UNIT I
INTRODUCTION
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).
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:
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.
Section 45 – Reduction of membership below statutory minimum: This section provides that if the members of a company is reduced below seven in the case of a public company and below two in the case of a private company (given in Section 12) and the company continues to carry on the business for more than six months, while the number is so reduced, every person who knows this fact and is a member of the company is severally liable for the debts of the company contracted during that time.
In the case of Madan lal v. Himatlal & Co.[vii] the respondent filed suit against a private limited company and its directors for recovery of dues. The directors resisted the suit on the ground that at no point of time the company did carry on business with members below the legal minimum and therefore, the directors could not be made severally liable for the debt in question. It was held that it was for the respondent being dominus litus, to choose persons of his choice to be sued.
Section 147- Misdescription of name: Under sub-section (4) of this section, an officer of a company who signs any bill of exchange, hundi, promissory note, cheque wherein the name of the company is not mentioned is the prescribed manner, such officer can be held personally liable to the holder of the bill of exchange, hundi etc. unless it is duly paid by the company. Such instance was observed in the case of Hendon v. Adelman.
Section 239 – Power of inspector to investigate affairs of another company in same group or management: It provides that if it is necessary for the satisfactory completion of the task of an inspector appointed to investigate the affairs of the company for the alleged mismanagement, or oppressive policy towards its members, he may investigate into the affairs of another related company in the same management or group.
Section 275- Subject to the provisions of Section 278, this section provides that no person can be a director of more than 15 companies at a time. Section 279 provides for a punishment with fine which may extend to Rs. 50,000 in respect of each of those companies after the first twenty.
Section 299- This Section gives effect to the following recommendation of the Company Law Committee: “It is necessary to provide that the general notice which a director is entitled to give to the company of his interest in a particular company or firm under the proviso to sub-section (1) of section 91-A should be given at a meeting of the directors or take reasonable steps to secure that it is brought up and read at the next meeting of the Board after it is given.[ix] The section applies to all public as well as private companies. Failure to comply with the requirements of this Section will cause vacation of the office of the Director and will also subject him to penalty under sub-section (4).
Sections 307 and 308- Section 307 applies to every director and every deemed director. Not only the name, description and amount of shareholding of each of the persons mentioned but also the nature and extent of interest or right in or over any shares or debentures of such person must be shown in the register of shareholders.
Section 314- The object of this section is to prohibit a director and anyone connected with him, holding any employment carrying remuneration of as such sum as prescribed or more under the company unless the company approves of it by a special resolution.
Section 542- Fraudulent conduct: If in the course of the winding up of the company, it appears that any business of the company has been carried on with intent to defraud the creditors of the company or any other person or for any fraudulent purpose, the persons who were knowingly parties to the carrying on of the business, in the manner aforesaid, shall be personally responsible, without any limitation of liability for all or any of the debts or other liabilities of the company, as the court may direct. In Popular Bank Ltd., In re[x] it was held that section 542 appears to make the directors liable in disregard of principles of limited liability. It leaves the Court with discretion to make a declaration of liability, in relation to ‘all or any of the debts or other liabilities of the company’. This section postulates a nexus between fraudulent reading or purpose and liability of persons concerned.
JUDICIAL INTERPRETATIONS
By contrast with the limited and careful statutory directions to ‘lift the veil’ judicial inroads into the principle of separate personality are more numerous. Besides statutory provisions for lifting the corporate veil, courts also do lift the corporate veil to see the real state of affairs. Some cases where the courts did lift the veil are as follows:
United States v. Milwaukee Refrigerator Transit Company– In this case, the U.S. Supreme Court held that “where the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or defend crime, the law will disregard the corporate entity and treat it as an association of persons.”
Some of the earliest instances where the English and Indian Courts disregarded the principle established in Salomon’s case are:
Daimler Co. Ltd. v. Continental Tyre and Rubber Co. (Great Britain) Ltd– This is an instance of determination of the enemy character of a company. In this case, there was a German company. It set up a subsidiary company in Britain and entered into a contract with Continental Tyre and Rubber Co. (Great Britain) Ltd. for the supply of tyres. During the time of war, the British company refused to pay as trading with an alien company is prohibited during that time. To find out whether the company was a German or a British company, the Court lifted the veil and found out that since the decision making bodies, the board of directors and the general body of share holders were controlled by Germans, the company was a German company and not a British company and hence it was an enemy company.
Gilford Motor Co. v. Horne– This is an instance for prevention of façade or sham. In this case, an employee entered into an agreement that after his employment is terminated he shall not enter into a competing business or he should not solicit their customers by setting up his own business. After the defendant’s service was terminated, he set up a company of the same business.
His wife and another employee were the main share holders and the directors of the company. Although it was in their name, he was the main controller of the business and the business solicited customers of the previous company. The Court held that the formation of the new company was a mere cloak or sham to enable him to breach the agreement with the plaintiff.
Re, FG (Films) Ltd– In this case the court refused to compel the board of film censors to register a film as an English film, which was in fact produced by a powerful American film company in the name of a company registered in England in order to avoid certain technical difficulties. The English company was created with a nominal capital of 100 pounds only, consisting of 100 shares of which 90 were held by the American president of the company. The Court held that the real producer was the American company and that it would be a sham to hold that the American company and American president were merely agents of the English company for producing the film.
Jones v. Lipman– In this case, the seller of a piece of land sought to evade the specific performance of a contract for the sale of the land by conveying the land to a company which he formed for the purpose and thus he attempted to avoid completing the sale of his house to the plaintiff. Russel J. describing the company as a “devise and a sham, a mask which he holds before his face and attempt to avoid recognition by the eye of equity” and ordered both the defendant and his company specifically to perform the contract with the plaintiff.
