Company Law

Topics Covered

• Explain the Advantages and Disadvantages of Incorporation of a Company.
• The distinction between Company and Partnership
• When can the Corporate Veil of a Company be Lifted?
• Write a Note on Pre-incorporation Contracts
• Is the company a citizen?
• Explain the Procedure for Registration of a Company.
• Write a Note on Certificate of Incorporation (sec 34 and 35)
• Explain the Clauses of Memorandum of Association OR Explain the Importance of Memorandum of Association.
• Explain the Procedure for Alteration of Memorandum of Association.
• Articles of Association.
• Difference between articles and memorandum.
• Explain the Doctrine of Ultra-vires.
• Explain the Doctrine of Constructive Notice.
• Explain the Doctrine of Indoor Management OR
• Explain the Rule laid down in Royal British Bank v. Turquand.
• Prospectus
• Promoters.
• Directors- Powers, Duties and Position.
• Kinds of Companies.
• Conversion of a Private Company into a Public Company.
• What are the Advantages of a Private Company?
• Dividends.
• Debentures.
• Floating Charge
• What are the Kinds of Share Capital?
• Allotment of Shares.

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Explain the Advantages and Disadvantages of Incorporation of a Company.

Introduction

A company, in common parlance, means a group of persons associated together for the attainment of a common end, social or economic. It has “no strictly technical or legal meaning.”

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, which can be termed as incorporation.

Advantages of incorporation

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 vested with corporate personality, which is independent of, and distinct from its members. A company is a legal person. The decision of the House of Lords in Salomon v. Salomon & Co. Ltd. (1897 AC 22) 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 co was incorporated, it never had an independent existence. It was S himself trading under another name, but the House of Lords held Salomon & Co. Ltd. must be regarded as a separate person from S.

2)      Limited liability– limitation of liability is another major advantage of incorporation. The company, being a separate entity, leading its own business life, the members are not liable for its debts. The liability of members is limited by shares; each member is bound to pay the nominal value of shares held by them and his liability ends there.

3)      Perpetual succession– An incorporated company never dies. Members may come and go, but the company will go on forever. During the war all the members of a private company, while in general meeting, were killed by a bomb. But the company survived, not even a hydrogen bomb could have destroyed it (K/9 Meat Supplies (Guildford) Ltd., Re, 1966 (3) All E.R. 320).

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 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 the great 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 property of an incorporated company is vested in the corporate body. 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 impleaded.

8) Professional management– A company is capable of attracting professional managers. It is due to the fact that being attached to the management of the company gives them the status of business or executive class.

Disadvantages of incorporation

1) Lifting of corporate veil– though for all purposes of law a company is regarded as a separate entity it is sometimes necessary to look at the persons behind the corporate veil.

a) Determination of character– The House of Lords in Daimler Co Ltd. v. Continental Tyre and Rubber Co., held that a company though registered in England would assume an enemy character if the persons in de facto control of the company are residents of an enemy country.

b) For benefit of revenue– The separate existence of a company may be disregarded when the only purpose for which it appears to have been formed is the evasion of taxes. – Sir Dinshaw Maneckjee, Re / Commissioner of Income Tax v. Meenakshi Mills Ltd.

c) Fraud or improper conduct– In Gilford Motor Co v. Horne, a company was restrained from acting when its principal shareholder was bound by a restraint covenant and had incorporated a company only to escape the restraint.

d) Agency or Trust or Government company– The separate existence of a company may be ignored when it is being used as an agent or trustee. In State of UP v. Renusagar Power Co, it was held that a power generating unit created by a company for its exclusive supply was not regarded as a separate entity for the purpose of excise.

e) Under statutory provisions– The Act sometimes imposes personal liability on persons behind the veil in some instances like, where business is carried on beyond six months after the knowledge that the membership of company has gone below statutory minimum(sec 45), when contract is made by misdescribing the name of the company(sec 147), when business is carried on only to defraud creditors(sec 542).

2) Formality and expense- Incorporation is a very expensive affair. It requires a number of formalities to be complied with both as to the formation and administration of affairs.

3) 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.

Distinction between Company and Partnership.

     The principal points of distinction between a company and a partnership are:

1)      Legal status– A company is a distinct legal person. A partnership firm is not distinct from the several members who compose it.

2)      Property– In partnership, the property of the firm is the property of the members comprising it. In a company, it belongs to the company and not to the members comprising it.

3)      Mode of creation– A company comes into existence after registration under the Companies Act, 1956, while registration is not compulsory in case of a partnership firm.

4)      Agents– Partners are the agents of the firm, but members of a firm are not its agents.

5)      Contracts– A partner cannot contract with his firm, whereas a member of a company can.

6)      Transferability of shares– A partner cannot transfer his share and make the transferee a member of the firm without the consent of other partners whereas a company’s share can easily be transferred unless the Articles provide otherwise and the transferee becomes a member of the firm.

7)      Liability– A partner’s share is always unlimited whereas that of a shareholder may be limited either by shares or a guarantee.

8)      Perpetual succession– The death or insolvency of a shareholder or all of them does not affect the life of the company, whereas the death or insolvency of a partner dissolves the firm, unless otherwise provided.

9)      Audit– A company is legally required to have its accounts audited annually by a chartered accountant, whereas the accounts of the partnership are audited at the discretion of its members.

10)  Number of members– The minimum number of partners in a firm is 2 and maximum is 20 in any business and 10 in banking business. In case of a private company the minimum number of members are 2 and maximum is 50. In case of a public company the min num of members are 7 and no max limit.

11)  Dissolution- a company can only be dissolved as laid down by law. A partnership firm can be dissolved at any time by an agreement.

When can Corporate Veil of a Company be Lifted?

     For all purposes of law a company is regarded as a separate entity from its shareholders. But sometimes it is sometimes necessary to look at the persons behind the corporate veil. The separate entity of the company is disregarded and the schemes and intentions of the persons behind are exposed to full view which is known as lifting or piercing the corporate veil. This is usually done in the following cases

1). Determination of character– In Daimler Co Ltd. v. Continental Tyre and Rubber Co., a company was incorporated in England for the purpose of selling tyres manufactured in Germany by a German company. The German company held the bulk of the shares in the English company and all the directors of the company were Germans, resident in Germany. During the First World War the English company commenced an action to recover a trade debt. And the question was whether the company had become an enemy company and should therefore be barred from maintaining the action.

The House of Lords held that though the company was registered in England it is not a natural person with a mind or conscience. It is neither loyal nor disloyal; neither friend nor enemy. But it would assume an enemy character if the persons in de facto control of the company are residents of an enemy country.

2) For benefit of revenue– The separate existence of a company may be disregarded when the only purpose for which it appears to have been formed is the evasion of taxes. In Sir Dinshaw Maneckjee, Re, the assessee was a wealthy man enjoying large dividend and interest income. He formed four private companies and agreed with each to hold a block of investment as an agent for it. Income received was credited in the company accounts but company handed the amount to him as pretended loan. Thus he divided his income in four parts to reduce his tax liability. The Court disregarded corporate entity as it was formed only to evade taxes.

     In Bacha F Guzdar v. CIT, Bombay, the SC rejected the plea of the plaintiff, a member of a tea company, who claimed that the dividend held by her in respect of her shares should be treated as agricultural income(as it was exempted from tax) and not income from manufacture and sale of tea.

3)  Fraud or improper conduct– In Gilford Motor Co v. Horne, H was appointed at the managing director of the plaintiff company on the condition that he shall not solicit the customers of the company. He formed a new company which undertook solicitation of plaintiff’s customers. The company was restrained by the Court.

4) Agency or Trust or Government company– The separate existence of a company may be ignored when it is being used as an agent or trustee. In State of UP v. Renusagar Power Co, it was held that a power generating unit created by a company for its exclusive supply was not regarded as a separate entity for the purpose of excise.

In Re R.G.Films Ltd., an American company produced film in India technically in the name of a British company, 90% of whose share was held by the President of the American company. Board of Trade refused to register the film as the English company acted merely as the agent of the American company.

5)  To avoid welfare legislation– where it was found that the sole purpose of formation of new company was to use it as a device to reduce the amount to be paid by way of bonus to workmen, the SC pierced its corporate veil. –The Workmen Employed in Associated Rubber Industries Ltd. v. The Associated Rubber Industries Ltd, Bhavnagar.

