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FEATURES OF A COMPANY
- Separate Legal Personality : It is a different ‘person’ from the members who compose it. – Capable of owning property , incurring debts, borrowing money, having a bank account, employing people, entering into contracts and suing or being sued in the same manner as an individual. – The Company does not hold its property as an agent or trustee for its members Case : Kondoli Tea Co. Ltd., Re , ILR (1886) 13 Cal 43. Facts : Certain persons transferred a tea estate to a Company and claimed exemptions from ad valorem duty on the ground that they themselves were the shareholders in the Company and, therefore, it was nothing but a transfer from them in one name to themselves in another name. Held : Rejecting this view, the Court held that “The Company was a separate person, a separate body altogether from the shareholders and the transfer was as much a conveyance, a transfer of property, as if the shareholders were totally different persons from the Company. Case : Salomon v. Salomon and Co. Ltd., (1897) A.C. Facts : Salomon transferred his business of boot making, initially run as a sole proprietorship, to a Company (Salomon Ltd.), incorporated with members comprising of himself and his family. The price for such transfer was paid to Salomon by way of shares, and debentures having a floating charge (security against debt) on the assets of the Company. Later, when the Company's business failed and it went into liquidation, Salomon's right of recovery (secured through floating charge) against the debentures stood aprior to the claims of unsecured creditors, who would, thus, have recovered nothing from the liquidation proceeds. – To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged that the Company was sham, was essentially an agent of Salomon, and therefore, Salomon being the principal, was personally liable for its debt. In other words, the liquidator sought to overlook the separate personality of Salomon Ltd., distinct from its member Salomon, so as to make Salomon personally liable for the Company's debt as if he continued to conduct the business as a sole trader. Issue : The case concerned claims of certain unsecured creditors in the liquidation process of Salomon Ltd., a Company in which Salomon was the majority shareholder, and accordingly, was sought to be made personally liable for the Company's debt. Hence, the issue was whether, regardless of the separate legal identity of a Company, a shareholder/controller could be held liable for its debt, over and above the capital contribution, so as to expose such member to unlimited personal liability. Held : The Court of Appeal, declaring the Company to be a myth, reasoned that Salomon had incorporated the Company contrary to the true intent of the then Companies Act, 1862, and that the latter had conducted the business as an agent of Salomon, who should, therefore, be responsible for the debt incurred in the course of such agency. – The House of Lords, however, upon appeal, reversed the above ruling, and unanimously held that, as the Company was duly incorporated, it is an independent person with its rights and liabilities appropriate to itself, and that " the motives of those who took part in the promotion of the Company are absolutely irrelevant in discussing what those rights and liabilities are ". Thus, the legal fiction of
Page 2 of 61 "corporate veil" between the Company and its owners/controllers was firmly created by the Salomon case.
- Limited Liability : The Company, being a separate person, is the owner of its assets and bound by its liabilities. – The liability of a member as shareholder, extends to the contribution to the capital of the Company up to the nominal value of the shares held and not paid by him. – Buckley, J. in Re. London and Globe Finance Corporation , (1903) 1 Ch.D. 728 at 731, has observed: ‘The statutes relating to limited liability have probably done more good than any legislation of the last fifty years to further the commercial prosperity of the country. They have, to the advantage of the investor as well as of the public, allowed and encouraged aggregation of small sums into large capitals which have been employed in undertakings of “great public utility largely increasing the wealth of the country”. Exceptions to the Principle of Limited Liability: 1. A Company has been incorporated by furnishing false or incorrect information or representation or by suppressing any material fact or information. – 2. Business of the Company has been carried on with an intent to defraud creditors of the Company or any other persons or for any fraudulent purpose. – 3. Unlimited Company. – 4. A prospectus has been issued with intent to defraud the applicants for the securities of a Company. – 5. Company fails to repay the deposit or part thereof or any interest thereon. – 6. Where the report made by an inspector states that fraud has taken place in a Company and, from such fraud, any Director, key managerial personnel, other officer of the Company or any other person or entity, has taken undue advantage or benefit.