Tata Engineering and Locomotive Co. Ltd. State of Bihar– In this case, it was stated that a company is also not allowed to lay claim on fundamental rights on the basis of its being an aggregation of citizens. Once a company is formed, its business is the business of an incorporated body thus formed and not of the citizens and the rights of such body must be judged on that footing and cannot be judged on the assumption that they are the rights attributable to the business of the individual citizens.
N.B. Finance Ltd. v. Shital Prasad Jain– In this case the Delhi High Court granted to the plaintiff company an order of interim injunction restraining defendant companies from alienating the properties of their ownership on the ground that the defendant companies were merely nominees of the defendant who had fraudulently used the money borrowed from the plaintiff company and bought properties in the name of defendant companies. The court did not in this case grant protection under the doctrine of the corporate veil.
Shri Ambica Mills Ltd. v. State of Gujarat– It was held that the petitioners were as good as parties to the proceedings, though their names were not expressly mentioned as persons filing the petitions on behalf of the company. The managing directors in their individual capacities may not be parties to such proceedings but in the official capacity as managing directors and as officers of the company, they could certainly be said to represent the company in such proceedings. Also as they were required to so act as seen from the various provisions of the Act and the Rules they could not be said to be total strangers to the company petition.
A. Types of Company on the basis of Incorporation
1. Statutory Companies :
These companies are constituted by a special Act of Parliament or State Legislature. These companies are formed mainly with an intention to provide the public services.
Though primarily they are governed under that Special Act, still the CA, 2013 will be applicable to them except where the said provisions are inconsistent with the provisions of the Act creating them (as Special Act prevails over General Act).
Examples of these types of companies are Reserve Bank of India, Life Insurance Corporation of India, etc.
2. Registered Companies:
Companies registered under the CA, 2013 or under any previous Company Law are called registered companies.
Such companies comes into existence when they are registered under the Companies Act and a certificate of incorporation is granted to it by the Registrar.
B. Types of Company on the basis of Liability
1. Companies limited by shares:
A company that has the liability of its members limited by the memorandum to the amount, if any, unpaid on the shares respectively held by them is termed as a company limited by shares.
The liability can be enforced during existence of the company as well as during the winding up. Where the shares are fully paid up, no further liability rests on them.
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.
2. Companies limited by guarantee:
Company limited by guarantee is a company that has the liability of its members limited to such amount as the members may respectively undertake, by the memorandum, to contribute to the assets of the company in the event of its being wound-up. In case of such companies the liability of its members is limited to the amount of guarantee undertaken by them.
The members of such company are placed in the position of guarantors of the company’s debts up to the agreed amount.
Clubs, trade associations, research associations and societies for promoting various objects are various examples of guarantee companies.
3. Unlimited Liability Companies
A company not having a limit on the liability of its members is termed as unlimited company. Here the members are liable for the company’s debts in proportion to their respective interests in the company and their liability is unlimited.
Such companies may or may not have share capital. They may be either a public company or a private company.
C. Types of Company on the basis of number of members
1. Public Company:
Defined u/s 2(71) of the CA, 2013 – A public company means a company which is not a private company.
Section 3(1) of the CA, 2013– Public company may be formed for any lawful purpose by 7 or more persons.
Section 149(1) of the CA, 2013 – Every public company shall have minimum 3 director in its Board.
Section 4(1)(a) of the CA, 2013 – A public company is required to add the words “Limited” at the end of its name.
It is the essence of a public company that its shares and debentures can be transferable freely to the public unlike private company. Only the shares of a public company are capable of being dealt in on a stock exchange.
A private company that is a subsidiary of a public company, will be considered a public company.
2. Private company:
Defined u/s 2(68) of the CA, 2013 –
A private company means a company which by its articles—
a. Restricts the right to transfer its shares;
b. Limits the number of its members to 200 hundred (except in case of OPC)
Note:
Persons who are in the employment of the company; and persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased, shall be excluded.
Where 2 or more persons hold 1 or more shares in a company jointly they shall be treated as a single member.
Prohibits any invitation to the public to subscribe for any securities of the company;
Section 3(1) of the CA, 2013 – Private Company may be formed for any lawful purpose by 2 or more persons.
Section 149(1) of the CA, 2013 – Every Private company shall have minimum 2 director in its Board.
Section 4(1)(a) of the CA, 2013 – A private company is required to add the words “Private Ltd” at the end of its name.
Special privileges – Private Companies enjoys several privileges and exemptions under the Companies Act.
3. One Person Company (OPC):
With the enactment of the Companies Act, 2013 several new concepts was introduced that was not in existence in Companies Act, 1956 which completely revolutionized corporate laws in India. One of such was the introduction of OPC concept.
This led to the avenue for starting businesses giving flexibility which a company form of entity can offer, while also offering limited liability that sole proprietorship or partnerships does not offers.
Defined u/s 2(62) of the CA, 2013 – One Person Company means a company which has only one person as a member.
Section 3(1) of the CA, 2013 – OPC (as private company) may be formed for any lawful purpose by 1 persons.
Section 149(1) of the CA, 2013 – OPC shall have minimum 1 director in its Board, its sole member can also be director of such OPC.
Some Feature explained
Single-member: OPCs can have only 1 member or shareholder, unlike other private companies.
Nominee: A unique feature of OPCs that separates it from other kinds of companies is that the sole member of the company has to mention a nominee while registering the company. Since there is only one member in an OPC, his death will result in the nominee choosing or rejecting to become its sole member. This does not happen in other companies as they follow the concept of perpetual succession.
Special privileges: OPCs enjoys several privileges and exemptions under the Companies Act.
D. Types of Company on the basis of Domicile
1. Foreign company:
Defined u/s 2(42) of the CA, 2013 – “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.
Section 379 to Section 393 of the CA, 2013 prescribes the provisions which are applicable on such companies.
2. Indian Company:
A company formed and registered in India is known as an Indian Company.
