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B.COM. PART-II B.C. 403
Semester-IV C O M P A N Y L A W
L E S S O N NO. 1 AUTHOR : RITU LEHAL
M E A N I N G , N A T U R E A N D F E A T U R E S O F A C O M P A N Y
Lesson Structure 1.0. Objectives 1.1. Introduction 1.2. Meaning and Definitions of a company 1.3. Features of a company 1.4. A Company is not a citizen 1.5. Lifting the corporate veil 1.5.1 Statutory Exceptions 1.6. Summary 1.7. Key Words 1.8. Answers to Self-Check Exercise 1.0 Objectives W i t h t h e f a s t c h a n g e s i n t h e e c o n o m i c p o l i c i e s o f I n d i a n g o v e r n m e n t , t h e c o m p a n y f o r m o f b u s i n e s s h a s g a i n e d a s p e c i a l i m p o r t a n c e i n t h e e c o n o m y. T h e o b j e c t i v e s o f t h i s l e s s o n are t o d e f i n e c l e a r l y t h e m e a n i n g o f t h e w o r d ' c o m p a n y ' a n d a l s o g i v e m a i n f e a t u r e s o f a c o m p a n y w h i c h d i f f e r e n t i a t e i t f r o m o t h e r t y p e s o f business. Some related issues have been discussed in the lesson like : C i t i z e n s h i p o f a c o m p a n y , l i f t i n g t h e c o r p o r a t e v e i l e t c. 1.1. Introduction The present Companies Act, came into force with effect from 12 th Sept., 2013. T h e C o m p a n i e s A c t a b o u n d s i n r e s t r i c t i o n s , a p p r o v a l s , s a n c t i o n s a n d p u n i s h m e n t s. T h e d e f i n i t i o n g i v e n i n t h e A c t i s n o t e x h a u s t i v e a n d d o e s n o t c l e a r l y r e v e a l t h e t r u e c h a r a c t e r i s t i c s o f a c o m p a n y. O n b e i n g i n c o r p o r a t e d , a c o m p a n y e n j o y s c e r t a i n a d v a n t a g e s o v e r o t h e r a s s o c i a t i o n s. S u c h a d v a n t a g e s w h i c h a r e t e r m e d a s c h a r a c t e r i s t i c s o r f e a t u r e s o f a c o m p a n y h a ve a l s o b e e n d i s c u s s e d i n d e t a i l i n t h i s l e s s o n. T h e C o m p a n y i s n o t a m e r e c o l l e c t i o n o f i n d i v i d u a l s l i k e a partnership firm, but at law it is a separate and different person from its subscribers to the memorandum of association.
1.2. Meaning and Definitions of a company Indian Companies Act, 2013 does not define a company clearly. According to Section 2(20) of Companies Act, 2013 a company means, "A company formed and registered under this act or an existing company." An existing company means. "A Company formed and registered under any of previous companies Laws." This definition does not clearly reveal the true meaning and characteristics of a company. In simple words, a company is an artificial person, created by law, with a common seal and a permanent existence. According to Chief Justice Marshall of U.S.A., "A Company is a person artificial, invisible, intangible and existing only in the contemplation of the l a w. " S o , c o m p a n y e x i s t s i n t h e e y e s o f l a w a n d i t h a s n o p h y s i c a l existence. Sometimes the term 'corporation' is used for a company. However, the term corporation is wider than the company. A Corporation is an association of persons incorporated according to the law of land, with a legal personality which is separated from the persons who constitute it. A company is an association of many persons who contributed money or money's worth to a common stock and employed for a common purpose. If we compare company form of business with other types, it has many advantages over them. For example, in case of sole trading type of business only one person has to manage all the affairs of the business. Even in case of partnership, it is also suitable for small scale business. But in case of a company, huge financial resources are available along with having experts to manage the affairs of the company. In this way the company has become the most dominant form of business organisation. 1.3 Features of a Company ( 1 ) Separate Legal Entity A company is an artificial person having a distinct legal entity. A company is created by law being invisible and intangible person, but not a natural person. It has individuality. It has power to sue and be sued in its own name, has the right to own property and has the right to enter into a contract with third parties in its own name. It's personality is separate and distinct from the personality of those who promote it. This principle was established in the leading case. Saloman Vs. Saloman & Co. Ltd. Saloman sold his business and formed a company. There were seven members, his wife, one daughter and four sons, who took 1 share each. S himself took 20,000 shares. He also took debentures worth 10,000 pounds. After sometime, the company was wound up. The assets of the company were 6,000 pounds only. The unsecured creditors were to