6)  Under statutory provisions– The Act sometimes imposes personal liability on persons behind the veil in some instances like, where business is carried on beyond six months after the knowledge that the membership of company has gone below statutory minimum(sec 45)- Madanlal v. Himatlal, when contract is made by misdescribing the name of the company(sec 147), when business is carried on only to defraud creditors(sec 542).

Write a Note on Pre-incorporation Contracts.

     Sometimes contracts are made on behalf of a company even before it is duly incorporated. These are called as pre-incorporation contracts. Two consenting parties are necessary to a contract, whereas a company before incorporation is a non-entity. Therefore, following are the effects of pre-incorporation contracts.

Company cannot be sued on pre-incorporation contracts– A company, when it comes into existence, cannot be sued on pre-incorporation contracts. In English and Colonial Produce Co, Re, a solicitor on the request of promoters prepared a company’s documents and spent time and money in getting it registered. But the company was not held to be bound to pay for those services and expenses.

Company cannot sue on pre-incorporation contracts– A company cannot by adoption or ratification obtain the benefit of a contract made on its behalf before the company came into existence. In Natal Land and Colonization Co v. Pauline Colliery Syndicate, the promoters of a proposed company obtained an agreement from a landlord that he would grant lease of coal mining rights to the company. The company could not, after incorporation, enforce this contract.

Agents may incur personal liability– The agents who contract for a proposed company may sometimes incur personal liability. In Kelner v. Baxter, the promoters of a projected hotel company purchased wine from the plaintiff on behalf of the company. The company came into being but, before paying the price went into liquidation. They were held personally liable to the plaintiff.

Ratification of a pre-incorporation contract

     So far as the company is concerned it is neither bound by nor can have the benefit of a pre-incorporation contract. But this is subject to the provisions of the Specific Relief Act, 1963.

     Section 15 of the Act provides that where the promoters of a company have made a contract before its incorporation for the purposes of the company, and if the contract is warranted by the terms of incorporation, the company may adopt and enforce it. In Vali Pattabhirama Rao v. Ramanuja Ginning and Rice Factory, a promoter of a company acquired a leasehold interest for it. He held it for sometime for a partnership firm, converted the firm into a company which adopted the lease. The lessor was held bound to the company under the lease.

     Section 19 of the Specific Relief Act provides that the other party can also enforce the contract if the company has adopted it after incorporation and the contract is within the terms of incorporation.

Is company a citizen?

     A company, though a legal person, is not a citizen. This has been the conclusion of a special bench of the Supreme Court in State Trading Corporation of India v. CTO (AIR 1963 SC 1811).

The State Trading Corporation of India is incorporated as a private company under the Companies Act, 1956. All the shares are held by the President of India and two secretaries in their official capacities. The question was whether the corporation was a citizen. One of the contentions put forth on behalf of the corporation was that “if the corporate veil is pierced, one sees three persons who are admittedly the citizens of India”, and, therefore, the corporation should also be regarded as a citizen.

     But it was held that, “neither the provisions of the Constitution, Part II, nor of the Citizenship Act, either confer the right of citizenship on or recognize as citizen, any person other than a natural person. In striking words the Supreme Court observed,

     “If all the members are citizens of India the company does not become a citizen of India any more than, if all are married the company would not be a married person.”

     A company can have the benefit of only such fundamental rights as guaranteed to every “person” whether a citizen or not. However, it has a nationality, domicile and residence.

     The hardship caused by the above pronouncement was later modified by holding that a citizen shareholder may petition, proceeding on behalf of the company, against violation of his company’s fundamental rights.

Explain the Procedure for Registration of a Company.

     Sec 33 of the Companies Act deals with registration of a company. To obtain registration an application has to be filed to the Registrar of Companies. The application must be accompanied by the following documents:

1)      Memorandum of Association.

2)      Articles of Association, if necessary.

3)      A copy of the agreement, if any, which the company proposes to enter into with any individual for his appointment as the managing or the whole-time director or the manager.

4)      A declaration that all the requirements of the Act have been complied with.

     Articles are compulsory only for unlimited companies, companies limited by guarantee and private companies limited by shares(s 26). The declaration must be signed by an advocate of the SC, or of a HC, or an attorney or a pleader entitled to appear before a HC, or any proposed director, manager or secretary of the company or by a secretary or chartered accountant who is in whole time practice in India[s 33(2)].

     Section 12, which states the mode of forming an incorporated company, enables any seven persons (two for private company) to associate for any lawful purpose and to get themselves incorporated into a company with or without limited liability. They can do so by subscribing their names to a memorandum of association and by complying with other documents.

     If the Registrar finds the documents to be satisfactory, he registers them and enters the name of the company in the Register of Companies and issues a certificate called the Certificate of Incorporation. Certificate of Incorporation brings the company into existence as a legal person. It is the conclusive evidence that all the requirements under the Act in respect of registration and matters precedent and incidental thereto have been complied with and that the association is a company authorized to be registered and duly registered under the Act.

Write a Note on Certificate of Incorporation (sec 34 and 35)

     Certificate of Incorporation is the certificate issued by the Registrar of Companies ion registration of a company. It brings the company into existence as a legal person. It marks the birth of the company, and the date mentioned on it is conclusive, even if wrong.

     Certificate of Incorporation is the conclusive evidence that all the requirements under the Act in respect of registration and matters precedent and incidental thereto have been complied with and that the association is a company authorized to be registered and duly registered under the Act(s 35). This is illustrated by the Privy Council in Moosa Goolam Ariff v. Ebrahim Goolam Ariff, in which the memorandum of a company was signed by two adult members and by a guardian on behalf of the other five members, who were minors. The Registrar, however, registered the company. The plaintiff’s contention that the Certificate of Incorporation should be declared void was rejected as the certificate is conclusive for all purposes.

     However, the illegal objects of the company do not become legal by the issue of the certificate. The certificate is subject to judicial review where it happens to be issued to a company which on account of illegal objects should not have been registered. This is so because a company cannot be registered for illegal purposes.

Explain the Clauses of Memorandum of Association OR

Explain the Importance of Memorandum of Association.

Introduction

     One of the essentials for the registration of a company is memorandum of association (sec 33). It is the first step in the formation of a company. Its importance lies in the fact that it contains the fundamental clauses which have often been described as the conditions of the company’s incorporation.

     Memorandum of association is divided into 5 clauses:

1)      Name clause

2)      Registered office clause

3)      Objects clause

4)      Liability clause and

5)      Capital clause

Name clause

     The first clause states the name of the proposed company. The name of a corporation is the symbol of its personal existence. The name should not be, in the opinion of the Central Government, undesirable. Generally it is so when it is identical with or too nearly resembles the name of another company. If the company is with “limited liability” the last word of the name should be “limited” and in case of a private company “private limited”. The Central Govt. may permit a company to drop the word limited from its name, if

a)      If the company is formed for the promotion of arts, commerce, religion, science, charity or any other useful object.

b)      The company is to apply its income in promoting its objects and prohibits the payment of dividend to its members.

     The name of a company must be painted outside of every place where the company carries on business and printed on every business document and official letter of the company. Misdescription entails personal liability(s 147).

Registered office clause

     The second clause of the memorandum must specify the State in which the registered office of the company shall be situate (sec 146). Within 30 days of incorporation or commencement of business, whichever is earlier, the exact place where the registered office is to be located must be decided and sent to the Registrar for recording of the same.

Objects clause

     The third clause states the objects of the proposed company. The objects clause s divided into two sub-clauses (sec 13):

a)      Main objects clause: states the main objects to be pursued by the company and the objects incidental or ancillary to the main objects.

b)      Other objects: states any other objects which are not included in the main objects clause.

     The essence of this clause is that the investors must be informed of the objects of the company in which their money is going to be employed and the creditors must feel protected when they know the assets are being used for the authorized objects.

Liability clause

     The fourth clause states the nature of liability the members incur. The clause will state whether the liability of the members shall be limited by shares or by guarantee or unlimited.

Capital clause

     The last clause states the amount of capital with which the company is proposed to be registered and the kinds, number and value of shares into which the capital is to be divided.

     After the Companies (Amendment) Act, 2000, the minimum paid up capital of a public company must be five lakh rupees or more and one lakh or more for a private company.