E. Other Types of Company:
1. Government Company:
Defined u/s 2(45) of the CA, 2013 – “Government company” means any company in which not less than 51 % 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. Explanation – “paid-up share capital” shall be construed as “total voting power”, where shares with differential voting rights have been issued.
Special privileges: Government Company enjoys several privileges and exemptions under the Companies Act.
2. Subsidiary Company:
Defined u/s 2(87) of the CA, 2013 – “subsidiary company” or “subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding company—
a) controls the composition of the Board of Directors; or
b) exercises or controls more than one-half of the total voting power either at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.
Explanation: For the purposes of this clause-
a) a company shall be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
b) the composition of a company’s Board of Directors shall be deemed to be controlled by another company if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors;
c) the expression “company” includes any body corporate;
d) “layer” in relation to a holding company means its subsidiary or subsidiaries.
3. Holding Company:
Defined u/s 2(46) of the CA, 2013 –“holding company”, in relation to one or more other companies, means a company of which such companies are subsidiary companies;
Explanation: For the purposes of this clause, the expression “company” includes any body corporate.
Key Takeaways:
a) Companies registered under the CA, 2013 or under any previous Company Law are called registered companies.
b) Where 2 or more persons hold 1 or more shares in a company jointly they shall be treated as a single member.
Association not for profit
There are three ways of registering a Non-Profit Organizations or Non-Governmental Organizations- Society, Trust and Section 8 Company. Trusts and Societies do not have central laws as its laws are restricted within that state only where it is established.
Section 8 Company (earlier known as Section 25 Company) is a legal form of Non Profit Organizations or Non Governmental Organizations registered under Section 8 of the Companies Act, 2013 and has its objective of promotion of arts, science, commerce, education, sports, research, religion, social welfare, charity or any other similar object.
Income earned by the Company is applied only for promoting the objects of the Company and it cannot be distributed to promoters. It shall enjoy all the privileges of limited Company subject to the obligations.
Main requirements and privileges for incorporating a section 8 company are as follows:
1) There should be minimum two Shareholders;
2) There should be minimum two Directors;
3) At least one of the Director should be resident in India;
4) No requirement of Minimum capital is there, it can be formed with or without share capital;
5) It shall obtain a license from Central Government for registration of persons as a Limited Company. Further, the power of Central Government is delegated to the Registrar of Companies having jurisdiction over the place where the registered office of the Company is proposed to be situated.
6) These Companies are not required to add Limited or Private Limited as the case may be at the end of their names. Instead, it shall use the words Foundation, Forum, Association, Federation, Chambers, Confederation, council, Electoral trust etc.
7) It takes 30-40 days to incorporate a Section 8 Company. The time can be reduced if a license is issued and other forms are approved earlier by respected Registrar of Companies..
Section 8 Company is identical to trust or society but it has certain advantages over trust or society like legal recognition, better standing, and higher credibility. Other advantages of Section 8 Company are as follows:
1) Limited Liability.
2) Separate legal entity.
3) Perpetual Succession.
4) Lesser Compliances as compared to other entities.
5) Easy to transfer shares.
6) Various tax benefits.
PROCEDURE FOR INCORPORATING SECTION 8 COMPANY IS AS FOLLOWS:
1) Obtain the below-mentioned documents and information:
a. Name of the Proposed Company along with its business activity in brief.
b. PAN, Identity Proof and Address Proof of all the Directors and Shareholder of the proposed Company
(Note: Voter ID/Aadhaar Card/Passport/Driving Licence can be considered as Identity Proof and Latest Bank Statement/Electricity bill/Mobile Bill/Telephone Bill can be considered as Address Proof)
c. Photo, Email Id and Mobile Number of all the Directors of the proposed Company.
d. Complete address of Registered Office including Latest Electricity Bill for the same and rent agreement if premises are rented.
e. Initiate the process of obtaining Digital Signature Certificate of proposed Directors;
f. An application has to be filed to respected ROC under RUN for name approval;
g. Reserved name shall be valid for 20 days. After obtaining name approval, an application in E-Form INC-12 has to be filed to respected ROC for license approval of Section 8 Company i.e. to run a charitable organization;
h. After obtaining a license, an application has to be filed in Spice forms (INC-32, INC-33 and INC-34) for final approval of ROC for incorporating the Company stating the Details of Directors, Shareholding Pattern, Objects of the Company along with necessary attachments including PAN, ID and Address Proof of all the Directors and shareholders.
i. Once the ROC gets satisfied with all the above formalities, a Certificate of Incorporation will be issued to the Company.
Hence, from the above, it is concluded that Section 8 Company is the most reliable source of establishing a Non-Profit Organization because of Central recognition and better laws as mentioned.
Illegal Association
An illegal Association is governed by Section 464 of the Companies Act. Section 464 of the Act provides that no company, association or partnership consisting of more than 50 persons be formed to carry on any business for gain unless it is registered under Companies Act or any other Indian law. It is not necessary that such an association must be registered under the Indian Companies Act. It may be registered under some other Indian law.
For example, a limited liability partnership formed for carrying on business for gain by professionals, registered under the Limited Liability Partnership Act, 2008 is a legal body corporate. There is no limit to the maximum number of members in such a limited liability partnership.
The objective of such an association must be to carry on a business for gain. Section 464 does not apply to Non-Profit-Organizations or Charitable Associations because the objective is not to earn the profit. Section 464 further provides that the above restriction as to number of persons shall, not apply to a Hindu Undivided Family (HUE) carrying on any business or an association or Partnership formed by Professionals who are governed by special Acts (e.g., Limited Liability Partnership Act, 2008).
Rule for counting the number of persons
A person, natural or artificial, would be treated as one person. Therefore, a company is treated as a single person. Similarly, a joint Hindu Family managed by Karta is also treated as a single person.