- Perpetual Succession : Perpetual succession means that the membership of a Company may keep changing from time to time, but that shall not affect the Company’s continuity. – Membership of a Company can change either by transfer or transmission. Transfer (occurs by act of parties): If a member transfers her shares in a Company and the transferee is entered in the register of members, the transferee becomes a member. Transmission (occurs by operation of law): a) If a member dies, automatically, by operation of law, her legal representatives will become members; and b) If a member becomes insolvent, by operation of law, her assignee will become a member of the Company. – A Company’s life is determined by the terms of its Memorandum of Association. – It may be perpetual, or it may continue for a specified time to carry on a task or object as laid down in the Memorandum of Association.
- Transferability of Shares : Section 44 of the Companies Act, 2013 enunciates this principle by providing that the shares held by the members are movable property and can be transferred from one person to another in the manner provided by the Articles of Association. – If the Articles do not provide for the transfer of shares and the Regulations contained in Table “F” in Schedule I to the Companies Act, 2013, are also expressly excluded, the transfer of shares will be governed by the general law relating to transfer of movable property.
- Delegated Management with a Board Structure : Members of the Company do not have effective and intimate control over the workings of the Company’s management; they elect their representatives (so to say) onto the Board of Directors of the Company to conduct corporate functions through managerial personnel employed by the latter.
- Common Seal : The Common Seal acts as the official signature of a Company. – The name of the Company must be engraved on its common seal. A rubber stamp does not serve the purpose. - A document not bearing the common seal of the Company, when such document is a
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DOCTRINE OF LIFTING OF OR PIERCING THE CORPORATE
VEIL
The separate personality of a Company is a statutory privilege and it must be used for legitimate business purposes only. – The advantages of incorporation are allowed only to those who want to make an honest use of the ‘Company’. – Where a fraudulent and dishonest use is made of the legal entity, the individuals concerned will not be allowed to take shelter behind the corporate personality. The Court will break through the corporate shell and apply the principle/doctrine of what is called as “lifting of or piercing the corporate veil”. – The Court will look behind the corporate entity and take action as though no entity separate from the members existed and make the members or the controlling persons liable for debts and obligations of the Company. The Companies Act, 2013 itself contains some provisions which lift the corporate veil to reach the real forces of action: Section 7(7) deals with punishment for incorporation of Company by furnishing false information; – Section 251(1) deals with liability for making fraudulent application for removal of name of Company from the register of companies; Section 339 deals with liability for fraudulent conduct of business during the course of winding up; Section 34 deals with criminal liability for misstatements in the prospectus – Section 35 deals with civil liability for misstatement in the prospectus – Section 12 (8) deals with penalty for not complying with requisite formalities in registering a Company – Section 216 deals with investigation of the ownership of a Company. Case : Re. Sir Dinshaw Manakjee Petit , A.I.R. 1927 Bombay 371 (Where it was found that the sole purpose for which the Company was formed was to evade taxes, the Court will ignore the concept of separate entity and make the individuals concerned liable to pay the taxes.) Facts : The facts of the case are that the assesse 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 accounts of the Company but the Company handed back the amount to him as a pretended loan. This way he divided his income in four parts in a bid to reduce his tax liability. Held : But it was held “the Company was formed by the assesse purely and simply as a means of avoiding supertax and the Company was nothing more than the assesse himself. It did no business, but was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assesse as pretended loans”. The Court decided to disregard the corporate entity as it was being used for tax evasion. Case : Daimler Co. Ltd. v. Continental Tyre and Rubber Co. (Where the conduct conflicts with public policy, courts lift the corporate veil for protecting the public policy.) The respondent Company was floated in London for marketing tyres manufactured in Germany. The majority of the Company’s shares were held by German nationals also residing in Germany. During World War I, the Company filed a suit against Daimler Co. Ltd., the