Explain the Procedure for Alteration of Memorandum of Association.

Alteration of name (sec 21)

     A company may change its name at any time by passing a special resolution and with the prior approval of the Central Government. Where a company has been registered with a name which is undesirable, the same may be changed by an ordinary resolution and with the prior approval of the Central Government. In such a case the central government may also within 12 months of registration direct the company to rectify its name and the company must change the name within 3 months from the date of direction unless the time is extended. The new name would also require the prior approval of the Central Govt. The British Diabetic Society was compelled to change its name to something that would not impinge the goodwill of the British Diabetic Association (British Diabetic Association v. The Diabetic Society).

     When a company changes its name, the Registrar of Companies has to enter the new name in the register and a new certificate of incorporation must be issued with necessary alterations.

     However, it should be noted that no approval will be required if the change consists merely addition or deletion of the word “private” consequent on the conversion of a public company into a private company or vice versa.

     Effect of such change: The old name of the company will stand abolished and the new name will come into existence from the date of passing such resolution. However, it does not affect the rights and obligations of the company (sec 23).

Alteration of registered office clause (sec 17)

     Shifting of registered office from one State to another is a complicated affair. For this purpose, sec 17 requires

a)      A special resolution of the company.

b)      The sanction of the Company Law Board.

     The Board can confirm the alteration only if the shifting of the registered office from one state to another is necessary for any purposes detailed in sec 17(1).

Alteration of objects (sec 17)

     A company may alter its objects with the passing of a special resolution. The confirmation of the Company Law Board is not required for this purpose. An alteration of the objects is allowed only for the purposes mentioned in sec 17(1).

Registration of alteration (sec 18)

     In case of alteration of objects, a copy of the resolution should be filed with the Registrar of Companies within one month from the date of resolution. In the case of inter-state shifting of the registered office a certified copy of the Board’s order and a printed copy of the altered memorandum must be filed with the Registrar within three months of the Board’s order. Within one month the Registrar will certify the registration. Alteration takes effect when it is so registered.

Articles of Association.

Introduction

    Articles of Association is the second important document, which in case of some companies, has to be registered along with the memorandum. As per sec 26, companies which must have articles are:

1)      Unlimited companies;

2)      Companies limited by guarantee;

3)      Private companies limited by shares.

     This document contains rules, regulations and bye-laws for the general administration of the company. Schedule I of the Act sets out tables of model forms of articles for different companies.

Contents

     A of A may prescribe such regulations for the company as the subscribers to the memorandum deem expedient. The Act gives the subscribers a free hand. Any stipulations as to the relation between the company and its members or members inter se may be inserted in the articles. But everything stated therein is subject to the Companies Act. Usually, articles contain provisions relating to the following matters:

1)      Share capital, rights of shareholders, share certificates, payment of commission.

2)      Lien on shares.

3)      Call on shares.

4)      Transfer of shares.

5)      Transmission of shares.

6)      Forfeiture of shares.

7)      Conversion of shares into stock.

8)      Share warrants.

9)      Alteration of capital.

10)  General meetings and proceedings there at.

11)  Voting rights of members, voting and poll, proxies.

12)  Directors, their appointment, remuneration, qualifications, powers and proceedings of Board of Directors.

13)  Manager.

14)  Secretary.

15)  Dividends and reserves.

16)  Accounts, audit and borrowing power.

17)  Capitalization of profits.

18)  Winding up.

Importance of Articles of Association

     Under sec 36, the memorandum and the articles when registered, shall bind the company and its members to the same extent as if it had been signed by them and had contained a covenant on their part that the memorandum and the articles shall be observed.

     With respect to the above section, the importance of articles of association can be summed up as follows:

1)      Binding on members in their relation to the company– the members are bound to the company by the provisions of the articles just as much as if they had all put their seals to them.

2)      Binding on company in relation to its members– just as members are bound to the company, the company is bound to the members to observe and follow the articles.

3)      Neither company, nor members bound to outsiders– articles bind the members to the company and company too the members but neither of them is bound to an outsider to give effect to the articles.

4)      Binding between members inter se– the articles define rights and liabilities of the members. As between members inter se the articles constitute a contract between them and are also binding on each member as against the other or others. Such contract can be enforced only through the medium of the company.

Difference between articles and memorandum.

1)      The memorandum contains the fundamental condition upon which alone the company is allowed to be incorporated. The articles are for the internal regulation and management of the company.

2)      Memorandum defines the scope of the activities of the company, or the area beyond which the actions of the company cannot go. Articles are the rules for carrying out the objects of the company as set out in the memorandum.

3)      Memorandum being the character of the company, is the supreme document. Art are subordinate to the memorandum. If any conflict between them, the memorandum prevails.

4)      Every company must have its own memorandum. A company limited by shares need not have articles of its own. In such a case, Table A applies.

5)      An action of the company outside the scope of its memorandum is void and incapable of ratification. An act of the company outside the scope of its articles can be confirmed by the shareholders.

6)      There are strict restrictions on its alteration. The change of name requires the prior permission of central government and change of registered office to another state requires the prior approval of the Company Law Board. Articles can be altered by a special resolution, to any extent, provided they do not conflict with the memorandum and the Companies Act.

Alteration of articles (sec 31)

     Section 31 empowers every company to alter its articles at any time with the authority of a special resolution of the company and filing copy with the Registrar. Since it is a statutory power a company will not be deprived of the power of alteration by a contract wit anyone.

     The power of alteration of articles conferred by sec 31 is almost absolute. It is subject only to two restrictions-

It must not be in contravention with the provisions of the Act.

It is subject to the conditions contained in the memorandum of association.

     The proviso to sub-section (1) says that an alteration which has the effect of converting a public company into a private company would not have any effect unless it is approved by the Central Government.

Alteration against memorandum– in Hutton v. Scarborough Cliff Hotel Co, a resolution was passed in a general meeting of a company altered the articles by inserting the power to issue preference shares which did not exist in the memorandum. It was held inoperative. However, after Andrews v. Gas Meter Co Ltd this view has been changed where a company was allowed by changing articles to issue preference shares when its memorandum was silent on the point. The power of alteration of art is subject only to what is clearly prohibited by the memorandum, expressly or impliedly.

Alteration in breach of contract– a company may change its articles even if the alteration would operate as a breach of contract. If the contract is wholly dependant on the articles, the company would not be liable in damages if it commits breach by changing articles. But if the contract is independent of the articles, the co will be liable in damages if it commits breach by changing articles. Thus in Southern Foundries Ltd v. Shirlaw, where a Managing Director was appointed for a term of ten years, but was removed earlier under the new articles on amalgamation with another company, the company was held liable for breach of contract.

Alteration as fraud on minority shareholders– an alteration must not constitute a fraud on the minority. It should not be an attempt to deprive the company or its minority shareholders of something that in equity belongs to them.

Alteration increasing liability of members­– no alteration can require a person to purchase more shares in the company or to increase his liability in any manner except with his consent in writing.

     Thus, the power of alteration should be exercised in absolute good faith in the interest of the company.

Explain the Doctrine of Ultra-vires.

Introduction

     The object clause of the Memorandum of the company contains the object for which the company is formed. An act of the company must not be beyond the objects clause, otherwise it will be ultra vires and, therefore, void and cannot be ratified even if all the members wish to ratify it. This is called the doctrine of ultra vires.

     The word ‘ultra’ means beyond and ‘vires’ means powers. Thus the expression ultra vires means an act beyond the powers. Here the expression ultra vires is used to indicate an act of the company which is beyond the powers conferred on the company by the objects clause of its memorandum.

     The application of the doctrine of ultra-vires was first demonstrated by the House of Lords in Ashbury Railway Carriage & Railway Co. v. Riche, where the mem of a co defined its objects: 1) to manufacture and sell railway carriages etc; 2) to carry on the business of mechanical engineers and general contractors. The company contracted with Richie to finance the construction of a railway line in Belgium and subsequently repudiated it as one beyond its powers. Richie brought an action for breach of contract. The House of Lords held that the contract was ultra vires and void. They were of the opinion that general terms like general contractors must be taken in reference to the main objects of the company which otherwise would authorize every kind of activity making the memorandum meaningless.