If two or more Joint Hindu Families form an association, in that case, all the adult members of the family would be taken into consideration while counting the number of members.
A partnership firm is not a separate legal entity. All the partners would be treated as different persons.
If two or more persons hold a share jointly, they would be treated as one single person.
Consequences of an Illegal Association
No Legal Existence: Such an association cannot enter into binding contracts. Neither the association nor the members can file a suit against the third party who has contracted with it. One member cannot sue other member in respect of any matter connected with the association. Further, a third party or a member cannot file a suit against the association.
Unlimited Personal Liability of the Members: The liability of the members is unlimited. Every member of such an association is personally liable for all liabilities incurred in the business. The third party can take action against the members.
Fine: Every member of such an association will be punishable with a fine which may extend to one lakh.
If the number of members in an illegal association comes within the statutory limit, the illegal association would not become legal by virtue of such reduction.
Section 2(69) of Companies Act 2013, deals with the term Promoter:
1. A person who has been named as such in a prospectus or is identified by the company in the annual return in section 92; or
2. A person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
3. A person who is in agreement with whose advice, directions or instructions the Board of Directors of the company is accustomed to act.
In a simple word, the promoter may be an individual, a firm or a company that does all the necessary preliminary duties to bring a company into existence. The promoter’s work is to formulate new ideas and to develop it and also persuade others to join the company.
According to L.J. Brown. “The term promoter is a term not of law but of business, usefully summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence.”
According to Justice C. Cockburn. “Promoter is one who undertakes to form a company with reference to a given object and to set it going, and who takes the necessary steps to accomplish that purpose.”
Legal Position of a Promoter is that he is not an agent or trustee of the company. Promoter has a fiduciary relationship with the company which is based on trust and confidence. Therefore, a promoter is obliged to disclose all the relevant facts and any secret profit which is made by him in relation to the formation of the Company.
In Erlanger v. New Sombrero Phosphate Co., Lord Carins stated, The promoter of the company has a fiduciary position. They can create and mold the company as well. The promoter has full authority to define how and when and in what shape and under what supervision, it will start into existence and begin to act as a trading corporation.
Legal status/position of a promoter:
1) The statutory provisions are silent regarding the legal status of a promoter.
2) A promoter cannot be an agent or trustee for the proposed company (or) company under incorporation.
3) However, the law imposes certain duties, functions, responsibilities and liabilities on a promoter which are “like that of an agent or trustee” of a proposed/under incorporation company.
4) This position of the promoter “like that of an agent or trustee” is called the “fiduciary duties or fiduciary role or fiduciary position” of a promoter.
Fiduciary position of the promoter: The promoter stands in a fiduciary relation to the company which he promotes. They are follows:-
(1)Not to make any profit at the expense of the company: The promoter cannot make any profit of the company he promotes either directly (or) indirectly without knowledge and the consent of the company. Similarly he is not allowed to drive any profit from the sale of his own property to the company unless all material facts are disclosed. If any such secrete profits is violated to this rule, the company may compel him to account for and surrender for such profits.
(2) To give benefit of negotiations to the company: The promoter must give benefit to the company of any contracts (or) negotiations enter into by him in respect of the company. Thus where he purchases some property for the company and he cannot rightfully sell that property to the company, he may sell at a higher price than he gave for it. If he does do, the company may on discovering the fact, the company may have the following remedies against such promoter:
a) Rescind the contract and recover the money if any already paid on the transaction (or)
b) Retain the property, pay the promoter only the cost value and deprive him the profit,(or)
c) Where the above remedies are inappropriate, the company may sue for misfeasance (i.e.., breach of duty to disclose)
Example: Erlanger (vs) New Sombrero Phosphates Co., (1878):
Facts: A Syndicate, of which ‘E’ was the head, purchased an island with valuable minerals. ‘E’, as promoter, sold the island to a newly formed company for the purpose of buying it. A contact was entered into between ‘X’, a nominee of the Syndicate, and the company for purchase at double the price actually paid by ‘E’.
Judgment: It was held by the court that as there had been no disclosure by the promoters of the profit that were making, the company was entitled to rescind the contract and to recover the purchase money from ‘E’ and the other members of the syndicate.
(3) To make full disclosure of interest and profits: if the promoter fails to disclose the relevant facts, the company may sue him for damages for breach of his fiduciary duty and recover them from him any secrete profit. It is important to note that profit is permissible, if full disclosure of the facts is given to the independent Board of director (or) shareholders.
(4) Not to make unfair use of the position: The promoter must not make an unfair (or) reasonable use of his position and must take care to avoid anything which has the appearance of undue influence (or) fraud.
Key Takeaways:
Preliminary Contracts or Pre-Incorporation Contracts
As the name stands, these contracts are made before the formation of a company. For the formation of the company, the promoters are required to enter into various contracts with third parties e.g. purchasing some property or hiring the services of professions like lawyers, technicians, etc.
After the incorporation of the company such contracts are not attached to the company, as the company obtains legal entity status only after its incorporation.
As per the Act, the company can neither sue nor it can be sued on the basis of such contracts because the company was not a party to such contracts. At the same time, company cannot even ratify or adopt such contracts to get the benefit of such contracts.
Highlights of Preliminary Contracts
a) Contracts entered by the promoters on behalf of the company which is yet to be incorporated.
b) Can be applicable to public limited and private limited companies.
c) Company is not bound by pre-incorporation contracts.
d) Company cannot sue or be sued on the basis of such contracts.
e) Promoters, themselves, remain personally liable on all such contracts, unless a new contract on the same terms as that of the old one is made by the company after incorporation.
f) Company, after its incorporation, cannot even ratify such contracts.
g) The liability of the promoter ceases on the adoption of such agreement by the company after incorporation
h) As per the Act, either party can rescind the agreement if the incorporation is not obtained in a specific period of time.
