
the Central Government. If the Company Law Board has declared a person unfit to occupy any office
connected with the conduct and management of the company, the Central Government shall remove
such person from office.
Such person shall not be entitled to hold office of a director or any other office connected with the
management of the affairs of any company during a period of 5 years from the date of the order of
removal.

(iii) Removal by Company Law Board:


Where an application is made to the Company Law Board (Tribunal after it is formed) under section 397
and 398 against oppression and mismanagement of a company’s affairs, the Company Law Board may, if
satisfied, order for the termination or setting aside of an agreement which the company might have made
with its directors (Sec. 402).

The effect of such order will be removal of such director or directors from his or their office. Such a
director (including managing director) shall not be entitled to serve as a manager, managing director or
director of any company without the sanction of the Company Law Board for a period of 5 years from the
date of the Company Law Board’s order terminating or setting aside his contract with the company. He
shall also not be entitled to claim any sort of compensation from the company for the loss of office (Sec.
407).

Useful Notes on Power of Directors in a Company – (Section 219 of Companies Act 1956)

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The powers of directors of a company are co-extensive with the powers of the company. As per section
291 of the Companies Act, the Board of Directors of a company shall be entitled to exercise all such
powers and to do all such acts and things as the company is authorised to exercise and do.
There are however, two limitations upon the powers of the Board:

1. The Board cannot exercise those powers which the Act, or Memorandum or Articles require to be
exercised by the shareholders in the general meeting.

ADVERTISEMENTS:

2. In the exercise of their powers, the directors are subject to the provisions of the Act, Memorandum and
Articles and other regulations made by the company in the general meeting.

Powers of a company are distributed between the Board of Directors and the shareholders. Powers
vested in the Board of Directors can be exercised by it alone. The shareholders cannot interfere with the
decision of the directors, unless they are acting contrary to the provisions of the Act or the Articles.
However, the inherent residuary and ultimate powers of a company lie with the general meeting of the
shareholders, and therefore, the general meeting i.e., the shareholders can act even in a matter
delegated to the Board in the following exceptional cases:

1. Where the directors’ actions are found to be mala fide:


ADVERTISEMENTS:

Where the actions of directors are mala fide and against the interests of the company, e.g. clash of
directors’ personal interest with the duties towards the company.

2. Where the Board becomes incompetent to act:


Where the Board of Directors has for some valid reasons become incompetent to act, e.g. all the directors
are interested in a particular transaction.

3. Deadlock in the Board:


Where directors are unable to act because of a deadlock in the meeting of the Board of Directors. They
are equally divided and, therefore, cannot come to any decision.

5 General Duties of the Directors of a Company (Companies Act 1956)

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Under general law, a director’s relationship with the company is regarded as fiduciary in nature.
Consequently, directors owe a duty of loyalty and care in performing their responsibilities on behalf of the
company. These duties are owed to the company meaning generally the shareholders collectively, both
present and future, not the shareholders at a given point in time.

These are enforceable by the company, although derivative actions may be brought by individual
shareholders on behalf of the company in certain limited circumstances. A breach of these equitable
obligations gives rise to liability to account for improper profits and to pay equitable compensation for
improper loss of company assets. Besides the statutory duties, the general duties of the directors are as
follows:

(1) Duty of good faith:


Directors must act honestly and diligently in the interests of the company. They must exercise their
powers bona fide i.e. in what they consider, is in the interests of company and not for any collateral
purpose.
ADVERTISEMENTS:

It is expected from them to behave as honest men of business may be expected to act. They may be held
liable for breach of duty if they have acted in their own interests or that of some third party without
considering whether it was also in the interest of the company though they might not have acted with any
conscious dishonesty.

The directors have to look after the interest of the company. Interest of the company implies the interests
of present and future members of the company. On the footing that the company would be continued as a
going concern, they have to balance a long-term view against the short-term interests of present
members.