     In the next leading case of Attorney General v. Great Eastern Railway Co, this doctrine was made clearer. The House of Lords held that the doctrine of UV as explained in Ashbury case should be maintained but reasonably understood and applied. Thus, an act which is incidental to the objects authorized ought not to be held as UV, unless it is expressly prohibited. Thus in Evans v. Brunner, Mond & Co, a chemicals manufacturing company was allowed to donate 1,00,000 pounds to universities and scientific institutions for research as this would be conducive for the progress of the company.

     In India the Supreme Court has affirmed the doctrine in A Lakshmanaswami Mudaliar v. LIC, where the donation made as charity was held ultra vires and the directors were held personally liable to compensate the money.

     Thus an act of the company is ultra vires if it is not

a)      Essential for the fulfillment of the objects stated in the memorandum;

b)      Incidental or consequential to that attainment of its objects

c)      Which the company is authorized to do by the Company’s Act, in course of its business.

Present position

     In England the doctrine of ultra vires has been restricted by the European Communities Act, 1972. Thus, as against a third person acting in good faith, the company can no longer plead that the contract was ultra-vires.

     In India, the principles laid down in Ashbury case are still applied without restrictions and modifications. Thus, in India the ultra vires act is still regarded, as void and it cannot be validated by ratification.

Consequences

1)      Injunction– whenever an ultra vires act has been or is about to be done, any member of the company can get an injunction to restrain the co from proceeding further.

2)      Personal liability of the directors- it is the duty of the directors to see that the funds of the company are used only for legitimate business of the company. If the funds of the company are used for a purpose foreign to its memorandum, the directors will be personally liable to restore it.

3)      Breach of warranty of authority– an agent who acts beyond the scope of his authority will be held personally liable. The directors of a company are its agents. If they induce an outsider to contract in a matter the company does not have power to act, they will be personally liable to him.

4)      Ultra vires acquired property– if a company’s money has been spent ultra vires in purchasing some property, the company’s right over that property must be held secure. For that asset, though wrongfully acquired, represents corporate capital.

5)      Ultra vires contracts– an ultra vires contract being void ab initio, cannot become intra vires by reason of estoppel, lapse of time, ratification, acquiescence or delay. No performance of either side can give an unlawful contract any validity or right of action upon it.

6)      Ultra vires torts– a company can be made liable for an ultra vires tort committed, provided, it is shown that

a)      The activity in the course of which it has been committed falls within the scope of the mem.

b)      That the servant committed the tort.

Conclusion

     It can be concluded that an UV act is void and cannot be ratified. It prevents the wrongful application of the company’s assets likely to result in the insolvency of the company and thereby protects creditors. It also prevents directors from departing the object for which the company has been formed and, thus, puts a check over the activities of the directions. However, it has sometimes led to injustice of third parties acting in good faith.

Explain the Doctrine of Constructive Notice.

Introduction

     Every person who enters into any contract with a company will be presumed to know the contents of the memo of ass and the articles of ass. This is known as the doctrine of constructive notice.

     The memorandum and the articles of association of every company are registered with the Registrar of Companies. The office of the Registrar is a public office. Hence, the memo and the articles of ass become public documents. It is therefore the duty of person dealing with a company to inspect its public documents and make sure that his contract is in conformity with their provisions.

     As observed by Lord Hatherley, “…whether a person actually reads them or not, he is to be in the same position as if he had read them”. Every person will be presumed to know the contents of the documents.

     The practical effects of this rule can be observed in Kotla Venkataswamy v. Ramamurthy– The articles of a company provided that its deeds etc should be signed by the managing director, the secretary and a working director on behalf of the co. the plaintiff accepted a deed of mortgage executed by the secretary and a working director only. The plaintiff could not claim his deed. It was held that, “notwithstanding, therefore, she may have acted in good faith and the money may have been applied for the purposes of the company, the bond is nevertheless invalid.”

     Another effect of this rule is that a person dealing with the company is taken not only to have read the documents but also to have understood them according to their proper meaning. Further, there is a constructive notice not merely of the memo and art, but also of all the documents, such as special resolutions and particulars of charges 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 account.

Statutory reform of constructive notice

The ‘doctrine of constructive notice’ is more or less an unreal doctrine. It does not take notice of the realities of business life. People know a company through its officers and not through its documents. Section 9 of the European Communities Act, 1972 has abrogated this doctrine. These provisions are now incorporated in sec 35 of the (English) Companies Act, 1985.

Position in India

     The courts in India do not seem to have taken the doctrine seriously.  For example, the Calcutta High Court in Charnock Collieries Co Ltd. v. Bholanath, enforced a security which was not signed in accordance with the company’s articles.

     Also, in Dehra Dun Mussorie Electric Tramway Co. v. Jagmandardas, the Allahabad High Court allowed an overdraft incurred by the managing agent of a company when under the articles the directors had no power to delegate their borrowing power. 

Conclusion

     Thus, the doctrine of constructive notice seeks too protect the company against the outsider by deeming that such an outsider had the notice of the public documents of the company. However, in India the courts with a view to protect the innocent third parties acting in good faith have not relied upon the doctrine seriously.

Explain the Doctrine of Indoor Management OR

Explain the Rule laid down in Royal British Bank v. Turquand.

Introduction

The doctrine of indoor management is an exception to the rule of constructive notice. It imposes an important limitation on the doctrine of constructive notice. According to this doctrine, a person dealing with a company is bound to read only the public documents. He will not be affected by any irregularity in the internal management of the company.

     The rule of indoor management had its genesis in Royal British Bank v. Turquand– The directors of the company borrowed a sum of money from the plaintiff. The company’s articles provided that the directors might borrow on bonds such sums as may from time to time be authorized by a resolution passed at a general meeting of a company. The shareholders claimed that there was no such resolution authorizing the loan and, therefore, it was taken without their authority.

     The company was however held bound for the loan. Once it was found that the directors could borrow subject to a resolution, the plaintiff had the right to assume that the necessary resolution must have been passed.

     The rule is based on public convenience and justice and the following obvious reasons:
     1. The internal procedure is not a matter of public knowledge. An outsider is presumed to know the constitution of a company, but not what may or may not have taken place within the doors that are closed to him.
     2. The lot of creditors of a limited company is not a particularly happy one; it would be unhappier still if the company could escape liability by denying the authority of officials to act on its behalf. 

     The rule/doctrine is applied to protect persons contracting with companies from all kinds of internal irregularities. It has been applied to cover the acts of de facto directors, who have not been appointed but have only assumed office at the acquiescence of the shareholders or whose appointment is defective, or have exercised authority which could have been delegated to them under the Act but actually not delegated, or who have acted without quorum.

Exceptions to the rule

1)      Knowledge of irregularity A person who has actual knowledge of the internal irregularity cannot claim the protection of this rule, because he could have taken steps for self-protection. A person who himself is a party to the inside procedure, such as a director is deemed to know the irregularities, if any.

     T.R Pratt (Bombay) Ltd. V. E.D. Sassoon & Co. Ltd. – Company A lent money to Company B on a mortgage of its assets. The procedure laid down in the articles for such transactions was not complied with. The directors of the two companies were the same. Held, the lender had notice of the irregularity and hence the mortgage was not binding.

2)      Negligence and suspicion of irregularity: where a person dealing with a company could discover the irregularity if he had made proper inquiries, he cannot claim the benefit of the rule of indoor management. The protection of the rule is also not available where the circumstances surrounding the contract are so suspicious
as to invite inquiry, and the outsider dealing with the company does not make proper inquiry.

3)      Forgery: The rule in Turquand’s case does not apply where a person relies upon a document that turns out to be forged since nothing can validate forgery. In Ruben v. Great Fingall Ltd, a co was not held bound by a certificate issued by tit secretary by forging the signature of two directions. However, in Official Liquidator v. Commr of Police, the Madras High Court held the company liable where the Managing Director had forged the signature of two other directors.

4)      Representation through articles: A person who does not have actual knowledge of the company’s articles cannot claim as against the company that he was entitled to assume that a power which could have been delegated to the directors was in fact so delegated. In Rama Corporation v. Proved Tin and General Investment Co, the plaintiffs contracted with the defendant co and gave a cheque under the contract. The director could have been authorized but in fact, was not. The plaintiffs had not read the articles. The director misappropriated the cheques and plaintiff sued. Held, director not liable as it was outside his authority.