Further to the incorporation of the company, the company may adopt the preliminary agreement. In certain cases, the company can enforce a pre-incorporation contract if it is warranted by the terms of incorporation. At the same time, specific performance of such contracts can be enforced by other parties against the company if such contracts are for the purposes of the company and are warranted by the terms of incorporation of the company. This is so provided under the provisions of Specific Relief Act, 1963.
Provisional Contracts
As per the Act, the contracts made after incorporation of the company but before it is entitled to commence business are termed as Provisional Contracts.
Any contract made by a company before the date on which it is entitled to commence business shall be provisional only and binding on the company until that date, and on that date, it shall become binding.
The private companies can commence its business immediately after the incorporation of the company, however, for a public limited company, the commencement of business occurs only after obtaining certificate of commencement of business. The term Provisional Contract applies only to the companies with share capital.
Major differences between Pre-incorporation and provisional contract
Preliminary contracts are those contracts made before the formation of the company, whereas the contract entered by a company after incorporation but before it is entitled to commence business is termed as provisional contracts.
As per the provisions of the act, neither the company can sue nor can it be sued to enforce the preliminary contracts, whereas the provisional contracts can be enforced only on receiving a certificate of Commencement of Business.
Preliminary contracts are the liabilities of promoters, his liability ceases only after adoption of such contract by the company after incorporation. However, provisional contracts are the responsibilities of the company. Preliminary contracts may relate to property which the promoters desire to purchase for the company or they may be made with the persons whose know-how is vital to the success of the company.
As per the Act, both private and public company have the right to undertake these contracts, whereas only public limited companies can undertake provisional contracts.
As the provisional contracts are being entered in a period after incorporation and before obtaining business commencement certificate, it can be applied only to public limited companies.
However, no such case arises in private limited companies as private limited company obtain legal feature immediately on receipt of incorporation certificate.
Key Takeaways:
Memorandum of association
Memorandum of Association is the most important document of a company. It states the objects for which the company is formed. It contains the rights, privileges and powers of the company. Hence it is called a charter of the company. It is treated as the constitution of the company. It determines the relationship between the company and the outsiders.
The whole business of the company is built up according to Memorandum of Association. A company cannot undertake any business or activity not stated in the Memorandum. It can exercise only those powers which are clearly stated in the Memorandum.
Definition of Memorandum of Association
Lord Cairns:
“The memorandum of association of a company is the charter and defines the limitation of the power of the company established under the Act”.
Thus, a Memorandum of Association is a document which sets out the constitution of the company. It clearly displays the company’s relationship with outside world. It also defines the scope of its activities. MoA enables the shareholders, creditors and people who has dealing with the company in one form or another to know the range of activities.
Contents of Memorandum of Association
According to the Companies Act, the Memorandum of Association of a company must contain the following clauses:
1. Name Clause of Memorandum of Association
The name of the company should be stated in this clause. A company is free to select any name it likes. But the name should not be identical or similar to that of a company already registered. It should not also use words like King, Queen, Emperor, Government Bodies and names of World Bodies like U.N.O., W.H.O., World Bank etc. If it is a Public Limited Company, the name of the company should end with the word ‘Limited’ and if it is a Private Limited Company, the name should end with the words ‘Private Limited’.
2. Situation Clause of Memorandum of Association
In this clause, the name of the State where the Company’s registered office is located should be mentioned. Registered office means a place where the common seal, statutory books etc., of the company are kept.The company should intimate the location of registered office to the registrar within thirty days from the date of incorporation or commencement of business.
The registered office of a company can be shifted from one place to another within the town with a simple intimation to the Registrar. But in some situation, the company may want to shift its registered office to another town within the state. Under such circumstance, a special resolution should be passed. Whereas, to shift the registered office to other state, Memorandum should be altered accordingly.
3. Objects Clause of Memorandum of Association
This clause specifies the objects for which the company is formed. It is difficult to alter the objects clause later on. Hence, it is necessary that the promoters should draft this clause carefully. This clause mentions all possible types of business in which a company may engage in future.
The objects clause must contain the important objectives of the company and the other objectives not included above.
4. Liability Clause of Memorandum of Association
This clause states the liability of the members of the company. The liability may be limited by shares or by guarantee. This clause may be omitted in case of unlimited liability.
5. Capital Clause of Memorandum of Association
This clause mentions the maximum amount of capital that can be raised by the company. The division of capital into shares is also mentioned in this clause. The company cannot secure more capital than mentioned in this clause. If some special rights and privileges are conferred on any type of shareholders mention may also be made in this clause.
6. Subscription Clause of Memorandum of Association
It contains the names and addresses of the first subscribers. The subscribers to the Memorandum must take at least one share. The minimum number of members is two in case of a private company and seven in case of a public company.
Thus, the Memorandum of Association of the company is the most important document. It is the foundation of the company.
Articles of Association
Articles of Association is an important document of a Joint Stock Company. It contains the rules and regulations or bye-laws of the company. They are related to the internal working or management of the company. It plays a very important role in the affairs of a company. It deals with the rights of the members of the company between themselves.
The contents of articles of association should not contradict with the Companies Act and the MoA. If the document contains anything contrary to the Companies Act or the Memorandum of Association, it will be inoperative. The private concerns that are limited by shares and those limited by guarantee and unlimited companies must have their articles of association. Public companies may not have their articles but may adopt Model articles given in Table A of Schedule I of Companies Act, 1956. If a public company has only some articles of its own, for the rest, articles of Table A will be applicable.
Articles that are profound to be registered should be printed, segmented well and sequenced consecutively. Each subscriber to Memorandum of Association must sign the articles in the presence of at least one witness.