Self Check Exercise No. 1 L was holding 2,999 shares in company out of the total of 3,000 shares. He elected himself as governing director and chief pilot of the same air farming company. L was killed in an air crash while he was working for the company. His widow claimed compensation because he got the injuries and died while in the course of employment. It was argued that L and his company were the same person, so no compensation should be given, comment. 1.4 A Company is not a Citizen A company being an artificial person can be sued and it can hold p r o p e r t y a l s o. B u t n o p r o v i s i o n o f C o m p a n y ' s A c t e x p r e s s l y c o n f e r s citizenship. A company does not enjoy the fundamental rights of an Indian citizen. Although company has no citizenship, it has domicile, nationality and residence. A Company can have only one nationality and one domicile but may have several residences at the same time. 1.5 Lifting the Corporate Veil A company has a different identity from members. This principle is r e g a r d e d a s a c u r t a i n , a v e i l o r s h i e l d b e t w e e n t h e c o m p a n y a n d i t s members, thus protecting the latter from the liability of the former. E x a m p l e : W h e r e t h e b u s i n e s s o f l a d y w a s i n t h e n a m e o f t h e company, Lady's attempt to regain tenanted area for self business could not succeed. The courts have also given the decision which are strongly in favour of the principle of Separate Legal Entity. The rule of separate legal entity cannot be pushed to unnatural limits. Circumstances may occur which compel the courts to identify a company with its members. When the notion of legal entity is used to defeat public convenience or to protect fraud, the law will not regard the company as a separate entity. SC also observed that lifting of the corporate veil is permitted in the expanding horizon of modern jurisprudence. But it must depend primarily on the realities of the situation. The corporate veil has been lifted in the following cases : ( 1 ) Determination of Character A company is not a natural person with any mind/conscience. But it may assume when persons who have effective control over affairs of the company, are residents in any enemy country. In times of war, the court will lift the veil to see whether the company's affairs are controlled by alien enemy. A company being an artificial person, cannot be loyal or disloyal, friend or enemy but it may assume the character of an enemy if persons in
defector control of its affairs, are residents in any enemy country. ( 2 ) Where Company is a Sham If the Company is a mere cloak or sham, court can lift the veil e.g. if the company is formed for some illegal or improper purposes. In P.N.B. Finance Vs. Shital Prashad, when a person borrowed money from a company and invested it in 3 different companies in which he and his son were the only members. The lending company was permitted to attach the assets of all 3 companies as they were created to hood wink the lending company. ( 3 ) Fraud or Improper Conduct If the company is formed for some fraudulent purpose or to avoid legal obligations, the court will lift the veil. In Gilford Motor Co. Ltd. Vs. Horne, was appointed as Managing Director of the company with the condition that Horne will not solicit the customers of the company. He formed a new company to carry on same business. An injunction was granted against Horne and his company both because the court held that the company was a mere cloak for defendant to commit a breach of agreement. ( 4 ) Where the Company is acting as the Agent of the Shareholders If a company is acting as an agent of its shareholders or another company e.g. A government company is not an agent of the state unless it is performing subsistence governmental or sovereign functions. ( 5 ) Protection of Revenue The court may lift the corporate veil if corporate entity is used for tax evasion. Supreme Court held that the income tax authorities are entitled to p i e r c e t h e v e i l o f c o r p o r a t e e n t i t y a n d t o l o o k a t t h e r e a l i t y o f t h e transaction. In Sir Dinashaw Mancekjee Petit case, D was a man getting huge d i v i d e n d s a n d i n c o m e s. I n o r d e r t o a v o i d t a x , h e f o r m e d f o u r p r i v a t e companies. Dividends received were credited in the account of the company and amount was handed back to him as loan. The Court held that as the companies did no business, the 4 companies were nothing more than he himself. ( 6 ) Avoidance of Welfare Legislation A v o i d a n c e o f w e l f a r e l e g i s l a t i o n i s a s c o m m o n a s a v o i d a n c e o f taxation. It is the duty of the court in such a case to go behind the screen and discover the true state of affairs. In such a case the Supreme Court disregarded the existence of a separate company for the purpose of working out bonus of its employees.