Good faith also requires that directors should not make any secret profit from their dealings with the
company nor they should make any profit by corporate opportunities.

(2) Duty of reasonable care:


ADVERTISEMENTS:

A director is bound to observe reasonable care in the performance of his duties. He is expected to act
with that much of skill and diligence which an ordinary man would take in his own case.

A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably
be expected from a person of his knowledge and experience.

He cannot be held liable for mere errors of judgment. “If directors act within their powers, if they act with
such care as is to be reasonably expected of them having regard to their knowledge and experience and
if they act honestly for the benefit of the company they represent, they discharge both their equitable as
well as legal duty to the company.”

The directors’ duty of care has been explained by Roamer J. in Re. City Equitable Fire Insurance Co.:

ADVERTISEMENTS:

(i) A director need not exhibit in the performance of his duties a greater degree of skill than may be
reasonably expected from a person of his knowledge and experience.

(ii) A director is not bound to give continuous attention to the affairs of his company. His duties are of an
intermittent nature, to be performed at periodical board meetings, at any meetings of any committees of
the board, upon which he happens to be placed. He is however, not bound to attend all such meetings,
though he ought to attend whenever, in the circumstances he is reasonably able to do so.

(iii) In respect of all duties that, having regard to the exigencies of business and the Articles of
Association, may properly be left to some other official, a director is in the absence of grounds of
suspicion, justified in trusting that official to perform such duties honestly.

(3) Duty to attend board meetings:


Meetings of the board of directors are held from time to time to exercise the company’s powers. Each
director should attend such meetings. Of course, a director is not bound to give continuous attention to
the affairs of the company nor he is bound to attend all the meetings of the Board, but, in case he fails to
attend three consecutive meetings of the Board or if he absents himself from all the meetings of the
Board for a consecutive period of three months (whichever is longer) without obtaining the leave of
absence from the Board, he will be deemed to have vacated his office.

(4) Personal attendance:


Directors should perform the entire duties place upon them by the Act and Articles, personally. They can,
however, delegate their certain functions to the extent to which the Articles of the company permit or
according to the demand of exigencies of business. Directors shall be justified in the absence of grounds
of suspicion, in trusting the old and trusted servants of the company.

(5) Duty to disclose interest:


According to Section 299, a director interested in a contract with the company must disclose the nature of
his interest at the Board’s meeting. A director stands in a fiduciary capacity with the company and he
must not place himself in a position in which his personal interest conflicts with his duty.

He must not vote as a director on any contract or arrangement in which he is directly or indirectly
interested, unless authorised by the company’s articles. If he votes in such a case, his vote would not be
counted and his presence would not be counted towards the quorum. There is no ban on company
entering into a contract in which a director is interested. The only requirement is that such interest must
be disclosed, bona fide and fair.

Useful Notes on Liabilities of the Directors of a Company in India

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The liabilities of the directors of a company can be grouped under the following three heads:
1. Liability to Outsiders:
Directors are not personally liable to the outsiders for any acts done by them on behalf of the company.
They act as agents of the company and, therefore, they will be liable only under those circumstances
under which ordinarily an agent can be held liable.

ADVERTISEMENTS:

The directors would, be personally liable to third parties in the following circumstances:

(a) Directors shall be held liable for all the ultra-vires transactions amounting to a breach of an implied
warranty of authority held out by the directors.

(b) Directors shall also be liable on all those contracts which they enter in their own name. They shall also
be personally liable on contracts entered into on behalf of the company when they have expressly or by
implication personally undertaken the responsibility for the same.

(c) Directors shall be personally liable to the outsiders if they are found guilty of fraud or other torts.
Outsiders who have subscribed for shares on the basis of false statement can make the directors liable
either under Section 62 by an action for damage or by an action for deceit under general law.

2. Liability to the Company:


ADVERTISEMENTS:

The liability of directors towards the company may arise in the following four circumstances:

(a) Liability for “ultra-vires” acts:


Directors are responsible to the company for any loss that it may suffer on account of ultra-vires acts e.g.
application of funds of company for objects not sanctioned by the company’s memorandum or payment of
dividend out of capital. The acts may not have been committed with any fraudulent intention on their part.

(b) Liability for negligence:


ADVERTISEMENTS:

Directors shall be liable to the company for negligence, when they do not use so much skill and care in
the management of the affairs of the company as an ordinary man would reasonably use in his own case
or which may be expected from person of such experience and knowledge.
Directors are, however, not liable for mere errors of judgment when they have acted within their powers in
the bona fide exercise of their discretion or negligence of the subordinates relied upon by them, in the
absence of any ground for suspicion.

(c) Liability for breach of trust:


Directors shall be held liable for misapplication of the funds of the company or for misappropriation of
assets or for making a secret profit out of their dealings on behalf of the company.

He will also be liable for breach of trust if he fails to act honestly and in the interests of the company as a
whole. He will be liable to make good any loss sustained by the company as a result of any wrongful act
committed or authorised by him or which he has joined in sanctioning at a board’s meeting.

(d) Liability for misfeasance:


Misfeasance implies misconduct on the part of a director concerning the company’s affairs which cause
loss to the company. In order to take action against a director on the ground of misfeasance, two
conditions must be fulfilled: (i) there must be misconduct or negligence on the part of a director and (ii)
such misconduct or negligence must be willful. Mere failure on the part of the director to take certain
steps for the benefit of the company, e.g., recovery of a debt, will not amount to misfeasance.

3. Criminal Liability of the Directors:


When the directors fail to fulfill the statutory obligations imposed upon them by law, they may be held
criminally liable. There are various provisions in the Companies Act under which directors shall be
criminally liable.

The directors can also be held criminally liable for fraud, misapplication and embezzlement of the
company’s funds under the provisions of the Indian Penal Code.

Liability for the acts of co-directors:


A director is not liable for the misconduct or wrongful acts committed by his co-directors unless he has
expressly or impliedly authorized the same. A director would be liable for loss or damage to the company
resulting from carrying out such decisions if he has taken an active part in giving effect to the decisions of
the board. It will be immaterial whether he attended such meeting of the board or not. In case of breach of
trust, directors are jointly and severally liable.

167. Vacation of office of director


(1) The office of a director shall become vacant in case—
(a) he incurs any of the disqualifications specified in section 164;
(b) he absents himself from all the meetings of the Board of Directors held
during a period of twelve months with or without seeking leave of absence of the
Board;
(c) he acts in contravention of the provisions of section 184 relating to entering
into contracts or arrangements in which he is directly or indirectly interested;
(d) he fails to disclose his interest in any contract or arrangement in which he is
directly or indirectly interested, in contravention of the provisions of section 184;
(e) he becomes disqualified by an order of a court or the Tribunal;
(f) he is convicted by a court of any offence, whether involving moral turpitude
or otherwise and sentenced in respect thereof to imprisonment for not less than six
months:
Provided that the office shall be vacated by the director even if he has filed an
appeal against the order of such court;
(g) he is removed in pursuance of the provisions of this Act;
(h) he, having been appointed a director by virtue of his holding any office or
other employment in the holding, subsidiary or associate company, ceases to hold
such office or other employment in that company.
(2) If a person, functions as a director even when he knows that the office of director
held by him has become vacant on account of any of the disqualifications specified in subsection
(1), he shall be punishable with imprisonment for a term which may extend to one
year or with fine which shall not be less than one lakh rupees but which may extend to five
lakh rupees, or with both.
(3) Where all the directors of a company vacate their offices under any of the
disqualifications specified in sub-section (1), the promoter or, in his absence, the Central
Government shall appoint the required number of directors who shall hold office till the
directors are appointed by the company in the general meeting.
(4) A private company may, by its articles, provide any other ground for the vacation
of the office of a director in addition to those specified in sub-section (1).

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