Contents of Articles of Association
The articles generally deal with the following
1. Classes of shares, their values and the rights attached to each of them.
2. Calls on shares, transfer of shares, forfeiture, conversion of shares and alteration of capital.
3. Directors, their appointment, powers, duties etc.
4. Meetings and minutes, notices etc.
5. Accounts and Audit
6. Appointment of and remuneration to Auditors.
7. Voting, poll, proxy etc.
8. Dividends and Reserves
9. Procedure for winding up.
10. Borrowing powers of Board of Directors and managers etc.
11. Minimum subscription.
12. Rules regarding use and custody of common seal.
13. Rules and regulations regarding conversion of fully paid shares into stock.
14. Lien on shares.
Alteration of Articles of Association
The alteration of the Articles should not sanction anything illegal. They should be for the benefit of the company. They should not lead to breach of contract with the third parties. The following are the regulations regarding alteration of articles:
A company may alter its Articles with a special resolution. Due importance and care should be given to ensure that the alteration of AoA does not conflict with the provisions of the Memorandum of Association or the Companies Act. A copy of every special resolution altering the Articles must be filed with the Registrar within 30 days of its passing.
1. The proposed alteration should not contravene the provisions of the Companies Act.
2. The proposed alteration should not contravene the provisions of the Memorandum of Association.
3. The alteration should not propose anything that is illegal.
4. The alteration should be bonafide for the benefit of the company.
5. The proposed alteration should in no way increase the liability of existing members.
6. Alteration can be made only by a special resolution.
7. Alteration can be done with retrospective effect.
8. The Court does not have any power to order alteration of the Articles of Association.
Key Takeaways:
The Doctrine of ultra vires is related to actions taken by a private in relevancy corporation or company. Each company has what's known as a Memorandum of Association of Company (Memorandum), that is the company’s constitution. The memorandum defines the company’s objectives, powers, and areas of operation, each internal and external. The memorandum are an overview and a guide that the executives of the corporate will follow to make sure of the scope of their own powers, and what lines they can't and may not cross.
This commitment to uphold the company’s memorandum is cited as doctrine of ultravires. If the corporate performs an act that's on the far side the scope of the powers afforded to that by its memorandum, then that act is ultra vires, or on the far side its powers. The Doctrine of ultravires could be a reasonably policy that reassures a company’s shareholders and creditors that the corporate won't use their assets or funds for any functions aside from people who afforded to that, and such that among the ultra vires school of thought.
The Doctrine of ultra vires could be a basic rule of Company Law. It states that the objects of a corporation, as laid out in its memorandum of Association, may be departed from solely to the extent allowable by the Act. Hence, if the corporate will act, or enters into a contract on the far side the powers of the administrators or the corporate itself, then the aforesaid act/contract is void and not wrongfully binding on the corporate.
The term ultra vires means that ‘Beyond Powers’. In legal terms, it's applicable solely to the acts performed in way over the legal powers of the someone. This works on assumption that the powers restricted in nature. Since the Doctrine of ultra vires limits the corporate to the objects laid out in the memorandum, the corporate will be:
1) Restrained from exploitation its funds for functions aside from those laid out in the memorandum.
2) Restrained from carrying on trade totally different from the one licensed.
The company cannot sue on ultra vires dealings. Further, it cannot be sued too. If a corporation provides product or offers service or lends cash on Associate in Nursing ultra vires contract, then it cannot get payment or recover the loan. However, if an investor loans cash to a corporation that has not been extended nevertheless, then he will stop the corporate from parting with it via Associate in Nursing injunction.
The investor has this right as a result of the corporate doesn't become the owner of the money because it is ultra vires to the corporate and also the investor remains the owner. Further, if the corporate borrows cash in ultra vires dealings to repay a legal loan, then the investor is entitled to recover his loan from the corporate.
Sometimes act that is ultra vires may be regularised by the shareholders of the corporate. for instance:
1) If act is ultra vires the facility of administrators, then the shareholders will validate it.
2) If act is ultra vires the Articles of the corporate, then the corporate will alter the Articles.
Remember, you cannot bind a corporation through ultra vires contract. Estoppel, acquiescence, lapse of your time, delay, or approval cannot build it ‘Intra vires’
Effects of an Ultra Vires Act
The effects of an ultra vires act may be summed up as follows:
1) An ultra vires act is going to be totally void and it'll not bind the corporate; neither the company nor the outsider will enforce the contract.
2) Any member of the corporate will bring injunction against the corporate to stop it from doing any ultra vires act.
3) The administrators of the corporate are going to be in person susceptible to keep the funds used for the ultra vires acts.
4) Wherever a company’s cash has been used ultra vires to amass some property, the correct of the corporate over such property is command secure.
5) Since ultra vires contracts are treated as invalid from the kick-off, it cannot become intra vires by reason of rule of evidence or approval.
6) Ultra vires borrowing doesn't produce the link of mortal and person. the sole attainable remedy in such case is in rem and not in personam.
Types of Ultravires Acts-
There are 3 sorts of ultra vires acts, that mentioned below:
a) Ultra Vires the memo by the corporate – Acts performed by the corporate that are on the far side or beyond the powers granted to that within the memo are ultra vires.
b) Ultra Vires the Articles, intra vires the corporate – These are acts performed on the far side the powers granted to the corporate by its Articles of Association, however that are still inside the powers of its memo. These acts are ultra vires the Articles, however intra vires the corporate.
c) Ultra Vires the administrators, however intra vires the corporate – These are acts performed by the company’s administrators that are ultra vires their authority, however intra vires the corporate as an entire.
d) Ultra vires acts cannot be sanctioned. this implies that when somebody commits Associate in Nursing ultra vires act, that act cannot retroactively be created valid. it's for good invalid and on the far side the scope of that actor’s powers, as granted to him by the company’s memo.
Will Ultra Vires Act be Ratified?
An ultra vires act cannot be sanctioned even by the full body of the shareholders and create it binding on the corporate. In alternative words, even the shareholders cannot do Associate in Nursing ultra vires act. this is often the peculiar feature of this philosophical system.