incorporation if he thinks it necessary, specially in case of investigating the affairs of holding and subsidiary company. The doctrine of lifting the corporate veil does not extend to statutory corporations and their members cannot claim any benefit which is not legally available to such corporations, unless there is any specific provision in the statute in this regard. Further, the corporate veil cannot be lifted in case of Government companies so as to enable the employees of such companies to claim the statute of Government employees. 1.6 S u m m a r y Meaning and Definition of a Company The Indian Companies Act, 2013, Sec 2(20), defines a company as a company formed and registered under this Act or an existing company. In general, a company is an artificial person created by law, with a common seal and perpetual succession. A company has no physical existence and sometimes it is confused with a corporation. But corporation is a wider term than company. Features of a Company The main features of a company are as under:
- Separate Legal Entity
- Separate Property
- Perpetual Succession
- Limited Liability
- Common Seal
- Transferability of Shares A Company is not a Citizen No provision of Companies Act expressly confers citizenship to a company. But a company has a nationality, domicile and residence. Lifting the Corporate Veil The company has a different entity and members and directors have different entities. But certain circumstances gives the court a power to lift the corporate veil to go through the matter properly. The corporate veil has been lifted in following cases:
- Determination of character
- Where company is a sham
- Fraud or improper conduct
- Where the Company is acting as an agent of the Shareholders
- Protecting the Revenue
- Avoidance of Welfare Legislation. Along with the above mentioned cases, there are some statutory
exceptions also when the court can lift the corporate veil. 1.7 Key Words Word Meaning Perpetual Succession Permanent Existence Embossed Design or word sticks up slightly from the surface Tenure Period of Time Seal An Official mark which confirms the legality of documents A l i e n Something that belongs to a different country V e i l Something that hides an activity or situation 1.8 Answers to Self-Check Exercises
- The decision was in favour of giving compensations to L's wife on the basis of the principle of separate legal entity of a company.
- T h e c o u r t c a n c h e c k i n t h i s c a s e b e c a u s e t h e c o m p a n y i s misusing corporate personality as the company has not fulfilled the condition of having minimum 2 members and carried on the business for more than 6 months.
2.3.1 On the Basis of Incorporation (i) Chartered Companies I n e a r l i e r d a y s , t r a d i n g c o m p a n i e s w e r e o f t e n c r e a t e d b y r o y a l charter. The 'crown' in the exercise of the royal prerogative had power to create a corporation by the grant of a charter to persons assenting to be incorporated. These type of companies are known as chartered companies. East India Company and Bank of England are the examples of such type of companies. (ii) Statutory Companies The company which is formed by passing a special Act of the Parliament or any State Legislature are known as statutory companies. Generally, the purpose or formation of such companies is to create special public undertaking e.g. Railways, Electricity Generation, Reserve Bank of India, Life Insurance Corporation, State Trading Corporations, Unit Trust of India, Food Corporation of India, State Financial Corporations, etc. These companies have to follow the provisions of Companies Act 2013, if no other provisions are given in the Act creating them. Even changes in their structure are possible only by Amendment in the Act creating them. A statutory company although owned by Government, has a separate entity. (iii) Registered Companies A company formed and registered under Companies Act 2013, or any
of the earlier Companies Act are registered companies. A registered company may be limited by Shares or limited by guarantee. 2.3.2 On the Basis of Liability (i) Company Limited by Shares This type of company is very common and popular also. If the word 'company' is pronounced the first thing comes into mind is a company limited by shares. In case of such companies, the liability of the members is l i m i t e d u p t o t h e v a l u e o f s h a r e s h e l d b y t h e m e. g. I f a p e r s o n h a s purchased 1000 shares of value of Rs. 10 each, it means during the lifetime of the company liability of this member is limited upto Rs. 10,000 only. E v e n i n e x t r a o r d i n a r y c i r c u m s t a n c e s , a c o m p a n y c a n n o t a s k a n y shareholders to contribute more than the value of shares (unpaid) held by them. The personal property of a member is entirely his personal affair, a company in which he has invested his money in forms of shares, has no right over his personal property. (ii) Companies Limited by Guarantee Such companies generally do not have any share capital. The liability of members is limited upto the amount of guarantee undertaken by them. T h e p u r p o s e o f f o r m i n g s u c h c o m p a n i e s i s n o t p r o f i t e a r n i n g. C l u b s , S o c i e t i e s , T r a d e A s s o c i a t i o n s , e t c. , a r e t h e e x a m p l e s o f t h e s e k i n d o f c o m p a n i e s. E v e r y c o m p a n y l i m i t e d b y g u a r a n t e e m u s t h a v e i t s memorandum and articles of association. The memorandum shall state that each member undertakes to contribute to the assets of the company in the event of its being wound up while he is a member or within one year after his membership is over. (iii) Unlimited Company In case of such a company, the liability of members is not limited. The liability of members extends to the whole amount of the company's debt and liability. Such companies are rarely formed and are not popular in India. Unlimited Company cannot use the word 'Limited' with its name. 2.3.3 On the Basis of Membership (i) Private Company u/s 2(68) of the Companies Act, 2013 This type of company is suitable for carrying on, family business or small scale business. The Companies Act, 2013, explains it as a company which, by its articles: (a) restricts the right of transfer of shares' (b) except in case of one person company, limits the number of its members to 200. (c) prohibits any invitation to public to subscribe for any securities of
company.
- Directors of a private company may be appointed by a single resolution, but it is not so in case of a public company. In a public company, each director is to be appointed by a separate resolution.
- In a private company, there is no restriction on exceeding the n u m b e r o f d i r e c t o r s b e y o n d t w e l v e. B u t i n c a s e o f a p u b l i c company if number of directors is to be increased beyond twelve, approval of Central Govt. is necessary. 2.3.3.2 Conversion of Private Company into a Public Company u/s 14 A private company may become a public company by any mode like- conversion by default, or conversion by choice. On the conversion of a private company into a public company, no new company comes into existence. As such, conversion does not affect the identity of the company. Where a private company makes any default in company with the provisions u/s 2(20), the company loses the priveleges and exemptions and the provisions of the Act apply to the company as if it were not a private company. However, the company may be relieved of the Central Government on being satisfied that the failure to comply with the conditions is not wilful or that it is just and equitable, may grant relief 2.3.3.3 Conversion of Public Company into Private Company u/s 14 A company of any class registered under this Act may convert itself as a company of other class under this Act by alteration of Memorandum & articles. Self-Check Exercise In a private limited company, it was found that there are in fact 206 members. Out of these 206, members were the employees of the company in past but still they are acquiring their shares in the company. Is it necessary to convert the company into a public limited company? 2.3.4 On the Basis of Control Holding Company and Subsidiary Company A c o m p a n y w h i c h c o n t r o l s a n o t h e r c o m p a n y i s k n o w n a s t h e 'holding' Company. According to Section 2 (46) of Companies Act 2013, a holding Company is that which (a) controls the composition of Board of Directors of another Company or (b) holds more than half of the nominal value of equity share capital of another company or (c) is a subsidiary of any company which is in turn a subsidiary of
another Company. For Example: If X is Holding Company and Y is a Subsidiary Company. The Co. X should fulfil the conditions related to Holding Company. If Co. X controls composition of Board of Directors of Co. Y or if Co. X holds than half of Y's Equity share capital or if there is a company Z which is a Subsidiary Co. of Company Y then, automatically Co. Z is also a subsidiary of Co. X. 2.3.5 On the Basis of Ownership (i) Government Company Section 2(45) of Companies Act defines a Government Company as a Company in which not less 51% of paid-up share capital is held by Central Government or by State Governments or partly by the Central Government and partly by one or State Government or Governments. It also includes a Company which is a subsidiary of a Government Company. The Act lays down certain special provisions for government companies like - appointment of auditor, submission of audit report to the Comptroller and Auditor-General of India, presentation of annual reports before both the house of parliament, etc. But a Government company also has a separate legal entity. In a related case, the Chief Justice of India, 1982 observed that even though the entire share capital of a company has been subscribed by the Government of India, it can not be predicted that the companies themselves are owned by the Government of India. The companies incorporated under Companies Act, have a corporate personality of their own, distinct from Government of India. The Govt. can only own the share capital. (ii) Non-Government Companies Those companies in which Govt. is not the Controlling Authority but private hands have the control over the functioning of the Company are known as Non-government companies.