Prospectus

Definition

  Section 2(36)-“ any document described or issued as a prospectus and includes any notice, circular, advertisement, or other document inviting deposits from the public or inviting offers from the public for the subscription or purchase of any share in, or debentures of, a corporate body.”

     In simple words, any document inviting deposits from the public or inviting offers from the public for the subscription of shares or debentures of a company is a prospectus.

Contents

     “The Companies Act contains a comprehensive set of regulations intended to protect the investing public from victimization”. The intention of the Legislature in making these regulations, is “to secure the fullest disclosure of material and essential particulars and lay the same in full view of all the intending purchasers of shares”

     The relevant rules and regulations are-

1. Every prospects must be dated(section 55)
2. A copy of the prospectus must be registered with the Registrar and this fact must be stated on the face of the prospectus. The Registrar can refuse to register a prospectus which does not comply with the disclosure requirements.(section 60). The prospectus must be issued within 90 days of its registration.
3. If the prospectus includes a statement purporting to be made by an expert, consent in writing of that expert must be obtained and this fact must be stated in the prospectus. (Section 58). The expert should be unconnected with the formation or management of the company. (Section 57). Section 59 provides that the expression “expert” includes an engineer, a valuer, an accountant and any other person whose profession gives authority to a statement made by him. Thus the expert becomes a party to the prospectus and liable for untrue statements, if any.
4. Section 56 requires every prospectus to disclose the matters specified in Schedule II of the Act. The information required to be disclosed refers to the objects of the company, details as to shares, managerial personnel, minimum subscription, underwriting, preliminary expenses, material contracts, etc.
5. Lastly, the “golden rule” –the public is at the mercy of the company promoters. Everything must, therefore, be stated with strict and scrupulous accuracy”

Prospectus- Remedies for Misrepresentation

1. Rescission for misrepresentation-the shareholder can also sue the company for rescission of the contract. Under this remedy the contract is cancelled and the money given by the shareholder refunded. Under Section 75 of the Contract Act, a person who lawfully rescinds a contract is entitled to compensation for any damage which he has sustained through non-fulfillment of the contract.

             Loss of right of rescission

(a)    By affirmation-if the allottee with full knowledge of the misrepresentation upholds the contract, he cannot afterwards rescind.

(b)   By unreasonable delay– any man who claims to retire from a company on the ground that he was induced to become a member by misrepresentation, is bound to come at the earliest possible moment after he becomes aware of the misrepresentation.” An action after 5 months was held to be too late.

(c)    By commencement of winding up-the right of rescission is lost on the commencement of the winding up of the company. “But where a shareholder has started active proceedings to be relieved of his shares, the passing of the winding up order during their pendency would not prevent his getting the relief.”

2. Damages for deceit-any person induced by a fraudulent statement in a prospectus to take shares, is entitled to sue the company for damages. He must prove the same matters in claiming damages for deceit as in claiming rescission of the contract. He cannot both retain the shares and get damages against the company. He must show that he has repudiated the shares and has not acted as a shareholder after discovering the fraud or misrepresentation.
3. Compensation-Section 62-every director, promoter and every person authorizes the issue of the prospectus is liable to pay compensation to the aggrieved party for loss or damage he may have incurred by reason of any untrue statement in the prospectus.

The persons who are liable to pay compensation are

(a)    directors at the time of issue of prospectus

(b)   persons who have authorized themselves to be named as directors in the prospectus

(c)    promoters

(d)   persons who have authorized the issue of prospectus.

Defences

(a)    Withdrawal of consent-a director, etc is not liable if he withdrew his consent before the issue of the prospectus and it was issued without his consent or authority

(b)   Absence of consent-where a prospectus was issued without the a directors’, etc knowledge or consent, and on becoming aware of its issue, he forthwith gave reasonable public notice of that fact, he is not liable.

(c)    Ignorance of untrue statement-a director, etc may sometimes be ignorant of the untrue statement contained in the prospectus. If after te issue of the prospectus and before allotment there under, he on becoming aware of any untrue statement therein withdrew his consent to the prospectus and gave reasonable public notice of the withdrawal and of the reasons therefore, he is not liable.

(d)   Reasonable ground for belief-if a director, etc has reasonable ground to believe that the statement was true and he, in fact, believed it to be true up to the time of allotment, he is not liable.

(e)    Statement of expert-if the statement is a correct and fair representation or extract or copy of the statement made by an expert who is competent to make it and had given his consent and not withdrawn it, the director, etc is not liable.

Promoters.

     A promoter is a person who does the necessary preliminary work incidental to the formation of a company. It is a compendious term used for a person who undertakes, does and goes through all the necessary and incidental preliminaries, keeping in view the object, to bring into existence an incorporated company.

Chronologically, the first persons who control a company’s affairs are its promoters.

Functions

1. The promoter of a company decides its name and ascertains that it will be accepted by the Registrar of Companies.
2. He settles the details of the company’s Memorandum and Articles, the nominations of directors, solicitors, bankers, auditors and secretary and the registered office of the company.
3. He arranges for the printing of the Memorandum and Articles, the registration of the company, the issue of prospectus, where a public issue is necessary

He is responsible for bringing the company into existence for the object which he has in view.

Quasi-trustee-a promoter is neither an agent nor a trustee of the company under incorporation but certain fiduciary duties have been imposed on him under the Companies Act, 1956.He is not an agent because there is no principal born at the time and he is not a trustee because there is no cesti que trust in existence. Hence he occupies the peculiar position of a quasi-trustee.

Fiduciary position

1. Not to make any profit at the expense of the company-the promoter must not make, either directly or indirectly, any profit at the expense of the company which is being promoted. If any secret profit is made in violation of this rule, the company may, on discovering it, compel him to account for and surrender such profit.
2. To give benefit of negotiations to the company–the promoter must, when once he has begun to act in the promotion of a company, give to the company the benefit of any negotiations or contracts into which he enters in respect of the company. Thus where he purchases some property for the company, he cannot rightfully sell that property to the company at a price higher than he have for it. If he does so, the company may, on discovering it, rescind the contract and recover the purchase money.
3. To make a full disclosure of interest or profit–if the promoter fails to make a full disclosure of all the relevant facts, including any profit and his personal interest I a transaction with the company, the company may sue him for damages for breach of his fiduciary duty and recover from him any secret profit made even though rescission is not asked or is impossible.
4. Not to make unfair use of position-the promoter must not make an unfair or t take care to avoid any unreasonable use of his position and must take care to avoid anything which has the appearance of undue influence or fraud

Further, a promoter cannot relive himself of his liability by making provisions to that effect in the Articles of the company.

5. Duty of promoter as regards prospectus-the promoter must see, in connection with the prospectus, if any is issued, that the prospectus –

(a)    contains the necessary particulars

(b)   does not contain any untrue or misleading statements or does not omit any material fact.

Remuneration

     A promoter has no right to get compensation from the company for his services in promoting the company unless there is a contact to that effect. In practice, a promoter takes remuneration for his services in one of the following ways-

1. he my sell his own property at a profit to the company for cash or fully- paid shares provided he makes a disclosure to this effect
2. He may be given an option to buy a certain number of shares in the company at par.
3. He may take a commission on the shares sold
4. He may be paid a lump sum by the company.

Directors- Powers, Duties and Position.

     A company in the eyes of the law is an artificial person. It has no physical existence. It has neither soul nor a body of its own. As such, it cannot act in its own person.

     The directors are the brain of a company. They occupy a pivotal position in the structure of the company. They are in fact the mainspring of the company.

Definition

     ‘Director’ includes any person occupying the position of director, by whatever name called. The important factor to determine whether a person is or not a director is to refer to the nature of the office and its duties. Thus a director may be defined as a person having control over the direction, conduct, management or superintendence of the affairs of the company.

Only individuals can be directors-no body corporate, association or firm can be appointed director of a company. Only an individual can be so appointed.

Position of directors

1. Directors as agents–a company, as an artificial person, acts through directors who are elected representatives of the shareholders. They are, in the eyes of the law, agents of the company for which they act-Ferguson v Wilson. The general principles of the law of principal and agent regulate in most respects the relationship between the company and its directors.
2. Directors as servants–they are not servants of the company. A director may, however, become a servant in a different capacity.  For example, the creator and controller of an air farming company was also working as its pilot. He died in an accident. His widow was allowed workman’s compensation –Lee v Lee’s Farming Ltd.
3. Directors as officers– a director is an officer of the company. As such they are liable to certain penalties if the provisions of the Companies Act are not strictly complied with.
4. Director as trustees–

(a)    Directors as trustees of the company’s money and property in the sense that they must account for all the company’s money and property over which they exercise control.

Directors are, however, not trustees in the real sense of the world because they are not vested with the ownership of the company’s property. It is only as regards some of their obligations to the company and certain powers that they are regarded as trustees of the company.

(b)   Directors as trustees of the power entrusted to them in the sense that they must            exercise their powers honestly and in the interest of the company and the shareholders and not in their own interest.

Trustees of the company-directors are trustees for the company and not for the third party who have made contracts with the company or for the individual shareholders.

Quasi-trustees-directors are only quasi-trustees because-

(i)                 they are not vested with ownership of the company’s property

(ii)               their functions are not the same as those of trustees

(iii)             their duties of care are not as onerous as those of trustees.

Powers of directors

General Powers of the Board (Section 291)

The powers of the Board of directors are co-extensive with those of the company. This proposition is, however, subject to two conditions:

First, the Board shall not do any act which is to be done by the company in general meeting

Second, the Board shall exercise its powers subject to the provisions contained in the Companies Act, or in the Memorandum or the Articles of the company or in any regulations made by the company in general meeting.

Powers to be exercised at Board meetings (Section 292)

The Board of directors of a company shall exercise the following powers on behalf of the company by means of resolutions passed at the meetings of the Board, viz, the power to-

(a)    make calls on shareholders in respect of money unpaid on their shares

(b)   issue debentures

(c)    borrow money otherwise than on debentures

(d)   invest the funds of the company

(e)    make loans

Powers to be exercised with the approval of company in general meeting

(a)    sale or lease of the company’s undertaking

(b)   extension of the time for payment of a debt due by a director

(c)    investment of compensation received on acquisition of the company’s assets in securities other than trust securities

(d)   borrowing of money beyond the paid-up capital of the company

(e)    contributions to any charitable fund beyond Rs.50,000 in one financial year or 5% of the average et profits during the preceding three financial years, whichever is greater.

Duties of the Directors

1. Fiduciary duties-as fiduciaries, the directors must-

(a)    exercise their powers honestly and bona fide for the benefit of the company as a whole; and

(b)   not place themselves in a position in which there is a conflict between their duties to the company and their personal interests. They must not make any secret profit out of their position. If they do, they have to account for it to the company.

2. Duties of care, skill and diligence– directors should carry out their duties with reasonable care and exercise such degree of skill and diligence as is reasonably expected of persons of their knowledge and status. He is not bound to bring any special qualifications to his office.

Standard of care-the standard of care, skill and diligence depends upon the nature of the company’s business and circumstances of the case. They are various standards of the care depending upon:

(a)    the type and nature of work

(b)   division of powers between directors and other officers

(c)    general usages and customs in that type of business; and

(d)   whether directors work gratuitously or remuneratively

3. Duty to disclose interest–where a director is personally interested in a transaction of the company, he is required to disclose his interest to the board. An interested director is neither to vote on the matter of his interest nor his presence shall count for the purposes of quorum.
4. Duty to attend board meetings–the Act only says that the office of a director is automatically vacated if he fails to attend three consecutive meetings of the board or all meetings for a period of 3 months, whichever is longer. Moreover, a director’s habitual absence may become evidence of negligence.
5. Duty not to delegate– a director should not delegate his functions to another person. But delegation of functions may be made to the extent to which it is authorized by the Act or the constitution of the company.

Quorum (Section 174).(S)

     ‘Quorum’ means the minimum number of members who must be present in order to constitute a valid meeting and transact busies thereat. The quorum is generally fixed by the Articles. If the Articles of a company do not provide for a large quorum, the following rules apply:

1.) Quorum for public company-5 members personally present

      Quorum for other companies-2

For the purpose of quorum a person may be counted as 2 or more members if he holds shares in different capacities.

2. if within half an hour a quorum is not present, the meeting, if called upon the requisition of members, shall stand dissolved. In any other case, it shall stand adjourned to the same day, place and time in the next week. The Board of Directors may adjourn the meeting to be convened on any particular day, time and place to b fixed on the date of the meeting itself or at least before the commencement of the same in the next week. Where the Board of directors fails to do so, the meeting stands statutorily adjourned to the same day in the next week.

     The Articles may provide for a large quorum-The Articles cannot provide for a quorum smaller than the statutory minimum. For the purpose of quorum, only members present in person and not proxies are to be counted.

     When quorum should be present-Article 49(1) of Table A requires the quorum to be present at the time when the meeting proceeds to transact business. It need not be present throughout or at the time of taking vote on any resolution.

Kinds of Companies.

Classification on the basis of liability

1. Companies with limited liability

(a)    Companies limited by shares– where the liability of the members of a company is limited to the amount unpaid on the shares, such a company is known as a company limited by shares

(b)   Companies limited by guarantee– where the liability of the members of a company is limited to a fixed amount which the members undertake to contribute to the assets of the company in the event of its being wound up, the company is called a company limited b guarantee.

2. Unlimited companies– A company without limited liability is known as an unlimited company. In case of such a company, every member is liable for the debts of the company.

Classification on the basis of number of members

1. Private company-a private company is normally what the Americans call a ‘close corporation’. According to Section3(1), a private company means a company which has a minimum paid-up capital of Rs. 1,00,000 or such higher paid-up capital as may be prescribed, and by its Articles-

(i)                 restricts the right to transfer its shares, if any. The restriction is meant to preserve the private character of the company

(ii)               limits the number of its members to 50 not including its employee-members

(iii)             prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company

(iv)             prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives.

Ever private company, existing on the commencement of the Companies(Amendment)Act, 2000, with a paid-up capital of less than Rs. 1,00,000 shall, within a period of 2 years from such date of commencement, enhance its paid up capital to Rs. 1,00,000.

2. Public company– A public company means a company which –

(i)                 has a minimum paid-up capital of Rs. 5 lakh or such higher paid-up capital, as may be prescribed

(ii)               is a private company which is a subsidiary of a company which is not a private company.

Ever public company, existing on the commencement of the Companies(Amendment)Act, 2000, with a paid-up capital of less than Rs. 5,00,000 shall, within a period of 2 years from such date of commencement, enhance its paid up capital to Rs. 5,00,000.

Classification on the basis of control

1. Holding company-Section 4(4)– a company is known as the holding company of another company if is has control over that other company
2. Subsidiary company-Section 4(1)—a company is known as a subsidiary of another company when control is exercised by the latter(called holding company) over the former called a subsidiary company.

A company is deemed to be a subsidiary of another company when-

(i) where the company controls the composition of Board of Directors of the subsidiary company

(ii) where the company holds more than half the nominal value of equity share capital of another company

(iii) where a company is subsidiary of another company, which is itself is subsidiary of the controlling company.

Classification on the basis of ownership

1. Government company-a Government company means any company in which not less than 51 % of the paid-up share capital is held by-

(i)                 the Central government

(ii)               any State government or governments

(iii)             partly by the Central government and partly by one or more State governments.

2. Non-government company

Foreign company– it means any company incorporated outside India which has an established place of business in India. (Section 591(1)

Government Company.

A Government company means any company in which not less than 51% of the paid-up share capital is held by-

(a) the Central Government, or

(b) any State Government or Governments, or

(c) partly by the Central Government and partly by one or more State Governments.

Example– State Trading Corporation of India

Rules applicable by Government companies

1. Appointment of auditor and audit reports-Section 619-the auditor of a Government company shall be appointed or re-appointed by the Comptroller and Auditor-General of India. The Comptroller and Auditor-General shall have power to direct the manner in which the company’s accounts shall be audited by the auditor. A copy of the audit reports are to be submitted to the Comptroller and Auditor-General who shall have the right to comment upon it or supplement it.

2. Annual report to be placed before Parliament-Section 619-A-where the Central Government is a member of a Government company, it shall cause an annual report on the working and affairs of the company to be prepared within 3 months of its annual meeting before which the audit report is placed. The report shall be laid before both Houses of Parliament together with a copy of the audit report.

3. Provisions of Section 619 to apply to certain companies-the provisions of Section 619 shall apply to a company in which not less than 51% of the paid-up capital is held jointly by Government, Government companies and public financial corporations.

4. Certain provisions of the Companies Act do not apply-Section 620-the Central Government may, by notification in the Official Gazette, direct that any of the provisions of the Companies Act(other than Sections 618, 619), specified in the notification –

(a) shall not apply to any Government company,

(b) shall apply to any Government company, with such exceptions, modifications and adaptations, as may be specified in the notification.

Conversion of a Private Company into a Public Company.

A private company may become a public company by-

1. Conversion by default-Section 43–where a default is made by a private company in complying with the essential requirements of a private company, the company ceases to enjoy the privileges and exceptions conferred on a private company. In such a case, the provisions of the Companies Act apply to it as if it were not a private company. Company Law Board may relieve the company from the consequences as aforesaid, if it is of opinion that the non-compliance was accidental or due to inadvertence or other sufficient cause.

2. Conversion by operation of law (deemed public company)-Section 43A–a private company becomes a public company-

(a) where not less that 25% of the paid-up share capital of the private company is held by one or more bodies corporate.

(b) where the average annual turnover of the private company at ny time is not less than such amount as may be prescribed for 3 consecutive financial years.

(c) where the private company holds not less than 25% of the paid-up share capital of a public company, having a share capital.

(d) where the private company invites, accepts or renews deposits from the public.

3. Conversion by choice or volition-Section 44-if a private company so alters its Articles that they do not contain the provision which make it a private company, it shall cease to be a private company as on the date of the alteration. It shall than file with the Registrar, within 30 days, either a prospectus or statement in lieu of prospectus. When this is done, the company becomes a public company

A private company which becomes a public company shall also-

(i) file a copy of the resolution altering the Articles, within 30 days of passing thereof, with the Registrar;

(ii) take steps to raise its membership to at least 7 if it is below that number on the date of conversion, and also increase the number of its directors to more than 2 if it is below that number;

(iv)  alter the regulations contained in the Articles which are inconsistent with those of a public company.

What are the Advantages of a Private Company?

1. Number of members-its formation requires only 2 persons. This facilitates its harmonious functioning and makes the choice of a private company must suitable for friendly or family concerns.
2. Allotment before minimum subscription-a private company can allot shares before the minimum subscription is subscribed for or paid.
3. Kinds of shares-a private company may issue share capital of any kind and with such voting rights as it may think fit.
4. Commencement of business-a private company can commence business immediately on incorporation without having to obtain a certificate for commencement.
5. Number of directors-a private company need not have more than 2 directors. All the directors can be given permanent appointment by a single resolution.
6. Index of members-a private company need not keep an index of members.
7. Prospectus or statement in lieu of prospectus– a private company may allot shares without issuing a prospectus or delivering to the Registrar a statement in lieu of prospectus.
8. Issue of new shares-it can issue new shares to outsiders. Section 81 does not apply.
9. Statutory meeting and statutory report–a private company need not hold statutory meeting or file with the Registrar the statutory report.
10. Rules regarding directors-the rules regarding directors are less stringent.

Dividends.

     One of the main objects of commercial enterprises is to earn profits which are disturbed among shareholders by way of ‘dividend’. In commercial usage, ‘dividend’ is the share of the Company profits distributed among the members. Under Section 2(14A) of the Companies Act, 1956, ‘dividend’ includes any interim dividend.

In Commr. Of Income-tax v Girdhadas & Co, it was observed that the term ‘dividend’ has two meanings:

1. as applied to a company which is a going concern, it ordinarily means the portion of the profits of the company which is allocated to the holders of shares in the company
2. in the case of a winding up, it means a division of the realized assets among the creditors and contributories according to their respective rights

Rules regarding dividend

1. Resolution at the annual general meetings-the dividend is declared by a company by a resolution passed at the annual general meetings. The Board of directors determines the rate of dividend. The rate determined by the Board is to be sanctioned by the members of the company in general meeting. The members may reduce the rate recommended by the Board but they cannot increase it.
2. Payment of dividend in proportion to paid up capital (Section 93)–a company may, if authorized by its Articles, pay dividends in proportion to the amount paid up on each share. In the absence of such a clause in the Articles, members are entitled to dividend in proportion to the nominal value of the shares and not in proportion to the amounts paid thereon.
3. Dividend to be paid only out of profits( Section 205)–the dividend can be declared or paid by a company for any financial year only-

(a)    out of profits of the company for that year arrived at after providing for depreciation in the manner laid down in the Act, or

(b)   out of the profits of the company for any previous financial year or years arrived at after providing for depreciation and remaining undistributed, or

(c)    out of both, or

(d)   out of moneys provided by the Central Government or a State Government for the payment of dividend in pursuance of a guarantee given by the Governmnet

4. Unpaid dividend to be transferred to special dividend account-(Section 205-A)– where a dividend has been declared by a company but has not been paid to or claimed by any shareholder within a period of 30 days from the date of declaration, the company shall, within 7 days from the date of expiry of the 30 days, transfer the unpaid or unclaimed dividend to a special account with any scheduled bank to be called “unpaid dividend account of….company limited/company private limited”
5. If any amount remains unpaid or unclaimed for 7 years from the date of such transfer, it should be transferred to “Investor Education & Protection Fund”
6. Dividend to be paid to the registered shareholder-Section 206– the dividend shall be paid only to

(a)    to the registered shareholder or to his order or to his bankers,

(b)   in case a share warrant has been issued, to the bearer of such warrant or to his bankers.

7. Penalty for defaulting directors-section 207–every director, who is knowingly a party to the default, is punishable with simple imprisonment up to 3 years and liable to a fine of Rs. 1000 for every day during which such default continues ad the company shall be liable to pay interest @ 18% p.a during the period of default.

Debentures.

     The most usual form of borrowing by a company is by the issue of debentures. According to Section 2(12), ‘debenture’ includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. Section 2(12) however does not explain as to what a debenture really is.

‘Debenture’ means a document which either creates a debt or acknowledges it.-Levy v Abercorris Slate & Slab Co.

Kinds of debentures

Classification according to negotiability

1. Bearer debentures/unregistered debentures-these debentures are payable to the bearer. These are regarded as negotiable instruments and are transferable by delivery and a bona fide transferee for value is not affected by the defect in the title of the prior holder.
2. Registered debentures-these are debentures which are payable to the registered holders. A holder is one whose name appears both on the debenture certificate and in the company’s register of debentures.

Classification according to security

1. Secured debentures-debentures which create some charge on the property of the company are known as secured debentures. The charge may be a fixed charge or  floating charge.
2. Unsecured or naked debentures.-debentures which do not create any charge on the assets of the company are known as unsecured debentures. The holders of these debentures like ordinary unsecured creditors may sue the company for recovery of debt.

Classification according to permanence

1. Redeemable debentures-debentures are usually issued on the condition that they shall be redeemed after a certain period. Such debentures are known as redeemable debentures. They may be re-issued after redemption in accordance with the provisions of Section 121.
2. Irredeemable or perpetual debentures-when debentures are irredeemable, they are called perpetual debentures.

Classification according to convertibility

1. Convertible debentures-these debentures give an option to the holders to convert them into preference or equity shares at stated rates of exchange, after a certain period.
2. Non-convertible debentures-these debentures do not give any option to their holders to convert them into preference or equity shares. They are to be duly paid as and when they mature.

Classification according to priority

1. First debentures-these are the debentures which are to be repaid in priority to other debentures which may be subsequently issued.
2. Second debentures-these are the debentures which are to be paid after the ‘first debentures’ have been redeemed.

Remedies of debenture holders

     The remedies of a debenture-holder of a company vary according to whether he is secured or unsecured. An unsecured debenture-holder is in exactly the same position as an ordinary trade creditor. Like any other unsecured creditor he has two remedies-

1. He may sue for his principal and interest
2. He may, if he wishes, petition under Section 439 for the winding up of the company by the Court on the ground that the company is unable to pay its debts.

A secured debenture-holder has both the above remedies in addition to the following-

1. Debenture-holder’s action-he may sue on behalf of himself and all other debenture-holders of the same class to obtain payment and enforce his security by sale. If several debenture holders sue separately, the Court can consolidate their suits into one.

2. Appointment of receiver-he may appoint a receiver if the conditions which give him power to do so are fulfilled or apply to the Court in a debenture-holders’ action to appoint one.

3. Foreclosure-he may apply to the Court for foreclosure of the company’s right to redeem the debentures. Foreclosure is a process by which the mortgagor, failing to repay the money lent on the security of property, is compelled to forfeit his right to redeem the property.

4. Sale-he may sell the property charged as security if an express power to do so is contained in the terms of issue of debentures. He may also have the property sold through trustees if such power is given by the debenture trust deed.

5. Proof of balance-if the company is insolvent and his security is insufficient, he may value his security and prove for the balance. In the alternative, he may surrender his security and prove for the whole amount of his debt.

Floating Charge

     A floating charge is an equitable charge which is created on some class of property which is constantly changing, e.g, a charge on stock-in-trade, trade debtors, etc. The company can deal in such property in the normal course of its business until the charge becomes fixed on the happening of an event. The main idea behind floating charge is to allow the company to carry on its business in the ordinary course as if no charge had been created.

     Debentures usually create a floating charge on the assets of a company.

Characteristics

     In Re Yorkshire Woolcombers’ Ass. Ltd-

1. it is a charge on a class of assets of the company both present and future
2. that class of assets is one which, in the ordinary course of the business of the company, is changing from time to time
3. It is contemplated by the charge that, until some steps are taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way.

Consequences of a floating charge

     The company can-

1. deal in the property on which a floating chare is created, till the charge crystallizes
2. notwithstanding the floating charge, create specific mortgages of its property having priority over the floating charge
3. sell the whole of is undertaking if that is one of its objects in the Memorandum, in spite of the floating charge on the undertaking.

Crystallization

      Crystallization gets fixed when               

1. the company goes into liquidation
2. the company ceases to carry on business
3. a receiver is appointed
4. a default is made in paying the principal and/or interest and the holder of the charge brings an action to enforce his security.

What are the Kinds of Share Capital?

     Share capital means the capital raised by a company by the issue of shares. The capital of a company may be of two kinds-

1.      Equity share capital–

(i)                 with voting rights

(ii)               with differential rights as to dividend, voting or otherwise in accordance with such rules and subject to such conditions as may be prescribed.

Shares with differential rights– it means a share that is issued with differential rights in    accordance with the provisions of Section 86.

2.      Preference share capital-it means, in the case of a company limited by shares, that part of the capital of the company which carries a preferential right as to-

(a)    payment of dividend during the lifetime of the company

(b)   repayment of capital on winding up

Equity share capital means, with reference to a company limited by shares, all share capital which is not preference share capital. In other words it is capital which does not carry preferential right as to-

(a)    payment of dividend

(b)   repayment of capital on winding up.

Called-up capital-this is that part of the issued capital which has been called up on the shares.

Paid-up capital-this is that part of the issued capital which has been paid up by the shareholders or which is credited as paid-up on the shares

Uncalled capital-this is the remainder of the issued capital which has not yet been called.

Reserve capital-this is that part of the uncalled capital of a company which can be called only in the event of its winding up.

Authorized or nominal capital-This is the nominal value of the shares which a company is authorized to issue by its Memorandum of Association.

Issued or subscribed capital-issued capital is the nominal value of the shares which are offered to the public for subscription.

Bonus shares.

     ‘Bonus’ is something given in addition to what is usually or strictly due”. It comes to shareholders in addition to what they get in the form of dividend. It may also be paid-

1) in case the company has surplus cash and has no use for it, or

2) by making partly paid shares as fully paid. Normally bonus is paid to the shareholders in the form of fully paid shares free of cost. This augments the resources and earning capacity of the company.

     A company may be following a conservative policy of not disturbing all the profits every year accumulate large reserves over time. If the Articles so permit, it may convert a part of these reverses into share capital by issuing fully paid bonus shares to the existing shareholders. This is called capitalization of profits.

     Issue of bonus shares results in capitalization of profits and reserves of the company.

Allotment of Shares.

     The capital of company is divided into certain indivisible units of a fixed amount. These units are called shares. ‘Share’ means share in the share capital of a company.

     A share has been defined as “an interest having a money value and made up of diverse rights specified under the Articles of Association”- Commr of Income Tax v Standard Vaccum Oil Co. Ltd

     A share is evidenced by a share certificate. A share certificate is issued by a company under its common seal.

     Each share is to be distinguished by appropriate number (Section 83). Each share in a company having share capital is distinguished by its appropriate number.

General principles

     An effective allotment has to comply with the requirements of the law of contract relating to acceptance of an offer.

1. Allotment by proper authority-an allotment must be made by a resolution of the board of directors. “Allotment is a duty primarily falling upon the directors.”, and this duty cannot be delegated except in accordance with the provisions of the articles.
2. Within reasonable time-allotment must be made within a reasonable period of time, otherwise the application lapses. What is reasonable time must remain a question of fact in each case. The interval of about six months between application and allotment has been held to be reasonable. On the expiry of reasonable time Section 6 of the Contract Act applies and the application must be deemed to have been revoked.
3. Must be communicated-the allotment must be communicated to the applicant. Posting of a properly addressed and stamped letter of allotment is a sufficient communication even if the letter is delayed or lost in the course of post. Household Fire & Carriage Accident Insurance Co. v Grant is the leading authority.
4. Absolute and unconditional-allotment must be absolute and in accordance with the terms and conditions of the applicant, if any. Thus where a person applied for 400 shares on the condition that he would be appointed cashier of a new branch of the company. He was not bound by any allotment unless he was so appointed.

     A condition which is to operate subsequently to allotment will not affect its validity. An applicant to whom shares were allotted on the condition that he would pay for them only when the company paid dividends was held to be bound even though the company had gone into liquidation before paying any dividend.

    The applicant must promptly reject the allotment when shares have been allotted to him without his condition being fulfilled. An acquiescence on his part would amount to a waiver of the condition.

Reduction of Capital.

     The law regards the capital of a country as something sacred. The general principle of law founded on principles of public policy and rigidly enforced by Courts is that no action resulting in a reduction of capital of a company should be permitted unless the reduction is effected-

(a)    under statutory authority or by forfeiture

(b)   in strict accordance with the procedure, if any, laid down in that behalf in the Articles of Association. Any reduction of capital contrary to this principle is illegal and ultra vires.

Reduction of capital with the consent of the court

1. It may extinguish or reduce the liability on any of its shares in respect of share capital not paid-up
2. It may, either with or without extinguishing or reducing liability on any of its shares, cancel any paid-up share capital which is lost, or is unrepresented by available assets.
3. It may, either with or without extinguishing or reducing liability on any of its shares, pay off any paid-up share capital which is in excess of the wants of the company.

Procedure for reduction of share capital

1. Special resolution-Section 100– a company shall first pass a special resolution for reduction of capital. Power to reduce capital must be granted in the Articles of the company. If the Articles do not grant such power, they may be altered by a special resolution giving such power.
2. Application to the Court-Section 101-the company shall then apply to the Court by petition for an order confirming the reduction.
3. Registration of order of Court with Registrar-Section 103– the order of the Court confirming the reduction shall be produced before the Registrar and a certified copy thereof shall be filed with him for registration. With such a copy shall also be filed a minute, showing with respect to the share capital of the company as altered by the order.

Reduction of capital without the sanction of the Court

1. Forfeiture of shares-the company may, if authorized by its Articles, forfeit shares for non-payment of calls. This results in reduction of capital if the forfeited shares are not re-issued
2. Surrender of shares-the company may accept surrender of partly paid shares to save it from going through the formalities of forfeiture.
3. Cancellation of shares-the company may, if so authorized by its Articles, cancel shares which have not been taken or agreed to be taken by any person and diminish the amount of its share capital by the amount of the shares so cancelled.
4. Purchase of the shares by the company under Section 402(b)-the Court may order the purchase of the shares of any members of the company by the company.
5. Redemption of redeemable shares-the company may redeem redeemable preference shares in accordance with the provisions of Section 80
6. Buy-back of shares-a company may purchase its own shares, subject to fulfillment of conditions laid down in Section 79-A (2),purchase its own shares.