The principles of law on this subject were 1st pronounced by Lord Cairons, L.J., in Ashbury Railway Carriage & Iron Co. Ltd. V. Riche. therein case, an organization was shaped with the subsequent objects:
a) to make, sell, lend or rent, railway carriages and wagons, and
b) to purchase, lease, work and sell mines, minerals and land and buildings.
The directors contractile to finance the development of a railway line in Belgium with Mls Riche. The Court control that the contract was ultra vires the corporate and void, in order that even the following assent of the full body of the shareholders couldn't formalise it.
However, later on, the House of Lords control in alternative cases that the philosophical system of ultra vires ought to be applied fairly and unless it's expressly prohibited, an organization could do Associate in Nursing act, that is very important for, or attendant attainment of its objectives.
Exception to the Doctrine of Ultravires-
There are, however, sure exceptions to the current philosophical system, that are as follows:
a) An act, that is intra vires the corporate however outside the authority of the administrators is also sanctioned by the shareholders in correct form.
b) Act that is intra vires the corporate however drained the act in irregular manner, is also valid by the consent of the shareholders. The law, however, doesn't need that the consent of all the shareholders ought to be obtained at identical place and within the same meeting.
c) If the corporate has nonheritable property through an investment, that is ultra vires, the company’s right over such a property shall still be secured.
d) Whereas applying philosophical system of ultra vires, the consequences that are incidental or important to the act shall not be invalid unless they're expressly prohibited by the Company’s Act.
e) There are sure acts underneath the corporate law, that tho' not expressly declared within the memo, are deemed impliedly inside the authority of the corporate and so they're not deemed ultra vires. for instance, a business company will raise its capital by borrowing.
f) If act of the corporate is ultra vires the articles of association, the corporate will alter its articles so as to validate the act.
The memorandum and articles of association of every company are registered with the Registrar of Companies. The office of the Registrar is a public office and consequently the memorandum and articles become public documents. They are open and accessible to all. It is therefore, the duty of every person dealing with a company to inspect its public documents and make sure that his contract is in conformity with their provisions. But whether a person actually reads them or not, he is to be in the same position as if he had read them. He will be presumed to know the contents of those documents.
Another effect of this rule is that a person dealing with the company is taken not only to have read those documents but to have understood them according to their proper meaning. He is presumed to have understood not merely the company powers but also those of its officers. Further, there is a constructive notice not merely of the memorandum and articles, but also of all the documents, such as special resolutions [S. 117] and particulars of charges [S. 77] which are required by the Act to be registered with the Registrar. But there is no notice of documents which are filed only for the sake of record, such as returns and accounts. According to Palmer, the principle applies only to the documents which affect the powers of the company.
The common law doctrine of constructive notice should apply to the form. To reiterate the form is a public document which contains particulars of directors who are the mind and will of a company, as well as managers and secretaries who are responsible for the day to day running of the company. It is a document which affects the powers of the company and its agents. Certainly, its purpose must be more than just to provide information about the company’s directors, managers and secretary. Therefore, persons dealing with company should check with the Registrar of Companies who its directors, mangers and secretaries are at given time.
Oakbank Oil Co. v. Crum (1882 8 A.C.65)-
-It has been held that anyone dealing with the Company is presumed not only to have read the memorandum and Articles, but understood them properly.
-Thus, Memorandum and Articles of a company are presumed to be notice to the public.
-Such a notice is called Constructive notice.
MOA and AOA become public documents after registration of a Company.
It is taken for granted that everyone who deals with the company knows of these documents.
Legal effect: If a person deals with a company in a manner which is inconsistent with the provisions contained in MOA and AOA own risk and cost and shall have to bear the consequences thereof.
The role of the doctrine of indoor management is opposed to that of the rule of constructive notice. The latter seeks to protect the company against the outsider; the former operates to protect outsiders against the company. The rule of constructive notice is confined to the external position of the company and, therefore, it follows that there is no notice as to how the company’s internal machinery is handled by its officers. If the contract is consistent with the public documents, the person contracting will not be prejudiced by irregularities that may beset the indoor working of the company.
Royal British Bank v. Turquand-
Turquand, a company, had a clause in its constitution that allowed the company to borrow money once it had been approved and passed by resolution (decision) of the shareholders at a general meeting. Turquand entered into a loan with the Royal British Bank and two of the co-directors signed and attached the company seal to the loan agreement. Loan had not been approved by the shareholders.
Company defaulted on their payments and the bank sought restitution. Company refused to repay claiming that the directors had no right to enter into such an arrangement
It was held that “The Turquand was entitled to assume that the resolution was passed. The Company was therefore bound by the rule. Doctrine is also popularly known as the Turquand rule.
Exceptions to the Doctrine of Indoor Management-
1.Knowledge of irregularity-
The first and the most obvious restriction is that the rule has no application where the party affected by an irregularity had actual notice of it. Knowledge of irregularity may arise from the fact that the person contracting was himself a party to the inside procedure.
Howard v Patent Ivory-
The directors could not defend the issue of debentures to themselves because they should have known that the extent to which they were lending money to the company required the assent of the general meeting which they had not obtained.
The principle is clear that a person who is himself a part of the internal machinery cannot take advantage of irregularities.
2. Forgery-
Doctrine of indoor management does not apply to forgery because forgery is voidab- initio.
Ruben v. Great Fingall Consolidated-
The plaintiff was the transferee of a share certificate issued under the seal of the defendant company. The certificate was issued by the company’s secretary, who had affixed the seal of the company and forged the signatures of two directors.
The plaintiff contended that whether the signatures were genuine or forged was a part of internal management and, therefore, the company should be estopped from denying genuineness of document. But it was held that the rule has never been extended to cover such a complete forgery.