2.3.6 On the Basis of Nationality (i) Indian Companies The Companies which are formed and registered under Indian Companies Act or any of the Companies' Act. (ii) Foreign Companies u/s 2 (42) Foreign Company is a Company which is incorporated outside India and establishes a place of business in India. Section 591, defines a foreign company as a Company incorporated outside India (a) and has established a place of business within India after
Companies Act or is formed in pursuance of some other India law. An illegal association under this section is not an association for illegal purpose. The illegality of an association cannot be cured by subsequent reduction of the number of its members. Consequences of Illegal Associations i. Every member of such an association shall be personally liable for all liabilities incurred in such business and shall also be liable to a fine which may extend upto Rs 1,00,000. ii. A n i l l e g a l a s s o c i a t i o n c a n n o t s u e t o r e c o v e r a n y d e b t o r o t h e r property. But such an association may get itself registered and after becoming legal may enforce its claims. i i i. Such an association cannot be dissolved under the act either at the instance of a creditor, member or the association itself. Such an association cannot be wound up even under the provisions relating to winding up of unregistered companies. E v e r y p e r s o n w h o i s a m e m b e r o f a c o m p a n y , a s s o c i a t i o n o r partnership formed in contravention of Section 464 shall be punishable with fine which may extend to one lakh rupees. Some new companies introduced under Companies Act. 2013 Small Company u/s 2(85), means a company other than a public company (a) With paidup capital not more than Rs. 50 lakh or such higher amout as may be prescribed, which shall not be more than Rs. 5 crores. (b) With turnover per its last profit and loss amount not exceeding Rs. 2 crore or such higher amount as may be prescribed, not exceeding Rs. 20 crore. Following companies are excluded: (a) Holding company or subsidiary co (b) a company registered under sec 8 (c) A company or body corporate governed by any special act. Listed Company u/s 2(52) means a company, which has any of its securities listed an any recognised stock exchange. Dormant Company u/s 455 "When a company is formed and registered under this Act for a future project or to hold an asset or intellectual property and has no significant accounting transaction, such a company is active company may make as application to the registrar for obtaining the status of dormant company. Banking Company u/s 52(9) defines a banking company as defined under sec 5(c) of the Banking Regulation Act, 1949. It is a company "which transacts the business of banking, which means accepting, for the purpose of lending or investment of deposits of money from the public, repayable on demand or
otherwise and withdrawable by cheque, draft, order or otherwise. S u m m a r y The lesson includes different kinds of companies, on the basis of some factors:
- On the basis of Incorporation, a Company can be divided in three t y p e s , v i z. C h a r t e r e d c o m p a n i e s , S t a t u t o r y c o m p a n i e s a n d Registered companies.
- On the basis of Liability of Company may be limited by share or limited by guarantee or even unlimited Company.
- On the basis of Membership a Company may be a Public Company or a Private Company. A Private Company can also be converted into a Public Company.
- On the basis of Control, Companies can be divided as holding and subsidiary companies.
- On the basis of Ownership, a Company may be a Government Company or a Non-Government Company.
- On the basis of Nationality, Companies may be Indian or Foreign C o m p a n i e s. A f o r e i g n c o m p a n y h a s t o f o l l o w t h e s p e c i a l provisions meant under the Act, for such companies. In the end, one more type of companies has been discussed which is one man Company. 2.6 Key Words Words Meaning Non-compliance Not fulfilling any provision Conversion To change Extraordinary Not common Prohibit To stop 2.7 Answer to Self Check Exercise As per Sec. 2 (68), a private company must restrict its membership to 200 only. However, in counting the number of members, employee members and ex-employee members are to excluded. So, in this case, there's no need t o c o n v e r t t h e c o m p a n y i n t o a p u b l i c l i m i t e d c o m p a n y. C o m p a n y c a n continue with it's status as a private company.
- Promotion Stage
- Incorporation Stage
- Subscription Stage
- Commencement Stage 3.3 Promotion Stage In this stage, the idea for the formation of a company is conceived by the individuals. To give practical shape to the idea conceived they have to take the help of several experts. The persons who conceive the idea are called promoters and the process by which a company is incorporated is known as promotion. Promotion may be defined, according to Gestenberg as, "The discovery of business opportunities and the subsequent organization of funds, property and managerial ability into a business concern for the purpose of making profits there form". The promotion of company involves: (a) Discovery of an Opportunity (b) Detailed investigation of the Idea (c) Estimation of Capital (d) Acquisition of Assets (e) Recruitment of Staff and (f) Incorporation of a Company 3.3.1 Promoter To form a company, some persons must conceive the idea that they act as the pioneers of the Company. The persons who act as pioneers of the Company are known as the promoters. It is difficult to give statutory d e f i n i t i o n o f t h e w o r d p r o m o t e r b e c a u s e i t i s n o w h e r e e x p l a i n e d i n Company Law. The promoters carry considerable risk because if the idea sometimes goes wrong, the time and money spent by them are in vain. 3.3.2 Legal Position of Promoters A p r o m o t e r i s n e i t h e r a t r u s t e e n o r a n a g e n t o f t h e c o m p a n y b e c a u s e n e i t h e r t h e t r u s t n o r t h e p r i n c i p a l e x i s t s a t t h e t i m e o f h i s efforts. The promoters stand in fiduciary capacity to the company. The p r i n c i p l e s o f a g e n c y a n d t r u s t e e s h i p , h o w e v e r a r e a p p l i c a b l e t o t h e p r o m o t e r s b e c a u s e t h e p r o m o t e r i s b o u n d t o d i s c l o s e t h e m a t e r i a l facts including the profit made if any, to the comp an y. The Promoters (i) Must not make any secret profit in the transaction made by him on behalf of the company. (ii) Must not use his position unreasonably or undue influence of the position must not be made. (iii) Must disclose all the material facts to the company.
3.3.3 P R O M O T E R ' S D U T I E S
The following are the duties of promoters: ( 1 ) To disclose the Secret Profits The promoters of a company must disclose all the money secretly o b t a i n e d b y w a y o f p r o f i t , n o d o u b t h e i s e m p o w e r e d t o d e d u c t t h e reasonable expenses incurred by him. ( 2 ) To disclose all the Material Facts The promoters should actively disclose all material facts. Now, the question arises as to when the material facts be disclosed. It is quite clear with the case of Salomon Vs. Salomon & Co. The disclosure must be made to the shareholders as a body and not to a selected circle of the promoter's nominees. ( 3 ) He must make good the damages to the Company what he has obtained as a Trustee A promoter stands in a fiduciary position to the Company. It is his duty to make good to the Company what he has obtained as trustee and not what he may get at any time. ( 4 ) Duty of Promoter against the Future When it is said that promoters stand in a fiduciary position to the company then it does not mean that they stand in such relation only to the company or for the signatories of memorandum but they stand in this relation to the future allottees of shares also. ( 5 ) Duty to Disclose the Private Arrangements It becomes the duty of the promoters to disclose all the private arrangements resulting in his profit by the promotion of the company. 3.3.4 PROMOTER'S LIABILITIES The following are the liabilities of the promoters: ( 1 ) Liability to account for Profit T h e p r o m o t e r s s t a n d i n a f i d u c i a r y p o s i t i o n t o a c o m p a n y. A n y profit made by the promoter after the existence of the company must b e f u l l y d i s c l o s e d t o t h e c o m p a n y. H e c a n n o t r e t a i n a n y p r o f i t m a d e o u t o f t h e t r a n s a c t i o n t o w h i c h h e i s p a r t y w i t h o u t a c c o u n t o f i t t o c o m p a n y. T h e c o m p a n y m a y a d o p t a n y o n e o f t h e f o l l o w i n g t w o courses if the promoter fails to disclose the profits. (i) It may sue the promoter for an amount of profit and recover the same with interest. (ii) It may rescind the contract and can recover the money paid. ( 2 ) Liability towards Misstatement in the Prospectus If promoters make any default on the issue of prospectus then they are liable to the shareholders for the misstatement therein. They may be held liable for breach of trust also.