Page 5 of 61 appellant, for the recovery of trade debt. The appellant Company contented that the respondent Company was an alien enemy Company (Germany being at war with England at the time) and that the payment of the debt would amount to trade with the enemy, leading to an action against public interest. The court agreed with the appellant and held that where the Company formed is against public interest or public policy, for the purpose of determining the characters of the members, the corporate veil may be lifted. Case : Macaura v. Northern Assurance Company (1925) AC 619 A member does not even have an insurable interest in the property of the Company. A person was the holder of nearly all the shares, except one, of a timber Company and was also a substantial creditor. He insured the Company’s timber in his own name. The timber having been destroyed by fire, insurance Company was held not liable to him. The Company was the owner of the timber and not the member in question. Case: Prest V Petrodel Resources Ltd & Others [2013] UKSC 34 Introduction : Since Salomon v Salomon, it has been well established in UK law that a Company has a separate personality to that of its members, and that such members cannot be liable for the debts of a Company beyond their initial financial contribution to it. However, there have been circumstances in which the courts have been prepared to "pierce the veil" of corporate personality to find the members of the Company liable for Company actions in certain circumstances. The law in this area has been rife with conflicting principles and many commentators felt that the Supreme Court decision in Prest v Petrodel provided a unique opportunity to resolve the "never ending story" of when the corporate veil can be pierced. Facts : The divorcing couple, Mr and Mrs Prest, were wealthy. They owned a substantial matrimonial home in the UK and a second home in Nevis. Mrs Prest contended that her husband's wealth vastly exceeded this and argued that properties held by several companies which Mr Prest "wholly owned and controlled" were in reality owned by him. It should be noted that although the matrimonial home itself was also owned by one of the companies, it was established in the Court of Appeal that this was held on trust for Mrs Prest and did not form part of the appeal to the Supreme Court. – The case was originally heard in the family court as an application for ancillary relief by the wife in a case of divorcing spouses, where it was held by Moylan LJ that although there was no general principle by which the corporate veil could be pierced, this was possible under Section 24(1)(a) of the Matrimonial Causes Act. Three of the companies of which Mr Prest was the majority shareholder appealed to the Court of Appeal, in which the majority criticised not only Moylan LJ's dicta but the general practice of the family courts to use the MCA to pierce the corporate veil and asserted that in the absence of abuse of the Salomon principle, the law did not permit this. Patten LJ asserted that this practice "amounts almost to a separate system of legal rules unaffected by the relevant principles of English property and Company law" and must cease. Mrs Prest appealed the decision to the Supreme Court. Issues : The issue for the Supreme Court was how to ensure that, particularly in cases of divorcing spouses and in single-man companies, Company law could not be used as a tool to conceal assets or avoid liability in relation to those assets, whilst maintaining the integrity of the Salomon principle.
Page 7 of 61 Held : Renusagar was brought into existence by Hindalco who consumed all of the power generated. There were no other transmission lines going anywhere. The capacity of Renusagar was made specifically for the requirements of Hindalco. Further, power lines to Hindalco from the state grid were cut on the basis that it had its own power source. Renusagar has no independent existence- it cannot sell power to anyone but Hindalco. The concept of lifting the corporate veil is a changing concept. In the expanding horizon of modern jurisprudence, lifting of corporate veil is permissible. Its frontiers are unlimited. It must, however, depend primarily on the realities of the situation. The veil on corporate personality, even though not lifted sometimes, is becoming more and more transparent in modern Company law jurisprudence. – “Own source of generation” is an expression connected with the question of lifting or piercing the corporate veil. The following three factors must be considered: (1) Renusagar Power Co. was the wholly owned subsidiary of Hindalco. The former was under the complete control of the latter, even with regard to its day-to-day affairs. This includes the undertaking of various obligations for the running of the subsidiary Company; (2) Renusagar Power Co. did not indicate its independent volition at any point in time. Hindalco was the sole consumer of the electrical energy generated by Renusagar Power Co.; (3) Renusagar Power Co. only generated electrical energy to the extent required by Hindalco. – Lifting the corporate veil the court held that Renusagar Power Co. was the own source of generation for Hindalco. Thus, Hindalco and Renusagar must be considered to be one and the same entity as Hindalco seemed to take an advantage of a regulation which otherwise, would not be available to it. The rate of sale was different for self consumption and what Renusagar was doing here was a sale of electricity – which was shown as self-consumption. Case : Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613 Facts : In 2007, the Indian tax department issued a show-cause notice to Vodafone to explain why tax was not paid on payments made to HTIL for acquiring stake in CGP which had the effect of indirect transfer of assets situated in India. Capital gains should have been taxed as the purchase was intended to buy Indian asset. Vodafone filed a writ petition in the Bombay HC challenging the jurisdiction of the tax authorities – Bombay HC, ruled that where the underlying assets of the transaction between two or more offshore entities lies in India, it is subject to capital gains tax under relevant income tax laws in India. Vodafone appealed before the SC. Issue : Can the corporate veil be lifted to know the real essence of the transfer? Held : When it comes to taxation of a Holding Structure, at the threshold, the burden is on the Revenue to allege and establish abuse, in the sense of tax avoidance in the creation or use of such structure(s). In the application of a judicial anti-avoidance rule, the Revenue may invoke the “substance over form” principle or “piercing the corporate veil” test only after it is able to establish, on the basis of the facts and circumstances surrounding the transaction, that the impugned transaction is a sham or tax avoidant. – To give an example, if a structure is used for circular trading or round tripping or to pay bribes then such transactions, though having a legal form, should be discarded by applying the test of fiscal nullity. Similarly, in a case where the Revenue finds that in a Holding Structure, an entity which has no commercial/business substance, has been interposed only to avoid tax then in such cases applying the test of fiscal nullity it would be open to the Revenue to discard such inter-positioning of that entity. However, this has to be done at the threshold. In this connection, we may reiterate the “look at” principle which states that the Revenue or the Court must look at a document or a transaction in a context to which it properly belongs to. – It is the task of the Revenue/Court to ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as
Page 8 of 61 a whole and not to adopt a dissecting approach. Thus, whether a transaction is used principally as a colourable device for the distribution of earnings, profits and gains, is determined by a review of all the facts and circumstances surrounding the transaction – The Revenue cannot start with the question as to whether the impugned transaction is a tax deferment/saving device but that it should apply the “look at” test to ascertain its true legal nature - Applying the above tests, we are of the view that every strategic foreign direct investment coming to India, as an investment destination, should be seen in a holistic manner. – While doing so, the Revenue/Courts should keep in mind the following factors: the concept of participation in investment, the duration of time during which the Holding Structure exists; the period of business operations in India; the generation of taxable revenues in India; the timing of the exit; the continuity of business on such exit. In short, the onus will be on the Revenue to identify the scheme and its dominant purpose. – The corporate business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or artificial device. The stronger the evidence of a device, the stronger the corporate business purpose must exist to overcome the evidence of a device. Applying the above tests to the facts of the present case, we find that the Hutchison structure has been in place since 1994. It operated during the period 1994 to 11.02.2007. It has paid income tax ranging from 3 crore to250 crore per annum during the period 2002-03 to 2006. This indicates “continuity” of the telecom business on the exit of its predecessor, namely, HTIL. Thus, it cannot be said that the structure was created or used as a sham or tax avoidant. It cannot be said that HTIL or VIH was a “fly by night” operator/short time investor. – If one applies the look at test discussed hereinabove, without invoking the dissecting approach, then, in our view, extinguishment took place because of the transfer of the CGP share and not by virtue of various clauses of SPA. In a case like the present one, where the structure has existed for a considerable length of time generating taxable revenues right from 1994 and where the court is satisfied that the transaction satisfies all the parameters of participation in investment then in such a case the court need not go into the questions such as de facto control vs. legal control, legal rights vs. practical rights, etc. Case : State of Rajasthan v. Gotan Lime Stone Khanji Udyog Pvt. Ltd. Facts : Gotan Limestone Khanji Udhyog (GLKU), a partnership firm, held a mining lease for mining limestone at village Dhaappa, Nagaur. The said lessee applied for transfer of the lease in favour of Gotan Limestone Khanji Udhyog Pvt. Ltd. (GLKUPL) which was nothing but the change in the form of GLKU i.e. a case of a partnership becoming a limited Company on 28th March, 2012. The partners of the firm and Directors of the Company were the same. – The newly formed private limited Company to which the mining leases were transferred, instead of operating the mining lease itself sold its entire shareholding to another Company allegedly for Rs. 160 crores which is alleged to be the sale price of mining lease. The Company subsequently became a subsidiary of Ultra Tech Cement Limited Company (UTCL) which was quoted on the Bombay Stock Exchange. There were also allegations that the partnership firm had not revealed the true facts that led to the sale of the Company. – Ultimately, the competent authority held that the transfer of mining rights was in violation of Rule 15 of the Rajasthan Minor Mineral Concession Rules, 1986 (the Rules) the sum and substance being that the erstwhile partners of the firm which was original lessee, had in effect transferred the lease in favour UTCL. – Issue: The question was whether in the sale of the shares to UTCL, whether it was a sale of a Company or whether it was in substance a sale of mining lease which amounted to violation of Rule 15? Held : The Supreme Court held that there were two transactions ostensibly, i.e. (a) transfer of lease from the firm to the Company, with the permission of the competent authority, and (b)
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TYPES OF COMPANIES
1. Public Company [ S.2(71) r/w S.3(1)(a) ] 2. Private Company [ S.2(68) r/w S.3(1)(b) ] – Section 14 (1): If a Private Company alters its Articles in such manner that they do not include the restrictions and limitations as laid down in Section 2(68), it shall cease to a private Company from the date on which such alteration took place. – Section 149(1) further lays down that a private Company shall have a minimum number of two Directors. – The only two subscribing members to the MoA may also be the two Directors of the private Company. 3. One Person Company [ S.2(62) r/w S.3(1)(c) + Provisos to S.3 ] – Privileges of OPC: S. 2(40) The financial statement, with respect to One Person Company, may not include the cash flow statement; S. 67(2) Financial assistance can be taken by the member from the OPC for purchase of or subscribing to its own shares; S. 92(1) The annual return shall be signed by the Company secretary, or where there is no Company secretary, by the Director of the Company; S. 96(1) Need not hold annual general meeting; S. 121(1) Need not prepare a report on Annual General Meeting; Holding of actual meetings are not required; S. 134(1) Financial statement and Board’s report can be signed only by one Director; S. 149(1) One person Company need not to have more than one Director on its Board; S. 149(4) Need not to appoint Independent Directors on its Board; S. 152(6) Retirement by rotation is not applicable; S. 164(3) Additional grounds for disqualification for appointment as a Director may be specified by way of Articles; S. 173 (5) It is required to hold at least one meeting of the Board of Directors in each half of a calendar year and the gap between the two meetings should not be less than ninety days. 4. Small Company [S.2(85)] – Privileges of Small Company: S. 2(40) The financial statement, with respect to Small Company may not include the cash flow statement; S. 67(2) Financial assistance can be given for purchase of or subscribing to its own shares or shares in its holding Company; S. 92(1) The annual return shall be signed by the Company secretary, or where there is no Company secretary, by the Director of the Company; S. 121(1) Need not prepare a report on Annual General Meeting; S. 149(4) Need not appoint Independent Directors on its Board; S. 152(6) A proportion of Directors need not to retire every year; S. 164(3) Additional grounds for disqualification for appointment as a Director may be specified in the Articles; S. 173 (5) It is required to hold at least one meeting of the Board of Directors in each half of a calendar year and the gap between the two meetings should not be less than ninety days. – 5. Association not-for-profit [ S.8 ] – 6. Government Company [ S.2(45) ], – 7. Foreign Company [ S.2(42) r/w S.379 ] – 8. Holding Company [ S.2(46) ] and Subsidiary Company [ S.2(87) ], – meaning of ‘Control’ [ S.2( 2 7) ] – r/w S.19 , – 9. Associated Company [ S.2(6) r/w S.2(76) ] – 10. Dormant Company [ S.455(1) and (6) r/w exceptions in S.2(40) and S.173(5) ] – 11. Producer Company [ S.581A(I) ]
Page 11 of 61 Classification Based on Liability
1. Unlimited Liability Companies: In this type of Company, the members are liable for the Company's debts in proportion to their respective interests in the Company and their liability is unlimited. Such companies may or may not have share capital. 2. Companies limited by guarantee: A Company that has the liability of its members limited to such amount as the members may respectively undertake, by the Memorandum, to contribute to the assets of the Company in the event of its being wound-up, is known as a Company limited by guarantee. The members of a guarantee Company are, in effect, placed in the position of guarantors of the Company's debts up to the agreed amount. 3. 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.
Page 13 of 61 Organisation Sole proprietorship Partnership LLP One person Company Private Company Public Company Ownership Individual Partners Partners Individual 2 to 7 shareholders Shareholders in excess of 7 Liability Unlimited Unlimited- Each Partner is jointly and severally liable Limited to the extent of partner’s contribution. Limited to shareholding Limited to shareholding Limited to shareholding Management Owner Partners Partners Board of Directors Board of Directors Board of Directors Succession None None after death of all partners Separate legal entity- will continue after death of partners Separate legal entity- but requires a nominee Separate Legal Entity Separate Legal Entity Formation Minimal Optional registration Compulsory registration but minimal paperwork Considerable paperwork. Application to RoC to be made Considerable paperwork. Application to RoC to be made Considerable paperwork. Application to RoC and SEBI to be made Profits Individual Partners Partners Individual Shareholders Shareholders
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INCORPORATION, MoA & AoA
Section 3 – Formation of a Company, Section 4 – MoA, Section 5 – AoA, Section 6 – Act to override Memorandum, Articles, etc., Section 7 – Incorporation of a Company, Section 8 – Formation of Company with charitable objects, Section 9 – Effect of registration, Section 10 – Effect of MoA and AoA, Section 12 – Registered office of the Company, Section 13 – Alteration of MoA, Section 14 – Alteration of AoA, Section 16 – Rectification of Company’s name. Memorandum of Association: Memorandum and Articles of Association are the most essential pre-requisites for incorporating any form of Company under the Act. – Section 3 of the Act, which provides the mode of incorporation of a Company and states that a Company may be formed for any lawful purpose by subscribing their name(s) to a Memorandum. – The Memorandum of Association is a document which sets out the constitution of a Company and is therefore the foundation on which the structure of the Company is built. It defines the scope of the Company’s activities and its relations with the outside world. Doctrine of Ultra Vires : Whatever is not stated in the Memorandum as the objects or powers is prohibited by the doctrine of ultra vires. As a result, an act which is ultra vires is void, and does not bind the Company. – The general rule is that an act which is ultra vires the Company is incapable of ratification. An act which is intra vires the Company but outside the authority of the Directors may be ratified by the Company in proper form. – The rule is meant to protect shareholders and the creditors of the Company. If the act is ultra vires (beyond the powers of) the Directors only, the shareholders can ratify it. If it is ultra vires the Articles of Association, the Company can alter its Articles in the proper way. – Purpose of the doctrine: The purpose of this doctrine is two-fold: 1) to protect the investors so that they may know for what purpose their money will be employed and 2) to protect the creditors, so that the fund to which they must look for repayment is not dissipated in unauthorized activities. – Rational of the doctrine: The rationale behind the doctrine is competency to enter into a contract. For an individual, such competency is determined by age, soundness of mind, etc. A Company, however, being an artificial person does not have a body or mind. “It does not have a body to be injured or a soul to be damned.” Hence, contractual competency for a corporation is determined by its own charter, namely the MoA. “The Memorandum states affirmatively what the Company can do ; it states negatively what the Company cannot do. The corporate life cannot be spent for any other purpose other than those specified in the Memorandum:” Ashburry Railway Carriage Co. v. Richie [1875] L.R. 7 H.L. 653 Case : Ashburry Railway Carriage Co. v. Richie [1875] L.R. 7 H.L. 653 Facts : The object of the Company was, inter alia, to build railway coaches. The AoA to carry on any object, provided a proper resolution was passed. The Company entered into a contract to construct a railway line in Belgium. This act of the Directors was ratified by a resolution. When a dispute arose, the question before the court was whether the Memorandum or Articles was the superior document.
Page 16 of 61 Effect of Ultra Vires transaction and Borrowing : An ultra vires transaction, being void, does not vest the transferee with any right, nor does it divest the transferor. In other words, the transferor does not lose any right and the transferee does not gain any right. Money taken by a Company under an ultra vires borrowing cannot be recovered once it is spent by the Company. However, the lender is not completely without any remedy. If the money is utilized by the Company to purchase any particular asset, the lender will have a charge on that asset. This is a charge created by the operation of law. If the money is kept in a separate account, the lender can trace it to the hands of the Company. If the money is utilized to discharge an intra vires debt, the lender will be surrogated to the rights of the creditor whose debt has been discharged. Implied Powers: The powers exercisable by a Company are to be confined to the objects specified in the Memorandum. While the objects are to be specified, the powers exercisable in respect of them may be express or implied and need not be specified. – Every Company may necessarily possess certain powers which are implied, such as, a power to appoint and act through agents, and where it is a trading Company, a power to borrow and give security for the purposes of its business, and also a power to sell. Such powers are incidental and can be inferred from the powers expressed in the Memorandum. Powers which are not implied: (1) acquiring any business similar to the Company’s own business. [ Ernest v. Nicholls ]; (2) entering into an agreement with other persons or companies for carrying on business in partnership or for sharing profit, joint venture or other arrangements. Very clear powers are necessary to justify such transactions [ Re European Society Arbitration Act (1878)]; (3) taking shares in other companies having similar objects. [Re William Thomas & Co. Ltd. ]; (4) taking shares of other companies where such investment authorizes doing indirectly that which will not be intra vires if done directly; (5) promoting other companies or helping them financially [ Joint Stock Discount Co. v. Brown ]; (6) a power to sell and dispose of the whole of a Company’s undertaking; (7) a power to use funds for political purposes; (8) a not relating to the objects stated in power to give gifts and make donations or contribution for charities the Memorandum; (9) acting as a surety or as a guarantor. Articles of Association: In terms of Section 5(1), the Articles of a Company shall contain the regulations for management of the Company. – The Articles of Association of a Company are its bye-laws or rules and regulations that govern the management of its internal affairs and the conduct of its business. – It deals with the rights of the members of the Company, defining the powers of its officers and establishing a contract between the Company and the members and between the members inter se. – They are subordinate to and are controlled by the Memorandum of Association. Entrenchment Provisions: The Articles may contain provisions for entrenchment to the effect that specified provisions of the Articles may be altered only if conditions or procedures that are more restrictive than those applicable in the case of a special resolution, are met or complied with. [Section 5 (3)]. This provision acts as a protection to the minority shareholders and is of specific interest to the investment community. This shall empower the enforcement of any pre- agreed rights and provide greater certainty to investors, especially in joint ventures. The provisions for entrenchment referred to in Section 5(3) shall be made either on formation of a Company, or by an amendment in the Articles agreed to by all the members of the Company in the case of a private Company and by a special resolution in the case of a public Company. [Section 5 (4)]. Notice to the Registrar. [Section 5 (5)]
Page 17 of 61 Doctrine of Constructive Notice: The Memorandum and Articles, when registered, become public documents and can be inspected by anyone on payment of nominal fee. – Therefore, every person who contemplates entering into a contract with a Company has the means of ascertaining and is consequently presumed to know, not only the exact powers of the Company but also the extent to which these powers have been delegated to the Directors, and of any limitations placed upon the exercise of these powers. – In other words, every person dealing with the Company is deemed to have a “constructive notice” of the contents of its Memorandum and Articles. – For example, if the Articles provide that a bill of exchange to be effective must be signed by two Directors, a person dealing with the Company must see that it is so signed; otherwise he cannot claim under it. Doctrine of Indoor Management: It operates to protect outsiders against the Company. It protects innocent parties who are doing business with the Company and are not in a position to know if some internal rule has not been complied with. – Persons dealing with a Company having satisfied themselves that the proposed transaction is not in its nature inconsistent with the Memorandum and Articles, are not bound to enquire into the regularity of any internal proceedings. – In other words, while persons contracting with a Company are presumed to know the provisions of the contents of the Memorandum and Articles, they are entitled to assume that the provisions of the Articles have been observed by the officers of the Company.
- It is no part of the duty of an outsider to see that the Company carries out its own internal regulations. Case : Royal British Bank v. Turquand (1856) 6 E&B 327 The Directors of a banking Company were authorized by the Articles to borrow on bonds such sums of money as should from time to time, by resolution of the Company in general meeting, be authorized to borrow. The Directors gave a bond to Turquand without the authority of any such resolution. – It was held that Turquand could sue the Company on the strength of the bond, as he was entitled to assume that the necessary resolution had been passed. – Lord Hatherly observed : “Outsiders are bound to know the external position of the Company, but are not bound to know its indoor management”. -- Section 176 Provides for the Validity of Acts of Directors - No act done by a person as a Director shall be deemed to be invalid, notwithstanding that it was subsequently noticed that his appointment was invalid by reason of any defect or disqualification or had terminated by virtue of any provision contained in this Act or in the Articles of the Company. – Provided that nothing in this Section shall be deemed to give validity to any act done by the Director after his appointment has been noticed by the Company to be invalid or have been terminated. – The object of the Section is to protect persons dealing with the Company - outsiders as well as members by providing that the acts of a person acting as Director will be treated as valid although it may afterwards be discovered that his appointment was invalid.
Page 19 of 61 contained a clause that on the bankruptcy of a member his shares would be sold to other persons and at a price fixed by the Directors. B, a shareholder was adjudicated bankrupt. His trustee in bankruptcy claimed that he was not bound by these provisions and should be at liberty to sell the shares at their true value. It was held that the trustee was bound by the Articles, as the shares were purchased by B in terms of the Articles Conflict between a shareholders’ agreement and AoA: Shareholders’ Agreement (SHA): This is an agreement between the shareholders of a Company that outlines the rights, duties, operational control and liabilities of the shareholders. Generally, new businesses or start-ups, as well as large corporations undertake shareholder agreements, though it is not mandatory to get a shareholders’ agreement. A shareholder agreement is not enforceable either. In order to enforce agreements against third parties, it is necessary to include the same clauses in an agreement in the by-laws of the Company. It would be apt to note that conflicts between SHA and the Articles of a Company can be of two types; first , where the conflict relates to the management of the Company (affirmative vote, Board of Directors, accounts, etc.) and second , where the conflict relates to the transferability of shares. As regards the latter, two main questions arise; 1) Whether a provision in an SHA that is contrary to the Articles of the Company is valid and enforceable? 2) What are the possible remedies for a shareholder against breach of an SHA by other shareholders even though such action would not be construed as a breach under the Articles of the Company? Case Laws : In V.B. Rangaraj v. V.B. Gopalakrishnan and others , the Supreme Court took the view that the provisions of a SHA imposing restrictions even when consistent with the Companies Act, are to be authorised only when they are incorporated in the Articles of the Company. In World Phone India Pvt. Ltd. and Ors. v. WPI Group Inc., USA, the Board of Directors of the Company passed a resolution approving a rights issue in accordance with the Articles of the Company, even though such an action required the affirmative vote of the Appellant in accordance with a SHA entered into between the shareholders of the Company. The Company Law Board had held that since the provisions of the SHA granting an affirmative vote to the appellant were not incorporated in the Articles of the Company, the said provision is unenforceable and the Board resolution approving the rights issue was valid. On appeal, Justice Muralidhar of the Delhi High court held: “the legal position is that where the Articles of Association are silent on the existence of an affirmative vote, it will not be possible to hold that a clause in an agreement between shareholders would be binding without being incorporated in the Articles of Association. The question to be asked is whether the provisions of an agreement, that are not inconsistent with the Act, but are also not part of the Articles of Association, can be said to be applicable. All that Section 9 states is that the clauses in the agreement that RE “repugnant” to the Act shall be “void”. This does not mean that the clauses in the agreement which are not repugnant to the Act would be enforceable, notwithstanding that they are not incorporated in the Articles of Association.” Thus, the court held that the provisions of the SHA, though silent in the Articles of the Company, and not in contradiction with them, will not be enforceable. This ruling, as it stands, brings in a lot of confusion to the issue of conflicts between SHAs and Articles of a Company,
Page 20 of 61 because the issues don’t stand resolved merely with the conflicting provisions being unenforceable. In Vodafone International Holdings BV v. Union of India & anr , three main observations were made by the Supreme Court on the issue: a) That the Supreme Court does not subscribe to the view in Rangaraj that restrictions in a SHA, though consistent with Company law, are to be authorised only when they are incorporated in the Articles of the Company. (it is still doubtful whether Rangaraj has been overruled as the Court didn’t explicitly say so) b) Shareholders can enter into any arrangement in the best interests of the Company, but the only thing is that the provisions of SHA shall not go contrary to the Articles of the Company. c) Breach of SHA which does not breach the Articles of a Company is a valid corporate action, but the parties agreed can get remedies under the general law for breach of any agreement and not under the Companies Act. In light of the above, a logical extension of the judgment in World Phone would be that even though the provisions of an affirmative vote are not incorporated in the Articles of the Company, and though the action of the Company in providing for a rights issue would be valid under the Companies Act, such an action will still be in breach of the SHA for which the aggrieved shareholder can pursue an action for breach of contract.