Lord Loreburn said: It is quite true that persons dealing with limited liability companies are not bound to inquire into their indoor management and will not be affected by irregularities of which they have no notice. But this doctrine, which is well established, applies to irregularities which otherwise might affect a genuine transaction. It cannot apply to a forgery.
3. Negligence on the part of the outsider-
Anand Bihari Lal vs. Dinshaw and Co.-
In this case the plaintiff accepted transfer of Company’s property from its accountant, the transfer was held void.
Prospectus meaning
The prospectus is a legal document, which outlines the company’s financial securities for sale to the investors.
According to the companies act 2013, there are four types of the prospectus, abridged prospectus, deemed prospectus, red herring prospectus, and shelf prospectus.
The prospectus is a legal document for market participants and investors to pursue, detailing the features, prospects, and promise of a financial product.
It is mandated by the law to be supplied to prospective customers.
Prospectus Example-
In an IPO, the prospectus tells potential shareholders about the company’s plans and business model.
For insurance and investment fund customers, a prospectus lists out the objective of the product, inclusions, and exclusions, fees, etc.
For an ETF, a prospectus informs likely investors of the fund’s goals, history, portfolio, fees and costs, and other financial details.
Importance of Prospectus
The company provides prospectus with capital raising intention. Prospectus helps the investors to make a well-informed decision because of the prospectus all the required information of the securities which are offered to the public for sale.
Whenever the company issues the prospectus, the company must file it with the regulator. The prospectus includes the details of the company’s business, financial statements.
a) To notify the public of the issue.
b) To put the company on record with regards to the terms of the issue and allotment process.
c) To establish accountability on the part of the directors and promoters of the company.
Types of prospectus
According to Companies Act 2013, there are four types of prospectus.
Deemed Prospectus – Deemed prospectus has mentioned under Companies Act, 2013 Section 25 (1). When a company allows or agrees to allot any securities of the company, the document is considered as a deemed prospectus via which the offer is made to investors. Any document which offers the sale of securities to the public is deemed to be a prospectus by implication of law.
Red Herring Prospectus – Red herring prospectus does not contain all information about the prices of securities offered and the number of securities to be issued. According to the act, the firm should issue this prospectus to the registrar at least three before the opening of the offer and subscription list.
Shelf prospectus – Shelf prospectus is stated under section 31 of the Companies Act, 2013. Shelf prospectus is issued when a company or any public financial institution offers one or more securities to the public. A company shall provide a validity period of the prospectus, which should not be more than one year. The validity period starts with the commencement of the first offer. There is no need for a prospectus on further offers. The organization must provide an information memorandum when filing the shelf prospectus.
Abridged Prospectus – Abridged prospectus is a memorandum, containing all salient features of the prospectus as specified by SEBI. This type of prospectus includes all the information in brief, which gives a summary to the investor to make further decisions. A company cannot issue an application form for the purchase of securities unless an abridged prospectus accompanies such a form.
Contents of Prospectus
The prospectus contents are specified in the Companies Act. The prospectus must touch over the following content points:
Key Takeaways:
Every business organisation needs funds for its business activities. It can raise funds either externally or through internal sources. When the companies want to go for the external sources, they use various means for the same. Two of the most popular means to raise money are Initial Public Offer (IPO) and Follow on Public Offer (FPO).
During the IPO or FPO, the company offers its shares to the public either at fixed price or offers a price range, so that the investors can decide on the right price. The method of offering shares by providing a price range is called book building method. This method provides an opportunity to the market to discover price for the securities which are on offer.
Book Building may be defined as a process used by companies raising capital through Public Offerings-both Initial Public Offers (IPOs) and Follow-on Public Offers (FPOs) to aid price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional investors as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process.
Book Building vs. Fixed Price Method:
The main difference between the book building method and the fixed price method is that in the former, the issue price to not decided initially. The investors have to bid for the shares within the price range given. The issue price is fixed on the basis of demand and supply of the shares.
On the other hand, in the fixed price method, the price is decided right at the start. Investors cannot choose the price. They have to buy the shares at the price decided by the company. In the book building method, the demand is known every day during the offer period, but in fixed price method, the demand is known only after the issue closes.
Book Building in India:
The introduction of book-building in India was done in 1995 following the recommendations of an expert committee appointed by SEBI under Y.H. Malegam. The committee recommended and SEBI accepted in November 1995 that the book-building route should be open to issuer companies, subject to certain terms and conditions. In January 2000, SEBI came out with a compendium of guidelines, circulars and instructions to merchant bankers relating to issue of capital, including those on the book-building mechanism.
Book Building Process:
The principal intermediaries involved in a book building process are the companies, Book Running Lead Manager (BRLM) and syndicate members are the intermediaries registered with SEBI and eligible to act as underwriters. Syndicate members are appointed by the BRLM. The book building process is undertaken basically to determine investor appetite for a share at a particular price. It is undertaken before making a public offer and it helps determine the issue price and the number of shares to be issued.
The following are the important points in book building process:
1. The Issuer who is planning an offer nominates lead merchant banker(s) as ‘book runners’.
2. The Issuer specifies the number of securities to be issued and the price band for the bids.
3. The Issuer also appoints syndicate members with whom orders are to be placed by the investors.
4. The syndicate members put the orders into an ‘electronic book’. This process is called ‘bidding’ and is similar to open auction.
5. The book normally remains open for a period of 5 days.
6. Bids have to be entered within the specified price band.
7. Bids can be revised by the bidders before the book closes.
8. On the close of the book building period, the book runners evaluate the bids on the basis of the demand at various price levels.
9. The book runners and the Issuer decide the final price at which the securities shall be issued.
10. Generally, the number of shares is fixed; the issue size gets frozen based on the final price per share.
11. Allocation of securities is made to the successful bidders. The rest bidders get refund orders.
Key Takeaways:
References:
